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EDGAR FILINGS

Year 2000 / November 14

FIRST SHARES BANCORP INC (FRSH.OB)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Certain statements in this section constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Such forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of First Shares to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

Such risks could include: increases in competitive pressure from other financial institutions in our markets, unexpected increases in loan losses, changes in market interest rates, unanticipated changes in our level of growth or our ability to manage the growth, changes in economic conditions in our markets, or legislation or regulatory changes.

RESULTS OF OPERATIONS FOR THE QUARTERS AND NINE-MONTH PERIODS ENDED

SEPTEMBER 30, 2000 AND 1999

Net Income

During the current year, we have focused on growth as outlined in our strategic plan. Banking offices total 6, with the opening of the Bargersville location in January 2000.

Growth and expansion opportunities have had an adverse impact on profits in the short term, with a net loss of $(787,000) or $(1.11) per share reported for the 9 months ended September 30, 2000 compared to a net loss of $(161,000) or $(.26) per share for the same 9 months in 1999. Return on average assets (ROA) for 2000 was (1.20)% compared to (.46)% for 1999 on an annualized basis, while return on average equity (ROE) was (22.81)% compared to (4.35)% for the same period last year, also on an annualized basis.

Net Interest Income

Net interest income is the difference between interest and fees realized on interest earning assets and interest paid on interest bearing liabilities. The net interest margin is this difference expressed as a percentage of average earning assets.

For the 9 months ended September 30, 2000, net interest income totaled $2.3 million, representing a $900,000 or 65.7% increase over the same period for 1999. This increase in net interest margin is the result of our continued growth in earning assets, with our expanded branch network and continued gains in market share in existing markets.

Interest income through September 30, 2000 was $5.4 million, compared to $2.6 million in 1999, an increase of $2.8 million or more than double from last year. While the investment portfolio has maintained a higher average balance through September 30, 2000 than September 30, 1999, most of the improvement in interest income is attributed to growth in the loan

FIRST SHARES BANCORP

portfolio. Average investments, including securities and federal funds sold, were $18.8 million in 2000, up by $5.1 million from 1999's $13.7 million level, an increase of 36.4%. The average loan balance showed even stronger growth, increasing from $29.8 million in 1999 to $61.9 million in 2000, an increase of $32.1 million or 107.6 %. The increased volume of earning assets has been the key contributor to growth in interest income, although average yields, on a fully tax equivalent basis, increased moderately, rising to 8.87% in 2000 from 7.99% in 1999.

Interest expense reflects similar growth trends, with deposits and other borrowings funding asset growth. Interest expense year to date in 2000 increased $1.9 million, or 156.9%, compared to 1999. The increase is volume driven, as average deposits increased by a total of $32.6 million, or 91.4%, compared to 1999. Time deposits comprised most of the increase, with the average balance rising by $26.2 million. Average other liabilities increased from $171,000 for year to date 1999 to $5.8 million for 2000. These borrowings consist primarily of short-term federal funds purchased and bore an average cost of 6.98% in 2000. The average cost of interest bearing liabilities reflects the current increases in interest rates made by the Federal Reserve Bank, and was 5.58% in 2000 compared to 4.48% in 1999

The effect of the cost of liabilities rising faster than the yield on earning assets was a tightening of the net interest margin. Through September 30, 2000, the net interest margin was 3.77%, compared to 4.30% for 1999. A portion of this margin compression can be attributed to growth. Year to date for 2000, the average noninterest bearing liabilities and equity supported 16.6% of average earning assets while that figure was 25.6% for the same period in 1999.

For the quarters ended September 30, 2000 and 1999, interest income increased from $1.0 million to $2.1 million, with the increase in loan interest being the primary contributor due to the growth in the loan portfolio. Interest expense experienced similar increases, with expense reaching $1.2 million for the second quarter of 2000 compared to $463,000 for the same period last year. Net interest income was $833,000 for the third quarter of 2000, compared to $497,000 in 1999, an increase of $336,000 or 67.6%.

Provision for Loan Losses and Asset Quality

The provision for loan losses represents charges made to earnings to maintain an adequate allowance for loan losses. The allowance is maintained at an amount that we believe to be sufficient to absorb losses inherent in the loan portfolio. We conduct, on a quarterly basis, a detailed evaluation of the adequacy of the allowance.

The provision for loan losses was $335,000 for the nine months of 2000 compared to $133,000 in 1999 and the allowance grew to $828,000 at September 30, 2000 from $549,000 at December 31, 1999. The 2000 provision and relative increase in the allowance was in recognition of the strong loan growth, rather than a response to significant charge-off activity. Net charge offs through the first nine months of 2000 were $56,000, representing .09% of the total loan portfolio. The allowance for loan losses at the end of the September 2000 was $828,000, or 1.12% of total loans, compared to $524,000, or 1.37% of total loans at September 30, 1999.

Nonperforming loans have increased $146,000, to $287,000 since year-end. While nonperforming loans have increased since year end, as a percentage of the total loan portfolio,

FIRST SHARES BANCORP, INC.

the amount of nonperforming loans remains modest (.39% at September 30, 2000 compared to .31% at year end 1999).

We designate certain loans for internal monitoring purposes on a watch list. Loans may be placed on the watch list as a result of delinquent status, concern about the borrower's financial condition or the value of the collateral securing the loan, substandard classification during regulatory examinations, or simply as a result of our desire to monitor more closely a borrower's financial condition and performance.

For the quarters ended September 30, 2000 and 1999, provision expense decreased to $45,000 from $115,000. The higher level for the third quarter of 1999 was driven by loan growth during that period and the decline in 2000 reflects slowed growth and controlled problem loan levels.

Noninterest Income and Expense

Noninterest income increased $221,000, or 131.6% to $389,000 for 2000 compared to $168,000 in 1999. The increase is attributed to the larger number of deposit accounts and a change in fee structure on those accounts, which increased service charge income by 55.7%. Other noninterest income in 2000 includes $76,000 income from mortgage banking activities (gains on the sale of loans, service released, to secondary market buyers) and a $37,000 increase in ATM fees.

Noninterest expense increased $1.5 million or 89.9%, to $3.1 million for the first 9 months of 2000.

The largest contributor to the increase in noninterest expense is employee salaries and benefits. Three branches were opened in the second half of 1999, and another was opened in January 2000. A mortgage banking division was formed in the second quarter of 1999. With the expansion in the bank branch network and addition of a new division, staffing levels increased from approximately 45 at September 30, 1999 to approximately 60 at September 30, 2000.

Salary and employee benefits expense reflects the growth in staff, as expense increased from $956,000 for the 9 months ended September 30, 1999 to $1.7 million for the same 9-month period in 2000, an increase of $792,000 or 82.8%. This increase reflects not only the higher staffing levels, but also that those positions were in place for the full 9 months ended September 30, 2000. While the increase in salary and employee benefits has had an adverse impact on profits, we believe that it is critical to have bank operations properly staffed to allow us to maintain proper controls and better serve our customers. We believe current staffing levels are sufficient to support our growth strategy through the next several years, and expect that expenditures in this area will level off.

Nine-month comparisons for 1999 and 2000 reflect the four new branches that were fully operational during essentially the entire 9 months ended September 30, 2000. Premises and equipment expense increased from $249,000 in 1999 to $570,000 in 2000, an increase of $321,000. Approximately $61,000 of this increase was attributable to rental expense, as we entered into operating leases for the four new branch locations. Depreciation expense, which is included in premises and equipment expense, rose significantly as well, increasing from

FIRST SHARES BANCORP, INC.

$97,000 in 1999 to $236,000 in 2000, an increase of $139,000 or 143.3% Advertising expense increased to $99,000 compared to $38,000 in 1999, as we expanded our marketing program in our new and existing markets. We believe that our marketing efforts in the past year have effectively established our institution in the market place, and plan to curtail advertising for the balance of 2000.

For the quarters ended September 30, 2000 and 1999, noninterest income increased from $66,000 to $159,000, a change of $93,000 or 140.9%. Much of this increase is attributable to the increased mortgage banking activity. Noninterest expense increased from $645,000 to $999,000, an increase of $454,000 or 54.9%. Salary and employee benefits accounted for much of the increase.

Income Taxes

No tax benefit has been recorded in 2000. We have a net operating loss carryforward of approximately $1.4 million.

FINANCIAL CONDITION

Total assets were $98.2 million at September 30, 2000 compared to $68.7 million at year-end 1999, an increase of $29.6 million or 43.1%. Increased loan totals were funded primarily by increased deposits, with some short-term borrowings utilized as well.

We were the successful bidder on a branch in Nashville, IN, the consummation of which was contingent upon regulatory approval. Given our rapid growth in the past year and the adverse impact the acquisition would have had on the Bank's capital ratios, we withdrew our application. We continue to maintain our current branch facility in the Nashville market, and will explore opportunities to build or lease a larger, permanent location.

Securities

See Note 2 to the financial statements. Securities are designated as either available for sale or as held to maturity. To provide more flexibility and better support for our current strategy, held to maturity securities have been allowed to mature and pay-off, with all security purchases since March 1999 classified as available for sale.

Loans

See Note 3 to the financial statements. Total loans, excluding loans held for sale, increased $28.6 million or 62.9% from year end 1999 to September 30, 2000, as we entered into new market areas and new lines of business. Loan growth occurred in nearly all categories.

Consumer loan growth remains strong, with consumer loans surpassing residential real estate loans and comprising the largest segment of the portfolio (30.1% for consumer loans compared

FIRST SHARES BANCORP, INC.

to 27.4% for residential real estate). Consumer loans totaled $22.3 million at September 30, 2000, increasing $12.0 million or 115.5% from year-end. The indirect loan market remains robust, with relationships maintained with local auto and recreational vehicle dealers, providing this segment with strong growth opportunities. Underwriting standards for indirect loans are consistent with the standards applied to direct loans in an effort to maintain strong asset quality.

Commercial and commercial real estate loans grew by 34.9% or $5.8 million from December 31, 1999 to September 30, 2000 and comprised 30.0% of our portfolio at the period end. Growth in this segment was attributed to the continued strong local economy, primarily in the Greenwood area, and further penetration in our market areas. Residential mortgages, including loans held for sale, increased $6.1 million or 42.3% to $20.5 million.

Mortgage banking provides our customers with a wider array of mortgage loan products. At period end 2000, loans held for sale, which are carried at the lower of cost or fair value, totaled $172,000. All loans are sold servicing released.

Deposits and Other Borrowings

Total deposits increased $23.4 million or 37.1%, from year-end 1999 to September 30, 2000, as we continue to gain market share. Noninterest-bearing deposits increased to $10.1 million from $7.0 million. At September 30, 2000, $20.8 million or 41.4% of our time deposits had balances greater than $100,000. The average balance of time deposits issued in amounts greater than $100,000 totaled $16.9 million in 2000 and $5.0 million in 1999, representing 37.0% and 22.6% of total average time deposits in each period.

While deposits have funded a significant portion of our growth, we have also obtained funding from the Federal Home Loan Bank (FHLB). The advance from the FHLB has a variable interest rate, which was 6.75% at September 30, 2000 and matures September 10, 2001. At September 30, 2000, we also had federal funds purchased, which were obtained to meet the daily reserve requirement as set by the Federal Reserve Bank. Additionally, we obtained financing at the holding company level, with a significant portion of these proceeds contributed to First Bank to support continued growth. We have a $2.0 million line of credit with $1.75 million drawn at September 30, 2000.

Capital

We are subject to various regulatory capital guidelines as required by federal banking agencies. These guidelines define the various components of core capital and assign risk weights to various categories of assets.

Tier 1 capital consists of shareholders' equity net of intangible assets and excluding unrealized gains and losses on securities available or sale, as defined by bank regulators. The definition of Tier 2 capital includes the amount of allowance for loan losses which does not exceed 1.25% of gross risk weighted assets. Total capital is the sum of Tier 1 and Tier 2 capital.

FIRST SHARES BANCORP, INC.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires federal regulatory agencies to define capital tiers. These are: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Under these regulations, a "well capitalized" institution must achieve a Tier 1 risk-based capital ratio of at least 6.00%, and a total capital ratio of at least 10.00%, and a leverage ratio of at least 5.00% and not be under a capital directive order. Failure to meet capital requirements can result in regulatory action that could have a direct material effect on our financial statements. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions, asset growth, and expansion are limited, in addition to the institution being required to submit a capital restoration plan.

At September 30, 2000, our Tier 1 risked based capital ratio and leverage ratio for the Bank were 10.0% and 8.2%, levels which meet the regulatory guidelines of "well capitalized." Our total risk based capital ratio was 11.0%, meeting the regulatory guidelines to be designated as "well capitalized."

Given our rapid growth rate, the regulatory agencies have suggested we maintain a Bank leverage ratio of 7%, calculated using actual assets rather than average assets. At September 30, 2000, this ratio was 8.1%.

At December 31, 1999 total risk based capital ratio was 9.1%, above the 8% "adequate" requirement but below the 10% level required to be designated as "well capitalized." The increase in capital ratios since year-end resulted from borrowings and equity at the holding company being contributed to the Bank to offset net operating losses and provide for growth.

Liquidity and Rate Sensitivity

Liquidity refers to the availability of funds to meet deposit withdrawals and borrowing repayments, fund loan commitments and pay expenses. We have many sources of liquid funds, including cash and cash equivalents, payments and maturities of loans and securities, and growth in deposits. In addition, we have the ability to sell securities available for sale, and may borrow from the Federal Reserve and the Federal Home Loan Bank.

We believe we have sufficient liquidity to meet reasonable borrower, depositor, and creditor needs in the present economic environment. We have not received any recommendations from regulatory authorities which would materially affect liquidity, capital resources or operations.

Our interest rate sensitivity position is influenced by the timing of the maturity or repricing of interest earning assets and interest-bearing liabilities. One method of gauging sensitivity is by a static gap analysis.

Rate sensitivity gap is defined as the difference between the repricing of interest earning assets and the repricing of interest bearing liabilities within certain defined time frames. Rising interest rates are likely to increase net interest income in a positive gap position, while declining rates are likely to be beneficial in a negative gap position.

FIRST SHARES BANCORP, INC.

At September 30, 2000, we had a negative one-year interest rate gap of 31.7% of interest earning assets. This compares to a negative 25.7% at December 31, 1999. The increased negative gap is primarily the result of increasing borrowings with the FHLB to support growth and reinvesting proceeds from commercial paper into longer-term government agency issues.

Initial Public Offering

The Company received the initial proceeds from its public offering in closings held on September 29, 2000 and thereafter. The offering was terminated on October 6, 2000. The offering was on a best efforts basis, with a minimum number of shares set at 350,000 and the maximum number of shares set at 700,000. The per share price is $8.50. Through September 30, 2000, 379,005 shares have been sold with net proceeds of $2.6 million received, all of which were downstreamed to the Bank. At termination, 388,267 shares had been sold with net proceeds of approximately $2.7 million. Costs totaling approximately $610,000 have been netted against proceeds from the offering.