Murfreesboro Bancorp 10QSB 2002 Q3 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 nine month period ended September 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 Incorporation or Organization)	(IRS Employer Identification No.)

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 November 12, 2002.

TABLE OF CONTENTS

Section 906 Certification of the CEO

Section 906 Certification of the CFO

PART I – FINANCIAL INFORMATION

ITEM  1.   FINANCIAL STATEMENTS

Murfreesboro Bancorp, Inc.

Consolidated Financial Statements
(Unaudited)

September 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		6-8

1

Murfreesboro Bancorp, Inc.

Consolidated Balance Sheets

As of September 30, 2002 and December 31, 2001
(Tabular amounts are in thousands)

			(Unaudited)
			September 30,		December 31,
			2002		2001
ASSETS
Cash and due from banks			$	3,536	$	3,710
Federal funds sold				2,595		1,675
	Total cash and cash equivalents			6,131		5,385
Securities available for sale				32,669		20,309
Loans, less allowance for possible loan losses of $941,000 and $1,000,000, respectively				102,504		96,519
Premises and equipment, net				4,890		5,124
Accrued interest receivable				831		687
Other assets				2,258		2,207
Deferred tax assets				340		319
	Total assets		$	149,623	$	130,550
		LIABILITIES AND SHAREHOLDERS’ EQUITY
Liabilities:
Deposits			$	126,101	$	111,017
Short-term borrowings				2,286		1,926
Accrued interest payable				492		388
Accrued expenses and other liabilities				1,437		845
Federal Home Loan Bank advances				6,000		4,000
Subordinated convertible capital debentures				3,000		3,000
	Total liabilities			139,316		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, 5,000,000 shares authorized and 907,609 shares issued and outstanding				4,538		4,538
Additional paid-in capital				4,530		4,530
Retained earnings				961		276
	Realized shareholders’ equity			10,029		9,344
Accumulated other comprehensive income				278		30
	Total shareholders’ equity			10,307		9,374
	Total liabilities and shareholders’ equity		$	149,623	$	130,550

See notes to consolidated financial statements.

2

Murfreesboro Bancorp, Inc.

Consolidated Statements of Operations

For the nine months ended September 30, 2002 and 2001
(Unaudited)
(Tabular amounts are in thousands except per share amounts)

					2002		2001
Interest income:
		Interest and fees on loans			$	5,746	$	5,755
		Interest on taxable investment securities				740		635
		Interest on federal funds sold				52		185
				Total interest income		6,538		6,575
Interest expense:
		Interest on negotiable order of withdrawal accounts				105		112
		Interest on money market demand accounts				294		437
		Interest on savings deposits				9		8
		Interest on time deposits less than $100,000				1,287		1,902
		Interest on time deposits of $100,000 or more				766		1,038
				Total interest expense on deposits		2,461		3,497
		Interest on short-term borrowings and advances from FHLB				88		102
		Interest on subordinated convertible capital debentures				146		160
			Total interest expense			2,695		3,759
Net interest income						3,843		2,816
Provision for possible loan losses						4		90
			Net interest income after provision for possible loan losses			3,839		2,726
Non-interest income:
	Service charges and deposits					60		31
	Insufficient fund charges on deposits					463		315
	Other fees and commissions					87		182
	Increase in cash surrender value of officers’ life insurance					73		64
	Income from mortgage loan originations					119		259
	Brokerage fees					193		109
	Other non-interest income					101		109
			Total non-interest income			1,096		1,069
Non-interest expense:
	Salaries and employee benefits					2,064		1,792
	Occupancy expenses, net					251		196
	Furniture and equipment expense					282		222
	Advertising expenses					112		116
	Data processing expenses					277		222
	Other non-interest expense					906		889
			Total non-interest expense			3,892		3,437
Income before income taxes						1,043		358
Income tax expense						358		114
				Net income	$	685	$	244
Earnings per share:
				Basic net income	$	0.75	$	0.27
				Diluted net income	$	0.66	$	0.26

See notes to consolidated financial statements.

3

Murfreesboro Bancorp, Inc.
Consolidated Statements of Operations
For the quarters ended September 30, 2002 and 2001
(Unaudited)
(Tabular amounts are in thousands except per share amounts)

					2002		2001
Interest income:
	Interest and fees on loans				$	1,914	$	2,046
	Interest on taxable investment securities					314		161
	Interest on federal funds sold					15		60
				Total interest income		2,243		2,267
Interest expense:
	Interest on negotiable order of withdrawal accounts					37		32
	Interest on money market demand accounts					105		153
	Interest on savings deposits					3		3
	Interest on time deposits less than $100,000					426		576
	Interest on time deposits of $100,000 and greater					262		309
		Total interest expense on deposits				833		1,073
	Interest on short-term borrowings and advances from FHLB					36		39
	Interest on subordinated convertible capital debentures					49		49
			Total interest expense			918		1,161
Net interest income						1,325		1,106
Provision for possible loan losses						—		38
			Net interest income after provision for possible loan losses			1,325		1,068
Non-interest income:
	Service charges on deposits					27		13
	Insufficient fund charges on deposits					160		101
	Other fees and commissions					28		52
	Increase in cash surrender value of officers’ life insurance					25		22
	Income from mortgage loan originations					41		92
	Brokerage fees					72		21
	Other non-interest income					19		45
			Total non-interest income			372		346
Non-interest expense:
	Salaries and employee benefits					687		669
	Occupancy expenses, net					85		70
	Furniture and equipment expense					97		82
	Advertising expenses					39		39
	Data processing expenses					67		77
	Other non-interest expense					334		355
			Total non-interest expense			1,309		1,292
Income before income taxes						388		122
Income tax expense						145		37
				Net income	$	243	$	85
Earnings per share:
				Basic net income	$	0.27	$	0.09
				Diluted net income	$	0.23	$	0.09

