UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

Commission file number 000-25141

METROCORP BANCSHARES, INC.

9600 Bellaire Boulevard, Suite 252
Houston, Texas 77036
(Address of principal executive offices including zip code)

(713) 776-3876
(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 þ No o.

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

     As of August 16, 2004, the number of outstanding shares of Common Stock, par value $1.00 per share, was 7,181,437.

Table of Contents

PART I

FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements.

METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share amounts)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In thousands, except per share amounts)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
(Unaudited)

METROCORP BANCSHARES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
For the Six Months Ended June 30, 2004
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

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METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

     The unaudited condensed consolidated financial statements include the accounts of MetroCorp Bancshares, Inc. (the “Company”) and its wholly-owned subsidiary MetroBank, National Association (the “Bank”). The Bank was formed in 1987 and is engaged in commercial banking activities through its fourteen branches in Houston and Dallas, Texas. The Company considers itself one reporting segment. All material intercompany accounts and transactions have been eliminated in consolidation.

     The accompanying unaudited condensed consolidated financial statements were prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions for Form 10-Q. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments, consisting only of normal and recurring adjustments, necessary for a fair presentation of the Company’s financial position at June 30, 2004, results of operations for the three and six months ended June 30, 2004 and 2003, and cash flows for the six months ended June 30, 2004 and 2003. Interim period results are not necessarily indicative of results for a full-year period.

     Certain amounts applicable to the prior periods have been reclassified to conform to the classifications currently used. Such reclassifications had no effect on net income, total assets or shareholders’ equity.

     These financial statements and the notes thereto should be read in conjunction with Amendment No. 1 to the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2003. See Note 2 for information regarding the restatement of prior period financial statements.

Stock Compensation

     The Company grants stock options under several stock-based incentive compensation plans. The Company utilizes the intrinsic value method for its stock compensation plans. No compensation cost is recognized for fixed stock options in which the exercise price is equal to or greater than the estimated market price on the date of grant. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, which, if fully adopted by the Company, would change the method the Company applies in recognizing the cost of the plans to the fair value method. Adoption of the cost recognition provisions of SFAS No. 123 is optional and the Company has decided to continue to follow the intrinsic value method. However, pro forma disclosures as if the Company adopted the fair value method are required. If the fair value based method of accounting under SFAS No. 123 had been applied, the Company’s net income available to common shareholders and earnings per common share would have been reduced to the pro forma amounts indicated below (assuming that the fair value of options granted during the year are amortized over the vesting period) (in thousands except per share amounts):

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METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Stock Compensation (Continued)

     The effects of applying SFAS No. 123 in this pro forma disclosure are not indicative of future amounts. SFAS No. 123 does not apply to awards prior to 1995, and the Company anticipates making awards in the future under its stock-based compensation plans. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

2. RESTATEMENT

     The Company restated its condensed consolidated financial statements as of June 30, 2003 and for the three and six months ended June 30, 2003 to correct the amortization of deferred loan fees, net of costs, to interest income. The restatement decreased net loss by $95,000 for the three months ended June 30, 2003, increased net income by $164,000 for six months ended June 30, 2003, increased retained earnings by $1.9 million and $2.2 million as of June 30, 2003 and December 31, 2003, respectively.

     The restatement resulted from a review of the Company’s application of FASB Statement No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” Loan fees net of the associated costs should be recognized over the life of the related loan as an adjustment to yield. The Company recently discovered that $4.0 million of net deferred loan fees were not being amortized to interest income. These net deferred fees were not entered into the Company’s loan system, and therefore, amortization was not calculated each period. Accordingly, the restatement reflects the amortization of these net deferred fees. Additionally, in connection with the restatement of net deferred fees, the Company adjusted accruals of other noninterest expense previously deemed immaterial which resulted in an increase to retained earnings at December 31, 2003 of $63,000.

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METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

     The following table reflects the previously reported amounts for the three and six months ended June 30, 2003 and as of December 31, 2003 and the restated amounts.

3. EARNINGS PER COMMON SHARE

     Basic earnings per share (“EPS”) is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares and potentially dilutive common shares outstanding during the period. Potentially dilutive common shares are computed using the treasury stock method.

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METROCORP BANCSHARES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

4. SECURITIES AVAILABLE-FOR-SALE

     The amortized cost and approximate fair value of securities classified as available-for-sale is as follows:

     The following table displays the gross unrealized losses and fair value of investments as of June 30, 2004 that were in a continuous unrealized loss position for the periods indicated:

     Declines in the fair value of individual securities below their cost that are other than temporary would result in write-downs, as a realized loss, of the individual securities to their fair value. Management believes that based upon the credit quality of the debt securities and the Company’s intent and ability to hold the securities until their recovery, none of the unrealized losses on securities should be considered other than temporary.

