SOUTHFIRST BANCSHARES, INC.

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-KSB/A

(Mark One)


( X )		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended September 30, 2004

( )		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF THE
		SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

Commission File Number: 1-13640

SOUTHFIRST BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

A Delaware Corporation
I.R.S. Employer Identification No. 63-1121255
126 North Norton Ave.
Sylacauga, Alabama 35150
(256) 245-4365

Securities Registered Pursuant to Section 12(b)
of the Exchange Act:


Title of Each Class		Name of Each Exchange on Which Registered

Common Stock, $.01 par value		American Stock Exchange, Inc.

Securities Registered Pursuant to Section 12(g)
of the Exchange 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-B is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB, or any amendment to this Form 10-KSB. [ ]

Issuer’s Revenues for the fiscal year ended September 30, 2004: $10,360,454

The aggregate market value of the common equity held by non-affiliates of the Registrant (594,691 shares), computed using the closing price as reported on the American Stock Exchange for the Registrant’s Common Stock on December 9, 2004 was $9,158,241. For the purposes of this response, officers, directors and holders of 10% or more of the Registrant’s Common Stock are considered the affiliates of the Registrant.

The number of shares outstanding of the Registrant’s Common Stock as of December 9, 2004: 709,406 shares of $.01 par value Common Stock.

Transitional Small Business Disclosure Format: Yes [ ] No [ X ]

DOCUMENTS INCORPORATED BY REFERENCE: None

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

Management has endeavored in its communications, in its Annual Report and in this Form 10-KSB/A to highlight the trends and factors that might have an impact on SouthFirst Bancshares, Inc. (“SouthFirst,” or the “Company”) and the industry in which SouthFirst competes. Any “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, which statements generally can be identified by the use of forward-looking terminology, such as “may,” “will,” “expect,” “estimate,” “anticipate,” “believe,” “target,” “plan,” “project,” or “continue” or the negatives thereof or other variations thereon or similar terminology, are made on the basis of management’s plans and current analyses of SouthFirst, its business and the industry as a whole. These forward-looking statements are subject to risks and uncertainties, including, but not limited to, economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. The above factors, in some cases, have affected, and in the future could affect, SouthFirst’s financial performance and could cause actual results for fiscal year 2005 and beyond to differ materially from those expressed or implied in such forward-looking statements. SouthFirst does not undertake to publicly update or revise its forward-looking statements, even if experience or future changes make it clear that any projected results expressed or implied therein will not be realized.

PART I

ITEM 1. BUSINESS

Business of SouthFirst

General

SouthFirst Bancshares, Inc. (“SouthFirst” or the “Company”) was formed in April of 1994, at the direction of the Board of Directors of First Federal of the South (“First Federal”), a federally chartered savings association subject to the regulatory oversight of the Office of Thrift Supervision (“OTS”) for the purpose of becoming a holding company to own all of the outstanding common stock of First Federal. On February 13, 1995, First Federal was converted from a mutual to a stock form of ownership (the “Conversion”), whereupon SouthFirst, approved by the OTS as a thrift holding company, acquired all of the issued and outstanding shares of First Federal. SouthFirst’s business primarily involves directing, planning and coordinating the business activities of its wholly-owned subsidiary, First Federal, along with First Federal’s two wholly-owned operating subsidiaries, (i) Pension & Benefit Financial Services, Inc., d/b/a Pension & Benefit Trust Company (“Pension & Benefit”), an employee benefit plan consulting firm and trust company located in Montgomery, Alabama, and (ii) SouthFirst Mortgage, Inc. (“SouthFirst Mortgage”), residential mortgage and construction lending operations located in Hoover and Chelsea, Alabama. Further, SouthFirst organized, as a wholly-owned subsidiary, SouthFirst Financial Services, Inc. (“SouthFirst Financial”), located in Montgomery and Sylacauga, Alabama, through which SouthFirst provides insurance products and other financial services to the customers of First Federal. In the future, SouthFirst may acquire or organize other operating affiliates or subsidiaries, including other financial institutions.

To date, SouthFirst has neither owned nor leased any property, but, instead, has used the premises, equipment and furniture of First Federal. At the present time, because SouthFirst does not intend to employ any persons other than officers, it will continue utilizing the support staff of First Federal from time to time. Additional employees may be hired as appropriate to the extent SouthFirst expands in the future.

Business of First Federal

General

First Federal was organized in 1949 as a federally chartered mutual savings and loan association under the name Sylacauga Federal Savings and Loan Association. In 1959, First Federal changed its name to First Federal Savings and Loan Association of Sylacauga. In the conversion, First Federal changed its name to First Federal of

the South. First Federal is a member of the Federal Home Loan Bank (the “FHLB”) System and its deposit accounts are insured up to the maximum amount allowable by the FDIC.

At September 30, 2004, First Federal conducted business from three full-service locations in Alabama. These locations included its main office in Sylacauga and branches in Talladega and Clanton. In addition, SouthFirst Mortgage, the wholly-owned subsidiary of First Federal, operates loan production offices in the Alabama cities of Hoover and Chelsea (suburbs of metropolitan Birmingham), primarily to enhance First Federal’s construction-lending activities in the growing residential markets of metropolitan Birmingham. First Federal also pursues other types of loans, such as consumer and commercial loans, in the Birmingham market area, as demands dictate.

In January 2004, First Federal of the South’s wholly-owned subsidiary, SouthFirst Mortgage, acquired all of the assets and work in progress of Walton Mortgage, located in Chelsea, Alabama. In addition to being based in Chelsea, a rapidly growing area on the outskirts of Birmingham, Walton Mortgage has loan originators who generate mortgage loans in other locations within Alabama, including Huntsville, Montgomery, Cullman and Alexander City. These lending areas will complement the mortgage banking activities of SouthFirst Mortgage located in Birmingham.

First Federal’s principal business has been, and continues to be, attracting retail deposits from the general public and investing those deposits, together with funds generated from operations, primarily in one-to-four family mortgage loans, residential constructions loans, mortgage-backed securities, collateralized mortgage obligations (“CMOs”) and investment securities.

First Federal’s revenues are derived principally from interest and fees on loans in its portfolio and from mortgage-backed securities, CMOs, investment securities portfolios and customer service fees. First Federal’s primary sources of funds are deposits and proceeds from principal and interest payments on loans, mortgage-backed securities, CMOs, FHLB advances and other investment securities. First Federal’s primary expense is interest paid on deposits.

First Federal markets its one-to-four family residential loans and deposit accounts primarily to persons in Talladega and Chilton Counties in Alabama. Mortgage loans are generated from depositors, walk-in customers, referrals from local real estate brokers and developers and, to a limited extent, local radio and newspaper advertising. Construction-loan originations are attributable largely to First Federal’s lending officers’ reputations and their long-standing relationships with builders and developers in the market areas they serve. See “— Construction Lending.”

First Federal offers its customers fixed-rate and adjustable-rate residential mortgage loans, residential construction loans, as well as other consumer loans, including savings account loans. Fixed-rate mortgage loans are generally sold upon origination to the secondary market. One-year adjustable-rate loans with 30-year maturities are generally originated for retention in First Federal’s loan portfolio. All consumer loans are retained in First Federal’s portfolio.

To attract deposits, First Federal offers a selection of deposit accounts, including NOW accounts, money-market accounts, passbook savings accounts and certificates of deposit. First Federal offers competitive rates and relies substantially on customer service, advertising and long-standing relationships with customers to attract and retain deposits.

Market Area

First Federal’s primary deposit gathering and lending area covers Talladega and Chilton Counties in central Alabama. To a lesser extent, First Federal’s deposit gathering and lending area covers the adjoining Alabama counties of Coosa, Shelby, Clay, Cleburne, Calhoun, St. Clair and Jefferson. Talladega County has a population of approximately 80,000 and Chilton County had a population of approximately 40,000, based on 2000 census data, as published by the U.S. Bureau of Vital Statistics. First Federal’s main office in Sylacauga is

situated approximately 38 miles southeast of Birmingham, the largest city in Alabama. First Federal’s branch office in the city of Talladega is situated approximately 55 miles east of Birmingham. First Federal’s Clanton office is located approximately 55 miles north of Montgomery. The loan production office of SouthFirst Mortgage, located in the city of Hoover, is situated within the Birmingham metropolitan area. Walton Mortgage, located south of Hoover in Chelsea, Alabama, is in Shelby County, which is considered the fastest growing county in the state of Alabama.

First Federal is the largest financial institution headquartered in Sylacauga and is the second largest in Talladega County. Talladega County has a diversified economy, based primarily on textile and other manufacturing, wholesale, retail, mining, service, government, agriculture and tourism. Manufacturing accounts for approximately one-third of the total employment in Talladega County. The economy is generally stable, and there has been no substantial increase or decrease in the population in the last five years.

Sylacauga’s economy is based primarily on major industrial employers such as Imery’s USA, Inc. American Color Graphics, Inc., Avondale Mills, Blue Bell Ice Cream, Pursell Industries and Georgia Marble. Bowater, Inc., a paper manufacturer, is a major employer in Childersburg, Alabama, located 10 miles from Sylacauga in Talladega County. Teksid, Inc., another major employer in the region, recently completed construction on a new aluminum casting manufacturing facility. The new plant, operated by Teksid Automotive Components, Inc., is located in Sylacauga, and employs approximately 400 skilled workers.

Talladega’s economy is based largely on major textile manufacturing employers such as Brecon Knitting Mills and Image Industries, Inc. Georgia-Pacific Corporation also employs a number of persons in Talladega. American Honda Motor Co., Inc. (“Honda”) operates a comprehensive automobile manufacturing facility near the town of Lincoln, Talladega County, Alabama that was completed in the Fall of 2001. The plant is located on a 1,350-acre tract, approximately forty miles east of Birmingham and 20 miles north of the city of Talladega. Construction was completed in 2004 on a record assembly line that put employment well over the 4,000 mark. The $70 million expansion nearly doubles the size of the already impressive 160,000 square foot facility. Talladega is the home of the Talladega Superspeedway which hosts the EA Sports 500 and other NASCAR events and attracts individuals to Talladega County primarily from the southeast region of the United States.

Although Chilton County is generally a rural area in which the economy is largely based on the growth and harvesting of peaches, this county has been experiencing relatively higher growth rates than Talladega County in terms of population and households. Chilton County employers include GulfStates Paper Corp., International Paper Corp. and Union Camp Corp.

Residential Lending

General

First Federal’s primary lending activity consists of the origination of one-to-four family, owner-occupied, residential mortgage loans, secured by property located in First Federal’s market area. Originations for such loans are generally obtained from existing or past customers, realtors, referrals, walk-ins, and, to a lesser extent, local newspaper and radio advertising. Loans are originated by First Federal lending personnel. No loan brokers are used. Conventional residential loans are priced based on rates offered by the local competition and in the secondary market. At September 30, 2004, First Federal had $44.9 million, or 47.5% of its loan portfolio, invested in one-to-four family residential mortgage loans. Management believes that this policy of focusing on one-to-four family lending has been effective in contributing to net interest income, while reducing credit risk by keeping loan delinquencies and losses to a minimum.

First Federal offers conventional fixed-rate, one-to-four family mortgage loans, with terms of 15 and 30 years. Fixed-rate loans are generally underwritten according to, either, Federal Home Loan Mortgage Corporation (“FHLMC”) or Federal National Mortgage Association (“FNMA”) guidelines, utilizing their approved documents so that the loans qualify for sale in the secondary mortgage market. Generally, First Federal

holds a portion of its fixed-rate mortgage loans, with maturities not exceeding 15 years, in its portfolio as long-term investments.

Adjustable-rate-mortgage (“ARM”) loans originated by First Federal consist of one, three, five, and seven-year ARMs that are indexed to the comparable maturity Treasury index or various cost-of-funds indexes. At September 30, 2004, First Federal held approximately $37.7 million ARMs, which represented approximately 39.4% of First Federal’s total loan portfolio. First Federal’s ARM loans are subject to a limitation of 2.0% per year adjustment for interest rate increases and decreases. In addition, ARM loans currently originated by First Federal typically have a lifetime cap of 6.0% on increases in the interest rate. These limits, based on the initial rate, may reduce the interest rate sensitivity of such loans during periods of changing interest rates. The repayment terms of ARM loans may increase the likelihood of delinquencies during periods of rising interest rates. First Federal offers teaser rates on ARM loans to remain competitive. Adjustable-rate loans which provide for teaser rates may be subject to increased risk of delinquency or default as the higher, fully indexed rate of interest subsequently replaces the lower, initial rate.

Regulations limit the amount which a savings association may lend in relationship to the appraised value of the real estate securing the loan, as determined by an appraisal at the time of loan origination. Such regulations permit a maximum loan-to-value ratio of 100% for residential property and 90% for all other real estate loans. First Federal’s lending policies, however, generally limit the maximum loan-to-value ratio to 95% of the appraised value of the property, based on an independent appraisal. For Federal Housing Administration (“FHA”), Veterans’ Administration (“VA”) and Farmers’ Home Loans, First Federal generally limits the maximum loan-to-value ratio to 100% of the appraised value of the property. When First Federal makes a loan in excess of 80% of the appraised value or purchase price, private mortgage insurance is required.

The loan-to-value ratio, maturity and other provisions of the residential real estate loans made by First Federal reflect the policy of making loans generally below the maximum limits permitted under applicable regulations. For all residential mortgage loans originated by First Federal, upon receipt of a completed loan application from a prospective borrower, a credit report is ordered, income, employment and certain other information are verified; and, if necessary, additional financial information is requested. First Federal requires an independent appraisal, title insurance (or an attorney’s opinion), flood hazard insurance (if applicable), and fire and casualty insurance on all properties securing real estate loans made by First Federal. First Federal reserves the right to approve the selection of which title insurance companies’ policies are acceptable to insure the real estate in the loan transactions.

Members of the First Federal Board of Directors receive a monthly summary of all loans which are closed. Construction loans in excess of $350,000 require authorizations by the Loan Committee of the First Federal Board prior to closing. First Federal issues written, formal commitments as to interest rates to prospective borrowers upon request on real estate loans at the date of application. The interest rate commitment remains valid for 30 to 60 days (the “lock-in period”) from the date of the application. Upon receipt of loan approval, the borrower has the balance of the lock-in period to close the loan at the interest rate committed.

Originated mortgage loans held in First Federal’s portfolio generally include due-on-sale clauses which provide First Federal with the contractual right to deem the loan immediately due and payable in the event that the borrower transfers ownership of the property without First Federal’s consent. It is First Federal’s policy to enforce due-on-sale provisions or to require that the interest rate be adjusted to the current market rate when ownership is transferred.

First Federal also offers loans secured by second mortgages on real estate, such as home improvement and home equity loans. At September 30, 2004, such loans amounted to $16.7 million. Second mortgage loans are extended for up to 80% of the appraised value of the property, less existing liens, at an adjustable or fixed interest rate. Home equity loans are extended in amounts up to 90% of the appraised value of the property. First Federal generally holds the first mortgage loans on the properties securing the second mortgages.

Residential Lending - Birmingham Market Area

Residential Lending in the Birmingham area was particularly strong during fiscal year 2004. With interest rates dropping to a forty year low refinances and purchases increased significantly. However, during fiscal 2004, the refinancing boom in the Birmingham market decreased significantly due primarily to the “bottoming out” of refinances in the market. During the first six months of fiscal 2004, SouthFirst Mortgage experienced significant operational losses as a result of this market change. In an effort to slow or curtail these losses, the bank downsized and restructured the SouthFirst Mortgage operation in order to meet the changing market demands associated with refinances and first mortgages. Additionally, the bank sought economies of scale in mortgage operations by dove-tailing the operations of SouthFirst Mortgage in Hoover with the acquisition of Walton Mortgage in Chelsea, Alabama. For fiscal 2004, SouthFirst Mortgage, both locations, had 177 residential loan originations, resulting in a pretax gain on sale of loans for approximately $454,000. For the years ended September 30, 2004 and 2003, First Federal’s total residential loan originations (including the originations by SouthFirst Mortgage) resulted in a pretax gain on sale of loans of approximately $719,000 and $1,170,000, respectively.

Construction Lending

SouthFirst Mortgage, Inc.

The majority of the residential construction lending of First Federal is conducted in the Birmingham metropolitan area, through its wholly-owned subsidiary, SouthFirst Mortgage, located in Hoover, Alabama, a suburb of Birmingham. At September 30, 2004, committed construction loans secured by single-family residential property totaled $22.9 million; of this amount, approximately $6.8 million was not disbursed. SouthFirst Mortgage makes construction loans primarily to builders for the construction of single-family residences, on both a pre-sold and speculative basis. SouthFirst Mortgage also makes construction loans on single-family residences to individuals who will ultimately be the owner-occupant of the house.

Construction loan proceeds are disbursed in increments as construction progresses. Disbursements are scheduled by contract, with SouthFirst Mortgage reviewing the progress of the underlying construction project prior to each disbursement. The construction loan agreements of SouthFirst Mortgage with builders generally provide that principal repayments are required as individual units are sold to third parties.

Construction loans are principally made to builders who have an established credit history with SouthFirst Mortgage and First Federal, as well as to builders who are referred by such borrowers. New builders must be approved by First Federal’s Loan Committee and, further, must display the same levels of knowledge and financial strength similar to that of existing builders. The application process includes a submission to SouthFirst Mortgage of plans, specifications and costs of the project to be constructed or developed. SouthFirst Mortgage and the Loan Committee of First Federal also review the borrower’s existing financial condition and total debt outstanding. All borrower relationships are reviewed annually by the SouthFirst Mortgage and the Loan Committee. The residential construction loans are originated with adjustable or fixed rates of interest that are negotiated with the builders, but typically will be tied to the prime rate plus a spread and have terms of 12 months or less. Construction loans generally have a maximum loan-to-value ratio of 80% on an “as completed” basis. SouthFirst Mortgage generally obtains personal guarantees for all of its construction loans and converts many of its construction loans to permanent loans upon completion of the construction phase.

Construction loans generally involve a higher level of credit risk than permanent single-family residential lending, due to the concentration of principal in a limited number of borrowers and the effects of changing economic, governmental and weather conditions. The nature of these loans is such that they require a sophisticated knowledge of building standards, material costs, union rules, real estate values and housing demand; and, thus, are more difficult to evaluate and monitor. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property’s value upon completion of the project and the estimated cost (including interest) of the project. If the estimate of construction cost proves to be inaccurate, SouthFirst Mortgage may be required to advance funds beyond the amount originally committed in order to permit

completion of the project and will be confronted, at or prior to the maturity of the loan, with a project having a value which is insufficient to assure full repayment.

During fiscal year ending September 30, 2004, the Construction Loan Division of SouthFirst Mortgage continued to operate under the supervisory agreement imposed by the OTS on First Federal in fiscal year 2002 (See, “Construction Lending – Supervisory Agreement and Organizational Restructure” below). Curt Reamer, Vice President of construction lending and mortgage operations, manages both areas in the Hoover office. Senior management of First Federal has oversight of both lending groups as set forth by the Board of Directors. The organizational structure for SouthFirst Mortgage is set forth below.

Supervisory Agreement and Organizational Restructure

The construction-lending activity of SouthFirst Mortgage was placed under certain loan-amount restrictions, and related requirements during all of fiscal year ended September 30, 2004, as a result of a supervisory agreement imposed on First Federal (the “Supervisory Agreement”), in March, 2002, by the OTS. On December 16, 2004, First Federal received notification from the OTS that First Federal had complied with the obligations contained in the Supervisory Agreement and that the Supervisory Agreement was rescinded as of December 14, 2004. See also “Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULT OF OPERATIONS — Supervisory Agreement.”

Pursuant to the requirements of the Supervisory Agreement, and in light of the resignation of Ms. Bryant, it was determined by the Board of Directors of First Federal that Senior Management of First Federal should provide direct managerial oversight of SouthFirst Mortgage. Thereafter, Joe K. McArthur, President and Chief Executive Office of First Federal, was appointed as the Chief Executive Officer of SouthFirst Mortgage, Sandra Stephens, Executive Vice President and Chief Operating Officer of First Federal, was appointed as President of SouthFirst Mortgage, and Janice Browning, Vice President and Controller of First Federal, was appointed as Vice President and Controller of SouthFirst Mortgage.

Further, certain Vice Presidents of First Federal were appointed as additional Vice Presidents of SouthFirst Mortgage, in order to perform credit review analysis and assist in certain administrative functions within the SouthFirst Mortgage construction lending and permanent mortgage lending operations. Any Vice President of SouthFirst Mortgage with construction lending authority can originate construction loans up to $350,000 with co-approval of another Vice President. Any construction loan between $350,000 and $500,000 must be presented to the loan committee of First Federal for approval. All construction loans greater than $500,000 require approval of the Board of Directors of First Federal.

To further enhance the overall organizational structure of SouthFirst Mortgage, in, both, the residential lending and construction lending functions, SouthFirst Mortgage named a Vice President of Billing and Collections who has many years of experience in the collection function with another financial institution.

First Federal, pursuant to the provisions of the Supervisory Agreement, has previously instituted a system of internal procedures to help ensure that construction loan interest, construction loan balances, and other provisions set forth in the Supervisory Agreement regarding construction lending are met and fairly stated.

Commercial Lending

At September 30, 2004, commercial lending totaled $14.0 million, or 14.6%, of First Federal’s total loan portfolio. First Federal’s commercial loans are secured by real estate or other acceptable collateral. In addition, borrowers generally must personally guarantee loans secured by commercial real estate. Commercial loans are mostly made at adjustable rates.

Commercial loans generally involve a greater degree of risk than residential mortgage loans. Because payments on loans are often dependent on successful operation or management of business, repayment of such loans may be subject to a greater extent to adverse economic conditions. First Federal seeks to minimize these

risks by lending to established customers and generally restricting such loans to its primary market area. Due to the growth in commercial lending in recent years, First Federal has increased its commercial loan portfolio.

Consumer Lending and Other Lending

As a community-oriented financial institution, First Federal offers certain consumer loans, including both unsecured loans and loans secured by assets such as deposits, vehicles, and heavy equipment. At September 30, 2004, consumer loans totaled $4.0 million, or 4.1% of First Federal’s total loan portfolio. This amount includes $0.8 million of loans secured by savings accounts, $2.1 million of loans secured by vehicles, and $1.1 million in other secured loans.

The underwriting standards employed by First Federal for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. In addition, the stability of the applicant’s monthly income from primary employment is considered during the underwriting process. Creditworthiness of the applicant is of primary consideration; however, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount.

Loan Approval

All permanent residential mortgage loans, other than residential construction loans less than $350,000, are underwritten and approved by the loan committee of First Federal. Any Vice President of SouthFirst Mortgage with construction lending authority, with the co-approval of another Vice President, has underwriting and loan approval authority for any construction loan up to $350,000. Construction loans in amounts greater than $350,000, but less than $500,000, must be approved by the loan committee of the First Federal Board of Directors. All permanent residential mortgage loans and residential construction loans in excess of $500,000 require approval of the Board of Directors of First Federal.

Loan Origination, Commitment and Other Fees and Commissions

In addition to interest earned on loans, First Federal charges fees for originating and making loan commitments, prepayments of non-residential loans, late payments, changes in property ownership and other miscellaneous services. The income realized from such fees varies with the volume of loans made or repaid, and the fees vary from time to time depending upon the supply of funds and other competitive conditions in the mortgage markets. Loan demand and the availability of money also affect these conditions. Fees, net of related origination costs, are deferred as an adjustment to yield. First Federal also charges commissions on the sale of credit life insurance and fees in connection with retail banking activities which are reflected in First Federal’s non-interest operations income.

Competition

First Federal has significant competition for its loan products in Talladega, Jefferson and Chilton Counties and in the Birmingham market area. The cities of Birmingham, Sylacauga, Talladega and Clanton have a high density of financial institutions, some of which are larger, have a state-wide or regional presence and have greater financial resources than First Federal. First Federal also faces significant competition in attracting deposits in its relevant market areas. First Federal’s competition for its loan products comes principally from savings and loan associations and commercial banks. In addition, there are a number of mortgage bankers, mortgage brokers, finance companies and insurance companies that compete with First Federal for loan customers. Credit unions, securities firms and mutual funds compete with First Federal in raising deposits. Many of these institutions also seek to provide the same community-oriented services as First Federal. First Federal competes for deposit accounts by offering depositors competitive interest rates and a high level of personal service. First Federal competes for loans primarily through the interest rates and loan fees it charges and the efficiency and quality of service it provides borrowers and contractors. Competition in the financial services industry has increased significantly within the past several years as a result of federal and state legislation which

has, in several respects, deregulated financial institutions. The full impact of this legislation and subsequent laws cannot be fully assessed or predicted.

First Federal is a community and retail-oriented financial institution serving its relevant market areas with deposit services and loan services. Management considers First Federal’s reputation for financial strength and quality customer service to be its major competitive advantage in attracting and retaining customers in its market areas.

Data Processing

During fiscal 2004, First Federal converted the bank’s data processing function to the FISERV Vision system, replacing the data processing services provided by Kirchman Corp., whose contractual agreement expired during 2004.

FISERV provides First Federal a full range of data processing services, including an automated general ledger, deposit accounting, commercial, real estate and consumer lending data processing platforms, central information file, investment portfolio accounting and ATM processing.

Employees

First Federal presently employs 74 individuals on a full-time basis, including 21 officers and 4 individuals on a part-time basis. First Federal will hire additional persons as needed, including additional tellers and financial service representatives.

Business of Subsidiaries

SouthFirst Mortgage, Inc.

SouthFirst Mortgage was incorporated on July 23, 1999, as a wholly-owned operating subsidiary of First Federal. Through SouthFirst Mortgage, First Federal is conducting residential mortgage and construction lending activities in Birmingham, Alabama, and intends to pursue such activities in other markets. See “Business of First Federal - Construction Lending — SouthFirst Mortgage, Inc.” above.

Pension & Benefit Trust Company

Pension & Benefit was acquired by SouthFirst in April of 1997, and was, initially, a wholly-owned subsidiary thereof. On April 27, 1998, SouthFirst and First Federal submitted an application to the OTS, seeking approval to exercise limited trust powers through Pension & Benefit and to establish Pension & Benefit as an operating subsidiary. Upon being granted limited trust powers from the OTS, SouthFirst transferred the ownership of Pension & Benefit to First Federal. Upon the transfer, Pension & Benefit became the wholly-owned subsidiary of First Federal.

The primary business of Pension & Benefit is rendering actuarial and administrative services to employee benefit plans of corporate employers, including their plan administrators and plan trustees, and, under appropriate circumstances, serving as an employee benefit plan trustee. These actuarial, administrative and trust services are rendered to approximately 250 retirement plans and, generally, are as follows:

Actuarial Services

The actuarial services include: the computation of retirement benefits, the determination of plan costs, the projection of benefit payments, contributions, and non-income, and the analysis of turnover rates and other contingencies for specific groups of plan participants.

Administrative Services

The administrative services include: the preparation of the annual returns and reports for retirement plans (including Form 5500, or 5500-C/R, and related schedules and attachments), the preparation of summary plan descriptions, summary annual reports, statements of accrued benefits and various other notices and reports required under ERISA, and the preparation of accounting records for plan trustees, including the preparation and maintenance of participants’ accounts.

Trust Services

The trust services rendered by Pension & Benefit are limited to those trust services required by self-directed profit sharing plans, 401(k) plans and Employee Stock Ownership Plans.

Magnolia Title Service, Inc.

During part of fiscal year 2004 SouthFirst owned a 50% interest in Magnolia Title Services, Inc. (“Magnolia”), a company which provides title insurance and related services to borrowers and lenders. Start-up losses at Magnolia resulted in a write-off of SouthFirst’s investment in the amount of $245,000. In November 2003, SouthFirst sold its entire interest back to Magnolia for $25,000.

SouthFirst Financial Services, Inc.

SouthFirst Financial was incorporated on June 16, 2000, as a wholly-owned subsidiary of SouthFirst. Through SouthFirst Financial, SouthFirst provides insurance products and other financial services to the customers of First Federal and to others.

Supervision and Regulation

General

SouthFirst and First Federal are subject to regulations, supervision and examination by the OTS, the FDIC and other state and federal regulators. These regulators have significant discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. The system of regulation and supervision applicable to SouthFirst and First Federal establishes a comprehensive framework for the operations of SouthFirst and First Federal, and is intended primarily for the protection of the FDIC and the depositors of First Federal. Changes in the regulatory framework could have a material adverse effect on First Federal and its operations that, in turn, could have a material adverse effect on SouthFirst. To the extent that the following information describes certain statutory and regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of SouthFirst.

Regulation of SouthFirst

General

As the owner of all of the stock of only one federal savings association, First Federal, SouthFirst is a “unitary” thrift holding company subject to regulatory oversight by the OTS and the SEC. As such, SouthFirst is required to register and file reports with the OTS and the SEC and is subject to regulation and examination by the OTS. In addition, the OTS’s enforcement authority over SouthFirst and its non-savings association subsidiaries permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings association. This regulation and oversight is intended primarily for the protection of the depositors of First Federal rather than for the benefit of stockholders of SouthFirst.

Qualified Thrift Lender Test

As a unitary thrift holding company, SouthFirst generally is allowed to engage and invest in a broad range of business activities not permitted to commercial bank holding companies or multiple savings and loan holding companies, provided that First Federal continues to qualify as a “qualified thrift lender” (see “- Regulation of First Federal — Qualified Thrift Lender Test” below). Although the Gramm-Leach-Bliley Act, enacted in November 1999, prohibits new unitary thrift holding companies from engaging in nonfinancial activities or affiliating with nonfinancial entities, such prohibition does not apply, for a period of 10 years if the non-financial activities constitute no more than 15% of its business, to companies, such as SouthFirst, which became unitary thrift holding companies pursuant to applications filed with the OTS prior to May 4, 1999. Because SouthFirst filed its application prior to this date, it is considered a “grandfathered” unitary thrift holding company; as such, SouthFirst retains the authority to engage in nonfinancial activities, but SouthFirst cannot be acquired by a nonfinancial company. In the event that SouthFirst acquires control of another savings association as a separate subsidiary, it would become a multiple savings and loan holding company and would thereafter be subject to further restrictions on its activities.

Restrictions on Acquisitions

SouthFirst must obtain approval from the OTS before acquiring control of any other SAIF-insured association or savings and loan holding company. Federal law generally provides that no “person,” acting directly or indirectly or through or in concert with one or more other persons, may acquire “control,” as that term is defined in OTS regulations, of a federally insured savings association without giving at least 60 days’ written notice to the OTS and providing the OTS an opportunity to disapprove the proposed acquisition. Such acquisition of control may be disapproved if it is determined, among other things, that (i) the acquisition would substantially lessen competition; (ii) the financial condition of the acquiring person might jeopardize the financial stability of the savings association or prejudice the interests of its depositors; or (iii) the competency, experience or integrity of the acquiring person or the proposed management personnel indicates that it would not be in the interest of the depositors or the public to permit the acquisition of control by such person. Control of a savings association or a savings and loan holding company is conclusively presumed to exist if, among other things, a person or group of persons acting in concert, directly or indirectly, acquires more than 25.0% of any class of voting stock of the institution or holding company or controls in any manner the election of a majority of the directors of the insured institution or the holding company. Control is rebuttably presumed to exist if, among other things, a person acquires 10.0% or more of any class of voting stock (or 25.0% of any class of stock) and is subject to any of certain specified “control factors.”

The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) amended provisions of the Bank Holding Company Act of 1956 (the “BHCA”) to specifically authorize the Federal Reserve Board to approve an application by a bank holding company to acquire control of a savings association. FIRREA also authorized a bank holding company that controls a savings association to merge or consolidate the assets and liabilities of the savings association with, or transfer assets and liabilities to, any subsidiary bank which is a member of the Bank Insurance Fund (“BIF”) with the approval of the appropriate federal banking agency and the Federal Reserve Board. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) further amended the BHCA to permit federal savings associations to acquire or be acquired by any insured depository institution. As a result of these provisions, there have been a number of acquisitions of savings associations by bank holding companies and other financial institutions in recent years.

As discussed above, the Gramm-Leach-Bliley Act has further restricted the acquisitions of nonfinancial companies by unitary thrift holding companies formed after May 4, 1999, and has eliminated the acquisition of “grandfathered” unitary thrift holding companies, such as SouthFirst, as well as “new” unitary thrift holding companies (formed after May 4, 1999) by nonfinancial companies.

Federal Securities Laws

Shares of common stock of SouthFirst (“Common Stock”), held by persons who are affiliates (generally officers, directors and principal stockholders) of SouthFirst, may not be resold without registration or unless sold in accordance with certain resale restrictions. If SouthFirst meets specified current public information requirements, however, each affiliate of SouthFirst is able to sell in the public market, without registration, a limited number of shares of Common Stock in any three-month period.

Regulation of First Federal

First Federal derives its lending and investing powers, as a federal savings association, from the Home Owners’ Loan Act, as amended (“HOLA”), which is implemented by regulations adopted and administered by the OTS. As a federal savings association, First Federal is subject to regulation, supervision and regular examination by the OTS. Federal banking laws and regulations control, among other things, First Federal’s required reserves, investments, loans, mergers and consolidations, payment of dividends and other aspects of First Federal’s operations. First Federal’s deposits are insured by the SAIF, which is administered by the FDIC, to the maximum extent provided by law ($100,000 for each depositor). In addition, the FDIC has certain regulatory and examination authority over OTS-regulated savings associations and may recommend enforcement actions against savings associations to the OTS.

As a federally insured depository institution, First Federal is subject to various regulations promulgated by the Federal Reserve Board, including Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD (Truth in Savings).

Insurance of Deposit Accounts

First Federal’s deposit accounts are insured by the SAIF to a maximum of $100,000 for each insured member (as defined by law and regulation). Insured institutions are members of either the SAIF or the BIF. Pursuant to FIRREA, an insured institution may not convert from one insurance fund to the other without the advance approval of the FDIC.

Under FIRREA, the FDIC is given the authority, should it initiate proceedings to terminate an institution’s deposit insurance, to suspend the insurance of any such institution without tangible capital. However, if a savings association has positive capital when it includes qualifying intangible assets, the FDIC cannot suspend deposit insurance unless capital declines materially or the institution fails to enter into and remain in compliance with an approved capital plan.

Regardless of an institution’s capital level, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the institution’s primary regulator. The management of First Federal is unaware of any practice, condition or violation that might lead to termination of its deposit insurance.

As an insurer, the FDIC issues regulations, conducts examinations and generally supervises the operations of its insured members. FDICIA directed the FDIC to establish a risk-based premium system under which the FDIC is directed to charge an annual assessment for the insurance of deposits based on the risk a particular institution poses to its deposit insurance fund. Under the FDIC’s risk-related insurance regulations, an institution is classified according to capital and supervisory factors. Institutions are assigned to one of three capital groups: “well capitalized,” “adequately capitalized” or “undercapitalized.” Within each capital group, institutions are assigned to one of three supervisory subgroups. There are nine combinations of groups and subgroups (or assessment risk classifications) to which varying assessment rates are applicable.

As a result of the recapitalization of the SAIF implemented by the Economic Growth and Regulatory Paperwork Reduction Act of 1996 (the “EGRPRA”), SAIF-insured institutions were required, until December 31, 1999, to pay assessments to the FDIC at an annual rate of between 6.0 and 6.5 basis points to help fund interest payments on certain bonds issued by the Financing Corporation (“FICO”), an agency of the federal government established to recapitalize the predecessor to the SAIF. During this period, BIF member banks were assessed for payment of the FICO obligations at one-fifth the annual rate applicable to SAIF member institutions. After December 31, 1999, BIF and SAIF members were assessed at the same rate for FICO obligations.

The EGRPRA also provides that the FDIC may not assess regular insurance assessments for the SAIF unless required to maintain or to achieve the designated reserve ratio of 1.25%, except for such assessments on those institutions that are not classified as “well capitalized” or that have been found to have “moderately severe” or “unsatisfactory” financial, operational or compliance weaknesses. First Federal is classified as “well capitalized” and has not been found by the OTS to have such supervisory weaknesses.

OTS Supervisory Assessments

In addition to federal deposit insurance premiums, savings associations like First Federal are required by OTS regulations to pay assessments to the OTS to fund the operations of the OTS. The general assessment is paid on either a semi-annual or quarterly basis, as determined by the OTS on an annual basis, and is computed based on total assets of the institution, including consolidated subsidiaries, as reported in the association’s latest quarterly Thrift Financial Report. Regulations base the assessment for an individual savings association on three components: the size of the association, on which the basic assessment is based; the association’s supervisory condition, which results in percentage increases for any savings association with a composite rating of 3, 4, or 5 in its most recent safety and soundness examination; and the complexity of the savings association’s operations, which results in a percentage increase for a savings association that manages over $1 billion in trust assets, provides services for other loans aggregating more than $1 billion, or has certain off-balance sheet assets aggregating more than $1 billion. In order to avoid a disproportionate impact upon smaller savings institutions, whose total assets never exceeded $100 million, the OTS regulations provide that the portion of the assessment based on asset size will be the lesser of the assessment under the amended regulations or the regulations before the amendment.

Regulatory Capital Requirements

General. The OTS has adopted capital regulations which establish capital standards applicable to all savings associations. To meet its regulatory capital requirements, a savings association must satisfy each of the following capital requirements: (i) a risk-based capital requirement, where a savings association’s minimum risk-based capital requirement shall be an amount equal to 8% of its risk-weighted assets; (ii) a leverage ratio requirement, where a savings association’s minimum leverage ratio requirement shall be: (a) for a savings association assigned a composite rating of “1” on the CAMELS financial institutions rating system, equal to a ratio of core capital to adjusted total assets of 3%; (b) for all other savings associations which are assigned a value lower than “1” on the CAMELS financial institutions rating system, equal to a ratio of core capital to adjusted total assets of 4%; and (iii) a tangible capital requirement, where the savings association’s minimum tangible capital requirement shall be an amount equal to at least 1.5% of adjusted total assets.

