Murfreesboro Bancorp 10QSB 2002 Q2 Quarterly report (small business)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-QSB

MARK ONE

[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the six month period ended JUNE 30, 2002

[  ]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 0-24161

MURFREESBORO BANCORP, INC.
(Exact Name of Registrant as Specified in Its Charter)

Tennessee	62-1694317
(State or Other Jurisdiction of	(IRS Employer Identification No.)
Incorporation or Organization)

615 Memorial Boulevard, Murfreesboro, Tennessee 37129
(Address of principal executive offices and Zip Code)

(615) 890-1111
(Registrant’s telephone Number, including area code)

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 the number of shares outstanding of each of the issuer’s classes of
common stock as of the latest practicable date.

Common stock outstanding: 907,609 shares at July 15, 2002.

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Murfreesboro Bancorp, Inc.

Consolidated Financial Statements
(Unaudited)

June 30, 2002

C O N T E N T S

	Page
	Number
Consolidated Balance Sheets		2
Consolidated Statements of Operations		3-4
Consolidated Statements of Cash Flows		5
Notes to Consolidated Financial Statements		6

1

Murfreesboro Bancorp, Inc.
Consolidated Balance Sheets
As of June 30, 2002 (Unaudited) and December 31, 2001

(Tabular amounts are in thousands)

     ASSETS

			June 30,		December 31,
			2002		2001
Cash and due from banks			$	3,047	$	3,710
Federal funds sold				5,967		1,675
	Total cash and cash equivalents			9,014		5,385
Securities available for sale				34,442		20,309
	Total investment securities			34,442		20,309
Loans, less allowance for possible loan losses of $955,000 and $1,000,000, respectively				98,081		96,519
Premises and equipment, net				4,968		5,124
Accrued interest receivable				850		687
Officers’ life insurance — cash surrender value				1,874		1,825
Other assets				463		382
Other real estate				103		—
Deferred tax benefits				340		319
	Total assets		$	150,135	$	130,550
		LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits			$	129,720	$	111,017
Short-term borrowings				2,081		1,926
Advances from Federal Home Loan Bank				4,000		4,000
Accrued interest payable				446		388
Accrued expenses and other liabilities				942		845
Subordinated convertible capital debentures				3,000		3,000
	Total liabilities			140,189		121,176
Shareholders’ equity:
Preferred stock, no assigned value or rights, 1,000,000 shares authorized, no shares issued or outstanding				—		—
Common stock, $5.00 par value, 2,000,000 shares authorized and 907,609 shares issued and outstanding				4,538		4,538
Additional paid-in capital				4,530		4,530
Retained earnings				718		276
	Realized shareholders’ equity			9,786		9,344
Accumulated other comprehensive income				160		30
	Total shareholders’ equity			9,946		9,374
	Total liabilities and shareholders’ equity		$	150,135	$	130,550

See notes to consolidated financial statements

2

Murfreesboro Bancorp, Inc.
Consolidated Statements of Operations
For the six months ended June 30, 2002 and 2001
(Unaudited)

(Tabular amounts are in thousands except per share amounts)

				2002		2001
Interest income:
	Interest and fees on loans			$	3,832	$	3,709
	Interest on taxable investment securities				426		474
	Interest on federal funds sold				37		125
	Total interest income				4,295		4,308
Interest expense:
	Interest on negotiable order of withdrawal accounts				68		79
	Interest on money market demand accounts				189		285
	Interest on savings deposits				6		5
	Interest on certificates of deposit				1,365		2,055
	Total interest expense on deposits				1,628		2,424
	Interest on short-term borrowings and advances from FHLB				52		64
	Interest on subordinated convertible capital debentures				97		110
	Total interest expense				1,777		2,598
Net interest income					2,518		1,710
Provision for possible loan losses					4		52
	Net interest income after provision for possible loan losses				2,514		1,658
Non-interest income:
	Service charges on deposits				33		18
	Insufficient fund income				303		205
	Other fees and commissions				59		42
	Increase in cash surrender value of officers’ life insurance				68		42
	Mortgage loan origination fees				78		177
	Brokerage fees				121		88
	Other non-interest income				62		151
	Total non-interest income				724		723
Non-interest expense:
	Salaries and employee benefits				1,377		1,123
	Occupancy expenses, net				166		126
	Furniture and equipment expense				185		140
	Advertising expenses				73		77
	Data processing expenses				210		145
	Other non-interest expense				572		534
	Total non-interest expense				2,583		2,145
	Income before income taxes				655		236
	Income tax expense				213		77
			Net income	$	442	$	159
Earnings per share:
		Basic:
			Net income	$	0.49	$	0.18
		Diluted:
			Net income	$	0.43	$	0.17

See notes to consolidated financial statements

3

Murfreesboro Bancorp, Inc.
Consolidated Statements of Operations
For the quarters ended June 30, 2002 and 2001
(Unaudited)

(Tabular amounts are in thousands except per share amounts)

					2002		2001
Interest income:
	Interest and fees on loans				$	1,927	$	1,922
	Interest on taxable investment securities					241		208
	Interest on federal funds sold					22		30
			Total interest income			2,190		2,160
Interest expense:
	Interest on negotiable order of withdrawal accounts					33		36
	Interest on money market demand accounts					100		151
	Interest on savings deposits					3		2
	Interest on certificates of deposit					675		977
			Total interest expense on deposits			811		1,166
	Interest on short-term borrowings and advances from FHLB					27		22
	Interest on subordinated convertible capital debentures					49		51
			Total interest expense			887		1,239
Net interest income						1,303		921
Provision for possible loan losses						4		39
			Net interest income after provision for possible loan losses			1,299		882
Non-interest income:
	Service charges on deposits					12		13
	Insufficient fund income					163		96
	Other fees and commissions					34		28
	Increase in cash surrender value of officers’ life insurance					44		21
	Mortgage loan origination fees					32		126
	Brokerage fees					66		49
	Other non-interest income					15		121
			Total non-interest income			366		454
Non-interest expense:
	Salaries and employee benefits					702		631
	Occupancy expenses, net					87		63
	Furniture and equipment expense					97		77
	Advertising expenses					24		37
	Data processing expenses					116		71
	Other non-interest expense					261		291
			Total non-interest expense			1,287		1,170
Income before income taxes						378		166
Income tax expense						112		59
				Net income	$	266	$	107
Earnings per share:
		Basic:
				Net income	$	0.29	$	0.12
		Diluted:
				Net income	$	0.25	$	0.12

See notes to consolidated financial statements

4

Murfreesboro Bancorp, Inc.
Consolidated Statements of Cash Flows
For the six months ended June 30, 2002 and 2001
(Unaudited)

(Tabular amounts are in thousands)

				2002			2001
Operating activities:
	Net income			$	442		$	159
	Adjustments to reconcile net income to net cash provided by (used in) operating activities:
		Provision for possible loan losses			4			52
		Provision for deferred taxes			(21	)		(42	)
		Provision for depreciation, amortization and accretion, net			201			172
		Stock dividend on FHLB stock			(8	)		(8	)
		Changes in assets and liabilities:
			Decrease in accrued interest receivable		163			163
			Increase in cash surrender value of officers’ life insurance		(49	)		(42	)
			Increase in other assets		(49	)		(96	)
			Increase in accrued interest payable		58			17
			Increase in accrued expenses and other liabilities		97			83
		Net cash provided by operating activities			838			458
Investing activities:
	Purchase of securities available for sale				(24,133	)		(11,960	)
	Maturities and calls of securities available for sale				10,000			11,500
	Maturities and calls of securities held to maturity				—			8,850
	Increase in loans, net				(1,566	)		(11,268	)
	Additions to premises and equipment				(368	)		(184	)
	Net cash used by investing activities				(16,067	)		(3,062	)
Financing activities:
	Net increase in deposits				18,703			4,127
	Net increase in short-term borrowings				155			1,386
	Net cash provided by financing activities				18,858			5,513
Net increase in cash and cash equivalents					3,629			2,909
Cash and cash equivalents at the beginning of the period					5,385			8,524
Cash and cash equivalents at the end of the period				$	9,014		$	11,433
Supplemental disclosure of cash flow information:
Cash paid during the six months for:
			Interest	$	1,475		$	2,581
			Income taxes	$	105		$	100
Non-cash transactions:
			Increase in unrealized gain on securities available for sale, net of taxes	$	130		$	3
			Increase in other real estate	$	103			—

