**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM10-K**

**(Mark One)**

| **x**      | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**     |
|------------|------------|-----------------------------------------------------------------------------------------------|
| ** ** | ** ** | ** **                                                                                    |
|       |       | **For the  fiscal year ended December 31, 2006**                                              |
|       |       | ** **                                                                                    |
|       |       | **OR**                                                                                        |
|       |       | ** **                                                                                    |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the transition period from                     to                    .**

**Commission FileNumber 000-51281**

**Tennessee Commerce Bancorp,Inc.**

(Exact name of registrant asspecified in its charter)

| **Tennessee**                                                 |   | **62-1815881**       |
|---------------------------------------------------------------|--------|----------------------|
| (State or other  jurisdiction                                 |   | (I.R.S. Employer     |
| of incorporation  or organization)                            |   | Identification  No.) |
|                                                          |   |                 |
| **381  Mallory Station Road, Suite 207, Franklin, Tennessee** |   | **37067**            |
| (Address of  principal executive offices)                     |   | (Zip Code)           |

 

Registrant’stelephone number, including area code ** (615) 599-2274**

Securities registered pursuant toSection 12(b) of the Act:  

| **Common Stock, $0.50 par value per share** |   | **NASDAQ  Global Market**  |
|---------------------------------------------|--------|----------------------------|
| (Title of each  class)                      |   | (Name of each  exchange of |
|                                        |   | which  registered)         |

 

Securities registered pursuant toSection 12(g) of the Act: 

| **Common Stock, $0.50 par value per share** |
|---------------------------------------------|
| (Title of each  class)                      |

 

Indicate by checkmark if the registrant is a well-known, seasoned issuer, as defined in Rule 405of the Securities Act. Yes  o No  x

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes  o  No  x

Indicate by checkmark whether registrant (1) has filed reports required to be filed by Section13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to file suchreports), and (2) has been subject to such filing requirements for the past 90days:  Yes  x  No  o.

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-Kis not contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form10-K.  x

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act.

(Check one): Large accelerated filer  o            Accelerated filer  o             Non-accelerated filer  x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). Yes  o  No  x

The aggregatemarket value of the registrant’s voting stock held by non-affiliates of theregistrant at June 30, 2006 was $45.4 million, based upon the average saleprice on that date.

As of March 22,2007, there were 4,495,024 shares of the registrant’s common stock outstanding.

Documents Incorporated by Reference:

Part IIIinformation is incorporated herein by reference, pursuant to Instruction G ofForm 10-K, to registrant’s Definitive Proxy Statement for its 2007 AnnualMeeting of shareholders to be held on June 8, 2007, which will be filed withthe Commission no later than April 30, 2007 (the Proxy Statement). Certain PartII information required by Form 10-K is incorporated by reference to theregistrant’s Annual Report to Shareholders, but the Annual Report toShareholders shall not be deemed filed with the Commission.

 

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TABLE OF CONTENTS
| **PART I**   | ** ** | ** **                                                                                                           |
|--------------|------------|----------------------------------------------------------------------------------------------------------------------|
|         |       |                                                                                                                 |   |   |
| ITEM  1.     |       | BUSINESS                                                                                                             |   | 1 |
| ITEM  1A.    |       | RISK  FACTORS                                                                                                        |   | 18 |
| ITEM 1B.     |       | UNRESOLVED STAFF  COMMENTS                                                                                           |   | 24 |
| ITEM  2.     |       | PROPERTIES                                                                                                           |   | 24 |
| ITEM  3.     |       | LEGAL  PROCEEDINGS                                                                                                   |   | 24 |
| ITEM 4.      |       | SUBMISSION OF  MATTERS TO A VOTE OF SECURITY HOLDERS                                                                 |   | 24 |
|         |       |                                                                                                                 |   |   |
| **PART II**  | ** ** | ** **                                                                                                           |
|         |       |                                                                                                                 |   |   |
| ITEM 5.      |       | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES  OF EQUITY SECURITIES |   | 25 |
| ITEM 6.      |       | SELECTED FINANCIAL  DATA                                                                                             |   | 29 |
| ITEM 7.      |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION                           |   | 31 |
| ITEM 7A.     |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                          |   | 55 |
| ITEM 8.      |       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                                         |   | 58 |
| ITEM 9.      |       | CHANGES IN AND  DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                                |   | 58 |
| ITEM 9A.     |       | CONTROLS AND  PROCEDURES                                                                                             |   | 58 |
| ITEM 9B.     |       | OTHER INFORMATION                                                                                                    |   | 58 |
|         |       |                                                                                                                 |   |   |
| **PART III** |       |                                                                                                                 |
|         |       |                                                                                                                 |   |   |
| ITEM 10.     |       | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                              |   | 59 |
| ITEM 11.     |       | EXECUTIVE  COMPENSATION                                                                                              |   | 59 |
| ITEM 12.     |       | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS                     |   | 59 |
| ITEM 13.     |       | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                           |   | 59 |
| ITEM 14.     |       | PRINCIPAL  ACCOUNTING FEES AND SERVICES                                                                              |   | 59 |
|         |       |                                                                                                                 |   |   |
| **PART IV**  |       |                                                                                                                 |
|         |       |                                                                                                                 |   |   |
| ITEM 15.     |       | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES                                                                             |   | 60 |

 

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**PART I**

**ITEM1.****                                                     BUSINESS**

**General**

Tennessee Commerce Bancorp, Inc. (the “Corporation” or“we” or “us”) is a one bank holding company formed as a Tennessee corporationto own the shares of Tennessee Commerce Bank (the”Bank”). The Bank commencedoperations January 14, 2000, and is a full service financial institutionlocated in Franklin, Tennessee, fifteen miles south of Nashville. Franklin isin Williamson County, one of the most affluent and rapidly growing counties inthe nation and the Bank conducts business from a single location in the CoolSprings commercial area of Franklin. The Bank had total assets at December 31,2006, of $624 million. Although the Bank offers a full range of bankingservices and products, it operates with a focused “Business Bank” strategy. The Business Bank strategy emphasizes banking services for small to mediumsized businesses, entrepreneurs, and professionals in the local market. TheBank competes by combining the personal service and appeal of a community bankinstitution with the sophistication and flexibility of a larger bank. This strategy distinguishes the Bank from its competitors in efforts to attractloans and deposits of local businesses. In addition, the Bank accesses anational market through a network of financial service companies and vendorpartners that provide indirect funding opportunities for the Bank nationwide.

The Bank does not compete based on the traditionaldefinition of “convenience” and does not have a branch network for thatpurpose. Business is conducted from a single office with no teller line,drive-through window or extended banking hours.  The Bank competes byproviding responsive and personalized service to meet customer needs. Convenience is created by technology and by a free courier service whichtransports deposits directly from the local business location to theBank.  The Bank provides free electronic banking and cash management toolsand on-site training for business customers.  The Bank competes for localconsumer business by providing superior products, attractive deposit rates,free Internet Banking services, and access to a third party regional ATMnetwork. The Bank targets service, manufacturing, and professional customersand avoids retail businesses with high transaction volume.

The Bank offers a full range of competitive retail andcommercial banking services.  The deposit services offered include varioustypes of checking accounts, savings accounts, money market investment accounts,certificates of deposits, and retirement accounts.  Lending servicesinclude consumer installment loans, various types of mortgage loans, personallines of credit, home equity loans, credit cards, real estate constructionloans, commercial loans to small and medium size businesses and professionals,and letters of credit. The Bank issues VISA credit cards and is a merchantdepository for cardholder drafts under VISA credit cards.  The Bank alsooffers check cards and debit cards.  The Bank offers its local customerscourier services, access to third-party automated teller machines (“ATMs”), andstate of the art electronic banking. The Bank has trust powers but does nothave a trust department.

The Business Bank strategy is evident in differencesbetween the financial statements of the Bank and more traditional financialinstitutions.   The Business Bank model creates a high degree ofleverage.  By avoiding the investment and maintenance costs of a typicalbranch network, the Bank is able to maintain Earning Assets at a higher levelthan peer institutions.  Management targets a minimum Earning Asset Ratioof 97% compared to the average of 90 to 92% for all FDIC insured banks. Assetsof the Bank are centered in the loan portfolio which consists primarily ofcommercial and industrial loans.  Management targets a loan mix of 60%commercial loans and 40% real estate.  At December 31, 2006, thecomposition of the $546 million loan portfolio was 64.89% commercial, 33.24%secured by real estate (both commercial and consumer), and .60% in consumer andcredit card loans.

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The Bank offers a full range of loan products to localconsumers and businesses.  Consumer products include secured and unsecuredlines of credit, term loans, and credit cards.  Loans secured by realestate include construction and acquisition loans in the form of 1st and 2nd mortgage term loans and home equitylines.  The Bank specializes in lending to businesses.  Customizedbusiness loans include lines of credit and term loans secured by accountsreceivable, inventory, equipment, and real estate.  Commercial real estateproducts include acquisition and construction loans for business properties andterm loan financing of commercial real estate.  The Bank additionallyoffers Letters of Credit and business credit cards.

In addition to lending in the local marketplace, theBank generates assets in the national market by providing collateral-basedloans to business borrowers located in other states through two types ofindirect funding programs. In both programs, the transactions are originated bya third party, such as an equipment vendor or financial services company, whoprovides the Bank with a borrower’s financial information and arranges for aborrower’s execution of loan documentation. The Bank funds these transactionsearning strong yields and has no servicing expense or residual risk in anytransaction originated by these financial service companies and vendors. TheBank has management and personnel who are experienced in this type oftransaction and are able to evaluate and partner effectively with the companieswho originate these transactions. All indirect funding is secured by thebusiness asset financed, and is subject to the Bank’s minimum credit score anddocumentation standards.  These national market transactions providegeographic and collateral diversity for the portfolio and representapproximately 37.08% of the total loan portfolio at December 31, 2006.

The two national market funding programs funddifferent size loans through two different networks. In the first type, theBank uses an established network of financial service companies and vendorpartners that provide the Bank funding opportunities to national middle-marketand investment grade companies. At December 31, 2006, the average size of thistype of loan in the loan portfolio was $237,000 and earned an average yield of7.37%. Funding under this program represents approximately 16.24% of the $546million total loan portfolio.  In the second program, the Bank partnerswith a second network of financial service companies and vendors located inTennessee, Alabama, Georgia, California and Michigan. This program is forsmaller transactions. These loans that finance business assets are less than$125,000 at origination. Management has installed a standardized creditapproval process which delivers quick responsive service. At December 31, 2006,the average size of this type of loan in the loan portfolio was $40,000, andthe average yield on these loans was 9.77%. Funding under this programrepresents approximately 20.85% of the $546 million total loan portfolio.

Management believes the Business Bank model is highlyefficient.  The Bank targets the non-retail sector of the commercialmarket which is characterized by lower levels of transactions and processingcosts.  The commercial customer mix and the strategic outsourcing ofcertain administrative functions, such as data processing, allow the Bank tooperate with a smaller, more highly trained staff.  Management targets anaverage asset per employee ratio of $7.5 million compared to the average ofless than $3.5 million in assets per employee for Tennessee state charteredbanks at the end of June 2006. The Bank also promotes the use of technology,both internally and externally, to maximize the efficiency of operations. Management targets an operating efficiency ratio (total operating expensedivided by total revenue) of 40% to 45%.

The Bank is subject to the regulatory authority of theDepartment of Financial Institutions of the State of Tennessee (“TDFI”) and theFederal Deposit Insurance Corporation (“FDIC”).

The Bank’s principal executive offices are located at381 Mallory Station Road, Suite 207, Franklin, Tennessee 37067, and itstelephone number is (615) 599-2274.

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We were incorporated on March 22, 2000, for thepurpose of acquiring 100% of the shares of the Bank by means of a shareexchange, and becoming a registered bank holding company under the FederalReserve Act.  The share exchange was completed on May 31, 2000.  Theactivities of the Corporation are subject to the supervision of the Board ofGovernors of the Federal Reserve System (“Federal Reserve Board”).  Ouroffices are the same as the principal office of the Bank.  On March 29,2005, we formed a wholly owned subsidiary, Tennessee Commerce Bank StatutoryTrust I, (the “Trust I”). The Bank and the Trust I are our only subsidiaries.At this time, we have no plans to conduct any business apart from theactivities of the Bank. The Bank commenced operations as a Tennessee statechartered bank on January 14, 2000, and is headquartered in Franklin,Tennessee.

# **Market Area and Competition**

All phases of the Bank’s business are highlycompetitive.  The Bank is subject to intense competition from variousfinancial institutions and other companies or firms that offer financialservices.  The Bank competes for deposits with other commercial banks,savings and loan associations, credit unions and issuers of commercial paperand other securities, such as money-market and mutual funds.  In makingloans, the Bank is expected to compete with other commercial banks, savings andloan associations, consumer finance companies, credit unions, leasingcompanies, and other lenders.

The Bank’s primary market area is Davidson County andWilliamson County in Tennessee.  In Davidson County, as of June 30, 2006, therewere 26 banks and no savings and loan institutions, with at least 193 officesactively engaged in banking activities, including 10 major state-wide financialinstitutions.  Total deposits held by banks in Davidson County as of June30, 2006, were approximately $15.8 billion.  In Williamson County, as ofJune 30, 2006, there were 24 banks and 2 savings and loan institutions, with atleast 83 offices actively engaged in banking activities, including 9 majorstate-wide financial institutions.  Total deposits held by banks andsavings and loan associations in Williamson County as of June 30, 2006, wereapproximately $4.3 billion.  In addition, there are numerous creditunions, finance companies, and other financial services providers.

