FIRST SECURITY GROUP INC/TN - 10-Q Quarterly Report

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2004

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from ____________________ to _____________________.

COMMISSION FILE NO. 000-49747

FIRST SECURITY GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

Tennessee		58-2461486
(State of Incorporation)		(I.R.S. Employer Identification No.)

817 Broad Street, Chattanooga, TN		37402
(Address of principal executive offices)		(Zip Code)

(423) 266-2000

(Registrant's telephone number, including area code)

Not Applicable

(Former name, former address, and former fiscal year,

if changed since last report)

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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

Common Stock, $.0083 par value:

10,587,639 shares outstanding and issued as of November 3, 2004

First Security Group, Inc. and Subsidiary

Form 10-Q

INDEX

PART I.	FINANCIAL INFORMATION	Page No.

Item 1.	Financial Statements

	Consolidated Balance Sheets September 30, 2004, December 31, 2003 and September 30, 2003	3

	Consolidated Income Statements Three months and Nine months ended September 30, 2004 and 2003	4

	Consolidated Statement of Stockholders' Equity Nine months ended September 30, 2004	6

	Consolidated Statements of Cash Flows Nine months ended September 30, 2004 and 2003	7

	Notes to Consolidated Financial Statements	9

Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	10

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	24

Item 4.	Controls and Procedures	25

Part II	OTHER INFORMATION

Item 5.	Other Information	26

Item 6.	Exhibits	26

SIGNATURES		27


	2

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

First Security Group, Inc. and Subsidiary
Consolidated Balance Sheets	September 30,		December 31,			September 30,
	2004		2003			2003
	(unaudited)					(unaudited)
	(in thousands)
ASSETS
Cash and due from banks	$	22,156	$	25,662		$	23,835
Federal funds sold and securities purchased
under agreements to resell		-		6,972			23,962
Cash and cash equivalents		22,156		32,634			47,797
Interest-bearing deposits in banks		2,760		4,512			3,681
Securities available for sale		90,435		86,499			86,650
Loans		514,168		478,013			446,578
Less: Allowance for loan losses		5,448		5,827			6,378
		508,720		472,186			440,200
Premises and equipment, net		25,886		24,517			21,463
Intangible assets		15,319		15,704			12,449
Other assets		10,397		8,713			9,422
TOTAL ASSETS	$	675,673	$	644,765		$	621,662

LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES
Deposits
Noninterest bearing demand	$	116,097	$	100,192		$	99,832
Interest bearing demand		52,293		51,505			38,710
Savings		137,182		128,662			125,860
Certificates of deposit of $100 thousand or more		100,598		95,162			96,996
Certificates of deposit less than $100 thousand		160,003		164,783			149,605
Total deposits		566,173		540,304			511,003
Federal funds purchased and securities sold
under agreement to repurchase		16,302		12,069			16,039
Other borrowings		4,152		6,159			9,161
Other liabilities		4,279		3,795			4,507
Total liabilities		590,906		562,327			540,710
STOCKHOLDERS' EQUITY
Common stock - $.0083 par value - 20,000,000 shares
authorized; 10,587,639 issued as of September 30,
2004; 10,584,867 issued as of December 31, 2003;
and 10,497,867 issued as of September 30, 2003		88		88			88
Paid-in surplus		77,981		77,958			77,397
Retained earnings		6,318		3,995			3,190
Accumulated other comprehensive income		380		430			360
Deferred compensation on restricted stock		-		(33	)		(83	)
Total stockholders' equity		84,767		82,438			80,952
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	675,673	$	644,765		$	621,662

See Notes to Consolidated Financial Statements


	3

First Security Group, Inc. and Subsidiary
Consolidated Income Statements
(Unaudited)
	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In thousands except per share amounts)	2004		2003			2004		2003
INTEREST INCOME
Loans, including fees	$	8,225	$	7,511		$	23,696	$	21,064
Debt securities - taxable		572		421			1,650		1,292
Debt securities - non-taxable		236		154			621		351
Other		85		152			192		417
Total interest income		9,118		8,238			26,159		23,124

INTEREST EXPENSE
Interest bearing demand deposits		47		27			134		92
Savings deposits		295		293			809		1,055
Certificates of deposit of $100 thousand or more		640		751			1,855		2,169
Certificates of deposit of less than $100 thousand		983		1,092			3,025		3,178
Other		100		120			268		353
Total interest expense		2,065		2,283			6,091		6,847

NET INTEREST INCOME		7,053		5,955			20,068		16,277
Provision for loan losses		675		366			2,025		1,499
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES		6,378		5,589			18,043		14,778

NONINTEREST INCOME
Service charges on deposit accounts		1,055		642			2,866		1,693
Mortgage loan fee income		346		350			989		1,412
Gain (loss) on securities		-		(3	)		84		24
Other noninterest income		226		481			666		867
Total noninterest income		1,627		1,470			4,605		3,996

NONINTEREST EXPENSE
Salaries and employee benefits		3,715		3,030			10,608		8,760
Net occupancy		537		415			1,485		1,078
Equipment expense		575		451			1,602		1,195
Data processing fees		294		348			893		851
Amortization expense - CDI		191		154			616		376
Advertising expense		121		86			356		223
Supplies expense		142		194			463		440
Communications expense		137		131			366		330
Professional services		224		151			713		662
Postage expense		151		134			451		356
Other noninterest expense		650		789			1,742		1,859
Total noninterest expense		6,737		5,883			19,295		16,130


	4

INCOME BEFORE INCOME TAX PROVISION		1,268		1,176		3,353		2,644
Income tax provision		411		432		1,030		993
NET INCOME	$	857	$	744	$	2,323	$	1,651

NET INCOME PER SHARE
BASIC AND DILUTED	$	0.08	$	0.07	$	0.22	$	0.16
WEIGHTED AVERAGE SHARES OUTSTANDING
BASIC		10,588		10,497		10,587		10,043
DILUTED		10,763		10,605		10,763		10,141

See Notes to Consolidated Financial Statements


	5

First Security Group, Inc. and Subsidiary
Consolidated Statement of Stockholders' Equity
												Deferred
									Accumulated			Compensation
									Other			on
	Common Stock				Paid-In		Retained		Comprehensive			Restricted
(In thousands)	Shares		Amount		Surplus		Earnings		Income (Loss)			Stock			Total
Balance - December 31, 2003		10,585	$	88	$	77,958	$	3,995	$	430		$	(33	)	$	82,438
Comprehensive income -
Net income (unaudited)								2,323								2,323
Change in net unrealized
loss on securities available
for sale, net of tax (unaudited)										(50	)					(50	)
Total comprehensive income (unaudited)																2,273
Common stock issued (unaudited)		3				23							33			56
Balance - September 30, 2004 (unaudited)		10,588	$	88	$	77,981	$	6,318	$	380		$	-		$	84,767