See notes to consolidated financial statements

5

Murfreesboro Bancorp, Inc.
Notes to Consolidated Financial Statements
June 30, 2001
(Unaudited)

(1) Basis of Presentation
The unaudited consolidated financial statements include the accounts of Murfreesboro Bancorp, Inc. (the Company) and its subsidiary, Bank of Murfreesboro (the Bank), which is a full service bank, and its wholly owned subsidiaries: Bank M Insurance Group, Inc. (BIG), Bank M Mortgage Group, Inc. (BMG), Bank M Investment Center, Inc. (BIC), Hometown World, Inc (HTW), and Bank M( BM). The consolidated financial statements also include BMG’s wholly owned subsidiary, Bank M Mortgage Trust, Inc. (BMT), and its formerly 51% controlled limited liability companies; Realty Financial Services, LLC (RFS) and Woodmont Financial Services, LLC (WFS). BIC, HTW, BM, and WFS were formed during the year ended December 31, 2001. During 2001, BMG acquired the other 50% interest in BMT and sold 49% interests in RFS and WFS. BIG offers insurance products, principally to the Bank or for loans originated by the Bank or its subsidiaries. BMG provides loan closing services for the Bank, BMT, RFS, and WFS. BMT, RFS, and WFS originate mortgage loans for sale to third parties as loan correspondents. BIC, HTW and BM had minimal activity during the quarter and six months ended June 30, 2002. On February 1, 2002, BMG sold its 51% controlling interest in RFS and WFS for its recorded carrying value plus $25,000. BMG may receive up to $50,000 additional compensation from allocations of 25.5% of any future net profits subject to certain conditions. Intercompany accounts and transactions have been eliminated. The accompanying consolidated financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the consolidated financial statements contain all adjustments and disclosures necessary to summarize fairly the financial position of the Company as of June 30, 2002 and December 31, 2001, the results of operations for the six months and the quarters ended June 30, 2002 and 2001, and changes in cash flows for the six months ended June 30, 2002 and 2001. The interim consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements presented in the Company’s Annual Report to Shareholders. The results of the interim periods are not necessarily indicative of the results to be expected for the complete fiscal year.

6

(2) Comprehensive Income

Statement of Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive Income,” was adopted by the Company on January 1, 1998. SFAS 130 establishes standards for reporting comprehensive income. Comprehensive income includes net income and other comprehensive net income which is defined as non-owner related transactions in equity. The following table sets forth the amounts of other comprehensive income (loss) included in equity along with the related tax effect for the six months ended June 30, 2002 and 2001, respectively.

			Tax		Net of
	Pre-Tax		Expense		Tax
	Amount		(Benefit)		Amount
	(In thousands)
Six months ended June 30, 2002:
Net unrealized gain on securities available for sale	$	210	$	80	$	130
Other comprehensive income	$	210	$	80	$	130
Six months ended June 30, 2001:
Net unrealized gain on securities available for sale	$	63	$	38	$	25
Other comprehensive income	$	63	$	38	$	25

The following table sets forth the amounts of other comprehensive income (loss) included in equity along with the related tax effect for the quarters ended June 30, 2002 and 2001, respectively.

				Tax			Net of
	Pre-Tax			Expense			Tax
	Amount			(Benefit)			Amount
	(In thousands)
Quarter ended June 30, 2002:
Net unrealized gain on securities available for sale	$	348		$	132		$	216
Other comprehensive income	$	348		$	132		$	216
Quarter ended June 30, 2001:
Net unrealized loss on securities available for sale	$	(4	)	$	(2	)	$	(2	)
Other comprehensive loss	$	(4	)	$	(2	)	$	(2	)

(3)

Earnings Per Share

The weighted average number of common shares outstanding during the six months and quarters ended June 30, 2002 and 2001 was 907,609. The effect of dilutive common stock options was 17,800 shares for the quarter ended June 30, 2001. The dilutive effect of common stock options is estimated at 24,981 for the quarter ended June 30, 2002. The effect of dilutive common stock options was 17,800 shares for the six months ended June 30, 2001. The dilutive effect of common stock options is estimated at 22,645 for the six months ended June 30, 2002. The contingent issuance of common stock as related to the subordinated convertible capital debentures was anti-dilutive for the quarter and six months ended June 30, 2001, as the effect of the related interest expense exceeded the impact of contingent issuance of common stock shares. For the quarter and six months ended June 30, 2002, the effect of the subordinated convertible capital debentures was to reflect the issuance of 240,000 shares of common stock and a reduction in interest expense of $49,000 and $97,000, and an additional tax expense of $19,000 and $37,000, respectively.

7

PART I

ITEM 2.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

The Company’s Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the information and tables which follow.

Summary

Net income for the six months ended June 30, 2002 was $442,000 and the net income for the six months ended June 30, 2001 was $159,000.

Financial Condition

Earning Assets. Average earning assets for the six months ended June 30, 2002 totaled $127,368,000, which represents 92.1% of average total assets. Average earning assets for the six months ended June 30, 2001 totaled $103,552,000, which represented 88.5% of average total assets. Earning assets totaled $139,035,000 at June 30, 2002 and $119,209,000 at December 31, 2001.

Loan Portfolio.The Company’s average loans for the six months ended June 30, 2002 were $98,666,000 and for the six months ended June 30, 2001 were $81,938,000. The balance in total loans at June 30, 2002 was $99,036,000, $97,225,000 at December 31, 2001 and $90,150,000 at June 30, 2001.

Investment Portfolio.The Company’s investment securities portfolio averaged $24,383,000 for the six months ended June 30, 2002 and $16,673,000 for the six months ended June 30, 2001. The portfolio totaled $34,442,000 at June 30, 2002, $20,309,000 at December 31, 2001 and $14,557,000 at June 30, 2001.

The Company maintains an investment strategy of seeking portfolio yields within acceptable risk levels, as well as providing liquidity. The Company maintains two classifications of investment securities: “Held to Maturity” and “Available for Sale.” The “Available for Sale” securities are carried at fair market value, whereas the “Held to Maturity” securities are carried at amortized cost. At June 30, 2002, there was an unrealized gain in the “Available for Sale” portfolio of $257,000, an unrealized gain of $47,000 at December 31, 2001 and an unrealized gain of $51,000 at June 30, 2001.

The average balance of securities “Available for Sale” during the six months ended June 30, 2002 was $24,383,000 and the balance at June 30, 2002 was $34,442,000. The average balance of securities “Held to Maturity” during the six months ended June 30, 2002 was zero and there were no securities classified as “Held to Maturity” at June 30, 2002.

The average balance of securities “Available for Sale” during the six months ended June 30, 2001 was $16,673,000 and the balance at June 30, 2001 was $14,557,000. The average balance of securities “Available for Sale” during the quarter ended June 30, 2002 was $27,289,000 and $15,566,000 for the quarter ended June 30, 2001. The average balance of securities “Held to Maturity” during the six months ended June 30, 2001 and the balance at June 30, 2001 was zero. The average balance of securities “Held to Maturity” during the quarter ended June 30, 2002 was zero and $788,000 for the quarter ended June 30, 2001.

Deposits.The Company’s average deposits were $118,622,000 for the six months ended June 30, 2002. This included average non-interest-bearing deposits of $8,891,000, average certificates of deposit of $75,944,000, average saving deposits of $1,204,000 and average interest-bearing transaction accounts of $32,583,000.

8

The Company’s average deposits for the six months ended June 30, 2001 were $100,204,000. This included average non-interest-bearing deposits of $7,321,000, average certificates of deposit of $66,885,000, average savings deposits of $784,000 and average interest-bearing transaction accounts of $25,214,000. Deposits totaled $129,720,000 at June 30, 2002, $111,017,000 at December 31, 2001 and $104,217,000 at June 30, 2001.

Capital Resources.Shareholders’ equity totaled $9,946,000 as of June 30, 2002. This included $9,068,000 of common stock and additional paid-in-capital plus retained earnings of $718,000 and accumulated other comprehensive income in the form of an unrealized gain on securities available for sale of $160,000.