The OTS, also, has established, pursuant to FDICIA, five classifications for institutions based upon the capital requirements: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically under capitalized. At September 30, 2004, First Federal was “well capitalized.” Failure to maintain that status could result in greater regulatory oversight or restrictions on First Federal’s activities.

Core Capital and Tangible Capital. The OTS requires savings associations receiving a composite examination rating of “1,” the best possible rating under the CAMELS examination rating system, to maintain a ratio of core capital to adjusted total assets of 3.0%. All other savings associations are required to maintain minimum core capital of at least 4.0% of total adjusted assets. “Core capital” includes, generally, (i) common stockholders’ equity (including retained earnings), (ii) non-cumulative perpetual preferred stock and related

surplus, (iii) non-withdrawable accounts and certain pledged deposits of mutual savings associations, (iv) minority interests in fully-consolidated subsidiaries, and (v) the remaining goodwill resulting from certain prior regulatory accounting practices, less a savings association’s (A) investments in certain “non-includable” subsidiaries (as determined by regulation) and (B) intangible assets (with limited exceptions for purchased mortgage servicing rights, purchased credit card relationships and certain intangible assets arising from prior regulatory accounting practices). At September 30, 2004, First Federal’s ratio of tangible and core capital to total adjusted assets was 8.08%.

The “tangible capital” requirement requires a savings association to maintain tangible capital in an amount not less than 1.5% of its adjusted total assets. “Tangible capital” means (i) common stockholders’ equity (including retained earnings), (ii) non-cumulative perpetual preferred stock and related earnings, (iii) non-withdrawable accounts and pledged deposits that qualify as core capital, and (iv) minority interests in equity accounts of fully-consolidated subsidiaries, less (A) any intangible assets (except for purchased mortgage servicing rights and purchased credit card relationships included in core capital), and (B) investments, both equity and debt, in certain subsidiaries that are not “includable subsidiaries”

Risk-Based Capital. The risk-based capital standard for savings associations requires the maintenance of total regulatory capital (which is defined as core capital plus supplementary capital) of 8.0% of risk-weighted assets. The components of supplementary capital include, among other items, cumulative perpetual preferred stock, perpetual subordinated debt, mandatory convertible subordinated debt, intermediate-term preferred stock and the general allowance for credit losses. The portion of the allowance for credit losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, supplementary capital is limited to 100.0% of core capital. Risk-weighted assets equal assets plus consolidated off-balance sheet items where each asset or item is multiplied by the appropriate risk weight. The risk weight assigned to a particular asset or on-balance sheet credit equivalent amount determines the percentage of that asset/credit equivalent amount that is included in the calculation of risk-weighted assets. Thus, to determine the ratio of total capital to total risk-weighted asset: (i) each off-balance sheet item must be converted to an on-balance sheet credit equivalent amount by multiplying the face amount of such item by a credit conversion factor ranging from 0.0% to 100.0% (depending upon the nature of the item); (ii) the credit equivalent amount of each off-balance sheet item and each on-balance sheet asset must be multiplied by a risk factor ranging from 0% to 100.0% (again depending on the nature of the item); and (iii) the resulting amounts are added together and constitute total risk-weighted assets. At September 30, 2004, First Federal’s ratio of total capital to total risk-weighted assets was 13.18%.

The OTS and other federal banking regulators adopted, effective October 1, 1998, an amendment to their risk-based capital guidelines that permits insured depository institutions to include in supplementary capital up to 45% of the pretax net unrealized holding gains on certain available-for-sale equity securities, as such gains are computed under the guidelines.

The OTS regulations require a savings association with “above normal” interest rate risk to deduct a portion of such capital from its total capital to account for the “above normal” interest rate risk. A savings association’s interest rate risk is measured by the decline in the net portfolio value of its assets (i.e. the difference between incoming and outgoing discounted cash flows from assets, liabilities, and off-balance sheet contracts) that would result from a hypothetical 200 basis point increase or decrease in market rates of interest (whichever results in a lower net portfolio value), divided by the estimated economic value of the savings association’s assets, as calculated in accordance with guidelines set forth by the OTS. A savings association’s interest rate risk exposure is measured by the decline in the net portfolio value that would result from a 200 basis point increase or decrease in market interest rates, except when the 3-month Treasury bond equivalent yield falls below 400 basis points. In that case, the decrease would be equal to one-half of that Treasury rate.

A savings association whose measured interest rate risk exposure exceeds 0.02 (2%) must deduct an interest rate risk component in calculating its total capital for purposes of determining whether it meets its risk-based capital requirement. The interest rate risk component is an amount equal to one-half of the difference between its measured interest rate risk and 0.02, multiplied by the estimated economic value of its total assets.

Any required deduction for interest rate risk becomes effective on the last day of the third quarter following the reporting date of the association’s financial data on which the interest rate risk was computed.

The OTS has indefinitely deferred the implementation of the interest rate risk component in the computation of an institution’s risk-based capital requirements. The OTS continues to monitor the interest rate risk of individual institutions and retains the right to impose additional capital requirements on individual institutions.

See “Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Capital Resources” for tables setting forth First Federal’s compliance with its regulatory capital requirements as of September 30, 2004.

Prompt Corrective Action

Under the OTS final rule implementing the prompt corrective action provisions of FDICIA, an institution shall be deemed to be: (i) “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, has a Tier 1 risk-based capital ratio (ratio of Tier 1 capital (core capital) to risk-weighted assets) of 6.0% or greater, has a Tier 1 leverage capital ratio of 5.0% or greater and is not subject to any order or capital directive to meet and maintain a specific capital level for any capital measure; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 4.0% or greater and a Tier 1 leverage ratio of 4.0% or greater (3% under certain circumstances) and does not meet the definition of “well capitalized;” (iii) “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, or has a Tier 1 risk-based capital ratio that is less than 4.0% or a Tier 1 leverage ratio that is less than 4.0% (3% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, or a Tier 1 risk-based capital ratio that is less than 3.0% or a Tier 1 leverage ratio that is less than 3.0%; and (v) “critically undercapitalized” if the financial association has a ratio of tangible equity to total assets that is equal to or less than 2.0%. However, under certain circumstances, a federal banking agency may reclassify a “well capitalized” institution as “adequately capitalized” and may require an “adequately capitalized” institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a “significantly undercapitalized” institution as “critically undercapitalized”). At September 30, 2004, First Federal was classified as a “well capitalized” institution.

The severity of the action, authorized or required to be taken under the prompt corrective action regulations, increases as an association’s capital deteriorates within the three undercapitalized categories. All associations are prohibited from paying dividends or other capital distributions or paying management fees to any controlling person, if, following such distribution, the association would be undercapitalized. An undercapitalized association is required to file a capital restoration plan within 45 days of the date the association receives notice that it is within any of the three undercapitalized categories. The OTS is required to monitor closely the condition of an undercapitalized association and to restrict the asset growth, acquisitions, branching, and new lines of business of such an association. Significantly undercapitalized associations are subject to restrictions on compensation of senior executive officers; such an association may not, without OTS consent, pay any bonus or provide compensation to any senior executive officer at a rate exceeding the officer’s average rate of compensation during the 12 months preceding the month when the association became undercapitalized. A significantly undercapitalized association may also be subject, among other things, to forced changes in the composition of its board of directors or senior management, additional restrictions on transactions with affiliates, restrictions on acceptance of deposits from correspondent associations, further restrictions on asset growth, restrictions on rates paid on deposits, forced termination or reduction of activities deemed risky, and any further operational restrictions deemed necessary by the OTS.

When appropriate, the OTS can require corrective action by a savings association holding company under the “prompt corrective action” provisions of FDICIA.

Standards for Safety and Soundness

Under FDICIA, as amended by the Riegle Community Development and Regulatory Improvements Act of 1994, the federal banking agencies were required to establish safety and soundness standards for institutions under its authority. The federal banking agencies, including the OTS, have adopted interagency guidelines establishing standards for safety and soundness and final rules establishing deadlines for submission and review of safety and soundness compliance plans. The guidelines require savings associations to maintain internal controls and information systems and internal audit systems that are appropriate for the size, nature and scope of the institution’s business. The guidelines also establish certain basic standards for loan documentation, credit underwriting, interest rate risk exposure, and asset growth. The guidelines further provide that savings associations should maintain safeguards to prevent the payment of compensation, fees and benefits that are excessive or that could lead to material financial loss, and should take into account factors such as compensation practices at comparable institutions. Additionally, the OTS guidelines require savings associations to maintain internal controls over their asset quality and earnings. Under the guidelines, a savings association should maintain systems, commensurate with its size and the nature and scope of its operations, to identify problem assets and prevent deterioration in those assets as well as to evaluate and monitor earnings and ensure that earnings are sufficient to maintain adequate capital and reserves. If the OTS determines that a savings association is not in compliance with the safety and soundness guidelines, it may require the institution to submit an acceptable plan to achieve compliance with the guidelines. A savings association must submit an acceptable compliance plan to the OTS within 30 days of receipt of a request for such a plan. Failure to submit or implement a compliance plan may subject the institution to regulatory sanctions.

Dividends and Other Capital Distribution Limitations

OTS regulations impose limitations upon savings associations’ capital distributions, such as cash dividends, payments to repurchase or otherwise acquire its shares and other distributions charged against capital. Under the OTS regulations governing capital distributions, certain savings associations are permitted to pay capital distributions during a calendar year that do not exceed the association’s net income for the year plus its retained net income for the prior two years, without application or notice to, or the approval of, the OTS. However, a savings association subsidiary of a savings and loan holding company, such as the Company, will continue to have to file a notice and to receive the approval of the OTS. The OTS may disapprove a notice or deny an application regarding a proposed capital distribution, if the OTS determines that the proposed distribution by a savings association would constitute an unsafe or unsound practice or that, after making the distribution, the savings association would be “undercapitalized” under the OTS regulations.

Qualified Thrift Lender Test

HOLA requires savings associations to meet the Qualified Thrift Lender (“QTL”) test, or suffer a number of regulatory sanctions, including restrictions on business activities and on FHLB advances. To qualify as a QTL, a savings association must either (i) be deemed a “domestic building and loan association” under the Internal Revenue Code, as amended (the “Code”), by maintaining at least 60% of its total assets in specified types of assets, including cash, certain government securities, loans secured by and other assets related to residential real property, educational loans, and investments in premises of the institution, or (ii) maintain at least 65% of its “portfolio assets” in certain “qualified thrift investments” in at least nine months of the most recent twelve-month period. “Portfolio assets” means, in general, a savings association’s total assets less the sum of (a) certain intangible assets, including goodwill and credit card and purchased mortgage servicing rights, (b) the value of property used by a savings association in its business, and (c) specified liquid assets up to 20% of total assets. “Qualified thrift investments” include (i) various types of loans made to finance, construct, improve or repair domestic residential or manufactured housing, (ii) home equity loans, (iii) securities backed by or representing interest in mortgages or domestic residential or manufactured housing, (iv) obligations issued by the federal deposit insurance agencies, (v) shares of stock issued by any Federal home loan bank, (vi) loans for educational purposes, (vii) loans to small business, and (viii) loans made through credit cards or credit card accounts. In addition, subject to a limit of 20% of portfolio assets, savings associations are able to treat as Qualified Thrift Investments 200% of their investments in loans to finance “starter homes” and loans for construction,

development or improvement of housing and community service facilities or for financing small business in “credit needy” areas. At September 30, 2004, First Federal was a Qualified Thrift Lender.

A savings association that does not maintain its status as a QTL in at least nine out of every 12 months must either convert to a bank charter to become one or more banks or comply with the following restrictions on its operations: (i) the savings association may not engage in any new activity or make any new investment, directly or indirectly, unless such activity or investment is permissible for a national bank and for a savings association; (ii) the branching powers of the savings association are restricted to those of a national bank in the savings association’s home state; (iii) the savings association is not eligible to obtain any advances from its FHLB; and (iv) payment of dividends by the savings association are subject to the rules regarding payment of dividends by a national bank. In addition, within one year of the date a savings association ceases to meet the QTL test, any company controlling the association has to register under, and become subject to, the requirements of the Bank Holding Company Act of 1956, as amended. If the savings association does not requalify as a QTL within the three-year period after it fails the QTL test, it is required to cease any activity and not retain any investment not permissible for a national bank, and immediately repay any outstanding FHLB advances as promptly as prudently can be done, consistent with the safe and sound operation of the savings association. A savings association that has failed the QTL test may requalify as a QTL and be free of such limitations.

Loans to One Borrower

Under HOLA, savings associations are subject to the national bank limits on loans to one borrower. Generally, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15.0% of unimpaired capital and surplus. An additional amount, not in excess of 10.0% of unimpaired capital and surplus, may be loaned, if such loan is secured by readily-marketable collateral, which is defined to include certain debt and equity securities and bullion, but generally does not include real estate. Prior to March 2002, First Federal had permission from the OTS to increase its loans to one borrower limit for single-family, residential builders, as permitted under applicable federal law and regulations. The increased limit for these borrowers was 30.0% of unimpaired capital and surplus of First Federal, with an aggregate limit to all such borrowers equal to 150.0% of First Federal’s unimpaired capital and surplus. As a result of the Supervisory Agreement between First Federal and the OTS, entered into in March 2002, the 30% limit had been revoked during all of fiscal year ended September 30, 2004. See, also, “Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Supervisory Agreement.”

Lending Guidelines

All financial institutions must adopt and maintain comprehensive written real estate lending policies that are consistent with safe and sound banking practices. These lending policies must reflect consideration of the Interagency Guidelines for Real Estate Lending Policies adopted by the federal banking agencies (the “Guidelines”). The Guidelines set forth, pursuant to the mandates of FDICIA, uniform regulations prescribing standards for real estate lending. “Real estate lending” is defined as the extension of credit secured by liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate, regardless of whether a lien has been taken on the property.

Such real estate lending policies must address certain lending considerations set forth in the Guidelines, including loan-to-value (“LTV”) limits, loan administration procedures, underwriting standards, portfolio diversification standards, and documentation, approval and reporting requirements. These policies must also be appropriate to the size of the institution and the nature and scope of its operations, and must be reviewed and approved by the institution’s board of directors at least annually. The LTV ratio framework, with a LTV ratio being the total amount of credit to be extended, divided by the appraised value of the property securing or being improved by the extension of credit, plus the amount of readily-marketable collateral or other acceptable collateral, must be established for each category of real estate loans. If not a first lien, the lender must combine all senior liens when calculating this ratio. The Guidelines, among other things, establish the following supervisory LTV limits: raw land (65.0%); land development (75.0%); construction (commercial, multifamily and nonresidential) (80.0%); improved property (85.0%). There is no maximum LTV limit for one-to-four family

residential (owner occupied); however, any LTV ratio in excess of 90.0% requires appropriate credit enhancement in the form of either mortgage insurance or readily marketable collateral.

Certain institutions may make real estate loans that do not conform with established LTV limits, up to 100.0% of the institution’s total capital. Within this aggregate limit, total loans for all commercial, agricultural, multi-family and other non-one-to-four family residential properties should not exceed 30.0% of total capital. An institution will come under increased supervisory scrutiny as the total of such loans approaches these levels. Certain loans are also exempt from the LTV ratios, such as loans guaranteed by a government agency, loans to facilitate the sale of real estate owned, and loans renewed, refinanced or restructured by the original lender(s) to the same borrower(s) where there is no advancement of new funds.

Community Reinvestment

Under the Community Reinvestment Act of 1977 (the “CRA”), as implemented by OTS regulations, a savings association has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions, nor does it limit an institution’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OTS, in connection with its examination of a savings association, to assess the institution’s record of meeting the credit needs of its community and to take this record into account in its evaluation of certain applications by the institution. FIRREA amended the CRA to require public disclosure of an institution’s CRA rating and to require the OTS to provide a written evaluation of an institution’s CRA performance, utilizing a four-tiered descriptive rating system in lieu of the existing five-tiered numerical rating system. First Federal received a satisfactory rating as a result of its latest evaluation on December 31, 2003.

Consumer Credit Regulation

First Federal’s mortgage lending activities are subject to the provisions of various federal and state statutes, including, among others, the Truth in Lending Act, the Equal Credit Opportunity Act, the Real Estate Settlement Procedures Act, the Fair Housing Act, and the regulations promulgated thereunder. These statutes and regulations, among other provisions, prohibit discrimination, prohibit unfair and deceptive trade practices, require the disclosure of certain basic information to mortgage borrowers concerning credit terms and settlement costs, and otherwise regulate terms and conditions of credit and the procedures by which credit is offered and administered. Many of the above regulatory requirements are designed to protect the interests of consumers, while others protect the owners or insurers of mortgage loans. Failure to comply with these requirements can lead to administrative enforcement actions, class action lawsuits and demands for restitution or loan rescission.

Transactions with Affiliates

Generally, statutory restrictions, promulgated in OTS regulations and by Section 23A and 23B of the Federal Reserve Act, limit the authority of First Federal to engage in transactions with affiliates. These restrictions require that transactions between a savings association, or its subsidiaries, and its affiliates be on terms as favorable to the institution as comparable transactions with non-affiliates. In addition, extensions of credit and certain other transactions with affiliates are restricted to an aggregate percentage of a savings association’s capital, and collateral in specified amounts must usually be provided by affiliates to receive loans from the institution. Affiliates of First Federal include, among others, SouthFirst and any company which would be under common control with First Federal. In addition, a savings association may not lend to any affiliate engaged in activities not permissible for a bank holding company or acquire the securities of any affiliate which is not a subsidiary. Currently, a subsidiary of a savings association that is not also a depository institution is not treated as an affiliate of the savings association for purposes of Section 23A and 23B of the Federal Reserve Act.

A savings association’s authority to extend credit to its officers, directors and 10% stockholders, as well as to entities that such persons control, is governed by Sections 22(g) and 22(h) of the Federal Reserve Act and

Regulation O promulgated by the Federal Reserve Board. Among other things, these laws and regulations require such loans to be made on terms substantially similar to those offered to unaffiliated individuals, place limits on the amount of loans a savings association may make to such persons based, in part, on the institution’s capital position, and require certain approval procedures to be followed. OTS regulations, with minor variations, apply Regulation O to savings associations.

Branching by Federal Associations

Subject to certain limitations, HOLA and the OTS regulations permit federally chartered savings associations to establish branches in any state of the United States. The authority to establish such a branch is available (a) in states that expressly authorize branches of savings associations located in another state and (b) to an association that either satisfies the QTL test or qualifies as a “domestic building and loan association” under the Code, which imposes qualification requirements similar to those for a “qualified thrift lender” under HOLA. The authority for a federal savings association to establish an interstate branch network would facilitate a geographic diversification of the association’s activities. This authority under HOLA and the OTS regulations preempts any state law purporting to regulate branching by federal savings associations.

Liquidity Requirements

The Asset and Liability Committee (ALCO) of First Federal’s Board of Directors monitors and manages the liquidity needs of the Company to ensure that there is sufficient cash flow to satisfy demand for credit and deposit withdrawals, to fund operations and to meet other Company obligations and commitments on a timely and cost effective basis. Under current regulations, First Federal is required to maintain sufficient liquidity to assure its safe and sound operation. The requirement to maintain a specific minimum amount of liquid assets, established by previous regulation, has been eliminated. Presently, there is no objective standard or guideline regarding the application of the current regulatory requirement that a savings association maintain a liquidity sufficient to ensure its safe and sound operation.

Under the previous regulation, First Federal was required to maintain an average daily balance of liquid assets, in each calendar quarter, of not less than 4% of (i) the amount of its liquidity base at the end of the preceding calendar quarter, or (ii) the average daily balance of its liquidity base during the preceding quarter. For purposes of this computation, liquid assets included specified short-term assets (e.g., cash, certain time deposits, certain banker’s acceptances and short-term U.S. Government, state or federal agency obligations), and long-term assets (e.g., U. S. Government obligations of more than one and less than five years and state agency obligations maturing in two years or less).

As of September 30, 2004, First Federal’s average daily balance of liquid assets was approximately 11.3% of its June 30, 2004 liquidity base, far exceeding the 4% requirement set by the previous regulation. These liquid assets included approximately $5,097,000 in cash and cash equivalents, and approximately $7,068,000 in other qualifying assets. As of September 30, 2004, the fair market value of the Company’s investment securities portfolio, which is held for sale, was $14,180,000. The Company uses its investment securities portfolio to manage liquidity and interest rate risk, whereby liquidity is available through those securities that are not pledged. Further, cash flows from operations, resulting primarily from net income adjusted for certain items such as interest expense and provision for loan losses, are an additional source of liquidity for the Company.

With respect to current funding sources, deposits provide a significant portion of SouthFirst’s cash flow needs and continue to provide a relatively stable, low cost source of funds. Other sources of funding used by SouthFirst include commercial lines of credit and advances from the Federal Home Loan Bank of Atlanta. See “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION – Liquidity.”

Federal Home Loan Bank System

General. First Federal is a member of the FHLB System, which consists of twelve regional FHLBs subject to supervision and regulation by the Federal Housing Finance Board (the “FHFB”). The FHLBs maintain central credit facilities primarily for member institutions.

First Federal, as a member of the FHLB of Atlanta, is required to acquire and hold shares of capital stock in the FHLB of Atlanta in an amount at least equal to the greater of: (i) one percent of the aggregate outstanding principal amount of its unpaid home mortgage loans, home purchase contracts and similar obligations as of the beginning of each year or, (ii) $500. First Federal is in compliance with this requirement with an investment in stock of the FHLB of Atlanta, at September 30, 2004, of $1,117,000.

Federal Home Loan Bank Advances

Each FHLB serves as a reserve or central bank for its members within its assigned region. Each FHLB is funded from proceeds derived from the sale of consolidated obligations of the FHLB system. FHLB makes advances (i.e., loans) to members in accordance with policies and procedures established by the Board of Directors of the FHLB. Long-term advances may only be made for the purpose of providing funds for residential housing.

On April 15, 2002, First Federal was notified that the amount available under its credit line with the Federal Home Loan Bank of Atlanta had been changed from a variable amount, equal to 30% of total assets. or approximately $42,000,000, to a fixed amount of $22,000,000. This amount was subsequently changed to an amount equal to 10% of its total assets. At September 30, 2004, First Federal owed the Federal Home Loan Bank of Atlanta $20,670,000 in outstanding advances. The Federal Home Loan Bank of Atlanta has notified First Federal that it will not require First Federal’s existing borrowings to be reduced to the new fixed amount prior to the existing advance maturities, but that it will require that any additional borrowings by First Federal be approved through application by First Federal to the Federal Home Loan Bank of Atlanta’s Credit Committee. Management believes that this reduction in the amount available under this credit line, because of the existing liquidity and other funding sources available to SouthFirst and First Federal, will have no adverse impact on the operations of SouthFirst or First Federal.

As a result of FIRREA, the FHLBs are required to provide funds for the resolution of troubled savings associations and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low and moderate income housing projects. These contributions have adversely affected the level of dividends paid on FHLB stock and could continue to do so in the future. For the years ended September 30, 2004 and 2003, dividends were paid by the FHLB to First Federal in the amounts of $39,904 and $54,302, respectively. Were these dividends to be reduced, or were interest subsidies on future FHLB advances were to increase, First Federal’s net interest income likely would be reduced.

Federal Reserve System

The Federal Reserve Board requires all depository institutions to maintain non-interest bearing reserves at specified levels against their deposit transaction accounts (e.g., primarily checking, NOW and Super NOW checking accounts) and non-personal time deposits. Under current Federal Reserve Board regulations, no reserves are required to be maintained on the first $6.6 million of transaction accounts, while reserves equal to 3% must be maintained on the next $45.4 million of transaction accounts, plus reserves equal to 10% of the remainder. Because required reserves must be maintained in the form of vault cash or in a non-interest bearing account at a Federal Reserve Bank, the reserve requirement has the effect of reducing the amount of depository institutions’ interest-earning assets. At September 30, 2004, First Federal was in compliance with the reserve requirements of the Federal Reserve Board.

Savings associations have authority to borrow from the Federal Reserve Bank’s “discount window,” but Federal Reserve policy generally requires savings associations to exhaust all OTS sources before borrowing from the Federal Reserve System. First Federal did not have any such borrowings at September 30, 2004.

ITEM 2. PROPERTIES.

First Federal conducts its business through its main office located in Sylacauga, Alabama, branch offices located in Talladega and Clanton, Alabama, and loan production offices in Hoover and Chelsea, Alabama. In addition, First Federal has purchased a parcel of land in Birmingham, Alabama at a total price of $1,445,000.

The following table sets forth information relating to the offices of SouthFirst, First Federal and Pension & Benefit at September 30, 2004. The total net book value of these properties at September 30, 2004 was approximately $3,863,000.

Net Book Value

Deposits

Leased

as of

Location

or Owned

Date Opened

Sept. 30, 2004

(In thousands)

SouthFirst and First Federal

Main Office

126 North Norton Avenue
Sylacauga, Alabama 35150

Owned

April 1966

693

51,908

Office/Storage Building

North Norton Avenue
Sylacauga, Alabama 35150

Owned

November 1995

237

N/A

First Federal Branch Offices

301 West North Street
Talladega, Alabama 35160

Owned

April 1961

181

12,976

102 Fifth Street North
Clanton, Alabama 35045

Owned

November 1997

1,043

32,909

SouthFirst Mortgage

Loan Production Offices

2159 Rocky Ridge Road
Birmingham, Alabama 35216

Leased

March 1994

1,445

N/A

70 Chelsea Corners
Chelsea, AL 35043

Leased

January 2004

—

N/A

Pension & Benefit

260 Commerce Street
Third Floor
Montgomery, Alabama 36101

Owned

April 1997

264

N/A

Total

3,863

97,793

ITEM 3. LEGAL PROCEEDINGS

In the normal course of business, SouthFirst and First Federal from time to time are involved in legal proceedings. SouthFirst and First Federal management believe that there are no pending or threatened legal proceedings which, upon resolution, are expected to have a material effect upon SouthFirst’s or First Federal’s financial condition. Nonetheless, descriptions of certain legal proceedings, including previously-disclosed legal proceedings, follow:

Pending Legal Proceedings

First Federal is currently involved in three (3) pending legal proceedings, descriptions of which are set forth below. All three (3) of these pending lawsuits have been consolidated before Chilton County Circuit Court Judge Sibley Reynolds into one proceeding. First Federal’s insurance carrier has been notified of the preceedings and has entered an appearance and is defending the claims made against First Federal.

1. In a lawsuit brought by Mike Burford and his company styled Burford, d/b/a Burford’s Wood Waste and also Burford’s Tree Surgeons v. Harry Eugene Hammock and Janice C. Hammock, in the Circuit Court of Chilton County, CV 03-337, First Federal has now been named as a defendant for allegedly improperly cashing checks presented by the Hammocks to First Federal, but made payable to Burford and/or his company. First Federal has turned over copies of all checks it was able to find that were deposited directly either into the Hammocks’ checking and/or savings accounts. Damages could be assessed against First Federal if it is ultimately held liable for improperly cashing and/or improperly depositing checks. Mr. Buford has estimated his total damages in the existing lawsuit to fall in the broad range of between $250,000 and $650,000.

On November 4, 2003, Judge Reynolds issued a Temporary Restraining Order enjoining the Hammocks from disposing of any assets acquired before that date, including any funds held in any checking or savings accounts on December 8, 2003. That Order was extended indefinitely by Judge Reynolds.

2. First Federal is a plaintiff in an interpleader action filed by it originally styled First Federal of the South v. Danny E. Hammock, Janice Hammock, Burford Tree Surgeons and Mike Burford in the Circuit Court of Chilton County, Alabama, CV 03-338. First Federal has interpleaded those funds held in checking and savings accounts in the names of Janice Hammock and/or her husband, Danny Hammock into the Circuit Court Clerk’s Office. Burford Tree Surgeons and Mike Burford have filed an Answer to First Federal’s Complaint, claiming that they are entitled to the funds.

3. In the suit originally styled Danny E. Hammock and Janice Hammock v. First Federal and Sandra Stephens (CV 03-347), the Hammocks requested that the Court issue an order directing First Federal to unfreeze the Hammocks’ accounts. That request was denied. The Hammocks have also made monetary claims, for unspecified amounts, against First Federal for negligence, wantonness, and recklessness in freezing the accounts. First Federal received the Chilton County District Attorney’s subpoena on October 29, 2003, and froze the Hammocks’ accounts on that date. Any allegedly “improper freezing” of assets took place at most for only six days because the assets were frozen by Court Order in case number CV 03-337 on November 4, 2003.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted during the fourth quarter ended September 30, 2004 to a vote of security holders of SouthFirst.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

As of Decmeber 21, 2004, SouthFirst’s Common Stock was held by approximately 304 persons. SouthFirst’s Common Stock trades on the American Stock Exchange, under the symbol “SZB.” The following

data reflects, by fiscal quarter, the high and low sale prices, as well as cash dividends declared for each quarter from October 1, 2001 through September 30, 2004:

Cash

Dividends

High Sale

Low Sale

Declared⁽¹⁾

Fiscal Year Ended September 30, 2004

First Quarter ended December 31, 2003

17 1/3

15 1/2

106,500

Second Quarter ended March 31, 2004

17 4/5

106,501

Third Quarter ended June 30, 2004

18 3/4

15 5/9

106,495

Fourth Quarter ended September 30, 2004

16 3/4

15 1/7

106,487

Fiscal Year Ended September 30, 2003

First Quarter ended December 31, 2002

11 3/5

121,076

Second Quarter ended March 31, 2003

13 5/9

116,876

Third Quarter ended June 30, 2003

15 1/7

13 4/9

107,801

Fourth Quarter ended September 30, 2003

15 1/3

107,794

⁽¹⁾ Certain cash dividends associated with SouthFirst’s Management Recognition Plans and Employee Stock Option Plan shares are reflected as compensation expense in the consolidated financial statements. See “Item 10. EXECUTIVE COMPENSATION — Management Recognition Plans” and “— Employee Stock Ownership Plan.”

Holders of SouthFirst Common Stock are entitled to receive such dividends as may be declared by SouthFirst’s Board of Directors. The amount and frequency of cash dividends will be determined in the judgment of SouthFirst’s Board of Directors based upon a number of factors, including the company’s earnings, financial condition, capital requirements, and other relevant factors. SouthFirst management presently intends to continue its present dividend policies. See “Item 1. BUSINESS — Supervision and Regulation — Regulation of First Federal — Dividends and Other Capital Distribution Limitations.”

The amount of dividends payable by First Federal is limited by law and regulation. The need for First Federal to maintain adequate capital also limits dividends that may be paid to SouthFirst. Although Federal Reserve policy could restrict future dividends on SouthFirst Common Stock, such policy places no current restrictions on such dividends. See “Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Capital Resources” and “Item 1. BUSINESS — Supervision and Regulation — Regulation of First Federal — Dividends and Other Capital Distribution Limitations.”

ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis is designed to provide a better understanding of the major factors that affected SouthFirst’s results of operations and financial condition for the referenced periods.

The purpose of this discussion is to focus on significant changes in the financial condition and results of SouthFirst’s operations during the two-year period ended September 30, 2004 This discussion and analysis is intended to supplement and highlight information contained in the accompanying consolidated financial statements and the selected financial data presented elsewhere herein.

Forward Looking Statements

As stated in the opening paragraph to this Annual Report on Form 10-KSB/A, entitled “Safe Harbor Statement Under the Private Securities Litigation Reform Act of 1995,” this Annual Report on Form 10-KSB/A contains certain forward-looking statements, including management’s discussion and analysis of financial condition and results of operation under this Item 6. While SouthFirst believes that the statements contained in this Item 6, and throughout this Annual Report on Form 10-KSB/A, are accurate, SouthFirst’s business is dependent upon general economic conditions and various conditions specific to its industry. Future trends and conditions could cause actual results to differ materially from the forward-looking statements made herein.

Results of Operations

Net Income

For the fiscal year ended September 30, 2004, net income decreased $643,799 (555.65%) from net income of $115,864 in fiscal 2003. Earnings/(loss) per common share was ($0.74) and $0.16 for the fiscal years ended September 30, 2004 and 2003, respectively. The decrease in net income for fiscal 2004 was due primarily to an increase in loan loss reserves, an increase in non-interest expense and a decrease in non-interest income. First Federal’s net interest income after provision for loan losses decreased $391,172 (11.7%) during fiscal 2004, from $3,342,849 to $2,951,677. This decrease was primarily attributable to an increase in the provision for loan losses of $807,334, from an expense of $549,603 at September 30, 2003 compared to an expense of $1,356,937 for the fiscal year ended September 30, 2004, the reasons for which are discussed below under the heading “Provision for Loan Losses.” This decrease in net interest income was partially offset by an increase in net interest income before provision for loan losses in the amount of $416,162, (10.7%) resulting primarily from the changes in balances and the effect in the changes in interest rates between interest-earning assets and interest-bearing liabilities. Fee income received by Pension and Benefit Trust Company increased $350,435 (28.5%) during fiscal 2004, from $1,231,622 to $1,582,057. The gain from the sale of loans decreased $451,064 (38.5%) from $1,170,453 to $719,389. Other expenses increased $144,905 (2.1%) from $6,897,411 to $7,042,316 during fiscal 2004.

For the fiscal year ended September 30, 2003, net income decreased $554,941 (82.73%) from net income of $670,805 in fiscal 2002. Earnings (losses) per common share were $0.16 for the fiscal year ended September 30, 2003. The decrease in net income for fiscal 2003 was due primarily to an increase in the provision for loan losses and an increase in non-interest expense.

The components of net income discussed in the preceding paragraphs are discussed more fully below.

Net Interest Income

Net interest income was $4,308,614 for the twelve months ended September 30, 2004, which represents an increase of $416,162 (10.7%) from fiscal 2003. Net interest income is the difference between the interest earned on loans, investment securities and other earning assets and the interest cost associated with deposits and borrowed funds. The increase in 2004 is primarily due to an increase in the net interest rate spread. The net

interest rate spread increased as rates on interest-earning assets decreased twenty-nine (29) basis points to 5.80% and the cost of funds also decreased sixty-one (61) basis points to 2.32%. The combined effect of the changes in average balances and the changes in rates above resulted in an increase in net interest income.

Net interest income was $3,892,452 for the twelve months ended September 30 2003. The increase of $95,056 (2.5%) over the comparable twelve months of 2002 was primarily the result of an increase in the interest rate spread of thirty (30) basis points from 2.86% at September 30, 2002 to 3.16% at September 30, 2003.

First Federal’s Asset/Liability Committee (“ALCO”) conducts a gap analysis in order to assist in analyzing the yields on earning assets and the rates paid on interest-bearing liabilities. There can be no assurance, however, that such analysis will positively affect earnings.

Rate/Volume Variance Analysis

The following table sets forth information regarding the extent to which changes in interest rates, changes in volume of interest assets, and changes in volume of interest related assets and liabilities have affected First Federal’s interest income and expense during the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided for changes attributable to (i) changes in volume (change in volume multiplied by old rate), (ii) changes in rates (change in rate multiplied by old volume) and (iii) changes in rate/volume (change in rate multiplied by change in volume). Changes in rate/volume have been allocated proportionately between changes in volume and changes in rates.


	Year Ended September 30,
	2004 vs. 2003									2003 vs. 2002									2002 vs. 2001
	Increase (Decrease)									Increase (Decrease)									Increase (Decrease)
	Due to									Due to									Due to
	Volume			Rate			Total			Volume			Rate			Total			Volume			Rate			Total
	(Dollar amounts in thousands)
Interest income:
Securities	$	167		$	(30	)	$	197		$	(215	)	$	4		$	(211	)	$	(286	)	$	(400	)	$	(686	)
Loans receivable		(152	)		(301	)		(513	)		(154	)		(726	)		(880	)		(534	)		(1,145	)		(1,679	)

Total interest income		15			(331	)		(316	)		(369	)		(722	)		(1,091	)		(820	)		(1,545	)		(2,365	)

Interest expense:
NOW accounts		(1	)		(43	)		(44	)		1			(81	)		(80	)		14			(31	)		(17	)
Money market demand		—			—			—			—			(1	)		(1	)		(1	)		—			(1	)
Passbook savings		(1	)		(47	)		(48	)		1			(106	)		(105	)		4			(41	)		(37	)
CDs other than Jumbos		25			(567	)		(542	)		(57	)		(749	)		(806	)		(314	)		(899	)		(1,213	)
Jumbos		(139	)		(13	)		(152	)		68			(46	)		22			(10	)		(208	)		(218	)
Borrowed funds		148			(94	)		54			(194	)		(22	)		(216	)		(185	)		(584	)		(769	)

Total interest expense		32			(764	)		(732	)		(181	)		(1,005	)		(1,186	)		(492	)		(1,763	)		(2,255	)

Change in net interest income	$	(17	)	$	433		$	416		$	(188	)	$	283		$	95		$	(328	)	$	218		$	(110	)

Interest Income

Interest income is a function of both the volume of interest earning assets and their related yields. Interest income was $7,121,000, $7,436,000 and $8,527,000 for the twelve months ended September 30, 2004, 2003 and 2002, respectively. Average interest earning assets increased $524,000 (.43%) during 2004, decreased $6,472,000 (5.0%) during 2003 and decreased $12,945,000 (9.1%) during 2002. The yield for 2004, 2003 and 2002 decreased primarily due to rates on mortgage and residential construction loans decreasing during the year. Interest and fees on loans were $5,436,000, $5,948,000 and $6,828,000 for the twelve months ended September 30, 2004, 2003 and 2002, respectively. Although actual loans receivable increased substantially during fiscal 2004, average loan balances decreased approximately $2,600,000 (2.7%). This decrease in average balances is attributable to the sale of approximately $6,400,000 in commercial, residential mortgage and other consumer

loans as the result of the sale of the Centreville branch office in Centreville, Alabama to First Financial Bank in Bessemer, Alabama occurring during the last quarter of fiscal 2003. The sale of these loans resulted in the decrease in average loans receivable in fiscal 2003 of approximately $2,400,000.

