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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C. 20549

FORM 10-K

For the fiscal year ended December 31, 2003

For the transition period from              to             

Commission file number 001-15373

ENTERPRISE FINANCIAL SERVICES CORP

(Exact Name of Registrant as Specified in its Charter)

Registrant’s telephone number, including area code: 314-725-5500

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

None

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

Common Stock, par value $.01 per share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.     Yes  x    No  ¨

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

The aggregate market value of the common stock held by non-affiliates of the Registrant as of March 10, 2004: Common Stock, par value $.01, $101,969,354

The number of shares outstanding of the Registrant’s common stock as of March 10, 2004: Common Stock, par value $.01, 9,670,532 shares outstanding

Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule 12b-2 of the Securities Exchange Act of 1934.    Yes  x    No  ¨

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ENTERPRISE FINANCIAL SERVICES CORP

2003 ANNUAL REPORT ON FORM 10-K

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Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995

Readers should note that in addition to the historical information contained herein, some of the information in this report contains forward-looking statements within the meaning of the federal securities laws. Forward-looking statements typically are identified with use of terms such as “may,” “will,” “expect,” “anticipate,” “estimate” and similar words, although some forward-looking statements are expressed differently. You should be aware that Enterprise Financial Services Corp’s actual results could differ materially from those contained in the forward-looking statements due to a number of factors, including burdens imposed by federal and state regulation of banks, credit risk, exposure to local economic conditions, risks associated with rapid increase or decrease in prevailing interest rates, consolidation within the banking industry and competition from banks and other financial institutions, all of which could cause Enterprise Financial Services Corp’s, actual results to differ from those set forth in the forward-looking statements.

PART I

ITEM 1: BUSINESS

General

Enterprise Financial Services Corp, formerly known as Enterbank Holdings Inc. (the “Company”) was incorporated under the laws of the State of Delaware on December 30, 1994, for the purpose of providing a holding company structure for the ownership of Enterprise Bank, (the “Bank”) which commenced operations in 1988. The Company acquired the Bank in May 1995 through a tax-free exchange with the Bank’s shareholders. In January 2004 the Bank changed its legal name to Enterprise Bank & Trust. In June of 2000, the Company and Commercial Guaranty Bancshares, Inc. (“CGB”), the parent company for First Commercial Bank, N.A. (the “Kansas Bank”), merged under a tax-free reorganization. The holding company ownership structure gives the Bank a source of capital and financial strength and allows the Company some flexibility in expanding the products and services offered to clients. In 2000, the Company elected to change its status from a bank holding company to a financial holding company.

From 1988 through 1996, the Bank provided commercial banking services to its customers from a single location in the City of Clayton, St. Louis County, Missouri. During 1997, the Bank opened two additional facilities located in St. Charles County, Missouri and the City of Sunset Hills, located in St. Louis County, Missouri. During 1998, the Bank opened an operations facility in St. Louis County, Missouri.

Enterprise Trust (“Trust”), formerly referred to as Enterprise Financial Advisors (“EFA”), a division of the Bank, was organized in late 1998 to provide fee-based trust services, personal financial planning, estate planning, and corporate planning services to the Company’s target market on a full time basis.

The Kansas Bank began operations on February 20, 1996 as a new Kansas banking corporation in Overland Park, Kansas located in Johnson County. The Kansas Bank acquired First National Bank of Humboldt in December of 1997, adding three additional locations in Humboldt, Chanute and Iola, all located in Southeast Kansas. In June of 2000, the Company completed a merger transaction under which the Kansas Bank became a subsidiary of the Company. On January 1, 2001, the Kansas Bank changed its legal name to Enterprise Banking, N.A. and on September 30, 2001 Enterprise Banking, N.A. merged into Enterprise Bank with Enterprise Bank as the surviving entity.

