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SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d)

OF THE SECURITIES EXCHANGE ACT OF 1934

SOUTHERN BANCSHARES (N.C.), INC.

(Exact name of registrant as specified in its charter)

116 East Main Street

Mount Olive, North Carolina 28365

(Address of Principal Executive offices, Zip Code)

(919) 658-7000

(Registrant’s Telephone Number, including Area Code)

Securities registered pursuant to:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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

The aggregate market value of the Registrant’s common equity held by nonaffiliates computed by reference to the price at which the common equity was last sold as of the last business day of the Registrant’s most recently completed second fiscal quarter was approximately $21.8 million. (There is no established market, published quotes or reported prices for the Registrant’s common stock. The market value of shares held by nonaffiliates has been calculated based on prices known to management of Registrant in privately negotiated transactions.)

The number of shares outstanding of the Registrant’s common stock as of March 10, 2004: Common Stock, $5.00 par value - 111,429 shares

Portions of the Registrant’s definitive Proxy Statement dated March 19, 2004 for the 2004 Annual Meeting of Shareholders are incorporated by reference into Part III.

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CROSS REFERENCE INDEX

Information required by Item 11 is incorporated herein by reference to the information that appears under the captions “Director Compensation”, “Compensation Committee Interlocks and Insider Participation” and “Executive Compensation” on pages 5, 8 and 9 of the Registrant’s definitive Proxy Statement dated March 19, 2004.

Information required by Item 12 is incorporated herein by reference to the information that appears under the caption “Beneficial Ownership of Voting Securities” on pages 2 through 4 of the Registrant’s definitive Proxy Statement dated March 19, 2004.

Information required by Item 13 is incorporated herein by reference to the information that appears under the caption “Transactions with Related Parties” on page 11 of the Registrant’s definitive Proxy Statement dated March 19, 2004.

Information required by Item 14 is incorporated herein by reference to the information that appears under the caption “Services and Fees During 2002 and 2003” on page 12 of the Registrant’s definitive Proxy Statement dated March 19, 2004.

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BUSINESS

General. Southern BancShares (N.C.), Inc. (hereinafter, with all of its subsidiaries, referred to as “BancShares” or “Registrant”), is a bank holding company which was organized during 1986 as the successor to Southern BancShares (N.C.), Inc., a North Carolina corporation (“SBS”). SBS was formed in 1982 as the parent company of Southern Bank and Trust Company (“Southern”). During 1986, SBS was merged into BancShares to effect the reincorporation of Southern’s parent company in Delaware.

Southern is BancShares’ principal operating subsidiary and is currently engaged in commercial banking through 50 offices located primarily in eastern North Carolina.

Bancshares’ executive offices are located at 116 East Main Street, Mount Olive, North Carolina 28365, and its telephone number is (919) 658-7000.

BancShares’ principal assets are its investments in and receivables from its bank subsidiary and its investment securities portfolio. Its primary sources of income are dividends from its bank subsidiary and interest income on its investment securities portfolio. Certain laws and regulations restrict the ability of Southern to transfer funds to BancShares in the form of cash dividends or loans. All significant activities of BancShares and its subsidiaries are banking related so that BancShares operates within one industry segment. Neither BancShares nor its subsidiaries has any foreign operations.

Services. Southern provides a full range of banking and financial services to individuals, small and medium-sized businesses and governmental units located in its banking markets, including regular and interest checking accounts, money market, savings and time deposit accounts, personal and business loans and a variety of other services incidental to commercial banking. Southern has a wholly-owned subsidiary, Goshen, Inc., which acts as a trustee and agent for credit life and credit accident and health insurance written in connection with loans made by Southern.

Employees. All of BancShares’ Officers serve as Officers of Southern. BancShares has no employees of its own. As of December 31, 2003, Southern employed 400 full-time employees (including executive officers) and 37 part-time employees. Southern is not a party to any collective bargaining agreement with its employees and it considers its relations with its employees to be good.

Supervision and Regulation. The business and operations of BancShares and Southern are subject to extensive federal and state governmental regulation and supervision.

BancShares is a bank holding company registered with the Federal Reserve Board (the “FRB”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”). It is subject to supervision and examination by, and the regulations and reporting requirements of, the FRB. Under the BHCA, a bank holding company’s activities are limited to banking, managing or controlling banks, or engaging in any other activities which the FRB determines to be closely related and a proper incident to banking or managing or controlling banks. The internal affairs of BancShares, including the rights of its shareholders, are governed by Delaware law and by its Articles of Incorporation and Bylaws. BancShares files periodic reports under the Securities Exchange Act of 1934 and is subject to the jurisdiction of the Securities and Exchange Commission.

The BHCA prohibits a bank holding company from acquiring direct or indirect control of more than 5.0% of the outstanding voting stock, or substantially all of the assets, of any financial institution, or merging or consolidating with another bank holding company or savings bank holding company, without prior approval of the FRB. Additionally, the BHCA generally prohibits bank holding companies from engaging in, or acquiring ownership or control of more than 5.0% of the outstanding voting stock of any company that engages in a non-banking activity unless that activity is determined by the FRB to be closely related and a proper incident to managing or controlling banks.