Interest income on total securities available-for-sale decreased $95,000 (6.8%) to $1,302,000 in 2004. The average balance outstanding of securities available-for-sale decreased $3,038,000 (11.2%) to $24,200,000 in 2004, decreased $3,670,000 (11.9%) to $27,238,000 in 2003, and decreased $5,612,000 (15.4%) to $30,907,000 in 2002. The yields on securities available-for-sale were 5.38% in 2004 and 5.13% in 2003. Interest income on securities available-for-sale decreased $203,000 (12.7%) in 2003 from 2002.

Interest income on securities held-to-maturity increased approximately $345,000 in 2004. This increase in interest income is the result of the re-classification of approximately $16,000,000 from available-for-sale to held-to-maturity investments during the third quarter of fiscal 2004. The yield earned on securities held to maturity was 5.50% at September 30, 2004.

Interest Expense

Total average interest-bearing liabilities were $121,142,000, $120,924,000 and $125,364,000 for fiscal years 2004, 2003, and 2002, respectively. Interest bearing liabilities increased by $218,000 (0.2%) in 2004, decreased by $4,439,000 (3.5%) in 2003, and decreased $10,636,000 (7.8%) in 2002. The rates paid on these liabilities decreased by 61 basis points to 2.32% in 2004, decreased by 84 basis points to 2.93% in 2003, and increased by 137 basis points to 3.77% in 2002. Total interest expense was $2,812,000, $3,544,000 and $4,730,000 for 2004, 2003, and 2002, respectively, which represents a decrease of $732,000 (20.6%), a decrease of $1,186,000 (25.1%), and a decrease of $2,254,000 (32.3%), during 2004, 2003, and 2002, respectively. The decrease in 2004 was primarily due to the decrease in interest rates. The decrease in 2003 and 2002 was primarily due to the decrease in interest-bearing liabilities, along with the reduction in interest rates.

Interest on deposits, the primary component of total interest expense decreased to $1,735,000 in 2004, decreased to $2,521,000 in 2003 and decreased to $3,491,000 in 2002. The average balance of interest-bearing deposits decreased to $91,900,000 in 2004 from $95,707,000 in 2003, representing a decrease of $3,806,000 (4.0%). In 2003, the balance of $95,707,000 represented an increase of $344,000 (0.4%) from the balance of $95,363,000 in 2002.

Interest expense on borrowed funds, including both short-term and other borrowed funds was $1,077,000, $1,023,000 and $1,239,000 for fiscal 2004, 2003 and 2002, respectively. Interest expense increased in 2004 approximately $54,000 (5.3%) from fiscal 2003. Although interest rates on borrowed funds decreased 38 basis points to 3.68% from 4.06%, average balances increased from $25,218,000 to $29,242,000 in fiscal 2004, representing an increase of approximately $4,000,000 (16.0). The decrease in 2003 and 2002 was primarily due to lower interest rates, along with principal reductions in average borrowings of approximately $4,800,000 and $4,471,000, respectively. The average balance of FHLB advances outstanding was $22,124,000, $22,340,000 and $27,044,000 for 2004, 2003, and 2002, respectively. The average balance of total borrowed funds, including both short-term and other borrowed funds was $29,242,000, $25,218,000 and $30,001,000 for 2004, 2003 and 2002, respectively.

Provision for Loan Losses

The provision for loan losses is based on management’s current assessment of the risk in the loan portfolio and is influenced primarily by the amount of recent loan losses. The provision for loan losses (benefit) was $1,356,937, $549,603, and ($667,650) for fiscal 2004, 2003 and 2002, respectively. The amount of the provision for loan losses for fiscal 2004 is primarily the result of the write down of an acquisition and development loan in Columbiana, Alabama, which entered into foreclosure in January 2004. At the date of foreclosure, this loan had a disbursed balance of approximately $1,948,000, with previously recognized allowances of approximately $525,000. At the time of foreclosure, the fair value of the property was estimated to be $500,000. The year to date provision also includes approximately $312,000 of additional general loan loss

reserves recorded to increase the balance in allowance for loan losses to an appropriate level, based on continuing reviews of asset quality. The amount of the provision for loan losses for fiscal 2003 is primarily the result of a specific reserve for approximately $525,000 relative to the above mentioned acquisition and development loan. As of September 30, 2003, the disbursed balance on this loan was approximately $1,790,000. (See Allowance for Loan Losses and Risk Elements for further discussion.) The amount of the provision for loan losses for fiscal 2002 is primarily the result of a reversal of an additional provision for a loan, which defaulted, in the fourth quarter of fiscal 2001 in the principal amount of $657,000. This loan was made to Vawter Properties and Resources, LP, an Alabama limited partnership whose general partner is Charles R. Vawter, Jr., a former director of the Company and the Bank, and who also personally guaranteed the loan. The total of the loan loss and the related expenses associated with this loan in the fourth quarter of 2001 was $713,000, including the loss of principal and unpaid interest, as well as related legal and accounting expenses. The Bank brought suit against Mr. Vawter, Vawter Properties and Resources, LP, and other related parties to recover the total amount of the loan loss and related expenses. A settlement was reached on August 28, 2002, for which the bank received $761,000.

First Federal’s provision for loan losses also reflects management’s current assessment of economic and other factors which management deems relevant to its risk analysis, including loan concentrations in particular markets, economic activity in particular markets, certain regulatory requirements regarding loan loss reserves and related safety and soundness issues, as well as management’s view of the general economic outlook.

As previously discussed, the loan portfolio is comprised primarily of one-to-four family residential mortgage loans and residential construction loans. The one-to-four family residential mortgage loans are originated in First Federal’s primary market area of Talladega and Chilton County, Alabama. Management believes that the credit risks associated with this type of loan are significantly lower than other loan types.

Although residential construction loans have characteristics of relatively higher credit risks, such as concentrations of amounts due from a smaller number of borrowers and dependence on the expertise of the builder, management believes that its residential construction lending policies and procedures reduce the credit risks associated with this type of loan, and that its current provisions for loan losses in the construction loan portfolio (1%) is adequate in light of these policies and procedures. First Federal entered the residential construction lending area in 1994 by purchasing the portfolio of another Alabama thrift. A significant portion of First Federal’s residential construction loans were originated in Hoover, Alabama, a suburb of Birmingham and one of the most affluent areas of the state. Since acquiring the portfolio, First Federal has not suffered a significant loss on a residential construction loan.

Significant write-offs in fiscal 2004 consisted of the acquisition and development loan mentioned above, and other charge-offs for various types of consumer loans of approximately $103,000. Significant write-offs in fiscal 2003 consisted primarily of a commercial real estate loan in Clanton, Alabama, which was foreclosed and subsequently sold in 2003. There were no significant charge-offs in 2002. In addition, management has also specifically reserved approximately $395,000, of which approximately $316,000 is reserved on a commercial loan to a used automobile dealership, and approximately $79,000 on other types of consumer loans. Management believes the allowances for loan losses at September 30, 2004 ($911,964) to be an adequate level relative to the total loan portfolio and to non-performing loans, and in light of the other factors, which are relevant to the assessment of risks in the loan portfolio.

Future additions to the allowance may be necessary based on changes in economic conditions and other factors. In addition, various regulatory agencies periodically review First Federal’s allowance for loan losses and may require First Federal to recognize additions to the allowance based upon and analysis of information available at the time of their review.

Other Income

Other income decreased $502,000 (13.4%) in 2004 from $3,742,000 in 2003. Other income increased $708,000 (23.3%) in 2003 from $3,033,000 in 2002. The decrease in 2004 was due to a decrease in the gain on the sale of mortgage loans from $1,170,000 to $719,000, a decrease in the gain from the sale of securities

available-for-sale from $238,000 to $84,000, and a decrease in the profit from the sale of deposits of $250,000, which was a one-time profit as a result of the sale of the Centreville branch location in the fourth quarter of fiscal 2003. Service charges and other fees decreased from $569,000 to $546,000, while other income decreased from $345,000 to $314,000. Off-setting these decreases in income are increases in fee income generated from Pension & Benefit Trust Company from $1,232,000 to $1,582,000 and a decrease in the loss from the sale of foreclosed and other assets from $70,000 to $7,000. The increase in 2003 was due to an increase in fee income from Pension & Benefit Trust Company from $1,173,000 to $1,232,000, an increase in the gain from the sale of mortgage loans from $612,000 to $1,170,000, and a gain from service charges and other fees from $448,000 to $569,000.

The gain on sale of mortgage loans decreased $451,000 (38.5%) in 2004, increased $558,000 (91.3%) in 2003 and increased $218,000 (55.4%) in 2002. The restructuring process in the mortgage banking division, along with increased rates as the refinancing boom of 2003 closed, has resulted in decreased volumes of originations and sales of mortgage loans in fiscal 2004. During 2003 and 2002, with the addition of mortgage loan originators, along with the decrease in mortgage loan rates, the volume of originations and sales of mortgage loans increased.

The gain on sale of securities available-for-sale decreased approximately $155,000 (64.9%) for fiscal year 2004. The gain on sale of securities available-for-sale remained approximately the same for fiscal 2003 and 2002 at $238,000 and $236,000, respectively. In 2002, the gain from the sale of available-for-sale securities increased $232,000.

Service charges and other fees were $546,000, $569,000 and $448,000 in fiscal 2004, 2003 and 2002, respectively. The fluctuations are primarily due to changes in overdraft and non-sufficient charges.

Other Expense

Total other expense increased to $7,042,000 in 2004 from $6,897,000 in 2003. Other expense increased in 2002 to $6,407,000. This represented an increase of $145,000 (2.1%) in 2004, an increase of $490,000 (7.7%) in 2003, and an increase of $382,000 (6.3%) in 2002.

Compensation and benefits totaled $4,331,000, $4,279,000 and $3,636,000 for fiscal 2004, 2003 and 2002, respectively. These levels reflect an increase of $52,000 (1.2%) in 2004, an increase of $644,000 (17.7%) in 2003 and an increase of $518,000 (16.6%) in 2002. In 2004, the increase was attributable to the acquisition of Walton Mortgage in January 2004 and certain severance payments made in connection with the restructuring of SouthFirst Mortgage and certain other areas within the company. The increases in 2003 and 2002 was primarily attributable to new salaries associated with the restructuring process, along with merit and cost of living raises and the costs of benefits associated with such increases.

Increases in other expenses during fiscal 2004 occurred in occupancy, furniture and fixtures expense, office supplies and related expenses, and data processing of approximately $27,000, $54,000, $6,000 and $123,000, respectively. The increase in data processing costs resulted primarily from the conversion of the Bank’s data processing function to FISERV. These increases in other expenses were partially offset with decreases in expenses related to deposit insurance premiums, legal and other in the amount of $5,000, $58,000 and $54,000, respectively.

Income Tax Expense

Income tax expenses (benefit) were (323,000), 71,000 and $421,000 for fiscal 2004, 2003 and 2002, respectively. These levels represent an effective tax rate on pre-tax earnings (losses) of 38% in 2004, 38% in 2003 and 39% in 2002.

Supervisory Agreement

On March 29, 2002, SouthFirst announced that First Federal, on March 22, 2002, had entered into a Supervisory Agreement with the OTS that formalized certain understandings between First Federal and the OTS with respect to actions that First Federal and its Board of Directors had to undertake to comply with the requirements of the OTS. On December 16, 2004, First Federal received notification from the OTS that First Federal had complied with the obligations contained in the Supervisory Agreement and that the Supervisory Agreement was rescinded as of December 14, 2004.

New Accounting Pronouncements

In March 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan Commitments, which summarized the views of the staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. The SAB requires that the fair value measurement of a loan commitment that is accounted for as a derivative includes only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected cash flows related to the customer relationship or loan servicing. This SAB is effective for loan commitments entered into after March 31, 2004. The Company adopted SAB 105 on April 1, 2004, and the effect was not material.

In March 2004, the FASB’s Emerging Issues Task Force reached a consensus of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other-than-temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance provided to evaluate whether an impairment is other than temporary has been delayed by FASB Staff Position EITF Issue 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, posted September 30, 2004. The delay of the effective date for paragraphs 10-20 will be superseded concurrent with the final issuance of proposed FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, while the disclosure requirements are effective for annual reporting periods ending after December 15, 2003. The Company has adopted the disclosure requirements of this EITF, and is currently evaluating the impact of the adoption of the accounting guidance in the EITF.

In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004) Share-Based Payment. The Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. This Statement supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. The Statement establishes standards for the accounting for transactions in which an entity exchanges its equity instruments for goods or services. It also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. The Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The Statement eliminates the alternative to use APB Opinion 25’s intrinsic value method of accounting that was provided in Statement 123 as originally issued. Under Opinion 25, issuing stock options to employees generally resulted in recognition of no compensation cost. This Statement requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The Statement is effective for public entities that do not file as small business issuers as of the beginning of the first interim or annual reporting period that begins after June 15, 2005, and for public entities that file as small business issuers as of the beginning of the first interim or annual reporting period that begins

after December 15, 2005. The Company is currently evaluating the impact the adoption of this statement will have on its statement of condition and results of operations.

Interest Rate Sensitivity

An integral aspect of the funds management of First Federal is the maintenance of a reasonably balanced position between interest rate sensitive assets and liabilities. ALCO is charged with the responsibility of managing, to the degree prudently possible, First Federal’s exposure to “interest rate risk,” while attempting to provide a stable and steadily increasing flow of depositors and borrowers and to seek earnings enhancement opportunities. An asset or liability is said to be interest rate sensitive within a specific period if it will mature or reprice within that period. First Federal measures its interest rate risk as the ratio of cumulative interest sensitivity gap to total interest-earning assets (“ratio”). The ratio is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period, divided by the total interest earning assets. This ratio is positive when the amount of interest rate sensitive assets exceeds the amount of interest sensitive liabilities, and is negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Generally, during a period of rising interest rates, a negative ratio would adversely affect net interest income, while a positive ratio would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative ratio would result in an increase in net interest income and a positive ratio would adversely affect net interest income. Due to the nature of First Federal’s balance sheet structure and its use of the market approach to pricing liabilities, First Federal’s management and the First Federal Board of Directors recognize that achieving a perfectly matched gap position in any given time frame would be extremely rare. At September 30, 2004, First Federal had a negative one-year cumulative ratio of 7.08% and a five-year cumulative ratio of 1.39%, as a result of which its net interest income could be negatively affected by rising interest rates and positively affected by falling interest rates. At September 30, 2003, First Federal had a positive one-year cumulative ratio of 8.82% and a positive five-year cumulative ratio of 4.13%. During the declining interest rate environment for the early months of fiscal year 2004, and most of fiscal year 2003, First Federal’s interest rate spread increased.

There are other factors that may affect the interest rate sensitivity of First Federal’s assets and liabilities. These factors generally are difficult to quantify but can have a significant impact on First Federal when interest rates change. Such factors include features in adjustable rate loans that limit the changes in interest rates on a short-term basis and over the life of a loan. First Federal’s portfolio of one-to-four family residential mortgage loans included $29.3 million and $22.54 million (30.7% and 26.7% of First Federal’s total loan portfolio) of adjustable rate loans at September 30, 2004 and 2003, respectively. These loans have restrictions limiting interest rate changes to 1.0% or 2.0% per year and 6.0% over the life of the loan. In a rapidly declining or rising interest rate environment, these restrictions could have a material effect on interest income by slowing the overall response of the portfolio to market movements. ALCO utilizes the “Asset and Liability Management Report” prepared by Farin & Associates (the Strategic Asset Liability Management) in order to assist First Federal in determining First Federal’s gap and interest rate position. Through use of the Farin & Associates analysis, ALCO analyzed the effect of an increase or decrease of up to 300 basis points on the market value of First Federal’s portfolio equity (“MVPE”) at September 30, 2004 and 2003. At a 300 basis point increase, First Federal’s MVPE decreased approximately $5,090,000 and $2,288,000 at September 30, 2004 and 2003, respectively, and at a 300 basis point decrease, First Federal’s MVPE increased approximately $3,290,000 and $1,377,000 at September 30, 2004 and 2003, respectively. At the 300 basis point increase, the equity exposure was a negative 44.18%, which represents a negative variance of 4.18% from the board established limit as outlined in First Federal’s interest rate risk policy. The ALCO committee is in the process of analyzing different strategies to address this variance and reduce the interest rate risk associated with a sudden change in interest rates.

The following table sets forth information regarding the projected maturities and repricing of the major asset and liability categories of First Federal, as of September 30, 2004 and 2003. The projected maturity and repricing dates were arrived at by applying the assumptions set forth below. Classifications of items in the table are different from those presented in other tables and the financial statements and accompanying notes included therein.

Interest Rate Sensitivity Gap


	At September 30, 2004
	One year			One to			Three to			Over
	or less			three years			five years			five years			Total
Interest-earning assets:
Mortgage loans	$	46,690		$	19,994		$	12,337		$	6,766		$	85,796
All other loans		3,340			3,087			1,726			1,938			10,091
Collateralized mortgage obligations		875			—			—			—			875
Mortgage-backed securities		1,431			2,233			1,585			3,004			8,253
Other Investments (1)		25,235			100			—			—			25,335

Total interest- earning assets	$	77,580		$	25,414		$	15,648		$	11,708		$	130,350

Interest-bearing liabilities:
Deposits	$	58,621		$	24,634		$	10,123		$	4,477		$	97,855
Borrowed funds		28,186			2,500			—			—			30,686

Total interest-bearing liabilities	$	86,807		$	27,134		$	10,123		$	4,477		$	128,541

Interest sensitivity gap	$	(9,227	)	$	(1,720	)	$	5,525		$	7,231		$	1,809
Cumulative interest sensitivity gap	$	(9,227	)	$	(10,947	)	$	(5,422	)	$	1,809		$	—
Ratio of cumulative interest sensitivity gap to total interest earning assets		(7.08	)%		(8.40	)%		(4.16	)%		1.39	%		—
Ratio of cumulative interest sensitivity gap to total assets of $140,470		(6.57	)%		(7.79	)%		(3.86	)%		1.29	%		—

[Additional columns below]

[Continued from above table, first column(s) repeated]


	At September 30, 2003
	One year			One to			Three to			Over
	Or less			three years			five years			five years			Total
Interest-earning assets:
Mortgage loans	$	51,969		$	13,066		$	8,099		$	3,395		$	76,529
All other loans		5,080			2,645			1,283			1,173			10,181
Collateralized mortgage obligations		1,440			—			—			—			1,440
Mortgage-backed securities		2,578			2,947			1,349			1,043			7,917
Other Investments (1)		29,247			—			—			—			29,247

Total interest- earning assets	$	90,314		$	18,658		$	10,731		$	5,611		$	125,314

Interest-bearing liabilities:
Deposits	$	54,848		$	24,079		$	11,307		$	4,820		$	95,054
Borrowed funds		24,412			673			—			—			25,085

Total interest-bearing liabilities	$	79,260		$	24,752		$	11,307		$	4,820		$	120,139

Interest sensitivity gap	$	11,054		$	(6,094	)	$	(576	)	$	791		$	5,175
Cumulative interest sensitivity gap	$	11,054		$	4,960		$	4,384		$	5,175		$	—
Ratio of cumulative interest sensitivity gap to total interest earning assets		8.82	%		3.96	%		3.50	%		4.13	%		—
Ratio of cumulative interest sensitivity gap to total assets of $140,470		8.25	%		3.70	%		3.27	%		3.86	%		—

⁽¹⁾

Includes investments in overnight deposits.

Gap Sensitivity

The Farin & Associates analysis for 2004 and the preceding table were based upon the contractual terms of the asset or liability and in consideration of the following assumptions regarding prepayment of loans, collateralized mortgage obligations (“CMOs”) and mortgage-backed securities, and decay rates of deposits. These prepayment and decay rate assumptions are management’s estimates based on expectations of future interest rates. Fixed rate mortgage loans are assumed to prepay at approximately 6.3%. Adjustable rate loans, CMOs and mortgage-backed securities are presented in the period in which they next reprice. All other loans (principally consumer installment loans) are presented at their contractual maturities. Fixed rate CMOs are assumed to prepay at rates ranging from 15% to 20%. The decay rates for money market demand accounts are assumed to be 50% each year. The decay rates for passbook accounts are assumed to be 33% each year, and the decay rates for NOW accounts are assumed to be 25% each year. Certificate accounts and borrowed funds are presented at their contractual maturities. Certain shortcomings are inherent in the method of analysis presented in the table above. Although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in the market interest rates. The interest rates on certain liabilities may lag behind changes in market interest rates. Certain assets, such as ARMs, generally have features, which restrict changes in interest rates on a short-term basis and over the life of the asset. In the event of a change in interest rates, prepayments and early withdrawal levels would cause significant deviations in the table. Additionally, an increased credit risk may result if the ability of many borrowers to service their debt decreases in the event of an interest rate increase. A majority of the adjustable rate loans in First Federal’s portfolio contain conditions, which restrict the periodic change in interest rates.

Interest Rate Risk Strategy

First Federal has employed various strategies intended to minimize the adverse effect of interest rate risk on future operations by attempting to balance the interest rate sensitivities of its assets and liabilities. First Federal’s strategies are intended to stabilize long term net interest income by protecting its interest rate spread against decreases and increases in interest rates. To offset the interest rate risk associated with holding a substantial amount of fixed rate loans and having a predominantly short-term certificate of deposit base, First Federal maintains a portfolio of residential adjustable-rate mortgage loans that reprice in less than one year. The amount of loans in this portfolio was equal to $23,890,000 at September 30, 2004 and $22,392,000 at September 30, 2003. First Federal also sells a significant portion of its fixed rate loan originations in the secondary markets, and directs excess cash flow into short-term and adjustable rate investment securities. Diversification into more interest-sensitive securities directs excess cash flow into short-term and adjustable rate investment securities. Diversification into more interest-sensitive mortgage loans and construction loans in the Birmingham area has also served to reduce First Federal’s interest rate risk exposure.

Effects of Inflation and Changing Prices

Inflation generally increases the costs of funds and operating overhead, and, to the extent that loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. In addition, inflation affects a financial institution’s cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity, earnings, and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase and would likely reduce First Federal’s earnings from such activities. Further, First Federal’s income from the sale of residential mortgage loans in the secondary market likely would decrease if interest rates increased.

Average Balance, Interest, Yields and Rates

The following table sets forth certain information relating to First Federal’s average interest-earning assets and interest-bearing liabilities and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average monthly balance of assets or liabilities, respectively, for the periods presented. Average balances are derived from month-end balances. Management does not believe that the use of month-end balances instead of daily balances has caused any material difference in the information presented.

The following table also presents information for the periods indicated with respect to the difference between the average yield earned on interest-earning assets and average rate paid on interest-bearing liabilities, or “interest rate spread,” which savings associations have traditionally used as an indicator of profitability. Another indicator of an institution’s net interest income is its “net yield on total interest-earning assets,” which is its net interest income divided by the average balance of interest-earning assets. Net interest income is affected by the interest rate spread and by the relative amounts of interest-earning assets and interest-bearing liabilities. When interest-earning assets reflect or exceed interest-bearing liabilities, any positive interest rate spread will generate net interest income.

Average Balance, Interest, Yields and Rates


	Year Ended September 30,
	2004								2003
	Average					Yield/			Average					Yield/
	Balance			Interest		Cost			Balance			Interest		Cost
Interest Earning Assets:
Interest earnings deposited in other financial institutions	$	602,805		$	37,776		6.27	%	$	761,750		$	91,223		11.98	%
Total securities		30,476,375			1,647,473		5.41	%		27,237,544			1,397,105		5.13	%
Loans receivable		91,610,652			5,435,692		5.93	%		94,166,707			5,948,317		6.32	%

Total interest earning assets		122,689,832			7,120,941		5.80	%		122,166,001			7,436,645		6.09	%
Allowance for loan losses		(980,380	)							(927,683	)
Cash and amounts due from depository institutions		5,592,476								8,364,641
Premises and equipment		4,568,474								4,507,558
FHLB stock, at cost		1,117,000								1,262,833
Foreclosed real estate		495,330								420,213
Accrued interest receivable		665,166								605,552
Other assets		3,299,720								2,650,805

Total Assets	$	137,447,618							$	139,049,920

Interest Bearing Liabilities:
Deposits:
NOW accounts	$	10,612,198		$	19,403		.18	%	$	11,208,905		$	63,071		.56	%
Money market demand		54,929			54		.10	%		46,293			161		.35	%
Statement savings		11,494,036			25,921		.23	%		12,142,016			74,506		.61	%
CDs, other than Jumbos		64,272,679			1,482,260		2.31	%		63,192,912			2,024,399		3.20	%
Jumbo certificates		5,466,536			207,212		3.79	%		9,116,476			358,691		3.93	%

Total interest-bearing deposits		91,900,378			1,734,850		1.89	%		95,706,602			2,520,828		2.63	%
Borrowed funds		29,241,967			1,077,477		3.68	%		25,217,611			1,023,365		4.06	%

Total interest-bearing liabilities		121,142,345			2,812,327		2.32	%		120,924,213			3,544,193		2.93	%
Non-interest bearing demand accounts		4,077,675								3,585,780
Advances by borrowers for property taxes		179,793								208,122
Accrued interest payable		490,022								726,747
Income taxes payable		(396,075	)							447,058
Accrued expenses and other liabilities		1,002,548								431,172

Total liabilities		126,496,308								126,323,092
Stockholders’ equity		10,951,309								12,726,828

Total liabilities & stockholders’ equity equity	$	137,447,617							$	139,049,920

Net interest income				$	4,308,614							$	3,892,451

Interest rate spread							3.48	%							3.16	%
Net yield on total interest earning assets							3.51	%							3.19	%
Average interest-earning assets to average total interest-bearing liabilities ratio							101.28	%							101.03	%

[Additional columns below]

[Continued from above table, first column(s) repeated]


	Year Ended September 30,
	2002
	Average					Yield/
	Balance			Interest		Cost
Interest Earning Assets:
Interest earnings deposited in other financial institutions	$	1,131,360		$	99,189		8.77	%
Total securities		30,907,198			1,600,346		5.18	%
Loans receivable		96,599,905			6,827,657		7.07	%

Total interest earning assets		128,638,463			8,527,192		6.63	%
Allowance for loan losses		(1,386,892	)
Cash and amounts due from depository institutions		6,341,587
Premises and equipment		4,881,979
FHLB stock, at cost		2,229,800
Foreclosed real estate		226,899
Accrued interest receivable		783,703
Other assets		2,532,819

Total Assets	$	144,248,358

Interest Bearing Liabilities:
Deposits:
NOW accounts	$	10,968,447		$	142,688		1.30	%
Money market demand		66,441			850		1.28	%
Statement savings		11,946,198			179,579		1.50	%
CDs, other than Jumbos		64,985,484			2,830,798		4.36	%
Jumbo certificates		7,396,298			336,800		4.55	%

Total interest-bearing deposits		95,362,868			3,490,715		3.66	%
Borrowed funds		30,000,755			1,239,081		4.13	%

Total interest-bearing liabilities		125,363,623			4,729,796		3.77	%
Non-interest bearing demand accounts		3,472,967
Advances by borrowers for property taxes		258,250
Accrued interest payable		1,032,802
Income taxes payable		9,084
Accrued expenses and other liabilities		381,893

Total liabilities		130,518,619
Stockholders’ equity		13,729,739

Total liabilities & stockholders’ equity equity	$	144,248,358

Net interest income				$	3,797,396

Interest rate spread							2.86	%
Net yield on total interest earning assets							2.95	%
Average interest-earning assets to average total interest-bearing liabilities ratio							102.61	%

Financial Condition

Investment Securities

First Federal’s portfolio of securities available-for-sale totaled $14,180,000 and $32,600,000 at September 30, 2004 and 2003, respectively. First Federal’s portfolio of securities held-to-maturity totaled $15,082,000 and $0 at September 30, 2004 and 2003, respectively. The balance in held-to-maturity securities at September 30, 2004 is based on management’s decision to reclassify approximately $16,000,000 of available-for-sale securities to held-to-maturity to better meet the investment strategy of the Company.

The composition of First Federal’s total investment securities portfolio partly reflects First Federal’s former investment strategy of providing acceptable levels of interest income from portfolio yields while maintaining a level of liquidity allowing First Federal a degree of control over its interest rate position. In previous years, First Federal invested primarily in investment grade CMOs and mortgage-backed securities because of their liquidity, credit quality and yield characteristics. The yields, values and duration of such securities generally vary with interest rates, prepayment levels, and general economic conditions and, as a result, the values of such instruments may be more volatile than other instruments with similar maturities. Such securities also may have longer stated maturities than other securities, which may result in further price volatility.

With First Federal’s purchase of the construction loan portfolio of another Alabama thrift institution in April of 1994, First Federal revised its investment strategy, curtailing its purchases of CMOs and mortgage-backed securities and utilizing principal repayments on these securities to fund construction loans. Accordingly, First Federal did not purchase any CMOs or mortgage-backed securities from 1994 through 1997. However, as a result of First Federal’s acquisition of Chilton County in October 1997, First Federal acquired approximately $466,000 in CMOs and $16,101,000 in mortgage-backed securities. In addition, as a result of the excess cash on hand from the Chilton County acquisition, First Federal purchased approximately $18,670,000 in mortgage-backed securities in 1998. During 1999, First Federal purchased approximately $10,500,000 of FNMA and FHLMC adjustable rate CMOs that reprice to LIBOR on a monthly basis. These CMOs were funded by FHLB advances that also reprice each month to LIBOR.

During fiscal year 2003, First Federal re-invested available liquidity in purchases of FNMA and FHLMC fixed rate callable notes and bonds in the amount of approximately $35,000,000. In an interest rate environment of record lows, the yield on these investments was higher than normal, therefore enhancing the overall yield of First Federal’s investment portfolio. Of this amount, First Federal sold $8,000,000 in callable bonds, and booked a gain from the sale of this investment in the amount of $83,750. In addition, First Federal purchased a mortgage-backed security in the amount of $3,425,000 during fiscal 2003.

During fiscal year 2004, First Federal purchased $3,500,000 in FHLMC callable bonds and approximately $8,000,000 in FNMA fixed rate mortgage backed securities. Also, during the fiscal year, the company sold mortgage-backed securities, callable notes and callable bonds for approximately $5,500,000, $1,000,000 and $5,000,000, respectively. As a result of the sale of these investments, a pre-tax gain was recorded for approximately $80,000.

Principal repayments on both CMOs and mortgage-backed securities for the years ended September 30, 2004, 2003 and 2002 were $8,159,000, $10,041,000, and $674,700, respectively. As of September 30, 2004, First Federal had an investment in available-for-sale U.S. Government agencies of $4,533,000 compared to $22,608,000 as of September 30, 2003. As a result of a change in investment strategy, management made a decision to reclassify approximately $16,000,000 of available-for-sale securities to held-to-maturity during the June 2004 quarter. At September 30, 2004, First Federal had investments of approximately $1,129,000 in equity securities, such as FHLB stock and other common stock.

The following table indicates the fair value of the portfolio of investment securities available for sale at September 30, 2004, 2003 and 2002.


	Total Fair Value
	2004		2003		2002
	(in thousands)
Available-for-Sale Securities :
U.S. Government agencies	$	4,533	$	22,608	$	9,867
Corporate obligations		403		355		98
Mortgage-backed securities		8,350		8,175		11,679
Collateralized mortgage obligations		882		1,456		5,115
Other investments		12		6		8

Total Available-for-Sale Securities	$	14,180	$	32,600	$	26,767

Held-to-Maturity Securities :
U.S. Government agencies	$	15,675	$	—	$	+

At September 30, 2004, First Federal owned CMOs totaling $882,000. These securities are all backed by federal agency guaranteed mortgages.

The mortgage backed securities portfolio, consists of fixed rate mortgages totaling $8,350,000 at September 30, 2004. Adjustable rate mortgage-backed securities totaling $357,240 were sold during fiscal year 2003. When purchasing these securities, First Federal looks at various prepayment speeds and makes the purchase based on the ability to accept the yield and average life based on both increasing and decreasing prepayment speeds.

The following table presents the contractual maturities and weighted average yields of investment securities, other than equity securities, available for sale at September 30, 2004.


	Maturities of Securities
			After one		After five
	Within		through		through		After
	one year		five years		ten years		ten years
	(in thousands)
Available-for-Sale Securities:
U.S. Government agencies, excluding mortgage-backed securities	$	—	$	—	$	—	$	4,533
Mortgage-backed securities		—		48		4,872		3,430
Collateralized mortgage obligations		—		882		—		—
Corporate obligations		100		153		150		—

Total Available-for-Sale Securities	$	100	$	1,083	$	5,022	$	7,963

Held-to-Maturity Securities	$	—	$	—	$	—	$	15,675


	Weighted Average Yields
	(Taxable-equivalent basis) (1)
				After one			After five
	Within			through			through			After
	one year			five years			ten years			Ten years
Available-for-Sale Securities:
U.S. Government agencies, excluding mortgage-backed securities		—			—			—			5.390	%
Mortgage-backed securities		—			6.760	%		4.450	%		4.900	%
Collateralized mortgage obligations		—			2.740	%		—			—
Corporate obligations		3.470	%		4.950	%		6.600	%		—
Total Weighted Average Yield		3.470	%		3.230	%		4.514	%		5.179	%
Held-to-Maturity Securities:
U.S. Government agencies		—			—			—			5.290	%

⁽¹⁾

None of First Federal’s investment securities are tax exempt.

The maturities for the CMOs and mortgage-backed securities presented above represent contractual maturities of such securities. Due to the nature of these securities, the timing and the amount of principal repayments is generally unpredictable. However, assuming current prepayment rates are normal and required principal repayments, the following table sets forth certain information regarding the expected principal payments, carrying values, fair values, and weighted average yields of First Federal’s CMOs and mortgage-backed securities at September 30, 2004.

Principal Payments Expected During the Year Ended September 30,
(Dollars in thousands)


																	Weighted
													Amortized		Fair		Average
	2005		2006		2007		2008		2009		Thereafter		Cost		Value		Yield
Collateralized mortgage Obligations	$	370	$	260	$	180	$	65	$	—	$	—	$	875	$	882		2.74	%
Mortgage-backed securities		1,600		1,339		1,118		929		773		2,494		8,253		8,350		4.65	%
Agencies		—		—		—		—		—		19,671		19,671		20,208		5.31	%
Corporate obligations		100		100		50		100		—		50		400		403		5.15	%

Loans

Total loans of $94,574,000 at September 30, 2004 reflected an increase of $10,192,000 (12.1%) compared to September 30, 2003. Total loans of $84,383,000 at September 2003 reflected a decrease of 9.2% from total loans of $92,985,000 at September 30, 2002. The increase in the volume of loans for fiscal 2004 was due primarily to the strategy to rebuild portfolio loans in an effort to enhance our overall net interest margin. The decrease in the volume of loans for fiscal 2003 was due primarily to the sale of loans of approximately $6,400,000 to First Financial Bank, Bessemer, Alabama, as result of closing the Centreville branch location in September 2003. The decrease in the volume of loans for fiscal 2002 was due primarily to the sale of loans in the amount of $8,392,000 to another financial institution in Dothan, Alabama, as a result of closing the Dothan loan production office in February 2002. First Federal has experienced strong demand in its one-to-four family construction loan portfolio since First Federal’s purchase of the construction loan portfolio and the opening of a loan production office in Birmingham in 1994.

One-to-four family real estate mortgage loans increased $5,065,000 (12.7%) from September 30, 2003 to September 30, 2004 and decreased $4,508,000 (10.2%) from September 30, 2002 to September 30, 2003. First Federal aggressively pursues real estate mortgage loans within its market area. In addition to originating mortgage loans for its own portfolio, First Federal also actively originates residential mortgage loans, which are sold in the secondary market, with servicing released. First Federal sells a significant portion of all fixed rate residential mortgage loans. For the most part, such sales are composed of residential mortgage loans with terms of 30 years. Proceeds from loan sales were $31,097,000, $55,990,000 and $27,159,000 for the years ended September 30, 2004, 2003 and 2002, respectively. Had First Federal not sold residential mortgage loans over the last several years, the one-to-four family real estate mortgage loan portfolio would have increased by a larger margin (or decreased by lesser margin) than the percentage indicated above. The low interest rate environment that has existed for much of 2004, 2003 and 2002 resulted in an increase in the volume of loans sold during the periods indicated above compared to previous years, which had a higher interest rate environment. The following table presents the composition of the loan portfolio for each of the past five years:


	Loan Portfolio Composition
	At September 30,
	(Dollars in thousands)
	2004						2003						2002
				Percent						Percent						Percent
	Amount			of Total			Amount			of Total			Amount			of Total
Real estate mortgage loans:
One-to-four family	$	44,904			47.48	%	$	39,839			47.21	%	$	44,347			47.69	%
Multi-family and commercial		14,003			14.81	%		11,407			13.52	%		13,490			14.51	%
Construction loans		12,836			13.57	%		12,629			14.97	%		16,621			17.87	%
Land		3,271			3.46	%		3,635			4.31	%		5,077			5.46	%
Savings account loans		768			.81	%		881			1.04	%		1,190			1.28	%
Installment loans		3,192			3.38	%		3,921			4.65	%		3,599			3.87	%
Second mortgage loans		16,670			17.63	%		13,404			15.88	%		9,665			10.39	%

Total loans		95,644						85,716						93,989
Less:
Loans in process		—			—			—			—			—			—
Discounts and other, net		(158	)		(.17	)%		(142	)		(0.17	)%		(149	)		(.16	)%
Allowance for loan losses		(912	)		(.96	)%		(1,191	)		(1,41	)%		(855	)		(.92	)%

Total loans, net	$	94,574			100.00	%	$	84,383			100.00	%	$	92,985			100.00	%

[Additional columns below]

[Continued from above table, first column(s) repeated]


	Loan Portfolio Composition
	At September 30,
	(Dollars in thousands)
	2001						2000
				Percent						Percent
	Amount			of Total			Amount			Of Total
Real estate mortgage loans:
One-to-four family	$	51,083			50.51	%	$	58,595			54.08	%
Multi-family and commercial		14,205			14.05	%		13,790			12.73	%
Construction loans		25,378			25.09	%		24,381			22.50	%
Land		—			—			—			—
Savings account loans		1,144			1.13	%		1,097			1.01	%
Installment loans		3,507			3.47	%		4,089			3.77	%
Second mortgage loans		7,593			7.51	%		7,334			6.77	%

Total loans		102,910						109,286
Less:
Loans in process		(8	)		(.01	)%		(39	)		(.03	)%
Discounts and other, net		(189	)		(.19	)%		(192	)		(.18	)%
Allowance for loan losses		(1,578	)		(1.56	)%		(701	)		(.65	)%

Total loans, net	$	101,135			100.00	%	$	108,354			100.00	%

The following table shows the maturity of First Federal’s loan portfolio at September 30, 2004, based upon contractual maturity dates. Demand loans, loans having no schedule of repayment and no stated maturity and overdrafts are reflected as due during the twelve months ended September 30, 2005. The table below does not include an estimate of prepayments, the occurrence of which would significantly shorten the average life of all mortgage loans and cause First Federal’s actual repayment to be different from the table set forth below.