5. LITIGATION

     In September 2003, Advantage Finance Corporation (“AFC”), a subsidiary of the Company that is no longer active, was served in connection with a lawsuit based on alleged “malicious prosecution” and “conspiracy”. Also included in the lawsuit are BDO Seidman LLP and the CIT Group/Commercial Services, Inc. The plaintiff has filed his case in both Federal and State courts. In December 2003, the case was dismissed from Federal court; however, the plaintiff subsequently filed an appeal. Management is unable to determine whether the outcome will have a material impact on the Company’s financial statements. The lawsuit does not seek a specified amount.

6. GUARANTEES

     The Bank enters into a stand-by letters of credit to guarantee performance of a customer to a third party. These guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved is represented by the contractual amounts of those instruments. Under the stand-by letters of credit, the Bank is required to make payments to the beneficiary of the letters of credit upon request by the beneficiary so long as all performance criteria have been met. Most guarantees extend up to one year. At June 30, 2004, the maximum

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potential amount of future payments was $5.6 million. The Company has recorded a liability of approximately $13,224 at June 30, 2004 and $2,542 at December 31, 2003.

7. NEW ACCOUNTING PRONOUNCEMENTS

          On December 16, 2003 the American Institute of Certified Public Accountants issued Statement of Position 03-3 (“SOP 03-3”), Accounting for Certain Loans or Debt Securities Acquired in a Transfer. SOP 03-3 provides guidance on the accounting for differences between contractual and expected cash flows from the purchaser’s initial investment in loans or debt securities acquired in a transfer, if those differences are attributable, at least in part, to credit quality. Among other things, SOP 03-3: (1) prohibits the recognition of the excess of the contractual cash flows over expected cash flows as an adjustment of yield, loss accrual, or valuation allowance at the time of purchase; (2) requires that subsequent increases in expected cash flows be recognized prospectively through an adjustment of yield; and (3) requires the subsequent decreases in expected cash flows be recognized as an impairment. In addition, SOP 03-3 prohibits the creation or carrying over of a valuation allowance in the initial accounting of all loans within its scope that are acquired in a transfer. SOP 03-3 becomes effective for loans or debt securities acquired in fiscal years beginning after December 15, 2004. The Company does not expect the requirements of SOP 03-3 to have a material impact on its financial condition or results of operations.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

          Special Cautionary Notice Regarding Forward-looking Statements

          The Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q are not historical facts are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which describe the Company’s future plans, strategies and expectations, are based on assumptions and involve a number of risks and uncertainties, many of which are beyond the Company’s control. The important factors that could cause actual results to differ materially from the results, performance or achievements expressed or implied by the forward-looking statements include, without limitation:

•

Changes in interest rates and market prices, which could reduce the Company’s net interest margins, asset valuations and expense expectations;

	•		Changes in the levels of loan prepayments and the resulting effects on the value of the Company’s loan portfolio;
	•		Changes in local economic and business conditions which adversely affect the ability of the Company’s customers to transact profitable business with the Company, including the ability of borrowers to repay their loans according to their terms or a change in the value of the related collateral;

•

Increased competition for deposits and loans adversely affecting rates and terms;

•

The timing, impact and other uncertainties of the Company’s ability to enter new markets successfully and capitalize on growth opportunities;

•

Increased credit risk in the Company’s assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of the total loan portfolio;

•

The failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;

•

Changes in the availability of funds resulting in increased costs or reduced liquidity;

•

Increased asset levels and changes in the composition of assets and the resulting impact on the Company’s capital levels and regulatory capital ratios;

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•

The Company’s ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes;

•

The loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels; and

•

Changes in statutes and government regulations or their interpretations applicable to bank holding companies and our present and future banking and other subsidiaries, including changes in tax requirements and tax rates.

          The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, unless the securities laws require the Company to do so. All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

Restatement of Financial Statements

          The Company restated its condensed consolidated financial statements as of June 30, 2003 and for the three and six months ended June 30, 2003 to correct the amortization of deferred loan fees, net of costs, to interest income. The restatement decreased net loss by $95,000 for the three months ended June 30, 2003, and increased net income by $164,000 for six months ended June 30, 2003, and increased retained earnings by $1.9 million and $2.2 million as of June 30, 2003 and December 31, 2003, respectively.