On April 4, 2003, the Company transferred loans of $27.2 million, fixed assets of $1.1 million, and deposits of $48.2 when it sold its Humboldt, Chanute and Iola, Kansas branches (“Southeast Kansas branches”) to Emprise Financial Corporation based in Wichita, Kansas. Assets of $36.4 million and deposits of $50.1 million associated with these branches were shown as “held for sale” on the Company’s consolidated balance sheet at December 31, 2002. The Company received a 2.0% premium on loans and a 4.75% premium on deposits, which generated a $3.1 million pretax gain less a $150,000 write-off of related goodwill associated with these branches. All other items were sold at book value. There were approximately $352,000 in expenses incurred related to the sale. The Southeast Kansas branches were included in the Enterprise Banking segment. These branches were sold because they were not a strategic fit for the Company and allowed the Company to redeploy bank capital and management resources to the key markets of St. Louis and Kansas City.

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The Company’s executive offices are located at 150 North Meramec, Clayton, Missouri 63105. The Company’s telephone number is (314) 725-5500.

Strategy

The Company’s strategy is to provide a complete range of financial services designed to appeal to closely-held businesses, their owners and to professionals in the St. Louis and Kansas City metropolitan areas. The Company’s goal is to grow its operations within its defined market niche by being well-managed, well-capitalized, and disciplined in its approach to managing and expanding its operations as growth opportunities arise. The Company believes its goals can be achieved while providing attractive returns to shareholders. Net income, earnings per share growth, and long term return on shareholders’ equity are the financial performance indicators the Company considers most critical in measuring success.

The Bank

The Bank is a Missouri state chartered trust company which offers a broad range of commercial and personal banking services to clients. Loans include commercial, commercial real estate, financial and industrial development, real estate construction and development, residential real estate, and a smaller amount of consumer loans. Other services include treasury management and safe-deposit boxes.

The Bank’s primary source of funds has historically been customer deposits. The Bank offers a variety of accounts for depositors designed to attract both short-term and long-term deposits. These accounts include certificates of deposit, savings accounts, money market accounts, commercial sweep accounts, checking and negotiable order of withdrawal accounts, and individual retirement accounts. Interest-bearing accounts earn interest at rates established by management based on competitive market factors and management’s desire to increase or decrease certain types of deposits.

The Bank experiences significant competition in attracting depositors and borrowers. Competition in lending activities comes principally from other commercial banks, savings associations, insurance companies, governmental agencies, credit unions, brokerage firms, and pension funds. The primary factors in competing for loans are interest rate and overall lending services. Competition for deposits comes from other commercial banks, savings associations, money market and mutual funds, credit unions, insurance companies, and brokerage firms. The primary factors in competing for deposits are overall deposit services, interest rates paid on deposits, account liquidity, convenience of office location and overall financial condition. We believe that the Bank’s size provides flexibility, which enables the Bank to offer an array of banking products and services. We believe that the Bank’s financial condition also contributes to a favorable competitive position in the markets it serves.

Management believes the Bank is able to compete effectively in its market because: 1) the Bank’s relationship officers and management maintain close working relationships with their commercial clients, 2) the Bank’s management structure enables it to react to customer requests for loan and deposit services more quickly than many competitors, 3) the Bank’s management and officers have significant experience in the communities served by the Bank, and 4) the Bank is highly focused on the closely-held business and professional market. Additionally, industry consolidation has resulted in fewer independent banks and fewer banks serving the Banks target market niche. Management believes the Bank is one of only a few with a business model specifically designed for closely-held businesses, their owners and the professional markets.

The Bank’s historical growth strategy has been both client and asset driven. The Bank continuously seeks to add clients that fit its target market. This strategy enables the Bank to attract clients whose borrowing needs have grown along with the Bank’s increasing capacity to fund client loan requests. Additionally, the Bank increased its loan portfolio based on lending opportunities developed by relationship officers. The Bank funds loan growth by attracting deposits from business and professional clients, by borrowing from the Federal Home Loan Bank, and by issuing brokered certificates of deposits which are priced at or below the Bank’s alternative cost of funds.

The Bank can expand its customer relationships and control operating costs by: 1) operating a small number of offices with a high per office asset base, 2) emphasizing commercial loans which tend to be larger than retail loans, 3) employing an experienced staff, all of whom are rewarded on the basis of performance and customer service, 4) improving data processing and operational systems to increase productivity and to control risk, 5) leasing rather than owning facilities where possible so that capital can be deployed more effectively to support growth in earning assets, and 6) outsourcing services where possible.