	Loan Maturities
	Due during the
	year ending Sept 30,
							Due after		Due after		Due After		Due After
	2005		2006		2007		3-5 years		5-10 years		10-15 years		15 years		Total
	(Dollars in thousands)
Residential loans	$	1,419	$	681	$	1,705	$	9,409	$	6,155	$	13,280	$	22,735	$	55,384
Commercial loans		1,447		286		1,097		2,161		1,947		3,982		2,916		13,836
Construction loans		16,105		—		—		—		—		—		—		16,105
Consumer loans		1,447		486		817		1,462		2,208		2,026		1,873		10,319

Total	$	20,418	$	1,453	$	3,619	$	13,032	$	10,310	$	19,288	$	27,524	$	95,644

⁽¹⁾

The maturity period for construction loans is typically one year. If the home is not sold at the maturity date, however, the loan may be extended for an additional six months, provided that the builder restructures the loan to provide for principal reduction or arranges for permanent financing that will pay off the construction loan.

The following tables set forth, at September 30, 2004 and 2003, the dollar amount of loans due after September 30, 2004 and 2003, respectively, based upon whether such loans have fixed interest rates or adjustable interest rates:


	September 30, 2004
	Fixed		Floating or
	Rates		Adjustable Rate		Total
	(Dollars in thousands)
Residential loans	$	26,037	$	26,347	$	55,384
Commercial loans		5,466		8,370		13,836
Construction loans		16,105		—		16,105
Consumer loans		10,319		—		10,319

Total	$	57,927	$	37,717	$	95,644


	September 30, 2003
	Fixed		Floating or
	Rates		Adjustable Rate		Total
	(Dollars in thousands)
Residential loans	$	26,129	$	22,490	$	48,619
Commercial loans		4,611		5,792		10,403
Construction loans		16,263		—		16,263
Consumer loans		10,431		—		10,431

Total	$	57,434	$	28,282	$	85,716

The following table sets forth First Federal’s loan originations, sales and principal repayments for the periods indicated.


	Year ended September 30,
	2004		2003		2002
	(Dollars in thousands)
Loan Originations:
Real estate mortgage loans	$	86,214	$	101,134	$	87,131
All other loans		4,026		4,407		6,790

Total	$	90,240	$	105,541	$	93,921

Portfolio Loan Purchases:
Real estate mortgage loans	$	—	$	—	$	—

Portfolio Loan Sales Proceeds:
Real estate mortgage loans	$	31,097	$	55,222	$	32,346

Principal Repayments:
Real estate mortgage loans	$	24,835	$	53,222	$	46,578
All other loans		4,889		4,394		6,652

Total	$	29,724	$	57,616	$	53,230

Allowance for Loan Losses and Risk Elements

The performance of loans is evaluated primarily on the basis of a review of each customer relationship over a period of time and the judgment of lending officers as to the ability of borrowers to meet the repayment terms of loans. If there is a reasonable doubt as to the repayment of a loan in accordance with the agreed terms, the loan may be placed on a non-accrual basis pending the sale of any collateral or a determination as to whether sources of repayment exist. Generally, delinquency of 90 days or more creates reasonable doubt as to repayment. This action may be taken even though the financial condition of the borrower or the collateral may be sufficient to ultimately reduce or satisfy the obligation. Generally, when a loan is placed on a non-accrual basis, all payments are applied to reduce principal to the extent necessary to eliminate doubt as to the repayment of the loan. Interest income on a non-accrual loan is recognized only on a cash basis. See “Non Performing Assets” below.

The Asset Classification committee is responsible for the on going review and administration of each particular loan. As such, they make the initial identification of loans, which present some difficulty in collection or where circumstances indicate that the probability of loss exists. Once the committee determines there is a potential collection problem, the loan is turned over to First Federal’s collections officer. It is the responsibility of the collections officer to coordinate all collection efforts on troubled and delinquent loans. Senior management and the First Federal board of directors are informed of the status of delinquent loans on a monthly basis. Senior management reviews the allowance for loan losses and makes recommendations to the board as to loan charge offs on a monthly basis.

At September 30, 2004, 2003 and 2002, loans accounted for on a non-accrual basis were approximately $1,194,000, $2,149,000, and $764,000, respectively, or 1.3%, 2.6%, and .8% of the total loans outstanding, net of unearned income. The balances of accruing loans past due 90 days or more as to principal and interest payments were $0 at September 30, 2004, 2003 and 2002.

The allowance for loan losses represents management’s assessment of the risk associated with extended credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain a level considered adequate to absorb all anticipated loan losses. In assessing the adequacy of the allowance, management reviews the size, quality, and risk of loans in the portfolio. Management also considers such factors as First Federal’s historical loan loss experience, the level, severity, and trend of criticized assets, the distribution of loans by risk class, and various qualitative factors such as current and anticipated economic conditions.

While it is First Federal’s policy to charge off loans in the period in which the loss is considered probable, there are additional risks of future losses, which cannot be quantified precisely or attributed to the particular loans or classes of loans. Because these risks include the state of the economy, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

In assessing the adequacy of the allowance, management relies predominately on the on going review of the loan portfolio, which is undertaken both to ascertain whether there are probable losses which must be charged off and to assess the risk characteristics of the portfolio in the aggregate. This review takes into consideration the judgments of the responsible lending officers, senior management and those of bank regulatory agencies that review the loan portfolio as part of First Federal’s examination process. Specific percentages are allocated to each loan type. Management recognizes that there is more risk traditionally associated with commercial and consumer lending as compared to real estate mortgage lending; correspondingly, a greater allocation is made for commercial and consumer loans than real estate mortgage loans. While management to recognize losses in the loan portfolio utilizes all information, there can be no assurances that future additions to the allowance will not be necessary. First Federal’s Board of Directors reviews the assessments of management in determining the adequacy of the allowance for loan losses. Generally, the only loans, including construction loans, which are classified, are loans, which are greater than 90 days delinquent. However, the Board of Directors may classify loans less than 90 days delinquent should such classification be deemed necessary.

First Federal’s allowance for loan losses is also subject to regulatory examinations and determinations as to the adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan loss reserves and the size of the loan loss reserve in comparison to a group of peer banks identified by the regulators. During its routine examinations of banks, the OTS has, from time to time, required additions to the banks’ provisions for loan losses and allowances for loan losses as the regulators’ credit evaluations and allowance for loan loss methodology have differed from those of management of such banks. Such regulatory examinations have focused on loan quality, particularly that of real estate loans. First Federal attempts to reduce the risks of real estate lending through maximum loan-to-value requirements as well as systematic cash flow and initial customer credit history analyses.

Management believes that the $912,000 allowance for loan losses, at September 30, 2004, is adequate to absorb known risks in the portfolio. No assurance can be given, however, that adverse economic circumstances will not result in increased losses in First Federal’s loan portfolio. At September 30, 2004, $335,000 of the allowance for loan losses was reserved for possible losses on real estate mortgage loans and $577,000 was reserved for possible losses on all other loans. See also, “Item 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS — Provision for Loan Losses.”

The following table summarizes the levels of the allowance for loan losses at the end of the last five fiscal years:


	Year Ended September 30,
	2004			2003			2002			2001			2000
	(Dollars in thousands)
Balance at beginning of period	$	1,191		$	854		$	1,578		$	701		$	852

Charge-offs:
Real estate		1,561			219			—			—			54
Installment		103			22			79			49			138

Total charge-offs		1,664			241			79			49			192

Recoveries:
Real estate mortgage		—			1			—			—			—
Installment		28			27			23			68			35

Total recoveries		28			28			23			68			35

Net loans (recovered) charged off		1,636			213			56			(19	)		157
Provisions for loan losses (benefit)		1,357			550			(668	)		858			6

Balance at end of period	$	912		$	1,191		$	854		$	1,578		$	701

Ratio of net charge-offs to total loans outstanding, net of unearned income		1.73	%		0.25	%		0.06	%		( .02	)%		0.14	%

Ratio of allowance for loan losses to loans outstanding, net of unearned income		.96	%		1.41	%		0.92	%		1.56			0.65	%

Total Loans Outstanding — Net	$	94,574		$	84,383		$	92,985		$	101,135		$	108,354

As indicated in the above table, First Federal decreased its loan loss allowance in fiscal year 2002 from the level reported in 2001. This decrease in loss allowance is primarily due to the successful repayment of the Vawter loan in 2002, which had been classified in the loan loss reserve in 2001.

The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated. Management believes that the allowance can be allocated by category only on an approximate basis. The allocation of the allowance to each category is not necessarily an indication of future losses and does not restrict the use of the allowance to absorb losses in any category.


	At September 30,
	2004					2003					2002
			Percent of					Percent of					Percent of
			loans in each					loans in each					loans in each
			category					category					category
	Amount		to total loans			Amount		to total loans			Amount		to total loans
	(Dollars in thousands)
Real estate mortgage loans	$	335		36.73	%	$	738		61.96	%	$	303		35.48	%
All other loans		577		63.27	%		453		38.04	%		551		64.52	%

Total allowance for loan losses	$	912		100.00	%	$	1,191		100.00	%	$	854		100.00	%

At September 30, 2004 and 2003, the total recorded investment in impaired loans was approximately $618,000 and $2,393,000, respectively. The average recorded investment in impaired loans amounted to approximately $822,000 and $413,000 for the years ended September 30, 2004 and 2003, respectively. The allowance for loan losses related to impaired loans was approximately $393,000 and $896,000 for fiscal 2004 and 2003, respectively. Interest income on impaired loans of approximately $25,000 and $23,000 was recognized in 2004 and 2003, respectively. Loans impaired at September 30, 2002 were $874,000.

Non-Performing Assets

First Federal has policies, procedures and underwriting guidelines intended to assist in maintaining the overall quality of its loan portfolio. First Federal monitors delinquency levels for any adverse trends. Non-performing assets consist of loans on non-accrual status, accruing loans, which are 90 days or more past due and foreclosed real estate.

First Federal’s policy generally is to place a loan on non-accrual status when there is reasonable doubt as to the repayment of the loan in accordance with the agreed terms. Generally, delinquency for 90 days or more creates reasonable doubt as to repayment. At the time the loan is placed on non-accrual status, interest previously accrued but not collected is reversed and charged against current earnings. Income is subsequently recognized only to the extent that cash payments are received until, in management’s judgment, the borrower is able to make periodic interest and principal payments and the loan is no longer delinquent and is returned to accrual status.

Non-performing assets were $1,703,000, $2,217,000, and $844,000 at September 30, 2004, 2003 and 2002, respectively. As a percentage of total loans, non-performing assets continued to be at levels which management considers to be acceptable and commensurate with First Federal’s conservative lending policies.

An analysis of the components of non-performing assets at September 30, 2004, 2003 and 2002 is presented in the following table:


	At September 30,
	2004			2003			2002
	(Dollars in thousands)
Loans accounted for on a non-accrual basis:
Real estate mortgage loans	$	891		$	2,077		$	762
All other loans		303			72			2

Total		1,194			2,149			764

Accruing loans which are past due 90 days or more:
Real estate mortgage loans		—			—			—
All other loans		—			—			—

Total		—			—			—

Total of non-accrual and 90 days past due loans		1,194			2,149			764
Foreclosed real estate (net of related loss provisions)		509			68			80

Total non-performing assets	$	1,703		$	2,217		$	844

Non-accrual and 90 days past due loans as a percent of total loans		1.26	%		2.55	%		0.82	%

Non-performing assets as a percent of total loans		1.80	%		2.63	%		0.91	%

Total loans outstanding	$	94,574		$	84,383		$	92,985

Management regularly reviews and monitors the loan portfolio in an effort to identify borrowers experiencing financial difficulties, but such measures are subject to uncertainties that cannot be predicted.

Deposits

Total deposits increased $4,235,000 (4.5%) in fiscal 2004 to $97,793,000, and decreased $2,925,000 (3.0%) to $93,558,000 in fiscal 2003. In fiscal 2002 deposits decreased $2,572,000 (2.6%) to $96,483,000. Non interest-bearing deposits were $4,003,000, $3,657,000, and $2,850,000, while total interest-bearing deposits were $93,790,000, $89,901,000, and $93,632,000 at September 30, 2004, 2003 and 2002, respectively.

First Federal’s deposit mix, at September 30, 2004, changed when compared to that at September 30, 2003. NOW accounts increased $598,000 (5.9%), while money-market demand accounts increased $75,000 (48.3%). Certificates of deposit, other than jumbo certificates of deposit, which are certificates of deposit greater than or equal to $100,000 with specially negotiated rates (“Jumbos”), increased $5,278,000 (8.7%). Non-interest bearing demand deposits increased $346,000 (9.5%). During 2004, certificates of deposit, excluding Jumbos, comprised approximately 67.3% of total deposits, while low cost of funds, including NOW accounts, money market demand accounts, and passbook savings accounts made up 27.1% of First Federal’s total deposits. Jumbos comprised 5.6% of total deposits as of September 30, 2004.

In order to offset the sale of deposits at the Centreville branch to First Financial Bank on September 9, 2003, First Federal purchased $7,382,000 of brokered certificates of deposit with a weighted average rate of 2.1%. At September 30, 2004, First Federal has approximately $18,300,000 in brokered certificates of deposits with a weighted average interest rate of approximately 1.93%, varying in terms from six months to thirty-three months.

The composition of total deposits for the last three fiscal years is set forth in the following table:


	September 30,
	2004					2003					2002
			Percent					Percent					Percent
			change					change					change
			from prior					from prior					from prior
	Amount		year-end			Amount		year-end			Amount		year-end
						(Dollars in thousands)
Non-interest bearing demand deposits	$	4,003		9.46	%	$	3,657		28.32	%	$	2,850		(14.90	)%
Interest bearing deposits:
NOW accounts		10,662		5.94	%		10,064		(2.24	)%		10,295		8.48	%
Money market demand		230		48.39	%		155		(66.88	)%		468		14.99	%
Passbook savings		11,634		1.19	%		11,497		(5.37	)%		12,149		8.88	%
CDs other than Jumbos		65,796		8.72	%		60,518		(4.46	)%		63,346		(5.82	)%
Jumbos		5,468		(28.68	)%		7,667		3.97	%		7,374		(.18	)%

Total interest bearing deposits		93,790		4.33	%		89,901		(3.98	)%		93,632		(2.17	)%

Total deposits	$	97,793		4.53	%	$	93,558		(3.03	)%	$	96,483		(2.60	)%

The following tables set forth the distribution of First Federal’s deposit accounts, at the dates indicated and the weighted average nominal interest rates on each category of deposits presented, based on average balances:


		At September 30, 2004
							Percentage
Interest							of Total
Rate	Term	Category	Minimum		Balance		Balances
		(Dollars in thousands, except minimum balance)
0.00%	None	Non-interest bearing demand	$	50	$	4,003		4.09	%
0.10%	None	NOW accounts		250		10,507		10.74	%
0.10%	None	Non-profit		100		155		.16	%
0.10%	None	Money market checking		50		230		.24	%
0.15%	None	Statement savings		100		11,634		11.90	%
1.50%	3 months	Fixed-term fixed rate certificate		2,500		696		.71	%
1.60%	6 months	Fixed-term fixed rate certificate		2,500		8,248		8.43	%
2.30%	12 months	Fixed-term fixed rate certificate		500		12,754		13.04	%
2.50%	14 months	Fixed-term fixed rate certificate		500		360		.37	%
2.25%	18 months	Fixed-term fixed rate certificate		500		2,957		3.02	%
2.25%	18 mth Roth IRA	Fixed-term fixed rate certificate		500		88		.09	%
2.25%	18 mth IRA	Fixed-term fixed rate certificate		500		8,202		8.39	%
3.75%	60 mth IRA	Fixed-term fixed rate certificate		500		2,194		2.24	%
2.75%	24 months	Fixed-term fixed rate certificate		500		14		.01	%
2.80%	30 months	Fixed-term fixed rate certificate		500		6,262		6.40	%
3.70%	4 year	Fixed-term fixed rate certificate		1,500		332		.34	%
3.75%	5 year	Fixed-term fixed rate certificate		1,500		5,410		5.53	%
5.08%	Jumbo	Fixed-term fixed rate certificate		100,000		5,468		5.59	%
1.46%	6 months	6 month brokered TD		—		2,463		2.52	%
1.78%	9 months	9 month brokered TD		—		3,926		4.01	%
1.88%	12 months	12 month brokered TD		—		2,871		2.94	%
1.75%	13 months	13 month brokered TD		—		2,244		2.29	%


		At September 30, 2004
							Percentage
Interest							of Total
Rate	Term	Category	Minimum		Balance		Balances
		(Dollars in thousands, except minimum balance)
1.77%	14 months	14 month brokered TD		—		3,099		3.17	%
2.25%	24 months	24 month brokered TD		—		1,559		1.59	%
2.60%	30 months	30 month brokered TD		—		1,055		1.08
2.75%	33 months	33 month brokered TD		—		1,062		1.09

					$	97,793		100.00	%


		At September 30, 2003
							Percentage
Interest							of Total
Rate	Term	Category	Minimum		Balance		Balances
		(Dollars in thousands, except minimum balance)
0.00%	None	Non-interest bearing demand	$	50	$	3,657		3.91	%
0.10%	None	NOW accounts		250		9,956		10.64	%
0.10%	None	Non-profit		100		108		.12	%
0.10%	None	Money market checking		50		155		.17	%
0.15%	None	Statement savings		100		11,497		12.29	%
0.50%	3 months	Fixed-term fixed rate certificate		2,500		138		.15	%
1.20%	6 months	Fixed-term fixed rate certificate		2,500		8,613		9.21	%
1.30%	12 months	Fixed-term fixed rate certificate		500		16,915		18.08	%
1.50%	18 months	Fixed-term fixed rate certificate		500		3,604		3.85	%
1.25%	18 mth Roth IRA	Fixed-term fixed rate certificate		250		74		.08	%
1.25%	18 mth IRA	Fixed-term fixed rate certificate		250		9,452		10.10	%
2.75%	60 mth IRA	Fixed-term fixed rate certificate		250		1,798		1.92	%
2.00%	30 months	Fixed-term fixed rate certificate		500		7,439		7.95	%
2.50%	4 year	Fixed-term fixed rate certificate		1,500		332		.35	%
3.00%	5 year	Fixed-term fixed rate certificate		1,500		4,771		5.10	%
1.30%	Jumbo	Fixed-term fixed rate certificate		100,000		7,667		8.19	%
1.40%	9 months	9 month brokered TD		0		2,495		2.67	%
1.50%	12 months	12 month brokered TD		0		1,693		1.81	%
1.60%	14 months	14 month brokered TD		0		1,466		1.57	%
2.10%	24 months	24 month brokered TD		0		1,728		1.85	%

					$	93,558		100.00	%

The following table provides information about the average balances of interest-bearing demand deposits and time deposits, for the periods indicated, based upon average balances:


	Year ended September 30,
	2004						2003						2002
	(Dollars in thousands)
	Interest bearing			Time			Interest bearing			Time			Interest bearing			Time
	demand deposits			Deposits			demand deposits			deposits			demand deposits			deposits
Average balance	$	22,161		$	69,739		$	23,397		$	72,309		$	22,981		$	72,382
Average rate		.20	%		2.42	%		.59	%		3.29	%		1.41	%		4.38	%

The following table presents, by various interest rate categories, the amount of certificate accounts outstanding at the end of the last three fiscal years:


	Year ended September 30,
Interest Rate	2004		2003		2002
			(Dollars in thousands)
0.00 - 1.99%	$	36,801	$	24,554	$	2,775
2.00 - 2.99%		22,498		21,937		22,060
3.00 - 3.99%		3,781		11,570		18,771
4.00 - 4.99%		1,946		3,520		11,694
5.00 - 5.99%		2,179		2,411		3,922
6.00 - 6.99%		529		626		5,471
7.00 - 7.99%		3,530		3,567		6,028

Total	$	71,264	$	68,185	$	70,721

At September 30, 2004, First Federal had approximately $71.3 million outstanding in certificate accounts that mature as follows:


	Amount due
	Less than		One to		Two to		Three to		Four to
Interest Rate	one year		two years		three years		Four years		five years		Thereafter		Total
					(Dollars in thousands)
0.00 - 1.99%	$	30,782	$	3,589	$	—	$	—	$	—	$	2,430	$	36,801
2.00 - 2.99%		13,615		6,444		2,140		61		238		—		22,498
3.00 - 3.99%		1,362		71		63		1,176		1,109		—		3,781
4.00 - 4.99%		576		45		727		568		30		—		1,946
5.00 - 5.99%		119		310		1,750		—		—		—		2,179
6.00 - 6.99%		277		252		—		—		—		—		529
7.00 - 7.99%		3,164		366		—		—		—		—		3,530

Total	$	49,895	$	11,077	$	4,680	$	1,805	$	1,377	$	2,430	$	71,264

At September 30, 2004, First Federal had approximately $34.3 million outstanding in certificate accounts of $100,000 or more, that mature as follows:


	Amount
Maturity Period	(In Thousands)
Three months or less	$	10,386
After three within six months		7,810
After six within twelve months		6,388
Over twelve months		9,761

	$	34,345

The following table presents the maturities of certificates of deposit, as of September 30, 2004, 2003 and 2002:


	Maturities of Time Deposits
	September 30,
	2004			2003			2002
	(Dollars in thousands)
Three months or less	$	17,577		$	13,566		$	13,824
After three within six months		15,543			12,736			16,557
After six within twelve months		16,775			19,421			19,772
One year to two years		11,077			12,750			8,941
Two years to three years		4,680			2,830			7,593
Three years to four years		1,805			2,617			1,357
Four years to five years		1,377			1,833			2,677
Over five years		2,430			2,432			—

Total	$	71,264		$	68,185		$	70,721

Weighted average rate on all certificates of deposit at period-end		2.03	%		2.64	%		3.74	%

Short-Term Borrowings

SouthFirst has a line of credit of up to $2,500,000, which bears interest at the prime lending rate, plus 25 basis points. Accrued interest on the unpaid balance of the principal is due monthly and continuing until June 2005, at which time the entire unpaid balance along with any unpaid accrued interest is due. The prime-lending rate was 4.75% at September 30, 2004.

Borrowings also include borrowings from the FHLB of Atlanta. These borrowings included advances with both fixed and variable interest rates.

First Federal also has short term borrowings through reverse repurchase agreements with Morgan Keegan.

A summary of these borrowings is as follows:


	At or for the Year Ended
	September 30,
	2004			2003
	(Dollars in Thousands)
Amounts outstanding at end of period:
Line of credit	$	903		$	1,918
FHLB advances		20,670			22,340
Reverse repurchase agreements		10,016			2,743
Weighted average rate paid at period-end:
Line of credit		5.00	%		4.25	%
FHLB advances		4.46	%		4.04	%
Reverse repurchase agreements		1.85	%		1.22	%
Maximum amount of borrowings outstanding at any month-end:
Line of credit		2,353			2,118
FHLB advances		22,340			22,340
Reverse repurchase agreements		10,016			5,347
Approximate average amount outstanding for period:
Line of credit		2,081			1,558
FHLB advances		22,124			22,340
Reverse repurchase agreements		4,901			1,335


	At or for the Year Ended
	September 30,
	2004			2003
	(Dollars in Thousands)
Approximate weighted average rate paid during period (1):
Line of credit		4.36	%		4.36	%
FHLB advances		4.17	%		4.19	%
Reverse repurchase agreements		1.32	%		1.35	%

(1)

The approximate weighted average rate paid during the period was computed by dividing the average amounts outstanding into the related interest expense for the period.

Capital Resources

Stockholders’ Equity

SouthFirst’s consolidated stockholders’ equity was $10,355,000 and $11,677,000 at September 30, 2004 and 2003, respectively. The 2004 decrease was due to the net loss of $528,000 and the change in “accumulated other comprehensive income” in the amount of $317,000 resulting from the increase in unrealized holding losses on available-for-sale securities. Further, SouthFirst repurchased shares of its common stock, in the amount of $81,316, pursuant to its previously announced stock repurchase program.

Cash dividends were declared on SouthFirst Common Stock in the amount of $425,728, $425,031 and $497,345, or $0.60 per share, for the years ended September 30, 2004, 2003 and 2002, respectively. Management believes that a strong capital position is vital to the continued profitability of First Federal and SouthFirst and provides a foundation for future growth, as well as promoting depositor and investor confidence.

The following table provides certain financial ratios for SouthFirst, as of the end of the most recent three fiscal years:


	Equity and Asset Ratios
	September 30,
	2004			2003			2002
Return on average assets		(.38	)%		.08	%		.47	%
Return on average stockholder’s equity		(4.82	)%		.91	%		4.89	%
Common dividend payout ratio		N/A			391.45	%		74.14	%
Average stockholders’ equity to average assets ratio		7.97	%		9.15	%		9.52	%
Net Income (Loss)	$	(527,935	)	$	115,864		$	670,805
Average Assets		137,447,618			138,049,920			144,248,358
Average Equity		10,951,309			12,726,828			13,729,739
Cash Dividends Paid		425,729			453,547			497,345

Capital

The regulations of the OTS provide certain capital requirements applicable to thrifts, including First Federal, and the consequences for failing to comply with such requirements (as amended from time to time, the “OTS Capital Regulations). The regulatory capital standards contained in the OTS Capital Regulations include (i) a core capital requirement, (ii) a tangible capital requirement, and (iii) a risk-based capital requirement and identity certain minimum regulatory capital requirements, including a tangible capital ratio equal to 1.50% of adjusted total assets, a core capital ratio equal to 4.0% of adjusted total assets, and a minimum risk-based capital ratio of 8.0% of risk-weighted assets. As shown in the table below, First Federal was in compliance with these regulatory capital requirements, at September 30, 2004 and 2003.


	At September 30, 2004									At September 30, 2003
	Tangible			Core			Risk-based			Tangible			Core			Risk-based
	Capital			Capital			Capital			Capital			Capital			Capital
Capital	$	11,432,000		$	11,432,000		$	11,432,000		$	13,651,000		$	13,651,000		$	13,651,000
Adjustments:
General valuation allowance		—			—			516,000			—			—			295,000
Goodwill		(544,000	)		(544,000	)		(544,000	)		(544,000	)		(544,000	)		(544,000	)
Unrealized gains		536,000			536,000			536,000			218,000			218,000			218,000

Regulatory capital	$	11,424,000		$	11,424,000		$	11,940,000		$	13,325,000		$	13,325,000		$	13,620,000

Regulatory asset base	$	141,469,000		$	141,469,000		$	90,574,000		$	133,400,000		$	133,400,000		$	82,915,000
Capital ratio		8.08	%		8.08	%		13.18	%		9.99	%		9.99	%		16.43	%
Minimum required ratio		1.50	%		4.00	%		8.00	%		1.50	%		4.00	%		8.00	%
Capital ratio required for “well-capitalized” designation		—			5.00	%		10.00	%		—			5.00	%		10.00	%

Liquidity

First Federal

Liquidity is a bank’s ability to convert assets into cash equivalents in order to meet daily cash flow requirements, primarily for deposit withdrawals, loan demand, and maturing liabilities. Without proper management, First Federal could experience higher costs of obtaining funds due to insufficient liquidity. On the other hand, excessive liquidity could lead to a decline in earnings due to the cost of foregoing alternative higher-yielding investment opportunities.

Asset liquidity is provided primarily through the repayment and maturity of investment securities, and the sale and repayment of loans.

Sources of liability liquidity include customer deposits and participation in the FHLB advance program. Although deposit growth historically has been a primary source of liquidity, such balances may be influenced by changes in the banking industry, interest rates available on other investments, general economic conditions, competition and other factors. FHLB advances include both fixed and variable terms and are taken out with varying maturities. First Federal can borrow an amount equal to 10% of its total assets, based on the most recent quarterly financial information submitted to the appropriate regulatory agency. At September 30, 2004, First Federal had outstanding FHLB advances in the amount of $20,670,000, which exceeds the present credit availability. The bank is not required to re-pay the existing advances to an amount equivalent to 10% of its current assets, however, new requested advances would be subject to approval from the FHLB credit review committee.

On a consolidated basis, net cash provided by operating activities in fiscal 2004 was $719,000, a $1,014,000 decrease from 2003. The $10,119,000 in net cash used by investing activities during 2004 consisted primarily of a $12,088,000 increase in loan funding activities. Cash provided by calls and maturities of securities available-for-sale and proceeds from the sale of securities available-for-sale increased to $14,472,000 from $32,028,000 in 2003, while cash decreased from the purchase of securities available-for-sale to $11,570,000 from $38,713,000 in 2003. The $8,366,000 in net cash provided by financing activities resulted from an increase of $4,235,000 in total deposits and an increase of $4,588,000 as a result of the net proceeds of borrowed funds. Payments for common stock dividends totaled $425,000, and the acquisition of treasury stock totaled $81,000.

First Federal’s liquidity ratio at September 30, 2004 and 2003 was 11.31% and 37.05%, respectively. Liquidity levels may be increased or decreased depending upon the yields on investment alternatives, management’s expectations to the level of yield that will be available in the future, and management’s projections as to the short-term demand for funds to be used in loan originations. First Federal is subject to certain regulatory limitations with respect to the payment of dividends to SouthFirst. First Federal paid $1,500,000 and $500,000 to SouthFirst during 2004 and 2003, respectively.

SouthFirst

SouthFirst also requires cash for various purposes including servicing debt, paying dividends to stockholders and paying general corporate expenses. The primary source of funds for SouthFirst is dividends from First Federal. First Federal’s capital levels meet the requirements of the OTS Capital Regulations for classification as a “well capitalized” institution and, thereby, enable First Federal to pay dividends to SouthFirst. In addition to dividends, SouthFirst has access to various capital markets and other sources of borrowings, including a line of credit in the amount of $2,500,000, from First Commercial Bank in Birmingham, Alabama. The line of credit is renewable annually and is secured by all of the issued and outstanding shares of First Federal, pledged by SouthFirst. SouthFirst, at September 30, 2004, has drawn $903,000 against the line of credit.

SouthFirst retained $3,624,000 of the net proceeds from the initial public offering of Common Stock in 1994. Substantially all of those funds have been used to pay dividends (including a special $2.00 per share dividend in 1996) to repurchase SouthFirst Common Stock, to invest in affiliates and to pay general corporate expenses. Accordingly, SouthFirst likely will rely on dividends from First Federal to repay borrowings under its line of credit, which has been used, in part, to pay dividends to stockholders and to repurchase shares of SouthFirst pursuant to the current repurchase program announced by SouthFirst in January 2003, authorizing the Company to repurchase up to 77,000 shares, or approximately ten percent (10%) of its outstanding common stock. As of December 9, 2004, SouthFirst has repurchased 69,677 shares of the intended repurchase of up to 77,000 shares of Common Stock. Under the previous stock repurchase program, which commenced in January, 2002, the Company repurchased 81,700 shares of the intended repurchase of up to 85,000 shares of Common Stock, which concluded in January, 2003.

ITEM 7. FINANCIAL STATEMENTS

The following financial statements are included as part of this Form 10KSB/A following the signature page of this Form 10KSB/A.

Report of Independent Registered Public Accounting Firm of Jones & Kirkpatrick, P.C.

Consolidated Statements of Financial Condition as of September 30, 2004 and 2003

Consolidated Statements of Operations for the years ended September 30, 2004, 2003 and 2002

Consolidated Statements of Stockholders’ Equity for the years ended September 30, 2004, 2003 and 2002

Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002

Notes to Consolidated Financial Statements

ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

There have been no changes in, or disagreements with, the Company’s accountants on accounting and financial disclosure in the preceding two fiscal years.

ITEM 8A. CONTROLS AND PROCEDURES

Within 90 days prior to the filing date of this annual report, pursuant to Rule 13a-15 of the Securities Exchange Act of 1934 (the “Exchange Act”), SouthFirst’s Chief Executive Officer and Controller (principal financial officer) evaluated the effectiveness of the design and operation of SouthFirst’s disclosure controls and

procedures (as defined in Rule13a-14(c) of the Exchange Act). Based on their evaluation, the Chief Executive Officer and Controller have concluded that SouthFirst’s disclosure controls and procedures are effective in timely alerting them to material information, relating to SouthFirst and SouthFirst’s consolidated subsidiaries, required to be included in periodic reports, including this annual report, filed by SouthFirst with the SEC.

There have not been any significant changes in SouthFirst’s internal controls, or in other factors that could significantly affect these controls, subsequent to the date of the Chief Executive Officer’s and Controller’s evaluation.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS OF THE REGISTRANT

Management of SouthFirst

The SouthFirst Board of Directors currently consists of eight persons and is divided into three classes, each of which contains approximately one-third of the members. The directors of SouthFirst are elected by the stockholders of SouthFirst for staggered, three-year terms, so that approximately one-third of the directors are elected at each annual meeting of stockholders, to hold office until their successors are elected and qualified. The executive officers of SouthFirst are elected annually by the Board of Directors of SouthFirst and hold office until their successors are elected and qualified.

The direction and control of First Federal is vested in the First Federal Board of Directors, which currently consists of eight members and is divided into three classes, each of which contains approximately one-third of the members. The directors of First Federal serve three-year terms. The terms of the directors of First Federal are staggered (as in the case of SouthFirst), so that approximately one-third of the directors are elected at each annual meeting of stockholders. Since SouthFirst owns all of the issued and outstanding shares of common stock of First Federal, SouthFirst elects the directors of First Federal, in accordance with applicable law.

There are no arrangements or understandings pursuant to which the directors or executive officers of SouthFirst or First Federal were elected, and there are no family relationships between or among such persons.

The following table sets forth certain information regarding certain of the executive officers and directors of SouthFirst and First Federal.


				Year First
				Elected as a		Year
				Director of		Term
Name	Age⁽¹⁾		Position Held	SouthFirst		Expires
Joe K. McArthur		53	Chief Executive Officer of SouthFirst and First Federal; President of First Federal; Director of SouthFirst and First Federal		1996		2005

J. Malcomb Massey		55	President of SouthFirst; Director of SouthFirst and First Federal; President and Chief Executive Officer of Pension & Benefit		1997		2006

Allen Gray McMillan, III		47	Chairman of SouthFirst and First Federal; Director of SouthFirst and First Federal		1994		2005

H. David Foote, Jr.		55	Director of SouthFirst and First Federal		1994		2007

Kenneth E. Easterling		61	Director of SouthFirst and First Federal		2001		2007

L. Neal Bice		64	Director of SouthFirst and First Federal		2001		2007

Donald R. Hardy		54	Director of SouthFirst and First Federal		2001		2005

Sandra H. Stephens		45	Executive Vice President and Chief Operating Officer of SouthFirst and First Federal; Director of SouthFirst and First Federal		2002		2006

Ruth M. Roper		54	Executive Vice President of Pension & Benefit

⁽¹⁾

At September 30, 2004

Set forth below is certain information with respect to the directors and executive officers of SouthFirst and First Federal. Unless otherwise indicated, the principal occupation listed for each person below has been his or her principal occupation for the past five years.

Joe K. McArthur has served as a director of First Federal and SouthFirst since February 1996. Effective September 1, 2001, Mr. McArthur was elected President and Chief Executive Officer of SouthFirst and First Federal. Thereafter, as part of the Company’s restructuring efforts, Mr. McArthur resigned as President of SouthFirst to allow J. Malcomb Massey to assume that office, as of October 1, 2001. Prior to assuming his

current positions, Mr. McArthur served as the Executive Vice President, Chief Financial Officer and Secretary of First Federal and SouthFirst from 1992 and 1994, respectively. Mr. McArthur has over 27 years of experience in the banking industry and received a B.S. in Accounting from the University of Alabama-Birmingham and a Masters of Business Administration equivalent from the National School of Finance and Management. He has also completed all courses with the Institute of Financial Education. Prior to joining First Federal, Mr. McArthur was Assistant Executive Director of Finance of Humana, a hospital, from 1990 to 1992, and Senior Vice President of First Federal of Alabama from 1983 to 1990. He has also served as a manager of various Little League and Babe Ruth Baseball teams, as well as Boys’ Club basketball teams. Mr. McArthur is a member of the First United Methodist Church of Sylacauga.

J. Malcomb Massey has served as a director of First Federal and SouthFirst since May 1997. On September 26, 2001, Mr. Massey was elected President of SouthFirst to be effective October 1, 2001. In addition, Mr. Massey is President and Chief Executive Officer of Pension & Benefit, First Federal’s wholly-owned, operating subsidiary. This is a position he has held since he joined Pension & Benefit in 1997, after it acquired substantially all of the assets of Lambert, Massey, Roper & Taylor, Inc., an employee benefits consulting firm, based in Montgomery, for which Mr. Massey had served as President since 1980. Mr. Massey is a member of the American Society of Pension Actuaries, South Central Alabama Association of Insurance and Financial Advisors, Life and Qualifying Member of Million Dollar Roundtable, Top of the Table, Montgomery Lions Club and Young Meadows Presbyterian Church.

