MANAGEMENT’S DISCUSSION AND ANALYSIS

The following discussion reviews our results of operations and assesses our financial condition.  You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements.  The commentary should be read in conjunction with the discussion of forward-looking statements, the financial statements and the related notes and the other statistical information included in this report.

DISCUSSION OF FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements” relating to, without limitation, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by and information currently available to management.  The words “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” and “intend,” as well as other similar words and expressions of the future, are intended to identify forward-looking statements.  Our actual results may differ materially from the results discussed in the forward-looking statements, and our operating performance each quarter is subject to various risks and uncertainties that are discussed in detail in our filings with the Securities and Exchange Commission, including, without limitation:

•                   significant increases in competitive pressure in the banking and financial services industries;

•                   changes in the interest rate environment which could reduce anticipated or actual margins;

•                   changes in political conditions or the legislative or regulatory environment;

•                   general economic conditions, either nationally or regionally and especially in primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

Overview

We were incorporated in March 1999 to organize and serve as the holding company for Greenville First Bank, N.A.  Since we opened our bank in January 2000, we have experienced consistent growth in total assets, loans, deposits, and shareholders’ equity, which has continued during the first six months of 2004.

Like most community banks, we derive the majority of our income from interest received on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible.  We maintain this allowance by charging a provision for loan losses against our operating earnings for each period.  We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our customers.  We have also included a discussion of the various components of this noninterest income, as well as of our noninterest expense.

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The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in our filings with the Securities and Exchange Commission.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements.  Our significant accounting policies are described in the footnotes to our audited consolidated financial statements as of December 31, 2003, as filed in our annual report on Form 10-KSB.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities.  We consider these accounting policies to be critical accounting policies.  The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements.  Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses.  Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements.  Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Effect of Economic Trends

During the three years ended December 31, 2003, and the six months ended June 30, 2004, our rates on both short-term or variable rate earning-assets and short-term or variable rate interest-bearing liabilities declined primarily as a result of the actions taken by the Federal Reserve.

During most of 2001 and during 2002, the United States experienced an economic decline.  During this period, the economy was affected by lower returns of the stock markets.  Economic data led the Federal Reserve to begin an aggressive program of reducing rates that moved the Federal Funds rate down 11 times during 2001 for a total reduction of 475 basis points.  During the fourth quarter of 2002 and the first six months of 2003, the Federal Reserve reduced the Federal Funds rate down an additional 75 basis points, bringing the Federal Funds rate to its lowest level in 40 years.

Despite sharply lower short-term rates, stimulus to the economy during 2003 was muted and consumer demand and business investment activity remained weak.  During all of 2003 and substantially all of the six months ended June 30, 2004, the financial markets operated under historically low interest rates. As a result of these unusual conditions, Congress passed an economic stimulus plan in 2003.  During the first six months of 2004, many economists believed the economy began to show signs of strengthening and at the end of the second quarter the Federal Reserve increased the short-term interest rate by 25 basis points.  Many economists believe that the Federal Reserve will continue to increase rates during the remainder of 2004 and during most of 2005.  However, no assurance can be given that the Federal Reserve will take such action.

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Results of Operations

Income Statement Review

Summary

Three months ended June 30, 2004 and 2003

Our net income was $413,851 and $229,455 for the three months ended June 30, 2004 and 2003, respectively, an increase of $184,396, or 80.4%.  Our income was fully taxable in both three month periods.  The $184,396 increase in net income resulted primarily from increases of $533,863 in net interest income and $116,623 in noninterest income.  These increases were partly offset by $253,067 of additional noninterest expense, a $100,000 increase in provisions for loan losses, and a $113,023 increase in income tax expense.  Our efficiency ratio continues to improve because we are earning more income without substantially increasing our overhead expenses.  Our efficiency ratio was 55.23% and 62.26% for the three months ended June 30, 2004 and 2003, respectively.

S ix months ended June 30, 2004 and 2003

Our net income was $801,801 and $396,381 for the six months ended June 30, 2004 and 2003, respectively, an increase of $405,420, or 102.3%.  Our income was fully taxable in both six month periods.  The $405,420 increase in net income resulted primarily from increases of $1.1 million in net interest income and $131,793 in noninterest income.  These increases were partly offset by $455,651 of additional noninterest expense, a $150,000 increase in provisions for loan losses, and a $248,491 increase in income tax expense.  Our efficiency ratio continues to improve because we are earning more income without substantially increasing our overhead expenses.  Our efficiency ratio was 54.35% and 61.96% for the six months ended June 30, 2004 and 2003, respectively.

Net Interest Income

Our level of net interest income is determined by the level of earning assets and the management of our net interest margin.  The continuous growth in our loan portfolio is the primary driver of the increase in net interest income.  During the three months ended June 30, 2004, our loan portfolio had increased an average of $17.2 million compared to first quarter of 2004.  The growth in the first six months of 2004 was $38.3 million.  We anticipate the growth in loans will continue to drive the growth in assets and the growth in net interest income.  However, no assurance can be given that we will be able to continue to increase loans at the same levels we have experienced in the past.

Our decision to grow the loan portfolio at the current pace created the need for a higher level of capital and the need to increase deposits and borrowings.  This loan growth strategy also resulted in a significant portion of our assets being in higher earning loans than in lower yielding investments.  At June 30, 2004, loans represented 89.4% of total assets, while investments and federal funds sold represented 8.1% of total assets.  While we plan to continue our focus on increasing the loan portfolio, as rates on investment securities begin to rise and additional capital and deposits are obtained, we also anticipate increasing the size of the investment portfolio.

The historically low interest rate environment in the last three years allowed us to obtain short-term borrowings and wholesale certificates of deposit at rates that were lower than certificate of deposit rates being offered in our local market.  Therefore, we decided not to begin our retail deposit expansion program until the end of 2004.  This funding strategy allowed us to continue to operate in one location, maintain a smaller staff, and not incur marketing costs to advertise deposit rates, which in turn allowed us to focus on the fast growing loan portfolio.  At June 30, 2004, retail deposits represented $106.9 million, or 39.1% of total assets, borrowings represented $81.2 million, or 29.7% of total assets, and wholesale out-of-market deposits represented $71.1 million, or 26.0% of total assets.

In anticipation of rising interest rates, we are planning to open two retail deposit offices, one in the fourth quarter of 2004 and the other in the second quarter of 2005.  We plan to focus our efforts in these two locations to obtain low cost transaction accounts that are less affected by rising rates.  Also, in anticipation of rising rates, during the first six months of 2004, we offered aggressive promotional rates on new checking accounts and new money market accounts.  The promotional rates offered are 2.00% on checking accounts and 2.25% on money market accounts and are guaranteed until January 31, 2005.  Based on prior experience, we anticipate the majority of these funds to be retained at the end of the promotion.  Our goal is to increase both the percentage of assets being funded by “in market” retail deposits and to

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increase the percentage of low-cost transaction accounts to total deposits.  No assurance can be given that these objectives will be achieved; however, we anticipate that the two additional retail deposit offices will assist us in meeting these objectives.  We also anticipate the current deposit promotion and the opening of the two new offices will have a negative impact on earnings in the years ending 2004 and 2005.  However, we believe that these two strategies will provide additional clients in our local market and will provide a lower alternative cost of funding in a higher or rising interest rate environment, which we believe will increase earnings in future periods.

As more fully discussed in the – “Market Risk” and – “Liquidity and Interest Rate Sensitivity” sections below, at June 30, 2004, 68.0% of our loans had variable rates.  Given our high percentage of rate-sensitive loans, our primary focus during the three years ended December 31, 2003 and for first six months of 2004 has been to obtain short-term liabilities to fund our asset growth.  This strategy allows us to manage the impact on our earnings resulting from changes in market interest rates.  At December 31, 2003, 83.4% of interest-bearing liabilities had a maturity of less than one year.

In anticipation of rising rates, in May 2004 we converted a total of $25.0 million of short-term deposits and borrowings with a term of less than three months into $25.0 million of deposits and borrowings with a weighted average life of five years.  As of June 30, 2004, 80.2% of interest-bearing liabilities had a maturity of less than one year.  We believe that we are positioned to benefit from future increases in short-term rates.  At June 30, 2004, we had $23.5 million more assets than liabilities that reprice within the next three months.

We intend to maintain a capital level for the bank that exceeds the OCC requirements to be classified as a “well capitalized” bank.  To provide the additional capital needed to support our bank’s growth in assets, we issued $6.2 million in junior subordinated debentures in connection with our trust preferred securities offering, and we have borrowed $3.0 million under a short-term holding company line of credit.

In addition to the growth in both assets and liabilities, and the timing of repricing of our assets and liabilities, net interest income is also affected by the ratio of interest-earning assets to interest-bearing liabilities and the changes in interest rates earned on our assets and interest rates paid on our liabilities.

Our net interest income for the three months ended June 30, 2004 and the six months ended June 30, 2004 increased because we had more interest-earning assets than interest-bearing liabilities.  For the three and six months ended June 30, 2004, interest-earning assets exceeded interest-bearing liabilities by $6.6 million and $7.0 million, respectively.  The estimated $2.5 million cost of the two additional retail offices will reduce the amount by which interest-earning assets exceed interest-bearing liabilities.

During the three months and the six months ended June 30, 2004, our rates on both short-term or variable rate earning-assets and short-term or variable rate interest-bearing liabilities declined primarily as a result of the actions taken by the Federal Reserve to lower short-term rates.

The impact of the Federal Reserve’s actions resulted in a decline in both the yields on our variable rate assets and the rates that we paid for our short-term deposits and borrowings.  Our net interest spread and net interest margins also declined since more of our rate sensitive assets repriced sooner than our rate sensitive liabilities during the three month and six month periods ending June 30, 2004.  Our net interest margin for the three month and six month periods were 3.07% and 3.15%, respectively.

We anticipate that the 25 basis point increase in short-term rates at the end of the second quarter of 2004 will result in an increase in loan yields, while our $25.0 million of longer-term, higher interest deposits and borrowings will result in a higher cost of funds to us.  Accordingly, we believe that our net interest margin may continue to decline until further action is taken by the Federal Reserve to increase short-term rates.

We have included a number of tables to assist in our description of various measures of our financial performance.  For example, the “Average Balances” tables show the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during both the three months ended June 30, 2004 and 2003 and the first six months of 2004 and 2003.  A review of these tables shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio.  Similarly, the “Rate/Volume Analysis” tables help demonstrate the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown.  We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning accounts and interest-

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bearing accounts.  Finally, we have included various tables that provide detail about our investment securities, our loans, our deposits, and other borrowings.

The following tables set forth information related to our average balance sheets, average yields on assets, and average costs of liabilities.  We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities.  We derived average balances from the daily balances throughout the periods indicated.  During the six months ended June 30, 2004 and 2003, all investments were taxable.  During the same period, we had no interest-bearing deposits in other banks or any securities purchased with agreements to resell.  All investments were owned at an original maturity of over one year.  Nonaccrual loans are included in the following tables.  Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status.  The net of capitalized loan costs and fees are amortized into interest income on loans.

(1) Annualized for the three month period.

Our net interest spread was 3.02% for the three months ended June 30, 2004, compared to 3.22% for the three months ended June 30, 2003.

Our net interest margin for the three months ended June 30, 2004 was 3.07%, compared to 3.30% for the three months ended June 30, 2003.  During the three months ended June 30, 2004, earning assets averaged $257.1 million, compared to $173.5 million in the three months ended June 30, 2003.

The lower rate on loans for the three months ended June 30, 2004 compared to the three months ended June 30, 2003 resulted primarily from a reduction in the prime rate of 25 basis points in the second quarter of 2003.  The deposit and borrowing cost did not decline as much as the reduction in the rates earned on interest-earning assets because of our decision to aggressively market interest-bearing transaction accounts by paying an above market rate.  Also, we extended the maturity dates on various jumbo time deposits and FHLB advances.  These decisions were intended to compensate for anticipated higher rates in the future.

Net interest income, the largest component of our income, was $2.0 million and $1.4 million for the three months ended June 30, 2004 and 2003, respectively.  The significant increase in 2004 related to higher levels of both average earning

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assets and interest-bearing liabilities, offset by a slightly lower net interest margin.  Average earning assets increased $83.6 million during the three months ended June 30, 2004 compared to the same period in 2003.

As previously discussed, our net interest margin for the three months ended June 30, 2004 and 2003, was 3.07% and 3.30%, respectively.

The $533,863 increase in net interest income for the three months ended June 30, 2004 compared to the same period in 2003 resulted primarily from a $570,000 increase in net income offset by a $66,000 decrease in net interest income.  The increase in net income related to higher average earning assets and interest—bearing liabilities.  The decrease in net interest income was related to the lower net interest margin.

Interest income for the three months ended June 30, 2004 was $3.2 million, consisting of $3.0 million on loans, $220,364 on investments, and $4,703 on federal funds sold.  Interest income for the three months ended June 30, 2003 was $2.3 million, consisting of $2.2 million on loans, $62,569 on investments, and $5,179 on federal funds sold.  Interest on loans for the three months ended June 30, 2004 and 2003 represented 92.9% and 97.0%, respectively, of total interest income, while income from investments and federal funds sold represented only 7.1% and 2.7% of total interest income.  The high percentage of interest income from loans was related to our strategy to maintain a significant portion of our assets in higher earning loans compared to lower yielding investments.  Average loans represented 91.0% and 95.2% of average interest—earning assets for the three months ended June 30, 2004 and 2003, respectively.  Included in interest income on loans for the three months ended June 30, 2004 and 2003, was $131,810 and $95,258, respectively, related to the net amortization of loan fees and capitalized loan origination costs.

Interest expense for the three months ended June 30, 2004 was $1.2 million, consisting of $840,564 related to deposits and $374,606 related to borrowings.  Interest expense for the three months ended June 30, 2003 was $860,820, consisting of $682,896 related to deposits and $177,924 related to borrowings.  Interest expense on deposits for the three months ended June 30, 2004 and 2003 represented 69.2% and 79.3%, respectively, of total interest expense, while interest expense on borrowings represented 30.8% and 20.7%, respectively, of total interest expense for the three months ended June 30, 2004 and 2003.  The lower percentage of interest expense on deposits and the higher percentage of interest on borrowings for the three months ended June 30, 2004 compared to the three months ended June 30, 2003 resulted from our decisions to delay our retail deposit office expansion program and instead utilize additional borrowings from the FHLB and from the sale of securities under agreements to repurchase with brokers.  During the three months ended June 30, 2004, average interest—bearing deposits increased by $40.7 million over the same period in 2003, while other borrowing during the three months ended June 30, 2004 increased $43.0 million over the same period in 2003.  During the three months ended June 30, 2004, we were able to pledge additional collateral to the FHLB, allowing us the ability to increase our FHLB borrowings.  Both the short—term borrowings from the FHLB and the sale of securities under agreements to repurchase provide us with the opportunity to obtain low cost funding with various maturities similar to the maturities on our loans and investments.

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