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Each of the banking units has its own operating Board of Directors. Each Board of Directors is comprised of business owners and professionals who fit the target client profile. Each Board of Directors takes an active role in the business development activities of its respective banking unit. Input and understanding of the needs of the Bank’s current and target clients has been critical in the Bank’s past success and will be important in the Bank’s plans for future growth.

Wealth Management

In 1998, the Bank entered the trust and financial planning business on a full time basis when the Bank was granted trust powers. As a part of the organization of trust operations (“Trust” or “Enterprise Trust), the Bank entered into solicitation and referral agreements with Moneta Group, Inc. (“Moneta”), a large financial planning company based in St. Louis, Missouri. On December 24, 2003, the Bank entered into a new agreement with Moneta that superseded all previous agreements. The new agreement calls for Moneta to provide training for new Trust employees, ongoing training for Trust employees, compliance and technical expertise, and access to institutional services for Trust in exchange for a flat fee in the form of cash. Moneta will refer clients to Trust and in return will receive a portion of the revenue earned by Trust in the form of cash. Moneta will continue to refer banking business to the Bank and receive compensation in the form of options to purchase the Company’s common stock.

Enterprise Trust provides fee-based personal and corporate financial consulting and trust services to the Company’s target market. Personal financial consulting includes estate planning, investment management, and retirement planning. Corporate consulting services are focused in the areas of retirement plans, management compensation and management succession issues. Some investment management services are provided through Argent Capital Management LLC (“Argent”), a money management company that invests principally in large capitalization companies. The Company owns approximately 4.8% of Argent’s outstanding shares.

In addition, the Company acquired approximately 11% of Retirement Plan Services, LLC (“RPS”) in October of 2000 and in December of 2000 elected to move its 401(k) plan from the Principal Group to RPS. RPS provides retirement plan administration to small and medium size businesses. During 2001, the Company increased its ownership percentage to approximately 20% and actively refers business to RPS on a fee sharing arrangement.

In 2004, the Company plans to establish Enterprise Business Consulting (“EBC”) and Enterprise Wealth Products Group (“WPG”). Along with Trust, these products and service offerings will make up the Company’s Wealth Management business segment. Through a network of independent professionals, EBC will offer business consulting services such as strategic planning, executive recruiting, compensation analysis, marketing, and WPG will offer an array of life, annuity, disability income, long-term care and selected mutual funds through a wholly-owned insurance general agency and a branch of an outside broker-dealer.

Market Areas and Approach to Expansion

In the St. Louis metropolitan area, the Bank has facilities in Clayton, St. Charles County, and the city of Sunset Hills. The Bank also has facilities in Johnson County, Kansas and an office in the Country Club Plaza on the Missouri side of Kansas City. The Company chose to locate in all of these markets based on high expectations for growth, high concentration of closely-held businesses and the high number of professionals in those markets. As mentioned above, the Company believes that local management and the involvement of a Board of Directors comprised of local business persons and professionals are key ingredients for success. Management believes that credit decisions, pricing matters, business development strategies, and other decisions should be made locally by managers who have an equity stake in the Company while complying with the Bank’s policies and procedures. The Company, as part of its expansion effort, plans to continue its strategy of operating a small number of offices with a high per office asset base, emphasizing commercial loans and employing experienced staff who are rewarded on the basis of performance and customer service.

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Enterprise Merchant Banc

The Company had organized Enterprise Merchant Banc, Inc. (“Merchant Banc”) (formerly Enterprise Capital Resources, Inc.) in 1995 as a wholly owned subsidiary to provide merchant banking services to closely-held business and their owners. Its operations included a minority investment in Enterprise Merchant Banc, LLC (“EMB LLC”), which focused on providing equity capital and equity-linked debt investments to growing companies in need of additional capital to finance internal and acquisition-related growth.

After experiencing significant losses on merchant banking investments in 2001, the Company considered that the merchant banking investments were no longer a viable part of its long term business strategy. Enterprise Merchant Banc is now inactive.

