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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2003

OR

For the transition period from                      to                     

Commission file number 000-33071

Charter Financial Corporation

(Exact name of registrant as specified in its charter)

600 Third Avenue, West Point, Georgia 31833

(Address of principal executive offices)

(Zip Code)

(706) 645-1391

(Registrant’s telephone number including area code)

NA

(Former name, former address and former fiscal year, if changed from 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 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 requirement 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 Securities Exchange Act).

Yes x No ¨

As of January 31, 2004, the registrant had 19,822,405 shares of common stock, $0.01 par value, outstanding. Of such shares outstanding, 15,857,924 shares were held by First Charter, MHC, the registrant’s mutual holding company and 3,964,481 shares were held by the public and directors, officers and employees of the registrant.

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FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains “forward-looking statements” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition and results of operation and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2003 and September 30, 2003

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Three Months Ended December 31, 2003 and 2002

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended December 31, 2003 and 2002

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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Charter Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(1) Basis of Presentation

Charter Financial Corporation (“Charter Financial”) is a federal corporation organized on October 16, 2001 by CharterBank (“Bank”) in connection with the reorganization of the Bank from a federal mutual savings and loan association into a two-tiered mutual holding company structure, as described more fully in Note 2.

The accompanying unaudited consolidated financial statements include the accounts of Charter Financial and its wholly-owned subsidiaries, CharterBank and Charter Insurance Company, as of December 31, 2003 and September 30, 2003, and for the three-month periods ended December 31, 2003 and 2002. Significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements for the three months ended December 31, 2003 and 2002 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in Charter Financial’s annual report on Form 10-K for the year ended September 30, 2003.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management the unaudited consolidated financial statements include all necessary adjustments, consisting of normal recurring accruals, necessary for a fair presentation for the periods presented.

Charter Financial believes that the disclosures are adequate to make the information presented not misleading; however, the results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year.

(2) Plan of Reorganization

On October 16, 2001, CharterBank converted from a federally-chartered mutual savings and loan association into a two-tiered mutual holding company structure and became a wholly-owned subsidiary of Charter Financial. Charter Financial sold 3,964,481 shares of its common stock to the public, representing 20% of the outstanding shares, at $10.00 per share and received net proceeds of $37.2 million. Charter Financial contributed 50% of the net proceeds from the initial public offering to CharterBank. An additional 15,857,924 shares, or 80% of the outstanding shares of Charter Financial, were issued to First Charter, MHC. An Employee Stock Ownership Plan (ESOP) was established and such ESOP acquired 317,158 shares of Charter Financial in the offering, using the proceeds of a loan from Charter Financial. The ESOP loan is

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recorded as unearned compensation reducing stockholders’ equity of Charter Financial. The net proceeds of the offering, adjusted for the ESOP, totaled approximately $34.0 million.

As part of its reorganization in structure, CharterBank organized First Charter, MHC as a federally-chartered mutual holding company which is registered as a savings and loan holding company with the Office of Thrift Supervision (“OTS”). First Charter, MHC’s principal assets are its investment in Charter Financial and 400,000 shares of Freddie Mac common stock. First Charter, MHC does not engage in any business activity other than its investment in a majority of the common stock of Charter Financial, management of Freddie Mac common stock, and the management of any cash dividends received from Freddie Mac common stock. Federal law and regulations require that as long as First Charter, MHC is in existence it must own at least a majority of Charter Financial’s common stock.

(3) Earnings per Share

Earnings per share are calculated according to the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 128 “Earnings per Share.” ESOP shares are only considered outstanding for earnings per share calculations when the shares have been committed to be released. Presented below are the calculations for basic and diluted earnings per share for the three months ended December 31, 2003 and 2002:

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(4) Comprehensive Income

The primary component of other comprehensive income for the Company is net unrealized gains and losses on Freddie Mac common stock and investment and mortgage-backed securities available for sale. The table below summarizes total comprehensive income for the three months ended December 31, 2003 and 2002.