Demographic information published by SNL Financial,shows a total estimated population of 159,022 for Williamson County in 2006.That is a 25.57% increase from 126,638 in 2000. The estimated number ofhouseholds in the county in 2006 is 56,994 up from 44,725 in 2000, averaging2.79 persons per household. In 2006, the median household income was $88,410,while per capita income was $44,023.  At the end of 2006, the unemploymentrate was 2.6%.

Demographic information published by SNL Financialshows an estimated population of 596,829 for Davidson County in 2006. That is a4.73% increase over the population of 569,891 in 2000. The estimated number ofhouseholds in the county in 2006 is 250,628 averaging 2.38 persons perhousehold. In 2006, the median household income was $50,420, while per capitaincome was $29,695.  At the end of 2006, the unemployment rate was 3.6%.

**Employees**

At December 31, 2006, the Bank employed 50 persons ona full-time basis. The Bank’s employees are not represented by any union orother collective bargaining agreement and management of the Bank believes itsemployee relations are satisfactory.

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Supervisionand Regulation

**BankHolding Company Regulation**

We are a bank holding company within the meaning ofthe Bank Holding Company Act of 1956, as amended (the “Holding Company Act”),and are registered with the Federal Reserve Board. Our bankingsubsidiaries are subject to restrictions under federal law which limit thetransfer of funds by the subsidiary banks to their respective holding companiesand nonbanking subsidiaries, whether in the form of loans, extensions ofcredit, investments, or asset purchases.  Such transfers by any subsidiarybank to its holding company or any non-banking subsidiary are limited in amountto 10% of the subsidiary bank’s capital and surplus and, with respect to us andall such nonbanking subsidiaries, to an aggregate of 20% of such bank’s capitaland surplus.  Furthermore, such loans and extensions of credit arerequired to be secured in specified amounts.  The Holding Company Act alsoprohibits, subject to certain exceptions, a bank holding company from engagingin or acquiring direct or indirect control of more than 5% of the voting stockof any company engaged in non banking activities.  An exception to thisprohibition is for activities expressly found by the Federal Reserve Board tobe so closely related to banking or managing or controlling banks as to be aproper incident thereto or financial in nature.

As a bank holding company, we are required to filewith the Federal Reserve Board semi-annual reports and such additionalinformation as the Federal Reserve Board may require.  The Federal ReserveBoard also makes examinations of us at its discretion.

According to Federal Reserve Board policy, bankholding companies are expected to act as a source of financial strength to eachsubsidiary bank and to commit resources to support each such subsidiary. This support may be required at times when a bank holding company may not beable to provide such support.  Furthermore, in the event of a losssuffered or anticipated by the FDIC - either as a result of default of ourbanking or thrift subsidiary or related to FDIC assistance provided to asubsidiary in danger of default — our other banking subsidiaries may beassessed for the FDIC’s loss, subject to certain exceptions.

Various federal and state statutory provisions limitthe amount of dividends the subsidiary banks can pay to their holding companieswithout regulatory approval.  The payment of dividends by any bank alsomay be affected by other factors, such as the maintenance of adequate capitalfor such subsidiary bank.  In addition to the foregoing restrictions, theFederal Reserve Board has the power to prohibit dividends by bank holdingcompanies if their actions constitute unsafe or unsound practices.  TheFederal Reserve Board has issued a policy statement on the payment of cashdividends by bank holding companies, which expresses the Federal Reserve Board’sview that a bank holding company experiencing earnings weaknesses should notpay cash dividends that exceed its net income or that could only be funded inways that weaken the bank holding company’s financial health, such as byborrowing.  Furthermore, the TDFI also has authority to prohibit thepayment of dividends by a Tennessee bank when it determines such payment to bean unsafe and unsound banking practice.

A bank holding company and its subsidiaries are alsoprohibited from acquiring any voting shares of, or interest in, any bankslocated outside of the state in which the operations of the bank holdingcompany’s subsidiaries are located, unless the acquisition is specificallyauthorized by the statutes of the state in which the target is located. Further, a bank holding company and its subsidiaries are prohibited from engagingin certain tie-in arrangements in connection with the extension of credit orprovision of any property or service.  Thus, an affiliate of a bankholding company may not extend credit, lease or sell property, or furnish anyservices or fix or vary the consideration for these on the condition that (i)the customer must obtain or provide some additional credit, property orservices from or to its bank holding company or subsidiaries thereof or (ii)the customer may not obtain some other credit, property, or services from acompetitor, except to the extent reasonable conditions are imposed to assurethe soundness of the credit extended.

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In approving acquisitions by bank holding companies ofbanks and companies engaged in the banking-related activities described above,the Federal Reserve Board considers a number of factors, including the expectedbenefits to the public such as greater convenience, increased competition, orgains in efficiency, as weighed against the risks of possible adverse effectssuch as undue concentration of resources, decreased or unfair competition,conflicts of interest, or unsound banking practices.  The Federal ReserveBoard is also empowered to differentiate between new activities and activitiescommenced through the acquisition of a going concern.

The Attorney General of the United States may, within30 days after approval by the Federal Reserve Board of an acquisition, bring anaction challenging such acquisition under the federal antitrust laws, in whichcase the effectiveness of such approval is stayed pending a final ruling by thecourts.  Failure of the Attorney General to challenge an acquisition doesnot, however, exempt the holding company from complying with both state andfederal antitrust laws after the acquisition is consummated or immunize theacquisition from future challenge under the anti-monopolization provisions ofthe Sherman Act.

## Capital Guidelines

The Federal Reserve Board has risk based capitalguidelines for bank holding companies and member banks.  Under the guidelines,the minimum ratio of capital to risk weighted assets (including certain offbalance sheet items, such as standby letters of credit) is 8%.  To beconsidered a “well capitalized” bank or bank holding company under theguidelines, a bank or bank holding company must have a total risk based capitalratio in excess of 10%.  At December 31, 2006, we were sufficientlycapitalized to be considered “well capitalized”.

At least half of the total capital is to be comprisedof common equity, retained earnings, and a limited amount of perpetualpreferred stock, after subtracting goodwill and certain other adjustments (“TierI capital”).  The remainder may consist of perpetual debt, mandatoryconvertible debt securities, a limited amount of subordinated debt, otherpreferred stock not qualifying for Tier I capital, and a limited amount of loanloss reserves (“Tier II capital”).  The Bank is subject to similar capitalrequirements adopted by the FDIC.  In addition, the Federal Reserve Boardand the FDIC have adopted a minimum leverage ratio (Tier I capital to totalassets) of 3%.  Generally, banking organizations are expected to operatewell above the minimum required capital level of 3% unless they meet certainspecified criteria, including that they have the highest regulatory ratings.Most banking organizations are required to maintain a leverage ratio of 3%,plus an additional cushion of at least 1% to 2%.  State regulatoryauthorities and the FDIC encourage most community banks to maintain a leverageratio of 6.5% to 7.0%. The Bank’s leverage ratio at December 31, 2006, was8.78%.  The guidelines also provide that banking organizationsexperiencing internal growth or making acquisitions will be expected tomaintain strong capital positions substantially above the minimum supervisorylevels without significant reliance upon intangible assets.

Under the Financial Institutions Reform, Recovery andEnforcement Act of 1989 (“FIRREA”), failure to meet the capital guidelinescould subject a banking institution to a variety of enforcement remediesavailable to federal regulatory authorities, including the termination ofdeposit insurance by the FDIC.

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## Sarbanes-Oxley Act of 2002

On July 30, 2002, President Bush signed into law theSarbanes-Oxley Act of 2002. This legislation represents a comprehensiverevision of laws affecting corporate governance, accounting obligations andcorporate reporting. The Sarbanes-Oxley Act is applicable to all companies withequity securities registered, or that file reports under the SecuritiesExchange Act of 1934.  In particular, the act establishes (i) newrequirements for audit committees, including independence, expertise andresponsibilities; (ii) additional responsibilities regarding financialstatements for the chief executive officer and chief financial officer of thereporting company and new requirements for them to certify the accuracy ofperiodic reports; (iii) new standards for auditors and regulation of audits;(iv) increased disclosure and reporting obligations for the reporting companyand its directors and executive officers, including an accelerated time framefor reporting of insider transactions; and (v) new and increased civil andcriminal penalties for violations of the federal securities laws. Thelegislation also established a new accounting oversight board to enforceauditing standards and restrict the scope of services that accounting firms mayprovide to their public company audit clients.

Because our common stock is registered with the SEC,we are subject to the requirements of this legislation.  At the presenttime, and subject to the final rules and regulations to be adopted and issuedby the SEC, management anticipates that we will incur additional expense as aresult of the act but does not expect that the our compliance will have amaterial impact on our business. To the extent that we have already implementedthe requirements of this legislation and the related regulations, compliancehas been accomplished with our existing personnel.

We file periodic reports with the SEC. The public mayread and copy any materials we file with the SEC at the SEC’s Public ReferenceRoom at 450 Fifth Street, N.W., Washington, D.C. 20549.  Informationregarding the Public Reference Room may be obtained by calling the SEC at1-800-SEC-0330.  The SEC also maintains an internet site that containsreports, proxy and information statements, and other information regarding usthat we file electronically with the SEC.  This information may be foundat www.sec.gov and a link to the same information may be found on the Bank’swebsite at www.tncommercebank.com under the Investor Relations heading.

**TennesseeBanking Act; Federal Deposit Insurance Act**

The Bank is a Tennessee state-chartered bank and issubject to the regulations of and supervision by the FDIC as well as the TDFI,Tennessee’s state banking authority.  The Bank is also subject to variousrequirements and restrictions under federal and state law, includingrequirements to maintain reserves against deposits, restrictions on the types andamounts of loans that may be granted and the interest that may be chargedthereon and limitations on the types of investments that may be made and thetypes of services that may be offered.  Various consumer laws andregulations also affect the operations of the Bank.  In addition to theimpact of regulation, commercial banks are affected significantly by theactions of the Federal Reserve Board as it attempts to control the money supplyand credit availability in order to influence the economy.

From time to time, legislation is enacted which hasthe effect of increasing the cost of doing business, limiting or expandingpermissible activities or affecting the competitive balance between banks andother financial institutions.  Proposals to change the laws andregulations governing the operations and taxation of banks, bank holdingcompanies and other financial institutions are frequently made in Congress, inthe Tennessee legislature and before various bank regulatory and otherprofessional agencies.  The likelihood of any major legislative changesand the impact such changes might have on the Bank are impossible to predict.

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General

The Bank, as a Tennessee state chartered bank, issubject to primary supervision, periodic examination and regulation by the Commissionerof the TDFI (“Commissioner”) and the FDIC.  If, as a result of anexamination of a bank, the FDIC should determine that the financial condition,capital resources, asset quality, earnings prospects, management, liquidity orother aspects of the Bank’s operations are unsatisfactory or that the Bank orits management is violating or has violated any law or regulation, variousremedies are available to the FDIC.  Such remedies include the power toenjoin “unsafe or unsound” practices, to require affirmative action to correctany conditions resulting from any violation or practice, to issue anadministrative order that can be judicially enforced, to direct an increase incapital, to restrict the growth of the Bank, to assess civil monetary penalties,to remove officers and directors and ultimately to terminate a Bank’s depositinsurance.  The Commissioner has many of the same remedial powers,including the power to take possession of a bank whose capital becomesimpaired.  As of December 31, 2006, the Bank is not the subject of anysuch action by the FDIC or the Commissioner.

The deposits of the Bank are insured by the FDIC inthe manner and to the extent provided by law.  For this protection, theBank pays a semiannual statutory assessment.  Although the Bank is not amember of the Federal Reserve System, it is nevertheless subject to certainregulations of the Federal Reserve Board.

Various requirements and restrictions under the lawsof the State of Tennessee and the United States affect the operations of theBank.  State and federal statutes and regulations relate to many aspectsof the Bank’s operations, including reserves against deposits, interest ratespayable on deposits, loans, investments, mergers and acquisitions, borrowings,dividends, locations of branch offices and capital requirements. Furthermore, the Bank is required to maintain certain levels of capital.

Tennessee law contains limitations on the interestrates that may be charged on various types of loans and restrictions on thenature and amount of loans that may be granted and on the types of investmentswhich may be made.  The operations of banks are also affected by variousconsumer laws and regulations, including those relating to equal creditopportunity and regulation of consumer lending practices.  All Tennesseebanks must become and remain insured banks under the Federal Deposit InsuranceAct (FDIA). (See 12 U.S.C. §1811, et seq.).

## Payment of Dividends

The Bank is subject to the Tennessee Banking Act,which limits a bank’s ability to pay dividends.  The payment of dividendsby any bank is dependent upon its earnings and financial condition and subjectto the statutory power of certain federal and state regulatory agencies to actto prevent what they deem unsafe or unsound banking practices.  Thepayment of dividends could, depending upon the financial condition of the Bank,be deemed to constitute such an unsafe or unsound banking practice.  UnderTennessee law, the board of directors of a state bank may not declare dividendsin any calendar year that exceeds the total of its retained net income of thepreceding two (2) years without the prior approval of the TDFI.  The FDIAprohibits a state bank, the deposits of which are insured by the FDIC, frompaying dividends if it is in default in the payment of any assessments due theFDIC.  The Bank is also subject to the minimum capital requirements of theFDIC which impact the Bank’s ability to pay dividends.  If the Bank failsto meet these standards, it may not be able to pay dividends or to acceptadditional deposits because of regulatory requirements.