There are a number of obligations and restrictions imposed by law on a bank holding company and its insured bank subsidiaries that are designed to minimize potential loss to depositors and the FDIC insurance funds. For example, if a bank holding company’s insured bank subsidiary becomes “undercapitalized,” the bank holding company is required to guarantee (subject to certain limits) the subsidiary’s compliance with the terms of any capital restoration plan filed with its federal banking agency. A bank holding company is required to serve as a source of financial strength to its bank subsidiaries and to commit resources to support those banks in circumstances where it otherwise might not do so, absent such policy. Under the BHCA, the FRB may require a bank holding company to terminate any activity or to relinquish control of a non-bank subsidiary if the FRB determines that the activity or control constitutes a serious risk to the financial soundness and stability of a bank subsidiary of the bank holding company.

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Regulation of Southern. Southern is an insured, state-chartered bank. Southern’s deposits are insured by the FDIC’s Bank Insurance Fund, and is subject to supervision and examination by, and the regulations and reporting requirements of, the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Commissioner of Banks (the “Commissioner”). Southern is not a member of the Federal Reserve System.

As an insured bank, Southern is prohibited from engaging as a principal in an activity that is not permitted for national banks unless (i) the FDIC determines that the activity would pose no significant risk to the deposit insurance fund and (ii) Southern is, and continues to be, in compliance with all applicable capital standards. Southern is also prohibited from directly acquiring or retaining any equity investment of a type or in an amount not permitted for national banks.

The FDIC and the Commissioner regulate all areas of Southern’s business, including its reserves, loans, mergers, the payment of dividends, and other aspects of its operations. The regulators conduct regular examinations of Southern, and Southern must furnish periodic reports to its regulators containing detailed financial and other information regarding its affairs. The federal and state regulators have broad powers to enforce laws and regulations that apply to Southern and to require corrective action of conditions that affect its safety and soundness. Among others, these powers include issuing cease and desist orders, imposing civil penalties, removing officers and directors, and the ability otherwise to intervene in the operation and management of Southern if examinations of and reports filed by Southern reflect the need to do so.

Even though it is not a member of the Federal Reserve System, the business of Southern is influenced by the monetary and fiscal policies of the FRB. The actions and policy directives of the FRB determine to a significant degree the cost and the availability of funds obtained from money market sources for lending and investing and also influence, directly and indirectly, the rates of interest paid by Southern on time and savings deposits. Additionally, Southern’s earnings are affected by general economic conditions, management policies, changes in state and Federal legislation and actions of various regulatory authorities, including those referred to above.

The following paragraphs summarize some of the other significant statutes and regulations that affect BancShares and Southern, but they are not a complete discussion of all the laws that affect their business. Each paragraph is qualified in its entirety by reference to the particular statutory or regulatory provision or proposal being described.

Gramm-Leach-Bliley Act. The federal Gramm-Leach-Bliley Act (the “GLB Act”) adopted by Congress during 1999 has dramatically changed various federal laws governing the banking, securities and insurance industries. The GLB Act expanded opportunities for banks and bank holding companies to provide services and engage in other revenue-generating activities that previously were prohibited to them.

The GLB Act permits bank holding companies to become “financial holding companies” and, in general (i) expands opportunities to affiliate with securities firms and insurance companies; (ii) overrides certain state laws that would prohibit certain banking and insurance affiliations; (iii) expands the activities in which banks and bank holding companies may participate; (iv) requires that banks and bank holding companies engage in some activities only through affiliates owned or managed in accordance with certain requirements; and (v) reorganizes responsibility among various federal regulators for oversight of certain securities activities conducted by banks and bank holding companies.

Among its other provisions, the GLB Act also contains extensive customer privacy protection provisions which require banks to adopt and implement policies and procedures for the protection of the financial privacy of their customers, including procedures that allow customers to elect that certain financial information not be disclosed to certain persons. Under these provisions, a bank must provide to its customers, at the inception of the customer relationship and annually thereafter, the Bank’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The GLB Act provides that, except for certain limited exceptions, a bank may not provide such personal information to unaffiliated third parties unless the bank discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. A bank may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLB Act permits states to adopt customer privacy protections that are stricter than those contained in the Act, and it makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer information of a financial nature by fraudulent or deceptive means.

BancShares has not chosen to become a “financial holding company,” and to date it has not engaged in any new activity authorized as a result of the GLB Act. The GLB Act has expanded opportunities for Southern to provide other services and obtain other revenues in the future. However, this expanded authority also may present it with new challenges as its larger competitors are able to expand their services and products into areas that are not feasible for smaller, community oriented financial institutions.

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Payment of Dividends. Under current law, BancShares is authorized to pay dividends such as are declared by its Board of Directors, provided that no such distribution results in its insolvency on a going concern or balance sheet basis. However, BancShares is a legal entity separate and distinct from Southern, and its principal source of funds with which it can pay dividends to its shareholders is dividends it receives from Southern. Therefore, BancShares’ ability to pay dividends effectively is subject to the same limitations that apply to Southern.

In general, Southern may pay dividends only from its undivided profits. However, if its surplus is less than 50 percent of its paid-in capital stock, then Southern’s directors may not declare any cash dividend until it has transferred from undivided profits to surplus 25 percent of its undivided profits or any lesser percentage necessary to raise its surplus to an amount equal to 50 percent of its paid-in capital stock.

Under federal law, and as an insured bank, Southern is prohibited from making any capital distributions, including paying a cash dividend, if it is, or after making the distribution it would become, “undercapitalized” as that term is defined in the Federal Deposit Insurance Act (the “FDIA”). Additionally, if in the opinion of the FDIC an insured bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the bank, could include the payment of dividends), the FDIC may require, after notice and hearing, that the bank cease and desist from that practice. The federal banking agencies have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsafe and unsound banking practice. The federal agencies have issued policy statements which provide that insured banks generally should only pay dividends out of current operating earnings, and under the FDIA no dividend may be paid by an FDIC-insured bank while it is in default on any assessment due the FDIC. The payment of dividends by Southern also may be affected or limited by other factors, such as requirements that its regulators have the authority to impose to maintain its capital above regulatory guidelines.

Capital Adequacy. BancShares and Southern each is required to comply with the capital adequacy standards established by the FRB in the case of BancShares, and by the FDIC in the case of Southern. The FRB and FDIC have promulgated risk-based capital and leverage capital guidelines for determining the adequacy of the capital of a bank holding company or a bank, and all applicable capital standards must be satisfied for a bank holding company or a bank to be considered in compliance with these capital requirements.

Under the risk-based capital measure, the minimum ratio (“Total Capital Ratio”) of an entity’s total capital (“Total Capital”) to its risk-weighted assets (including certain off-balance-sheet items, such as standby letters of credit) is 8.0%. At least half of Total Capital must be composed of common equity, undivided profits, minority interests in the equity accounts of consolidated subsidiaries, qualifying non-cumulative perpetual preferred stock, and a limited amount of cumulative perpetual preferred stock, less goodwill and certain other intangible assets (“Tier 1 Capital”). The remainder (“Tier 2 Capital”) may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock, and a limited amount of loan loss reserves. A bank or bank holding company that does not satisfy minimum capital requirements may be required to adopt and implement a plan acceptable to its federal banking regulator to achieve an adequate level of capital.

Under the leverage capital measure, the minimum ratio (the “Leverage Capital Ratio”) of Tier 1 Capital to average assets, less goodwill and certain other intangible assets, is 3.0% for entities that meet certain specified criteria, including having the highest regulatory rating. All others generally are required to maintain an additional cushion of 100 to 200 basis points above the stated minimum. The guidelines also provide that banks experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum levels without significant reliance on intangible assets, and a bank’s “Tangible Leverage Ratio” (deducting all intangibles) and other indicia of capital strength also will be taken into consideration by banking regulators in evaluating proposals for expansion or new activities.

The following table lists Southern’s capital ratios at December 31, 2003:

The FRB and the FDIC also consider interest rate risk (when the interest rate sensitivity of an institution’s assets does not match the sensitivity of its liabilities or its off-balance-sheet position) in the evaluation of an entity’s capital adequacy. The bank regulatory agencies’ methodology for evaluating interest rate risk requires banks with excessive interest rate risk exposure to hold additional amounts of capital against their exposure to losses resulting from that risk. The regulators also require banks to incorporate market risk components into their risk-based capital. Under these market risk requirements, capital is allocated to support the amount of market risk related to a bank’s trading activities.

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Capital categories are determined solely for the purpose of applying “prompt corrective action” rules described below which have been adopted by the various federal banking regulators, and they do not necessarily constitute an accurate representation of a bank’s overall financial condition or prospects for other purposes. A failure to meet capital guidelines could subject a bank holding company or bank to a variety of enforcement remedies under those rules, including the issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on the taking of brokered deposits, and certain other restrictions on its business. As described below, substantial additional restrictions can be imposed on banks that fail to meet applicable capital requirements.

Prompt Corrective Action. Current federal law establishes a system of prompt corrective action to resolve the problems of undercapitalized banks. Under this system, the FDIC has established five capital categories (“well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized”), and it is required to take certain mandatory supervisory actions, and is authorized to take other discretionary actions, with respect to banks in the three undercapitalized categories. The severity of any actions taken will depend upon the capital category in which a bank is placed. Generally, subject to a narrow exception, current federal law requires the FDIC to appoint a receiver or conservator for a bank that is critically undercapitalized.

Under the FDIC’s rules implementing the prompt corrective action provisions, an insured, state-chartered bank that (1) has a Total Capital Ratio of 10.0% or greater, a Tier 1 Capital Ratio of 6.0% or greater, and a Leverage Ratio of 5.0% or greater, and (2) is not subject to any written agreement, order, capital directive, or prompt corrective action directive issued by the FDIC, is considered to be “well capitalized.” A bank with a Total Capital Ratio of 8.0% or greater, a Tier 1 Capital Ratio of 4.0% or greater, and a Leverage Ratio of 4.0% or greater, is considered to be “adequately capitalized.” A bank that has a Total Capital Ratio of less than 8.0%, a Tier 1 Capital Ratio of less than 4.0%, or a Leverage Ratio of less than 4.0%, is considered to be “undercapitalized.” A bank that has a Total Capital Ratio of less than 6.0%, a Tier 1 Capital Ratio of less than 3.0%, or a Leverage Ratio of less than 3.0%, is considered to be “significantly undercapitalized,” and a bank that has a tangible equity capital to assets ratio equal to or less than 2.0% is deemed to be “critically undercapitalized.” For purposes of these rules, the term “tangible equity” includes core capital elements counted as Tier 1 Capital for purposes of the risk-based capital standards, plus the amount of outstanding cumulative perpetual preferred stock (including related surplus), minus all intangible assets (with various exceptions). A bank may be deemed to be in a capitalization category lower than indicated by its actual capital position if it receives an unsatisfactory examination rating.

A bank that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to the FDIC. An “undercapitalized” bank also is generally prohibited from increasing its average total assets, making acquisitions, establishing any branches, or engaging in any new line of business, except in accordance with an accepted capital restoration plan or with the approval of the FDIC. In addition, the FDIC has authority with respect to any “undercapitalized” bank to take any of the actions it is required to or may take with respect to a “significantly undercapitalized” bank if it determines that those actions are necessary to carry out the purpose of the law. On December 31, 2003, Southern had capital sufficient to qualify as “well capitalized.”

Reserve Requirements. Under regulations of the FRB, all FDIC-insured banks must maintain average daily reserves against their transaction accounts. No reserves are required to be maintained on the first $6.6 million of transaction accounts, but reserves equal to 3.0% must be maintained on the aggregate balances of those accounts between $6.6 million and $45.4 million, and reserves equal to 10.0% must be maintained on aggregate balances in excess of $45.4 million. Those percentages are subject to adjustment by the FRB. Because required reserves must be maintained in the form of vault cash or in a non-interest-bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of Southern’s interest-earning assets.

FDIC Insurance Assessments. The FDIC currently uses a risk-based assessment system that takes into account the risks attributable to different categories and concentrations of assets and liabilities for purposes of calculating deposit insurance assessments to be paid by insured banks. The risk-based assessment system categorizes banks as “well capitalized,” “adequately capitalized” or “undercapitalized.” These three categories are substantially similar to the prompt corrective action categories described above, with the “undercapitalized” category including banks that are “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized” for prompt corrective action purposes. Banks also are assigned by the FDIC to one of three supervisory subgroups within each capital group, with the particular supervisory subgroup to which a bank is assigned being based on a supervisory evaluation provided to the FDIC by the Bank’s primary federal banking regulator and information which the FDIC determines to be relevant to the Bank’s financial condition and the risk posed to the deposit insurance funds (which may include, if applicable, information provided by the Bank’s state supervisor). A different insurance assessment rate (ranging from zero to 27 basis points) applies to each of the nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups). A bank’s assessment rate is determined based on the capital category and supervisory subgroup to which it is assigned.

The FDIC may terminate a bank’s deposit insurance upon a finding that the bank has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.

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The FDIC is charged with the responsibility of maintaining the adequacy of the Bank Insurance Fund and the Savings Association Insurance Fund, and the amounts paid by banks for deposit insurance is influenced not only by the bank’s capital category and supervisory subgroup but also by the adequacy of the insurance fund at any time. FDIC insurance assessments could be increased substantially in the future if the FDIC finds such an increase to be necessary in order to adequately maintain the insurance fund.

Restrictions on Transactions with Affiliates. Southern is subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

For purposes of Section 23A, BancShares and any other company or entity controlled by or under common control with BancShares, will be treated as an affiliate of Southern.

The total amount of the above transactions by Southern is limited in amount, as to any one affiliate, to 10% of Southern’s capital and surplus and, as to all affiliates combined, to 20% of Southern’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. Southern also must comply with other provisions of Section 23A designed to avoid the taking of low-quality assets from an affiliate.

Southern is also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits a bank from engaging in the above transactions with its affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Federal law also places restrictions on Southern’s ability to extend credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

USA Patriot Act of 2001. The USA Patriot Act of 2001 was enacted in response to the terrorist attacks that occurred in New York, Pennsylvania and Washington, D.C. on September 11, 2001. The Act is intended to strengthen the ability of U.S. law enforcement and the intelligence community to work cohesively to combat terrorism on a variety of fronts. The potential impact of the Act on financial institutions of all kinds is significant and wide ranging. The Act contains sweeping anti-money laundering and financial transparency laws which require various new regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. The Act has required financial institutions to adopt new policies and procedures to combat money laundering, and it grants the Secretary of the Treasury broad authority to establish regulations and impose requirements and restrictions on financial institutions’ operations.

Community Reinvestment. Under the Community Reinvestment Act (“CRA”), as implemented by regulations of the federal bank regulatory agencies, an insured bank has a continuing and affirmative obligation, consistent with its safe and sound operation, to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for banks, nor does it limit a bank’s discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the federal bank regulatory agencies, in connection with their examination of insured banks, to assess Southern’s records of meeting the credit needs of its communities, using the ratings of “outstanding,” “satisfactory,” “needs to improve,” or “substantial noncompliance,” and to take that record into account in its evaluation of certain applications by those banks. All insured banks are required to make public disclosure of their CRA performance ratings. Southern received an “outstanding” rating in its most recent CRA examination.

Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (the “SOX Act”) represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. Among other requirements, the SOX Act established: (1) new requirements for audit committees of listed companies, including independence, expertise, and responsibilities; (2) additional responsibilities regarding financial statements for the chief executive officers and chief financial officers of reporting companies; (3) new standards for auditors and regulation of audits; (4) increased disclosure and reporting obligations for reporting companies regarding various matters relating to corporate governance, and (5) new and increased civil and criminal penalties for violation of the securities laws.

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Statistical Data. Certain statistical disclosures for bank holding companies required by SEC Guide 3 regulations are included in the information under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

PROPERTIES

BancShares does not own or lease any real property. Except for three tracts of land that are leased and upon which are constructed leasehold improvements for the conduct of its banking business, Southern owns all of the real property utilized in its operations.

Southern’s home office is located at 116 East Main Street, Mount Olive, North Carolina. All of Southern’s offices are in North Carolina. At December 31, 2003 there were 50 Southern offices.

MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction

This discussion provides information concerning changes in the consolidated financial condition and results of operations of Southern BancShares (N.C.), Inc. (“BancShares”) and its subsidiary, Southern Bank and Trust Company (“Southern”), for 2003, 2002 and 2001. The comments are intended to supplement and should be reviewed in conjunction with the consolidated financial statements, related notes and selected financial data presented elsewhere herein.

Summary

BancShares’ earnings and cash flows are primarily derived from the commercial banking activities conducted by Southern. Southern’s commercial banking activities include commercial and consumer lending, deposit and cash management products and various other financial management products and services typically associated with commercial banking. Southern gathers interest-bearing and noninterest-bearing deposits from retail and commercial customers and gathers supplemental short-term funding through various non-deposit sources. The liquidity generated from these funding sources is primarily invested in interest-earning assets consisting of various types of loans, investment securities, overnight funds sold investments and the banking premises and equipment used in the delivery of financial services.

Numerous factors influence customer demand for Southern’s deposit and loan products including the overall economy within Southern’s markets and the overall level of financial services competition within those markets. During 2003 and 2002, overall economic uncertainty and very low interest rates managed by the Federal Reserve significantly impacted customer demand for both deposit and loan products. The low interest rate market caused some customers to choose shorter term deposit products including short-term certificates of deposit, transaction, savings and money market accounts. The low interest rate market also provided many customers with an opportunity to refinance existing loans and the ability to either reduce their overall loan requirements or expand their loan requirements at much lower interest rates.

The overall strength of the economy also influences the quality and collectibility of loans and the level of customer bankruptcies. Southern utilizes various asset and liability management tools to minimize the potential adverse impact of economic trends and to maximize opportunities provided by favorable economic trends.

Financial institutions typically focus their strategic planning and operating goals on maximizing profitability and the improvement of the return on average assets and return on average shareholders equity performance profitability measures. BancShares has historically placed significant emphasis on asset quality, liquidity and capital conservation, even when those goals may ultimately be detrimental to current period earnings performance as reflected by the return on average assets and return on average shareholders equity performance measures so, BancShares’ return on average assets and return on average equity has historically compared unfavorably to financial institutions of similar size.

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BancShares strategic analysis of its corporate and competitive strengths indicate many opportunities for growth and expansion of financial services within its markets. Southern operates in diverse geographic markets that offer opportunities to expand varying types of services to existing customers as well as opportunities to expand market share through strategic acquisitions of branch locations from competitor financial institutions. Southern also believes that, through superior customer service, there are opportunities to increase earnings performance by attracting customers of its financial competitors.

BancShares focuses on mitigating, where possible, growth and profitability risks. BancShares has limited control of risks such as economic, competitive and regulatory risks. Southern considers overall economic risk to be its greatest risk area. Primarily, economic risks of recession, rapid changes in market interest rates and significant increases in inflation are of the most concern to Management. Southern’s smaller asset size and limited capital resources, as compared to its primary market financial service competitors, require significant and constant Management attention to all areas of economic risk.

An analysis of BancShares’ overall financial condition and growth can be made by examining the changes and trends in the interest-earning asset and interest-bearing components in the following tables, discussions, consolidated financial statements and notes to the consolidated financial statements. Tables and discussions are also presented detailing the impact of branch acquisitions, capital position, loan loss experience, and allowance for loan losses, non-interest expenses and non-interest income.

Consolidated net income was $8.1 million for 2003 compared to $9.1 million for 2002 and $8.2 million for 2001. A change in accounting principle related to amortization of intangibles associated with branch acquisitions prior to 2002 was the principal reason for the 2002 increase. Net income per share for the year ended December 31, 2003 totaled $68.31 compared to $76.77 in 2002 and $68.66 in 2001. Return on average assets totaled 0.85 percent during 2003, 1.05 percent during 2002 and 0.99 percent during 2001. Table 1 provides a five year summary of financial information for BancShares.

BancShares experienced an 11.52 percent decrease in net income during 2003, compared to 2002. The principal cause of this decrease was reduced net interest income created by declining interest rate market managed by the Federal Reserve during 2003 that resulted in interest earning assets repricing downward faster than interest bearing liabilities. In addition, in 2003, income considered to be noncore earnings and consisting of gains on sales of available-for-sale securities and gains on the sales of mortgage loans, totaled $2.7 million, a 4.82 percent decrease from $2.9 million for such noncore 2002 income.

In 2002, as a result of the overall economy, there were greater opportunities for management to realize earnings from the sale of securities. In 2003, as a result of the significantly increased mortgage financing and refinancing resulting from the Federal Reserve’s maintaining the lowest interest rates in several decades, there were significantly increased opportunities for management to profitably sell mortgage loans.

An analysis of BancShares’ financial condition and growth can be made by examining the changes and trends in interest-earning assets and interest-bearing liabilities. Such an analysis also requires an evaluation of noninterest income and noninterest expenses. In recent years, increasing total noninterest income has been a significant focus for BancShares. The introduction of new revenue sources and modifications to existing products and services has allowed service related noninterest income to grow.

In recent years the recognition of gains and losses on sales of mortgage loans and the recognition of gains and losses on sales of available-for-sale securities has also had a significant impact on total noninterest income, although management does not consider these sources of noninterest income to be a core source of revenues for BancShares. The sale of mortgage loans also results in the recognition of mortgage servicing rights (MSRs) income. MSRs represent the estimated value of the right to service mortgage loans for others. Capitalization of MSRs occurs when the underlying mortgage loans are sold and the servicing rights for the mortgage loans sold are retained. Capitalized MSRs are amortized into income over the projected servicing life of the underlying loans.

Franchise expansion has also contributed to the growth in noninterest income, but has also resulted in large increases in noninterest expense, especially personnel-related costs, occupancy expenses, equipment expenses and intangible asset amortization expenses. In 2003 one denovo branch was opened in the first quarter and one branch acquisition was completed in the third quarter. Management continues to look for growth opportunities offered though acquisition opportunities and to plan for denovo expansion within its eastern North Carolina markets. The acquisition of existing branches from other financial institutions also results in the payment of acquisition premiums which are allocated to non-earning assets or charged to operating earnings over time.

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Members of the Holding family, including Frank B. Holding who serves as a director and the Chairman of BancShares’ Executive Committee, have been actively involved in the management of BancShares. Currently, various members of the Holding family control an aggregate of 68.28% of BancShares’ common stock. Southern is party to contracts with an affiliated financial institution, First-Citizens Bank & Trust Company, Raleigh, North Carolina, pursuant to which Southern is provided with various management consulting, support and data processing services. See “Beneficial Ownership of Voting Securities” and “Transactions with Related Parties” in Note 15, Related Parties in the NOTES TO CONSOLIDATED FINANCIAL STATEMENTS contained in this report.

CRITICAL ACCOUNTING POLICIES

BancShares’ significant accounting policies are set forth in note 1 of the consolidated financial statements. Of these significant accounting policies, BancShares considers its policy regarding the allowance for loan losses to be its primary critical accounting policy, because it requires management’s most subjective and complex judgments. In addition, changes in economic conditions can have a significant impact on the allowance for loan losses and therefore the provision for loan losses and results of operations. Bancshares has developed appropriate policies and procedures for assessing the adequacy of the allowance for loan losses, recognizing that this process requires a number of assumptions and estimates with respect to its loan portfolio. BancShares’ assessments may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers which is not known to management at the time of the issuance of the consolidated financial statements. For additional discussion concerning BancShares’ allowance for loan losses and related matters, see Asset Quality.

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Table 1

SELECTED FINANCIAL DATA

(Dollars in thousands, except share data and ratios)

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Branch Acquisitions

During both 2003 and 2002, Southern purchased a North Carolina branch office of another bank. These branch acquisitions were accounted for as purchases, and, therefore, the results of operations prior to purchase of these branch offices are not included in the consolidated financial statements. Information regarding these purchases is contained in the following table:

Table 2

BRANCH ACQUISITIONS

(dollars in thousands)

INTEREST-EARNING ASSETS

Interest-earning assets include loans, investment securities and overnight investments. Interest-earning assets reflect varying interest rates based on the risk level and maturity of the asset. Riskier investments typically carry a higher rate and expose the investor to potentially higher levels of default. Southern has historically focused on maintaining high asset quality requiring management to perform significant underwriting and monitoring procedures. Southern’s investment portfolio includes primarily United States Treasury and government agency securities. The level of investment securities is primarily the result of overall loan and deposit trends. When deposit growth exceeds loan growth the excess liquidity primarily increases investment securities. When loan growth exceeds deposit growth primarily maturing investment securities are utilized to fund the loan growth rather than being reinvested into the securities market. Southern maintains an operating liquidity level of overnight funds sold investments with other financial institutions that are within Southern’s risk tolerance levels.

Interest-earning assets averaged $880.8 million during 2003, an increase of $83.1 million or 10.42 percent over 2002 levels, compared to a $50.6 million or 6.77 percent increase in 2002 over 2001 levels. Growth among average interest-earning assets during 2003 was primarily due to internal loan growth, the October acquisition of the $1.2 million of Norlina loans above and the additional cash resulting from the October acquisition.

Loans. Loan production is principally driven by the eastern North Carolina economy. Management seeks commercial lending opportunities collateralized by real estate. Traditional mortgage loan production is also a goal of management. Most mortgage loan production is then sold into the mortgage secondary markets with the servicing rights retained by the Bank. Loan demand in recent years for consumer loans has declined as consumers have responded to retailer financing promotions and utilized mortgage equity lines of credit to finance their purchases.

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As of December 31, 2003, gross loans outstanding were $631.2 million, a 2.27 percent increase over the December 31, 2002 balance of $617.2 million, which was a 13.18 percent increase over the December 31, 2001 balance of $545.3 million. Loan growth during 2003 resulted principally from internal loan growth and the October acquisition of the $1.2 million of Norlina loans above. Loan growth during 2002 resulted principally from internal loan growth and the October acquisition of the $4.1 million of Scotland Neck loans above. Loan balances for the last five years are provided in Table 3.

Table 3

LOANS

All information presented in this table relates to domestic loans as BancShares makes no foreign loans.

Loans secured by real estate averaged $470.2 million during 2003, compared to $407.7 million during 2002, an increase of 15.33 percent. Much of the $62.5 million average increase in real estate secured loans during 2003 was among construction, commercial real estate and retail home equity loans. Commercial and industrial loans averaged $97.9 million during 2003 compared to $62.9 million during 2002, an increase of 55.64 percent. The commercial and industrial loan increase during 2003 resulted from the overall low interest rate environment and overall improving economy.

Consumer loans averaged $33.4 million during 2003 compared to $40.3 during 2002. The $6.9 million decrease during 2003 was primarily due to customers who have traditionally favored closed-end installment lending continuing to migrate to revolving lines of credit secured by home equity and the significant increase in mortgage refinancing created by the very low mortgage loan interest rates for the majority of 2003.

During 2004, management anticipates increased loan growth among loans to commercial borrowers due to the continued low interest rate environment and the overall improvement in the economy. The current low market interest rates are expected to remain for most of 2004. Demand among retail customers has shifted to open-end credit products such as equityline. Growth in equityline loans is also expected during 2004.

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To minimize the potential adverse impact of interest rate fluctuations, management monitors the maturity and repricing distribution of the loan portfolio. BancShares offers variable rate loan products and fixed rate callable loans to reduce interest rate risk. Table 4 details the maturity and repricing distribution as of December 31, 2003. Of the gross loans outstanding on December 31, 2003, 11.93 percent have scheduled maturities or repricing dates that extend beyond five years.

Table 4

LOAN MATURITY DISTRIBUTION AND INTEREST RATE SENSITIVITY

Investment Securities. Due to the overall weakness in the 2003 eastern North Carolina economy, loan production opportunities were relatively weak. As a result of the deposit growth in existing markets, the Norlina branch acquisition, relatively weak loan demand and the expected relatively low interest rate market management by the Federal Reserve in the short-term, investments in primarily two-year maturity or less, held-to-maturity, U. S. Treasury securities have been made by management. At December 31, 2003 the investment portfolio totaled $253.0 million and at December 31, 2002 the investment portfolio totaled $190.6 million resulting in an increase of $62.5 million or 32.78 percent. Investment securities averaged $191.2 million during 2003, $199.6 million during 2002 and $186.3 million during 2001. In each period U. S. Treasury and government agency securities represented substantially all of the portfolio. The increase in the average securities portfolio in 2003 resulted primarily from deposit growth. The decrease in the average securities portfolio during 2002 and 2001 resulted primarily from growth in loans.

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The weighted-average maturity of the investment securities portfolio was 21 months at December 31, 2003 and 28 months at December 31, 2002. Management continues to maintain a portfolio of securities with short maturities and call dates, consistent with BancShares’ focus on liquidity. Investment securities available for sale include marketable equity securities that are recorded at their fair value, with the unrealized net gain included as a component of shareholders’ equity, net of deferred taxes. Table 5 presents detailed information relating to the consolidated balance sheet value of the investment securities portfolio.

Table 5

INVESTMENT SECURITIES

Income on Interest-Earning Assets. Table 6 analyzes the interest-earning assets and interest-bearing liabilities for the three years ended December 31, 2003. Table 9 identifies the causes for changes in interest income and interest expense for 2003 and 2002. Interest income amounted to $46.4 million during 2003, a $3.6 million decrease from 2002 levels, compared to a $5.6 million decrease from 2001 to 2002. During 2003, decreased interest rates was the primary factor for the decrease in interest income from 2002. During 2002, decreased interest rates was also the primary factor for the decrease in interest income from 2001.

Total interest-earning assets yielded 5.27 percent during 2003, a 100 basis point decrease from the 6.27 percent reported in 2002. The average taxable-equivalent yield on the loan portfolio decreased from 7.18 percent in 2002 to 6.28 percent in 2003. The decreased loan yield during 2003 reflects general market conditions throughout the year, consisting primarily of a decreasing interest rate environment. Loan interest income decreased $694,000 or 1.71 percent from 2002. This followed a decrease of 5.84 percent in loan interest income in 2002 from 2001. During 2003, the decrease in loan interest income was the result of loan growth offset by lower loan yields. During 2002, the decrease in loan interest income was the result of loan growth with lower loan yields as the average yield on loans declined from 8.17 percent in 2001 to 7.18 percent in 2002.

Interest income earned on the investment portfolio amounted to $5.9 million for the year ended December 31, 2003, $8.9 million for the year ended December 31, 2002 and $11.3 million for the year ended December 31, 2001. The average taxable-equivalent yield on the portfolio for 2003 was 3.11 percent. The average taxable-equivalent yield on the portfolio for 2002 was 4.48 percent. The average taxable-equivalent yield on the portfolio for 2001 was 6.06 percent. The $3.0 million decrease in investment interest income during 2003 results from a decrease in average yields that more than offset an increase in average volume. The $2.4 million decrease in 2002 investment interest income compared to 2001 investment interest income was due to decreased average volume and a decrease in the tax-equivalent yield on investments from 6.06 percent in 2001 to 4.48 percent for 2002.

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INTEREST-BEARING LIABILITIES

Interest-bearing liabilities include interest-bearing deposits, short-term borrowings and long-term obligations. Southern’s primary funding source is deposits. Other short-term funding sources include commercial customer requirements for cash management services and a borrowing line of credit from another financial institution. Long-term borrowings also provide capital strength under guidelines established by the Federal Reserve.

At December 31, 2003 interest-bearing liabilities totaled $741.9 million, an increase of $54.9 million or 8.00 percent over December 31, 2002. Interest-bearing liabilities averaged $709.4 million during 2003, an increase of $49.1 million or 7.41 percent over 2002 levels. Interest-bearing deposits increased $50.3 million. During 2002, interest-bearing liabilities averaged $660.3 million, an increase of $14.2 million or 2.15 percent over 2001.

Deposits. Total deposits averaged $825.2 million in 2003, an increase of $75.3 million or 10.04 percent over the 2002 average balance. Average interest-bearing deposits were $671.0 million during 2003, an increase of $50.3 million or 8.11 percent compared to 2002. Money market accounts averaged $110.0 million during 2003, an increase of $15.6 million or 16.52 percent over the 2002 average balance. Checking with interest balances averaged $98.2 million during 2003, an increase of $8.4 million or 9.31 percent over the 2002 average balance. Time deposit balances averaged $395.2 million during 2003, an increase of $20.1 million or 5.37 percent from the 2002 average balance. The overall growth in average deposits during 2003 resulted primarily from internal growth within the existing branches, the opening of the Kenansville branch and the acquisition of the Norlina branch.

Total deposits averaged $749.9 million in 2002, an increase of $29.0 million or 4.02 percent over the 2001 average balance. Average interest-bearing deposits were $620.7 million during 2002, an increase of $13.7 million or 2.25 percent compared to 2001. Money market accounts averaged $94.4 million during 2002, an increase of $20.7 million or 28.02 percent over the 2001 average balance. Checking with interest balances averaged $105.4 million during 2002, an increase of $5.0 million or 5.01 percent over the 2001 average balance. Time deposit balances averaged $375.1 million during 2002, a decrease of $16.3 million or 4.17 percent from the 2001 average balance. The overall growth in average deposits during 2002 resulted primarily from internal growth.

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Table 6

AVERAGE BALANCE SHEET ITEMS, NET INTEREST DIFFERENTIAL AVERAGE BALANCES AND AVERAGE RATES EARNED AND PAID