See Notes to Consolidated Financial Statements


	6

First Security Group, Inc. and Subsidiary
Consolidated Statements of Cash Flows
(Unaudited)
	Nine Months Ended
	September 30,
(In thousands)	2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	2,323		$	1,651
Provision for loan losses		2,025			1,499
Net amortization of securities		580			677
Amortization of intangibles		616			376
Amortization of deferred stock compensation		33			116
Depreciation		1,260			873
Loss (gain) on disposal of assets		11			(9	)
Gain on sale of available-for-sale securities		(84	)		(24	)
Changes in operating assets and liabilities -
Increase in -
Interest receivable		(76	)		(22	)
Other assets		(1,813	)		(2,717	)
Increase (decrease) in -
Interest payable		(659	)		(108	)
Other liabilities		1,143			793
Net cash provided by operating activities		5,359			3,105

CASH FLOWS FROM INVESTING ACTIVITIES
Net change in interest bearing deposits		1,752			25
Activity in available-for-sale securities -
Sales		8,412			2,555
Maturities, prepayments, and calls		24,268			18,178
Purchases		(37,188	)		(45,023	)
Loan originations and principal collections, net		(38,559	)		(41,615	)
Proceeds from sale of fixed assets		-			43
Additions to premises and equipment		(2,640	)		(5,151	)
Net cash acquired in transaction accounted for
under the purchase method of accounting		-			14,198
Net cash used by investing activities		(43,955	)		(56,790	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		25,869			52,699
Net increase in federal funds purchased and
securities sold under agreements to repurchase		4,233			4,317
Repayments of other borrowings		(2,007	)		(7	)
Proceeds from sale of common stock, net		23			-
Net cash provided by financing activities		28,118			57,009
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS		(10,478	)		3,324
CASH AND CASH EQUIVALENTS - beginning of period		32,634			44,473
CASH AND CASH EQUIVALENTS - end of period	$	22,156		$	47,797


	7

Supplemental disclosures of noncash investing and
financing activities
Change in unrealized depreciation of securities,
net of deferred taxes of $(26) for 2004 and $(123) for 2003	$	(50	)	$	(235	)
Assets (noncash) acquired in business combination	$	-		$	75,314
Liabilities assumed in business combination	$	-		$	78,025
Issuance of common stock in business combination	$	-		$	11,487
Issuance of common stock pursuant to incentive plan	$	-		$	200
Supplemental schedule of cash flows
Interest paid	$	6,750		$	6,955
Income taxes paid	$	1,007		$	1,436

See Notes to Consolidated Financial Statements


	8

FIRST SECURITY GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature. Certain reclassifications have been made to prior year amounts to conform with the current year presentation. Operating results for the nine-month period ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004 or any other period. The balance sheet as of December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2003.

NOTE B - COMPREHENSIVE INCOME

In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard No. 130, "Reporting Comprehensive Income," the Company is required to report "comprehensive income," a measure of all changes in equity, not only reflecting net income but certain other changes as well. Comprehensive income for the three-month and nine-month period ended September 30, 2004 and 2003, respectively, was as follows:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(in thousands)	2004		2003			2004			2003

Net income	$	857	$	744		$	2,323		$	1,651
Unrealized gain (loss) - securities, net of tax		1,177		(458	)		(50	)		(235	)
Comprehensive income, net of tax	$	2,034	$	286		$	2,273		$	1,416

NOTE C - EARNINGS PER SHARE

Reference is made to Note 14, Long-Term Incentive Plan, in the Notes to Consolidated Financial Statements in First Security's Form 10-K, which contains descriptions of First Security's Stock Option Plan (the "Plan"). Shares under option under the Plan had a dilutive impact of less than $.01 on net income per share for the nine months ended September 30, 2004.

NOTE D - REGULATORY AND ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (FASB) issued Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46), which establishes guidance for determining when an entity should consolidate another entity that meets the definition of a variable interest entity. FIN 46 requires a variable interest entity to be consolidated by a company if that company will absorb a majority of the expected losses, will receive a majority of the expected residual returns, or both. Transferors to qualified special-purpose entities ("QSPEs") and certain other interests in a QSPE are not subject to the requirements of FIN 46. On December 17, 2003, the FASB revised FIN 46 (FIN 46R) and deferred the effective date of FIN 46 to no later than the end of the first reporting period that ends after March 15, 20 04. However, for special-purpose entities, First Security would have been required to apply FIN 46 as of December 31, 2003. The Interpretation had no effect on First Security's consolidated financial statements.


	9

In March 2004, the FASB’s Emerging Issues Task Force (EITF) concluded its discussion of Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” A consensus was reached regarding disclosures about unrealized losses on available-for-sale debt and equity securities accounted for under FASB Statements No. 115, Accounting for Certain Investments in Debt and Equity Securities, and No. 124, Accounting for Certain Investments Held by Not-for-Profit Organizations. The EITF provided guidance for evaluating whether an investment is other-than-temporarily impaired. Initially, this guidance was to be applied in other-than-temporary impairment evaluations made in reporting periods beginning after June 15, 2004. The EITF has subsequently delayed the effective date of this pronouncement as it relates to other-than-temporary impairment valuation pending further discussion of the definition of “other-than-temporarily impaired”. The EITF consensus also requires certain quantitative and qualitative disclosures which were effective in annual financial statements for fiscal years ending after December 15, 2003, for investments accounted for under Statements 115 and 124. For all other investments within the scope of this Issue, the disclosures are effective in annual financial statements for fiscal years ending after June 15, 2004. The additional d isclosures for cost method investments are effective for fiscal years ending after June 15, 2004. The EITF consensus is not expected to have a material effect on First Security’s consolidated financial statements.

ITEM 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Form 10-Q, "First Security," "FSG," "we," "us," “the Company” and "our" refer to First Security Group, Inc.

THIRD QUARTER 2004 AND RECENT EVENTS

The following discussion and analysis sets forth the major factors that affected First Security's results of operations and financial condition reflected in the unaudited financial statements for the three-month and nine-month periods ended September 30, 2004 and 2003. Such discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and the notes attached thereto.

On June 9, 2004, the OCC granted fiduciary powers to FSGBank N.A., the wholly-owned subsidiary of First Security, enabling the formation of our wealth management department. This department became fully operational in the third quarter of 2004. The department is staffed with six employees who collectively have over 80 years of trust experience.