Investments

The Bank’s investment policy is designed to enhance its net income and return on equity through prudent management of risk; ensure liquidity to meet cash-flow requirements; help manage interest rate risk; ensure collateral is available for public deposits, advances and repurchase agreements; and to seek asset diversification. The Company, through its Asset/Liability Management Committee (“ALCO”), monitors the Bank’s investment activity and manages its liquidity by structuring the maturity dates of its investments to meet anticipated customer funding needs. However, the primary goal of the Bank’s investment policy is to maintain an appropriate relationship between assets and liabilities while maximizing interest rate spreads. Accordingly, the ALCO monitors the sensitivity of its assets and liabilities with respect to changes in interest rates and maturities and directs the overall acquisition and allocation of funds. ALCO also utilizes derivative financial instruments to assist in the management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities.

Employees

At December 31, 2003 the Company had approximately 207 full time equivalent employees. None of the Company’s employees is covered by a collective bargaining agreement. Management believes that its relationship with its employees is good.

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ITEM 2: PROPERTIES

All of the Company’s St. Louis banking facilities are leased under agreements that expire in 2004, 2008, 2011 and 2016, for Clayton, St. Louis County, the City of Sunset Hills, and St. Charles County, respectively. The Company has the option to renew the Clayton facility lease for one additional five-year period with future rentals to be agreed upon. The Company has the option to renew the St. Louis County facility lease for three additional five-year periods with future rentals to be agreed upon. The Company has the option to renew the Sunset Hills facility lease for two additional five-year periods with future rentals to be agreed upon. The Company has no future rental options for the St. Charles County facility; however, during the term of the lease, the monthly rentals are adjusted periodically based on then-current market conditions and inflation. The Company’s Kansas City Country Club Plaza banking facility is leased under an agreement that expires in 2011. The Company has the option to renew the Plaza facility lease for one 5 year term. The banking facility in Overland Park, Kansas is owned by the Company.

The following is a list of the Company’s current facilities:

ITEM 3: LEGAL PROCEEDINGS

The Company and its subsidiaries are, from time to time, parties to various legal proceedings arising out of their businesses. Management believes that there are no such proceedings pending or threatened against the Company or its subsidiaries which, if determined adversely, would have a material adverse effect on the business, financial condition, results of operations or cash flows of the Company or any of its subsidiaries.

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ITEM 4: SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders in the quarter ended December 31, 2003.

PART II

ITEM 5: MARKET FOR COMMON STOCK AND RELATED STOCKHOLDER MATTERS

As of March 10, 2004, the Company had approximately 1,100 common stock shareholders of record and a market price of $13.75 per share. The common stock is not traded on an exchange but is traded on the Over-The-Counter Bulletin Board. The Company believes the high and low sale prices for the common stock and dividends declared were as follows in the quarters indicated:

There may have been other transactions at prices not known to the Company.

Dividends

The holders of shares of common stock of the Company are entitled to receive dividends when, as, and if declared by the Company’s Board of Directors out of funds legally available for the purpose of paying dividends. The amount of dividends, if any, that may be declared by the Company will be dependent on many factors, including future earnings, bank regulatory capital requirements and business conditions as they affect the Bank. As a result, no assurance can be given that dividends will be paid in the future with respect to the common stock. In addition, the Company currently plans to retain most of its earnings for growth rather than increasing dividends.

Common Stock

The authorized capital stock of the Company consists of 20,000,000 shares of common stock, par value $.01 per share (the “Common Stock”). Holders of Common Stock are entitled to one vote per share on all matters on which the holders of Common Stock are entitled to vote. In all elections of directors, holders of Common Stock have the right to cast votes equaling the number of shares of Common Stock held by such stockholder multiplied by the number of directors to be elected. All of such votes may be cast for a single director or may be distributed among the number of directors to be elected, or any two or more directors, as such stockholder may deem fit. Holders of Common Stock have no preemptive, conversion, redemption, or sinking fund rights. In the event of a liquidation, dissolution or winding-up of the Company, holders of Common Stock are entitled to share equally and ratably in the assets of the Company, if any, remaining after the payment of all liabilities of the Company.

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ITEM 6: SELECTED FINANCIAL DATA

The following selected financial data should be read in connection with and are qualified by reference to the consolidated financial statements, related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this report. This selected financial data presented below is derived from the Company’s audited consolidated financial statements as of and for the years ended: December 31, 2003, 2002, 2001, 2000, and 1999.