See notes to consolidated financial statements.

4

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

(Tabular amounts are in thousands)

				2002			2001
Operating activities:
	Net income			$	685		$	244
	Adjustments to reconcile net income to net cash provided by operating activities:
		Provision for loan losses			4			182
		Provision for depreciation, amortization and accretion, net			402			90
		Stock dividend on FHLB stock			(8	)		(13	)
		Changes in assets and liabilities:
			(Increase) decrease in accrued interest receivable		(144	)		276
			Increase in cash surrender value of officers’ life insurance		(73	)		(64	)
			Increase in deferred tax asset		(21	)		(4	)
			(Increase) decrease in other assets		22			(576	)
			Increase in accrued interest payable		104			54
			Increase in accrued expenses and other liabilities		594			348
		Net cash provided by operating activities		$	1,565			537
Investing activities:
	Purchase of securities available for sale				(28,119	)		(16,967	)
	Maturities and calls of securities available for sale				15,925			20,000
	Maturities and calls of securities held to maturity				—			8,850
	Increase in loans, net				(5,989	)		(16,137	)
	Additions to premises and equipment				(80	)		(257	)
	Outlays for other assets				—			75	)
	Net cash used by investing activities				(18,263	)		(4,586	)
Financing activities:
	Net increase in deposits				15,084			5,505
	Net increase (decrease) in short-term borrowings				360			(2,397	)
	Federal Home Loan Bank advances				2,000			4,000
	Net cash provided by financing activities				17,444			7,108
Net increase in cash and cash equivalents					746			3,059
Cash and cash equivalents at the beginning of the period					5,385			8,524
Cash and cash equivalents at the end of the period				$	6,131		$	11,583
Supplemental disclosure of cash flow information:
Cash paid during the nine months for:
			Interest	$	2,591		$	3,705
			Income taxes	$	160		$	250
Non-cash transactions:
			Change in unrealized gain on securities available for sale, net of taxes, of $201,000 and $55,000, respectively	$	248		$	53

See notes to consolidated financial statements.

5

Murfreesboro Bancorp, Inc.
Notes to Consolidated Financial Statements
September 30, 2002

(Unaudited)

(1)

Basis of Presentation

The unaudited consolidated financial statements include the accounts of Murfreesboro Bancorp, Inc. 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% interest 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, HTW, and BM had minimal activity during the quarter and nine months ended September 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 accounting principles generally accepted in the United States 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 September 30, 2002 and December 31, 2001, the results of operations for the quarters and nine months ended September 30, 2002 and 2001, the changes in cash flows for the nine months ended September 30, 2002 and 2001. All significant intercompany transactions have been eliminated. 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 included in equity along with the related tax effect for the nine months ended September 30, 2002 and 2001, respectively.

			Tax		Net of
	Pre-Tax		Expense		Tax
	Amount		(Benefit)		Amount
	(In thousands)
Nine months ended September 30, 2002
Net unrealized gain on securities available for sale	$	449	$	201	$	248
Other comprehensive income	$	449	$	201	$	248
Nine months ended September 30, 2001
Net unrealized gain on securities available for sale	$	108	$	55	$	53
Other comprehensive income	$	108	$	55	$	53

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

					Tax		Net of
			Pre-Tax		Expense		Tax
			Amount		(Benefit)		Amount
			(In thousands)
Quarter ended September 30, 2002
Net unrealized gain on securities available for sale			$	192	$	80	$	112
Other comprehensive income			$	192	$	80	$	112
Quarters ended September 30, 2001
	Net unrealized gain on securities available for sale		$	45	$	17	$	28
		Other comprehensive income	$	45	$	17	$	28

-7-

(3)

Earnings Per Share

The weighted average number of common shares outstanding during the nine months and quarters ended September 30, 2002 and 2001 was 907,609. The effect of dilutive common stock options was 17,800 shares for the quarter ended September 30, 2001. The effect of dilutive common stock options was 29,834 shares for the quarter ended September 30, 2002. The effect of dilutive stock options was 17,800 shares for the nine months ended September 30, 2001. The dilutive effect of common stock options is estimated at 24,285 for the nine months ended September 30, 2002. The contingent issuance of common stock as related to the subordinated convertible capital debentures was anti-dilutive for the quarter and nine months ended September 30, 2001, as the effect of the related interest expense exceeded the impact of contingent issuance of common stock shares. For the quarter and nine months ended September 30, 2002, the effect of the subordinated convertible capital debentures was to reflect the issuance of 240,000 shares of common stock and reduction in interest expense of $49,000 and $146,000, respectively, and an additional tax expense of $19,000 and $55,000, respectively.