Allen Gray McMillan, III has served as a director of First Federal since 1993 and of SouthFirst since 1994. On August 15, 2001, Mr. McMillan was elected Chairman of SouthFirst and First Federal. Mr. McMillan also currently serves as a member of the audit committee of SouthFirst. Mr. McMillan is also President of Brecon Knitting Mill, where he has been employed since 1979. Mr. McMillan has been active in the Kiwanis Club, United Way, and Boy Scouts of America. He is a member of the First United Methodist Church.

H. David Foote, Jr. has served as a director of First Federal since 1988 and of SouthFirst since 1994. Mr. Foote also currently serves as a member of the audit committee of SouthFirst. Mr. Foote has been President and owner of Foote Bros. Furniture since 1973. Mr. Foote has been a director of the Sylacauga Chamber of Commerce, the Coosa Valley Country Club and Talladega County E-911. He has served as President of Wesley Chapel Methodist Men’s Club and head of the Wesley Chapel Methodist Administrative Board.

Kenneth E. Easterling has served as a director of First Federal since 1997 and of SouthFirst since 2001. Mr. Easterling also currently serves as a member of the audit committee of SouthFirst. Mr. Easterling previously served as a member of the Board of Directors of First Federal Savings and Loan of Chilton County from 1992 to 1997. Mr. Easterling is the owner of Home Printing Company, located in Clanton, Alabama, which was established in 1969. Mr. Easterling served in the Army National Guard from 1963 to 1969, is a Charter Member of the Exchange Club of Chilton County, a member of the Board of Directors of Chilton County Cattlemen’s Association, a member of the Board of Directors of Alfa, and has served as a Deacon of the West End Baptist Church from 1969 to the present.

L. Neal Bice has served as a director of First Federal since 1997 and of SouthFirst since 2001. Mr. Bice also currently serves as a member of the audit committee of SouthFirst and as the “audit committee financial expert” as that term is defined in Item 401(e)(2) of Regulation S-B. Mr. Bice previously served as a director of First Federal Savings and Loan of Chilton County, from 1989 to 1997. Mr. Bice is an owner and a director of Chilton County Feed and Seed Company, located in Clanton, Alabama. Mr. Bice presently is a professor of economics and business at the Clanton extension of the George C. Wallace State Community College. Mr. Bice is a past professor of finance at Auburn University, a past professor of economics, finance and banking at the University of Southwestern Louisiana, and a past professor of finance at the University of Alabama. Mr. Bice is a member of the Chilton County Board of Education, the Alabama Education Association, the Southern School Board Association, Omicron Delta Epsilon Society in Economics, the Chilton County High School Athletic Association, and the Chilton County Cattlemen’s Association. He is a past President of the Chilton County Board of Education, and serves as director of the Chilton County Chamber of Commerce, the President of the Chilton

County University of Alabama Alumni Association, the Zone Chairman of the Clanton Lion’s Club, and the President of the War Eagle Lion’s Club, Auburn, Alabama. Mr. Bice is a member of the Concord Baptist Church.

Donald R. Hardy has served as a director of First Federal and SouthFirst since January 2001. Mr. Hardy also currently serves as a member of the audit committee of SouthFirst. Mr. Hardy is the owner, President and CEO of H & B Builders, Inc., located in Sylacauga, Alabama. He is a member of the Business Council of Alabama, Sylacauga Chamber of Commerce and has served on the Sylacauga Planning Commission since 1992. Mr. Hardy is an active member of the First Baptist Church of Sylacauga.

Sandra H. Stephens was elected as director of SouthFirst and First Federal, effective November 12, 2002, and Ms. Stephens was elected as Executive Vice President and Chief Operating Officer of SouthFirst and First Federal, effective November 1, 2001. Ms. Stephens previously served as the Chief Operating Officer, from 1997 to 2001, and Chief Financial Officer, from 1992 to 1997, of First Federal Bank, in Tuscaloosa, Alabama. Prior to her employment with First Federal Bank, Ms. Stephens held various executive positions with Federal Home Loan Mortgage Corporation, Atlanta, Georgia from 1990 until 1992, and with Pinnacle Bank, Jasper, Alabama from 1981 until 1990. Ms. Stephens is a member of the American Society of Women Accountants, and she is a member of Saint Mark United Methodist Church in Birmingham, Alabama and serves on the Board of Trustees of the North Alabama Conference of the United Methodist Church..

Ruth M. Roper is Executive Vice President of Pension & Benefit, First Federal’s wholly-owned, operating subsidiary. This is a position she has held since she joined Pension & Benefit in 1997, after it acquired substantially all of the assets of Lambert, Massey, Roper & Taylor, Inc., a Montgomery based employee benefits consulting firm of which Ms. Roper was a named shareholder. Since 1983, when Ms. Roper first joined Lambert, Massey & Associates, Inc., she has served in various capacities related to qualified plan and employee benefit consulting, including qualified plan administration activities and the provision of employee benefit consulting services. Ms. Roper is a member of the American Society of Pension Actuaries and the Montgomery Association of Life Underwriters.

Audit Committee Financial Expert

SouthFirst has determined that Mr. Bice, a member of the Audit Committee of the Board, is an “audit committee financial expert,” as that term is defined in Item 401(e)(2) of Regulation S-B. Mr. Bice is an “independent director” based on the definition of independence in Rule 4200A(a)(14) of the listing standards of the National Association of Securities Dealers currently applicable to small business issuers.

Compliance With Section 16(a) of the Securities Exchange Act of 1934

Section 16(a) of the Securities Exchange Act of 1934 requires SouthFirst’s directors, certain of SouthFirst’s officers and persons who own more than 10% of the outstanding Common Stock of SouthFirst (“Reporting Persons”) to file with the SEC reports of changes in ownership of the Common Stock of SouthFirst held by such persons (“Section 16(a) Reports”). Reporting Persons are also required to furnish SouthFirst with copies of all Section 16(a) Reports that they file. SouthFirst has been subject to this regulation since February 13, 1995.

To SouthFirst’s knowledge, based solely on a review of copies of Section 16(a) Reports furnished to SouthFirst and representations that no other Section 16(a) Reports were required, all Section 16(a) filing requirements applicable to such Reporting Persons were complied with during fiscal 2004.

Code of Ethics for Senior Financial Officers

Our Board of Directors has adopted a Code of Ethics for our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A copy of the Code of Ethics is filed as an exhibit to our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2003.

We intend to disclose any amendments to or waivers of our Code of Ethics on our corporate website www.southfirst.com.

ITEM 10. EXECUTIVE COMPENSATION

The following table provides certain summary information for fiscal 2004, 2003, and 2002 concerning compensation paid, or accrued, by SouthFirst and First Federal to, or on behalf of, SouthFirst’s Chief Executive Officer and the other executive officers of SouthFirst whose total annual salary and bonus exceeded $100,000 during fiscal 2004 (the “Named Executive Officers”):

Summary Compensation Table




			Annual Compensation (1)							Long Term Compensation
										Securities
Name and	Fiscal							Other Annual		Underlying			All Other
Principal Position	Year		Salary		Bonus			Compensation (2)		Options (No.)			Compensation
Joe K. McArthur		2004	$	150,000	$	23,788	(3)	$	21,000		0		$	2,451	(4)
Chief Executive		2003		150,000		26,669	(5)		24,000		4,300	(6)		2,451	(7)
Officer of		2002		142,917		25,439	(8)		22,995		0			2,451	(9)
SouthFirst and First Federal, President of First Federal
J. Malcomb Massey (1)		2004	$	150,000	$	15,551	(10)	$	21,000		0		$	2,488	(11)
President of		2003		150,000		5,850	(12)		24,000		4,300	(13)		2,488	(14)
SouthFirst,		2002		150,000		13,270	(15)		22,995		0			2,488	(16)
President and Chief Executive Officer of Pension & Benefit
Sandra H. Stephens		2004	$	125,000	$	11,887	(17)	$	21,000		0		$	1,747	(18)
Executive Vice		2003		125,000		14,290	(19)		22,500		4,300	(20)		1,537	(21)
President, and Chief		2002		105,417		39,500	(22)		4,500		7,500	(23)		1,537	(24)
Operating Officer of SouthFirst and First Federal
Ruth M. Roper		2004	$	100,000	$	12,649	(25)	$	2,850		0		$	2,744	(26)
Executive Vice		2003		100,000		5,598	(27)		3,000		1,950	(28)		2,744	(29)
President of Pension		2002		98,000		5,778	(30)		3,000		0			2,744	(31)
& Benefit

(1)		All compensation received by the Named Executive Officers was paid by First Federal and Pension & Benefit, except for an annual salary, in the amount of $20,000, paid by SouthFirst to its President, J. Malcomb Massey.

(2)		Fees received as a member of the Board of Directors of SouthFirst, First Federal, Pension & Benefit and/or SouthFirst Mortgage.

(3)		Consists of a regular bonus of $5,769 as well as $18,019 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(4)		Represents a $1,485 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(5)		Consists of a regular bonus of $8,650 as well as $18,019 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “– Compensation of Directors” below.

(6) On October 16, 2002, SouthFirst issued 4,300 options under the 1998 plan to Mr. McArthur at an exercise price of $12.10 per share. These options vest in equal increments commencing October 16, 2002 through October 16, 2007.

(7) Represents a $1,485 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(8) Consists of a regular bonus of $10,000 as well as $15,439 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(9) Represents a $1,485 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(10) Consists of a regular bonus of $9,701 as well as $5,850 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(11) Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(12) Consists of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(13) On October 16, 2002, SouthFirst issued 4,300 options under the 1995 plan to Mr. Massey at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(14) Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(15) Consists of a regular bonus of $10,000 as well as $3,270 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(16) Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(17) Consists of a regular bonus of $ 4,807 as well as $7,080 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(18) Represents a $1,117 automobile allowance and income of $630 recognized on employer provided group term life insurance in excess of $50,000.

(19) Consists of a regular bonus of $7,210 as well as $7,080 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(20) On October 16, 2002, SouthFirst issued 2,589 options under the 1995 plan and 1,711 options under the 1998 plan to Ms. Stephens at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(21) Represents a $1,117 automobile allowance and income of $420 recognized on employer provided group term life insurance in excess of $50,000.

(22) Consists of a signing bonus of $17,500, a regular bonus of $10,000, a tax bonus, with respect to MRP shares (see “ – Management Recognition Plans” below), of $7,500, and $4,500 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(23) On December 1, 2001, SouthFirst issued 7,500 options under the 1995 plan to Ms. Stephens at an exercise price of $9.92 per share. These options vest in equal annual increments commencing on December 1, 2002 through December 1, 2006.

(24) Represents a $1,117 automobile allowance and income of $420 recognized on employer provided group term life insurance in excess of $50,000.

(25) Consists of a regular bonus of $9,701 as well as $2,948 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(26) Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(27) Consists of a regular bonus of $2,650 as well as $2,948 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(28) On October 16, 2002, SouthFirst issued 1,950 options under the 1998 plan to Ms. Roper at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(29) Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(30) Consists of a regular bonus of $4,000 as well as $1,778 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(31) Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

Employment Agreements

SouthFirst, First Federal and Pension & Benefit have entered into employment agreements with each of the following executive officers (including each of the Named Executive Officers). The terms and conditions of these employment contracts are described below.

Joe K. McArthur

Chief Executive Officer of SouthFirst and First Federal, President of First Federal

The amended and restated employment agreement by and between First Federal and Mr. McArthur was effective as of October 1, 2003, and is for a term of two years. Mr. McArthur’s term of employment was due to be extended on the first anniversary of the effective date for an additional one-year period beyond the then effective expiration date, provided the First Federal Board determined, in a duly adopted resolution, that the performance of Mr. McArthur had met the Board’s requirements and standards, and that such employment agreement shall be extended. The compensation committee and Mr. McArthur are currently negotiating an extension of such agreement beyond its stated termination date of October 1, 2005. Once an extension of this agreement has been entered into, First Federal will file such document with the SEC on Form 8-K.

Under the current agreement, SouthFirst is jointly and severally liable for the payment of all amounts due under Mr. McArthur’s employment agreement pursuant to a separate employment agreement entered into with SouthFirst, which was previously filed by SouthFirst as part of its Annual Report on Form 10 KSB for the year ended September 30, 2003. Under the terms of the employment agreement with First Federal, First Federal agrees to pay Mr. McArthur a salary at the rate of $150,000 per annum, payable in cash not less frequently than monthly. Beginning on the effective date, Mr. McArthur shall be eligible to receive such performance bonuses as may be determined in the sole discretion of the First Federal Board. In addition, Mr. McArthur shall participate in standard retirement and medical plans, and is entitled to customary fringe benefits, vacation and sick leave.

Mr. McArthur’s employment agreement terminates upon his death or disability, and is terminable for “cause” as defined in the employment agreement. In the event of termination for cause, no severance benefits are payable to Mr. McArthur. If SouthFirst or First Federal terminate Mr. McArthur without cause, he will be entitled to a continuation of his salary from the date of termination through the remaining term of the employment agreements plus an additional twelve-month period, and he will be entitled to the cost of obtaining benefits in which Mr. McArthur would have been eligible to participate through the termination date. The total amount of such payments would be required to be paid, at the option of Mr. McArthur, either (i) in periodic payments over the remaining term of the employment agreement, as if Mr. McArthur’s employment had not been terminated, or (ii) in one lump sum within ten (10) days of such termination; provided however, that the amount to be paid by First Federal to Mr. McArthur shall not exceed two (2) times his “average annual compensation” (as defined in the employment agreement). Mr. McArthur may voluntarily terminate his employment agreement by providing sixty days written notice to the Boards of Directors of SouthFirst and First Federal, in which case he is entitled to receive only his compensation, vested rights and benefits up to the date of termination.

Mr. McArthur’s employment agreement further provides that, in the event of Mr. McArthur’s involuntary termination in connection with, or within two years after any change in control of First Federal or SouthFirst, other than for “cause,” or death or disability, Mr. McArthur will be paid, within 10 days of such termination, an amount equal to the difference between (i) 2.99 times his “base amount,” as defined in Section 280G(b)(3) of the Code, and (ii) the sum of any other “parachute payments,” as defined under Section 280G(b)(2) of the Code, that Mr. McArthur receives on account of the change in control. Under Mr. McArthur’s employment agreement, a “change in control” generally refers to a change in ownership, holding or power to vote more than 25% of SouthFirst’s or First Federal’s voting stock, a change in the ownership or possession of the ability to control the election of a majority of First Federal’s or SouthFirst’s directors or the exercise of a controlling influence over the management or policies of SouthFirst or First Federal. In addition, under Mr. McArthur’s employment agreement, a change in control occurs when, during any consecutive two-year period, the directors of SouthFirst or First Federal, at the beginning of such period, cease to constitute two-thirds of the Boards of Directors of SouthFirst or First Federal, unless the election of replacement directors was approved by a two-thirds (66 2/3%) vote of the initial directors then in office. Mr. McArthur’s employment agreement also provides for a similar lump sum payment to be made in the event of his voluntary termination of employment within one year following a change in control of First Federal or SouthFirst.

Sandra H. Stephens

Executive Vice President and Chief Operating Officer

The amended and restated employment agreement by and between First Federal and Ms. Stephens was effective as of October 1, 2003 and is for a term of two years. Ms. Stephens’s term of employment was due to be extended on the first anniversary of the effective date for an additional one-year period beyond the then effective expiration date, provided the First Federal Board determined, in a duly adopted resolution, that the performance of Ms. Stephens had met the Board’s requirements and standards, and that such employment agreement shall be extended. The compensation committee and Ms. Stephens are currently negotiating an extension of such agreement beyond its stated termination date of October 1, 2005. Once an extension of this agreement has been entered into, First Federal will file such document with the SEC on Form 8-K.

Pursuant to Ms. Stephens’ employment agreement, First Federal pays Ms. Stephens an annual base salary of $125,000, payable in cash not less frequently than monthly. Beginning on the Effective Date, Ms. Stephens shall be eligible to receive such performance bonuses as may be determined in the sole discretion of the First Federal Board. In addition, Ms. Stephens shall participate in standard retirement and medical plans, and is entitled to customary fringe benefits, vacation and sick leave.

Ms. Stephens’ employment agreement terminates upon her death or disability, and is terminable for “cause” as defined in the employment agreement. In the event of termination for cause, no severance benefits are payable to Ms. Stephens. If First Federal terminates Ms. Stephens without cause, she will be entitled to a continuation of her salary from the date of termination through the remaining term of the employment agreement plus an additional twelve-month period, and she will be entitled to the cost of obtaining benefits in which Ms. Stephens would have been eligible to participate through the termination date. Ms. Stephens may voluntarily terminate her employment agreement by providing sixty days written notice to the Board of Directors of First Federal, in which case she is entitled to receive only her compensation, vested rights and benefits up to the date of termination.

Ms. Stephens’ employment agreement further provides that, in the event of her involuntary termination in connection with, or within two years after any change in control of First Federal or SouthFirst, other than for “cause,” or death or disability, Ms. Stephens will be paid, within 10 days of such termination, an amount equal to the difference between (i) 2.99 times her “base amount,” as defined in Section 280G(b)(3) of the Code, and (ii) the sum of any other “parachute payments,” as defined under Section 280G(b)(2) of the Code, that Ms. Stephens receives on account of the change in control. Under Ms. Stephens’ employment agreement, a “change in control” generally refers to a change in ownership, holding or power to vote more than 25% of First Federal’s or SouthFirst’s voting stock, a change in the ownership or possession of the ability to control the election of a

majority of First Federal’s or SouthFirst’s directors, or the exercise of a controlling influence over the management or policies of First Federal or SouthFirst. In addition, under Ms. Stephens’ employment agreement, a change in control occurs when, during any consecutive two-year period, the directors of First Federal or SouthFirst, at the beginning of such period, cease to constitute two-thirds of the Board of Directors of First Federal or SouthFirst, unless the election of replacement directors was approved by a two-thirds (66 2/3%) vote of the initial directors then in office. Ms. Stephens’ employment agreement also provides for a similar lump sum payment to be made in the event of her voluntary termination of employment within one year following a change in control of First Federal or SouthFirst.

J. Malcomb Massey

President and Chief Executive Officer of Pension & Benefit

The amended and restated employment agreement by and between Pension & Benefit and Mr. Massey was effective as of October 1, 2003 and provides for a term of two years. Mr. Massey’s term of employment was due to be extended on the first anniversary of the effective date for an additional one-year period beyond the then effective expiration date, provided the Pension & Benefit Board determined, in a duly adopted resolution, that the performance of Mr. Massey had met the Pension & Benefit Board’s requirements and standards, and that such employment agreement shall be extended. The Pension & Benefit Board and Mr. Massey are currently negotiating an extension of such agreement beyond its stated termination date of October 1, 2005. Once an extension of this agreement has been entered into, First Federal will file such document with the SEC on Form 8-K.

The employment agreement with Mr. Massey provides for an annual base salary of $150,000, payable in cash not less frequently than monthly. In addition, as a provision of a prior employment agreement, Mr. Massey received 15,512 shares of restricted SouthFirst Common Stock, one-fifteenth of which vest on each of the first fifteen anniversaries of April 11, 1997. Should Mr. Massey’s employment be terminated due to death, disability or the termination of his employment “without cause,” as defined in the employment agreement, all unvested shares shall be deemed earned and fully vested as of such date and shall be distributed as soon as practicable thereafter. All unvested shares will also vest upon a “change in control” of Pension & Benefit, First Federal or SouthFirst. Under Mr. Massey’s employment agreement, “change in control” generally refers to a change in ownership, holding or power to vote more than 25% of Pension & Benefit’s, First Federal’s or SouthFirst’s voting stock, a change in the ownership or possession of the ability to control the election of a majority of Pension & Benefit’s, First Federal’s or SouthFirst’s directors, or the exercise of a controlling influence over the management or policies of Pension & Benefit, First Federal or SouthFirst. In addition, under Mr. Massey’s employment agreement, a change in control occurs when, during any consecutive two-year period, directors of Pension & Benefit, First Federal or SouthFirst, at the beginning of such period, cease to constitute two-thirds of the Boards of Directors of Pension & Benefit, First Federal or SouthFirst, unless the election of replacement directors was approved by a two-thirds (66 2/3%) vote of the initial directors then in office.

Mr. Massey’s employment agreement entitles him to participate in an equitable manner with all other senior management employees of Pension & Benefit in discretionary bonuses that the Pension & Benefit Board may award from time to time to senior management employees. Mr. Massey may also participate in standard retirement and medical plans, and is entitled to customary fringe benefits, vacation and sick leave.

Mr. Massey’s employment agreement terminates upon his death or disability, and is terminable for “cause,” as defined in the employment agreement. In the event of termination for cause, no severance benefits are payable to Mr. Massey. If Mr. Massey is terminated without cause, he will be entitled to severance pay equal to the amount of his salary and benefits from the date of termination through the remaining term of the employment agreement plus an additional twelve-month period. Mr. Massey has the option to receive this payment either (i) in periodic payments, as if the termination had not occurred, or (ii) in one lump sum payment within ten days of the termination of his employment. In either case, however, the severance pay shall not exceed two (2) times Mr. Massey’s “average annual compensation,” which is the average total annual compensation received by Mr. Massey under the employment agreement over the five full fiscal years preceding the termination, or, if Mr.

Massey has been employed less than five full fiscal years, over each full fiscal year preceding the termination. Mr. Massey may voluntarily terminate his employment agreement by providing sixty days written notice to the Pension & Benefit Board, in which case he is entitled to receive only his compensation, vested rights and benefits up to the date of termination.

In addition to Mr. Massey’s employment agreement, SouthFirst, First Federal, Pension & Benefit and Mr. Massey have entered into a guaranty of employment agreement pursuant to which SouthFirst and First Federal have guaranteed the performance of Pension & Benefit under the terms of the employment agreement by and between Pension & Benefit and Mr. Massey.

Ruth M. Roper

Executive Vice President of Pension & Benefit

The amended and restated employment agreement by and between Pension & Benefit and Ms. Roper was effective as of October 1, 2003 and provides for a term of two years. Ms. Roper’s term of employment was due to be extended on the first anniversary of the effective date for an additional one-year period beyond the then effective expiration date, provided the Pension & Benefit Board determined, in a duly adopted resolution, that the performance of Ms. Roper had met the Pension & Benefit Board’s requirements and standards, and that such employment agreement shall be extended. The Pension & Benefit Board and Ms. Roper are currently negotiating an extension of such agreement beyond its stated termination date of October 1, 2005. Once an extension of this agreement has been entered into, First Federal will file such document with the SEC on Form 8-K.

The employment agreement with Ms. Roper provides for an annual base salary of $100,000, payable in cash not less frequently than monthly. In addition, as a provision of a prior employment agreement, Ms. Roper received 5,623 shares of restricted SouthFirst Common Stock, one-fifteenth of which vest on each of the first fifteen anniversaries of April 11, 1997. Should Ms. Roper’s employment be terminated due to death, disability or the termination of her employment “without cause,” as defined in the employment agreement, all unvested shares shall be deemed earned and fully vested as of such date and shall be distributed as soon as practicable thereafter. All unvested shares will also vest upon a “change in control” of Pension & Benefit, First Federal or SouthFirst. Under Ms. Roper’s employment agreement, “change in control” generally refers to a change in ownership, holding or power to vote more than 25% of Pension & Benefit’s, First Federal’s or SouthFirst’s voting stock, a change in the ownership or possession of the ability to control the election of a majority of Pension & Benefit’s, First Federal’s or SouthFirst’s directors, or the exercise of a controlling influence over the management or policies of Pension & Benefit, First Federal or SouthFirst. In addition, under Ms. Roper’s employment agreement, a change in control occurs when, during any consecutive two-year period, directors of Pension & Benefit, First Federal or SouthFirst, at the beginning of such period, cease to constitute two-thirds of the Boards of Directors of Pension & Benefit, First Federal or SouthFirst, unless the election of replacement directors was approved by a two-thirds (66 2/3%) vote of the initial directors then in office.

Ms. Roper’s employment agreement entitles her to participate in an equitable manner with all other senior management employees of Pension & Benefit in discretionary bonuses that the Pension & Benefit Board may award from time to time to senior management employees. Ms. Roper may also participate in standard retirement and medical plans, and is entitled to customary fringe benefits, vacation and sick leave.

Ms. Roper’s employment agreement terminates upon her death or disability, and is terminable for “cause,” as defined in the employment agreement. In the event of termination for cause, no severance benefits are payable to Ms. Roper. If Ms. Roper is terminated without cause, she will be entitled to severance pay equal to the amount of her salary and benefits from the date of termination through the remaining term of the employment agreement plus an additional twelve-month period. Ms. Roper has the option to receive this payment either (i) in periodic payments, as if the termination had not occurred, or (ii) in one lump sum payment within ten days of the termination of her employment. In either case, however, the severance pay shall not exceed two (2) times Ms. Roper’s “average annual compensation,” which is the average total annual compensation received by Ms. Roper under the employment agreement over the five full fiscal years preceding the termination, or, if Ms. Roper has

been employed less than five full fiscal years, over each full fiscal year preceding the termination. Ms. Roper may voluntarily terminate her employment agreement by providing sixty days written notice to the Board, in which case she is entitled to receive only her compensation, vested rights and benefits up to the date of termination.

In addition to Ms. Roper’s employment agreement, SouthFirst, First Federal, Pension & Benefit and Ms. Roper have entered into a guaranty of employment agreement pursuant to which SouthFirst and First Federal have guaranteed the performance of Pension & Benefit under the terms of the employment agreement by and between Pension & Benefit and Ms. Roper.

Deferred Compensation Agreements

First Federal previously entered into deferred compensation agreements (collectively, the “Deferred Compensation Agreements”) with each of Mr. McArthur and Ms. Roper, pursuant to which each would receive certain retirement benefits at age 65. Under the Deferred Compensation Agreements, benefits would be payable for 15 years. A portion of the retirement benefits would accrue each year until age 65 or, if sooner, until termination of employment. If Mr. McArthur remains in the employment of First Federal until age 65, his annual benefit will be $45,000. If Mr. McArthur dies prior to age 65, while in the employment of First Federal, the full retirement benefits available under the deferred compensation agreement will accrue and will, thereupon, be payable to his beneficiaries. Similarly, if Ms. Roper remains in the employment of First Federal until age 65, her annual benefit will be $30,000. If Ms. Roper dies prior to age 65, while in the employment of First Federal, the full retirement benefits available under the deferred compensation agreement will accrue and will, thereupon, be payable to her beneficiaries.

The retirement benefits available under the Deferred Compensation Agreements are unfunded. However, First Federal has purchased life insurance policies on the lives Mr. McArthur and Ms. Roper that will be available to SouthFirst and First Federal to provide, both, for retirement benefits and for “key person” insurance. The costs of these arrangements was $36,141 for each of 2004, 2003 and 2002.

Management Recognition Plans

The SouthFirst Board of Directors has adopted two management recognition plans (“MRPs”), denominated SouthFirst Bancshares, Inc. Management Recognition Plan “A” (“Plan A”) and SouthFirst Bancshares, Inc. Management Recognition Plan “B” (“Plan B”) (collectively, the “MRP Plans”). The objective of the MRP Plans is to enable SouthFirst and First Federal to reward and retain personnel of experience and ability in key positions of responsibility by providing such personnel with a proprietary interest in SouthFirst and by recognizing their past contributions to SouthFirst and First Federal, and to act as an incentive to make such contributions in the future.

Except for the fact that Plan B provides for awards only to employees of SouthFirst and First Federal, while Plan A provides for awards to employees as well as to non-employee directors of SouthFirst and First Federal, the terms of the MRP Plans are the same. The MRP Plans are administered by a committee (the “Committee”) of the SouthFirst Board of Directors. Awards under the MRP Plans are in the form of restricted stock grants (“MRP grants”). Each MRP Plan has reserved a total of 16,600 shares of SouthFirst Common Stock for issuance pursuant to awards made by the Committee. Such shares, with respect to each MRP Plan, are held in trust until awards are made by the Committee, at which time the shares are distributed from the trust to the award recipient. Such shares will bear restrictive legends until vested, as described below. The Committee may make awards to eligible participants under the MRP Plans in its discretion, from time to time. Under Plan A, on November 15, 1995, each non-employee director, serving in such capacity on February 13, 1995 (the effective date of the conversion of SouthFirst from a mutual to a stock form of ownership), automatically received an award of 1,660 shares. In selecting the employees to whom awards are granted under the MRP Plans, the Committee considers the position, duties and responsibilities of the employees, the value of their services to SouthFirst and First Federal and any other factors the Committee may deem relevant.

Awards under the MRP Plans vest at the rate of 20% per year, commencing on the first anniversary of the date of the award. The Committee may, however, from time to time and in its sole discretion, accelerate the vesting with respect to any participant, if the Committee determines that such acceleration is in the best interest of SouthFirst. If a participant terminates employment for reasons other than death or disability, the participant forfeits all rights to any shares which have not vested, including the dividends received with respect to such non-vested shares. If the participant’s termination is caused by death or disability, all shares become vested. Participants will recognize compensation income on the date their interests vest, or at such earlier date pursuant to a participant’s election to accelerate recognition pursuant to Section 83(b) of the Code.

During the year ended September 30, 2001, SouthFirst repurchased 11,525 shares of its Common Stock, which shares subsequently were designated MRP shares. During 2002, 1,750 shares were issued to employees under MRP grants and during 2004, 373 shares were cancelled, leaving 9,402 shares in trust at September 30, 2004, which the Committee may issue in its sole discretion.

Stock Option Plans

The SouthFirst Board of Directors has adopted two stock option plans. The first was adopted November 15, 1995 and is denominated the SouthFirst Bancshares, Inc. Stock Option and Incentive Plan (the “1995 Plan”), and the second was adopted on January 28, 1998 and is denominated the 1998 Stock Option and Incentive Plan (the “1998 Plan”) (collectively, the “Stock Option Plans”). The objective of each of the Stock Option Plans is to attract, retain, and motivate the best possible personnel for positions of substantial responsibility with SouthFirst and First Federal. In order to attract and retain members of the Board of Directors of SouthFirst who contribute to SouthFirst’s success, each of the Stock Option Plans also provides for the award of non-qualified stock options to non-employee directors of SouthFirst.

The 1995 Plan authorizes the grant of up to 83,000 shares of Common Stock to select officers and employees in the form of (i) incentive and non-qualified stock options (“Options”) or (ii) Stock Appreciation Rights (“SARs”) (Options and SARs are referred to herein collectively as “Awards”), as determined by the committee administering the 1995 Plan. As of September 30, 1996, options to purchase a total of 83,000 shares had been issued under the 1995 Stock Option Plan, and, as of that date, no other shares were available for future issuance. Subsequently, options to purchase 8,300 shares were exercised, which shares are no longer available for issuance under the 1995 Plan; options to purchase 56,649 shares expired prior to being exercised, which shares then became available for re-issuance under the 1995 Plan; and additional options to purchase 55,649 shares were issued. Thus, at September 30, 2004, 1,000 shares were available for issuance under the 1995 Plan.

The 1998 Plan authorizes the grant of up to 63,361 shares of Common Stock to select officers and employees in the form of (i) Options or (ii) SARs, all of which shares were granted under the 1998 Plan. Subsequently, options to purchase 38,450 shares expired prior to being exercised, which shares then became available for re-issuance under the 1998 Plan, and additional options to purchase 35,388 shares were issued. Thus, at September 30, 2004, 3,062 shares were available for issuance under the 1998 Plan.

The terms and conditions of the Stock Option Plans are substantially the same. The exercise price for Options and SARs granted under the Stock Option Plans may not be less than the fair market value of the shares on the day of the grant, and no Awards shall be exercisable after the expiration of ten years from the date of this grant. Each Stock Option Plan has a term of 10 years unless earlier terminated by the SouthFirst Board of Directors. The Stock Option Plans are administered by a committee of the directors of SouthFirst (the “Option Plan Committee”). Except as discussed below with respect to non-employee directors, the Option Plan Committee has complete discretion to make Awards to persons eligible to participate in the Stock Option Plans, and determines the number of shares to be subject to such Awards, and the terms and conditions of such Awards. In selecting the persons to whom Awards are granted under the Stock Option Plans, the Option Plan Committee considers the position, duties, and responsibilities of the employees, the value of their services to SouthFirst and First Federal, and any other factor the Option Plan Committee may deem relevant to achieving the stated purpose of the Stock Option Plan.

Options granted under the Stock Option Plans become exercisable at rates ranging from 20% to 33% per year commencing one year from the date of grant, with the exception that all options will become immediately exercisable in the event the optionee’s employment is terminated due to the optionee’s death, disability or retirement, or in the event of a “change in control” of First Federal or SouthFirst, as such term is defined in the respective Stock Option Plan.

Under the 1995 Plan, all directors who were not employees of SouthFirst as of November 15, 1995 (the date of the approval of the Stock Option Plan by the stockholders of SouthFirst and the OTS), received non-qualified stock options to purchase 4,150 shares, which options had an exercise price of $14.00 per share, the fair market value of SouthFirst Common Stock on the date of grants. Likewise, under the 1998 Plan, all directors who were not employees of SouthFirst as of January 28, 1998 (the date of the approval of the Stock Option Plan by the Board of Directors of SouthFirst) received non-qualified stock options to purchase 2,700 shares, which options had an exercise price of $21.25 per share, the fair market value of SouthFirst Common Stock on the date of grants.

See also, “Item 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.”

Repricing of Stock Options under the Stock Option Plans

On January 28, 1998, the Wage and Compensation Committee, acting on the approval of the Board of Directors, granted incentive stock options to purchase 7,428 and 3,726 options to Joe K. McArthur and J. Malcomb Massey, respectively (i.e., the Named Executive Officers at that time). Options to purchase an aggregate of 50,597 shares were concurrently granted to approximately 19 non-executive employees of SouthFirst and/or First Federal and two former executive officers. Such options were granted at an exercise price of $21.25 per share, which was equal to the fair market value of SouthFirst’s Common Stock on the date of grant. During the ensuing nine and one half months, the market price of SouthFirst’s Common Stock declined significantly to a point at which such options no longer served the intended purpose for which they were issued. In order to protect the intended value of the January 28, 1998 options, the Board of Directors elected to reprice all such options by the cancellation of such options and the regrant of an equal number of new options at the then current, lower market price. Such replacement options were granted on November 4, 1998 at an exercise price of $15.75 per share, which was equal to the fair market value of SouthFirst’s Common Stock on the date of grants. The following table provides, with respect to the Named Executive Officers, the name of grantee, number of securities underlying the options repriced, the original exercise price, the new exercise price, and the length of original option term remaining after the repricing, as of September 30, 2004:

Ten-Year Option/SAR Repricings

Number of

Securities

Length of Original

Underlying

Option Term

Options

Original Exercise

New Exercise Price

Remaining at Date

Name

Date

Repriced(1)

Price ($)

($)

of Repricing

Joe K. McArthur

November 4, 1998

7,428

21.25

15.75

9.2 years

(1998 Plan)

J. Malcomb Massey

November 4, 1998

3,726

21.25

15.75

9.2 years

(1998 Plan)

(1) The 1998 Plan authorizes the grant of up to 63,361 shares of Common Stock to select officers and employees in the form of (i) Options or (ii) SARs, all of which shares were granted under the 1998 Plan. Subsequently, options to purchase 36,778 shares expired prior to being exercised, which shares then became available for re-issuance under the 1998 Plan, and additional options to purchase 35,388 shares were issued. Thus, at September 30, 2004, 3,062 shares were available for issuance under the 1998 Plan.

The following table provides certain information concerning the exercise of stock options under SouthFirst’s Stock Option Plans during the fiscal year ended September 30, 2004, by the Named Executive Officers and the fiscal-year-end value of unexercised options held by those individuals:

Aggregated Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values

Number of Securities

Value of

Underlying

Unexercised

Unexercised Options

In-the-Money

Options at Fiscal

Shares

Fiscal Year End

Year End

Acquired

Value

Exercisable/

Name

on Exercise

Realized

Unexercisable

Unexercisable⁽¹⁾

Joe K. McArthur

26,592 / 3,440

49,816 / $11,352

J. Malcomb Massey

6,310/3,440

12,579 / $11,352

Sandra H. Stephens

3,860/7,940

19,278 / $36,012

Ruth M. Roper

3,354/1,560

6,734 / $5,148

(1)

Represents the value of unexercised, in-the-money stock options on September 30, 2004, using the $15.40 closing price of SouthFirst Common Stock on that date.

Employee Retirement Savings Plan

First Federal has established a savings and profit-sharing plan that qualifies as a tax-deferred savings plan under Section 401(k) of the Internal Revenue Code (the “401(k)Plan”) for its employees who are at least 21 years old and who have completed one year of service with First Federal. Under the 401(k) Plan, eligible employees may contribute up to $13,000 of their gross salary to the plan. Currently, all contributions are fully vested under the 401(k) Plan at the time of contribution. Prior to April 1, 2003, all contributions up to 3% by eligible employees were 100% matched. However, since 401(k) matching is discretionary, upon review by the board of directors, effective April 1, 2003, all matching contributions were temporarily suspended. The board of directors will review the 401(k) Plan on an annual basis and implement any changes as appropriate.

Employee Stock Ownership Plan

First Federal has adopted an Employee Stock Ownership Plan (the “ESOP”) for the exclusive benefit of participating employees. All employees of First Federal who are at least 21 years old and who have completed a year of service with First Federal are eligible to participate in the ESOP. SouthFirst loaned the ESOP $664,000, which the ESOP used to purchase 66,400 shares of SouthFirst Common Stock. This loan is secured by the shares purchased with the proceeds of the loan. Shares purchased with the loan proceeds are held in a suspense account for allocation among participants as the loan is repaid. All loan proceeds had been repaid at September 30, 2004.