(5) Stock-Based Compensation

During 2003, the Company amended the 2001 Stock Option Plan (the Plan) to allow for stock option awards for up to 707,943 shares of the Company’s common stock to eligible directors and employees. At December 31, 2003, the Company had granted 152,000 options under the Plan. Under the provisions of the Plan, the option price is determined by a committee of the board of directors at the time of grant and may not be less than 100% of the fair market value of the common stock on the date of grant of such option. When granted, these options vest over a five-year period. The Company accounts for the Plan under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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(6) Business Combination

Effective February 21, 2003, Charter Financial acquired all of the issued and outstanding shares of EBA Bancshares, Inc. (EBA), Opelika, Alabama, and its wholly-owned banking subsidiary, Eagle Bank of Alabama, for a purchase price of approximately $8,600,000 in cash. The acquisition has been accounted for using the purchase method of accounting and, hence, the results of operations of EBA have been included in the consolidated financial statements beginning on the aforementioned effective date.

The following summarizes the unaudited pro forma consolidated results of operations assuming EBA was acquired in a purchase accounting transaction on October 1, 2001.

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(7) Goodwill and Other Intangible Assets

In conjunction with the acquisition of EBA, Charter Financial acquired the following goodwill and other intangible assets:

Goodwill and other intangible assets include cost in excess of net assets acquired and deposit premiums recorded in connection with the acquisition of EBA. The deposit premium is being amortized using the double-declining balance method over thirteen years. Charter Financial recorded amortization expense related to the deposit premium of $57,543 for the three months ended December 31, 2003.

At December 31, 2003, other intangible assets is summarized as follows:

(8) Covered Call Program

At December 31, 2003, the Company had covered call options on Freddie Mac common stock outstanding on 116,800 shares for which it received $218,504 in premium. During the three months ended December 31, 2003, holders of the covered call options exercised their options to purchase 9,500 shares of Freddie Mac common stock. The Company recorded a pretax gain of $532,742 on the sale of these shares to the option holders. At December 31, 2003, the fair value of the remaining options was $68,974. The Company has recorded the unrealized gain in the income statement as the derivative instruments are not accounted for as hedges.

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Item 2

Management’s Discussion and Analysis of Financial Condition

and Results of Operations

Executive Summary

The purpose of this summary is to provide an overview of the items management focuses on when evaluating the condition of the Company and our success in implementing our stockholder value strategy. Our stockholder value strategy has three major themes: (1) creating a larger, more profitable and more valuable retail banking franchise; (2) managing the substantial appreciation in our Freddie Mac common stock investment; and (3) efficiently utilizing our capital. Management believes the following points were the most important to that analysis this quarter.

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Management Strategy

We have a growth-oriented strategy focused on (1) expanding our retail banking operations and thus the franchise value of our retail bank (2) managing our Freddie Mac common stock while periodically reviewing strategies to increase or realize its value for our shareholders, and (3) effectively managing our capital.

Expanding Retail Banking Operations. Our retail banking strategy is to operate as a well-capitalized community bank dedicated to providing quality products, excellent service, and a superior customer experience at competitive prices. We have sought to implement this strategy by concentrating on our core product offerings, including residential and commercial mortgage loans and a variety of checking and saving products, while at the same time broadening our product lines and services, expanding delivery systems for our customers, and filling in our branch network.

Managing Our Freddie Mac Common Stock Investment. We manage our Freddie Mac common stock in several ways. Over the past ten years our total annual return on Freddie Mac common stock has averaged approximately 18%. Dividends on our Freddie Mac common stock are an important component of our shareholder value. Seventy percent of the Freddie Mac dividends are excluded from Charter Financial’s taxable income through the corporate dividends received exclusion. The Freddie Mac dividend, when combined with the 70% corporate dividend exclusion and the recently enacted 15% personal tax rate reduction on dividends received by individuals, creates a tax efficient means for our stockholders to receive value from our Freddie Mac common stock investment. First Charter, MHC and the Office of Thrift Supervision make their own determination with respect to each dividend payment as to whether that dividend payment to First Charter, MHC will be waived. In 2003 we implemented a pilot program of selling covered call options on the Freddie Mac common stock as a means of enhancing our return on this investment. We continue to review our investment in Freddie Mac common stock in light of existing conditions and what is in the best interests of our shareholders.

Managing our Capital. The third major component of our strategy is capital management. We increased our capital leverage with the additional retail assets and deposits acquired in the Eagle acquisition. While our current retail focus is increasing market share within our existing market, we regularly evaluate expanding our capital leverage by extending the market area through de novo branching or acquisitions. We maintained our wholesale leverage of mortgage securities and borrowings. Wholesale leverage generally enhances income, but not franchise value, and thus is a low priority capital management tool for us. During the third fiscal quarter of 2003, we increased our quarterly dividend from 10 cents to 20 cents per share. Our capacity to pay dividends is enhanced when First Charter, MHC is willing and permitted by the Office of Thrift Supervision to waive receipt of its portion of the dividends. We continue to evaluate our dividend policy and the appropriateness of special dividends and/or share repurchases.