-8-

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 nine months ended September 30, 2002 was $685,000 and the net income for the nine months ended September 30, 2001 was $244,000.

Financial Condition

Earning Assets. Average earning assets for the nine months ended September 30, 2002 totaled $131,354,000 which represents 92.2% of average total assets. Earning assets totaled $142,494,000 at September 30, 2002. Average earning assets for the nine months ended September 30, 2001 totaled $106,698,000, which represented 89.8% of average total assets. Earning assets totaled $137,333,000 at September 30, 2002 and $119,209,000 at December 31, 2001.

Loan Portfolio.The Company’s average loans for the nine months ended September 30, 2002 were $99,263,000 and for the nine months ended September 30, 2001 were $85,569,000. The balance in total loans at September 30, 2002 was $103,010,000, $97,225,000 at December 31, 2001, and $95,021,000 at September 30, 2001.

Investment Portfolio.The Company’s investment securities portfolio averaged $27,906,000 for the nine months ended September 30, 2002 and $15,605,000 for the nine months ended September 30, 2001. The portfolio totaled $32,669,000 at September 30, 2002, $20,309,000 at December 31, 2001, and $11,305,000 at September 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 September 30, 2002, there was unrealized gain of $449,000 in the “Available for Sale” portfolio and there was an unrealized gain of $96,000 at September 30, 2001. The average balance of securities “Available for Sale” during the nine months ended September 30, 2002 was $27,906,000 and the balance at September 30, 2002 was $32,669,000. There were no securities “Held to Maturity” during the nine months ended September 30, 2002 and there were no securities classified as “Held to Maturity” at September 30, 2002. The average balance of securities “Available for Sale” during the nine months ended September 30, 2001 was $15,605,000 and the balance at September 30, 2001 was $11,305,000. The average balance of securities “Available for Sale” during the quarter ended September 30, 2002 was $34,953,000 and $13,471,000 for the quarter ended September 30, 2001.

Deposits.The Company’s average deposits were $121,882,000 for the nine months ended September 30, 2002. This included average non-interest-bearing deposits of $9,151,000, average certificates of deposit of $77,777,000, average saving deposits of $1,278,000 and average interest-bearing transaction accounts of $33,676,000. The Company’s average deposits for the nine months ended September 30, 2001 were $101,613,000. This included average non-interest-bearing deposits of $7,451,000, average certificates of deposit of $66,699,000, average savings deposits of $819,000 and average interest-bearing transaction accounts of $26,644,000. Deposits totaled $126,101,000 at September 30, 2002, $111,017,000 at December 31, 2001, and $105,595,000 at September 30, 2001.

-9-

Long-Term Debt.The Company issued $3,000,000 of floating rate subordinated convertible capital debentures (“debentures) on September 29, 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%. The minimum rate paid on the debentures is 6.5%

Capital Resources.Shareholders’ equity totaled $10,307,000 at of September 30, 2002. This included $9,068,000 of common stock and additional paid-in-capital plus retained earnings of $961 ,000 and other comprehensive income in the form of an unrealized gain on securities available for sale (net of tax) of $278,000.

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 September 30, 2002 and December 31, 2001, the Company had $3,500,000 of federal funds purchase lines available at three correspondent banks. None of these lines were drawn at September 30, 2002.

At September 30, 2002 and December 31, 2001, the Bank had $3,375,000 and $ 6,865,000, respectively, as a secured line of credit with a regional bank. This line has not been drawn. Investment securities with par values of $3,750,000 and $7,500,000 were pledged toward this line of credit at September 30, 2002 and December 31, 2001, respectively.

Results of Operations for the Nine months Ended September 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 nine months ended September 30, 2002 totaled $3,843,000. This was the result of interest income of $6,538,000 and interest expense of $2,695,000. Interest income produced by the loan portfolio totaled $5,746,000, interest income on investment securities totaled $740,000, and interest income on federal funds totaled $52,000. Interest expense included $2,053,000 of interest expense on certificates of deposit, interest expense of $408,000 on interest-bearing transaction accounts, money market demand accounts, and savings accounts, interest expense on other borrowings of $88,000 and interest expense on subordinated convertible capital debentures of $146,000.

-10-

Net interest income for the nine months ended September 30, 2001 totaled $2,816,000. This was the result of interest income of $6,575,000 and interest expense of $3,759,000. Interest income produced by the loan portfolio totaled $5,755,000, interest income on investment securities totaled $635,000 and interest income on federal funds totaled $185,000. Interest expense included $2,940,000 of interest expense on certificates of deposit, interest expense of $557,000 on interest-bearing transaction accounts, money market demand accounts, and savings accounts, interest expense on other borrowings of $102,000 and interest expense on subordinated convertible capital debentures of $160,000.

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 nine months ended September 30, 2002 was 3.91%. The net cost of funds, defined as interest expense divided by average-earning assets, was 2.74% and the yield on earning assets was 6.65% for the nine months ended September 30, 2002. The net interest margin for the nine months ended September 30, 2001 was 3.53%. The net cost of funds for the nine months ended September 30, 2001 was 4.71% and the yield on earning assets was 8.24%.

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 nine months ended September 30, 2002 was 3.70% and for the nine months ended September 30, 2001 was 3.27%.

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.

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 $941,000 at September 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

-11-

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, loans past due ninety days or more or foreclosed real estate held for sale at September 30, 2002 or at December 31, 2001. Loans on non-accrual status at September 30, 2002 totaled $51,000 and $59,000 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. Total non-interest income totaled $1,096,000 for the nine months ended September 30, 2002. This included $523,000 from service charges on deposit accounts, other fees of $87,000, $73,000 from the increase in the cash surrender value of officer’s life insurance and $101,000 of other non-interest income brokerage fees of $193,000 and $119,000 income from mortgage loan originations.

Non-interest income totaled $1,069,000 for the nine months ended September 30, 2001. This included $346,000 on service charges and insufficient fund charges on deposit accounts, $182,000 of other fees and commissions and $64,000 from the increase in the cash surrender value of the officer’s life insurance, mortgage loan origination fees of $259,000, brokerage fees of $109,000 and other non-interest income of $218,000.

Non-interest Expenses. Non-interest expense for the nine months ended September 30, 2002 totaled $3,892,000. Salaries and employee benefits for the nine months ended September 30, 2002 totaled $2,064,000. Occupancy expense for the nine months ended September 30, 2002 totaled $251,000 while furniture and equipment expense totaled $282,000. Advertising expenses totaled $112,000 and data processing charges were $277,000. All other non-interest expenses totaled $906,000 for the nine months ended September 30, 2002. Other non-interest expenses include supplies and printing, telephone, postage and legal and audit fees.

Non-interest expense for the nine months ended September 30, 2001 totaled $3,437,000. Salaries and employee benefits for the nine months ended September 30, 2001 totaled $1,792,000. Occupancy expenses for the nine months ended September 30, 2001 totaled $196,000 while furniture and equipment expenses totaled $222,000. Advertising expenses totaled $116,000 and data processing expense totaled $222,000. Other non-interest expenses totaled $889,000. Other non-interest expenses include supplies and printing, telephone, postage and legal and audit fees.

For the nine months ended September 30, 2002, the Company incurred income tax expenses of $358,000 for an effective tax rate of 34.3%.

For the nine months ended September 30, 2001, the Company incurred income tax expenses of $114,000 for an effective tax rate of 31.8%.

-12-

Results of Operations for the Quarters Ended September 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 quarter ended September 30, 2002 totaled $1,325,000. This was the result of interest income of $2,243,000 and interest expense of $918,000. Interest income produced by the loan portfolio totaled $1,914,000, interest income on investment securities totaled $314,000, and interest income on federal funds totaled $15,000. Interest expense included $688,000 of interest expense on certificates of deposit, interest expense of $145,000 on interest-bearing transaction accounts, savings accounts, and money market accounts, interest expense of $49,000 on subordinated convertible capital debentures and interest expense of $36,000 on other borrowings.

Net interest income for the quarter ended September 30, 2001 totaled $1,106,000. This was the result of interest income of $2,267,000 and interest expense of $1,161,000. Interest income produced by the loan portfolio totaled $2,046,000, interest income on investment securities totaled $161,000 and interest income on federal funds totaled $60,000. Interest expense included $885,000 of interest expense on certificates of deposit, interest expense of $188,000 on interest-bearing transaction accounts, money market demand accounts, and savings accounts, interest expense on other borrowings of $39,000 and interest on subordinated convertible capital debentures of $49,000.

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 quarter ended September 30, 2002 was 3.77%. The net cost of funds, defined as interest expense divided by average-earning assets, was 2.61% and the yield on earning assets was 6.39% for the quarter ended September 30, 2002. The net interest margin for the quarter ended September 30, 2001 was 3.93%. The net cost of funds for the quarter ended September 30, 2001 was 4.12% and the yield on earning assets was 8.05%.

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 September 30, 2002 was 3.56% and for the quarter ended September 30, 2001 was 3.64%.

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 officers’ 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. Total non-interest income totaled $372,000 for the quarter ended September 30, 2002. This included $187,000 from service charges and insufficient fund charges on deposit accounts, other fees and commissions of $28,000, $25,000 from the increase in cash surrender value of officers’ life insurance, $41,000 of income from mortgage loan originations, brokerage fees of $72,000 and other non-interest income of $19,000.

Non-interest income totaled $346,000 for the quarter ended September 30, 2001. This included $114,000 on service charges and insufficient fund charges on deposit accounts, other fees and commissions of $52,000 and $22,000 from the increase in the cash surrender value of the officers’ life insurance, $92,000 from mortgage loan originations, brokerage fees of $21,000 and other non-interest income of $45,000.

-13-

Non-interest Expenses. Non-interest expense for the quarter ended September 30, 2002 totaled $1,309,000. Salaries and employee benefits for the quarter ended September 30, 2002 totaled $687,000. Occupancy expense for the quarter ended September 30, 2002 totaled $85,000 while furniture and equipment expense totaled $97,000. Advertising expenses totaled $39,000 and data processing expenses totaled $67,000. All other non-interest expenses totaled $334,000 for the quarter ended September 30, 2001. Other non-interest expenses include supplies and printing, telephone, postage and legal and audit fees.

Non-interest expense for the quarter ended September 30, 2001 totaled $1,292,000. Salaries and employee benefits for the quarter ended September 30, 2001 totaled $669,000. Occupancy expenses for the quarter ended September 30, 2001 totaled $70,000 while furniture and equipment expenses totaled $82,000. Advertising expenses totaled $39,000 and data processing expenses totaled $77,000. Other non-interest expenses totaled $355,000.

For the quarter ended September 30, 2002, the Company incurred income tax expense of $145,000 for an effective tax rate of 37.4%.

For the quarter ended September 30, 2001, the Company incurred income tax expenses of $37,000 for an effective tax rate of 30.3%.

Return on Equity and Assets

Return on assets (annualized net income divided by average total assets) for the nine months ended September 30, 2002 was 0.64%. Return on assets for the nine months ended September 30, 2001 was 0.27%. Return on assets for the quarter ended September 30, 2002 was 0.64% while return on assets for the quarter ended September 30, 2001 was 0.28%.

Return on equity (annualized net income divided by average equity) for the nine months ended September 30, 2002 was 9.08%. Return on equity for the nine months ended September 30, 2001 was 3.55%. Return on equity for the quarter ended September 30, 2002 was 9.05% while return on equity for the quarter ended September 30, 2001 was 3.72%.

Equity to assets (average equity divided by average total assets) for the nine months ended September 30, 2002 was 7.10%. Equity to assets for the nine months ended September 30, 2001 was 7.72%. Equity to assets for the quarter ended September 30, 2002 was 7.06% while equity to assets for the quarter ended September 30, 2001 was 7.44%.

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

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 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 nine months ended September 30, 2002 and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
	(Fully taxable equivalent - dollars in thousands)
Assets:
Interest-earning assets:
Loans	$	99,263		$	5,746		7.74	%
U.S. Treasury and other U.S. government agencies		27,906			740		3.55	%
Federal funds sold		4,185			52		1.66	%
Total interest-earning assets/interest income		131,354			6,538		6.65	%
Cash and due from banks		2,960
Other assets		9,162
Allowance for possible loan losses		(982	)
Total assets	$	142,494
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	34,954			408		1.56	%
Certificates of deposit		77,777			2,053		3.53	%
Other borrowings		6,338			88		1.86	%
Subordinated convertible capital debentures		3,000			146		6.51	%
Total interest-bearing liabilities/interest expense		122,069			2,695		2.95	%
Non-interest-bearing demand deposits		9,151
Other liabilities		1,150
Shareholders’ equity		10,124
Total liabilities and shareholders’ equity	$	142,494
Net interest earnings				$	3,843
Net interest income on interest-earning assets							3.91	%
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 nine months ended September 30, 2001 and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
	(Fully taxable equivalent – dollars in thousands)
Assets:
Interest-earning assets:
Loans	$	85,569		$	5,755		8.99	%
U.S. Treasury and other U.S. government agencies		15,605			635		5.44	%
Federal funds sold		5,524			185		4.47	%
Total interest-earning assets/interest income		106,698			6,575		8.24	%
Cash and due from banks		4,807
Other assets		8,332
Allowance for possible loan losses		(974	)
Total assets	$	118,863
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	27,463			557		2.71	%
Certificates of deposit		66,699			2,940		5.89	%
Other borrowings		3,968			102		3.45	%
Subordinated convertible capital debentures		3,000			160		7.11	%
Total interest-bearing liabilities/interest expense		101,130			3,759		4.97	%
Non-interest-bearing demand deposits		7,451
Other liabilities		1,105
Shareholders’ equity		9,177
Total liabilities and shareholders’ equity	$	118,863
Net interest earnings				$	2,816
Net interest income on interest-earning assets							3.53	%
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 nine months ended September 30, 2002 to the nine months ended September 30, 2001 (in thousands).

										Increase
				Increase			Increase			(Decrease)
				(Decrease)			(Decrease)			Due to
	Increase			Due to			Due to			Rate and
	(Decrease)			Rate			Volume			Volume
ASSETS
Interest-earning assets:
Federal funds sold	$	(133	)	$	(116	)	$	(45	)	$	28
Investment securities		105			(221	)		501			(175	)
Loans		(9	)		(802	)		921			(128	)
Total interest earning assets		(37	)		(1,139	)		1,377			(275	)
LIABILITIES
Interest-bearing liabilities:
Demand deposits and savings accounts		(149	)		(236	)		152			(65	)
Certificates of deposits		(887	)		(1,179	)		488			(196	)
Other borrowings		(14	)		(47	)		61			(28	)
Subordinated convertible capital debentures		(14	)		(14	)					—
Total interest bearing liabilities		(1,064	)		(1,476	)		701			(289	)
Total	$	1,027		$	337		$	676		$	14

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.

