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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended December 31, 2004

OR

For the transition period from              to             

Commission file number 000-33071

Charter Financial Corporation

(Exact name of registrant as specified in its charter)

600 Third Avenue, West Point, Georgia 31833

(Address of principal executive offices)

(Zip Code)

(706) 645-1391

(Registrant’s telephone number including area code)

NA

(Former name, former address and former fiscal year, if changed from last Report)

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

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

As of January 28, 2005, the registrant had 19,830,705 shares of common stock, $0.01 par value, outstanding. Of such shares outstanding, 15,857,924 shares were held by First Charter, MHC, the registrant’s mutual holding company and 3,972,781 shares were held by the public and directors, officers and employees of the registrant.

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FORWARD LOOKING STATEMENTS

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

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

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2004 and September 30, 2004

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Three Months Ended December 31, 2004 and 2003

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended December 30, 2004 and 2003

(unaudited)

See accompanying notes to the unaudited consolidated financial statements.

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Charter Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(1) Basis of Presentation

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

The accompanying unaudited consolidated financial statements include the accounts of Charter Financial and its wholly-owned subsidiaries, CharterBank and Charter Insurance Company (which was liquidated into Charter Financial as of December 31, 2004), as of December 31, 2004 and September 30, 2004, and for the three-month periods ended December 31, 2004 and 2003. Significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements for the three months ended December 31, 2004 and 2003 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in Charter Financial’s annual report on Form 10-K for the year ended September 30, 2004.

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

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

(2) Plan of Reorganization

On October 16, 2001, CharterBank converted from a federally-chartered mutual savings and loan association into a two-tiered mutual holding company structure and became a wholly-owned subsidiary of Charter Financial. Charter Financial sold 3,964,481 shares of its common stock to the public, representing 20% of the outstanding shares, at $10.00 per share and received net proceeds of $37.2 million. Charter Financial contributed 50% of the net proceeds from the initial public offering to CharterBank. An additional 15,857,924 shares, or 80% of the outstanding shares of Charter Financial, were issued to First Charter, MHC. An Employee Stock Ownership Plan (ESOP) was established and such ESOP acquired 317,158 shares of Charter Financial in the offering, using the proceeds of a loan from Charter Financial. The ESOP loan is recorded as unearned compensation reducing stockholders’ equity of Charter Financial. The net proceeds of the offering, adjusted for the ESOP, totaled approximately $34.0 million.

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

(3) Earnings per Share

Earnings per share are calculated according to the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 128 “Earnings per Share.” ESOP shares are only considered outstanding for earnings per share calculations when the shares have been committed to be released. Presented below are the calculations for basic and diluted earnings per share for the three months ended December 31, 2004 and 2003:

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(4) Comprehensive Income

The primary component of other comprehensive income for the Company is net unrealized gains and losses on Freddie Mac common stock and investment and mortgage-backed securities available for sale. The table below summarizes total comprehensive income for the three months ended December 31, 2004 and 2003.

(5) Stock-Based Compensation

During 2003, the Company amended the 2001 Stock Option Plan (the “Plan”) to allow for stock option awards for up to 707,943 shares of the Company’s common stock to eligible directors and employees. At December 31, 2004, the Company had granted 291,250 options under the Plan, of which 3,400 have been exercised and 1,250 forfeited. Under the provisions of the Plan, the option price is determined by a committee of the board of directors at the time of grant and may not be less than 100% of the fair market value of the common stock on the date of grant of such option. When granted, these options vest over a five-year period. The Company accounts for the Plan under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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As no options have been granted since September 30, 2004, please see note number 17 in our 10K for the assumptions used in the evaluation for the options outstanding.

(6) Intangible Assets, Net

Intangible assets, net include cost in excess of net assets acquired and deposit premiums recorded in connection with the acquisition of EBA Bancshares, Inc. as follows:

At December 31, 2004 and September 30, 2004, other intangible assets are summarized as follows:

The deposit premium is being amortized using the double-declining balance method over thirteen years. Charter Financial recorded amortization expense related to the deposit premium of $50,593 and $57,543 for the three months ended December 31, 2004 and 2003, respectively.

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(7) Derivative Instruments – Covered Call Program

At December 31, 2004, the Company had covered call options on Freddie Mac common stock outstanding on 247,700 shares for which it received $292,611 in premium. At December 31, 2004 and September 30, 2004, the fair value of the options outstanding were $609,973 and $92,654, respectively, which at December 31, 2004 included a mark-to-market loss of $317,362 and deferred income of $292,611 and at September 30 included a mark-to-market gain of $105,190 and deferred income of $197,844. The Company has recorded the unrealized loss and gain in the income statement as the derivative instruments are not accounted for as hedges. The mark to market loss or gain is recorded in noninterest income of our financials. During the three months ended December 31, 2004, holders of the covered call options exercised their options to purchase 37,500 shares of Freddie Mac common stock. The Company recorded a pretax gain of $2,576,777 on the sale of these shares to the option holders.

Item 2

Management’s Discussion and Analysis of Financial

Condition and Results of Operations

Overview

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

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Management Strategy

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

Expanding Retail Banking Operations. Our retail banking strategy is to operate as a well-capitalized community bank dedicated to providing quality products, excellent service, and a superior customer experience at competitive prices. We have sought to implement this strategy by concentrating on our core product offerings, including residential and commercial mortgage loans and a variety of checking and saving products, while at the same time broadening our product lines and services, expanding delivery systems for our customers, and filling in our branch network. We are planning to convert our loan and deposit application systems to new systems during the second quarter of fiscal 2005. The new systems should improve our customer experience at a similar or lower cost. We are also planning to consolidate our support and management functions into a new facility in West Point, Georgia during the second and third quarters of fiscal 2005. This consolidation from five facilities to one should help us improve our focus on our customer’s experience at a similar to lower cost. The combined acquisition and set up cost is expected to total about $1.5 million.

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Managing Our Freddie Mac Common Stock Investment. We manage our Freddie Mac common stock in several ways. Over the past ten years our total annual return on Freddie Mac common stock has averaged approximately 21%. Dividends on our Freddie Mac common stock are an important component of our shareholder value. Seventy percent of the Freddie Mac dividends are excluded from Charter Financial’s taxable income through the corporate dividends received exclusion. The Freddie Mac dividend, when combined with the 70% corporate dividend exclusion and the 15% personal tax rate reduction on dividends received by individuals, creates a tax efficient means for our stockholders to receive value from our Freddie Mac common stock investment. First Charter, MHC and the Office of Thrift Supervision (“OTS”) make their own determination with respect to each dividend payment as to whether that dividend payment to First Charter, MHC will be waived. In 2003, we implemented a program of selling covered call options on the Freddie Mac common stock as a means of enhancing our return on this investment. We continue to review our investment in Freddie Mac common stock in light of existing conditions and what is in the best interests of our shareholders.

Managing our Capital. The third major component of our strategy is capital management. We increased our capital leverage with the additional retail assets and deposits acquired in the acquisition of EBA Bankshares, Inc. and its wholly owned banking subsidiary, Eagle Bank of Alabama (the “Eagle Bank Acquisition”). While our current retail focus is increasing market share within our existing market, we regularly evaluate expanding our capital leverage by extending the market area through de novo branching or acquisitions. We maintained our wholesale leverage of mortgage securities and borrowings. Wholesale leverage generally enhances income, but not franchise value, and thus is a low priority capital management tool for us. During the current quarter, we declared a $2.00 per share special dividend. During the third quarter of fiscal 2004, we increased our quarterly dividend from 20 cents to 25 cents per share. Our capacity to pay dividends is enhanced when First Charter, MHC is willing and permitted by the Office of Thrift Supervision to waive receipt of its portion of the dividends. We continue to evaluate our dividend policy and the appropriateness of special dividends and/or share repurchases.

General

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

Charter Financial’s principal business is its ownership of CharterBank. Charter Financial also owns 2,012,500 shares of Freddie Mac common stock. Additionally, CharterBank owns 2,555,000 shares of Freddie Mac common stock. On a consolidated basis, Charter Financial owns 4,567,500 shares of Freddie Mac common stock.

Our balance sheet at December 31, 2004 contains $336.6 million of Freddie Mac common stock, of which $330.4 million is unrealized gain. Noninterest-bearing liabilities include $127.6 million

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in deferred taxes related to the unrealized gain on the Freddie Mac common stock. Accumulated other comprehensive income includes $202.9 million representing the net unrealized gain on the Freddie Mac common stock.

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

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

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

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

Capital and Capital Management

CharterBank has traditionally been a well-capitalized savings association. The following table sets forth the tier 1 capital levels, risk-based capital levels, and ratios for the past several quarters.

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At December 31, 2004 and September 30, 2004, we exceeded each of the applicable regulatory capital requirements. Tier 1 capital as a percent of total regulatory assets is consistently above the “well-capitalized” requirement of 5.0%. Total risk-based capital ratios significantly exceed the applicable “well-capitalized” requirement for risk-based capital of 10.0%. CharterBank exceeded the “well-capitalized” level of its various regulatory capital requirements by amounts ranging from $34.4 million to $94.6 million at December 31, 2004.

We announced a special dividend of $2.00 per share to be paid in February 2005. We initiated a quarterly dividend of $0.10 per share in June 2002, doubled the dividend in June 2003 and increased it again to $0.25 per share in June 2004. The MHC waived its receipt of dividends in all periods. Our Board of Directors will determine future dividends as well as other capital management strategies such as additional leverage, stock repurchases and special dividends. The Board of Directors will consider, among other factors, capital levels, results of operations, tax considerations, regulatory and regulatory business plan considerations, industry standards and economic conditions in determining such future dividends.

Charter Financial’s reporting of certain information under generally accepted accounting principles in the United States of America (“GAAP”) is not necessarily reflective of the process considered by the Board of Directors in connection with its dividend policy. Included in GAAP earnings per share calculations are the average shares held by Charter Financial’s majority shareholder, the MHC. The MHC has waived its right to receive dividends from Charter Financial since its formation and intends to continue to do so, subject to the approval of the OTS. The following table reconciles the total voting shares with the number of shares receiving dividends as adjusted for the waiver of dividends by the MHC at December 17, 2004 and shows that the number of shares that typically receive dividends is a fraction, approximately one-fifth, of the total voting shares.

As indicated in the table above, we paid dividends on the 3,493,856 shares held by our minority stockholders. The regular quarterly dividend of $0.25 per share declared in December totaled $873,464 or approximately 30% of our net income of $2,924,116 for the quarter.

Our capacity to pay dividends is limited by several factors including cash availability at Charter Financial, tax considerations, regulatory requirements and the MHC’s willingness and ability to waive its dividends on the approximately 80% of our stock that it owns. Historically, the MHC has waived its portion of the dividends we pay and intends to waive future dividends. The MHC is required to obtain approval of the OTS prior to waiving a dividend. The OTS considers a variety of factors in approving dividend waivers including its assessment of the rights of the MHC’s stakeholders.

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Charter Financial’s primary sources of cash are distributions from CharterBank, dividends on the Freddie Mac stock it owns and proceeds from possible sales of Freddie Mac common stock. CharterBank is generally permitted by the OTS to distribute its current year’s and prior two years’ undistributed earnings if CharterBank is well capitalized after the distribution. Distributions in excess of this level require additional approval from the OTS.

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

Accumulated other comprehensive income (“unrealized equity”) is comprised of net unrealized holding gains on securities available for sale. Unrealized equity at December 31, 2004 was $203.0 million, a $22.6 million increase from $180.4 million at September 30, 2004. This increase was attributable to the $65.24 to $73.70 price per share increase in our investment in Freddie Mac common stock. The following table shows realized and unrealized equity and the Freddie Mac common stock price for the past several quarters. A comparison of the unrealized equity and Freddie Mac common stock price demonstrates the relationship between the price of Freddie Mac common stock and our unrealized equity.

As indicated in the following tables, other comprehensive income was $22.7 million for the three months ended December 31, 2004, compared to other comprehensive income of $17.4 million for the three months ended December 31, 2003. The other comprehensive income for the period ended December 31, 2003 was primarily the result of the increase in the price of Freddie Mac common stock during the period. For the period ended December 31, 2004, the income was the result of the increase in the price of Freddie Mac stock which was partly offset by the unrealized loss on mortgage securities due to higher interest rates. The price of Freddie Mac common stock increased by $8.46 and $5.97 per share for the quarters ended December 31, 2004 and December 31, 2003, respectively.

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We believe that our ownership of Freddie Mac common stock continues to present attractive appreciation and dividend growth potential. Since the sale of Freddie Mac common stock would result in the realization of a substantial current tax liability for us, we have no current plans to liquidate a significant portion of our Freddie Mac common stock investment. We continually evaluate our investment in Freddie Mac common stock, taking into account the appreciation and dividend potential of the Freddie Mac common stock, the income tax impact of a strategy, alternative investments or uses of sales proceeds and the portion of our capital that the after-tax unrealized gain represents.

In June 2003, we implemented a program of writing covered call options on Freddie Mac common stock with 250,000 shares of stock. When we write a call option, we receive a fee or premium. If the call option expires unexercised, we retain this premium and record it as income. If the call option is exercised, the premium is added to the sale proceeds and increases the gain on the sale of Freddie Mac stock. If a call option is in the money as the maturity of the call approaches, we evaluate the economics of allowing the call to be exercised or buying the call to prevent its exercise. The decision whether to allow the exercise or to repurchase the option is based on several factors including the strike price at which the option would be exercised, alternative investments for the proceeds of the sale, tax considerations, the proportion of realized to unrealized equity and the cost to repurchase the option. To the extent that the premium on unexercised options exceeds the premium when we repurchase a call option to prevent its exercise, and thus the sale of the underlying Freddie Mac stock, the net premiums enhance our income and our return on investment. We entered into the pilot program with a limited number of shares to improve our understanding of the mechanics and the economics of the program. We expanded the program to 400,000 shares during the December 2004 quarter. During the three months ended December 31, 2004, we sold 37,500 shares of Freddie Mac common stock, and during the year ended September 30, 2004, we sold 35,000 shares of Freddie Mac common stock through exercises of call options.

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Critical Accounting Policies

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

These policies are described in Note 1 to the consolidated financial statements which were presented in the Company’s 2004 annual report on Form 10-K. Of these policies, management believes that the accounting for the allowance for loan losses is one of the most critical. Please see “Asset Quality” for a further discussion of the Company’s methodology in determining the allowance.

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

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

The Company segments its allowance for loan losses into the following four major categories: 1) identified losses for impaired loans; 2) general reserves for Classified/Watch loans; 3) general reserves for loans with satisfactory ratings; and 4) an unallocated amount. Risk ratings are initially assigned in accordance with the Bank’s loan and collection policy. On an ongoing basis, an organizationally independent department reviews grade assignments and considers current information regarding a borrowers’ financial condition and debt service capacity, collateral condition and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan, generally based on the fair value of the collateral as the measure for the amount of the impairment. Impaired and Classified/Watch loans are aggressively monitored. The reserves for loans rated satisfactory are further subdivided into various types of loans. The Company has developed specific quantitative reserve factors which it applies to each loan type to develop reserve components. These reserve factors are based upon economic, market and industry conditions that are specific to the Company’s local markets and consider, but are not limited to, national and local economic conditions, bankruptcy trends, unemployment trends, loan concentrations, dependency upon government installations and facilities, and competitive factors in the local market. They are subjective in nature and require considerable judgment on the part of the Bank’s management. However, it is the Bank’s opinion that these items do represent uncertainties in the Bank’s business environment that must be factored into the Bank’s analysis of the allowance for loan losses. The unallocated component of the allowance is established for losses that specifically exist in the remainder of the portfolio, but have yet to be identified.

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Management believes that the allowance for loan losses is adequate. The loan portfolio is broadly composed of residential real estate loans of 42.8%, construction loans of 7.2%, commercial purpose loans of 44.0% and consumer loans of 6.0%. A total of 86.2 % of the Bank’s loan portfolio is secured by real estate loans.

In recent years, the Bank has made an effort to build its business lines, and loans secured by commercial real properties now make up 36.0% of the loan portfolio. The Company’s largest funded real estate secured loan is a $6.0 million loan on a medical office building in the metro Atlanta area. The largest industry concentration of commercial purpose loans is the hospitality industry where we have an aggregate of $22.4 million in loans to various hotel and motel operations. In a significant number of the loans secured by commercial properties, the properties are occupied by the owner and the ongoing operations of the business provide the cash to service the debt. Construction and development loans, which comprise 7.2% of the real estate loan portfolio, are carefully monitored since the repayment is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions.

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

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

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

Income taxes are a material expense for the Company. The Company receives a dividends received deduction for tax purposes on dividend income from our investment in Freddie Mac

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common stock. This deduction is the lesser of 70% of dividends received or 70% of taxable income before the dividends received deduction. The difference between 70% of taxable income and 70% of dividends can be significant. Since the Company does not file a consolidated tax return, this determination is made at the individual company level. The actual deduction will be determined at September 30, 2005 based on the level of dividends and the level of taxable income.

Comparison of Financial Condition at December 31, 2004

and September 30, 2004

At December 31, 2004 our total assets were $1.1 billion, up $59.0 million from September 30, 2004.

The risk and return characteristics of loans vary significantly by the type of loan. The following table shows the actual balance of loans outstanding at December 31, 2004 as well as the average balances of loans outstanding for the past five quarters beginning with December 31, 2003.

The nonresidential real estate loan growth reflects our strategy to increase this portion of the portfolio. Future growth of our nonresidential real estate portfolio depends on interest rates, economic conditions and competitive pricing of these loans within our market.

Mortgage-backed securities and collateralized mortgage obligations increased 7.2% from $378.4 million at September 30, 2004 to $405.8 million at December 31, 2004. The market value of Freddie Mac common stock increased $36.2 million, or 12.1%, from $300.4 million to $336.6 million as the price per share of Freddie Mac common stock increased from $65.24 at September 30, 2004 to $73.70 at December 31, 2004.

Total deposits declined from $279.6 million at September 30, 2004 to $270.2 million at December 31, 2004 as the Bank has de-emphasized certificates of deposit as sources of funding and focused on attracting and retaining core deposits in order to reduce interest expense. However, as shown in the following table, over the last two years, core deposits (checking, money market and savings accounts) have increased from $68.1 million to $122.5 million. Core deposits at September 30, 2004 included a couple of large balance short-term deposits, which were not retained at December 31, 2004. Approximately $21.9 million of the increase in the March 2003 quarter was a result of the Eagle Bank Acquisition. Fees on core deposit accounts increased from $356,000 in the March 2003 quarter to $670,000 in the December 2004 quarter.

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Management will continue to use FHLB advances and repurchase agreements to fund the securities and loan portfolio growth. The maturity dates of new advances will be determined at the time the advance is taken down and will be based on interest rates, the Company’s interest rate risk profile and other factors. Repurchase agreements are generally less than 90 days to maturity and carry rates at or slightly above LIBOR. Borrowings increased $29.8 million or 7.6% from $392.8 million at September 30, 2004 to $422.6 million at December 31, 2004 primarily to fund the increased balances of mortgage securities.

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

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

Total stockholders’ equity increased to $290.2 million at December 31, 2004 from $272.5 million at September 30, 2004. Unrealized equity increased to $203.0 million at December 31, 2004 from $180.4 million at September 30, 2004, primarily as a result of the price of Freddie Mac stock increasing to $73.70 per share at December 31, 2004 from $65.24 at September 30, 2004. Realized equity decreased to $87.2 million at December 31, 2004 from $92.1 million at September 30, 2004. This decrease was due to the special dividend of $2.00 per share.

Comparison of Operating Results for the Three Months

Ended

December 31, 2004 and 2003

General

Net income was $2.9 million for the three months ended December 31, 2004, which was $1.2 million higher than the net income of $1.7 million for the three months ended December 31, 2003. The most significant factor in the net income increase was significantly higher noninterest income which included a $2.6 million gain on the sale of Freddie Mac common stock related to our covered call program compared to the December 2003 quarter which included a $533,000 gain on the sale of Freddie Mac common stock related to our covered call program.

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Net Interest Income

As shown in the following table, net interest income increased $463,000 from $5.2 million for the three months ended December 31, 2003 to $5.6 million for the three months ended December 31, 2004. For the same periods, our net interest spread decreased from 1.19% to 0.97% and our net interest margin increased from 2.07% to 2.12%.

As the preceding table illustrates, the appreciation in the price of Freddie Mac stock, which causes its stated dividend yield to decline negatively, impacts our stated net interest spread.

The net amortization of premiums on mortgage securities has had a significant impact on net interest income, spread and margin. Charges against interest income for net premium amortization reached its peak in the March 2003 quarter, with amortization of $995,000. By the December 2004 quarter, net amortization of premiums on mortgage-related securities had decreased to $90,000 due to the increase of interest rates. The high level of premium amortization in the earlier periods was caused by the “refinancing boom” in one-to-four family mortgages which was triggered by low mortgage interest rates. As borrowers refinanced, mortgages underlying the securities we owned were paid off earlier than expected, causing our securities to pay off sooner than expected and triggering acceleration of amortization.

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

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

Costs of borrowings decreased from 3.79% in the December 2002 quarter to 2.94% in the March 2004 quarter and have subsequently increased to 3.67%. While the majority of the borrowings have monthly rate resets, we have $287.0 million of fixed rate borrowings with a remaining maturity of approximately four years and an average rate of 4.31%.

The yield on mortgage securities has varied over the past nine quarters from a high in the December 2004 quarter of 4.12% to a low of 2.78% in June 2003. The yield in the March, June and September 2003 quarters was significantly impacted by high net premium amortization as mortgage security portfolios were paid off rapidly due to low mortgage rates and record rates of refinancing. Additionally, yields on securities declined during 2003 as a result of management’s decision to reinvest the heavy cash inflows from rapidly prepaying fixed rate mortgage securities into adjustable rate mortgage securities. In August of 2003, management increased its investment in fixed rate mortgage securities and by December 31, 2004 fixed rate mortgage securities comprised 62% of the total mortgage securities portfolio, compared to 40% at December 31, 2003.

As shown in the preceding table, the yield on loans has increased 31 basis points over the past four quarters from 5.79% for the March 2004 quarter to 6.1% for the December 2004 quarter. The yield increase is primarily the result of adjustable rate loans increasing in yield as short term interest rates have increased. During June of 2003, the Bank started retaining 15-year single-family loans in its loan portfolio. As of December 31, 2004, the Bank had accumulated $30.3 million of these loans with rates of approximately 4.87%. Average loans outstanding increased from $303.6 million during the December 2003 quarter to $324.2 million for the December 2004 quarter.

Also, as shown in the preceding table, the costs of deposits increased 24 basis points from 1.81% for the March 2004 quarter to 2.05% for the December 2004 quarter. While certificate of deposit rates have started to increase as overall short-term interest rates have increased, transaction account rates have not moved to the same magnitude as certificates of deposit.

The 23 basis point increase in loan yield, from the December 2003 quarter to the December 2004 quarter, was slightly higher than the 10 basis point increase in the costs of deposits for the same

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period. For these same two periods the increase in mortgage securities yields, at 65 basis points, was equivalent to the increase of 66 basis points in the cost of borrowings. The increased spread between loan yields and deposit costs and the increase in dividends on Freddie Mac common stock contributed to the increase in net interest income. The increase in the price of Freddie Mac stock, which reduced the stated yield on Freddie Mac stock, was the primary cause of the decrease in interest rate spread.