ANNUAL REPORT ON FORM 10-K

DECEMBER 31, 2004

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

Commission File Number 0-19297

First Community Bancshares, Inc.

(Exact name of Registrant as specified in its charter)

Registrant’s telephone number, including area code:

(276) 326-9000

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

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

      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 þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.                               

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

      State the aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 30, 2004. $351,070,611 based on the closing sales price at that date

      Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of March 8, 2005. Common Stock, $1 par value- 11,258,748

DOCUMENTS INCORPORATED BY REFERENCE

      Portions of the Proxy Statement for the annual meeting of shareholders to be held April 26, 2005 are incorporated by reference in Part III of this Form 10-K.

TABLE OF CONTENTS

Part I

General

      First Community Bancshares, Inc. (“FCBI” or the “Company”, “Corporation” or “Registrant”) is a one-bank holding company incorporated in the State of Nevada and serves as the holding company for First Community Bank, N. A. (“FCBNA” or the “Bank”), a national association that conducts commercial banking operations within the states of Virginia, West Virginia, North Carolina and Tennessee. United First Mortgage, Inc. (“UFM”), acquired in the latter part of 1999, was a wholly owned subsidiary of FCBNA through August 17, 2004 and served as a wholesale and retail distribution channel for FCBNA’s mortgage banking business segment. In August, the Company sold 100% of its interest in UFM. Accordingly, the Company’s financial statements have been reformatted to segregate the assets, liabilities, operations and cash flows of this “discontinued operating segment.” The required information concerning discontinued operations is set forth in Note 18 of the Consolidated Financial Statements included herein. FCBNA also owns Stone Capital Management (“Stone Capital”), an investment advisory firm purchased in January, 2003. The Company had total consolidated assets of approximately $1.8 billion at December 31, 2004 and conducts commercial and mortgage banking business through 53 full-service banking locations, six loan production offices, and two trust and investment management offices.

      On March 31, 2004, the Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company (“PCB Bancorp”) headquartered in Johnson City, Tennessee. PCB Bancorp has six full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. At acquisition, PCB Bancorp had total assets of $171.0 million, total net loans of $128.0 million and total deposits of $150.0 million. These resources were included in the Company’s financial statements beginning with the second quarter of 2004. Concurrent with the PCB Bancorp acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB Bancorp, was merged into the Bank.

      Currently, the Registrant is a bank holding company and the banking operations are expected to remain the principal business and major source of revenue. The Registrant provides a mechanism for ownership of the subsidiary banking operations, provides capital funds as required and serves as a conduit for distribution of dividends to stockholders. The Registrant also considers and evaluates options for growth and expansion of the existing subsidiary banking operations. The Registrant currently derives substantially all of its revenues from dividends paid by its subsidiary bank. Dividend payments by the Bank are determined in relation to earnings, asset growth and capital position and are subject to certain restrictions by regulatory agencies as described more fully under Regulation and Supervision of this item.

      At December 31, 2004, the principal assets of FCBI included all of the outstanding shares of common stock of the Bank. FCBNA is a nationally chartered bank organized under the banking laws of the United States. FCBNA engages in general commercial and retail banking business in West Virginia, Virginia, North Carolina and Tennessee through 53 full-service branch facilities and six loan production offices. It provides safe deposit services and makes all types of loans, including commercial, mortgage and personal loans. FCBNA also provides trust services and its bank deposits are insured by the FDIC. FCBNA is a member of the Federal Reserve System and is a member of the Federal Home Loan Bank (FHLB) of Atlanta. Regulatory oversight of the banking subsidiary is conducted by the Office of the Comptroller of the Currency (OCC).

Forward-Looking Statements

      This Annual Report on Form 10-K may include “forward-looking statements”, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements with respect to the Company’s beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors (many of which are beyond the Company’s control). The words “may”, “could”, “should”, “would”, “believe”,

“anticipate”, “estimate”, “expect”, “intend”, “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from that expressed in such forward-looking statements; the strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; 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; inflation, interest rate, market and monetary fluctuations; the timely development of competitive new products and services of the Company and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services and vice versa; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes; the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions; the growth and profitability of the Company’s non-interest or fee income being less than expected; unanticipated regulatory or judicial proceedings; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

      The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement.

Risk Factors

      We are unable to predict actual fluctuations of market interest rates with complete accuracy. Rate fluctuations are affected by many factors, including inflation, recession, a rise in unemployment, tightening the money supply and domestic and international disorder and instability in domestic and foreign financial markets.

      Changes in the interest rate environment may reduce profits. We expect that the Company and FCBNA will continue to realize income from the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. The Company is vulnerable to continued declines in interest rates because of its slightly asset sensitive balance sheet profile, in which its assets will reprice downward at rates exceeding the repricing characteristics of liabilities. As a result, material and prolonged declines in interest rates would decrease the Company’s net interest income and corresponding net interest margin. Conversely, an increase in the general level of interest rates may adversely affect the ability of some borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially and adversely affect the Company’s net interest spread, asset quality, levels of prepayments and cash flows as well as the market value of its securities portfolio and overall profitability.

      Changes in interest rates affect the net interest income earned on the Company’s debt securities portfolios as well as the value of the securities portfolio. In addition, changes in interest rates affect the net interest income FCBNA earns on loans held for investment. Consequently, changes in the levels of market interest rates could materially and adversely affect the Company’s net interest spread, the market value of the loans and securities and the overall profitability.

      FCBI is a separate legal entity from FCBNA and its subsidiaries and does not have significant operations of its own. FCBI currently depends on FCBNA’s cash and liquidity as well as dividends to pay FCBI’s operating expenses and dividends to shareholders. No assurance can be made that in the future FCBNA will have the capacity to pay the necessary dividends and that the Company will not require dividends from

FCBNA to satisfy FCBI’s obligations. The availability of dividends from FCBNA is limited by various statutes and regulations. It is possible, depending upon the financial condition of the Company and other factors that the Office of the Comptroller of the Currency (OCC), the Bank’s primary regulator, could assert that payment of dividends or other payments by FCBNA are an unsafe or unsound practice. In the event FCBNA is unable to pay dividends sufficient to satisfy FCBI’s obligations and FCBNA is unable to pay dividends to the Company, FCBI may not be able to service its obligations as they become due, including payments required to be made to the FCBI Capital Trust, a business trust subsidiary of FCBI, or pay dividends on the Company’s common stock. Consequently, the inability to receive dividends from FCBNA could adversely affect FCBI’s financial condition, results of operations, cash flows and prospects.

      Like all financial institutions, we maintain an allowance for loan losses to provide for probable loan defaults and non-performance. FCBNA’s allowance for loan losses may not be adequate to cover actual loan losses, and future provisions for loan losses could materially and adversely affect FCBNA’s operating results. FCBNA’s allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions of our regulators, changes in the size and composition of the loan portfolio and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates that may be beyond FCBNA’s control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review FCBNA’s loans and allowance for loan losses. While we believe that FCBNA’s allowance for loan losses is adequate to provide for probable losses, we cannot assure you that we will not need to increase FCBNA’s allowance for loan losses or that regulators will not require us to increase this allowance. Either of these occurrences could materially and adversely affect FCBNA’s earnings and profitability.

      Changes in economic conditions, particularly an economic slowdown, could hurt FCBI’s business. FCBI’s business is directly affected by political and market conditions, broad trends in industry and finance, legislative and regulatory changes, and changes in governmental monetary and fiscal policies and inflation, all of which are beyond FCBI’s control. A deterioration in economic conditions, in particular an economic slowdown within the Company’s geographic region, could result in the following consequences, any of which could hurt FCBI’s business materially:

      FCBI’s business activities and credit exposure are concentrated in West Virginia, Virginia, North Carolina, Tennessee and the surrounding southeast region. A downturn in this regional real estate market could hurt FCBI’s business because of the geographic concentration within this regional area. If there is a significant decline in real estate values, the collateral for FCBI’s loans will provide less security. As a result, FCBI’s ability to recover on defaulted loans by selling the underlying real estate would be diminished, and we would be more likely to suffer losses on defaulted loans.

      At December 31, 2004, the Bank’s commercial and commercial real estate portfolio was $538.7 million, an increase of $151.9 million since December 2003, largely the result of the PCB acquisition completed in the second quarter of 2004. As the portfolio increased, so did the relative weighting of this category of loans from 37.8% to 43.5% of the portfolio balance from December 31, 2003 to year-end 2004. Commercial business and commercial real estate loans generally are considered riskier than single-family residential loans because they have larger balances to a single borrower or group of related borrowers. Commercial business and commercial real estate loans involve risks because the borrower’s ability to repay the loan typically depends primarily on the successful operation of the business or the property securing the loan. Most of the commercial business loans are made to small business or middle market customers who may have a heightened vulnerability to economic conditions. Moreover, a portion of these loans have been made or acquired by the Company in the last several years and the borrowers may not have experienced a complete business or economic cycle.