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General

Charter Financial Corporation (“Charter Financial,” “Company”, “us,” or “we”) is a federally-chartered corporation organized in 2001, as more fully described in Note 2 to the unaudited consolidated financial statements, and is registered as a savings and loan holding company with the Office of Thrift Supervision (“OTS”). Charter Financial serves as the holding company for CharterBank (“Bank”). First Charter, MHC owns 80% of the outstanding shares of Charter Financial’s common stock. Our common stock is quoted on the National Market System of the Nasdaq Stock Market under the symbol “CHFN.” Unless the context otherwise requires, all references herein to the Company, Bank or Charter Financial include Charter Financial and the Bank on a consolidated basis.

Charter Financial’s principal business is its ownership of CharterBank. Charter Financial also owns 1,675,500 shares of Freddie Mac common stock and Charter Insurance Company, a Hawaiian corporation which generates fee income by reinsuring a portion of CharterBank’s loan originations which carry private mortgage insurance. Charter Insurance Company owns 400,000 shares of Freddie Mac common stock. Additionally, CharterBank owns 2,555,000 shares of Freddie Mac common stock. On a consolidated basis, Charter Financial owns 4,630,500 shares of Freddie Mac common stock.

Our balance sheet at December 31, 2003 contains $270.1 million of Freddie Mac common stock, of which $263.8 million is unrealized gain. Noninterest-bearing liabilities include $101.8 million in deferred taxes related to the unrealized gain on the Freddie Mac common stock. Accumulated other comprehensive income includes $162.0 million representing the net unrealized gain on the Freddie Mac common stock.

CharterBank completed the cash acquisition of EBA Bancshares, Inc. and its wholly-owned subsidiary, Eagle Bank of Alabama, in February 2003. The acquisition added three branches in the Auburn-Opelika area of Alabama with $53.8 million in net loans and $62.1 million in deposits. CharterBank now operates a main office, seven full-service branch offices, and four loan production offices in Georgia and Alabama.

CharterBank is a service-oriented bank providing retail and small business customers with products and services designed to create long-term, profitable relationships. We offer numerous loan products, including residential mortgage loans, commercial real estate loans, commercial loans, home equity loans, second mortgages, and other products. CharterBank also offers deposit products, including consumer and commercial checking accounts, savings accounts, money market accounts, and certificates of deposit.

CharterBank’s results of operations depend primarily on net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on interest-bearing liabilities. Our interest-earning assets consist primarily of residential mortgage loans, commercial real estate loans, consumer loans, mortgage related securities, and equity securities such as our Freddie Mac common stock investment. Interest-bearing liabilities consist primarily of retail and wholesale deposits, repurchase agreements and borrowings from the Federal Home Loan Bank (FHLB) of Atlanta.

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Our results of operations also depend on our provision for loan losses, noninterest income and noninterest expense. Noninterest expense includes salaries and employee benefits, occupancy expenses and other general and administrative expenses. Noninterest income includes gains on sale of loans, gains (losses) on sales of investment and mortgage-backed securities, deposit fees and other service fees and charges.

Our operating results may also be affected significantly by economic and competitive conditions in our market area and elsewhere, including those conditions that influence market interest rates, government policies and the actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially impact us. Furthermore, because our lending activity is concentrated in loans secured by real estate located in Georgia and Alabama, downturns in the regional economy encompassing these states could have a negative impact on our earnings.

Critical Accounting Policies

In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies which are used in preparing the consolidated financial statements of the Company.

These policies are described in Note 1 to the consolidated financial statements which were presented in the Company’s 2003 annual report on Form 10-K. Of these policies, management believes that the accounting for the allowance for loan losses is one of the most critical. Please see “Asset Quality” for a further discussion of the Company’s methodology in determining the allowance.

The accounting and financial reporting policies of Charter Financial Corporation conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as a critical accounting policy that requires subjective judgment and is important to the presentation of the financial condition and results of operations of the Company.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectibility of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay.

The Company segments its allowance for loan losses into the following four major categories: 1) identified losses for impaired loans; 2) general reserves for Classified/Watch loans; 3) general reserves for loans with satisfactory ratings; and 4) an unallocated amount. Risk ratings are initially assigned in accordance with the Bank’s loan and collection policy. On an ongoing basis, an organizationally independent department reviews grade assignments and considers current information regarding a borrowers’ financial condition and debt service capacity, collateral condition and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management

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classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan, generally based on the fair value of the collateral as the measure for the amount of the impairment. Impaired and Classified/Watch loans are aggressively monitored. The reserves for loans rated satisfactory are further subdivided into various types of loans as defined by loan type. The Company has developed specific quantitative reserve factors which it applies to each loan type to develop reserve components. These reserve factors are based upon economic, market and industry conditions that are specific to the Company’s local markets and consider, but are not limited to, national and local economic conditions, bankruptcy trends, unemployment trends, loan concentrations, dependency upon government installations and facilities, and competitive factors in the local market. They are subjective in nature and require considerable judgment on the part of the Bank’s management. However, it is the Bank’s opinion that these items do represent uncertainties in the Bank’s business environment that must be factored into the Bank’s analysis of the allowance for loan losses. The unallocated component of the allowance is established for losses that specifically exist in the remainder of the portfolio, but have yet to be identified.

Management believes that the allowance for loan losses is adequate. The loan portfolio is broadly composed of residential real estate loans of 43.8%, construction loans of 5.9%, commercial purpose loans of 43.8% and consumer loans of 6.5%. Nearly 81% of the bank’s loan portfolio is secured by real estate loans.

In recent years, the Bank has made an effort to build its business lines, and loans secured by commercial real properties now make up 37.08% of the loan portfolio. The Company’s largest funded real estate secured loan is a $6.2 million loan on a medical office building in the metro Atlanta area. The largest industry concentration of commercial purpose loans is the hospitality industry where we have an aggregate of $21.8 million to various hotel and motel operations. In a significant number of the loans secured by commercial properties, the properties are occupied by the owner and the ongoing operations of the business provide the cash to service the debt. Construction and development loans, which comprise nearly 6% of the real estate loan portfolio, are carefully monitored since the repayment is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions. Less than 7% of the total loan portfolio is either unsecured or secured by something other than real estate.

While most originations of residential real estate loans are sold into the secondary market, the Bank chooses to keep some of them due to attractive risk and return characteristics. Such loans primarily make up the residential real estate mortgage portfolio. The remainder of the residential portfolio is composed of residential real estate mortgages “held for sale.” These loans are in the process of being sold into the secondary market and, since the credit, the rate and the purchase price have been approved by the buyer, the Company takes no credit or interest rate risk with respect to these loans.

While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. If we are required to make additions to our allowance for loan losses by the regulatory agencies the additions would reduce our net income and our capital.

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Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale comprise a significant portion of the Company’s balance sheet, and income on these assets is important to our operating results. Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale are reported at fair value, as determined by independent price quotations. Purchase premiums and discounts on investment securities are amortized and accreted to interest income using a method which approximates a level yield over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities and collateralized mortgage obligations are amortized and accreted to interest income using the interest method over the remaining lives of the securities, taking into consideration assumed prepayment patterns.

Income taxes are a material expense for the Company. The Company receives a dividends received deduction for tax purposes on dividend income from our investment in Freddie Mac common stock. This deduction is the lesser of 70% of dividends received or 70% of taxable income before the dividends received deduction and the difference between 70% of taxable income and 70% of dividends can be significant. Since the Company does not file a consolidated tax return, this determination is made at the individual company level. The actual deduction will be determined at September 30, 2004 based on the level of dividends and the level of taxable income.

Comparison of Financial Condition at December 31, 2003 and September 30, 2003

At December 31, 2003 our total assets were $1.0 billion, up $30.2 million from September 30, 2003.

The risk and return characteristics of loans vary significantly by the type of loan. The following table shows the actual balance of loans outstanding at December 31, 2003 as well as the average balances of loans outstanding for the past five quarters beginning with December 31, 2002.

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The June quarter was the first full quarter which included the loans acquired in the Eagle Bank acquisition. Loans acquired in the Eagle Bank acquisition in February 2003 were $55.3 million. One-to-four family loans have increased since the June quarter when we started retaining 15 year conforming loans. Future portfolio growth of these 15 year loans is dependent on interest rates as well as our future decisions to retain or sell these loans. The nonresidential real estate loan growth reflects our strategy to increase this portion of the portfolio. Future growth of our nonresidential real estate portfolio depends on interest rates, economic conditions and competitive pricing of these loans within our market. The average balance of commercial non-real estate loans increased in the June quarter reflecting the loans acquired in the Eagle acquisition. Reductions in the following quarters represent our efforts to strategically evaluate the portfolio.

Mortgage-backed securities and collateralized mortgage obligations increased 3.8% from $394.4 million at September 30, 2003 to $409.5 million at December 31, 2003. The market value of Freddie Mac common stock increased $27.2 million, or 11.2%, from $242.9 million to $270.1 million as the price per share of Freddie Mac common stock increased from $52.35 at September 30, 2003 to $58.32 at December 31, 2003.

Total deposits declined from $279.4 million at September 30, 2003 to $271.3 million at December 31, 2003 as the bank has de-emphasized certificates of deposit as sources of funding and focused on attracting and retaining core deposits in order to reduce interest expense. However, as shown in the table following, over the last two years, core deposits (checking, money market and savings accounts) have increased from $50.4 million to $99.6 million. Approximately $21.9 million of the increase in the March 2003 quarter was a result of the acquisition of Eagle Bank. Fees on core deposit accounts increased from $179,000 in the December 2001 quarter to $448,000 in the December 2003 quarter.

Management will continue to use FHLB advances and repurchase agreements to fund the securities and loan portfolio growth. The maturity dates of new advances will be determined at the time the advance is taken down and will be based on interest rates, the Company’s interest rate risk profile and other factors. Repurchase agreements are generally less than 90 days to maturity and carry rates at or slightly above LIBOR. Borrowings increased $10.8 million or 2.8% from $388.4 million at September 30, 2003 to $399.2 million at December 31, 2003.

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Charter Financial recorded $4.3 million of goodwill and $2.0 million of core deposit intangible as a result of the acquisition of Eagle Bank in fiscal 2003. The core deposit intangible is amortized over approximately 13 years using an accelerated method of amortization.

Our total stockholders’ equity is made up of realized equity and unrealized equity. Realized equity includes common stock, additional paid-in capital, treasury stock, unearned compensation, and retained earnings, while unrealized equity is comprised of accumulated other comprehensive income.

Accumulated other comprehensive income (“Unrealized Capital”) is comprised of net unrealized holding gains on securities available for sale. Accumulated other comprehensive income at December 31, 2003 was $161.3 million, a $17.4 million increase from the balance at September 30, 2003 of $143.9 million as the price per share of our investment in Freddie Mac common stock increased from $52.35 to $58.32. The following table shows the changes in realized and unrealized capital and the Freddie Mac common stock price for the past five quarters. A comparison of the unrealized capital and Freddie Mac common stock price demonstrates the relationship between the price of Freddie Mac common stock and our unrealized capital.

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As indicated in the tables following, other comprehensive income was $17.4 million for the three months ended December 31, 2003, compared to $9.7 million for the three months ended December 31, 2002. The income was primarily the result of the increase in the price of Freddie Mac common stock during the periods ended December 31, 2003 and 2002. The price of Freddie Mac common stock increased by $5.97 and $3.15 per share, respectively for the quarters ended December 31, 2003 and December 31, 2002.

Comparison of Operating Results for the Three Months Ended December 31, 2003 and 2002

General

Net income was $1.7 million for the three months ended December 31, 2003, which was $1.2 million higher than the net income of $499,000 for the three months ended December 31, 2002. The most significant factors in the earnings increase were the significantly higher net interest income and the $532,742 gain on the sale of Freddie Mac common stock related to our covered call program.

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Net Interest Income

As shown in the table following, net interest income increased $1.6 million from $3.6 million for the three months ended December 31, 2002 to $5.2 million for the three months ended December 31, 2003. For the same periods, our net interest spread increased from 0.18% to 1.19% and our net interest margin from 1.51% to 2.07%.

As the preceding table illustrates, the net amortization of premiums on mortgage securities has had a significant impact on net interest income, spread and margin. Charges against interest income for net premium amortization reached its peak in the March 2003 quarter, with amortization of $995,000. By December 2003, net amortization of premiums on mortgage-related securities had returned to a more normal level at $204,000. The high level of premium amortization in the earlier periods was caused by the “refinancing boom” in one-to-four family mortgages which was triggered by low mortgage interest rates. As borrowers refinanced, mortgages underlying the securities we owned were paid off earlier than expected causing our securities to pay off sooner than expected and triggering acceleration of amortization.

Our net interest spread and, to a lesser extent, our net interest margin are impacted by the yield on Freddie Mac common stock. Net interest rate spread is the difference between yield on assets and cost of liabilities. Net interest margin is net interest income as a percentage of interest earning assets. As indicated in the table above, the yield on Freddie Mac common stock has increased and helped the net interest spread. A portion of the increase in the Freddie Mac yield is from the increased dividend and a portion is from a lower market price of Freddie Mac common stock.

The table below shows the yields or costs of other significant components of our net interest income.

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Costs of borrowings have steadily decreased from 4.65% in the December 2001 quarter to 3.01% in the December 2003 quarter. While the majority of the borrowings have monthly rate resets, we have $130.8 million of fixed rate borrowings with a remaining maturity of approximately seven years and an average rate of 5.75%. Approximately $25.0 million of borrowings with a fixed rate of 4.85% matured in December 2003.

The yield on mortgage securities has varied over the past nine quarters from a high in the December 2001 quarter of 4.32% to a low of 2.78% in June 2003 and ending at 3.47% in December 2003. The yield in the March, June and September 2003 quarters was significantly impacted by high net premium amortization as mortgage security portfolios were paid off rapidly due to low mortgage rates and record rates of refinancing. Additionally, yields on securities declined during 2003 as a result of management’s decision to reinvest the heavy cash inflows from rapidly prepaying fixed rate mortgage securities into adjustable rate mortgage securities. In August of 2003, management increased its investment in fixed rate mortgage securities and by December 31, 2003 fixed rate mortgage securities comprised 40% of the total mortgage securities portfolio, which is consistent with the percentage at December 31, 2002.

As shown in the preceding table, the yield on loans has declined 113 basis points over the past five quarters from 7.00% for the December 2002 quarter to 5.87% for the December 2003 quarter. The yield reduction is primarily the result of older, higher yield loans paying off in the low interest rate environment and being replaced with new lower yielding loans. During June of 2003 the bank started retaining 15 year single family loans in its loan portfolio. As of December 31, 2003, the bank had accumulated $26.1 million of these loans with rates of approximately 5%. Average loans outstanding increased from $218.2 million during the December 2002 quarter to $303.6 million for the December 2003 quarter. Approximately $55.3 million of loans were acquired in the Eagle Bank acquisition.

Also, as shown in the preceding table, the costs of deposits decreased 237 basis points from 4.32% for the December 2001 quarter to 1.95% for the December 2003 quarter. The average cost of certificates of deposits dropped 264 basis points, more than overall deposits. At current rates, management’s ability to lower the price of non-certificate accounts is very limited.

The 230 basis point drop in loan yield, from the December 2001 quarter to the December 2003 quarter, was comparable to the 237 basis point decrease in the costs of deposits for the same period. For these same two periods the decline in mortgage securities yields, at 85 basis points, was significantly less than the decrease of 164 basis points in the cost of borrowings. This provided a significant boost to the net interest spread, margin and income. In addition, the increase in dividends on Freddie Mac common stock contributed to the increase in net interest income.

Interest income increased by $887,000 to $9.5 million for the three months ended December 31, 2003 from $8.6 million for the three months ended December 31, 2002. The main driver was an increase in interest on loans of $635,952 resulting from higher average loan balances. Higher loan balances were due, in part, to the loans acquired in the Eagle acquisition.

Interest expense fell by $727,884 from $5.0 million for the three months ended December 31, 2002 to $4.3 million for the three months ended December 31, 2003. Interest expense on deposits and borrowings decreased $136,963 and $590,921, respectively, in 2003 compared to

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2002. The reduction in interest expense on both borrowings and deposits is due to lower interest rates.

In the table following, we derived the yields and costs by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. We derived average balances from actual daily balances over the periods indicated. Interest income includes the recognition of certain fees over the lives of the underlying loans. The table also shows the actual balances of interest-earning assets and interest-bearing liabilities as of December 31, 2003.

The table also depicts the significant effect of the Freddie Mac common stock on our traditional bank measures, such as net interest income, net interest rate spread, and net interest margin. The table shows these measures with and without the effects of the Freddie Mac common stock. We believe this comparison provides our shareholders with useful information so that they may compare CharterBank with its peer group using traditional bank ratios, excluding the effect of the Freddie Mac common stock. Freddie Mac common stock had a dividend return on cost basis of approximately 76.86% at December 31, 2003. However, the dividend yield on the market value of the Freddie Mac common stock was 1.91%. The appreciation in the market value of the Freddie Mac common stock is the reason for our strong accumulated comprehensive income.

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