(Dollars in thousands, except per share amounts)

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ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

The following discussion and analysis is intended to review the significant factors of the financial condition and results of operations of the Company for the three-year period ended December 31, 2003. It should be read in conjunction with the accompanying consolidated financial statements and the selected financial data presented elsewhere in this report.

The Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In preparing the consolidated financial statements in accordance with U.S. GAAP, the Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.

OVERVIEW OF MANAGEMENT’S DISCUSSION AND ANALYSIS

This overview of management’s discussion and analysis highlights selected information in this document and may not contain all of the information that is important to you. For a more complete understanding of trends, events, commitments, uncertainties, liquidity, capital resources and critical accounting estimates, you should carefully read this entire document. These have an impact on the Company’s financial condition and results of operations.

Net income for 2003 was $6.9 million, or $0.70 per fully diluted share, an increase of $1.9 million or 38.5% compared to $5.0 million, or $0.52 per share for the prior year. The Company experienced significant growth in both of its primary business segments: Banking and Wealth Management. The improvement in earnings for 2003 was due to several factors: 1) earning asset growth funded mainly with core deposits; 2) a stable net interest rate margin; 3) strong fee income growth in trust and gains on sale of mortgages; 4) the gain on sale of the Southeast Kansas branches less related expenses; and 5) minimal increases in noninterest expenses. Partially offsetting these positive factors were higher provision for loan losses and a higher effective tax rate.

The majority of the Company’s revenues are net interest income in the Banking Segment. Net interest income is a byproduct of earning asset volumes (i.e. loans and investment securities) and the net interest rate margin (i.e. the spread between earning asset yields and the overall cost of funding those assets). The Company realized strong earning asset growth in 2003 and maintained the net interest rate margin in spite of continued falling interest rates. Along with managing credit risk and liquidity risk, managing interest rate risk is a key determinant of future earnings growth.

Given the level of financial institution merger activity in the past year, the Company has significant opportunities for growing its client base. The Company has hired experienced production staff from its competitors to complement the existing sales force, and is targeting increased levels of loan, deposit and wealth management sales production as a result. In less than vibrant local economies where competitors are also pushing for growth in earnings, margins have been under pressure. Management has developed a model to capture relationship “contribution margin” and uses this tool to help make decisions on loan or deposit pricing.

The Bank’s average relationship size is expected to increase resulting in greater efficiencies. In addition, it is anticipated that the credit requirements of these clients will require a heavier underwriting emphasis on cash flow as the primary credit granting criteria. Given larger average relationships, heavier emphasis on cash flows for repayment, and the relatively stagnant local economies, the credit risk inherent in the loan portfolio has increased and the provision for loan losses and resultant allowance for loan losses reflect these factors.

During 2003, the Company sold three branches in Southeast Kansas for a pre-tax gain of $3.1 million. These branches did not fit in the Company’s long-term strategy as they were rural, community banks with a retail focus. In addition, this sale allowed the Company to redeploy bank capital and management time to the strategic markets of St. Louis and Kansas City. There were $352,000 of expenses and a $150,000 write-off of goodwill associated with the sale.

Given the reliance on net interest income for revenue growth, the Company continues to develop and expand fee income opportunities. Continued growth in new relationships and penetration of banking products into existing

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relationships should continue to drive service charge revenue. In addition, the Bank offers single family residential mortgages that are sold servicing-released into the secondary mortgage market. Interest rate levels significantly impact this revenue item. The Company believes that Wealth Management services offer an attractive value proposition to our targeted client base and in the long run provide the necessary fee income growth and revenue diversification the Company seeks. Trust income, currently comprised of income from fiduciary and financial advisory activities, continues to grow rapidly. Assets under administration in the Wealth Management segment exceeded $1.1 billion during 2003. New capabilities and products will be introduced in 2004 that should provide additional bases for growth.

The Company is focused on leveraging its current expense base and measures the “efficiency ratio” as a benchmark for improvement. The efficiency ratio is equal to noninterest expense divided by total revenue (net interest income plus noninterest income). This ratio has improved in 2003 from 2002 to 66% versus 76%. Continued improvement is targeted to maintain strong earnings per share growth and generate higher returns on equity.