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If, in the opinion of the applicable federal bankregulatory authority, a depository institution is engaged in or is about toengage in an unsafe or unsound practice (which, depending on the financialcondition of the depository institution, could include the payment ofdividends), such authority may require that such institution cease and desistfrom such practice.  The federal banking agencies have indicated thatpaying dividends that deplete a depository institution’s capital base to aninadequate level would be such an unsafe or unsound banking practice. Moreover, the Federal Reserve Board, the Comptroller of the Currency and theFDIC have issued policy statements which provide that bank holding companiesand insured depository institutions generally should only pay dividends out ofcurrent operating earnings.

The payment of dividends by the Bank may also beaffected or limited by other factors, such as the requirement to maintain adequatecapital above regulatory guidelines.

## FIRREA

Congress enacted the Financial Institutions Reform,Recovery and Enforcement Act of 1989 (“FIRREA”) on August 9, 1989.  FIRREAprovides that a depository institution insured by the FDIC can be held liable forany loss incurred by, or reasonably expected to be incurred by, the FDIC afterAugust 9, 1989 in connection with (i) the default of a commonly controlled FDICinsured depository institution or (ii) any assistance provided by the FDIC to acommonly controlled FDIC insured depository institution in danger ofdefault.  FIRREA provides that certain types of persons affiliated withfinancial institutions can be fined by the federal regulatory agency havingjurisdiction over a depository institution with federal deposit insurance (suchas the Bank) up to $1 million per day for each violation of certain regulationsrelated (primarily) to lending to and transactions with executive officers,directors, principal shareholders and the interests of these individuals. Other violations may result in civil money penalties of $5,000 to $30,000 perday or in criminal fines and penalties.  In addition, the FDIC has beengranted enhanced authority to withdraw or to suspend deposit insurance incertain cases.

## FDICIA

The Federal Deposit Insurance Corporation ImprovementAct of 1991 (“FDICIA”) which was enacted on December 19, 1991, substantiallyrevised the depository institution regulatory and funding provisions of theFDIA and made revisions to several other federal banking statutes.  Amongother things, FDICIA requires the federal banking regulators to take “promptcorrective action” in respect of FDIC-insured depository institutions that donot meet minimum capital requirements. FDICIA establishes five capital tiers: “wellcapitalized,” “adequately capitalized,” “undercapitalized,” “significantlyundercapitalized” and “critically undercapitalized.”  Under applicableregulations, a FDIC-insured depository institution is defined to be wellcapitalized if it maintains a Leverage Ratio of at least 5%, a risk adjustedTier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10%and is not subject to a directive, order or written agreement to meet andmaintain specific capital levels.  An insured depository institution isdefined to be adequately capitalized if it meets all of its minimum capitalrequirements as described above.  In addition, an insured depositoryinstitution will be considered undercapitalized if it fails to meet any minimumrequired measure, significantly undercapitalized if it is significantly belowsuch measure and critically undercapitalized if it fails to maintain a level oftangible equity equal to not less than 2% of total assets.  An insureddepository institution may be deemed to be in a capitalization category that islower than is indicated by its actual capital position if it receives anunsatisfactory examination rating.

The capital-based prompt corrective action provisionof FDICIA and their implementing regulations apply to FDIC-insured depositoryinstitutions and are not directly applicable to holding companies which controlsuch institutions.  However, the Federal Reserve Board has indicated that,in regulating bank holding companies, it will take appropriate action at theholding company level based on an assessment of the effectiveness ofsupervisory actions imposed upon subsidiary depository institutions pursuant tosuch provisions and regulations.

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FDICIA generally prohibits an FDIC-insured depositoryinstitution from making any capital distribution (including payment ofdividends) or paying any management fee to its holding company if thedepository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to restrictions onborrowing from the Federal Reserve System.  In addition, undercapitalizeddepository institutions are subject to growth limitations and are required tosubmit capital restoration plans.  A depository institution’s holdingcompany must guarantee the capital plan, up to an amount equal to the lesser of5% of the depository institution’s assets at the time it becomesundercapitalized or the amount of the capital deficiency when the institutionfails to comply with the plan.  The federal banking agencies may notaccept a capital plan without determining, among other things, that the plan isbased on realistic assumptions and is likely to succeed in restoring thedepository institution’s capital.  If a depository institution fails tosubmit an acceptable plan, it is treated as if it is significantlyundercapitalized.

Significantly undercapitalized depository institutionsmay be subject to a number of requirements and restrictions, including ordersto sell sufficient voting stock to become adequately capitalized, requirementsto reduce total assets and cessation of receipt of deposits from correspondentbanks.  Critically undercapitalized depository institutions are subject toappointment of a receiver or conservator generally within 90 days of the dateon which they became critically undercapitalized.

Management of the Bank believes that at December 31,2006, the Bank was well capitalized under the criteria discussed above.

FDICIA contains numerous other provisions, includingaccounting, audit and reporting requirements, termination of the “too big tofail” doctrine except in special cases, limitations on the FDIC’s payment ofdeposits at foreign branches, new regulatory standards in such areas as assetquality, earnings and compensation and revised regulatory standards for, amongother things, powers of state banks, real estate lending and capitaladequacy.  FDICIA also requires that a depository institution provide 90days prior notice of the closing of any branches.

Various other legislation, including proposals torevise the bank regulatory system and to limit the investments that adepository institution may make with insured funds, is from time to timeintroduced in Congress.  The TDFI and FDIC will examine the Bankperiodically for compliance with various regulatory requirements.  Suchexaminations, however, are for the protection of the Deposit Insurance Fund (“DIF”)and for depositors, and not for the protection of investors and shareholders.

## Interstate Act

The Riegle-Neal Interstate Banking and BranchingEfficiency Act of 1994 (“Interstate Act”), which was enacted on September 29,1994, among other things and subject to certain conditions and exceptions,permits on an interstate basis (i) bank holding company acquisitions commencingone year after enactment of banks of a minimum age of up to five years asestablished by state law in any state, (ii) mergers of national and state banksafter May 31, 1997 unless the home state of either bank has opted out of theinterstate bank merger provision, (iii) branching de novo by national and statebanks if the host state has opted-in to this provision of the Interstate Act,and (iv) certain bank agency activities after one year after enactment. The Interstate Act contains a 30% intrastate deposit cap, except for theinitial acquisition in the state, restriction that applies to certaininterstate acquisitions unless a different intrastate cap has been adopted bythe applicable state pursuant to the provisions of the Interstate Act and a 10%national deposit cap restriction.  Tennessee has opted-in to theInterstate Act.  Management cannot predict the extent to which thebusiness of the Bank may be affected.  Tennessee has also adoptedlegislation allowing banks to acquire branches across state lines subject tocertain conditions, including the availability of similar legislation in theother state.

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## Brokered Deposits and Pass-Through Insurance

The FDIC has adopted regulations under FDICIAgoverning the receipt of brokered deposits and pass-through insurance. Under the regulations, a bank cannot accept or rollover or renew brokereddeposits unless (i) it is well capitalized or (ii) it is adequately capitalizedand receives a waiver from the FDIC.  A bank that cannot receive brokereddeposits also cannot offer “pass-through” insurance on certain employee benefitaccounts.  Whether or not it has obtained such a waiver, an adequatelycapitalized bank may not pay an interest rate on any deposits in excess of 75basis points over certain index prevailing market rates specified by regulation. There are no such restrictions on a bank that is well capitalized. Because it believes that the Bank was well capitalized as of December 31, 2006,the Bank believes the brokered deposits regulation will have no material effecton the funding or liquidity of the Bank.

## FDIC Insurance Premiums

The Bank is required topay semiannual FDIC deposit insurance assessments to the Deposit Insurance Fund(“DIF”).  The FDIC merged the BankInsurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”) to formthe DIF on March 31, 2006 in accordance with the Federal Deposit InsuranceReform Act of 2005.  The FDIC maintainsthe DIF by assessing depository institutions an insurance premium.  The amount each institution is assessed isbased upon statutory factors that include the balance of insured deposits aswell as the degree of risk the institution poses to the insurance fund.  The FDIC uses a risk-based premium systemthat assesses higher rates on those institutions that pose greater risks to theDIF.  Under the rule adopted by the FDICin November 2006, beginning in 2007, the FDIC will place each institution inone of four risk categories using a two-step process based first on capitalratios (the capital group assignment) and then on other relevant information(the supervisory group assignment). Beginning in 2007, rates will range between $.05 and $.43 per $100 inassessable deposits.  Any change in theserates and the category of risk into which the Bank will fall could have anadverse effect on the Bank’s earnings.

Under the FDIA, insuranceof deposits may be terminated by the FDIC upon a finding that the institutionhas engaged in unsafe or unsound practices, is in an unsafe or unsoundcondition to continue operations or has violated any applicable law, regulation,rule, order or condition imposed by a federal bank regulatory agency.

## Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act adopted in November 1999has been referred to as the most important banking bill in over 60 years. The most significant provisions ratify new powers for banks and bank holdingcompanies, especially in the areas of securities and insurance.  The Actalso includes requirements regarding the privacy and protection of customerinformation held by financial institutions, as well as many other providers offinancial services.  There are provisions providing for functionalregulation of the various services provided by institutions among differentregulators.  There are other provisions which limit the future expansionof unitary thrift holding companies which now prevent companies like Wal-Martfrom owning a thrift institution.  Finally, among many other sections ofthe Act, there is some relief for small banks from the regulatory burden of theCommunity Reinvestment Act.  The regulatory agencies have been adoptingmany new regulations to implement the Act.

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## USA Patriot Act

The USA PATRIOT Act of 2001 became law on October 26,2001. This act contains the International Money Laundering Abatement andFinancial Anti-Terrorism Act of 2001 (the “IMLAFA”).  The IMLAFAsubstantially broadens existing anti-money laundering legislation and theextraterritorial jurisdiction of the United States, imposes new compliance anddue diligence obligations, creates new crimes and penalties, compels the productionof documents located both inside and outside the United States, including thoseof foreign institutions that have a correspondent relationship in the UnitedStates, and clarifies the safe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulations implementingthe USA PATRIOT Act that apply certain of its requirements to financialinstitutions such as our banking subsidiary.  The regulations impose newobligations on financial institutions to maintain appropriate policies,procedures and controls to detect, prevent and report money laundering andterrorist financing.  The Treasury Department is expected to issue anumber of additional regulations which will further clarify the USA PATRIOT Act’srequirements.

The IMLAFA requires all “financial institutions,” asdefined, to establish anti-money laundering compliance and due diligenceprograms no later than April 2003.  Such programs must include, amongother things, adequate policies, the designation of a compliance officer,employee training programs, and an independent audit function to review andtest the program.  The Bank has established anti-money launderingcompliance and due diligence programs to comply with IMLAFA.

## Capital Requirements

The federal regulatory agencies use capital adequacyguidelines in their examination and regulation of banks.  If the capitalfalls below the minimum levels established by these guidelines, the Bank may(i) be denied approval to acquire or establish additional banks or non-bankbusinesses or to open facilities, or (ii) be subject to other regulatoryrestrictions or actions.

Banking organizations historically were required tomaintain a minimum ratio of primary capital to total assets of 5.5%, and aminimum ratio of total capital to total assets of 6.0%.  The primary andtotal capital ratio requirements have been replaced by the adoption ofrisk-based and leverage capital requirements.

Risk-Based Capital Requirements. The FDIC adopted risk-based capital guidelines for banks and bank holdingcompanies effective after December 31, 1990.  The risk-based capitalguidelines are designed to make regulatory capital requirements more sensitiveto differences in risk profile among banks to account for off-balance sheet exposureand to minimize disincentives for holding liquid assets.  Assets andoff-balance sheet items are assigned to broad risk categories each withappropriate weights.  The resulting capital ratios represent capital as apercentage of total risk-weighted assets and off-balance sheet items.  Theratios are minimums.  The guidelines require all federally regulated banksto maintain a minimum risk-based total capital ratio of 8%, of which at least4% must be Tier I capital (see the description of Tier I capital and Tier IIcapital below).

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A banking organization’s qualifying total capitalconsists of two components:  Tier I capital (core capital) and Tier IIcapital (supplementary capital).  Tier I capital is an amount equal to thesum of:  (i) common shareholders’ equity (including adjustments for anysurplus or deficit); (ii) non-cumulative perpetual preferred stock; and (iii)the company’s minority interests in the equity accounts of consolidatedsubsidiaries.  Intangible assets generally must be deducted from Tier Icapital, subject to limited exceptions for goodwill arising from certainsupervisory acquisitions.  Other intangible assets may be included in anamount up to 25% of Tier I capital, provided that the asset meets each of thefollowing criteria:  (i) the asset must be able to be separated and soldapart from the banking organization or the bulk of its assets; (ii) the marketvalue of the asset must be established on an annual basis through anidentifiable stream of cash flows and there must be a high degree of certaintythat the asset will hold this market value notwithstanding the future prospectsof the banking organization; and (iii) the banking organization mustdemonstrate that a liquid market exists for the asset.  Intangible assetsin excess of 25% of Tier I capital generally are deducted from a bankingorganization’s regulatory capital.  At least 50% of the bankingorganization’s total regulatory capital must consist of Tier I capital.

Tier II capital is an amount equal to the sum of (i)the allowance for possible credit losses in an amount up to 1.25% ofrisk-weighted assets; (ii) cumulative perpetual preferred stock with anoriginal maturity of 20 years or more and related surplus; (iii) hybrid capitalinstruments (instruments with characteristics of both debt and equity),perpetual debt and mandatory convertible debt securities; and (iv) in an amountup to 50% of Tier I capital, eligible term subordinated debt andintermediate-term preferred stock with an original maturity of five years ormore, including related surplus.  The inclusion of the foregoing elementsof Tier II capital are subject to certain requirements and limitations of theFDIC.