Contributions to the ESOP were used to repay the ESOP loan. Shares released from the suspense account, as the ESOP loan was repaid, any contributions to the ESOP that were not used to repay the ESOP loan, and forfeitures will be allocated among participants on the basis of their relative compensation. With the exception of terminations due to death, disability or retirement, a participant must be employed by First Federal on the last day of the ESOP plan year and must have completed 1,000 hours of service during the plan year in order to share in the allocation for the plan year. Any dividends paid on unallocated shares of SouthFirst Common Stock were

used to repay the ESOP loan; any dividends paid on shares of SouthFirst Common Stock allocated to participant accounts will be credited to said accounts.

Benefits under the ESOP vest at a rate of 20% per year of service, with the first 20% vesting after a participant has served for two years. Participant’s benefits also become fully vested upon his or her death, disability, attainment of normal retirement age, or the termination of the ESOP. For vesting purposes, a year of service means any plan year in which an employee completes at least 1,000 hours of service with First Federal. An employee’s years of service prior to the ESOP’s effective date will be considered for purposes of determining vesting under the ESOP.

A participant who separates from service because of death, disability or retirement will be entitled to receive an immediate distribution of his or her benefits. A participant who separates from service for any other reason and who is not reemployed by an employer will receive a lump sum distribution of the vested portion of his account as soon as administratively feasible after his date of termination, unless the participant elects a later distribution. Distributions generally will be made in whole shares of SouthFirst Common Stock, with the value of fractional shares being paid in cash. Although accounts generally will be distributed in a lump sum, if the fair market value of a participant’s account is in excess of $500,000, as of the date distribution is required to begin, distributions will be made in substantially equal annual payments over a period not longer than five (5) years, plus an additional one (1) year (up to an additional five (5) years) for each $100,000 increment, or fraction of such increment, by which the value of the participant’s account exceeds $500,000.

Pension & Benefit serves as the plan administrator and trustee of the ESOP (the “ESOP Trustee”). Participants may vote the shares of SouthFirst Common Stock that are allocated to their account. Any unallocated shares of SouthFirst Common Stock and allocated shares of SouthFirst Common Stock for which no timely direction is received are voted by the ESOP Trustee in accordance with its fiduciary obligations.

Dividend Incentive Plan

SouthFirst, in November 1995, adopted, by resolution of the Board of Directors of SouthFirst, a dividend incentive plan (the “Dividend Incentive Plan”), pursuant to which each director and/or employee in the SouthFirst family, who holds options to purchase SouthFirst Common Stock under the Stock Option Plans, is paid an amount equal to the number of shares underlying the stock options held by him or her, multiplied by the amount of dividends SouthFirst pays to the holders of its Common Stock. If the service of an employee or director is terminated prior to the full vesting of his or her stock options, then the employee or director immediately forfeits, and must repay to SouthFirst, all amounts received under the Dividend Incentive Plan with respect to the non-vested options.

Compensation of Directors

Director Fees and Dividends

Each member of the First Federal Board of Directors, with the exception of the Chairman of the Board, receives a fee of $1,000 which covers any and all necessary board meetings occurring during any given month (with one excused absence). The Chairman of the Board receives a fee of $1,500 for each board meeting attended. Each non-employee director of First Federal, if a member of a committee, receives $300 for each committee meeting attended. The members of the SouthFirst Board of Directors receive a fee in the amount of $750 for each board meeting attended.

During fiscal 2004, each non-employee director was paid from $3,414 to $7,524 under the Dividend Incentive Plan with respect to the shares of Common Stock underlying the stock options held by each non-employee director. Further, certain SouthFirst directors, during fiscal 2004, received a cash dividend in the amount of $996 with respect to the restricted shares held by such directors, as granted under Management Recognition Plans “A” and “B.”

Director Retirement Benefits

The Board of Directors of First Federal has adopted, effective as of October 1, 2001, the Bank Director Supplemental Retirement Plan (the “Director Plan”), under which First Federal will make certain payments to each participating director, upon the director’s retirement, or to the director’s beneficiary(ies) in the event of the director’s death. The Director Plan is an unfunded arrangement maintained primarily to provide supplemental retirement benefits for each participating director and constitutes a non-qualified benefit plan for purposes of the Employee Retirement Income Security Act of 1974, as amended (“ERISA”). A “pre-retirement account” is established under the Director Plan, as a liability reserve account on the books of First Federal for the benefit of each participating director. Such liability reserve account shall be increased or decreased each plan year, until the participating director either retires, or has a termination of service, as a director of First Federal.

The annual increase or decrease in this liability reserve account is determined by an index which, generally, measures the amount of aggregate annual after-tax income from certain life insurance contracts, owned by First Federal on the lives of each participating director, against the annual cost of funds of First Federal represented by the net premiums paid on these life insurance policies. Each participating director of First Federal will receive, on a monthly basis beginning at retirement or termination of service, as a supplemental retirement benefit, the amount attributed to their liability service account, adjusted, as applicable, under the terms of the Director Plan. The cost of the Director Plan was $26,073 and $33,869 for fiscal years 2004 and 2003, respectively. However, no benefits were paid under the Director Plan in fiscal year 2004 or 2003.

Compensation Committee Interlocks and Insider Participation

SouthFirst presently does not have a compensation committee because, except for an annual salary, in the amount of $20,000, paid by SouthFirst to its President, J. Malcomb Massey, no officers of SouthFirst receive any compensation for services to SouthFirst. All officers of SouthFirst are compensated by First Federal solely for their services to First Federal. In addition, directors are paid for attendance at First Federal committee meetings, but employee members of committees are not paid. Joe K. McArthur, Chief Executive Officer of First Federal and SouthFirst, and President of First Federal, and J. Malcomb Massey, President of SouthFirst and Pension & Benefit, serve as members of the Wage and Compensation Committee of First Federal. First Federal’s Wage and Compensation Committee is responsible for reviewing salaries and benefits of directors, officers, and employees of First Federal. SouthFirst had no “interlocking” relationships existing at or before the year ended September 30, 2004 in which (i) any executive officer was a member of the board of directors/trustees of another entity, one of whose executive officers was a member of the First Federal Board of Directors, or where (ii) any executive officer was a member of the compensation committee of another entity, one of whose executive officers was a member of the First Federal Board of Directors.

ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth certain information as of December 9, 2004 with respect to the beneficial ownership of SouthFirst’s Common Stock by (i) each person known by SouthFirst to own beneficially more than five percent (5%) of SouthFirst Common Stock, (ii) each director of SouthFirst, (iii) each of the Named Executive Officers (as defined herein) and (iv) all directors and executive officers of SouthFirst as a group. Unless otherwise indicated, each of the stockholders has sole voting and investment power with respect to the shares beneficially owned.


	Shares of
	Common Stock			Percent of
	Beneficially			Outstanding
Beneficial Owner	Owned⁽¹⁾			Shares⁽²⁾
Joe K. McArthur⁽³⁾		40,541			5.5	%
471 Alta Vista Dr. Chelsea, AL 35043
H. David Foote, Jr.⁽⁴⁾		16,113			2.2	%
2517 Overhill Rd. Sylacauga, AL 35150
J. Malcomb Massey⁽⁵⁾		31,174			4.4	%
8318 Longneedle, Dr. Montgomery, AL 36117
Allen Gray McMillan, III⁽⁶⁾		21,613			3.0	%
One Gunston Ave. Talladega, AL 35160
Kenneth E. Easterling⁽⁷⁾		27,903			3.9	%
4141 Co. Road 85 Clanton, AL 35045
L. Neal Bice⁽⁸⁾		33,484			4.7	%
304 Eastwood Dr. Clanton, AL 35045
Donald R. Hardy⁽⁹⁾		3,303			0.5	%
130 Stone Ridge Dr. Sylacauga, AL 35150
Jeffrey L. Gendell, et. al.⁽¹⁰⁾		62,800			8.9	%
55 Railroad Ave., 3^rd Floor Greenwich, CT 06830
Robert J. Salmon and Mary Anne J. Salmon⁽¹¹⁾		47,600			6.7	%
3623 Raymond St. Chevy Chase, MD 20815
Sandra H. Stephens⁽¹²⁾		7,163			1.0	%
4004 Charring Cross Lane Hoover, AL 35226
Ruth M. Roper⁽¹³⁾		12,622			1.8	%
1111 Buck Ridge Rd Wetumpka, AL 36093
Pension & Benefit Financial Services, Inc.⁽¹⁴⁾		37,510			5.3	%
260 Commerce St., 3^rd Floor Montgomery, AL 36101
All directors and executive officers as a group (9 persons)		193,916	(15)		24.6	%

⁽¹⁾

“Beneficial Ownership” includes shares for which an individual, directly or indirectly, has or shares voting or investment power or both and also includes options which are exercisable within sixty days of the date hereof. Beneficial ownership as reported in the above table has been determined in accordance with Rule 13d-3 of the Exchange Act.

⁽²⁾ The percentages are based upon 709,406 shares outstanding, except for certain parties who hold presently exercisable options to purchase shares. The percentages for those parties holding presently exercisable options are based upon the sum of 709,406 shares plus the number of shares subject to presently exercisable options held by them, as indicated in the following notes.

⁽³⁾ Of the amount shown, 5,781 shares are held in Mr. McArthur’s account under SouthFirst’s 401(k) Plan, 7,064 shares are held in his account under First Federal’s ESOP, 27,452 shares are subject to presently exercisable options and 244 shares represent restricted stock granted under SouthFirst’s Management Recognition Plans “A” and “B,” all of which are fully vested.

⁽⁴⁾ Of the amount shown, 3,000 shares are owned jointly by Mr. Foote and his wife, 1,500 shares are held by Mr. Foote as custodian for each of his two minor children, 9,953 shares are subject to presently exercisable options and 1,660 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan “A,” all of which are fully vested.

⁽⁵⁾ Of the amount shown, 15,521 shares are restricted stock acquired pursuant to that certain employment agreement between Mr. Massey and Pension & Benefit, vesting in equal increments over a period of 15 years beginning on April 11, 1997, 3,782 shares are held in his account under SouthFirst’s 401(k) plan, 2,642 shares are held in an Individual Retirement Account, 2,059 shares are held in his account under First Federal’s ESOP, and 7,170 shares are subject to exercisable options.

⁽⁶⁾ Of the amount shown, 10,000 shares are held jointly by Mr. McMillan and his wife, 9,953 shares are subject to presently exercisable options and 1,660 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan “A,” all of which are fully vested.

⁽⁷⁾ Of the amount shown, 21,099 shares are held jointly by Mr. Easterling and his wife, 1,001 shares are held individually by Mr. Easterling and 5,803 shares are subject to exercisable options.

⁽⁸⁾ Of the amount shown, 27,681 are held individually by Mr. Bice and 5,803 shares are subject to exercisable options.

⁽⁹⁾ Of the amount shown, 200 shares are held jointly by Mr. Hardy and his wife and 3,103 shares are subject to exercisable options.

⁽¹⁰⁾ Of the amount shown, Jeffrey L. Gendell has shared voting power with respect to 62,800 shares, Tontine Management, L.L.C. (“TM”) has shared voting power with respect to 62,800 shares, and Tontine Financial Partners, L.P. (“TFP”) has shared voting power with respect to 62,800 shares. TM, the general partner of TFP, has the power to direct the affairs of TFP. Mr. Gendell is the Managing Member of Tontine Management, L.L.C. and, in that capacity, directs its operations. The business address of Mr. Gendell and TFP is 237 Park Avenue, 9^th Floor, New York, New York 10017. The foregoing information is based on a Schedule 13F, dated November 12, 2004 filed by Mr. Gendell, TM, and TFP. SouthFirst makes no representation as to the accuracy or completeness of the information reported.

⁽¹¹⁾ Robert J. Salmon and Mary Anne J. Salmon beneficially own and have shared voting and dispositive power with respect to 47,600 shares. The foregoing information is based on a Schedule 13G, dated October 8, 1998 received by SouthFirst from Mr. and Mrs. Salmon. SouthFirst makes no representation as to the accuracy or completeness of the information reported therein.

⁽¹²⁾ Of the amount shown, 6,220 shares are subject to presently exercisable options, 243 shares are held in her account under First Federal’s ESOP, and 700 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan(s), all of which shares are fully vested.

⁽¹³⁾ Of the amount shown, 1,914 shares are owned jointly by Ms. Roper and her husband, 5,623 shares are restricted stock acquired pursuant to that certain employment agreement between Ms. Roper and Pension & Benefit, vesting in equal increments over a period of 15 years beginning on April 11, 1997, 1,341 shares are held in her account in First Federal’s ESOP, and 3,744 shares are subject to presently exercisable options.

⁽¹⁴⁾ These shares are held in trust by Pension & Benefit as trustee of First Federal’s ESOP. See “Item 10. EXECUTIVE COMPENSATION — Employee Stock Ownership Plan.”

⁽¹⁵⁾ Of the amount shown, 79,201 shares are subject to exercisable options.

There are no arrangements known to SouthFirst pursuant to which a change in control of SouthFirst would result.

The following table provides information with respect to shares of SouthFirst Common Stock authorized for issuance under equity compensation plans:

Equity Compensation Plan Information (1)

Number of securities

remaining available for

Number of securities

Weighted-average

future issuance under

to be issued upon exercise

exercise price of

equity compensation plans

of outstanding options,

outstanding options,

(excluding securities

warrants and rights

reflected in column (a))

Plan category

(a)

(b)

(c)

Equity compensation plans approved by security holders (2)

133,999

12.84

4,062

Equity compensation plans not approved by security holders

⁽¹⁾		The term “equity compensation plan,” as used in this table, refers to compensation plans and individual compensation arrangements for employees and directors of the Company and its affiliates, which authorize the issuance of equity securities of the Company, excluding all compensation plans and arrangements which meet the qualification requirements under Section 401(a) of the Code.

⁽²⁾		Includes the SouthFirst Bancshares, Inc. Stock Option and Incentive Plan, the 1998 Stock Option and Incentive Plan, the SouthFirst Bancshares, Inc. Management Recognition Plan “A” and the SouthFirst Bancshares, Inc. Management Recognition Plan “B.” See, also, “Item 10. EXECUTIVE COMPENSATION – Management Recognition Plans, and – Stock Option Plans.”

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

First Federal, like many financial institutions, has followed a policy of granting various types of loans to officers, directors and employees. The loans have been made in the ordinary course of business and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with First Federal’s other customers, and do not involve more than the normal risk of collectibility, nor present other unfavorable features. All loans by First Federal to its officers and executive officers are subject to OTS regulations restricting loans and other transactions with affiliated persons of First Federal. In addition, all future credit transactions with such directors, officers and related interests of SouthFirst and First Federal will be on substantially the same terms as, and following credit underwriting procedures that are not less stringent than those prevailing at the time for comparable transactions with unaffiliated persons and must be approved by a majority of the directors of SouthFirst, including a majority of the disinterested directors. At September 30, 2004, the aggregate of all loans by First Federal to its officers, directors, and related interests was $739,000.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this report:

(1) Financial Statements

The following financial statements are included as part of this Form 10KSB following the signature page of this Form 10KSB.


		Report of Independent Registered Public Accounting Firm of Jones & Kirkpatrick, P.C.
		Consolidated Statements of Financial Condition as of September 30, 2004 and 2003
		Consolidated Statements of Operations for the years ended September 30, 2004, 2003 and 2002
		Consolidated Statements of Stockholders’ Equity for the years ended September 30, 2004, 2003 and 2002
		Consolidated Statements of Cash Flows for the years ended September 30, 2004, 2003 and 2002
		Notes to Consolidated Financial Statements

(2) Exhibits

The following exhibits are filed with or incorporated by reference into this report. The exhibits which are denominated by an asterisk (*) were previously filed with the SEC as a part of, and are hereby incorporated by reference from, SouthFirst’s: Registration Statement on Form S-1 under the Securities Act of 1933 Registration No. 33-80730 (“1994 S-1”); Registration Statement on Form S-8 under the Securities Act of 1933, Registration No. 333-4534 (“Plan ‘A’ S-8”); Registration Statement on From S-8 under the Securities Act of 1933, Registration No. 333-4536 (“Plan ‘B’ S-8”); Registration Statement on Form S-8, Registration No. 333-4538 (“Option Plan S-8”); Registration Statement on Form S-8, Registration No. 333-85705 (“Amended Option Plan S-8”); Annual Report on Form 10-K for the year ended September 30, 1995 (“1995 10-K”); Annual Report on Form 10-K for the year ended September 30, 1998 (“1998 Form 10-K”); Annual Report on Form 10-KSB for the year ended September 30, 2001 (“2001 Form 10-KSB”); Annual Report on Form 10-KSB for the year ended September 30, 2002 (“2002 Form 10-KSB”); Annual Report on Form 10-KSB for the year ended September 30, 2003 (“2003 Form 10-KSB”); Other Event on Form 8-K, filed on March 29, 2002 (“March 29, 2002 Form 8-K”); Quarterly Report on Form 10-QSB for the period ended December 31, 2001 (“December 31, 2001 10-QSB”); Other Event on Form 8-K, filed on July 2, 2002 (“July 2, 2002 Form 8-K”); Other Event on Form 8-K, filed on December 21, 2004 (“December 21, 2004 Form 8-K”). Unless otherwise indicated, the exhibit number corresponds to the exhibit number in the referenced document.


Exhibit No.		Description of Exhibit

3.1*		Amended and Restated Certificate of Incorporation (1994 S-1).

3.2*		Bylaws (1994 S-1, Exhibit 3.2).

3.3*		Amendment to Article III, Section 2 of the Bylaws (2002 Form 10-KSB).

4*		Form of Common Stock Certificate (1994 S-1).

10.1*		Form of Employment Agreement between SouthFirst Bancshares, Inc. and Joe K. McArthur (2001 Form 10-KSB).

10.2*		Form of Amended and Restated Employment Agreement effective as of October 1, 2003 between First Federal of the South and Joe K. McArthur (2003 Form 10-KSB).


Exhibit No.		Description of Exhibit

10.3*		Form of Amended and Restated Employment Agreement effective as of October 1, 2003 between First Federal of the South and Sandra H. Stephens (2003 Form 10-KSB).

10.4*		Form of Amended and Restated Employment Agreement effective as of October 1, 2003 between Pension & Benefit Financial Services, Inc. and J. Malcomb Massey (2003 Form 10-KSB).

10.5*		Form of Guaranty of Employment Agreement among SouthFirst Bancshares, Inc., First Federal of the South, Pension & Benefit Financial Services, Inc. and J. Malcomb Massey (2001 Form 10-KSB, Exhibit 10.4.2).

10.6*		Form of Amended and Restated Employment Agreement effective as of October 1, 2003 between Pension & Benefit Financial Services, Inc. and Ruth M. Roper (2003 Form 10-KSB).

10.7*		Form of Guaranty of Employment Agreement among SouthFirst Bancshares, Inc., First Federal of the South, Pension & Benefit Financial Services, Inc. and Ruth M. Roper (2001 Form 10-KSB, Exhibit 10.5.2).

10.8*		Form of Management Recognition Plan A (1994 S-1, Exhibit 10.5).

10.9 *		Form of Management Recognition Plan A, as amended (1995 Form 10-K, Exhibit 10.8.2).

10.10*		Management Recognition Plan A Restated and Continued (Plan “A” S-8, Exhibit 4.1).

10.11*		Form of Management Recognition Plan B (1994 S-1, Exhibit 10.6).

10.12*		Form of Management Recognition Plan B, as amended (1995 Form 10-K, Exhibit 10.9.2).

10.13*		Management Recognition Plan B, Restated and Continued (Plan “B” S-8, Exhibit 4.1).

10.14*		Form of Stock Option and Incentive Plan (1994 S-1, Exhibit 10.7) (1995 Form 10-K, Exhibit 10.10.1).

10.15*		Form of Stock Option and Incentive Plan, as amended (1995 Form 10-K, Exhibit 10.10.2).

10.16 *		From of Stock Option and Incentive Plan, Restated and Continued (Option Plan S-8, Exhibit 4.1).

10.17*		Form of Stock Option and Incentive Plan, as Amended (Amended Option Plan S-8, Exhibit 10.10.4).

10.18*		Form of Incentive Stock Option Agreement (Option Plan S-8, Exhibit 4.2).

10.19*		Form of Incentive Stock Option Agreement, as Amended (Amended Option Plan S-8, Exhibit 10.10.6)

10.20 *		Form of SouthFirst Bancshares, Inc. Employee Stock Ownership Plan (1994 S-1, Exhibit 10.8).


Exhibit No.		Description of Exhibit

10.21*		Third Amendment to the SouthFirst Bancshares, Inc. Employee Stock Ownership Plan executed as of September 29, 2001 (2001 Form 10-KSB, Exhibit 10.11.2).

10.22*		Deferred Compensation Agreement between First Federal of the South and Joe K. McArthur (1995 Form 10-K, Exhibit 10.12).

10.23*		Deferred Compensation Agreement between Pension & Benefit and Ruth M. Roper (2001 Form 10-KSB, Exhibit 10.14).

10.24*		Stock Option Agreement between SouthFirst Bancshares, Inc. and Sandra H. Stephens (December 31, 2001 10-QSB, Exhibit 10.16).

10.25*		Supervisory Agreement dated March 22, 2002, by and between First Federal of the South and the Office of Thrift Supervision (March 29, 2002 Form 8-K, Exhibit 99.1).

10.26*		Form of Settlement Agreement dated June 28, 2002, by and between First Federal of the South and Charles R. Vawter, Jr., Charles R. Vawter, Sr., Vawter Properties & Resources, LP, Angela H. Vawter and Automatic Gas & Appliance Co., Inc. (July 2, 2002 Form 8-K, Exhibit 99.1).

10.27*		Letter from the Office of Thrift Supervision dated December 14, 2004 rescinding Supervisory Agreement dated March 22, 2002, by and between First Federal of the South and the Office of Thrift Supervision as of December 14, 2004 (December 21, 2004 Form 8-K, Exhibit 99.1).

11		Statement Regarding Computation of Per Share Earnings.

14*		Code of Ethics for Principal Executive Officers and Senior Financial Officers (2003 Form 10-KSB)

21		Subsidiaries of Registrant.

23.1		Consent of Jones & Kirkpatrick, P.C.

31.1		Rule 13a — 14a Certification of the Chief Executive Officer

31.2		Rule 13a — 14a Certification of the Controller (Chief Financial Officer)

32.1		Written Statement of the Chief Executive Officer, Pursuant to 18 U.S.C. Section 1350

32.2		Written Statement of the Chief Financial Officer, Pursuant to 18 U.S.C. Section 1350

(b) Reports on Form 8-K during the fourth quarter

SouthFirst filed a report on Form 8-K on December 21, 2004 announcing that the Office of Thrift Supervision has agrees to rescind the Supervisory Agreement dated March 22, 2002, by and between First Federal of the South and the Office of Thrift Supervision, effective as December 14, 2004.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Fees billed by our independent accounting firm, Jones & Kirkpatrick, P.C., for audit services, SEC compliance reviews and tax preparation services for the SouthFirst were as follows, for the fiscal years ending September 30, 2004 and 2003:


	Audit		Audit-Related		Tax		Other		Total
	Fees		Fees(1)		Fees(2)		Fees (3)		Fees
Fiscal Year 2004	$	109,685	$	29,550	$	10,100	$	—	$	149,335
Fiscal Year 2003	$	91,988	$	24,862	$	10,190	$	2,470	$	129,510

(1) Audit related fees are for SEC compliance reviews of Form 10-QSB.

(2) Tax fees are for preparation of federal and state income tax returns.

(3) “Other Fees” included primarily assistance with OTS accounting consultation. No financial information systems implementation or design services were rendered by Jones & Kirkpatrick, P.C. during fiscal year 2004 or 2003.

In addition to the foregoing, Jones & Kirkpatrick, P.C., performed audit services and tax preparation services for Pension & Benefit and was paid as follows:


	Audit		Tax		Total
	Fees		Fees		Fees
Fiscal Year 2004	$	9,000	$	185	$	9,185
Fiscal Year 2003	$	5,500	$	185	$	8,685

Effective May 6, 2003, the Securities and Exchange Commission adopted rules that require that before our independent auditor is engaged by us to render any auditing or permitted non-audit related service, the engagement be:

• approved by our audit committee; or

• entered into pursuant to pre-approval policies and procedures established by the audit committee, provided the policies and procedures are detailed as to the particular service, the audit committee is informed of each service, and such policies and procedures do not include delegation of the audit committee’s responsibilities to management.

The audit committee pre-approves all services provided by our independent auditors, including those set forth above. The audit committee has considered the nature and amount of fees billed by Jones & Kirkpatrick, P.C. and believes that the provision of services for activities unrelated to the audit is compatible with maintaining Jones & Kirkpatrick, P.C.’s independence.

[signatures on following page]

SIGNATURES

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Sylacauga, State of Alabama, on the 29^th day of December 2004.


		SOUTHFIRST BANCSHARES, INC.

		By:		/s/ Joe K. McArthur

				Joe K. McArthur
				Chief Executive Officer

In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date
/s/ Joe K. McArthur	Chief Executive Officer &
	Director (principal executive
Joe K. McArthur	officer)	December 29, 2004

/s/ Sandra H. Stephens	Executive Vice President,
	Chief Operating Officer,
Sandra H. Stephens	Secretary & Director	December 29, 2004

/s/ Janice Browning	Controller, Treasurer
	(Principal Accounting
Janice Browning	Officer)	December 29, 2004

/s/ Allen Gray McMillan, III	Chairman and Director	December 29, 2004

Allen Gray McMillan, III

/s/ J. Malcomb Massey	President and Director	December 29, 2004

J. Malcomb Massey

/s/ Kenneth E. Easterling	Director	December 29, 2004

Kenneth E. Easterling

/s/ H. David Foote, Jr.	Director	December 29, 2004

H. David Foote, Jr.

/s/ L. Neal Bice	Director	December 29, 2004

L. Neal Bice

/s/ Donald R. Hardy	Director	December 29, 2004

Donald R. Hardy

REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM

November 10, 2004, except for Note 13, as to which the date is December 14, 2004

Board of Directors
SouthFirst Bancshares, Inc.
Sylacauga, Alabama

We have audited the accompanying consolidated statements of financial condition of SouthFirst Bancshares, Inc. (a Delaware corporation) and subsidiaries (the Company) as of September 30, 2004 and 2003, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2004. 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 audits in accordance with the standards of the Public Company Accounting Oversight Board (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 financial position of SouthFirst Bancshares, Inc. and subsidiaries as of September 30, 2004 and 2003, and the consolidated results of their operations and their cash flows for each of the three years in the period ended September 30, 2004, in conformity with accounting principles generally accepted in the United States of America.

As discussed in Note 1 to the consolidated financial statements, on October 1, 2002 the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets.

/s/ Jones & Kirkpatrick, P.C.
Certified Public Accountants
Birmingham, Alabama

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Financial Condition
September 30, 2004 and 2003


	2004			2003
ASSETS
Cash and cash equivalents	$	5,015,108		$	6,049,325
Interest-bearing deposits in other financial institutions		713,807			533,003
Securities available for sale, at fair value		14,180,243			32,599,988
Securities held to maturity (fair value of $15,674,973)		15,081,723			—
Loans receivable, net of allowance for loan losses of $911,964 in 2004 and $1,191,033 in 2003		94,574,236			84,382,703
Loans held for sale at cost (which approximates fair value)		1,092,619			1,107,805
Foreclosed assets, net		514,507			77,680
Premises and equipment, net		4,796,390			4,298,889
Federal Home Loan Bank stock, at cost		1,117,000			1,117,000
Goodwill		543,706			543,706
Accrued interest receivable		625,639			679,402
Other assets		3,278,179			2,264,952

Total Assets	$	141,533,157		$	133,654,453

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Non-interest bearing	$	4,003,251		$	3,657,079
Interest bearing		93,789,575			89,900,902

Total deposits		97,792,826			93,557,981
Advances by borrowers for property taxes and insurance		259,427			213,042
Accrued interest payable		458,017			576,676
Borrowed funds		31,588,773			27,000,861
Accrued expenses and other liabilities		1,078,510			628,522

Total liabilities		131,177,553			121,977,082

Stockholders’ equity:
Common stock, $.01 par value, 2,000,000 shares authorized; 990,241 shares issued and 709,406 shares outstanding in 2004; 989,868 shares issued and 713,944 shares outstanding in 2003;		9,996			9,996
Additional paid-in capital		9,838,965			9,837,058
Treasury stock, at cost (280,835 shares in 2004; 275,924 shares in 2003)		(3,891,155	)		(3,809,839	)
Deferred compensation on common stock employee benefit plans		(159,427	)		(183,179	)
Shares held in trust, at cost (9,402 shares in 2004 and 9,775 shares in 2003)		(103,483	)		(107,161	)
Retained earnings		5,195,161			6,148,255
Accumulated other comprehensive income (loss)		(534,453	)		(217,759	)

Total stockholders’ equity		10,355,604			11,677,371

Total Liabilities and Stockholders’ equity	$	141,533,157		$	133,654,453

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Operations
Years Ended September 30, 2004, 2003 and 2002


	2004		2003		2002
Interest and dividend income:
Interest and fees on loans	$	5,435,692	$	5,948,317	$	6,827,657
Interest and dividend income on securities available for sale		1,302,001		1,397,105		1,600,346
Interest and dividend income on securities held to maturity		345,472		—		—
Other interest income		37,776		91,223		99,189

Total interest and dividend income		7,120,941		7,436,645		8,527,192

Interest expense:
Interest on deposits		1,734,850		2,520,828		3,490,715
Interest on borrowed funds		1,077,477		1,023,365		1,239,081

Total interest expense		2,812,327		3,544,193		4,729,796

Net interest income		4,308,614		3,892,452		3,797,396
Provision for loan losses (benefit)		1,356,937		549,603		(667,650	)

Net interest income after provision for loan losses		2,951,677		3,342,849		4,465,046

Other income:
Service charges and other fees		546,035		568,701		447,728
Employee benefit trust and consulting fees		1,582,057		1,231,622		1,172,628
Gain on sale of loans		719,389		1,170,453		611,971
Gain on sales and calls of securities available-for-sale		83,614		238,291		236,414
Gain on sale of premises and equipment		927		7,759		162
Insurance benefits in excess of related compensation costs		—		—		186,727
Net premium on transfer of deposits		—		249,769		—
Other		307,491		275,149		377,824

Total other income		3,239,513		3,741,744		3,033,454

(Continued)

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Operations (Continued)
Years Ended September 30, 2004, 2003 and 2002


	2004			2003		2002
Other expenses:
Compensation and benefits	$	4,331,282		$	4,279,501	$	3,635,805
Net occupancy expense		419,776			392,354		358,244
Furniture and fixtures		505,295			451,577		459,314
Data processing		382,885			259,685		317,093
Office supplies and expenses		442,189			436,677		420,272
Deposit insurance premiums		102,938			107,706		85,610
Legal expenses		156,519			214,261		404,203
Other professional services		225,212			259,913		286,068
Goodwill amortization		—			—		53,946
Other		476,220			495,737		386,176

Total other expenses		7,042,316			6,897,411		6,406,731

Income (loss) before income taxes		(851,126	)		187,182		1,091,769
Income tax expense (benefit)		(323,191	)		71,318		420,964

Net income (loss)	$	(527,935	)	$	115,864	$	670,805

Earnings (loss) per share:
Basic	$	(0.74	)	$	0.16	$	0.82
Diluted	$	(0.71	)	$	0.15	$	0.82
Weighted average shares outstanding:
Basic		709,106			744,641		819,260
Diluted		738,511			759,550		822,631

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity
Years Ended September 30, 2004, 2003 and 2002


									Deferred									Accumulated
									Compensation									Other
									on Common									Compre-
			Additional						Stock									hensive
	Common		Paid-in			Retained			Employee			Shares Held			Treasury			Income
	Stock		Capital			Earnings			Benefit Plans			in Trust			Stock			(Loss)			Total
Balance — September 30, 2001	$	9,996	$	9,814,268		$	6,249,938		$	(383,442	)	$	(126,411	)	$	(1,648,439	)	$	366,629		$	14,282,539

Comprehensive Income:
Net income				—			—			670,805			—			—			—			670,805
Change in net unrealized gain (loss) on available-for-sale securities, net of reclassification adjustments and tax effect		—		—			—			—			—			—			63,091			63,091

Total comprehensive income																						733,896

Release of unallocated ESOP shares		—		5,419			—			55,871			—			—			—			61,290
Acquisition of ESOP shares		—		—			—			(188	)		—			—			—			(188	)
Vesting of shares on Management Recognition Plans		—		(11	)		—			3,047			—			—			—			3,036
Issue of Management Recognition Plan shares		—		—			—			(19,250	)		19,250			—			—			—
Vesting of deferred compensation shares		—		—			—			19,902			—			—			—			19,902
Acquisition of Treasury stock		—		—			—			—			—			(758,792	)		—			(758,792	)
Cash dividends declared ($ .60/share)		—		—			(463,300	)		—			—			—			—			(463,300	)

Balance — September 30, 2002		9,996		9,819,676			6,457,443			(324,060	)		(107,161	)		(2,407,231	)		429,720			13,878,383

Comprehensive Income (Loss):
Net income		—		—			115,864			—			—			—			—			115,864
Change in net unrealized gain (loss) on available-for-sale securities, net of reclassification adjustments and tax effect		—		—			—			—			—			—			(647,479	)		(647,479	)

Total comprehensive loss																						(531,615	)

Release of unallocated ESOP shares		—		16,349			—			58,730			—			—			—			75,079
Acquisition of ESOP shares										58,399						58,363	)					36
Vesting of shares on Management Recognition Plans		—		1,033			—			3,850			—			—			—			4,883
Vesting of deferred compensation shares		—		—			—			19,902			—			—			—			19,902
Acquisition of Treasury stock		—		—			—			—			—			(1,344,245	)		—			(1,344,245	)
Cash dividends declared ($ .60/share)		—		—			(425,052	)		—			—			—			—			(425,052	)

Balance — September 30, 2003		9,996		9,837,058			6,148,255			(183,179	)		(107,161	)		(3,809,839	)		(217,759	)		11,677,371

(Continued)

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity (Continued)
Years Ended September 30, 2004, 2003 and 2002


								Deferred									Accumulated
								Compensation									Other
								on Common									Compre-
			Additional					Stock									hensive
	Common		Paid-in		Retained			Employee			Shares Held			Treasury			Income
	Stock		Capital		Earnings			Benefit Plans			in Trust			Stock			(Loss)			Total
Balance — September 30, 2003	$	9,996	$	9,837,058	$	6,148,255		$	(183,179	)	$	(107,161	)	$	(3,809,839	)	$	(217,759	)	$	11,677,371

Comprehensive Income (Loss):
Net income (loss)		—		—		(527,935	)		—			—			—			—			(527,935	)
Change in net unrealized gain (loss) on available-for-sale securities, net of reclassification adjustments and tax effect		—		—		—			—			—			—			(316,694	)		(316,694	)

Total comprehensive loss																					(844,629	)

Release of unallocated ESOP shares		—		—		—			—			—			—			—			—
Cancellation of shares held in trust		—		—		—			—			3,678			—			—			3,678
Vesting of shares on Management Recognition Plans		—		1,907		—			3,850			—			—			—			5,757
Vesting of deferred compensation shares		—		—		—			19,902			—			—			—			19,902
Acquisition of Treasury stock																					(81,316	)
Cash dividends declared ($ .60/share)		—		—		(425,159	)		—			—			—			—			(425,159	)

Balance — September 30, 2004	$	9,996	$	9,838,965	$	5,195,161		$	(159,427	)	$	(103,483	)	$	(3,891,155	)	$	(534,453	)	$	10,355,604

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows
Years Ended September 30, 2004, 2003 and 2002


	2004			2003			2002
OPERATING ACTIVITIES
Net income (loss)	$	(527,935	)	$	115,864		$	670,805
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Provision for loan losses (benefit)		1,356,937			549,603			(667,650	)
Depreciation and amortization		377,681			331,198			406,184
Proceeds from sales of loans		31,096,549			55,989,812			27,159,678
Loans originated for sale		(30,361,974	)		(53,634,764	)		(28,567,757	)
Gain on sale of loans		(719,389	)		(1,170,453	)		(611,971	)
Gain on sale of premises and equipment		(927	)		(7,759	)		(162	)
Gain on sale of affiliate		(25,000	)		—			—
Loss on sale of foreclosed assets		6,770			69,885			41,566
Compensation expense on ESOP and MRPs		25,659			99,864			84,228
Gain on sale of securities available-for-sale		(83,614	)		(238,291	)		(236,414	)
Net amortization of premium on securities		7,906			46,663			38,126
(Increase) decrease in accrued interest receivable		53,763			54,766			226,057
(Increase) decrease in other assets		(1,013,227	)		(156,421	)		(1,105,037	)
Increase (decrease) in accrued interest payable		(118,659	)		(249,174	)		(502,333	)
Increase (decrease) in accrued expenses and other liabilities		644,087			(67,463	)		535,771

Net cash provided (used) by operating activities		718,627			1,733,330			(2,528,909	)

INVESTING ACTIVITIES
Net change in interest-bearing deposits in other financial institutions		(180,804	)		350,259			15,271
Proceeds from calls and maturities of securities available-for-sale		2,931,352			15,438,689			3,559,206
Proceeds from sales of securities available-for-sale		11,541,353			16,589,714			18,598,208
Proceeds from redemption of Federal Home Loan Bank stock		—			1,112,800			—
Purchase of securities available-for-sale		(11,569,768	)		(38,713,047	)		(15,572,588	)
Net (increase) decrease in loans		(12,088,252	)		7,443,226			8,441,922
Proceeds from sale of premises and equipment		10,377			452,058			10,095
Purchase of premises and equipment		(884,632	)		(207,151	)		(463,528	)
Proceeds from sale of foreclosed assets		96,185			541,708			512,628
Proceeds from sale of affiliate		25,000			—			—

Net cash provided (used) by investing activities		(10,119,189	)		3,008,256			15,101,214

(Continued)

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows (Continued)
Years Ended September 30, 2004, 2003 and 2002


	2004			2003			2002
FINANCING ACTIVITIES
Net increase (decrease) in demand accounts and savings accounts	$	1,156,098		$	(390,261	)	$	1,358,136
Net increase (decrease) in certificates of deposit		3,078,747			(2,535,020	)		(3,930,454	)
Proceeds from borrowed funds		70,534,271			18,588,000			32,091,611
Repayment of borrowed funds		(65,946,359	)		(20,644,750	)		(38,639,000	)
Cash dividends paid		(425,159	)		(425,052	)		(463,300	)
Acquisition of ESOP and MRP shares		3,678			36			(188	)
Acquisition of treasury stock		(81,316	)		(1,344,245	)		(758,792	)
(Increase) decrease in advances by borrowers for property taxes and insurance		46,385			(63,867	)		(127,606	)

Net cash provided (used) by financing activities		8,366,345			(6,815,159	)		(10,469,593	)

Increase (decrease) in cash and cash equivalents		(1,034,217	)		(2,073,573	)		2,102,712
Cash and cash equivalents — beginning of year		6,049,325			8,122,898			6,020,186

Cash and cash equivalents — end of year	$	5,015,108		$	6,049,325		$	8,122,898

Supplemental information on cash payments:
Interest paid	$	2,930,986		$	3,793,367		$	5,232,129

Income taxes paid	$	148,326		$	210,320		$	31,857

Supplemental information on non-cash transactions:
Real estate owned, obtained through foreclosure	$	539,782		$	609,290		$	376,294

See accompanying notes to consolidated financial statements.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

17. PARENT COMPANY

The condensed financial information for SouthFirst Bancshares, Inc. (Parent Company) is presented below:

Parent Company
Condensed Balance Sheets
September 30, 2004 and 2003


	2004			2003
ASSETS
Cash and cash equivalents	$	49,303		$	35,351
Securities available for sale		12,000			5,400
Investment in financial institution subsidiary		10,388,146			12,793,544
Investment in other subsidiaries		1,044,303			859,591
Other assets		24,044			78,805

Total Assets	$	11,517,796		$	13,772,691

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Borrowed funds	$	902,861		$	1,917,861
Other liabilities		259,331			177,459

Total liabilities		1,162,192			2,095,320

Stockholders’ equity:
Common stock, $.01 par value, 2,000,000 shares authorized; 990,241 shares issued and 709,406 shares outstanding in 2004 989,868 shares issued and 713,944 shares outstanding in 2003		9,996			9,996
Additional paid-in capital		9,838,965			9,837,058
Treasury stock		(3,891,155	)		(3,809,839	)
Deferred compensation on common stock employee benefit plans		(159,427	)		(183,179	)
Shares held in trust		(103,483	)		(107,161	)
Retained earnings		5,195,161			6,148,255
Accumulated other comprehensive income (loss)		(534,453	)		(217,759	)

Total stockholders’ equity		10,355,604			11,677,371

Total Liabilities and Stockholders’ Equity	$	11,517,796		$	13,772,691

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

17. PARENT COMPANY (Continued)

Parent Company
Condensed Statements of Operations
Years Ended September 30, 2004, 2003 and 2002


	2004			2003			2002
Cash dividends from financial institution subsidiary	$	1,500,000		$	500,000		$	1,100,000
Interest and dividend income		—			10,986			31,785
Gain (loss) on sale of securities available-for-sale		—			(78,610	)		47,553
Gain on sale of affiliate		25,000			—			—
Commission income		739			95,015			—

Total income		1,525,739			527,391			1,179,338

Expenses:
Interest on borrowed funds		90,774			67,914			130,208
Compensation and benefits		44,000			62,000			44,585
Management fee		30,000			30,000			30,000
Other		67,470			70,029			13,800

		232,244			229,943			218,593

Income before income taxes		1,293,495			297,448			960,745
Income tax benefit		78,472			76,971			47,913

Income before equity in undistributed earnings of subsidiaries		1,371,967			374,419			1,008,658

Equity in undistributed earnings of subsidiaries (dividends in excess of earnings):
Financial institution		(2,085,177	)		(335,185	)		(364,604	)
Other		185,275			76,630			26,751

		(1,899,902	)		(258,555	)		(337,853	)

Net income (loss)	$	(527,935	)	$	115,864		$	670,805

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes To Consolidated Financial Statements

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    This summary of significant accounting policies of SouthFirst Bancshares, Inc. (the “Company”) is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of the Company’s management who is responsible for the integrity and objectivity of the financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.

