10-K 1 r10k1202.txt 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 For the fiscal year ended December 31, 2002 Commission file number 2-71249 SOUTH BANKING COMPANY (Exact name of registrant as specified in its charter Georgia 58-1418696 (State or other jurisdiction of (I.R.S. Employer Identification incorporation or organization) Number) 104 North Dixon Street, Alma, Georgia 31510 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (912) 632-8631 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: None 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 on information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. (X) Not applicable. Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) Yes No X State the aggregate market value of the voting and non-voting common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold, or the average bid and ask price of such common equity, as of the last business day of the registrant's must recently completed second fiscal quarter: $2,067,024. The price is based on the price of the last sales price known to the registrant, which occurred on September 13, 2001. Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the most recent practicable date. Class Outstanding at February 28, 2003 Common stock $1.00 par value per share 399,500 DOCUMENTS INCORPORATED BY REFERENCE List hereunder the following documents if incorporated by reference and the part of the Form 10-K into which the documents are incorporated: (1) any annual reports to security holders; (2) any prospectus filed pursuant to Rule 424(b) or (c) under the Securities Act of 1933. None PART 1. SPECIAL CAUTIONARY NOTICE REGARDING FORWARD LOOKING INFORMATION Statements and financial discussion and analysis contained in this Annual Report on Form 10-K that are not historical facts are forward- looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements describe the Company's future plans, strategies and expectations, are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company's control. The important factors that could cause actual results to differ materially from the forward-looking statements include, without limitation: changes in interest rates and market prices, which could reduce the Company's net interest margins, asset valuations and expense expectations; changes in the levels of loan prepayments and the resulting effects on the value of the Company's loan portfolio; changes in local economic and business conditions which adversely affect the Company's customers and their ability to transact profitable business with the Company, including the ability of its borrowers to repay their loans according to their terms or a change in the value of the related collateral; increased competition for deposits and loans adversely affecting rates and terms; the timing, impact and other uncertainties of the Company's potential future acquisitions, including the Company's ability to identify suitable future acquisition candidates, the success or failure in the integration of their operations, and the Company's ability to enter new markets successfully and capitalize on growth opportunities; increased credit risk in the Company's assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio; the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses; changes in the availability of funds resulting in increased costs or reduced liquidity; changes in the Company's ability to pay dividends on its Common Stock; increased asset levels and changes in the composition of assets and the resulting impact on the Company's capital levels and regulatory capital ratios; the Company's ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; the loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; changes in statutes and government regulations or their interpretations applicable to bank holding companies and the Company's present and future banking and other subsidiaries, including changes in tax requirements and tax rates; all written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements. Item 1. Business South Banking Company (the "Registrant") is a bank holding company organized at the direction of Alma Exchange Bank & Trust ("Alma Bank") and Citizens State Bank ("Citizens Bank"). Pursuant to the terms and provision of an agreement of merger dated June 12, 1989 between South Banking and Georgia Peoples Bankshares, Inc. and approved by shareholders of Georgia Peoples on February 26, 1990, Georgia Peoples Bankshares were merged into South Banking Company. In connection with the merger, the outstanding shares of Georgia Peoples Bankshares were converted into shares of the Registrant at specified ratios. Georgia Bankshares, Inc.'s subsidiary Georgia bank, Peoples State Bank ("Peoples Bank") is now a wholly-owned subsidiary bank of the Registrant. During 1993, South Banking Company formed Banker's Data Services, Inc. ("Banker's Data") for the purpose of handling all the computer functions of the Banks. Operations began in April, 1994. South Banking entered into an agreement in October of 1995 to acquire all the stock of Pineland State Bank ("Pineland Bank" and, collectively with Alma Bank, Citizens Bank and Peoples Bank, the "Banks")) in Metter, Georgia. On January 11, 1996, the transaction was completed. On August 1, 2000, Pineland Bank acquired branches from Flag Inc. in Metter, Georgia, Cobbtown, Georgia, and Statesboro, Georgia. During 1998, Alma Bank formed South Financial Products, Inc. ("SFP") as a vehicle to enter the financial services market and provide service to its customers. SFP offers a complete array of investment options including stocks, bonds, mutual funds, financial and retirement planning, tax advantaged investments and asset allocations. SFP offers securities through Unvest, a North Carolina based independent clearing firm. SFP is licensed and regulated through the National Association of Securities Dealers, the Securities and Exchange Commission and various state and federal banking authorities. The maturing of the baby boomer generation is creating a market for asset management services. The Company expects growth in this department and anticipates that resulting fees will provide a stable stream of income. Recent Developments During the fourth quarter of 2002 and the first quarter of 2003, the Board of Directors decided to propose an amendment to the Registrant's articles of incorporation, which would effect a 1-for-50 reverse stock split of the Registrant's outstanding common stock, thereby reducing the number of authorized shares of common stock from 1,000,000 to 20,000 and increasing the par value of the common stock from $1.00 per share to $50. The Registrant is proposing the reverse stock split in order to "go private" - meaning that the Registrant would terminate its status as a "public" company. The Registrant can terminate the periodic report filing and other obligations it has under the federal Securities Exchange Act if it reduces the number of its record shareholders below 300, which the proposed reverse stock split is designed to do. The Banks The Banks operate full service banking business in Bacon, Appling, Candler, Tattnall, Bulloch, and Camden Counties, Georgia, providing such customary banking services as checking and savings accounts, various other types of time deposits, safe deposit facilities and money transfers. The Banks also finance commercial and agricultural transactions, make secured and unsecured loans, and provide other financial services to its customers. The Banks do not conduct trust activities. The Banks make and service both secured and unsecured loans to individuals, firms, and corporations. Commercial lending operations include various types of credit for the Banks' customers. The Banks' installment loan departments make direct loans to individuals and, to a limited extent, purchase installment obligations from retailers both with and without recourse. The Banks make a variety of residential, industrial, commercial, and agricultural loans secured by real estate, including interim construction financing. Each bank has established desired mixes of real estate, commercial, agricultural, and consumer lending depending upon activities within the local area. The ratios are established in accordance with risk diversification goals. All banks are located in small rural areas with low to moderate income levels. The banks primarily look to real estate lending as a major portion of portfolio. Real estate values have remained fairly stable over the past few years to give stability to lending activities. Loan to value ratios are maintained in the 60% to 80% level for various real estate lending. Loan to value ratio of non real estate loans vary from 50% for the inventory or receivables to 90% for vehicles and other consumer lending. The economy of the area remains fairly constant without great fluctuation. The national economy will effect the area primarily in the timber and other agricultural products; however, the movement is not as wide locally as national movement indicates. Citizens Bank, Pineland Bank and Peoples Bank act as agents for another bank in offering "Master Card" and "VISA" credit cards to its customers and does not assume the credit risk on these transactions. Alma Bank offers "Master Card" credit cards to its customers. At December 31, 2002, the Banks had correspondent relationships with 6 other commercial banks. These correspondent banks provide certain services to the banks such as processing checks and other items, buying and selling federal funds, handling money transfers and exchanges, shipping coins and currency, providing security and safekeeping of funds or other valuable items and furnishing limited management information and advice. As compensation for the services, the Banks maintain certain balances with its correspondents in non- interest bearing accounts. Employees On December 31, 2002, the Registrant and its subsidiaries had 95 full-time and 34 part-time employees. The Registrant is not a party to any collective bargaining agreement and employee relations are deemed to be good. Competition The Banking business is highly competitive. The Banks compete primarily with other commercial banks operating in Bacon, Camden, Appling, Tattnall, Bulloch, and Candler Counties. In addition, the Banks compete with other financial institutions, including savings and loan associations, credit unions and finance companies and, to a lesser extent, insurance companies and certain governmental agencies. The banking industry is also experiencing increased competition for deposits from less traditional sources such as money-market mutual funds. Many of these competitors have substantially greater resources than do the Banks. Customers The majority of the Banks' customers are individuals and small to medium-sized businesses headquartered within its service area. The Banks are not dependent upon a single or a very few customers, the loss of which would have a material adverse effect on the Banks. No customer accounts for more than 5% of the Banks' total deposits at any time. Management does not believe that the Banks' loan portfolio is dependent on a single customer or group of customers concentrated in a particular industry whose loss or insolvency would have a material adverse effect on the Banks. Monetary Policies The results of operations of the Banks, and therefore of the Registrant, are affected by credit policies of monetary authorities, particularly the Board of Governors of the Federal Reserve System (the "Board of Governors"), even though the Banks are not members of the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U. S. Government securities and changes in the discount rate on member bank borrowing changes in reserve requirements against member bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary and fiscal authorities, including the Federal Reserve System, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and earnings of the Banks. Supervision and Regulations The Registrant is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the "Act"), and is required to register as such with the Board of Governors. The Registrant is required to file with the Board of Governors an annual report and such other information as may be required to keep the Board of Governors informed with respect to the Registrant's compliance with the provisions of the Act. The Board of Governors may also make examinations of the Registrant and its subsidiaries from time to time. The Act requires every bank holding company to obtain the prior approval of the Board of Governors before it may (i) acquire substantially all the assets of any bank or ownership or control of any voting shares of any bank; (ii) it may acquire directly or indirectly, more than five percent of the voting shares of a bank; or (iii) it may merge or consolidate with any other bank holding company. In addition, a bank holding company is generally prohibited from engaging in or acquiring direct or indirect control of voting shares of any company engaged in nonbanking activities. One of the principal exceptions to this prohibition is for activities found by the Board of Governors, by order or regulation, to be so closely related to banking, managing or controlling banks as to be a proper incident thereto. Some of the activities that the Board of Governors has determined by regulation to be closely related to banking are: making or servicing loans and certain types of leases; performing certain data processing services; acting as fiduciary, investment or financial advisor; making investments in corporations or projects designed primarily to promote community welfare. Although the activities of bank holding companies have traditionally been limited to the business of banking and activities closely related or incidental to banking (as discussed above), the Gramm-Leach-Bliley Act became effective in 2000, and relaxed the previous limitations thus permitting bank holding companies to engage in a broader range of financial activities. Specifically, bank holding companies may elect to become financial holding companies which may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Among the activities that will be deemed "financial in nature" include: lending, exchanging, transferring, investing for others or safeguarding money or securities; insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker with respect thereto; providing financial, investment, or economic advisory services, including advising an investment company; issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; and underwriting, dealing in or making a market in securities. A bank holding company may become a financial holding company under this statute only if each of its subsidiary banks is well capitalized, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. A bank holding company that falls out of compliance with such requirement may be required to cease engaging in certain activities. Any bank holding company that does not elect to become a financial holding company remains subject to the current restrictions of the Act. Under this legislation, the Federal Reserve Board serves as the primary "umbrella" regulator of financial holding companies with supervisory authority over each parent company and limited authority over its subsidiaries. The primary regulator of each subsidiary of a financial holding company will depend on the type of activity conducted by the subsidiary. For example, broker-dealer subsidiaries will be regulated largely by securities regulators and insurance subsidiaries will be regulated largely by insurance authorities. The Registrant has no plans of becoming a financial holding company. The Registrant must also register with the Department of Banking and Finance of the State of Georgia (the "DBF") and file periodic information with the DBF. As part of such registration, the DBF requires information with respect to the Registrant's financial condition, operations, management and inter-company relationships, and related matters. The DBF may also require such other information as is necessary to keep itself informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been complied with, and the DBF may examine the Registrant and each of the Banks. The Registrant is an "affiliate" of the Banks under the Federal Reserve Act, which imposes certain restrictions on (i) loans by the Banks to the Registrant, (ii) investments in the stock or securities of the Registrant by the Banks, (iii) the Banks taking the stock or securities of an "affiliate" as collateral for loans by the Banks to a borrower and (iv) the purchase of assets from the Registrant by the Banks. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. The Banks, as Georgia banks, are subject to the supervision of, and are regularly examined by, the Federal Deposit Insurance Corporation (the "FDIC") and the DBF. Both the FDIC and the DBF must grant prior approval of any merger, consolidation or other corporate reorganization involving the Banks. A bank can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly-controlled institution. Payment of Dividends and Other Restrictions The Registrant is a legal entity separate and distinct from its subsidiaries. There are various legal and regulatory limitations under federal and state law on the extent to which the Banks can pay dividends or otherwise supply funds to the Registrant. Under Georgia law, the prior approval of the DBF is required before any cash dividends may be paid by a state bank if: (i) total classified assets at the most recent examination of such bank exceed 80% of the equity capital (as defined, which includes the reserve for loan losses) of such bank; (ii) the aggregate amount of dividends declared or anticipated to be declared in the calendar year exceeds 50% of the net profits (as defined) for the previous calendar year; or (iii) the ratio of equity capital to adjusted total assets is less than 6%. The payment of dividends by the Registrant and the Banks may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending upon the financial condition of the Banks, could include the payment of dividends) such authority may require, after notice and hearing, that such bank cease and desist from such practice. The FDIC has issued a policy statement providing that insured banks should generally only pay dividends out of current operating earnings. In addition to the formal statutes and regulations, regulatory authorities consider the adequacy of each of the Bank's total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends to the Banks. Capital Adequacy The Federal Reserve and FDIC have adopted substantially identical risk-based capital guidelines for banks and bank holding companies. The minimum ratio of total capital ("Total Capital") to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%. At least half of the Total Capital is to be composed of common stock, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of perpetual preferred stock, less goodwill ("Tier I Capital"). The remainder may consist of subordinated debt, other preferred stock and a limited amount of loan loss reserves. In addition, banks and bank holding companies must also have a minimum stockholders' equity to risk-weighted assets of 4%. In addition, the FRB has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier I Capital to total assets, less goodwill (the "Leverage Ratio") of 3% for bank holding companies that meet certain specified criteria, including those having the highest regulatory rating. All other bank holding companies generally are required to maintain a Leverage Ratio of at least 3% plus an additional cushion of 100 to 200 basis points. 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 significant reliance on intangible assets. Furthermore, the Federal Reserve has indicated that it will consider a "tangible Tier I capital leverage ratio" (deducting all intangibles) and other indications of capital strength in evaluating proposals for expansion or new activities. Effective December 19, 1992, a new Section 38 to the Federal Deposit Insurance Act implemented the prompt corrective action provisions that Congress enacted as a part of the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "1991 Act"). The "prompt corrective action" provisions set forth five regulatory zones in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a Bank's financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank's capital leverage ratio reaches two percent. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with less amounts of capital. The FDIC has adopted regulations implementing the prompt corrective action provisions of the 1991 Act, which place financial institutions in the following five categories based upon capitalization ratios: (i) a "well capitalized" institution has a total risk-based capital ratio of at least 10%, a Tier I risk-based ratio of at least 6% and a leverage ratio of at least 5%; (ii) an "adequately capitalized" institution has a total risk-based capital ratio of at least 8%, a Tier I risk-based ratio of at least 4% and a leverage ratio of at least 4%, (iii) an "undercapitalized" institution has a total risk-based capital ratio of under 8%, a Tier I risk-based ratio of under 4% or a leverage ratio of under 4%; (iv) a "significantly undercapitalized" institution has a total risk-based capital ratio of under 6%, a Tier I risk-based ratio of under 3% or a leverage ratio of under 3%; and (v) a "critically undercapitalized" institution has a leverage ratio of 2% or less. Institutions in any of the three undercapitalized categories would be prohibited from declaring dividends or making capital distributions. The FDIC regulations also establish procedures for "downgrading" an institution to a lower capital category based on supervisory factors other than capital. The downgrading of an institution's category is automatic in two situations: (i) whenever an otherwise well-capitalized institution is subject to any written capital order or directive; and (ii) where an undercapitalized institution fails to submit or implement a capital restoration plan or has its plan disapproved. The Federal banking agencies may treat institutions in the well-capitalized, adequately capitalized and undercapitalized categories as if they were in the next lower level based on safety and soundness considerations relating to factors other than capital levels. All insured institutions regardless of their level of capitalization are prohibited by the Federal Deposit Insurance Corporation Improvement Act of 1991 (the "FDIC Act") from paying any dividend or making any other kind of capital distribution or paying any management fee to any controlling person if following the payment or distribution the institution would be undercapitalized. While the prompt corrective action provisions of the FDIC Act contain no requirements or restrictions aimed specifically at adequately capitalized institutions, other provisions of the FDIC Act and the agencies' regulations relating to deposit insurance assessments, brokered deposits and interbank liabilities treat adequately capitalized institutions less favorably than those that are well- capitalized. Under the FDIC's regulations, all of the Banks are "well capitalized" institutions. The written policies of the DBF require that state banks in Georgia generally maintain a minimum ratio of primary capital to total assets of 6.0%. At December 31, 2002, the Banks were in compliance with these requirements. In addition, the DBF is likely to compute capital obligations in accordance with the risk-based capital rules while continuing to require a minimum absolute level of capital. Support of Subsidiary Banks Under the FRB policy, the Registrant is expected to act as a source of financial strength to, and to commit resources to support, each of the Banks. This support may be required at times when, absent such FRB policy, the Registrant may not be inclined to provide it. In the event of a bank holding company's bankruptcy, any commitment by the bank holding company to a Federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to a priority of payment. As a result of the enactment of Section 206 of the Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA") on August 9, 1989, a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to any commonly controlled FDIC- insured depository institution "in danger of default" is defined generally as the existence of certain conditions indicating that a default is likely to occur in the absence of regulator assistance. FDIC Insurance Assessments The Banks are subject to FDIC deposit insurance assessments for the Bank Insurance Fund (the "BIF"). Since 1989, the annual FDIC deposit insurance assessments increased from $.083 per $100 of deposits to a minimum level of $.23 per $100, an increase of 177 percent. The FDIC implemented a risk-based assessment system whereby banks are assessed on a sliding scale depending on their placement in nine separate supervisory categories, from $.23 per $100 of deposits for the healthiest banks (those with the highest capital, best management and best overall condition) to as much as $.31 per $100 of deposits for the less-healthy institutions, for an average of $.259 per $100 of deposits. On August 8, 1995, the FDIC lowered the BIF premium for "healthy" banks 83% from $.23 per $100 in deposits to $.04 per $100 in deposits, while retaining the $.31 level for the riskiest banks. The average assessment rate was therefore reduced from $.232 to $.044 per $100 of deposits. The new rate took effect on September 29, 1995. On November 14, 1995, the FDIC again lowered the BIF premium for "healthy" banks from $.04 per $100 of deposits to zero for the highest rated institutions (92% of the industry). All of the Banks are insured under the BIF fund and it is expected that they will be required to pay only the legally required annual minimum payments during 2002. Industry Developments Certain recently-enacted and proposed legislation could have an effect on both the costs of doing business and the competitive factors facing the financial institution's industry. Because of the uncertainty of the final terms and likelihood of passage of the proposed legislation, the Registrant is unable to assess the impact of any proposed legislation on its financial condition or operations at this time. Available Information. The Registrant is subject to the information requirements of the Securities Exchange Act of 1934, which means that it is required to file certain reports and other information, all of which are available at the Public Reference Section of the Securities and Exchange Commission at Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549. You may also obtain copies of the reports and other information from the Public Reference Section of the SEC, at prescribed rates, by calling 1-800-SEC-0330. The SEC maintains a World Wide Web site on the Internet at www.sec.gov where you can access reports, information and registration statements, and other information regarding registrants that file electronically with the SEC through the EDGAR system. Selected Statistical Information The tables and schedules on the following pages set forth certain significant statistical data with respect to: (i) the distribution of assets, liabilities and shareholders' equity and the interest rates and interest differentials experienced by, the Registrant and its subsidiaries; (ii) the investment portfolio of the Registrant and its subsidiaries; (iii) the loan portfolio of the Registrant and its subsidiaries, including types of loans, maturities and sensitivity to changes in interest rates and information on nonperforming loans; (iv) summary of the loan loss experience and reserves for loan losses of the Registrant and its subsidiaries; (v) types of deposits of the Registrant and its subsidiaries; and (vi) the return on assets and equity for the Registrant and its subsidiaries. I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY; INTEREST RATES AND INTEREST DIFFERENTIALS A. The condensed average balance sheets for the periods indicated are presented below. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 ASSETS (In Thousands) Cash and due from banks $ 7,013 $ 6,705 $ 6,283 Cash in bank - interest bearing 1,634 957 822 Taxable investment securities 16,115 16,518 16,884 Nontaxable investment securities 1,018 1,326 1,613 Others 983 1,343 1,487 Federal funds sold and securities purchased under agreements to resell 18,976 18,028 9,945 Loans - net 167,750 166,639 148,195 Other assets 14,285 14,555 10,762 Total Assets $ 227,774 $ 226,071 $ 195,991 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand - non-interest bearing $ 29,724 $ 24,903 $ 22,444 Demand - interest bearing 34,293 30,600 24,959 Savings 12,001 11,809 11,122 Time 121,984 131,154 114,026 Total Deposits $ 198,002 $ 198,466 $ 172,551 Federal funds purchased 19 23 114 Other borrowed funds 6,912 6,065 4,518 Other liabilities 2,062 2,453 1,768 Total Liabilities $ 206,995 $ 207,007 $ 178,951 Shareholders' equity 20,779 19,064 17,040 Total Liabilities and Shareholders' Equity $ 227,774 $ 226,071 $ 195,991 B. Interest Rates. The tables below show for the periods indicated the average amount outstanding for major categories of interest earning assets and interest bearing liabilities; the average interest rates earned or paid; the interest income and expense earned or paid thereon; net interest earnings and the net yield on interest-earning assets. Year Ended December 31, 2002 Average Yield/ Average Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 1,634 $ 60 3.67% Loans 167,750 13,614 8.11% Taxable investments 16,115 716 4.44% Non-taxable investments 1,018 52 5.11% Other 983 39 3.97% Federal funds sold and securities purchased under agreements to resell 18,976 307 1.62% Total Interest-Bearing Assets $ 206,476 $ 14,788 7.16% LIABILITIES Demand - interest bearing $ 34,293 $ 419 1.22% Savings deposits 12,001 194 1.62% Other time deposits 121,984 4,459 3.66% Other borrowing 6,912 258 3.73% Federal funds purchased 19 - -% Total Interest-Bearing Liabilities $ 175,209 $ 5,330 3.04% Net interest earnings $ 9,458 Net interest margin 4.12% Year Ended December 31, 2001 Average Yield/ Average Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 957 $ 54 5.64% Loans 166,639 16,737 10.04% Taxable investments 16,518 947 5.73% Non-taxable investments 1,326 66 4.97% Other 1,343 60 4.47% Federal funds sold and securities purchased under agreements to resell 18,028 741 4.11% Total Interest-Bearing Assets $204,811 $ 18,605 9.08% LIABILITIES Demand - interest bearing $ 30,600 $ 694 2.27% Savings deposits 11,809 314 2.65% Other time deposits 131,154 7,897 6.02% Other borrowing 6,065 429 7.07% Federal funds purchased 23 1 4.34% Total Interest-Bearing Liabilities $179,651 $ 9,335 5.20% Net interest earning $ 9,270 Net interest margin 3.88% Year Ended December 31, 2000 Average Yield/ Average Balance Interest Rate ASSETS (In Thousands) Cash in banks - interest bearing $ 822 $ 53 6.44% Loans 148,195 16,604 11.20% Taxable investments 16,884 1,021 6.05% Non-taxable investments 1,613 79 4.90% Other 1,487 73 4.91% Federal funds sold and securities purchased under agreements to resell 9,945 623 6.26% Total Interest-Bearing Assets $178,946 $ 18,453 10.31% LIABILITIES Demand -interest bearing $ 24,959 $ 648 2.59% Savings deposits 11,122 359 3.23% Other time deposits 114,026 7,115 6.24% Other borrowing 4,518 448 9.91% Federal funds purchased 114 8 7.02% Total Interest-Bearing Liabilities $154,739 $ 8,578 5.54% Net interest earnings $ 9,875 Net interest margin 4.77% (1) Note: Loan fees are included for rate calculation purposes. Loan fees included in interest amounted to approximately $1,097,015 in 2002, $1,208,871 in 2001 and $999,520 in 2000. Non accrual loans have been included in the average balances. C. Interest Differentials. The following tables set forth for the periods indicated a summary of the changes in interest earned and interest paid resulting from changes in volume and changes in rates. 2002 Compared to 2001 Increase (Decrease) Due to (1) Volume Rate Change Interest earned on: (In Thousands) Cash in banks - interest bearing $ 38 $( 32) $ 6 Loans 98 ( 3,221) (3,123) Taxable investments ( 23) ( 208) ( 231) Nontaxable investments ( 15) 1 ( 14) Other ( 16) ( 5) ( 21) Federal funds sold and securities purchased under agreement to resell 39 ( 473) ( 434) Total Interest-Earning Assets$ 121 $( 3,938) $(3,817) Interest paid on: NOW deposits $ 83 $( 358) $( 275) Savings deposits 5 ( 125) ( 120) Other time deposits ( 552) ( 2,886) (3,438) Other borrowing 60 ( 231) ( 171) Federal funds purchased - ( 1) ( 1) Total Interest-Bearing Liabilities $( 404) $( 3,601) $(4,005) Net Interest Earnings $ 525 $( 337) $ 188 (1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year. 2001 Compared to 2000 Increase (Decrease) Due to (1) Volume Rate Change Interest earned on: (In Thousands) Cash in banks - interest bearing $ 9 $( 8) $ 1 Loans 2,066 ( 1,933) 133 Taxable investments ( 22) ( 52) ( 74) Nontaxable investments ( 14) 1 ( 13) Other ( 7) ( 6) ( 13) Federal funds sold and securities purchased under agreement to resell 505 ( 387) 118 Total Interest-Earning Assets $ 2,537 $( 2,385) $ 152 Interest paid on: NOW deposits $ 144 $( 98) $ 46 Savings deposits 22 ( 67) ( 45) Other time deposits 1,070 ( 288) 782 Other borrowing 153 ( 172) ( 19) Federal funds purchased ( 6) ( 1) ( 7) Total Interest-Bearing Liabilities $ 1,383 $( 626) $ 757 Net Interest Earnings $ 1,154 $( 1,759) $( 605) (1) The change in interest due to volume has been determined by applying the rate from the earlier year to the change in average balances outstanding from one year to the next. The change in interest due to rate has been determined by applying the change in rate from one year to the next to average balances outstanding in the later year. II. INVESTMENT PORTFOLIO A. Types of Investments The carrying amounts of investment securities at the dates indicated are summarized as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31 , 2002 2001 2000 (In Thousands) U. S. Treasury and other U. S. government agencies and corporations $ 17,233 $ 15,691 $ 18,449 State and political subdivisions (domestic) 933 1,131 1,529 Mortgage backed securities 20 236 399 Equities 753 262 465 Totals $ 18,939 $ 17,320 $ 20,842 B. Maturities The amounts of investment securities in each category as of December 31, 2002 are shown in the following table according to maturity classifications (1) one year or less, (2) after one year through five years, (3) after five years through ten years, (4) after ten years. U. S. Treasury and Other U. S. Government State Agencies and and Political Mortgage Backed Corporations Subdivisions Securities Average Average Yield Yield Average Amount (1) Amount (1)(2) Amount Yield (In Thousands) Maturity: One year or less $ 458 3.30% $ 406 7.29% $ - - After one year through five years 16,012 3.92% - - - - After five years through ten years 763 6.00% 267 7.36% - - After ten years - - 260 8.76% 20 7.72% Totals $ 17,233 4.00% $ 933 7.72% $ 20 7.72% (1) Yields were computed using coupon interest, adding discount accretion or subtracting premium amortization, as appropriate, on a ratable basis over the life of each security. The weighted average yield for each maturity range was computed using the acquisition price of each security in that range. (2) Yields on securities of state and political subdivisions are stated on a tax equivalent basis, using a tax rate of 34%. III. Loan Portfolio A. Types of Loans The amount of loans outstanding at the indicated dates are shown in the following table according to type of loan. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 (In Thousands) Commercial, financial and agricultural $ 43,939 $ 49,558 $ 42,973 Real estate - mortgage 90,492 85,876 81,314 Real estate - construction 8,809 9,015 7,646 Installments 26,565 27,929 31,294 $ 169,805 $ 172,378 $ 163,227 Less - Unearned income 237 289 253 Reserve for possible losses 2,893 2,756 2,728 Total Loans $ 166,675 $ 169,333 $ 160,246 B. Maturities and Sensitivity to Changes in Interest Rates The amount of total loans by category outstanding as of December 31, 2002 which, based on remaining repayments of principal, are due in (1) one year or less, (2) more than one year but less than five and (3) more than five years are shown in the following table. The amounts due after one year are classified according to the sensitivity to changes in interest rates. Maturity Classification Over One One Year Through Over or Less Five Years Five Years Total Types of Loans (In Thousands) Commercial, financial and agricultural $ 37,692 $ 5,381 $ 866 $ 43,939 Real estate mortgage 68,206 20,762 1,524 90,492 Real estate construction 7,661 410 738 8,809 Installment 12,762 11,136 2,667 26,565 Total loans due after one year with: Predetermined interest rate 42,447 Floating interest rate 1,037 C. Nonperforming Loans The following table presents, at the dates indicated, the aggregate amounts of nonperforming loans for the categories indicated. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 (In Thousands) Loans accounted for on a non-accrual basis $ 748 $ 1,002 $ 876 Loans contractually past due ninety days or more as to interest or principal payments 466 1,028 734 Loans, the terms of which have been renegotiated to provide a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower - 4 8 Loans now current about which there are serious doubts as to the ability of the borrower to comply with present loan repayment terms - - - Loans are placed on non-accrual basis when loans are past due ninety days or more. Management can elect not to place loans on non- accrual status if net realizable value of collateral is sufficient to cover the balance and accrued interest. D. Commitments and Lines of Credit The banks provide commitments and lines of credit to their most worthy customers only. Commitments are for short terms, usually not exceeding 30 days, and are provided for a fee of 1% of the amount committed. Lines of credit are for periods extending up to one year. No fee is usually charged with respect to the unused portion of a line of credit. Interest rates on loans made pursuant to commitments or under lines of credit are determined at the time that the commitment is made or line is established. E. Rate Sensitivity Analysis SOUTH BANKING COMPANY DECEMBER 31, 2002 INTEREST RATE RISK Note: Dollar amounts in columns are cumulative amounts Total assets on this date equaled $230,758 Interest Rate Risk 0-3 0-12 0-3 0-5 0-15 Months Months Years Years Years Rate sensitive assets: Securities (fixed rates)$ 201 $ 864 $ 5,699 $ 16,876 $ 18,166 Securities (floating rates) 21 21 21 21 21 Mutual funds 48 48 48 48 48 CD's at banks 396 2,667 3,760 3,860 3,860 Loans (fixed rates) 19,881 41,714 70,060 80,083 87,124 Loans (floating rates) 79,079 80,699 81,042 81,736 81,736 Federal funds sold 18,600 18,600 18,600 18,600 18,600 Total rate sensitive assets $118,226 $144,613 $ 179,230 $201,224 $209,555 Rate sensitive liabilities: CD/IRA's under $100M $ 27,709 $ 77,882 $ 85,384 $ 85,845 $ 85,845 CD/IRA's => $100M 11,335 32,407 35,701 35,972 35,972 Regular savings/Christmas 13,061 13,061 13,061 13,061 13,061 Now/Super Now 25,597 25,597 25,597 25,597 25,597 Money market deposit 9,634 9,634 8,634 9,634 9,634 Treasury, tax & loan note 25 25 25 25 25 Federal funds purchased - - - - - Note payable-Ford Motor - 8 16 16 16 Note payable-Banker's Bank - 375 1,275 2,375 4,400 Note payable-Waycross Bank & Trust - - - - - Note payable-Banker's Bank (BDS) 54 216 619 619 619 Note payable-FHLB 3,000 3,000 3,000 3,000 3,000 Total rate sensitive liabilities $ 90,415 $162,205 $174,312 $176,144 $178,169 Rate sensitive assets less Rate sensitive liabilities $ 27,811 $(17,592) $ 4,918 $ 25,080 $ 31,386 Rate sensitive assets less Rate sensitive liabilities/Total assets 12.05% ( 7.62%) 2.13% 10.87% 13.60% Rate sensitive assets/ Rate sensitive liabilities 130.76% 89.15% 102.82% 114.24% 117.62% Notes to Market Risk Sensitivity Table: (1) Expected maturities are contractual maturities adjusted for prepayments of principal when possible. The Company uses certain assumptions to estimate expected maturities. (2) For loans, the Company has used contractual maturities due to the fact that the Company has no historical information on prepayment speeds. Since most of these loans are consumer and commercial loans, and since the Company's customer base is community-based, the Company feels its prepayment rates are insignificant. (3) For mortgage-backed securities, expected maturities are based upon contractual maturity, projected repayments and prepayment of principal. The prepayment experience herein is based on industry averages as provided by the Company's investment trustee. (4) Loans receivable includes non-performing loans. (5) Interest-bearing liabilities are included in the period in which the balances are expected to be withdrawn as a result of contractual maturities. For accounts with no stated maturities, the balances are included in the 0 to 90 day category. (6) The interest rate sensitivity gap represents the difference between total interest-earning assets and total interest-bearing liabilities. The rate sensitivity analysis table is designed to demonstrate South's sensitivity to changes in interest rates by setting forth in comparative form the repricing maturities of South's assets and liabilities for the period shown. A ratio of greater than 1.0 times interest earnings assets to interest bearing liabilities indicates that an increase in interest rates will generally result in an increase in net income for South and a decrease in interest rates will result in a decrease in net income. A ratio of less than 1.0 times earnings assets to interest-bearing liabilities indicates that a decrease in interest rates will generally result in an increase in net income for South and an increase in interest rates will result in a decrease in net income. IV. Summary of Loan Loss Experience The following table summarizes loan balances at the end of each period and average balances during the year for each category; changes in the reverse for possible loan losses arising from loans charged off and recoveries on loans previously charged off; additions to the reserve which have been charged to operating expense; and the ratio of net charge-offs during the period to average loans. Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 (In Thousands) A. Average amount of loans outstanding $ 167,750 $ 166,639 $ 148,195 B. Balance of reserve for possible loan losses at beginning of period $ 2,757 $ 2,728 $ 2,169 C. Loans charged off: Commercial, financial and agricultural $ 398 $ 398 $ 274 Real estate - mortgage 278 225 127 Installments 330 379 263 $ 1,006 $ 1,002 $ 664 D. Recoveries of loans previously charged off: Commercial, financial and agricultural $ 27 $ 4 $ 83 Real estate 18 49 29 Installment 93 85 99 $ 138 $ 138 $ 211 E. Net loans charged off during period $ 868 $ 864 $ 453 Additions to reserve charged to operating expense during period (1)$ 1,004 $ 893 $ 424 Addition from bank acquisition - - 588 $ 1,004 $ 893 $ 1,012 F. Balance of reserve for possible loan losses at end of period $ 2,893 $ 2,757 $ 2,728 G. Ratio of net loans charged off during the period to average loans outstanding .52 .52 .31 (1) Although the provisions exceeded the minimum provision required by regulatory authorities, the Board of Directors believe that the provision has not been in excess of the amount required to maintain the reserve at a sufficient level to cover potential losses. The amount charged to operations and the related balance in the reserve for loan losses is based upon periodic evaluations by management of the loan portfolio. These evaluations consider several factors including, but not limited to, general economic conditions, loan portfolio composition, prior loan loss experience and management's estimation of future potential losses. (2) Management's review of the loan portfolio did not allocate reserves by category due to the portfolio's small size. The reserves were allocated on the basis of a review of the entire portfolio. The portfolio does not contain excessive concentrations in any industry or loan category that might expose South to significant risk. V. Deposits A. Average deposits, classified as demand deposits, savings deposits and time certificates of deposit for the periods indicated are presented below: Year Ended December 31, 2002 2001 2000 Average Average Average Balance Interest Balance Interest Balance Interest Rate Rate Rate Noninterest- $29,724 - $24,903 - $22,444 - bearing demand Interest- 34,293 1.22% 30,600 2.27% 24,959 2.59% bearing demand deposits Savings 12,001 1.62% 11,809 2.65% 11,122 3.23% deposits Time deposits 121,984 3.66% 131,154 6.02% 114,026 6.24% Total deposits $198,002 2.56% $198,466 3.91% $172,551 4.71% B. The amounts of time certificates of deposit issued in amounts of $100,000 or more as of December 31, 2002 are shown below by category, which is based on time remaining until maturity of (1) three months or less, (2) over three through six months, (3) over six through twelve months and (4) over twelve months. Three months or less $ 11,335 Over three through twelve months 20,972 Over twelve months 3,564 Total $ 35,871 VI. Return on Assets and Shareholders' Equity The following rate of return information for the periods indicated is presented below: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Return on assets (1) .79% .74% 1.35% Return on equity (2) 8.61% 8.83% 15.53% Dividend payout ratio (3) 15.63% 16.63% 10.57% Equity to assets ratio (4) 9.12% 8.43% 8.69% (1) Net income divided by average total assets. (2) Net income divided by average equity. (3) Dividends declared per share divided by net income per share. (4) Average equity divided by average total assets. Item 2. Properties Alma Bank's main banking office and the Registrant's principal executive offices are located at 104 North Dixon Street, Alma, Georgia 31510. The building, containing approximately 13,040 square feet of usable office and banking space, and the land, approximately 1.2 acres, are owned by Alma Bank. Alma Bank also has a separate drive-in banking facility located at 505 South Pierce Street, Alma, Georgia. The building, containing 510 square feet, in which the branch is located and the land, approximately .4 acres, on which it is located are owned by Alma Bank. Citizens Bank's main banking office is located at 205 East King Street, Kingsland, Georgia 31548. The building, containing approximately 6,600 square feet of usable office and banking space, and the land, approximately 2 acres, are owned by Citizens Bank. Peoples Bank's main banking office is located at Comas and E. Parker Streets, Baxley, Georgia 31513. The building, containing approximately 7,800 square feet of usable office and banking space, and the land, approximately 2.5 acres, are owned by the Peoples Bank. The Bank does not have branches. Pineland Bank's main banking office is located at 257 North Broad Street, Metter, Georgia 30439. The building, containing approximately 10,000 square feet of usable office and banking space, and the land, approximately 1 acre, are owned by the Pineland Bank. Pineland Bank also has two branches. The branch in Metter, Georgia is a limited service drive-in facility containing approximately 500 square feet and is situated on land covered by a long term lease. A building acquired in the Flag acquisition houses the branch in Cobbtown, Georgia. This facility consists of a 3,396 square foot building on a 90 x 120 ft. lot. Item 3. Legal Proceedings Neither the Registrant or its subsidiaries are parties to, nor is any of their property the subject of, any material pending legal proceedings, other than ordinary routine proceedings incidental to the business of the Banks, nor to the knowledge of the management of the Registrant are any such proceedings contemplated or threatened against it or its subsidiaries. Item 4. Submission of Matters to a vote of Security Holders None applicable. Part II. Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters There is no public market for the common stock of South or the Banks. The last known selling price of South's common stock, based on information available to South's management, was $12.00 per share on September 13, 2001. As of March 1, 2003, the Company had 454 shareholders with 399,500 shares outstanding. For the years ended December 31, 2002, 2001 and 2000, South paid cash dividends of $279,628 or $.70 per share, $279,628 or $.70 per share, and $279,628 or $.70 per share, respectively. These dollars equate to dividend payout ratios (dividends declared divided by net income) of 15.63%, 16.63% and 10.57% in 2002, 2001 and 2000, respectively. Certain other information concerning dividends and historical trading prices is set forth below: QUARTERLY COMMON STOCK DATA Set forth below is information concerning high and low sales prices by quarter for each of the last two fiscal years and dividend information for the last two fiscal years. The Company's common stock is not traded on any established pubic trading market. The Company acts as its own transfer agent, and the information concerning sales prices set forth below is derived from the Company's stock transfer records. As of December 31, 2002, there were 454 shareholders of record. SALES PRICES BY QUARTER High Low Fiscal Year 2002 First Quarter $ - $ - Second Quarter - - Third Quarter - - Fourth Quarter - - SALES PRICES BY QUARTER High Low Fiscal Year 2001 First Quarter $ - $ - Second Quarter - - Third Quarter 12.00 12.00 Fourth Quarter - - DIVIDENDS PAID PER SHARE Fiscal Year 2002 2001 March 31 $ .00 .00 June 30 .00 .00 September 30 .00 .00 December 31 .70 .70 Item 6. Selected Financial Data Years Ended December 31, 2002 2001 2000 1999 1998 (In Thousands) Total Assets $ 230,758 $ 224,791 $ 220,450 $173,807 $164,890 Operations: Interest income$ 14,788 $ 18,605 $ 18,454 $ 14,518 $ 13,920 Interest expense 5,330 9,335 8,578 6,261 6,392 Net interest income $ 9,458 $ 9,270 $ 9,876 $ 8,257 $ 7,528 Provision for loan losses 1,004 893 424 503 286 Net interest income after provision for loan losses $ 8,454 $ 8,377 $ 9,452 $ 7,754 $ 7,242 Other income $ 2,988 $ 3,125 $ 2,718 $ 2,298 $ 1,905 Other expenses $ 8,829 $ 9,085 $ 8,302 $ 6,906 $ 6,387 Income before income taxes $ 2,613 $ 2,417 $ 3,868 $ 3,146 $ 2,760 Federal income taxes 824 733 1,222 1,017 831 Net income before extraordinary items $ 1,789 $ 1,684 $ 2,646 $ 2,129 $ 1,929 Extraordinary items $ - $ - $ - $ - $ - Net income $ 1,789 $ 1,684 $ 2,646 $ 2,129 $ 1,929 Per Share Data: Income after extraordinary items $ 4.48 $ 4.21 $ 6.62 $ 5.33 $ 4.83 Net income $ 4.48 $ 4.21 $ 6.62 $ 5.33 $ 4.83 Dividends declared $ .70 $ .70 $ .70 $ .65 $ .65 Book value $ 54.37 $ 49.71 $ 45.73 $ 39.57 $ 35.56 Profitability Ratios Net income to average total assets .79% .74% 1.35% 1.28% 1.23% Net income to average stockholders' equity 8.61% 8.83% 15.52% 14.18% 14.45% Net interest Margin 4.12% 3.88% 4.77% 4.83% 4.52% Item 7. Management's Discussion and Analysis of Financial Condition And Results of Operations The purpose of this discussion is to focus on information about South Banking Company's financial condition and results of operations which is not otherwise apparent from the consolidated financial statement included in this report. Reference should be made to those statements, selected statistical information and the selected financial data presented elsewhere in this report for an understanding of the following discussion and analysis. Critical Accounting Policies The accounting and reporting policies of the Registrant and its subsidiaries conform with generally accepted accounting principles and with practices within the banking industry. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Financial Condition The Registrant functions as a financial institution and as such its financial condition should be examined in terms of trends in its sources and uses of funds. A comparison of daily average balances indicate how the Registrant has managed its sources and uses of funds. Included in the selected statistical information, the comparison of daily average balance in the business portion of the filing indicated how the Registrant has managed its sources and uses of funds. The Registrant used its funds primarily to support its lending activities. The Registrant's total assets increased to $230,758,333 at year end 2002 from $224,790,523 at year end 2001. This increase of $5,967,810 represents a 2.6% increase in 2002 compared to 1.9% increase in 2001. This increase is attributable to normal growth within the banking area with limited entry into competitive situations for large deposits. The net interest margins have remained stable in 2002 after two years of decline. The net interest margin is not anticipated to change much in 2002 as the effect of the new competition and rate reductions have leveled off. However, increase in the prime rate could impact the margins. The interest rate sensitivity analysis, which is a part of this report, gives some indication of the repricing opportunities of the Registrant. The gap ratios for the first twelve months are outside the limits established by the Bank as ideal, however, the current interest rates are not favorable to customers purchasing certificates in excess of twelve months. Loan demand has leveled after years of sustained growth with loans decreasing $2,573,379 in 2002. The Banks continue to look for good quality loans as loans represent the highest yielding asset on the Bank's books. The rural economy of the Banks' market area, which had been stable prior to 1998 has declined beginning in 1999 and continued into 2002 especially in the agricultural and timber industries. While the Banks are not heavy into these industries, the decline in these areas has impacted the overall economy. Classified loans for regulatory purposes remain at acceptable levels and, despite the problem in the local economies, do not represent any trend or uncertainties which management reasonably expects will materially impact future operating results, liquidity of capital resources, or represents material credits about which management is aware that causes management to have serious doubts as to the ability of such borrowers to comply with the loan payment terms. The Registrant's investment portfolio, including certificates of deposits in other banks, increased to $22,844,919 from $18,593,836. The increase of $4,251,083 from operations is an indication of the declining loan demand of the banks and the desire of the banks to utilize the assets of the Registrant in the highest yielding manner available to the banks without creating liquidity problems. The Registrant has maintained adequate federal funds sold and investments available for sale to sufficiently maintain adequate liquidity. The Registrant's securities remain primarily short term of five years or less in maturity, enabling the Registrant to better monitor the rate sensitivity of these assets, however, some extended terms on securities have been secured for yield purposes. Unrealized gain and losses on this portfolio is not material to the statement as the Registrant maintains a slight unrealized gain of $221,257. As the primary source of funds, aggregate deposits increased by $3,765,403 in 2002 compared to $3,321,388 in 2001. This represents a 1.92% increase for the year compared to a 1.72% increase in 2001. This illustrates the efforts of the banks to maintain good core deposits. Most of the growth was from the demand accounts which have lower interest rates as time certificate rates have dropped to levels customers do not wish to lock-in rates for extended periods. Liquidity The primary function of asset/liability management is to assure adequate liquidity and maintain an appropriate balance between interest sensitive earning assets and interest bearing liabilities. Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors desiring to withdraw funds or borrowers requiring assurance that sufficient funds will be available to meet their credit needs. Interest rate sensitivity management seeks to avoid fluctuating net interest margins and to enhance consistent growth of net interest income through periods of changing interest rates. Interest rate sensitivity varies with different types of interest- earning assets and interest bearing liabilities. Overnight federal funds on which rates change daily and loans which are tied to prime differ considerably from long-term investment and fixed rate loans. Similarly, time deposits over $100,000 and money market accounts are much more interest sensitive than passbook savings and long-term capital notes. The shorter-term interest rate sensitivities are key to measuring the interest sensitivity gap, or excess interest- sensitive earning assets over interest-bearing liabilities. An interest rate sensitivity table is included elsewhere in this document, and it shows the interest sensitivity gaps for different time intervals as of December 31, 2002. The first 30 days there is an excess of interest-bearing assets over interest-bearing liabilities. The Registrant becomes more sensitive to interest rate fluctuations on a short time period. While the cumulative gap declines during the first twelve months, the Registrant remains within a manageable position. Marketable investment securities, particularly those of shorter maturities, CD's at other banks and federal funds sold are the principal sources of asset liquidity. Securities and CD's maturing in one year or less amounted to $3,552,000 and federal funds sold net of federal funds purchased with daily maturities amounted to $18,600,000 at year end 2002, an increase from prior years as deposit growth exceeded loan demand. Maturing loans and certificates of deposits in other banks are other sources of liquidity. The overall liquidity of the Registrant has been enhanced by a significant aggregate amount of core deposits. These core deposits have remained constant during this period. The Registrant has utilized less stable short-term funding sources to enhance liquidity such as large denomination time deposits and money market certificates within its current customer base, but has not attempted to acquire these type of accounts from non-core deposit customers. The Registrant has utilized its core deposit base to help insure it maintains adequate liquidity. Historically, the trend in cash flows as represented in the statement of cash flows shows a steady increase in cash generated by operations from the last three years. This is a result of increasing net income for each year until 2001. While income is not predictable, it is anticipated that liquidity will continue to be enhanced by the operations of the bank. Operations activity, however, generate only a small portion of the cash flow activities of the bank. Primary cash flow comes from investing activities such as sales and/or maturity of investment securities and in the financing activity through an increase in deposits. The primary use of cash flow includes the purchase of securities and making new loans as investing activities. The history of the Banks' cash flow indicates a nonrepeating source such as proceeds from borrowings utilized as sources of cash for the purpose of acquisition or expansion. The Registrant's overall cash flows indicate the relative stability and manageable growth of the bank's assets. The Registrant utilized deposit growth as its primary source of funds to handle growth. The Registrant's liquidity is maintained at levels determined by management to be sufficient to handle the cash needs that might arise at any given date. Outside sources are maintained, but the Registrant looks to these sources only on a very short term basis. The Registrant's long term liquidity plans include utilizing internally generated deposits as its primary source of cash flows and utilizing the shifting of the make up of assets to handle short term demands on cash. Capital Resources In January 1989, the Federal Reserve Board released new standards for measuring capital adequacy for U. S. banking organizations. These standards are based on the original risk-based capital requirements first proposed in early 1986 by U. S. bank regulators and then developed jointly by authorities from the twelve leading industrial countries. As a result, the standards are designed to not only provide more risk-responsive capital guidelines for financial institutions in the U. S., but also incorporate a consistent framework for use by financial institutions operating in the major international financial markets. In general, the standards require banks and bank holding companies to maintain capital based on "risk-adjusted" assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments and interest rate swaps. The Federal Reserve Board standards classify capital into two tiers, referred to as Tier 1 and Tier 2. Tier 1 capital consists of common shareholders' equity, noncumulative and cumulative (BHCs only) perpetual preferred stock and minority interest less goodwill. Tier 2 capital consists of allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term subordinated debt and intermediate-term preferred stock. By December 31, 1992, all banks were required to meet a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets with at least 4% Tier 1 capital. Capital that qualifies as Tier 2 capital is limited to 100% of Tier 1 capital. Loans and Asset Quality Management of the Registrant believes that the loan portfolio is adequately diversified. Commercial loans are spread through numerous types of businesses with no particular industry concentrations. Loans to individuals are made primarily to finance consumer goods purchased. At December 31, 2002, total loans, net of unearned discounts, were 80% of total earning assets. Loans secured by real estate accounted for 58% of total loans as of December 31, 2002. Most of the loans classified as real estate-mortgage are commercial loans where real estate provides additional collateral. The Banks do not participate in the secondary loan market. Nonperforming assets include nonaccrual loans, accruing loans past due 90 days or more and other real estate, which includes foreclosures, deeds in lieu of foreclosure and in-substance foreclosures. A loan is generally classified as nonaccrual when full collectibility of principal or interest is doubtful or a loan becomes 90 days past due as to principal or interest, unless management determines that the estimated net realizable value of the collateral is sufficient to cover the principal balance and accrued interest. When interest accruals are discontinued, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged to the allowance for loan losses. Nonperforming loans are returned to performing status when the loan is brought current and has performed in accordance with contract terms for a period of time. A summary of the Registrant's loan loss experience is included elsewhere in this report. Distribution of Nonperforming Assets 2002 2001 2000 (In Thousands) Nonaccrual loans $ 748 $ 1,002 $ 876 Past due 90 days still accruing 466 1,028 734 Other real estate (ORE) 314 1,265 725 $ 1,528 $ 3,295 $ 2,335 Nonperforming loans to year end loans .71% 1.18% .99% Nonperforming assets to year end loan and ORE .90% 1.91% 1.42% The ratio of nonperforming assets has increased each year from 1999 to 2001. However in 2002, a decrease occurred as the banks put special attention to the problem loans. During 2000 and 2001, the economy in the banks' market area declined with certain loans deteriorating to nonperforming status. Management continues to work on nonperforming assets to reduce this ratio even lower. Asset-Liability Management and Market Risk Sensitivity Market risk is the risk of loss from adverse changes in market prices and rates. The Registrant's market risk arises principally from interest rate risk inherent in its lending, deposit and borrowing activities. Management actively monitors and manages its inherent rate risk exposure. Although the Registrant manages other risks, as in credit quality and liquidity risk, in the normal course of business, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Registrant's financial condition and results of operations. Other types of market risks, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Registrant's business activities. The Registrant's profitability is affected by fluctuations in interest rates. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase in interest rates may adversely impact the Registrant's earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same extent or on the same basis. The Registrant monitors the impact of changes in interest rates on its net interest income using several tools. The Banks' goal is to minimize interest rate risk between interest bearing assets and liabilities at various maturities through its Asset-Liability Management ("ALM"). ALM involves managing the mix and pricing of assets and liabilities in the face of uncertain interest rates and an uncertain economic outlook. It seeks to achieve steady growth of net interest income with an acceptable amount of interest rate risk and sufficient liquidity. The process provides a framework for determining, in conjunction with the profit planning process, which elements of the Registrant's profitability factors can be controlled by management. Understanding the current position and implications of past decisions is necessary in providing direction for the future financial management of the Registrant. The Registrant uses an asset-liability model to determine the appropriate strategy for current conditions. Interest sensitivity management is part of the asset-liability management process. Interest sensitivity gap ("GAP") is the difference between total rate sensitive assets and rate sensitive liabilities in a given time period. The Registrant's rate sensitive assets are those repricing within one year and those maturing within one year. Rate sensitive liabilities include insured money market accounts, savings accounts, interest-bearing transaction accounts, time deposits and borrowings. The profitability of the Registrant is influenced significantly by management's ability to manage the relationship between rate sensitive assets and liabilities. At December 31, 2002, approximately 69% of the Registrant's earnings assets could be repriced within one year compared to approximately 91% of its interest-bearing liabilities. This compares to 69% and 92% in 2001. The Registrant's current GAP analysis reflects that in periods of increasing interest rates, rate sensitive assets will reprice slower than rate sensitive liabilities. The Registrant's GAP analysis also shows that at the interest repricing of one year, the Registrant's net interest margin would be adversely impacted. This analysis, however, does not take into account the dynamics of the marketplace. GAP is a static measurement that assumes if the prime rate increases by 100 basis points, all assets and liabilities that are due to reprice will increase by 100 basis points at the next opportunity. However, the Registrant is actually able to experience a benefit from rising rates in the short term because deposit rates do not follow the national money market. They are controlled by the local market. Loans do follow the money market; so when rates increase they reprice immediately, but the Registrant is able to manage the deposit side. The Registrant generally does not raise deposit rates as fast or as much. The Registrant also has the ability to manage its funding costs by choosing alternative sources of funds. The Registrant's current GAP position would also be interpreted to mean that in periods of declining interest rates, the Registrant's net interest margin would benefit. However, competitive pressures in the local market may not allow the Registrant to lower rates on deposits, but force the Registrant to lower rates on loans. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Registrant could undertake in response to changes in interest rates. The rate sensitivity analysis as presented in the selected statistical information shows the Registrant's financial instruments that are sensitive to changes in interest rates, categorized by expected maturity. Market risk sensitive instruments are generally defined as on and off balance sheet derivatives and other financial instruments. An important aspect of achieving satisfactory net interest income is the composition and maturities of rate sensitive assets and liabilities. The table generally reflects that in periods of rising interest rates, rate sensitive liabilities will reprice faster than rate sensitive assets, thus having a negative effect on net interest income. It must be understood, however, that such an analysis is only a snapshot picture and does not reflect the dynamics of the market place. Therefore, management reviews simulated earnings statements on a monthly basis to more accurately anticipate its sensitivity to changes in interest rates. The Registrant also measures its short-term exposure to interest rate risk by simulating the impact to net interest income under several rate change levels. Interest-earning assets and interest-bearing liabilities are rate shocked to stress test the impact to the Banks' net interest income and margin. The rate shock levels span three 100 basis point increments up and down from current interest rates. This information is used to monitor interest rate exposure risk relative to anticipated interest rate trends. ALM strategies are developed based on this analysis in an effort to limit the Banks' exposure to interest rate risk. Results of Operations 2002 Compared to 2001 Net interest income remains an effective measurement of how well management has balanced the Registrant's interest rate sensitive assets and liabilities. Net interest income increased by $187,682. The increase of 2.0% compared to a 6.1% increase in 2001. The primary determinants of the increase were rates associated with deposits. Loan demand decreased slightly and funds were channeled into securities and CD's at other banks as they represent the highest available yielding asset. Management continued its policy of limited solicitation of high interest deposits. The drastic reduction in rates by the Federal Reserve system resulted in repricing of most of interest rate sensitive assets and deposits. After 2001 where asset rates decreased faster than deposits, deposit rates in 2002 stabilized which allowed the net interest margin to increase slightly. The yield on interest earning assets decreased to 7.16% from 9.08% while interest bearing deposits yield decreased to 3.04% from 5.20%. The net interest margin increased to 4.12% from 3.88%. With the rate reduction not anticipated to continue and possible increase in late 2003 the banks anticipate that net interest margins will not change much and margins will remain low. Interest and fees on loans decreased $3,122,564 or 18.7% in 2002 from 2001 due to rate decreases of 193 basis points and loan demand declining 1.5% in 2002. Interest on investment securities decreased $251,189 or 22.3% in 2002 from 2001 due to a decrease in the yield in investments as rates have decreased. Interest income on federal funds sold decreased $434,001 or 58.6% due to lower rates as the rates on federal funds sold reached lows not seen in years. Total interest expense decreased 42.9% or $4,004,436 from 2001 to 2002. The largest component of total interest expense is interest expense on deposits, which decreased $3,832,492 or 43.0% from 2001 to 2002 due to a substantial reduction in rates. The average rate paid on deposits was 3.04%, 5.20% and 5.54% in 2002, 2001 and 2000, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $1,004,000 and $893,000, respectively, for the years ended December 31, 2002 and 2001. The provision in 2002 reflects replenishing the allowance for loan losses to cover net charge-offs of $867,569, plus providing for the increase as a result of the local economies. The allowance for loan losses to total loans outstanding is 1.70% at December 31, 2002. Net charge-offs to average loans are 0.52% for 2002 as compared to 0.52% for 2001. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration has been noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. Non-Interest Income Non-interest income for 2002 decreased by $137,200 or 4.4% over 2001, as compared to an increase in 2001 of $407,219 or 15.0% over 2000. These increases generally resulted from increased activity in data processing and decreased in financial services, other income loss on sale of fixed assets and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which decreased 1.3%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Registrant realizes the maximum contribution to profits from this area. Non-Interest Expense Non-interest expenses totaled $8,829,471 in 2002 as compared to $9,084,778 in 2001. This represented a 2.8% decrease from 2001 to 2002, compared to a 9.4% increase from 2000 to 2001. The overall decreases during the year were attributable primarily to salaries and employee benefits and includes reduction of staff and expenses of small branch closed during 2002. Salaries and other personnel expenses, which comprised 50% of total non-interest expenses for 2002, were down $497,717 or 10.1% over 2001 due to staff reductions from branch closing and from continuing operations. During 2001 and 2000, salaries and other personnel expenses accounted for 50% and 52% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses increased $284,255, or 21.2% from 2001 to 2002, as compared to a decrease of $130,966, or 8.8% in 2001. The increase is primarily a result of addition at two banks and the complete remodeling of one bank. Income Taxes Income tax expense totaled $823,633 in 2002 as compared to $733,859 in 2001. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Registrant works actively with outside tax consultants to minimize tax expenses. 2001 Compared to 2000 Net interest income remains an effective measurement of how well management has balanced the Registrant's interest rate sensitive assets and liabilities. Net interest income decreased by $605,669. The decrease of 6.1%, which included a full year of the 2000 branch acquisitions, compared to a 25.8% increase in 2000 when the branch acquisitions were included after August. The primary determinants of the decrease were loans and time deposits. Loan demand increased slightly and funds were channeled into loans as they represent the highest yielding asset. Management continued its policy of limited solicitation of high interest deposits. The drastic reduction in rates by the Federal Reserve system resulted in repricing of most of interest rate sensitive assets and deposits. As the tables presented earlier demonstrate the assets rates decreased faster than deposits therefore, the margins were squeezed resulting in the decrease in net interest income. The yield on interest earning assets decreased to 9.08% from 10.31% while interest bearing deposits yield decreased to 5.20% from 5.54%. The net interest margin decreased to 3.88% from 4.77%. With the rate reduction not anticipated to continue this trend should correct itself during 2002; however, with the low rates currently in the market, this margin will remain low. Interest and fees on loans increased only $133,211 or .8% in 2001 from 2000 due to rate decreases of 123 basis points and loan growth of 5.6% in 2001. Interest on investment securities decreased $131,101 or 11.1% in 2001 from 2000 due to a slight decrease in the yield in investments as rates have decreased. Interest income on federal funds sold increased $117,989 or 18.9% due to higher average balances invested and lower rates. Total interest expense increased 8.8% or $756,847 from 2000 to 2001. The largest component of total interest expense is interest expense on deposits, which increased $783,123 or 9.6% from 2000 to 2001 due to a growth in deposits. The average rate paid on deposits was 5.13%, 5.54% and 4.82% in 2001, 2000 and 1999, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $893,000 and $424,000, respectively, for the years ended December 31, 2001 and 2000. The provision in 2001 reflects replenishing the allowance for loan losses to cover net charge-offs of $864,439, plus providing for the increase in total loans outstanding. The allowance for loan losses to total loans outstanding is 1.60% at December 31, 2001. Net charge-offs to average loans are .52% for 2001 as compared to 0.31% for 2000. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration has been noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. Non-Interest Income Non-interest income for 2001 increased by $407,219 or 15.0% over 2000, as compared to an increase in 2000 of $420,249 or 15.5% over 1999. These increases generally resulted from increased activity in data processing, financial services and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which increased 13.4%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Registrant realizes the maximum contribution to profits from this area. The addition of the branch acquisition contributed to the increase in fees. Non-Interest Expense Non-interest expenses totaled $9,084,778 in 2001 as compared to $8,301,997 in 2000. This represented a 9.4% increase from 2000 to 2001, and a 20.2% increase from 1999 to 2000. The overall increases during the year were attributable to growth in all geographic markets, and includes operations of branches acquired during 2000. Salaries and other personnel expenses, which comprised 54% of total non- interest expenses for 2001, were up $694,299 or 16.4% over 2000 due to normal salary increases, benefit cost increases, and increased personnel due to two new branches. During 2000 and 1999, salaries and other personnel expenses accounted for 52% and 54% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses decreased $130,966, or 8.8% from 2000 to 2001, as compared to an increase of $298,051, or 25.4% in 2000. Income Taxes Income tax expense totaled $733,859 in 2001 as compared to $1,221,738 in 2000. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Registrant works actively with outside tax consultants to minimize tax expenses. Results of Operations 2000 Compared to 1999 Net interest income remains an effective measurement of how well management has balanced the Registrant's interest rate sensitive assets and liabilities. Net interest income increased by $1,619,133. The increase of 25.8%, which included the results of the branch acquisitions, compared to a 9.68% increase in 1999. The primary determinants of the increase were loans and time deposits. As loan demand increased, funds were channeled into higher yielding loans. Management continues its policy of not soliciting high interest deposits and was able to maintain stable cost of funds. The growth of assets and liabilities was primarily the reason for the increase as net interest margin decreased slightly to 4.77% from 4.83%. With the low interest rate currently in the market and the Registrant's current rate gap, the Registrant continued its efforts to channel funds into higher yielding assets. Due to the rate sensitivity gap, the Registrant attempted to improve its current position with a controlled attempt to lengthen its maturity of interest rate sensitive liabilities although this is difficult without rate adjustments upward. Interest and fees on loans increased $3,744,981 or 29.13% in 2000 from 1999 due to rate increased of 59 basis points and loan growth of 23.8% in 2000. Interest on investment securities increased $53,083 or 4.8% in 2000 from 1999 due to a slight increase in the yield in investments as rates have increased slightly. Interest income on federal funds sold increased $160,488 or 34.7% due to higher average balances invested and higher rates. Total interest expense increased 37% or $2,316,587 from 1999 to 2000. The largest component of total interest expense is interest expense on deposits, which increased $2,109,540 or 35.1% from 1999 to 2000 due to a rate increase and growth in deposits. The average rate paid on deposits was 5.54%, 4.82% and 5.27% in 2000, 1999 and 1998, respectively. The allowance for possible loan losses is established through charges to expense in the form of a provision for loan losses. The provision for loan losses was $424,000 and $503,000, respectively, for the years ended December 31, 2000 and 1999. The provision in 2000 reflects replenishing the allowance for loan losses to cover net charge-offs of $452,964, plus providing for the increase in total loans outstanding. The allowance for loan losses to total loans outstanding is 1.67% at December 31, 2000. Net charge-offs to average loans are .31% for 2000 as compared to 0.25% for 1999. The allowance for loan losses is based on an in-depth analysis of the loan portfolio. Specifically included in that analysis are the following types of loans: loans determined to be of a material amount, loans commented on by regulatory authorities, loans commented on by internal and external auditors, loans past due more than 60 days, and loans on a nonaccrual status. The allowance for loan losses is not allocated to specific credit risk, but rather to the overall loan portfolio as the individual banks are relatively small and can be looked at as a whole. The overall loan portfolio remains of good quality, however, some deterioration was noted in the economy which reflects on the loan portfolio. The Banks have made provisions where necessary to reflect the overall quality of loans. Non-Interest Income Non-interest income for 2000 increased by $420,249 or 15.5% over 1999, as compared to an increase in 1999 of $392,788 or 20.6% over 1998. These increases generally resulted from increased activity in data processing, financial services and service charges on deposits. A significant contributor to non-interest income is service charges on deposit accounts which increased 24.2%. Management views deposit fee income as critical influence on profitability. Periodic monitoring of competitive fee schedules and examination of alternative opportunities ensure that the Registrant realizes the maximum contribution to profits from this area. The addition of the branch acquisition contributed to the increase in fees. Non-Interest Expense Non-interest expenses totaled $8,301,997 in 2000 as compared to $6,905,856 in 1999. This represented a 20.2% increase from 1999 to 2000, and an 8% increase from 1998 to 1999. The overall increases during the year were attributable to growth in all geographic markets, and includes operations of branches acquired during the year. Salaries and other personnel expenses, which comprised 51% of total non- interest expenses for 2000, were up $535,840 or 14.5% over 1999 due to normal salary increases, benefit cost increases, and increased personnel due to the one new branch. During 1999 and 1998, salaries and other personnel expenses accounted for 54% and 51% of total other operating expenses, respectively. Combined net occupancy and furniture and equipment expenses increased $298,051, or 25.4% from 1999 to 2000, as compared to an increase of $26,489, or 2.3% in 1999. Income Taxes Income tax expense totaled $1,221,738 in 2000 as compared to $1,017,056 in 1999. The changes in net income tax expense for the years were due to changes in taxable income for each respective year. Taxable income is affected by net income, income on tax exempt investment securities and loans, and the provision for loan losses. For tax purposes, the Bank can only recognize actual loan losses. The Registrant works actively with outside tax consultants to minimize tax expenses. Regulatory Matters During the year 2002, federal and state regulatory agencies completed asset quality examinations at the Registrant's subsidiary banks. The Registrant's level and classification of identified potential problem loans was not revised significantly as a result of this regulatory examination process. However, one bank has seen some increase in classified loans as a result of branch acquisitions in the year 2000. Examination procedures require individual judgments about a borrower's ability to repay loans, sufficiency of collateral values and the effects of changing economic circumstances. These procedures are similar to those employed by the Registrant in determining the adequacy of the allowance for loan losses and in classifying loans. Judgments made by regulatory examiners may differ from those made by management. Management and the boards of directors of the Registrant and affiliates evaluate existing practices and procedures on an ongoing basis. In addition, regulators often make recommendations during the course of their examinations that relate to the operations of the Registrant and its affiliates. As a matter of practice, management and the boards of directors of the Registrant and its subsidiaries consider such recommendations promptly. Impact of Inflation and Changing Prices The majority of assets and liability of a financial institution are monetary in nature; therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. However, inflation does have an important impact on the growth of total assets in the banking industry and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity-to-assets ratio. An important effect of this has been the reduction of asset growth to maintain appropriate levels. Another significant effect of inflation is on other expenses, which tend to rise during periods of general inflation. Management believes the most significant impact on financial results is the Registrant's ability to react to changes in interest rates. As discussed previously, management is attempting to maintain an essentially balanced position between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations. Item 7A. Quantitative And Qualitative Disclosures About Market Risk The Registrant is exposed only to U.S. dollar interest rate changes and accordingly, the Registrant manages exposure by considering the possible changes in the net interest margin. The Registrant does not have any trading instruments nor does it classify any portion of the investment portfolio as held for trading. The Registrant does not engage in any hedging activities or enter into any derivative instruments other than mortgage backed securities, which are commonly pass through securities. Finally, the Registrant has no exposure to foreign currency exchange rate risk, commodity price risk, and other market risks. Interest rates play a major part in the net interest income of a financial institution. The sensitivity to rate changes is known as "interest rate risk." The repricing of interest earning assets and interest-bearing liabilities can influence the changes in net interest income. See "Management's Discussion and Analysis of Financial Condition and Results of Operations - Asset-Liability Management and Market Risk Sensitivity." Item 8. Financial Statements and Supplementary Data The following consolidated financial statements of the Registrant and its subsidiaries are included on pages F1 through F42 of this Annual report on Form 10-K. Consolidated Balance Sheets - December 31, 2002 and 2001 Consolidated Statements of Income and Other Comprehensive Income - Years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Changes in Stockholders' Equity - Years ended December 31, 2002, 2001 and 2000 Consolidated Statements of Cash Flow - Years ended December 31, 2002, 2001 and 2000 Notes to Consolidated Financial Statements Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures Not applicable. Part III. Item 10. Directors and Executive Officers of the Registrant The name, present principal occupation or employment, five-year employment history and ownership of common stock of the directors, executive officers and controlling persons of the Registrant is set forth below. Companies listed other than the Registrant are its subsidiaries. None of the persons listed below has engaged in transactions with respect to the common stock during the past 60 days. During the last five years, none of the persons listed below has been convicted in a criminal proceeding nor were any of such persons a party to a judicial or administrative proceeding that resulted in a judgment, decree or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws or finding any violation of such laws. All such persons are U.S. citizens, and except as otherwise indicated, the address of the corporation in which such persons conduct their present principal occupation or employment is 501 West 12th Street, Alma, Georgia 31510. Beneficial ownership information is given o the extent known after reasonable inquiry, and is based on 399,500 shares of common stock outstanding as of March 21, 2003. Each of persons named below has been principally employed by South Banking Company or its subsidiaries for at least five years. Number of Director Shares Position with Company and (Officer) Owned Name Principal Occupation or Since (Percent Employment of Outstanding) Olivia Executive Vice President, 1969 189,372 Bennett(1)(2) Secretary and Director, South (47.40%) Banking Company; Chairman and Director, Alma Exchange Bank & Trust; Director, Banker's Data Services, Inc.; Chairman, President and Director, Citizens State Bank; Chairman, President and Director, Peoples State Bank & Trust Paul T. President, Treasurer and 1978 19,526 Bennett(1)(3) Director, South Banking Company; (4.89%) Vice Chairman and Director, Citizens State Bank; Vice Chairman and Director, Peoples State Bank & Trust; Director and President, Banker's Data Services, Inc.; Vice Chairman and Director, Alma Exchange Bank & Trust; Director, Chairman and President, Pineland State Bank Lawrence Director, South Banking Company; 1987 12,814 Bennett(1)(4) President and Director, Alma (3.21%) Exchange Bank & Trust; Director and Secretary, Banker's Data Services, Inc.; Director, Peoples State Bank & Trust; Director, Pineland State Bank Kenneth F. Director, South Banking Company; 1980 4,934 Wade Executive Vice President and (1.24%) Director, Alma Exchange Bank & Trust; Director, Banker's Data Services, Inc. Charles Director, South Banking Company; 1990 992 Stuckey Executive Vice President and (0.25%) Director, Peoples State Bank & Trust; Director, Banker's Data Services, Inc. James W. Director, South Banking Company; 1989 279 Whiddon Executive Vice President and (0.07%) Director, Citizens Bank; Director, Banker's Data Services Richard Director, South Banking Company; 2001 - Williams Executive Vice President and Director, Pineland State Bank; Director, Banker's Data Services, Inc. (1) Olivia Bennett is the mother of Paul T. Bennett and Lawrence Bennett. (2) Includes 166,085 shares owned by Estate of Valene Bennett of which Olivia Bennett is the Executrix and 23,287 shares owned by Bennett Family Limited Partnership of which she is the general partner. (3) The shares reported include 226 shares owned by Paul T. Bennett's wife and 150 shares owned jointly with each of two children. (4) Owned jointly with Lawrence Bennett's wife. None of the directors are a director of a publicly-held corporation which is required to file reports with the Securities and Exchange Commission. Each of the Directors and Executive Officers have been engaged in his or her present principal occupation for at least five years. Olivia Bennett is the mother of Paul T. Bennett and Lawrence Bennett. There are no other family relationships between any other Director or Executive Officer. Directors serve until the next annual meeting of shareholders or until their successors are elected and qualified. Officers serve at the pleasure of the Board of Directors. Item 11. Executive Compensation The following information is given as to the cash and cash equivalent forms of renumeration received by South's Chief Executive Officer and only other executive officer whose salary and bonus exceeded $100,000 during the last fiscal year. Long-Term Compensation Annual Compensation Securities All Other Name and Underlying Annual Principal Year Salary Bonus Options/SARS Compensation Paul T. Bennett Chief 2002 203,896 31,505 Executive 2001 196,700 32,090 Officer 2000 182,848 31,440 Olivia Bennett Secretary 2002 202,355 21,975 2001 202,618 20,875 2000 215,099 20,915 (1) Does not include fees and dues for clubs and fraternal and civic organizations paid by the Banks to certain officers for business related purposes. Also, does not include any amounts for use of an automobile. (2) Other compensation consists of director fees from registrant and subsidiary banks. The Registrant has no compensation plans (including individual compensation arrangements) under which equity securities of the Registrant are authorized for issuance. Directors' Compensations. The members Registrant's Board of Directors currently receive a fee of $2,500 per year for service on the Registrants's Board of Directors. Agreements with Officers The Registrant has no employment or change in control agreements with any of its executive officers. Compensation Committee Interlocks and Insider Participation The Board of Directors of the Registrant reviewed the compensation of Paul Bennett and Olivia Bennett and of the Registrant's other executive officers for the 2002 fiscal year. Although Mr. Bennett participated in deliberations regarding the salaries of executive officers, he did not participate in any decisions regarding his own compensation as an executive officer. Report on Executive Compensation Under rules established by the SEC, the Registrant is required to provide certain information with respect to compensation provided to the Registrant's President and Chief Executive Officer and other executive officers. The SEC regulations require a report setting forth a description of the Registrant's executive compensation policy in general and the considerations that led to the compensation decisions affecting Paul Bennett and Olivia Bennett. In fulfillment of this requirement, the Board of Directors and Compensation Committee have prepared the following report for inclusion in this Form 10-K. The fundamental policy of the Registrant's compensation program is to offer competitive compensation and benefits for all employees, including the President and Chief Executive Officer and the other officers of the Registrant, to compete for and retain talented personnel who will lead the Registrant in achieving levels of financial performance that enhance shareholder value. The Registrant's executive compensation package historically has consisted of salary, annual bonus, and other customary fringe benefits. The members of the Board of Directors of the Registrant participated in deliberations regarding salaries of executive officers. Mr. Bennett did not participate in deliberations concerning his own compensation. Although subjective in nature, factors considered by the Board in setting the salaries of executive officers were Mr. Bennett's recommendations (except with respect to his own salary), compensation paid by comparable companies to their executive officers (although such information was obtained informally and the Registrant did not attempt to pay any certain percentage of salary for comparable positions with other companies), each executive officer's performance, contribution to the Registrant, tenure in his or her position, and internal comparability considerations. The Board of Directors set the salary of Mr. Bennett based on Mr. Bennett's salary during the preceding fiscal year, his tenure, the salaries of chief executive officers of comparable bank holding companies, and the increase in earnings of the Registrant in recent years. The Board did not assign relative weights to the factors considered in setting salaries of executive officers, including Mr. Bennett. The Board of Directors Item 12. Security Ownership of Certain Beneficial Owners and Management The following table sets forth, as of March 1, 2003, the beneficial ownership of Common Stock of Registrant by the Only "person" (as that term is defined by the Securities and Exchange Commission), who owns of record or is known by the Registrant to own beneficially 5% or more of the outstanding shares of Common Stock of the Registrant and by all Executive Officers and Directors of the Registrant as a group. Number of Percent of Shares Owned Outstanding Name Beneficially Shares Estate of Valene Bennett Route 4 Alma, Georgia 31510 166,085 41.57% Olivia Bennett Route 4 Alma, Georgia 31510 23,287 5.83% ll Executive Officers and Directors as a group (7 persons) 227,248 57.0% Item 13. Certain Relationships and Related Transactions The Banks have had, and expect to have in the future, banking transactions in the ordinary course of business with Directors and Officers of the Banks and their associates, including corporations, partnerships and other organizations in which such Directors and Officers have an interest, on substantially the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with unrelated parties. Such transactions have not involved more than the normal risk of collectibility or presented other unfavorable features. Item 14. Controls And Procedures The Registrant's management, including the Chief Executive Officer and Chief Financial Officer, supervised and participated in an evaluation of its disclosure controls and procedures (as defined in federal securities rules) within 90 days prior to the filing of this report. Based on, and as of the date of, that evaluation, the Registrant's Chief Executive Officer and Chief Financial Officer have concluded that the Registrant's disclosure controls and procedures were effective in accumulating and communicating information to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures of that information under the Securities and Exchange Commission's rules and forms and that the Registrant's disclosure controls and procedures are designed to ensure that the information required to be disclosed in reports that are filed or submitted by the Registrant under the Securities Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms. There were no significant changes in the Registrant's internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation. Item 15. Exhibits, Financial Statement Schedule and Reports on Form 8-K (a) The following documents are filed as part of this report: 1. Financial Statements (a) South Banking Company and Subsidiaries: (i) Consolidated Balance Sheets - December 31, 2002 and 2001 (ii) Consolidated Statements of Income and Other Comprehensive Income - Years ended December 31, 2002, 2001 and 2000 (iii) Consolidated Statements of Stockholders' Equity - Years ended December 31, 2002, 2001 and 2000 (iv) Consolidated Statements of Cash Flow - Years ended December 31, 2002, 2001 and 2000 (b) South Banking Company (Parent Corporation Only): (i) Balance Sheets - December 31, 2002 and 2001 (ii) Statements of Income and Other Comprehensive Income - Periods ended December 31, 2002, 2001 and 2000 (iii) Statements of Stockholders' Equity - Periods ended December 31, 2002, 2001 and 2000 (iv) Statements of Cash Flow - Years ended December 31, 2002, 2001, and 2000 3. Exhibits required by Item 601 of regulation S-K: (3.1) Articles of Incorporation (included as Exhibit 3(a) to Appendix II to Registrant's Registration Statement on Form S-14, File No. 2-71249, previously filed with the Commission and incorporated herein by reference). (3.2) By-Laws (included as Exhibit 3(b) to Appendix II to Registrant's Registration Statement on Form S-14, File No. 2-71249, previously filed with the Commission and incorporated herein by reference). (21) List of the Registrant's subsidiaries: (99.1) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) The registrant has not filed a Form 8-K during the last quarter of the period. (c) The response to this Item 14(c) is included in Item 14(a). (d) Financial Statements Schedules - None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SOUTH BANKING COMPANY Date: March 28, 2003 By: /s/ Paul T. Bennett President, Treasurer and Director POWER OF ATTORNEY Know all men by these present, that each person whose signature appears below constitutes and appoints Paul T. Bennett, his attorney- in-fact, to sign any amendments to this Report, and to file the same, with exhibits thereto, and other documents in connection therewith. The Securities and Exchange Commission hereby ratifying and confirming all that said attorney-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof. Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Date: March 28, 2003 /s/ Paul T. Bennett Principal Executive, Financial and Accounting Officer and Director Date: March 28, 2003 /s/ Olivia Bennett Executive Vice President And Director Date: March 28, 2003 /s/ Charles Stuckey Director Date: March 28, 2003 /s/ James W. Whiddon Director Date: March 28, 2003 /s/ Kenneth F. Wade Director Date: March 28, 2003 /s/ Lawrence Bennett Director SUPPLEMENTAL INFORMATION The proxy statement for the 2003 annual meeting of shareholders has not been sent to the Registrant's shareholders, but will be sent subsequent to the filing of this Annual Report on Form 10-K. The foregoing material will be furnished to the Commission when they are sent to the shareholders since the Registrant does not have securities registered pursuant to Section 12 of the Securities Exchange Act of 1934. The foregoing materials shall not be deemed to be "filed" with the Commission or otherwise subject to the liabilities of Section 18 of that Act. CERTIFICATION I, Paul T. Bennett, certify that: 1. I have reviewed this annual report on Form 10-K of South Banking Company, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls. 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Dated this 28th day of March 2003. /s/ Paul T. Bennett Chief Executive Officer Chief Financial Officer EXHIBIT INDEX (21) List of the Registrant's subsidiaries: (99.1) Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. EXHIBIT 21 Subsidiaries (1) Alma Exchange Bank & Trust (2) Citizens State Bank (3) Peoples State Bank & Trust (4) Bankers' Data Services, Inc. (5) Pineland State Bank (6) South Financial Products, Inc. All of the Registrant's subsidiaries were incorporated under the laws of the State of Georgia and are doing business in Georgia under the above names. EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350 I, Paul T. Bennett, Chief Executive and Chief Financial Officer of South Banking Company, Inc. (the "Company"), certify, pursuant to 18 U.S.C. 1350 as adopted by 906 of the Sarbanes-Oxley Act of 2002, that: (1) the Annual Report on Form 10-K of the Company for the annual period ended December 31, 2002 (the "Report") fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: March 28, 2003 /s/ Paul T. Bennett Chief Executive Officer Chief Financial Officer SOUTH BANKING COMPANY ALMA, GEORGIA FINANCIAL STATEMENTS DECEMBER 31, 2002 F1 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors South Banking Company Alma, Georgia 31510 We have audited the accompanying consolidated balance sheets of South Banking Company and Subsidiaries as of December 31, 2002 and 2001 and the related consolidated statements of income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of South Banking Company and Subsidiaries at December 31, 2002 and 2001 and the consolidated results of its operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Respectfully submitted, DALTON & BENNETT, CPA'S Waycross, Georgia February 7, 2003 F2 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEETS December 31, December 31, 2002 2001 ASSETS Cash and due from banks $ 9,436,272 $ 11,140,462 Deposits in other banks - interest bearing $ 3,905,136 $ 1,273,000 Investment securities Available for sale $ 18,892,037 $ 17,173,350 Held to maturity - market value of $52,445 in 2002 and $152,583 in 2001 $ 47,746 $ 147,536 Georgia Bankers stock $ 547,283 $ 547,283 Federal Home Loan Bank stock $ 438,100 $ 426,100 Federal funds sold $ 18,600,000 $ 10,252,000 Loans $169,805,432 $ 172,378,811 Less: Unearned discount ( 236,926) ( 288,968) Reserve for loan losses ( 2,893,211) ( 2,756,780) $166,675,295 $ 169,333,063 Bank premises and equipment $ 6,590,001 $ 6,715,813 Intangible assets $ 1,444,786 $ 1,680,572 Other assets $ 4,181,677 $ 6,101,344 Total Assets $230,758,333 $ 224,790,523 The accompanying notes are an integral part of these financial statements. F3 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED BALANCE SHEETS (Con't) December 31, December 31, 2002 2001 LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities Deposits: Demand - non-interest bearing $ 31,335,371 $ 29,999,788 Demand - interest bearing 35,171,392 32,764,586 Savings 11,863,852 10,537,057 Time 121,395,391 122,699,172 $199,766,006 $ 196,000,603 Borrowing 5,035,257 5,581,251 Accrued expenses and other liabilities 1,235,777 1,850,430 Federal funds purchased - - N/P - Federal Home Loan Bank 3,000,000 1,500,000 Total Liabilities $209,037,040 $ 204,932,284 Stockholders' Equity Common stock $1 par value; shares authorized - 1,000,000, shares issued and outstanding - 2002 and 2001 - 399,500 and 399,500, respectively $ 399,500 $ 399,500 Surplus 3,070,831 3,070,831 Undivided profits 17,800,222 16,291,126 Accumulated other comprehensive income 450,740 96,782 Total Stockholders' Equity $ 21,721,293 $ 19,858,239 Total Liabilities and Stockholders' Equity $230,758,333 $ 224,790,523 The accompanying notes are an integral part of these financial statements. F4 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Interest Income Interest and other fees on loans $ 13,614,595 $ 16,737,159 $ 16,603,948 Interest on deposits - interest bearing 59,690 54,303 53,224 Interest on federal funds sold 306,768 740,769 622,780 Interest on investment securities: U. S. Treasury 21,853 31,021 77,571 U. S. Government agencies 689,777 898,919 910,190 Mortgage backed securities 4,481 16,360 33,411 State and municipal subdivisions 51,733 66,100 79,343 Other securities 39,011 60,031 73,017 Total Interest Income $ 14,787,908 $ 18,604,662 $ 18,453,484 Interest Expense Interest on deposits $ 5,072,288 $ 8,904,780 $ 8,121,657 Interest - other borrowing 257,930 429,874 456,150 Total Interest Expense $ 5,330,218 $ 9,334,654 $ 8,577,807 Net interest income $ 9,457,690 $ 9,270,008 $ 9,875,677 Provision for loan losses 1,004,000 893,000 424,000 Net interest income after provision for loan losses$ 8,453,690 $ 8,377,008 $ 9,451,677 Other Operating Income Service charge on deposits$ 1,763,507 $ 1,787,500 $ 1,576,094 Commission on insurance 81,600 81,052 89,036 Other income 456,387 528,323 429,101 Securities gains (losses) 6,699 ( 3,684) 7 Data processing fees 615,594 537,212 459,036 Gain (Loss) on sale of fixed assets ( 44,394) 60,333 2,019 Financial service income 108,744 134,601 162,825 Total Other Operating Income $ 2,988,137 $ 3,125,337 $ 2,718,118 The accompanying notes are an integral part of these financial statements. F5 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (Con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Other Operating Expenses Salaries $ 3,530,330 $ 3,676,504 $ 3,354,689 Profit sharing and other personnel expenses 896,401 1,247,944 875,460 Occupancy expense of bank premises 482,441 514,595 475,452 Furniture and equipment expense 1,143,073 826,664 996,773 Stationery and supplies 192,885 199,901 254,881 Data processing 233,800 295,852 310,141 Director fees 187,925 182,760 174,260 Other real estate expenses 171,286 92,080 13,006 Other expenses 1,991,330 2,048,478 1,847,335 Total Other Operating Expenses $ 8,829,471 $ 9,084,778 $ 8,301,997 Income before income taxes$ 2,612,356 $ 2,417,567 $ 3,867,798 Applicable income taxes 823,633 733,859 1,221,738 Net Income $ 1,788,723 $ 1,683,708 $ 2,646,060 Other comprehensive income before tax Unrealized gain on securities $ 567,603 $ 291,307 $ 151,160 Other comprehensive income before tax $ 567,603 $ 291,307 $ 151,160 Income tax expenses related to items of other comprehensive income 213,645 107,708 57,048 Other comprehensive income, net of tax $ 353,958 $ 183,599 $ 94,112 Comprehensive Income $ 2,142,681 $ 1,867,307 $ 2,740,172 Per share data based on weighted outstanding shares: Weighted average outstanding 399,500 399,500 399,500 Net Income $ 4.48 $ 4.21 $ 6.62 The accompanying notes are an integral part of these financial statements. F6 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY Accumulated Other Total Compre- Stock- Common Undivided hensive holders' Stock Surplus Profits Income Equity Balance, December 31,1999 $399,500 $3,070,831 $12,520,614 $(180,929)$15,810,016 Net income - - 2,646,060 - 2,646,060 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 94,112 94,112 Redemption of shares - - - - - Balance, December 31,2000 $399,500 $3,070,831 $14,887,046 $(86,817)$18,270,560 Net income - - 1,683,708 - 1,683,708 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss) on securities available for sale - - - 183,599 183,599 Redemption of shares - - - - - Balance, December 31,2001 $399,500 $3,070,831 $16,291,126 $ 96,782 $19,858,239 Net income - - 1,788,723 - 1,788,723 Cash dividends - - ( 279,627) - ( 279,627) Unrealized gain (loss) on securities available for sale - - - 353,958 353,958 Redemption of shares - - - - - Balance, December 31,2002 $399,500 $3,070,831 $17,800,222 $450,740 $21,721,293 The accompanying notes are an integral part of these financial statements. F7 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Cash Flows From Operating Activities: Net income $ 1,788,723 $ 1,683,708 $ 2,646,060 Add expenses not requiring cash: Provision for depreciation and amortization 1,126,529 1,080,954 930,972 Provision for loan losses 1,004,000 893,000 424,000 Provision for loss on ORE 75,518 52,000 3,408 Bond portfolio losses (gains) ( 6,699) 3,685 - (Gain) loss on sale of premises & equipment 44,395 ( 60,070) ( 2,019) (Gain) loss on sale of other real estate owned 48,099 20,625 23,040 Increase (decrease) in taxes payable ( 33,749) 136,792 ( 236,230) Increase (decrease) in interest payable ( 429,046) ( 403,513) 568,654 Increase (decrease) in other liabilities ( 151,858) ( 119,749) 324,957 (Increase) decrease in interest receivable 384,228 341,390 ( 460,066) (Increase) decrease in prepaid expenses 145,737 ( 175,310) ( 80,167) (Increase) decrease in other assets 179,195 260,171 ( 284,686) Recognition of unearned loan income ( 52,042) 60,094 - Net Cash Provided By Operating Activities $ 4,123,030 $ 3,773,777 $ 3,857,923 Cash Flows From Investing Activities: Proceeds from maturities of securities held to maturity $ 100,000 $ - $ 600,000 Purchase of securities held to maturity - - - Proceeds from maturity of securities available for sale 18,714,220 25,668,030 2,101,866 Net loans to customers 1,087,543 ( 11,476,813) (13,197,595) Proceeds from sale of securities available for sale - 295,094 - The accompanying notes are an integral part of these financial statements. F8 SOUTH BANKING COMPANY ALMA, GEORGIA CONSOLIDATED STATEMENTS OF CASH FLOWS (Con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Cash Flows From Investing Activities: (con't) Purchase of securities available for sale $( 19,851,099) $( 22,139,058) $( 4,339,254) Purchase of premises and equipment ( 833,062) ( 2,044,019) ( 1,645,225) Proceeds from sale of premises and equipment 16,020 639,520 29,970 Proceeds from sale of other real estate owned 1,491,512 659,090 885,084 Purchase of Bank stock - - - Purchase of FHLB stock ( 12,000) - - Purchase of Bank Branches - - ( 4,193,634) Net Cash Provided By Investing Activities $ 713,134 $( 8,398,156) $(19,758,788) Cash Flows From Financing Activities: Net increase (decrease) in demand deposits, NOW and money markets $ 3,742,389 $ 11,061,093 $ 1,686,060 Net increase in savings and time deposits 23,014 ( 7,739,705) 19,819,341 Proceeds from borrowing 1,500,000 1,523,810 4,756,750 Payments on borrowing ( 545,994) ( 1,705,722) ( 256,463) Dividends paid ( 279,627) ( 279,628) ( 279,628) Payments to retire stock - - - Increase in federal funds purchased - - ( 1,140,000) Net Cash Provided By Financing Activities $ 4,439,782 $ 2,859,648 $ 24,586,060 Net increase (decrease)in Cash and Cash Equivalents$ 9,275,946 $( 1,764,731) $ 8,685,195 Cash and Cash Equivalents at Beginning of Year 22,665,462 24,430,193 15,744,998 Cash and Cash Equivalents at End of Year $ 31,941,408 $ 22,665,462 $ 24,430,193 The accompanying notes are an integral part of these financial statements. F9 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies The accounting and reporting policies of South Banking Company, Inc. and its subsidiaries conform with generally accepted accounting principles and with practices within the banking industry. (a) Basis of Presentation During 1996, Pineland State Bank was acquired by South Banking Company. The transaction was accounted for using the purchase method. During 2000, Pineland State Bank acquired, in its immediate vicinity, three branches of Flag, Inc. The transaction was accounted for using the purchase method. (b) Principles of Consolidation The consolidated financial statements include the accounts of South Banking Company, Alma, Georgia (The Bank) and its wholly owned bank subsidiaries, Alma Exchange Bank, Alma, Georgia; Peoples State Bank, Baxley, Georgia; Citizens State Bank, Kingsland, Georgia; Pineland State Bank, Metter, Georgia; and its wholly owned computer center, Bankers' Data Services, Inc., Alma, Georgia. All significant intercompany transactions and balances have been eliminated in consolidation. (c) Nature of Operations: The Banks provide a variety of banking services to individuals and businesses through its offices in Alma, Georgia; Kingsland, Georgia; Baxley, Georgia; Metter, Georgia; Cobbtown, Georgia; and Statesboro, Georgia. Its primary source of revenue is loans to customers who are primarily low to middle income individuals and small to mid size businesses. (d) Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure 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. F10 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies (Con't) (d) Use of Estimates (Con't) Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for losses on loans and the valuation of fore-closed real estate. In connection with the determination of the estimated losses on loans and foreclosed real estate, management obtains independent appraisals for significant properties. While management uses available information to recognize losses on loans and foreclosed real estate, further reductions in the carrying amounts of loans and foreclosed assets may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans and foreclosed real estate. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans and foreclosed real estate may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated. (e) Securities: The Bank's investments in securities are classified in two categories and accounted for as follows. Securities to be Held to Maturity. Bonds, notes and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for amortization of premiums and accretion of discounts which are recognized in interest income using the interest method over the period to maturity. Securities Available for Sale. Securities available for sale consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as securities to be held to maturity. Declines in fair value of individual held-to-maturity and available-for-sale securities below their cost that are other than temporary have resulted in write-downs of the individual securities to their fair value. The related write-downs have been included in earnings as realized losses. F11 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies (Con't) (e) Securities (Con't) Unrealized holding gains and losses, net of tax, on securities available for sale are reported as a net amount in a separate component of shareholders' equity until realized. Gains and losses on the sale of securities available- for-sale are determined using the specific-identification method. Federal Home Loan Bank Stock Individual banks within the holding company have joined the Federal Home Loan Bank ("FHLB") of Atlanta to increase the Bank's available liquidity. As a FHLB member, the Banks are required to acquire and retain shares of capital stock in FHLB of Atlanta in an amount equal to the greater of (1) 1.0% of the aggregate outstanding principal amount of the residential mortgage loans, home purchase contracts, and similar obligations, or (2) 0.3% of total assets at the beginning of each year. The Bank is in compliance with this requirement with an investment in FHLB stock of $438,100 and $426,100 at December 31, 2002 and 2001, respectively. No ready market exists for this stock and it has no quoted market value. However, redemption of this stock has historically been at par value. (f) Loans Receivable: Loans and Interest Income Loans are carried at principal amounts outstanding reduced by unearned discounts. Interest income on all loans is recorded on an accrual basis. The accrual of interest is generally discontinued on loans which become 90 days past due as to principal or interest. The accrual of interest on some loans, however, may continue even though they are 90 days past due, if the loans are well secured, in the process of collection, and management deems inappropriate. If non-accrual loans decrease their past due status to 60 days or less, they are reviewed individually by management to determine if they should be returned to accrual status. Impaired Loans The Bank accounts for its impaired loans in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, which requires that all creditors value all specifically F12 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies (Con't) Impaired Loans (Con't) reviewed nonhomogeneous loans for which it is probable that the creditor will be unable to collect all amounts due according to the terms of the loan agreement at the loan's fair value. Fair value may be determined based upon the present value of expected cash flows, market price of the loan, if available, or value of the underlying collateral. Expected cash flows are required to be discounted at the loan's effective interest rate. SFAS No. 114 was amended by SFAS No. 118 to allow a creditor to use existing methods for recognizing interest income on impaired loans and by requiring additional disclosures about how a creditor recognizes interest income related to impaired loans. The Bank determines which loans are impaired through a loan review process. When the ultimate collectibility of an impaired loan's principal is in doubt, wholly or partially, all cash receipts are applied to principal. When this doubt no longer exists, cash receipts are applied under the contractual terms of the loan agreement first to principal and then to interest income. Once the recorded principal balance has been reduced to zero, future cash receipts are applied to interest income, to the extent that any interest has been foregone. Further cash receipts are recorded as recoveries or any amounts previously charged off. SFAS No. 114 specifically states that it need not be applied to "large groups of smaller-balance homogeneous loans that are collectively evaluated for impairment". Thus, the Company determined that the statement does not apply to its consumer loan, credit card, or residential mortgage loan portfolios, except that it may choose to apply it to certain specific larger loans determined by management. In effect, these portfolios are covered adequately in the Company's normal formula for determining loan loss reserves. Loan Fees and Costs Nonrefundable fees and certain direct costs associated with originating or acquiring loans are recognized as yield adjustment over the contractual life of the related loans, or if the related loan is held for resale, until the loan is sold. Recognition of deferred fees and costs is discontinued on non-accrual loans until they return to accrual status or are charged-off. Commitment fees associated with lending are deferred and if the commitment is exercised, the fee is F13 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies (Con't) Loan Fees and Costs (Con't) recognized over the life of the related loan as a yield adjustment. If the commitment expires unexercised, the amount is recognized upon expiration of the commitment. (g) Allowances for Loan Losses: The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions, and other risks inherent in the portfolio. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. (h) Premises and Equipment: Land is carried at cost. Other premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line and the declining balance methods based principally on the estimated useful lives of the assets. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations. (i) Other Real Estate (ORE) Real estate acquired in satisfaction of a loan and in- substance foreclosures are reported in other assets. In- substance foreclosures are properties in which a borrower with F14 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 1. Significant Accounting Policies (Con't) (i)Other Real Estate (ORE) (Con't) little or no equity in the collateral, effectively abandons control of the property or has no economic interest to continue involvement in the property. The borrower's ability to rebuild equity based on current financial conditions also is considered doubtful. Properties acquired by foreclosure or deed in lieu of foreclosure and properties classified as in- substance foreclosures are transferred to ORE and recorded at the lower of cost of fair market value based on appraised value at the date actually or constructively received. Loan losses arising from the acquisition of such property are charged against the allowance for loan losses. Losses on ORE due to subsequent valuation adjustments are recorded on a specific property basis. (j) Income Taxes Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the basis of the allowance for loan losses and accumulated depreciation. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. The Bank files a consolidated federal income tax return with its subsidiaries. Each subsidiary provides for income taxes on a separate return basis and remits to the parent company amounts determined to be currently payable. (k) Intangibles The intangibles (Goodwill and Core Deposits) recorded by the Company in the acquisition of Pineland State Bank and subsequent branches are being amortized on a straight line basis over eight to ten years. (l) Earnings Per Share Earnings per share are based on the weighted average number of shares outstanding. F15 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2002 Note 1. Significant Accounting Policies (Con't) (m) Comprehensive Income Comprehensive income includes net income and all other changes in equity during a period except those resulting from investments by owners and distributions to owners. Other comprehensive income includes revenues, expenses, gains, and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Comprehensive income and accumulated other comprehensive income are reported net of related income taxes. Accumulated other comprehensive income for the Bank consists solely of unrealized holding gains or losses on available-for-sale securities. In accordance with SFAS No. 130, the Company elected to disclose changes in comprehensive income in its Consolidated Statements of Income and Comprehensive Income. (n) Cash Flow Information For purposes of the statements of cash flows, the Company considers cash, federal funds sold and due from banks as cash and cash equivalents. Cash paid during the years ended December 31, 2002, 2001 and 2000 for interest was $5,759,264, $9,738,167, and $8,117,741, respectively. Total income tax payments during 2002, 2001 and 2000 were $790,000, $844,223, and $1,552,939, respectively. (o) Recent Pronouncements and Accounting Changes The Financial Accounting Standards Board (FASB) issued Statement of Financial Standards (SFAS) No. 141, Business Combinations, and SFAS No.142, Goodwill and Other Intangible Assets, on July 20, 2001. SFAS No. 141 provides that all business combinations shall be accounted for using the purchase method of accounting; the use of the pooling-of-interests method is now prohibited. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001 or to all business combinations accounted for by the purchase method that are completed after June 30, 2001. The Company has not been involved in any recent business combination discussions. F16 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2002 Note 1. Significant Accounting Policies (Con't) (o) Recent Pronouncements and Accounting Changes (Con't) SFAS No. 142 provides that goodwill shall not be amortized but should be tested for impairment on an annual basis, using criteria prescribed in the statement. If the carrying amount of goodwill exceeds its implied fair value, as recalculated, an impairment loss equal to the excess shall be recognized. Recognized intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No.121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of (superseded by SFAS No. 144, see discussion which follows). SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001. The Company's intangible assets at December 31, 2002 are classified as intangible assets other than goodwill. Approximately $1.393 million of the intangibles recorded on the balance sheet at December 31, 2002 represents the remaining unamortized intangible related to the Company's 2000 acquisition of three branch offices from another bank. The balance of $52 thousand is the remaining intangibles from the original purchase of the bank in 1996. The intangible are being amortized over eight to ten years in accordance with SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions, which was not superseded by SFAS No. 142. During December 2001, the FASB announced it will undertake a limited-scope project to reconsider part of the guidance in SFAS No. 72. SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of, was issued by the FASB on October 3, 2001 and is effective for fiscal years beginning after December 15, 2001. This statement effectively supersedes SFAS No. 121 and Accounting Principles Board (APB) Opinion No. 30 and requires that long-lived assets, including discontinued operations, that are to be disposed of by sale be measured at the lower of carrying amount or fair value less cost to sell. The statement also resolves certain implementation issues regarding SFAS No. 121. This statement is not expected to have a material impact on the Company's statements of financial condition or results of operations. F17 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31,2002 Note 2. Investment Securities The amortized cost and estimated market values of investments in debt securities are as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value Securities available for sale - December 31, 2002: U.S. Government and agency securities $17,042,611 $ 190,160 $ - $17,232,771 State and municipal securities 848,460 37,063 - 885,523 Mortgage backed securities 20,453 190 - 20,643 Equity securities 259,253 500,000 6,153 753,100 Totals $18,170,777 $ 727,413 $ 6,153 $18,892,037 December 31, 2001: U.S. Government and agency securities $15,583,819 $ 165,042 $ 57,519 $15,691,342 State and municipal securities 948,774 34,883 - 983,657 Mortgage backed securities 227,844 8,207 - 236,051 Equity securities 259,253 3,047 - 262,300 Totals $17,019,690 $ 211,179 $ 57,519 $17,173,350 Securities to be Held to Maturity - December 31, 2002: U.S. Government and agency securities $ - $ - $ - $ - State and municipal securities 47,746 4,699 - 52,445 Mortgage backed securities - - - - Totals $ 47,746 $ 4,699 $ - $ 52,445 F18 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 2. Investment Securities (Con't) Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 2001 U.S. Government and agency securities $ - $ - $ - $ - State and municipal securities 147,536 5,047 - 152,583 Mortgage backed securities - - - - Totals $ 147,536 $ 5,047 $ - $ 152,583 Gross realized gains and loses on sales of available-for- sale securities were $6,699 and $-0- in 2002, respectively and $-0- and $(3,685), respectively for 2001 and $-0- and $-0-, respectively in 2000. During the year ended December 31, 2001, investment securities available for sale, with a fair value at the date of sale of $295,094, were sold. In the years 2002 and 2000, no securities were sold. Securities called in 2002 resulted in gain of $6,699. Assets, principally securities carried at approximately $13,265,987 at December 31, 2002 and $11,615,367 at December 31, 2001, were pledged to secure public deposits and for other purposes required or permitted by law. The scheduled contractual maturities of securities to be held to maturity and securities available for sale at December 31, 2002 were as follows: Securities Securities To Be Held Available To Maturity for Sale Amortized Amortized Cost Fair Value Cost Fair Value Due in one year or less $ - $ - $ 852,634 $ 864,704 Due from one year to five years - - 15,839,960 16,011,428 Due from five years to ten years - - 1,000,000 1,030,502 Due after ten years 47,746 52,445 218,930 232,303 $ 47,746 $ 52,445 $17,911,524 $18,138,937 F19 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 2. Investment Securities (Con't) The market value of State and Other Political Subdivision Obligations is established with the assistance of an outside bond department and is based on available market data which often reflects transactions of relatively small size and is not necessarily indicative of prices at which large amounts of particular issues could readily be sold or purchased. Expected maturities will differ from contractual maturities because issuers may have the right to call on prepay obligations with or without call on prepayment penalties. Note 3. Loans The composition of the bank's portfolio was as follows: 2002 2001 (In Thousands) Commercial, financial and agricultural $ 43,939 $ 49,558 Real estate - mortgage 90,492 85,876 Real estate - construction 8,809 9,015 Installment and consumer 26,565 27,929 Total Loans $ 169,805 $ 172,378 Less: Unearned discount ( 237) ( 289) Reserve for loan losses ( 2,893) ( 2,756) Loans, net $ 166,675 $ 169,333 Non-accrual loans (principally collateralized by real estate) amounted to approximately $748,000, $1,002,000 and $876,000 at December 31, 2002, 2001, and 2000, respectively. Impaired loans were $-0- and $-0- at December 31, 2002 and 2001. The Company and its subsidiaries have granted loans to the officers and directors of the Company, its subsidiaries, and to their associates. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. The aggregate dollar amount of these loans was $546,892 and $805,074 at December 31, 2002 and 2001. During 2002, $232,658 of new loans were made, and repayments totaled $490,840. F20 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 4. Reserve for Loan Losses Transactions in the reserve for loan losses are summarized as follows: Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Balance at beginning of period $ 2,756,780 $ 2,728,219 $ 2,168,877 Additions: Provision charged to operating expenses $ 1,004,000 $ 893,000 $ 424,000 Balance from bank acquisition - - 588,306 $ 3,760,780 $ 893,000 $ 1,012,306 Deductions: Loans charged off $ 1,006,028 $ 1,002,886 $ 664,298 Less: recoveries 138,459 138,447 211,334 $ 867,569 $ 864,439 $ 452,964 Balance at end of period $ 2,893,211 $ 2,756,780 $ 2,728,219 Additions to the reserve for loan losses are based on management's evaluation of the loan portfolio under current economic conditions, past loan loss experience and such other factors which, in management's judgment, deserve recognition in estimating loan losses. Loans are charged off when, in the opinion of management, such loans are deemed to be uncollectible. Recognized losses are charged to the reserve and subsequent recoveries added. Loans having carrying values of $618,267 and $1,436,843 were transferred to foreclosed real estate in 2002 and 2001, respectively. The bank is not committed to lend additional funds to debtors whose loans have been modified. F21 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 5. Deposits The aggregate amount of short-term jumbo CDs, each with a minimum denomination of $100,000, was approximately $35,871,828 in 2002 and $31,805,741 in 2001. At December 31, 2002, the scheduled maturities of CDs are as follows: (In Thousands) 2003 $ 109,907 2004 and 2005 10,790 2006 and thereafter 698 $ 121,395 Note 6. Premises and Equipment A summary of the account: Year Ended Year Ended December 31, December 31, 2002 2001 Land $ 684,387 $ 640,582 Buildings 5,512,798 5,971,572 Furniture and equipment 5,643,224 5,697,359 $11,840,409 $12,309,513 Less: Accumulated depreciation 5,250,408 5,593,700 $ 6,590,001 $ 6,715,813 Depreciation expense was $898,459 in 2002, $860,117 in 2001 and $803,318 in 2000. Note 7. Borrowings Data relating to borrowing is as follows: Year Ended Year ended December 31, December 31, Parent Company - 2002 2001 Note payable in 10 annual payments with interest payable quarterly and accrues at prime rate minus 50 basis points. Subsidiary bank stock is pledged to secure loan. $ 4,400,000 $ 4,725,000 F22 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 7. Borrowings (Con't) Year Ended Year Ended December 31, December 31, 2002 2001 Subsidiary - Bankers Data Services, Inc. Note payable due January 27, 2003 monthly principal amount of $10,833.33 plus interest. Interest accrues at prime minus 1%. Computer equipment is pledged as collateral for loan. 611,466 824,419 Note payable in 36 monthly payments of $434.02. Interest accrues at 1.9% rate and is secured by vehicle. - 433 Note payable in 24 monthly payments of $664.13. Interest accrues at 5.9% rate and is secured by vehicle. - 6,465 Note payable in 24 monthly payments of $791.66. Interest accrues at 0% and is secured by auto. 7,917 17,416 Subsidiary - Alma Exchange Bank Note payable in 36 monthly payments of $696.98. Interest accrues at 3.9% rate and is secured by vehicle. - 7,517 Note payable in 3 annual payments of $7,937. Interest accrues at 0% and is secured by auto. 15,874 23,811 Following are maturities of long term debt for each of the next five years. 2003 $ 52,853 2004 562,937 2005 605,000 2006 655,000 2007 666,466 F23 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 8. Income Taxes Income tax expense (benefit) was $823,633 for 2002, (an effective rate of 31.53%), $733,859 for 2001 (an effective rate of 30.4%) and $1,221,738 for 2000 (an effective rate of 31.6%). The actual expense for 2002, 2001 and 2000 differs from the "expected" tax expense for those years (computed by applying the federal corporate rate of 34%) as follows: 2002 2001 2000 Computed "expected" tax expenses 34.0% 34.0% 34.0% Alternative minimum tax - - - Effect of State Income Tax 1.2% ( .1%) 1.1% Tax exempt interest on securities and loans ( 3.8%) ( 4.6%) ( 3.6%) Other,net .1% 1.1% .1% 31.5% 30.4% 31.6% The current and deferred amounts of these tax provisions were as follows: 2002 2001 2000 Current - Federal $ 716,252 $ 725,56 $ 1,178,493 - State - - 83,299 Deferred - Federal 89,838 7,123 ( 24,534) - State 17,543 1,170 ( 15,520) $ 823,633 $ 733,859 $ 1,221,738 The tax effects of each type of income and expense item that gave rise to deferred taxes are: December 31, December 31, 2002 2001 Net unrealized appreciation on securities available for sale $( 272,843) $( 55,726) Depreciation ( 322,901) ( 219,899) Deferred loan fees 83,448 101,281 Allowance for credit losses 786,372 788,595 Other 55,833 32,728 Purchase accounting treatment ( 65,820) ( 65,820) Net deferred tax asset (liability) $ 264,089 $ 581,159 F24 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 9. Employee Benefit Plans The Company maintains a 401K deferred compensation plan for all subsidiaries effective January 1, 1993. The Company elected to match 75% of employee contributions for 2002, 2001 and 2000. The expense to the Company for 2002, 2001 and 2000 was $128,120, $140,000, and $134,297, respectively. Note 10. Leases The Pineland State Bank leases 5.35 acres of land in Candler County under an operating lease expiring December 31, 2054 with an option to lease the land for an additional 75 years. Minimum future rental payments under non-cancelable operating lease having remaining term in excess of 1 year as of December 31, 2001 for each of the next 5 years and in the aggregate is: Year Ended 2003 $ 4,000 2004 4,000 2005 4,000 2006 4,000 2007 4,000 Subsequent to 2008 188,000 Total minimum future rental payments $208,000 In June, 1997, the parties amended the lease to allow Pineland State Bank to sublet part of the property and in consideration, the landlord will receive 50% of gross rental under the sublease in addition to the minimum amount above. Note 11. Liabilities Standby Letters of Credit. These transactions are used by the Company's customers as a means of improving their credit standing in their dealings with others. Under these agreements, the Company agrees to honor certain financial commitments in the event that its customers are unable to do so. As of December 31, 2002 and 2001, the Company had $622,179 and $911,779 in outstanding standby letters of credit. Loan Commitments. As of December 31, 2002 and 2001, the Company had commitments outstanding to extend credit totaling $14,493,616 and $15,710,009, respectively. These commitments generally require the customers to maintain certain credit standards. Management does not anticipate any material losses as a result of these commitments. F25 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 12. Financial Instruments The Bank is a party to financial instruments with off- balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, and standby letters of credit, and financial guarantees. Those instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, standby letters of credit, and financial guarantees written is represented by the contractual notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. Commitments to Extend Credit and Financial Guarantees. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if it is deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies; but, may include accounts receivable; inventory, property, plant and equipment; and income-producing commercial properties. Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support private borrowing arrangements, including commercial paper and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank holds various assets as collateral supporting those commitments for which collateral is deemed necessary. The Bank has not been required to perform on any financial guarantees during the past two years. The Bank has not incurred any losses on its commitments in 2002, 2001 or 2000. F26 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 13. Restrictions on Subsidiary Dividends, Loans or Advances Dividends are paid by the Company from its assets which are mainly provided by dividends from the Banks. However, certain restrictions exist regarding the ability of the Banks to transfer funds to the Company in the form of cash dividends, loans or advances. The approval of the Georgia Department of Banking is required to pay dividends in excess of 50% of the Bank's net profits for the prior year. Note 14. Restrictions on Cash and Due from Banks Under Federal Reserve regulation, the Bank also is limited as to the amount it may loan to its affiliates, including the Company, unless such loans are collateralized by specified obligations. At December 31, 2002, the maximum amount available for transfer from the Bank to the Company in the form of loans approximated 20% of consolidated net equity. The bank is required to maintain reserve balances with the Federal Reserve Bank. The average amount of those reserve balances for the year ended December 31, 2002 was approximately $-0-. Note 15. Related Party Transactions The Company has entered into a split dollar life insurance arrangement with a director and substantial shareholder. The Company and director's trust each contribute toward the payment of premium for life insurance policy. The Company records its contribution at the present value of anticipated future return or total cash surrender value of policy, whichever is higher; however, the carrying amount cannot exceed the amount of premiums paid by the Company. The Company will receive all reimbursement from anticipated withdrawal of cash surrender value or from the proceeds of policy in the event of the death of the director. All cash surrender value of the policy accrues to the benefit of the Company until such time as the cash surrender value exceeds advances made by the Company. As of December 31, 2002, $920,596 is carried in other assets related to this arrangement. F27 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 16. Fair Value of Financial Instruments The following table shows the estimated fair value and the related carrying values of South Banking Company's financial instruments at December 31, 2002 and 2001. Items which are not financial instruments are not included. 2002 Carrying Estimated Cash and due from financial Amount Fair Value institutions $ 9,436,272 $ 9,436,272 Interest earning balances with financial institutions 3,905,136 3,905,136 Federal funds sold 18,600,000 18,600,000 Securities available for sale 18,892,037 18,892,037 Securities held to maturity 47,746 52,445 Federal Home Loan Bank stock 438,100 438,100 Georgia Bankers Bank - stock 547,283 1,312,830 Loans - net of allowances 166,675,295 169,209,000 Demand and savings deposits 78,370,615 78,370,615 Time deposits 121,395,391 121,844,000 Federal funds purchased - - 2001 Cash and due from financial institutions 11,140,462 $11,140,462 Interest earning balances with financial institutions 1,273,000 1,273,000 Federal funds sold 10,252,000 10,252,000 Securities available for sale 17,173,350 17,173,350 Securities held to maturity 147,536 152,583 Federal Home Loan Bank stock 426,100 426,100 Georgia Bankers Bank - stock 547,283 770,240 Loans - net of allowances 169,333,063 161,938,092 Demand and savings deposits 73,301,431 73,301,431 Time deposits 122,699,172 123,606,169 Federal funds purchased - - For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2002 and 2001. The estimated fair value for cash and due from financial institutions and federal funds sold are considered to approximate cost. The estimated fair value for interest- earning balances with financial institutions, securities available-for-sale, securities held-to-maturity, and Georgia Bankers Bank stock are based on quoted market values for the individual securities or for equivalent securities. The estimated fair value for commercial loans is based on estimates of the difference in interest rates the F28 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 16. Fair Value of Financial Instruments (Con't) Company would charge the borrowers for similar such loans with similar maturities made at December 31, 2002 and 2001, applied for an estimated time period until the loan is assumed to reprice or be paid. The estimated fair value for other loans is based on estimates of the rate the Company would charge for similar such loans at December 31, 2002 and 2001 applied for the time period until estimated repayment. The estimated fair value for individual retirement account deposits and time deposits is based on estimates of the rate the Company would pay on such deposits or borrowings at December 31, 2002 and 2001, applied for the time period until maturity. The estimated fair value for other financial instruments and off-balance-sheet loan commitments are considered to approximate cost at December 31, 2002 and 2001. While these estimates of fair value are based on management's judgment of the most appropriate factors, there is no assurance that were the Company to have disposed of such items at December 31, 2002 and 2001, the estimated fair values would necessarily have been achieved at that date, since market values may differ depending on various circumstances. The estimated fair values at December 31, 2002 and 2001 should not necessarily be considered to apply at subsequent dates. In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above disclosures, such as property and equipment. Also, non-financial instruments typically not recognized in the financial statements, nevertheless, may have value but are not included in the above disclosures. These include, among other items, the estimated earnings power of core deposit accounts, the earnings potential of loan servicing rights, the trained work force, customer goodwill, and similar items. Note 17. Regulatory Matters The Company and its subsidiaries are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary-actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital F29 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 17. Regulatory Matters (Con't) guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2002, that the Company and its subsidiaries meet all capital adequacy requirements to which it is subject. As of December 31, 2002, the most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that, management believes, have changed the institution's category. The Company and its subsidiaries' actual capital amounts and ratios are also presented in the table. To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2002: Total Capital (to Risk Weighted Assets) Consolidated $ 22,137 12.0% > $ 14,655 > 8.0% > $ 18,320 > 10.0% Subsidiary - Alma 7,993 12.8% > 4,977 > 8.0% > 6,221 > 10.0% Subsidiary - Baxley 7,141 15.2% > 3,750 > 8.0% > 4,687 > 10.0% Subsidiary - Kingsland 3,343 13.4% > 1,997 > 8.0% > 2,496 > 10.0% Subsidiary - Metter 5,622 11.7% > 3,840 > 8.0% > 4,800 > 10.0% F30 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 17. Regulatory Matters (Con't) To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2002: Tier I Capital (to Risk Weighted Assets) Consolidated $ 19,825 10.8% > $ 7,328 > 4.0% > $ 7,328 > 6.0% Subsidiary - Alma 7,207 11.6% > 2,488 > 4.0% > 3,732 > 6.0% Subsidiary - Baxley 6,540 13.9% > 1,875 > 4.0% > 2,812 > 6.0% Subsidiary - Kingsland 3,030 12.1% > 998 > 4.0% > 1,498 > 6.0% Subsidiary - Metter 5,019 10.5% > 1,920 > 4.0% > 2,880 > 6.0% As of December 31, 2002: Tier I Capital (to Average Assets) Consolidated $19,825 8.7% > $ 9,123 > 4.0% > $11,404 > 5.0% Subsidiary - Alma 7,207 9.2% > 3,132 > 4.0% > 3,915 > 5.0% Subsidiary - Baxley 6,540 11.9% > 2,197 > 4.0% > 2,747 > 5.0% Subsidiary - Kingsland 3,030 9.1% > 1,331 > 4.0% > 1,663 > 5.0% Subsidiary - Metter 5,019 8.2% > 2,440 > 4.0% > 3,050 > 5.0% F31 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 17. Regulatory Matters (Con't) To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2001: Total Capital (to Risk Weighted Assets) Consolidated $ 20,435 10.9% > $ 15,041 > 8.0% > $ 18,801 > 10.0% Subsidiary - Alma 7,775 11.5% > 5,384 > 8.0% > 6,730 > 10.0% Subsidiary - Baxley 6,737 15.9% > 3,381 > 8.0% > 4,227 > 10.0% Subsidiary - Kingsland 3,192 12.4% > 2,065 > 8.0% > 2,581 > 10.0% Subsidiary - Metter 5,410 10.4% > 4,159 > 8.0% > 5,199 > 10.0% As of December 31, 2001: Tier I Capital (to Risk Weighted Assets) Consolidated 18,080 9.6% > 7,520 > 4.0% > 11,280 > 6.0% Subsidiary - Alma 6,924 10.3% > 2,692 > 4.0% > 4,038 > 6.0% Subsidiary - Baxley 6,207 14.7% > 1,691 > 4.0% > 2,536 > 6.0% Subsidiary - Kingsland 2,868 11.1% > 1,032 > 4.0% > 1,549 > 6.0% Subsidiary - Metter 4,769 9.2% > 2,080 > 4.0% > 3,120 > 6.0% F32 SOUTH BANKING COMPANY ALMA, GEORGIA NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002 Note 17. Regulatory Matters (Con't) Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio As of December 31, 2001: Tier I Capital (to Average Assets) Consolidated $ 18,080 8.1% > $ 8,924 4.0% > $11,155 > 5.0% Subsidiary - Alma 6,924 8.9% > 3,104 4.0% > 3,881 > 5.0% Subsidiary - Baxley 6,207 12.1% > 2,052 4.0% > 2,565 > 5.0% Subsidiary - Kingsland 2,868 9.1% > 1,266 4.0% > 1,583 > 5.0% Subsidiary - Metter 4,769 7.8% > 2,435 4.0% > 3,043 > 5.0% F33 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA FINANCIAL STATEMENTS DECEMBER 31, 2002 F34 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors South Banking Company Alma, Georgia 31510 Under date of February 7, 2003, we reported on the consolidated balance sheets of South Banking Company, as of December 31, 2002 and 2001, and the related statements of income, cash flows and stockholders' equity for the three years in the period ended December 31, 2002. In connection with our examination of the aforementioned consolidated financial statements, we also audited the accompanying balance sheets (Parent Corporation Only) as of December 31, 2002 and 2001 and the related statements of income, cash flows and stockholders' equity for each of the three years in the period ended December 31, 2002. These financial statements are the responsibility of the company's management. Our responsibility is to express an opinion on the financial statements based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of South Banking Company (Parent Corporation Only) as of December 31, 2002 and 2001, and the results of its operations, stockholders' equity and its cash flows for the three years then ended in conformity with accounting principles generally accepted in the United States of America. Respectfully submitted, DALTON & BENNETT, CPA'S February 7, 2003 F35 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA BALANCE SHEETS December 31, December 31, 2002 2001 ASSETS Cash and due from banks Interest bearing $1,337,688 $ 1,243,497 Non-interest bearing 43,077 36,862 Investment in bank's subsidiaries 23,386,303 22,543,800 Investment in nonbank subsidiaries 648,074 463,535 Investment-Nexity Financial-available for sale 750,000 250,000 Other assets 63,837 16,423 Prepaid income taxes 362,355 351,370 Due from subsidiaries - - Total Assets $26,591,334 $24,905,487 LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities Accounts payable $ 186 $ 186 Other liabilities 195,754 3,018 Accrued income taxes - - Notes payable 4,400,000 4,725,000 Due to subsidiaries 274,101 319,044 Total Liabilities $ 4,870,041 $ 5,047,248 Stockholders' Equity Common stock of $1 par value; authorized 1,000,000 shares; issued and outstanding, 2002 and 2001 399,500 and 399,500, respectively $ 399,500 $ 399,500 Surplus 3,070,831 3,070,831 Undivided profits 17,800,222 16,291,126 Accumulated other comprehensive income 450,740 96,782 Total Stockholders' Equity $21,721,293 $19,858,239 Total Liabilities and Stockholders'Equity $26,591,334 $24,905,487 The accompanying note is an integral part of these financial statements. F36 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF INCOME Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Income Dividends from bank subsidiaries $ 978,593 $ 994,156 $ 985,387 Miscellaneous income - - 788 Interest income 25,738 45,641 23,479 Management fees 112,800 108,000 102,000 Dividends - other - 2,673 5,345 Loss on sale of stock - ( 4,906) - Total Income $ 1,117,131 $1,145,564 $ 1,116,999 Expenses Salaries $ 82,158 $ 80,543 $ 83,169 Amortization - 1,498 13,526 Interest 200,222 337,286 318,822 Professional fees 36,236 25,791 75,045 Other 91,840 67,837 75,621 Total Expenses $ 410,456 $ 512,955 $ 566,183 Income before income taxes and equity in undistributed income (loss) of subsidiaries$ 706,675 $ 632,609 $ 550,816 Provision (credit) for income taxes ( 97,665) ( 136,526) ( 164,606) Income before equity in undistributed income in subsidiaries $ 804,340 $ 769,135 $ 715,422 Equity in undistributed income of bank subsidiaries $ 799,845 $ 792,336 $ 1,904,756 Equity in undistributed income (loss) of nonbank subsidiaries 184,538 122,237 25,882 $ 984,383 $ 914,573 $ 1,930,638 Net Income $ 1,788,723 $1,683,708 $ 2,646,060 The accompanying note is an integral part of these financial statements. F37 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF INCOME (con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Other Comprehensive Income before tax Unrealized gain on securities $ 567,712 $ 278,166 $ 151,160 Other Comprehensive Income before tax $ 567,712 $ 278,166 $ 151,160 Income tax expenses related to items of other comprehensive income 213,754 94,577 57,048 Other comprehensive income, net of tax $ 353,958 $ 183,589 $ 94,112 Comprehensive income $ 2,142,681 $1,867,297 $ 2,740,172 Per share data based on weighted outstanding shares: Weighted average outstanding 399,500 399,500 399,500 Net Income $ 4.48 $ 4.21 $ 6.62 The accompanying note is an integral part of these financial statements. F38 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF STOCKHOLDERS' EQUITY Accumulated Other Total Compre- Stock- Common Undivided hensive holders' Stock Surplus Profits Income Equity Balance, December 31, 1999$ 399,500 $3,070,831$12,520,614$( 180,929)$15,810,016 Net income - - 2,646,060 - 2,646,060 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss)on securities available for sale - - - 94,112 94,112 Redemption of shares - - - - - Balance, December 31,2000 $ 399,500 $3,070,831$14,887,046$( 86,817)$18,270,560 Net income - - 1,683,708 - 1,683,708 Cash dividends - - ( 279,628) - ( 279,628) Unrealized gain (loss)on securities available for sale - - - 183,599 183,599 Redemption of shares - - - - - Balance, December 31,2001 $ 399,500 $3,070,831$16,291,126$ 96,782 $19,858,239 Net income - - 1,788,723 - 1,788,723 Cash dividends - - ( 279,627) - ( 279,627) Unrealized gain (loss) on securities available for sale - - - 353,958 353,958 Redemption of shares - - - - - Balance, December 31, 2002$ 399,500 $3,070,831$17,800,222 $450,740 $21,721,293 The accompanying note is an integral part of these financial statements. F39 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS Year Ended Year Ended Year Ended December 31, December 31, December31, 2002 2001 2000 Cash Flows From Operating Activities: Net income $ 1,788,723 $ 1,683,708 $ 2,646,060 Add expenses not requiring cash: Depreciation and Amortization 11,569 11,731 21,870 Undistributed earnings of Subsidiaries ( 984,383) ( 914,573) ( 1,930,638) Loss on sale of stock - 4,906 - Increase (decrease) in other liabilities 4,035 2,230 788 Increase (decrease) in accrued income taxes - - ( 21,653) (Increase) decrease in other assets 360 1,369 725 (Increase) decrease in prepaid income taxes ( 10,985) ( 136,793) ( 214,577) (Increase) decrease in due from subsidiary-taxes - - 105,672 Increase (decrease) in due to subsidiary ( 44,943) 189,573 129,471 Net Cash Provided by Operating Activities $ 764,376 $ 842,151 $ 737,718 Cash Flows From Investing Activities: Capital contribution to Subsidiary $ - $( 200,000) $(2,700,000) Purchase of fixed assets ( 59,343) - ( 27,532) Sale of CB Financial - 295,094 - Net Cash Used by Investing Activities $( 59,343) $ 95,094 $(2,727,532) The accompanying note is an integral part of these financial statements. F40 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA STATEMENT OF CASH FLOWS (con't) Year Ended Year Ended Year Ended December 31, December 31, December 31, 2002 2001 2000 Cash Flows From Financing Activities: Payments on note payable Bank $( 325,000) $( 475,000) $( 60,000) Proceeds from notes payable to banks - - 2,900,000 Dividends paid ( 279,627) ( 279,628) ( 279,628) Redemption of common stock - - - Net Cash Provided (Used) by Financing Activities $( 604,627) $( 754,628) $ 2,560,372 Net increase (decrease) in cash and cash equivalents $ 100,406 $ 182,617 $ 570,558 Cash and Cash Equivalents at beginning of year 1,280,359 1,097,742 527,184 Cash and Cash Equivalents at end of year $ 1,380,765 $ 1,280,359 $ 1,097,742 The accompanying note is an integral part of these financial statements. F41 SOUTH BANKING COMPANY (PARENT CORPORATION ONLY) ALMA, GEORGIA NOTES TO FINANCIAL STATEMENTS (A) Summary of Significant Accounting Policies General- The following notes to the financial statements of South Banking Corporation, formed on July 28, 1981, (parent corporation only) (the corporation) includes only that information which is in addition to information presented in the consolidated financial statements and notes to consolidated financial statements. Investment in subsidiaries- The corporation reports its investment in the common stock of its subsidiaries at its equity in the net assets of the subsidiaries. Organization costs- Organization costs have been deferred and are being amortized on a straight-line basis over a period of five years. F42