Investments in unconsolidated banking and financesubsidiaries, investments in securities subsidiaries and reciprocal holdings ofcapital instruments must be deducted from capital.  The federal bankingregulators may require other deductions on a case-by-case basis.

Under the risk-weighted capital guidelines, balancesheet assets and certain off-balance sheet items, such as standby letters ofcredit, are assigned to one of four risk weight categories (0%, 20%, 50%, or100%) according to the nature of the asset and its collateral or the identityof any obligor or guarantor.  For example, cash is assigned to the 0% riskcategory, while loans secured by one-to-four family residences are assigned tothe 50% risk category.  The aggregate amount of such assets andoff-balance sheet items in each risk category is adjusted by the risk weightassigned to that category to determine weighted values, which are addedtogether to determine the total risk-weighted assets for the bankingorganization.  Accordingly, an asset, such as a commercial loan, which isassigned to a 100% risk category is included in risk-weighted assets at itsnominal face value, whereas a loan secured by a single-family home mortgage isincluded at only 50% of its nominal face value.  The application ratiosare equal to capital, as determined, divided by risk-weighted assets, asdetermined.

Leverage Capital Requirements. The FDIC has a regulation requiring certain banking organizations to maintainadditional capital of 1% to 2% above a 3% minimum Tier I Leverage Capital Ratio(Tier I capital, less intangible assets, to total assets).  In order foran institution to operate at or near the minimum Tier I leverage capitalrequirement of 3%, the FDIC expects that such institution would havewell-diversified risk, no undue rate risk exposure, excellent asset quality,high liquidity and good earnings.  In general, the Bank would have to beconsidered a strong banking organization, rated in the highest category underthe bank rating system and have no significant plans for expansion. Higher Tier I leverage capital ratios of up to 5% will generally be required ifall of the above characteristics are not exhibited, or if the institution isundertaking expansion, seeking to engage in new activities, or otherwise facesunusual or abnormal risks.

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The FDIC rule provides that institutions not incompliance with the regulation are expected to be operating in compliance witha capital plan or agreement with the regulator.  If they do not do so,they are deemed to be engaging in an unsafe and unsound practice and may besubject to enforcement action.  In addition, failure by an institution tomaintain capital of at least 2% of assets constitutes an unsafe and unsoundpractice and may subject the institution to enforcement action.  Aninstitution’s failure to maintain capital of at least 2% of assets constitutesan unsafe and unsound condition justifying termination of FDIC insurance.

## Depositor Preference

The Omnibus Budget Reconciliation Act of 1993 providesthat deposits and certain claims for administrative expenses and employeecompensation against an insured depositary institution would be afforded apriority over other general unsecured claims against such an institution,including federal funds and letters of credit, in the “liquidation or otherresolution” of such an institution by any receiver.

## Effect of Governmental Policies

The Bank is affected by the policies of regulatoryauthorities, including the Federal Reserve System.  An important functionof the Federal Reserve System is to regulate the national money supply. Among the instruments of monetary policy used by the Federal Reserve are:purchases and sales of U.S. Government securities in the marketplace; changesin the discount rate, which is the rate any depository institution must pay toborrow from the Federal Reserve; and changes in the reserve requirements of depositoryinstitutions.  These instruments are effective in influencing economic andmonetary growth, interest rate levels and inflation.

The monetary policies of the Federal Reserve Systemand other governmental policies have had a significant effect on the operatingresults of commercial banks in the past and are expected to continue to do soin the future.  Because of changing conditions in the national economy andin the money market, as well as the result of actions by monetary and fiscalauthorities, it is not possible to predict with certainty future changes ininterest rates, deposit levels, loan demand or the business and earnings of theBank or whether the changing economic conditions will have a positive ornegative effect on operations and earnings.

Bills are pending before the United States Congressand the Tennessee General Assembly which could affect the business of the Bank,and there are indications that other similar bills may be introduced in thefuture.  It cannot be predicted whether or in what form any of theseproposals will be adopted or the extent to which the business of the Bank maybe affected thereby.

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**Loan Policy**

Lending activity is conducted under guidelines definedin the Bank’s Loan Policy.  The Loan Policy establishes guidelines foranalyzing financial transactions including an evaluation of the borrower’scredit history, repayment capacity, collateral value, and cash flow. Loans may be fixed or variable rate, with the maximum maturity of fixed rateloans set at five years.

All lending activities of the Bank are under thedirect supervision and control of the Officers Loan Committee, The ExecutiveCommittee of the Board, and in some cases, the full Board of Directors. TheOfficers Loan Committee consisting of Arthur F. Helf, Michael R. Sapp and H.Lamar Cox approve loans up to one million dollars. The Executive Committeeconsisting of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox and four outsidedirectors approve loans up to 15% of Tier I capital. The full Board of Directorsapproves all loans above those limits. The full Board of Directors approvesloan authorizations, if any, for each Executive Officer. The Bank’s establishedmaximum loan volume to deposits is 100%. The Executive Committee of the Boardmakes a monthly review of loans which are 90 days or more past due and the fullBoard of Directors makes a quarterly review of loans which are 90 days or morepast due.

Management of the Bank periodically reviews the loanportfolio, particularly non-accrual and renegotiated loans.  The reviewmay result in a determination that a loan should be placed on a non-accrualstatus for income recognition.  In addition, to the extent that managementidentifies potential losses in the loan portfolio, it reduces the book value ofsuch loans, through charge-offs, to their estimated collectible value. The Bank’s policy is that accrual of interest is discontinued on a loan whenmanagement of the Bank determines upon consideration of economic and businessfactors affecting collection efforts that collection of interest is doubtful.

When a loan is classified as non-accrual, any unpaidinterest is reversed against current income.  Interest is included inincome thereafter only to the extent received in cash.  The loan remainsin a non-accrual classification until such time as the loan is brought current,when it may be returned to accrual classification.  When principal orinterest on a non-accrual loan is brought current, if in management’s opinionfuture payments are questionable, the loan would remain classified asnon-accrual.  After a non-accrual or renegotiated loan is charged off, anysubsequent payments of either interest or principal are applied first to anyremaining balance outstanding, then to recoveries and lastly to income.

The Bank’s underwriting guidelines are applied to fourmajor categories of loans, commercial and industrial, consumer, agriculturaland real estate which includes residential, construction and development andcertain other real estate loans.  The Bank requires its loan officers andloan committee to consider the borrower’s character, the borrower’s financialcondition, the economic environment in which the loan will be repaid, as wellas, for commercial loans, the borrower’s management capability and the borrower’sindustry. Before approving a loan, the loan officer or committee must determinethat the borrower is basically honest and creditworthy, determine that theborrower is a capable manager, understand the specific purpose of the loan,understand the source and plan of repayment, determine that the purpose, planand source of repayment as well as collateral are acceptable, reasonable andpractical given the normal framework within which the borrower operates.

The maintenance of an adequate loan loss reserve is oneof the fundamental concepts of risk management for every financialinstitution.  Management is responsible for ensuring that controls are inplace to constantly monitor the adequacy of the loan loss reserve in accordancewith generally accepted accounting principles (GAAP), the Bank’s statedpolicies and procedures, and regulatory guidance.  Quantification of thelevel of reserve which is prudently conservative, but not excessive, involves ahigh degree of judgment.

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Management’s assessment of the adequacy of the loanloss reserve considers a wide range of factors including portfolio growth, mix,collateral and geographic diversity, and terms and structure.  Portfolioperformance trends, including past dues and charge-offs, are monitored closely. Management’s assessment includes a continuing evaluation of current andexpected market conditions and the potential impact of economic events onborrowers.  Management’s assessment program is monitored by an ongoingloan review program conducted by an independent accounting firm and periodicexaminations by bank regulators.

Management uses a variety of financial methods toquantify the level of the loan loss reserve.  At inception, each loantransaction is assigned a risk rating that ranges from “RR1 — Excellent” to “RR4-Average”. The risk rating is determined by an analysis of the borrower’s credit historyand capacity, collateral, and cash flow.  The weighted average risk ratingof the portfolio provides an indication of overall risk and identifiestrends.  The portfolio is additionally segmented by loan type, collateral,and purpose.  Loan transactions which have exhibited signs of increasedrisk are downgraded to a “Watch”, “Critical”, or “Substandard” classification,i.e. RR5, RR6, and RR7, respectively.  These loans are closely monitoredfor rehabilitation or potential loss and the loan loss reserve is adjustedaccordingly.

It is management’s intent to maintain a loan lossreserve which is adequate to absorb current and estimated losses which areinherent in a loan portfolio.  The historical loss ratio (net charge-offsas a percentage of average loans) was 0.89%, 0.76% and 0.41% for the years2004, 2005 and 2006.  The year end loan loss reserve as a percentage ofend of period loans was 1.31%, 1.26% and 1.28% for the same years.  Due tothe commercial emphasis of the bank’s operation, management has kept a reservelevel in excess of historical results.

The provision for loan losses in 2006 was $4,350,000,an increase of $650,000 over the $3,700,000 provision in 2005.  In 2006,expense reflects the impact of $2,037,000 in charge-offs during the year andthe incremental provision required as a result of the $197 million increase inloan volume.

Credit Risk Management and Reserve for Loan Losses

Credit risk and exposure to loss are inherent parts ofthe banking business.  Management seeks to manage and minimize these risksthrough its loan and investment policies and loan review procedures. Management establishes and continually reviews lending and investment criteriaand approval procedures that it believes reflect the risk sensitive nature ofthe Bank.  The loan review procedures are set to monitor adherence to theestablished criteria and to ensure that on a continuing basis such standardsare enforced and maintained.  Management’s objective in establishinglending and investment standards is to manage the risk of loss and provide forincome generation through pricing policies.

The Bank targets small and medium sized businesses asloan customers. Because of their size, these borrowers may be less able towithstand competitive or economic pressures than larger borrowers in periods ofeconomic weakness. If loan losses occur to a level where the loan loss reserveis not sufficient to cover actual loan losses, the Bank’s earnings willdecrease. The Bank uses an independent accounting firm to review our loans forquality in addition to the reviews that may be conducted by bank regulatoryagencies as part of their usual examination process.

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The loan portfolio is regularly reviewed andmanagement determines the amount of loans to be charged-off.  In addition,such factors as the Bank’s previous loan loss experience, prevailing andanticipated economic conditions, industry concentrations and the overallquality of the loan portfolio are considered.  While management usesavailable information to recognize losses on loans and real estate owned,future additions to the allowance may be necessary based on changes in economicconditions.  In addition, various regulatory agencies, as an integral partof their examination process, periodically review the allowances for losses onloans and real estate owned.  Such agencies may require the Bank torecognize additions to the allowances based on their judgments about informationavailable at the time of their examinations.  In addition, any loan orportion thereof which is classified as a “loss” by regulatory examiners ischarged-off.

**Capital Resources / Liquidity**

Liquidity- Of primary importance to depositors, creditors and regulators is the abilityto have readily available funds sufficient to repay fully maturingliabilities.  The Bank’s liquidity, represented by cash and cash due frombanks, is a result of its operating, investing and financing activities. In order to insure funds are available at all times, the Bank devotes resourcesto projecting on a monthly basis the amount of funds which will be required andmaintains relationships with a diversified customer base so funds areaccessible.  Liquidity requirements can also be met through short-termborrowings or the disposition of short-term assets which are generally matchedto correspond to the maturity of liabilities.

Although the Bank has no formal liquidity policy, inthe opinion of management, its liquidity levels are consideredadequate.   The Bank is subject to general FDIC guidelines which donot require a minimum level of liquidity.  Management believes itsliquidity ratios meet or exceed these guidelines.  Management does notknow of any trends or demands that are reasonably likely to result in liquidityincreasing or decreasing in any material manner.

Impact of Inflation andChanging Prices - The financial statements and relatedfinancial data presented herein have been prepared in accordance with U.S.generally accepted accounting principles which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time anddue to inflation.  The impact of inflation on operations of the Bank isreflected in increased operating costs.  Unlike most industrial companies,virtually all of the assets and liabilities of the Bank are monetary innature.  As a result, interest rates have a more significant impact on theBank’s performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the samemagnitude as the price of goods and services.

**Capital Adequacy**

Capital adequacy refers to the level of capital requiredto sustain asset growth over time and to absorb losses.  To continue togrow, the Bank must increase capital by generating earnings, issuing equitysecurities, borrowing funds, or a combination of those activities. If growthexceeds expectations, the Bank may need to raise capital in the capitalmarkets. The Bank’s ability to raise capital will depend in part on conditionsin the capital markets which are outside the Bank’s control. If the Bank cannotraise capital on terms acceptable to it, the Bank’s ability to continue growingwould be materially impaired.

The objective of the Bank’s management is to maintaina level of capitalization that is sufficient to take advantage of profitablegrowth opportunities while meeting regulatory requirements including remainingwell capitalized. This is achieved by improving profitability througheffectively allocating resources to more profitable businesses, improving assetquality, strengthening service quality, and streamlining costs.  Theprimary measures used by management to monitor the results of these efforts arethe ratios of average equity to average assets, average tangible equity toaverage tangible assets, and average equity to net loans.

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The Federal Reserve Board has adopted capitalguidelines governing the activities of bank holding companies.  Theseguidelines require the maintenance of an amount of capital based onrisk-adjusted assets so that categories of assets with potentially highercredit risk will require more capital backing than assets with lowerrisk.  In addition, banks and bank holding companies are required tomaintain capital to support, on a risk-adjusted basis, certain off-balancesheet activities such as loan commitments.

The capital guidelines classify capital into twotiers, referred to as Tier I and Tier II.  Under risk-basedcapital requirements, total capital consists of Tier I capital which isgenerally common stockholders’ equity less goodwill and Tier II capital whichis primarily a portion of the allowance for loan losses and certain qualifyingdebt instruments.  In determining risk-based capital requirements, assetsare assigned risk-weights of 0% to 100%, depending primarily on the regulatoryassigned levels of credit risk associated with such assets.  Off-balancesheet items are considered in the calculation of risk-adjusted assets throughconversion factors established by the regulators.  The framework forcalculating risk-based capital requires banks and bank holding companies tomeet the regulatory minimums of 4% Tier I and 8% total risk-basedcapital.  In 1990, regulators added a leveraged computation to the capitalrequirements, comparing Tier I capital to total average assets lessgoodwill.

We and the Bankare required to maintain certain capital ratios. These include Tier I, TotalCapital and Leverage Ratios. Certain ratios for us and the Bank for 2006 and2005 are set forth below:
| ** **              | ** ** | **Capital Level Meeting**    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------|------------|----------------------------------------|------------|-----------------|------------|------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | **Regulatory Definition of** | ** ** | **Corporation** | ** ** | **Bank**   | ** ** |
| ** **              | ** ** | **“Well Capitalized”**  | ** ** | **2006**        | ** ** | **2005**   | ** ** | **2006**   | ** ** | **2005**   | ** ** |
| ** **              | ** ** | **(%)**                                | ** ** | **(%)**         | ** ** | **(%)**    | ** ** | **(%)**    | ** ** | **(%)**    | ** ** |
| Tier I Capital  Ratio   |       |  6.00                             |       | 10.45           |       | 9.56       |       | 9.23       |       | 9.30       | ** ** |
|                    |       |                                   |       |            |       |       |       |       |       |       |       |
| Total Risk-Based  Ratio |       | 10.00                                  |       | 11.68           |       | 10.77      |       | 10.45      |       | 10.51      |       |
|                    |       |                                   |       |            |       |       |       |       |       |       |       |
| Leverage Ratio          |       |  5.00                             |       | 9.94            |       | 9.33       |       | 8.78       |       | 9.08       |       |

 

Based solely on our analysis of federal banking regulatorycategories, it appears on December 31, 2006 that we and the Bank fall withinthe “well capitalized” categories under the regulations.

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**1A.****                             RISKFACTORS**

**RisksRelated to Our Business**

**Our business strategy includes the continuation ofgrowth plans, and our financial condition and results of operations could benegatively affected if our business strategies are not effectively executed.**

We intend to continuepursuing a growth strategy for our business through organic growth of the loanportfolio. Our prospects must be considered in light of the risks, expenses anddifficulties that can be encountered by financial service companies in rapid growthstages, which include the risks associated with the following:

·                  maintainingloan quality;

·                  maintainingadequate management personnel and information systems to oversee such growth;

·                  maintainingadequate control and compliance functions; and

·                  securingcapital and liquidity needed to support our anticipated growth.

Operating Results.There is no assurance that we will maintain or achieve deposit levels, loanbalances or other operating results necessary to avoid losses or produceprofits. Our growth will cause growth in overhead expenses as we routinely addstaff. Our historical results may not be indicative of future results.

Regulatory and EconomicFactors. We may be adversely affected by a number ofregulatory and economic developments or other events. Failure to obtainrequired regulatory approvals, changes in laws and regulations or otherregulatory developments, and changes in prevailing economic conditions or otherunanticipated events may prevent our execution of certain business strategiesor adversely affect us.

Failure to successfullyaddress the issues identified above could have a material adverse effect on ourbusiness, future prospects, financial condition or results of operations.

**We could sustain losses if our assetquality declines.**

Our earnings are affectedby our ability to properly originate, underwrite and service loans.  We could sustain losses if we incorrectlyassess the creditworthiness of our borrowers or fail to detect or respond todeterioration in asset quality in a timely manner.  Problems with asset quality could cause ourinterest income and net interest margin to decrease and our provision for loanlosses to increase, which could adversely affect our results of operations andfinancial condition.

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**An inadequate allowance for loan losses wouldreduce our earnings.**

The risk of credit losseson loans varies with, among other things, general economic conditions, the typeof loan being made, the creditworthiness of the borrower over the term of theloan and, in the case of a collateralized loan, the value and marketability ofthe collateral for the loan. Management maintains an allowance for loan lossesbased upon, among other things, historical experience, an evaluation ofeconomic conditions and regular reviews of delinquencies and loan portfolioquality. Based upon such factors, management makes various assumptions andjudgments about the ultimate collectibility of the loan portfolio and providesan allowance for loan losses based upon a percentage of the outstanding balancesand takes a charge against earnings with respect to specific loans when theirultimate collectibility is considered questionable. If management’s assumptionsand judgments prove to be incorrect and the allowance for loan losses isinadequate to absorb losses, or if the bank regulatory authorities require usto increase the allowance for loan losses as a part of their examinationprocess, our earnings and capital could be significantly and adverselyaffected.

**National market funding outside of the Nashville MSAhas different risks.**

Approximately 37.08% ofour loan portfolio is composed of national market funding loans to non-MiddleTennessee businesses referred to us by a small network of equipment vendors andfinancial service companies. These loans account for approximately 32.04% and45.22%, respectively, of the increase in total loans at December 31, 2006 and2005, over the prior year. This lending causes us to have somewhat differentrisks than those typical for community banks generally. Our loan portfolio ismore geographically diverse, and as a result the loan collateral is also morewidely dispersed geographically. This may result in longer time periods tolocate collateral and higher costs to dispose of collateral in the event thatthe collateral is used to satisfy the loan obligation. This part of ourportfolio also provides geographic risk diversification by reducing the adverseimpact of a regional downturn in the economy.

**Our ability to continue to engage in and grow ournational market funding programs depends on stable business relationships.**

Our ability to continueto grow the national market funding portion of our portfolio is dependent uponour retaining those members of our senior management and those loan officerswho have experience and relationships with those equipment vendors andfinancial services companies who originate the underlying lease transactions.In the event that any of these members of senior management, particularlyPresident Mike Sapp, were to terminate his or her employment with us, or in theevent that our relationships with any of these vendor/brokers were to bediscontinued, our ability to continue to increase our national market fundingportfolio could be adversely affected.

19

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**Liquidity needs could adversely affect our resultsof operations and financial condition.**

The primary source of ourfunds are customer deposits and loan repayments. While scheduled loanrepayments are a relatively stable source of funds, they are subject to theability of borrowers to repay the loans. The ability of borrowers to repayloans can be adversely affected by a number of factors, including changes ingeneral economic conditions, adverse trends or events affecting businessindustry groups, reductions in real estate values or markets, business closingsor lay-offs, inclement weather, natural disasters and internationalinstability. Additionally, deposit levels may be affected by a number offactors, including rates paid by competitors, general interest rate levels,returns available to customers on alternative investments and general economicconditions. Accordingly, we may be required from time to time to rely onsecondary sources of liquidity to meet withdrawal demands or otherwise fundoperations. These sources include Federal Home Loan Bank advances and federalfunds lines of credit from correspondent banks. While our management believesthat these sources are currently adequate, there can be no assurance they willbe sufficient to meet future liquidity demands. We may be required to slowor discontinue loan growth, capital expenditures or other investments orliquidate assets should these sources not be adequate.

**Competition from financial institutions and otherfinancial service providers may adversely affect our profitability.**

The banking business ishighly competitive and we experience competition in our markets from many otherfinancial institutions.  We compete withcommercial banks, credit unions, savings and loan associations, mortgagebanking firms, consumer finance companies, securities brokerage firms,insurance companies, money market funds, and other mutual funds, as well asother community banks and super-regional and national financial institutionsthat operate offices in the Nashville MSA and elsewhere.  We not only compete with these companies inthe Nashville MSA, but also in the regional and national market in which weengage in our indirect funding programs.

Additionally, in theNashville MSA, we face competition from de novo community banks, includingthose with senior management who were previously affiliated with other local orregional banks or those controlled by investor groups with strong localbusiness and community ties. These de novo community banks may offerhigher deposit rates or lower cost loans in an effort to attract our customers,and may attempt to hire our management and employees.

We compete with theseother financial institutions both in attracting deposits and in making loans.In addition, we have to attract our customer base in the Nashville MSA fromother existing financial institutions and from new residents.  We expect competition to increase in thefuture as a result of legislative, regulatory and technological changes and thecontinuing trend of consolidation in the financial services industry. Our profitabilitydepends upon our continued ability to successfully compete with an array offinancial institutions in the Nashville MSA and regionally and nationally withrespect to our indirect funding programs.

**Our business is subject to the success of the localeconomies where we operate.**

Our success significantlydepends upon the growth in population, income levels, deposits and newbusinesses in the Nashville MSA and our other market areas. If the communitiesin which we operate do not grow or if prevailing economic conditions locally ornationally are unfavorable, our business may not succeed. Adverse economicconditions in our specific market areas could reduce our growth rate, affectthe ability of our customers to repay their loans to us and generally affectour financial condition and results of operations. Moreover, we cannot give anyassurance that we will benefit from any market growth or favorable economicconditions in our primary market areas if they do occur.

20

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**Changes in interest rates could adversely affect our results ofoperations and financial condition.**

Changes in interest ratesmay affect our level of interest income, the primary component of ourgross revenue, as well as the level of our interest expense. Interest rates arehighly sensitive to many factors that are beyond our control, including generaleconomic conditions and the policies of various governmental and regulatoryauthorities.  Accordingly, changes ininterest rates could decrease our net interest income.  Changes in the level of interest rates alsomay negatively affect our ability to originate loans, the value of ourassets and our ability to realize gains from the sale of our assets, all ofwhich ultimately affects our earnings.

**Changes in monetary policy could adversely affect operating results.**

Like all regulatedfinancial institutions, we are affected by monetary policies implemented by theFederal Reserve and other federal instrumentalities.  A primary instrument of monetary policyemployed by the Federal Reserve is the restriction or expansion of the moneysupply through open market operations. This instrument of monetary policy frequently causes volatilefluctuations in interest rates, and it can have a direct, adverse effect on theoperating results of financial institutions. Borrowings by the United States government to finance the governmentdebt may also cause fluctuations in interest rates and have similar effects onthe operating results of such institutions.

**We rely heavily on the services of key personnel.**

We depend substantiallyon the strategies and management services of our executive officers, Arthur F.Helf, Chairman and Chief Executive Officer, Michael R. Sapp, President, GeorgeW. Fort, Chief Financial Officer and H. Lamar Cox, Chief AdministrativeOfficer. Although we have entered into an employment agreement with theseexecutive officers, the loss of their services could have a material adverseeffect on our business, results of operations and financial condition. We arealso dependent on certain other key officers who have important customerrelationships or are instrumental to our operations. Changes in key personneland their responsibilities may be disruptive to our business and couldhave a material adverse effect on our business, financial condition and resultsof operations.  We believe that ourfuture results will also depend in part upon our attracting and retaininghighly skilled and qualified management, as well as sales and marketingpersonnel. Competition for such personnel is intense, and we cannot assure youthat we will be successful in attracting or retaining such personnel.

**Our ability to attract deposits may restrict growth.**

We derive a substantialportion of our deposits through internet-based wholesale funding alternatives.In the event that we were no longer able to sell our deposits easily toinstitutional and retail investors, our ability to fund our loan portfoliocould be adversely affected. We post rates to an internet-based program thatretail and institutional investors nationwide subscribe to in order to investfunds. Our wholesale funding portfolio is therefore geographically dispersedand generally made up of deposits in FDIC insured amounts of $100,000 or less.

**Material fluctuations in non-interest income may occur.**

A substantial portion ofour non-interest income is derived from the sale of loans, particularly loansgenerated for our national market funding portfolio. The timing and extent ofthese loan sales may not be predictable, and could cause material variation inour non-interest income on a quarter to quarter basis.

21

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**We are subject to extensive regulation that could limit or restrict ouractivities.**

We operate in a highlyregulated industry and are subject to examination, supervision andcomprehensive regulation by various federal and state agencies including theFederal Reserve Board, the FDIC and the Tennessee Department of FinancialInstitutions, or TDFI. Our regulatory compliance is costly and restrictscertain of our activities, including payment of dividends, mergers andacquisitions, investments, loans and interest rates charged, and interest ratespaid on deposits. We are also subject to capitalization guidelines establishedby our regulators, which require us to maintain adequate capital to support ourgrowth.

The laws and regulationsapplicable to the banking industry could change at any time, and we cannotpredict the effects of these changes on our business and profitability. Becausegovernment regulation greatly affects the business and financial results of allcommercial banks and bank holding companies, our cost of compliance couldadversely affect our ability to operate profitably.

The Sarbanes-Oxley Act of2002, and the related rules and regulations promulgated by the Securitiesand Exchange Commission and Nasdaq that are now applicable to us, haveincreased the scope, complexity and cost of corporate governance, reporting anddisclosure practices. As a result, we have experienced, and may continueto experience, greater compliance costs.

**Our recent results may not be indicative of our future results.**

We may not be ableto sustain our historical rate of growth or may not even be able to growour business at all. In addition, our recent growth may distort some ofour historical financial ratios and statistics. In the future, we may nothave the benefit of several recently favorable factors, like a generally stableinterest rate environment, a strong local business environment, andrelationships with an extensive group of equipment vendors and financial servicescompanies. Various factors, such as economic conditions, regulatory andlegislative considerations and competition, may also impede or prohibitour ability to grow.

**Our ability to maintain adequate capital may restrict our activities.**

Our continued pace of growthmay require us to raise additional capital in the future, but that capital maynot be available when it is needed.  Weare required by federal and state regulatory authorities to maintain adequatelevels of capital to support our operations, so we may at some point need toraise additional capital to support any continued growth.

Our ability to raiseadditional capital, if needed, will depend on conditions in the capital marketsat that time, which are outside our control, and on our financial performance.Accordingly, we cannot assure our shareholders that we will be able to raiseadditional capital if needed on terms acceptable to us. If we cannot raiseadditional capital when needed, our ability to continue our growth could bematerially impaired.

**The success and growth of our business will depend on our ability toadapt to technological changes.**

The banking industry andthe ability to deliver financial services is becoming more dependent ontechnological advancement, such as the ability to process loan applicationsover the Internet, accept electronic signatures, provide process status updatesinstantly and offer on-line banking capabilities and other customer expectedconveniences that are cost efficient to our business processes. As thesetechnologies are improved in the future, we may, in order to remaincompetitive, be required to make significant capital expenditures.

22

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**Eventhough our common stock is currently traded on the Nasdaq Global Market, thetrading volume in our common stock has been low and the sale of substantialamounts of our common stock in the public market could depress the price of ourcommon stock.**

While we believe that since we are listed on theNasdaq Global Market, the trading volume of our common stock should increase,we cannot be certain when a more active and liquid trading market for ourcommon stock will develop or be sustained. Because of this, our shareholdersmay not be able to sell their shares at the volumes, prices or times thatthey desire.

We cannot predict the effect, if any, that futuresales of our common stock in the market, or availability of shares of ourcommon stock for sale in the market, will have on the market price of ourcommon stock. We, therefore, can give no assurance that sales of substantialamounts of our common stock in the market, or the potential for large amountsof sales in the market, would not cause the price of our common stock todecline or impair our ability to raise capital through sales of our commonstock.

The market price of our common stockmay fluctuate in the future, and these fluctuations may be unrelatedto our performance. General market price declines or overall market volatilityin the future could adversely affect the price of our common stock, and thecurrent market price may not be indicative of future market prices.

**Wemay issue additional common stock or other equity securities in the futurewhich could dilute the ownership interest of existing shareholders.**

In order to maintain our capital at desired levels orrequired regulatory levels, or to fund future growth, our board of directorsmay decide from time to time to issue additional shares of common stock,or securities convertible into, exchangeable for or representing rights toacquire shares of our common stock. The sale of these securitiesmay significantly dilute our shareholders’ ownership interest as ashareholder and the per share book value of our common stock. New investors inthe future may also have rights, preferences and privileges senior to ourcurrent shareholders which may adversely impact our current shareholders.

**Holders ofour subordinated debentures have rights that are senior to those of our commonshareholders.**

We have supported our continued growth through theissuance of trust preferred securities from an affiliated special purpose trustand accompanying subordinated debentures. At December 31, 2006, we hadoutstanding trust preferred securities and accompanying subordinated debenturestotaling $8.2 million. We conditionally guarantee payments of the principal andinterest on the trust preferred securities. Further, the accompanyingsubordinated debentures we issued to the trust are senior to our shares ofcommon stock. As a result, we must make payments on the subordinated debenturesbefore any dividends can be paid on our common stock and, in the event of ourbankruptcy, dissolution or liquidation, the holders of the subordinateddebentures must be satisfied before any distributions can be made on our commonstock. We have the right to defer distributions on our subordinated debentures(and the related trust preferred securities) for up to five years (from thedate of issuance) during which time we may not pay dividends on our commonstock.

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**Ourability to declare and pay dividends on our common stock is limited by law andwe may be unable to pay future dividends.**

We derive our income solely from dividends on theshares of common stock of the bank. The bank’s ability to declare and paydividends to us is limited by its obligations to maintain sufficient capitaland by other general restrictions on its dividends that are applicable to banksthat are regulated by the FDIC and the Tennessee Department of FinancialInstitutions, or TDFI. The Federal Reserve Board may also impose restrictionson our ability to pay dividends on our common stock. In addition, we must makepayments on the subordinated debentures before any dividends can be paid on ourcommon stock, and we may not pay dividends while we are deferring interestpayments on our trust preferred securities and the related subordinateddebentures. As a result, we cannot assure our shareholders that we will declareor pay dividends on shares of our common stock in the future.

**ITEM 1B.               UNRESOLVEDSTAFF COMMENTS**

None

**ITEM 2.                PROPERTIES**

Our main office is located in Williamson County at 381Mallory Station Road, Suite 207, Franklin, Tennessee 37067, which is also themain office of the Bank.  This location is centrally located and in a hightraffic/exposure area. The Bank leases 21,200 square feet at competitive rates.The term of the lease extends until December 2010.  The Bank providesservices throughout the community by use of a network of couriers, third partyautomated teller machines, and state of the art electronic banking. The Bankalso operates a loan production office located in Jefferson County at One ChaseCorporate Center, Suite 400, Birmingham, AL 35244.  The Bank leases 280square feet at competitive rates under the terms of a lease that extends untilFebruary 2008.

**ITEM 3.                LEGALPROCEEDINGS**

To the best of our knowledge, there are no pendinglegal proceedings, other than routine litigation incidental to the business, towhich we or the Bank is a party or of which any of our or the Bank’s propertyis the subject.

**ITEM 4.                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

No matter was submitted to a vote of security holdersduring the fourth quarter of 2006 through the solicitation of proxies orotherwise.

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**PART II**

**ITEM5.****                                                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUERPURCHASES OF EQUITY SECURITIES**

Our common stock is traded on the NASDAQ Global Marketsince June 9, 2006. Before that date, it was traded on the NASDAQOver-The-Counter Bulletin Board Market from December 16, 2005. Prior to thattime, our common stock was not traded through an organized exchange. The numberof shareholders of record at March 22, 2007, was 497. Holders of our commonstock are entitled to receive dividends when declared by the Board of Directorsout of funds legally available. Dividends will be affected by other factorsincluding applicable government regulations and policies.  The followingtable shows the quarterly range of high and low sale prices for our commonstock during the fiscal years 2006 and 2005. These sale prices represent knowntransactions and do not necessarily represent all trading transactions for theperiods.
| Year   | ** ** | ** **          | ** ** | **High** | ** ** | **Low** | ** ** |
|--------|------------|---------------------|------------|----------|------------|---------|------------|
|   |       |                |       |     |       |    |       |
| 2005:  |       | First  Quarter      |       | $        | 15.00      |    | $          | 15.00 |   |
|        |       | Second  Quarter     |       | $        | 15.00      |    | $          | 15.00 |   |
|        |       | Third  Quarter      |       | $        | 16.00      |    | $          | 16.00 |   |
|        |       | Fourth  Quarter (1) |       | $        | 35.00      |    | $          | 16.00 |   |
|   |       |                |       |     |       |    |       |
| 2006:  |       | First  Quarter      |       | $        | 25.00      |    | $          | 19.00 |   |
|        |       | Second  Quarter     |       | $        | 20.50      |    | $          | 17.90 |   |
|        |       | Third  Quarter      |       | $        | 22.23      |    | $          | 15.91 |   |
|        |       | Fourth Quarter      |       | $        | 32.20      |    | $          | 22.15 |   |

 

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(1)       The high sales price of$35.00 was achieved in December after trading began on the NASDAQOver-The-Counter Bulletin Board Market on December 16, 2005.

**Dividends**

The payment of cash dividends is subject to thediscretion of our Board of Directors and the Bank’s ability to paydividends.  The Bank’s ability to pay dividends is restricted byapplicable regulatory requirements. For more information on these restrictions,please see PART I, ITEM 1 “DESCRIPTION OF BUSINESS - Payment ofDividends”.  No assurances can be given that any dividend will be declaredor, if declared, what the amount of such dividend would be or whether suchdividends would continue in future periods.

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**Securities Authorized for IssuanceUnder Equity Compensation Plans**

The Bank issued Stock Option agreements to certainofficers and employees (“Options”), at various times beginning on January 14,2000.  These Options were not approved by the shareholders, as suchapproval is not necessary for these non-qualified option agreements.  Uponconsummation of the Share Exchange, the Corporation became party to theseoptions issued by the Bank.

The following table reflects the number of shares tobe issued upon the exercise of options granted under the Option agreements, theweighted-average exercise price of all such options, and the total number ofshares of common stock reserved for issuance upon the exercise of authorized,not-yet-granted options as of December 31, 2006:

**Equity Compensation Plan Information**
| **Plan Category**                                                                                                            | ** ** | **Number of Securities to be  Issued Upon Exercise of  Outstanding Options,  Warrants and Rights  (a)** | ** ** | **Weighted-average Exercise  Price of Outstanding Options,  Warrants, and Rights  (b)** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under Equity  Compensation Plans  (Excluding Securities  Reflected in Column (a))  (c)** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                                                                                              |       |                                                                                                                                                      |       |                                                                                                                  |       |                                                                                                                                                                                                                  |       |
| Equity  Compensation Plans Approved by Shareholders                                                                               |       | —                                                                                                                                                    |       | —                                                                                                                |       | —                                                                                                                                                                                                                |       |
|                                                                                                                              |       |                                                                                                                                                      |       |                                                                                                                  |       |                                                                                                                                                                                                                  |       |
| Equity  Compensation Plans Not Approved by Shareholders (incentive options for  executive officers, directors, and incorporators) |       | 871,092                                                                                                                                                   |       | $                                                                                                                     | 8.78       |                                                                                                                                                                                                                  | 0          |   |
|                                                                                                                              |       |                                                                                                                                                      |       |                                                                                                                  |       |                                                                                                                                                                                                                  |       |
| Total                                                                                                                             |       | 871,092                                                                                                                                                   |       | $                                                                                                                     | 8.78       |                                                                                                                                                                                                                  | 0          |   |

 

The original fourteenincorporators and members of the Board of Directors were granted an aggregateof 122,500 options to purchase shares at $5.00 per share in connection withorganization activities. Each of the 122,500 options were immediately vested onthe date of grant. In 2002 and 2006, 10,000 and 11,000 options respectivelywere exercised leaving 101,500 options outstanding to purchase shares.

In August 2003, the Boardof Directors approved an option plan for active directors and incorporators inrecognition of their four years of service to the Bank without compensation. Anaggregate of 320,000 options to purchase shares at a price of $10.50 per sharewere included in this plan. The 320,000 options were immediately vested on thedate of grant. In 2006, 50,000 options were exercised leaving 270,000 optionsoutstanding to purchase shares.

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Pursuant to employmentagreements, three executive officers received options equal to 14% of theshares sold in the original offering at an exercise price of $5.00 per share.Based on the initial sale of 1,817,440 shares, executive officer optionstotaled 254,440. These options vest over three years. Of this total, 24,232options were exercised and 12,116 options were forfeited in 2002, and 2,000options were exercised in 2004. In 2006, 1,000 options were exercised leavingan outstanding balance of 215,092 options to purchase shares. In February 2003,three executive officers were granted 30,000 options each at an exercise priceof $7.50 to vest over three years. In March 2004, three executive officers weregranted 20,000 options each at an exercise price of $11.00. These options wereimmediately vested on the date of grant. In August 2005, one executive officerwas granted 5,000 options. Of these 2,500 options immediately vested and theremaining vested one year later. In November 2005, one executive officer was granted6,250 options that immediately vested. Of these 2005 grants, all 11,250 optionswere outstanding at December 31, 2006.

The Board of Directors has granted incentive optionsto various employees who are not executive officers. Incentive options are usedfor recruiting and retention purposes and to recognize performance. Employeeincentive options include 13,000 options to purchase shares at $5.00 per sharegranted in 2000 and 2001. 5,000 options to purchase shares have been forfeitedby former employees, 3,000 options were exercised on December 31, 2003, and1,000 options were exercised in 2004. The remaining 4,000 are fully vested. InMarch 2003, 9,000 options to purchase shares at $7.50 per share were granted.In December 2003, 31,000 options to purchase shares at $10.50 per share weregranted. Of these, 5,000 options were forfeited in 2004. In 2006, 1,000 optionswere exercised leaving 25,000 options to purchase shares. All of theseincentive options vested in two years. In July 2005 and August 2005, 69,000 and10,000 options respectively were granted. On each grant date half immediatelyvested with the remaining options vesting one year later. In November 2005,10,000 options were granted to employees and were immediately vested. Of these2005 grants, 3,750 options were forfeited leaving 85,250 options outstanding topurchase shares.

The total number of options outstanding in allprograms is 871,092, all of which are fully vested at December 31, 2006. In theevent we merge or consolidates with or into any other corporation, or sells orotherwise transfers its property, assets, and business substantially in itsentirety to a successor corporation, there shall thereafter be deliverable uponany exercise of an option the number of shares of stock or other securities orproperty (including cash) to which a holder of the number of shares of commonstock which would otherwise have been deliverable upon the exercise of suchoption would have been entitled upon such merger, consolidation, sale ortransfer if such option had been exercised in full immediately prior thereto.

We will provide the information required by Item201(e) of Regulation S-K in our Annual Report to Shareholders under the caption“Total Shareholder Return Performance Graph.” That information is not “filed”with this report and is not incorporated by reference herein.

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**Recent Sales of Unregistered Securities**

During 2006, options to purchase 63,000 shares wereexercised at exercise prices ranging from $5.00 to $10.50 per share. Theseexercises of stock options were transactions by us that did not involve apublic offering. We relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

During 2005, we did not offer any shares of its commonstock for sale and no option holders exercised their options to purchaseshares.

During 2004, we sold 775,000 shares of our commonstock in a public offering at a per share price of $11.00.  The proceedswere used for general corporate purposes.  This offering was limited toresidents of the State of Tennessee, and we relied on the exemption provided bySection 3(a)(11) of the Securities Act of 1933, relating to securities issuedonly in the state where the issuer is located.

Also during 2004, H. Lamar Cox, the Chief FinancialOfficer exercised the option to purchase 2,000 shares of common stock at anexercise price of $11.00 per share. This exercise of stock options was atransaction by us that did not involve a public offering. We relied on theexemption provided by Section 4(2) of the Securities Act of 1933.

Also during 2004, options to purchase 1,000 shares ofcommon stock at an exercise price of $7.00 per share were exercised. Thisexercise of stock options was a transaction by us that did not involve a publicoffering. We relied on the exemption provided by Section 4(2) of the SecuritiesAct of 1933.

**Purchases of Equity Securities by theRegistrant and Affiliated Purchasers**

The Corporation made no repurchases of its equitysecurities, and no Affiliated Purchasers (as defined in Rule 10b - 18(a)(3)under the Securities Exchange Act of 1934) purchased any shares of theCorporation’s equity securities during the fourth quarter of the fiscal yearended December 31, 2006.

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**ITEM6.****                                                     SELECTEDFINANCIAL DATA**

The following selected financial data for the yearsended December 31, 2006, 2005, 2004, 2003 and 2002 should be read inconjunction with the financial statements included in Item 8:

**SELECTED FINANCIAL DATA**
| ** **                                          | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                          | ** ** | **(Dollars in Thousands except share data)** | ** ** |
| **Operating  Data:**                                |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Total interest income                               |       | $                                                                     | 41,245     |     | $          | 23,633   |       | $        | 13,185     |     | $          | 8,205 |   | $ | 5,181 |   |
| Total interest expense                              |       | 21,868                                                                |       | 10,006   |       | 4,265    |       | 2,976    |       | 2,452    |       |
| Net interest income                                 |       | 19,377                                                                |       | 13,627   |       | 8,920    |       | 5,229    |       | 2,729    |       |
| Provision for loan losses                           |       | (4,350                                                                | )          | (3,700   | )          | (2,420   | )          | (1,115   | )          | (318     | )          |
| Net interest income after provision for loan losses |       | 15,027                                                                |       | 9,927    |       | 6,500    |       | 4,114    |       | 2,411    |       |
| Non-interest income:                                |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Investment securities gains                         |       | —                                                                |       | 4        |       | 33       |       | 132      |       | 139      |       |
| Gain on sale of loans                               |       | 2,025                                                                 |       | 1,106    |       | 504      |       | —   |       | —   |       |
| Other income                                        |       | (262                                                                  | )          | 201      |       | 263      |       | 300      |       | 119      |       |
| Non-interest expense                                |       | (9,056                                                                | )          | (6,246   | )          | (4,552   | )          | (3,459   | )          | (2,183   | )          |
| Income before income taxes                          |       | 7,734                                                                 |       | 4,992    |       | 2,748    |       | 1,087    |       | 486      |       |
| Income tax (expense) benefit                        |       | (2,985                                                                | )          | (1,925   | )          | (1,082   | )          | (188     | )          | 650      |       |
| Net income                                          |       | $                                                                     | 4,749      |     | $          | 3,067    |       | $        | 1,666      |     | $          | 899 |   | $ | 1,136 |   |
|                                                |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Per  Share Data :**                               |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Net income, basic                                   |       | $                                                                     | 1.24       |     | $          | 0.95     |       | $        | 0.57       |     | $          | 0.40 |   | $ | 0.62 |   |
| Net income, assuming dilution                       |       | $                                                                     | 1.14       |     | $          | 0.87     |       | $        | 0.53       |     | $          | 0.38 |   | $ | 0.59 |   |
| Book value                                          |       | $                                                                     | 11.51      |     | $          | 8.16     |       | $        | 7.29       |     | $          | 5.44 |   | $ | 4.78 |   |

 

29

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| ** **                                                  | ** ** | **2006**                                                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                  | ** ** | **(Dollars in Thousands except share data)** | ** ** |
| **Financial  Condition Data:**                              |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Assets                                                      |       | $                                                                     | 623,518    |     | $          | 404,040  |       | $        | 245,917    |     | $          | 156,075 |   | $ | 97,779 |   |
| Loans, net                                                  |       | 538,550                                                               |       | 344,187  |       | 213,326  |       | 133,187  |       | 76,258   |       |
| Investments                                                 |       | 56,943                                                                |       | 31,992   |       | 18,690   |       | 12,978   |       | 15,567   |       |
| Cash and due from financial institutions                    |       | 177                                                                   |       | 6,877    |       | 3,838    |       | 5,224    |       | 2,287    |       |
| Federal funds sold                                          |       | 13,820                                                                |       | 12,535   |       | 6,582    |       | 2,498    |       | 1,918    |       |
| Premises and equipment, net                                 |       | 1,633                                                                 |       | 769      |       | 609      |       | 673      |       | 420      |       |
| Deposits                                                    |       | 560,567                                                               |       | 367,705  |       | 221,394  |       | 142,293  |       | 87,261   |       |
| Federal funds purchased                                     |       | —                                                                |       | —   |       | —   |       | —   |       | 1,500    |       |
| Long term debt                                              |       | 8,248                                                                 |       | 8,248    |       | —   |       | —   |       | —   |       |
| Other liabilities                                           |       | 3,479                                                                 |       | 1,657    |       | 923      |       | 384      |       | 218      |       |
| Shareholders’ equity                                   |       | 51,224                                                                |       | 26,430   |       | 23,600   |       | 13,398   |       | 8,800    |       |
|                                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Selected  Ratios:**                                       |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Overhead ratio (1)                                          |       | 1.80                                                                  | %          | 1.98     | %          | 2.26     | %          | 2.70     | %          | 2.90     | %          |
| Efficiency ratio (2)                                        |       | 42.84                                                                 | %          | 41.81    | %          | 46.83    | %          | 61.11    | %          | 73.10    | %          |
| Net yield on earning assets                                 |       | 8.46                                                                  | %          | 7.70     | %          | 6.74     | %          | 6.62     | %          | 7.28     | %          |
| Cost of funds                                               |       | 4.94                                                                  | %          | 3.66     | %          | 2.54     | %          | 2.75     | %          | 3.80     | %          |
| Net Interest margin                                         |       | 3.98                                                                  | %          | 4.44     | %          | 4.56     | %          | 4.22     | %          | 3.83     | %          |
| Operating expenses to average earning assets                |       | 1.86                                                                  | %          | 2.03     | %          | 2.33     | %          | 2.79     | %          | 3.06     | %          |
| Return on average assets                                    |       | .95                                                                   | %          | 0.97     | %          | 0.83     | %          | 0.70     | %          | 1.51     | %          |
| Return on average equity                                    |       | 12.68                                                                 | %          | 12.29    | %          | 8.92     | %          | 8.00     | %          | 16.52    | %          |
| Average equity to average assets                            |       | 7.46                                                                  | %          | 7.90     | %          | 9.28     | %          | 8.78     | %          | 9.14     | %          |
| Ratio of nonperforming assets to average assets             |       | .94                                                                   | %          | 1.40     | %          | 1.90     | %          | 1.99     | %          | 1.47     | %          |
| Ratio of allowance for loan losses to average assets        |       | 1.39                                                                  | %          | 1.39     | %          | 1.41     | %          | 1.56     | %          | 1.47     | %          |
| Ratio of allowance for loan losses to nonperforming  assets |       | 146.91                                                                | %          | 99.43    | %          | 74.45    | %          | 78.59    | %          | 99.91    | %          |
|                                                             |            |                                                                       |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

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(1) Operating expenses divided by average assets

(2)Operating expenses divided by net interest income and noninterest income

30

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**ITEM7.****                                                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION**

**Forward-Looking Statements**

Management’s discussion and analysis of our operationsand prospects, and other matters, may include forward-looking statements withinthe meaning of the provisions of various federal and state securitieslaws.  Although we believe that the assumptions underlying suchforward-looking statements contained in this Report are reasonable, any of theassumptions could be inaccurate and, accordingly, there can be no assurancethat the forward-looking statements included herein will prove to be accurate.The use of such words as expect, anticipate, forecast, and comparable termsshould be understood by the reader to indicate that the statement is“forward-looking” and thus subject to change in a manner that can beunpredictable.  Factors that could cause actual results to differ from theresults anticipated, but not guaranteed, in this Report, include (withoutlimitation) economic and social conditions, competition for loans, mortgages,and other financial services and products, changes in interest rates,unforeseen changes in liquidity, results of operations, and financialconditions affecting our customers, as well as other risks that cannot beaccurately quantified or completely identified.  Many factors affectingour financial condition and profitability, including changes in economicconditions, the volatility of interest rates, political events and competitionfrom other providers of financial services simply cannot be predicted andbecause these factors are unpredictable and beyond our control, earnings mayfluctuate from period to period.  The purpose of this type of informationis to provide readers with information relevant to understanding and assessingour financial condition and results of operations, and not to predict thefuture or to guarantee results.  We are unable to predict the types ofcircumstances, conditions, and factors that can cause anticipated results tochange.  We undertake no obligation to publish revised forward-lookingstatements to reflect the occurrence of changes or unanticipated events,circumstances, or results.

**Overview**

**(dollars in thousands except sharedata in the remainder of this Item 7)**

The results of operations for the year 2006 comparedto 2005 reflected a 54.84% increase in net income and a 31.03% increase inearnings per share, assuming dilution.  The increase in earnings resultedprimarily from a 42.20% increase in net interest income due to higher averageloan balances.  The net interest margin for 2006 was 3.98%. The increasedrevenue was partially offset by increases in non-interest expense and theprovision for loan losses.  The year 2006 reflected a continuation of theBank’s trend of rapid asset growth.  The asset growth is a result of thestrength of the Middle Tennessee economy and the success of our Business Bankoperating strategy.

Our growth in assets is a result of growth in themarket area and effective marketing. The improvement in results including netincome and earnings per share is a result of the business focus of the Bank.From 2000 to 2006, the Bank’s market area experienced explosive growth. InWilliamson County, demographic information shows a 27.43% growth in the numberof households from 2000 to 2006.  Estimates are that by 2011 the number ofhouseholds will have grown by another 21.63%. Although estimates of growth arenot guaranteed and actual growth may be affected by factors beyond our control,Management believes that the projected growth of our market area will positivelyimpact the Bank’s future growth.

The Bank has also grown by marketing to businessowners that have been left without a long standing banking relationship. TheMiddle Tennessee area has experienced several bank mergers or acquisitions inthe last ten years resulting in many long standing relationships beingterminated. These acquisitions also resulted in loan funding decisions beingmade out of state creating confusion for local lending personnel anduncertainty for local businesses. The Bank has taken advantage of thisconfusion by offering loans at a fair rate and funded locally in a timelymanner. Management believes the competitive advantage created by thisenvironment will continue to positively impact results from operations.

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The Business Bank operating strategy has enabledmanagement to focus on managing results. Rather than focusing on building amulti-branch infrastructure including hiring and construction of buildings,management focuses on managing net interest margin aggressively and controllingnon-interest expense. This has resulted in a 0.40% increase in the net interestmargin from 2001 to 2006. Non-interest expense is controlled by efficientlystaffing the Bank’s operations. In 2006, that resulted in $12.5 million inassets per employee at year end. Management believes that the Business Bankoperating strategy will continue to be an effective model in the future.

**Changes in Results of Operations**

(dollars in thousands except share data)

**NetIncome** - Net income for 2006 was $4,749, an increase of$1,682 or 54.84%, compared to the $3,067 earned in 2005. The increase isattributable to a 42.20% increase in net interest income from $13,627 in 2005to $19,377 in 2006. The increase of $5,750 in net interest income was theresult of higher average loan balances. Non-interest income increased by $452from $1,311 to $1,763, or 34.48%, primarily due to gains on loan sales. Thesepositive effects were partially offset by a 17.57% increase in the provisionfor loan losses, from $3,700 in 2005 to $4,350 in 2006 and an increase of$2,810 in non-interest expense, up 44.99% to $9,056 in 2006 compared to $6,246in 2005. The increase in the provision for loan losses was the result offunding the loan loss reserve to match the growth in the loan portfolio and loancharge-offs. The increase in non-interest expense was due to the increase inpersonnel and general operating expenses due to the Corporation’s growth.

Net income for 2005 was $3,067 an increase of $1,401or 84.09%, compared to the $1,666 earned in 2004.  The increase isattributable to a 52.77% increase in net interest income from $8,920 in 2004 to$13,627 in 2005.  The increase of $4,707 in net interest income was theresult of higher average loan balances.  Non-interest income increased by$511 from $800 to $1,311, or 63.88%, primarily due to gains on loansales.  These positive effects were partially offset by a 52.89% increasein the provision for loan losses, from $2,420 in 2004 to $3,700 in 2005 and anincrease of $1,694 in non-interest expense, up 37.21% to $6,246 in 2005compared to $4,552 in 2004.  The increase in the provision for loan losseswas the result of funding the loan loss reserve to match the growth in the loanportfolio and loan charge-offs.  The increase in non-interest expense was dueto the increase in personnel and general operating expenses due to theCorporation’s growth.

**NetInterest Income** - The primary source of earnings for theBank is net interest income which is the difference between the interest earnedon interest earning assets and the interest paid on interest bearingliabilities.  The major factors which affect net interest income arechanges in volumes, the yield on earning assets, and the cost of interestbearing liabilities.  Management’s ability to respond to changes ininterest rates by effective asset-liability management techniques is criticalto maintaining the stability of the net interest margin and the momentum of theBank’s primary source of earnings.