    Basis of Presentation – The accompanying consolidated financial statements include the accounts of SouthFirst Bancshares, Inc. (the Corporation) and its wholly-owned subsidiaries, First Federal of the South (the Bank) (a wholly-owned subsidiary of SouthFirst Bancshares, Inc.), Pension & Benefit Trust Company (a wholly-owned subsidiary of First Federal of the South, which is an employee benefits consulting company), SouthFirst Mortgage, Inc. (a wholly-owned subsidiary of First Federal of the South) and SouthFirst Financial Services, Inc. (a wholly-owned subsidiary of SouthFirst Bancshares, Inc.), collectively as the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

    Business – The Company provides a full range of banking services to individual and corporate customers in its primary market area of the cities of Sylacauga, Clanton and Talladega in the state of Alabama, and provides lending services in Birmingham, Alabama. The Company is subject to competition from other financial institutions. The Company is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.

    Use of Estimates – The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with generally accepted accounting principles and with general practice within the savings and loan industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the period. Actual results could differ significantly from those estimates.

    Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for properties collateralizing significant troubled loans.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Significant Group Concentrations of Credit Risk – A substantial portion of the Company’s loans are secured by real estate in the Company’s primary market area. Note 3 discusses the types of lending that the Company engages in. The Company does not have any significant concentration to any one industry or customer.

    Cash and Cash Equivalents – For purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from other depository institutions.

    Interest-bearing Deposits in Other Financial Institutions – Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.

    Securities – The Company classifies its securities in one of the following three categories: (i) held-to-maturity securities, (ii) securities available-for-sale, and (iii) trading account securities. Securities held to maturity represent securities which management has both the positive intent and ability to hold to maturity. These securities are reported at cost adjusted for amortization of premiums and accretion of discounts using the interest method. Securities available-for-sale represent securities which management may decide to sell prior to maturity for liquidity, tax planning or other valid business purposes. Available-for-sale securities are reported at fair value with any unrealized gains or losses excluded from earnings and reflected as a net amount in a separate component of stockholders’ equity until realized. Trading account securities represent securities which management has purchased and is holding principally for the purpose of selling in the near term. Trading account securities are reported at fair value with any unrealized gains or losses included in earnings.

    Declines in fair value of securities (available-for-sale or held-to-maturity) that are considered other than temporary are charged to securities losses, reducing the carrying value of such securities. Gains or losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and are shown separately in non-interest income in the consolidated statements of operations. No securities were classified as trading account securities as of September 30, 2004 or 2003.

    The stock of the Federal Home Loan Bank has no quoted fair value and no ready market exists. The investment in the stock is required of insured institutions that utilize the services of the Federal Home Loan Bank. The Federal home Loan Bank periodically reviews the required investment and will redeem any excess stock at cost. The Federal Home Loan Bank will also purchase the stock at its cost basis from the Company in the event the Company ceases to utilize the services of the Federal Home Loan Bank.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Loans – The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout the Company’s primary market area. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

    Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance.

    The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

    All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

    Allowance for Loan Losses – The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

    The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for loan losses and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

    Loan Origination Fees, Premiums and Discounts on Loans, Mortgage-Backed Securities and Collateralized Mortgage Obligations – Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the loan yields using the interest method. Premiums or discounts on loans, mortgage-backed securities, and collateralized mortgage obligations are amortized over the estimated lives of the related mortgage loans, adjusted for prepayments, using a method approximating the interest method. Premiums and discounts on loans, mortgage-backed securities, and collateralized mortgage obligations were insignificant at September 30, 2004.

    Loans Held for Sale – Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains or losses on loan sales are recognized at the time of sale and are determined by the difference between net sales proceeds and the carrying value of the loans sold.

    The Company enters into interest rate locks, where customers have locked into mortgages at a set interest rate, and forward sales commitments, which are sales of mortgage loans to third parties at a specified price. These interest rate locks and forward sales commitments qualify as derivatives; however, the change in fair value of these derivatives during the year did not have a material impact on the Company’s financial position or results of operations.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Goodwill — In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, which changed the accounting for goodwill from an amortization method to an impairment only approach. Upon adoption of SFAS No. 142 on October 1, 2002, the Company ceased amortizing goodwill. Based upon the initial goodwill impairment test completed October 1, 2002, as required by SFAS No. 142, no goodwill impairment was indicated. In addition, the goodwill impairment testing completed at September 30, 2004 and 2003 indicated there was no goodwill impairment. Therefore, the Company had no changes in the carrying amount of goodwill from September 30, 2002 to September 30, 2004.

    The following is a reconciliation of net income (loss), basic earnings (loss) per share and diluted earnings (loss) per share with and without goodwill amortization:


	For the Year Ended September 30,
	2004			2003		2002
Reported net income (loss)	$	(527,935	)	$	115,864	$	670,805
Add back: Goodwill amortization (net of taxes)		—			—		33,447

Adjusted net income (loss)	$	(527,935	)	$	115,864	$	704,252

Basic earnings (loss) per share:
Reported net income (loss)	$	(.74	)	$	.16	$	.82
Goodwill amortization		.00			.00		.04

Adjusted net income (loss)	$	(.74	)	$	.16	$	.86

Diluted earnings (loss) per share:
Reported net income (loss)	$	(.71	)		.15		.82
Goodwill amortization		.00			.00		.04

Adjusted net income (loss)	$	(.71	)		.15		.86

Foreclosed Assets – Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Cost related to the development and improvement of property are capitalized, where as costs relating to the holding of the property are expensed.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Long-Lived Assets — Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation computed on a straight-line basis over the estimated service lives of the related assets (30 to 50 years for buildings and 3 to 10 years for equipment). Expenditures for maintenance and repairs are charged to operations as incurred; expenditures for renewals and improvements are capitalized and written off through depreciation and amortization charges. Equipment retired or sold is removed from the asset and related accumulated depreciation amounts and any gain or loss resulting therefrom is reflected in the accompanying consolidated statements of operations.

    The Company continually evaluates whether events and circumstances have occurred that indicate such long-lived assets have been impaired. Measurement of any impairment of such long-lived assets is based on those assets’ fair values and is recognized through a valuation allowance with the resulting charge reflected in the accompanying consolidated statements of operations. There were no impairment losses recorded during any period reported herein.

    Stock-Based Compensation — The Company applies Accounting Principles Bulletin (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for employee stock compensation plans and, accordingly, does not recognize compensation cost for stock options granted when the option price is greater than or equal to the underlying stock price. This accounting method is referred to as the intrinsic value method. The Company follows the pro-forma disclosures of Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, using the fair value method of accounting for stock-based compensation.

    Income Taxes — The Company provides for income taxes based upon pretax income, adjusted for permanent differences between reported and taxable earnings. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.

    Advertising — Advertising costs are charged to operations when incurred. Advertising expense was $90,625, $84,259 and $59,431 for the years ended September 30, 2004, 2003 and 2002, respectively.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Earnings per Share – Basic earnings per share of common stock has been computed on the basis of the weighted-average number of shares of common stock outstanding. Fully diluted earnings per share reflects the potential dilution that could occur if the Company’s outstanding options to acquire common stock were exercised. The exercise of these options accounts for the differences between basic and diluted weighted average shares outstanding. Options on 60,834 shares in 2003 and 2002 of common stock were not included in computed diluted earnings per share because their effects were antidilutive.

    Reclassification — Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported stockholders’ equity or net income during the periods involved.

    Comprehensive Income – Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

    The components of other comprehensive income and related tax effects are as follows:


	2004			2003			2002
Unrealized holding gains (losses) on available- for-sale securities arising during the period	$	(453,227	)	$	(806,032	)	$	338,161
Amortization of discount of securities transferred to held to maturity		26,048			—			—
Reclassification adjustment for losses (gains) realized in income		(83,614	)		(238,291	)		(236,414	)

Net unrealized gains (losses)		(510,793	)		(1,044,323	)		101,747
Tax effect		194,099			396,844			(38,656	)

Net-of-tax amount	$	(316,694	)	$	(647,479	)	$	63,091

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

    Recent Accounting Pronouncements — In March 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan Commitments, which summarized the views of the staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. The SAB requires that the fair value measurement of a loan commitment that is accounted for as a derivative includes only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected cash flows related to the customer relationship or loan servicing. This SAB is effective for loan commitments entered into after March 31, 2004. The Company adopted SAB 105 on April 1, 2004, and the effect was not material.

    In March 2004, the FASB’s Emerging Issues Task Force reached a consensus of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other-than-temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance provided to evaluate whether an impairment is other than temporary has been delayed by FASB Staff Position EITF Issue 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, posted September 30, 2004. The delay of the effective date for paragraphs 10-20 will be superseded concurrent with the final issuance of proposed FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, while the disclosure requirements are effective for annual reporting periods ending after December 15, 2003. The Company has adopted the disclosure requirements of this EITF, and is currently evaluating the impact of the adoption of the accounting guidance in the EITF.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

2. SECURITIES

Debt and equity securities have been classified in the consolidated statements of financial condition according to management’s intent. The carrying amount of securities and their approximate fair value at September 30 were as follows:


	Amortized		Gross Unrealized		Gross Unrealized
	Cost		Gains		Losses			Fair Value
Available-for-Sale Securities
September 30, 2004:
U.S. Government agency	$	4,588,937	$	444	$	(56,476	)	$	4,532,905
Collateral mortgage obligations (CMO’s)		875,317		6,320		—			881,637
Mortgage-backed securities		8,252,500		97,855		—			8,350,355
Corporate obligations		400,000		4,381		(1,035	)		403,346
Other common stock		9,000		3,000		—			12,000

	$	14,125,754	$	112,000	$	(57,511	)	$	14,180,243

September 30, 2003:
U.S. Government agency	$	23,236,750	$	109,238	$	738,052		$	22,607,936
Collateral mortgage obligations (CMO’s)		1,439,648		16,441		—			1,456,089
Mortgage-backed securities		7,915,826		259,598		—			8,175,424
Corporate obligations		350,000		6,131		992			355,139
Other common stock		9,000		—		3,600			5,400

	$	32,951,224	$	391,408	$	742,644		$	32,599,988

Held-to-Maturity Securities
September 30, 2004:
U.S. Government agency	$	15,081,723	$	593,250	$	—		$	15,674,973

The Company sold securities available-for-sale for total proceeds of $11,541,353, $16,589,714 and $18,598,208, resulting in gross realized gains of $83,614, $238,291 and $236,414 in 2004, 2003 and 2002, respectively.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

2.   SECURITIES (Continued)

    At September 30, 2003, certain securities classified as available-for-sale were written down to their estimated realizable values because, in the opinion of management, the decline in market value of those securities was considered to be other than temporary.

    The scheduled maturities at September 30, 2004 of securities (other than equity securities) by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the borrower may have the right to call or prepay obligations with or without call or prepayment penalties.


	Available-for-Sale				Held-to-Maturity
	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	100,000	$	100,675	$	—	$	—
Due from one to five years		1,120,790		1,132,726		—		—
Due from five to ten years		4,954,451		5,022,568		—		—
Due after ten years		7,941,513		7,912,274		15,081,723		15,674,973

	$	14,116,754	$	14,168,243	$	15,081,723	$	15,674,973

Securities available-for-sale with a carrying amount of approximately $3,714,000 and $2,535,000 at September 30, 2004 and 2003, respectively, were pledged to secure public deposits as required by law and for other purposes required or permitted by law.

In May 2004, the Company transferred certain securities from the available-for-sale to held-to-maturity category. The securities were transferred at fair value on the date of transfer. The unrealized loss at the date of transfer was $942,565 and continues to be reported in accumulated other comprehensive income (loss) in stockholders’ equity. That amount is being amortized over the remaining lives of the securities as an adjustment of yield. The amortization of the unrealized loss offsets the effect of the amortization of the discount for those held-to-maturity securities. The amount of such amortization was $26,048 for the year ended September 30, 2004, and the unamortized balance of the unrealized losses, net of applicable income taxes which is included in stockholders’ equity was $568,241 at September 30, 2004.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

2. SECURITIES (Continued)

The following table shows the Company’s combined investments’ gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2004:


	Less Than 12 Months					More Than 12 Months					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Gross Losses			Fair Value		Gross Losses			Fair Value		Gross Losses
U.S. Government agency	$	6,907,740	$	(67,260	)	$	13,249,694	$	(312,483	)	$	20,157,434	$	(379,743	)
Corporate obligations		148,965		(1,035	)		—		—			148,965		(1,035	)

	$	7,056,705	$	(68,295	)	$	13,249,694	$	(312,483	)	$	20,306,399	$	(380,778	)

At September 30, 2004, the Company had five individual available-for-sale securities and four held-to-maturity securities that were in an unrealized loss position. Of those, five had been in an unrealized loss position for longer than 12 months. The unrealized losses on the Company’s investment in U.S. Government agency securities were caused by interest rate increases. The contractual term of these investments do not permit the issuer to settle the securities at a price less than the par value of the investments (which approximate the original purchase price). Because the Company has the ability and intent to hold their investments until a recovery of fair value, which may be maturity, the Company does not consider these investments to be other than temporarily impaired at September 30, 2004. The unrealized losses in the Company’s investment in corporate obligations are deemed not to be other than temporary impairment and are primarily due to the fact that these securities have experienced volatility in their market prices as a result of current market conditions, with no credit concerns related to the entities that issued the securities. The Company does not expect any permanent impairment to develop related to these securities.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

3. LOANS

Loans consisted of the following at September 30, 2004 and 2003:


	2004		2003
Real estate mortgage loans:
First mortgage loans:
Single family residential	$	44,904,742	$	39,838,693
Multi-family and commercial real estate		14,002,478		11,407,220
Second mortgage loans		16,670,204		13,404,006
1-4 family construction loans		16,106,277		16,264,065
Savings account loans		768,088		881,192
Installment loans		3,192,169		3,920,955

		95,643,958		85,716,131

Deduct:
Deferred loan fees		157,758		142,395
Allowance for loan losses		911,964		1,191,033

		1,069,722		1,333,428

Total loans receivable – net	$	94,574,236	$	84,382,703

Activity in the allowance for loan losses was as follows for the years ended September 30, 2004, 2003 and 2002:


	2004			2003			2002
Beginning balance	$	1,191,033		$	854,013		$	1,577,952
Provision (benefit) charged to income		1,356,937			549,603			(667,650	)
Recovery of amounts charged off in prior years		28,432			27,930			22,585
Loans charged off		(1,664,438	)		(240,513	)		(78,874	)

Ending balance	$	911,964		$	1,191,033		$	854,013

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

3. LOANS (Continued)

The following is a summary of information pertaining to impaired loans:


	September 30,
	2004		2003
Impaired loans without a valuation allowance	$	—	$	—
Impaired loans with a valuation allowance		618,035		2,393,009

Total impaired loans	$	618,035	$	2,393,009

Valuation allowance related to impaired loans	$	393,203	$	895,856


	Years Ended September 30,
	2004		2003		2002
Average investment in impaired loans	$	821,854	$	413,387	$	890,066
Interest income recognized on impaired loans		25,294		23,068		65,022
Interest income recognized on a cash basis on impaired loans		25,294		23,068		61,994

    Interest on impaired loans is generally recorded on a “cash basis” and is included in earnings only when actually received in cash.

    At September 30, 2004 and 2003, the total recorded investment in loans on non-accrual amounted to approximately $1,194,034 and $2,149,000, respectively, and the total recorded investment in loans past due ninety days or more and still accruing interest was $0 for each year.

    In January 2004, the Company agreed to modify the terms of several loans to one customer. The modified terms included a reduction in interest rates from an original range of prime plus .50% to 15% to a restructured range of 7% to 10%. Additional funds of approximately $55,000 were advanced on the restructuring and additional collateral was received for those advances. The recorded investment in the loans was approximately $210,000 at September 30, 2004. Interest income of approximately $13,000 has been recorded in 2004 on the restructured note. Had the terms of the note not been modified, interest income of approximately $14,000 would have been recorded.

    The Company sells loans to third party investors with limited recourse, primarily related to prepayment. The total amount of recourse liability at September 30, 2004 was approximately $93,000. Because historical losses related to these guarantees have been insignificant, no liability has been recorded for these at September 30, 2004 or 2003.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

4. PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows at September 30, 2004 and 2003:


	2004		2003
Land	$	1,798,595	$	1,610,559
Buildings and improvements		3,162,549		3,136,659
Furniture, fixtures and equipment		1,363,035		830,695
Automobiles		191,940		179,620

		6,516,119		5,757,533
Less: Accumulated depreciation		1,719,729		1,458,644

Premises and equipment, net	$	4,796,390	$	4,298,889

    Depreciation expense charged to operations was $377,681, $331,198 and $352,238 in 2004, 2003 and 2002, respectively.

5.   ACCRUED INTEREST RECEIVABLE

    Accrued interest receivable consists of the following at September 30, 2004 and 2003:


	2004		2003
Loans	$	339,002	$	338,537
Investment securities available-for-sale		286,637		340,865

Total accrued interest receivable	$	625,639	$	679,402

6. INVESTMENTS IN AFFILIATE

In March 1995, the Company obtained a 50% ownership interest in Magnolia Title Services, Inc. (Magnolia) for an investment of $100,000. Magnolia provides title insurance and related services to various borrowers and lenders in the state of Alabama. The Company accounted for this investment under the equity method. As of September 30, 2003, the Company had written down its investment to $0. In November 2003, the Company sold its investment for $25,000, thereby realizing a gain of $25,000, which is included in other income.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

7. LEASES

The Company leases certain real estate and office equipment under operating leases expiring in various years through 2008. Minimum future rental payments under non-cancellable operating leases having remaining terms in excess of one year as of September 30, 2004 are as follows:


Year Ending
September 30,	Amount
2005	$	134,034
2006		112,047
2007		81,745
2008		3,489

Total	$	331,315

    Lease expense charged to operations was $140,637, $127,930 and $101,768 for the years ended September 30, 2004, 2003 and 2002, respectively.

    The Company is also the lessor of a portion of its office space under a lease expiring in 2007.

    Minimum future rentals to be received on non-cancelable leases as of September 30, 2004 for each of the next five years and in the aggregate are as follows:


Year Ending
September 30,	Amount
2005	$	12,000
2006		12,000
2007		12,000
2008		3,000

Total minimum future rentals	$	39,000

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

8. DEPOSITS

An analysis of deposit accounts at the end of the period is as follows at September 30, 2004 and 2003:


	2004		2003
Demand accounts:
Non interest-bearing checking accounts	$	4,003,251	$	3,657,079
Interest-bearing:
NOW accounts		10,661,374		10,063,517
Money market demand		230,010		155,217

Total demand accounts		14,894,635		13,875,813
Statement savings accounts		11,633,972		11,496,696
Certificate accounts		71,264,219		68,185,472

Total	$	97,792,826	$	93,557,981

Certificate accounts greater than or equal to $100,000 were $34,345,365 and $25,253,505 at September 30, 2004 and 2003, respectively. Overdrafts of demand deposits in the amounts of $43,356 and $163,042 have been reclassified as loan balances at September 30, 2004 and 2003, respectively.

Scheduled maturities of certificate accounts were as follows at September 30, 2004:


Year	Amount
2005	$	49,885,296
2006		11,074,207
2007		4,692,841
2008		1,804,054
2009		1,377,821
Thereafter		2,430,000

Total	$	71,264,219

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

8. DEPOSITS (Continued)

Interest expense on deposits for the years ended September 30, 2004, 2003 and 2002 was as follows:


	2004		2003		2002
Demand accounts	$	19,457	$	63,232	$	143,538
Statement savings accounts		25,921		74,506		179,579
Certificate accounts		1,689,472		2,383,090		3,167,598

Total	$	1,734,850	$	2,520,828	$	3,490,715

9. BORROWED FUNDS

Federal Home Loan Bank Advances
The Company was liable to the Federal Home Loan Bank of Atlanta on the following advances at September 30, 2004 and 2003:


Maturity Date	Callable Date	Type	Rate at 9/30			2004			2003
April 2004		Adjustable		1.11	%	$	—		$	4,000,000
July 2004		Adjustable		1.21	%		—			1,670,000
April 2005		Adjustable		1.80	%		4,000,000			—
May 2005		Adjustable		2.11	%		1,670,000			1,670,000
March 2010	December 2004	Fixed Rate		5.88	%		5,000,000			5,000,000
November 2010	November 2004	Fixed Rate		5.43	%		5,000,000			5,000,000
January 2011	October 2004	Fixed Rate		4.65	%		2,500,000			2,500,000
January 2011	January 2006	Fixed Rate		5.30	%		2,500,000			2,500,000

						$	20,670,000		$	22,340,000

Weighted average rate							4.46	%		4.04	%

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

9.   BORROWED FUNDS (Continued)

    At September 30, 2004 and 2003, the advances were collateralized by first-mortgage residential loans with carrying values of approximately $42,907,000 and $33,349,000, respectively

    On April 15, 2002, the Bank was notified that the amount available under its credit line with the Federal Home Loan Bank of Atlanta had been changed from a variable amount, equal to 30% of total assets to a fixed amount of $22,000,000. This amount was subsequently changed to an amount equal to 10% of its total assets. The Federal Home Loan Bank of Atlanta has notified the Bank that it will not require the Bank’s existing borrowings to be reduced to the new amount prior to the existing advance maturities, but that it will require that any additional borrowing by the Bank be approved through application by the Bank to the Federal Home Loan Bank of Atlanta’s Credit Committee.

    Line of Credit
The Corporation also has a line of credit with a commercial bank. A summary of this line of credit at September 30, 2004 and 2003 is as follows:


	Outstanding Balance
	at September 30,
	2004		2003
$2,500,000 line of credit, due June 1, 2005, interest at prime plus .25% (5.00% at September 30, 2004), secured by the Company’s stock in its subsidiary, First Federal of the South	$	902,861	$	1,917,861

Securities Sold Under Agreements to Repurchase

Securities sold under agreements to repurchase, which are classified as secured borrowings and are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. A summary of such agreements is as follows:

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

9. BORROWED FUNDS (Continued)


	2004		2003
Agreement to repurchase on October 15, 2003, plus interest at 1.23%	$	—	$	1,743,000
Agreement to repurchase on October 20, 2003, plus interest at 1.21%		—		534,109
Agreement to repurchase on October 20, 2003, plus interest at 1.21%		—		465,891
Agreement to repurchase on October 12, 2004, plus interest at 1.76%		1,002,375		—
Agreement to repurchase on October 15, 2004, plus interest at 1.81%		1,476,425		—
Agreement to repurchase on October 20, 2004, plus interest at 1.88%		976,400		—
Agreement to repurchase on October 20, 2004, plus interest at 1.88%		993,037		—
Agreement to repurchase on October 20, 2004, plus interest at 1.88%		983,580		—
Agreement to repurchase on October 22, 2004, plus interest at 1.90%		1,000,000		—
Agreement to repurchase on October 25, 2004, plus interest at 1.85%		1,480,470		—
Agreement to repurchase on November 1, 2004, plus interest at 1.87%		1,103,625		—
Agreement to repurchase on November 1, 2004, plus interest at 1.87%		1,000,000		—

	$	10,015,912	$	2,743,000

Securities underlying such borrowings had a carrying value of $13,441,238 and $4,077,854 at September 30, 2004 and 2003, respectively.

Total borrowed funds at September 30, 2004 have maturities (or call dates) in future years as follows:


Year Ending
September 30,	Amount
2005	$	29,088,773
2006		2,500,000

	$	31,588,773

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

10. INCOME TAX EXPENSE

Income tax expense (benefit) for the years ended September 30, 2004, 2003 and 2002 consists of the following:


	2004			2003			2002
Federal:
Current	$	(513,893	)	$	272,976		$	305,068
Deferred		248,685			(237,810	)		87,242

		(265,208	)		35,166			392,310

State:
Current		(76,269	)		53,638			22,239
Deferred		18,286			(17,486	)		6,415

		(57,983	)		36,152			28,654

Total	$	(323,191	)	$	71,318		$	420,964

Income tax expense includes taxes related to investment security gains in the approximate amount of $32,000, $91,000 and $90,000 in 2004, 2003 and 2002, respectively.

The actual income tax expense differs from the “expected” income tax expense computed by applying the U.S. federal corporate income tax rate of 34% to income before income taxes as follows:


	2004			2003			2002
Computed “expected” income tax expense	$	(289,383	)	$	63,642		$	371,201
Increase (reduction) in income tax resulting from:
Compensation expense for ESOP		—			(8,260	)		(15,734	)
Management Recognition Plan		193			265			329
State tax, net of federal income tax benefit		(44,540	)		12,527			12,937
Other — net		10,539			3,144			52,231

Total	$	(323,191	)	$	71,318		$	420,964

Effective tax rate		38	%		38	%		39	%

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

10. INCOME TAX EXPENSE (Continued)

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at September 30, 2004 and 2003 are as follows:


	2004		2003
Deferred taxes:
Foreclosed real estate gain	$	55,869	$	55,869
Bad debts		223,806		325,666
Accrued salaries		33,305		41,062
Investment in equity of affiliate		—		89,425
Deferred compensation		163,556		136,795
Unrealized loss on securities available-for-sale		328,718		133,478
Other		28,692		—

Total deferred tax assets		833,946		782,295

Deferred tax liabilities:
Management Recognition Plan		1,344		3,446
FHLB stock		237,138		237,138
Depreciation		220,208		135,627
Prepaid expenses		59,423		58,538
Federal/state tax deduction on a cash basis		25,422		1,852
Goodwill		72,845		56,397

Total deferred tax liabilities		616,380		492,998

Net deferred tax asset	$	217,566	$	289,297

There was no valuation allowance at September 30, 2004 or 2003.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

11.   EMPLOYEE BENEFIT PLANS

    Employee Stock Ownership Plan — Effective October 1, 1994, the Corporation established the SouthFirst Bancshares, Inc. Employee Stock Ownership Plan (ESOP). The ESOP is available to all employees who have met certain age and service requirements. Contributions to the plan are determined by the Board of Directors and may be in cash or in common stock. The Corporation loaned $664,000 to the trustee of the ESOP, who purchased, on behalf of the trust of the ESOP, 66,400 shares of the shares sold by the Corporation in the public offering.

    The common stock of the Corporation acquired for the ESOP was held as collateral for the loan and was released for allocation to the ESOP participants as principal payments were made on the loan. The Bank made contributions to the ESOP in amounts sufficient to make loan interest and principal payments. Contributions, which include dividends on ESOP shares, of $71,657 and $74,488 were made to the ESOP in 2003 and 2002, respectively. During 2003, the Trustee distributed cash of $55,744 in lieu of shares to retiring participants.

    The ESOP’s loan was repayable in ten annual installments of principal and interest. The interest rate was adjusted annually and was equal to the prime rate on each October 1st, beginning with October 1, 1995, until the note was paid in full. Principal and interest for the years ended September 30, 2003 and 2002 were $71,657 and $74,488, respectively. The loan was paid in full at September 30, 2003. These payments resulted in the commitment to release 5,383 shares in 2003 and 5,587 shares in 2002. The Company has recognized compensation expense, equal to the fair value of the committed-to-be released shares of $75,079 and $61,290 in 2003 and 2002, respectively. Suspense shares are excluded from weighted average shares in determining earnings per share.

    Stock-based Compensation Plan — During 1995, the Company adopted a Stock Option and Incentive Plan for directors and key employees of the Company. The exercise price cannot be less than the market price on the grant date and number of shares available for options cannot exceed 83,000. Stock appreciation rights may also be granted under the plan. During 1998, the Company adopted the 1998 Stock Option & Incentive Plan for directors and key employees of the Company. Under the 1998 plan, options to acquire 63,361 shares had been granted. The term of the options range from seven to ten years and they vest equally over periods from three to five years.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

11. EMPLOYEE BENEFIT PLANS (Continued)

Following is a summary of the status of the 1995 and 1998 plans:


	1995 Plan					1998 Plan
	Number of Shares			Weighted Average		Number of Shares			Weighted Average
	Under Option			Exercise Price		Under Option			Exercise Price
Outstanding at September 30, 2001		70,550		$	13.15		67,511		$	14.05
Granted		9,000			9.92		—			.00
Forfeited		(34,239	)		13.05		(20,423	)		14.86

Outstanding at September 30, 2002		45,311			12.59		47,088			13.69
Granted		28,389			12.10		16,211			12.10
Forfeited		—			—		(1,328	)		9.75

Outstanding at September 30, 2003		73,700			12.40		61,971			13.36
Granted		—			—		—
Forfeited		—			—		(1,256	)		13.55
Exercised/sold		—			—		(416	)		10.22

Outstanding at September 30, 2004		73,700			12.40		60,299			13.38

Information pertaining to options outstanding at September 30, 2004 is as follows:


			Options Outstanding			Options Exercisable
			Weighted Average
			Remaining	Weighted Average				Weighted Average
Exercise Price	Number Outstanding		Contractual Life	Exercise Price		Number Exercisable		Exercise Price
9.75		20,905	3.09 years				20,905
9.92		9,000	7.17 years				3,600
12.10		43,760	8.04 years				8,752
14.00		29,880	.93 years				29,880
15.75		30,454	3.32 years				30,454

Outstanding at end of year		133,999	4.55 years	$	12.84		93,591	$	13.29

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

11. EMPLOYEE BENEFIT PLANS (Continued)

The Company applies APB Opinion 25 and related interpretations in accounting for its stock option plans. Accordingly, no compensation cost has been recognized for the plans in 2004, 2003 or 2002. Had compensation cost been determined on the basis of fair value pursuant to SFAS No. 123, net income and earnings per share would have been adjusted to the pro forma amounts indicated below:


	2004			2003		2002
Net income (loss):
As reported	$	(527,935	)	$	115,864	$	670,805
Pro forma		(530,678	)		108,785		659,986
Basic earnings (loss) per share:
As reported		(.74	)		.16		.82
Pro forma		(.75	)		.15		.79
Fully diluted earnings (loss) per share:
As reported		(.71	)		.15		.82
Pro forma		(.72	)		.14		.79

Because the SFAS No. 123 method of accounting has not been applied to options granted prior to October 1, 1995, the resulting pro forma compensation costs may not be representative of that to be expected in future years.

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model. The following assumptions were made in estimating fair value during the period granted:


	2003			2002
Dividend yield		5.38	%		5.20	%
Expected life	9 years			8 years
Expected volatility		8.10	%		8.72	%
Risk-free interest rate		4.73	%		5.39	%

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

11.   EMPLOYEE BENEFIT PLANS (Continued)

    Management Recognition Plan — On November 15, 1995, the Company issued 33,200 shares of common stock (Initial Shares) to key employees under the terms of the Company’s Management Recognition Plans (MRP’s). These shareholders receive dividends on the shares and have voting rights. However, the sale or transferability of the shares is subject to the vesting requirements of the plan. These vesting requirements provide for the removal of the transferability restrictions upon the performance of employment services. The restrictions were fully removed in November 2000. Participants who terminate employment prior to satisfying the vesting requirements must forfeit the unvested shares and the accumulated dividends on the forfeited shares. The Company has recorded compensation expense equal to the fair value of the portion of vested shares attributable to 2004, 2003 and 2002. In addition, the dividends paid on unvested shares are also reflected as compensation expense. Total compensation expense attributable to the MRP’s in 2004, 2003 and 2002 was $5,757, $4,883 and $3,036, respectively.

    During the year ended September 30, 2001, the Company’s MRP purchased an additional 11,525 shares of common stock at an aggregate price of $126,411. Shares held in trust related to the MRP are shown as a reduction of stockholders’ equity in the accompanying consolidated statements of financial condition. As these shares are granted to employees, an amount equal to the award is reclassified from shares held in trust to unearned compensation. Of these shares, 1,750 were issued to key employees during the year ended September 30, 2002. During 2004, 373 shares in the plan were cancelled. No additional shares were issued during the year ended September 30, 2004 or 2003.

    401 (k) Plan — The Company also has a 401(k) plan that covers all employees who meet minimum age and service requirements. The plan provides for elective employee salary deferrals and discretionary company matching contributions. Company matching contributions were $0, $28,324 and $52,540 in 2004, 2003 and 2002, respectively.

    Deferred Compensation Agreements — The Company has entered into deferred compensation agreements with two of its senior officers and one former officer, pursuant to which each will receive from the Company certain retirement benefits at age 65. Such benefits will be payable for 15 years to each officer or, in the event of death, to such officer’s respective beneficiary. A portion of the retirement benefits will accrue each year until age 65 or, if sooner, until termination of employment. The annual benefits under these arrangements range from approximately $24,000 to $45,000.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

11.   EMPLOYEE BENEFIT PLANS (Continued)

    The retirement benefits available under the deferred compensation agreements are unfunded. However, the Company has purchased life insurance policies on the lives of these officers that will be available to the Company to provide, both, for retirement benefits and for key person insurance. The costs of these arrangements was $47,245, $44,945 and $42,758 in 2004, 2003 and 2002, respectively.

    In addition to the deferred compensation arrangements discussed above, the Company entered into arrangements with two officers in April 1997, under which the Company issued a total of 21,135 shares of common stock to these officers. The shares vest ratably over the 15 year term of their employment contracts. The Company has recognized compensation expense equal to the fair value of the vested shares of $19,902 in 2004, 2003 and 2002.

    Directors’ Retirement Agreements — The Bank has also entered into supplemental retirement agreements with its directors. The agreements provide for certain benefits payable to the directors based on the earnings of certain life insurance policies in excess of the Bank’s cost of funds, as defined under the agreements. The cost of these agreements was $26,073 and $33,869 in 2004 and 2003, respectively.