      FCBNA seeks to mitigate the risks inherent in FCBNA’s loan portfolio by adhering to specific underwriting practices. These practices include analysis of a borrower’s prior credit history, financial statements, tax returns and cash flow projections, valuation of collateral based on reports of independent appraisers and verification of liquid assets. Although FCBNA believes that its underwriting criteria are appropriate for the various kinds of loans it makes, FCBNA may incur losses on loans that meet its underwriting criteria, and these losses may exceed the amounts set aside as reserves in FCBNA’s allowance for loan losses.

      FCBI and its subsidiaries’ operations are subject to extensive regulation by federal, state and local governmental authorities and are subject to various laws and judicial and administrative decisions imposing requirements and restrictions on part or all of FCBI’s operations. FCBI believes that it is in substantial compliance in all material respects with applicable federal, state and local laws, rules and regulations. Because FCBI’s business is highly regulated, the laws, rules and regulations applicable to it are subject to regular modification and change. There are currently proposed various laws, rules and regulations that, if adopted, would impact FCBI’s operations, including, among other things, matters pertaining to corporate governance, requirements for listing and maintenance on national securities exchanges and over the counter markets, Securities and Exchange Commission (SEC) rules pertaining to public reporting disclosures and banking regulations governing the amount of loans that a financial institution, such as FCBNA, can acquire for investment from an affiliate. In addition, the Financial Accounting Standards Board, made changes which will require, among other things, the expensing of the costs relating to the issuance of stock options. There can be no assurance that these proposed laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive, restrict FCBI’s ability to originate, broker or sell loans, further limit or restrict the amount of commissions, interest or other charges earned on loans originated or sold by FCBNA or otherwise adversely affect FCBI’s business, financial condition or prospects.

      FCBI’s business operations are centered primarily in West Virginia, Virginia, North Carolina, Tennessee and the surrounding southeast region. Increased competition within this region may result in reduced loan originations and deposits. Ultimately, we may not be able to compete successfully against current and future competitors. Many competitors offer the types of loans and banking services that we offer. These competitors include other savings associations, national banks, regional banks and other community banks. FCBI also faces competition from many other types of financial institutions, including finance companies, brokerage

firms, insurance companies, credit unions, mortgage banks and other financial intermediaries. In particular, FCBNA’s competitors include other state and national banks and major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns.

      Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger clients. These institutions, particularly to the extent they are more diversified than FCBI, may be able to offer the same loan products and services that FCBI offers at more competitive rates and prices. If FCBI is unable to attract and retain banking clients, FCBI may be unable to continue FCBNA’s loan and deposit growth and the Company’s business, financial condition and prospects may be negatively affected.

Employees

      The Registrant and its subsidiary, FCBNA, employed 688 full time equivalent employees at December 31, 2004. Management considers employee relations to be excellent.

Regulation and Supervision

      The following discussion sets forth the material elements of the regulatory framework applicable to the Company and the Bank. This regulatory framework primarily is intended for the protection of depositors and the deposit insurance funds that insure deposits of banks, and not for the protection of security holders. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. A change in the statutes, regulations or regulatory policies applicable to the Company or its subsidiaries may have a material effect on its business.

      General. The Company is a bank holding company within the meaning of the Bank Holding Act of 1956, as amended (“BHCA”), and is registered as such with the Board of Governors of the Federal Reserve System. The registrant is required to file with the Board of Governors quarterly reports of the Company and the Bank and such other information as the Board of Governors may require. The Federal Reserve makes periodic examinations of the Company, typically on an annual basis.

      BHCA Activities and Other Limitations. The BHCA prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or increasing such ownership or control of any bank, without prior approval of the Federal Reserve Board.

      The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. In making such determinations, the Federal Reserve Board is required to weigh the expected benefit to the public, such as greater convenience, increased competition or gains in efficiency, against the possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices.

      The Federal Reserve Board has by regulation determined that certain activities are closely related to banking within the meaning of the BHCA. These activities include operating a mortgage company, finance company, credit card company, factoring company, trust company or savings association; performing certain data processing operations; providing limited securities brokerage services; acting as an investment or financial advisor; acting as an insurance agent for certain types of credit-related insurance; leasing personal property on a full-payout, non-operating basis; providing tax planning and preparation services; operating a collection agency; and providing certain courier services. The Federal Reserve Board also has determined that certain

other activities including land development, property management and underwriting of life insurance not related to credit transactions, are not closely related to banking and a proper incident thereto.

      Capital Requirements. The Federal Reserve Board has adopted capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the BHCA. The Federal Reserve Board capital adequacy guidelines generally require bank holding companies to maintain total capital equal to 8% of total risk-adjusted assets, with at least one-half of that amount consisting of Tier I or core capital and up to one-half of that amount consisting of Tier II or supplementary capital. Tier I capital for bank holding companies generally consists of the sum of common stockholders’ equity and perpetual preferred stock (subject in the case of the latter to limitations on the kind and amount of such stocks which may be included as Tier I capital), less goodwill and, with certain exceptions, intangibles. Tier II capital generally consists of hybrid capital instruments; perpetual preferred stock which is not eligible to be included as Tier I capital; term subordinated debt and intermediate-term preferred stock; and, subject to limitations, general allowances for loan losses. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no additional capital) for assets such as cash to 100% for the bulk of assets which are typically held by a bank holding company, including multi-family residential and commercial real estate loans, commercial business loans and consumer loans. Single-family residential first mortgage loans which are not past-due (90 days or more) or non-performing and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighting system, as are certain privately-issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics. At December 31, 2004, the Company’s Tier I capital and total capital ratios were 10.80% and 12.09%, respectively.

      In addition to the risk-based capital requirements, the Federal Reserve Board requires bank holding companies to maintain a minimum leverage capital ratio of Tier I capital to total assets of 3.0%. Total assets for this purpose does not include goodwill and any other intangible assets and investments that the Federal Reserve Board determines should be deducted from Tier I capital. The Federal Reserve Board has announced that the 3.0% Tier I leverage capital ratio requirement is the minimum for the top-rated bank holding companies without any supervisory, financial or operational weaknesses or deficiencies or those which are not experiencing or anticipating significant growth. Other bank holding companies are expected to maintain Tier I leverage capital ratios of at least 4.0% to 5.0% or more, depending on their overall condition. The Company’s leverage ratio, at December 31, 2004, was 7.62%.

      Trust Preferred Securities. Historically, issuer trusts that issued trust preferred securities have been consolidated by their parent companies and the accounts of such issuer trusts have been included in the consolidated financial statements of such parent companies. However, in January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”, or FIN 46. FIN 46 was effective immediately for interests in variable interest entities acquired after January 31, 2003, and, as originally issued, was effective in the first interim period after June 15, 2003 to interests in variable interest entities acquired before February 1, 2003. The Company followed the guidance on FIN 46, which provides guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity on the formation of the Company’s trust, FCBI Capital Trust, in September, 2003. The Company reports the aggregate principal amount of the junior subordinated debentures it issues to the trust as a liability, records offsetting assets for the cash and common securities received from the trust in its consolidated balance sheet, and reports interest payable on the junior subordinated debentures as an interest expense in its consolidated statements of operations.

      The Company is required by the Federal Reserve to maintain certain levels of capital for bank regulatory purposes. Since 1996, it has been the position of the Federal Reserve that certain qualifying amounts of cumulative preferred securities having the characteristics of preferred securities could be included as Tier 1 regulatory capital for bank holding companies; however, capital received from the sale of such cumulative preferred securities, including the preferred securities, cannot constitute, as a whole, more than 25% of Tier 1 regulatory capital (the “25% capital limitation”). Amounts in excess of the 25% capital limitation would constitute Tier 2 or supplementary capital. In March 2005, the Federal Reserve issued final rules that would

continue to allow trust preferred securities to be included in Tier 1 regulatory capital, subject to stricter quantitative and qualitative limits. Currently, trust preferred securities and qualifying perpetual preferred stock are limited in the aggregate to no more than 25% of a bank holding company’s core capital elements. As finalized, the Federal Reserve’s rule would retain trust preferred securities as an element of Tier 1 regulatory capital, but with stricter quantitative limitations following a five-year transition period. As of March 31, 2009, the aggregate amount of trust preferred securities and cumulative perpetual preferred stock, as well as certain additional elements of Tier 1 capital which are identified in the final rule, may not exceed 25% of a bank holding company’s Tier 1 capital, net of goodwill less any associated deferred tax liability.

      Financial Support of Affiliated Institutions. Under Federal Reserve Board policy, the Company is expected to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances when it might not do so absent such policy. In addition, any capital loans by a bank holding company to a subsidiary bank are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

      General. The Bank is a nationally chartered bank organized under the banking laws of the United States and is subject to extensive regulation and examination by the OCC and the FDIC. The federal laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of and collateral for certain loans. There are periodic examinations by the aforementioned regulatory authorities to test the Bank’s compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the OCC, the FDIC or the U.S. Congress could have a material adverse impact on the Company and its operations.