Long-Term Debt.The Company issued $3,000,000 of floating rate subordinated convertible capital debentures (debentures) during September 1999. The debentures convert to common stock of the Corporation on August 31, 2011 at a conversion factor based upon the market value of the common stock on that date. If converted before that date, the conversion will be based upon one share of common stock for every $12.50 of debentures held. The debentures began accruing interest on January 1, 2000 and pay interest every December 15 with the final interest payment being made at maturity. Interest payment is based upon a rate equal to the weighted average prime rate less 0.5%. There is a 6.5% floor on the average annual rate. Interest expense for the six months ended June 30, 2002 and 2001 on the debentures totaled $97,000 and $110,000, respectively.

Balance Sheet Management

Liquidity Management.Liquidity is the ability of a company to convert assets into cash without significant loss and to raise funds by increasing liabilities. Liquidity management involves having the ability to meet the day-to-day cash flow requirements of its customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs.

The primary function of asset/liability management is not only to assure adequate liquidity in order for the Company to meet the needs of its customer base, but to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that the Company can profitably deploy its assets. Both assets and liabilities are considered sources of liquidity funding and both are, therefore, monitored on a daily basis.

The asset portion of the balance sheet provides liquidity primarily through investments in federal funds and maturities of investment securities. Additional sources of liquidity are loan repayments and possible prepayments from the mortgage-backed securities from the investment portfolio.

The liability portion of the balance sheet provides liquidity through various interest bearing and non-interest bearing deposit accounts. At June 30, 2002 and December 31, 2001, the Company had $3,500,000 of federal funds purchase lines available at two correspondent banks. None of these lines were drawn at June 30, 2002 or December 31, 2001.

At June 30, 2001 and December 31, 2001, the Bank had a $6,865,000 secured line of credit with a regional bank. This line was not drawn. Investment securities with a par value of $7,500,000 were pledged toward this line of credit.

Because of the level of capital obtained in formation and from the funds derived from the long-term debt issued in September 1999, no additional capital funds or long-term debt are anticipated to be deemed necessary during the next twelve months.

9

Results of Operations for the Six Months Ended June 30, 2002 and 2001

Net Interest Income.Net interest income is the principal component of a financial institution’s income stream and represents the spread between interest and fee income generated from earning assets and the interest expense paid on deposits. The following discussion is on a fully taxable equivalent basis.

Net interest income for the six months ended June 30, 2002 totaled $2,518,000. This was the result of interest income of $4,295,000 and interest expense of $1,777,000. Interest income produced by the loan portfolio totaled $3,832,000, interest income on investment securities totaled $426,000 and interest income on federal funds totaled $37,000. Interest expense included $1,365,000 of interest expense on certificates of deposit, interest expense of $68,000 on interest-bearing transaction accounts, interest expense of $189,000 on money market demand accounts, interest expense on savings accounts of $6,000, interest expense on short-term borrowings and advances from the FHLB of $52,000 and interest expense on subordinated convertible capital debentures of $97,000.

Net interest income for the six months ended June 30, 2001 totaled $1,710,000. This was the result of interest income of $4,308,000 and interest expense of $2,598,000. Interest income produced by the loan portfolio totaled $3,709,000, interest income on investment securities totaled $474,000, and interest income on federal funds totaled $125,000. Interest expense included $2,055,000 of interest expense on certificates of deposit, interest expense of $79,000 on interest-bearing transaction accounts, interest expense of $285,000 on money market demand accounts, interest expense of $5,000 on savings accounts, interest expense on short-term borrowings and advances from the FHLB of $64,000 and interest expense on subordinated convertible capital debentures of $110,000.

The trend in net interest income is commonly evaluated in terms of average rates using the net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield on average earning assets and the average rate paid for all funds used to support those earning assets.

The net interest margin for the six months ended June 30, 2002 was 3.99%. The net cost of funds, defined as interest expense divided by average-earning assets, was 2.81% and the yield on earning assets was 6.80% for the six months ended June 30, 2002. The net interest margin for the six months ended June 30, 2001 was 3.33%. The net cost of funds for the six months ended June 30, 2001 was 5.06% and the yield on earning assets was 8.39%.

The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing sources of funds. The interest rate spread eliminates the impact of non-interest bearing funds and gives a direct perspective on the effect of market interest rate movements. During recent years, the net interest margins and interest rate spreads have been under intense pressure to maintain historical levels, due in part to tax laws that discouraged investment in tax-exempt securities and intense competition for funds with non-bank institutions. The interest rate spread for the six months ended June 30, 2002 was 3.78% and for the six months ended June 30, 2001 was 3.09%.

Allowance for Possible Loan Losses.Lending officers are responsible for the ongoing review and administration of each loan. They make the initial identification of loans that present some difficulty in collection or where there is an indication that the probability of loss exists. Lending officers are responsible for the collection effort on a delinquent loan. Senior management is informed of the status of delinquent and problem loans on a monthly basis.

Senior management makes recommendations monthly to the board of directors as to charge-offs. Senior management reviews the allowance for possible loan losses on a quarterly basis. The Company’s policy is to discontinue interest accrual when payment of principal and interest is 90 days or more in arrears, unless there is sufficient collateral to justify continued accrual.

10

The allowance for possible loan losses represents management’s assessment of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for possible loan losses and the appropriate provisions required to maintain a level considered adequate to absorb 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 loan loss experience, the amount of past due and non-performing loans, specific known risk, the status and amount of non-performing assets, underlying collateral values securing loans, current and anticipated economic conditions and other factors which affect the allowance for potential credit losses.

While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of future losses that cannot be quantified precisely or attributed to 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.

Management believes that the $955,000 at June 30, 2002 and $1,000,000 at December 31, 2001 in the allowance for possible loan losses are 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 the loan portfolio, and require greater provisions for possible loan losses in the future.

Non-performing Assets. Non-performing assets include non-performing loans and foreclosed real estate held for sale. Non-performing loans include loans classified as non-accrual or renegotiated. The Company’s policy is to place a loan on non-accrual status when it is contractually past due 90 days or more as to payment of principal or interest unless there is reason to believe the collection of principal and interest is fairly certain. At the time a loan is placed on non-accrual status, interest previously accrued but not collected is reversed and charged against current earnings. Recognition of any interest after a loan has been placed on non-accrual is accounted for on a cash basis.

There were no impaired loans at June 30, 2002 or at December 31, 2001. There were no loans past due ninety days or more and still accruing interest at June 30, 2002 or December 31, 2001. Loans on non-accrual status at June 30, 2002 totaled $86,000 and $59,000 at December 31, 2001. Foreclosed real estate held for sale (other real estate) at June 30, 2002 totaled $103,000 and there was no other real estate at December 31, 2001

Non-interest Income. Non-interest income consists of revenues generated from a broad range of financial services and activities including fee-based services and increase in the cash surrender value of officer’s life insurance. In addition, any gains or losses realized from the sale of investment portfolio securities available for sale are included in non-interest income.

Non-interest income totaled $724,000 for the six months ended June 30, 2002. This included $33,000 on service charge on deposit accounts, insufficient funds income of $303,000, other fees of $59,000, $68,000 from the increase in the cash surrender value of the officer’s life insurance and $261,000 of other non-interest income including brokerage income and mortgage loan origination fees. There were no gains or losses on securities during the six months ended June 30, 2002.

Non-interest income totaled $723,000 for the six months ended June 30, 2001. This included $18,000 from service charges on deposit accounts, insufficient funds income of $205,000, other fees of $42,000, $42,000 from the increase in the cash surrender value of the officer’s life insurance and $416,000 of other non-interest income, including brokerage income and mortgage loan origination fees. There were no gains or losses on securities during the six months ended June 30, 2001.

Non-interest Expenses. Non-interest expense for the six months ended June 30, 2002 totaled $2,583,000. Salaries and employee benefits for the six months ended June 30, 2002 totaled $1,377,000. Occupancy expenses for the six months ended June 30, 2002 totaled $166,000 while furniture and equipment expenses totaled $185,000. Other non-interest expenses totaled $855,000. Other non-interest expenses include advertising, data processing expenses, supplies and printing, telephone, postage and legal and audit fees.

11

Non-interest expense for the six months ended June 30, 2001 totaled $2,145,000. Salaries and employee benefits for the six months ended June 30, 2001 totaled $1,123,000. Occupancy expense for the six months ended June 30, 2001 totaled $126,000 while furniture and equipment expense totaled $140,000. All other non-interest expenses totaled $756,000 for the six months ended June 30, 2001. Other non-interest expenses include advertising, data processing expense, supplies and printing, telephone, postage, legal and audit.