On October 21, 2004, FSGBank entered into an Assignment and Assumption Agreement with Warren E. Payne and National Bank of Commerce, whereby FSGBank accepted assignment of the rights, and assumed the obligations and commitments, of Mr. Payne under a Stock Purchase Agreement, dated October 21, 2004, between National Bank of Commerce and Mr. Payne. The transactions contemplated by the Stock Purchase Agreement closed October 21, 2004, with an effective date of October 1, 2004. Under the terms of the Assignment and Assumption Agreement and the Stock Purchase Agreement, FSGBank purchased 100% of the capital stock of Kenesaw Leasing, Inc. and J&S Leasing, Inc., both Tennessee corporations, from National Bank of Commerce. Kenesaw Leasing and J&S Leasing are equipment leasing companies based in Knoxville, Tennessee. The cumu lative purchase price was $13 million. First Security management expects that these transactions will be immediately accretive to earnings.

All per share data has been retroactively adjusted for the 12 for 10 stock split effected on June 16, 2003. As a result of the split, the par value has been adjusted from $.01 to $0.0083 per share.


	10

OVERVIEW

As of September 30, 2004 First Security had total consolidated assets of $675.7 million, total loans of $514.2 million, total deposits of $566.2 million and stockholders' equity of $84.8 million. Our net income was $857 thousand and $2.3 million for the three and nine months ended September 30, 2004. We expect our recent acquisitions, Kenesaw Leasing and J&S Leasing, will increase our net income in future periods.

RESULTS OF OPERATIONS

Net income for the three months ended September 30, 2004 was $857 thousand, or $.08 per share (basic and diluted), compared to a net income of $744 thousand, or $.07 per share (basic and diluted) in the same period of 2003. Net income for the nine months ended September 30, 2004 was $2.3 million, or $.22 per share (basic and diluted), compared to net income of $1.7 thousand or $.16 per share (basic and diluted), in the same period of 2003. Net interest income and noninterest income for the nine-month period ended September 30, 2004 increased by $4.4 million, collectively, while noninterest expense, including provision for loan losses, increased by $3.7 million. Income increases outpaced expense increases as a result of the additional earning assets acquired through our acquisitions and branching activity during 2003 and 2004.

Return on average assets (annualized) for the three months ended September 30, 2004 and 2003 was 0.51% and 0.48%, respectively. For the nine months ended September 30, 2004 and 2003, return on average assets (annualized) was 0.47% and 0.39%, respectively. Return on average equity (annualized) for the three months ended September 30, 2004 and 2003 was 4.1% and 3.7%, respectively; and for the nine months ended September 30, 2004 and 2003, was 3.7% and 2.9%, respectively.

Net Interest Income

Net interest income increased by $1.1 million or 18% to $7.1 million for the third quarter of 2004 compared to the same period a year ago. There are two factors that influence net interest income: (1) volume of earning assets and (2) rate of net interest margin on those earning assets.

Quarter-to-date average earning assets increased by $42.6 million or 7.6% to $600.7 million compared to average earning assets for the same period in 2003. On a year-to-year comparative basis, our earning assets increased due to (i) deposit gathering activities - deposits raised were used to fund or acquire earning assets and (ii) the acquisition of three Monroe County, Tennessee, branches from National Bank of Commerce in late 2003. These additional earning assets have enabled First Security to earn more interest income.

The other factors influencing net interest income are the yield on earning assets and the cost of funding liabilities. Changes in net interest margin did not influence net interest income as significantly as the changes in earning assets. On a fully tax equivalent basis, our net interest margin was 43 basis points higher in the third quarter of 2004 compared to the same period in 2003.

For the third quarter of 2004, 78.6% of average earning assets were funded with interest bearing liabilities, compared to 78.3% for the same period in 2003. In spite of a slight increase in reliance on interest bearing liabilities, our net interest margin improved from period-to-period because our weighted average yield earned on interest earning assets increased and our weighted average rate paid on interest bearing liabilities decreased. We increased the yield on interest earning assets by repositioning our mix of earning assets into higher yielding loans and investment securities. Furthermore, on June 30, 2004, August 11, 2004 and September 22, 2004 the Federal Reserve increased interest rates by 25 basis points on each date, f or a total increase of 75 basis points for the year. As a result, our net interest margin improved because our assets reprice more frequently than our liabilities (see Item 3, Quantitative and Qualitative Disclosures About Market Risk). Prior to the third quarter of 2004, we experienced decreases in our yield earned on earning assets and our rate paid on interest bearing liabilities due to the Federal Reserve Bank’s rate reduction initiative during the prior three years to stimulate economic growth in the weakening U.S. economy.


	11

The interest rate earned on loans for the three months ended September 30, 2004 decreased 33 basis points compared to the same period in 2003. The decrease is primarily attributable to the prior period decreases in the prime lending rate, which were effected by the Federal Reserve rate cut initiative and the subsequent repricing of loans at lower rates. As a result of the Federal Reserve’s three recent rate increases, our third quarter 2004 interest rate earned on loans increased by 21 basis points over the second quarter of 2004. The yields on investment securiti es and other earning assets increased over the same periods. The investment yield increased due to a change in our portfolio mix. The yield on other earning assets increased due to dividends from FRB stock and FHLB stock holdings. Proportionally, these holdings were a larger percentage of other earning assets in the third quarter of 2004 than for the same period in 2003 due to a decrease in federal funds sold (see Management’s Discussion and Analysis of Financial Condition and Results of Operation - Investment Securities and Other Earning Assets). The overall yield on earning assets increased 18 basis points in the third quarter of 2004 compared to the same period in 2003. The increase in yield on earning assets was more than the decrease in the yield on loans due to the change in our mix of average earning assets and due to higher yields on investment securities and other earning assets compared to the same period in 2003. Average loans, which are our highest yielding earning assets, comprised 85% of e arning assets in the third quarter of 2004, compared to 79% in the same period of the prior year.

For the third quarter of 2004, the cost of interest bearing liabilities decreased by 33 basis points from the same period in 2003. As a result, net interest spread for the first quarter of 2004 increased 51 basis points over the same period in the prior year. Deposit and loan rates are adjusted as market conditions and FSGBank’s needs allow. The following table summarizes net interest income and average yields and rates paid for the quarters ended September 30, 2004 and 2003.


	12

Average Consolidated Balance Sheets and Net Interest Analysis
For the Three Months Ended September 30
Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
	2004								2003
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
Assets
Earning assets:
Loans, net of unearned income	$	509,203		$	8,226		6.43	%	$	440,895		$	7,513		6.76	%
Investment securities		87,166			895		4.08	%		73,319			654		3.54	%
Other earning assets		4,295			79		7.32	%		43,814			152		1.38	%
Total earning assets		600,664			9,200		6.09	%		558,028			8,319		5.91	%
Allowance for loan losses		(5,588	)							(6,423	)
Intangible assets		15,061								12,534
Cash & due from banks		27,433								19,367
Premises & equipment		25,740								21,078
Other assets		5,933								5,706
TOTAL ASSETS	$	669,243							$	610,290

Liabilities and Stockholders' Equity

Interest bearing liabilities:
NOW accounts	$	52,294			45		0.34	%	$	39,250			27		0.27	%
Money market accounts		103,287			267		1.03	%		95,634			258		1.07	%
Savings deposits		33,572			29		0.34	%		24,397			35		0.57	%
Time deposits < $100		161,524			982		2.42	%		154,215			1,092		2.81	%
Time deposits > $100		97,353			641		2.62	%		102,048			751		2.92	%
Federal funds purchased		5,423			27		1.98	%		-			-		0.00	%
Repurchase agreements		14,664			20		0.54	%		12,407			26		0.83	%
Other borrowings		4,153			50		4.79	%		9,162			94		4.07	%
Total interest bearing liabilities		472,270			2,061		1.74	%		437,113			2,283		2.07	%
Net interest spread				$	7,139		4.35	%				$	6,036		3.84	%
Noninterest bearing demand deposits		109,593								88,679
Accrued expenses and other liabilities		3,393								3,616
Stockholders' equity		84,384								80,493
Unrealized gain on securities		(397	)							389
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY	$	669,243							$	610,290

Impact of noninterest bearing
sources and other changes in
balance sheet composition							0.38	%							0.46	%

Net yield on earning assets*							4.73	%							4.30	%
*Same as net interest margin


	13

The following table presents the dollar amount of changes in interest income and interest expense from the three month period ended September 30, 2004 to the three month period ended September 30, 2003. The table distinguishes between the changes related to average outstanding (volume) of earning assets and interest bearing liabilities, as well as the changes related to average interest rates (rate) on such assets and liabilities.

Change in Interest Income and Expense on a Tax Equivalent Basis
For the Three Months Ended September 30
(all dollar amounts in thousands)
	2004 Compared to 2003
	Increase (Decrease)
	in Interest Income and Expense
	Due to Changes in:
	Volume			Rate			Total
Interest earning assets:
Loans, net of unearned income	$	1,103		$	(390	)	$	713
Investment securities		143			98			241
Other earning assets		(727	)		654			(73	)
Total earning assets		519			362			881

Interest bearing liabilities:
NOW accounts		11			7			18
Money market accounts		20			(11	)		9
Savings deposits		8			(14	)		(6	)
Time deposits < $100		44			(155	)		(110	)
Time deposits > $100		(31	)		(79	)		(110	)
Federal funds purchased		27			-			27
Repurchase agreements		3			(9	)		(6	)
Other borrowings		(60	)		17			(44	)
Total interest bearing liabilities		22			(244	)		(222	)
Increase in net interest income	$	497		$	606		$	1,103

For the nine months ended September 30, 2004 the yield on interest earning assets decreased by two basis points and the cost of interest bearing liabilities decreased by 51 basis points from the same period in 2003. As a result, net interest spread for the nine months ended September 30, 2004 increased 49 basis points over the same period in the prior year. The following table summarizes net interest income and average yields and rates paid for the nine months ended September 30, 2004 and 2003.


	14

Average Consolidated Balance Sheets and Net Interest Analysis
For the Nine Months Ended September 30
Fully Tax-Equivalent Basis
(all dollar amounts in thousands)
	2004								2003
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate			Balance			Expense		Rate
Assets
Earning assets:
Loans, net of unearned income	$	499,038		$	23,698		6.34	%	$	409,349		$	21,069		6.88	%
Investment securities		85,666			2,607		4.07	%		66,940			1,887		3.77	%
Other earning assets		4,962			184		4.95	%		43,038			417		1.30	%
Total earning assets		589,666			26,489		6.00	%		519,327			23,373		6.02	%
Allowance for loan losses		(5,692	)							(6,216	)
Intangible assets		15,399								11,275
Cash & due from banks		25,215								17,145
Premises & equipment		25,308								17,745
Other assets		6,151								5,619
TOTAL ASSETS	$	656,047							$	564,895

Liabilities and Stockholders' Equity

Interest bearing liabilities:
NOW accounts	$	51,752			134		0.35	%	$	34,738			92		0.35	%
Money market accounts		100,102			723		0.96	%		90,359			931		1.38	%
Savings deposits		32,770			86		0.35	%		21,770			124		0.76	%
Time deposits < $100		164,057			3,025		2.46	%		144,323			3,178		2.94	%
Time deposits > $100		95,040			1,855		2.61	%		93,687			2,169		3.10	%
Federal funds purchased		4,696			58		1.65	%		-			-		0.00	%
Repurchase agreements		12,927			58		0.60	%		12,762			97		1.02	%
Other borrowings		4,323			151		4.67	%		8,175			256		4.19	%
Total interest bearing liabilities		465,667			6,090		1.75	%		405,814			6,847		2.26	%
Net interest spread				$	20,399		4.25	%				$	16,526		3.76	%
Noninterest bearing demand deposits		104,650								78,637
Accrued expenses and other liabilities		3,413								3,265
Stockholders' equity		82,656								76,623
Unrealized gain on securities		(339	)							556
TOTAL LIABILITIES AND
STOCKHOLDERS' EQUITY	$	656,047							$	564,895

Impact of noninterest bearing
sources and other changes in
balance sheet composition							0.37	%							0.50	%

Net yield on earning assets*							4.62	%							4.26	%
*Same as net interest margin


	15

The following table presents the dollar amount of changes in interest income and interest expense from the nine month period ended September 30, 2004 to the nine month period ended September 30, 2003. The table distinguishes between the changes related to average outstanding (volume) of earning assets and interest bearing liabilities, as well as the changes related to average interest rates (rate) on such assets and liabilities.