The Company is “well capitalized” under any regulatory definition and adequately reserved against loan losses as of December 31, 2003.

CRITICAL ACCOUNTING POLICIES

The following accounting policies are considered most critical to the understanding of the Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such policies affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies see Note 1 of our consolidated financial statements.

Allowance for Loan Losses

Subject to the use of estimates, assumptions, and judgments, management’s evaluation process used to determine the adequacy of the allowance for loan losses combines several factors: management’s ongoing review of the loan portfolio, consideration of past loan loss experience, trends in past due and nonperforming loans, risk characteristics of the various classifications of loans, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect probable credit losses. Because current economic conditions can change and future events are inherently difficult to predict, the anticipated amount of estimated loan losses, and therefore the adequacy of the allowance could change significantly. As an integral part of their examination process, various regulatory agencies also review the allowance for loan losses. Such agencies may require that certain loan balances be charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. The Company believes the allowance for loan losses is adequate and properly recorded in the consolidated financial statements

Derivative Financial Instruments

The Company employs derivative financial instruments to assist in its management of interest rate sensitivity by modifying the repricing, maturity and option characteristics of certain assets and liabilities. The judgments and assumptions that are most critical to the application of this critical accounting policy are those affecting the estimation of fair value and hedge effectiveness. Fair value is based on quoted market prices. Factors that affect hedge effectiveness include the initial selection of the derivative that will be used as a hedge and how well changes in its cash flow or fair value has correlated and is expected to correlate with change in the cash flow or fair value of the underlying hedged asset or liability. Past correlation is easy to demonstrate, but expected correlation depends upon projections and trends that may not always hold true with acceptable limits. Changes in assumptions and conditions could result in greater than expected inefficiencies that, if large enough, could reduce or eliminate the economic benefits anticipated when the hedges were established and/or invalidate continuation of hedge accounting. The consequence of greater inefficiency and discontinuation of hedge accounting results in increased volatility in reported earnings. For cash flow hedges, this would result in more or all of the change in the fair value of the affected derivative being reported in income. For fair value hedges, this would result in less or none of the change in the fair value of the derivative being offset by changes in the fair value of the underlying hedged asset or liability.

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Deferred Tax Assets

The Company recognizes deferred tax assets and liabilities for the estimated future tax effects of temporary differences, net operating loss carryforward and tax credits. Deferred tax assets are recognized subject to management’s judgment based upon available evidence that realization is more likely than not. Deferred tax assets are reduced if necessary, by a deferred tax asset valuation allowance. In the event that management determines it would not be able to realize all or part of net deferred tax assets in the future, the Company would need to adjust the recorded value of our deferred tax assets, which would result in a direct charge to income tax expense in the period that such determination is made. Likewise, the Company would reverse the valuation allowance when realization of the deferred tax asset is expected.

Goodwill and Other Intangible Assets

At December 31, 2003 the Company had $1.9 million of goodwill. Under Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, amortization of goodwill ceased as of January 1, 2002, and instead this asset must be periodically tested for impairment. Goodwill arose from the acquisition of CGB. Goodwill is tested for impairment utilizing the methodology and guidelines established in SFAS No. 142. This methodology involves assumptions regarding the valuation of the business segments that contain the acquired entities. Management believes that the assumptions utilized are reasonable. However, the Company may incur impairment charges related to goodwill in the future due to changes in business prospects or other matters that could affect our valuation assumptions.

RESULTS OF OPERATIONS ANALYSIS

Performance Summary

The Company recorded net income of $6.9 million for the year ended December 31, 2003, an increase of $1.9 million or 38.5% over the $5.0 million earned in 2002. Earnings per fully diluted share for 2003 were $0.70, a 34.6% increase over 2002 diluted earnings per share of $0.52. Key factors behind these results were as follows:

Taxable equivalent net interest income was $33.1 million for 2003, $2.0 million or 6.4% higher than 2002. Although taxable equivalent interest income decreased $1.8 million, interest expense decreased $3.8 million. The $2.0 million increase in taxable equivalent net interest income was due to increased volume of earning assets and liabilities (adding $1.9 million) and changes in interest rates (adding $100,000).

The net interest rate margin for 2003 was 4.01%, compared to 4.00% in 2002. The 1 basis point (bp) increase in net interest rate margin is attributable to the net of a 10 bp increase in interest rate spread (the net of a 65 bp lower cost of interest-bearing liabilities offset by a 55 bp decline in the yield on earning assets), and a 9 bp lower contribution from net free funds.

Total loans were $783.9 million at December 31, 2003, an increase of $104.1 million or 15.3% over December 31, 2002. This growth was generated internally from the Company’s sales force and funded from increases in deposits of $80.1 million and other liquidity sources.

The provision for loan losses was $3.6 million for 2003 compared to $2.3 million for 2002. This increase reflects strong growth in the loan portfolio and management’s perception of changes in credit risk levels in the portfolio. Driving these risk levels were robust growth in commercial and industrial loans and commercial real estate loans in the Company’s markets amidst heavy industry competition and relatively stagnant local economies during the last two years. The allowance for loan losses of $10.6 million at December 31, 2003 represents 1.35% of outstanding portfolio loans versus 1.27% at the end of 2002.

Noninterest income was $10.1 million for 2003, compared with $5.4 million in 2002. Excluding the $2.9 million of gain on the sale of the Southeast Kansas branches, noninterest income was up $1.8 million or 33.3% driven by increased trust income of $1.3 million, or 53.9%, and increased gains on the sale of mortgage loans of $156,000 or 20.2%. Service charges were flat with 2002 at $1.8 million.

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Noninterest expense was $28.2 million, up $852,000 or 3.1% over 2002. Adjusting for the $352,000 in expenses associated with the sale of the Southeast Kansas branches, noninterest expense was up 1.8%.

Income tax expense increased to $4.0 million, up $2.4 million from 2002. The increase was related to higher income before income tax in 2003 and the reversal of $800,000 in valuation allowance on deferred tax assets in 2002.

Net income was $5.0 million for the year ended December 31, 2002, an increase of $7.5 million, as compared to a net loss of $2.5 million for the same period in 2001. Diluted earnings (loss) per share for the years ended December 31, 2002 and 2001 were $0.52 and $(0.28), respectively.

The net loss for 2001 was attributed to $5.7 million in losses related to Merchant Banc investments. There was also a decrease in net interest rate margin, an increase in the provision for loan losses, and an increase in noninterest expense that contributed adversely to the 2001 results. The decrease in the net interest rate margin was precipitated by a dramatic decline in the interest rate environment since December 2000.

Net Interest Income

Net interest income is the primary source of the Company’s revenue. Net interest income is the difference between interest income on earning assets, such as loans and securities, and the interest expense on interest-bearing deposits and other borrowings, used to fund interest earning and other assets or activities. The amount of net interest income is affected by changes in interest rates and by the amount and composition of earning assets and interest-bearing liabilities. Additionally, net interest income is impacted by the sensitivity of the balance sheet to changes in interest rates which factors in characteristics such as the fixed or variable nature of the financial instruments, contractual maturities, and repricing frequencies.

Net interest spread and net interest rate margin are utilized to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on earning assets and the rate paid for interest-bearing liabilities that fund those assets. The net interest rate margin is expressed as the percentage of net interest income to average earning assets. The net interest rate margin exceeds the interest rate spread because noninterest-bearing sources of funds (net free funds), principally demand deposits and shareholders’ equity, also support earning assets.

Net interest income (presented on a tax equivalent basis) was $33.1 million for 2003, an increase of $2.0 million or 6.4% from 2002. The increase in net interest income was attributable to a higher level of earning assets and lower cost of interest-bearing liabilities partially offset by lower earning asset yields and higher volumes of interest-bearing liabilities. The net interest rate margin for 2003 was 4.01%, compared to 4.00% in 2002. The 1 bp increase in net interest rate margin is attributable to the net of a 10 bp increase in net interest spread (the net of a 65 bp lower cost of interest-bearing liabilities offset by a 55 bp decrease in the yield on earning assets), and a 9 bp lower contribution from net free funds.