      FDIC Insurance Assessments. The deposits of the Bank are insured up to regulatory limits by the FDIC, and, accordingly, are subject to deposit insurance assessments to maintain the Bank Insurance Fund (the “BIF”), which is administered by the FDIC. The FDIC has adopted regulations establishing a risk-related deposit insurance assessment system. Under this system, the FDIC places each insured bank in one of nine risk categories based on (1) the bank’s capitalization and (2) supervisory evaluations provided to the FDIC by the institution’s primary Federal regulator. Each insured bank’s insurance assessment rate is then determined by the risk category in which it is classified by the FDIC. The annual insurance premiums on bank deposits insured by the BIF currently vary between $0.00 per $100 of deposits for banks classified in the highest capital and supervisory evaluation categories to $0.27 per $100 of deposits for banks classified in the lowest capital and supervisory evaluation categories.

      The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is aware of no existing circumstances which would result in termination of the Bank’s deposit insurance.

      Prompt Corrective Action. The Federal Deposit Insurance Corporation Act, as amended (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” in respect of

depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” An FDIC-insured bank will be “well capitalized” if it has a total capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any order or written directive by any such regulatory authority to meet and maintain a specific capital level for any capital measure. A depository institution’s capital tier will depend upon where its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. As of December 31, 2004, the Bank had capital levels that qualify it as being “well capitalized” under such regulations.

      Capital Requirements. The Bank is subject to capital requirements adopted by the OCC similar to the capital requirements for the Company. The capital ratios of the Bank are set forth in Note 13 to the Consolidated Financial Statements included herewith.

      Payment of Dividends and Borrowings. The Bank is subject to certain restrictions which limit the amounts and the manner in which it may loan funds to the Company. The Bank is further subject to restrictions on the amount of dividends that can be paid to the Company in any one calendar year without prior approval by primary regulators. Payment of dividends by the Bank to the Company cannot exceed net profits, as defined, for the current year combined with net profits for the two preceding years. In addition, any distribution that might reduce the Bank’s equity capital to unsafe levels or which, in the opinion of regulatory agencies, is not in the best interests of the public, could be prohibited. For additional information, see Note 13 to the Consolidated Financial Statements included herewith.

      Community Reinvestment Act and the Fair Lending Laws. The Bank has a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of its community, including low and moderate income neighborhoods. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. An institution’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in regulatory restrictions on its activities and the denial of applications. In addition, an institution’s failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in the applicable federal regulatory agencies and/or the Department of Justice taking enforcement actions against the institution. Based on its most recent examination, the Bank received a satisfactory rating with respect to its performance pursuant to the Community Reinvestment Act.

      Federal Home Loan Bank System. The Bank is a member of the FHLB system. Among other benefits, each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the board of directors of the individual FHLB. As an FHLB member, the Bank is required to own capital stock in the FHLB. At December 31, 2004, the Bank had $10.5 million of FHLB stock.

      Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts (primarily checking, NOW, and Super NOW checking accounts) and non personal time deposits. At December 31, 2004, the Bank was in compliance with these requirements.

Recent Banking and Other Legislation

      Sarbanes-Oxley Act of 2002. In July 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002 (the “SOA”) implementing legislative reforms intended to address corporate and accounting improprieties. The SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules and mandates further studies of certain issues by the SEC and the Comptroller General. The SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

      The SOA addresses, among other matters: audit committees for all reporting companies; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; a prohibition on insider trading during pension plan black out periods; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers; expedited filing requirements for Form 4’s; disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code; “real time” filing of periodic reports; the formation of a public accounting oversight board; auditor independence; and various increased criminal penalties for violations of securities laws.

      The International Capital Accord, adopted by the Committee on Banking Supervision of the Bank for International Settlements in 1988, established the current risk-based capital standards for banking firms. The modifications to the original Basel Accord, after a thorough review, have resulted in a complete overhaul. The Committee has issued a number of Consultative Papers on this subject and in June 2004, issued the revised framework which remains the subject of additional impact assessments with a targeted implementation date of December 2007.

      The intended result of Basel II is a process that will significantly improve the current capital standards applied to internationally active banking institutions and a more appropriate allocation of capital to support the risks inherent in the balance sheets of these financial institutions. The implementation of the new Accord will be first applied to the largest financial institutions but will ultimately be directed throughout the industry on a global basis. The impact of the Accord on the industry has resulted in a new focus on the processes, methodologies and systems used to measure and monitor portfolio credit risks. In addition, it is intended to expand the scope of the risk-based capital standard to encompass all of the risks within a banking group and their subsidiaries as well as bank holding companies. Implementation of the new capital standards throughout the industry is anticipated to take several years, which will allow for systems processes and procedures to be developed.

Website Access to Company Reports

      The Company makes available free of charge on its website at www.fcbinc.com its annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and all amendments thereto, as soon as reasonably practicable after the Company files such reports with, or furnishes them to, the Securities and Exchange Commission. Investors are encouraged to access these reports, the Company’s Code of Conduct and the other information about the Company’s business on its website.

      The principal offices of the Corporation and FCBNA are located at One Community Place, Bluefield, Virginia, where the Company owns and occupies approximately 36,000 square feet of office space. The Bank operates with 53 full-service branches throughout Virginia, West Virginia, North Carolina and Tennessee and two trust and investment management offices, as well as Stone Capital, an investment advisory firm based in West Virginia. The Corporation’s banking subsidiary owns in fee 43 banking offices while others are leased or are located on leased land. There are no mortgages or liens against any property of the Bank or the Corporation. The Bank operates 51 Automated Teller Machines (“ATMs”).

First Community Bank, N. A.

1001 Mercer Street

Princeton, West Virginia

24740-5939

(304) 487-9000 or (304) 327-5175

Stafford Commons

One Stafford Commons

Princeton, WV 24740

(304) 431-9024

211 Federal Street

Bluefield, West Virginia 24701-0950

(304) 325-7151

Mercer Mall

Bluefield, WV 24701-0950

(304) 327-0431

101 Sanders Lane

Bluefield, Virginia 24605

(276) 322-5487

Highway 52

Bluefield, West Virginia 24701-3068

(304) 589-3301

100 Market Street

Man, West Virginia 25635

(304) 583-6525

Corner of Main & Latrobe Streets

Grafton, West Virginia 26354-0278

(304) 265-1111

216 Lincoln Street

Grafton, West Virginia 26354-1442

(304) 265-5111

Main Street

Rowlesburg, West Virginia 26425

(304) 454-2431

16 West Main Street

Richwood, West Virginia 26261

(304) 846-2641

Railroad and White Avenue

Richwood, West Virginia 26261

(304) 846-2641

874 Broad Street

Summersville, West Virginia 26651

(304) 872-4402

Route 20 & Williams River Road

Cowen, West Virginia 26206

(304) 226-5924

Route 55, Red Oak Plaza

Craigsville, West Virginia 26205

(304) 742-5101

111 Citizens Drive

Beckley, West Virginia 25801-2970

(304) 252-9400

50 Brookshire Lane

Beckley, West Virginia 25801-6765

(304) 254-9041 (lease expires 4/1/05)

298 Stokes Drive

Hinton, West Virginia 25951

(304) 466-5502 (lease expires 2/27/09)

U.S. 219 North

Lindside, West Virginia 24951

(304) 753-4311

643 E. Riverside Drive

Tazewell, Virginia 24651

(276) 988-5577

12410 Gayton Road

Richmond, Virginia 23233

(804) 754-8140 (lease expires 11/30/18)

101 Brookfall Dairy Road

Elkin, North Carolina 28621

(336) 835-2265

5519 Mountain View Road

Hays, North Carolina 28635

(336) 696-2265

57 N. Main Street

Sparta, North Carolina 28675

(336) 372-2265

150 N. Center Street

Taylorsville, North Carolina 28681

(828) 632-2265

5610 University Parkway

Winston-Salem, North Carolina 27105

(336) 776-9262

3001 Waughtown Street

Winston-Salem, North Carolina 27107

(336) 788-2005

101 Vermillion Street

Athens, West Virginia 24712

(304) 384-9010

Corner of Bank & Cedar Streets

Pineville, West Virginia 24874-0249

(304) 732-7011

East Pineville Branch

(304) 732-7011

Mullens Shopping Plaza

Route 54

Mullens, West Virginia 25882

(304) 294-0700 (land lease expires 8/31/07)

Route 10, Cook Parkway

Oceana, West Virginia 24870-1680

(304) 682-8244

2 West Main Street

Buckhannon, West Virginia 26201-0280

(304) 472-1112

302 Washington Square

Richlands, Virginia 24641

(276) 964-7454

Chase Street & Alley 7

Clintwood, Virginia 24228

(276) 926-4671

747 Fort Chiswell Road

Max Meadows, Virginia 24360

(276) 637-3122

8044 Main Street

Pound, Virginia 24279

(276) 796-5431

910 East Main Street

Wytheville, Virginia 24382

(276) 228-1901 (lease expires 2/20/07)

431 South Main Street

Emporia, Virginia 23847-2313

(434) 634-8866

4677 Main Street

Drakes Branch, Virginia 23937

(434) 568-3301

125 West Atlantic Street

Emporia, Virginia 23847

(434) 634-6555

511 Main Street

Clifton Forge, Virginia 24422

(540) 862-4251

901 Moorefield Park Drive

Suite 111

Richmond, Virginia 23236

(804) 237-7373 (lease expires 11/30/09)

9310 Midlothian Turnpike

Richmond, Virginia 23235

(804) 323-4100

707 East Main Street

Richmond, Virginia 23219

(804) 649-8030 (lease expires 11/30/08)

900 North Parham Road

Richmond, Virginia 23229

(804) 741-4600

2000 W. First Street, Suite 102

Winston-Salem, North Carolina 27104

(336) 723-0375 (lease expires 11/30/13)

901 Moorefield Park Drive

Suite 111

Richmond, VA 23236 (lease expires 11/30/09)

People’s Community Bank

(a division of First Community Bank, N. A.)

300 Sunset Drive

Johnson City, Tennessee 37604

(423) 915-2200

202 East Main Street

Johnson City, Tennessee 37601

(423) 975-5606 (lease expires 6/30/06)

2681 Boones Creek Road

Johnson City, Tennessee 37615

(423) 915-2270

1706 Highway 93

Fall Branch, Tennessee 37656

(423) 348-6330

1645 East Stone Drive

Kingsport, Tennessee 37660

(423) 230-4517 (lease expires 10/31/07)

5756 Bristol Highway

Piney Flats, Tennessee 37686

(423) 538-2980

Loan Production Offices:

1901 South Main Street

Blacksburg, VA 24060 (lease expires 6/1/06)

102 Cambridge Place

Bridgeport, WV 26330 (lease expires 11/14/07)

150 Boush Street

Town Center Point Suite 705

Norfolk, VA 23510 (lease expires 5/3/06)

259 North Main Street

Mount Airy, NC 27030 (lease expires 2/1/05)

Mallard Creek Five Building

Suite 130

8520 Cliff Cameron Drive

Charlotte, NC 28269 (lease expires 4/30/06)

Subsidiaries:

First Community Bank, N. A.

(Wholly-owned subsidiary of First Community Bancshares, Inc.)

One Community Place

Bluefield, Virginia 24605

Stone Capital Management, Inc.

(Wholly-owned subsidiary of First Community Bank, N. A.)

207 Brookshire Lane

Beckley, West Virginia 25801

(304) 256-3982

Corporate Headquarters

One Community Place

P.O. Box 989

Bluefield, Virginia 24605-0989

(276) 326-9000

(276) 326-9010 Fax

      The Company is currently a defendant in various legal actions and asserted claims involving lending and collection activities and other matters in the normal course of business. While the Company and legal counsel are unable to assess the ultimate outcome of each of these matters with certainty, they are of the belief that the resolution of these actions should not have a material adverse affect on the financial position of the Company.

      In November, 2003 the Company was named defendant in civil action CV941 in U.S. District Court for the Eastern District of Virginia by two former employees of The CommonWealth Bank, alleging among other things, violation of employment law and breach of contract, stemming from the two former employees being terminated from employment. The lawsuit sought damages of more than $180,000 and punitive damages for each of the two former employees of The CommonWealth Bank. This matter was settled in the fourth quarter of 2004 for a cash payment by the Company and a commitment to continue certain defined benefit payments. The resolution of this civil matter did not have a material adverse effect on the financial position or cash flows of the Company.

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

Part II

      The number of common stockholders of record on December 31, 2004 was 4,017 and outstanding shares totaled 11,250,927.

      The Company’s common stock trades on the NASDAQ National Market under the symbol FCBC. On December 31, 2004, the Company’s year-end common stock price was $36.08, an 8.81% increase over the $33.16 closing price on December 31, 2003.

      Book value per common share was $16.29 at December 31, 2004, compared with $15.57 at December 31, 2003, and $14.02 at the close of 2002. The year-end market price for the Company’s common stock of $36.08 represents 221.5% of the Company’s book value as of the close of the year and reflects total market capitalization of $405.9 million. Utilizing the year-end market price and 2004 diluted earnings per share, First Community common stock closed the year trading at a price/earnings multiple of 18.3 times diluted earnings per share.

      Cash dividends for 2004 totaled $1.00 per share, up $0.02 or 2.04% from the $0.98 paid in 2003. The 2004 dividends resulted in a cash yield on the year-end market value of 2.77%. Total dividends paid for the current and prior year totaled $11.2 million and $10.8 million, respectively.

      The following table sets forth the high and low stock prices and dividends paid per share of the Company’s common stock during the periods indicated.

      The Company’s stock repurchase plan allowing the purchase of up to 436,000 shares was announced September 18, 2001, amended by the Board of Directors to 500,000 shares on March 18, 2003 and again on May 18, 2004 to purchase up to 550,000 shares. The plan has no expiration date and no plans have expired during the reporting period. No determination has been made to terminate the plan or to stop making

purchases. The following table sets forth purchases by the Company (on the open market) of its equity securities during 2004.

Five-Year Selected Financial Data

Five-Year Selected Financial Data-continued

      This discussion should be read in conjunction with the consolidated financial statements, notes and tables included throughout this report. All statements other than statements of historical fact included in this report, including statements in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Exchange Act. As discussed below, the financial statements, footnotes, schedules and discussion within this report have been reformatted to conform to the presentation required for “discontinued operations” pursuant to the Company’s sale of its mortgage banking subsidiary.

EXECUTIVE OVERVIEW

      First Community Bancshares is a full service commercial bank which has positioned itself as a community bank and a financial services alternative to larger regional banks which often provide less emphasis on personal relationships, and smaller community banks which lack the capital and resources to efficiently serve customer needs. The Company has focused its growth efforts on building financial partnerships and more enduring and complete relationships with businesses and individuals through a very personal approach to banking and financial services. The Company also seeks to expand its resources, capabilities and geographic reach through acquisitions of like-minded community banking organizations and financial service providers. The Company and its operations are guided by a strategic plan which comprehends growth through acquisitions and through office expansion in new market areas including strategically identified metro markets in Virginia, West Virginia, North Carolina and Tennessee. While the Company’s mission remains that of a community bank, management believes that entry into new markets will accelerate the Company’s growth rate by diversifying the demographics of its customer base and customer prospects and by generally increasing its sales and service network.

      As part of the strategic plan, the Company has set long-term goals for growth and profitability. During the early phases of the strategic plan the Company has achieved some significant successes and, like most growth oriented companies, encountered challenges to achievement of these objectives. These challenges include, but are not limited to i) strong competition from bank and non-bank competitors, ii) aggressive pricing in the commercial and commercial real estate loan arena; and iii) slower internal deposit growth in certain banking markets which has been exacerbated by the historically low interest rate environment experienced over the past year.

      Despite these challenges, the Company has succeeded in establishing new offices in seven new market areas including six new loan production offices in the last year and three new full service offices since the second quarter of 2003. The Company has also completed two bank acquisitions and one wealth management acquisition since January 2003 and has grown total resources by almost 20% over the last two years and over 50% over the last four years. Along with these successes the Company has also experienced slower than planned internal deposit growth in legacy markets, and in August of 2004, exited the once lucrative mortgage banking segment. As a result of these events and in conjunction with its ongoing strategic planning process, the Company, in its third quarter report, downwardly revised its internal targets for planned growth, to a level that it believes more appropriately reflects prospects for continued expansion, internal growth and profitability.

      The Company continues its pursuit of community banking partners and is progressing with plans for new offices within its established target markets. Additional details regarding 2004 acquisitions and expansion are included under the heading Recent Acquisitions and Branching Activity.

      Throughout the first half of 2004 certain interest rates remained at forty year lows. This rate environment led to further compression of net interest margins until the third quarter of 2004 when increases in the federal funds target rate and the New York prime rate began to positively impact the loan portfolio. Lower interest rates, both commercial and residential, also helped to sustain loan demand and contribute to growth of the loan portfolio.

      Overall growth was moderated by a national economy which has begun a modest sustained recovery with moderate job growth on a national level. The economy in general has also been supportive of favorable trends in asset quality nationwide. The Company likewise has benefited from those economic factors, including interest rates and growth in GNP, which have a buoying effect on delinquencies, non-accruals, foreclosures and charge-offs.

      The local economies in which the Company operates are diverse and cover the majority portion of a four state region. West Virginia and Southwest Virginia has and should continue to benefit from the uncertainty of oil prices and spikes in oil prices in 2004. These economies have significant exposure to extractive industries; coal and natural gas, which become more active and lucrative when oil prices surge. In recent months we have seen more activity in development and start up in both coal and natural gas. The local economies in the central portion of North Carolina have suffered in recent years due to foreign competition in both furniture and textiles as well as consolidation in the financial services industry. Despite these detractions, the economies in this region continue to benefit from strong real estate development, good commercial occupancy rates and some recent announcements by national companies with relocation plans in the Triad and Central Piedmont areas. The eastern Virginia local economies, principally Greater Richmond and Fredericksburg, are experiencing strong growth in residential and commercial development as those areas continue to benefit from corporate activities and relocations and beltway sprawl, in the case of Stafford and Spotsylvania Counties.

      The mortgage industry outlook at the close of 2003 was on the decline on the expectation of rising interest rates. This was one factor leading to the Company’s decision to exit that business. Throughout the first half of 2004, rate increases had not materialized but the mortgage industry continued in malaise over the uncertainty of the economy and mortgage interest rates. Although the Federal Reserve eventually began increasing key overnight rates at midyear, mortgage interest rates and the treasury yield curve did not respond in the same fashion, possibly due to continued concerns over a start and stop recovery and slower than expected jobs growth. As a result, mortgage interest rates remained relatively low throughout the year and mortgage origination volumes, while down, did not contract to the degree anticipated.

      As the Company competes for increased market share and growth in both loans and deposits it continues to encounter strong competition from many sources. Bank expansion through de novo branches and Loan Production Offices (LPO’s) has grown in popularity as a means of reaching out to new markets. Many of the markets targeted by the Company are also being entered by other banks in nearby markets and, in some cases, from more distant markets. Despite strong competition from other banks, credit unions and mortgage companies, the Company has seen success in newly established offices in its Winston-Salem de novo markets as well as new LPO’s in Virginia and other markets in both Virginia and North Carolina. The Company attributes this measure of success to its recruitment of local, established bankers and loan personnel in those targeted markets. Competitive forces do impact the Company through pressure on interest yields, product fees and loan structure and terms; however, the Company has countered these pressures with its relationship style and pricing and a disciplined approach to loan underwriting.

Application of Critical Accounting Policies

      First Community’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. First Community’s financial position and results of operations are affected by management’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in First Community’s consolidated financial position and/or consolidated results of operations.

      Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by third party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal and external modeling techniques and/or appraisal estimates.

      First Community’s accounting policies are fundamental to understanding Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following is a summary of First Community’s more subjective and complex “critical accounting policies.” In addition, the disclosures presented in the Notes to the Consolidated Financial Statements and in management’s discussion and analysis, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan losses, the use of derivatives for hedging purposes accounting for income taxes and accounting for business acquisitions to be the accounting areas that require the most subjective or complex judgments. Derivatives hedging practices were eliminated in August 2004 with the disposition of UFM.

      Allowance for Loan Losses: The allowance for loan losses is established and maintained at levels management deems adequate to cover probable losses inherent in the portfolio as of the balance sheet date and is based on management’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. Estimates for loan losses are determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions of FCBI’s regulators, changes in the size and composition of the loan portfolio and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain. These events may include, but are not limited to, a general slowdown in the economy, fluctuations in overall lending rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting specific geographic areas in which First Community conducts business.

      As more fully described in Note 6 to the Notes to the Consolidated Financial Statements and in the discussion included in the Allowance for Loan Losses section of this discussion, the Company determines the allowance for loan losses by making specific allocations to impaired loans, loans that exhibit inherent weaknesses and loan pools that possess common credit risk factors. Allocations to loan pools are developed giving weight to risk ratings, historical loss trends and management’s judgment concerning those trends and other relevant factors. These factors may include, among others, actual versus estimated losses, regional and national economic conditions, business segment and portfolio concentrations, industry competition and consolidation, and the impact of government regulations. The foregoing analysis is performed by the Company’s credit administration department to evaluate the portfolio and calculate an estimated valuation allowance through a quantitative and qualitative analysis that applies risk factors to those identified risk areas.

      This risk management evaluation is applied at both the portfolio level and the individual loan level for commercial loans and credit relationships while the level of consumer and residential mortgage loan allowance is determined primarily on a total portfolio level based on a review of historical loss percentages and other qualitative factors including concentrations, industry specific factors and economic conditions. The commercial and commercial real estate portfolios require more specific analysis of individually significant loans and the borrower’s underlying cash flow, business conditions, capacity for debt repayment and the valuation of secondary sources of payment (collateral). This analysis may result in specifically identified weaknesses and corresponding specific impairment allowances.

      The use of various estimates and judgments in the Company’s ongoing evaluation of the required level of allowance can significantly impact the Company’s results of operations and financial condition and may result

in either greater provisions against earnings (reducing net income and earnings per share) to increase the allowance or reduced provisions (increasing net income and earnings per share). These estimates and judgments are based upon management’s current view of portfolio and economic conditions and the application of revised estimates and assumptions.

      UFM previously provided a distribution outlet for the sale of loans. It originated residential mortgage loans through its production offices and sold the majority of its loans through pooled commitments to national investors on a servicing released basis. UFM originated all loans with the positive intent to sell. Loans held for sale were stated at the lower of cost or market (“LOCOM”). The LOCOM analysis on pools of homogeneous loans were applied on a net aggregate basis. Interest income with respect to loans held for sale was accrued on the principal amount outstanding. LOCOM valuation techniques applicable to loans held for sale were based on estimated market price indications for similar loans. Pricing estimates were established by participating mortgage purchasers and prevailing economic conditions. The majority of the loans held for sale had established market pricing indications. The loans held for sale portfolio at December 31, 2003 were $18.2 million and they are now included in assets related to discontinued operations.

      Risks associated with this lending function included interest rate risk, which was mitigated through the utilization of financial instruments (commonly referred to as derivatives) to assist in offsetting the effect of changing interest rates. The Company accounted for these instruments in accordance with FASB Statement No. 133, as amended “Accounting for Derivative Instruments and Hedging Activity.” This Statement established accounting and reporting standards for derivative instruments and for hedging activities. UFM used forward mortgage contracts and options (short position sales and options) to manage interest rate risk in the pipeline of loans and interest rate lock commitments (“RLCs”) from the point of the loan commitment to the subsequent allocation and delivery to outside investors. As a result of the timing from origination to sale, and the likelihood of changing interest rates, forward commitments and options were placed with counter-parties to attempt to counter the effect of changing interest rates. The options and forward commitments to sell securities are considered to be derivatives and, as such, were recorded on the consolidated balance sheets at fair value and the changes in fair value are reflected in discontinued operations within the consolidated statements of income.

      The fair value of the RLCs is based on prevailing interest rates, expected servicing release premiums and the assumed probability of closing (pull-through). The assumption of a given pull-through percentage also enters into the determination of the volume of derivative contracts. Pull-through assumptions are continually monitored for changes in the interest rate environment and characteristics of the pool of RLCs. Differences between pull-through assumptions and actual pull-through could result in a mismatch in the volume of security contracts corresponding to RLCs and lead to volatility in profit margins on the loan products ultimately delivered.

      The foregoing discussion of derivatives and hedging relates to the historical operation of UFM which was sold in August 2004. Accordingly, these risks and the accounting policies and assumptions associated with derivatives and hedging are no longer considered material to the Company’s continuing operations. Further discussion of the impact of loans held for sale and derivatives is included in Footnote 1 of the Notes to Consolidated Financial Statements.

Acquisitions and Intangible Assets

      As part of its growth plan, the Company engages in business combinations with other companies. The acquisition of a business is generally accounted for under purchase accounting rules promulgated by the Financial Accounting Standards Board (FASB). Purchase accounting requires the recording of underlying assets and liabilities of the entity acquired at their fair market value. Any excess of the purchase price of the business over the net assets acquired and any identified intangibles is recorded as goodwill. Fair values are assigned based on quoted prices for similar assets, if readily available, or appraisal by qualified independent parties for relevant asset and liability categories. Financial assets and liabilities are typically valued using

discount models which apply current discount rates to streams of cash flow. All of these valuation methods require the use of assumptions which can result in alternate valuations and varying levels of goodwill and, in some cases, amortization expense or accretion income.

      Management must also make estimates of useful or economic lives of certain acquired assets and liabilities. These lives are used in establishing amortization and accretion of some intangible assets and liabilities, such as the intangible associated with core deposits acquired in the acquisition of a commercial bank.

      Goodwill is recorded as the excess of the purchase price, if any, over the fair value of the revalued net assets. Goodwill is tested at least annually in the month of November for possible impairment. This testing again uses a discounted cash flow model applied to the anticipated stream of cash flows from operations of the business or segment being tested. Impairment testing necessarily uses estimates in the form of growth and attrition rates and anticipated rates of return. These estimates have a direct bearing on the results of the impairment testing and serve as the basis for management’s conclusions as to impairment. In the fourth quarter of 2003 and in the second quarter of 2004, the company used impairment testing by a third party as part of its conclusion that the mortgage segment of the business had been impaired. This led to impairment charges (expense) in each of those quarters and the ultimate decision to sell the impaired business segment.

Income Taxes

      The establishment of provisions for federal and state income taxes is a complex area of accounting which also involves the use of judgments and estimates in applying relevant tax statutes. The company operates in multiple state tax jurisdictions and this requires the appropriate allocation of income and expense to each state based on a variety of apportionment or allocation bases. Management strives to keep abreast of changes in tax law and the issuance of regulations which may impact tax reporting and provisions for income tax expense. The company is also subject to audit by federal and state tax authorities. Results of these audits may produce indicated liabilities which differ from company estimates and provisions. The company continually evaluates its exposure to possible tax assessments arising from audits and records its estimate of probable exposure based on current facts and circumstances.

Recent Acquisitions and Branching Activity

      On March 31, 2004, the Company acquired PCB Bancorp, Inc., a Tennessee-chartered bank holding company (“PCB Bancorp”) headquartered in Johnson City, Tennessee. PCB Bancorp has six full service branch offices located in Johnson City, Kingsport and surrounding areas in Washington and Sullivan Counties in East Tennessee. At acquisition, PCB Bancorp had total assets of $171.0 million, total net loans of $128.0 million and total deposits of $150.0 million. These resources were included in the Company’s financial statements beginning with the second quarter of 2004.