Change in Interest Income and Expense on a Tax Equivalent Basis
For the Nine Months Ended September 30
(all dollar amounts in thousands)
	2004 Compared to 2003
	Increase (Decrease)
	in Interest Income and Expense
	Due to Changes in:
	Volume			Rate			Total
Interest earning assets:
Loans, net of unearned income	$	4,259		$	(1,630	)	$	2,629
Investment securities		571			149			720
Other earning assets		(1,412	)		1,179			(233	)
Total earning assets		3,418			(302	)		3,116

Interest bearing liabilities:
NOW accounts		43			(1	)		42
Money market accounts		70			(278	)		(208	)
Savings deposits		29			(67	)		(38	)
Time deposits < $100		363			(516	)		(153	)
Time deposits > $100		27			( 341	)		(314	)
Federal funds purchased		31			27			58
Repurchase agreements		1			(40	)		(39	)
Other borrowings		(134	)		29			(105	)
Total interest bearing liabilities		430			(1,187	)		(757	)
Increase in net interest income	$	2,988		$	885		$	3,873

Provision for Loan Losses

The provision for loan losses charged to operations during the three months ended September 30, 2004 was $675 thousand compared to $366 thousand in the same period of 2003. Net charge-offs for the third quarter of 2004 were $809 thousand compared to net charge-offs of $403 thousand for the same period in 2003. The provision for the nine months ended September 30, 2004 and 2003 was $2.0 million and $1.5 million, respectively. Net charge-offs for the nine months ended September 30, 2004 and 2003 were $2.4 million and $1.3 million, respectively. The 2004 charge-offs were the consequences of prior period decentralized credi t underwriting standards, the lack of a year-round loan review program in prior years, and an increase in bankruptcy filings.

The allowance for loan losses reflects management's assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. We periodically analyze our loan portfolio in an effort to establish an allowance for loan losses that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:

° our loan loss experience;


	16

° the amount of past due and nonperforming loans;

° specific known risks;

° the status and amount of past due and nonperforming assets;

° underlying estimated values of collateral securing loans;

° current and anticipated economic conditions; and

° other factors which management believes affect the allowance for potential credit losses.

An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by FSGBank’s credit administration department and presented to the director’s loan committee of the board of directors on a regular basis. In addition, our loan review department performs a regular review of the quality of the loan portfolio and adequacy of the allowance.

FSGBank’s allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses compared to a group of peer banks identified by the regulators. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance for loan loss methodology differ materially from ours.

While it is our policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, management's judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

As of September 30, 2004, the allowance for loan loss for FSGBank was $5.4 million or 1.06% of its outstanding loans. The peer group for FSGBank, as defined by the Federal Financial Institutions Examination Council's June 30, 2004 Uniform Bank Performance Report, includes all insured commercial banks between $300 million and $1 billion in average assets. This peer group, which includes 985 banks, had a ratio of the allowance for loan losses divided by total loans of 1.32% as of June 30, 2004, or 26 basis points more than FSGBank. Using our methodology, we believe that the allowance for loan loss for FSGBank was adequate as of September 30, 2004. For the fourth quarter of 2004, we believe that charge offs will be less than the amount of charge offs experienced during the third quarter of 2004.

Noninterest Income

Noninterest income totaled $1.6 million for the third quarter of this year, an increase of $157 thousand, or 10.7%, from the same period in 2003. Deposit related income, comprised primarily of account service charges and non-sufficient fund charges, totaled $1,055 thousand for the third quarter of 2004, which was $413 thousand, or 64.3%, more than the corresponding quarter in 2003. Deposit related income increased as we gained deposits in our market areas, assumed deposits through the acquisition of the three National Bank of Commerce branches in 2003, and implemented a “bounce protection” program for our customers (“bounce protection” is an overdraft product that pays our customers non-sufficient fund checks for a fee). We believe that deposit related income will continue to be boosted by further deposit growth. Mortgage loan fees decreased by $4 thousand, or 1.2%, to $346 thousand for the third quarter of 2004 from the prior year. During the first three quarters of 2004, rates for fixed rate residential 15- and 30-year loan products were similar to or higher than those in the preceding year, and as a result, the mortgage refinancing activity was not as strong as that of the previous year. Based on current loan volumes and the long term rate environment, we believe that mortgage loan fees may continue to decrease during the remainder of 2004.

For the first nine months of this year, noninterest income was $4.6 million, which is an increase of $609 thousand, or 15.2%, over the same period in 2003. For the first nine months of 2004, deposit related income totaled $2.9 million, an increase of $1.2 million, or 69.3%, over the first nine months of 2003. Mortgage loan fees totaled $989 thousand for the nine months ended September 30, 2004, which is $423 thousand, or 30.0% less than the same period in 2003.


	17

Noninterest Expense

Noninterest expense for the third quarter totaled $6.7 million, which was an increase of $854 thousand, or 14.5% over the third quarter of 2003. First Security's overhead ratio (noninterest expense, excluding amortization of intangible assets, provision for loan losses and income tax expenses, as a percentage of net interest income and noninterest income) decreased from 77.1% in the third quarter of 2003 to 75.4% for the same period in 2004.

Compared to the third quarter of 2003, salaries and benefits for the third quarter of 2004 increased $685 thousand, or 22.6%, to $3.7 million. The majority of the increase in salaries and benefits is related to staff additions for our branch openings and our acquisition of the three National Bank of Commerce’ branches. As of September 30, 2004, we had 28 full service branches and a total of 293 full time equivalent employees. As of September 30, 2003, we employed 238 full time equivalent employees and operated 21 full service branches and one loan production offices. We believe that salaries and benefits will increase for the remainder of 2004 as a result of our acquisition of Kenesaw Leasing and J&S Leasing, as well as our continued growth and branching efforts.

Net occupancy expense and equipment expense are higher in the third quarter 2004 versus the same period in the prior year as a result of our branching activities and acquisition of the three National Bank of Commerce bank branches. Occupancy expenses increased $122 thousand, or 29%, to $537 thousand. Furniture, fixtures and equipment expenses increased $124 thousand, or 27%, to $575 thousand. Cumulatively, all other non-interest expenses, excluding core deposit intangible amortization expense, decreased by $114 thousand or 6.2%.

The $191 thousand of third quarter amortization expense resulted from the amortization of the core deposit intangible assets created by the acquisitions of First State Bank (2002), Premier National Bank (2003) and the three National Bank of Commerce branches (2003). The core deposit intangible and goodwill created by the acquisition of First State Bank were $1 million and $1.4 million, respectively. The core deposit intangible and goodwill created by the acquisition of Premier National Bank were $1.3 million and $3 million, respectively. The core deposit intangible and goodwill created by the acquisition of the three National Bank of Commerce branches were $1.5 million and $754 thousand, respectively. The estimated useful life of each core deposit intangible asset is 10 years.

Noninterest expenses for the nine-month period ended September 30, 2004 were $3.2 million, or 19.6%, higher and totaled $19.3 million compared to the same period in 2003. The changes are explained similarly to the quarterly data above and were as follows. Salaries and benefits increased $1.8 million or 21%. Occupancy expenses increased $407 thousand or 38%. Furniture, fixtures, and equipment expenses increased $407 thousand or 34%. All other non-interest expenses, excluding core deposit intangible amortization, increased $263 thousand or 5.6%. Core deposit intangible amortization expense increased $240 thousand or 63.8% due to our acquisition activity in 2003.

STATEMENT OF FINANCIAL CONDITION

First Security's total assets at September 30, 2004 were $675.7 million, $621.7 million at September 30, 2003 and $644.8 million at December 31, 2003. Average assets for the third quarter of 2004 were $669.2 million versus $610.3 million for the same period a year earlier, an increase of 9.7%. Of the $30.9 million increase in total assets in the first nine months of 2004, approximately $25.9 million was funded by the growth of in-market deposits. First Security continues to actively pursue acquisitions and will continue to seek means to enhance our market share through further branching.


	18

Loans

Average loans of $509.2 million represented 85% of our average earning assets during the third quarter of 2004. From December 31, 2003 gross loans increased $36 million to $514.2 million at September 30, 2004. During 2004, the increase is attributable to our organic market growth from the relationships and ties of our bankers to the local communities in which they work. We believe that general loan demand will remain strong during 2004. Funding of future loan growth may be restricted by our ability to raise core deposits, although we will use alternative funding sources if necessary and cost effective. Loan growth may be further restricted by the necessity for us to maintain appropriate capital levels, as well as adequate liquidit y.

Asset Quality

The allowance for loan losses was $5.4 million or 1.06% of outstanding loans at September 30, 2004 and $5.8 million or 1.22% of outstanding loans at December 31, 2003. The allowance for loan losses was 276.8% of nonperforming loans (defined as loans 90 days or more past due and nonaccrual loans) at September 30, 2004 and 245.1% of nonperforming loans at December 31, 2003. For the first nine months of 2004, net charge-offs arising from loans secured by real estate totaled $322 thousand, commercial loans totaled $1.3 million, and consumer loans totaled $778 thousand (see Provision for Loan Losses). We believe that our reserve for inherent loan losses is adequate based on our assessment of the information available. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations of FSGBank, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant. The allocation of the allowance for loan losses by loan category at the dates indicated is presented below.

Allocation for Allowance for Loan Losses
As of September 30, 2004 and 2003
(in thousands)
	2004				2003
			Percentage of loans in each				Percentage of loans in each
Loan Categories	Amount		category to total loans		Amount		category to total loans
Commercial	$	1,479		21.9%	$	2,517		25.1%
Real estate-construction		408		13.1%		324		8.8%
Real estate-mortgage		2,937		51.9%		2,529		50.9%
Consumer		621		13.1%		883		15.2%
Unallocated		3		-		125		-
Total	$	5,448		100.0%	$	6,378		100.0%

Nonperforming Assets

Nonaccrual loans were $888 thousand at September 30, 2004, $183 thousand at December 31, 2003 and $1.3 million at September 30, 2003. The nonaccrual loans in September 2004 included $14 thousand of commercial loans, $161 thousand of consumer loans, and $713 thousand of real-estate secured loans. The ratio of nonaccrual loans to total loans was 0.17% at September 30, 2004 and 0.038% at December 31, 2003. At September 30, 2004 we owned other real estate in the amount of $1.6 million.

Loans past due 90 days and still accruing were $1.0 million at September 30, 2004, compared to $2.2 million at December 31, 2003. Of these past due loans at September 30, 2004, $910 thousand were secured by real estate, $54 thousand were commercial loans and $116 thousand were consumer loans.

At September 30, 2004 nonperforming loans (nonaccrual loans and loans past due 90 days or more) were 0.38% of total outstanding loans, which is 25 basis points less than our peer group and 17 basis points less than it was at June 30, 2004. Our Chief Loan Review Officer and Chief Credit Administration Officer are in their first full year of implementing new procedures for enhanced monitoring of problem loans, as well as early detection, prevention and co rrective action plans.


	19

Investment Securities and Other Earning Assets

Securities totaled $90.4 million at September 30, 2004, $86.5 million at December 31, 2003 and $86.7 million at September 30, 2003. From third quarter end 2003 to third quarter end 2004, the growth in the securities portfolio occurred as a result of our efforts to maintain our liquidity position. At September 30, 2004 the securities portfolio had unrealized net gains of approximately $576 thousand due to decreasing interest rates in the bond market and the resulting increase in bond prices. All investment securities purchased to date have been classified as available-for-sale, and we currently have the ability and intent to hold them to maturity. As a result, we do not anticipate real izing any unrealized losses. However, should conditions change, we may sell unpledged securities. Pledged securities as of September 30, 2004 totaled $26.8 million.

The following table provides the amortized cost of our investment securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the approximate tax equivalent yields for each maturity range.

(in thousands)	Less than		One to		Five to		More than
	One Year		Five Years		Ten Years		Ten Years
Municipal	$	1,760	$	2,380	$	11,015	$	12,185
Federal Agencies		10,279		51,582		658		-
Total	$	12,039	$	53,962	$	11,673	$	12,185
Tax Equivalent Yield		3.4%		3.9%		5.2%		5.8%

Our management considers the overall quality of the securities portfolio to be high. All securities held are traded in liquid markets, except for one bond. This $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by The Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee. As of September 30, 2004 we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders’ equity. As of the third quarter ended 2004, the amortized cost and market value of the securities from each such issuer are as follows:

(in thousands)	Amortized Cost		Market Value
Fannie Mae	$	25,094	$	25,155
Federal Home Loan Mortgage Corp (FHLMC)	$	24,898	$	24,911
Federal Home Loan Bank (FHLB)	$	10,849	$	10,918

The following table presents the amortized cost of the investments for the dates presented in the consolidated balance sheets.

(in thousands)	September 30, 2004		December 31, 2003		September 30, 2003
Federal agencies	$	62,519	$	63,964	$	65,226
Municipal		27,340		21,883		20,879
Total	$	89,859	$	85,847	$	86,105

At September 30, 2004 we held no federal funds sold, but at December 31, 2003 federal funds sold totaled $7 million. The decrease in federal funds is a direct result of our loan demand exceeding our deposit growth.


	20

Deposits and Other Borrowings

Total deposits increased 10.8% from September 30, 2003 to September 30, 2004, and 4.8% from December 31, 2003 to September 30, 2004. For the first nine months of 2004, our branching activities yielded organic deposit growth of approximately $25.9 million. We anticipate that our deposits will continue to increase as a result of branch openings in 2003 and 2004.

The following table details the maturities and rates of the term borrowings from the Federal Home Loan Bank.

Date	Type	Principal	Term	Rate	Maturity
1/8/2002	Fixed Rate Advance	500,000	36 months	4.48%	1/7/05
1/8/2002	Fixed Rate Advance	500,000	48 months	5.04%	1/6/06
1/10/2002	Fixed Rate Advance	500,000	36 months	4.45%	1/10/05
1/10/2002	Fixed Rate Advance	500,000	48 months	5.00%	1/10/06
1/15/2002	Fixed Rate Advance	500,000	36 months	4.22%	1/14/05
1/15/2002	Fixed Rate Advance	500,000	48 months	4.77%	1/13/06
1/17/2002	Fixed Rate Advance	500,000	36 months	4.37%	1/14/05
1/17/2002	Fixed Rate Advance	500,000	48 months	4.90%	1/17/06
		$ 4,000,000

Composite rate	4.65%
Composite 36 month rate	4.38%
Composite 48 month rate	4.92%

Liquidity

Liquidity refers to First Security’s ability to adjust its future cash flows to meet the needs of our daily operations. First Security relies primarily on management fees from FSGBank to fund our daily operations liquidity needs. Additionally, in connection with our 2002 private placement stock offering, we retained a portion of the proceeds of the offering as working capital and a portion of the proceeds for future investment into our subsidiary. First Security Group’s cash balance on deposit with FSGBank, which totaled approximately $6.7 million as of September 30, 2004, is available for funding activities for which FSGBank would not receive direct benefit, such as acquisition due diligence, shareholder relations, and holding company reporting and operations. Th ese funds should adequately meet our cash flow needs. If we determine that our cash flow needs will be satisfactorily met, we may deploy a portion of the funds into FSGBank or use them in an acquisition in order to support continued growth.

The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate securities available for sale.

At September 30, 2004, our liquidity ratio (defined as cash, due from banks, federal funds sold, and investment securities less securities pledged to secure liabilities divided by short-term funding liabilities less liabilities secured by pledged securities) was 16.1% (excluding anticipated loan repayments). As of December 31, 2003 and September 30, 2003, the liquidity ratios were 24.3% and 22.9% respectively. The decrease in our liquidity position is a direct result of our loan demand out pacing our deposit growth. FSGBank could increase its borrowing capacity at the FHLB, subject to more stringent collateral requirements, by pledging loans in addition to 1-4 family residential mortgage loans which are already pledged.


	21

Cumulatively, FSGBank also had unsecured federal funds lines in the aggregate amount of $82.5 million at September 30, 2004, under which it could borrow funds to meet short-term liquidity needs. Another source of funding that we have used and may continue to use is loan participations sold to other commercial banks (in which we retain the service rights). As of September 30, 2004 we had $8.7 million in loan participations sold. An additional source of short-term funding would be a line of credit at a commercial bank which we would secure by a pledge of investment securities. As of September 30, 2004 we had no borrowings against our investment securities, except for repurchase agreements entered into in the ordinary course of business. However, in the fourth quarter we pledg ed investment securities against a short term line of credit in order to fund the acquisition and operations of Kenesaw Leasing and J&S Leasing. To date, First Security has not initiated the use of brokered deposits or Internet deposits as a source of funding; however, we assumed $4.2 million in brokered deposits with our acquisition of Premier National Bank in 2003, with $1.1 million remaining on deposit at September 30, 2004. During the fourth quarter of 2004, we are implementing a disciplined approach for using brokered deposits. We anticipate that these brokered deposits will replace the line of credit collateralized with investment securities and will provide continued funding for the operations of Kenesaw Leasing and J&S Leasing. Our certificates of deposit greater than $100 thousand were gathered in our local communities. We believe that our liquidity sources are adequate to meet our operating needs.

First Security also has contractual cash obligations and commitments, which included certificates of deposit, other borrowings, operating leases, and loan commitments. As of September 30, 2004 certificates of deposit totaled $261million. Other borrowings included $4 million in FHLB advances (see Management’s Discussion and Analysis of Financial Condition and Results of Operation - Deposits and Other Borrowings). Unfunded loan commitments and stand by letters of credit totaled $153 million and $6 million, respectively, at September 30, 2004. The following table illustrates our outstanding contractual obligations, which included property and equipment leases, as of September 30, 2004.

	Total		Less than One Year		One to Three Years		Three to Five Years		More than Five Years
	(Dollar amounts in thousands)
Certificates of deposit	$	260,601	$	177,794	$	65,808	$	16,999	$	-
Securities sold under agreements to repurchase		16,302		16,302
FHLB borrowings		4,000		2,000		2,000
Operating lease obligations		5,399		733		1,139		972		2,555
Purchase obligations - facilities		165		165
Purchase obligations - license		150		150
Note payable		152		10		21		25		96
Total	$	286,769	$	197,154	$	68,968	$	17,996	$	2,651

Net cash provided from or used by operations results primarily from net income or loss, adjusted for the following noncash accounting items: provision for loan losses, depreciation and amortization, and deferred income taxes or benefits. These items amounted to cash provided of $5.4 million for the nine months ended September 30, 2004. Cash provided by operations was available to increase earning assets.

Capital Resources

We continue to maintain capital ratios in excess of regulatory minimum requirements. The current capital standards to be well capitalized call for a minimum total capital of 10% of risk-adjusted assets, including 6% Tier 1 capital, and a minimum leverage ratio of Tier 1 capital to total tangible assets of at least 5%. First Security and FSGBank maintain capital levels exceeding the minimum levels required for “well capitalized” banks and bank holding companies under applicable regulatory guidelines.


	22

September 30, 2004	Well Capitalized	Adequately Capitalized	First Security	FSGBank

Tier 1 capital to risk adjusted assets	6.0%	4.0%	12.6%	11.1%
Total capital to risk adjusted assets	10.0%	8.0%	13.6%	12.1%
Leverage ratio	5.0%	4.0%	10.6%	9.5%

December 31, 2003	Well Capitalized	Adequately Capitalized	First Security	FSGBank

Tier 1 capital to risk adjusted assets	6.0%	4.0%	13.1%	11.5%
Total capital to risk adjusted assets	10.0%	8.0%	14.3%	12.6%
Leverage ratio	5.0%	4.0%	11.0%	9.6%

September 30, 2003	Well Capitalized	Adequately Capitalized	First Security	FSGBank

Tier 1 capital to risk adjusted assets	6.0%	4.0%	14.3%	12.6%
Total capital to risk adjusted assets	10.0%	8.0%	15.5%	13.9%
Leverage ratio	5.0%	4.0%	11.4%	10.1%

We have never paid any cash dividends on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future. We currently intend to retain future earnings, if any, to support the development and growth of our business. Payment of future dividends, if any, will be at the discretion of our board of directors and will depend upon our earnings, our financial condition, the capital adequacy of First Security and our subsidiary, opportunities for growth and expansion, the need for funds of our subsidiary, and other relevant factors, including applicable restrictions and governmental policies and regulations.

EFFECTS OF INFLATION

Inflation generally increases the cost of funds and operating overhead, and, to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of our assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on our performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In 2000, the Federal Reserve increased interest rates three times for a total of 100 basis points in an attempt to control inflation. However, in 2001 the Federal Reserve reduc ed interest rates on 11 occasions for a total of 475 basis points in an effort to stimulate economic growth. On November 6, 2002, the Federal Reserve decreased interest rates by 50 basis points and on June 27, 2003, the Federal Reserve decreased interest rates 25 basis points in order to further stimulate economic growth. The Federal Reserve raised interest rates by 25 basis points on June 30, 2004, August 11, 2004, and again on September 22, 2004, for a cumulative total rate increase of 75 basis points. As a result of these rate increases, we increased our prime lending rate from 4.00% to 4.75%.

Inflation increases the cost of goods and services purchased, cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect the liquidity and earnings of our commercial banking and mortgage banking business, and our shareholders' equity. With respect to our mortgage banking business, mortgage originations and refinancings tend to slow as interest rates increase, and increased interest rates would likely reduce our earnings from such activities and our income from the sale of residential mortgage loans in the secondary market.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS


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Certain of the statements made under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere throughout this Form 10-Q are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking statements relate to future events or our future financial performance and may involve known or unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of First Security to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Forward-looking statements include statements using the words such as "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," "intend," "seeks," or other similar words and expressions of the future.

These forward-looking statements involve risks and uncertainties, and may not be realized due to a variety of factors, including, without limitation: the effects of future economic conditions, governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; interest rate risks; the costs of evaluating possible acquisitions and the risks inherent in integrating acquisitions; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in First Security's market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and the failure of assumptions underlying the establishment of reserves for possible loan losses. All written or oral forward-looking statements attributable to First Security are expressly qualified in their entirety by this Special Note.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk, with respect to First Security, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. First Security does not maintain a trading portfolio or deal in international instruments, and therefore First Security is not exposed to risk inherent to trading activities and foreign currency.

First Security's interest rate risk management is the responsibility of the Asset/Liability Committee ("ALCO"). ALCO has established policies and limits to monitor, measure and coordinate First Security's sources, uses, and pricing of funds.

Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with First Security's interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both a static and dynamic gap report to quantify the estimated exposure of net interest income to a sustained change in interest rates.

The gap analysis projects net interest income based on both a rise and fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month period. The model is based on actual repricing dates of interest sensitive assets and interest sensitive liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rates of certain assets.

First Security measures this exposure based on an immediate change in interest rates of up or down 200 basis points. Given this scenario, First Security had, at the end of the period, an exposure to falling rates and a benefit from rising rates. More specifically, for the nine month period ended September 30, 2004 the model forecasts a decline in net interest income of $2,880 thousand or 14.35%, as a result of a 200 basis point decline in rates. The model also predicts a $2,419 thousand increase in net interest income, or 12.05% as a result of a 200 basis point increase in rates. The forecasted results of the model are within the limits specified by ALCO. The following chart refl ects First Security's sensitivity to changes in interest rates as of September 30, 2004. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvested in like instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.


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Interest Rate Risk

Income Sensitivity Summary

As of September 30, 2004

(in thousands)

	DOWN 200 BP		CURRENT		UP 200 BP

Net interest income	$	17,188	$	20,068	$	22,487
Dollar change net interest income		(2,880)		-		2,419
Percent change net interest income		-14.35%		0.00%		12.05%

The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestment of paydowns and maturities of loans, investments and deposits, among others. In addition, there are no assumptions for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, management cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates.

First Security purchased software from IPS-Sendero that we believe will enhance our ability to measure and manage interest rate risk and more efficiently aggregate financial data. The software components purchased were Data Management System, Sendero Vision Asset/Liability, General Ledger, EIS.net, and Budget and Planning System. We are currently implementing these systems.

The Sendero Vision Asset/Liability system is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration, and income simulations using a wide range of scenarios. The system also has the capability to model derivative instruments such as interest rate swap contracts. We will continue to use existing measurement tools until this system is fully implemented. We recently engaged an outside consultant to validate our Sendero Vision Asset/Liability system.

ITEM 4.

CONTROLS AND PROCEDURES

As of the end of the period covered by this report, First Security carried out an evaluation, under the supervision and with the participation of the Company’s management, including First Security’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, First Security’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiary) that is required to be included in First Security’s periodic filings with th e Securities and Exchange Commission. There have been no changes in First Security’s internal controls over financial reporting during the quarter ended September 30, 2004 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.


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PART II. OTHER INFORMATION

ITEM 5.

OTHER INFORMATION

(a) On October 1, 2004, we obtained a $60 million short term line of credit. On October 21, 2004 we drew $60 million on the line to fund the acquisition and operations of Kenesaw Leasing and J&S Leasing. The line bears interest at 2.35% and expires on December 30, 2004. We anticipate paying off the line of credit prior to that time by replacing the line of credit funding with brokered deposits (see Management’s Discussion and Analysis - Statement of Financial Condition - Liquidity), and there are no pre-payment penalties. We have pledged investment securities as collateral for the line of credit.

ITEM 6. EXHIBITS


	EXHIBIT NUMBER	DESCRIPTION

	2.1	Assignment and Assumption Agreement, dated October 21, 2004, by and among Warren E. Payne, FSGBank, N.A. and National Bank of Commerce*

	2.2	Stock Purchase Agreement, dated October 21, 2004, by and between National Bank of Commerce and Warren E. Payne*

	31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

	31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934

	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934

	*Incorporated by reference to the exhibit of the same number filed with the Current Report on Form 8-K dated October 21, 2004 and filed October 27, 2004.


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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed by the undersigned, thereunto duly authorized.

	FIRST SECURITY GROUP, INC.
	(Registrant)

November 3, 2004	/s/ Rodger B. Holley
	Rodger B. Holley
	Chairman, Chief Executive Officer &
	President

November 3, 2004	/s/ William L. Lusk, Jr.
	William L. Lusk, Jr.
	Secretary, Chief Financial Officer &
	Executive Vice President


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