Net interest income was $31.1 million for 2002, an increase of $2.2 million or 7.6% from 2001. The increase in net interest income was attributable to a higher level of earning assets and lower cost of interest-bearing liabilities partially offset by lower earning asset yields and higher volumes of interest-bearing liabilities. The net interest rate margin for 2002 was 4.00%, compared to 4.12% in 2001. The 12 bp decline in net interest rate margin is attributable to the net of a 13 bp increase in net interest spread (the net of a 181 bp lower cost of interest-bearing liabilities offset by a 168 bp decrease in the yield on earning assets), and a 25 bp lower contribution from net free funds.

As shown in the rate/volume analysis on page 14, changes in the rates resulted in a $130,000 increase to net interest income, while increases in volume and changes to the mix of both earning assets and interest-bearing liabilities added $1.9 million, for a combined increase of $2.0 million in net interest income for 2003 over 2002. Rate changes on interest-bearing liabilities lowered interest expense by $4.1 million, while the changes in rates on earning assets reduced interest income by $4.0 million, for a net favorable impact of $130,000.

For 2003, the cost of interest-bearing liabilities decreased 65 basis points to 1.63%, aided by the low rate environment. The combined average cost of interest-bearing deposits was 1.36%, down 70 bp from 2002, with the most significant rate declines seen in the money market accounts down 53 bp and certificates of deposit down 116 bp. The rates on money market balances (including corporate sweep accounts) tend to track with treasury bill rates and national money market funds, both of which were falling in 2003. The Company’s certificate of deposit portfolio also repriced to lower rates during the year as renewals and new balances reflected lower rates for these products in our local markets. The interest-bearing liability rate changes resulted in $4.1 million lower interest expense with $4.0 million of that total attributable to interest-bearing deposits.

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For 2003, the yield on earning assets fell 55 bp to 5.29%, driven by a 61 bp decline in the loan yield. The average loan yield was 5.63%. The lower rate environment for new originations, competitive pricing pressures and refinancing in many loan categories put downward pressure on loan yields in 2003. The yield on securities and short term investments combined was down 23 basis points to 2.33%. The earning asset rate changes reduced interest income by $4.0 million, a combination of $3.5 million lower interest on loans and $466,000 lower interest on securities and short-term investments combined.

From a volume perspective, the growth and composition change of earning assets in 2003 contributed an additional $2.2 million to net interest income, while the growth and composition of interest-bearing liabilities cost an additional $309,000, netting a $1.9 million increase to net interest income.

Average earning assets were $826.0 million in 2003, an increase of $46.8 million or 6.0% from 2002. Loans accounted for the majority of the growth in earning assets, increasing by $45.0 million or 6.5% to $738.6 million on average in 2003 and representing 89.4% of average earning assets compared to 89.0% in 2002. For 2003, interest income on loans increased $1.9 million from growth, but decreased $3.5 million from the impact of the rate environment (as noted above), for a net decrease of $1.6 million versus 2002 (see table on page 14).

Average interest-bearing liabilities were $647.1 million in 2003, an increase of $17.4 million or 2.8% from 2002. The growth in earning assets was also supported by a $20.2 million or 15.4% increase in average noninterest-bearing deposits (a component of net free funds). The growth in interest-bearing liabilities came from a $10.5 million increase in interest-bearing deposits, a $2.0 million increase in subordinated debentures, and a $4.9 million increase in borrowed funds (includes Federal Home Loan Bank advances). For 2003, interest expense on interest-bearing liabilities increased $309,000 due to this growth while the impact of declining rates reduced interest expense on interest-bearing liabilities by $4.1 million versus 2002.

The table on page 13 provides average balances of earning assets and interest-bearing liabilities, the associated interest income and expense, and the corresponding interest rates earned and paid, as well as net interest income, net interest spread and net interest rate margin on a taxable equivalent basis for the three years ended December 31, 2003.

Please note that the balance of loans and deposits associated with the Southeast Kansas branches are included in the following tables of the section for 2001, 2002, and approximately three months of 2003.

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The following table sets forth, on a tax-equivalent basis for the periods indicated, a summary of the changes in interest income and interest expense resulting from changes in yield/rates and volume: