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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

(Mark One)

or

Commission File Number 0-24172

GEORGIA BANK FINANCIAL CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Registrant’s Telephone Number, Including Area Code: (706) 738-6990

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock

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

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 this Form 10-K or any amendment to this Form 10-K.    x

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

The number of shares outstanding of the Registrant’s Common Stock, as of December 31, 2003 was 5,247,204.

The aggregate market value of the common stock held by non-affiliates of the Registrant, based on the last sale price of $23.64 per share on June 30, 2003, was approximately $93,876,260.

Certain portions of the Company’s definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 14, 2004 (the “Proxy Statement”) filed pursuant to Rule 14a-6 of the Securities Exchange Act of 1934, as amended, are incorporated by reference into this Form 10-K. Other than those portions of the Proxy Statement specifically incorporated by reference pursuant to Items 10 through 13 of Part III hereof, no other portions of the Proxy Statement shall be deemed so incorporated.

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Item 1. Description of Business

General

Georgia Bank Financial Corporation (the “Company”) is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The Company had total consolidated assets of $630.6 million, total deposits of $484.0 million and total stockholders’ equity of $53.7 million at December 31, 2003. Through its wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta (the “Bank”), the Company operates a total of seven banking offices in the greater Augusta area in Richmond and Columbia Counties, Georgia. The Bank also has mortgage operations in Augusta, Georgia, Savannah, Georgia, and Nashville, Tennessee.

The Bank is community oriented and focuses primarily on offering real estate, commercial and consumer loans and various deposit and other services to individuals, small to medium sized businesses and professionals in its market area. The Bank is the only locally owned and managed commercial bank operating in Richmond and Columbia Counties. Each member of the Company’s management team is a banking professional with many years of experience in the Augusta market with this and other banking organizations. A large percentage of Bank management has worked together for many years. The Bank competes against the larger regional and super-regional banks operating in its market by emphasizing the stability and accessibility of its management, management’s long-term familiarity with the market, immediate local decision making and the pride of local ownership.

The Bank was organized by a group of local citizens from Richmond and Columbia Counties and commenced business from the main office location at 3530 Wheeler Road in Augusta on August 28, 1989. The Bank opened its first Augusta branch at 3111 Peach Orchard Road in December 1991 and its second Augusta branch at 1530 Walton Way in December 1992. The Bank became a subsidiary of the Company in February 1992 as a result of its holding company reorganization. The Company acquired FCS Financial Corporation and First Columbia Bank (“First Columbia”) on December 31, 1992. This allowed the Company to expand into neighboring Columbia County. In July 1993, First Columbia merged into the Bank, and the Bank now operates the former main office of First Columbia at 4105 Columbia Road, Martinez, Georgia as a branch. The Bank opened a second branch in Columbia County in November 1994 that is located in Evans, Georgia. In October 1995, the Bank opened its sixth banking office at 3133 Washington Road. The Company opened a full service branch in May 2001 in Martinez, Georgia, the third Columbia County branch. In 2003, the Bank purchased its eighth banking location in downtown Augusta, Georgia. It will be located in the Cotton Exchange historic building and will open for business in mid 2004.

The Bank was founded with an experienced management team, and that team has continued to expand with the growth of the Bank. The Bank’s President and Chief Executive Officer, R. Daniel Blanton, was involved in the organization of the Bank in 1988 and previously served with a predecessor to First Union National Bank, Georgia State Bank, for over 13 years. With the acquisition of First Columbia, the Bank obtained its Executive Vice President and Chief Operating Officer, Ronald L. Thigpen, who had served as Chief Executive Officer of First Columbia since 1991, and before that served in various capacities with First Union National Bank and its predecessors. J. Pierce Blanchard, Jr., Executive Vice President-Business Development, joined the team in 1994. He previously served for six years as President of Citizens Bank & Trust Company in Evans, Georgia, and had prior

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experience with First Union National Bank and its predecessors. The Bank’s senior loan officer and Group Vice President, Tom C. McLaughlin, has been associated with the Bank for twelve years, and worked previously with Mr. Blanton at Georgia State Bank, a predecessor to First Union National Bank. Regina W. Mobley, Group Vice President, Bank Operations has been with the Bank since the acquisition of First Columbia Bank. With over 26 years of bank operations experience, she previously served First Columbia Bank and C&S National Bank, as predecessor of Bank of America.

Market Area

The Bank’s market area includes Richmond and Columbia Counties and is centered in West Augusta. This area represents a significant portion of the Augusta-Richmond County, GA-SC metropolitan area. Augusta-Richmond County, GA-SC is one of 15 metropolitan statistical areas (MSA) in the United States and its 2002 population of 337,032 ranked 2nd in Georgia. The Augusta market area has a diversified economy based principally on government, transportation, public utilities, health care, manufacturing, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast. Significant medical facilities include the Medical College of Georgia, the University Hospital, Veteran’s Administration Hospital, Dwight D. Eisenhower Hospital, Gracewood State School and Hospital, Columbia/Augusta Regional Hospital and St. Joseph’s Hospital. Other major employers in the Augusta market area include the Fort Gordon military installation, E-Z Go (golf car manufacturer), International Paper Company (bleached paper board manufacturer), Thermal Ceramics (insulating material manufacturer), President Baking Company (cookie manufacturer), John Deere (tractor manufacturer) and Club Car (golf car manufacturer). The area is served by Interstate 20, which connects it to Atlanta, 140 miles to the west and Columbia, South Carolina, 70 miles to the east. Augusta is also served by a major commercial airport (Bush Field) and a commuter airport (Daniel Field). The average unemployment rate for the Augusta-Richmond County MSA was 5.6% in 2002. Between June 2002 and June 2003 (the latest date for which FDIC information is available), total commercial bank and thrift deposits in Richmond County increased 4.8% from $2.1 billion to $2.2 billion, and total commercial bank and thrift deposits in Columbia County increased 25.4% from $709.2 million to $889.2 million. Based on data reported as of June 30, 2003, the Bank has 14.19% of all deposits in Richmond County and 17.84% in Columbia County. In both Richmond and Columbia Counties, the Bank has 15.2% of all deposits and is the second largest depository institution. The demographic information as presented above is based upon information and estimates provided by the Selig Center for Economic Growth at the University of Georgia, Georgia Department of Labor and the Federal Deposit Insurance Corporation.

Lending Activities

General

The Bank offers a wide range of lending services, including real estate, commercial and consumer loans, to individuals, small to medium-sized businesses and professionals that are located in, or conduct a substantial portion of their business in, the Bank’s market area. The Bank’s total loans at December 31, 2003, were $432.8 million, or 73.4% of total interest-earning assets. An analysis of the composition of the Bank’s loan portfolio is set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Composition of Loan Portfolio.”

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Real Estate Loans. Loans secured by real estate are the primary component of the Bank’s loan portfolio, constituting $325.5 million, or 75.2% of the Bank’s total loans, at December 31, 2003. These loans consist of commercial real estate loans, construction and development loans, residential real estate loans, and home equity loans. See “-Consumer Loans.”

Commercial Real Estate Loans. At December 31, 2003, the Bank held $137.5 million of commercial real estate loans of various sizes secured by office buildings, retail establishments, and other types of property. These commercial real estate loans represented 31.8% of the Bank’s total loans at December 31, 2003. Loan terms are generally limited to five years and often do not exceed three years, although the installment payments may be structured on a 20-year amortization basis with a balloon payment at maturity. Interest rates may be fixed or adjustable. The Bank generally charges an origination fee. Management attempts to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied office and retail buildings where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. In addition, the Bank requires personal guarantees from the principal owners of the property supported with an analysis by the Bank of the guarantors’ personal financial statements in connection with a substantial majority of such loans. A number of the loans classified as commercial real estate loans are, in fact, commercial loans for which a security interest in real estate has been taken as additional collateral. These loans are subject to underwriting as commercial loans as described below.

Construction and Development Loans. Construction and development real estate loans comprise $90.3 million, or 20.9% of the Bank’s total loans at December 31, 2003.

A construction and development loan portfolio represents special problems and risks. The nature of that portfolio is that it requires additional administration and monitoring. This is necessary since most loans are originated as lines of credit and the draws under the line require specific activities which add value to the asset, such as progress on the completion of a building or the placement of utilities and roads in a development. This requires specialized knowledge on the part of our personnel to appraise and evaluate that progress, hence the higher level of administration and monitoring. The level of construction and development loans are representative of the character of the Bank’s market. Columbia County has been rated among the top five in the State of Georgia in population growth during each of the last four years. This growth has spawned a significant demand for residential housing in Columbia County. The Bank subjects this type of loan to underwriting criteria that include: certified appraisal and valuation of collateral; loan-to-value margins (typically not exceeding 75%); cash equity requirements; evaluations of borrowers’ cash flows and alternative sources of repayment; and a determination that the market is able to absorb the project on schedule.

To further reduce the risk related to construction and development loans, the Bank generally relies upon the long-standing relationships between its loan officers and the developer and contractor borrowers. In most cases these relationships exceed ten or more years. The Bank targets seasoned developers and contractors who have experience in the local market. Various members of the Bank’s Board of Directors have close contacts with the construction industry: Robert W. Pollard, Jr. owns and operates a lumber manufacturing company; E. G. Meybohm owns the largest local real estate brokerage firm; Larry S. Prather owns a utility and grading company and William J. Badger owns and operates a lumber company. Through these connections to the industry, the Bank attempts to monitor current economic conditions in the market place for residential real estate, and the financial standing and on-going reputation of its construction and development borrowers.

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Infrastructure development loans are generally made with an initial maturity of one year, although the Bank may renew the loan for up to two additional one-year terms to allow the developer to complete the sale of the lots comprising the property before requiring the payment of the related loan. These loans typically bear interest at a floating rate and the Bank typically charges an origination fee. These loans are repaid, interest only, on a monthly or quarterly basis until sales of lots begin, and then principal payments are made as each lot is sold at a rate allowing the Bank to be repaid in full by the time 75% of the lots have been sold. In order to reduce the credit risk associated with these loans, the Bank requires the project’s loan to value ratio (on an as completed basis) to be not more than 70%. The Bank experienced $25,000 in net loan charge-offs on these loans during 2003.

Residential construction loans are typically made for homes with a completed value in the range of $110,000 to $300,000. Loans for the lower-value homes are typically made for a term of six months, while loans for the larger homes are typically made for a term of nine to twelve months. Typically, these loans bear interest at a floating rate and the Bank collects an origination fee. The Bank may renew these loans for one additional term (equal to the original term) to allow the contractor time to market the home. In order to reduce the credit risk with respect to these loans, the Bank restricts the loans that are made for homes being built on a speculative basis, carefully manages its aggregate lending relationship with each borrower, and requires approval of the Loan Committee of the Board of Directors to lend more than $500,000 in the aggregate to any borrower and its related interests.

Residential Loans. The Bank originates, on a selective basis, residential loans for its portfolio on single-and multi-family properties, both owner-occupied and non-owner-occupied. At December 31, 2003, the Bank held $83.7 million of such loans, including home equity loans, representing 19.3% of the Bank’s loan portfolio, as compared to $75.2 million, or 19.0% of the Bank’s loan portfolio at December 31, 2002. There has been little growth in Residential Loans as most mortgage loans are sold in the secondary market. This portfolio includes, typically 15 or 30-year adjustable rate mortgage loans whose terms mirror those prevalent in the secondary market for mortgage loans or, less typically, floating rate non-amortized term loans for purposes other than acquisition of the underlying residential property. A limited number of fixed rate loans are maintained in the portfolio when there are compelling market reasons to do so. Generally, all fixed rate residential loans are sold into the secondary market. In the case of home equity loans and lines of credit, the underwriting criteria are the same as applied by the Bank when making a first mortgage loan, as described above. Home equity lines of credit typically expire ten years after their origination.

The Bank also originates residential loans for sale into the secondary market, an activity that began with the acquisition of First Columbia. Residential real estate lending for the purpose of sale of such loans was further expanded with the acquisition of Georgia Union Mortgage Company in May of 1997. The Bank further expanded its secondary market mortgage operations in June 2000 with the addition of experienced mortgage staff. The Bank moved its mortgage department from the Martinez Branch to its facilities located in the Operations Complex at 3515 Wheeler Road to accommodate this expansion. In September of 2000, the Bank acquired the mortgage origination offices of Prime Lending in Savannah, Georgia. In April of 2001, the Bank acquired the mortgage origination offices of Prime Lending in Nashville, Tennessee. The addition of experienced mortgage personnel well known to our management staff provides an opportunity to participate in that dynamic market. The Bank originates both fixed and variable rate residential mortgage loans for sale with servicing released. Loans originated for sale into the secondary market are approved for purchase by an investor prior to closing and the Bank takes no credit or interest rate risk with respect to these loans. The Bank generates loan

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origination fees, typically ranging from 1.0% to 1.5% of the loan balance, and servicing release fees, generally ranging from 0.25% to 0.75% of the loan balance, both of which are recognized as income when the loan is sold. The Bank limits interest rate and credit risk on these loans by locking the interest rate for each loan with the secondary investor and receiving the investor’s underwriting approval prior to originating the loan. The Bank had $14.0 million of such loans at December 31, 2003, representing 3.3% of the Bank’s total loans.

Commercial Loans. The Bank makes loans for commercial purposes in various lines of businesses. At December 31, 2003, the Bank held $56.5 million of these loans, representing 13.07% of the total loan portfolio, excluding for these purposes commercial loans secured by real estate. See “Real Estate Loans.” Equipment loans are made for a term of up to five years (more typically three years) at fixed or variable rates, with the loan being fully amortized over the term and secured by the financed equipment with a loan-to-value ratio of 80% or less. Working capital loans are made for a term typically not exceeding one year. These loans are usually secured by accounts receivable or inventory, and principal is either repaid as the assets securing the loan are converted into cash, or principal is due at maturity.

The Bank experienced net loan charge-offs on commercial loans of $249,000 during 2003 and $413,000 during 2002.

Consumer Loans. The Bank makes a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, and revolving lines of credit such as overdraft protection. At December 31, 2003, the Bank held $50.6 million of consumer loans, representing 11.7% of total loans. These loans typically carry balances of less than $25,000 and earn interest at a fixed rate. Non-revolving loans are either amortized over a period not exceeding 60 months or are ninety-day term loans. Revolving loans require monthly payments of interest and a portion of the principal balance (typically 2 to 3% of the outstanding balance). The Bank entered the indirect lending business in 1997 and currently purchases sales finance contracts from dealers for new and used automobiles and home improvements. At December 31, 2003, indirect loans outstanding totaled $24.0 million. The Bank experienced net loan charge-offs on consumer loans of $624,000 during 2003 and $547,000 during 2002.

Loan Approval and Review. The Bank’s loan approval policies provide for various levels of officer lending authority. When the aggregate amount of outstanding loans to a single borrower exceeds that individual officer’s lending authority, the loan request must be considered and approved by an officer with a higher lending limit or by the Directors’ Loan Committee. Individual officers’ lending limits range from $10,000 to $500,000 depending on seniority and the type of loan. Any loan in excess of the lending limit of senior bank officers must be approved by the Directors’ Loan Committee.

The Bank has a loan review procedure involving multiple officers of the Bank which is designed to promote early identification of credit quality problems. All loan officers are charged with the responsibility of rating all their loans and reviewing those loans on a periodic basis, the frequency of which increases as the quality of the loans decreases. The Bank’s Senior Vice President is charged with the responsibility of ensuring that all lending relationships of $300,000 and above are reviewed annually. In addition, the Credit Administration Department, under the direction of the Senior Credit Officer is involved in the analysis of all loans that require Directors Loan Committee approval.

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Deposits

The Bank offers a variety of deposit programs to individuals and to small to medium-sized businesses and other organizations at interest rates generally consistent with local market conditions. The following table sets forth the mix of depository accounts at the Bank as a percentage of total deposits at the dates indicated.

Deposit Mix

12/31/2003

The Bank accepts deposits at its main office and six branch banking offices, each of which maintains an automated teller machine. The Bank is a member of the “HONOR” network of automated teller machines, which permits Bank customers to perform certain transactions in many cities throughout Georgia and other regions. The Bank controls deposit volumes primarily through the pricing of deposits and to a certain extent through promotional activities such as “free checking”. The Bank also utilizes other sources of funding, specifically repurchase agreements and Federal Home Loan Bank borrowings and brokered certificates of deposit. Deposit rates are set weekly by executive management of the Bank. Management believes that the rates it offers are competitive with, or in some cases, slightly above those offered by other institutions in the Bank’s market area. The Bank does not actively solicit deposits outside of its market area.

Competition

The banking business generally is highly competitive, and sources of competition are varied. The Bank competes as a financial intermediary with other commercial banks, savings and loan associations, credit unions, mortgage banking companies, consumer finance companies, securities brokerages, insurance companies, and money market mutual funds operating in Columbia and Richmond Counties and elsewhere. In addition, recent legislative and regulatory changes and technological advances have enabled customers to conduct banking activities without regard to geographic barriers through computer-based banking and similar services.

Many of the financial organizations in competition with the Company have much greater financial resources, more diversified markets and larger branch networks than the Company and are able to offer similar services at varying costs with higher lending limits. In addition, with the enactment of federal and state laws affecting interstate and bank holding company expansion, there

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have been major interstate acquisitions involving Augusta financial institutions which have offices in the Company’s market area but are headquartered in other states. The effect of such acquisitions (and the possible increase in size of the financial institutions in the Company’s market areas) may further increase the competition faced by the Company. The Company believes, however, that it will be able to use its local independent image to its advantage in competing for business from certain Augusta individuals and businesses.

Employees

The Company had approximately 243 full-time equivalent employees at December 31, 2003. The Company maintains training, educational and affirmative action programs designed to prepare employees for positions of increasing responsibility in both management and operations, and provides a variety of benefit programs, including group life, health, accident and other insurance and retirement plans. None of the Company’s employees are covered by a collective bargaining agreement, and the Company believes its employee relations are generally good.

Supervision and Regulation

Both the Company and the Bank are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of their operations. These laws generally are intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to us.

The Company

Because the Company owns all of the capital stock of the Bank, it is a bank holding company under the federal Bank Holding Company Act of 1956. As a result, the Company is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve. As a bank holding company located in Georgia, the Georgia Department of Banking and Finance also regulates and monitors all significant aspects of the Bank’s operations.

Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or, substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and

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needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.

Under the Bank Holding Company Act, if adequately capitalized and adequately managed, the Company or any other bank holding company located in Georgia may purchase a bank located outside of Georgia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Georgia may purchase a bank located inside Georgia. In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits. Currently, Georgia law prohibits acquisitions of banks that have been incorporated for less than three years. Because the Bank has been incorporated for more than three years, this limitation does not apply to the Company or to the Bank.

Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is refutably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:

Our common stock is registered under the Securities Exchange Act of 1934. The regulations also provide a procedure for challenging the rebuttable presumption of control.

Permitted Activities. A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of more than 5% of the voting shares of any company engaged in the following activities:

Activities that the Federal Reserve has found to be so closely related to banking as to be a proper incident to the business of banking include:

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Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any of these activities or to terminate its ownership or control of any subsidiary when it has reasonable cause to believe that the bank holding company’s continued ownership, activity or control constitutes a serious risk to the financial safety, soundness, or stability of it or any of its bank subsidiaries.

In addition to the permissible bank holding company activities listed above, a bank holding company may qualify and elect to become a financial holding company, permitting the bank holding company to engage in activities that are financial in nature or incidental or complementary to financial activity. The Bank Holding Company Act expressly lists the following activities as financial in nature:

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, the Company must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve with 30 days’ written notice prior to engaging in a permitted financial activity. While the Company meets the qualification standards applicable to financial holding companies, the Company has not elected to become a financial holding company at this time.

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Support of Subsidiary Institutions. Under Federal Reserve policy, the Company is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy, the Company might not be inclined to provide it. In addition, any capital loans made by the Company to the Bank will be repaid only after its deposits and various other obligations are repaid in full. In the unlikely event of the Company’s bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

The Bank

The Bank is subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of our operations. These laws are generally intended to protect depositors and not shareholders. The following discussion describes the material elements of the regulatory framework that applies to us.

Because the Bank is a commercial bank chartered under the laws of the State of Georgia, it is primarily subject to the supervision, examination and reporting requirements of the FDIC and the Georgia Department of Banking and Finance. The FDIC and Georgia Department of Banking and Finance regularly examine the Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. Both regulatory agencies have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Additionally, the Bank’s deposits are insured by the FDIC to the maximum extent provided by law. The Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities and operations.

Branching. Under current Georgia law, the Bank may open branch offices throughout Georgia with the prior approval of the Georgia Department of Banking and Finance. In addition, with prior regulatory approval, the Bank may acquire branches of existing banks located in Georgia. The Bank and any other national or state-chartered bank generally may branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. Georgia law, with limited exceptions, currently permits branching across state lines through interstate mergers.

Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state. Currently, Georgia has not opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia. This provides a limited barrier of entry into the Georgia banking market, which protects us from an important segment of potential competition. However, because Georgia has elected not to opt-in, our ability to establish a new start-up branch in another state may be limited. Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if their home state has also elected to opt-in. Consequently, until Georgia changes its election, the only way we will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and

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critically undercapitalized) in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each of the other categories. At December 31, 2003, the Bank qualified for the well-capitalized category.

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized.

An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets at the time it became undercapitalized or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution to a lower capital category based on supervisory factors other than capital.

FDIC Insurance Assessments. The FDIC has adopted a risk-based assessment system for insured depository institutions’ that takes into account the risks attributable to different categories and concentrations of assets and liabilities. The system assigns an institution to one of three capital categories: (1) well capitalized; (2) adequately capitalized; and (3) undercapitalized. These three categories are substantially similar to the prompt corrective action categories described above, with the “undercapitalized” category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institution’s primary federal regulator provides to the FDIC and information that the FDIC determines to be relevant to the institution’s financial condition and the risk posed to the deposit insurance funds. Assessments range from 0 to 27 cents per $100 of deposits, depending on the institution’s capital group and supervisory subgroup. In addition, the FDIC imposes assessments to help pay off the $780 million in annual interest payments on the $8 billion Financing Corporation bonds issued in the late 1980s as part of the government rescue of the thrift industry. This assessment rate is adjusted quarterly and is set at 1.54 basis points of assessable deposits for the first quarter of 2004.

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the Federal Reserve or the FDIC shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

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Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. For example, under the Soldiers’ and Sailors’ Civil Relief Act of 1940, a lender is generally prohibited from charging an annual interest rate in excess of 6% on any obligation for which the borrower is a person on active duty with the United States military.

The Bank’s loan operations are also subject to federal laws applicable to credit transactions, such as the:

In addition to the federal and state laws noted above, the Georgia Fair Lending Act (“GAFLA”) imposes restrictions and procedural requirements on most mortgage loans made in Georgia, including home equity loans and lines of credit. On August 5, 2003, the Office of the Comptroller of the Currency issued a formal opinion stating that the entirety of GAFLA is preempted by federal law for national banks and their operating subsidiaries. GAFLA contains a provision that preempts GAFLA as to state banks in the event that the Office of the Comptroller of the Currency preempts GAFLA as to national banks. Therefore, the Bank and any of its operating subsidiaries that may be engaged in mortgage lending will be exempt from the requirements of GAFLA.

The Bank’s deposit operations are subject to:

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Capital Adequacy

The Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of the Company, and the FDIC, in the case of the Bank. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The Bank is also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2003, the Bank’s ratio of total capital to risk-weighted assets was 11.58% and our ratio of Tier 1 Capital to risk-weighted assets was 10.33%.

In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2003, our leverage ratio was 8.40%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

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Payment of Dividends

The Company is a legal entity separate and distinct from the Bank. The principal sources of the Company’s cash flow, including cash flow to pay dividends to its shareholders, are dividends that the Bank pays to its sole shareholder, the Company. Statutory and regulatory limitations apply to the Bank’s payment of dividends. If, in the opinion of the federal banking regulator, the Bank were engaged in or about to engage in an unsafe or unsound practice, the federal banking regulator could require, after notice and a hearing, that it stop or refrain from engaging in the questioned practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings. See “The Bank—Prompt Corrective Action.”

The Georgia Department of Banking and Finance also regulates the Bank’s dividend payments and must approve dividend payments that would exceed 50% of the Bank’s net income for the prior year. Our payment of dividends may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.

In 2003, the Bank declared $2.0 million in cash dividends payable to the Company. No cash dividends were declared in 2002. The Company paid a 10% stock dividend on August 29, 2003 and a 2:1 stock split on November 21, 2003.

Restrictions on Transactions with Affiliates

The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.

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The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Privacy

Financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties except under narrow circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers.

Consumer Credit Reporting

On December 4, 2003, the President signed the Fair and Accurate Credit Transactions Act (the FAIR Act), amending the federal Fair Credit Reporting Act (the FCRA). Although an amendment relating to consumer credit information provided in connection with employee investigations will become effective March 31, 2004, most of the amendments to the FCRA (the FCRA Amendments) will become effective in late 2004, depending on implementing regulations to be issued by the Federal Trade Commission and the federal bank regulatory agencies.

The FCRA Amendments include, among other things:

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The FCRA Amendments also will prohibit a business that receives consumer information from an affiliate from using that information for marketing purposes unless the consumer is first provided a notice and an opportunity to direct the business not to use the information for such marketing purposes (the “opt-out”), subject to certain exceptions. While the FCRA Amendments will limit the Company’s ability to share information with its affiliates for marketing purposes, the actual impact of these limitations will depend on the extent to which our customers elect to prohibit the use of their personal information for marketing purposes. We have no basis at this time to predict the volume of consumer “opt-outs.”

Prior to the effective date of the FCRA Amendments, the Company and its subsidiaries will implement policies and procedures to comply with the new rules.

Anti-Terrorism Legislation

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001, signed by the President on October 26, 2001, imposed new requirements and limitations on specified financial transactions and account relationships, intended to guard against money laundering and terrorism. Most of these requirements and limitations took effect in 2002. Additional “know your customer” rules became effective in June 2003, requiring the Bank to establish a customer identification program under Section 326 of the USA PATRIOT Act. The Company and its subsidiaries implemented procedures and policies to comply with those rules prior to the effective date of each of the rules.

Proposed Legislation and Regulatory Action

New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating or doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Effect of Governmental Monetary Polices

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. We cannot predict the nature or impact of future changes in monetary and fiscal policies.

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Item 2. Description of Property

The Company currently operates a main office, six branches and an operations center housed in a series of buildings adjacent to the main office. The principal administrative offices of the Company are located at 3530 Wheeler Road, Augusta, Georgia. The main office and three branch offices are located in Augusta, Georgia, two branches are located in Martinez, Georgia and one branch is located in Evans, Georgia.

With the exception of the Washington Road branch, each banking office is a brick building of Georgian architecture with a teller line, customer service area, offices for the Bank’s lenders, drive-in teller lanes, a vault with safe deposit boxes, and a walk-up or drive-up automated teller machine. The banking offices are generally 3,000 to 5,000 square foot buildings except for the main office and the Washington Road branch. The main office contains approximately 14,000 square feet of space. The Washington Road branch contains 1,800 square feet and was converted into a drive through only bank in May 2001 when the new Furys Ferry branch located in close proximity was opened. The new Furys Ferry branch is a 3,500 square feet, full-service banking office on Furys Ferry Road in Columbia County.

In 1997, the Company acquired 24,000 square feet of commercial office space located at 3515 Wheeler Road, across the street from the main office. The Company renovated 17,000 square feet of this newly acquired space to be utilized for a consolidation of all operational functions, including data processing, deposit operations, human resources, loan operations, security, credit administration, audit and accounting. The objective of the Company in acquiring this property and planning the renovation was to provide adequate space for existing operations and to meet future requirements necessitated by growth of the Company. Renovations were completed in June 1998 and operational functions were relocated. In June 2000, the mortgage operations were moved to this Operations Complex, and occupied 4,500 square feet. In August 2001, with the expiration of a 3,000 square foot tenant lease, the mortgage department expanded operations and now occupies a total of 6,000 square feet. In December 2003, the remaining 1,500 square feet that was leased was renovated and the construction lending department now occupies this location.

In November 2002, the Bank purchased approximately 23,400 square feet of commercial office space on Walton Way Ext., located in close proximity to the Operations Complex and Main Office. Approximately 10,400 square feet was renovated in 2003 to accommodate operational functions. Approximately 500 square feet of this property is used as a meeting room. All properties owned by the Company are adequately covered by the appropriate insurance for replacement value.

The Company’s automated teller machine network includes four drive-up machines located in major retail shopping areas in addition to those located in all branch offices.

See Note 5 to the Consolidated Financial Statements for additional information concerning the Bank’s premises and equipment and Note 7 to the Consolidated Financial Statements for additional information concerning the Bank’s commitments under various equipment leases.

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Item 3. Legal Proceedings

In the ordinary course of business, the Company and the Bank are parties to various legal proceedings. Although the amount of any ultimate liability with respect to such matters cannot be determined, in the opinion of management, there is no proceeding pending or, to the knowledge of management, threatened in which an adverse decision would result in a material adverse change to the consolidated results of operations or financial condition of the Company and the Bank.

Item 4. Submission of Matters to a Vote of Shareholders

There were no matters submitted to a vote of the shareholders of the Company during the fourth quarter of the Company’s fiscal year ended December 31, 2003.

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PART II

Item 5. Market for the Company’s Common Equity and Related Stockholder Matters

As of March 5, 2004, there were approximately 826 holders of record of the Company’s common stock. As of March 5, 2004, there were 5,247,204 shares of the Company’s common stock outstanding. Transactions in the Company’s common stock are generally negotiated through UBS PaineWebber and Robinson-Humphrey/Soloman Smith Barney Company, Inc. Both firms make a market in the common stock of the Company via the over-the-counter bulletin board. The following table reflects the range of high and low bid quotations, adjusted for stock dividends and splits, in the Company’s common stock for the past two years:

Georgia Bank Financial Corporation Stock Price

No cash dividends were paid on the common stock of the Company in 2002 or 2003. On January 23, 2004, the Company declared a cash dividend of $0.13 per share to shareholders of record on February 2, 2004. The Company currently has no source of income other than dividends and other payments received from the Bank. The amount of dividends that may be paid by the Bank to the Company depends upon the Bank’s earnings and capital position and is limited by federal and state law, regulations and policies.

Cash dividends on the Bank’s common stock may be declared and paid only out of its retained earnings, and dividends may not be declared at any time when the Bank’s paid-in capital and appropriated earnings do not, in combination, equal at least 20% of its capital stock account. In addition, the Georgia Department of Banking and Finance’s current rules and regulations require prior approval before cash dividends may be declared and paid if: (1) the Bank’s ratio of equity capital to adjusted total assets is less than 6%; (ii) the aggregate amount of dividends declared or anticipated to be declared in that calendar year exceeds 50% of the Bank’s net profits, after taxes but before dividends, for the previous calendar year; or (iii) the percentage of the Bank’s loans classified as adverse as to repayment or recovery by the Georgia Department of Banking and Finance at the most recent examination of the Bank exceeds 80% of the Bank’s equity as reflected at such examination.

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Item 6. Selected Consolidated Financial Data

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this discussion is to focus on significant changes in the financial condition and results of operations of the Company and the Bank during the past three years. The discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and related notes to the consolidated financial statements.

Overview

The Bank was organized by a group of local citizens and commenced business on August 28, 1989. It began operations with one branch. Today, the Bank operates six full service branches and one drive through branch in Richmond and Columbia counties in Augusta, Martinez, and Evans, Georgia. The Bank operates three mortgage origination offices in Augusta, Georgia, Savannah, Georgia, and Nashville, Tennessee. The Savannah, Georgia office also offers construction lending services. Bank and mortgage operations are located in Augusta, Georgia in two operations campuses located in close proximity to the main office in Augusta, Georgia. Trust and retail investment services are located in the main office. The Bank is Augusta’s largest community banking company.

Richmond and Columbia counties have a diversified economy based primarily on government, transportation, public utilities, health care, manufacturing, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast. The 2002 population of the Augusta-Richmond County, GA-SC metropolitan area was 337,032, the second largest in Georgia.

The Bank’s services include lending, residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Bank also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In both Richmond and Columbia counties, the Bank had 15.2% of all deposits and was the second largest depository institution at June 30, 2003, as cited from the Federal Deposit Insurance Corporation’s website. Securities sold under repurchase agreements are also offered. Additional services include trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on marketing and balance sheet considerations. The Bank continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on the customer relationship management philosophy. The Bank is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

The Bank’s primary source of income is from its lending activities. In 2003, the Bank’s second largest source of income was from gain on sale of loans in the secondary market. As interest rates rise, this source of income is expected to decrease, while loan income is expected to increase due to the increased loan volume. The Bank also generates income from its investment activities and service charges and fees on deposits. The Bank continues to concentrate on increasing trust service fees. Other significant contributors to income include retail investment income and increase in cash surrender value of bank-owned life insurance.

The Bank has experienced steady growth. Over the past five years, assets grew from $342.1 million at December 31, 1999 to $630.6 at December 31, 2003. From year end 1999 to year end 2003,

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loans increased $193.6 million, and deposits increased $200.8 million. Also, from 1999 to 2003, return on average equity increased from 13.48% to 15.62% and return on average assets increased from 1.21% to 1.31%. Net income for the year ended 1999 was $4.0 million compared to net income of $7.9 million at year end 2003. The Company has reached a level of maturity evidenced by long-term financial performance and stability that resulted in the January 23, 2004 declaration of its first quarterly cash dividend of $0.13 per share.

The Bank meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, paydowns from mortgage backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Bank funds loan and investment growth with core deposits, securities sold under repurchase agreements and wholesale borrowings. During inflationary periods, interest rates generally increase. When interest rates rise, variable rate loans and investments produce higher earnings, however, deposit and other borrowings interest expense and operating expenses also rise. The Bank monitors its interest rate risk in a ramp up and down annually 200 basis points (2%) scenario and a shock up and down 200 (2%) basis points scenario. The Bank monitors operating expenses through responsibility center budgeting. See “Interest Rate Sensitivity” below.

Critical Accounting Estimates

The accounting and financial reporting policies of Georgia Bank Financial Corporation and subsidiary conform to generally accepted accounting principles and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as a critical accounting estimate 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 five major categories: 1) identified losses for impaired loans; 2) general reserves for Classified/Watch loans; 3) general reserves for loans with satisfactory ratings; 4) general reserves based on economic and market risk qualitative factors, and 5) an unallocated amount. Risk ratings are initially assigned in accordance with the Bank’s loan and collection policy. An organizationally independent department reviews grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management 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 based upon the present value of future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral as the measure for the amount of the impairment.

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Impairment losses are included in the allowance for loan losses through a charge to the provision for losses on loans. Subsequent recoveries are added to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal and then to interest income. 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 call report codes. The qualitative factors are based upon economic, market and industry conditions that are specific to the Company’s local two county markets. These qualitative factors include, 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. These allocations for the qualitative factors are included in the various individual components of the allowance for loan losses. The qualitative factors 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 factors 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 Bank is committed to developing more historical data in the future to reduce the dependence on these qualitative factors. 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. While the Company has 75.2% of its loan portfolio secured by real estate loans, this percentage is not significantly higher than in previous years. Commercial real estate comprises 31.8 % of the loan portfolio and is primarily owner occupied properties where the operations of the commercial entity provide the necessary cash flow to service the debt. For this portion of real estate loans, repayment is not dependent upon liquidation of the real estate. Construction and development (20.9%) has been an increasingly important portion of the real estate loan portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions. The residential category represents those loans that the Company chooses to maintain in its portfolio rather than selling into the secondary market for marketing and competitive reasons. The residential held for sale comprises loans that are in the process of being sold into the secondary market. The credit has been approved by the investor and the interest rate locked so the Company takes no credit or interest rate risk with respect to these loans. The Company has no large loan concentrations to individual borrowers or industries. Only 11.7% of the Company’s portfolio consists of consumer loans. Unsecured loans at December 31, 2003 were $8.9 million. 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.

Please see “Provision for Loan Losses, Net Charge-offs, Non-Performing Assets and Allowance for Loan Losses” for a further discussion of the Company’s loans, loss experience, and methodology in determining the allowance.

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Results of Operations

The Company achieved record income of $7.9 million in 2003. This was a $1.9 million, or 32.0%, increase over 2002. Gain on sale of mortgage loans in the secondary market was the principal contributor, representing an increase of $3.0 million over 2002, to this increase. The Company anticipates a decrease in the gain on sale of mortgage loans as interest rates rise. Additionally, the Company experienced loan growth of $36.0 million in 2003, which despite the lower rates, resulted in an increase in loan interest income of $973,000 over 2002. Loan fees increased $328,000 over 2002. There was a $16.7 million increase in investments in 2003. However, investment interest income decreased $285,000 due to the lower interest rates. Additionally, securities at low interest rates were sold at a loss to increase future income by purchasing higher rate investments. This loss on sale of investments coupled with calls on high interest rate investments resulted in net investment losses of $203,000.

The Company had deposit growth of $44.4 million, or 10.7% in 2003. Despite the higher deposit volume, deposit expense decreased $1.4 million, due to a lower interest rate environment in 2003. The Company was in a $10.4 federal funds purchased position at 2003 year end, as compared to a $3.7 million federal funds sold position at 2002 year end. The Company has used federal funds purchased as a low interest rate funding source during 2003. The Company has also continued to utilize wholesale borrowings, including Federal Home Loan Bank borrowings, SunTrust Robinson Humphrey repurchase agreements, and brokered CDs, which totaled $76.0 million at year end. The $2.7 million increase in salaries and employee benefits was primarily the result of additional commissions and bonuses related to the gain on sale of mortgage loans in the secondary market. However, new employees to accommodate growth and additional salary continuation expense also contributed to the increase over the prior year. Other operating expenses increased $462,000 over 2002, primarily due to additional marketing, processing and loan costs. The Company continues to monitor operating expenses and uses responsibility center budgeting to assist in this endeavor. The operating efficiency ratio of 63.04% in 2003 is a decrease of .98% from 2002. In addition, trust services continue to grow and trust fees increased $126,000 over 2002. Total assets increased $60.8 million, or 10.7%, in 2003 compared to 2002, primarily due to loan and investment growth.

The earnings performance of the Company is reflected in its return on average assets and average equity of 1.31% and 15.62%, respectively, during 2003 compared to 1.14% and 13.95%, respectively, during 2002. The return on average assets and average equity was 1.02% and 12.19%, respectively, in 2001. Basic net income per share on weighted average common shares outstanding improved to $1.51 in 2003 compared to $1.15 in 2002 and $0.87 in 2001. Diluted net income per share on weighted average common and common equivalent shares outstanding improved to $1.48 in 2003 compared to $1.13 in 2002 and $0.87 in 2001. A 10% stock dividend was paid on August 29, 2003 and a 2:1 stock split was paid November 21, 2003. A 15% stock dividend was paid by the Company on August 31, 2001.

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Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, average yields earned and rates paid on those respective balances, and the resulting interest income and interest expense for the periods indicated:

Average Balances, Income and Expenses, Yields and Rates

The increase in average loans of $56.4 million and the increase in average investments of $16.1 million were funded by increases in average deposits of $61.9 million, federal funds purchased and securities sold under repurchase agreements of $7.2 million, and Federal Home Loan Bank borrowings of $1.3 million. For 2002, average total assets were $526.3 million, a 17.1% increase over 2001. Average interest earning assets for 2002 were $499.3 million, or 94.9% of average total assets.

Interest income is the largest contributor to income. Interest income on loans, including loan fees, increased $1.3 million from 2002 to $25.8 million. The increase in loan interest income resulted from the increased loan volume, despite the lower interest rates. This increase in loan interest income was somewhat offset by a decrease in investment income due to the lower investment yields in 2003,

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despite the increase in investment volume. Interest expense decreased $1.5 million from 2002 to $9.7 million in 2003. Despite higher volumes of interest-bearing liabilities, interest expense decreased due to lower interest rates. The result was an increase in net interest income of $2.4 million or 12.1% in 2003 from 2002. Average yields on interest-earning assets decreased to 5.66% in 2003, compared to 6.28% in 2002.

Net interest income increased $2.9 million in 2002 compared to 2001 as a result of the growth in the volume of average earning assets somewhat offset by a decrease in interest rates. Interest earning assets averaged $499.3 million in 2002, an increase of 34.1%, from the $372.2 million averaged in 2001. Average yields on earning assets decreased to 6.28% in 2002, compared to 7.76% in 2001.

A key performance measure for net interest income is the “net interest margin”, or net interest income divided by average interest-earning assets. Unlike the “net interest spread”, the net interest margin is affected by the level of non-interest sources of funding used to support interest-earning assets. The Company’s net interest margin decreased to 3.97% in 2003 from 4.04% in 2002. In 2001, the net interest margin was 4.13%. The net interest margin deteriorated in 2003 and 2002, as the average rate earned on interest earning assets decreased quicker than the average rate on interest-bearing deposits. The high level of competition in the local market for both loans and deposits continues to influence the net interest margin. The net interest margin continues to be supported by an increasing amount of demand deposits which provide a noninterest-bearing source of funds and helps prevent further deterioration in the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing sources of funds. The net interest spread eliminates the impact of noninterest-bearing funds and gives a direct perspective on the effect of market interest rate movements. As a result of changes in interest rates in 2003, the net interest spread increased 2 basis points to 3.63% in 2003. The 2002 net interest spread of 3.61% represented an increase from 2001’s 3.47%.

Changes in the net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits. The following table: “Analysis of Changes in Net Interest Income” indicates the changes in the Company’s net interest income as a result of changes in volume and rate from 2003 to 2002, and 2002 to 2001. The analysis of changes in net interest income included in the following table indicates that on an overall basis in 2003 and 2002, the increase in the balances or volumes of interest-earning assets created a positive impact in net income while the decreases in interest rates of interest-earning assets created a negative impact on net interest income. The decreases in the interest rates of interest-bearing liabilities more than offset the increase in the balances or volume of interest-bearing liabilities. In 2001, the volume of interest-earning assets had a positive impact on the net interest income while decreases in interest rates had a negative impact on interest income.

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Analysis of Changes in Net Interest Income

The variances for each major category of interest-earning assets and interest-bearing liabilities are attributable to (a) changes in volume (changes in volume times prior year rate), (b) changes in rate (changes in rate times prior year volume) and (c) combined (changes in rate times the change in volume).

NonInterest Income

Noninterest income consists of revenues generated from a broad range of financial services and activities, including gains on sales of loans, service charges on deposit accounts, fee-based services, and products where commissions are earned through sales of products such as real estate mortgages, retail investment services, trust services, and other activities. In addition, gains or losses realized from the sale of investment securities are included in noninterest income.

Noninterest income for 2003 was $23.6 million, an increase of $2.9 million or 25.3% from 2002. The increase is primarily attributable to a $3.0 million increase in the gain on sale of loans in the secondary mortgage market. This $3.0 million increase is a product of the lower interest rates in 2003 increasing both home purchases and mortgage refinancings. Service charges and fees on deposits were $4.5 million for the year ended 2003 and constitute the second largest contributor to noninterest income. Trust services continued to grow and accounted for $353,000 of the year end 2003 balance while retail investment income accounted for $280,000.

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Noninterest income for 2002 was $11.4 million, an increase of $3.6 million or 46.1% from 2001. The increase is primarily attributable to a $2.0 million increase in the gain on sale of loans in the secondary mortgage market. This $2.0 million increase is a product of the lower interest rates increasing both home purchases and mortgage refinancings, as well as the expanded mortgage operations in Augusta and Savannah, Georgia and Nashville, Tennessee. Service charges and fees on deposits increased $1.4 million, primarily related to increases in NSF fees due to the Bounce Overdraft Protection program implemented in October 2001 and increases in service charges related to higher volumes of deposits. Trust income increased $94,000 in 2002 compared to 2001 due to the second full year of operations. Investment security gains increased $138,000, retail investment income increased $46,000 due to increased volume, and miscellaneous income decreased $80,000 due to a conversion allowance from a check vendor in 2001, decreases in ATM surcharge income, and fees earned from an official check processing agreement slightly offset by an increase in credit card merchant fees.

The following table presents the principal components of noninterest income for the last three years:

Noninterest Income

Noninterest Expense

Noninterest expense totaled $23.6 million in 2003, an increase of 16.2% from 2002 noninterest expense of $20.3 million. Salaries and employee benefits account for $2.7 million of this increase. The increase in salaries and employee benefits was the result of increases in mortgage commissions and salaries, additional employees in 2003 due to the Company’s continued growth and expansion, and increases in salary continuation expense and medical and dental insurance. Other operating expenses increased $462,000, an increase of 8.5% from 2002 primarily due to increases in marketing, processing and mortgage loan costs. While the increase in marketing is due to the Company’s decision to increase marketing expenditures, processing expense increased primarily to ATM processing expenses and retail checking expenses related to new product development. Loan costs increased primarily due to the increase in the volume of mortgage loans sold in the secondary market.

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Noninterest expense totaled $20.1 million in 2002, an increase of 20.8% from 2001 noninterest expense of $16.7 million. Salaries and employee benefits account for $2.2 million of this increase. The increase in salaries and employee benefits was the result of increases in mortgage commissions, additional employees in 2002 due to the Company’s continued growth and expansion, an increase in the percentage contributed to the 401K plan and the incentive compensation plan, as well as normal increases in salaries and benefits. Other operating expenses increased $1.2 million, an increase of 27.0% from 2001 primarily due to increases in professional fees, contributions, loan costs, processing, and staff development.

The Company has improved its ability to monitor expenditures in all organizational units by implementing more specific cost accounting and reporting. In 2002, the Company implemented a departmental budgeting system. In 2004, the Company will implement Customer, Product and Organization profitability systems. The implementation of these systems emphasizes that management is committed to a continuing emphasis on expense control. The following table presents the principal components of noninterest expense for the years ended December 31, 2003, 2002 and 2001.

Noninterest Expense