Income Taxes.For the six months ended June 30, 2002 the Company incurred income tax expenses of $213,000 for an effective tax rate of 32.5%. For the six months ended June 30, 2001 the Company incurred income tax expenses of $77,000 for an effective tax rate of 32.6%. Approximately $68, 000 of income earned during the six months ended June 30, 2002 is exempt from income taxes and approximately $42,000 of income earned during the six months ended June 30, 2001 is exempt from income taxes.

Results of Operations for the Quarters Ended June 30, 2001 and 2000

Net Interest Income.Net interest income is the principal component of a financial institution’s income stream and represents the spread between interest and fee income generated from earning assets and the interest expense paid on deposits. The following discussion is on a fully taxable equivalent basis.

Net interest income for the quarter ended June 30, 2002 totaled $1,303,000. This was the result of interest income of $2,190,000 and interest expense of $887,000. Interest income produced by the loan portfolio totaled $1,927,000, interest income on investment securities totaled $241,000 and interest income on federal funds totaled $22,000. The interest expense included $675,000 of interest expense on certificates of deposit, interest expense of $33,000 on interest-bearing transaction accounts, interest expense of $100,000 on money market demand accounts, interest expense on savings accounts of $3,000, interest expense on short-term borrowings and advances from FHLB of $27,000 and interest expense on subordinated convertible capital debentures of $49,000.

Net interest income for the quarter ended June 30, 2001 totaled $921,000. This was the result of interest income of $2,160,000 and interest expense of $1,239,000. Interest income produced by the loan portfolio totaled $1,922,000, interest income on investment securities totaled $208,000, and interest income on federal funds totaled $30,000. Interest expense included $977,000 of interest expense on certificates of deposit, interest expense of $36,000 on interest-bearing transaction accounts, interest expense of $151,000 on money market demand accounts, interest expense on savings accounts of $2,000. Further interest expense was incurred related to short-term borrowings and subordinated convertible capital debentures of $22,000 and $51,000, respectively.

The trend in net interest income is commonly evaluated in terms of average rates using the net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference between the average yield on average earning assets and the average rate paid for all funds used to support those earning assets.

The net interest margin for the quarter ended June 30, 2002 was 3.95%. The net cost of funds, defined as interest expense divided by average-earning assets, was 2.69% and the yield on earning assets was 6.64% for the quarter ended June 30, 2002. The net interest margin for the quarter ended June 30, 2001 was 3.58%. The net cost of funds for the quarter ended June 30, 2001 was 4.81% and the yield on earning assets was 8.39%.

The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing sources of funds. The interest rate spread eliminates the impact of non-interest bearing funds and gives a direct perspective on the effect of market interest rate movements. During recent years, the net interest margins and interest rate spreads have been under intense pressure to maintain historical levels, due in part to tax laws that discouraged investment in tax-exempt securities and intense competition for funds with non-bank institutions. The interest rate spread for the quarter ended June 30, 2002 was 3.75% and for the quarter ended June 30, 2001 was 3.36%.

12

Non-interest Income. Non-interest income consists of revenues generated from a broad range of financial services and activities including fee-based services and increase in the cash surrender value of officer’s life insurance. In addition, any gains or losses realized from the sale of investment portfolio securities available for sale are included in non-interest income.

Non-interest income totaled $366,000 for the quarter ended June 30, 2002. This included $12,000 on service charge on deposit accounts, insufficient funds income of $163,000 other fees of $34,000, $44,000 from the increase in the cash surrender value of the officer’s life insurance and $113,000 of other non-interest income including brokerage income. There were no gains or losses on securities during the quarter ended June 30, 2002.

Non-interest income totaled $454,000 for the quarter ended June 30, 2001. This included $13,000 from service charges on deposit accounts, insufficient funds income of $96,000, other fees of $28,000, increase in cash surrender value of officers’ life insurance of $21,000 and $296,000 of other non-interest income including brokerage income. There were no gains or losses on securities during the quarter ended June 30, 2001.

Non-interest Expenses. Non-interest expense for the quarter ended June 30, 2002 totaled $1,287,000. Salaries and employee benefits for the quarter ended June 30, 2002 totaled $702,000. Occupancy expenses for the quarter ended June 30, 2002 totaled $87,000 while furniture and equipment expenses totaled $97,000. Other non-interest expenses totaled $401,000. Other non-interest expenses include advertising, data processing expenses, supplies and printing, telephone, postage and legal and audit fees.

Non-interest expense for the quarter ended June 30, 2001 totaled $1,170,000. Salaries and employee benefits for the quarter ended June 30, 2001 totaled $631,000. Occupancy expense for the quarter ended June 30, 2001 totaled $63,000 while furniture and equipment expense totaled $77,000. All other non-interest expenses totaled $399,000 for the quarter ended June 30, 2001 and included advertising, data processing expense, supplies and printing, telephone, postage legal and audit fees.

Income Taxes.For the quarter ended June 30, 2002 the Company incurred income tax expenses of $112,000 for an effective tax rate of 29.6%. For the quarter ended June 30, 2001 the Company incurred income tax expenses of $59,000 for an effective tax rate of 35.5%. Approximately $21,000 of income earned during the quarter ended June 30, 2001 is exempt from income taxes and approximately $44,000 of income earned during the six months ended June 30, 2002 is exempt from income taxes.

Return on Equity and Assets

Return on assets (net income divided by average total assets) for the six months ended June 30, 2002 was 0.64%. Return on assets for the six months ended June 30, 2001 was 0.27%. Return on assets for the quarter ended June 30, 2002 was 0.75% while return on assets for the quarter ended June 30, 2001 was 0.37%.

Return on equity (net income divided by average equity) for the six months ended June 30, 2002 was 9.29%. Return on equity for the six months ended June 30, 2001 was 3.49%. Return on equity for the quarter ended June 30, 2002 was 10.98% while return on equity for the quarter ended June 30, 2001 was 4.62%.

Equity to assets (average equity divided by average total assets) for the six months ended June 30, 2002 was 6.93%. Equity to assets for the six months ended June 30, 2001 was 7.85%. Equity to assets for the quarter ended June 30, 2002 was 6.79% while equity to assets for the quarter ended June 30, 2001 was 7.92%.

There were no dividends paid during the quarters or six months ended June 30, 2002 or 2001, so no dividend payout ratio is presented.

13

Effects of Inflation and Changing Prices

Inflation generally increases the cost of funds and operating overhead and to the extent 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 financial institutions’ 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 loan originations and refinancings tend to slow as interest rates increase and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

14

Average Balance Sheet and Net Interest Income

The following table sets forth weighted yields earned by the Company on its earning assets and the weighted average rates paid on its deposits and other interest-bearing liabilities for the six months ended June 30, 2002 and certain other information:

					Interest		Average
		Average			Income/		Yields/
		Balance			Expense		Rates
Assets:		(Fully taxable equivalent - dollars in thousands)
Interest-earning assets:
Loans		$	98,666		$	3,832		7.83	%
Investment securities:
	U.S. Treasury and other U.S. government agencies		24,383			426		3.52	%
	States and municipalities		—			—		N/A
Federal funds sold			4,319			37		1.73	%
Total interest-earning assets/interest income			127,368			4,295		6.80	%
Cash and due from banks			3,103
Other assets			8,831
Allowance for possible loan losses			(995	)
Total assets		$	138,307
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts		$	33,787			263		1.57	%
Certificates of deposit			75,944			1,365		3.62	%
Short-term borrowings			5,959			52		1.76	%
Subordinated convertible capital debentures			3,000			97		6.52	%
Total interest-bearing liabilities/interest expense			118,690			1,777		3.02	%
Non-interest-bearing demand deposits			8,891
Other liabilities			1,135
Shareholders’ equity			9,591
Total liabilities and shareholders’ equity		$	138,307
Net interest earnings					$	2,518
Net interest income on interest-earning assets								3.99	%
Taxable equivalent adjustment:						N/A

15

The following table sets forth weighted yields earned by the Company on its earning assets and the weighted average rates paid on its deposits and other interest-bearing liabilities for the six months ended June 30, 2001 and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
Assets:	(Fully taxable equivalent - dollars in thousands)
Interest-earning assets:
Loans	$	81,938		$	3,709		9.13	%
U.S. Treasury and other U.S. government agencies		16,673			474		5.73	%
States and municipalities		—			—		N/A
Federal funds sold		4,941			125		5.10	%
Total interest-earning assets/interest income		103,552			4,308		8.39	%
Cash and due from banks		5,719
Other assets		8,630
Allowance for possible loan losses		(950	)
Total assets	$	116,951
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	25,998			369		2.86	%
Certificates of deposit		66,885			2,055		6.20	%
Short-term borrowings		3,022			64		4.27	%
Subordinated convertible capital debentures		3,000			110		7.39	%
Total interest-bearing liabilities/interest expense		98,905			2,598		5.30	%
Non-interest-bearing demand deposits		7,321
Other liabilities		1,548
Shareholders’ equity		9,177
Total liabilities and shareholders’ equity	$	116,951
Net interest earnings				$	1,710
Net interest income on interest-earning assets							3.33	%
Taxable equivalent adjustment:					N/A

16

The following table presents changes in the Company’s various categories of interest income and interest expense based upon the change in the average rate and the change in the average volume from the six months ended June 30, 2002 to the six months ended June 30, 2001 (in thousands).