-17-

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 September 30, 2002 and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
	(Fully taxable equivalent – dollars in thousands)
Assets:
Interest-earning assets:
Loans	$	100,455		$	1,914		7.56	%
U.S. Treasury and other U.S. government agencies		34,953			314		3.56	%
Federal funds sold		3,917			15		1.52	%
Total interest-earning assets/interest income		139,325			2,243		6.39	%
Cash and due from banks		2,673
Other assets		9,828
Allowance for possible loan losses		(956	)
Total assets	$	150,870
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	37,288			145		1.54	%
Certificates of deposit		81,442			688		3.35	%
Other borrowings		7,098			36		2.01	%
Subordinated convertible capital debentures		3,000			49		6.48	%
Total interest-bearing liabilities/interest expense		128,828			918		2.83	%
Non-interest-bearing demand deposits		9,673
Other liabilities		1,712
Shareholders’ equity		10,657
Total liabilities and shareholders’ equity	$	150,870
Net interest earnings				$	1,325
Net interest income on interest-earning assets							3.77	%
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 September 30, 2001 and certain other information:

				Interest		Average
	Average			Income/		Yields/
	Balance			Expense		Rates
	(Fully taxable equivalent – dollars in thousands)
Assets:
Interest-earning assets:
Loans	$	92,832		$	2,046		8.84	%
U.S. Treasury and other U.S. government agencies		13,471			161		4.79	%
States and municipalities		—			—		N/A
Federal funds sold		6,689			60		3.55	%
Total interest-earning assets/interest income		112,992			2,267		8.05	%
Cash and due from banks		2,983
Other assets		8,152
Allowance for possible loan losses		(1,021	)
Total assets	$	123,106
Liabilities and shareholders’ equity:
Interest-bearing liabilities:
Demand deposits and savings accounts	$	30,392			188		2.45	%
Certificates of deposit		66,327			885		5.37	%
Other borrowings		5,861		��	39		2.67	%
Subordinated convertible capital debentures		3,000			49		6.57	%
Total interest-bearing liabilities/interest expense		105,580			1,161		4.41	%
Non-interest-bearing demand deposits		7,712
Other liabilities		637
Shareholders’ equity		9,177
Total liabilities and shareholders’ equity	$	123,106
Net interest earnings				$	1,106
Net interest income on interest-earning assets							3.93	%
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 September 30, 2002 to the quarter ended September 30, 2001 (in thousands):

												Increase
						Increase			Increase			(Decrease)
						(Decrease)			(Decrease)			Due to
			Increase			Due to			Due to			Rate and
			(Decrease)			Rate			Volume			Volume
ASSETS
Interest-earning assets:
Federal funds sold			$	(45	)	$	(34	)	$	(25	)	$	14
Investment securities				153			(40	)		257			(64	)
Loans				(132	)		(277	)		168			(23	)
Total interest earning assets				(24	)		(351	)		400			(73	)
LIABILITIES
Interest-bearing liabilities:
Demand deposits and savings accounts				(43	)		(70	)		43			(16	)
Certificates of deposits				(197	)		(325	)		202			(74	)
Other borrowings				(3	)		(9	)		8			(2	)
Subordinated convertible capital debentures				—			—			—			—
		Total interest bearing liabilities		(243	)		(404	)		253			(92	)
	Total		$	219		$	53		$	147		$	19

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.

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 September 30, 2002 and December 31, 2001 (in thousands):

	September 30, 2002		December 31, 2001
Interest-bearing deposits with banks	$	—	$	—
Investment securities		32,669		20,309
Federal funds sold		2,595		1,675
Loans:
Real estate		77,290		73,319
Commercial and other		25,720		23,906
Total loans		103,010		97,225
Interest-earning assets	$	138,274	$	119,209

-20-

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 September 30, 2002, approximately $32,669,000 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 $449,000 of unrealized gain and $47,000 of unrealized gain was included in shareholders’ equity related to the available for sale investment securities as of September 30, 2002 and December 31, 2001, respectively. There were no securities classified as “Held to Maturity” at September 30, 2002 or December 31, 2001.

