Edgar Filing: CHARTER FINANCIAL CORP/GA

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended December 31, 2004

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

For the transition period from to

Commission file number 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)

(IRS Employer

Identification No.)

600 Third Avenue, West Point, Georgia 31833

(Address of principal executive offices)

(Zip Code)

(706) 645-1391

(Registrant’s telephone number including area code)

(Former name, former address and former fiscal year, if changed from last Report)

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 requirement for the past 90 days. Yes x No ¨

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 ¨

As of January 28, 2005, the registrant had 19,830,705 shares of common stock, $0.01 par value, outstanding. Of such shares outstanding, 15,857,924 shares were held by First Charter, MHC, the registrant’s mutual holding company and 3,972,781 shares were held by the public and directors, officers and employees of the registrant.

TABLE OF CONTENTS


	PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements of Charter Financial Corporation

	Consolidated Statements of Financial Condition (Unaudited) December 31, 2004 and September 30, 2004	Page 1

	Consolidated Statements of Income (Unaudited) – Three months ended December 31, 2004 and 2003	Page 2

	Consolidated Statements of Cash Flows (Unaudited) – Three months ended December 31, 2004 and 2003	Page 3

	Notes to Unaudited Consolidated Financial Statements	Page 4

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	Page 8

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	Page 32

Item 4.	Controls and Procedures	Page 32

	PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	Page 33

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	Page 33

Item 3.	Defaults Upon Senior Securities	Page 33

Item 4.	Submission of Matters to a Vote of Security Holders	Page 33

Item 5.	Other Information	Page 33

Item 6.	Exhibits	Page 33

	Signatures	Page 34

	Certifications

FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q 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 Quarterly Report on Form 10-Q 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.

CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Financial Condition

December 31, 2004 and September 30, 2004

(unaudited)


	December 31, 2004			September 30, 2004
Assets

Cash and amounts due from depository institutions	$	10,695,661		10,128,105
Interest-bearing deposits in other financial institutions		2,691,198		2,243,124

Cash and cash equivalents		13,386,859		12,371,229

Loans held for sale, market value of $1,351,007 and $2,125,463 at December 31, 2004 and September 30, 2004, respectively		1,335,634		2,077,510
Freddie Mac common stock		336,624,750		300,430,200
Mortgage-backed securities and collateralized mortgage obligations available for sale		405,834,733		378,356,607
Other investment securities available for sale		13,902,781		22,156,750
Federal Home Loan Bank stock		15,852,600		14,842,500

Loans receivable		324,437,915		323,546,874
Unamortized loan origination fees, net		(778,236	)	(773,461	)
Allowance for loan losses		(6,409,690	)	(6,622,597	)

Loans receivable, net		317,249,989		316,150,816

Real estate owned		606,685		452,671
Accrued interest and dividends receivable		3,122,253		3,004,224
Premises and equipment, net		11,900,735		11,195,770
Intangible assets, net of amortization		5,903,526		5,954,119
Other assets		1,507,894		1,208,622

Total assets	$	1,127,228,439		1,068,201,018

Liabilities and Stockholders’ Equity

Liabilities:
Deposits	$	270,240,977		279,574,709
Borrowings		422,598,000		392,789,000
Advance payments by borrowers for taxes and insurance		540,995		1,189,587
Deferred income taxes		125,844,292		111,602,661
Other liabilities		17,778,019		10,544,824

Total liabilities		837,002,283		795,700,781

Stockholders’ Equity:
Common stock, $0.01 par value; 19,825,805 and 19,823,905 shares issued at December 31, 2004 and September 30, 2004, respectively; 19,598,774 and 19,596,874 shares outstanding at December 31, 2004 and September 30, 2004, respectively		198,258		198,239
Additional paid-in capital		37,887,150		37,831,575
Treasury stock, at cost; 227,031 and 227,031 shares at December 31, 2004 and September 30, 2004		(7,059,824	)	(7,059,824	)
Unearned compensation - ESOP		(2,454,940	)	(2,454,940	)
Retained earnings		58,642,653		63,626,113
Accumulated other comprehensive income:
Net unrealized holding gains on securities available for sale		203,012,859		180,359,074

Total stockholders’ equity		290,226,156		272,500,237

Total liabilities and stockholders’ equity	$	1,127,228,439		1,068,201,018

See accompanying notes to the unaudited consolidated financial statements.

CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Consolidated Statements of Income

For the Three Months Ended December 31, 2004 and 2003

(unaudited)


	Three Months Ended December 31, 2004			Three Months Ended December 31, 2003
Interest and dividend income:
Loans receivable	$	4,939,800		4,455,439
Mortgage-backed securities and collateralized mortgage obligations		4,080,860		3,597,359
Equity securities		1,521,896		1,321,523
Debt securities		117,171		80,803
Interest-bearing deposits in other financial institutions		19,635		14,275

Total interest and dividend income		10,679,362		9,469,399

Interest expense:
Deposits		1,300,029		1,243,855
Borrowings		3,739,715		3,049,199

Total interest expense		5,039,744		4,293,054

Net interest income		5,639,618		5,176,345
Provision for loan losses		—		30,000


Net interest income after provision for loan losses		5,639,618		5,146,345

Noninterest income:
Gain on sale of loans and servicing released loan fees		233,001		242,153
Service charges on deposit accounts		670,472		562,848
Gain on sale of Freddie Mac common stock		2,576,777		532,742
Gain on sale of mortgage-backed securities, collateralized mortgage obligations, and other investments		22,340		43,038
Loan servicing fees		61,599		31,968
(Loss) Gain on operations of covered call program		(365,829	)	59,231
Brokerage commissions		90,994		68,997
Other		2,749		6,121

Total noninterest income		3,292,103		1,547,098

Noninterest expenses:
Salaries and employee benefits		2,789,994		2,546,777
Occupancy		692,102		659,875
Legal and professional		236,894		265,373
Marketing		171,042		190,420
Furniture and equipment		195,128		123,107
Postage, office supplies, and printing		117,692		125,872
Federal insurance premiums and other regulatory fees		56,100		53,856
Net (income) cost of operations of real estate owned		(2,995	)	8,349
Deposit premium amortization expense		50,593		57,543
Other		294,417		368,387

Total noninterest expenses		4,600,967		4,399,559

Income before income taxes		4,330,754		2,293,884

Income tax expense		1,406,638		578,133

Net income	$	2,924,116		1,715,751

Basic and diluted net income per share	$	0.15		0.09

Weighted average number of common shares outstanding		19,506,259		19,410,159

Weighted average number of common and common equivalent shares outstanding		19,578,844		19,436,341

See accompanying notes to the unaudited consolidated financial statements.

CHARTER FINANCIAL CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

For the Three Months Ended December 30, 2004 and 2003

(unaudited)


	Three Months Ended December 31, 2004			Three Months Ended December 31, 2003
Cash flows from operating activities:
Net income	$	2,924,116		1,715,751
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		—		30,000
Depreciation and amortization		233,290		238,278
Allocation of ESOP common stock		88,039		103,542
Deferred income tax (benefit)		—		(51,018	)
Amortization of premiums and discounts, net		105,432		216,655
Gain on sale of loans		(233,001	)	(242,153	)
Proceeds from sale of loans		8,417,361		8,474,263
Originations and purchases of loans held for sale		(7,442,484	)	(6,928,964	)
Gain on sale of Freddie Mac common stock		(2,576,777	)	(532,742	)
Gain on sales of mortgage-backed securities, collateralized mortgage obligations, and other investments		(22,340	)	(43,038	)
Provision for credit for allowance in other real estate owned		(8,701	)	(3,480	)
Changes in assets and liabilities:
(Increase) decrease in accrued interest and dividends receivable		(118,029	)	353,607
(Increase) decrease in other assets		(319,096	)	305,036
Increase (decrease) in other liabilities		(762,420	)	(1,955,567	)