								INCREASE			INCREASE			INCREASE
								(DECREASE)			(DECREASE)			(DECREASE)
					INCREASE			DUE TO			DUE TO			DUE TO RATE
					(DECREASE)			RATE			VOLUME			AND VOLUME
				ASSETS
Interest earning assets:
Interest bearing deposits with other banks					$	—		$	—		$	—		$	—
Federal funds sold						(88	)		(83	)		(16	)		11
Investment securities						(48	)		(183	)		219			(84	)
Loans						123			(527	)		757			(107	)
		Total interest earning assets				(13	)		(793	)		960			(180	)
			LIABILITIES
Interest bearing liabilities:
Demand deposits and savings accounts						(106	)		(167	)		111			(50	)
Certificates of deposits						(690	)		(853	)		278			(115	)
Short-term borrowings and FHLB advances						(12	)		(38	)		62			(36	)
Subordinated convertible capital debentures						(13	)		(13	)		—			—
		Total interest bearing liabilities				(821	)		(1,071	)		451			(201	)
	Total				$	808		$	278		$	509		$	(21	)

17

Average Balance Sheet and Net Interest Income

     The following table sets forth weighted yields earned by the Company on its earning assets and the weighted average rates paid on its deposits and other interest-bearing liabilities for the quarter ended June 30, 2002 indicated and certain other information:

					Interest		Average
		Average			Income/		Yields/
		Balance			Expense		Rates
Assets:		(Fully taxable equivalent - dollars in thousands)
Interest-earning assets:
Loans		$	99,826		$	1,927		7.74	%
Investment securities:
	U.S. Treasury and other U.S. government agencies		27,288			241		3.54	%
	States and municipalities		—			—		N/A
Federal funds sold			5,170			22		1.71	%
Total interest-earning assets/interest income			132,284			2,190		6.64	%
Cash and due from banks			3,032
Other assets			8,861
Allowance for possible loan losses			(978	)
Total assets		$	143,199
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts		$	35,151			136		1.55	%
Certificates of deposit			79,051			675		3.42	%
Short-term borrowings and FHLB advances			6,018			27		1.80	%
Subordinated convertible capital debentures			3,000			49		6.55	%
Total interest-bearing liabilities/interest expense			123,220			887		2.89	%
Non-interest-bearing demand deposits			8,990
Other liabilities			1,272
Shareholders’ equity			9,717
Total liabilities and shareholders’ equity		$	143,199
Net interest earnings					$	1,303
Net interest income on interest-earning assets								3.95	%
Taxable equivalent adjustment:						N/A

18

The following table sets forth weighted yields earned by the Company on its earning assets and the weighted average rates paid on its deposits and other interest-bearing liabilities for the quarter ended June 30, 2001 indicated and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
Assets:	(Fully taxable equivalent - dollars in thousands)
Interest-earning assets:
Loans	$	84,997		$	1,922		9.07	%
U.S. Treasury and other U.S. government agencies		15,566			208		5.36	%
States and municipalities		—			—		—
Federal funds sold		2,758			30		4.36	%
Total interest-earning assets/interest income		103,321			2,160		8.39	%
Cash and due from banks		6,205
Other assets		8,973
Allowance for possible loan losses		(955	)
Total assets	$	117,544
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	27,394			189		2.77	%
Certificates of deposit		65,488			977		5.98	%
Short-term borrowings and FHLB advances		2,391			22		3.69	%
Subordinated convertible capital debentures		3,000			51		6.82	%
Total interest-bearing liabilities/interest expense		98,273			1,239		5.06	%
Non-interest-bearing demand deposits		8,124
Other liabilities		1,837
Shareholders’ equity		9,310
Total liabilities and shareholders’ equity	$	117,544
Net interest earnings				$	921
Net interest income on interest-earning assets							3.58	%
Taxable equivalent adjustment:					N/A

19

The following table presents changes in the Company’s various categories of interest income and interest expense based upon the change in the average rate and the change in the average volume from the quarter ended June 30, 2002 to the quarter ended June 30, 2001 (in thousands).

								INCREASE			INCREASE		INCREASE
								(DECREASE)			(DECREASE)		(DECREASE)
					INCREASE			DUE TO			DUE TO		DUE TO RATE
					(DECREASE)			RATE			VOLUME		AND VOLUME
				ASSETS
Interest earning assets:
Federal funds sold					$	(8	)	$	(18	)	$	26	$	(16	)
Investment securities						33			(71	)		157		(53	)
Loans						5			(281	)		335		(49	)
		Total interest earning assets				30			(370	)		518		(118	)
			LIABILITIES
Interest bearing liabilities:
Demand deposits and savings accounts						(53	)		(83	)		54		(24	)
Certificates of deposits						(302	)		(418	)		202		(86	)
Short-term borrowings and FHLB advances						5			(11	)		33		(17	)
Subordinated convertible capital debentures						(2	)		(2	)		—		—
		Total interest bearing liabilities				(352	)		(514	)		289		(127	)
	Total				$	382		$	144		$	229	$	9

Amounts are adjusted to a fully taxable basis, based on the statutory Federal income tax rates, adjusted for applicable state income taxes net of the related Federal tax benefit. The effect of volume change is computed by multiplying the change in volume by the prior year rate. The effect of rate change is computed by multiplying the change in rate by the prior year volume. Rate/volume change is computed by multiplying the change in volume by the change in rate.

20

Assets

The management of the Company considers many criteria in managing assets, including creditworthiness, diversification and structural characteristics, maturity and interest rate sensitivity. The following table sets forth the Company’s interest-earning assets by category at June 30, 2002 and December 31, 2001 (in thousands):

	June 30, 2002		December 31, 2001
Investment securities	$	34,442	$	20,309
Federal funds sold		5,967		1,675
Loans:
Real estate		72,942		73,319
Commercial and other		25,684		23,906
Total loans		98,626		97,225
Interest-earning assets	$	139,035	$	119,209

Investment Portfolio

The Company has classified all investment securities as either available for sale or held to maturity depending upon whether the Company has the intent and ability to hold the investment securities to maturity. The classification of certain investment securities as available for sale is consistent with the Company’s investment philosophy of maintaining flexibility to manage the portfolio. At June 30, 2002, approximately $34,442,000 of investment securities was classified as available for sale and at December 31, 2001, approximately $20,309,000 of investment securities was classified as available for sale. Approximately $257,000 and $47,000 of unrealized gains were included in shareholders’ equity related to the available for sale investment securities as of June 30, 2002 and December 31, 2001, respectively. There were no securities classified as held to maturity at June 30, 2002 and December 31, 2001, respectively.

At June 30, 2002, obligations of the United States Government or its agencies represented 100% of the total investment debt portfolio. The following table presents the carrying amounts of the Company’s investment portfolio at June 30, 2002 (in thousands):

	Amortized		Estimated
	Cost		Fair Value
Available for sale:
U.S. Treasury	$	1,002	$	1,012
U.S. Government agencies		32,428		32,675
States and political subdivisions		—		—
Other securities		—		—
Total available for sale-debt securities		33,430		33,687
Federal Reserve Bank stock		404		404
Federal Home Loan Bank stock		351		351
Total available for sale	$	34,185	$	34,442

21

At December 31, 2001, obligations of the United States Government or its agencies represented 100% of the total investment debt portfolio. The following table presents the carrying amounts of the Company’s investment portfolio at December 31, 2001 (in thousands):

	Amortized		Estimated
	Cost		Fair Value
Available for sale:
U.S. Treasury	$	1,003	$	1,003
U.S. Government agencies		18,588		18,635
States and political subdivisions		—		—
Other securities		—		—
Total available for sale — debt securities		19,591		19,638
Federal Reserve Bank stock		351		351
Federal Home Loan Bank Stock		320		320
Total available for sale	$	20,262	$	20,309

The following table presents the maturity distribution of the carrying value and estimated fair value of the Company’s investment debt portfolio at June 30, 2002. The weighted average yields on these instruments are presented based on final maturity (dollars in thousands).

	Amortized		Estimated		Weighted
	Cost		Fair Value		Average Yield
Available for sale:
U.S. Treasuries	$	1,002	$	1,012		3.09	%
U.S. Government agencies:
Due within 1 year		100		100		2.65	%
Due after 1 year but within 5 years		32,328		32,575		3.70	%
Due after 5 years but within 10 years		—		—		N/A
Due after 10 years		—		—		N/A
Total		33,430		33,687		3.68	%
States and political subdivisions		—		—		N/A
Other		—		—		N/A
Total investments available for sale-debt securities	$	33,430	$	33,687	$	3.68	%

22

The following table presents the maturity distribution of the carrying value and estimated fair value of the Company’s investment debt portfolio at December 31, 2001. The weighted average yields on these instruments are presented based on final maturity (dollars in thousands).

	Amortized		Estimated		Weighted
	Cost		Fair Value		Average Yield
Available for sale:
U.S. Treasuries due after 1 year but within 5 years	$	1,003	$	1,003		3.09	%
U.S. Government agencies:
Due within 1 year		9,064		9,089		3.71	%
Due after 1 year but within 5 years		9,524		9,546		3.44	%
Due after 5 years but within 10 years		—		—		N/A
Due after 10 years		—		—		N/A
Total		19,591		19,638		3.54	%
States and political subdivisions		—		—		N/A
Other		—		—		N/A
Total investments available for sale-debt securities	$	19,591	$	19,638		3.54	%

Investment Policy

The objective of the Company’s investment policy is to invest funds not otherwise needed to meet the loan demand of the Bank’s market area to earn the maximum return for the Bank, yet still maintain sufficient liquidity to meet fluctuations in the Bank’s loan demand and deposit structure. In doing so, the Company balances the market and credit risk against the potential investment return, makes investments compatible with the pledge requirements of the Bank’s deposits of public funds, maintains compliance with regulatory investment requirements, and assists the various public entities with their financing needs. The Investment Committee is comprised of the president and three other directors. The President is authorized to execute security transactions for the investment portfolio and to make decisions on purchases and sales of securities. All the investment transactions occurring since the previous board of directors’ meeting are reviewed by the board at its next monthly meeting. Limitations on the Committee’s investment authority include: (a) investment in any one municipal security may not exceed 20% of equity capital; (b) the entire investment portfolio may not increase or decrease by more than 10% in any one month; (c) investments in obligations of the State of Tennessee may not exceed 30% of equity capital; and (d) investment in mortgage-backed securities may not exceed more than 40% of equity capital. The investment policy allows portfolio holdings to include short-term securities purchased to provide the Bank’s needed liquidity and longer-term securities purchased to generate stable income for the Bank during periods of interest rate fluctuations.

23

Loan Portfolio

The following table sets forth the composition of the Company’s loan portfolio at June 30, 2002 (dollars in thousands).

				Percent of
	Balance			Total Loans
Real estate loans:
Construction and land development	$	8,071			8.2	%
Secured by residential properties		37,628			38.2	%
Secured by commercial real estate		27,243			27.6	%
Total real estate loans		72,942			74.0	%
Commercial and industrial loans		4,830			4.9	%
Other consumer loans		20,854			21.1	%
Total loans		98,626			100.0	%
Unamortized premiums and net deferred loan costs		410			N/A
Allowance for possible loan losses		(955	)		N/A
Net loans	$	98,081			N/A

The following table sets forth the composition of the Company’s loan portfolio at December 31, 2001 (dollars in thousands).

				Percent of
	Balance			Total Loans
Real estate loans:
Construction and land development	$	6,697			6.9	%
Secured by residential properties		39,968			41.1	%
Secured by commercial real estate		26,654			27.4	%
Total real estate loans		73,319			75.4	%
Commercial and industrial loans		5,406			5.6	%
Other consumer loans		18,500			19.0	%
Total loans		97,225			100.0	%
Unamortized premiums and net deferred loan costs		294			N/A
Allowance for possible loan losses		(1,000	)		N/A
Net loans	$	96,519			N/A

The following table sets forth the contractual maturities of the loan portfolio and the sensitivity to interest rate changes of the Company’s loan portfolio at June 30, 2002 (in thousands).

	Maturity Range
	One Year		One Through		Over
	or Less		Five Years		Five Years		Total
Loan maturity:
Real estate construction loans	$	4,168	$	3,903	$	—	$	8,071
Real estate mortgage loans		19,069		45,558		244		64,871
Commercial and industrial loans		3,578		1,006		246		4,830
All other loans		9,678		8,746		2,430		20,854
Total loans	$	36,493		59,213		2,920	$	98,626
Loan interest rate sensitivity:
Predetermined interest rates	$	8,193	$	29,918	$	2,920	$	41,031
Floating or adjustable interest rates		28,300		29,295		—		57,595
Total	$	36,493	$	59,213	$	2,920	$	98,626

24

The following table sets forth the contractual maturities of the loan portfolio and the sensitivity to interest rate changes of the Company’s loan portfolio at December 31, 2001 (in thousands).

	Maturity Range
	One Year		One Through		Over
	or Less		Five Years		Five Years		Total
Loan maturity:
Real estate construction loans	$	3,069	$	3,628	$	—	$	6,697
Real estate mortgage loans		14,629		46,143		5,850		66,622
Commercial and industrial loans		2,016		3,292		98		5,406
All other loans		8,217		4,164		6,119		18,500
Total loans	$	27,931	$	57,227	$	12,067		97,225
Loan interest rate sensitivity:
Predetermined interest rates	$	7,847	$	20,816	$	12,067	$	40,730
Floating or adjustable interest rates		20,084		36,411		—		56,495
Total		27,931	$	57,227	$	12,067		97,225

Loan Policy

All lending activities of the Bank are under the direct supervision and control of the Bank’s Board with secondary authority vested in the Executive Committee. The Senior Loan Committee, which consists of the president, one other director and two senior lending officers, enforces loan authorizations for each officer, decides on loans exceeding such limits, services all requests for officer credits to the extent allowable under current laws and regulations, administers all problem credits, and determines the allocation of funds for each lending division. The loan portfolio consists primarily of real estate, commercial, small business, residential construction and consumer installment loans. Maturity of term loans is normally limited to 15 years. Conventional real estate loans may be made up to 80% of the appraised value or purchase cost of the real estate for no more than a 30-year term. Installment loans are based on the earning capacity and vocational stability of the borrower.

The Bank board at its regularly scheduled meetings reviews all new loans made the preceding month and discusses and approves any loans that exceed a loan officer’s authority. Loans that are 30 days or more past due are reviewed monthly.

The Loan Committee of the Bank periodically reviews the loan portfolio, particularly nonaccrual and renegotiated loans. Each loan officer is responsible for monitoring and collecting his or her own loan portfolio. Loan Committee review may result in a determination that a loan should be placed on a nonaccrual status for income recognition, subject to Bank Board approval. In addition, to the extent that management identifies potential losses in the loan portfolio and reduces the book value of such loans through charge-offs, to their estimated collectible value, the Company’s policy is to classify as nonaccrual any loan on which payment of principal or interest is 90 days or more past due, unless there is adequate collateral to cover principal and accrued interest and the loan is in the process of collection. In addition, a loan will be classified as nonaccrual if, in the opinion of the Loan Committee, based upon a review of the borrower’s or guarantor’s financial condition, collateral value or other factors, payment is questionable, even though payments are not 90 days or more past due.