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

	Amortized		Estimated
	Cost		Fair Value
Available for sale:
U.S. Treasury	$	1,002	$	1,019
U.S. Government agencies		30,458		30,890
States and political subdivisions		—		—
Other securities		—		—
Total available for sale – debt securities		31,460		31,909
Federal Reserve Bank stock		351		351
Federal Home Loan Bank stock		409		409
Total investment portfolio	$	32,220	$	32,669

At December 31, 2001, obligations of the United States Government or its agencies represented approximately 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 investment portfolio	$	20,262	$	20,309

-21-

The following table presents the maturity distribution of the carrying value and estimated fair value of the Company’s investment debt portfolio at September 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 due after 1 year but within 5 years	$	1,002	$	1,019		3.09	%
U.S. Government agencies:
Due within 1 year		4,083		4,161		3.74	%
Due after 1 year but within 5 years		26,375		26,729		3.53	%
Due after 5 years but within 10 years		—		—		N/A
Due after 10 years		—		—		N/A
Total		31,460		31,909		3.54	%
States and political subdivisions		—		—		N/A
Other		—		—		N/A
Total investments available for sale-debt securities		31,460		31,909		3.54	%
Total investment portfolio-debt securities	$	31,460	$	31,909		3.54	%

-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	%
Total investment portfolio-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 September 30, 2002 (dollars in thousands).

				Percent of
	Balance			Total Loans
Real estate loans:
Construction and land development	$	9,152			8.9	%
Secured by residential properties		38,510			37.4	%
Secured by commercial real estate		29,628			28.8	%
Total real estate loans		77,290			75.1	%
Commercial and industrial loans		6,842			6.6	%
Other consumer loans		18,878			18.3	%
Total loans		103,010			100.0	%
Unamortized premiums and net deferred loan costs		435			N/A
Allowance for possible loan losses		(941	)		N/A
Net loans	$	102,504			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 September 30, 2002 (in thousands).

	Maturity Range
	One Year		One Through		Over
	or Less		Five Years		Five Years		Total
Loan maturity:
Real estate construction loans	$	3,564	$	5,588	$	—	$	9,152
Real estate mortgage loans		22,895		39,952		5,291		68,138
Commercial and industrial loans		5,696		1,146		—		6,842
All other loans		1,640		10,244		6,994		18,878
Total loans	$	33,795	$	56,930	$	12,285	$	103,010
Loan interest rate sensitivity:
Predetermined interest rates	$	9,835	$	20,938	$	12,285	$	43,058
Floating or adjustable interest rates		23,960		35,992		—		59,952
Total	$	33,795	$	56,930	$	12,285	$	103,010

-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.

-25-

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 $941,000 as of September 30, 2002 or 0.91% 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 nine months ended September 30, 2002 was $4,000. Loans totaling $84,000 were charged-off (with recoveries made of $21,000) during the nine months ended September 30, 2002. The provision for possible loan losses charged against earnings during the year ended December 31, 2001 was $123,000. Loans totaling $73,000 were charged-off (with recoveries made of $8,000) during the year ended December 31, 2001.

No loans were past due 90 days or more and still accruing interest at September 30, 2002 or December 31, 2001. There were $51,000 of loans classified as non-accrual at September 30, 2002 and $59,000 of loans were classified as non-accrual at December 31, 2001. Accrual of interest is discontinued when there is

-26-

reasonable doubt as to the full, timely collections 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 was no other real estate owned or foreclosed, any repossessed assets or impaired loans at September 30, 2002 or at December 31, 2001.

Deposits

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

	September 30		December 31,
	2002		2001
Non-interest-bearing deposits:
Individuals, partnerships and corporations	$	8,991	$	7,969
U. S. Government and states and political subdivisions		—		—
Certified and official checks		564		497
Total non-interest-bearing deposits		9,555		8,466
Interest-bearing deposits:
Interest-bearing demand accounts		35,981		30,429
Saving accounts		1,448		1,016
Certificates of deposit, less than $100,000		49,207		43,302
Certificates of deposit, $100,000 or greater		29,910		27,804
Total interest-bearing deposits		116,546		102,551
Total deposits	$	126,101	$	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 nine months ended September 30, 2002 and the year ended December 31, 2001 (dollars in thousands):

	Nine Months Ended				Year Ended
	September 30, 2002				December 31, 2001
Non-interest-bearing deposits	$	9,151	N/A		$	7,350	N/A
Interest-bearing demand deposits		33,676	1.58	%		27,370	2.47	%
Savings accounts		1,278	1.00	%		861	1.20	%
Certificates of deposit		77,777	3.53	%		67,370	5.70	%
Total deposits	$	121,882	2.70	%	$	102,951	4.40	%

-27-

At September 30, 2002, certificates of deposits greater than $100,000 aggregated approximately $29,910,000. The following table indicates, as of September 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	$	8,246	$	17,117	$	4,547		—

At December 31, 2001, certificates of deposits greater than $100,000 aggregated approximately $27,804,000. The following table indicates, as of December 31, 2000, 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		—

Long Term Debt

The Company has outstanding $3,000,000 of floating rate subordinated convertible capital debentures at September 30, 2002 and December 31, 2001. Such debentures earn interest at prime rate less 0.5% with a minimum rate paid being 6.5%. The debentures convert to one share of common stock for every $12.50 of debentures held.

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 the year ended December 31, 2001 was 85.6% and for the nine months ended September 30, 2002 was 81.4%.

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

-28-

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 2000, the ratio was modified to reduce Tier 1 Capital by the amount of investments in unconsolidated subsidiaries.