          The restatement resulted from a review of the Company’s application of FASB Statement No. 91, “Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases.” Loan fees net of the associated costs should be recognized over the life of the related loan as an adjustment to yield. The Company recently discovered that $4.0 million of net deferred loan fees were not being amortized to interest income. These net deferred fees were not entered into the Company’s loan system, and therefore, amortization was not calculated each period. Accordingly, the restatement reflects the amortization of these net deferred fees. Additionally, in connection with the restatement for net deferred fees, the Company adjusted accruals of other noninterest expense previously deemed immaterial which resulted in an increase to retained earnings at December 31, 2003 of $63,000. See Note 2 to condensed consolidated financial statements.

          As a result, all amounts disclosed herein impacted by the restatement have been restated accordingly.

Overview

          For the three months ended June 30, 2004, the Company had net income of $2.5 million, up approximately $3.8 million compared with a net loss of $1.3 million for the same quarter in 2003. The Company’s diluted earning per share was $0.35 for the three months ended June 30, 2004, versus diluted loss per share of $0.18 for the same quarter in 2003. This increase in net income and diluted earnings per share was primarily the result of a $4.0 million provision for loan losses for the three months ended June 30, 2003 compared with a $300,000 provision for loan losses for the same period in 2004.

          Net income for the six months ended June 30, 2004 was $4.7 million, up approximately $4.0 million from $719,000 for the same period in 2003. The Company’s diluted earnings per share for the six months ended June 30, 2004 was $0.64, up $0.54 from $0.10 for the same period in 2003. This increase in net income and diluted earnings per share was primarily the result of a $4.8 million provision for loan losses for the six months ended June 30, 2003 compared with an $850,000 provision for loan losses for the same period in 2004.

          At June 30, 2004, total assets were $879.1 million, up approximately $12.1 million or 1.4% from $867.0 million at December 31, 2003. The increase was primarily the result of new securities purchased during the period with borrowed funds from the Federal Home Loan Bank. Investment securities at June 30, 2004 were $280.0 million, up approximately $22.9 million or 8.9% from $257.1 million at December 31, 2003. Net loans, both held-for-investment and held-for-sale at June 30, 2004, were $543.1 million, down approximately $3.6 million or 0.7% from $546.7 million at December 31, 2003. Total deposits at June 30, 2004 were $717.0 million, down approximately $8.0 million or 1.1% from $724.9 million at December 31, 2003. Other borrowings at June 30, 2004 were $74.9 million, up approximately $20.7 million from $54.2 million at December 31, 200. The Company’s return on average assets (“ROAA”) for the three months ended June 30, 2004 and 2003 was 1.17% and (0.60%), respectively. The Company’s ROAA for the six months ended June 30, 2004 and 2003 was 1.09% and 0.17%, respectively.

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     Shareholders’ equity at June 30, 2004 was $79.0 million compared with $78.4 million at December 31, 2003, an increase of approximately $625,000. The Company’s return on average shareholders’ equity (“ROAE”) for the three months ended June 30, 2004 and 2003 was 12.94% and (6.56%), respectively. The Company’s ROAE for the six months ended June 30, 2004 and 2003 was 11.98% and 1.88%, respectively.

Results of Operations

     Net Interest Income and the Net Interest Margin. For the three months ended June 30, 2004, net interest income, before the provision for loan losses, was $8.1 million, up approximately $480,000 or 6.3% from $7.6 million for the same quarter in 2003. The increase was primarily due to lower interest expense as a result of lower interest-bearing liability balances that was partially offset by lower interest income resulting from lower yield of higher interest-earning asset balances. Average interest-earning asset balances for the three months ended June 30, 2004 were $821.0 million, up approximately $3.8 million or 0.5% from $817.3 million for the same quarter in 2003. The weighted average yield on interest-earning assets for the three months ended June 30, 2004 was 5.24%, down 7 basis points from 5.31% for the same quarter in 2003. Average interest-bearing liability balances for the three months ended June 30, 2004 were $601.2 million, down approximately $17.5 million or 2.8% from $618.7 million for the same quarter in 2003. The weighted average rate paid on interest-bearing liabilities for the three months ended June 30, 2004 was 1.73%, down 34 basis points from 2.07% for the same quarter in 2003.