When a loan is classified as nonaccrual, any unpaid interest is reversed against current income. Interest is included in income thereafter only to the extent received in cash. The loan remains in a nonaccrual classification until such time as the loan is brought current, when it may be returned to accrual classification. When principal or interest on a nonaccrual loan is brought current, if in management’s opinion future payments are questionable, the loan would remain classified as nonaccrual. After a nonaccrual or renegotiated loan is charged off, any subsequent payments of either interest or principal are applied first to any remaining balance outstanding, then to recoveries and finally to income.

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The large number of consumer installment loans and the relatively small dollar amount of each make an individual review impracticable. It is the Company’s policy to charge off any consumer installment loan that is past due 90 days or more and is not adequately collateralized.

In addition, mortgage loans secured by real estate are placed on nonaccrual status when the mortgagor is in bankruptcy, or foreclosure proceedings are instituted.

Credit Risk Management and Allowance for Possible Loan Losses

Credit risk and exposure to loss are inherent parts of the banking business. Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of the Company. The loan review procedures are set to monitor adherence to the established criteria and to ensure that on a continuing basis such standards are enforced and maintained.

Management’s objective in establishing lending and investment standards is to manage the risk of loss and to provide for income generation through pricing policies. To effectuate this policy, the Company makes commercial real estate loans with a three-year or less fixed maturity, which may be amortized over a maximum of 15 years.

The loan portfolio is regularly reviewed and management determines the amount of loans to be charged-off. In addition, such factors as the Company’s previous loan loss experience, prevailing and anticipated economic conditions, industry concentrations and the overall quality of the loan portfolio are considered. While management uses available information to recognize losses on loans and real estate owned, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowance for possible losses on loans and real estate owned. Such agencies may require the Company to recognize additions to the allowances based on their judgments about information available at the time of their examinations. In addition, any loan or portion thereof which is classified as a “loss” by regulatory examiners is charged-off.

The allowance for possible loan losses is increased by provisions charged to operating expense. The allowance for possible loan losses is reduced by charging off loans or portions of loans at the time they are deemed by management to be uncollectible and increased when loans previously charged off are recovered. The resulting allowance for possible loan losses is viewed by management as a single, unallocated reserve available for all loans and, in management’s opinion, is adequate to provide for reasonably foreseeable potential loan losses. The risk associated with loans varies with the creditworthiness of the borrower, the type of loan (consumer, commercial or real estate) and its maturity. Cash flow adequate to support a repayment schedule is an element considered for all types of loans. Real estate loans are impacted by market conditions regarding the value of the underlying property used as collateral. Commercial loans are also impacted by the management of the business as well as economic conditions. Management believes the allowance for possible loan losses is adequate to absorb such anticipated charge-offs.

Rules and formulas relative to the adequacy of the allowance for possible loan losses, although useful as guidelines to management, are not rigidly applied. The allowance for possible loan losses was $955,000 as of June 30, 2002 or 0.96% of loans outstanding. The allowance for possible loan losses was $1,000,000 as of December 31, 2001, or 1.03% of loans outstanding. The provision for possible loan losses charged against earnings during the first six months of 2002 was $4,000. Net charge-offs during the first six months of 2002 were $49,000 (Consisting of charge-offs of $66,000 and recoveries of $17,000). The provision for possible loan losses charged against earnings during the year ended December 31, 2001 was $123,000. Net charge-offs during 2001 were $65,000 (consisting of charge-offs of $73,000 and recoveries of $8,000.)

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No loans were past due 90 days or more and still accruing interest at June 30, 2002 or at December 31, 2001. There were $86,000 of loans classified as non-accrual at June 30, 2002 and $59,000 of loans were classified as non-accrual at December 31, 2001. Accrual of interest is discontinued when there is reasonable doubt as to the full and timely collection of interest or principal. When a loan becomes contractually past due ninety (90) days with respect to interest or principal, it is reviewed and a determination is made as to whether it should be placed on non-accrual status. When a loan is placed on non-accrual status, all interest previously accrued but not collected is reversed against current period interest income. Income on such loans is then recognized only to the extent that cash is received and where the future collection of principal is probable. Interest accruals are resumed on such loans only when they are brought fully current with respect to principal and interest and when, in the judgment of management, the loans are estimated to be fully collectible as to principal and interest. Restructured loans are those loans on which concessions in terms have been granted because of a borrower’s financial difficulty. Interest is generally accrued on such loans in accordance with the new terms. There were no impaired loans at June 30, 2002 or at December 31, 2001.

There was no other real estate owned at December 31, 2001 and $103,000 of other real estate owned at June 30, 2002.

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Deposits

The Company’s primary sources of funds are deposits. The following table sets forth the Company’s deposit structure at June 30, 2002 and December 31, 2001 (in thousands):

	June 30,		December 31,
	2002		2001
Non-interest-bearing deposits:
Individuals, partnerships and corporations	$	9,579	$	7,969
U. S. Government and states and political subdivisions		—		—
Certified and official checks		370		497
Total non-interest-bearing deposits		9,949		8,466
Interest-bearing deposits:
Interest-bearing demand accounts		34,727		30,429
Saving accounts		1,386		1,016
Certificates of deposit, less than $100,000		47,125		43,302
Certificates of deposit, $100,000 or greater		36,533		27,804
Total interest-bearing deposits		119,771		102,551
Total deposits	$	129,720	$	111,017

The following table presents a breakdown by category of the average amount of deposits and the average rate paid on deposits for the six months ended June 30, 2002 and the year ended December 31, 2001 (dollars in thousands):

	Six-Months Ended				Year Ended
	June 30, 2002				December 31, 2001
Non-interest-bearing deposits	$	8,891	N/A		$	7,350	N/A
Interest-bearing demand deposits		32,583	1.59	%		27,370	2.47	%
Savings accounts		1,204	1.00	%		861	1.20	%
Certificates of deposit		75,944	3.63	%		67,370	5.70	%
Total deposits	$	118,622	2.77	%	$	102,951	4.40	%

At June 30, 2002, certificates of deposits greater than $100,000 aggregated approximately $36,533,000. The following table indicates, as of June 30, 2002, the dollar amount of $100,000 or more by the time remaining until maturity (in thousands):

	3 Months		3 to 12		1 to 5		Over 5
	or less		Months		Years		Years
Certificates of deposit	$	13,033	$	20,103	$	3,397		—

At December 31, 2001, certificates of deposits greater than $100,000 aggregated approximately $27,804,000. The following table indicates, as of December 31, 2001, the dollar amount of $100,000 or more by the time remaining until maturity (in thousands):

	3 Months		3 to 12		1 to 5		Over 5
	or less		Months		Years		Years
Certificates of deposit	$	7,919	$	15,380	$	4,505		—

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Liquidity

Of primary importance to depositors, creditors and regulators is the ability to have readily available funds sufficient to repay fully maturing liabilities. The Company’s liquidity, represented by cash and cash due from banks, is a result of its operating, investing and financing activities. In order to insure funds are available at all times, the Company devotes resources to projecting on a monthly basis the amount of funds that will be required and maintains relationships with a diversified funding base so funds are accessible. Liquidity requirements can also be met through short-term borrowings or the disposition of short-term assets, which are generally matched to correspond to the maturity of liabilities.

The Company has a formal liquidity policy, and in the opinion of management, its liquidity levels are considered adequate. Neither the Company nor the Bank is subject to any specific regulation liquidity requirements imposed by regulatory authorities. The Bank is subject to general FDIC guidelines, which do not require a minimum level of liquidity. Management believes its liquidity ratios meet or exceed these guidelines. Management does not know of any trends or demands that are reasonably likely to result in liquidity increasing or decreasing in any material manner. The ratio for average loans to average deposits for 2001 was 85.6% and for the six-months ended June 30, 2002 was 83.2%.

Capital Adequacy

Capital adequacy refers to the level of capital required to sustain asset growth over time and to absorb losses. The objective of the Company’s management is to maintain a level of capitalization that is sufficient to take advantage of profitable growth opportunities while meeting regulatory requirements. This is achieved by improving profitability through effectively allocating resources to more profitable businesses, improving asset quality, strengthening service quality, and streamlining costs. The primary measures used by management to monitor the results of these efforts are the ratios of average equity to average assets, average tangible equity to average tangible assets, and average equity to net loans. The Federal Reserve Board and FDIC have adopted capital guidelines governing the activities of bank holding companies and banks. These guidelines require the maintenance of an amount of capital based on risk-adjusted assets so that categories of assets with potentially higher credit risk will require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as loan commitments.

The capital guidelines classify capital into two tiers, referred to as Tier I and Tier II. Under risk-based capital requirements, total capital consists of Tier I capital, which is generally common shareholders’ equity less goodwill and excess tax assets, and Tier II capital which is primarily the qualifying portion of the allowance for possible loan losses and certain qualifying debt instruments. In determining risk-based capital requirements, assets are assigned risk-weights of 0% to 100%, depending primarily on the regulatory assigned levels of credit risk associated with such assets. Off-balance sheet items are considered in the calculation of risk-adjusted assets through conversion factors established by the regulators. The framework for calculating risk-based capital requires banks and bank holding companies to meet the regulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990 regulators added a leverage computation to the capital requirements, comparing Tier I capital to total average assets less goodwill and excess tax assets. In 1999, the ratio was modified to reduce Tier 1 Capital by the amount of investments in unconsolidated subsidiaries.

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The following table gives the various capital ratios and balances at June 30, 2002 and December 31, 2001 (dollars in thousands) for the Company:

	June 30, 2002			December 31, 2001
Capital:
Tier I capital:
Shareholders’ equity	$	9,786		$	9,344
Less excess tax assets		340			319
Total Tier I capital		9,446			9,025
Tier II capital:
Qualifying debt		3,000			3,000
Qualifying allowance for loan losses		955			1,000
Total Tier II capital		3,955			4,000
Total capital	$	13,401		$	13,025
Risk-adjusted assets	$	106,153		$	101,689
Quarterly average assets	$	143,199		$	122,687
Ratios:
Tier I capital to risk-adjusted assets		8.9	%		8.9	%
Tier II capital to risk-adjusted assets		3.7	%		3.9	%
Total capital to risk-adjusted assets		12.6	%		12.8	%
Leverage — Tier I capital to quarterly average assets less disallowed intangibles		6.6	%		7.4	%

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The following table gives the various capital ratios and balances at June 30, 2002 and at December 31, 2001 (dollars in thousands) for the Bank:

	June 30, 2002			December 31, 2001
Capital:
Tier I capital:
Shareholders’ equity	$	12,420		$	11,966
Less excess tax assets		335			331
Total Tier I capital		12,085			11,635
Tier II capital:
Qualifying debt		—			—
Qualifying allowance for loan losses		955			1,000
Total Tier II capital		955			1,000
Total capital	$	13,040		$	12,635
Risk-adjusted assets		106,174			101,674
Quarterly average assets		143,199			128,047
Ratios:
Tier I capital to risk-adjusted assets		11.4	%		11.4	%
Tier II capital to risk-adjusted assets		0.9	%		1.0	%
Total capital to risk-adjusted assets		12.3	%		12.4	%
Leverage — Tier I capital to quarterly average assets less disallowed intangibles		8.4	%		9.1	%

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established five capital categories for banks and bank holding companies. The bank regulators adopted regulations defining these five capital categories in September 1992. Under these new regulations each bank is classified into one of the five categories based on its level of risk-based capital as measured by Tier I capital, total risk-based capital, and Tier I leverage ratios and its supervisory ratings. The following table lists the five categories of capital and each of the minimum requirements for the three risk-based capital ratios.

	Total Risk-Based	Tier I Risk-Based	Leverage
	Capital Ratio	Capital Ratio	Ratio
Well-capitalized	10% or above	6% or above	5% or above
Adequately capitalized	8% or above	4% or above	4% or above
Undercapitalized	Less than 8%	Less than 4%	Less than 4%
Significantly undercapitalized	Less than 6%	Less than 3%	Less than 3%
Critically undercapitalized	—	—	2% or less

On June 30, 2002 and December 31, 2001, the Company exceeded the regulatory minimums and qualified as a well-capitalized institution under the regulations.

31

Short-term Borrowings and FHLB Advances:

Short-term borrowings and FHLB advances at June 30, 2002 and December 31, 2001 is comprised of the following:

		June 30,		December 31,
		2002		2001
Securities sold under agreement to repurchase		$	2,081	$	1,926
Federal Home Loan Bank advances			4,000		4,000
	Total	$	6,081	$	5,926
Securities underlying the repurchase agreements — obligations of U.S. Government agencies and corporations with amortized cost of approximately $2,714,000 and $3,472,000 at June 30, 2002 and December 31, 2001, respectively, and estimated fair values of $2,747,000 and $3,489,000 at June 30, 2002 and December 31, 2001, respectively		$	2,081	$	1,926

The Bank pays interest on these repurchase agreements at approximately 0.50% below the federal funds rate. These repurchase agreements have maturities of one day.

Securities sold under agreement to repurchase averaged approximately $2,018,000 during the quarter ended June 30, 2002 and $2,300,000 during the year ended December 31, 2001 and the maximum amount outstanding at any month end during these periods was approximately $2,189,000 and $3,360,000, respectively.

The securities underlying the repurchase agreements are held in safekeeping by a separate third party bank.

The Bank pays interest of London Interbank Offering Rate (LIBOR) plus ten basis points on the Federal Home Loan Bank (FHLB) advances. The rate reprices quarterly and matures in June 2003. The Bank can pay of the balance without penalty at any repricing date. The are secured by 1-4 family residential mortgage loans.

Property Acquisitions:

The Company began in March 2001 to renovate an existing building to serve as a branch in Smyrna, Tennessee. The property is leased and opened for business in May 2001. The cost to renovate the existing building did not exceed $100,000. No other significant property acquisitions are planned for the next year.

Personnel:

The Company employed sixty-six employees at June 30, 2002 as well as December 31, 2001.

The Company anticipates increasing the number of employees during 2002 to approximately seventy employees to service the anticipated loan and deposit growth and related support services during the next twelve months.

Research and Development:

The Company does not engage in product research and development and does not anticipate any such activities during the next twelve months.

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Foreign Transactions:

The Company and the Bank have not had any investment securities, loans or deposits of foreign governments, corporations or other entities.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULT ON SENIOR SECURITIES

None

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

(a)  The Annual Meeting of Stockholders was held April 23, 2002.

(b)  Each of the persons named in the Proxy Statement as a nominee for director was elected and the selection of Rayburn, Betts and Bates, P.C. as independent auditors for the Company for 2002 was ratified. The following are the voting results on each of the matters:

(1)  Election of the entire board of directors who are as follows:

Total Number of Shares Voting:

	Shares								Broker
	Voting		For		Against		Withheld		Non-Votes
Melvin R. Adams		619,273		618,923		150		200		0
Thomas E. Batey		619,273		618,923		150		200		0
Joyce Ewell		619,273		618,923		150		200		0
J. Stanley Hooper		619,273		618,923		150		200		0
William E. Rowland		619,273		618,823		250		200		0
William R Sloan		619,273		618,923		150		200		0
Joseph M. Swanson		619,273		618,323		200		200		0
Olin O. Williams		619,273		618,923		150		200		0

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(2)  The election of Rayburn, Betts and Bates, P. C. as independent auditors for the Company was as follows:

Total Number of Shares Voting:

Shares							Broker
Voting	For		Against		Withheld		Non-Votes
619,273		617,623		250		1,400		0

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a)	Exhibits Charter — incorporated by reference to Form 10SB filed April 30, 1998
	By Laws — incorporated by reference to Form 10SB filed April 30, 1998
	Instruments referring to Rights of Security Folders including Debentures — incorporated by reference to Form 10SB filed April 30, 1998 and Form 8A filed May 2, 2000
	Material Contracts — incorporated by reference to Form 10SB filed April 30, 1998 and Form 10-KSB filed March 31, 1999
	Statement re: Computation of per share earnings — Incorporated by reference to note 1 of the consolidated financial statements as of December 31, 2001 in Form 10-KSB filed April 1, 2002.
(b)	No reports on Form 8-K have been filed during the quarter for which this report is filed

34

SIGNATURES

     In accordance with Section 12 of the Securities Exchange Act of 1934, the registrant caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized.

Murfreesboro Bancorp, Inc.

(Registrant)

Date July 18, 2002

By /s/ William L. Webb
(Signature) *
William L. Webb,
Principal Accounting Officer and Chief Financial Officer

• Print the name and title of each signing officer under his or her signature.