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

	September 30, 2002			December 31, 2001
Capital:
Tier I capital:
Realized shareholders’ equity	$	10,029		$	9,344
Less excess tax assets		340			319
Total Tier I capital		9,689			9,025
Tier II capital:
Qualifying debt		3,000			3,000
Qualifying allowance for loan losses		941			1,000
Total Tier II capital		3,941			4,000
Total capital	$	13,630		$	13,025
Risk-adjusted assets	$	111,453		$	101,689
Quarterly average assets	$	150,870		$	112,687
Ratios:
Tier I capital to risk-adjusted assets		8.7	%		8.9	%
Tier II capital to risk-adjusted assets		3.5	%		3.9	%
Total capital to risk-adjusted assets		12.2	%		12.8	%
Leverage — Tier I capital to quarterly
Average assets less disallowed intangibles		6.4	%		7.4	%

-29-

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

	September 30, 2002			December 31, 2001
Capital:
Tier I capital:
Realized shareholders’ equity	$	12,713		$	11,966
Less excess tax assets		335			331
Total Tier I capital		12,378			11,635
Tier II capital:
Qualifying debt		—			—
Qualifying allowance for loan losses		941			1,000
Total Tier II capital		941			1,000
Total capital	$	13,319		$	12,635
Risk-adjusted assets	$	111,434		$	101,674
Quarterly average assets	$	150,870		$	128,047
Ratios:
Tier I capital to risk-adjusted assets		11.1	%		11.4	%
Tier II capital to risk-adjusted assets		0.9	%		1.0	%
Total capital to risk-adjusted assets		12.0	%		12.4	%
Leverage — Tier I capital to quarterly
Average assets less disallowed intangibles		8.2	%		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 September 30, 2002 and December 31, 2001, the Company exceeded the regulatory minimums and qualified as a well-capitalized institution under the regulations.

-30-

Other Borrowings:

Other borrowings at September 30, 2002 and December 31, 2001 is comprised of the following:

		September 30,		Dec. 31,
		2002		2001
Federal Home Loan Bank borrowings		$	6,000	$	4,000
Securities sold under agreement to repurchase			2,286		1,926
	Total	$	8,286	$	5,926
Detail of securities sold under repurchase agreements:
Securities underlying the repurchase agreements — obligations of U.S. Government agencies and corporations with amortized cost of approximately $2,961,000 and $3,472,000 at September 30, 2002 and December 31, 2001, respectively, and estimated fair values of $3,020,000 and $3,489,000 at September 30, 2002 and December 31, 2001, respectively		$	2,286	$	1,926

The Company 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 $2,031,000 during the nine months ended September 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 $2,286,000 and $3,360,000, respectively.

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

The Company pays interest of London Interbank Offering Rate (LIBOR) plus ten basis points on the $4,000,000 of Federal Home Loan Bank borrowings. The rate reprices quarterly and matures in June 2003. The Bank can pay any or all of the amount borrowed without penalty at any repricing date. The borrowing is secured by 1-4 family residential mortgage loans. The Company pays 4.20% on the $2,000,000 advance from the Federal Home Loan Bank. The rate is fixed and the advance is due in August 2007.

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 was approximately $50,000. No other significant property acquisitions are planned for the next year.

Personnel:

The Company had sixty-four employees at September 30, 2002. The Company anticipates increasing the number of employees during the last quarter of 2002 to approximately sixty-six employees to service the anticipated loan and deposit growth and related support services during the next three 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.

-31-

Foreign Transactions:

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

PART I

ITEM 3. CONTROLS AND PROCEDURES

Within 90 days of the date of this report, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC reports. It should be noted that the design of any system of controls is based upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote.

In addition, we reviewed our internal controls, and there have been no significant changes in our internal controls or in other factors that could significantly affect those controls subsequent to the date of their last evaluation.

-32-

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

None

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 defining Rights of Security Holders including Debentures – incorporated by reference to Form 10SB filed April 30, 1998 and Form 8A field 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 2, 2001

99.1 Written certification of the Chief Executive Officer (principal executive officer) pursuant to 18 U.S.C. Section 1350

99.2 Written certification of the Chief Financial Officer (principal financial officer) pursuant to 18 U.S.C. Section 1350

(b)  Form 8-K was filed on August 12, 2002, for the certification of the principal executive officer and principal financial officer as a result of the Sarbanes-Oxley Act of 2002, which became effective after the Company filed its Form 10-QSB for June 30, 2002.

-33-

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 November 12, 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.

-34-

CERTIFICATIONS

I, William E. Rowland, certify that:

1.	I have reviewed this quarterly report on Form 10-QSB of Murfreesboro Bancorp, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)

All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

b)

any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002	/s/ William E. Rowland
	William E. Rowland Chief Executive Officer

-35-

CERTIFICATIONS

I, William L. Webb, certify that:

1.	I have reviewed this quarterly report on Form 10-QSB of Murfreesboro Bancorp, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)	All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: November 12, 2002	/s/ William L. Webb
	William L. Webb Chief Financial Officer

-36-