    Bank Owned Life Insurance — As discussed above, the Company has purchased approximately $4.9 million of Company owned life insurance on certain key officers (current and former) and directors. (The policies had a cash surrender value of approximately $1.7 million and $1.6 million at September 30, 2004 and 2003, respectively.) The life insurance policies were purchased to offset liabilities associated with certain employee and director benefits. Income earned on the policies will offset the corresponding benefit expenses on these employees and directors as the Company is the beneficiary of the insurance policies. Increases in the cash surrender value of the policies are recorded as a component of non-interest income.

12.   RELATED PARTY TRANSACTIONS

    In the normal course of business, loans are made to officers and directors of the Company. These loans are made on substantially the same terms, including interest rates and collateral, as those prevailing for comparable transactions with others. Total loans outstanding to these persons at September 30, 2004 and 2003 amounted to $738,521 and $850,666, respectively. The change from 2003 to 2004 reflects payments of $300,792 and advances of $188,647.

    Deposits from related parties held by the Bank at September 30, 2004 and 2003 amounted to $189,048 and $155,372, respectively.

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

13.   COMMITMENTS AND CONTINGENCIES

    Off Balance Sheet Items — At September 30, 2004, the Bank had outstanding loan commitments of approximately $14,520,000 including $6,790,000 in undisbursed construction loans in process, $6,191,000 in unused lines and letters of credit, $1,208,000 in commitments to originate mortgage loans consisting primarily of 30-day commitments, and $331,000 in undisbursed participation loan commitments. Commitments to originate conventional mortgage loans consisted of fixed rate mortgages for which interest rates had not been established, all having terms ranging from 15 to 30 years.

    These financial instruments are not reflected on the accompanying statements of financial condition, but do expose the Company to credit risk. The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance-sheet instruments.

    These 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 some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

    Litigation — The Company is involved in various legal actions arising in the normal course of business. In the opinion of management, based upon consultation with legal counsel, the ultimate resolution of all proceedings will not have a material adverse effect upon the financial position or operations of the Company.

    Employment Agreements — The Company has employment agreements with certain senior officers. The agreements provide for certain salaries and benefits for a 24-month period. The agreements further provide that if the employee is terminated without cause they will receive payments equal to the amount of salary and benefits remaining under the term of contract with a minimum amount of 12 months salary and benefits. The agreements also provide that if employment is terminated by the Company in connection with or within 24 months after any change in control of the Company, each employee shall be paid approximately three times their salary.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

13.   COMMITMENTS AND CONTINGENCIES (Continued)

    Significant Group Concentrations of Credit Risk — The Company maintains cash balances at several financial institutions. Cash balances at each institution are insured by the Federal Deposit Insurance Corporation (the “FDIC”) up to $100,000. At various times throughout the year cash balances held at these institutions will exceed federally insured limits. Management monitors such accounts and does not consider that such excess exposes the Company to any significant risk.

    Supervisory Agreement — On March 22, 2002, the Bank entered into a supervisory agreement (the “Supervisory Agreement”) with the Office of Thrift Supervision (the “OTS”). The Supervisory Agreement formalized the current understanding of both the Bank and the OTS of the actions that the Bank and its board of directors had to undertake to comply with the requirements of the OTS. Among other things, the Bank’s board of directors had to develop, adopt and implement certain policies and procedures to ensure appropriate monitoring of the Bank’s internal audit and control functions, management, asset quality, and transactions with affiliates and insiders. Additionally, the OTS revoked the expanded, loans-to-one-borrower lending authority originally granted by the OTS on July 26, 1994. After meeting such requirements, the Supervisory Agreement was rescinded by the OTS effective December 14, 2004.

14.   RETAINED EARNINGS AND REGULATORY CAPITAL

    The Bank is 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 Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

14. RETAINED EARNINGS AND REGULATORY CAPITAL (Continued)

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of September 30, 2004, that the Bank meets all capital adequacy requirements and meets the requirements to be classified as “well capitalized”.


						For Capital
	Actual					Adequacy Purposes					Well Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2004:
Total risk-based capital (to risk weighted assets)	$	11,940,000		13.18	%		³$7,246,000		³8.00	%		³$9,057,000		³10.00	%
Tier I capital (to risk weighted assets)		11,424,000		12.61	%		³ 3,623,000		³4.00	%		³ 5,434,000		³ 6.00	%
Tier I capital (to adjusted total assets)		11,424,000		8.08	%		³ 5,659,000		³4.00	%		³ 7,073,000		³ 5.00	%
Tangible equity (to adjusted total assets)		11,424,000		8.08	%		³ 2,829,000		³2.00	%
Tangible capital (to adjusted total assets)		11,424,000		8.08	%		³ 2,122,000		³1.50	%
As of September 30, 2003:
Total risk-based capital (to risk weighted assets)	$	13,620,000		16.43	%		³$6,633,000		³8.00	%		³$8,292,000		³10.00	%
Tier I capital (to risk weighted assets)		13,325,000		16.07	%		³ 3,317,000		³4.00	%		³ 4,975,000		³ 6.00	%
Tier I capital (to adjusted total assets)		13,325,000		9.99	%		³ 5,336,000		³4.00	%		³ 6,670,000		³ 5.00	%
Tangible equity (to adjusted total assets)		13,325,000		9.99	%		³ 2,668,000		³2.00	%
Tangible capital (to adjusted total assets)		13,325,000		9.99	%		³ 2,001,000		³1.50	%

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

14.   RETAINED EARNINGS AND REGULATORY CAPITAL (Continued)

    Savings institutions with more than a “normal” level of interest rate risk are required to maintain additional total capital. A savings institution with a greater than normal interest rate risk is required to deduct specified amounts from total capital, for purposes of determining its compliance with risk-based capital requirements. Management believes that the Bank was in compliance with capital standards at September 30, 2004 and 2003.

    Retained earnings at September 30, 2004 and 2003, include approximately $2,400,000 for which no provision for income tax has been made. This amount represents allocations of income to bad debt deductions for tax computation purposes. If, in the future, this portion of retained earnings is used for any purpose other than to absorb tax bad debt losses, income taxes may be imposed at the then applicable rates. Retained earnings is also restricted at September 30, 2004, as a result of the liquidation account established upon conversion to a stock company. No dividends may be paid to stockholders if such dividends would reduce the net worth of the Bank below the amount required by the liquidation account.

15.   SHAREHOLDERS’ RIGHTS PLAN

    In December 1997, the Company adopted a Stock Purchase Rights Plan that provides rights to holders of the Company’s common stock to receive common stock rights under certain circumstances. The rights will become exercisable ten days after a person or group acquires 15% or more of the company’s shares. If, after the rights become exercisable, the Company becomes involved in a merger, each right then outstanding (other than those held by the 15% holder) would entitle its holder to buy common stock of the Company worth twice the exercise price of each right. The rights expire in November 2007.

16.   FAIR VALUE OF FINANCIAL INSTRUMENTS

    The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Further, assets that are not financial instruments are not included in the following tables. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

16.   FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

    The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:

    Cash and Cash Equivalents — Fair value equals the carrying value of such assets due to their nature.

    Interest-bearing Deposits in Other Financial Institutions — Fair value equals the carrying value of such assets due to their nature.

    Securities and Accrued Interest Receivable — The fair value of securities is based on quoted market prices. The carrying amount of related accrued interest receivable approximates its fair value.

    Loans Receivable — The fair value of loans is calculated using discounted cash flows. The discount rate used to determine the present value of the loan portfolio is an estimated market discount rate that reflects the credit and interest rate risk inherent in the loan portfolio. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions. The carrying amount of related accrued interest receivable approximates its fair value.

    Deposits — Fair values for certificates of deposit have been determined using discounted cash flows. The discount rate used is based on estimated market rates for deposits of similar remaining maturities. The carrying amount of all other deposits, due to their short-term nature, approximate their fair values. The carrying amount of related accrued interest payable approximates its fair value.

    Borrowed Funds — Fair value for the fixed-rate borrowings has been determined using discounted cash flows. The discount rate used is based on estimated current rates for advances with similar maturities. The carrying amount of the variable rate borrowings, due to the short repricing periods, approximate their fair value.

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

17. PARENT COMPANY (Continued)

Parent Company
Condensed Statements of Cash Flows
Years Ended September 30, 2004, 2003 and 2002


	2004			2003			2002
Operating Activities:
Net income (loss)	$	(527,935	)	$	115,864		$	670,805
Adjustments to reconcile net income (loss) to cash from operating activities:
Equity in undistributed earnings of subsidiaries		1,899,902			258,555			337,853
Compensation expense on ESOP and MRP		25,659			99,864			84,228
(Gain) loss on sale of securities available-for-sale		—			78,610			(47,553	)
Gain on sale of affiliate		(25,000	)		—			—
(Increase) decrease in other assets		54,761			20,098			1,940,038
Increase (decrease) in other liabilities		81,872			(47,591	)		220,392

Net cash provided by operating activities		1,509,259			525,400			3,205,763

Investing Activities:
Investment in subsidiaries, net of dividends received		(2,510	)		(28,730	)		(2,937	)
Proceeds from sales of securities available-for-sale		—			—			751,640
Proceeds from sale of affiliate		25,000			—			—

Net cash provided (used) by investing activities		22,490			(28,730	)		748,703

Financing Activities:
Acquisition of ESOP and MRP shares		3,678			36			(188	)
Proceeds from borrowed funds		435,000			1,519,000			2,563,861
Repayment on borrowed funds		(1,450,000	)		(300,000	)		(5,220,000	)
Cash dividends paid		(425,159	)		(425,052	)		(463,300	)
Acquisition of treasury stock		(81,316	)		(1,344,245	)		(758,792	)

Net cash used in financing activities		(1,517,797	)		(550,261	)		(3,878,419	)

Net increase (decrease) in cash and cash equivalents		13,952			(53,591	)		76,047
Cash and cash equivalents — beginning of year		35,351			88,942			12,895

Cash and cash equivalents — end of year	$	49,303		$	35,351		$	88,942

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

18. SELECTED QUARTERLY INFORMATION (UNAUDITED)


	Year Ended September 30, 2004
	Three Months Ended
	September 30,		June 30,			March 31,			December 31,
Interest and dividend income	$	1,791,905	$	1,756,364		$	1,786,609		$	1,786,063
Interest expense		716,855		687,347			708,474			699,651

Net interest income		1,075,050		1,069,017			1,078,135			1,086,412
Provision for loan losses		111,979		9,268			1,235,690			—

Net interest income after provision for loan losses		963,071		1,059,749			(157,555	)		1,086,412
Non-interest income		789,051		853,788			909,110			687,564
Non-interest expenses		1,699,529		1,928,324			1,807,634			1,606,829

Income (loss) before taxes		52,593		(14,787	)		(1,056,079	)		167,147
Provision for income taxes (benefit)		18,838		(4,345	)		(401,262	)		63,578

Net income (loss)	$	33,755	$	(10,442	)	$	(654,817	)	$	103,569

Earnings (loss) per share:
Basic	$	0.05	$	(0.01	)	$	(0.92	)	$	0.15
Diluted	$	0.05	$	(0.01	)	$	(0.88	)	$	0.14
Dividends per share	$	0.15	$	0.15		$	0.15		$	0.15


	Year Ended September 30, 2003
	Three Months Ended
	September 30,			June 30,		March 31,		December 31,
Interest and dividend income	$	1,877,285		$	1,812,930	$	1,824,613	$	1,921,817
Interest expense		785,127			864,317		893,439		1,001,310

Net interest income		1,092,158			948,613		931,174		920,507
Provision for loan losses		431,152			29,488		13,963		75,000

Net interest income after provision for loan losses		661,006			919,125		917,211		845,507
Non-interest income		1,072,286			927,624		829,139		912,695
Non-interest expenses		1,873,816			1,721,630		1,685,664		1,616,301

Income (loss) before taxes		(140,524	)		125,119		60,686		141,901
Provision for income taxes (benefit)		(53,279	)		47,485		22,705		54,407

Net income (loss)	$	(87,245	)	$	77,634	$	37,981	$	87,494

Earnings (loss) per share:
Basic	$	(0.12	)	$	0.11	$	0.05	$	0.11
Diluted	$	(0.12	)	$	0.11	$	0.05	$	0.11
Dividends per share	$	0.15		$	0.15	$	0.15	$	0.15

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

19.   BUSINESS SEGMENT INFORMATION

    The Company organizes its business units into two reportable segments: traditional banking activities and employee benefits consulting. The banking segment provides a full range of banking services within its primary market areas of central Alabama. The employee benefits consulting firm operates primarily in the Montgomery, Alabama area.

    The segments’ accounting policies are the same as those described in the summary of significant accounting policies. The Company’s reportable business segments are strategic business units that offer different products and services. Each segment is managed separately because each unit is subject to different marketing and regulatory environments.

    The following table presents financial information for each reportable segment:


	September 30, 2004
				Employee Benefits
	Banking Activities			Consulting		Total
Interest and dividend income	$	7,096,079		$	24,862	$	7,120,941
Interest expenses		2,812,327			—		2,812,327

Net interest income		4,283,752			24,862		4,308,614
Provision for loan losses		1,356,937			—		1,356,937

Net interest income after provision for loan losses		2,926,815			24,862		2,951,677
Non-interest income		1,641,830			1,597,683		3,239,513
Non-interest expenses		5,718,985			1,323,331		7,042,316

Income (loss) before income taxes		(1,150,340	)		299,214		(851,126	)
Provision for income taxes (benefit)		(437,130	)		113,939		(323,191	)

Net income (loss)	$	(713,210	)	$	185,275	$	(527,935	)

Depreciation and amortization included in other expenses	$	310,154		$	67,527	$	377,681

Total assets at year-end	$	140,508,524		$	1,743,131	$	142,251,655

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

19. BUSINESS SEGMENT INFORMATION (Continued)


	September 30, 2003
			Employee Benefits
	Banking Activities		Consulting		Total
Interest and dividend income	$	7,416,268	$	20,377	$	7,436,645
Interest expenses		3,544,193		—		3,544,193

Net interest income		3,872,075		20,377		3,892,452
Provision for loan losses		549,603		—		549,603

Net interest income after provision for loan losses		3,322,472		20,377		3,342,849
Non-interest income		2,498,122		1,243,622		3,741,744
Non-interest expenses		5,757,392		1,140,019		6,897,411

Income before income taxes		63,202		123,980		187,182
Provision for income taxes		23,968		47,350		71,318

Net income	$	39,234	$	76,630	$	115,864

Depreciation and amortization included in other expenses	$	269,584	$	61,614	$	331,198

Total assets at year-end	$	132,459,815	$	1,512,626	$	133,972,441

(Continued)

SOUTHFIRST BANCSHARES, INC.
AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Continued)

19. BUSINESS SEGMENT INFORMATION (Continued)


	September 30, 2002
				Employee Benefits
	Banking Activities			Consulting		Total
Interest and dividend income	$	8,476,404		$	50,788	$	8,527,192
Interest expenses		4,729,796			—		4,729,796

Net interest income		3,746,608			50,788		3,797,396
Provision for loan losses (benefit)		(667,650	)		—		(667,650	)

Net interest income after provision for loan losses		4,414,258			50,788		4,465,046
Non-interest income		1,858,705			1,174,749		3,033,454
Non-interest expenses		5,224,580			1,182,151		6,406,731

Income before income taxes		1,048,383			43,386		1,091,769
Provision for income taxes		404,329			16,635		420,964

Net income	$	644,054		$	26,751	$	670,805

Depreciation and amortization included in other expenses	$	313,669		$	92,515	$	406,184

Total assets at year-end	$	140,547,478		$	2,257,518	$	142,804,996

(Continued)


PART I
Item 1.		Business
Item 2.		Property
Item 3.		Legal Proceedings
Item 4.		Submission of Matters to a Vote of Security Holders
PART II
Item 5.		Market for Common Equity and Related Stockholder Matters
Item 6.		Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7.		Financial Statements
Item 8.		Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
Item 8A.		Controls and Procedures
PART III
Item 9.		Directors, Executive Officers and Control Persons of the Registrant
Item 10.		Executive Compensation
Item 11.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 12.		Certain Relationships and Related Transactions
Item 13.		Exhibits and Reports on Form 8-K
Item 14		Principal Accountant Fees and Services
EX-11 STATEMENT REGARDING COMPUTATION OF PER SHARE EARNINGS
EX-21 SUBSIDIARIES OF THE REGISTRANT
EX-23.1 CONSENT OF JONES & KIRKPATRICK, P.C.
EX-31.1 SECTION 302 CERTIFICATION OF THE CEO
EX-31.2 SECTION 302 CERTIFICATION OF THE CFO
EX-32.1 SECTION 906 CERTIFICATION OF THE CEO
EX-32.2 SECTION 906 CERTIFICATION OF THE CFO


ITEM 5.	MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS


ITEM 6.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(6)		On October 16, 2002, SouthFirst issued 4,300 options under the 1998 plan to Mr. McArthur at an exercise price of $12.10 per share. These options vest in equal increments commencing October 16, 2002 through October 16, 2007.

(7)		Represents a $1,485 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(8)		Consists of a regular bonus of $10,000 as well as $15,439 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(9)		Represents a $1,485 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(10)		Consists of a regular bonus of $9,701 as well as $5,850 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(11)		Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(12)		Consists of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(13)		On October 16, 2002, SouthFirst issued 4,300 options under the 1995 plan to Mr. Massey at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(14)		Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(15)		Consists of a regular bonus of $10,000 as well as $3,270 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(16)		Represents a $1,522 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(17)		Consists of a regular bonus of $ 4,807 as well as $7,080 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(18)		Represents a $1,117 automobile allowance and income of $630 recognized on employer provided group term life insurance in excess of $50,000.

(19)		Consists of a regular bonus of $7,210 as well as $7,080 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(20)		On October 16, 2002, SouthFirst issued 2,589 options under the 1995 plan and 1,711 options under the 1998 plan to Ms. Stephens at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(21)		Represents a $1,117 automobile allowance and income of $420 recognized on employer provided group term life insurance in excess of $50,000.

(22)		Consists of a signing bonus of $17,500, a regular bonus of $10,000, a tax bonus, with respect to MRP shares (see “ – Management Recognition Plans” below), of $7,500, and $4,500 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(23)		On December 1, 2001, SouthFirst issued 7,500 options under the 1995 plan to Ms. Stephens at an exercise price of $9.92 per share. These options vest in equal annual increments commencing on December 1, 2002 through December 1, 2006.

(24)		Represents a $1,117 automobile allowance and income of $420 recognized on employer provided group term life insurance in excess of $50,000.

(25)		Consists of a regular bonus of $9,701 as well as $2,948 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(26)		Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(27)		Consists of a regular bonus of $2,650 as well as $2,948 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(28)		On October 16, 2002, SouthFirst issued 1,950 options under the 1998 plan to Ms. Roper at an exercise price of $12.10 per share. These options vest in equal annual increments commencing October 16, 2002 through October 16, 2007.

(29)		Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

(30)		Consists of a regular bonus of $4,000 as well as $1,778 of compensation consisting of dividends paid under SouthFirst’s Dividend Incentive Plan on unexercised stock options. See “ – Compensation of Directors” below.

(31)		Represents a $1,778 automobile allowance and income of $966 recognized on employer provided group term life insurance in excess of $50,000.

⁽²⁾		The percentages are based upon 709,406 shares outstanding, except for certain parties who hold presently exercisable options to purchase shares. The percentages for those parties holding presently exercisable options are based upon the sum of 709,406 shares plus the number of shares subject to presently exercisable options held by them, as indicated in the following notes.

⁽³⁾		Of the amount shown, 5,781 shares are held in Mr. McArthur’s account under SouthFirst’s 401(k) Plan, 7,064 shares are held in his account under First Federal’s ESOP, 27,452 shares are subject to presently exercisable options and 244 shares represent restricted stock granted under SouthFirst’s Management Recognition Plans “A” and “B,” all of which are fully vested.

⁽⁴⁾		Of the amount shown, 3,000 shares are owned jointly by Mr. Foote and his wife, 1,500 shares are held by Mr. Foote as custodian for each of his two minor children, 9,953 shares are subject to presently exercisable options and 1,660 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan “A,” all of which are fully vested.

⁽⁵⁾		Of the amount shown, 15,521 shares are restricted stock acquired pursuant to that certain employment agreement between Mr. Massey and Pension & Benefit, vesting in equal increments over a period of 15 years beginning on April 11, 1997, 3,782 shares are held in his account under SouthFirst’s 401(k) plan, 2,642 shares are held in an Individual Retirement Account, 2,059 shares are held in his account under First Federal’s ESOP, and 7,170 shares are subject to exercisable options.

⁽⁶⁾		Of the amount shown, 10,000 shares are held jointly by Mr. McMillan and his wife, 9,953 shares are subject to presently exercisable options and 1,660 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan “A,” all of which are fully vested.

⁽⁷⁾		Of the amount shown, 21,099 shares are held jointly by Mr. Easterling and his wife, 1,001 shares are held individually by Mr. Easterling and 5,803 shares are subject to exercisable options.

⁽⁸⁾		Of the amount shown, 27,681 are held individually by Mr. Bice and 5,803 shares are subject to exercisable options.

⁽⁹⁾		Of the amount shown, 200 shares are held jointly by Mr. Hardy and his wife and 3,103 shares are subject to exercisable options.

⁽¹⁰⁾		Of the amount shown, Jeffrey L. Gendell has shared voting power with respect to 62,800 shares, Tontine Management, L.L.C. (“TM”) has shared voting power with respect to 62,800 shares, and Tontine Financial Partners, L.P. (“TFP”) has shared voting power with respect to 62,800 shares. TM, the general partner of TFP, has the power to direct the affairs of TFP. Mr. Gendell is the Managing Member of Tontine Management, L.L.C. and, in that capacity, directs its operations. The business address of Mr. Gendell and TFP is 237 Park Avenue, 9^th Floor, New York, New York 10017. The foregoing information is based on a Schedule 13F, dated November 12, 2004 filed by Mr. Gendell, TM, and TFP. SouthFirst makes no representation as to the accuracy or completeness of the information reported.

⁽¹¹⁾		Robert J. Salmon and Mary Anne J. Salmon beneficially own and have shared voting and dispositive power with respect to 47,600 shares. The foregoing information is based on a Schedule 13G, dated October 8, 1998 received by SouthFirst from Mr. and Mrs. Salmon. SouthFirst makes no representation as to the accuracy or completeness of the information reported therein.

⁽¹²⁾		Of the amount shown, 6,220 shares are subject to presently exercisable options, 243 shares are held in her account under First Federal’s ESOP, and 700 shares represent restricted stock granted under SouthFirst’s Management Recognition Plan(s), all of which shares are fully vested.

⁽¹³⁾		Of the amount shown, 1,914 shares are owned jointly by Ms. Roper and her husband, 5,623 shares are restricted stock acquired pursuant to that certain employment agreement between Ms. Roper and Pension & Benefit, vesting in equal increments over a period of 15 years beginning on April 11, 1997, 1,341 shares are held in her account in First Federal’s ESOP, and 3,744 shares are subject to presently exercisable options.

⁽¹⁴⁾		These shares are held in trust by Pension & Benefit as trustee of First Federal’s ESOP. See “Item 10. EXECUTIVE COMPENSATION — Employee Stock Ownership Plan.”

⁽¹⁵⁾		Of the amount shown, 79,201 shares are subject to exercisable options.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

	This summary of significant accounting policies of SouthFirst Bancshares, Inc. (the “Company”) is presented to assist in understanding the Company’s financial statements. The financial statements and notes are representations of the Company’s management who is responsible for the integrity and objectivity of the financial statements. These accounting policies conform to accounting principles generally accepted in the United States of America and have been consistently applied in the preparation of the financial statements.

	Basis of Presentation – The accompanying consolidated financial statements include the accounts of SouthFirst Bancshares, Inc. (the Corporation) and its wholly-owned subsidiaries, First Federal of the South (the Bank) (a wholly-owned subsidiary of SouthFirst Bancshares, Inc.), Pension & Benefit Trust Company (a wholly-owned subsidiary of First Federal of the South, which is an employee benefits consulting company), SouthFirst Mortgage, Inc. (a wholly-owned subsidiary of First Federal of the South) and SouthFirst Financial Services, Inc. (a wholly-owned subsidiary of SouthFirst Bancshares, Inc.), collectively as the Company. All significant intercompany accounts and transactions have been eliminated in consolidation.

	Business – The Company provides a full range of banking services to individual and corporate customers in its primary market area of the cities of Sylacauga, Clanton and Talladega in the state of Alabama, and provides lending services in Birmingham, Alabama. The Company is subject to competition from other financial institutions. The Company is subject to the regulations of certain federal agencies and undergoes periodic examinations by those regulatory authorities.

	Use of Estimates – The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with generally accepted accounting principles and with general practice within the savings and loan industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of financial condition and revenues and expenses for the period. Actual results could differ significantly from those estimates.

	Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses. In connection with the determination of the allowance for loan losses, management obtains independent appraisals for properties collateralizing significant troubled loans.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Significant Group Concentrations of Credit Risk – A substantial portion of the Company’s loans are secured by real estate in the Company’s primary market area. Note 3 discusses the types of lending that the Company engages in. The Company does not have any significant concentration to any one industry or customer.

	Cash and Cash Equivalents – For purposes of presentation in the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from other depository institutions.

	Interest-bearing Deposits in Other Financial Institutions – Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.

	Securities – The Company classifies its securities in one of the following three categories: (i) held-to-maturity securities, (ii) securities available-for-sale, and (iii) trading account securities. Securities held to maturity represent securities which management has both the positive intent and ability to hold to maturity. These securities are reported at cost adjusted for amortization of premiums and accretion of discounts using the interest method. Securities available-for-sale represent securities which management may decide to sell prior to maturity for liquidity, tax planning or other valid business purposes. Available-for-sale securities are reported at fair value with any unrealized gains or losses excluded from earnings and reflected as a net amount in a separate component of stockholders’ equity until realized. Trading account securities represent securities which management has purchased and is holding principally for the purpose of selling in the near term. Trading account securities are reported at fair value with any unrealized gains or losses included in earnings.

	Declines in fair value of securities (available-for-sale or held-to-maturity) that are considered other than temporary are charged to securities losses, reducing the carrying value of such securities. Gains or losses on the sale of securities are recorded on the trade date and are determined using the specific identification method and are shown separately in non-interest income in the consolidated statements of operations. No securities were classified as trading account securities as of September 30, 2004 or 2003.

	The stock of the Federal Home Loan Bank has no quoted fair value and no ready market exists. The investment in the stock is required of insured institutions that utilize the services of the Federal Home Loan Bank. The Federal home Loan Bank periodically reviews the required investment and will redeem any excess stock at cost. The Federal Home Loan Bank will also purchase the stock at its cost basis from the Company in the event the Company ceases to utilize the services of the Federal Home Loan Bank.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Loans – The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout the Company’s primary market area. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in this area.

	Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance.

	The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Credit card loans and other personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

	All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

	Allowance for Loan Losses – The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

	The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowances for loan losses and foreclosed real estate. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available to them at the time of their examination.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

	Loan Origination Fees, Premiums and Discounts on Loans, Mortgage-Backed Securities and Collateralized Mortgage Obligations – Loan origination fees and certain direct loan origination costs are deferred and recognized over the lives of the related loans as an adjustment of the loan yields using the interest method. Premiums or discounts on loans, mortgage-backed securities, and collateralized mortgage obligations are amortized over the estimated lives of the related mortgage loans, adjusted for prepayments, using a method approximating the interest method. Premiums and discounts on loans, mortgage-backed securities, and collateralized mortgage obligations were insignificant at September 30, 2004.

	Loans Held for Sale – Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Gains or losses on loan sales are recognized at the time of sale and are determined by the difference between net sales proceeds and the carrying value of the loans sold.

	The Company enters into interest rate locks, where customers have locked into mortgages at a set interest rate, and forward sales commitments, which are sales of mortgage loans to third parties at a specified price. These interest rate locks and forward sales commitments qualify as derivatives; however, the change in fair value of these derivatives during the year did not have a material impact on the Company’s financial position or results of operations.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Goodwill — In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 142, Goodwill and Other Intangible Assets, which changed the accounting for goodwill from an amortization method to an impairment only approach. Upon adoption of SFAS No. 142 on October 1, 2002, the Company ceased amortizing goodwill. Based upon the initial goodwill impairment test completed October 1, 2002, as required by SFAS No. 142, no goodwill impairment was indicated. In addition, the goodwill impairment testing completed at September 30, 2004 and 2003 indicated there was no goodwill impairment. Therefore, the Company had no changes in the carrying amount of goodwill from September 30, 2002 to September 30, 2004.

	The following is a reconciliation of net income (loss), basic earnings (loss) per share and diluted earnings (loss) per share with and without goodwill amortization:

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Long-Lived Assets — Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation computed on a straight-line basis over the estimated service lives of the related assets (30 to 50 years for buildings and 3 to 10 years for equipment). Expenditures for maintenance and repairs are charged to operations as incurred; expenditures for renewals and improvements are capitalized and written off through depreciation and amortization charges. Equipment retired or sold is removed from the asset and related accumulated depreciation amounts and any gain or loss resulting therefrom is reflected in the accompanying consolidated statements of operations.

	The Company continually evaluates whether events and circumstances have occurred that indicate such long-lived assets have been impaired. Measurement of any impairment of such long-lived assets is based on those assets’ fair values and is recognized through a valuation allowance with the resulting charge reflected in the accompanying consolidated statements of operations. There were no impairment losses recorded during any period reported herein.

	Stock-Based Compensation — The Company applies Accounting Principles Bulletin (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for employee stock compensation plans and, accordingly, does not recognize compensation cost for stock options granted when the option price is greater than or equal to the underlying stock price. This accounting method is referred to as the intrinsic value method. The Company follows the pro-forma disclosures of Statement of Financial Accounting Standards (SFAS) No. 123, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure, using the fair value method of accounting for stock-based compensation.

	Income Taxes — The Company provides for income taxes based upon pretax income, adjusted for permanent differences between reported and taxable earnings. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be realized or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.

	Advertising — Advertising costs are charged to operations when incurred. Advertising expense was $90,625, $84,259 and $59,431 for the years ended September 30, 2004, 2003 and 2002, respectively.

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Earnings per Share – Basic earnings per share of common stock has been computed on the basis of the weighted-average number of shares of common stock outstanding. Fully diluted earnings per share reflects the potential dilution that could occur if the Company’s outstanding options to acquire common stock were exercised. The exercise of these options accounts for the differences between basic and diluted weighted average shares outstanding. Options on 60,834 shares in 2003 and 2002 of common stock were not included in computed diluted earnings per share because their effects were antidilutive.

	Reclassification — Certain amounts in the financial statements presented have been reclassified from amounts previously reported in order to be comparable between years. These reclassifications have no effect on previously reported stockholders’ equity or net income during the periods involved.

	Comprehensive Income – Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.

	The components of other comprehensive income and related tax effects are as follows:

1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

	Recent Accounting Pronouncements — In March 2004, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) 105, Application of Accounting Principles to Loan Commitments, which summarized the views of the staff regarding the application of generally accepted accounting principles to loan commitments accounted for as derivative instruments. The SAB requires that the fair value measurement of a loan commitment that is accounted for as a derivative includes only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any expected cash flows related to the customer relationship or loan servicing. This SAB is effective for loan commitments entered into after March 31, 2004. The Company adopted SAB 105 on April 1, 2004, and the effect was not material.

	In March 2004, the FASB’s Emerging Issues Task Force reached a consensus of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments. The guidance prescribes a three-step model for determining whether an investment is other-than-temporarily impaired and requires disclosures about unrealized losses on investments. The accounting guidance provided to evaluate whether an impairment is other than temporary has been delayed by FASB Staff Position EITF Issue 03-1-1, Effective Date of Paragraphs 10-20 of EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, posted September 30, 2004. The delay of the effective date for paragraphs 10-20 will be superseded concurrent with the final issuance of proposed FSP EITF Issue 03-1-a, Implementation Guidance for the Application of Paragraph 16 of EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”, while the disclosure requirements are effective for annual reporting periods ending after December 15, 2003. The Company has adopted the disclosure requirements of this EITF, and is currently evaluating the impact of the adoption of the accounting guidance in the EITF.

2.	SECURITIES

	Debt and equity securities have been classified in the consolidated statements of financial condition according to management’s intent. The carrying amount of securities and their approximate fair value at September 30 were as follows:

2.	SECURITIES (Continued)

	At September 30, 2003, certain securities classified as available-for-sale were written down to their estimated realizable values because, in the opinion of management, the decline in market value of those securities was considered to be other than temporary.

	The scheduled maturities at September 30, 2004 of securities (other than equity securities) by contractual maturity are shown below. Expected maturities will differ from contractual maturities because the borrower may have the right to call or prepay obligations with or without call or prepayment penalties.

	Securities available-for-sale with a carrying amount of approximately $3,714,000 and $2,535,000 at September 30, 2004 and 2003, respectively, were pledged to secure public deposits as required by law and for other purposes required or permitted by law.

	In May 2004, the Company transferred certain securities from the available-for-sale to held-to-maturity category. The securities were transferred at fair value on the date of transfer. The unrealized loss at the date of transfer was $942,565 and continues to be reported in accumulated other comprehensive income (loss) in stockholders’ equity. That amount is being amortized over the remaining lives of the securities as an adjustment of yield. The amortization of the unrealized loss offsets the effect of the amortization of the discount for those held-to-maturity securities. The amount of such amortization was $26,048 for the year ended September 30, 2004, and the unamortized balance of the unrealized losses, net of applicable income taxes which is included in stockholders’ equity was $568,241 at September 30, 2004.

2.	SECURITIES (Continued)

	The following table shows the Company’s combined investments’ gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at September 30, 2004:

3.	LOANS

	Loans consisted of the following at September 30, 2004 and 2003:

3.	LOANS (Continued)

	The following is a summary of information pertaining to impaired loans:

	Interest on impaired loans is generally recorded on a “cash basis” and is included in earnings only when actually received in cash.

	At September 30, 2004 and 2003, the total recorded investment in loans on non-accrual amounted to approximately $1,194,034 and $2,149,000, respectively, and the total recorded investment in loans past due ninety days or more and still accruing interest was $0 for each year.

	In January 2004, the Company agreed to modify the terms of several loans to one customer. The modified terms included a reduction in interest rates from an original range of prime plus .50% to 15% to a restructured range of 7% to 10%. Additional funds of approximately $55,000 were advanced on the restructuring and additional collateral was received for those advances. The recorded investment in the loans was approximately $210,000 at September 30, 2004. Interest income of approximately $13,000 has been recorded in 2004 on the restructured note. Had the terms of the note not been modified, interest income of approximately $14,000 would have been recorded.

	The Company sells loans to third party investors with limited recourse, primarily related to prepayment. The total amount of recourse liability at September 30, 2004 was approximately $93,000. Because historical losses related to these guarantees have been insignificant, no liability has been recorded for these at September 30, 2004 or 2003.

4.	PREMISES AND EQUIPMENT

	Premises and equipment are summarized as follows at September 30, 2004 and 2003:

	Depreciation expense charged to operations was $377,681, $331,198 and $352,238 in 2004, 2003 and 2002, respectively.

5.	ACCRUED INTEREST RECEIVABLE

	Accrued interest receivable consists of the following at September 30, 2004 and 2003:

6.	INVESTMENTS IN AFFILIATE

	In March 1995, the Company obtained a 50% ownership interest in Magnolia Title Services, Inc. (Magnolia) for an investment of $100,000. Magnolia provides title insurance and related services to various borrowers and lenders in the state of Alabama. The Company accounted for this investment under the equity method. As of September 30, 2003, the Company had written down its investment to $0. In November 2003, the Company sold its investment for $25,000, thereby realizing a gain of $25,000, which is included in other income.

7.	LEASES

	The Company leases certain real estate and office equipment under operating leases expiring in various years through 2008. Minimum future rental payments under non-cancellable operating leases having remaining terms in excess of one year as of September 30, 2004 are as follows:

	Lease expense charged to operations was $140,637, $127,930 and $101,768 for the years ended September 30, 2004, 2003 and 2002, respectively.

	The Company is also the lessor of a portion of its office space under a lease expiring in 2007.

	Minimum future rentals to be received on non-cancelable leases as of September 30, 2004 for each of the next five years and in the aggregate are as follows:

8.	DEPOSITS

	An analysis of deposit accounts at the end of the period is as follows at September 30, 2004 and 2003:

	Certificate accounts greater than or equal to $100,000 were $34,345,365 and $25,253,505 at September 30, 2004 and 2003, respectively. Overdrafts of demand deposits in the amounts of $43,356 and $163,042 have been reclassified as loan balances at September 30, 2004 and 2003, respectively.

	Scheduled maturities of certificate accounts were as follows at September 30, 2004:

8.	DEPOSITS (Continued)

	Interest expense on deposits for the years ended September 30, 2004, 2003 and 2002 was as follows:

9.	BORROWED FUNDS

	Federal Home Loan Bank Advances The Company was liable to the Federal Home Loan Bank of Atlanta on the following advances at September 30, 2004 and 2003:

9.	BORROWED FUNDS (Continued)

	At September 30, 2004 and 2003, the advances were collateralized by first-mortgage residential loans with carrying values of approximately $42,907,000 and $33,349,000, respectively

	On April 15, 2002, the Bank was notified that the amount available under its credit line with the Federal Home Loan Bank of Atlanta had been changed from a variable amount, equal to 30% of total assets to a fixed amount of $22,000,000. This amount was subsequently changed to an amount equal to 10% of its total assets. The Federal Home Loan Bank of Atlanta has notified the Bank that it will not require the Bank’s existing borrowings to be reduced to the new amount prior to the existing advance maturities, but that it will require that any additional borrowing by the Bank be approved through application by the Bank to the Federal Home Loan Bank of Atlanta’s Credit Committee.

	Line of Credit The Corporation also has a line of credit with a commercial bank. A summary of this line of credit at September 30, 2004 and 2003 is as follows: