Edgar Filing: CHARTER FINANCIAL CORP/GA

Form 10-K

United States

Securities and Exchange Commission

Washington, D.C. 20549

FORM 10-K

(Mark One)

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended September 30, 2004

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No.: 000-33071

Charter Financial Corporation

(Exact Name of Registrant as Specified in Its Charter)

United States

58-2659667

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

600 Third Avenue, West Point, Georgia 31833

(Address of Principal Executive Offices, including zip code)

(706) 645-1391

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None.

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share

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. x

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

The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 31, 2004 was $142,398,337, based on the per share closing price as of March 31, 2004 on the Nasdaq National Market for the registrant’s common stock, which was $39.37.

There were 19,823,905 shares of the registrant’s common stock, $.01 par value per share outstanding at November 23, 2004.

DOCUMENTS INCORPORATED BY REFERENCE:

Portions of the proxy statement for the 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

CHARTER FINANCIAL CORPORATION

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED

SEPTEMBER 30, 2004

TABLE OF CONTENTS


		PAGE
ITEM
	PART I

1	BUSINESS	4
2	PROPERTIES	51
3	LEGAL PROCEEDINGS	52
4	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	52

	PART II

5	MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	53
6	SELECTED FINANCIAL DATA	55
7	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	57
7A	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	94
8	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	94
9	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	94
9A	CONTROLS AND PROCEDURES	95
9B	OTHER INFORMATION	95

	PART III

10	DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT	95
11	EXECUTIVE COMPENSATION	95
12	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT	95
13	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS	96
14	PRINCIPAL ACCOUNTANT FEES AND SERVICES	96

	PART IV

15	EXHIBITS, FINANCIAL STATEMENT SCHEDULES	96

FORWARD LOOKING STATEMENTS

This Annual Report on Form 10-K contains “forward-looking statements” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition and results of operation and business that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

•

general and local economic conditions;

•

changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values, and competition;

•

the ability of our customers to make loan payments;

•

the performance of Freddie Mac common stock price and the level of dividends received;

•

changes in accounting principles, policies, or guidelines;

•

changes in legislation or regulation; and

•

other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products, and services.

Any or all of our forward-looking statements in this Annual Report on Form 10-K and in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We undertake no obligation to publicly update forward-looking statements, whether as a result of new information, future events or otherwise.

PART I

ITEM 1. BUSINESS

General. Charter Financial Corporation (“Charter Financial,” “us,” or “we”) is a federally-chartered corporation organized in 2001 and is registered as a savings and loan holding company with the Office of Thrift Supervision (“OTS”). Charter Financial serves as the holding company for CharterBank (“Bank”). First Charter, MHC owns 80% of the outstanding shares of Charter Financial’s common stock. Our common stock is quoted on the National Market System of the Nasdaq Stock Market under the symbol “CHFN.” Unless the context otherwise requires, all references herein to the Bank or Charter Financial include Charter Financial and the Bank on a consolidated basis.

Our focus is to build stockholder value by effectively deploying our capital. Our plan is to invest in and build our retail banking franchise, manage our Freddie Mac common stock investment wisely and make use of the full range of capital management strategies that are available to us. Our plan is to grow our retail franchise, focusing on core deposits, by enhancing convenience and customer service. This means expanding access through additional branches, either de novo or through acquisitions, and electronic delivery channels, and extending service hours. In this regard, we acquired EBA Bancshares, Inc. and its wholly-owned subsidiary, Eagle Bank of Alabama, in order to expand our presence in the Auburn-Opelika, Alabama market in February, 2003. In addition, we have a seventeen-year history with our investment in Freddie Mac common stock and, while we continually evaluate this investment and explore our options, we expect our investment to continue to provide a competitive return for our stockholders. We will also evaluate, as appropriate, capital management strategies such as leverage, stock buyback programs and the payment of cash dividends.

On October 16, 2001, CharterBank converted from a federally-chartered mutual savings and loan association into a two-tiered mutual holding company structure and became a wholly-owned subsidiary of Charter Financial. Charter Financial sold 3,964,481 shares of its common stock to the public, representing 20% of the outstanding shares, at $10.00 per share and received net proceeds of $37.2 million. Charter Financial contributed 50% of the net proceeds from the initial public offering to CharterBank. An additional 15,857,924 shares, or 80% of the outstanding shares of Charter Financial, were issued to First Charter, MHC. An Employee Stock Ownership Plan (ESOP) was established and such ESOP acquired 317,158 shares of Charter Financial in the offering, using the proceeds of a loan from Charter Financial. The ESOP loan is disclosed as unearned compensation reducing stockholders’ equity of Charter Financial. The net proceeds, adjusted for the ESOP, totaled approximately $34 million.

As part of our reorganization in structure, CharterBank organized First Charter, MHC as a federally-chartered mutual holding company which is registered as a savings and loan holding company with the OTS. First Charter, MHC’s principal assets are its investment in Charter Financial and 400,000 shares of Freddie Mac common stock, the fair value of which was $26.1 million as of September 30, 2004. First Charter, MHC does not engage in any business activity other than its investment in a majority of the common stock of Charter Financial, management of Freddie Mac common stock, and the management of any cash dividends received from Freddie

Mac common stock. Federal law and regulations require that as long as First Charter, MHC is in existence it must own at least a majority of Charter Financial’s common stock. During the year ended September 30, 2004, First Charter, MHC waived its right to receive cash dividends from Charter Financial. Upon continued regulatory approval, First Charter, MHC expects to waive its right to receive any future cash dividends from Charter Financial for the foreseeable future.

All historical financial information contained herein has been adjusted to retroactively reflect the transfer of 400,000 shares of Freddie Mac common stock and $100,000 in cash to First Charter, MHC which occurred in October 2001 upon the aforementioned reorganization. Operating data has also been retroactively adjusted for such effects.

At September 30, 2004, Charter Financial had total assets of $1.1 billion, of which $323.5 million was comprised of loans receivable and $378.4 million was comprised of mortgage-backed securities and collateralized mortgage obligations. At such date, total deposits were $279.6 million, borrowings were $392.8 million and total stockholders’ equity was $272.5 million. Charter Financial owns 4,605,000 shares of Freddie Mac common stock of which 1,650,000 shares are owned directly by Charter Financial and the remaining are owned by Charter Financial’s subsidiaries with CharterBank owning 2,555,000 shares and Charter Insurance owning 400,000 shares. Charter Financial’s 4,605,000 shares of Freddie Mac common stock had a market value of $300.4 million at September 30, 2004.

CharterBank was founded in 1954 and currently operates a main office, seven full-service branch offices and five loan production offices in Georgia and Alabama. CharterBank is a community-oriented financial institution serving primarily consumer households and small businesses. CharterBank is the only locally-owned and operated financial institution in Troup County, Georgia and the Valley area, consisting of Lanett and Valley, Alabama and West Point, Georgia. CharterBank is subject to extensive regulation, supervision, and examination by the OTS, its primary regulator, and the Federal Deposit Insurance Corporation (the “FDIC”), which insures its deposits. CharterBank’s savings deposits are insured up to the maximum allowable amount by the Savings Association Insurance Fund of the FDIC.

CharterBank is a service-oriented bank providing retail and small business customers with products and services designed to create a long-term, profitable relationship. We offer numerous loan products, including residential mortgage loans, commercial real estate loans, commercial loans, home equity loans, second mortgages, and other products. CharterBank also offers deposit products, including consumer and commercial checking accounts, savings accounts, money market accounts, and Certificates of Deposit. Prior to the reorganization, CharterBank founded The Charter Foundation, a non-profit foundation, which makes charitable contributions in CharterBank’s market area.

In February 2003, the Company acquired EBA Bancshares, Inc. (EBA) and its subsidiary bank, Eagle Bank of Alabama, and merged them into the Company’s banking subsidiary, CharterBank. As part of the Eagle acquisition, we acquired approximately $55.3 million in gross loans and $60.7 million in deposits. The acquisition was accounted for using the purchase method of accounting and, therefore, the results of operations of Eagle Bank of Alabama have been included in our operations since the effective date of the acquisition.

Internet Address. Our Internet address is www.charterbank.net. We make available free of charge, through our web site, annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

Market Area. We conduct our operations in west-central Georgia and east-central Alabama through our main office in West Point, Georgia, two branch offices in Valley, Alabama, one branch office in LaGrange, Georgia, two branch offices in Opelika, Alabama, and two branch offices in Auburn, Alabama. The main office and two Valley, Alabama offices serve the “Valley” region of our market area, which consists of West Point, Georgia, and Lanett and Valley, Alabama. The LaGrange office serves an adjacent community on Interstate 85. Four branches serve the Auburn-Opelika or Lee County, Alabama area. We also operate loan production offices in the Atlanta metropolitan area, Newnan and St. Mary’s, Georgia and Phenix City and Monroeville, Alabama. The Valley area is a small market area and we are expanding our market area to nearby counties along the Interstate I-85 corridor, which are larger and have more growth potential.

The economy of our market area has historically been supported by the textile industry. During the 1980’s and 1990’s employment growth in local telecommunications companies offset declining textile industry jobs in our area. With the telecommunications slump and continuing downward textile industry employment trends, unemployment rates have been increasing. Also, the median household income in our area is below national and statewide levels. Part of our retail strategy is to grow in areas that are more vibrant and economically diverse. To this end, we have generally located our loan production offices in more urban and higher income areas. In addition, our expansion into the Auburn-Opelika, Alabama market reflects our diversification and growth oriented strategy.

Competition. We face intense competition both in making loans and attracting deposits. West-central Georgia and east-central Alabama have a high concentration of financial institutions, many of which are branches of large money center, super-regional, and regional banks which have resulted from the consolidation of the banking industry in Alabama and Georgia. Many of these competitors have greater resources than we do and may offer services that we do not provide.

Our competition for loans comes from commercial banks, savings institutions, mortgage banking firms, credit unions, finance companies, credit card banks, insurance companies, and brokerage and investment banking firms. Our most direct competition for deposits has historically come from commercial banks, savings banks, savings and loan associations, credit unions, and mutual funds. We face additional competition for deposits from short-term money market funds and other corporate and government securities funds and from brokerage firms and insurance companies.

Lending Activities.

Loan Portfolio Composition. Our loan portfolio consists of one-to-four family residential first mortgage loans, commercial real estate loans, real estate construction loans, consumer loans and commercial loans. At September 30, 2004, we had total loans receivable of $323.5 million, or 30.3% of total assets. Residential mortgage loans comprised $142.2 million, or 44.0% of total loans at September 30, 2004. Loans secured by mortgages on commercial real estate totaled $119.6 million at September 30, 2004 representing an $8.4 million, or 7.6%, increase from the balance of commercial real estate loans at September 30, 2003.

At September 30, 2004, approximately $73.0 million of total commercial real estate loans are secured by real estate in the local bank market and approximately $41.8 million of total commercial real estate loans are secured by commercial real estate in other parts of Georgia and Alabama. Of the $41.8 million not in the local bank market, approximately $31.5 million of total commercial real estate loans are secured by real estate in the Atlanta metropolitan area. We expect continued growth in our commercial real estate portfolio in the future.

The remaining portion of our loan portfolio at September 30, 2004 consisted of consumer loans totaling $19.6 million, real estate construction loans of $21.5 million, and other commercial loans of $20.6 million. Our consumer loan portfolio contains approximately $1.9 million in auto loans.

Our loans are subject to federal and state law and regulations. The interest rates we charge on loans are affected principally by the demand for loans, the supply of money available for lending purposes and the interest rates offered by our competitors. These factors are, in turn, affected by general and local economic conditions, monetary policies of the federal government, including the Federal Reserve Board, legislative tax policies, and governmental budgetary matters.

The following table presents the composition of our loan portfolio in dollar amounts and in percentages of the total portfolio at the dates indicated.


	At September 30,
	2004					2003					2002					2001					2000
	Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total		Amount			Percent of Total
	(Dollars in thousands)
One-to-four family residential real estate(1)	$	142,250		44.0	%	$	133,305		44.5	%	$	100,471		46.9	%	$	129,223		56.2	%	$	152,822		58.9	%
Commercial real estate		119,618		37.0			111,189		37.1			68,016		31.8			61,225		26.6			60,838		23.4
Consumer and other(2)		19,580		6.0			19,673		6.5			19,970		9.3			23,537		10.2			29,915		11.5
Commercial		20,628		6.4			21,634		7.2			16,587		7.8			6,819		3.0			8,987		3.5
Real estate construction(3)		21,471		6.6			14,076		4.7			8,962		4.2			9,143		4.0			7,138		2.7

Total loans		323,547		100.0	%		299,877		100.0	%		214,006		100.0	%		229,947		100.0	%		259,700		100.0	%

Less:
Net deferred loan costs (fees)		(773	)				(544	)				(173	)				(66	)				113
Allowance for loan losses		(6,623	)				(6,780	)				(5,179	)				(5,290	)				(6,346	)

Loans receivable, net	$	316,151				$	292,553				$	208,654				$	224,591				$	253,467

(1)	Excludes loans held for sale.

(2)	Includes home equity loans and lines of credit, and second mortgage loans.

(3)	Net of undisbursed proceeds on loans-in-process.

Loan Maturity and Repricing. The following table shows the repricing dates or contractual maturity dates as of September 30, 2004. The table does not reflect prepayments but does reflect scheduled principal amortization. Demand loans, loans having no stated maturity, and overdrafts are shown as due in one year or less.


	At September 30, 2004
	1-4 Family Residential Real Estate Loans		Commercial Real Estate		Consumer and Other		Commercial		Real Estate Construction(1)		Totals
	(In thousands)
Amounts due or repricing:
Within one year	$	42,520	$	62,658	$	13,219	$	12,383	$	20,603	$	151,383

After one year:
One to three years		18,699		15,368		3,087		5,156		87		42,397
Three to five years		16,349		17,500		1,085		1,333		99		36,366
Five to ten years		47,286		18,690		1,276		1,058		330		68,640
Over ten years		17,396		5,402		913		698		352		24,761

Total due after one year		99,730		56,960		6,361		8,245		868		172,164

Total amount due:	$	142,250	$	119,618	$	19,580	$	20,628	$	21,471	$	323,547

(1)	Presented net of undisbursed proceeds on loans-in-process.

The following table presents, as of September 30, 2004, the dollar amount of all loans contractually due or scheduled to reprice after September 30, 2005 and whether such loans have fixed interest rates or adjustable interest rates.


	Due After September 30, 2005
	Fixed		Adjustable		Total
	(In thousands)
One-to-four family residential real estate	$	44,161	$	55,569	$	99,730
Commercial real estate		15,932		41,028		56,960
Consumer and other		4,909		1,452		6,361
Commercial		6,852		1,393		8,245
Construction		868		—		868

Total loans	$	72,722	$	99,442	$	172,164

The following table presents our loan originations, purchases, sales and principal payments for the periods indicated.


	For the Years Ended September 30,
	2004		2003		2002
	(In thousands)
Loans(1):
Balance outstanding at beginning of period	$	299,877	$	214,006	$	229,947

Loans acquired from Eagle Bank		—		55,276		—

Originations:
One-to-four family residential real estate		76,037		196,474		112,457
Commercial real estate and commercial		62,839		75,920		52,678
Consumer and other loans		11,530		20,220		3,614
Real estate construction		41,115		36,652		17,468

Total originations		191,521		329,266		186,217

Less:
Principal repayments, unadvanced funds and other, net		128,419		175,943		118,926
Sale of residential mortgage loans, principal balance		38,083		121,263		80,753
Loan charge-offs and transfers to foreclosed real estate		1,349		1,465		2,479

Total deductions		167,851		298,671		202,158
Net loan activity		23,670		85,871		(15,941	)

Ending balance	$	323,547	$	299,877	$	214,006

(1)	Excludes loans held for sale.

Residential Mortgage Loans and Originations. We emphasize the origination of first and second mortgages secured by one-to-four family properties within Georgia and Alabama. At September 30, 2004, and September 30, 2003, loans on one-to-four family properties accounted for 44.0% and 44.5% of our total loan portfolio, respectively.

Our mortgage origination strategy is to offer a broad array of products to meet customer needs. These products include conforming and nonconforming loans with a variety of maturities and interest rate adjustment terms. We generally sell conforming 30 year fixed rate loans servicing released. We generally retain for our portfolio conforming loans with maturities shorter than 30 years or that have interest rate resets or balloon terms. We also retain nonconforming loans. Nonconforming loans generally have interest rate resets or maturities of less than thirty years. Management’s current strategy is to sell loans with servicing released instead of keeping the servicing, as we believe that this improves our overall profitability. Our loan portfolio contains some loans that are nonconforming due to loan-to-value or credit exceptions.

Our originations of all types of residential first mortgages amounted to $76.0 million for the fiscal year ended September 30, 2004, and $196.5 million for the year ended September 30, 2003. Due to the low interest rate environment, a significant portion of loans originated in 2004, 2003 and 2002 were refinances, including refinances of our existing portfolio loans and loans in our servicing portfolio. The average size of our residential mortgage loans originated in the year ended September 30, 2004 was $115,000, and $100,000 for the year ended September 30, 2003.

We originate new mortgage loans through dedicated mortgage originators. Our mortgage originators develop referrals from current bank customers, real estate brokers, attorneys, past customers and other key referral sources.

We offer a variety of mortgage products to allow customers to select the best product for their needs. A description of the products and underwriting guidelines are highlighted below.

Adjustable Rate Mortgage Loans. We offer a variety of adjustable rate mortgage products that initially adjust after one, three, five, or seven years. After the initial term, adjustable rate mortgage loans generally adjust on an annual basis at a fixed spread over the monthly average yield on United States Treasury securities, the Wall Street Journal Prime or LIBOR. The interest rate adjustments are generally subject to a maximum increase of 2% per adjustment period and the aggregate adjustment is generally subject to a maximum increase of 6% over the life of the loan. At September 30, 2004, 64.84% of the residential mortgage loans in our portfolio were adjustable rate mortgage loans, most of which were hybrid loans with the rate fixed for the first five or seven years.

Generally, we offer adjustable rate mortgage loans in amounts up to $1.0 million depending on the loan-to-value ratio and the type of property. The loan-to-value ratio is the loan amount divided by the lower of (a) the appraised value of the property or (b) the purchase price of the property. The loan-to-value ratio is commonly used by financial institutions as one measure of potential exposure to risk. Loans on owner occupied one-to-four family residences are generally subject to a maximum loan to value ratio of 80% or require mortgage insurance if they exceed this ratio.

Fixed Rate Mortgage Loans Retained in Portfolio. Late in fiscal 2003 we stopped selling our 15-year conforming mortgage originations and started holding them in portfolio. These loans had better yields than securities with similar interest risk attributes that were available for purchase. As of September 30, 2004, we have $30.9 million of 15-year conforming mortgages in our portfolio.

Fixed Rate Mortgages Sold Servicing Released. We offer a variety of thirty-year fixed-rate products that we sell to investors on a servicing released basis. These loans are underwritten to the investors’ standards and are generally sold to the investor after the loan closes. The rate on these loans is committed with the investor on a best efforts basis when the borrower locks in their interest rate. Gains on sales of residential loans amounted to $1.2 million of our noninterest income for the year ended September 30, 2004.

Fixed Rate Mortgages Sold with Servicing Retained. We are an approved seller/servicer for Freddie Mac. Our fixed rate loans are underwritten to comply with Freddie Mac standards for sale to the secondary market. At September 30, 2004, CharterBank serviced loans for Freddie Mac with an aggregate balance of $34.6 million and serviced loans for other investors with an aggregate balance of $2.3 million.

Home Equity Credit Lines and Second Mortgages. We offer home equity lines of credit as a complement to our one-to-four family lending activities. We believe that offering home equity credit lines helps to expand and create stronger ties to our existing customer base by increasing the number of customer relationships and providing cross-marketing opportunities. Home equity credit lines provide adjustable-rate loans secured by a first or second mortgage on owner-occupied one- to four-family residences located primarily in Georgia and Alabama. Home equity credit lines enable customers to borrow at rates tied to the prime rate as reported in The Wall Street Journal. The underwriting standards applicable to home equity credit lines are similar to those applicable to one- to four-family first mortgage loans with the exception of loan to value ratios which may go to 100% and slightly more stringent credit to income and credit score requirements. At September 30, 2004, we had $13.5 million of home equity and second mortgage loans. We also had $8.3 million of unfunded home equity commitments at September 30, 2004.

Commercial Real Estate Loans. CharterBank embarked on a strategy of increasing its commercial real estate loan portfolio during fiscal 1998. In underwriting commercial real estate loans, we consider not only the property’s historic cash flow, but also its current and projected occupancy, location, and physical condition. We generally lend up to a maximum loan-to-value ratio of 80% on commercial properties and require a minimum debt coverage ratio of 1.15 to 1 after tax. At September 30, 2004, we had $119.6 million of loans in our commercial real estate portfolio. The average size of a loan in our portfolio at September 30, 2004 was $252,000. Our largest funded loan exposure is a commercial real estate loan with a balance of $6.2 million at September 30, 2004. This loan is secured by a medical office building located in the metro Atlanta, Georgia area.

Commercial real estate lending involves additional risks compared with one-to-four family residential lending. Payments on loans secured by commercial real estate properties often depend on the successful management of the properties, on the amount of rent from the properties, or on the level of expenses needed to maintain the properties. Repayment of such loans may therefore be adversely affected by conditions in the real estate market or the general economy. Also, commercial real estate loans typically involve large loan balances to single borrowers or groups of related borrowers. In order to mitigate this risk, we monitor our loan concentration and our loan policies generally limit the amount of loans to a single borrower or group of borrowers. We also utilize the services of an outside consultant to conduct credit quality reviews of the commercial loan portfolio. Because of increased risks associated with commercial real estate loans, our commercial real estate loans generally have higher rates and shorter maturities than our residential mortgage loans. We usually offer commercial real estate loans at fixed rates and adjustable rates tied to the prime rate. However, a portion of the commercial real estate portfolio is tied to yields on U.S. Treasury securities or LIBOR. We currently offer fixed rate terms of 3-7 years on these loans. However, in prior years we have had fixed rate loans with maturities of up to 25 years.

Commercial Loans. Commercial loans generally are limited to terms of five years or less. Whenever possible, we collateralize these loans with a lien on commercial real estate, or alternatively, with a lien on business assets and equipment. We also generally require the personal guarantee of the business owner. Interest rates on commercial loans generally have higher yields than residential or commercial real estate loans due to the risk inherent in this type of loan.

Commercial loans are generally considered to involve a higher degree of risk than residential or commercial real estate loans because the collateral may be in the form of intangible assets and/or inventory subject to market obsolescence. Commercial loans may also involve relatively large loan balances to single borrowers or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation and income stream of the borrower. Such risks can be significantly affected by economic conditions. In addition, business lending generally requires substantially greater supervision efforts by our management compared to residential or commercial real estate lending. Commercial loans, however, comprise a small portion of our loan portfolio, at approximately 6.4% of total loans receivable and approximately 1.9% of total assets at September 30, 2004.

Consumer Loans. We offer a variety of consumer loans to retail customers in the communities we serve. Examples of our consumer loans include:

•

home equity loans-open and closed end;

•

secured deposit and other loans; and

•

unsecured credit lines and installment loans.

At September 30, 2004, our consumer loan portfolio totaled $19.6 million, or 6.0% of total loans. Consumer loans are generally originated at higher interest rates than residential and commercial mortgage loans and tend to have a higher credit risk than residential loans because they may be secured by a home with a loan-to-value of 100%, secured by rapidly depreciable assets, or be unsecured. Despite these risks, our level of consumer loan delinquencies, excluding auto loans, has generally been low. We cannot assure you, however, that our delinquency rate on consumer loans will continue to remain low in the future, or that we will not incur future losses on these activities.

At September 30, 2004, the auto loan portfolio totaled $1.9 million, or 0.6% of total loans. Charge-offs on the auto loan portfolio amounted to approximately $23,000 for the year ended September 30, 2004, compared to charge-offs of approximately $82,000 for the year ended September 30, 2003.

We make loans for up to 100% of the amount of a borrower’s Certificates of Deposit balance. These savings secured loans totaled $1.3 million at September 30, 2004.

Loan Approval Procedures and Authority. Our lending policies provide that various loan personnel and management committees may review and approve secured loan relationships up to $1.5 million and unsecured loan relationships up to $500,000. All loan relationships above these amounts require approval of either the Board’s Executive Loan Committee or the full Board of Directors.

The following describes our current lending procedures for residential mortgages and home equity lines and loans. Upon receipt of a completed loan application from a prospective borrower, we order a credit report and verify other information. If necessary, we obtain additional financial or credit related information. We require an appraisal for all mortgage loans, except for home equity loans or lines where an alternative evaluation may be used to determine the loan to value ratio. Appraisals are performed by licensed or certified third-party appraisal firms and are reviewed by our lending department. We require title insurance or a title opinion on all mortgage loans.

We require borrowers to obtain hazard insurance and we may require borrowers to obtain flood insurance prior to closing. For properties with a private sewage disposal system, we also require evidence of compliance with applicable law on residential mortgage loans. Further, we generally require borrowers to advance funds on a monthly basis together with each payment of principal and interest to a mortgage escrow account from which we make disbursements for items such as real estate taxes, hazard insurance, flood insurance, and private mortgage insurance premiums, if required.

Commercial loans are approved through CharterBank’s Management Loan Committee process. The Management Loan Committee consists of the President, the Executive Vice President, the Chief Financial Officer, the Senior Credit Administrator, and certain other senior lending and credit officers. The Management Loan Committee has authority to approve loan relationships and modifications up to $1,500,000. Commercial loan relationships of $1,000,000 or less may be approved outside the Committee process by three officers who have commercial loan authority. Commercial loan relationships greater than $1,500,000 are approved by the Management Loan Committee and the Board’s Executive Loan Committee or the entire Board of Directors.

Asset Quality. One of our key operating objectives has been and continues to be the achievement of a high level of asset quality. We maintain a large proportion of loans secured by residential one-to-four family properties and commercial properties; we set sound credit standards for new loan originations; and we follow careful loan administration procedures. The following table sets forth the non-performing loans by loan category at the dates indicated. As indicated by the table, nonperforming loans increased during the year ended September 30, 2004.


	At September 30,
	2004		2003		Increase (Decrease)
1-4 family residential real estate mortgage	$	2,411,215	$	2,080,802	$	330,413

Commercial real estate		3,071,252		2,474,106		597,146
Commercial		348,077		429,810		(81,733	)
Consumer and other		34,512		139,199		(104,687	)

Total	$	5,865,056	$	5,123,917	$	741,139

Non-accrual loans increased $741,000 with the real estate secured loans, including one-to-four family and commercial real estate loans, increasing $928,000 and commercial, consumer and other loans decreasing $186,000. Commercial, consumer and other non-accrual loans decreased as we worked through the loans acquired in the Eagle Bank acquisition. The increase in non-accrual real estate secured loans reflects general softness in the economy.

Delinquent Loans and Foreclosed Assets. Our policies require that management continuously monitor the status of the loan portfolio and report to the Executive Loan Committee of the Board of Directors on a monthly basis. These reports include information on delinquent loans and foreclosed real estate, and our actions and plans to cure the delinquent status of the loans and to dispose of the foreclosed property. The Loan Committee approves action plans on all loans that are 90 days delinquent. The Loan Committee consists of three outside directors and two directors who are also members of management. Two of the outside directors, one of whom is the chairman, serve each time. The third outside slot rotates between two other outside directors.

The following table presents information regarding total nonaccrual loans, accruing loans delinquent 90 days or more, and foreclosed real estate as of the dates indicated. At September 30, 2004, 2003, and 2002, we had $5.9 million, $5.1 million, and $3.0 million, respectively, of nonperforming loans. If all nonaccrual loans had been performing in accordance with their original terms and had been outstanding from the earlier of the beginning of the period or origination, we would have recorded additional interest income on these loans of approximately $244,000 for the year ended September 30, 2004.


	At September 30,
	2004			2003			2002			2001			2000
	(Dollars in thousands)
Underperforming loans - accruing loans delinquent 90 days or more	$	195		$	633		$	133		$	218		$	159

Total non-performing loans	$	5,865		$	5,124		$	3,013		$	2,312		$	2,831
Foreclosed real estate, net		453			684			670			434			630

Total non-performing assets	$	6,318		$	5,808		$	3,683		$	2,746		$	3,461

Non-performing loans to total loans		1.81	%		1.71	%		1.41	%		1.01	%		1.09	%

Non-performing assets to total assets		0.59	%		0.58	%		0.38	%		0.31	%		0.37	%

Nonperforming assets at September 30, 2004, 2003, and 2002 were $6.3 million, $5.8 million, and $3.7 million, respectively. Primarily, the nonaccrual loans are residential and commercial real estate loans that are nonaccrual due to economic conditions.

We generally stop accruing income when interest or principal payments are 90 days in arrears. We may stop accruing income on such loans earlier than 90 days when we consider the timely collectibility of interest or principal to be doubtful. We may continue to accrue interest income beyond 90 days if the loan is well secured and we determine that the ultimate collection of all principal and interest is not in doubt. When we designate nonaccrual loans, we reverse all outstanding interest that we had previously credited. If we receive a payment on a nonaccrual loan, we may recognize a portion of that payment as interest income; if we determine that the ultimate collectibility of principal is no longer in doubt. However, such loans may remain on nonaccrual status.

Impaired loans are individually assessed to determine whether the carrying value exceeds the fair value of the collateral or the present value of the expected cash flows to be received. Smaller balance homogeneous loans, such as residential mortgage loans and consumer loans, are collectively evaluated for impairment. At September 30, 2004, 2003, and 2002, impaired loans totaled $3.9 million, $2.2 million, and $2.1 million, respectively. The average recorded investment in impaired loans for the years ended September 30, 2004, 2003, and 2002 was approximately $3.0 million, $2.2 million and $1.4 million, respectively. Interest income recognized on impaired loans for the years ended September 30, 2004, 2003, and 2002 was not significant.

At September 30, 2004, 2003, and 2002, we had $3.0 million, $2.7 million, and $2.0 million, respectively, of portfolio loans classified as troubled debt restructurings.

Foreclosed real estate consists of property we have acquired through foreclosure or deed in lieu of foreclosure. Foreclosed real estate properties are initially recorded at the lower of the recorded investment in the loan or fair value. Thereafter, we carry foreclosed real estate at the lower of cost or fair value. At September 30, 2004, 2003, and 2002 we had $453,000, $684,000 and $670,000 in foreclosed real estate, respectively.

Allowance for Loan Losses. The following table presents the activity in our allowance for loan losses and other ratios at or for the dates indicated.


	At or for Years Ended September 30,
	2004			2003			2002			2001			2000
	(Dollars in thousands)
Balance at beginning of year	$	6,780		$	5,179		$	5,290		$	6,346		$	5,710
Allowance for loan losses of acquired company(1)		—			2,177			—			—			—
Charge-offs:
1-4 residential real estate		(185	)		(209	)		(321	)		(132	)		(104	)
Commercial real estate		(15	)		—			—			—			(91	)
Commercial		(230	)		(497	)		(175	)		(554	)		(26	)
Consumer and other		(139	)		(338	)		(320	)		(1,387	)		(713	)
Real estate construction		(81	)		—			—			(23	)		(204	)

Total charge-offs		(650	)		(1,044	)		(816	)		(2,096	)		(1,138	)

Recoveries:
1-4 residential real estate		105			140			94			119			32
Commercial real estate		—			—			—			21			18
Commercial		105			25			—			—			20
Consumer and other		253			278			361			400			294
Real estate construction		—			—			—			—			—

Total recoveries		463			443			455			540			364

Net (charge-offs) recoveries		(187	)		(601	)		(361	)		(1,556	)		(774	)
Provision for loan losses		30			25			250			500			1,410

Balance at end of year	$	6,623		$	6,780		$	5,179		$	5,290		$	6,346

Total loans receivable	$	323,547		$	299,877		$	214,006		$	229,947		$	259,700

Average loans outstanding	$	311,480		$	256,792		$	215,632		$	243,243		$	242,868

Allowance for loan losses as a percent of total loans receivable (2)		2.05	%		2.26	%		2.33	%		2.30	%		2.44	%

Net loans (charged off) recovered as a percent of average outstanding		(.06	)%		(0.23	)%		(0.16	)%		(0.64	)%		(0.32	)%

(1)	Established as a result of the Eagle Bank acquisition in 2003.

(2)	Does not include loans held for sale or deferred fees.

Our evaluation of the loan portfolio includes the review of all loans on which the collection of principal might be at risk. We consider the following factors as part of this evaluation:

•

our historical loan loss experience;

•

estimated losses in the loan portfolio;

•

increases in categories with higher loss potential, such as commercial real estate loans;

•

credit scores and credit history;

•

the estimated value of the underlying collateral; and

•

current economic and market trends.

There may be other factors that warrant our consideration in maintaining the allowance at a level sufficient to cover probable losses. Although we believe that we have established and maintained the allowance for loan losses at adequate levels, it may be necessary to increase the allowance if economic, real estate and other conditions differ substantially from the current operating environment.

In addition, the OTS, as an integral part of its examination process, periodically reviews our loan and foreclosed real estate portfolios and the related allowance for loan losses and valuation allowance for foreclosed real estate. The OTS may require us to increase the allowance for loan losses or the valuation allowance for foreclosed real estate based on their judgments of information available to them at the time of their examination, thereby adversely affecting our results of operations.

For the year ended September 30, 2004, we expensed a $30,000 provision for loan losses based on our evaluation of the items discussed above. The recorded provision of $30,000 was less than net charge-offs because the majority of the 2004 net charge-offs represent losses associated with the Eagle portfolio and were already considered in their allowance for loan losses.

For the year ended September 30, 2003 we expensed a $25,000 provision. For that year we had $631,000 in net charge-offs of which $471,000 came from loans acquired in the Eagle Bank acquisition. Our reserve methodology indicated a higher provision was not appropriate.

Management believes to the best of its knowledge, the allowance for loan losses is sufficient to cover all known losses and inherent losses in the current loan portfolio at September 30, 2004. To determine the adequacy of the allowance, we look at historical trends in the growth and composition of our loan portfolio, among other factors. The most significant risk trends over the last five years are the growth of our commercial real estate loan portfolio, the growth of the nonconforming residential loan portfolio, and the nonperforming loans acquired in the Citizens and Eagle acquisitions. We believe that, despite using prudent underwriting standards, commercial real estate loans contain higher loss potential than one- to four-family residential mortgages.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations for the years ended September 30, 2004, and 2003, — Provision for Loan Losses.”

Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category, the total loan balances by category, and the percent of loans in each category to total loans indicated.


	At September 30,
	2004						2003						2002
Loan Category	Amount		Loan Balances by Category		Percent of loans in Each Category to Total Loans		Amount		Loan Balances by Category		Percent of loans in Each Category to Total Loans		Amount		Loan Balances by Category		Percent of loans in Each Category to Total Loans
							(Dollars in thousands)
One-to-four family residential real estate	$	1,364	$	142,250	44.0	%	$	1,185	$	133,305	44.5	%	$	1,017	$	100,471	46.9	%
Commercial real estate		2,769		119,618	37.0			2,920		111,189	37.1			2,394		68,016	31.8
Consumer loans and other(1)		550		19,580	6.0			592		19,673	6.5			620		19,970	9.3
Commercial		836		20,628	6.4			1,147		21,634	7.2			506		16,587	7.8
Real estate construction		399		21,471	6.6			258		14,076	4.7			377		8,962	4.2
Unallocated		705		—	—			678		—	—			265		—	—

Total allowance for loan losses	$	6,623	$	323,547	100.0	%	$	6,780	$	299,877	100.0	%	$	5,179	$	214,006	100.0	%


	At September 30,
	2001						2000
Loan Category	Amount		Loan Balances by Category		Percent of loans in Each Category to Total Loans		Amount		Loan Balances by Category		Percent of loans in Each Category to Total Loans
	(Dollars in thousands)
One-to-four family residential real estate	$	1,841	$	129,223	56.2	%	$	1,228	$	152,822	58.9	%
Commercial real estate		1,656		61,225	26.6			1,487		60,838	23.4
Consumer loans and other(1)		382		23,537	10.2			2,345		29,915	11.5
Commercial		359		6,819	3.0			623		8,987	3.5
Real estate construction		263		9,143	4.0			236		7,138	2.7
Unallocated		789		—	—			427		—	—

Total allowance for loan losses	$	5,290	$	229,947	100.0	%	$	6,346	$	259,700	100.0	%

(1)	Includes home equity lines of credit, excludes loans held for sale.

Investment Activities. The Board of Directors reviews and approves our investment policy on an annual basis. The President and Chief Financial Officer, as authorized by the Board, implement this policy based on the established guidelines within the written investment policy, and other established guidelines, including those set periodically by the Asset-Liability Management Committee.

The primary goal of our investment policy is to invest funds in assets with varying maturities which will result in the best possible yield while maintaining the safety of the principal invested and assisting in managing interest rate risk. We also seek to use our strong capital position to maximize our net income through investment in higher yielding mortgage related securities funded by borrowings. The investment portfolio is also viewed as a source of liquidity. The broad objectives of our investment portfolio management are to:

•

minimize the risk of loss of principal or interest;

•

generate a favorable return without incurring undue interest rate and credit risk;

•

manage the interest rate sensitivity of our assets and liabilities;

•

meet daily, cyclical and long term liquidity requirements while complying with our established policies and regulatory liquidity requirements;

•

diversify assets in stable economic regions and address maturity or interest repricing imbalances; and

•

provide collateral for pledging requirements.

In determining our investment strategies, we consider our interest rate sensitivity, yield, credit risk factors, maturity and amortization schedules, asset prepayment risks, collateral value and other characteristics of the securities to be held.

Our investment policies and procedures also encompass evaluating and monitoring our Freddie Mac common stock investment.

Liquidity. We calculate liquidity by taking the total of:

•

our cash;

•

cash we have in other banks;

•

unpledged U.S. Government or Government Agency Securities; and

•

unpledged mortgage-backed securities guaranteed by the U.S. Government or Agencies or rated AAA.

We utilize borrowing lines of credit supported by available collateral, including Freddie Mac common stock, which provides a high level of liquidity. We consider our Freddie Mac common stock a collateral source of last resort due to the adverse income tax consequences of losing the dividends received deduction. We borrow funds from the Federal Home Loan Bank based on eligible collateral of loans and securities up to a limit of 40% of CharterBank’s assets. Our maximum borrowing capacity from the Federal Home Loan Bank is approximately $373.3 million, of which $292.1 million of borrowings was utilized at September 30, 2004. We utilize Federal Home Loan Bank advances, reverse repurchase agreements and other borrowings to fund the purchase of investment securities in order to increase our net income and return on equity.

Investment Portfolio.

General. Federally chartered thrifts have authority to invest in various types of assets, including U.S. Treasury obligations, securities of various federal agencies, mortgage-backed securities, certain Certificates of Deposit of insured financial institutions, repurchase agreements, overnight and short term loans to other banks, corporate debt instruments, and Fannie Mae and Freddie Mac equity securities. Our investments primarily fall into two major categories:

•

equity investments, primarily Freddie Mac common stock and

•

collateralized mortgage obligations and mortgage-backed securities.

Securities can be classified as trading, held to maturity, or available for sale at the date of purchase. All of our securities are currently classified as “available for sale.” The weighted average annualized yield of our non-equity portfolio was 4.00% as of September 30, 2004. We believe the credit quality of the portfolio is high as it is invested in U.S. Government, U.S. Government Agency, or U.S. Government Agency-guaranteed mortgage-backed securities or mortgage related securities with a rating of AA or better or equities, primarily Freddie Mac common stock. For information see “Management Discussion and Analysis - Carrying Values, Yields and Maturities.”

The following table sets forth the composition of our investment securities portfolio at the dates indicated.


	At September 30,
	2004				2003				2002				2001				2000
	Amortized Cost		Market Value		Amortized Cost		Market Value		Amortized Cost		Market Value		Amortized Cost		Market Value		Amortized Cost		Market Value
	(Dollars in thousands)
Investment Securities:
U.S. Government agencies	$	—	$	—	$	12,981	$	12,892	$	—	$	—	$	—	$	—	$	14,449	$	12,880
Other debt securities		22,339		22,157		8,633		8,737		12,175		12,059		—		—		1,000		1,002

Total investment securities		22,339		22,157		21,614		21,629		12,175		12,059		—		—		15,449		13,882

Mortgage-backed and mortgage-related securities:
Ginnie Mae		19,876		20,170		14,532		14,919		24,189		24,714		20,081		20,230		85,700		82,172
Fannie Mae		129,954		130,652		89,365		90,408		31,103		31,590		16,518		16,620		52,832		50,783
Freddie Mac		9,852		9,902		13,378		13,267		6,744		6,732		—		—		25,043		24,355

Total mortgage-backed and mortgage- related securities		159,682		160,724		117,275		118,594		62,036		63,036		36,599		36,850		163,575		157,310

Collateralized mortgage obligations:
Fannie Mae		72,589		71,122		136,101		133,520		126,788		126,353		74,091		73,619		78,831		77,777
Freddie Mac		92,026		91,644		86,818		86,068		239,570		239,179		140,128		139,677		70,513		69,369
Non-agency		52,840		53,358		56,441		56,250		25,181		25,238		72,417		71,430		67,198		59,946
Ginnie Mae		1,510		1,509		—		—		2,139		2,134		5,081		5,037		3,518		3,306

Total collateralized mortgage Obligations		218,965		217,633		279,360		275,838		393,678		392,904		291,717		289,763		220,060		210,398

Total mortgage-backed securities and collateralized mortgage obligations		378,647		378,357		396,635		394,432		455,714		455,940		328,316		326,613		383,635		367,708

Total investment and mortgage securities	$	400,986	$	400,514	$	418,249	$	416,061	$	467,889	$	467,999	$	328,316	$	326,613	$	399,084	$	381,590

Freddie Mac common stock and other equity securities	$	6,213	$	300,430	$	6,285	$	242,904	$	6,317	$	260,215	$	6,365	$	302,623	$	6,316	$	251,661

Total investment and mortgage securities and Freddie Mac common stock	$	407,199	$	700,944	$	424,534	$	658,965	$	474,206	$	728,214	$	334,681	$	629,236	$	405,400	$	633,251

The following table sets forth the composition of the mortgage securities portfolio at the dates indicated and whether such investments have fixed or adjustable interest rates.


	At September 30, 2004							At September 30, 2003
	Amortized Costs		Market Value		Unrealized Gain/(Loss)			Amortized Costs		Market Value		Unrealized Gain/(Loss)
	(Dollars in thousands)
Fixed rate corporate debt	$	—	$	—	$	—		$	1,631	$	1,737	$	106
Fixed rate agency notes/bonds		20,339		20,197		(142	)		12,981		12,892		(89	)
Total fixed rate mortgage-backed and mortgage-related securities		104,828		105,814		986			77,611		79,222		1,611
Total fixed rate collateralized mortgage obligations		117,044		115,495		(1,549	)		106,303		103,124		(3,179	)

Total fixed rate investment and mortgage securities		242,211		241,506		(705	)		198,526		196,975		(1,551	)

Variable rate corporate		—		—		—			7,002		7,000		(2	)
Variable rate agency		2,000		1,960		(40	)		—		—		—
Variable rate mortgage-backed and mortgage-related securities		54,854		54,910		56			39,663		39,371		(292	)
Variable rate collateralized mortgage obligations		101,921		102,138		217			173,058		172,715		(343	)

Total variable rate investment and mortgage securities		158,775		159,008		233			219,723		219,086		(637	)

Freddie Mac common stock and other equity securities		6,213		300,430		294,217			6,285		242,904		236,619

Total investment and mortgage securities and Freddie Mac common stock	$	407,199	$	700,944	$	293,745		$	424,534	$	658,965	$	234,431

Investment Portfolio Maturities. The composition and maturities of the investment securities portfolio (debt securities) and the mortgage-backed securities portfolio at September 30, 2004 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or redemptions that may occur.


	One Year or Less				More than One Year through Five Years				More than Five Years through Ten Years				More than Ten Years				Total Securities
	Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Weighted Average Yield		Amortized Cost		Market Value		Weighted Average Yield
	(Dollars in thousands)
Investment securities available for sale:
U. S. Government agencies	$	—	—	%	$	11,300	2.54	%	$	11,039	3.05	%	$	—	—		$	22,339	$	22,157	2.79	%
Corporate debt		—	—			—	—			—	—			—	—			—		—	—

Total investment securities		—	—	%		11,300	2.54	%		11,039	3.05	%		—	—			22,339		22,157	2.79	%

Mortgage-backed securities Available for sale:
Ginnie Mae		—	—	%		—	—	%		3,943	6.10	%		15,933	4.70	%		19,876		20,170	4.98	%
Fannie Mae		—	—			—	—			8,480	4.13			121,474	4.41			129,954		130,652	4.39
Freddie Mac		—	—			—	—			—	—			9,852	3.16			9,852		9,902	3.16

Total mortgage-backed securities		—	—	%		—	—	%		12,423	4.76	%		147,259	4.36	%		159,682		160,724	4.39	%

Collateralized mortgage obligations:
Fannie Mae		—	—	%		—	—	%		—	—	%		72,590	3.14	%		72,589		71,122	3.14	%
Freddie Mac		—	—			—	—			5,957	3.48			86,069	3.07			92,026		91,644	3.10
Ginnie Mae		—	—			—	—			—	—			1,510	2.77			1,510		1,509	2.77
Other Non-agency		—	—			—	—			—	—			52,841	3.24			52,840		53,358	3.24

Total collateralized mortgage obligations		—	—	%		—	—	%		5,957	3.48	%		213,010	3.13	%		218,965		217,633	3.14	%

Total	$	—	—	%	$	11,300	2.54	%	$	29,419	3.86	%	$	360,269	3.63	%	$	400,986	$	400,514	3.62	%

Equity Securities. As of September 30, 2004, equity securities were primarily comprised of 4,605,000 shares of Freddie Mac common stock which had a per share market value of $65.24 per share, a total market value of $300.4 million and a cost basis of approximately $1.35 per share. The large unrealized pre-tax gain of approximately $294.2 million is the result of a series of well-timed investments in Freddie Mac common stock in the middle to late 1980’s. As a result of strong fundamental growth at Freddie Mac and a favorable stock market environment, our Freddie Mac common stock investment has appreciated significantly, constituting approximately 28.1% of our total assets. The unrealized gain in Freddie Mac common stock has substantially strengthened our capital and earnings. The after-tax unrealized gain in Freddie Mac common stock constitutes 66.3% of our equity capital. Dividends on Freddie Mac common stock have also significantly increased our dividend and interest income.

Our Freddie Mac common stock is held by different companies within the Charter group as follows:


CharterBank		2,555,000 shares
Charter Financial		1,650,000 shares
Charter Insurance		400,000 shares

Total		4,605,000 shares

In addition, the owner of 80% of Charter Financial’s common stock, First Charter, MHC, owns 400,000 shares of Freddie Mac common stock.

We believe that our ownership of Freddie Mac common stock continues to present attractive appreciation and dividend growth potential. Since the sale of Freddie Mac common stock would result in the realization of a substantial current tax liability for us, we have no current plans to liquidate our Freddie Mac common stock investment. In 2003, we implemented a pilot program and began writing covered calls on Freddie Mac common stock. We initially put 250,000 shares of stock in the program. If a call option is in the money as the maturity of the call approaches, we evaluate the economics of allowing the call to be exercised or buying the call to prevent its exercise. During fiscal year 2003, we sold 15,000 shares of Freddie Mac common stock and during fiscal year 2004, we sold 35,000 shares of Freddie Mac common stock. The net call premiums have been lower than we anticipated due to higher costs of repurchasing call options in lieu of allowing the exercise of the call options. The exercise of the call option results in the sale of the underlying stock. In the fifteen month period during which we have been writing calls, the underlying stock has appreciated from $50.77 per share to $65.24 per share. This has resulted in more repurchases than in a lower level of appreciation. We continually evaluate our investment in Freddie Mac common stock considering the appreciation and dividend potential of the Freddie Mac common stock, the income tax impact of a strategy, alternative investments or uses of sales proceeds and the portion of our capital that the after-tax unrealized gain represents.

Mortgage Related Securities. Our mortgage-backed security portfolio is composed of collateralized mortgage obligations and mortgage-backed securities. Collateralized mortgage obligations and mortgage-backed securities consist of various types of securities issued by the major secondary market issuers including Ginnie Mae, Fannie Mae and Freddie Mac, as well as a

variety of private issuers. The portfolio includes securities with a wide variety of structures including variable rate and fixed rate securities, including many hybrid securities with balloon terms.

Mortgage-backed securities generally yield less than the loans that underlie these securities because of the cost of payment guarantees or credit enhancements that reduce credit risk. However, mortgage-backed securities are more liquid than individual mortgage loans and may be used as collateral for our borrowings. In general, mortgage-backed securities issued or guaranteed by Fannie Mae, Freddie Mac, Ginnie Mae or private issuers that rate AA or better are weighted at not more than 20% for risk-based capital purposes, compared to 50% risk weighting assigned to most nonsecuritized residential mortgage loans.

While mortgage-backed securities carry a reduced credit risk as compared to whole loans, they remain subject to the risk of a fluctuating interest rate environment. Along with other factors, such as the geographic distribution of the underlying mortgage loans, changes in interest rates may alter the prepayment rate of those mortgage loans and affect both prepayment rates and the value of mortgage-backed securities. Prepayments impact the rate of amortization of premiums and accretion of discounts and thus impact the yield on our securities. The table below shows the premiums, discounts and projected weighted average lives for our mortgage-backed securities and collateralized mortgage obligations.


	At September 30, 2004
	Par		Premium		Discount		Amortized Cost		Average Life in Yrs.	Average Interest Yield
MBS - fixed rate	$	105,014,522	$	642,897	$	829,231	$	104,828,188	4.38	4.98	%
MBS – variable rate		54,423,507		452,749		22,588		54,853,668	4.00	3.37
CMO - fixed rate		117,171,101		539,483		665,910		117,044,674	2.89	4.22
CMO – variable rate		102,243,634		78,258		400,708		101,921,184	1.67	3.16

Total	$	378,852,764	$	1,713,387	$	1,918,437	$	378,647,714

While mortgage related securities have average lives as stated in the accompanying tables, average lives may be significantly shorter or longer based on interest rates and underlying loan prepayments. Based on interest rates and market prepayment assumptions as of September 30, 2004, the estimated average life of our fixed rate mortgage-backed security portfolio was 4.38 years and of our fixed rate collateralized mortgage obligation portfolio was 2.89 years. If prepayment rates are higher than estimated, our earnings will be negatively affected by the reinvestment of accelerated cash flows at lower yields. A portion of the fixed rate mortgage-backed securities are backed by multifamily loans that have prepayment penalties or yield maintenance agreements and thus are not as likely to prepay due to changes in interest rates.

As discussed above, we have sought to utilize our strong equity position to enhance our earnings and return on equity by using Federal Home Loan Bank advances, reverse repurchase agreements and other borrowings to fund the purchase of higher yielding investment securities. Historically our mortgage-backed securities portfolio has been effective in leveraging our strong capital and increasing net earnings levels. We will continue to purchase collateralized mortgage obligations and mortgage-backed securities and other securities in the future with the same general objectives.

Mortgage-Backed Securities and Mortgage-Related Securities. The following table discloses the amortized cost and fair value of our mortgage-backed and mortgage-related securities, all of which are classified as available for sale as of the dates indicated. Since 1994, all mortgage-backed and mortgage-related securities have been classified as available for sale.


	At September 30,
	2004						2003						2002
	Amortized Cost		Percent of Total		Fair Value		Amortized Cost		Percent of Total		Fair Value		Amortized Cost		Percent of Total		Fair Value
	(Dollars in thousands)
Mortgage-backed securities available for sale:
Ginnie Mae	$	19,876	5.25	%	$	20,170	$	14,532	3.66	%	$	14,919	$	24,189	5.31	%	$	24,714
Fannie Mae		129,954	34.32			130,652		89,365	22.53			90,408		31,103	6.83			31,590
Freddie Mac		9,852	2.60			9,902		13,378	3.37			13,267		6,744	1.48			6,732

Collateralized mortgage obligations available for sale:
Fannie Mae		72,589	19.17			71,122		136,101	34.32			133,520		126,788	27.82			126,353
Freddie Mac		92,026	24.30			91,644		86,818	21.89			86,068		239,570	52.57			239,179
Other		52,840	13.96			53,358		56,441	14.23			56,250		25,181	5.52			25,238
Ginnie Mae		1,510	.40			1,509		—	—			—		2,139	.47			2,134

Total	$	378,647	100	%	$	378,357	$	396,635	100.00	%	$	394,432	$	455,714	100.00	%	$	455,940


	At September 30,
	2001						2000
	Amortized Cost		Percent of Total		Fair Value		Amortized Cost		Percent of Total		Fair Value
	(Dollars in thousands)
Mortgage-backed securities available for sale:
Ginnie Mae	$	20,081	6.12	%	$	20,230	$	85,700	22.33	%	$	82,171
Fannie Mae		16,518	5.03			16,620		52,832	13.77			50,783
Freddie Mac		—	—			—		25,043	6.53			24,355

Collateralized mortgage obligations available for sale:
Fannie Mae		74,091	22.57			73,619		78,831	20.55			77,778
Freddie Mac		140,128	42.68			139,677		70,513	18.38			69,369
Other		72,417	22.06			71,430		67,198	17.52			59,946
Ginnie Mae.		5,081	1.54			5,037		3,518	0.92			3,306

Total	$	328,316	100.00	%	$	326,613	$	383,635	100.00	%	$	367,708

Federal Home Loan Bank Stock. Every federally insured financial institution that borrows funds from a Federal Home Loan Bank is required to invest in the stock of that Federal Home Loan Bank. The institution’s investment in Federal Home Loan Bank stock, along with other assets of the institution, is then pledged as collateral for the advances. As of September 30, 2004, we owned approximately $14.8 million of stock in the Federal Home Loan Bank of Atlanta.

Sources of Funds. Deposits (both retail and wholesale), borrowings, securities sold under agreements to repurchase, scheduled amortization and prepayments of loan principal and mortgage-backed securities, maturities and calls of investment securities and funds provided by operations are our primary sources of funds for use in lending, investing and for other general purposes. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

Deposits. At September 30, 2004, our total deposits amounted to $279.6 million, of which $245.5 million were retail deposits, $34.0 million were funds on deposit from credit unions, and $100,000 were brokered deposits. At September 30, 2003, our retail deposits totaled $229.6 million, and our wholesale deposits totaled $49.7 million. Wholesale deposits consist of funds on deposit from credit unions and brokered deposits.

Retail Deposits. We offer a variety of deposit products to meet the needs of retail and business customers. We currently offer non-interest bearing demand accounts, interest bearing demand accounts (NOW’s), savings passbook and statement accounts, money market accounts and Certificates of Deposits. Deposit products are developed to meet the needs of our targeted markets and products are changed as necessary to meet customer needs and marketing objectives.

Our deposit flows are influenced by a number of factors including:

•

general and local economic conditions;

•

the perceived strength of the stock and stock mutual fund market;

•

prevailing interest rates; and

•

competition.

Our retail deposits are primarily obtained from areas surrounding our offices. To attract and retain deposits, our primary strategy is to provide a superior customer experience and convenience. We determine our deposit rates by evaluating our competition’s pricing, the cost of Federal Home Loan Bank borrowings, rates on U.S. Treasury securities, the LIBOR swap curve and other related funds.

As of September 30, 2004, core deposits, consisting of demand deposits, NOW deposits, savings, and money market accounts, represented 52.7% of total retail deposits and 46.3% of total deposits. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Analysis of Net Interest Income” for information relating to the average balances and costs of our deposit accounts for the years ended September 30, 2004, 2003, and 2002. We

expect that our retail core deposit base will continue to expand to reflect the planned expansion of our retail branch network and that our transaction accounts will increase as a result of our increased marketing efforts related to such accounts within our targeted market area.

Wholesale Deposits. Our wholesale deposits consist of brokered deposits and/or funds on deposit from credit unions. CharterBank obtains credit union deposits by placing rates on a rate service. CharterBank pays to advertise its rates with the third party. Credit unions with an interest in depositing funds with CharterBank contact CharterBank directly. At September 30, 2004, we had $100,000 and at September 30, 2003 we had $7.6 million in brokered deposits. We had no brokered deposits as of September 30, 2002.

At September 30, 2004, our credit union Certificates of Deposit and brokered deposits totaled $34.1 million, or 12.2% of total deposits. At September 30, 2003, our credit union Certificates of Deposit and brokered deposits totaled $49.7 million, or 17.8% of total deposits.

Deposit Distribution Weighted Average. The following table sets forth the distribution of our deposit accounts, by account type, at the dates indicated.


	At September 30,
	2004						2003						2002
	Amount		Percent		Weighted Average Rates		Amount		Percent		Weighted Average Rates		Amount		Percent		Weighted Average Rates
	(Dollars in thousands)
Retail:
Non-certificated accounts:
Noninterest bearing-demand deposits (1)	$	24,612	8.80	%	—	%	$	22,418	8.02	%	—	%	$	7,853	3.73	%	—	%
NOW deposits		39,692	14.20		.55			30,630	10.96		0.53			26,384	12.52		1.10
Savings deposits		14,980	5.36		.25			15,419	5.53		0.30			9,132	4.33		0.75
Money market deposits		50,066	17.91		1.65			31,079	11.12		1.14			26,110	12.39		1.72

Total non-certificated accounts		129,350	46.27		.84			99,546	35.63		0.57			69,479	32.97		1.08

Certificates of Deposit:
One year or less		73,507	26.29		2.38			90,783	32.49		2.40			75,665	35.91		3.15
Over 1 year through 3 years		32,945	11.78		3.59			23,886	8.56		4.72			18,272	8.67		4.73
Over 3 years		9,662	3.46		3.73			15,434	5.52		4.38			9,662	4.58		5.03

Total retail Certificates of Deposit		116,114	41.53		2.83			130,103	46.57		2.68			103,599	49.16		3.61

Total retail deposits		245,464	87.80		1.78			229,649	82.20		1.83			173,078	82.13		2.62

Wholesale:
Certificates of Deposit
One year or less		24,720	8.84		2.45			38,731	13.86		2.11			33,700	15.99		3.28
Over 1 year through 3 years		6,958	2.49		3.13			11,006	3.94		2.78			3,968	1.88		3.83
Over 3 years		2,433	.87		3.94			—	—		—			—	—		—

Total wholesale:		34,111	12.20		2.70			49,737	17.80		2.26			37,668	17.87		3.34

Total Certificates of Deposit		150,225	53.73		2.80			179,840	64.37		2.56			141,267	67.03		3.53

Total deposit accounts	$	279,575	100.00	%	1.89		$	279,386	100.00	%	1.96	%	$	210,746	100.00	%	2.61	%

(1)	Excludes mortgagors’ escrow payments.

Deposit Flow. The following table summarizes the deposit activity of the Bank for the periods indicated. The increase in 2003 is mainly attributable to the approximately $60.7 million in deposits acquired in the Eagle acquisition.


	For the Years Ended September 30,
	2004			2003			2002
	(Dollars in thousands)
Balance at beginning of period	$	279,386		$	210,746		$	200,355
Net increase (decrease) before interest credited, wholesale		(15,626	)		12,073			1,296
Net increase (decrease) before interest credited, retail		12,244			52,335			4,696
Interest credited		3,571			4,232			4,399

Balance at end of period	$	279,575		$	279,386		$	210,746

Total increase (decrease) in deposit accounts	$	189		$	68,640		$	10,391

Percentage increase (decrease)		.07	%		32.57	%		5.19	%

The balances of our wholesale deposits are more volatile than retail deposits. As wholesale deposits mature, these deposits are less likely to remain with CharterBank, as compared to the relatively stable balances of our core retail deposit base. While we expect our retail deposit base to increase in the next several years, the maturities of our wholesale deposits may outpace the growth of our retail deposit base. Accordingly, we plan to either utilize borrowed funds or retain our wholesale Certificates of Deposit to fund loans.

C.D. Maturities. At September 30, 2004, we had $55.3 million in Certificates of Deposits with balances of $100,000 and greater maturing as follows:


Maturity Period	Amount		Weighted Average Rate
	(Dollars in thousands)
Retail:
Three months or less	$	9,534	1.66	%
Over three months through six months		8,513	2.91
Over six months through 12 months		7,778	3.49
Over 12 months		18,531	3.82

Total	$	44,356	3.12	%

Wholesale:
Three months or less	$	1,400	2.02	%
Over three months through six months		1,800	2.16
Over six months through 12 months		3,800	2.50
Over 12 months		3,900	3.28

Total		10,900	2.66

Total	$	55,256	3.03	%

C.D. Balances by Rates. The following table sets forth, by interest rate ranges, information concerning our Certificates of Deposit at the dates indicated.


	At September 30, 2004
	Period to Maturity
	Less than One Year		One to Two Years		Two to Three Years		More than Three Years		Total		Percent of Total
	(Dollars in thousands)
Retail:
2.00% and below	$	49,883	$	4,676	$	21	$	338	$	54,918	47.30	%
2.01% to 3.00%		5,228		14,293		3,829		991		24,341	20.96
3.01% to 4.00%		2,221		519		2,441		5,760		10,941	9.42
4.01% to 5.00%		1,310		718		3,521		2,292		7,841	6.75
5.01% to 6.00%		646		804		6,522		—		7,972	6.87
6.01% and above		8,050		1,759		—		292		10,101	8.70

Total	$	67,338	$	22,769	$	16,334	$	9,673	$	116,114	100.00	%

Wholesale:
2.00% and below	$	8,040	$	399	$	—	$	—	$	8,439	24.74	%
2.01% to 3.00%		13,504		2,382		297		—		16,183	47.44
3.01% to 4.00%		495		996		3,381		2,437		7,309	21.43
4.01% to 5.00%		1,289		—		—		297		1,586	4.65
5.01% to 6.00%		99		—		—		198		297	.87
6.01% and above		297		—		—		—		297	.87

Total	$	23,724	$	3,777	$	3,678	$	2,932	$	34,111	100.00	%

Borrowings. In addition to deposits, borrowings from the Federal Home Loan Bank and securities sold under agreements to repurchase provide an additional source of funds to finance our lending and investing activities. At September 30, 2004, our total borrowings were $392.8 million, as compared to $388.4 million at September 30, 2003. Our utilization of borrowings has generally contributed to our profitability and we will continue to employ borrowings as a source of funds. At the same time, we will consider whether to undertake future borrowings as a source of funds only after a review of numerous relevant factors including:

•

the potential interest spread and risks involved;

•

analysis of the current and anticipated interest rate environment;

•

the current and expected levels of our deposit base;

•

various other risk factors associated with using borrowings as a source of funds; and

•

the return and risk characteristics of the asset to be acquired or retained.

Federal Home Loan Bank Advances. At September 30, 2004, our outstanding FHLB advances totaled $292.1 million, as compared to $267.1 million at September 30, 2003. At September 30, 2004, CharterBank had pledged, under a blanket lien with the Federal Home Loan Bank of Atlanta:

•

all stock of the Federal Home Loan Bank of Atlanta held by CharterBank;

•

certain qualifying first mortgage loans with unpaid principal balances totaling $111.9 million;

•

certain commercial loans with unpaid principal balances totaling $17.7 million; and

•

certain mortgage-backed securities, collateralized mortgage obligations, and investment securities with an aggregate fair value of $233.5 million.

At September 30, 2004, CharterBank has available lines of credit commitments with the FHLB totaling $373.3 million, of which $292.1 million was advanced and $81.2 million was available.

Securities Sold Under Agreements to Repurchase. We had approximately $100.7 million of securities sold under agreements to repurchase outstanding at September 30, 2004, as compared to $121.3 million at September 30, 2003. At September 30, 2004, our securities sold under agreements to repurchase are secured by certain mortgage-backed securities, collateralized mortgage obligations, and investment securities had an aggregate fair market value, including accrued interest of $105.8 million, as compared to $150.7 million at September 30, 2003. All securities sold under the agreements to repurchase are under our control. The repurchase agreements at September 30, 2004 and 2003 have maturities of less than 45 days and provide for the purchase of identical securities and specify delivery of the underlying securities to an approved custodian.

The following table sets forth information concerning balances and interest rates on the Bank’s Federal Home Loan Bank advances and securities sold under agreement to repurchase at the dates and for the years indicated.


	At and for the Year Ended September 30,
	2004			2003			2002
	(Dollars in thousands)
Federal Home Loan Bank advances:
Average balance outstanding	$	259,235		$	264,293		$	260,253
Maximum amount outstanding at any month-end during the year		300,700			292,250			287,300
Balance outstanding at end of the year		292,050			267,100			274,000
Weighted average interest rate during the year		4.08	%		4.34	%		4.86	%
Weighted average interest rate at end of year		4.11	%		3.99	%		4.53	%

Securities sold under agreements to repurchase:
Average balance outstanding	$	132,623		$	108,498		$	107,076
Maximum amount outstanding at any month-end during the year		150,710			133,608			158,727
Balance outstanding at end of the year		100,739			121,341			136,963
Weighted average interest rate during the year		1.28	%		1.58	%		2.21	%
Weighted average interest rate at end of year		1.81	%		1.26	%		2.06	%

The following table sets forth additional information on the maturities, interest rates, and balances of FHLB advances at the dates and for the years indicated.


	2004					2003
Due	Amount	Interest rates		Weighted average rate		Amount		Interest rates		Weighted average rate
Less than one year	40,050,000	2.15	%	2.15	%	$	140,100,000	1.30-5.34	%	2.40	%
One to two years	25,000,000	2.97	%	2.97	%		—	—		—
Two to three years	75,000,000	2.62-3.68	%	3.18	%		—	—		—
Three to four years	25,000,000	2.87	%	2.87	%		—	—		—
Four to five years	—	—		—			—	—		—
Thereafter	127,000,000	5.40-6.22	%	5.75	%		127,000,000	5.40-6.22		5.75

	292,050,000			4.11	%	$	267,100,000			3.99	%

Current and Planned Sources of Funds. As discussed above, we expect to continue to rely on a combination of both retail and wholesale deposits to fund our operations. We seek to grow the retail component of our funding structure, while reducing our dependence on wholesale funds as a source of funds. We believe that the Auburn-Opelika market, where we currently have four branches, offers a larger, higher growth market than our other market areas. We are hopeful that our planned branch expansion within our targeted market area and ATMs will enhance our ability to attract retail deposits.

While we will reduce our reliance on wholesale fundings in the long term, the maturities of our wholesale fundings will most likely outpace the growth of our retail deposit base over the next several years. Thus, wholesale fundings, possibly including brokered deposits, credit union deposits and borrowings, will continue to remain a significant source of funds for CharterBank in the near term. In addition to deposits and borrowings, our other significant sources of funds include liquidity, loan repayments, maturing investments and retained earnings.

Investment in Limited Partnerships. In 1997, CharterBank purchased interests in two limited partnerships, for $7.0 million, which were formed to acquire mortgage servicing rights. CharterBank was allocated approximately 12% and 21% of the respective earnings or losses of these two partnerships. During 1998, CharterBank wrote off its entire limited partnership investment of $2.0 million in the partnership for which it had a previous 12% interest. During 2003, CharterBank wrote off the remainder of its limited partnership investment of $5.0 million in the partnership for which it had a previous 21% interest. For the year ended September 30, 2003, CharterBank recognized $106,746 equity in the net losses of the limited partnership, and $564,164 and $1,200,488 for the years ended September 30, 2002 and 2001, respectively. See Note 13 of the Notes to Consolidated Financial Statements for further discussion of our limited partnership interest.

Personnel. As of September 30, 2004, CharterBank had 181 full-time equivalent employees. The employees are not represented by a collective bargaining unit, and we consider our relationship with our employees to be excellent.

Federal Taxation.

General. For federal income tax purposes, we report income on the basis of a taxable year ending September 30, using the accrual method of accounting, and we are generally subject to federal income taxation in the same manner as other corporations. Since reorganization, CharterBank and Charter Financial constitute an affiliated group of corporations and, therefore, are eligible to report their income on a consolidated basis. However, Charter Financial and CharterBank file separate federal and state income tax returns. CharterBank and Charter Financial are not currently under audit by the IRS and have not been audited for the past five years. The last federal audit of CharterBank’s federal tax return was related to the fiscal year ended September 30, 1991.

Distributions. To the extent that CharterBank makes “non-dividend distributions” to Charter Financial, such distributions will be considered to result in distributions from unrecaptured tax bad debt reserve as of December 31, 1987 (“base year reserve”), to the extent thereof and then from supplemental reserve for losses on loans, and an amount based on the amount distributed will be included in income. Non-dividend distributions include distributions in excess of current and accumulated earnings and profits, distributions in redemption of stock and distributions in partial or complete liquidation. Dividends paid out of current or accumulated earnings and profits will not be included in income.

The amount of additional income created from a non-dividend distribution is equal to the lesser of the base year reserve and supplemental reserve for losses on loans or an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Thus, in some situations, approximately one and one-half times the non-dividend distribution would be included in gross income for federal income tax purposes, assuming a 34% federal corporate income tax rate.

Corporate Alternative Minimum Tax. The Internal Revenue Code of 1986, as amended (the “Code”), imposes a tax on alternative minimum taxable income at a rate of 20%. Only 90% of alternative minimum taxable income can be offset by alternative minimum tax net operating loss carryovers of which we currently have none. Alternative minimum taxable income is also adjusted by determining the tax treatment of certain items in a manner that negates the deferral of income resulting from the regular tax treatment of those items. We have been subject to a tax on alternative minimum taxable income during the past five years.

Elimination of Dividends. Charter Financial may exclude from its income 100% of dividends received from CharterBank as a member of the same affiliated group of corporations.

State Taxation. CharterBank currently files and will continue to file Georgia and Alabama income tax returns. Generally, the income of financial institutions in Georgia and Alabama, which is calculated based on federal taxable income, subject to certain adjustments, is subject to both Alabama and Georgia tax. We are not currently under audit with respect to our Georgia or Alabama income tax returns and our state tax returns have not been audited for the past five years.

Charter Financial is required to file a Georgia income tax return and is generally subject to a state income tax rate that is the same tax rate as the tax rate for financial institutions in Georgia.

Regulation of CharterBank and Charter Financial.

General. Charter Financial and First Charter, MHC, are regulated as savings and loan holding companies by the OTS. CharterBank, as a federal stock savings bank, is subject to regulation, examination and supervision by the OTS. CharterBank must file reports with the OTS concerning its activities and financial condition. Charter Financial and First Charter, MHC, are also required to file reports with, and otherwise comply with the rules and regulations of the OTS. Charter Financial is also required to file reports with, and otherwise comply with, the rules and regulations of the SEC under the federal securities laws.

Gramm-Leach-Bliley Act. On November 12, 1999, President Clinton signed into law landmark financial services legislation, titled the Gramm-Leach-Bliley Act (“GLB Act”). The GLB Act repeals depression-era laws restricting affiliations among banks, securities firms, insurance companies and other financial services providers. The impact of the GLB Act on Charter Financial, First Charter, MHC, and CharterBank where relevant, is discussed throughout the regulation section below.

Any change in such laws and regulations, whether by the OTS, the FDIC, or through legislation, could have a material adverse impact on Charter Financial and CharterBank and their operations and stockholders.

Federal Banking Regulation.

Activity Powers. CharterBank derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and the regulations of the OTS. Under these laws and regulations, CharterBank may invest in mortgage loans secured by residential and commercial real estate; commercial and consumer loans; certain types of debt securities; and certain other assets. CharterBank may also establish service corporations that may engage in activities not otherwise permissible for CharterBank, including certain real estate equity investments and securities and insurance brokerage. CharterBank’s authority to invest in certain types of loans or other investments is limited by federal law.

Loans-to-One-Borrower Limitations. CharterBank is generally subject to the same limits on loans to one borrower as a national bank. With specified exceptions, CharterBank’s total loans or extensions of credit to a single borrower cannot exceed 15% of CharterBank’s unimpaired capital and surplus which does not include accumulated other comprehensive income. CharterBank may lend additional amounts up to 10% of its unimpaired capital and surplus, if the loans or extensions of credit are fully-secured by readily-marketable collateral. CharterBank currently complies with applicable loans-to-one-borrower limitations.

QTL Test. Under federal law, CharterBank must comply with the qualified thrift lender, or “QTL” test. Under the QTL test, CharterBank is required to maintain at least 65% of its “portfolio assets” in certain “qualified thrift investments” in at least nine months of the most recent 12-month period. “Portfolio assets” means, in general, CharterBank’s total assets less the sum of:

•

specified liquid assets up to 20% of total assets;

•

goodwill and other intangible assets; and

•

the value of property used to conduct CharterBank’s business.

CharterBank may also satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986. CharterBank met the QTL test at September 30, 2004, and in each of the prior 12 months, and, therefore, qualifies as a thrift lender. For purposes of calculating compliance with the QTL test, we use the cost basis of our investment in our Freddie Mac common stock, rather than the current market value of the stock.

If CharterBank fails the QTL test it must either operate under certain restrictions on its activities or convert to a bank charter.

Capital Requirements. OTS regulations require CharterBank to meet three minimum capital standards:

(1)

A tangible capital ratio requirement of 1.5% of total assets, as adjusted under the OTS regulations;

(2)

a leverage ratio requirement of 3% of core capital to such adjusted total assets, if a savings association has been assigned the highest composite rating of 1 under the Uniform Financial Institutions Ratings System; and

(3)

a risk-based capital ratio requirement of 8% of core and supplementary capital to total risk-weighted assets.

The minimum leverage capital ratio for any other depository institution that does not have a composite rating of 1 will be 4%, unless a higher leverage capital ratio is warranted by the particular circumstances or risk profile of the depository institution. In determining compliance with the risk-based capital requirement, CharterBank must compute its risk-weighted assets by multiplying its assets and certain off-balance sheet items by risk-weights, which range from 0% for cash and obligations issued by the United States Government or its agencies to 100% for consumer and commercial loans, as assigned by the OTS capital regulation based on the risks that the OTS believes are inherent in the type of asset.

Tangible capital is defined, generally, as common stockholders’ equity (including retained earnings), certain non-cumulative perpetual preferred stock and related earnings and minority interests in equity accounts of fully consolidated subsidiaries, less intangibles (other than certain mortgage servicing rights) and investments in and loans to subsidiaries engaged in activities not permissible for a national bank. Core capital is defined similarly to tangible capital, but core capital also includes certain qualifying supervisory goodwill and certain purchased credit card relationships. Supplementary capital currently includes cumulative and other perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock and the allowance for loan and lease losses, as defined. In addition, up to 45% of unrealized gains on available-for-sale equity securities with a readily determinable fair value may

be included in tier 2 capital. The allowance for loan and lease losses, as defined, is included in tier 2 capital to a maximum of 1.25% of risk-weighted assets, and the amount of supplementary capital that may be included as total capital cannot exceed the amount of core capital.

At September 30, 2004, CharterBank met each of its capital requirements. See footnote 20 in the accompanying consolidated financial statements.

All the Federal banking agencies, including OTS, must revise their risk-based capital requirements to ensure that such requirements account for interest rate risk, concentration of credit risk and the risks of non-traditional activities, and that they reflect the actual performance of and expected loss on multi-family loans.

On May 10, 2002, the OTS adopted an amendment to its capital regulations which eliminated the interest rate risk component of the risk-based capital requirement.

Community Reinvestment Act. Under the Community Reinvestment Act (“CRA”), as implemented by OTS regulations, CharterBank has a continuing and affirmative obligation 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 CharterBank nor does it limit its 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 OTS, in connection with its examination of CharterBank, to assess CharterBank’s record of meeting the credit needs of its community and to take the record into account in its evaluation of certain applications by CharterBank. The CRA also requires all institutions to make public disclosure of their CRA ratings. CharterBank received a “Satisfactory” CRA rating in its most recent examination.

CRA regulations rate an institution based on its actual performance in meeting community needs. In particular, the system focuses on three tests:

•

a lending test, to evaluate the institution’s record of making loans in its assessment areas;

•

an investment test, to evaluate the institution’s record of investing in community development projects, affordable housing, and programs benefiting low or moderate income individuals and businesses; and

•

a service test, to evaluate the institution’s delivery of services through its branches, ATMs and other offices.

Transactions with Related Parties. CharterBank’s authority to engage in transactions with its “affiliates” is limited by the OTS regulations and by Sections 23A and 23B of the Federal Reserve Act (the “FRA”). In general, these transactions must be on terms which are as favorable to CharterBank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of CharterBank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from

CharterBank. In addition, the OTS regulations prohibit a savings association from lending to any of its affiliates that is engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary.

Effective April 1, 2003, the Federal Reserve Board, or FRB, rescinded its interpretations of Sections 23A and 23B of the FRA and replaced these interpretations with Regulation W. In addition, Regulation W expands the definition of what constitutes an affiliate subject to Sections 23A and 23B and exempting certain subsidiaries of state-chartered banks from the restrictions of Sections 23A and 23B.

Under Regulation W, all transactions entered into on or before December 12, 2002, which either became subject to Sections 23A and 23B solely because of Regulation W, and all transactions covered by Sections 23A and 23B, the treatment of which changed solely because of Regulation W, became subject to Regulation W on July 1, 2003. All other covered affiliate transactions became subject to Regulation W on April 1, 2003. The Federal Reserve Board expects each depository institution that is subject to Sections 23A and 23B to implement policies and procedures to ensure compliance with Regulation W. We do not expect that the changes made by Regulation W will have a material adverse effect on our business.

CharterBank’s authority to extend credit to its directors, executive officers and 10% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the FRA and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders (a) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features and (b) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of CharterBank’s capital. The regulations allow small discounts on fees on residential mortgages for directors, officers and employees. In addition, extensions of credit in excess of certain limits must be approved by CharterBank’s Board of Directors.

Section 402 of the Sarbanes-Oxley Act of 2002, or Sarbanes-Oxley, prohibits the extension of personal loans to directors and executive officers of issuers (as defined in Sarbanes-Oxley). The prohibition, however, does not apply to mortgages advanced by an insured depository institution, such as the Bank, which are subject to the insider lending restrictions of Section 22(h) of the FRA.

Enforcement. The OTS has primary enforcement responsibility over savings associations, including CharterBank. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist orders and to remove directors and officers. In general, these enforcement actions may be initiated in response to violations of laws and regulations and to unsafe or unsound practices.

Standards for Safety and Soundness. Under federal law, the OTS has adopted a set of guidelines prescribing safety and soundness standards. These guidelines establish general

standards relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings standards, and compensation, fees and benefits. In general, the guidelines require appropriate systems and practices to identify and manage the risks and exposures specified in the guidelines.

In addition, the OTS adopted regulations that authorize, but do not require, the OTS to order an institution that has been given notice that it is not satisfying these safety and soundness standards to submit a compliance plan. If, after being notified, an institution fails to submit an acceptable plan or fails in any material respect to implement an accepted plan, the OTS must issue an order directing action to correct the deficiency and may issue an order directing corrective actions and may issue an order directing other actions of the types to which an undercapitalized association is subject under the “prompt corrective action” provisions of federal law. If an institution fails to comply with such an order, the OTS may seek to enforce such order in judicial proceedings and to impose civil money penalties.

Limitation on Capital Distributions. The OTS imposes various restrictions or requirements on CharterBank’s ability to make capital distributions, including cash dividends. A savings institution that is the subsidiary of a savings and loan holding company must file a notice with the OTS at least 30 days before making a capital distribution. CharterBank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to CharterBank’s net income for that year plus CharterBank’s retained net income for the previous two years.

The OTS may disapprove of a notice or application if:

•

CharterBank would be undercapitalized following the distribution;

•

the proposed capital distribution raises safety and soundness concerns; or

•

the capital distribution would violate a prohibition contained in any statute, regulation or agreement.

Liquidity. CharterBank is required to maintain a sufficient amount of liquid assets to ensure its safe and sound operation.

Prompt Corrective Action Regulations. Under the OTS prompt corrective action regulations, the OTS is required to take certain, and is authorized to take other, supervisory actions against undercapitalized savings associations. For this purpose, a savings association would be placed in one of the following four categories based on the association’s capital:

•

well-capitalized;

•

adequately capitalized;

•

undercapitalized; and

•

critically undercapitalized.

At September 30, 2004, CharterBank met the criteria for being considered “well-capitalized.”

When appropriate, the OTS can require corrective action by a savings association holding company under the “prompt corrective action” provisions of federal law.

Insurance of Deposit Accounts. CharterBank is a member of the Savings Association Insurance Fund, and CharterBank pays its deposit insurance assessments to the SAIF. The FDIC also maintains another insurance fund, the Bank Insurance Fund, which primarily insures the deposits of banks and state chartered savings banks.

Under federal law, the FDIC established a risk-based assessment system for determining the deposit insurance assessments to be paid by insured depository institutions. Under the assessment system, the FDIC assigns an institution to one of three capital categories based on the institution’s financial information as of its most recent quarterly financial report filed with the applicable bank regulatory agency prior to commencement of the assessment period. An institution’s assessment rate depends on the capital category and supervisory sub-category to which it is assigned. Under the regulation, there are nine assessment risk classifications (i.e., combinations of capital groups and supervisory subgroups) to which different assessment rates are applied. Assessment rates currently range from 0.0% of deposits for an institution in the highest category (i.e., well-capitalized and financially sound, with no more than a few minor weaknesses) to 0.27% of deposits for an institution in the lowest category (i.e., undercapitalized and substantial supervisory concern). The FDIC is authorized to raise the assessment rates as necessary to maintain the required reserve ratio of 1.25%.

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately .0212% of insured deposits to fund interest payment on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the SAIF. These assessments will continue until the Financing Corporation bonds mature in 2017.

Federal Home Loan Bank System. CharterBank is a member of the Federal Home Loan Bank (the “FHLB”) of Atlanta, which is one of the regional FHLBs making up the FHLB System. Pursuant to regulations promulgated by the Federal Housing Finance Board, as required by Gramm-Leach, the FHLB of Atlanta has adopted a capital plan, which is expected to be implemented no earlier than December 2003, which will change the foregoing minimum stock ownership requirements for FHLB of Atlanta stock. Under the new capital plan, each member of the FHLB of Atlanta will have to maintain a minimum investment in FHLB of Atlanta stock in an amount estimated to be the sum of (i) an amount (up to a maximum of $25 million) equal to approximately 0.25% of the member’s total assets and (ii) 4.5% of the member’s outstanding advances, plus 4.5% of the outstanding assets purchased from the member and held by the FHLB under master commitments, plus 8% of any Affordable Multi-Family Participation Program loans purchased from the member. Any advances from a FHLB must be secured by specified types of collateral, and all long-term advances may be obtained only for the purpose of providing funds for residential housing finance.

FHLBs are required to provide funds for the resolution of insolvent thrifts and to contribute funds for affordable housing programs. These requirements could reduce the amount of earnings that the FHLBs can pay as dividends to their members and could also result in the FHLBs imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future FHLB advances increased, CharterBank’s net interest income would be affected.

Prohibitions Against Tying Arrangements. Federal savings banks are subject to the prohibitions of 12 U.S.C. § 1972 on certain tying arrangements. A depository institution is prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

Federal Reserve System. Under regulations of the Federal Reserve Board (the “FRB”), CharterBank is required to maintain noninterest-earning reserves against its transaction accounts. The amount of transaction accounts exempt from a reserve requirement is $6.6 million. A 3% reserve is required for transaction accounts from $6.6 million to $45.4 million. Transaction accounts over $45.4 million are subject to a 10% reserve requirement. CharterBank is in compliance with these requirements. Because required reserves must be maintained in the form of either vault cash, a noninterest-bearing account at a Federal Reserve Bank or a pass-through account as defined by FRB, the effect of this reserve requirement is to reduce CharterBank’s interest-earning assets, to the extent the requirement exceeds vault cash.

Holding Company Regulation. Charter Financial and First Charter, MHC, are savings and loan holding companies regulated by the OTS. As such, Charter Financial and First Charter, MHC, are registered with and are subject to OTS examination and supervision, as well as certain reporting requirements. In addition, the OTS has enforcement authority over Charter Financial and First Charter, MHC, and any of their non-savings institution subsidiaries. Among other things, this authority permits the OTS to restrict or prohibit activities that are determined to be a serious risk to the financial safety, soundness or stability of a subsidiary savings institution. Unlike bank holding companies, federal savings and loan holding companies are not subject to any regulatory capital requirements or to supervision by the Federal Reserve System.

Restrictions Applicable to Charter Financial. Because Charter Financial was organized after May 4, 1999, under the GLB Act, it is prohibited from engaging in non-financial activities. Unitary savings and loan associations acquired before this date are “grandfathered” under the GLB Act and generally have no restrictions on their business activities. Charter Financial’s activities, however, will be restricted to:

•

furnishing or performing management services for a savings institution subsidiary of such holding company;

•

conducting an insurance agency or escrow business;

•

holding, managing, or liquidating assets owned or acquired from a savings institution subsidiary of such company;

•

holding or managing properties used or occupied by a savings institution subsidiary of such company;

•

acting as trustee under a deed of trust;

•

any other activity (a) that the FRB, by regulation, has determined to be permissible for bank holding companies under Section 4(c) of the Bank Holding Company Act of 1956 (“BHC”), unless the Director of the OTS, by regulation, prohibits or limits any such activity for savings and loan holding companies, or (b) in which multiple savings and loan holding companies were authorized by regulation to directly engage on March 5, 1987;

•

purchasing, holding, or disposing of stock acquired in connection with a qualified stock issuance if the purchase of such stock by such holding company is approved by the Director of the OTS; and

•

any activity permissible for financial holding companies under section 4(k) of the BHC.

Permissible activities which are deemed to be financial in nature or incidental thereto under section 4(k) of the Banking Holding Company Act include:

•

lending, exchanging, transferring, investing for others or safeguarding money or securities;

•

insurance activities or providing and issuing annuities, and acting as principal, agent or broker;

•

financial, investment or economic advisory services;

•

issuing or selling instruments representing interests in pools of assets that a bank is permitted to hold directly;

•

underwriting, dealing in, or making a market in securities;

•

activities previously determined by the FRB to be closely related to banking;

•

activities that bank holding companies are permitted to engage in outside of the U.S.;

•

merchant banking activities; and

•

portfolio investments made by an insurance company.

In addition, Charter Financial cannot be acquired or acquire a company unless the acquirer is engaged solely in financial activities.

Restrictions Applicable to Activities of Mutual Holding Companies. Under federal law, a mutual holding company may engage only in the following activities:

•

investing in the stock of a savings institution;

•

acquiring a mutual association through the merger of such association into a savings institution subsidiary of such holding company or an interim savings institution subsidiary of such holding company;

•

merging with or acquiring another holding company, one of whose subsidiaries is a savings institution;

•

investing in a corporation the capital stock of which is available for purchase by a savings institution under federal law or under the law of any state where the subsidiary savings institution or association is located; and

•

the permissible activities described above for non-grandfathered savings and loan holding companies.

If a mutual holding company acquires or merges with another holding company, the holding company acquired or the holding company resulting from such merger or acquisition may only invest in assets and engage in activities listed above, and it has a period of two years to cease any non conforming activities and divest any non-conforming investments.

Restrictions Applicable to All Savings and Loan Holding Companies. Federal law prohibits a savings and loan holding company, including Charter Financial and First Charter, MHC, directly or indirectly, from acquiring:

•

control (as defined under HOLA) of another savings institution (or a holding company parent) without prior OTS approval;

•

through merger, consolidation, or purchase of assets, another savings institution or a holding company thereof, or acquiring all or substantially all of the assets of such institution (or a holding company) without prior OTS approval; or

•

control of any depository institution not insured by the FDIC (except through a merger with and into the holding company’s savings institution subsidiary that is approved by the OTS).

A savings and loan holding company may not acquire as a separate subsidiary an insured institution that has a principal office outside of the state where the principal office of its subsidiary institution is located, except:

•

in the case of certain emergency acquisitions approved by the FDIC;

•

if such holding company controls a savings institution subsidiary that operated a home or branch office in such additional state as of March 5, 1987; or

•

if the laws of the state in which the savings institution to be acquired is located specifically authorize a savings institution chartered by that state to be acquired by a savings institution chartered by the state where the acquiring savings institution or savings and loan holding company is located or by a holding company that controls such a state chartered association.

If the savings institution subsidiary of a federal mutual holding company fails to meet the QTL test set forth in Section 10(m) of the HOLA and regulations of the OTS, the holding company must register with the FRB as a bank holding company under the BHC Act within one year of the savings institution’s failure to so qualify.

The Sarbanes-Oxley Act. On July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act implements a broad range of corporate governance and accounting measures for public companies designed to promote honesty and transparency in corporate America and better protect investors from the type of corporate wrongdoing that occurred in Enron, WorldCom and similar companies. The Sarbanes-Oxley Act’s principal legislation includes:

•

the creation of an independent accounting oversight board;

•

auditor independence provisions which restrict non-audit services that accountants may provide to their audit clients;

•

additional corporate governance and responsibility measures, including the requirement that the chief executive officer and chief financial officer certify financial statements;

•

the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement;

•

an increase in the oversight of, and enhancement of certain requirements relating to audit committees of public companies and how they interact with the company’s independent auditors.

•

requirement that audit committee members must be independent and are absolutely barred from accepting consulting, advisory or other compensatory fees from the issuer;

•

requirement that companies disclose whether at least one member of the committee is a “financial expert” (as such term will be defined by the Securities and Exchange Commission) and if not, why not;

•

expanded disclosure requirements for corporate insiders, including accelerated reporting of stock transactions by insiders and a prohibition on insider trading during pension blackout periods;

•

a prohibition on personal loans to directors and officers, except certain loans made by insured financial institutions;

•

disclosure of a code of ethics and filing a Form 8-K for a change or waiver of such code;

•

mandatory disclosure by analysts of potential conflicts of interest; and

•

a range of enhanced penalties for fraud and other violations.

Although we anticipate that we will incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operations or financial condition.

USA Patriot Act. In response to the events of September 11, 2001, President George W. Bush signed into law the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, or the USA PATRIOT Act, on October 26, 2001. The USA PATRIOT Act gives the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, and increased amendments to the Bank Secrecy Act. Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act.

Among other requirements, Title III of the USA PATRIOT Act imposes the following requirements with respect to financial institutions:

•

Pursuant to Section 352, all financial institutions must establish anti-money laundering programs that include, at minimum: (i) internal policies, procedures, and controls, (ii) specific designation of an anti-money laundering compliance officer, (iii) ongoing employee training programs, and (iv) an independent audit function to test the anti-money laundering program.

•

Pursuant to Section 326, on May 9, 2003 the Secretary of the Department of Treasury, in conjunction with other bank regulators, issued Joint Final Rules that provide for minimum standards with respect to customer identification and verification. These rules became effective on October 1, 2003.

•

Section 312 requires financial institutions that establish, maintain, administer, or manage private banking accounts or correspondent accounts in the United States for non-United States persons or their representatives (including foreign individuals visiting the United States) to establish appropriate, specific, and, where necessary, enhanced due diligence policies, procedures, and controls designed to detect and report money laundering.

•

Effective December 26, 2001, financial institutions are prohibited from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks (foreign banks that do not have a physical presence in any country), and will be subject to certain recordkeeping obligations with respect to correspondent accounts of foreign banks.

•

Bank regulators are directed to consider a holding company’s effectiveness in combating money laundering when ruling on Federal Reserve Act and Bank Merger Act applications.

Federal Securities Law. Our common stock is registered with the SEC under Section 12(g) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.

ITEM 2. PROPERTIES

We currently conduct our business through eight full-service banking offices and five loan production offices. As of September 30, 2004, the properties and leasehold improvements owned by us had an aggregate net book value of $11.2 million.


Location	Ownership	Year Opened	Date of Lease or License Expiration(1)	Deposits as of September 30, 2004
				(In thousands)
Administrative/Main Office:
600 Third Avenue West Point, Georgia	Owned	1965	—	$	102,506

Branch Offices:
300 Church Street LaGrange, Georgia	Owned	1976	—		39,797

3500 20^th Avenue(2) Valley, Alabama	Leased	1963	7/31/08		54,403

91 River Road(2) Valley, Alabama	Owned	1989	—		14,422

1605 East University Drive Auburn, Alabama	Owned	2001	—		19,056

2320 Moore’s Mill Road (3) Auburn, Alabama	Owned	2002	—		6,756

114 South 7^th Street (3) Opelika, Alabama	Owned	1995	—		16,742

3702 Pepperell Parkway (3) Opelika, Alabama	Owned	1988	—		25,893

Loan Production Offices:
2959 Highway 154, Bld. C, Suite D Newnan, Georgia	Leased	1993	3/1/05

1212 7^th Avenue, Suite B and C Phenix City, Alabama	Leased	2001	2/15/05

27 North Mt. Pleasant Avenue Monroeville, Alabama	Leased	2000	Month-to Month

217 Osborne Street St. Mary’s, Georgia	Leased	2003	4/30/05

6525 The Corners Pkwy, Suite 111 Norcross, Georgia	Leased	2004	12/31/05

Brokerage Office:
304 Church Street LaGrange, Georgia	Owned	2002	—

Branches Under Development:
555 South Davis Road LaGrange, Georgia	Owned

2^nd Avenue Opelika, Alabama	Owned

1684 South College Street Auburn, Alabama	Owned

(1)	Lease expiration dates assume all options to extend lease terms are exercised.

(2)	Includes time period operated by Citizens National Bank prior to the Citizens acquisition.

(3)	Includes time period operated by Eagle Bank prior to the Eagle Bancshares acquisition.

ITEM 3. LEGAL PROCEEDINGS

We are not involved in and none of our property is the subject of any pending legal proceeding other than ordinary routine legal proceedings incidental to our business. We believe that these routine legal proceedings, in the aggregate, are immaterial to our consolidated financial condition and results of operations.

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

None.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock is listed on the Nasdaq National Market System for the Nasdaq Stock Market under the symbol “CHFN.” First Charter, MHC, owns 15,857,924 shares, or 80% of our outstanding common stock. At September 30, 2004, there were 19,596,874 shares of common stock issued and outstanding, and there were approximately 275 holders of record. The price range for our common stock for the period from October 1, 2002, to September 30, 2004, based on daily closing prices, and the amounts of dividends we paid during that period, are set forth in the following table.


Period	High	Low	Dividends Paid
October 1, 2002- December 31, 2002	$31.23	$26.20	$0.10 per share

January 1, 2003- March 31, 2003	$31.42	$29.59	$0.10 per share

April 1, 2003- June 30, 2003	$32.12	$26.08	$0.20 per share

July 1, 2003- September 30, 2003	$31.65	$28.76	$0.20 per share

October 1, 2003- December 31, 2003	$38.00	$30.01	$0.20 per share

January 1, 2004- March 31, 2004	$40.75	$37.13	$0.40 per share

April 1, 2004- June 30, 2004	$39.54	$31.98	$0.25 per share

July 1, 2004- September 30, 2004	$36.70	$31.20	$0.25 per share

The stock price information set forth above has been provided by Bloomberg. High, low, and closing prices and daily trading volumes are reported in most major newspapers.

During the years ended September 30, 2003, and September 30, 2004, we have paid dividends in the amounts set forth in the table above. The payment of future dividends will be subject to determination by our board of directors, which will take into account, among other factors, our financial condition, results of operations, tax considerations, industry standards, economic conditions and regulatory restrictions that affect the payment of dividends by CharterBank to Charter Financial. We cannot guarantee that we will not reduce or eliminate dividends in the future.

When Charter Financial pays dividends to its stockholders, it is required to pay dividends to First Charter, MHC, unless First Charter, MHC, elects to waive dividends. To date, First Charter, MHC, has waived dividends paid by Charter Financial. Any decision to waive dividends will be subject to regulatory approval.

Charter Financial is not subject to OTS regulatory restrictions on the payment of dividends. Our ability to pay dividends in the future depends on cash at Charter Financial and income at Charter Financial, including premiums on covered calls and exercises of covered calls on Freddie Mac common stock. It also depends on the amount of funds available from CharterBank. CharterBank must provide the OTS with 30 days notice of its intention to make a capital distribution to Charter Financial. OTS regulations may also limit, in certain circumstances, CharterBank’s ability to make capital distributions. CharterBank made a dividend distribution to Charter Financial in September, 2003, of $2.5 million, which was approved by the OTS.

ITEM 6. SELECTED FINANCIAL DATA

The summary information presented below at September 30 and for each of the years presented is derived in part from the consolidated financial statements of Charter Financial. The following information is only a summary, and you should read it in conjunction with our consolidated financial statements and notes beginning on page F-1.


	At September 30,
	2004		2003		2002		2001		2000
					(In thousands)
Selected Financial Data: (1)
Total assets	$	1,068,201	$	1,000,495	$	982,563	$	894,920	$	920,962
Loans receivable, net(2)		316,151		292,553		208,654		224,591		253,467
Investment and mortgage securities available for sale(3)		400,513		416,061		467,999		326,614		381,590
Freddie Mac common stock & other equity securities		300,430		242,904		260,215		302,623		251,661
Retail deposits		245,464		229,649		173,078		163,982		144,482
Total deposits		279,575		279,386		210,746		200,355		274,371
Deferred income taxes		111,603		88,196		96,040		112,379		92,120
Total borrowings		392,789		388,441		410,963		309,424		352,219
Total retained earnings		63,626		59,190		58,225		56,058		51,029
Accumulated other comprehensive income(4)		180,359		143,941		155,961		180,858		139,900
Total equity		272,500		230,359		249,166		236,916		190,929
Allowance for loan losses		6,623		6,780		5,179		5,290		6,346
Non-performing assets		6,318		5,808		3,683		2,746		3,461
	For the Years Ended September 30,
	2004		2003		2002		2001		2000
					(In thousands)
Selected Operating Data: (1)
Interest and dividend income	$	38,813	$	34,335	$	37,740	$	48,071	$	53,949
Interest expense		17,068		18,805		21,845		31,645		36,647

Net interest income		21,745		15,530		15,895		16,426		17,302
Provision for loan losses		30		25		250		500		1,410

Net interest and dividend income after provision for loan losses		21,715		15,505		15,645		15,926		15,892

Total noninterest income		6,508		5,733		1,939		1,652		1,949
Total noninterest expenses		17,156		18,064		14,200		11,416		15,943

Income before provision for income taxes		11,067		3,174		3,384		6,162		1,898

Income tax expense		2,850		83		484		1,406		1,260

Net income	$	8,217	$	3,091	$	2,900	$	4,756	$	638

Basic earnings per share	$	0.42	$	0.16	$	0.15
Fully Diluted earnings per share	$	0.42	$	0.16	$	0.15
Dividends declared per share	$	1.10	$	0.60	$	0.20

(1)	Reflects assets and liabilities transferred in reorganization on October 16, 2001 and income and expenses related thereto.

(2)	Loans are shown net of deferred loan (fees) costs and allowance for loan losses and exclude loans held for sale.

(3)	Includes all CharterBank investment and mortgage securities available for sale excluding Freddie Mac common stock.

(4)	Consists of unrealized holding gains and losses on Freddie Mac common stock, investments, mortgage-backed securities and collateralized mortgage obligations classified as available for sale, net of income taxes.


	At or for the Years Ended September 30,
	2004		2003		2002		2001		2000
Selected Financial Ratios and Other Data(5):

Performance:
Return on realized assets(6)	1.06	%	0.43	%	0.40	%	0.75	%	0.09	%
Return on average assets	0.79		0.32		0.29		0.50		0.07
Comprehensive return on average assets(7)	4.28		(0.91	)	(2.17	)	4.84		0.59
Return on realized equity(6)	9.16		3.46		2.22		8.54		1.18
Return on average equity	3.23		1.26		.93		1.94		0.38
Comprehensive return on average equity(8)	17.57		(3.64	)	(7.06	)	18.65		3.13
Average equity to average assets	24.35		25.07		30.71		25.96		18.90
Equity to total assets at end of period	25.51		23.02		25.36		26.47		20.73
Average interest rate spread(9)	1.20		0.49		0.10		(0.34	)	0.37
Net interest margin(9)(10)	2.14		1.62		1.67		1.83		1.99
Average interest-earning assets to average interest-bearing liabilities	1.55x		1.57x		1.69x		1.61x		1.38x
Total noninterest expense to average assets	1.64	%	1.85	%	1.40	%	1.24	%	1.78	%
Efficiency ratio(11)	65.92		88.71		76.25		63.15		82.27

Regulatory Capital Ratios:
Tangible capital	9.46		8.78		10.16		9.44		7.49
Core capital	9.46		8.78		10.16		9.44		7.49
Risk-based capital	28.37		27.23		32.67		29.94		26.45

Asset Quality Ratios:
Non-performing loans as a percent of total loans	1.81		1.71		1.41		1.01		1.09
Non-performing assets as a percent of total assets	0.59		0.58		0.38		0.31		0.38
Allowance for loan losses as a percent of total loans	2.05		2.26		2.42		2.30		2.44
Allowance for loan losses as a ratio of non-performing loans	1.12x		1.32x		1.30x		2.28x		2.24x

Number of:
Full-time equivalent employees	181		188		147		130		126

(5)	Asset quality ratios and regulatory capital ratios are end of period ratios.

(6)	Realized assets and equity exclude unrealized gains on available for sale securities. Please see the Ratio Analysis section in the Management’s Discussion and Analysis for further discussion.

(7)

Comprehensive return on average assets represents comprehensive income divided by average assets. We believe that this information is relevant because, in contrast to other financial institutions, a vast majority of Charter Financial’s comprehensive income is in the form of other comprehensive income instead of net income due to Charter Financial’s significant investment in Freddie Mac common stock. Please see the Ratio Analysis section in the Management’s Discussion and Analysis for further discussion.

(8)

Comprehensive return on average equity represents comprehensive income divided by average equity. We believe that this information is relevant because, in contrast to other financial institutions, a vast majority of Charter Financial’s comprehensive income is in the form of other comprehensive income instead of net income due to Charter Financial’s significant investment in Freddie Mac common stock. Please see the Ratio Analysis section in the Management’s Discussion and Analysis for further discussion.

(9)	The net interest spread and net interest margin are significantly impacted by the large balances of Freddie Mac common stock and the low dividend yield on that stock. Please see the net interest margin discussion in Management’s Discussion & Analysis for a discussion of this impact.

(10)	Net interest margin represents net interest income including dividend income from Freddie Mac common stock as a percentage of average interest-earning assets including Freddie Mac common stock.

(11)	The efficiency ratio represents the ratio of operating expenses (excluding certain elements of charitable contributions which relate to appreciation of donated stock) divided by the sum of net interest income and noninterest income less gain on sales of investments.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management Strategy. In recent years, we have adopted a growth-oriented strategy focused on (1) expanding our retail banking operations, (2) managing our Freddie Mac common stock investment while periodically reviewing strategies to increase or realize its value for our shareholders, and (3) effectively managing our capital.

Expanding Retail Banking Operations. Our retail banking strategy is to operate as a well-capitalized community bank dedicated to providing quality products, excellent service, and a superior customer experience at competitive prices. We have sought to implement this strategy by concentrating on our core product offerings, including residential and commercial mortgage loans and a variety of checking and saving products, while at the same time broadening our product lines and services, expanding delivery systems for our customers, and filling in our branch network.

Our current market includes the I-85 corridor from LaGrange, Georgia to Auburn, Alabama, including the economic communities of LaGrange, Georgia, Auburn-Opelika, Alabama and the Valley area which includes West Point, Georgia, and Lanett and Valley, Alabama. The Valley area is our historical home base. Based on data from the FDIC, as of June 30, 2004 we have 48% of the bank deposits in the Valley market, approximately 5% deposit market share in the Auburn-Opelika market and 7% deposit market share in the LaGrange market. Only one competitor has branches in all three of these markets. We have 13% of the combined deposit market share which is the second largest market share of any bank in these markets. Our competitors in the top five of deposit market share each compete in only one of the three markets. There are a significant number of customers and potential customers that live in one of these markets and work in another. Auburn-Opelika, and to a lesser extent LaGrange, have stronger economies and more growth potential than the Valley market. We currently have under development two branches in Auburn-Opelika and one branch in LaGrange. We are focusing on increasing our market share in these markets before expanding geographically.

Historically we have focused on the consumer with one-to-four family mortgage loans and Certificates of Deposit. We are continuing our consumer focus with one-to-four family mortgages, consumer loans to credit-worthy borrowers, and a full menu of core deposit products. Our core deposits have increased to 52.7% of our total retail deposits from the traditional thrift deposit base that was almost exclusively non-core deposits. We are expanding our customer base to include credit worthy small businesses and commercial real estate loans.

We seek to:

•

Improve customer service and convenience as a means to compete for an increased share of our customers’ financial service business;

•

Expand our retail banking franchise and our market share by increasing the number of households and the share of wallet of current households served within our market area;

•

Continue to expand our market coverage by taking advantage of opportunities to build or acquire branches or acquire delivery systems within our target market;

•

Improve customer use of our existing alternative delivery channels, such as ATMs, Internet banking and telephone banking: and

•

Expand our offerings to businesses by focusing our commercial loan and deposit products and services as a means to increase the yield on our loan portfolio, to attract lower cost deposit accounts and increase non-interest income through related fees.

We train our employees in providing outstanding quality service to customers as well as in the technical aspects of their jobs.

A significant component of expanding our retail franchise is improving the communities we serve. The Charter Foundation plays a major role in implementing change in our markets. The Charter Foundation was created in 1994 and endowed by CharterBank’s members with an initial gift of $1 million of Freddie Mac common stock. Subsequent gifts from CharterBank plus proceeds from the Foundation’s investments have put the Foundation’s corpus at approximately $7 million. The annual grant budget, which is a minimum of 5% of the Foundation’s average assets, now totals approximately $400,000. This is $400,000 with which The Charter Foundation, Inc. can make gifts to improve the quality of life in areas served by CharterBank. In 2002, The Charter Foundation, Inc. incorporated a member-voting component into the grant program. In June and July of each year, CharterBank’s customers in each market have an opportunity to vote for three $5,000 grants to be given in their community. This program is designed to more closely tie the Foundation and the Bank in the minds of customers and the general public. Since its inception in 1994, The Charter Foundation has awarded more than $2.5 million in grants in the communities served by CharterBank.

Another community development activity geared to expanding the retail franchise is the Honors Savings Club program. This program, currently available to students in all public high schools in Troup County, Georgia, and Chambers County, Alabama, pays students for making all A’s in a given semester. There is also a $500 bonus opportunity for the class Valedictorian, and a $500 bonus opportunity for any student who makes all A’s for all 4 years. To receive the award, each student must open an account at CharterBank, with one of the goals of the program being to cement a banking relationship with these students while they are young. Other goals are to reward academic excellence and to try to combat peer pressure that says it is not “cool” to be smart. Since its inception in 1996, more than $450,000 has been earned by students making all A’s. This program, while bearing the CharterBank name, is funded from First Charter, MHC.

Managing Our Freddie Mac Common Stock Investment. We manage our Freddie Mac common stock in several ways. Over the past ten years our total annual return on Freddie Mac

common stock has averaged 18.81%. Dividends on our Freddie Mac common stock are an important component of our shareholder value. Freddie Mac dividends exceed $0.30 per Charter Financial share, or over $1.30 per Charter Financial minority share. Seventy percent of the Freddie Mac dividends are excluded from Charter Financial’s taxable income through the corporate dividends received exclusion. The Freddie Mac dividend, when combined with the 70% corporate dividend exclusion and the 15% personal tax rate reduction on dividends received by individuals, creates a tax efficient means for our stockholders to receive value from our Freddie Mac common stock investment. Also, the dividend waiver by First Charter, MHC, where only our minority shareholders receive dividends, adds significant value to our minority shareholders.

In 2003, we implemented a program of selling covered calls on the Freddie Mac common stock as a means of enhancing the returns on this investment. The holders of the call options exercised their call on 35,000 shares in fiscal 2004 and 15,000 shares in 2003 resulting in the sale of these shares. The sales resulted in gain on the sale of stock of $2.1 million and $773,000 in fiscal 2004 and 2003, respectively. The call program resulted in net call premiums of $149,000 and $52,000 in 2004 and 2003, respectively. The net call premiums have been lower than we anticipated due to higher costs of repurchasing call options in lieu of allowing the exercise of the call options resulting in the sale of the underlying stock. In the fifteen month period during which we have been writing calls, the underlying stock has appreciated from $50.77 per share to $65.24 per share. This has resulted in more repurchases than in a lower level of appreciation. We continue to review this investment in Freddie Mac common stock in light of existing conditions and what is in the best interests of our shareholders.

Managing our Capital. The third major component of our strategy is capital management. We increased our capital leverage with the additional retail assets and deposits acquired in the Eagle Bank acquisition. While our current retail focus is increasing market share within our existing markets, we regularly evaluate expanding our capital leverage by extending the market area through de novo branching or acquisitions. We maintained our wholesale leverage of mortgage securities and borrowings. Wholesale leverage generally enhances income, but not franchise value, and thus is a low priority capital management tool. During the third fiscal quarter of 2004 we increased our quarterly dividend from 20 cents to 25 cents per share. We also paid a special dividend of 20 cents per share in addition to our regular quarterly dividend during March 2004. Our capacity to pay dividends is enhanced by First Charter, MHC’s willingness to waive receipt of its portion of the dividends. We continue to evaluate our dividend policy and the appropriateness of special dividends or share repurchases.

General. Charter Financial Corporation is the mid-tier holding company and the sole shareholder of CharterBank. In October 2001, Charter Financial was formed in connection with the conversion of the Bank from mutual to stock form (“Conversion”). At that time, the Company issued 80% or 15,857,924 shares of its common stock to First Charter, MHC (“MHC”). The Conversion, the offering of stock to depositors, and the issuance of Company stock to the MHC are referred to collectively as the “reorganization”. As a result of the reorganization, the Bank converted to a federally chartered savings bank and became a wholly-owned subsidiary of the Company, which is majority owned by the MHC, a federally chartered mutual holding company. Charter Financial’s common stock is traded on the NASDAQ National Market under the symbol “CHFN”. All references to Charter Financial prior to October 16, 2001, except where otherwise indicated, are to CharterBank.

Our principal business is attracting deposits from the general public and investing those funds primarily in real estate loans. We also own 4.6 million shares of Freddie Mac common stock with an after tax unrealized gain of $180.6 million. While our primary businesses are the collecting of deposits from the general public and investing those funds in real estate loans, we also make consumer, construction and commercial loans and invest in mortgage-related and investment securities.

The Company’s results of operations are primarily dependent on our net interest income, which is the difference between the interest and dividend income we earn on loans, mortgage related securities and investments, and the interest expense we pay on deposits and borrowings. Our net interest income is affected by economic, competitive and regulatory factors that influence interest rates, loan demand and deposit flows. In addition, we, like other savings institution holding companies, are subject to interest rate risk to the degree that our interest- earning assets mature, prepay or reprice at different times, or on a different basis, than our interest-bearing liabilities.

Our results of operations are also affected by, among other things, the level of operating expenses, fee income received, gains or losses on the sale of Freddie Mac common stock or other securities, gains or losses on loans held for sale, the establishment of provisions for losses on loans, and income taxes. Our operating expenses principally consist of employee compensation and benefits, occupancy expenses, professional services, federal deposit insurance premiums, marketing expenses and other general and administrative expenses.

The Company is significantly affected by prevailing economic conditions including federal monetary and fiscal policies and federal regulation of financial institutions. Deposit balances are affected by a number of factors including interest rates paid on competing personal investments, the level of personal income and the personal rate of savings within our market area. Lending activities are influenced by the demand for housing as well as competition from other lending institutions. The primary sources of funds for lending activities include deposits, loan repayments, borrowings and funds provided from operations.

Effective February 2003, Charter Financial acquired all of the outstanding shares of EBA Bancshares, Inc., Opelika, Alabama, and its wholly-owned banking subsidiary, Eagle Bank of Alabama, for a purchase price of approximately $8.6 million cash. The acquisition added three branches in the growing Auburn-Opelika area of Alabama, home of Auburn University, with $55.3 million in loans and $60.7 million in retail deposits.

The table below shows our quarterly operating results for the past eight quarters.


	2004											2003
	4^th qtr.			3^rd qtr.		2^nd qtr.			1^st qtr.			4^th qtr.			3^rd qtr.		2^nd qtr.		1^st qtr.
	(In thousands)
Interest and dividend income	$	10,239			9,662		9,443			9,469		$	8,824			8,545		8,384		8,583
Interest expense		4,549			4,203		4,023			4,293			4,479			4,594		4,712		5,021

Net interest and dividend income		5,690			5,459		5,420			5,176			4,345			3,951		3,672		3,562
Provision for loan losses		—			—					30			25			—		—		—
Net interest and dividend income after provision for loan losses		5,690			5,459		5,420			5,146			4,320			3,951		3,672		3,562

Noninterest income (loss)		1,987	*		1,130		1,844	*		1,547	*		2,124	*		1,468		1,128		1,175
Noninterest expense		4,361			4,113		4,283			4,399			4,658			4,795		4,600		4,174

Income before provision for income taxes		3,316			2,476		2,981			2,294			1,786			624		200		563

Income tax expense (benefit)		892			605		775			578			(98	)**		80		36		64

Net income	$	2,424		$	1,871	$	2,206		$	1,716		$	1,884		$	544	$	164	$	499

*	Includes the sale of Freddie Mac common stock related to the covered call program resulting in a gain of approximately $773,368, $532,742, $592,280, and $988,315 for quarters ending September 2003, December 2003, March 2004 and September 2004 respectively.

**	Includes the interaction of the Freddie Mac common stock sale with the exclusion of the Freddie Mac common stock dividends from income taxes resulting in an income tax benefit for the quarter.

Capital and Capital Management. CharterBank has traditionally been a well-capitalized savings bank, due, among other factors, to our unrealized gains on Freddie Mac common stock. At September 30, 2004 and 2003, we exceeded each of the applicable regulatory capital requirements. Our tier 1 capital was $72.3 million and $66.4 million at September 30, 2004 and 2003, respectively. Tier 1 capital represented 14.19% and 13.80% of risk-weighted assets at September 30, 2004 and 2003, respectively. Tier 1 capital represented 9.46% and 8.78% of total regulatory assets at September 30, 2004 and 2003, respectively, which exceeds the well-capitalized requirements of 5.0%. At September 30, 2004 and 2003, respectively, we had total risk-based capital of $144.6 million and $131.0 million and risk-based capital ratios of 28.37% and 27.23%, which significantly exceeds the applicable well-capitalized requirements of 10%. CharterBank exceeded its various regulatory capital requirements by amounts ranging from $41.7 million to $103.8 million at September 30, 2004.

The Company maintains the Recognition and Retention Plan which provides for restricted stock awards of Company common stock and the Stock Option Plan which provides for the grant of stock options to acquire Company common stock. The Recognition and Retention Plan holds shares available for award in a trust and completed the acquisition of the shares available for award under this plan during fiscal 2003. There were 133,240 shares and 77,598 shares granted under the Recognition and Retention Plan in July 2002 and July 2004, respectively. As of September 30, 2004, there are 227,031 shares under the Recognition and Retention Plan that are accounted for as treasury stock at a cost of $7.1 million. The Stock Option Plan may issue a maximum of 707,943 shares pursuant to options. As of September 30, 2004, the Stock Option Plan has granted options to acquire a total of 290,250 shares.

We paid regular dividends of $.20 per share in December 2003 and March 2004 and $0.25 per share in June and September 2004, and a special dividend of $0.20 in March 2004. We have declared a dividend of $.25 per share payable in January 2005. First Charter, MHC has waived its portion of these dividends. The Board of Directors will determine future dividends as well as other capital management strategies such as additional leverage, stock repurchases and special dividends. The Board of Directors will consider, among other factors, capital levels, results of operations, tax considerations, regulatory and regulatory business plan considerations, industry standards and economic conditions in determining such future dividends.

Critical Accounting Policies. In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies used in preparing our consolidated financial statements.

These policies are described in Note 1 to the consolidated financial statements. Also please see “Asset Quality” on page 14 for a further discussion of the Company’s methodology in determining the allowance. The accounting and financial reporting policies of Charter Financial Corporation conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as one of the most critical accounting policies that requires difficult subjective judgment and is important to the presentation of the financial condition and results of operations of the Company.

The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that management believes will be adequate to absorb losses on existing loans that become uncollectible, based on evaluations of the collectibility of loans. The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to repay.

The Company segments its allowance for loan losses into the following four major categories: 1) specific reserves; 2) general reserves for Classified/Watch loans; 3) general reserves for loans with satisfactory ratings; and 4) an unallocated amount. Risk ratings are initially assigned in accordance with CharterBank’s loan and collection policy. An organizationally independent department reviews risk grade assignments on an ongoing basis. Management reviews current information and events regarding a borrowers’ financial condition and strengths, cash flows available for debt repayment, the related collateral supporting the loan and the effects of known and expected economic conditions. When the evaluation reflects a greater than normal risk associated with the individual loan, management classifies the loan accordingly. If the loan is determined to be impaired, management allocates a portion of the allowance for loan losses for that loan based on the fair value of the collateral as the measure for the amount of the impairment. Impaired and Classified/Watch loans are aggressively monitored. The reserves for loans rated satisfactory are further subdivided into various types of loans as defined by loan type. The Company has developed specific quantitative reserve factors to apply

to each individual component of the reserve. These quantitative reserve factors are based upon economic, market and industry conditions that are specific to the Company’s local markets. These quantitative reserve factors consider, but are not limited to, national and local economic conditions, bankruptcy trends, unemployment trends, loan concentrations, dependency upon government installations and facilities, and competitive factors in the local market. These allocations for the quantitative reserve factors are included in the various individual components of the allowance for loan losses. In addition we use some qualitative reserve factors that are subjective in nature and require considerable judgment on the part of the Bank’s management. However, it is the Bank’s opinion that these items do represent uncertainties in the Bank’s business environment that must be factored into the Bank’s analysis of the allowance for loan losses. The unallocated component of the allowance is established for losses that specifically exist in the remainder of the portfolio, but have yet to be identified.

While management uses available information to recognize losses on loans, future additions or reductions to the allowance may be necessary based on changes in economic conditions or changes in accounting guidance on reserves. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the Bank to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

Management believes that the allowance for loan losses is adequate. The Company has 91.8% of its loan portfolio secured by real estate loans, with one-to-four family real estate comprising 44.0% of the total loan portfolio. Commercial real estate comprises 37.0% of the loan portfolio. Construction and development loans comprise 6.6% of the real estate loan portfolio. The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions. The residential category represents those loans the Company chooses to maintain in its portfolio rather than selling into the secondary market. The residential loans held for sale category comprises loans that are in the process of being sold into the secondary market. The credit has been approved by the investor and the interest rate and purchase price locked so the Company takes no credit or interest rate risk with respect to these loans. The Company’s largest individual funded loan exposure is a commercial real estate loan with a balance of $6.2 million at September 30, 2004. Our largest industry exposure is the hotel industry with approximately $20.3 million in loans, which includes a $6.6 million committed loan which is only partially funded. Only 6.0% of the Company’s portfolio consists of consumer loans, while 6.4% consists of commercial non-real estate loans.

Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale are reported at fair value, as determined by independent quotations. Purchase premiums and discounts on investment securities are amortized and accreted to interest income using a method that approximates a level yield over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities and collateralized mortgage obligations are amortized and accreted to interest income using the interest method over the remaining lives of the securities, taking into consideration assumed prepayment patterns.

The Company receives a dividends received deduction for tax purposes on dividend income from our investment in Freddie Mac common stock. This deduction is the lesser of 70% of dividends received or 70% of taxable income before the dividends received deduction. Since the Company does not file a consolidated tax return, this determination is made at the individual entity level. At September 30, 2004, the tax provision was based on a deduction of 70% of dividends received.

Also, goodwill and core deposit premiums are evaluated annually for impairment in accordance with SFAS No. 142 and SFAS No. 144. The evaluation of impairment is a critical accounting policy due to the subjective nature of the calculation and the assumptions used. Deposit premiums are amortized over the life of up to 13 years determined in the independent evaluation made as part of the purchase accounting determinations.

Management of Interest Rate Risk. As a financial institution, we face risk from interest rate volatility. Fluctuations in interest rates impact both our level of income and expense on a large portion of our assets and liabilities. Fluctuations in interest rates also affect the market value of all interest-earning assets.

The primary goal of our interest rate risk management strategy is to maximize net interest income while maintaining an acceptable profile. We seek to coordinate asset and liability decisions so that, under changing interest rate scenarios, portfolio equity and net interest income remain within an acceptable range.

Our lending activities have emphasized one-to-four family and commercial real estate loans. Our sources of funds include retail deposits, FHLB advances, repurchase agreements and wholesale deposits. Retail deposits consist primarily of Certificates of Deposit, which have shorter terms to maturity than the loan portfolio, and transaction accounts. We employ several strategies to manage the interest rate risk inherent in the asset/liability mix, including but not limited to:

•

selling the 30 year fixed rate mortgages we originate to the secondary market, generally on a servicing released basis;

•

maintaining the diversity of our existing loan portfolio through the origination of commercial real estate and consumer loans which typically have variable rates and shorter terms than residential mortgages;

•

emphasizing investments with adjustable interest rates;

•

maintaining fixed rate borrowings from the FHLB; and

•

increasing retail transaction deposits which typically have long durations.

The actual amount of time before loans are repaid can be significantly impacted by changes in market interest rates. Prepayment rates also vary due to a number of other factors, including the regional economy in the area where the loans were originated, seasonal factors, demographic variables, the assumability of the loans, related refinancing opportunities and competition. We monitor interest rate sensitivity so that we can attempt to adjust our asset and liability mix in a timely manner and thereby minimize the negative effects of changing rates.

Historically, we believed our high level of capital allowed us to support a high level of interest rate risk which enhanced our long term income at the cost of increased volatility in the income stream. During fiscal 2001, we reduced our interest risk profile by selling fixed rate mortgage securities and replacing variable rate borrowings with fixed rate borrowings. These actions moved the Company from being significantly liability sensitive, or having net income and net portfolio benefit from lower interest rates, to being modestly asset sensitive. During 2003, record levels of mortgage securities and loans were prepaid by borrowers in response to a decline in interest rates. Prepayments of fixed rate loans and securities eliminated the positive spread between these assets and the fixed rate borrowings and thus negatively affected our net interest income. These borrowings continued to be high cost in 2004 and continued to negatively impact our net interest income. Fiscal 2003 net interest income was also negatively impacted by the amortization of premiums on mortgage securities. Extension risk, or lower prepayments causing longer average lives, is our primary exposure to higher interest rates. Faster prepayment of loans and securities providing cash for reinvestment at lower interest rates creating a lower net interest income is our primary exposure to lower interest rates.

Interest Risk Simulation. We use a simulation model to monitor interest rate risk. An analysis is performed on changes in net interest income assuming changes in interest rates, both up and down 100, 200 and 300 basis points from current rates over the one year time period following the current financial statement. However, with certain interest rates currently at 2.00%, decreases of 200 and 300 basis points in our simulation model do not provide meaningful information.

The table following sets forth, as of September 30, 2004, the estimated changes in net portfolio value that would result from changes in interest rates as indicated over the applicable twelve-month period.


Net Portfolio Value
Change In Rates	% Change		Post Shock Capital Ratio
+300 bp	(15.79	)%	21.48	%
+200 bp	(9.77	)%	23.02	%
+100 bp	(4.79	)%	24.29	%
0 bp	0.00	%	25.51	%
-100 bp	(0.55	)%	25.37	%

The net portfolio value is the capital, the excess of assets over liabilities, after all assets and liabilities are marked to market. The net portfolio value decreases as interest rates increase because fixed rate loans and securities decline in value with the increase in rates. The net portfolio value also decreases as interest rates decrease because fixed rate loans and mortgage securities have a borrower option to prepay so the assets do not gain significantly in value as rates decline. Freddie Mac common stock is held at a constant value through the interest rate

shocks. The disparate result on net portfolio value of interest rate increases versus interest rate decreases is sometimes referred to as negative convexity and is the result of embedded options in mortgage securities, loans and borrowings. The post shock capital ratio is the post shock net portfolio value as a percent of total assets.

The effects of interest rates on net portfolio value and net interest income are not predictable. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, prepayments, and deposit run-offs, and should not be relied upon as indicative of actual results. Certain shortcomings are inherent in these computations. Although some assets and liabilities may have similar maturity or periods of repricing, they may react at different times and in different degrees to changes in the market interest rates. Rates on other types of assets and liabilities may lag behind changes in market interest rates. Assets, such as adjustable rate mortgages, generally have features that restrict changes in interest rates on a short-term basis and over the life of the asset. After a change in interest rates, prepayments and early withdrawal levels could deviate significantly from those assumed in making the calculations set forth above. Additionally, increased credit risk may result if our borrowers are unable to meet their repayment obligations as interest rates increase. The following gap table summarizes the anticipated maturities or repricing of CharterBank’s interest-earning assets and interest-bearing liabilities as of September 30, 2004, based on the information and assumptions set forth in the notes that follow.


At September 30, 2004 (Dollars In thousands)	Within Three Months			Three to Twelve Months			More Than One Year to Three Years			More Than Three Years to Five Years			Over Five Years			Total
Interest-earning assets:
Loans (1) (2)	$	110,563		$	69,715		$	66,282		$	35,421		$	43,136		$	325,117
Mortgage related securities(2)		80,667			45,028			85,020			97,977			69,956			378,648
Investment securities(3)		2,000			—			5,000			6,300			9,039			22,339
Other securities		—			—			—			—			3,551			3,551
Interest-bearing deposits		1,243			—			—			—			—			1,243
Other interest-earning assets		—			—			—			—			14,842			14,842

Total interest-earning assets	$	194,473		$	114,743		$	156,302		$	139,698		$	140,524		$	745,740

Interest-bearing liabilities:

Certificates of Deposit	$	31,514		$	73,083		$	39,874		$	11,306		$	250		$	156,027
Money market accounts (4)		8,753			41,168			10,146			—			—			60,067
NOW accounts (4)		33,906			—			—			—			—			33,906

Savings accounts (4)		—			—			8,988			2,996			2,996			14,980
Borrowed funds (5)		140,789			—			100,000			25,000			127,000			392,789

Total interest-bearing liabilities	$	214,962		$	114,251		$	159,008		$	39,302		$	130,246		$	657,769

Period gap	$	(20,489	)	$	492		$	(2,706	)	$	100,396		$	10,278		$	87,971

Cumulative gap	$	(20,489	)	$	(19,997	)	$	(22,703	)	$	77,693		$	87,971

Cumulative gap as a percentage of total assets		(2.19	)%		(2.14	)%		(2.43	)%		8.32	%		9.42	%

(1)

Adjustable-rate loans are included in the period in which the rate is next scheduled to adjust, rather than in the period in which the loans are due, or in the period in which repayments are expected to occur prior to their next rate adjustment, and fixed-rate loans are included in the periods in which they are scheduled to be repaid, based on scheduled amortization. Both fixed and adjustable rate loans are adjusted to take into account estimated prepayments in assessing their interest rate sensitivity.

(2)	Reflects estimated prepayments in the current interest rate environment.

(3)	Based on contractual maturities and if applicable, call dates.

(4)

Although our money market accounts, NOW accounts and savings accounts are subject to immediate withdrawal, management considers a substantial amount of such accounts to be core deposits having significantly longer effective maturities. The decay rates used on these accounts are based on management’s estimates and should not be regarded as indicative of the actual withdrawals that may be experienced by us.

(5)	Conversion features are not assumed to be exercised.

The preceding table indicates that we have more liabilities that reprice than assets in the next three years, after which we have more assets that reprice than liabilities. This normally indicates that our net interest income should benefit from lower rates in the short term and higher rates in the longer term. The gap table should be used in conjunction with the portfolio equity analysis. Each method of analysis provides a different analysis of interest risk and at times each has strengths and weaknesses. The gap table uses loan repricings based on current interest rates and thus probably indicates earlier repricings than would actually occur if interest rates were higher and later repricings than would actually occur if rates were lower.

Average Balance Sheet and Analysis of Net Interest Income. The following tables depict the significant effect of the Freddie Mac common stock on our traditional bank ratios, such as net interest income, net interest rate spread, and net interest margin. The tables show these measures with and without the effects of the Freddie Mac common stock. Freddie Mac common stock had a dividend return on cost basis of approximately 86.2% at September 30, 2004. However, the dividend yield on the market value of the Freddie Mac common stock was 1.94%. The appreciation over time in the market value of the Freddie Mac common stock has created our strong accumulated other comprehensive income.

Overall, ratios have improved for the year ended September 30, 2004, compared to the year ended September 30, 2003, due to less amortization of premiums on mortgage securities, a larger proportion of loans to total assets, lower borrowing costs, lower Certificate of Deposit rates and a higher proportion of low cost core deposits. During 2000 and 2001, we borrowed $127 million in long-term fixed rate FHLB advances which limited the decrease in the average cost of borrowings to 41 basis points from 2003 to 2004. However, yield on mortgage-related investments increased by 69 basis points in 2004 as the amortization of premiums decreased. The yield on loans receivable also decreased 70 basis points. The yield on Freddie Mac common stock increased from 1.80% to 1.94% as the impact of the increased dividend rate was partially offset by the higher market value. The cost of deposits decreased 57 basis points from 2.39% in 2003 to 1.82% in 2004. The decrease in the cost of deposits is due to overall lower interest rates, a higher proportion of lower cost transaction accounts and a balance-tiered Certificate of Deposit pricing strategy implemented during 2002. The combination of these rate changes increased the overall net interest margin by 52 basis points from 1.62% for the year ended September 30, 2003 to 2.14% for the year ended September 30, 2004. The increase in the yield on Freddie Mac common stock, the increase in the yield on mortgage securities, the increased loan balances, and the reduced costs of borrowings and deposits were only partially offset by the reduced yield on loans.

In the following tables, we derived the yields and costs by dividing income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods shown. We derived average balances from actual daily balances over the periods indicated. Interest income includes the recognition of certain fees over the lives of the underlying loans.


	At September 30, 2004
	Actual Balance		Yield/Cost
Assets:
Interest-earning assets:
Interest-bearing deposits in other financial institutions	$	2,243	1.81	%
FHLB common stock		14,843	3.50	%
Mortgage-backed securities and collateralized mortgage obligations available for sale		378,357	4.07	%
Other investment securities available for sale		22,157	2.81	%
Loans receivable		323,547	5.81	%

Total interest-earning assets excluding Freddie Mac common stock		741,147	4.77	%
Freddie Mac common stock		300,430	1.84	%

Total interest-earning assets including Freddie Mac common stock		1,041,577	3.93	%
Total noninterest-earning assets		26,624	—

Total assets	$	1,068,201	3.83	%

Liabilities and Stockholders’ Equity:
Interest-bearing liabilities:
NOW accounts	$	39,692	0.55	%
Savings accounts		14,980	0.25	%
Money market deposit accounts		50,066	1.65	%
Certificates of Deposit accounts		150,225	2.84	%

Total interest-bearing deposits		254,963	2.10	%
Borrowed funds		392,789	3.52	%

Total interest-bearing liabilities		647,752	2.96	%

Noninterest-bearing deposits		24,612	—
Other noninterest-bearing liabilities		123,337	—

Total noninterest-bearing liabilities		147,949	—

Total liabilities		795,701	2.41	%
Total stockholders’equity		272,500

Total liabilities and stockholders’ equity	$	1,068,201


	For the Years Ended September 30,
	2004							2003							2002
	Average Balance			Interest		Average Yield/ Cost		Average Balance			Interest		Average Yield/ Cost		Average Balance			Interest		Average Yield/ Cost
	(Dollars in thousands)
Assets:
Interest-earning assets:
Interest-bearing deposits in other financial institutions	$	3,651		$	61	1.67	%	$	7,315		$	98	1.34	%	$	4,013		$	79	1.97	%
FHLB common stock and other equity securities		13,051			457	3.50			13,424			563	4.19			13,623			769	5.64
Mortgage-backed securities and collateralized mortgage obligations available for sale		396,992			14,369	3.62			405,937			11,883	2.93			400,525			15,473	3.86
Other investment securities available for sale		17,065			488	2.86			13,096			442	3.38			13,467			513	3.81
Loans receivable(1)		311,480			18,080	5.80			256,792			16,694	6.50			215,632			16,903	7.84

Total interest-earning assets excluding Freddie Mac common stock		742,239			33,455	4.51			696,564			29,680	4.26			647,260			33,737	5.21
Freddie Mac common stock		275,981			5,358	1.94			259,242			4,655	1.80			302,149			4,003	1.32

Total interest-earning assets including Freddie Mac common stock		1,018,220			38,813	3.81			955,806			34,335	3.59			949,409			37,740	3.98
Total non-interest-earning assets		25,349			—	—			22,586			—	—			64,384			—	—

Total assets	$	1,043,569		$	38,813			$	978,392		$	34,335			$	1,013,793		$	37,740

Liabilities and Equity:
Interest-bearing liabilities:
NOW accounts	$	37,831			190	0.50			27,010			194	0.72			18,006			176	0.98
Savings accounts		14,762			39	0.26			12,684			63	0.50			8,848			80	0.90
Money market deposit accounts		45,583			646	1.42			30,967			417	1.35			22,049			349	1.58
Certificates of Deposit accounts		164,897			3,910	2.37			163,880			4,933	3.01			146,779			6,221	4.24

Total interest-bearing deposits		263,073			4,785	1.82			234,541			5,607	2.39			195,682			6,826	3.49
Borrowed funds		391,858			12,283	3.13			372,791			13,199	3.54			367,329			15,019	4.09

Total interest-bearing liabilities		654,931			17,068	2.61			607,332			18,806	3.10			563,011			21,845	3.88
Noninterest-bearing deposits		22,300				—			16,526			—	—			10,407			—	—
Other noninterest-bearing liabilities		112,252			—	—			109,259			—	—			129,005			—	—

Total noninterest-bearing liabilities		134,552			—	—			125,785			—	—			139,412			—	—

Total liabilities		789,483			17,068	2.16			733,117			18,806	2.57			702,423			21,845	3.11
Total stockholders’ equity		254,086			—	—			245,275			—	—			311,370			—	—

Total liabilities and stockholders’ equity	$	1,043,569		$	17,068			$	978,392		$	18,806			$	1,013,793		$	21,845

Net interest income, including Freddie Mac common stock				$	21,745						$	15,529						$	15,895

Net interest rate spread, including Freddie Mac common stock(2)						1.20	%						0.49	%						0.10	%
Net interest margin, including Freddie Mac common stock(3)						2.14	%						1.62	%						1.67	%
Ratio of interest-earning assets to average interest-bearing liabilities, including Freddie Mac common stock		155.47	%						157.38	%						168.63	%
Net interest income excluding Freddie Mac common stock dividends				$	16,387						$	10,874						$	11,892

Net interest rate spread excluding Freddie Mac common stock(4)						1.90	%						1.16	%						1.33	%
Net interest rate margin excluding Freddie Mac common stock (5)						2.21	%						1.56	%						1.84	%
Ratio of interest-earning assets to average interest-bearing liabilities, excluding Freddie Mac common stock		113.33	%						114.69	%						114.96	%

(1)	Interest income on loans is interest income as recorded in the income statement and therefore does not include interest income on non-accrual loans.

(footnotes on following page)

(2)	Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest bearing liabilities.

(3)	Net interest margin represents net interest income as a percentage of average interest-earning assets.

(4)	Net interest rate spread excluding Freddie Mac common stock represents the difference between the weighted average yield on total interest-earning assets excluding Freddie Mac common stock and the weighted average cost of interest-bearing liabilities.

(5)	Net interest margin excluding Freddie Mac common stock represents net interest income excluding Freddie Mac common stock dividends as a percentage of average interest-earning assets excluding Freddie Mac common stock.

(6)	Tax exempt or tax advantaged securities are shown at their contractual yields and are not shown at a tax equivalent yield.

The following tables show our net interest spread and margin with and without Freddie Mac common stock and the dividends on that stock.


	Year Ended September 30,
	2004		2003		2002
Net interest spread including Freddie Mac common stock	1.20	%	0.49	%	0.10	%
Net interest spread excluding Freddie Mac common stock	1.90		1.16		1.33

Difference attributable to Freddie Mac common stock	(0.70	)%	(0.67	)%	(1.23	)%
	2004		2003		2002
Net interest margin including Freddie Mac common stock	2.14	%	1.62	%	1.67	%
Net interest margin excluding Freddie Mac common stock	2.21		1.56		1.84

Difference attributable to Freddie Mac common stock	(0.07	)%	0.06	%	(0.17	)%

Rate/Volume Analysis. The following table shows how changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the periods indicated. Information is provided in each category with respect to:

•

interest income changes attributable to changes in volume (changes in volume multiplied by prior rate);

•

interest income changes attributable to changes in rate (changes in rate multiplied by prior volume); and

•

the net change.


	Year Ended September 30, 2004 Compared to Year Ended September 30, 2003 Increase/(Decrease)												Year Ended September 30, 2003 Compared to Year Ended September 30, 2002 Increase/(Decrease)
	Due to												Due to
	Volume			Rate			Combined			Net			Volume			Rate			Combined			Net
	(In thousands)
Interest-earning assets:
Interest-bearing deposits in other financial institutions	$	(49	)	$	24		$	(12	)	$	(37	)	$	65		$	(25	)	$	(21	)	$	19
FHLB common stock and other equity securities		(16	)		(93	)		3			(106	)		(9	)		(199	)		2			(206	)
Mortgage-backed securities and collateralized mortgage obligations available for sale		(262	)		2,810			(62	)		2,486			209			(3,748	)		(51	)		(3,590	)
Other investment securities available for sale		134			(67	)		(20	)		47			(14	)		(58	)		2			(71	)
Loans receivable		3,555			(1,788	)		(381	)		1,386			3,226			(2,886	)		(550	)		(209	)

Total interest-earning assets		3,362			886			(472	)		3,776			3,477			(6,916	)		(618	)		(4,057	)

Freddie Mac common stock(1)		(44	)		752			(5	)		703			(569	)		1,423			(202	)		652

Total interest-earning assets and Freddie Mac common stock	$	3,318		$	1,638		$	(477	)	$	4,479		$	254		$	(3,635	)	$	(24	)	$	(3,405	)

Interest-bearing liabilities:
NOW accounts	$	77		$	(58	)	$	(23	)	$	(4	)	$	88		$	(47	)	$	(23	)	$	18
Savings accounts		10			(29	)		(5	)		(24	)		35			(36	)		(16	)		(17	)
Money market deposit accounts		197			22			10			229			141			(52	)		(21	)		68
Certificates of Deposit		31			(1,047	)		(6	)		(1,022	)		725			(1,803	)		(210	)		(1,288	)

Total interest-bearing deposits		315			(1,112	)		(24	)		(821	)		989			(1,938	)		(270	)		(1,219	)
Borrowed funds		675			(1,514	)		(77	)		(916	)		223			(2,013	)		(30	)		(1,820	)

Total interest-bearing liabilities	$	990		$	(2,626	)	$	(101	)	$	(1,737	)	$	1,212		$	(3,951	)	$	(300	)	$	(3,039	)

Change in net interest income including Freddie Mac common stock	$	2,328		$	4,264		$	(376	)	$	6,216		$	2,265		$	(2,965	)	$	(318	)	$	(1,018	)

(1)	The rate/volume table shows the changes resulting from both rate and volume in the combined column in lieu of allocating this amount to the rate and volume columns.

Comparison of Financial Condition at September 30, 2004 and 2003. Our total assets increased $67.7 million, or 6.77%, to $1.1 billion at September 30, 2004, from $1.0 billion at September 30, 2003. The increase was primarily due to increases in loans receivable and the market value of Freddie Mac common stock. Total loans increased $23.7 million, or 7.89%, to $323.5 million at September 30, 2004.

The one-to-four family residential real estate portfolio increased by $8.9 million, or 6.71%, to $142.3 million at September 30, 2004. The consumer and other loan portfolio decreased $93,000 or .48% from September 30, 2003, to $19.6 million at September 30, 2004. The decrease in the consumer portfolio was primarily the result of reductions in second mortgage loans due to refinancings. Commercial real estate and other commercial loans increased by $7.4 million to $140.2 million during fiscal 2004, and real estate construction loans also increased by $7.4 million to $21.5 million during the year.

Our mortgage-backed securities and collateralized mortgage obligations decreased from $394.4 million at September 30, 2003, to $378.4 million at September 30, 2004, a decrease of $16.0 million or 4.08%. The market value of Freddie Mac common stock increased $57.5 million, or 23.68%, from $242.9 million at September 30, 2003, to $300.4 million at September 30, 2004.

Total deposits increased from $279.4 million at September 30, 2003, to $279.6 million at September 30, 2004. Core deposits increased by $29.8 million while Certificates of Deposits decreased $29.6 million.

For the foreseeable future, we intend to continue to rely on borrowings, especially Federal Home Loan Bank advances and repurchase agreements, to fund the securities portfolios and loans to the extent that loan growth exceeds deposit growth. The terms of new advances will be determined at the time of the advance based on interest rates, the Company’s interest risk profile, and other factors. Repurchase agreements are generally less than 90 days to maturity with rates at or slightly above LIBOR. Total borrowings increased 1.12% from $388.4 million at September 30, 2003, to $392.8 million at September 30, 2004.

Our total stockholders’ equity is comprised of realized equity and unrealized equity. Realized equity includes common stock, additional paid-in capital, treasury stock, unearned compensation, and retained earnings, while unrealized equity is comprised of accumulated other comprehensive income. Stockholders’ equity increased $42.1 million, or 18.29%, to $272.5 million at September 30, 2004. Realized equity increased by $5.7 million to $92.1 million at September 30, 2004, from $86.4 million at September 30, 2003. Accumulated other comprehensive income or unrealized equity is comprised of net unrealized holding gains on securities available for sale. Accumulated other comprehensive income increased by $36.4 million or 25.30%, to $180.4 million at September 30, 2004.

As indicated in the tables below, other comprehensive gain for the year was $36.4 million compared to a loss of $12.0 million for the year ended September 30, 2003. The gain was primarily the result of the increase in the price of Freddie Mac common stock, which increased by $12.89 per share, resulting in an after-tax increase in our Freddie Mac common

stock investment of $35.4 million. Other comprehensive income (loss) relating to mortgage securities and other investments increased by $2.5 million to a gain of $1.0 million from a loss of $1.4 million for the year ended September 30, 2003.


	For the Years Ended September 30,
	2004		2003			2002			2001		2000
Freddie Mac:
Number of shares		4,605,000		4,640,000			4,655,000			4,655,000		4,655,000
Market Price	$	65.24	$	52.35		$	55.90		$	65.00	$	54.0625
Market Value		300,430,200		242,904,000			260,214,500			302,575,000		251,660,938
Unrealized Gain Net of Tax		180,649,622		145,283,854			155,893,352			181,902,699		150,641,464

Other Comprehensive Gain(Loss)
Related to Mortgage Securities and other Investments		1,052,778		(1,410,665	)		1,112,500			9,696,208		(1,236,353	)
Freddie Mac Common Stock		35,365,768		(10,609,498	)		(26,009,347	)		31,261,235		5,894,975

Total Other Comprehensive Loss		36,418,546		(12,020,163	)		(24,896,847	)		40,957,443		4,658,622

Comparison of Operating Results for Years Ended September 30, 2004 and 2003.

General. Net income of $8.2 million for the year ended September 30, 2004, represents a $5.1 million increase from net income of $3.1 million for the year ended September 30, 2003. Net interest income increased by $6.2 million. We had an increase of $614,000 in noninterest income and a decrease of $1.1 million in noninterest expense. Our income tax expense was up $2.8 million as a result of our higher level of pretax income. The provision for loan losses was essentially the same at $30,000.

Ratio Analysis. We believe our return on equity can be measured in three ways. The first is the traditional return on total equity, or GAAP measure, which is net income divided by average total equity. The second is return on realized equity which is net income divided by realized equity (excluding unrealized gains on available for sale securities). The third is comprehensive return on equity which is comprehensive income divided by average total equity. We use all of these measures in evaluating our performance and setting goals. The following table shows these three measures.


	Year Ended September 30,
	2004		2003		2002		2001
Return on total equity	3.23	%	1.26	%	0.93	%	1.94	%
Return on realized equity	9.16		3.46		2.22		8.54

Difference attributable to unrealized equity	5.93	%	2.20	%	1.29	%	6.60	%

Return on total equity	3.23	%	1.26	%	0.93	%	1.94	%
Comprehensive return on equity	17.57		(3.64	)	(7.06	)	18.65

Difference attributable to unrealized equity and other comprehensive income(loss)	14.34	%	(4.90	)%	(7.99	)%	16.71	%

Each of these measures has its strengths and weaknesses and is useful to investors by providing different perspectives. Return on total equity is the traditional measure. However, in our case, the total equity measure shows a low result because it includes the unrealized gains on Freddie Mac stock and other available for sale securities in equity (the denominator) but does not reflect unrealized gains and losses on Freddie Mac common stock and other available for sale securities in net income (the numerator). The return on realized equity measure excludes unrealized gains on Freddie Mac common stock and other available for sale securities from both net income and equity and thus does not reflect a significant portion of the economic value in the Company, while it does include gains on Freddie Mac stock and other available for sale securities that are realized through the sale of stock. The comprehensive return on equity reflects the overall increase or decrease in value as reflected by the stock price of Freddie Mac common stock and other available for sale securities. Management believes this is an accurate long-term measure that exhibits high levels of volatility in short time periods.

The return on assets measures shown below similarly reflect the effects of including or not including the significant unrealized gains and losses on the Freddie Mac common stock and other available for sale securities.


	Year Ended September 30,
	2004		2003		2002		2001
Return on total assets	0.79	%	0.32	%	0.29	%	0.50	%
Return on realized assets	1.06		0.43		0.40		0.75

Difference attributable to unrealized assets	0.27	%	0.11	%	0.11	%	0.25	%

Return on total assets	0.79	%	0.32	%	0.29	%	0.50	%
Comprehensive return on assets	4.28		(0.91	)	(2.17	)	4.84

Difference attributable to other comprehensive income(loss)	3.49	%	(1.23	)%	(2.46	)%	4.34	%

Interest Income. Total interest and dividend income, including dividends on Freddie Mac common stock, was $38.8 million for 2004, a 13.04% increase over the total of $34.3 million for the year ended September 30, 2003. Dividend income on Freddie Mac common stock increased by $703,000 to $5.4 million from $4.7 million due to the increase in quarterly dividends of Freddie Mac common stock from $0.26 per share to $0.30 per share.

Total interest and dividend income, excluding Freddie Mac common stock, was $33.5 million for the year, a 12.72% increase over interest and dividend income, excluding Freddie Mac common stock, of $29.7 million for the year ended September 30, 2003.

Interest on loans increased $1.4 million, or 8.30%, to $18.1 million. The average balance of loans receivable increased $54.7 million to $311.5 million for the year ended September 30, 2004. Interest on investment debt securities available for sale increased $47,000 to $489,000 for the year from $442,000 for the prior year.

Interest on mortgage-backed securities and collateralized mortgage obligations increased by $2.5 million to $14.4 million for the year from $11.9 million a year earlier. The increase was due to higher yields as the Company increased the proportion of its securities invested in fixed rate securities, which have a higher yield than variable rate securities, and amortization of premiums on securities decreased. Lower interest rates on variable rate securities also meant that cash flow from investments was reinvested at lower rates. The yield on interest-earning assets excluding Freddie Mac common stock increased 25 basis points. Total interest-earning assets excluding Freddie Mac common stock averaged $742.2 million for the year, up from $696.6 million in the comparable 2003 period, a 6.56% increase. The average yield on loans decreased 70 basis points to 5.80%, while the yield on mortgage-related securities increased from 2.93% for 2003 to 3.62% in 2004, reflecting the reduced amortization of premiums and a higher proportion of fixed rate securities.

Interest Expense. Total interest expense for the year was $17.1 million, a $1.7 million, or 9.24%, decrease from 2003. The decrease is attributable to a 49 basis point decrease in the average cost of interest-bearing liabilities which was partially offset by a $47.5 million increase in the average balance of interest-bearing liabilities from $607.3 million for the year ended September 30, 2003, to $654.9 million for the year ended September 30, 2004. The decrease in average cost was primarily due to the 41 basis point decrease in the cost of borrowed funds and a 57 basis point drop in the cost of deposits as compared to the year ended September 30, 2003.

Interest expense on deposits decreased $822,000, or 14.66%, to $4.8 million for the year ended September 30, 2004, compared with $5.6 million for the prior year. The average balance of Certificates of Deposit of $164.9 million in 2004 was similar to the average balance of $163.9 million the prior year. Due to the declining interest rate environment during this period, an increased proportion of lower cost transaction deposit accounts, and a strategy of less aggressive rates paid for Certificates of Deposit, the average cost of interest-bearing deposits decreased 57 basis points during 2004. Interest expense on Certificate of Deposit balances decreased $1.0 million during the year ended September 30, 2004, compared with the year ended September 30, 2003, as the average balance of these accounts increased $1.0 million and the cost decreased 64 basis points.

Interest expense on borrowed funds decreased $916,000 as a result of the 41 basis point decrease in the average cost of borrowed funds which was partially offset by the $19.1 million increase in the average balance of borrowed funds. The decrease in the average cost was attributed to the declining interest rate environment.

Net Interest Income. Net interest income including Freddie Mac common stock dividends for the year ended September 30, 2004, increased $6.2 million, or 40.06%, to $21.7 million. The net interest rate spread including Freddie Mac common stock increased 71 basis points to 1.20% for the year ended September 30, 2004, from 0.49% for the prior year. Traditional bank measures such as net interest rate spread and net interest rate margin would improve if the market value of the Freddie Mac common stock and/or mortgage securities and borrowings become a smaller portion of our earning assets. The average balance of the Freddie Mac common stock was $276.0 million for the year ended September 30, 2004, as compared to $259.2 million for the year ended September 30, 2003. The net interest margin, which is net interest income including dividends on Freddie Mac common stock divided by average total interest-earning assets, increased 52 basis points to 2.14% for the year ended September 30, 2004.

Net interest income excluding the effects of Freddie Mac common stock increased $5.5 million, or 50.77%, to $16.4 million for the year ended September 30, 2004, compared with $10.9 million for the year ended September 30, 2003. The net interest rate spread excluding effects of Freddie Mac common stock, the difference between the average yield on average total interest-earning assets and the average cost of average total interest-bearing liabilities, increased by 74 basis points as the yield on interest-earning assets excluding Freddie Mac common stock increased at a higher rate than the average cost of interest-bearing liabilities. The net interest margin, which is net interest income divided by average total interest-earning assets excluding Freddie Mac common stock, increased 65 basis points.

Our net interest margin and net interest spread are low when compared to industry standards primarily due to two factors. First, under our wholesale investment strategy, our assets include a high proportion of securities with rates lower than those that would typically be earned on loans. Our liabilities include a high proportion of borrowings and wholesale deposits with higher costs than those typically paid on retail deposits. Each of these factors lowers our net interest margin and net interest spread. Our wholesale investment strategy has historically resulted in increases in net interest income and efficient use of our capital. Second, the dividend rate as compared to the market value of our Freddie Mac common stock is low. However, when compared to our cost basis in the investment, the dividend rate exceeds 86%.

Provision for Loan Losses and Asset Quality. The provision for loan losses was $30,000 for the year ended September 30, 2004, while $25,000 was recorded for the year ended September 30, 2003. The Bank had net charge-offs of $187,000 for the year ended September 30, 2004 compared to $602,000 for the year ended September 30, 2003. The difference in the provision and net charge-offs for the year ended September 30, 2004, is due in part to the fact that the Bank had $311,000 of the net charge-offs related to loans acquired in the Eagle Bank acquisition and net recoveries of $123,751 in the rest of the Bank. The following table further illustrates the relationship between our charge-offs and charge-offs of loans acquired in purchase business combinations.

Net Charge Offs(Recoveries)


Year	Provision		CharterBank			Eagle Bancshares		Citizen National			Total
1999	$	240,000	$	125,887		$	—	$	210,395		$	336,282
2000		1,410,000		408,421			—		365,380			773,801
2001		500,000		428,070			—		1,128,153			1,556,223
2002		250,000		313,241			—		47,489			360,730
2003		25,000		193,543			471,573		(63,275	)		601,841
2004		30,000		(21,311	)		310,730		(102,440	)		186,979

			$	1,447,851		$	782,303	$	1,585,702		$	3,815,856

Nonperforming loans are not accruing interest. The following table shows nonperforming loans, under-performing loans and nonperforming assets.


	September 30, 2004			September 30, 2003
	(In thousands)
Under-performing loans	$	195		$	633

Total nonperforming loans		5,865			5,124
Foreclosed real estate, net		453			684

Total nonperforming assets	$	6,318		$	5,808

Nonperforming loans to total loans		1.81	%		1.71	%
Nonperforming assets to total assets		0.59	%		0.58	%

Nonperforming loans rose from $5.1 million at September 30, 2003, to $5.9 million at September 30, 2004. Nonperforming loans acquired in the Eagle Bank acquisition made up $582,000 of these loans at September 30, 2004. Nonperforming loans as a percentage of total loans grew from 1.71% at September 30, 2003, to 1.81% at September 30, 2004. Approximately 94% of our nonaccrual loans had real estate as collateral at September 30, 2004.

Under-performing loans are loans 90 days or more delinquent or 90 days past maturity date that are still accruing interest. Under-performing loans decreased from $633,000 at

September 30, 2003, to $195,000 at September 30, 2004. Under-performing loans at September 30, 2003, included a loan in the amount of $585,000 that we have treated as nonperforming at September 30, 2004. Under-performing loans at September 30, 2004, are primarily 1-4 family loans with underlying collateral that indicate a very low risk of loss. None of the under-performing loans were acquired in the Eagle Bank acquisition.

The allowance for loan losses represents a reserve for probable loan losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans with particular emphasis on impaired, non-accruing, past due and other loans that management believes require special attention. The determination of the allowance for loan losses is considered a critical accounting policy.

During fiscal 2004, the allowance for loan losses decreased by $157,000 to $6.6 million at September 30, 2004, due to net charge-offs of $186,979. Net charge-offs of $310,730 related to loans acquired in the Eagle Bank acquisition, while loans not acquired from Eagle Bank resulted in net recoveries. When reviewing the allowance for loan losses, it is important to understand the Company’s lending strategy. The largest components of our loan portfolio are one-to-four family residential loans and commercial real estate loans. Economic downturns resulting in reduced capacity to repay and/or depreciated property values are the chief risks to this lending strategy. The Company has mitigated the risk associated with these types of borrowers through prudent loan to value ratios and regular monitoring of economic conditions.

Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on management’s analysis of loss inherent in the loan portfolio. The amount of the provision for loan losses is determined by an evaluation of the level of loans outstanding, loss risk as determined based on a loan grading system, the level of non-performing loans, historical loss experience, delinquency trends, the amount of losses charged to the allowance in a given period, and an assessment of economic conditions. A provision for losses of $30,000 was charged for the year ended September 30, 2004, while there was a $25,000 provision for the year ended September 30, 2003. Management considers the current allowance for loan losses to be adequate based on its analysis of the losses in the portfolio.

Our allowance for loan loss methodology is a loan classification based system. We base the required reserve on a percentage of the loan balance for each type of loan and classification level. Doubtful, substandard and special mention loans are reserved at 50.0%, 15.0% and 5.0%, respectively. Loans may be classified manually and are automatically classified if they are not previously classified when they reach certain levels of delinquency. Unclassified loans are reserved at different percentages based on our perception of the inherent losses in the type of loan. The conforming one-to-four family loans in the portfolio are reserved at lower percentages than other loans. Reserve percentages are based on each individual lending program and its loss history and underwriting characteristics, including loan to value, credit score, debt coverage, collateral, and capacity to service debt.

We have no loans that are not currently disclosed as non-accrual, past due, underperforming or restructured, where there is known information about possible credit problems of borrowers that causes management to have serious doubts about their ability to comply with present loan repayment terms

Noninterest Income. Noninterest income increased 10.41% to $6.5 million for the year ended September 30, 2004 compared with $5.7 million in the prior year. We had $2.2 million in net gains on the sale of mortgage and other investment securities, which included a $2.1 million gain on the sale of Freddie Mac common stock, during the year ended September 30, 2004, compared with a net gain of $880,000 in the prior year, which included a $773,000 gain on the sale of Freddie Mac common stock. Other factors included a decrease of $1.6 million in the gain on loans sold, an increase of 74% or $832,000 in fees on deposits, and a $200,000 loss in an investment in a de novo bank. We invested $200,000 in a bank holding company that applied for a charter to serve urban low income areas. The bank was denied its charter triggering the write off of our $200,000 investment in fiscal 2004. The decrease in the gain on loans sold reflects the record levels of one-to-four family loan originations in fiscal 2003. Future levels of gain on sale of loans are dependent on interest rates. The increase in deposit fees reflects our growth in core deposits and the Company’s focus on deposit fees. The following table shows the quarterly levels of deposit fees, core deposits and gain on sale of loans for the last three fiscal years.


(In thousands)	Core Deposits (at Quarter End)		Deposit Fees (for the Quarter)		Gain on Sale of Loans (for the Quarter)
September 30, 2004	$	129,349	$	689	$	255
June 30, 2004		130,250		625		345
March 31, 2004		130,002		673		310
December 31, 2003		99,555		563		242

September 30, 2003		99,546		496		657
June 30, 2003		98,605		463		886
March 31, 2003		95,557		356		643
December 31, 2002		68,090		402		589

September 30, 2002		69,480		351		539
June 30, 2002		68,303		289		354
March 31, 2002		56,762		246		438
December 31, 2001		50,365		229		529

The following table shows the yearly levels of gain on sale of loans, gain on sale of Freddie Mac common stock, and gain on sale of covered calls for the last five fiscal years.


(In thousands)	Gain on Sale of Loans		Gain on Sale of Freddie Mac Stock		Gain on Covered Calls
September 30, 2004	$	1,152	$	2,113	$	149
September 30, 2003		2,775		773		52
September 30, 2002		1,860		0		0
September 30, 2001		1,580		0		0
September 30, 2000		730		0		0

Gain on sale of securities, including Freddie Mac common stock, was $2.2 million for the year ended September 30, 2004, compared to $880,000 for the same period in 2003, an increase of $1.3 million in income for the year ended September 30, 2004. The $2.2 million gain on sale of securities was comprised of net gains of approximately $115,000 on mortgage securities and other investment securities, and a net gain of $2.1 million on the sale of Freddie Mac common stock.

The Company charged off its remaining investment of $106,746 in a loan servicing limited partnership in fiscal 2003. The limited partnership invested in mortgage loan servicing, and, as a result, income fluctuated based on the underlying market value of related mortgage servicing rights. This market value is impacted by loan prepayment activity and the future expectation of such activity. As rates fell, the level of prepayment and expectation for future prepayments increased which resulted in lower market values for the underlying servicing rights. Loan prepayments and a decline in interest rates adversely affected our equity in earnings of limited partnerships.

Noninterest Expense. Total noninterest expense decreased $1.0 million, or 5.86%, to $17.2 million for the year compared with $18.1 million for the prior year. The primary cause of the decrease was due to decreases in salaries and benefits, professional services and overall general and administrative expenses.

Salaries and employee benefits expense decreased $444,000 from $10.6 million in 2003 to $10.1 million in 2004. Components of compensation expense that decreased included ESOP expenses, commissions and restricted stock expense.

Occupancy and equipment expenses increased $115,000, or 4%, for the year ended September 30, 2004, as compared to the same period in 2003 primarily due to service bureau expenses and increased building maintenance. Marketing expenses were consistent with the prior year with legal and professional expenses being lower than the prior year. The following table shows the yearly levels of compensation and benefits, occupancy and equipment for the last five fiscal years.


(In thousands)	Compensation & Benefits		Occupancy		Equipment
September 30, 2004	$	10,130	$	2,414	$	569
September 30, 2003		10,574		2,238		631
September 30, 2002		7,412		1,978		475
September 30, 2001		6,245		1,578		399
September 30, 2000		4,956		1,942		419

Income Taxes. Income taxes increased from $83,000 for the year ended September 30, 2003 to $2.9 million for the year ended September 30, 2004. The effective tax rate was 25.75% in 2004, and 2.60% in 2003. In both years, the dividends received deduction relating to 70% of the Freddie Mac cash dividends received has reduced federal income tax. In fiscal 2003, dividends on Freddie Mac stock were higher compared to other components of taxable income and the dividend exclusion lowered the effective tax rate more than it would have if other components of taxable income had been higher and more than it did in fiscal 2004.

Comparison of Financial Condition at September 30, 2003 and 2002.

Our total assets increased $17.9 million, or 1.83%, to $1.0 billion at September 30, 2003, from September 30, 2002. The increase was primarily due to increases in loans receivable. Total loans increased $85.9 million, or 40.1%, to $299.9 million at September 30, 2003. The one-to-four family residential real estate portfolio increased by $32.8 million, or 32.6%, to $133.3 million at September 30, 2003. The one-to-four family loans acquired in the acquisition of Eagle Bank accounted for $15.2 million of this increase. The consumer and other loan portfolio decreased $200,000 or 1.0% from September 30, 2002, to $19.7 million at September 30, 2003. The decrease in the consumer portfolio was primarily the result of reductions in second mortgage loans due to refinancings, which more than offset $4.5 million of consumer loans acquired in the Eagle Bank acquisition. Commercial real estate and other commercial loans increased by $48.2 million during fiscal 2003, and real estate construction loans increased by $5.1 million during the year, with our acquisition of Eagle Bank accounting for $32.0 million of the increase in commercial real estate loans and $3.6 million of the increase in construction loans.

Our mortgage-backed securities and collateralized mortgage obligations decreased from $455.9 million at September 30, 2002, to $394.4 million at September 30, 2003, a decrease of $61.5 million or 13.49%. The market value of Freddie Mac common stock decreased $17.3 million, or 6.65%, from $260.2 million at September 30, 2002 to $242.9 million at September 30, 2003.

Total deposits increased from $210.7 million at September 30, 2002, to $279.4 million at September 30, 2003. This increase is predominantly the result of the fact we acquired deposits of $62.1 million in the Eagle Bank acquisition.

determined at the time of the advance based on interest rates, the Company’s interest risk profile, and other factors. Repurchase agreements are generally less than 90 days to maturity with rates at or slightly above LIBOR. Borrowings decreased 5.48% from $411.0 million at September 30, 2002, to $388.4 million at September 30, 2003.

The Company’s acquisition of Eagle Bank resulted in our recording $4.3 million of goodwill and $2.0 million of core deposit intangible. The core deposit intangible is amortized over approximately 13 years using an accelerated method of amortization.

Realized equity decreased by $6.8 million to $86.4 million at September 30, 2003, from $93.2 million at September 30, 2002, primarily due to the increase in treasury stock of $7.8 million. Treasury stock was acquired to fund the Company’s restricted stock benefit plan.

Accumulated other comprehensive income is comprised of net unrealized holding gains on securities available for sale. As indicated in the table below, other comprehensive loss for the year ended September 30, 2003, was $12.0 million compared to a loss of $24.9 million for the year ended September 30, 2002. The loss was primarily the result of the decrease in the price of Freddie Mac common stock, which decreased by $3.55 per share, resulting in an after-tax decrease in our Freddie Mac common stock investment of $10.6 million. Other comprehensive loss relating to mortgage securities and other investments increased by $2.5 million to a loss of $1.4 million from income of $1.1 million for the year ended September 30, 2002.


	For the Years Ended September 30,
	2003			2002			2001		2000
Freddie Mac:
Number of shares		4,640,000			4,655,000			4,655,000		4,655,000
Market Price	$	52.35		$	55.90		$	65.00	$	54.0625
Market Value		242,904,000			260,214,500			302,575,000		251,660,938
Unrealized Gain Net of Tax		145,283,854			155,893,352			181,902,699		150,641,464

Other Comprehensive Gain(Loss)
Related to Mortgage Securities and other Investments		(1,410,665	)		1,112,500			9,696,208		(10,741,370	)
Freddie Mac Common Stock		(10,609,498	)		(26,009,347	)		31,261,235		5,894,975

Total Other Comprehensive (Loss)Gain		(12,020,163	)		(24,896,847	)		40,957,443		4,658,622

Comparison of Operating Results for Years Ended September 30, 2003 and 2002.

General. Net income of $3.1 million for the year ended September 30, 2003, represents a $200,000 increase from net income of $2.9 million for the year ended September 30, 2002. The $3.8 million increase in noninterest income was essentially offset by the $3.8 million increase in noninterest expense. Our income tax expense was down $400,000, which more than offset the decrease in our net interest income after the loan loss provision. Net interest income during the year ended September 30, 2003, decreased slightly due to lower interest rates which was partially offset by a $225,000 decrease in the provision for loan losses.

Interest Income. Total interest and dividend income, including Freddie Mac common stock, was $34.3 million for the year, a 9.02% decrease over interest and dividend income, including Freddie Mac common stock, of $37.7 million for the year ended September 30, 2002. Dividend income on Freddie Mac common stock increased by $652,000 to $4.7 million from $4.0 million due to the increase in quarterly dividends of Freddie Mac common stock from $0.22 per share to $0.26 per share. Total interest and dividend income, excluding Freddie Mac common stock, was $29.7 million for the year, an 11.87% decrease over interest and dividend income, excluding Freddie Mac common stock, of $33.7 million for the year ended September 30, 2002. Interest on loans decreased $209,000, or 1.24%, to $16.7 million. The average balance of loans receivable increased $41.2 million to $256.8 million for the year ended September 30, 2003. Interest on investment debt securities available for sale decreased $71,000 to $442,000 for the year from $513,000 for the prior year.

Interest on mortgage-backed securities and collateralized mortgage obligations decreased by $3.6 million to $11.9 million for the year from $15.5 million a year earlier. The decrease was due to lower yields as the yields on both variable and fixed rate securities dropped with interest rates. The lower interest income due to lower interest rates was partially offset by increased volumes. The lower interest rates reduced yields by increasing amortization of premiums due to shorter projected average lives. Lower interest rates also meant that cash flow from investments was reinvested at lower rates. The yield on interest-earning assets excluding Freddie Mac common stock decreased 95 basis points. Total interest-earning assets excluding Freddie Mac common stock averaged $696.6 million for the year, up from $647.2 million in the comparable 2002 period, a 7.62% increase. The average yield on loans decreased 134 basis points to 6.50%, while the yield on mortgage-related securities decreased from 3.86% for 2002 to 2.93% in 2003, reflecting the declining interest rate environment during this time period.

Interest Expense. Total interest expense for the year was $18.8 million, a $3.0 million, or 13.91%, decrease from 2002. The decrease is attributable to a 78 basis point decrease in the average cost of interest-bearing liabilities which was partially offset by a $44.3 million increase in the average balance of interest-bearing liabilities from $563.0 million for the year ended September 30, 2002, to $607.3 million for the year ended September 30, 2003. The decrease in average cost was primarily due to the 55 basis point decrease in the cost of borrowed funds as compared to the year ended September 30, 2002, and a 110 basis point drop in the cost of deposits.

Interest expense on deposits decreased $1.2 million, or 17.65%, to $5.6 million for the year ended September 30, 2003, compared with $6.8 million for the prior year. The average balance of Certificates of Deposit increased $17.1 million to $163.9 million in 2003 from $146.8 million the prior year primarily as a result of the Certificates of Deposit we acquired in our acquisition of Eagle Bank, which was offset by decreases due to less aggressive retail Certificate of Deposit rates being offered by CharterBank. Due to the declining interest rate environment during this period, an increased proportion of lower cost transaction deposit accounts, and a strategy of less aggressive rates paid for Certificates of Deposit, the average cost of interest-bearing deposits decreased 110 basis points during 2003. Interest expense on Certificate of Deposit balances decreased $1.3 million during the year ended September 30, 2003, compared with the year ended September 30, 2002, as the average balance of these accounts increased $17.1 million and the cost decreased 123 basis points.

Interest expense on borrowed funds decreased $1.8 million as a result of the 55 basis point decrease in the average cost of borrowed funds which was partially offset by the $5.5 million increase in the average balance of borrowed funds. The decrease in the average cost was attributed to the declining interest rate environment.

Net Interest Income. Net interest income including Freddie Mac common stock dividends for the year ended September 30, 2003, decreased $366,000, or 2.30%, to $15.5 million. The net interest rate spread including Freddie Mac common stock increased 39 basis points to 0.49% for the year ended September 30, 2003, from 0.10% for the prior year. Traditional bank measures such as net interest rate spread and net interest rate margin will improve as the market value of the Freddie Mac common stock and/or mortgage securities and borrowings become a smaller portion of our earning assets. The average balance of the Freddie Mac common stock was $259.2 million for the year ended September 30, 2003, as compared to $302.1 million for the year ended September 30, 2002. The net interest margin, which is net interest income including dividends on Freddie Mac common stock divided by average total interest-earning assets, decreased five basis points to 1.62% for the year ended September 30, 2003.

Net interest income excluding the effects of Freddie Mac common stock decreased $1.0 million, or 8.40%, to $10.9 million for the year ended September 30, 2003, compared with $11.9 million for the year ended September 30, 2002. The net interest rate spread excluding effects of Freddie Mac common stock, the difference between the average yield on average total interest-earning assets and the average cost of average total interest-bearing liabilities, dropped by 17 basis points as the yield on interest-earning assets excluding Freddie Mac common stock decreased at a higher rate than the average cost of interest-bearing liabilities. The net interest margin, which is net interest income divided by average total interest-earning assets excluding Freddie Mac common stock, decreased 28 basis points.

Provision for Loan Losses. For the year ended September 30, 2003, we recorded a $25,000 provision for loan losses, compared to $250,000 for the year ended September 30, 2002. Gross charge-offs totaled $1.0 million for the year ended September 30, 2003, as compared to the prior year total of $816,000. Of the gross charge-offs in 2003, $539,000 were loans that were acquired in the Eagle Bank acquisition. The net charge-offs exeeed the provision for loan losses because our reserve methodology did not require a provision or higher reserves. While during 2003 CharterBank experienced an increase in nonperforming loans, the majority of nonperforming loans are real estate loans with a lower risk of loss than non-real estate loans. CharterBank’s reserve methodology requires reserves based on a percentage of the outstanding balance for each type of loan. The percentage is based on CharterBank’s estimate of losses inherent within that type of loan.

The allowance for loan losses as of September 30, 2003, was 2.26% of total loans compared with 2.42% of total loans at September 30, 2002. The allowance at September 30, 2003, was 1.32% of nonaccrual loans compared to 1.72% at September 30, 2002. Future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and its underlying collateral, the mix of loans within the portfolio, delinquency trends, economic conditions, current and prospective trends in real estate values, and other relevant factors.

The table below shows under-performing (loans 90 days or more delinquent that are still accruing interest) and non-performing assets:


	September 30, 2003			September 30, 2002
	(In thousands)
Underperforming loans	$	633		$	133

Total non-performing loans		5,124			3,013
Foreclosed real estate, net		684			670

Total non-performing assets	$	5,808		$	3,683

Non-performing loans to total loans		1.71	%		1.41	%
Non-performing assets to total assets		0.58	%		0.38	%

Underperforming loans at September 30, 2003 include one large loan on timber land and two smaller 1-4 family loans.

The allowance for loan losses represents a reserve for probable loan losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans, with particular emphasis on impaired, non-accruing, past due and other loans that Management believes require special attention.

When reviewing the allowance for loan losses, it is important to understand to whom the Company lends. The largest components of the loan portfolio are one-to-four family residential loans and commercial real estate loans. The inherent risk with this type of lending is that a downturn in the economic environment may result in reduced capacity of borrowers to repay and/or depreciated property values. We believe we have mitigated the risk to these types of borrowers through prudent loan to value ratios and regular monitoring of economic conditions.

Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based on Management’s analysis of potential risk in the loan portfolio. The amount of the provision for loan losses is determined by an evaluation of the level of loans outstanding, loss risk determined based on a loan grading system, the level of non-performing loans, historical loss experience, delinquency trends, the amount of losses charged to the allowance in a given period, and an assessment of economic conditions. Management considers the current allowance for loan losses to be adequate, based on its analysis of the potential risk in the portfolio.

Our allowance for loan loss methodology is a loan classification based system. We base the required reserve on a percentage of the loan balance for each type of loan and classification level. Doubtful, substandard and special mention loans are reserved at 50.0%, 15% and 5.0%, respectively. These percentages for doubtful and substandard were reduced during 2003 from 60% and 17.5% based on historical losses on the Company’s real estate loans. These changes reduced required reserves by approximately $357,000. Loans may be classified manually and are automatically classified if they are not previously classified when they reach certain levels of delinquency. Unclassified loans are reserved at different percentages based on our perception of the inherent losses in the type of loan. The conforming one-to-four family loans in the portfolio are reserved at lower percentages. Reserve percentages are based on each individual lending program and its loss history and underwriting characteristics including loan to value, credit score, debt coverage, collateral, and capacity to service debt.

Noninterest Income. Noninterest income increased 200% to $5.7 million for the year ended September 30, 2003, compared with $1.9 million in the prior year. We had $880,000 in net gains on the sale of mortgage and other investment securities, including a $773,000 gain on the sale of Freddie Mac common stock during the year ended September 30, 2003, compared with a loss of $816,000 in the prior year. Other factors included an increase of $915,000 in the gain on loans sold, an increase of $602,000 in fees on deposits, and a $457,000 decrease in the equity loss in a mortgage servicing limited partnership. The increase in the gain on loans sold reflects the record levels of one-to-four family loan originations. Future levels of gain on sale of loans are dependent on interest rates. The increase in deposit fees reflects our growth in core

deposits and the Company’s focus on deposit fees. The following table shows the quarterly levels of deposit fees, core deposits and gain on sale of loans.


(In thousands)	Core Deposits (at Quarter End)		Deposit Fees (for the Quarter)		Gain on Sale of Loans (for the Quarter)
September 30, 2003	$	99,546	$	496	$	657
June 30, 2003		98,605		463		886
March 31, 2003		95,557		356		643
December 31, 2002		68,090		402		589

September 30, 2002		69,480		351		539
June 30, 2002		68,303		289		354
March 31, 2002		56,762		246		438
December 31, 2001		50,365		229		529

As mentioned earlier, the limited partnership invested in mortgage loan servicing, and, as a result, income fluctuated based on the underlying market value of related mortgage servicing rights. This market value was impacted by loan prepayment activity and the future expectation of such activity. As rates fell, the level of prepayment and expectation for future prepayments increase which resulted in lower market values for the underlying servicing rights. Loan prepayments and a decline in interest rates adversely affected our equity in earnings of limited partnerships. During 2003, CharterBank wrote off its remaining equity investment of $106,746 in its limited partnership. The loss on the partnership was partially offset by $2.8 million in gains on the sale of loans and servicing released loan fees in 2003. The lower interest rate environment and related refinancing during 2003 contributed significantly to the increase in our gain on the sale of loans and servicing released loan fees from the prior year.

Gain on sale of securities, including Freddie Mac common stock, was $880,000 for the year ended September 30, 2003, compared to a loss of $816,000 for the same period in 2002, a difference of $1.7 million in income for the year ended September 30, 2003. The $880,000 income was comprised of net gains of approximately $107,000 on mortgage securities and other investment securities, and a net gain of $773,000 on the sale of Freddie Mac common stock. The loss in 2002 was due to a $1.5 million loss on the sale of a bond issued by Intermedia which was subsequently acquired by WorldCom, and net gains of approximately $700,000 on mortgage securities and other investment securities.

Noninterest Expense. Total noninterest expense increased $3.9 million, or 27.21%, to $18.1 million for the year compared with $14.2 million for the prior year. The primary cause of the increase was due to increases in salaries and benefits, of which the largest increase was in stock-based benefits that have accelerated amortization due to the vesting schedules.

Salaries and employee benefits expense increased $3.2 million from $7.4 million in 2002 to $10.6 million in 2003. The major factor in the increase of compensation expense was restricted stock grant expense and a smaller factor in the increase in compensation expense was the staffing expense for the three Eagle Bank branches that were acquired in fiscal 2003.

Occupancy and equipment expenses increased $317,000, or 16.44%, for the year ended September 30, 2003, as compared to the same period in 2002 primarily due to service bureau expenses and increased building maintenance. Marketing expenses and legal and professional expenses were consistent with the prior year.

Income Taxes. Income taxes decreased from $484,000 for the year ended September 30, 2002, to $83,000 for the year ended September 30, 2003. The effective tax rate was 2.60% in 2003 and 14.31% in 2002. In both years, the dividends received deduction relating to 70% of the Freddie Mac cash dividends received reduced federal income tax. Because dividends on Freddie Mac stock were high compared to other components of taxable income, the dividend exclusion lowered the effective tax rate more than it would have if other components of taxable income had been higher. There can be no assurance that future periods will result in similar effective tax rates.

Commitments. The Company had commitments to fund loans at September 30, 2004, of approximately $46.2 million which is composed of unused consumer credit lines of approximately $9.6 million, unused commercial credit lines of approximately $17.1 million, unfunded construction loans of approximately $13.4 million, mortgage loans of approximately $1.6 million, and nonresidential and commercial loans of approximately $4.5 million. Thirty-year conforming one-to-four family loans are generally sold on a best efforts basis so the Company has no binding commitments on these loans.

The Bank is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Lines of credit are unfunded commitments to extend credit. These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments. The Bank follows the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.

The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available for sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.

The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’s contractual obligations, consisting of deposits, FHLB advances and borrowed funds by contractual maturity date for the next five years.


	Commitments and Contractual Obligations
	Due in 1 Year		Due in 2 Years		Due in 3 Years		Due in 4 Years		Due in 5 Years
Loan commitments to originate mortgage loans	$	1,585,537	$	—	$	—	$	—	$	—
Loan commitments to fund construction loans in process		13,363,366		—		—		—		—
Loan commitments to originate nonresidential mortgage loans		4,495,000		—		—		—		—
Loan commitments to originate commercial loans		20,000		—		—		—		—
Available home equity and unadvanced lines of credit		26,723,831		—		—		—		—
Letters of credit		388,500		—		—		—		—
Lease agreements		83,620		47,361		44,292		36,910		—
Deposits		227,605,552		21,457,344		18,417,146		5,734,906		6,109,760
Securities sold under agreements to repurchase		100,739,000		—		—		—		—
FHLB advances		40,050,000		25,000,000		75,000,000		25,000,000		—

Total commitments and contractual obligations	$	415,054,406	$	46,504,705	$	93,461,438	$	30,771,816	$	6,109,760

Management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise. Management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.

Derivative Instruments. We did not have any commitments to originate loans held for sale at September 30, 2004. In prior periods these commitments were accounted for at fair value.

The commitments to sell loans are best effort, forward sale agreements, and not mandatory forward sale commitments. The best effort agreements are not derivative instruments and, therefore, are not accounted for as derivatives. The interest rate caps and floors in our adjustable rate loans are clearly and closely related to the interest rate on the loan and, therefore, the floors and caps are not accounted for separately from the loan as a derivative instrument.

Liquidity. The term “liquidity” refers to our ability to generate adequate amounts of cash to fund loan originations, loan purchases, deposit withdrawals and operating expenses. The OTS requires that CharterBank maintain a sufficient amount of liquid assets to maintain its safe and sound operation. Our primary sources of liquidity are deposits, borrowings, scheduled amortization and prepayments of loan principal and mortgage related securities, maturities and calls of investment securities and funds provided by our operations. We can borrow funds from the FHLB based on eligible collateral of loans and securities up to a limit of 40% of CharterBank’s assets. At September 30, 2004 and 2003, our maximum borrowing capacity from the FHLB was approximately $373.3 million and $306.5 million, respectively. At September 30, 2004 and 2003, we had outstanding borrowings of $292.1 million and $267.1 million, respectively, with unused borrowing capacity of $81.2 million and $39.4 million, respectively. In

addition, we may enter into reverse repurchase agreements with approved broker-dealers. Reverse repurchase agreements are agreements that allow us to borrow money using our securities as collateral. We can obtain funds in the brokered deposit markets. We can also obtain funds using our Freddie Mac common stock as collateral and have established a line of credit that provides for borrowing up to half of the market value of the stock. We consider this source of funds a last resort due to the potential adverse tax consequences on the dividends received deduction that exempts 70% of our Freddie Mac dividends from taxable income. CharterBank has relied on wholesale fundings, including advances from the FHLB, repurchase agreements and brokered deposits, to purchase securities in the past two fiscal years. CharterBank monitors its liquidity position frequently and anticipates that we will have sufficient funds to meet our current funding commitments.

At September 30, 2004, repurchase agreements totaled $100.7 million, a $20.6 million decrease from the amount outstanding at September 30, 2003, of $121.3 million. Wholesale deposits were $34.1 million at September 30, 2004, as compared to $49.7 million at September 30, 2003.

Loan repayment and maturing investment securities are a relatively predictable source of funds. However, deposit flows, calls of investment securities and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. Principal repayments on mortgage related securities totaled $244.8 million for the twelve months ended September 30, 2004. Ongoing levels of cash flow will depend on the level of mortgage rates and possible mortgage refinancing.

Our primary investing activities are the origination of commercial real estate, one-to four-family real estate, commercial, and consumer loans, and the purchase of mortgage and investment securities.

During the year ended September 30, 2004, we originated approximately $191.5 million in total loans. Residential mortgage loans accounted for 40% of the originations, construction loans for 21% of the originations, commercial and commercial real estate loans for 33% of the originations, and consumer loans for 6% of the originations during the year ended September 30, 2004. Of the $76.0 million in residential loans originated, $38.1 million were sold to investors. During the year ended September 30, 2003, we originated loans of approximately $329.3 million. In the year ended September 30, 2003, with the 1-4 family refinance boom residential mortgage loans accounted for 60.0% of total loan originations for fiscal 2003. Commercial real estate loans accounted for 23.0% of total originations for fiscal 2003.

Purchases of mortgage and investment securities totaled $353.4 million for the year ended September 30, 2004, and $672.2 million for the year ended September 30, 2003. At September 30, 2004 and 2003, CharterBank had loan commitments to borrowers of approximately $19.5 million and $39.2 million, respectively, and available home equity and unadvanced lines of credit of approximately $26.7 million and $14.8 million, respectively.

The low interest rate environment, specifically low one-to-four family mortgage rates, dramatically increased refinancing activity and, accordingly, cash flow on mortgage securities during fiscal 2003. The level of this cash flow in the future depends on the ongoing level of refinancing and, thus, is difficult to determine at this time although most projections indicate higher interest rates and significantly lower levels of refinancing, which would reduce this cash flow in 2004. We have reinvested a significant portion of this cash flow in securities. During the third quarter of 2003, the Company began retaining conforming 15-year one-to-four family loans, with approximately $30.9 million being retained as of September 30, 2004.

Deposit flows are affected by the level of interest rates, by the interest rates and products offered by competitors, and by other factors. Total deposits were $279.6 million at September 30, 2004, as compared to $279.4 million at September 30, 2003. Time deposit accounts scheduled to mature within one year were $98.3 million and $129.5 million at September 30, 2004 and 2003, respectively. While CharterBank has experienced Certificates of Deposit run-off, we anticipate that a significant portion of these Certificates of Deposit will remain on deposit. CharterBank continues to target growth of transaction-based deposit accounts to lower its overall cost of funds, provide deposit fees, and provide cross-sell opportunities.

Capital expenditures of $2.6 million during the twelve months ended September 30, 2004, included approximately $2.0 million for branch expansions. We anticipate that capital expenditures for acquisition of branch sites, construction, expansion and renovation of retail facilities, and the relocation of support functions to one location as well as a change in our core application system during fiscal 2005, will be between $3.0 million and $5.0 million Except for these expenditures and any changes in our intentions to repurchase shares as outlined in “Capital and Capital Management,” we do not anticipate any other material capital expenditures during fiscal year 2005. We do not have any balloon or other payments due on any long-term obligations or any off-balance sheet items, other than the commitments and unused lines of credit noted above.

Off-Balance Sheet Arrangements. Charter Financial does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on Charter Financial’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Recent Accounting Pronouncements

On March 9, 2004, the SEC issued Staff Accounting Bulletin 105, “Application of Accounting Principles to Loan commitments,” (“SAB 105”) to inform registrants of the Staff’s view that the fair value of the recorded loan commitments should not consider the expected future cash flows related to the associated servicing of the future loan. The provisions of SAB 105 must be applied to loan commitments accounted for as derivatives that are entered into after March 31, 2004. The Staff will not object to the application of existing accounting practices to loan commitments accounted for as derivatives that are entered into on or before March 31, 2004, with appropriate disclosures. The Company adopted the provisions of SAB 105. The Company records the value of its mortgage loan commitments at fair market value for mortgages it intends to sell. The Company does not currently include, and was not including, the value of mortgage

servicing or any other internally-developed intangible assets in the valuation of its mortgage loan commitments. Therefore, the adoption of SAB 105 did not have an impact on the Company’s financial condition or results of operations.

In March 2004, the EITF reached a consensus on Issue 03-1, Meaning of other Than Temporary Impairment (Issue 03-1). The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments. The basic model development by the Task Force in evaluating whether an investment within the scope of Issue 03-01 is other-than-temporarily impaired is as follows: Step 1: Determine whether the investment is impaired. An investment is impaired if its fair value is less than its cost. Step 2: Evaluate whether the impairment is other-than-temporary. Step 3: If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. In September 2004, the FASB approved an FSP to delay the requirement to record impairment losses under Issue 03-01. The approved delay will apply to all securities within the scope of Issue 03-01 and is expected to end when new guidance is issued and comes into effect. The FSP did not affect the disclosure requirements of Issue 03-01. The Company will continue to monitor changes to Issue 03-01, but does not consider it, or related FSP to have a material impact on the Company’s financial position or results of operations.

Impact of Inflation and Changing Prices. The consolidated financial statements and accompanying notes of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

See Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, pages 61 to 65, for a discussion of Quantitative and Qualitative Disclosures about Market Risk. The interest rate sensitivity analysis or the market value of portfolio equity for various changes in interest rate analysis calculated as of September 30, 2004 indicates a loss of market value of portfolio equity for a significant increase or decrease in interest rates.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

See pages F-1 through F-47 following the signature page of this Annual Report.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

ITEM 9A. CONTROLS AND PROCEDURES

Management, including the Company’s President and Chief Executive Officer and Chief Financial Officer, Treasurer and Senior Vice President, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, the Company’s President and Chief Executive Officer and Chief Financial Officer, Treasurer and Vice President concluded that the disclosure controls and procedures were effective, in all material respects, to ensure that information required to be disclosed in the reports the Company files and submits under the Exchange Act is recorded, processed, summarized and reported as and when required.

There have been no changes in the Company’s internal control over financial reporting identified in connection with the evaluation that occurred during the Company’s last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, the Company’s internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information included in the Company’s Proxy Statement for the 2005 Annual Meeting of Stockholders to be filed within 120 days after the Company’s fiscal year end (the “Proxy Statement”) under the captions: “Election of Directors,” “Nominees and Continuing Directors,” “Executive Officers who are not Directors,” “Code of Ethics,” and “Section 16(a) Beneficial Ownership Reporting Compliance” is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information included in the Proxy Statement under the captions: “Compensation Committee Report on Executive Compensation,” “Compensation Committee Interlocks and Insider Participation,” “Performance Graph,” “Change of Control Agreements,” “Director Compensation,” “Executive Compensation,” “Employment Agreements,” and “Benefit Plans” is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information included in the Proxy Statement under the captions: “Security Ownership of Certain Beneficial Owners and Management-Principal Shareholders of Charter Financial Corporation,” and “Security Ownership of Management” is incorporated herein by reference.

The following table sets forth the aggregate information regarding our equity compensation plans in effect as of September 30, 2004.


Plan category	Number of securities to be issued upon exercise or vesting of outstanding options, warrants and rights	Weighted-average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
	(a)	(b)		(c)
Equity compensation plans approved by security holders:
Options	288,750	$	31.06	417,693
Restricted stock	154,692		N/A	72,339

Equity compensation plans not approved by security holders	—		—	—

Total	443,442		N/A	490,032

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information included in the Proxy Statement under the caption: “Information about the Board of Directors and Management – Transactions with Certain Related Persons” is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information included in the Proxy Statement under the caption: “Principal Accountant Fees and Services” is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

Listed below are all financial statements and exhibits filed as part of this report:

a.	Financial Statements, Schedules, and Exhibits

(1)

The consolidated balance sheets of Charter Financial Corporation and its subsidiaries as of September 30, 2004 and 2003 and the related consolidated statements of income, stockholders’ equity and comprehensive income (loss), and

cash flows for each of the years in the three-year period ended September 30, 2004, together with the related notes and report of KPMG LLP, independent registered public accounting firm.

(2)

Schedules omitted as they are not applicable.

(3)

See Exhibit Index.

Exhibits


Exhibit		Description
2.1		CharterBank Amended Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance (1)

2.2		Business Combination Agreement, dated September 10, 2002 by and among Charter Financial Corporation, CharterBank and EBA Bancshares, Inc. (2)

3.1		Federal Stock Charter of Charter Financial Corporation (1)

3.2		Bylaws of Charter Financial Corporation (1)

4.1		Federal Stock Charter of Charter Financial Corporation (See Exhibit 3.1) (1)

4.2		Bylaws of Charter Financial Corporation (See Exhibit 3.2) (1)

4.3		Form of Stock Certificate of Charter Financial Corporation (1)

10.1		Form of Employee Stock Ownership Plan of Charter Financial Corporation (1)

10.2		Form of Benefit Restoration Plan of Charter Financial Corporation (1)

10.3		Form of Employment Agreement by and among Robert L. Johnson and Charter Financial Corporation (1)

10.4		Form of One Year Change in Control Agreement by and among certain officers, Charter Financial Corporation and CharterBank (1)

10.5		Form of Two Year Change in Control Agreement by and among certain officers, Charter Financial Corporation and CharterBank (1)

10.6		CharterBank 401(k) Plan and Adoption Agreement (3)

10.7		Charter Financial Corporation 2001 Stock Option Plan (4)

10.8		Charter Financial Corporation 2001 Recognition and Retention Plan (4)

14.0		Conflict of Interest Policy and Code of Ethics (5)

21.1		Subsidiaries of the Registrant

23.1		Consent of KPMG LLP

31.1		Rule 13a-14(a)/15d-14(a) Certifications.

32.1		Section 1350 Certifications.



(1)		Incorporated herein by reference to the Registration Statement No. 333-57684, on Form S-1 of Charter Financial filed with the SEC on March 27, 2001, as amended.
(2)		Incorporated herein by reference to the current report on Form 8-K dated September 11, 2002


(3	)	Incorporated herein by reference to the Registration Statement No. 333-67402, on Form S-8, filed with the SEC on August 13, 2001, as amended.
(4	)	Incorporated herein by reference to the definitive proxy statement on Schedule 14A as filed with the SEC on March 26, 2002.
(5	)	Incorporated herein by reference to the current report on Form 8-K dated April 30, 2004.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on December 14, 2004.


CHARTER FINANCIAL CORPORATION

By:		/s/ Robert L. Johnson
		Robert L. Johnson
		President and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1933, as amended, and any rules and regulations promulgated there under, this Annual Report on Form 10-K, has been signed by the following persons in the capacities and on the dates indicated.


Name	Title	Date
/s/ John W. Johnson, Jr. John W. Johnson, Jr.	Chairman of the Board	December 14, 2004

/s/ Robert L. Johnson Robert L. Johnson	President, Chief Executive Officer and Director (principal executive officer)	December 14, 2004

/s/ David Z. Cauble, III David Z. Cauble, III	Director	December 14, 2004

/s/ Jane W. Darden Jane W. Darden	Director	December 14, 2004

/s/ William B. Hudson William B. Hudson	Director	December 14, 2004

/s/ Thomas M. Lane Thomas M. Lane	Director	December 14, 2004

/s/ David L. Strobel David L. Strobel	Director	December 14, 2004

/s/ Curtis R. Kollar Curtis R. Kollar	Chief Financial Officer, Vice President and Treasurer (principal accounting officer)	December 14, 2004

Exhibit Index


Exhibit	Description	Method of Filing
2.1	CharterBank Amended Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance	(1)

2.2	Business Combination Agreement, dated September 10, 2002 by and among Charter Financial Corporation, CharterBank and EBA Bancshares, Inc.	(2)

3.1	Federal Stock Charter of Charter Financial Corporation	(1)

3.2	Bylaws of Charter Financial Corporation	(1)

4.1	Federal Stock Charter of Charter Financial Corporation	(1)

4.2	Bylaws of Charter Financial Corporation	(1)

4.3	Form of Stock Certificate of Charter Financial Corporation	(1)

10.1	Form of Employee Stock Ownership Plan of Charter Financial Corporation	(1)

10.2	Form of Benefit Restoration Plan of Charter Financial Corporation	(1)

10.3	Form of Employment Agreement by and among Robert L. Johnson and Charter Financial Corporation	(1)

10.4	Form of One Year Change in Control Agreement by and among certain officers, Charter Financial Corporation and CharterBank	(1)

10.5	Form of Two Year Change in Control Agreement by and among certain officers, Charter Financial Corporation and CharterBank	(1)

10.6	CharterBank 401(k) Plan and Adoption Agreement	(3)

10.7	Charter Financial Corporation 2001 Stock Option Plan	(4)

10.8	Charter Financial Corporation 2001 Recognition and Retention Plan	(4)

14.0	Conflict of Interest Policy and Code of Ethics	(5)

100



21.1		Subsidiaries of the Registrant

23.1		Consent of KPMG LLP

31.1		Rule 13a-14(a)/15d-14(a) Certifications

32.1		SSSection 1350 Certifications

(1)	Incorporated herein by reference to the Registration Statement No. 333-57684, on Form S-1 of Charter Financial filed with the SEC on March 27, 2001, as amended.

(2)	Incorporated herein by reference to the current report on Forms 8-K dated September 11, 2002.

(3)	Incorporated herein by reference to the Registration Statement No. 333-67402, on From S-8, filed with the SEC on August 13, 2001, as amended.

(4)	Incorporated herein by reference to the definitive proxy statement on Schedule 14A as filed with the SEC on March 26, 2002.

(5)	Incorporated herein by reference to the Annual Report as Form 10-K for the fiscal year ended September 30, 2003, filed with the SEC on December 22, 2003.

101

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Financial Statements

September 30, 2004 and 2003

(With Independent Auditors’ Report Thereon)

Report of Independent Registered Public Accounting Firm

The Board of Directors

Charter Financial Corporation:

We have audited the accompanying consolidated balance sheets of Charter Financial Corporation and subsidiaries (the Company) as of September 30, 2004 and 2003, and the related consolidated statements of income, stockholders’ equity and comprehensive income (loss), and cash flows for each of the years in the three-year period ended September 30, 2004. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Charter Financial Corporation and subsidiaries as of September 30, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended September 30, 2004, in conformity with United States generally accepted accounting principles.

Atlanta, Georgia

November 12, 2004

F-1

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Balance Sheets

September 30, 2004 and 2003


	2004			2003
Assets
Cash and amounts due from depository institutions (note 20)	$	10,128,105		9,926,321
Interest-bearing deposits in other financial institutions		2,243,124		1,994,168

Cash and cash equivalents		12,371,229		11,920,489

Loans held for sale, market value of $2,125,463 and $2,058,892 at September 30, 2004 and 2003, respectively		2,077,510		2,026,261
Freddie Mac common stock (note 5)		300,430,200		242,904,000
Mortgage-backed securities and collateralized mortgage obligations available for sale (notes 6 and 15)		378,356,607		394,432,288
Other investment securities available for sale (note 5)		22,156,750		21,628,603
Federal Home Loan Bank stock (notes 5 and 15)		14,842,500		13,610,000
Loans receivable		323,546,874		299,877,198
Unamortized loan origination fees, net		(773,461	)	(544,202	)
Allowance for loan losses		(6,622,597	)	(6,779,576	)

Loans receivable, net (notes 8 and 15)		316,150,816		292,553,420

Real estate owned (note 9)		452,671		683,577
Accrued interest and dividends receivable (note 10)		3,004,224		3,200,112
Premises and equipment, net (note 11)		11,195,770		9,382,894
Intangible assets, net of amortization (note 4)		5,954,119		6,168,074
Other assets (note 12)		1,208,622		1,985,645

Total assets	$	1,068,201,018		1,000,495,363

Liabilities and Stockholders’ Equity
Liabilities:
Deposits (note 14)	$	279,574,709		279,385,708
Borrowings (note 15)		392,789,000		388,441,220
Advance payments by borrowers for taxes and insurance		1,189,587		1,191,597
Deferred income taxes (note 16)		111,602,661		88,196,330
Other liabilities		10,544,824		12,921,426

Total liabilities		795,700,781		770,136,281

Stockholders’ equity (notes 17, 20, and 23):
Common stock, $0.01 par value; 19,823,905 and 19,822,405 shares issued in 2004 and 2003, respectively; 19,596,874 and 19,569,676 shares outstanding in 2004 and 2003, respectively		198,239		198,224
Additional paid-in capital		37,831,575		37,491,011
Treasury stock, at cost; 227,031 and 252,729 shares in 2004 and 2003, respectively		(7,059,824	)	(7,836,234	)
Unearned compensation – ESOP		(2,454,940	)	(2,624,940	)
Retained earnings		63,626,113		59,190,493
Accumulated other comprehensive income:
Net unrealized holding gains on securities available for sale		180,359,074		143,940,528

Total stockholders’ equity		272,500,237		230,359,082
Commitments and contingencies (notes 8, 18, and 21)

Total liabilities and stockholders’ equity	$	1,068,201,018		1,000,495,363

See accompanying notes to consolidated financial statements.

F-2

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Income

Years ended September 30, 2004, 2003, and 2002


	2004			2003		2002
Interest and dividend income:
Loans receivable	$	18,079,797		16,693,886		16,902,524
Mortgage-backed securities and collateralized mortgage obligations		14,369,588		11,883,281		15,473,241
Equity securities		5,814,828		5,218,004		4,771,563
Debt securities		488,583		441,848		513,168
Interest-bearing deposits in other financial institutions		60,968		98,411		79,211

Total interest and dividend income		38,813,764		34,335,430		37,739,707

Interest expense:
Deposits (note 14)		4,785,246		5,607,246		6,825,501
Borrowings (note 15)		12,282,777		13,198,597		15,019,296

Total interest expense		17,068,023		18,805,843		21,844,797

Net interest income		21,745,741		15,529,587		15,894,910
Provision for loan losses (note 8)		30,000		25,000		250,000

Net interest income after provision for loan losses		21,715,741		15,504,587		15,644,910

Noninterest income:
Gain on sale of loans and servicing released loan fees		1,151,996		2,775,256		1,859,961
Service charges on deposit accounts		2,549,231		1,717,198		1,115,308
Gain on sale of Freddie Mac common stock (note 5)		2,113,336		773,368		—
Gain (loss) on sale of mortgage-backed securities, collateralized mortgage obligations, and other investments (notes 5 and 6)		115,261		107,038		(816,223	)
Loan servicing fees		208,337		154,975		306,072
Equity in loss of limited partnership (note 13)		—		(106,746	)	(564,164	)
Write-off of investment		(200,000	)	—		—
Brokerage commissions		264,345		332,391		74,422
Other		305,332		140,802		53,596

Total noninterest income		6,507,838		5,894,282		2,028,972

Noninterest expenses:
Salaries and employee benefits (note 17)		10,129,840		10,574,311		7,412,111
Occupancy		2,414,329		2,237,969		1,977,751
Legal and professional		886,211		1,261,387		1,243,078
Marketing		861,781		855,826		805,423
Furniture and equipment		569,247		630,860		474,811
Postage, office supplies, and printing		469,288		571,189		535,901
Federal insurance premiums and other regulatory fees		222,007		210,651		213,096
Net cost of operations of real estate owned		69,372		151,036		135,014
Deposit premium amortization expense (note 4)		213,955		133,149		—
Other		1,320,171		1,598,654		1,492,119

Total noninterest expenses		17,156,201		18,225,032		14,289,304

Income before income taxes		11,067,378		3,173,837		3,384,578
Income tax expense (note 16)		2,850,102		82,543		484,443

Net income	$	8,217,276		3,091,294		2,900,135

Basic and diluted net income per share	$	0.42		0.16		0.15
Weighted average number of common shares outstanding		19,437,613		19,478,388		19,521,984
Weighted average number of common and common equivalent shares outstanding		19,478,037		19,482,326		19,521,984

F-3

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity and Comprehensive Income (Loss)

Years ended September 30, 2004, 2003, and 2002


				Common stock
	Comprehensive income			Number of shares	Amount		Additional paid-in capital		Treasury stock		Unearned compensation – ESOP		Retained earnings		Accumulated other comprehensive income		Total stockholders’ equity
Balance at September 30, 2001				—	$	—	—		—		—		56,058,287		180,857,538		236,915,825
Issuance of common stock				19,822,405		198,224	37,021,175		—		(3,171,580	)	—		—		34,047,819
Comprehensive loss:
Net income	$	2,900,135		—		—	—		—		—		2,900,135		—		2,900,135
Other comprehensive loss – unrealized loss on securities net of income taxes of $15,651,763 (note 23)		(24,896,847	)	—		—	—		—		—		—		(24,896,847	)	(24,896,847	)

Total comprehensive loss	$	(21,996,712	)

Dividends paid, $0.20 per share				—		—	—		—		—		(733,698	)	—		(733,698	)
Allocation of ESOP common stock				—		—	455,221		—		507,041		—		—		962,262
Purchase of common stock for treasury				—		—	—		(29,930	)	—		—		—		(29,930	)

Balance at September 30, 2002				19,822,405		198,224	37,476,396		(29,930	)	(2,664,539	)	58,224,724		155,960,691		249,165,566
Comprehensive loss:
Net income	$	3,091,294		—		—	—		—		—		3,091,294		—		3,091,294
Other comprehensive loss – unrealized loss on securities net of income taxes of $7,556,650 (note 23)		(12,020,163	)	—		—	—		—		—		—		(12,020,163	)	(12,020,163	)

Total comprehensive loss	$	(8,928,869	)

Dividends paid, $0.60 per share				—		—	—		—		—		(2,125,525	)	—		(2,125,525	)
Allocation of ESOP common stock				—		—	84,092		—		39,599		—		—		123,691
Grant of common stock from treasury				—		—	(69,477	)	909,842		—		—		—		840,365
Purchase of common stock for treasury				—		—	—		(8,716,146	)	—		—		—		(8,716,146	)

Balance at September 30, 2003				19,822,405		198,224	37,491,011		(7,836,234	)	(2,624,940	)	59,190,493		143,940,528		230,359,082
Comprehensive income:
Net income	$	8,217,276		—		—	—		—		—		8,217,276		—		8,217,276
Other comprehensive income – unrealized gain on securities net of income taxes of $22,895,046 (note 23)		36,418,546		—		—	—		—		—		—		36,418,546		36,418,546

Total comprehensive income	$	44,635,822

Dividends paid, $1.10 per share				—		—	—		—		—		(3,781,656	)	—		(3,781,656	)
Allocation of ESOP common stock				—		—	363,834		—		170,000		—		—		533,834
Grant of common stock from treasury				—		—	(67,145	)	776,410		—		—		—		709,265
Stock options exercised				1,500		15	43,875		—		—		—		—		43,890

Balance at September 30, 2004				19,823,905	$	198,239	37,831,575		(7,059,824	)	(2,454,940	)	63,626,113		180,359,074		272,500,237

See accompanying notes to consolidated financial statements.

F-4

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended September 30, 2004, 2003, and 2002


	2004			2003		2002
Cash flows from operating activities:
Net income	$	8,217,276		3,091,294		2,900,135
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		30,000		25,000		250,000
Depreciation and amortization		997,758		1,010,138		706,179
Allocation of ESOP common stock		533,834		123,691		962,262
Deferred income tax expense (benefit)		511,285		251,059		(686,521	)
Gain on sale of premises and equipment		(2,500	)	(667	)	—
Equity in loss of limited partnership		—		106,746		564,164
Write-off of investment		200,000		—		—
Amortization of premiums and discounts, net		584,235		3,152,840		729,532
Gain on sale of loans		(1,151,996	)	(2,775,256	)	(1,859,961	)
Proceeds from sale of loans		39,183,522		111,715,049		80,753,296
Originations and purchases of loans held for sale		(38,082,775	)	(102,528,645	)	(77,593,422	)
Gain on sale of Freddie Mac common stock		(2,113,336	)	(773,368	)	—
(Gain) loss on sales of mortgage-backed securities, collateralized mortgage obligations, and other investments		(115,261	)	(107,038	)	816,223
Provision for loss on other real estate owned		104,543		56,486		13,000
(Gain) loss on sales of real estate owned		(57,237	)	81,078		72,576
Changes in assets and liabilities:
Decrease (increase) in accrued interest and dividends receivable		195,888		329,009		(89,102	)
Decrease in other assets		426,093		88,224		251,239
(Decrease) increase in other liabilities		(1,667,336	)	(686,525	)	216,177

Net cash provided by operating activities		7,793,993		13,159,115		8,005,777


Cash flows from investing activities:
Proceeds from sales of mortgage-backed securities and collateralized mortgage obligations available for sale		104,608,929		8,253,369		136,845,298
Principal collections on mortgage-backed securities and collateralized mortgage obligations available for sale		244,793,078		709,327,602		147,147,443
Purchases of mortgage-backed securities and collateralized mortgage obligations available for sale		(331,825,548	)	(659,225,249	)	(412,888,459	)
Purchases of other investment securities available for sale		(21,561,000	)	(12,997,462	)	(36,337,911	)
Proceeds from sale of other investment securities available for sale		13,777,721		—		22,162,639
Proceeds from sale of Freddie Mac common stock		2,186,107		804,555		—
Proceeds from maturities of other securities available for sale		7,000,000		4,300,000		2,000,000
Purchase of FHLB stock		(11,667,500	)	(17,732,500	)	(2,777,500	)
Proceeds from redemption of FHLB stock		10,435,000		18,937,500		—
Net cash paid for EBA Bancshares, Inc.		—		(3,791,005	)	—
Net (increase) decrease in loans receivable, exclusive of loan sales		(24,325,777	)	(30,438,092	)	5,586,826
Proceeds from sale of real estate owned		881,981		508,001		1,341,575
Purchases of premises and equipment, net of dispositions		(2,443,249	)	(2,357,329	)	(1,894,341	)

Net cash (used in) provided by investing activities		(8,140,258	)	15,589,390		(138,814,430	)


		F-5		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Consolidated Statements of Cash Flows

Years ended September 30, 2004, 2003, and 2002


	2004			2003		2002
Cash flows from financing activities:
Stock options exercised	$	43,890		—		—
Issuance of common stock in stock offering		—		—		34,047,819
Purchase of common stock for treasury		—		(8,716,146	)	(29,930	)
Offering proceeds in escrow		—		—		(19,978,915	)
Dividends paid		(3,781,656	)	(2,125,525	)	(733,698	)
Net increase in deposits		189,001		6,582,421		10,391,355
Proceeds from Federal Home Loan Bank advances		581,375,000		814,050,000		220,450,000
Principal payments on advances from Federal Home Loan Bank		(556,425,000	)	(820,950,000	)	(158,200,000	)
Proceeds from other borrowings		1,694,902,600		1,334,401,330		1,428,577,887
Principal payments on other borrowings		(1,715,504,820	)	(1,350,023,110	)	(1,389,288,887	)
Net decrease in advance payments by borrowers for taxes and insurance		(2,010	)	(165,123	)	(437,565	)

Net cash provided by (used in) financing activities		797,005		(26,946,153	)	124,798,066

Net increase (decrease) in cash and cash equivalents		450,740		1,802,352		(6,010,587	)
Cash and cash equivalents at beginning of year		11,920,489		10,118,137		16,128,724

Cash and cash equivalents at end of year	$	12,371,229		11,920,489		10,118,137

Supplemental disclosures of cash flow information:
Interest paid	$	17,042,988		18,932,056		22,154,352
Income taxes paid		3,294,453		1,349,568		5,134,322

Investing activities:
Transfer of assets held for sale to premises and equipment		—		415,870		—
Financing activities:
Real estate acquired through foreclosure of loans receivable		698,381		419,524		1,662,627
Issuance of common stock under stock benefit plans		709,265		840,365		—

See accompanying notes to consolidated financial statements.

F-6

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(1)

Summary of Significant Accounting Policies

The consolidated financial statements of Charter Financial Corporation and subsidiaries (the Company) include the financial statements of Charter Financial Corporation and its wholly owned subsidiaries, CharterBank (the Bank) and Charter Insurance Company. All intercompany accounts and transactions have been eliminated in consolidation.

Charter Financial Corporation was formed through the reorganization of CharterBank in October 2001. The consolidated financial statements of Charter Financial Corporation and subsidiaries reflect the assets and liabilities transferred in such reorganization and the related earnings thereon. Refer to note 2 for further discussion of this reorganization.

CharterBank was organized as a federally chartered mutual savings and loan association in 1954. CharterBank is primarily regulated by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC), and undergoes periodic examinations by those regulatory authorities.

The Company primarily provides real estate loans and a full range of deposit products to individual and small business consumers through its main office in West Point, Georgia and seven full-service branch offices located in LaGrange, Georgia; Auburn, Opelika, and Valley, Alabama. In addition, the Company operates five loan production offices located in various Georgia and Alabama locations. The Company primarily competes with other financial institutions in its market area within west central Georgia and east central Alabama. The Company considers its primary lending market to be the states of Georgia and Alabama.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to prevailing practices within the financial institutions industry. The following is a summary of the significant accounting policies that the Company follows in presenting its consolidated financial statements.

(a)

Basis of Presentation

In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenue and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and mortgage loan prepayment assumptions used to determine the amount of revenue recognition on mortgage-backed securities and collateralized mortgage obligations. In connection with the determination of the allowance for loan losses and the value of real estate owned, management obtains independent appraisals for significant properties. In connection with the determination of revenue recognition on mortgage-backed securities and collateralized mortgage obligations, management obtains independent estimates of mortgage loan prepayment assumptions, which are based partly on historical prepayments and current interest rates.

F-7

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

A substantial portion of the Company’s loans is secured by real estate located in its market area. Accordingly, the ultimate collectibility of a substantial portion of the Company’s loan portfolio is susceptible to changes in the real estate market conditions of this market area.

(b)

Cash Equivalents

Cash equivalents, as presented in the consolidated financial statements, include amounts due from other depository institutions and interest-bearing deposits in other financial institutions. Generally, interest-bearing deposits in other financial institutions are for one-day periods.

(c)

Investments, Mortgage-Backed Securities, and Collateralized Mortgage Obligations

Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale are reported at fair value, as determined by independent quotations. Investment in stock of a Federal Home Loan Bank is required of every federally insured financial institution which utilizes its services. Generally, the Federal Home Loan Bank will repurchase excess stock at cost; accordingly, the investment in Federal Home Loan Bank stock is carried at cost which approximates its fair value.

Purchase premiums and discounts on investment securities are amortized and accreted to interest income using a method which approximates a level yield over the period to maturity of the related securities. Purchase premiums and discounts on mortgage-backed securities and collateralized mortgage obligations are amortized and accreted to interest income using the interest method over the remaining lives of the securities, taking into consideration assumed prepayment patterns.

Gains and losses on sales of investments, mortgage-backed securities, and collateralized mortgage obligations are recognized on the trade date, based on the net proceeds received and the adjusted carrying amount of the specific security sold.

A decline in the market value of any available for sale security below cost that is deemed other than temporary results in a charge to earnings and the establishment of a new cost basis for that security. At September 30, 2004, the Company did not have any securities with other than temporary impairment.

(d)

Loans and Interest Income

Loans are reported at the principal amounts outstanding, net of unearned income, deferred loan fees/origination costs, and the allowance for loan losses. Loans held for sale are carried at the lower of aggregate cost or market, with market determined on the basis of open commitments for committed loans. For uncommitted loans, market is determined on the basis of current delivery prices in the secondary mortgage market.

Interest income is recognized using the simple interest method on the balance of the principal amount outstanding. Unearned income, primarily arising from deferred loan fees, net of certain origination costs, and deferred gains on the sale of the guaranteed portion of Small Business Administration (SBA) loans, is amortized over the lives of the underlying loans using the interest method.


		F-8		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The accrual of interest income is discontinued on loans which become contractually past due by 90 days or when reasonable doubt exists as to the full timely collection of interest or principal. Interest previously accrued but not collected is reversed against current period interest income when such loans are placed on nonaccrual status. Interest on nonaccrual loans which is ultimately collected is credited to income in the period received.

Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement. Large pools of smaller balance homogeneous loans, such as consumer and installment loans, are collectively evaluated for impairment by the Company. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on impaired loans which are accruing interest are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are recorded as income when received unless full recovery of principal is in doubt.

Gains or losses on the sale of mortgage loans are recognized at settlement dates and are computed as the difference between the sales proceeds received and the net book value of the mortgage loans sold. At the time of sale, a servicing asset is recorded if expected servicing revenues exceed an amount approximating adequate servicing compensation. The servicing asset, included in other assets, is amortized using the interest method over the estimated life of the serviced loans considering assumed prepayment patterns.

(e)

Allowance for Loan Losses

The allowance for loan losses is adjusted through provisions for loan losses charged or credited to operations. Loans are charged off against the allowance for loan losses when management believes that the collection of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is determined through consideration of such factors as changes in the nature and volume of the portfolio, overall portfolio quality, delinquency trends, adequacy of collateral, loan concentrations, specific problem loans, and economic conditions that may affect the borrowers’ ability to pay.

To the best of management’s ability, all known and inherent losses that are both probable and reasonable to estimate have been recorded. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to adjust the allowance based on their judgment about information available to them at the time of their examination.


		F-9		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(f)

Real Estate Owned

Real estate acquired through foreclosure, consisting of properties obtained through foreclosure proceedings or acceptance of a deed in lieu of foreclosure, is reported on an individual asset basis at the lower of cost or fair value, less disposal costs. Fair value is determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources. When properties are acquired through foreclosure, any excess of the loan balance at the time of foreclosure over the fair value of the real estate held as collateral is recognized and charged to the allowance for loan losses. Subsequent write-downs are charged to a separate allowance for losses pertaining to real estate owned, established through provisions for estimated losses on real estate owned charged to operations. Based upon management’s evaluation of the real estate acquired through foreclosure, additional expense is recorded when necessary in an amount sufficient to restore the allowance to an adequate level. Gains recognized on the disposition of the properties are recorded in other income.

Costs of improvements to real estate are capitalized, while costs associated with holding the real estate are charged to operations.

(g)

Premises and Equipment

Premises and equipment are stated at cost, less accumulated depreciation which is computed using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of the assets range from 20 to 50 years for buildings and improvements and three to 15 years for furniture, fixtures, and equipment.

(h)

Mortgage Banking Activities

Statement of Financial Accounting Standards (SFAS) No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on consistent application of a financial-components approach that focuses on control. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes financial assets when control has been surrendered, and derecognizes liabilities when extinguished. This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.

Mortgage loan servicing rights are included in other assets. Mortgage servicing rights are stated at cost, less accumulated amortization and impairment valuation allowance. The Company recognizes, as separate assets, rights to service mortgage loans for others, either purchased or through Company originations. Mortgage servicing rights which are acquired through either the purchase or origination of mortgage loans are recognized as separate assets when the Company sells or securitizes those loans with servicing rights retained. For originated and purchased mortgage loans, the amount of the mortgage servicing rights to be recognized is determined based upon an allocation of the total cost of the mortgage loans to the mortgage servicing rights and the loans (without the mortgage servicing rights) based on their relative fair values. Fair value is determined by discounted cash flow analyses using appropriate assumptions for servicing fee income, servicing fee costs, prepayment rates, and


		F-10		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

discount rates. For mortgage servicing rights acquired separate from the mortgage loans, the Company capitalizes the amount paid.

The cost of the mortgage servicing rights is amortized in proportion to and over the period of net servicing income which is estimated to be generated by the underlying mortgage servicing rights.

In accordance with SFAS No. 140, the Company periodically assesses its capitalized mortgage servicing rights for impairment based upon the fair value of those rights. To measure the fair value of its mortgage servicing rights, the Company uses discounted cash flow analyses taking into consideration appropriate assumptions for servicing fee income, servicing fee costs, prepayment rates, and discount rates. The Company stratifies its capitalized mortgage servicing rights for the purpose of evaluating impairment, taking into consideration relevant risk characteristics, including loan type, note rate, and note term. If the recorded amount of the mortgage servicing rights exceeds the fair value, the amount of the impairment is recognized through a valuation allowance, with a corresponding charge to operations. Additionally, the Company will prospectively accelerate future amortization if a reduction in expected future net servicing income is estimated.

Fees for servicing loans for investors are based on the outstanding principal balance of the loans serviced and are recognized as income when earned.

(i)

Insurance

At September 30, 2004, the Company was covered under a $5,000,000 banker’s blanket bond policy and a $3,000,000 errors and omissions policy. The Company is also covered with a $10,000,000 umbrella policy.

(j)

Investment in Limited Partnerships

The carrying value of the Company’s share (based on its underlying ownership interest) of limited partnerships is based on the Company’s original investment adjusted for its pro rata share of the partnerships’ net income or losses.

(k)

Income Taxes

The Company accounts for income taxes in accordance with the provisions of SFAS No. 109, Accounting for Income Taxes. Under the asset and liability method of SFAS No. 109, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under SFAS No. 109, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

(l)

Comprehensive Income

Comprehensive income for the Company consists of net income for the period and unrealized holding gains and losses on investments, mortgage-backed securities, and collateralized mortgage obligations classified as available for sale, net of income taxes.


		F-11		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(m)

Goodwill and Other Intangible Assets

Goodwill and other intangible assets include costs in excess of net assets acquired and deposit premiums recorded in connection with the acquisition of EBA Bancshares, Inc. The deposit premium is being amortized using the double-declining balance method over 13 years.

In accordance with the provisions of SFAS No. 142, the Company tests its goodwill for impairment annually. If indicators of impairment were present in amortizable intangible assets and undiscounted future cash flows were not expected to be sufficient to recover the assets’ carrying amount, an impairment loss would be charged to expense in the period identified. No impairment charges have been recognized through September 30, 2004.

(n)

Stock-Based Compensation

In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure an amendment of FASB Statement No. 123. SFAS No. 148 amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, SFAS No. 148 also amends Accounting Principles Board (APB) Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in the interim financial information. The Company adopted the provisions of SFAS No. 148 effective October 1, 2002.

The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations in accounting for its stock option plans. Accordingly, compensation cost is measured as the excess, if any, of the quoted market price of the Company’s stock at the date of grant over the amount an employee must pay to acquire the stock.


		F-12		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Had compensation cost for the Company’s stock option plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method included in SFAS No. 123, the Company’s net income and income per share would have been reduced to the pro forma amounts indicated below:


	Years ended September 30
	2004		2003	2002
Net income	$	8,217,276	3,091,294	2,900,135
Deduct:
Total stock-based compensation expense determined under fair value based method, net of related tax effect		238,324	377,168	105,885

Pro forma net income	$	7,978,952	2,714,126	2,794,250

Net income per common share – basic:
As reported	$	0.42	0.16	0.15
Pro forma		0.41	0.14	0.14
Net income per common share – diluted:
As reported	$	0.42	0.16	0.15
Pro forma		0.41	0.14	0.14

Options on 139,250 shares were granted during the year ended September 30, 2004.

(o)

Income Per Share

Basic net income per share is computed on the weighted average number of shares outstanding in accordance with SFAS No. 128, Earnings Per Share. Diluted net income per share is computed by dividing net income by weighted average shares outstanding plus common share equivalents resulting from dilutive stock options, determined using the treasury stock method.

(p)

Recent Accounting Pronouncements

In January 2003, the FASB issued FIN 46, which clarifies the application of Accounting Research Bulletin (ARB) 51, Consolidated Financial Statements, to certain entities (called variable interest entities) in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The disclosure requirements of this interpretation were effective for all financial statements issued after January 31, 2003. The consolidation requirements applied to all variable interest entities created after January 31, 2003. This Interpretation was amended in October 2003 by FSP 46-6, Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities. This FSP deferred the effective date for applying the provisions of FIN 46 for interests held by public companies in variable interest entities or


		F-13		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

potential variable interest entities created before February 1, 2003. As amended, public companies must apply the consolidation requirements to variable interest entities that existed prior to February 1, 2003 and remain in existence as of the end of annual or interim periods ending after December 15, 2003. In December 2003, FIN 46R was issued, which again deferred the effective date for interests held by public companies in special-purpose entities for periods ending after December 15, 2003, and for all other types of entities for periods ending after March 15, 2004. The Company adopted FIN 46 and its amendment as prescribed. The effect of this Interpretation on the consolidated financial statements was not material.

In October 2003, the American Institute of Certified Public Accountants (AICPA) issued SOP 03-3, which addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes such loans acquired in purchase business combinations and applies to all nongovernmental entities, including not-for-profit organizations. This SOP does not apply to loans originated by the entity. This SOP limits the yield that may be accreted (accretable yield) to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. This SOP requires that the excess of contractual cash flows over cash flows expected to be collected (nonaccretable difference) not be recognized as an adjustment of yield, loss accrual, or valuation allowance. The SOP prohibits investors from displaying accretable yield and nonaccretable difference in the balance sheet. Subsequent increases in cash flows expected to be collected generally would be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected would be recognized as impairment. This SOP prohibits “carrying over” or creation of valuation allowances in the initial accounting for all loans acquired in a transfer that are within the scope of this SOP. The prohibition of the valuation allowance carryover applies to the purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. Management is currently assessing the potential impact of this SOP to the consolidated financial statements.

In March 2004, the EITF reached a consensus on Issue 03-1, Meaning of Other Than Temporary Impairment (Issue 03-1). The Task Force reached a consensus on an other-than-temporary impairment model for debt and equity securities accounted for under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities and cost method investments. The basic model development by the Task Force in evaluating whether an investment within the scope of Issue 03-01 is other-than-temporarily impaired is as follows: Step 1: Determine whether the investment is impaired. An investment is impaired if its fair value is less than its cost. Step 2: Evaluate whether the impairment is other-than-temporary. Step 3: If the impairment is other-than-temporary, recognize an impairment loss equal to the difference between the investment’s cost and its fair value. In September 2004, the FASB approved an FSP to delay the requirement to record impairment losses under Issue 03-01. The approved delay will apply to all securities within the scope of Issue 03-01 and is expected to end when new guidance is issued and comes into effect. The FSP did not affect the disclosure requirements of Issue 03-01. The Company will continue to monitor changes to


		F-14		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Issue 03-01, but does not consider it, or related FSP to have a material impact on the Company’s financial position or results of operations.

(q)

Reclassifications

Certain reclassifications have been made to the 2003 and 2002 financial statements to conform to the presentation adopted in 2004.

(2)

Reorganization

On October 16, 2001, CharterBank completed a reorganization into a two-level holding company structure with a sale of 20% of the stock of the mid-tier holding company – Charter Financial Corporation. CharterBank converted its charter into a mutual holding company charter and changed its name to First Charter, MHC which then contributed all its assets except $100,000 cash and 400,000 shares of Freddie Mac common stock to a newly formed mid-tier holding company, Charter Financial Corporation, in exchange for 80% of the stock in Charter Financial Corporation. Charter Financial Corporation sold 20% of its stock in a minority stock offering for net proceeds of $37,219,399, including proceeds for 317,158 shares purchased by Charter Financial Corporation for its Employee Stock Ownership Plan (ESOP). Charter Financial Corporation then contributed 2,555,000 shares of Freddie Mac common stock, 50% of the net proceeds of the offering and the banking assets and liabilities to its newly formed, wholly owned thrift subsidiary, CharterBank. Charter Financial Corporation also contributed 400,000 shares of Freddie Mac common stock to its wholly owned insurance subsidiary, Charter Insurance Company. Charter Financial Corporation retained the stock of Charter Insurance Company, 1,700,000 shares of Freddie Mac common stock, and 50% of the net proceeds of the stock offering. Management believes that CharterBank has continued its classification as “well capitalized” under the regulatory framework for prompt corrective action, following this reorganization.


		F-15		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(3)

Business Combinations

Effective February 21, 2003, the Company acquired all of the issued and outstanding shares of EBA Bancshares, Inc. (EBA), Opelika, Alabama, and its wholly owned banking subsidiary, Eagle Bank of Alabama, for a purchase price of approximately $8,600,000 in cash. The acquisition has been accounted for using the purchase method of accounting and, hence, the results of operations of EBA have been included in the consolidated financial statements beginning on the aforementioned effective date. The assets and liabilities of EBA, including purchase accounting adjustments, as of the date of the acquisition, were as follows:


Loans, net	$	53,846,691
Other earning assets		8,050,055
Other assets		2,659,402
Goodwill and other intangibles		6,301,223

		70,857,371
Deposits		62,056,965
Other liabilities		156,833

Purchase price, including acquisition costs	$	8,643,573

(4)

Goodwill and Other Intangible Assets

In conjunction with the acquisition of EBA, the Company acquired the following goodwill and other intangible assets:


Goodwill	$	4,325,282
Deposit premium		1,975,941

	$	6,301,223

Goodwill and other intangible assets include cost in excess of net assets acquired and deposit premiums recorded in connection with the acquisition of EBA. The deposit premium is being amortized using the double-declining balance method over 13 years. The Company recorded amortization expense related to the deposit premium of $213,955 and $133,149 for the years ended September 30, 2004 and 2003, respectively.

At September 30, 2004 and 2003, other intangible assets is summarized as follows:


	2004		2003
Deposit premium	$	1,975,941	1,975,941
Less accumculated amortization		347,104	133,149

	$	1,628,837	1,842,792


		F-16		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Amortization expense for the next five years is as follows:


2005	$	188,627
2006		166,675
2007		147,684
2008		136,864
2009		134,402

	$	774,252

(5)

Investment Securities

Investment securities available for sale are summarized as follows:


	September 30, 2004
	Amortized cost		Gross unrealized gains	Gross unrealized losses		Estimated fair value
Freddie Mac common stock	$	6,212,574	294,217,626	—		300,430,200

Other:
U.S. Government agencies	$	22,338,849	—	(182,099	)	22,156,750


	September 30, 2003
	Amortized cost		Gross unrealized gains	Gross unrealized losses		Estimated fair value
Freddie Mac common stock	$	6,285,345	236,618,655	—		242,904,000

Other:
U.S. Government agencies	$	12,981,472	57,457	(146,794	)	13,185,723
Corporate debt		8,632,364	106,057	(1,953	)	8,740,374

	$	21,613,836	163,514	(148,747	)	21,926,097


		F-17		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The amortized cost and estimated fair value of investment debt securities available for sale as of September 30, 2004, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Amortized cost		Estimated fair value
3-4 years	$	5,000,000	4,975,000
4-5 years		6,300,000	6,284,250
Thereafter		11,038,849	10,897,500

	$	22,338,849	22,156,750

The Company’s investment in Federal Home Loan Bank stock was $14,842,500 and $13,610,000 at September 30, 2004 and 2003, respectively. Under SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, the investment in Federal Home Loan Bank stock is carried at cost because it is considered a restricted stock investment. The investment in Federal Home Loan Bank stock was not considered impaired at September 30, 2004 and 2003.

Proceeds from sales of investment securities during 2004 and 2002 were $13,777,721 and $22,162,639, respectively. There were no sales in 2003. Gross gains of $8,486 and $129,068 were realized on those sales for 2004 and 2002, respectively, and gross realized losses on sales of investment securities for 2004 and 2002 were $0 and $1,565,121, respectively.

Investment securities available for sale that have been in a continuous unrealized loss position for less than 12 months follow:


Amortized cost	Gross unrealized losses	Estimated fair value
$18,302,080	(95,330)	18,206,750

Investment securities available for sale that have been in a continuous unrealized loss position for 12 months or greater are as follows:


Amortized cost	Gross unrealized losses		Estimated fair value
$4,036,769	(86,769	)	3,950,000

Investment securities with an aggregate carrying amount of $18,206,750 and $19,891,948 at September 30, 2004 and 2003, respectively, were pledged to collateralize Federal Home Loan Bank advances and securities sold under agreements to repurchase.


		F-18		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Proceeds from the sale of Freddie Mac common stock during 2004 and 2003 were $2,186,107 and $804,555, respectively. There were no sales in 2002. Gross gains of $2,113,336 and $773,368 were realized on those sales for 2004 and 2003, respectively.

(6)

Mortgage-Backed Securities and Collateralized Mortgage Obligations

Mortgage-backed securities and collateralized mortgage obligations available for sale are summarized as follows:


	September 30, 2004
	Amortized cost		Gross unrealized gains	Gross unrealized losses		Estimated fair value
Mortgage-backed securities:
FNMA certificates	$	129,953,880	1,338,753	(640,678	)	131,933,311
GNMA certificates		19,876,161	321,101	(27,600	)	20,224,862
FHLMC certificates		9,851,814	65,828	(15,898	)	9,933,540
Collateralized mortgage obligations:
FNMA		72,589,464	34,162	(1,501,184	)	74,124,810
FHLMC		92,025,883	207,358	(589,367	)	92,822,608
GNMA		1,510,364	—	(944	)	1,511,308
Other		52,840,147	573,916	(56,553	)	53,470,616

	$	378,647,713	2,541,118	(2,832,224	)	384,021,055


	September 30, 2003
	Amortized cost		Gross unrealized gains	Gross unrealized losses		Estimated fair value
Mortgage-backed securities:
FNMA certificates	$	89,364,541	1,223,688	(180,269	)	90,768,498
GNMA certificates		14,531,391	387,325	—		14,918,716
FHLMC certificates		13,378,196	2,125	(113,799	)	13,494,120
Collateralized mortgage obligations:
FNMA		136,101,123	142,161	(2,723,134	)	138,966,418
FHLMC		86,818,483	121,579	(872,118	)	87,812,180
Other		56,441,159	159,496	(349,659	)	56,950,314

	$	396,634,893	2,036,374	(4,238,979	)	402,910,246


		F-19		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Proceeds from sales of mortgage-backed securities and collateralized mortgage obligations during 2004, 2003, and 2002 were $104,608,929, $8,253,369, and $136,845,298, respectively. Gross gains of $684,549, $107,038, and $785,965 and gross losses of $577,774, $0, and $166,135 were realized on those sales for 2004, 2003, and 2002, respectively.

Mortgage-backed securities and collateralized mortgage obligations with an aggregate carrying amount of $321,023,333 and $335,955,405 at September 30, 2004 and 2003, respectively, were pledged to secure Federal Home Loan Bank advances and to collateralize securities sold under agreements to repurchase.

The following table shows additional information related to the collateralized mortgage obligations held by the Company:


	September 30, 2004
	Fair value		Weighted average life	Yield		Net unrealized gain (loss)
Fixed rate	$	115,494,808	2.69 years	4.11	%	$	(1,549,867	)
Variable rate		102,138,438	4.46 years	2.71			217,255

Total	$	217,633,246	3.52 years	3.46	%	$	(1,332,612	)


	September 30, 2003
	Fair value		Weighted average life	Yield		Net unrealized gain (loss)
Fixed rate	$	103,123,995	1.71 years	3.28	%	$	(3,179,137	)
Variable rate		172,715,095	6.52 years	2.18			(342,538	)

Total	$	275,839,090	5.43 years	2.59	%	$	(3,521,675	)

The weighted average lives and yields in the above table are based on the average life utilizing the previous three months of prepayment speeds from September 30, 2004 and 2003, respectively. Different prepayment assumptions may result in different average lives and thus different yields.


		F-20		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Mortgage-backed securities and collateralized mortgage obligations that have been in a continuous unrealized loss position for less than 12 months are as follows:


	Amortized cost		Gross unrealized losses		Estimated fair value
Mortgage-backed securities:
FNMA certificates	$	64,057,251	(640,678	)	63,416,573
GNMA certificates		8,684,062	(27,600	)	8,656,462
FHLMC certificates		2,177,437	(4,606	)	2,172,831
Collateralized mortgage obligations:
FNMA		34,500,315	(182,480	)	34,317,835
GNMA		1,510,364	(944	)	1,509,420
FHLMC		42,019,798	(222,509	)	41,797,289
Other		4,700,228	(24,350	)	4,675,878

	$	157,649,455	(1,103,167	)	156,546,288

Mortgage-backed securities and collateralized mortgage obligations that have been in a continuous unrealized loss position for greater than 12 months are as follows:


	Amortized cost		Gross unrealized losses		Estimated fair value
Mortgage-backed securities:
FHLMC certificates	$	3,183,478	(11,292	)	3,172,186
Collateralized mortgage obligations:
FNMA		34,292,524	(1,318,704	)	32,973,820
FHLMC		11,004,034	(366,858	)	10,637,176
Other		4,976,268	(32,203	)	4,944,065

	$	53,456,304	(1,729,057	)	51,727,247

(7)

Derivative Instruments

During 2003, the Company initiated a covered call program on its Freddie Mac common stock. The Company sold a total of 326,500 options during 2003 of which 165,000 options expired or were bought back by the Company, and of which 15,000 were exercised by the holder. At no time during 2003 did the Company have more than 250,000 options outstanding.

During 2004, the Company sold a total of 567,900 options, of which 594,200 options expired or were bought back by the Company and 35,000 were exercised by the holder. At no time during 2004 did the Company have more than 400,000 options outstanding.


		F-21		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The covered call options written on Freddie Mac common stock are derivative instruments as defined by SFAS No. 133 and as such are recorded at fair value. The Company does not account for the options as hedges and as a result the change in fair value is recorded in the consolidated statement of income. At September 30, 2004 and 2003, 85,200 and 146,500 options were outstanding with a fair value of $92,654 and $87,935, respectively, included in other liabilities.

(8)

Loans Receivable

Loans receivable are summarized as follows:


	September 30
	2004			2003
1-4 family residential real estate mortgage	$	142,249,868		133,305,460
Commercial real estate		119,618,117		111,188,786
Commercial		20,628,156		21,633,914
Real estate construction		34,834,682		26,530,498
Consumer and other		19,579,417		19,672,561
Undisbursed proceeds of loans in process		(13,363,366	)	(12,454,021	)

Loans receivable, net of undisbursed proceeds of loans in process		323,546,874		299,877,198
Less:
Unamortized loan origination fees, net		773,461		544,202
Allowance for loan losses		6,622,597		6,779,576

	$	316,150,816		292,553,420

In addition to the above, the Company was servicing loans primarily for others with aggregate principal balances of $36,877,285, $50,477,309, and $95,879,380 at September 30, 2004, 2003, and 2002, respectively.

Loans to certain executive officers, directors, and their associates totaled $1,496,440 and $418,666 at September 30, 2004 and 2003, respectively. Management believes that such loans were made in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with other persons, and did not involve more than the normal credit risk nor present other unfavorable features. The following is a summary of activity during 2004 with respect to such aggregate loans to these individuals and their associates and affiliated companies:


Balance at September 30, 2003	$	418,666
New loans		1,320,500
Repayments		242,726

Balance at September 30, 2004	$	1,496,440


		F-22		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

At September 30, 2004 and 2003, the Company had $5,865,057 and $5,123,917, respectively, of nonaccrual loans. The following is a summary of interest income relating to nonaccrual loans for the years ended September 30, 2004, 2003, and 2002.


	2004			2003		2002
Interest income at contractual rates	$	450,906		468,007		262,125
Interest income actually recorded		(206,882	)	(331,571	)	(213,210	)

Reduction of interest income	$	244,024		136,436		48,915

The following is a summary of transactions in the allowance for loan losses:


	2004			2003		2002
Balance at beginning of year	$	6,779,576		5,179,048		5,289,778
Allowance acquired in business combination		—		2,177,369		—
Loans charged off		(650,377	)	(1,044,152	)	(816,074	)
Recoveries on loans previously charged off		463,398		442,311		455,344
Provision for loan losses charged to operations		30,000		25,000		250,000

Balance at end of year	$	6,622,597		6,779,576		5,179,048

At September 30, 2004, 2003, and 2002, pursuant to the definition within SFAS No. 114, the Company had impaired loans of approximately $3,876,000, $2,220,000, and $2,113,000, respectively. There were specific allowances attributable to impaired loans at September 30, 2004, 2003, and 2002 of $22,000, $0, and $0, respectively.

The average recorded investment in impaired loans for the years ended September 30, 2004, 2003, and 2002 was approximately $3,048,000, $2,167,000, and $1,405,000, respectively. Interest income recognized on impaired loans for the years ended September 30, 2004, 2003, and 2002, was not significant.

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the financial statements. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

The Company’s exposure to credit loss, in the event of nonperformance by the customer for commitments to extend credit is represented by the contractual or notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for recorded loans.


		F-23		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

A summary of the Company’s financial instruments with off-balance sheet risk at September 30, 2004 and 2003 is as follows:


	2004		2003
Financial instruments whose contract amounts represent credit risk – commitments:
Mortgage loans	$	6,080,537	11,989,625
Open-end consumer loans		9,579,913	8,686,462
Open-end commercial loans		17,143,918	6,087,590
Construction loans		13,363,366	12,454,021

Total commitments	$	46,167,734	39,217,698

The Company was also committed to sell loans of approximately $431,537 and $88,500 at September 30, 2004 and 2003, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the agreement. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but consists primarily of residential real estate.

The following summarizes the Company’s commitments to fund fixed rate loans at September 30, 2004 and 2003:


	Amount		Range of rates
September 30, 2004	$	1,189,537	5.25-7.00	%
September 30, 2003		10,630,150	5.25-7.00	%

In the origination of mortgage loans, the Company enters into adjustable interest rate contracts with caps and floors written with the intent of managing its interest rate exposure. Interest rate caps and floors enable customers and the Company to transfer, modify, or reduce their interest rate risk. At September 30, 2004 and 2003, adjustable rate mortgage loans with interest rate caps and floors amounted to $49,317,000 and $55,819,000, respectively.

(9)

Real Estate Owned

At September 30, 2004 and 2003, real estate owned is summarized as follows:


	2004		2003
Real estate acquired through foreclosure	$	452,671	683,577


		F-24		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(10)

Accrued Interest and Dividends Receivable

At September 30, 2004 and 2003, accrued interest and dividends receivable are summarized as follows:


	2004		2003
Loans	$	1,389,502	1,405,339
Mortgage-backed securities and collateralized mortgage obligations		1,335,026	1,405,408
Investment securities		151,945	280,125
Other		127,751	109,240

	$	3,004,224	3,200,112

(11)

Premises and Equipment

Premises and equipment at September 30, 2004 and 2003 is summarized as follows:


	2004		2003
Land	$	4,830,576	3,601,947
Buildings and improvements		6,663,305	6,890,774
Furniture, fixtures, and equipment		3,077,600	3,910,989
Construction in progress		1,132,412	335,400

		15,703,893	14,739,110
Less accumulated depreciation		4,508,123	5,356,216

	$	11,195,770	9,382,894

(12)

Mortgage Servicing Rights

Activity in mortgage servicing rights (which are included in other assets) for the years ended September 30, 2004, 2003, and 2002 consists of the following:


	2004			2003		2002
Balance at beginning of year	$	263,222		591,900		815,984
Capitalized during the year		—		—		5,795
Amortization expense		(150,930	)	(328,678	)	(229,879	)

Balance at end of year	$	112,292		263,222		591,900

There was no valuation allowance at September 30, 2004, 2003, and 2002.


		F-25		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(13)

Investment in Limited Partnership

During 1997, the Company purchased an interest in a limited partnership, which was formed to acquire mortgage servicing rights, for $5,000,000. The Company was allocated approximately 21% of the respective earnings or losses of this partnership. As discussed in note 1, the Company used the equity method of accounting for its investment in this limited partnership. Accordingly, the Company recognized equity in the net losses of the limited partnership of $106,746 during 2003 and $564,164 during 2002. At September 30, 2004 and 2003, the Company’s carrying value in this investment was zero.

Financial information (unaudited), including the balance sheet as of September 30, 2003 and the income statements for the years ended September 30, 2003 and 2002 for the partnership, was as follows:


	2003
Cash	$	466,646
Accounts receivable		1,278,471
Mortgage servicing rights, net		604,385
Other assets, primarily current		720,498

	$	3,070,000

Long-term debt	$	3,070,000
Other liabilities		—
Partners’ capital:
CharterBank		—
Other partners		—

	$	3,070,000


	Years ended September 30
	2003			2002
Revenues	$	597,566		2,097,144
Expenses		1,115,122		4,832,485

Net loss	$	(517,556	)	(2,735,341	)

CharterBank’s equity in net loss	$	(106,746	)	(564,164	)


		F-26		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(14)

Deposits

At September 30, 2004 and 2003, deposits are summarized as follows:


	2004						2003
	Amount		Range of interest rates		Weighted average interest rate		Amount		Range of interest rates		Weighted average interest rate
Demand, NOW, and money market accounts	$	114,369,765	0.00-2.00	%	0.90	%	$	84,126,615	0.00-1.64	%	0.58	%
Savings deposits		14,979,726	0.25-4.50		0.25			15,419,473	0.00-4.50		0.30
Time deposits by original term:
Time deposits over $100,000		36,555,804	0.00-8.25		3.04			46,220,957	0.96-8.00		3.04
Other time deposits:
12 months or less		78,335,634	1.01-8.00		2.37			96,191,722	0.84-7.50		2.32
13-36 months		26,260,787	1.21-7.13		3.46			27,809,364	1.05-8.00		3.80
37 months or more		9,072,993	1.65-6.97		3.73			9,617,577	1.20-5.54		4.29

Total deposits		279,574,709			1.85	%		279,385,708			1.95	%

Accrued interest payable		410,963						502,606

	$	279,985,672					$	279,888,314

During 2004 and 2003, the Company pursued out of market time deposits from various credit unions and/or brokers as a source of funds. The balance of the credit union deposits was $34,111,447 and $42,180,547 and of the broker deposits was $100,000 and $7,556,601 at September 30, 2004 and 2003, respectively.

At September 30, 2004, scheduled maturities of time deposits are as follows:


Year ending September 30:
2005	$	98,256,061
2006		21,457,344
2007		18,417,146
2008		5,734,906
2009		6,109,760
2010 and thereafter		250,001

	$	150,225,218


		F-27		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Interest expense on deposits for the years ended September 30, 2004, 2003, and 2002 is summarized as follows:


	2004		2003	2002
Demand, NOW, and money market accounts	$	836,509	611,164	524,784
Savings deposits		38,681	63,176	79,700
Time deposits		3,910,056	4,932,906	6,221,017

	$	4,785,246	5,607,246	6,825,501

Deposits of certain officers, directors, and their associates totaled $588,828 and $621,331 at September 30, 2004 and 2003, respectively. Management believes that such deposits have substantially the same terms as those for comparable transactions with other persons.

(15)

Borrowings

At September 30, 2004 and 2003, borrowings are summarized as follows:


	2004		2003
Federal Home Loan Bank advances	$	292,050,000	267,100,000
Securities sold under agreements to repurchase		100,739,000	121,341,220

	$	392,789,000	388,441,220

Federal Home Loan Bank advances at September 30, 2004 and 2003 are summarized by year of maturity in the table below:


	2004						2003
Due	Amount		Interest rates		Weighted average rate		Amount		Interest rates		Weighted average rate
Less than one year	$	40,050,000	2.15	%	2.15	%	$	140,100,000	1.30-5.34	%	2.40	%
One to two years		25,000,000	2.97		2.97			—	—		—
Two to three years		75,000,000	2.62-3.68		3.18			—	—		—
Three to four years		25,000,000	2.87		2.87			—	—		—
Four to five years		—	—		—			—	—		—
Thereafter		127,000,000	5.40-6.22		5.75			127,000,000	5.40-6.22		5.75

	$	292,050,000			4.11	%	$	267,100,000			3.99	%

At September 30, 2004, the Company has pledged, under a blanket floating collateral lien with the Federal Home Loan Bank (FHLB), all stock of the FHLB, certain qualifying first mortgage loans with unpaid principal balances totaling $111,908,793, certain commercial loans with unpaid principal balances totaling $17,686,082, and certain mortgage-backed securities, collateralized mortgage obligations, and investment securities with an aggregate fair value of $233,455,629.


		F-28		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The Company has $40,050,000 in adjustable rate advances and $252,000,000 in fixed rate advances from the FHLB at September 30, 2004. As of September 30, 2004, the Company’s fixed rate FHLB advances include $97,000,000 of advances that are callable by the FHLB under certain circumstances.

At September 30, 2004, the Company had available line of credit commitments with the FHLB totaling $373,288,929 of which $292,050,000 was advanced and $81,238,929 was available at September 30, 2004.

The securities sold under agreements to repurchase are secured by certain mortgage-backed securities, collateralized mortgage obligations, and investment securities with an aggregate fair value of $105,774,454 and $150,187,501 at September 30, 2004 and 2003, respectively. All securities sold under the agreements to repurchase are under the Company’s control. The repurchase agreements at September 30, 2004 and 2003 have maturities of less than 45 days, and provide for the purchase of identical securities and specify delivery of the underlying securities to an approved custodian. The aggregate carrying amount of such securities sold under the agreements to repurchase exceeded the amount of repurchase liabilities by $5,035,454 at September 30, 2004.

The following summarizes pertinent data related to securities sold under the agreements to repurchase for the years ended September 30, 2004, 2003, and 2002:


	2004			2003		2002
Weighted average borrowing rate at year-end		1.81	%	1.26	%	2.06	%
Weighted average borrowing rate during the year		1.28		1.58		2.21
Average daily balance during year	$	132,622,831		108,497,899		107,076,110
Maximum month-end balance during the year		150,710,000		133,608,000		158,727,000

Interest expense on borrowings for the years ended September 30, 2004, 2003, and 2002 is summarized as follows:


	2004		2003	2002
Securities sold under agreements to repurchase	$	1,697,549	1,718,641	2,369,757
Federal Home Loan Bank advances		10,585,228	11,479,956	12,649,539

	$	12,282,777	13,198,597	15,019,296


		F-29		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(16)

Income Taxes

Income tax expense (benefit) attributable to income from continuing operations for the years ended September 30, 2004, 2003, and 2002 consists of:


	2004		2003		2002
Federal:
Current	$	1,921,934	6,175		940,638
Deferred		475,495	64,747		(613,127	)

Total Federal tax expense		2,397,429	70,922		327,511

State:
Current		416,883	(174,691	)	230,326
Deferred		35,790	186,312		(73,394	)

Total state tax expense		452,673	11,621		156,932

	$	2,850,102	82,543		484,443

The difference between the actual total provision for Federal and state income taxes and Federal income taxes computed at the statutory rate of 34% for the years ended September 30, 2004, 2003, and 2002, is summarized as follows:


	2004			2003		2002
Computed “expected” tax expense	$	3,762,909		1,079,105		1,150,757
Increase (decrease) in tax expense resulting from:
Dividends received deduction		(1,248,374	)	(1,012,874	)	(799,570	)
State income taxes, net of Federal tax effect		298,764		7,670		103,575
Tax-exempt income of subsidiary		—		(109,103	)	(108,783	)
Change in the deferred tax asset valuation allowance		—		(69,190	)	69,190
Market value appreciation of ESOP shares		90,248		117,091		154,776
Other, net		(53,445	)	69,844		(85,502	)

	$	2,850,102		82,543		484,443

The effective tax rate for the years ended September 30, 2004, 2003, and 2002 was 25.75%, 2.60%, and 14.31%, respectively.


		F-30		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of September 30, 2004 and 2003 are presented below:


	2004		2003
Deferred tax assets:
Allowance for loan losses	$	1,596,956	1,605,909
Interest on nonaccrual loans		96,168	101,785
Deferred compensation		859,564	684,968
Investment in limited partnership		57,513	393,208
Real estate acquired through foreclosure		145,984	170,235
Net operating loss carryforward		—	306,755
Alternative minimum tax credit carryforward		418,401	501,819
Covered calls market adjustment for tax reporting		39,972	—
Other		27,046	96,553

Total gross deferred tax assets		3,241,604	3,861,232
Less valuation allowance		—	—

Net deferred tax assets		3,241,604	3,861,232

Deferred tax liabilities:
Deferred loan costs, net		480,886	434,891
Depreciation		274,989	128,458
Mortgage servicing rights		42,255	99,050
Investment securities market adjustment for tax reporting		606,310	816,881
Net unrealized holding gains on securities available for sale		113,385,345	90,490,299
Federal Home Loan Bank stock dividends		5,131	11,198
Other		49,349	76,785

Total gross deferred tax liabilities		114,844,265	92,057,562

Net deferred tax liabilities	$	111,602,661	88,196,330

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment.

Based upon the level of historical taxable income and projections for future taxable income over the periods which the temporary differences resulting in the deferred tax assets are deductible, management believes it is more likely than not the Company will realize the benefits of these deductible differences at September 30, 2004.


		F-31		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(17)

Employee Benefits

The Company has a 401(k) Profit Sharing Plan and Trust (Plan) which covers substantially all of its employees. Prior to January 1, 2002, the Company matched up to 50% of employee contributions to the Plan, up to 8% of employee compensation, and made additional discretionary contributions. Effective January 1, 2002, the Company terminated its match of employee contributions to the Plan. The Company made contributions to the Plan of $45,859 in 2002.

During 1996, the Company implemented a short-term incentive plan which covers substantially all employees. The Company also implemented a long-term incentive plan which covers key employees. For the years ended September 30, 2004, 2003, and 2002, the Company expensed $1,427,268, $1,024,324, and $361,066, respectively, related to the incentive plans.

During 2002, the Company adopted the 2001 Stock Option Plan (the 2001 Plan) which allows for stock option awards for up to 396,448 shares of the Company’s common stock to eligible directors and key employees of the Company. During 2003, the Company amended the 2001 Plan to allow for stock option awards for up to 707,943 shares. Under the provisions of the 2001 Plan, the option price is determined by a committee of the board of directors at the time of grant and may not be less than 100% of the fair market value of the common stock on the date of grant of such option. When granted, the options vest within five years or upon death, disability, or qualified retirement. All options must be exercised within a ten-year period. The Company may grant either incentive stock options, which qualify for special Federal income tax treatment, or nonqualified stock options, which do not receive such tax treatment.

The following table summarizes activity for shares under option and weighted average exercise price per share:


	Shares		Exercise price/share
Options outstanding – September 30, 2001	—		$	—
Granted in 2002	152,000			29.26

Options outstanding – September 30, 2002	152,000			29.26
Granted in 2003	—			—

Options outstanding – September 30, 2003	152,000			29.26
Options exercised	(1,500	)		29.26
Options forfeited	(1,000	)		29.26
Granted in 2004	139,250			32.99

Options outstanding – September 30, 2004	288,750		$	31.06

Options exercisable at end of year – September 30, 2002	—		$	—
Options exercisable at end of year – September 30, 2003	35,200			29.26
Options exercisable at end of year – September 30, 2004	58,300			29.26


		F-32		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The following table summarizes information about the options outstanding at September 30, 2004:


Number outstanding at September 30, 2004	Weighted average remaining contractual life in years	Exercise price per share		Weighted average exercise price per share
149,500	8	$	29.26	$	29.26
139,250	10		32.99		32.99

288,750				$	31.06

The fair value of each option grant is estimated on the date of grant using a minimum value option price assessment with weighted average assumptions used and estimated fair values for the years ended September 30, 2004 and 2002 as follows:


	2004			2002
Risk-free interest rate		4.34	%		3.76	%
Dividend yield		6.06	%		3.00	%
Expected life at date of grant		7 years			7 years
Volatility		22.00	%		29.00	%
Weighted average grant-date fair value	$	4.00		$	7.52

No options were granted during the year ended September 30, 2003.

During 2002, the Company implemented a benefit restoration plan (Benefit Plan) which covers the chief executive officer of the Company and any employees of the Company who are designated as eligible to participate in the Benefit Plan by resolution of the board of directors of the Company. The Benefit Plan restores the benefits in tax-qualified plans that are limited by the Internal Revenue Code. Also, in the case of a participant who retires before the repayment in full of a loan to the Employee Stock Ownership Plan, the restorative payments include a payment in lieu of the shares that would have been allocated if employment had continued through the full term of the loan. The participant in the Benefit Plan is entitled to contributions to the Benefit Plan upon termination of service, attainment of age 55, retirement or death. The Company expensed $97,664, $62,949, and $137,894 related to the Benefit Plan during the years ended September 30, 2004, 2003, and 2002, respectively.

During 2002, the Company implemented the 2001 Recognition and Retention Plan (Retention Plan). During 2003, the Company amended the Retention Plan to allow for restricted stock awards for up to 283,177 awards. The Company has established a grantor trust to purchase these common shares of the Company on the open market or in private transactions. The grantor trust will not purchase previously authorized but unissued common shares from the Company and is not authorized to purchase more than 283,177 shares of common stock of the Company.

In July 2002, the Company granted as restricted stock awards 133,240 shares. Such common shares had a fair value of $27.60 per share at date of grant which aggregated $3,678,445 in fair value. Vesting in the


		F-33		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

shares in the 2002 grant is 20% per year for each year of service with full vesting after five years of service or upon death, disability, or qualified retirement. In July 2004, the Company granted as restricted stock awards 77,598 shares of the 283,177 shares reserved for the plan to eligible employees and directors of the Company, as defined by the Retention Plan. Such common shares had a fair value of $32.99 per share at date of grant which aggregated $2,559,958 in fair value. Vesting in the shares in the 2004 grant is at years 2008 through 2013 or upon death, disability, or qualified retirement.

The Company expensed $1,054,738, $1,637,177, and $433,283 related to the Retention Plan during the years ended September 30, 2004, 2003, and 2002, respectively, and will continue to record compensation over the vesting period. As of September 30, 2004 and 2003, the grantor trust had purchased all of the stock approved for the Plan and the trust holds 227,031 shares of the Company’s common stock which are disclosed as treasury shares in the consolidated balance sheet until such shares are vested in the Retention Plan.

During 2002, the Company implemented the Employee Stock Ownership Plan (ESOP) which covers substantially all of its employees. During the stock offering of the Company, the ESOP trust borrowed $3,171,580 from the Company to purchase 317,158 shares for allocation under the ESOP. The loan to the ESOP is reflected as unearned compensation in stockholders’ equity. As the Company receives principal payments on the loan, shares are released for allocation to participants in the ESOP and unearned compensation is reduced. Shares of the Company are freed for allocation to participants in the ESOP based on the principal and interest allocation method. Vesting in the shares of the ESOP occurs after five years of service. Participants in the ESOP may receive a distribution equal to the value of their account upon retirement, death, disability, termination of employment, or termination of the ESOP. The Company records compensation expense associated with the ESOP based on the average market price of the total shares committed to be released during the year as well as the dividends declared on the unallocated shares. The Company expensed $439,999, $675,701, and $1,021,461 related to the ESOP during the years ended September 30, 2004, 2003, and 2002, respectively. The Company committed to be allocated 16,500 shares, 17,000 shares, and 33,704 shares to participants in the plan during the years ended September 30, 2004, 2003, and 2002, respectively. At September 30, 2004, there were 4,945 shares in suspense in the ESOP, representing shares which were not allocated to participants resulting from additional principal payments made by the Company over the principal amount determined under the principal and interest allocation method.

(18)

Commitments and Contingent Liabilities

In the normal course of business, the Company is party (both as plaintiff and defendant) to certain matters of litigation. In the opinion of management and counsel, none of these matters should have a material adverse effect on the Company’s financial position or results of operations.


		F-34		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Future minimum lease payments for all leases of the Company are as follows:


2005	$	83,620
2006		47,361
2007		44,292
2008		36,910
2009		—

	$	212,183

(19)

Fair Value of Financial Instruments

SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below for the Company’s financial instruments.

(a)

Cash and Cash Equivalents

The carrying amount approximates fair value because of the short maturity of these instruments.

(b)

Investments and Mortgage-Backed Securities and Collateralized Mortgage Obligations Available for Sale

The fair value of investments and mortgage-backed securities and collateralized mortgage obligations available for sale is estimated based on bid quotations received from securities dealers. The Federal Home Loan Bank stock is considered a restricted stock and is carried at cost which approximates its fair value.

The following table presents the fair value at September 30, 2004 and 2003:


	2004		2003
Freddie Mac common stock	$	300,430,200	242,904,000
U.S. Government agencies		22,156,750	12,892,135
Corporate debt		—	8,736,468
Mortgage-backed securities and collateralized
mortgage obligations		378,356,607	394,432,288
Federal Home Loan Bank stock		14,842,500	13,610,000

	$	715,786,057	672,574,891

(c)

Loans Receivable

Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by type. The fair value of performing loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit risk inherent in the loan. The estimate of maturity is based on the Company’s historical experience with


		F-35		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

repayments for each loan classification, modified, as required, by an estimate of the effect of the current economic and lending conditions.

Fair value for significant nonperforming loans is based on recent external appraisals. If appraisals are not available, estimated cash flows are discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows, and discount rates are judgmentally determined using available market information and specific borrower information.

The following table presents information for loans at September 30, 2004 and 2003:


	2004					2003
	Carrying amount			Estimated fair value		Carrying amount		Estimated fair value
1-4 family residential real estate	$	142,249,868		143,363,299		133,305,460		134,808,908
Commercial real estate		119,618,117		120,011,966		111,188,786		113,267,706
Commercial		20,628,156		20,611,295		21,633,914		21,700,390
Real estate construction		21,471,316		21,440,029		14,076,477		14,101,548
Consumer and other		19,579,417		19,603,789		19,672,561		19,823,050
Unamortized loan origination fees, net		(773,461	)	(773,461	)	(544,202	)	(544,202	)
Allowance for loan losses		(6,622,597	)	(6,622,597	)	(6,779,576	)	(6,779,576	)

	$	316,150,816		317,634,320		292,553,420		296,377,824

Loans held for sale	$	2,077,510		2,125,463		2,026,261		2,058,892

(d)

Mortgage Servicing Rights

The fair value of mortgage servicing rights approximates its carrying value due to the Company’s evaluation of the underlying loan portfolio and subsequent adjustment for loan prepayments and other market conditions.


		F-36		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(e)

Deposits

Under SFAS No. 107, the fair value of deposits with no stated maturity, such as non-interest-bearing demand deposits, savings, NOW accounts, and money market and checking accounts, is equal to the amount payable on demand as of September 30, 2004 and 2003. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The following table presents information for deposits at September 30, 2004 and 2003:


	2004			2003
	Carrying amount		Estimated fair value	Carrying amount	Estimated fair value
Demand, NOW, and money market accounts	$	114,369,765	114,369,765	84,126,615	84,126,615
Savings deposits		14,979,726	14,979,726	15,419,473	15,419,473
Time deposits		150,225,218	151,430,153	179,839,620	182,985,178

	$	279,574,709	280,779,644	279,385,708	282,531,266

(f)

Borrowings

The fair value of the Company’s borrowings is estimated based on the discounted value of contractual cash flows. The discount rate is estimated using rates quoted for the same or similar issues or the current rates offered to the Company for debt of the same remaining maturities. The following presents information for borrowings at September 30, 2004 and 2003:


	2004			2003
	Carrying amount		Estimated fair value	Carrying amount	Estimated fair value
Federal Home Loan Bank advances	$	292,050,000	305,639,871	267,100,000	284,688,977
Securities sold under agreements to repurchase		100,739,000	100,739,000	121,341,220	121,341,220

	$	392,789,000	406,378,871	388,441,220	406,030,197

(g)

Accrued Interest and Dividends Receivable and Payable

The carrying amount of accrued interest and dividends receivable on loans and investments and payable on borrowings and deposits approximate their fair values.

(h)

Commitments

The fair value of commitments to extend credit to fund home equity, real estate construction, and real estate mortgage loans is immaterial because the underlying interest rates on such commitments approximate market rates.


		F-37		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(i)

Derivatives

The fair value of the outstanding covered call options is determined by the Company based on the current market price of the option.

(j)

Limitations

Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial assets or liabilities include deferred tax liabilities and premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

(20)

Regulatory Matters

The Company is required to maintain non-interest-bearing cash reserve balances. The aggregate average cash reserve balances maintained at September 30, 2004 and 2003 to satisfy the regulatory requirement were $3,307,000 and $1,942,400, respectively.

Under Office of Thrift Supervision regulations, the Company is required to measure its interest rate risk and maintain the interest rate risk within limits the Company establishes. Based on its asset/liability structure at September 30, 2004, the Company’s earnings may be negatively impacted if interest rates increase or decrease significantly.

Under provisions of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA) of 1989, the Company is required to meet certain core, tangible, and risk-based capital ratios. The regulations require institutions to have a minimum regulatory tangible capital ratio equal to 1.5% of total assets, a minimum 3% core capital ratio, and 8% risk-based capital ratio.

The Federal Deposit Insurance Corporation Improvement Act (FDICIA) was signed into law on December 19, 1991. Regulations implementing the prompt corrective action provisions of FDICIA became effective on December 19, 1992. In addition to the prompt corrective action requirements, FDICIA


		F-38		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

includes significant changes to the legal and regulatory environment for insured depository institutions, including reductions in insurance coverage for certain kinds of deposits, increased supervision by the Federal regulatory agencies, increased reporting requirements for insured institutions, and new regulations concerning internal controls, accounting, and operations.

The prompt corrective action regulations define specific capital categories based on an institution’s capital ratios. The capital categories, in declining order, are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Institutions categorized as “undercapitalized” or worse are subject to certain restrictions, including the requirement to file a capital plan with its primary Federal regulator, prohibitions on the payment of dividends and management fees, restrictions on executive compensation, and increased supervisory monitoring, among other things. Other restrictions may be imposed on the institution either by its primary Federal regulator or by the FDIC, including requirements to raise additional capital, sell assets, or sell the entire institution. Once an institution becomes “critically undercapitalized,” it must generally be placed in receivership or conservatorship within 90 days.

To be considered “adequately capitalized,” an institution must generally have a leverage ratio of at least 4%, a Tier 1 risk-based capital ratio of at least 4%, and a total risk-based capital ratio of at least 8%. An institution is deemed to be “critically undercapitalized” if it has a tangible equity ratio of 2% or less.

As of September 30, 2004, the most recent notification from the OTS categorized CharterBank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, CharterBank must maintain minimum total risk-based, Tier 1 risk-based and core/leverage ratios as set forth in the following table. Management is not aware of the existence of any conditions or events occurring subsequent to September 30, 2004 which would affect CharterBank’s well-capitalized classification.


		F-39		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The table of compliance with minimum capital requirements for CharterBank is presented below at September 30, 2004 and 2003 (in thousands):


	2004
	Tangible capital			Core/ leverage capital			Tier I risk-based capital		Total risk-based capital
Total equity	$	178,138			178,138		178,138		178,138
General valuation allowances		—			—		—		6,372
Allowable unrealized gains		—			—		—		65,936
Goodwill and other intangible assets		(5,954	)		(5,954	)	(5,954	)	(5,954	)
Accumulated other comprehensive income		(99,876	)		(99,876	)	(99,876	)	(99,876	)

Regulatory capital	$	72,308			72,308		72,308		144,616

Total assets	$	933,228			933,228		933,228		933,228
Regulatory total assets		764,610			764,610
Risk-weighted assets							509,668		509,668
Capital ratio		9.46	%		9.46	%	14.19	%	28.37	%
Regulatory capital category:
Adequately capitalized or minimum FIRREA requirement equal to or greater than		1.50	%		3.00	%	N/A		8.00	%
Capital exceeding requirement	$	60,839			49,370		N/A		103,843
Adequately capitalized or minimum FDICIA requirement equal to or greater than		N/A			4.00	%	4.00	%	8.00	%
Capital exceeding requirement		N/A		$	41,724		51,921		103,843
Well capitalized, equal to or greater than		N/A			5.00	%	6.00	%	10.00	%
Capital exceeding requirement		N/A		$	34,077		41,728		93,649


		F-40		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003


	2003
	Tangible capital			Core/ leverage capital			Tier I risk-based capital		Total risk-based capital
Total equity	$	151,127			151,127		151,127		151,127
General valuation allowances		—			—		—		6,016
Allowable unrealized gains		—			—		—		58,592
Goodwill and other intangible assets		(6,168	)		(6,168	)	(6,168	)	(6,168	)
Accumulated other comprehensive income		(78,602	)		(78,602	)	(78,602	)	(78,602	)

Regulatory capital	$	66,357			66,357		66,357		130,965

Total assets	$	889,640			889,640		889,640		889,640
Regulatory total assets		755,456			755,456
Risk-weighted assets							480,902		480,902
Capital ratio		8.78	%		8.78	%	13.80	%	27.23	%
Regulatory capital category:
Adequately capitalized or minimum FIRREA requirement equal to or greater than		1.50	%		3.00	%	N/A		8.00	%
Capital exceeding requirement	$	55,025			43,693		N/A		92,493
Adequately capitalized or minimum FDICIA requirement equal to or greater than		N/A			4.00	%	4.00	%	8.00	%
Capital exceeding requirement		N/A		$	36,139		47,121		92,493
Well capitalized, equal to or greater than		N/A			5.00	%	6.00	%	10.00	%
Capital exceeding requirement		N/A		$	28,584		37,503		82,875

(21)

Related Parties

During the years ended September 30, 2004, 2003, and 2002, the Company paid approximately $157,000, $111,000, and $140,000, respectively, in legal fees in the normal course of business to a law firm in which a partner is related to two board members.

The Company currently leases a branch facility and parking lot. The leases are from a partnership in which a Company executive and other related parties are partners. The facility lease expires July 31, 2008. The parking lot lease is presently being paid month-to-month. During each of the years ended September 30, 2004, 2003, and 2002, lease expense relating to these leases was $50,297.


		F-41		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(22)

Condensed Financial Statements of Charter Financial Corporation (Parent Only)

The following represents Parent Company only condensed financial information of Charter Financial Corporation:

Condensed Balance Sheets


	September 30
	2004			2003
Assets
Cash	$	10,537,683		9,984,913
Interest-bearing deposits in other banks		708,506		586,608
Freddie Mac common stock		107,646,000		88,209,750
Investment in subsidiaries		195,781,600		165,194,160
Other assets		242,958		975,445

	$	314,916,747		264,950,876

Liabilities and Stockholders’ Equity
Liabilities:
Accrued expenses	$	2,104,817		1,763,001
Deferred income taxes		40,311,693		32,828,793

Total liabilities		42,416,510		34,591,794

Stockholders’ equity:
Common stock, $0.01 par value; 19,823,905 and 19,822,405 shares issued in 2004 and 2003, respectively; 19,596,874 and 19,569,676 shares outstanding in 2004 and 2003, respectively		198,239		198,224
Additional paid-in capital		37,831,575		37,491,011
Treasury stock, at cost; 227,031 and 252,729 shares in 2004 and 2003, respectively		(7,059,824	)	(7,836,234	)
Unearned compensation – ESOP		(2,454,940	)	(2,624,940	)
Retained earnings		63,626,113		59,190,493
Accumulated other comprehensive income		180,359,074		143,940,528

Total stockholders’ equity		272,500,237		230,359,082

	$	314,916,747		264,950,876


		F-42		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Condensed Statements of Income


	Years ended September 30,
	2004			2003		2002
Income:
Interest income	$	288,989		308,107		298,874
Dividend income		1,929,930		1,700,000		1,462,616
Dividend received from Bank		—		2,500,000		—
Gain on sale of Freddie Mac common stock		2,113,336		773,368		—
Write-off of investment		(200,000	)	—		—
Other income		118,929		51,975		463

Total operating income		4,251,184		5,333,450		1,761,953

Expenses:
Salaries and employee benefits		730,481		643,789		333,584
Occupancy		16,819		16,929		14,925
Legal and professional		224,387		294,190		320,798
Marketing		152,600		166,631		51,641
Other		37,465		71,534		46,347

Total operating expenses		1,161,752		1,193,073		767,295

Income before income taxes		3,089,432		4,140,377		994,658
Income tax expense		655,755		169,882		112,555

Income before equity in undistributed net income of subsidiaries		2,433,677		3,970,495		882,103
Equity in undistributed net income (distributions in excess of net income) of subsidiaries		5,783,599		(879,201	)	2,018,032

Net income	$	8,217,276		3,091,294		2,900,135


		F-43		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

Condensed Statements of Cash Flows


	Years ended September 30,
	2004			2003		2002
Cash flows from operating activities:
Net income	$	8,217,276		3,091,294		2,900,135
Adjustments to reconcile net income to net cash provided by operating activities:
Gain on sale of Freddie Mac common stock		(2,113,336	)	(773,368	)	—
Deferred tax benefit		(47,582	)	(233,834	)	(85,812	)
(Equity in undistributed net income) distributions in excess of net income of subsidiaries		(5,783,599	)	879,201		(2,018,032	)
Allocation of ESOP common stock		170,000		39,599		507,041
Decrease (increase) in other assets		732,487		(616,162	)	(359,283	)
Increase in other liabilities		1,051,081		1,813,887		789,479

Net cash provided by operating activities		2,226,327		4,200,617		1,733,528

Cash flows from investing activities:
Proceeds from the sale of Freddie Mac common stock		2,186,107		804,555		—
Proceeds of common stock investment in subsidiary		—		—		(18,609,699	)

Net cash (used in) provided by investing activities		2,186,107		804,555		(18,609,699	)

Cash flows from financing activities:
Stock options exercised		43,890		—		—
Issuance of common stock in stock offering		—		—		34,047,819
Purchase of common stock for treasury		—		(8,716,146	)	(29,930	)
Dividends paid		(3,781,656	)	(2,125,525	)	(733,698	)

Net cash (used in) provided by financing activities		(3,737,766	)	(10,841,671	)	33,284,191

Net increase (decrease) in cash		674,668		(5,836,499	)	16,408,020
Cash and cash equivalents at beginning of period		10,571,521		16,408,020		—

Cash and cash equivalents at end of period	$	11,246,189		10,571,521		16,408,020

Supplemental disclosures of cash flow information:
Income taxes paid	$	714,681		322,150		147,500
Capital contribution from parent in the form of net assets		—		—		236,915,825
Grant of common stock under stock benefit plans		709,265		840,365		—


		F-44		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

The OTS imposes various restrictions or requirements on CharterBank’s ability to make capital distributions, including cash dividends. A savings bank that is the subsidiary of a savings and loan holding company must file an application or a notice with the OTS at least 30 days before making a capital distribution. CharterBank must file an application for prior approval if the total amount of its capital distributions, including the proposed distribution, for the applicable calendar year would exceed an amount equal to CharterBank’s net income for that year plus CharterBank’s retained net income for the previous two years. The OTS may disapprove a notice or application if: (a) CharterBank would be undercapitalized following the distribution; (b) the proposed capital distribution raises safety and soundness concerns; or (c) the capital distribution would violate a prohibition contained in any statute, regulation, or agreement. Based on the aforementioned limitation on capital distributions, substantially all of Charter Financial Corporation’s investment in CharterBank was restricted from transfer by CharterBank to Charter Financial Corporation in the form of dividends.


		F-45		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(23)

Comprehensive Income (Loss)

Comprehensive income (loss) includes net income and other comprehensive income (loss) which includes the effect of unrealized holding gains (losses) on investment and mortgage securities available for sale in stockholders’ equity. The following table sets forth the amounts of other comprehensive income (loss) included in stockholders’ equity along with the related tax effect for the years ended September 30, 2004, 2003, and 2002.


	Pretax amount			Tax effect		After tax amount
2004:
Net unrealized holding gains on investment and mortgage securities available for sale arising during the year	$	61,542,189		(23,755,285	)	37,786,904
Less reclassification adjustment for net gains realized in net income		2,228,597		(860,239	)	1,368,358

Other comprehensive income	$	59,313,592		(22,895,046	)	36,418,546

2003:
Net unrealized holding losses on investment and mortgage securities available for sale arising during the year	$	(18,696,407	)	7,216,813		(11,479,594	)
Less reclassification adjustment for net gains realized in net income		880,406		(339,837	)	540,569

Other comprehensive loss	$	(19,576,813	)	7,556,650		(12,020,163	)

2002:
Net unrealized holding losses on investment and mortgage securities available for sale arising during the year	$	(41,364,833	)	15,966,825		(25,398,008	)
Less reclassification adjustment for net losses realized in net income		(816,223	)	315,062		(501,161	)

Other comprehensive loss	$	(40,548,610	)	15,651,763		(24,896,847	)


		F-46		(Continued)

CHARTER FINANCIAL CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

September 30, 2004 and 2003

(24)

Condensed Balance Sheet of First Charter, MHC

The following represents the condensed balance sheets of First Charter, MHC:


	September 30
	2004		2003
Assets:
Cash and cash equivalents	$	196,957	325,947
Freddie Mac common stock		26,096,000	20,940,000
Investment in Charter Financial Corporation		218,000,189	184,287,266
Other assets		3,128	2,667

Total assets	$	244,296,274	205,555,880

Liabilities:
Deferred income taxes	$	9,853,197	7,862,971
Other liabilities		46,389	57,255

Total liabilities		9,899,586	7,920,226

Equity:
Contributed capital		11,600,381	10,570,790
Retained earnings		62,835,829	59,405,006
Accumulated other comprehensive income		159,960,478	127,659,858

Total equity		234,396,688	197,635,654

Total liabilities and equity	$	244,296,274	205,555,880


		F-47		(Continued)