     For the six months ended June 30, 2004, net interest income, before the provision for loan losses, was $16.1 million, up approximately $807,000 or 5.3% from $15.3 million for the same period in 2003. The increase was primarily due to lower interest expense as a result of lower interest-bearing liability balances that was partially offset by lower interest income resulting from lower yield of higher interest-earning asset balances. Average interest-earning asset balances for the six months ended June 30, 2004 were $821.5 million, up approximately $10.6 million or 1.3% from $810.9 million for the same period in 2003. The weighted average yield on interest-earning assets for the six months ended June 30, 2004 was 5.22%, down 19 basis points from 5.41% for the same period in 2003. Average interest-bearing liability balances for the six months ended June 30, 2004 were $604.4 million, down approximately $11.5 million or 1.9% from $615.9 million for the same period in 2003. The weighted average rate paid on interest-bearing liabilities for the six months ended June 30, 2004 was 1.74%, down 37 basis points from 2.11% for the same period in 2003.

     The net interest margin for the three months ended June 30, 2004 was 3.97%, up 23 basis points from 3.74% for the same quarter in 2003 and was primarily the result of a decrease of the cost of interest-bearing liabilities of 34 basis points that was partially offset by a decrease in the yield on interest-earning assets of 7 basis points. The net interest margin for the six months ended June 30, 2004 was 3.94%, up 13 basis points from 3.81% for the same period in 2003 and was primarily the result of a decrease of the cost of interest-bearing liabilities of 37 basis points that was partially offset by a decrease in the yield on interest-earning assets of 19 basis points. The Company’s net interest margin may experience further pressure depending on the future interest rate environment.

     Total Interest Income. Total interest income for the three months ended June 30, 2004 was $10.7 million, down approximately $125,000 or 1.2% from $10.8 million for the same quarter in 2003. Total interest income for the six months ended June 30, 2004 was $21.3 million, down approximately $414,000 or 1.9% from $21.7 million for the same period in 2003. The lower interest income for both periods in 2004, compared with 2003, was primarily the result of lower yields on interest-earning assets that was partially offset by increases in average interest-earning assets.

     Interest Income from Loans. Interest income from loans for the three months ended June 30, 2004 was $8.3 million, down approximately $503,000 or 5.7% from $8.8 million for the same quarter in 2003 primarily due to lower loan yields as a result of the current interest rate environment that was partially offset by higher average loan balances. Average total loans for the three months ended June 30, 2004 were $555.3 million compared to average total loans for the same quarter in 2003 of $553.0 million, an increase of approximately $2.3 million or 0.4%. For the three months ended June 30, 2004, the average yield on total loans was 6.00%, compared to 6.37% for the same quarter in 2003, a decrease of 37 basis points.

     Approximately $470.8 million or 87.9% of the loans in the loan portfolio are variable rate loans that reprice as the prime rate moves and therefore, are sensitive to interest rate movement. At June 30, 2004, the average yield

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on the total loan portfolio was approximately 144 basis points above the prime rate, which was supported by variable rate loans with interest rate floors that consisted of approximately $367.9 million or 68.7% of the total loan portfolio. These loans carried a weighted average interest rate of 5.70% at June 30, 2004 compared to 61.6% of the total loan portfolio with a weighted average interest rate of 6.16% at June 30, 2003. Future prime rate increases will not immediately impact the entire loan portfolio because of the interest rate floors. The prime rate may have to increase several times for some loans to begin re-pricing because the prime-based pricing may continue to be less than the floor rate.

     Interest income from loans for the six months ended June 30, 2004 was $16.5 million, down approximately $1.0 million or 5.9% from $17.5 million for the same period in 2003 primarily due to the lower loan yields as a result of the interest rate environment that was partially offset by higher average loan balances. Average total loans for the six months ended June 30, 2004 were $559.3 million compared to average total loans for the same period in 2003 of $547.4 million, an increase of approximately $11.8 million or 2.2%. For the six months ended June 30, 2004, the average yield on total loans was 5.92%, compared to 6.44% for the same period in 2003, a decrease of 52 basis points.

     Interest Income from Investments. Interest income from investments (which includes investment securities, Federal Funds sold, and other investments) for the three months ended June 30, 2004 was $2.4 million, up approximately $378,000 or 18.6% compared to $2.0 million for the same quarter in 2003, primarily due to a more normalized premium amortization experienced in 2004 compared to 2003. The majority of the portfolio is invested in mortgage-backed securities and the record level of home refinancing in 2003 created unprecedented levels of cash flows which, in turn, forced accelerated premium amortization on securities purchased at a premium. New purchase yields have also been generally higher in 2004. Average total investments for the three months ended June 30, 2004, were $265.7 million compared to average total investments for the same quarter in 2003 of $264.3 million, and increase of approximately $1.5 million or 0.6%. For the three months ended June 30, 2004, the average yield on investments was 3.64% compared to 3.08% for the same quarter in 2003, an increase of 56 basis points.

     Interest income from investments for the six months ended June 30, 2004 was $4.9 million, up approximately $608,000 or 14.3% compared to $4.3 million for the same period in 2003, primarily due to the same reason discussed above. Average total investments for the six months ended June 30, 2004, were $262.2 million compared to average total investments for the same period in 2003 of $263.4 million, a decrease of approximately $1.2 million or 0.5%. For the six months ended June 30, 2004, the average yield on investments was 3.73% compared to 3.26% for the same period in 2003, an increase of 47 basis points.

     Total Interest Expense. Total interest expense for the three months ended June 30, 2004 was $2.6 million, down approximately $605,000 or 19.0% compared to $3.2 million for the same quarter in 2003. Total interest expense for the six months ended June 30, 2004 was $5.2 million, down approximately $1.2 million or 19.0% from $6.4 million for the same period in 2003. The lower interest expense for both periods in 2004, compared to 2003, was primarily the result of lower interest rates paid on decreased average interest-bearing liabilities.

     Interest Expense on Deposits. Interest paid on interest-bearing deposits for the three months ended June 30, 2004 was $2.1 million, down approximately $571,000 or 21.0% compared to $2.7 million for the same period in 2003 and was primarily due to lower interest rates paid for interest-bearing deposits and lower interest-bearing deposit balances. Average interest-bearing deposits for the three months ended June 30, 2004 were $537.6 million compared to average interest-bearing deposits for the same quarter in 2003 of $557.1 million, a decrease of $19.5 million or 3.5%. The average interest rate paid on interest-bearing deposits for the three months ended June 30, 2004 was 1.60% compared to 1.95% for the same quarter in 2003, a decrease of 35 basis points.

     Interest paid on interest-bearing deposits for the six months ended June 30, 2004 was $4.3 million, down approximately $1.1 million or 20.5% compared to $5.5 million for the same period in 2003 and was primarily due to lower interest rates paid for interest-bearing deposits and lower interest-bearing deposit balances. Average interest-bearing deposits for the six months ended June 30, 2004 were $542.3 million compared to average interest-bearing deposits for the same period in 2003 of $551.0 million, a decrease of $8.7 million or 1.6%. The average interest rate paid on interest-bearing deposits for the six months ended June 30, 2004 was 1.61% compared to 2.00% for the same period in 2003, a decrease of 39 basis points.

     Interest Expense on Other Borrowed Funds. Interest paid on other borrowed funds for the three months ended June 30, 2004 was $440,000, down approximately $34,000 compared to $474,000 for the same period in 2003 and was primarily due to lower interest rates paid for borrowed funds that were partially offset by higher borrowed

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funds balances. Average borrowed funds for the three months ended June 30, 2004 were $63.6 million compared to average borrowed funds for the same quarter in 2003 of $61.6 million, an increase of $2.0 million. The increase in borrowed funds reflected advances obtained from the Federal Home Loan Bank (“FHLB”) to fund mortgage-related securities investments to increase earning assets. The average interest rate paid on borrowed funds for the three months ended June 30, 2004 was 2.78%, compared to 3.09% for the same quarter in 2003, a decrease of 31 basis points.

     Interest paid on other borrowed funds for the six months ended June 30, 2004 was $876,000, down approximately $103,000 compared to $979,000 million for the same period in 2003 and was primarily due to lower borrowed funds balances and lower interest rates paid for borrowed funds. Average borrowed funds for the six months ended June 30, 2004 were $62.2 million compared to average borrowed funds for the same period in 2003 of $64.9 million, a decrease of $2.8 million. The average interest rate paid on borrowed funds for the six months ended June 30, 2004 was 2.83%, compared to 3.04% for the same period in 2003, a decrease of 21 basis points.

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     The following tables present the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates for the periods indicated. No tax-equivalent adjustments were made and all average balances are daily average balances. Nonaccruing loans have been included in the tables as loans having a zero yield.

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     The following tables present the dollar amount of changes in interest income and interest expense for the major components of interest-earning assets and interest-bearing liabilities and distinguishes between changes in outstanding balances and changes in interest rates for the three and six months ended June 30, 2004 compared with the three and six months ended June 30, 2003. For purposes of this table, changes attributable to both rate and volume have been allocated to each accordingly.