      Under the terms of the merger agreement, shares of PCB Bancorp common stock were purchased for $40.00 per share in cash. The total deal value, including the cash-out of outstanding stock options, was approximately $36.0 million. Concurrent with the PCB Bancorp acquisition, Peoples Community Bank, the wholly-owned subsidiary of PCB Bancorp, was merged into the Bank. As a result of the acquisition and preliminary purchase price allocation, approximately $22.8 million in goodwill was recorded which represents the excess of the purchase price over the fair market value of the net assets acquired and identified intangibles.

      Late in the second quarter of 2004, the Company also established additional commercial lending offices in Norfolk, Virginia and Blacksburg, Virginia. These new offices will assist in the development of commercial business in both the Hampton Roads and New River Valley regions and will be supported by full service offices in nearby divisions.

      In January 2003, the Bank completed the acquisition of Stone Capital, based in Beckley, West Virginia. This acquisition expanded the Bank’s operations to include a broader range of financial services, including wealth management, asset allocation, financial planning and investment advice. At December 31, 2004, Stone Capital had a total market value of assets under management of $71.9 million. Stone Capital was acquired

through the issuance of 8,409 shares of Company common stock, which represents 50% of the total consideration. In 2003 and 2004 Stone Capital exceeded the annual revenue requirement outlined in the acquisition agreement and additional shares were paid to the original shareholders. The balance of the remaining consideration is payable on January 1, 2006 in the form of Company common stock subject to revenue minimums outlined in the acquisition agreement.

      In June 2003, the Company acquired CommonWealth, a Virginia-chartered commercial bank for total consideration of approximately $23.2 million. The merger was accomplished through the exchange of .9015 shares of the Company’s common stock valued at $30.50, cash, or a combination of the Company’s stock and cash equivalent to $30.50 for each share of CommonWealth common stock. At acquisition, CommonWealth had total assets of $136.5 million, net loans of $120.0 million and total deposits of $105.0 million. As a result of the preliminary purchase price allocation, the $15.3 million excess of purchase price over the fair market value of the net assets acquired and identified intangibles was recorded as goodwill.

      In the second, third and fourth quarters of 2003, the Company opened three de novo branches in Winston-Salem, North Carolina. In February 2004, the Company also established commercial loan offices in Charlotte and Mount Airy, North Carolina. At present, these offices are not involved in deposit gathering activities. However, they will assist in commercial real estate loan origination. These offices are in the development stages and produced startup operating losses throughout most of 2004. Near year-end 2004, certain of these offices began to produce monthly profits as business development efforts began to produce sufficient loan volume.

Results of Operations

      Net income for 2004 was $22.4 million, down $2.8 million from $25.2 million in 2003 and down $2.3 million from 2002 net income of $24.7 million. Basic and diluted earnings per share for 2004 were $1.99 and $1.97, respectively, compared to basic and diluted earnings per share of $2.27 and $2.25, respectively, in 2003 and $2.26 and $2.25 basic and diluted earnings per share, respectively, in 2002. A $3.7 million net loss in the mortgage banking operation which has been reclassified as a loss from discontinued operations was the major factor impacting the Company’s 2004 earnings performance. After absorbing additional costs associated with the opening of new branches and loan production offices, continuing operations reflected a decrease in net income of $0.7 million, or 2.6% in 2004 compared to the prior year and a $1.8 million increase, or 7.4%, compared to 2002. The loss from discontinued operations increased from $1.5 million for the year ended December 31, 2003 to a loss of $3.7 million in 2004. This loss included a charge-off of the now discontinued mortgage segment goodwill of $1.4 million. The discontinued mortgage banking segment is discussed more fully later in this management’s discussion.

      The Company’s key profitability ratios of Return on Average Assets (ROA) and Return on Average Equity (ROE) compare favorably with the average of the Company’s national peer ratios of 1.20% and 14.00%, respectively, based on the September 2004 Bank Holding Company Performance Report. ROA, which measures the Company’s stewardship of assets, was at 1.24%, compared to 1.56% in 2003 and 1.68% in 2002. ROE for the Company was 12.53% in 2004, compared to 15.13% in 2003 and 17.16% in 2002. ROA for continuing operations was 1.45% in 2004 vs. 1.70% in 2003; ROE for continuing operations was 14.58% in 2004 compared to 16.02% in 2003.

Net Interest Income

      The primary source of the Company’s earnings is net interest income, the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and securities while deposits and short-term borrowings represent the major portion of interest-bearing liabilities.

      Net interest income from continuing operations, the largest contributor to earnings, was $69.2 million for the year ended December 31, 2004 compared to $64.2 million for the corresponding period in 2003. For

purposes of the following discussion, comparison of net interest income is done on a tax equivalent basis for continuing operations, which provides a common basis for comparing yields on earning assets exempt from federal income taxes to those which are fully taxable. As indicated in Table I, tax equivalent net interest income totaled $72.9 million for 2004, an increase of $5.0 million from the $67.9 million reported in 2003. This $5.0 million increase includes a $9.5 million increase due to an increase in earning assets, which were added to the portfolio at declining replacement rates. This increase was partially offset by a net $4.4 million reduction due to rate changes on the underlying assets and liabilities as asset yields fell in the declining rate environment. Management was able to help offset the effect of the declining asset yield through aggressive management of deposit rates. Average earning assets increased $187.7 million while interest-bearing liabilities increased $175.4 million. As indicated in Table I, the yield on average earning assets decreased 39 basis points from 6.44% for the year ended December 31, 2003 to 6.05% for the year ended December 31, 2004. This decrease was accompanied by a 24 basis point decline in the cost of funds during the same periods. As a result, the net interest rate spread (the difference between interest income on earning assets and expense on interest bearing liabilities) at December 31, 2004 was lower at 4.11% compared to 4.26% for the same period last year. The Company’s tax equivalent net interest margin of 4.41% for the year ended December 31, 2004 decreased 23 basis points from 4.64% in 2003.

      The largest contributor to the decrease in the yield on average earning assets in 2004, on a volume-weighted basis, was the decrease in the overall tax equivalent yield on loans held for investment of 60 basis points from the prior year to 6.63%, as loans repriced downward in response to the declining rate environment of the preceding year and continued low rates in the first half of 2004. The average balance increased $182.5 million, largely due to the PCB acquisition in Tennessee and expansion offices in North Carolina. The decline in asset yield is attributable to the recent interest rate environment which created refinancing or repricing incentives for fixed rate borrowers to lower their borrowing costs. Strong competition for commercial loans also held loan yields lower in 2004.

      During 2004, the taxable equivalent yield on securities available for sale decreased 24 basis points to 4.62% while the average balance increased by $16.2 million. Consistent with the current rate environment, the Company and the securities industry as a whole have experienced rapid turnover in securities as higher yielding securities are either called or prepaid as the refinancing opportunity presented itself. The increasing average security balance is the result of continued reinvestment of available funds. The average balance of investment securities held to maturity decreased $3.7 million, while the yield decreased 23 basis points to 8.00%. Securities held to maturity are largely comprised of tax-free municipal securities. Compared to 2003, average interest-bearing balances with banks decreased $6.6 million between 2003 and 2004, while the yield increased 30 basis points to 1.82%.

      The Company actively manages its product pricing by staying abreast of the current economic climate and competitive forces in order to enhance repricing opportunities available with respect to the liability side of its balance sheet. In doing so, the cost of interest-bearing liabilities decreased by 24 basis points from 2.18% in 2003 to 1.94% in 2004 while the average volume of interest-bearing liabilities increased $175.4 million.

      Compared to 2003, the average balance of FHLB and other short-term convertible and callable borrowings increased in 2004 by $58.6 million to $240.6 million while the rate decreased 3 basis points to 3.15%, the result of the addition of balances acquired with the CommonWealth and PCB acquisitions, the addition of new advances at lower rates partially offset by the maturity of a $25 million FHLB advance in December 2004. The average balance of all other borrowings increased $5.1 million in 2004 compared to 2003, the result of the issuance of $15 million in subordinated debentures late in the third quarter of 2003, while the rate paid decreased 30 basis points.

      In addition, the average balances of interest-bearing demand and savings deposits increased $20.4 million and $86.1 million, respectively. The average rate paid on demand deposits decreased by 5 basis points while the average rate paid on savings increased by 7 basis points (the result of higher rates paid by PCB on certain money market accounts). Average time deposits increased $5.1 million while the average rate paid decreased 41 basis points from 2.85% in 2003 to 2.44% in 2004. The level of average non-interest-bearing demand deposits increased $33.8 million to $212.8 million at December 31, 2004 compared to 2003. Average interest-

bearing deposits and non-interest bearing demand deposits for the acquired CommonWealth Bank branches totaled $66.1 million and $25.1 million, respectively in 2004 and $35.9 million and $18.1 million, respectively in 2003. Included in the 2004 average balances related to the PCB acquisition were interest-bearing and non-interest bearing deposits of $97.7 million and $14.2 million at December 31, 2004.

      Net interest income from continuing operations was $64.2 million for the year ended December 31, 2003 compared to $60.3 million for the corresponding period in 2002. Tax equivalent net interest income (Table I) totaled $67.9 million for 2003, an increase of $3.8 million from the $64.1 million reported in 2002. This $3.8 million increase includes a $4.9 million increase due to an increase in earning assets. This increase was partially offset by a $1.1 million reduction due to rate changes on the underlying assets as asset yields fell in the declining rate environment. Average earning assets increased $140.2 million while interest-bearing liabilities increased $113.9 million. The yield on average earning assets decreased 85 basis points from 7.29% for the year ended December 31, 2002 to 6.44% for the year ended December 31, 2003. However, this decrease was largely offset by a 76 basis point decline in the cost of funds during the same periods leaving the net interest rate spread at December 31, 2003 slightly lower at 4.26% compared to 4.35% for 2002. The Company’s tax equivalent net interest margin of 4.64% for the year ended December 31, 2003 decreased 21 basis points from 4.85% in 2002.

      The largest contributor to the decrease in the yield on average earning assets in 2003, on a volume-weighted basis, was the decrease in the overall tax equivalent yield on loans held for investment of 68 basis points from the prior year to 7.23%, as loans repriced downward in response to the declining rate environment while the average balance increased $58.7 million. The decline in asset yield is attributable to the interest rate environment which created refinancing or repricing incentives for fixed rate borrowers to lower their current borrowing costs. In addition, due to the volume of loans directly tied to prime and other indices that are either adjustable incrementally or are variable rate advances, asset yields declined in response to Federal Funds rate cuts and drops in the prime loan rate which began in 2001 and continued in 2003.

      During 2003, the taxable equivalent yield on securities available for sale decreased 106 basis points to 4.86% while the average balance increased by $68.4 million. The increased average security balance was the result of continued reinvestment of available funds largely created by higher average deposit levels. Both the average balance and tax equivalent yield on investment securities held to maturity remained relatively stable with a slight increase in yield of 7 basis points to 8.23% and a $1.4 million decrease in average balance from 2002. Securities held to maturity are largely comprised of tax-free municipal securities.

      Compared to 2002, average interest-bearing balances with banks increased $14 million while the yield remained the same at 1.52%. This average balance increase was largely the result of funds received from new deposit growth in existing markets and deposits obtained in the acquisition of The Bank of Greenville in the fourth quarter of 2002 and CommonWealth in June 2003 as well as the continued cash flow roll-off experienced in the loan and investment portfolio.

      The cost of interest-bearing liabilities decreased by 76 basis points from 2.94% in 2002 to 2.18% in 2003 while the average volume increased $113.9 million. Average short-term borrowings, increased $29.1 million in 2003 when compared to 2002, because of additional borrowings assumed in the acquisition of CommonWealth and a general increase in the level of retail repurchase agreements, net of reclassifications to discontinued operations. The average rate paid on these borrowings decreased 96 basis points to 3.18% in 2003 versus 4.14% in 2002. Average long-term borrowings increased $1.8 million as a result of the September 2003 issuance of $15 million in trust preferred securities and the payment of an $8 million advance from the FHLB. The average rate paid on these borrowings decreased 50 basis points in 2003 compared to 2002.

      In addition, the average balances of interest-bearing demand and savings deposits increased $13.5 and $36.1 million, respectively, during 2003 while the corresponding average rate paid on these deposit categories declined 25 and 53 basis points, respectively. Average time deposits increased $33.4 million while the average rate paid decreased 89 basis points from 3.74% in 2002 to 2.85% in 2003. The level of average non-interest-bearing demand deposits increased $21.7 million to $179.0 million in 2003 compared to 2002. Approximately

$58.4 million of the $82.9 million increase in average interest-bearing deposit growth is attributable to the acquisitions of The Bank of Greenville ($22.5 million) in the fourth quarter of 2002 and CommonWealth ($35.9 million) in June 2003, respectively. CommonWealth also contributed significant non-interest bearing deposit balances with its high balance deposit product for title companies and real estate settlement firms.

Distribution of Assets, Liabilities and Stockholders’ Equity, Interest Rates and Interest Differential

Average Balance Sheets-Net Interest Income Analysis-TABLE I

      The following table recaps the adjustments incorporated when converting net interest earnings to a tax-equivalent basis:

Rate and Volume Analysis of Interest

      The following table summarizes the changes in interest earned and paid resulting from changes in volume of earning assets and paying liabilities and changes in their interest rates. In this analysis, the change in interest due to both rate and volume has been allocated to the volume and rate columns in proportion to absolute dollar amounts. This table will assist you in understanding the changes in the Company’s principal source of revenues, net interest income (“NII”). The principal themes or trends which are evident in this table include:

Non-interest Income

      Non-interest income consists of all revenues which are not included in interest and fee income related to earning assets. Total non-interest income increased approximately $2.8 million, or 19.2%, from $14.5 million for the year ended December 31, 2003 to $17.3 million for the corresponding period in 2004. Along with an increase in deposits stemming from bank charges on deposit accounts increased $1.1 million or 13.02% while other service charges, commissions and fees reflected gains of $386,000 or 16.19%. A 70.3% or $774,000 improvement in other operating income in 2004 is due to several factors, including improvement in ATM usage fees on foreign cards and an increase in commission income generated by Stone Capital Management, Inc. Stone Capital asset management fees grew from $371,000 in 2003 to $531,000 in 2004. This growth reflects the initial stages of expansion of the retail asset management services under Stone Capital and its addition of 2 investment advisors and the licensing of a number of investment associates within the bank branches.

      During 2004, the Company realized a gain on sale of securities of approximately $1.6 million due largely to the sale of $25.0 million of corporate bonds held in the Company’s available-for-sale investment portfolio, the market value of which had declined in step with the flattening of the Treasury yield curve. The proceeds from the sale of these securities in the second quarter of 2004 provided sufficient liquidity to pay-off overnight borrowings and assisted the Company in funding increased loan demand. These gains, along with smaller gains on securities called, compared to those of the same period of 2003 reflect a year over year increase of $406,000.

      Fiduciary revenues, which include fees for trust services, increased $170,000 in 2004 versus 2003. The increase in fiduciary revenues in 2004 relates to both account and asset growth within the trust division which came under new management in early 2004. The increase in fiduciary revenues includes an increase of $106,000 in mutual fund shareholder service fees which were previously retained by an outsourced investment advisor and increased estate fees of $52,000.

      Total non-interest income from continuing operations increased approximately $3.9 million, or 37.0%, from $10.6 million for the year ended December 31, 2002 to $14.5 million for 2003. Gains on the sale of securities of $1.2 million, or a year over year change of $1.6 million was the largest contributor to this increase, almost entirely due to the sale of certain short-term equity investments in the third quarter of 2003.

      Service charges on deposit accounts increased $1.0 million, or 14.4% primarily as the result of the Company’s overdraft program that allows well-managed customer deposit accounts flexibility in managing overdrafts to their accounts. Other service charges, commissions and fees also increased $1.0 million in 2003 compared to 2002. These fees are dependent upon customer behaviors and usage of the various products and services of the Company and are transaction oriented. Revenues in this category include, among others, commissions on sales of credit life insurance and other fee sources of revenue including the new revenues from Stone Capital of $356,000 and an increase in ATM service charge revenues of $321,000, partially generated in the new market areas.

      Fiduciary earnings representing asset management fees on trust and agency accounts of $1.8 million were consistent with the prior year. All other operating income increased $305,000.

Non-interest Expense

      Total non-interest expense from continuing operations was $48.0 million, an increase of 27.8% or $10.4 million for 2004 over 2003. A $6.0 million or 29.1% increase in salaries and benefits and a $2.8 million increase in other operating expenses account for 85% of this increase, resulting from the Company’s expansion into Blacksburg, Virginia, Eastern Virginia, East Tennessee, and Charlotte, Winston-Salem and Mount Airy,

North Carolina. This expansion brings with it the associated costs of additional branch personnel, corporate services and support, added technology and infrastructure as further detailed below.

      The $6.0 million increase in salaries and benefits includes the addition of CommonWealth Bank in June 2003 ($1.0 million), the acquisition of PCB in the second quarter of 2004 ($1.9 million), the salaries and benefits associated with three North Carolina de novo branches opened in late 2003 and the opening of two new North Carolina loan production offices in the first quarter of 2004 ($1.2 million), and three new loan production offices in Virginia and West Virginia ($230,000), as well as a general increase in salaries and benefits as staffing needs at several locations were satisfied in order to support added corporate services and continued branch growth.

      Occupancy and furniture and fixture expenses increased $647,000 and $878,000, respectively, compared to 2003 for a total of $1.5 million. The general level of occupancy and equipment costs grew largely as a result of the CommonWealth acquisition ($156,000), the PCB Bancorp acquisition ($477,000), increases in depreciation and insurance costs associated with new de novo branches ($210,000) and depreciation associated with continued investment in operating equipment and technology infrastructure.

      All other operating expense accounts increased $2.8 million in 2004 compared to 2003. Significant increases were related to the additional costs associated with the opening of three new branches in Winston-Salem and two loan production offices in Charlotte and Mount Airy, North Carolina ($119,000), the opening of three loan production offices in Virginia and West Virginia ($68,000), the acquisition of CommonWealth in Richmond, Virginia ($263,000) and the Tennessee acquisition of PCB Bancorp ($616,000). Other operational and data processing expenses also increased as a result of the acquisition and branching activity, such as correspondent bank fees, insurance, courier and FDIC/ OCC assessments.

      The Company has, for many years, used a traditional efficiency ratio that is a non-GAAP financial measure of operating expense control and efficiency of operations. Management believes that its traditional ratio better focuses attention on the operating performance of the Company over time than does a GAAP based ratio, and is highly useful in comparing period-to-period operating performance of the Company’s core business operations. It is used by management as part of its assessment of its performance in managing non-interest expenses. However, this measure is supplemental, and is not a substitute for an analysis of performance based on GAAP measures. The reader is cautioned that the traditional efficiency ratio used by the Company may not be comparable to GAAP or non-GAAP efficiency ratios reported by other financial institutions.

      In general, the efficiency ratio is non-interest expenses as a percentage of net interest income plus non-interest income. Non-interest expenses used in the calculation of the traditional, non-GAAP efficiency ratio exclude amortization of goodwill and intangibles and non-recurring expenses. Income for the traditional ratio is increased for the favorable effect of tax-exempt income (see Table I), and excludes securities gains and losses, which vary widely from period to period without appreciably affecting operating expenses, and non-recurring gains. The measure is different from the GAAP based efficiency ratio, which also is presented in this report. The GAAP based measure is calculated using non-interest expense and income amounts as shown on the face of the Consolidated Statements of Income. The GAAP and traditional based efficiency ratios are reconciled in the table below.

      The efficiency ratios for continuing operations for 2004, 2003, and 2002 were 53.2%, 45.2%, and 42.7%, respectively. Increases in the current year is reflective of the higher direct costs associated with the

acquisitions and new offices in 2003 and 2004 and added corporate overhead required to support Company expansion. The following table details the components used in calculation of the efficiency ratios.

      Non-interest expense from continuing operations totaled $37.6 million for 2003 increasing $4.9 million, or 14.88% over year-end 2002. This increase is primarily attributable to a $3.5 million increase in salaries and benefits as a result of the addition of Greenville in late 2002 ($349,000), the addition of CommonWealth in June 2003 ($854,000) as well as a general increase in salaries and benefits as staffing needs at several locations were satisfied in order to support added corporate services and continued branch growth, including three newly established branches in Winston-Salem, North Carolina ($342,000).

      In 2003, occupancy and furniture and equipment expense increased by $752,000 compared to 2002. The general level of occupancy cost grew largely as a result of the Greenville ($145,000) and CommonWealth acquisitions ($251,000) as well as increases in depreciation and insurance costs associated with new de novo branches ($63,000) and depreciation associated with a significant investment in operating equipment and technology infrastructure.

      All other operating expense accounts increased $660,000, or 5.93% in 2003 compared to 2002. This increase was largely attributable to The Bank of Greenville acquisition in late 2002 and the CommonWealth acquisition along with the three de novo branches opened in the second, third and fourth quarters of 2003.

Income Tax Expense

      Income tax expense is comprised of federal and state current and deferred income taxes on pre-tax earnings of the Company. Income taxes as a percentage of pre-tax income may vary significantly from statutory rates due to items of income and expense which are excluded, by law, from the calculation of taxable income. These items are commonly referred to as permanent differences. The most significant permanent differences for the Company include i) income on state and municipal securities which are exempt from federal income tax, ii) certain dividend payments which are deductible by the company, iii) for 2003 and 2004, goodwill impairment expense which is not deductible, and iv) for the third quarter of 2004, the loss on

the sale of the UFM subsidiary which had a significant tax basis over and above its book carrying value. The two latter items are reflected in the tax benefit from discontinued operations in 2003 and 2004.

      State and municipal bond income represents the most significant permanent difference that occurs on a regular basis. Goodwill impairment expense is infrequent and has historically been related to the UFM subsidiary, which was sold in August 2004. The difference related to the excess tax over book basis of the UFM subsidiary was a one time event linked to the sale of the mortgage subsidiary. This item resulted in a substantial reduction in the effective income tax rate for 2004. This difference arose due to the non-deductible goodwill impairment charges associated with the sale of the UFM subsidiary. Because those charges (expenses) were not deductible, they resulted in permanent differences which increased the effective tax rate in 2003 and the first two quarters of 2004. Goodwill expense, by its very nature, is a permanent difference. These expenses did, however, reduce the carrying basis of the mortgage subsidiary and resulted in a permanent difference tax affect of approximately $950,000 in the third quarter of 2004 upon the sale of the entity, which reduced the combined effective tax in 2004 to 25.6% from 29.1% in 2003.

      Income tax expense is classified according to continuing operations and discontinued operations. The $950,000 tax benefit associated with the loss on the sale of UFM is included in Income Tax Benefit — Discontinued Operations on the income statement.

      Throughout 2004, the Company has been engaged in a state tax audit involving state income, franchise and sales tax in one of its state tax jurisdictions. While the Company has received early indications of the state tax department’s estimates of potential additional state income and franchise tax liabilities, the Company’s review of the potential assessments revealed a position which favors the Company and which, if sustained, could result in the Company receiving state income and franchise tax refunds. The Company and tax counsel continue to evaluate possible exposure under the state tax audit as well as the referenced favorable tax position and believe that the Company has established appropriate provisions for state income and franchise taxes consistent with the uncertainty of the state tax audit and changes in the Company’s state tax filings.

Financial Position

      Investment securities held to maturity are comprised largely of U.S. Agency obligations and state and municipal bonds. Obligations of States and Political Subdivisions represent the largest portion of the held to maturity portfolio which totaled $34.2 million at December 31, 2004. These are comprised of high-grade municipal securities generally carrying AAA bond ratings, most of which also carry credit enhancement insurance by major insurers of investment obligations.

      The average final maturity of the investment portfolio decreased from 8.11 years in 2003 to 7.42 years in 2004 with the tax equivalent yield decreasing from 8.23% at year-end 2003 to 8.00% at the close of 2004. The average maturity of the investment portfolio, based on market assumptions for prepayment, is 1.91 years and 2.8 years at December 2004 and 2003, respectively. The average maturity data differs from final maturity data because of the use of assumptions as to anticipated prepayments.

      Further detail of the amortized costs and fair value of securities held to maturity is included in Note 4 of the Notes to Consolidated Financial Statements included within this report with respect to 2004 and 2003. The following table details amortized cost and fair value at December 31, 2002.

Securities Available for Sale

      Securities available for sale were $388.7 million at December 31, 2004 compared to $444.2 million at December 31, 2003, a decrease of $55.5 million. This change reflects the purchase of $118.4 million in securities, $58.3 million in maturities and calls, proceeds from sales of $50.0 million, the acquisition of $28 million in securities with the PCB Bancorp purchase, a market value decrease of approximately $4.3 million, the continuation of larger pay-downs of $87.0 million on mortgage-backed securities and collateralized mortgage obligations triggered by the low interest rate environment and approximately $2.2 million in bond premium amortization.

      The average final maturity of the available for sale portfolio was 11.9 years at December 31, 2004 compared to 15.2 years at December 31, 2003. Although substantial reinvestment has been made in the available for sale security portfolio, the Company has attempted to maintain a shorter portfolio duration (the cash-weighted term to maturity of the portfolio) to reduce the sensitivity of the portfolio to changes in interest rates and lessen interest rate risk. The longer the duration, the greater the impact of changing market rates for similar instruments. At December 31, 2004, the estimated average life of the investment portfolio was 4.2 years (reflective of currently anticipated prepayments) for both 2004 and 2003.

      Securities available for sale are recorded at their estimated fair market value. The unrealized gain or loss, which is the difference between amortized cost and estimated market value, net of related deferred taxes, is recognized in the stockholders’ equity section of the balance sheet as accumulated other comprehensive income or loss. The unrealized gains after taxes of $2.4 million at December 31, 2004, represent a decrease of $2.6 million from the $5.0 million gain at December 31, 2003, the result of market value depreciation in reaction to rate movements on similar instruments as well as gains realized on sales in 2004.

      The fair value of a security is determined based on quoted market prices. If quoted market prices are not available, fair value is determined based on quoted prices of similar instruments. Available-for-sale and held to maturity securities are reviewed quarterly for possible other-than-temporary impairment. This review includes an analysis of the facts and circumstances of each individual investment such as the length of time the fair value has been below cost, the expectation for that security’s performance, the credit worthiness of the issuer and the Registrant’s intent and ability to hold the security to recovery or maturity. A decline in value that is considered to be other-than-temporary is recorded as a loss within non-interest income in the Consolidated Statements of Income.

      Further detail of the amortized costs and fair value of securities available for sale is included in Note 3 of the Notes to Consolidated Financial Statements included within this report with respect to 2004 and 2003. The following table details amortized cost and fair value at December 31, 2002.