Net cash provided by operating activities		285,390		1,680,170

Cash flows from investing activities:
Proceeds from sales of mortgage-backed securities and collateralized mortgage obligations available for sale		4,717,289		45,623,663
Principal collections on mortgage-backed securities and collateralized mortgage obligations available for sale		40,346,869		59,966,379
Purchases of mortgage-backed securities and collateralized mortgage obligations available for sale		(72,008,189	)	(119,509,948	)
Proceeds from sale of other investment securities available for sale		8,300,000		10,519,236
Proceeds from sale of Freddie Mac common stock		2,614,425		552,494
Proceeds from maturities of other securities available for sale		—		7,000,000
Purchase of FHLB stock		(3,698,600	)	(2,315,000	)
Proceeds from redemption of FHLB stock		2,688,500		3,296,200
Net (increase) decrease in loans receivable, exclusive of loan sales		(1,509,892	)	(7,226,247	)
Proceeds from sale of real estate owned		265,406		60,030
Purchases of premises and equipment, net of dispositions		(867,839	)	(338,701	)

Net cash used in investing activities		(19,152,031	)	(2,371,894	)

Cash flows from financing activities:
Stock options exercised		55,594		—
Net decrease in deposits		(9,333,731	)	(8,066,519	)
Proceeds from Federal Home Loan Bank advances		121,650,000		225,175,000
Principal payments on advances from Federal Home Loan Bank		(101,800,000	)	(243,700,000	)
Proceeds from other borrowings		414,681,000		454,983,900
Principal payments on other borrowings		(404,722,000	)	(425,658,120	)
Net decrease in advance payments by borrowers for taxes and insurance		(648,592	)	(597,549	)

Net cash provided by financing activities		19,882,271		2,136,712

Net increase in cash and cash equivalents		1,015,630		1,444,988

Cash and cash equivalents at beginning of period		12,371,229		11,920,489

Cash and cash equivalents at end of period	$	13,386,859		13,365,477

Supplemental disclosures of cash flow information:
Interest paid	$	5,269,914		4,325,845

Income taxes paid	$	433,113		105,973

Financing activities:
Real estate acquired through foreclosure of loans receivable	$	410,718		41,935

See accompanying notes to the unaudited consolidated financial statements.

Charter Financial Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

(1) Basis of Presentation

Charter Financial Corporation (“Charter Financial”), a federally chartered corporation, was organized on October 16, 2001 by CharterBank (“Bank”) in connection with the reorganization of the Bank from a federal mutual savings and loan association into a two-tiered mutual holding company structure, as described more fully in Note 2.

The accompanying unaudited consolidated financial statements include the accounts of Charter Financial and its wholly-owned subsidiaries, CharterBank and Charter Insurance Company (which was liquidated into Charter Financial as of December 31, 2004), as of December 31, 2004 and September 30, 2004, and for the three-month periods ended December 31, 2004 and 2003. Significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements for the three months ended December 31, 2004 and 2003 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in Charter Financial’s annual report on Form 10-K for the year ended September 30, 2004.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. In the opinion of management the unaudited consolidated financial statements include all necessary adjustments, consisting of normal recurring accruals, necessary for a fair presentation for the periods presented.

Charter Financial believes that the disclosures are adequate to make the information presented not misleading; however, the results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year.

(2) Plan of Reorganization

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 recorded as unearned compensation reducing stockholders’ equity of Charter Financial. The net proceeds of the offering, adjusted for the ESOP, totaled approximately $34.0 million.

As part of its 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 Office of Thrift Supervision (“OTS”). First Charter, MHC’s principal assets are its investment in Charter Financial and 400,000 shares of Freddie Mac common stock. 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.

(3) Earnings per Share

Earnings per share are calculated according to the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 128 “Earnings per Share.” ESOP shares are only considered outstanding for earnings per share calculations when the shares have been committed to be released. Presented below are the calculations for basic and diluted earnings per share for the three months ended December 31, 2004 and 2003:


	Three Months Ended December 31, 2004		Three Months Ended December 31, 2003
Basic:
Net income	$	2,924,116	$	1,715,751
Weighted average number of common shares outstanding		19,506,259		19,410,159
Basic earnings per share	$	0.15	$	0.09

Diluted:
Net income	$	2,924,116	$	1,715,751
Weighted average number of common and common equivalent shares outstanding		19,578,844		19,436,341
Diluted earnings per share	$	0.15	$	0.09

(4) Comprehensive Income

The primary component of other comprehensive income for the Company is net unrealized gains and losses on Freddie Mac common stock and investment and mortgage-backed securities available for sale. The table below summarizes total comprehensive income for the three months ended December 31, 2004 and 2003.


	Three Months Ended December 31,
	2004		2003
Total comprehensive income	$	25,577,901	$	19,074,147

Change in net unrealized holding gains on securities, net of income taxes		22,653,785		17,358,396

Net income	$	2,924,116	$	1,715,751

(5) Stock-Based Compensation

During 2003, the Company amended the 2001 Stock Option Plan (the “Plan”) to allow for stock option awards for up to 707,943 shares of the Company’s common stock to eligible directors and employees. At December 31, 2004, the Company had granted 291,250 options under the Plan, of which 3,400 have been exercised and 1,250 forfeited. Under the provisions of the 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, these options vest over a five-year period. The Company accounts for the Plan under the recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under the Plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.


	Three Months Ended December 31, 2004			Three Months Ended December 31, 2003
Net income, as reported	$	2,924,116		$	1,715,751
Deduct: Total stock-based employee compensation expense determined under fair value based method for all stock options, net of related tax effects		(59,787	)		(59,512	)

Pro forma net income	$	2,864,329		$	1,656,239

Earnings per share:
Basic – as reported	$	0.15		$	0.09
Basic – pro forma	$	0.15		$	0.09

Diluted – as reported	$	0.15		$	0.09
Diluted – pro forma	$	0.15		$	0.09

As no options have been granted since September 30, 2004, please see note number 17 in our 10K for the assumptions used in the evaluation for the options outstanding.

(6) Intangible Assets, Net

Intangible assets, net include cost in excess of net assets acquired and deposit premiums recorded in connection with the acquisition of EBA Bancshares, Inc. as follows:


Goodwill	$	4,325,282
Deposit premium		1,975,941

	$	6,301,223

At December 31, 2004 and September 30, 2004, other intangible assets are summarized as follows:


	December 31, 2004		September 30, 2004
Deposit premium	$	1,975,941	1,975,941
Less accumulated amortization		397,697	347,104

	$	1,578,244	1,628,837

The deposit premium is being amortized using the double-declining balance method over thirteen years. Charter Financial recorded amortization expense related to the deposit premium of $50,593 and $57,543 for the three months ended December 31, 2004 and 2003, respectively.

(7) Derivative Instruments – Covered Call Program

At December 31, 2004, the Company had covered call options on Freddie Mac common stock outstanding on 247,700 shares for which it received $292,611 in premium. At December 31, 2004 and September 30, 2004, the fair value of the options outstanding were $609,973 and $92,654, respectively, which at December 31, 2004 included a mark-to-market loss of $317,362 and deferred income of $292,611 and at September 30 included a mark-to-market gain of $105,190 and deferred income of $197,844. The Company has recorded the unrealized loss and gain in the income statement as the derivative instruments are not accounted for as hedges. The mark to market loss or gain is recorded in noninterest income of our financials. During the three months ended December 31, 2004, holders of the covered call options exercised their options to purchase 37,500 shares of Freddie Mac common stock. The Company recorded a pretax gain of $2,576,777 on the sale of these shares to the option holders.

Item 2

Management’s Discussion and Analysis of Financial

Condition and Results of Operations

Overview

The purpose of this summary is to provide an overview of the items management focuses on when evaluating the condition of Charter Financial Corporation (“Charter Financial”, the “Company”, “us”, or “we”) and our success in implementing our stockholder value strategy. Our stockholder value strategy has three major themes: (1) creating a larger, more profitable and more valuable retail banking franchise; (2) managing the substantial appreciation in our Freddie Mac common stock investment; and (3) efficiently utilizing our capital. Management believes the following points were the most important to that analysis this quarter.

•

Earnings per share increased which enhances the Company’s ability to support a regular quarterly dividend on a going forward basis.

•

A $2.00 per share special dividend was declared in addition to the regular quarterly dividend of 25 cents per share. These dividends were paid to our minority shareholders as First Charter, MHC waived the receipt of its dividends.

•

CharterBank’s (“CharterBank” or the “Bank”) net interest income, while slightly down from the September quarter, has significantly improved over the past two years due to lower amortization of premiums on mortgage securities, reinvestment of cash flow, loan growth and overall margin expansion.

•

Consistent with the Bank’s emphasis on attracting and retaining core deposits, deposit fee growth has had a strongly positive trend which leveled off this quarter.

•

Gains from sales of one-to-four family mortgage loans declined due to sharply lower refinance volumes and, to a much lesser extent, the retention of 15 year fixed rate mortgage loans and hybrid ARM loans for the Bank’s own portfolio.

•

Our exposure to interest rate risk was stable to slightly improved from the prior quarter.

•

Non-performing loans were lower than they were for the previous quarter. Management believes that the allowance for loan losses is adequate. A high percentage of the non-performing loans are secured by real estate.

•

The program of writing covered call options on Freddie Mac common stock resulted in the exercise of calls resulting in $2.6 million in pre-tax gain on sale of such stock.

•

Our book value per share was $14.88 at December 31, 2004, of which $10.40 is provided by the after tax equity in our Freddie Mac stock investment.

•

Freddie Mac common stock appreciated from $65.24 per share at September 30, 2004 to $73.70 at December 31, 2004. This was the primary reason for the increase in our other comprehensive income of $22.7 million. Our book value per share increased $0.91 per share.

Management Strategy

We have a growth-oriented strategy focused on (1) expanding our retail banking operations and thus the franchise value of our retail bank, (2) managing our Freddie Mac common stock 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. We are planning to convert our loan and deposit application systems to new systems during the second quarter of fiscal 2005. The new systems should improve our customer experience at a similar or lower cost. We are also planning to consolidate our support and management functions into a new facility in West Point, Georgia during the second and third quarters of fiscal 2005. This consolidation from five facilities to one should help us improve our focus on our customer’s experience at a similar to lower cost. The combined acquisition and set up cost is expected to total about $1.5 million.

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 approximately 21%. Dividends on our Freddie Mac common stock are an important component of our shareholder value. 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. First Charter, MHC and the Office of Thrift Supervision (“OTS”) make their own determination with respect to each dividend payment as to whether that dividend payment to First Charter, MHC will be waived. In 2003, we implemented a program of selling covered call options on the Freddie Mac common stock as a means of enhancing our return on this investment. We continue to review our 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 acquisition of EBA Bankshares, Inc. and its wholly owned banking subsidiary, Eagle Bank of Alabama (the “Eagle Bank Acquisition”). While our current retail focus is increasing market share within our existing market, 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 for us. During the current quarter, we declared a $2.00 per share special dividend. During the third quarter of fiscal 2004, we increased our quarterly dividend from 20 cents to 25 cents per share. Our capacity to pay dividends is enhanced when First Charter, MHC is willing and permitted by the Office of Thrift Supervision to waive receipt of its portion of the dividends. We continue to evaluate our dividend policy and the appropriateness of special dividends and/or share repurchases.

General

Charter Financial is a federally chartered corporation organized in 2001, as more fully described in Note 2 to the unaudited consolidated financial statements, and is registered as a savings and loan holding company with the OTS. Charter Financial serves as the holding company for CharterBank. First Charter, MHC (“First Charter” or the “MHC”), a federal mutual holding company, 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 Company, Bank or Charter Financial include Charter Financial and the Bank on a consolidated basis.

Charter Financial’s principal business is its ownership of CharterBank. Charter Financial also owns 2,012,500 shares of Freddie Mac common stock. Additionally, CharterBank owns 2,555,000 shares of Freddie Mac common stock. On a consolidated basis, Charter Financial owns 4,567,500 shares of Freddie Mac common stock.

Our balance sheet at December 31, 2004 contains $336.6 million of Freddie Mac common stock, of which $330.4 million is unrealized gain. Noninterest-bearing liabilities include $127.6 million

in deferred taxes related to the unrealized gain on the Freddie Mac common stock. Accumulated other comprehensive income includes $202.9 million representing the net unrealized gain on the Freddie Mac common stock.

CharterBank is a service-oriented bank providing retail and small business customers with products and services designed to create long-term, profitable relationships. 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. CharterBank operates a main office, seven full-service branch offices, and five loan production offices in Georgia and Alabama.

CharterBank’s results of operations depend primarily on net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on interest-bearing liabilities. Our interest-earning assets consist primarily of residential mortgage loans, commercial real estate loans, consumer loans, mortgage related securities, and equity securities such as our Freddie Mac common stock investment. Interest-bearing liabilities consist primarily of retail and wholesale deposits, repurchase agreements and borrowings from the Federal Home Loan Bank (FHLB) of Atlanta.

Our results of operations also depend on our provision for loan losses, noninterest income and noninterest expense. Noninterest expense includes salaries and employee benefits, occupancy expenses and other general and administrative expenses. Noninterest income includes gains on sale of loans, gains (losses) on sales of investment and mortgage-backed securities, deposit fees and other service fees and charges.

Our operating results may also be affected significantly by economic and competitive conditions in our market area and elsewhere, including those conditions that influence market interest rates, government policies and the actions of regulatory authorities. Future changes in applicable laws, regulations or government policies may materially impact us. Furthermore, because our lending activity is concentrated in loans secured by real estate located in Georgia and Alabama, downturns in the regional economy encompassing these states could have a negative impact on our earnings.

Capital and Capital Management

CharterBank has traditionally been a well-capitalized savings association. The following table sets forth the tier 1 capital levels, risk-based capital levels, and ratios for the past several quarters.


For the Quarters Ended	Tier 1 Capital		Risk-Weighted Capital Ratio		Regulatory Core Capital Ratio		Total Risk -Based Capital		Total Risk -Based Capital Ratio
					(Dollars in millions)
December 31, 2004	$	73.8	13.93	%	9.38	%	$	147.5	27.87	%
September 30, 2004		72.3	14.19		9.46			144.6	28.37
June 30, 2004		70.8	13.73		9.08			141.5	27.46
March 31, 2004		69.2	14.16		9.38			135.6	27.71
December 31, 2003		67.4	13.90		8.89			134.7	27.81
September 30, 2003		66.4	13.80		8.78			131.0	27.23
June 30, 2003		68.0	14.22		8.81			130.7	27.34
March 31, 2003		67.6	14.33		9.38			135.2	28.67
December 31, 2002		73.9	16.39		11.03			147.8	32.78

At December 31, 2004 and September 30, 2004, we exceeded each of the applicable regulatory capital requirements. Tier 1 capital as a percent of total regulatory assets is consistently above the “well-capitalized” requirement of 5.0%. Total risk-based capital ratios significantly exceed the applicable “well-capitalized” requirement for risk-based capital of 10.0%. CharterBank exceeded the “well-capitalized” level of its various regulatory capital requirements by amounts ranging from $34.4 million to $94.6 million at December 31, 2004.

We announced a special dividend of $2.00 per share to be paid in February 2005. We initiated a quarterly dividend of $0.10 per share in June 2002, doubled the dividend in June 2003 and increased it again to $0.25 per share in June 2004. The MHC waived its receipt of dividends in all periods. Our 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.

Charter Financial’s reporting of certain information under generally accepted accounting principles in the United States of America (“GAAP”) is not necessarily reflective of the process considered by the Board of Directors in connection with its dividend policy. Included in GAAP earnings per share calculations are the average shares held by Charter Financial’s majority shareholder, the MHC. The MHC has waived its right to receive dividends from Charter Financial since its formation and intends to continue to do so, subject to the approval of the OTS. The following table reconciles the total voting shares with the number of shares receiving dividends as adjusted for the waiver of dividends by the MHC at December 17, 2004 and shows that the number of shares that typically receive dividends is a fraction, approximately one-fifth, of the total voting shares.


Total Voting Shares outstanding at December 17, 2004	19,824,305
Less: Unallocated shares in ESOP	(245,494	)
Treasury Stock-MRP	(227,031	)
Shares held by MHC	(15,857,924	)

Total Shares receiving dividends at December 17, 2004	3,493,856

As indicated in the table above, we paid dividends on the 3,493,856 shares held by our minority stockholders. The regular quarterly dividend of $0.25 per share declared in December totaled $873,464 or approximately 30% of our net income of $2,924,116 for the quarter.

Our capacity to pay dividends is limited by several factors including cash availability at Charter Financial, tax considerations, regulatory requirements and the MHC’s willingness and ability to waive its dividends on the approximately 80% of our stock that it owns. Historically, the MHC has waived its portion of the dividends we pay and intends to waive future dividends. The MHC is required to obtain approval of the OTS prior to waiving a dividend. The OTS considers a variety of factors in approving dividend waivers including its assessment of the rights of the MHC’s stakeholders.

Charter Financial’s primary sources of cash are distributions from CharterBank, dividends on the Freddie Mac stock it owns and proceeds from possible sales of Freddie Mac common stock. CharterBank is generally permitted by the OTS to distribute its current year’s and prior two years’ undistributed earnings if CharterBank is well capitalized after the distribution. Distributions in excess of this level require additional approval from the OTS.

Our total stockholders’ equity is made up of realized equity and unrealized equity. Realized equity includes common stock, additional paid-in capital, treasury stock, unearned compensation, and retained earnings, while unrealized capital is comprised of accumulated other comprehensive income.

Accumulated other comprehensive income (“unrealized equity”) is comprised of net unrealized holding gains on securities available for sale. Unrealized equity at December 31, 2004 was $203.0 million, a $22.6 million increase from $180.4 million at September 30, 2004. This increase was attributable to the $65.24 to $73.70 price per share increase in our investment in Freddie Mac common stock. The following table shows realized and unrealized equity and the Freddie Mac common stock price for the past several quarters. A comparison of the unrealized equity and Freddie Mac common stock price demonstrates the relationship between the price of Freddie Mac common stock and our unrealized equity.


	Total Capital		Realized Equity		Unrealized Equity		Percentage of Unrealized Capital to Total Capital		Freddie Mac Common Stock Price
	(Dollars In Thousands)
December 31, 2004	$	290,226	$	87,213	$	203,013	69.95	%	$	73.70
September 30, 2004		272,500		92,141		180,359	66.19			65.24
June 30, 2004		261,012		89,881		171,131	65.56			63.30
March 31, 2004		252,938		88,856		164,082	64.87			59.06
December 31, 2003		248,743		87,444		161,299	64.85			58.32
September 30, 2003		230,359		86,419		143,940	62.49			52.35
June 30, 2003		226,997		84,408		142,589	62.82			50.77
March 31, 2003		236,784		87,208		149,576	63.17			53.10
December 31, 2002		257,528		91,825		165,703	64.34			59.05

As indicated in the following tables, other comprehensive income was $22.7 million for the three months ended December 31, 2004, compared to other comprehensive income of $17.4 million for the three months ended December 31, 2003. The other comprehensive income for the period ended December 31, 2003 was primarily the result of the increase in the price of Freddie Mac common stock during the period. For the period ended December 31, 2004, the income was the result of the increase in the price of Freddie Mac stock which was partly offset by the unrealized loss on mortgage securities due to higher interest rates. The price of Freddie Mac common stock increased by $8.46 and $5.97 per share for the quarters ended December 31, 2004 and December 31, 2003, respectively.


	For the Quarters Ended
	December 31. 2004		September 30, 2004		June 30, 2004			March 31. 2004		December 31. 2003
Freddie Mac:
Number of shares		4,567,500		4,605,000		4,620,500			4,620,500		4,630,500
Market Price	$	73.70	$	65.24	$	63.30		$	59.06	$	58.32
Market Value	$	336,624,750	$	300,430,200	$	292,477,650		$	272,886,730	$	270,050,760
Unrealized Gain Net of Tax	$	202,896,191	$	180,649,622	$	175,746,969		$	163,718,144	$	161,964,092

Other Comprehensive Income (Loss)
Related to Mortgage Securities and other Investments	$	407,216	$	4,325,607	$	(4,980,486	)	$	1,029,498	$	678,158
Freddie Mac Common Stock	$	22,246,569	$	4,902,653	$	12,028,825		$	1,754,052	$	16,680,238

Total Other Comprehensive Income	$	22,653,785	$	9,228,260	$	7,048,339		$	2,783,550	$	17,358,396

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 a significant portion of our Freddie Mac common stock investment. We continually evaluate our investment in Freddie Mac common stock, taking into account 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.

In June 2003, we implemented a program of writing covered call options on Freddie Mac common stock with 250,000 shares of stock. When we write a call option, we receive a fee or premium. If the call option expires unexercised, we retain this premium and record it as income. If the call option is exercised, the premium is added to the sale proceeds and increases the gain on the sale of Freddie Mac stock. 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. The decision whether to allow the exercise or to repurchase the option is based on several factors including the strike price at which the option would be exercised, alternative investments for the proceeds of the sale, tax considerations, the proportion of realized to unrealized equity and the cost to repurchase the option. To the extent that the premium on unexercised options exceeds the premium when we repurchase a call option to prevent its exercise, and thus the sale of the underlying Freddie Mac stock, the net premiums enhance our income and our return on investment. We entered into the pilot program with a limited number of shares to improve our understanding of the mechanics and the economics of the program. We expanded the program to 400,000 shares during the December 2004 quarter. During the three months ended December 31, 2004, we sold 37,500 shares of Freddie Mac common stock, and during the year ended September 30, 2004, we sold 35,000 shares of Freddie Mac common stock through exercises of call options.

Critical Accounting Policies

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

These policies are described in Note 1 to the consolidated financial statements which were presented in the Company’s 2004 annual report on Form 10-K. Of these policies, management believes that the accounting for the allowance for loan losses is one of the most critical. Please see “Asset Quality” for a further discussion of the Company’s methodology in determining the allowance.

The accounting and financial reporting policies of Charter Financial 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 a critical accounting policy that requires 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) identified losses for impaired loans; 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 the Bank’s loan and collection policy. On an ongoing basis, an organizationally independent department reviews grade assignments and considers current information regarding a borrowers’ financial condition and debt service capacity, collateral condition 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, generally 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. The Company has developed specific quantitative reserve factors which it applies to each loan type to develop reserve components. These reserve factors are based upon economic, market and industry conditions that are specific to the Company’s local markets and 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. They 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.

Management believes that the allowance for loan losses is adequate. The loan portfolio is broadly composed of residential real estate loans of 42.8%, construction loans of 7.2%, commercial purpose loans of 44.0% and consumer loans of 6.0%. A total of 86.2 % of the Bank’s loan portfolio is secured by real estate loans.

In recent years, the Bank has made an effort to build its business lines, and loans secured by commercial real properties now make up 36.0% of the loan portfolio. The Company’s largest funded real estate secured loan is a $6.0 million loan on a medical office building in the metro Atlanta area. The largest industry concentration of commercial purpose loans is the hospitality industry where we have an aggregate of $22.4 million in loans to various hotel and motel operations. In a significant number of the loans secured by commercial properties, the properties are occupied by the owner and the ongoing operations of the business provide the cash to service the debt. Construction and development loans, which comprise 7.2% of the real estate loan portfolio, are carefully monitored since the repayment is generally dependent upon the liquidation of the real estate and is impacted by national and local economic conditions.

While most originations of residential real estate loans are sold into the secondary market, the Bank chooses to keep some of them due to attractive risk and return characteristics. Such loans primarily make up the residential real estate mortgage portfolio. The remainder of the residential portfolio is composed of residential real estate mortgages “held for sale.” These loans are in the process of being sold into the secondary market and, since the credit, the rate and the purchase price have been approved by the buyer, the Company takes no credit or interest rate risk with respect to these loans.

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 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. If the regulatory agencies require us to make additions to our allowance for loan losses, the additions would reduce our net income and our capital.

Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale comprise a significant portion of the Company’s balance sheet, and income on these assets is important to our operating results. Investments, mortgage-backed securities, and collateralized mortgage obligations available for sale are reported at fair value, as determined by independent price quotations. 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.

Income taxes are a material expense for the Company. 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. The difference between 70% of taxable income and 70% of dividends can be significant. Since the Company does not file a consolidated tax return, this determination is made at the individual company level. The actual deduction will be determined at September 30, 2005 based on the level of dividends and the level of taxable income.

Comparison of Financial Condition at December 31, 2004

and September 30, 2004

At December 31, 2004 our total assets were $1.1 billion, up $59.0 million from September 30, 2004.

The risk and return characteristics of loans vary significantly by the type of loan. The following table shows the actual balance of loans outstanding at December 31, 2004 as well as the average balances of loans outstanding for the past five quarters beginning with December 31, 2003.


For the Quarters Ended	1-4 Family Residential		Construction		Nonresidential Real Estate		Consumer		Commercial Non - Real Estate		Total Loans		Percent Change per Quarter
	(Dollars in thousands)
Actual Balance:
December 31, 2004	$	139,048	$	23,380	$	116,654	$	19,366	$	25,990	$	324,438

Average Balance:
December 31, 2004	$	140,779		20,780		119,403		19,504		23,684		324,150	0.8
September 30, 2004	$	140,885		21,213		119,602		19,838		20,011		321,549	2.4
June 30, 2004	$	138,549		18,612		117,190		19,428		20,290		314,069	2.3
March 31, 2004	$	135,671		17,145		113,155		19,778		20,967		306,716	1.0
December 31, 2003	$	132,894		15,956		111,629		19,886		23,200		303,565

The nonresidential real estate loan growth reflects our strategy to increase this portion of the portfolio. Future growth of our nonresidential real estate portfolio depends on interest rates, economic conditions and competitive pricing of these loans within our market.

Mortgage-backed securities and collateralized mortgage obligations increased 7.2% from $378.4 million at September 30, 2004 to $405.8 million at December 31, 2004. The market value of Freddie Mac common stock increased $36.2 million, or 12.1%, from $300.4 million to $336.6 million as the price per share of Freddie Mac common stock increased from $65.24 at September 30, 2004 to $73.70 at December 31, 2004.

Total deposits declined from $279.6 million at September 30, 2004 to $270.2 million at December 31, 2004 as the Bank has de-emphasized certificates of deposit as sources of funding and focused on attracting and retaining core deposits in order to reduce interest expense. However, as shown in the following table, over the last two years, core deposits (checking, money market and savings accounts) have increased from $68.1 million to $122.5 million. Core deposits at September 30, 2004 included a couple of large balance short-term deposits, which were not retained at December 31, 2004. Approximately $21.9 million of the increase in the March 2003 quarter was a result of the Eagle Bank Acquisition. Fees on core deposit accounts increased from $356,000 in the March 2003 quarter to $670,000 in the December 2004 quarter.


For the Quarters Ended	Deposit Fees		Transaction Accounts		Savings		Money Market Accounts		Total Core Deposits		Certificates of Deposit
	(Dollars in thousands)
December 31, 2004	$	670	$	61,164	$	14,674	$	46,662	$	122,500	$	147,741
September 30, 2004		689		64,304		14,980		50,066		129,350		150,225
June 30, 2004		625		61,783		14,430		54,038		130,251		162,753
March 31, 2004		673		61,672		14,816		53,514		130,002		160,999
December 31, 2003		563		56,061		14,610		28,884		99,555		171,765
September 30, 2003		496		53,048		15,419		31,079		99,546		179,840
June 30, 2003		463		50,024		14,647		33,934		98,605		178,006
March 31, 2003		356		46,609		14,779		34,169		95,557		181,926
December 31, 2002		402		32,621		9,302		26,167		68,090		140,462
September 30, 2002		351		34,237		9,132		26,110		69,479		141,267

Management will continue to use FHLB advances and repurchase agreements to fund the securities and loan portfolio growth. The maturity dates of new advances will be determined at the time the advance is taken down and will be based on interest rates, the Company’s interest rate risk profile and other factors. Repurchase agreements are generally less than 90 days to maturity and carry rates at or slightly above LIBOR. Borrowings increased $29.8 million or 7.6% from $392.8 million at September 30, 2004 to $422.6 million at December 31, 2004 primarily to fund the increased balances of mortgage securities.

Charter Financial recorded $4.3 million of goodwill and $2.0 million of core deposit intangible as a result of the Eagle Bank Acquisition in fiscal 2003. The core deposit intangible is amortized over approximately 13 years using an accelerated method of amortization.

Our total stockholders’ equity is made up 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.

Total stockholders’ equity increased to $290.2 million at December 31, 2004 from $272.5 million at September 30, 2004. Unrealized equity increased to $203.0 million at December 31, 2004 from $180.4 million at September 30, 2004, primarily as a result of the price of Freddie Mac stock increasing to $73.70 per share at December 31, 2004 from $65.24 at September 30, 2004. Realized equity decreased to $87.2 million at December 31, 2004 from $92.1 million at September 30, 2004. This decrease was due to the special dividend of $2.00 per share.

Comparison of Operating Results for the Three Months

Ended

December 31, 2004 and 2003

General

Net income was $2.9 million for the three months ended December 31, 2004, which was $1.2 million higher than the net income of $1.7 million for the three months ended December 31, 2003. The most significant factor in the net income increase was significantly higher noninterest income which included a $2.6 million gain on the sale of Freddie Mac common stock related to our covered call program compared to the December 2003 quarter which included a $533,000 gain on the sale of Freddie Mac common stock related to our covered call program.

Net Interest Income

As shown in the following table, net interest income increased $463,000 from $5.2 million for the three months ended December 31, 2003 to $5.6 million for the three months ended December 31, 2004. For the same periods, our net interest spread decreased from 1.19% to 0.97% and our net interest margin increased from 2.07% to 2.12%.


For the Quarters Ended	Net Interest Income	Net Interest Rate Spread		Net Interest Margin		Net Amortization of Premium on Mortgage- related Securities	Yield on Freddie Mac Common Stock
	(Dollars in thousands)
December 31, 2004	$5,640	0.97	%	2.12	%	$90	1.79	%
September 30, 2004	5,690	1.15		2.17		84	1.85
June 30, 2004	5,460	1.25		2.16		101	2.05
March 31, 2004	5,419	1.23		2.13		129	1.97
December 31, 2003	5,176	1.19		2.07		204	1.91
September 30, 2003	4,345	0.89		1.79		456	2.04
June 30, 2003	3,951	0.53		1.64		663	1.83
March 31, 2003	3,672	0.34		1.56		995	1.84
December 31, 2002	3,562	0.18		1.51		970	1.51

As the preceding table illustrates, the appreciation in the price of Freddie Mac stock, which causes its stated dividend yield to decline negatively, impacts our stated net interest spread.

The net amortization of premiums on mortgage securities has had a significant impact on net interest income, spread and margin. Charges against interest income for net premium amortization reached its peak in the March 2003 quarter, with amortization of $995,000. By the December 2004 quarter, net amortization of premiums on mortgage-related securities had decreased to $90,000 due to the increase of interest rates. The high level of premium amortization in the earlier periods was caused by the “refinancing boom” in one-to-four family mortgages which was triggered by low mortgage interest rates. As borrowers refinanced, mortgages underlying the securities we owned were paid off earlier than expected, causing our securities to pay off sooner than expected and triggering acceleration of amortization.

Our net interest spread and, to a lesser extent, our net interest margin are impacted by the yield on Freddie Mac common stock. Net interest rate spread is the difference between yield on assets and cost of liabilities. Net interest margin is net interest income as a percentage of interest earning assets. As indicated in the table above, the yield on Freddie Mac common stock impacts the net interest spread. A portion of the increase in the Freddie Mac yield is from the increased dividend and a portion is from a lower market price of Freddie Mac common stock. The yield on Freddie Mac stock is down because the stock price appreciation outpaced the increase in the dividend.

The table below shows the yields or costs of other significant components of our net interest income.


For the Quarters Ended	Yield on Mortgage Securities		Yield on Loans		Costs of Certificates of Deposit		Costs of Deposits		Costs of Borrowings
December 31, 2004	4.12	%	6.10	%	2.67	%	2.05	%	3.67	%
September 30, 2004	4.01		5.80		2.34		1.80		3.41
June 30, 2004	3.62		5.75		2.26		1.72		3.19
March 31, 2004	3.40		5.79		2.38		1.81		2.94
December 31, 2003	3.47		5.87		2.48		1.95		3.01
September 30, 2003	2.84		6.12		2.64		2.08		3.19
June 30, 2003	2.78		6.31		2.91		2.31		3.53
March 31, 2003	2.85		6.73		3.16		2.52		3.66
December 31, 2002	3.22		7.00		3.45		2.76		3.79

Costs of borrowings decreased from 3.79% in the December 2002 quarter to 2.94% in the March 2004 quarter and have subsequently increased to 3.67%. While the majority of the borrowings have monthly rate resets, we have $287.0 million of fixed rate borrowings with a remaining maturity of approximately four years and an average rate of 4.31%.

The yield on mortgage securities has varied over the past nine quarters from a high in the December 2004 quarter of 4.12% to a low of 2.78% in June 2003. The yield in the March, June and September 2003 quarters was significantly impacted by high net premium amortization as mortgage security portfolios were paid off rapidly due to low mortgage rates and record rates of refinancing. Additionally, yields on securities declined during 2003 as a result of management’s decision to reinvest the heavy cash inflows from rapidly prepaying fixed rate mortgage securities into adjustable rate mortgage securities. In August of 2003, management increased its investment in fixed rate mortgage securities and by December 31, 2004 fixed rate mortgage securities comprised 62% of the total mortgage securities portfolio, compared to 40% at December 31, 2003.

As shown in the preceding table, the yield on loans has increased 31 basis points over the past four quarters from 5.79% for the March 2004 quarter to 6.1% for the December 2004 quarter. The yield increase is primarily the result of adjustable rate loans increasing in yield as short term interest rates have increased. During June of 2003, the Bank started retaining 15-year single-family loans in its loan portfolio. As of December 31, 2004, the Bank had accumulated $30.3 million of these loans with rates of approximately 4.87%. Average loans outstanding increased from $303.6 million during the December 2003 quarter to $324.2 million for the December 2004 quarter.

Also, as shown in the preceding table, the costs of deposits increased 24 basis points from 1.81% for the March 2004 quarter to 2.05% for the December 2004 quarter. While certificate of deposit rates have started to increase as overall short-term interest rates have increased, transaction account rates have not moved to the same magnitude as certificates of deposit.

The 23 basis point increase in loan yield, from the December 2003 quarter to the December 2004 quarter, was slightly higher than the 10 basis point increase in the costs of deposits for the same

period. For these same two periods the increase in mortgage securities yields, at 65 basis points, was equivalent to the increase of 66 basis points in the cost of borrowings. The increased spread between loan yields and deposit costs and the increase in dividends on Freddie Mac common stock contributed to the increase in net interest income. The increase in the price of Freddie Mac stock, which reduced the stated yield on Freddie Mac stock, was the primary cause of the decrease in interest rate spread.

Interest income increased by $1.2 million to $10.7 million for the three months ended December 31, 2004 from $9.5 million for the three months ended December 31, 2003 due to an increase in interest on loans of $484,361 resulting from higher average loan balances and rates, and an increase of $483,501 in interest on mortgage securities.

Interest expense increased by $746,690 from $4.3 million for the three months ended December 31, 2003 to $5.0 million for the three months ended December 31, 2004. Interest expense on deposits and borrowings increased $56,174 and $690,516, respectively, in 2004 compared to 2003 due primarily to higher interest rates.

In the table following, 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. The table also shows the actual balances of interest-earning assets and interest-bearing liabilities as of December 31, 2004.

The table also depicts the significant effect of the Freddie Mac common stock on our traditional bank measures, such as net interest income, net interest rate spread, and net interest margin. The table shows these measures with and without the effects of the Freddie Mac common stock. We believe this comparison provides our shareholders with useful information so that they may compare CharterBank with its peer group using traditional bank ratios, excluding the effect of the Freddie Mac common stock. Freddie Mac common stock had a dividend return on cost basis of approximately 88.92% at December 31, 2004. However, the dividend yield on the market value of the Freddie Mac common stock was 1.79%. The appreciation in the market value of the Freddie Mac common stock is the reason for our strong accumulated comprehensive income.

For the quarters ended December 31, 2004 and 2003


	For the Three Months Ended December 31,
	2004						2003
	Average Balance		Interest		Average Yield/ Cost		Average Balance		Interest		Average Yield/ Cost		Balance as of December 31, 2004
					(Dollars in thousands)
Assets:
Interest-earning assets:
Interest-bearing deposits in other financial institutions	$	3,996	$	20	2.00	%	$	4,199	$	14	1.33	%	$	2,691
FHLB common stock		15,292		144	3.77			13,330		118	3.54			15,853
Mortgage-backed securities and collateralized mortgage obligations available for sale		395,864		4,081	4.12			414,825		3,597	3.47			405,835
Other investment securities available for sale		16,436		117	2.85			10,383		81	3.12			13,903
Loans receivable (1)		324,150		4,940	6.10			303,565		4,455	5.87			324,438

Total interest-earning assets excluding Freddie Mac common stock		755,738		9,302	4.92			746,302		8,265	4.43			762,720
Freddie Mac common stock		307,111		1,378	1.79			251,805		1,204	1.91			336,625

Total interest-earning assets including Freddie Mac common stock (2)		1,062,849		10,680	4.02			998,107		9,469	3.79			1,099,345
Total noninterest-earning assets		26,935		—				23,947		—				27,883

Total assets	$	1,089,784		10,680			$	1,022,054		9,469			$	1,127,228

Liabilities and Equity:
Interest-bearing liabilities:
NOW accounts	$	39,404	$	56	0.57		$	32,935	$	44	0.53		$	37,196
Savings accounts		14,892		9	0.24			15,028		11	0.29			14,674
Money market deposit accounts		50,449		243	1.93			31,143		96	1.23			46,662
Certificate of deposit accounts		148,384		992	2.67			176,344		1,093	2.48			147,741

Total interest-bearing deposits		253,129		1,300	2.05			255,450		1,244	1.95			246,273
Borrowed funds		407,345		3,740	3.67			405,835		3,049	3.01			422,598

Total interest-bearing liabilities		660,474		5,040	3.05			661,285		4,293	2.60			668,871
Noninterest-bearing deposits		24,752						21,035		—				23,968
Other noninterest-bearing liabilities		124,948		—				102,468		—				144,163

Total noninterest-bearing liabilities		149,700		—				123,503		—				168,131
Total liabilities		810,174		5,040				784,788		4,293				837,002
Total stockholders’ equity		279,610		—				237,266						290,226

Total liabilities and stockholders’ equity	$	1,089,784		5,040			$	1,022,054		4,293			$	1,127,228

Net interest income including Freddie Mac common stock			$	5,640					$	5,176

Net interest rate spread, including Freddie Mac common stock (3)					0.97	%					1.19	%
Net interest margin including Freddie Mac common stock (4)					2.12	%					2.07	%
Ratio of interest-earning assets to average interest-bearing liabilities, including Freddie Mac common stock					160.92	%					150.93	%
Net interest income, excluding Freddie Mac common stock dividends			$	4,262					$	3,972

Net interest rate spread, excluding Freddie Mac common stock (5)					1.87	%					1.83	%
Net interest margin, excluding Freddie Mac common stock (6)					2.26	%					2.13	%
Ratio of interest-earning assets to average interest-bearing liabilities, excluding Freddie Mac common stock					114.42	%					112.86	%

(1)	Non accrual loans have been included in the average balance of loans outstanding while interest income on these loans has been included only to the extent that interest income has been recognized in the income statement.

(2)	Dividends on Freddie Mac common stock, of which the lesser of 70% of the dividend or 70% of taxable income in excluded from taxable income, are not computed on a tax equivalent basis. We do not hold any other tax exempt or tax advantaged securities.

(3)	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.

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

(5)	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.

(6)	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.

The relatively low spread is a combination of a balance sheet structure with a high proportion of Freddie Mac common stock, which has a low yield of 1.79% compared to loans and mortgage securities, and a high proportion of mortgage securities which also yield significantly less than loans. The margin is also impacted by high rate borrowings, which were put in place in fiscal 2001 to reduce interest rate risk as well as the recent effects of low interest rates on residential mortgage loans, including amortization of premium on mortgage securities and the high prepayments of portfolio mortgage loans and securities.

The following table is a reconciliation of net interest margin with and without Freddie Mac common stock.


	Three Months Ended December 31, 2004				Three Months Ended December 31, 2003
	Net Interest Spread		Net Interest Margin		Net Interest Spread		Net Interest Margin
Including Freddie Mac Common Stock	0.97	%	2.12	%	1.19	%	2.07	%
Excluding Freddie Mac Common Stock	1.87		2.26		1.83		2.13

Attributable to Freddie Mac Common Stock	(0.90	)%	(0.14	)%	(0.64	)%	(0.06	)%

Provision for Loan Losses

The provision for loan losses was $30,000 for the three months ended December 31, 2003, while no provision was taken for the three months ended December 31, 2004. The Bank had net charge-offs of $67,383 for the quarter ended December 31, 2003 compared to $212,907 for the quarter ended December 31, 2004. Of the chargeoffs in the December 2004 quarter, $222,000 related to a loan acquired in the acquisition of Citizens National Bank in 1999 for which specific allowances were held.

Noninterest Income

Noninterest income increased from $1.5 million for the three months ended December 31, 2003 to $3.3 million for the three months ended December 31, 2004. The table below shows the

components of noninterest income for the last nine quarters. There was a $2.6 million gain on sale of securities during the three months ended December 31, 2004 compared to $575,780 for the three months ended December 31, 2003. The December 2004 gain on sale of securities included $2.6 million in gain on the sale of Freddie Mac common stock resulting from the exercise of calls written as a part of the Company’s covered call program. Other income included a loss of $365,829, primarily a mark to market loss, on the covered call program, which was started during fiscal 2003. The December 2004 gain on sale of loans of $233,001 is the lowest level recorded in the last nine quarters as one-to-four family mortgage rates have increased and the levels of refinancing and originations of conforming loans have dropped. During fiscal 2003, the Company began retaining conforming 15-year one-to-four family loans. By December 31, 2004, the Bank had accumulated approximately $30.3 million of such loans. 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. Other income for the December 2004 quarter included $90,994 in brokerage commissions which was a slight increase from the same quarter the prior year.


For the Quarters Ended	Loan Servicing Fees			Deposit Fees		Gain on Sale of Loans		Gain on Sale of Investments, Net	Equity in Gain (Loss) of Limited Partnership			Other Income (Expense)
	(Dollars in thousands)
December 31, 2004	$	62		$	670	$	233	$ 2,599	$	—		$	(272	)
September 30, 2004		62			689		255	988		(200	)		193
June 30, 2004		57			625		345	38		—			65
March 31, 2004		58			672		309	627		—			177
December 31, 2003		32			563		242	576		—			134
September 30, 2003		27			496		657	773		—			170
June 30, 2003		(11	)		463		886	4		—			126
March 31, 2003		79			356		643	—		(61	)		111
December 31, 2002		61			402		589	103		(46	)		66

Noninterest Expense

Noninterest expense increased $201,408 to $4.6 million for the three months ended December 31, 2004 from $4.4 million for the same period in 2003. The table following shows the components of noninterest expense for the past five quarters.


	For the Quarters Ended
	December 2004		September 2004	June 2004	March 2004	December 2003
	(Dollars in thousands)
Compensation & employee benefits	$2,790		$2,593	$2,482	$2,505	$2,547
Occupancy	692		599	535	621	660
Legal & professional	237		212	170	239	265
Marketing	171		228	196	248	190
Furniture & equipment	195		157	154	134	123
Postage, office supplies, and printing	118		128	121	94	126
Federal insurance premiums and other regulatory fees	56		56	56	56	54
Net cost (gain) of operations of real estate owned	(3	)	3	15	43	8
Deposit premium amortization expense	51		51	51	55	58
Other	294		334	333	288	369

Total	$4,601		$4,361	$4,113	$4,283	$4,400

Compensation and benefits for the quarter ended December 31, 2004 was $2.8 million; this reflects an increase of $243,217 over the quarter ended December 31, 2003 and an increase of $196,742 over the quarter ended September 30, 2004. The quarterly cost of the Company’s restricted stock grants increased $309,384 as the $2.00 per share special dividend is treated as restricted stock compensation expense on unvested restricted stock grants. Future levels of expense will depend on the level of dividends, the number of shares granted, the price of the stock on the date of the grant, and the vesting period.

Income Taxes

Income taxes increased to $1,406,638 for the three months ended December 31, 2004 from $578,133 for the three months ended December 31, 2003, for an increase of $828,505. The effective tax rate increased from 25.2% for the three months ended December 31, 2003 to 32.48% for the three months ended December 31, 2004. The impact of the corporate dividends received deduction, which applies to dividends on Freddie Mac common stock, was the primary driver of the lower effective tax rate in the quarter ended December 31, 2003, and had a lesser impact on the quarter ended December 31, 2004 due to the higher level of taxable income in the 2004 quarter.

Asset Quality

The following table shows that nonperforming loans fell from $5.9 million at September 30, 2004 to $5.4 million at December 31, 2004. Nonperforming loans acquired in the Eagle Bank Acquisition made up $584,000 of these loans at December 31, 2004. Nonperforming loans as a percent of total loans fell from 1.81% at September 30, 2004 to 1.68% at December 31, 2004. Approximately 91% of our nonaccrual loans had real estate as collateral at December 31, 2004.

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


	December 31, 2004			September 30, 2004
	(In thousands)
Underperforming loans	$	320		$	195

Total nonperforming loans		5,436			5,865
Foreclosed real estate, net		607			453

Total nonperforming assets	$	6,043		$	6,318

Nonperforming loans to total loans		1.68	%		1.81	%
Nonperforming assets to total assets		0.54	%		0.59	%

Under-performing loans are loans 90 days or more delinquent or 90 days past maturity date that are still accruing interest. Under-performing loans increased from $195,000 at September 30, 2004 to $320,000 at December 31, 2004.

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.

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.

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 classification system, the level of nonperforming loans, historical loss experience, delinquency trends, the amount of losses charged to the allowance in a given period, and an assessment of economic conditions. The provision for loan losses was $30,000 for the three months ended December 31, 2003, while no provision was taken for the three months ended December 31, 2004. Management considers the current allowance for loan losses to be adequate based on its analysis of the losses in the portfolio.

During fiscal 2005, the allowance for loan losses decreased by $212,907 to $6.4 million at December 31, 2004. Of the net charge-offs, $208,409 related to loans acquired in the Citizens National Bank acquisition, which occurred in 1999, while loans not acquired from Citizen’s National Bank resulted in $4,318 in net chargeoffs. When reviewing the allowance for loan losses, it is important to understand our 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. We have mitigated the risk associated with these types of borrowers through prudent loan to value ratios and regular monitoring of economic conditions.

We have no loans that are not currently disclosed as non-accrual, adversely classified, past due, under-performing 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.

Commitments

CharterBank had commitments to fund loans at December 31, 2004 of approximately $46.1 million. Commitments to fund loans include unused consumer credit lines of approximately $9.3 million, unused commercial credit lines of approximately $15.7 million, unfunded construction loans of approximately $13.2 million, mortgage loans, primarily for portfolio, of approximately $1.0 million, and nonresidential loans of approximately $6.9 million. Conforming one-to-four family thirty year fixed rate loans are generally sold on a best efforts basis at the time the rate is committed to the customer so the Company has no interest rate risk on these loans.

CharterBank is party to lines of credit 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.

Our commitments are funded through internal funding sources. These internal sources include 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 our commitments to extend credit, leases and funding sources consisting of deposits, FHLB advances and borrowed funds.


	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 1-4 family mortgage loans	$	1,003,070	$	—	$	—	$	—	$	—
Loan commitments to fund construction loans in process		13,237,163		—		—		—		—
Loan commitments to originate nonresidential mortgage loans		6,870,000		—		—		—		—
Available home equity and unadvanced lines of credit		24,974,761		—		—		—		—
Letters of credit		455,111		—		—		—		—
Lease agreements		106,428		63,003		56,866		37,910		—
Deposits		218,895,543		21,720,277		18,229,985		5,310,825		5,833,469
Securities sold under agreements to repurchase		110,698,000		—		—		—		—
FHLB advances		24,900,000		25,000,000		100,000,000		25,000,000		10,000,000

Total commitments and contractual obligations	$	401,140,076	$	46,783,280	$	118,286,851	$	30,348,735	$	15,833,469

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 had no material commitments to originate loans for sale at December 31, 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 in the loan and, therefore, the floors and caps are not accounted for separately from the loan as a derivative instrument. The commitment to purchase investment securities is a firm forward commitment which is accounted for as a derivative instrument and recorded at fair value

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. CharterBank monitors its liquidity position frequently and anticipates that we will have sufficient funds to meet our current funding commitments.

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

•

Funds provided by operations

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 $270.2 million at December 31, 2004, compared to $279.6 million at September 30, 2004, for a decrease of $9.4 million during the three months ended December 31, 2004. Wholesale deposits were $32.0 million at December 31, 2004 compared to $34.1 million at September 30, 2004. Wholesale deposits included $99,000 and $100,000 in brokered deposits at December 31, 2004 and September 30, 2004, respectively. Time deposit accounts scheduled to mature within one year were $96.4 million and $98.3 million at December 31, 2004 and September 30, 2004, 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 fee income and provide cross-selling opportunities.

We can borrow funds from the FHLB based on eligible collateral of loans and securities. At December 31, 2004 our borrowed funds limit from FHLB was based on 40% of CharterBank’s assets, or approximately $390.9 million. At December 31, 2004, we had outstanding FHLB borrowings of $311.9 million compared to $292.1 million at September 30, 2004, with unused borrowing capacities of $79.0 million and $81.2 million, respectively.

In addition, we may enter into reverse repurchase agreements with approved broker-dealers. At December 31, 2004, repurchase agreements totaled $110.7 million, a $10.0 million increase from the amount outstanding at September 30, 2004 of $100.7 million. Reverse repurchase agreements are agreements that allow us to borrow money using our securities as collateral. We can also 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.

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 $40.3 million for the three months ended December 31, 2004. Ongoing levels of cash flow will depend on the level of mortgage rates and possible mortgage refinancing.

The interest rate environment, specifically one-to-four family mortgage rates, impacts refinancing activity and, accordingly, cash flow from prepayments of mortgage securities. The level of this cash flow depends on the ongoing level of refinancing, and, thus, it is difficult to determine at this time.

Our primary investing activities are:

•

The origination of commercial real estate, one-to-four family real estate, commercial and consumer loans;

•

The purchase of mortgage and investment securities; and

•

Capital expenditures.

During the three months ended December 31, 2004, we originated approximately $35.7 million in total loans. Residential mortgage loans accounted for 42.33% of the originations, construction loans for 26.64%, commercial and commercial real estate for 25.98%, and consumer loans for 5.05%. At December 31, 2004 and September 30, 2004, CharterBank had loan commitments to borrowers of approximately $21.1 million and $19.5 million, respectively, and available home equity and unadvanced lines of credit of approximately $25.0 million and $26.7 million,

respectively. Of the $15.1 million in residential mortgage loans originated, $8.4 million were sold to investors. During the third quarter of 2003, CharterBank began retaining conforming 15-year one-to-four family loans, with approximately $30.3 million being retained as of December 31, 2004.

Purchases of mortgage-backed securities, collateralized mortgage obligations, and other investment securities totaled $72.0 million for the three months ended December 31, 2004 and $119.5 million for the three months ended December 31, 2003. 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.

Capital expenditures of $868,000 during the three months ended December 31, 2004 included approximately $665,500 for branch expansions. We anticipate that capital expenditures for acquisition of branch sites, construction, expansion and renovation of retail facilities and possibly relocating support functions to one location as well as a change in our core application system during fiscal 2005 will be between $2.0 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

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 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.

On December 16, 2004, the FASB issued a revised Statement No 123^® titled Share-Based Payments that addresses accounting for equity-based compensation arrangements. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25, Accounting for Stock Issued to Employees and replaces some of the existing requirements under FASB Statement No. 123, Accounting for Stock-Based Compensation. The statement requires that such arrangements are accounted for using the fair-value-based method of accounting and the related cost expensed over the corresponding service period. The statement is effective for the first annual or interim period beginning after June 15, 2005. The Company provides pro forma disclosures related to stock-based compensation in Note 5.

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 3

Quantitative and Qualitative Disclosures about

Market Risk

As of December 31, 2004, there were no substantial changes from 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. The foregoing disclosures related to the market risk of Charter Financial should be read in conjunction with Charter Financial’s audited consolidated financial statements, related notes and management’s discussion and analysis of financial condition and results of operations for the year ended September 30, 2004 included in Charter Financial’s 2004 annual report on Form 10-K.

Item 4

Controls and Procedures

Management, including the Company’s President and Chief Executive Officer and Chief Financial Officer, Treasurer and 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-15e 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.

Part II

OTHER INFORMATION

Item 1. Legal Proceedings

None.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

Item 5. Other Information

None.

Item 6. Exhibits

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

32.1 Section 1350 Certifications

SIGNATURES

Pursuant to the requirements 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.


	CHARTER FINANCIAL CORPORATION (Registrant)

Date: February 9, 2005	By:	/s/ Robert L. Johnson
		Robert L. Johnson
		President and Chief Executive Officer

Date: February 9, 2005	By:	/s/ Curtis R. Kollar
		Curtis R. Kollar
		Chief Financial Officer, Senior Vice
		President and Treasurer

EXHIBIT INDEX


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

32.1		Section 1350 Certifications

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