In mid-2004, the Federal Reserve Open Market Committee(FOMC) began a series of increases in short-term interest rates.  Byyear-end 2006, the FOMC had increased rates by 425 basis points. Inanticipation of continued rising interest rates, management has placed the Bankin a moderately asset sensitive position.  This means that more assets arescheduled to reprice within the next year than liabilities, thereby takingadvantage of the anticipated rise in interest rates. During 2006, $24,971 ofthe net loan growth occurred in floating rate construction loans and approximately20.05% of the $13,272 increase in commercial loans were floating ratetransactions. Management expects to continue its practice of competing forloans based on providing superior service rather than the lowest price.

32

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Net interest income for 2006 was $19,377 compared to$13,627, a gain of $5,750 or 42.20%. The increase in net interest income waslargely attributable to strong loan growth. Net loans increased from $344,187at December 31, 2005 to $538,550 at December 31, 2006—an increase of$194,363, or 56.47%. Net interest income was favorably impacted by the increasein the Bank’s indirect funding program for small transactions. These loans,which are purchased at a minimum rate of 8%, increased from $87.0 million atyear-end 2005 to $113.4 million at the end of 2006. The loan growth was matchedby an increase in deposits from $367,705 at December 31, 2005 to $560,567in 2006—an increase of $192,862 or 52.45%.

Net interest income for 2005 was $13,627 compared to$8,920 in 2004, a gain of $4,707 or 52.77%.  The increase in net interestincome was largely attributable to strong loan growth.  Net loansincreased from $213,326 at December 31, 2004 to $344,187 at December 31, 2005 —an increase of $130,861, or 61.34%. Net interest income was favorably impactedby the expansion of the Bank indirect funding program for small transactions.These loans, which are purchased at a minimum rate of 8%, increased from $50.3million at year-end 2004 to $87.0 million at the end of 2005.  This highyielding portfolio is a key component in the stability and strength of netinterest income.  The loan growth was matched by an increase in depositsfrom $221,394 at December 31, 2004 to $367,705 in 2005 — an increase of$146,311 or 66.09%.

**Investments**- The Bank views the investment portfolio as a source of income and liquidity.Management’s investment strategy is to accept a lower immediate yield in theinvestment portfolio by targeting shorter term investments.   TheInvestment Policy requires a minimum portfolio level equal to 7.00% of totalassets and a maximum portfolio level of 20.00% of total assets. Management has maintained the portfolio at the lower end of the policyguidelines with the portfolio at 9.13%, 7.91% and 7.60% of total assets at endof year in 2006, 2005 and 2004 respectively.

The investment portfolio at December 31, 2006 was$56,943 compared to $31,992 at year end 2005. The interest earned oninvestments rose from $967 in 2005 to $2,216 in 2006. That was a result ofhigher average portfolio balances as well as increased yields. The averageyield on the investment portfolio investments rose from 4.19% in 2005 to 4.91%in 2006 or 72 basis points.

The investment portfolio at December 31, 2005 was$31,992 compared to $18,690 at year-end 2004.    The averageyield on the investment portfolio was 4.19% in 2005 compared to 3.79% in 2004.

**NetInterest Margin Analysis** -  The net interest marginis impacted by the average volumes of interest sensitive assets and interestsensitive liabilities and by the difference between the yield on interestsensitive assets and the cost of interest sensitive liabilities (spread). Loan fees collected at origination represent an additional adjustment to theyield on loans. The Bank’s spread can be affected by economic conditions, thecompetitive environment, loan demand, and deposit flows.  The net yield onearning assets is an indicator of the effectiveness of a bank’s ability tomanage the net interest margin by managing the overall yield on assets and thecost of funding those assets.

The two factors that make up the spread are theinterest rates received on loans and the interest rates paid on deposits. TheBank has been disciplined in raising interest rates on deposits only as themarket demanded and thereby managing the cost of funds. Also, the Bank has notcompeted for new loans on interest rate alone but has relied on effectivemarketing to business customers. Business customers are not influenced byinterest rates alone but are influenced by other factors such as timely funding.By working to positively impact both factors that make up the spread, the Bankhas been able to improve its net interest margin by 0.40% from the end of 2001to the end of 2006. That is an improvement of 11.17% over a five-year period.While the Bank continues to strive to improve its net interest margin, it isnot reasonable to assume that the spread will continue to improve at the samerate.

33

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The net interest margin declined from 4.44% in 2005 to3.98% in 2006 due to the cost of funds rising faster than the yield on earningassets during the year. Interest income increased by $17,612, or 74.52%, from$23,633 in 2005 to $41,245 in 2006. The increase was primarily due to increasedvolume. Average earning assets increased from $306,765 in 2005 to $486,668 in2006, an increase of $179,903 or 58.65%. The increase in earning assets was dueto loan growth. Average loans increased $150,365 or 54.12%. The average yieldon earning assets increased from 7.70% in 2005 to 8.46% in 2006 or 76 basispoints. The increase in the Bank’s indirect funded small loan portfoliofavorably impacted the average yield on earning assets. The average yield onthis type of loan in 2006 was 9.77%. These loans increased 30.20% from $87.1million at year-end 2005 to $113.4 million at the end of 2006.  Interest expense increased from $10,006 in 2005 to $21,868 in 2006. The$11,862, or 118.55%, increase in expense was due to increases in the volume ofdeposits as well as an increase in the cost of funds. Average depositsincreased from $273,040 in 2005 to $442,704 in 2006, an increase of $169,664 or62.14%. The cost of funds increased from 3.66% in 2005 to 4.94% in 2006 or 128basis points.

The net interest margin declined from 4.56% in 2004 to4.44% in 2005 due to the cost of funds rising faster than the yield on earningassets during the year.  Interest income increased by $10,448, or 79.24%,from $13,185 in 2004 to $23,633 in 2005.  The increase was primarily dueto increased volume.  Average earning assets increased from $195,449 in2004 to $306,765 in 2005, an increase of $111,316 or 56.95%.  The increasein earning assets was due to loan growth. Average loans increased $103,522 or59.39%.  The average yield on earning assets increased from 6.74% in 2004to 7.70% in 2005 or 96 basis points. The net interest margin was favorablyimpacted by the expansion of the Bank’s indirect funded small loanportfolio.  These loans increased from $50.3 million at year-end 2004 to$87.1 million at the end of 2005.  This high yielding portfolio is a keycomponent in the strength of the net interest margin. During 2004, a period ofhistorically low interest rates, the market for quality loans was highlycompetitive.  Management emphasized pricing discipline throughout the yearto ensure that growth was not achieved by competing on reduced pricing. TheBank will continue to focus its marketing efforts on customers who are moresensitive to service than price.

Interest expense increased from $10,006 in 2005 to$21,868 in 2006.  The $11,862, or 118.55%, increase in expense was due toincreases in the volume of deposits as well as interest rates. Average interestbearing deposits increased from $273,040 in 2005 to $442,704 in 2006, anincrease of $169,664 or 62.14%. Additionally, the cost of funds increased from3.66% in 2005 to 4.94% in 2006.

Interest expense increased from $4,265 in 2004 to$10,006 in 2005.  The $5,741, or 134.61%, increase in expense was due toincreases in the volume of deposits.   Average interest bearingdeposits increased from $167,647 in 2004 to $273,040 in 2005, an increase of$105,393 or 62.87%.  Despite the fact that rates started increasing in thelast half of 2004, management was aggressive in lowering interest rates onsavings accounts and other products during the year.  As a result, thecost of funds increased from 2.54% in 2004 to 3.66% in 2005, an increase of 112basis points. The local deposit market is highly competitive and rates tend tolead national averages.  The Bank partially offsets the higher cost oflocal deposits by acquisition of wholesale funding in the national market.

**Provisionfor Loan Losses** - Management assesses the adequacy of theallowance for loan losses with a combination of qualitative and quantitativefactors.  At inception, each loan is assigned a risk rating that rangesfrom “RR1 to RR4”.  An RR1 assignment indicates a “Superior” credit, RR2represents an “Excellent” credit, RR3 represents an “Above-Average” loan, andRR4 designates an “Average” credit.  The assignment of a risk rating isbased on an evaluation of the credit risk in the transaction.  Theevaluation includes consideration of the borrower’s financial capacity,collateral, cash flows, liquidity, and alternative sources of repayment. If a loan deteriorates and the level of risk increases, management downgradesthe loan to RR5-”Watch”, RR6-”Criticized”, or RR7-”Substandard”, depending onthe circumstances.  A review by an independent accounting firm of theassigned risk ratings is an integral part of the Bank’s external Loan Reviewprogram.

34

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Management reviews the loan portfolio regularly todetermine if loans should be placed on non-accrual for revenue recognition. Ifa loan is placed on non-accrual, all interest earned since the last currentpayment is immediately reversed.  Loans may remain on non-accrual statusuntil the underlying collateral is repossessed and valued or until the amountof loss in the credit can be reasonably determined.  Once collateral isrepossessed and appraised, the collateral is recorded as a repossession at thelower of fair value or the investment in the related loan.  Any differencebetween the estimated fair value of the collateral and the loan balance is chargedoff.  Variances in fair value estimates are recorded as a gain or loss onsale when the collateral is sold.   Non-accrual loans totaled $2,689,$2,928 and $2,161 at year-end 2006, 2005 and 2004.  These amountsrepresented 0.50%, 0.85% and 1.01% of net loans at the end of each year.

Management uses the weighted average risk rating tomonitor the overall credit quality and trends in the loan portfolio. AtDecember 31, 2006, the weighted average risk rating of the $538,550 net loanportfolio was 3.56. At December 31, 2005, the weighted average risk rating ofthe $344,187 net loan portfolio was 3.62.  The Board of Directors reviewsthe weighted average risk rating of loans booked during the previousmonth.  In addition, the Board reviews all credits classified RR5 orhigher monthly.  Management closely monitors other key loan qualityindicators including delinquencies, changes in the portfolio mix and generaleconomic conditions.  These actions provide a degree of objectivity inassessing the risk in the portfolio and establishing an adequate loan lossreserve.  To the extent that actual and anticipated losses differ,adjustments are made to the loan loss provision or to the level of theallowance for loan losses. At December 31, 2006, the loan loss reserve of$6,968 was 1.28% of gross loans of $545,518.

The provision for loan losses in 2006 was $4,350, anincrease of $650, or 17.57%, above the provision of $3,700 expensed in 2005.$2,569 of the provision, or 59.06%, was attributable to loan growth recorded during2006. The remainder of the loan loss provision in 2006 funded net charge offsof $1,781.

The provision for loan losses in 2005 was $3,700, anincrease of $1,280, or 52.89%, above the provision expensed in 2004. $1,558 of the provision, or 42.11%, was attributable to maintaining a generalreserve for the loan growth recorded during 2005.  The remainder of theloan loss provision in 2005 funded net charge offs of $2,142.

The Bank targets small and medium sized businesses asloan customers. Because of their size, these borrowers may be less able towithstand competitive or economic pressures than larger borrowers in periods ofeconomic weakness. If loan losses occur to a level where the loan loss reserveis not sufficient to cover actual loan losses, the Bank’s earnings willdecrease. The Bank uses an independent accounting firm to review our loansquarterly for quality in addition to the reviews that may be conducted by bankregulatory agencies as part of their usual examination process.

35

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The following table presents information regardingnon-accrual, past due and restructured loans at December 31, 2006, 2005, 2004,2003 and 2002:
| ** **                                                                                               | ** ** | **December 31,**          | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                               | ** ** | **2006**                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                               | ** ** | **($ in thousands)** | ** ** |
| Non-accrual  loans                                                                                       |       |                           |       |   |   |   |   |   |   |   |   |
| Number                                                                                                   |       | 60                             |       | 46 |   | 17 |   | 12 |   | 10 |   |
| Amount                                                                                                   |       | $                              | 2,689      |   | $ | 2,928 |   | $ | 2,161 |   | $ | 1,136 |   | $ | 1,104 |   |
|                                                                                                     |       |                           |       |   |   |   |   |   |   |   |   |
| Accruing loans  which are contractually past due 90 days or more as to principal and interest  payments: |       |                           |       |   |   |   |   |   |   |   |   |
| Number                                                                                                   |       | 18                             |       | 9 |   | 4 |   | 6 |   | — |   |
| Amount                                                                                                   |       | $                              | 940        |   | $ | 352 |   | $ | 111 |   | $ | 308 |   | $ | — |   |
|                                                                                                     |       |                           |       |   |   |   |   |   |   |   |   |
| Loans defined as  “troubled debt restructurings”                                               |       |                           |       |   |   |   |   |   |   |   |   |
| Number                                                                                                   |       | 3                              |       | 3 |   | 2 |   | 1 |   | — |   |
| Amount                                                                                                   |       | $                              | 1,114      |   | $ | 1,144 |   | $ | 1,544 |   | $ | 1,101 |   | $ | — |   |
|                                                                                                     |       |                           |       |   |   |   |   |   |   |   |   |
| Gross interest  income lost on the above loans                                                           |       | $                              | 174        |   | $ | 133 |   | $ | 82 |   | $ | 193 |   | $ | 158 |   |
|                                                                                                     |       |                           |       |   |   |   |   |   |   |   |   |
| Interest income  included in net income on the above loans                                               |       | $                              | 73         |   | $ | 31 |   | $ | 48 |   | $ | 29 |   | $ | 24 |   |
|                                                                                                          |            |                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

As of December 31, 2006, there are no loans classifiedfor regulatory purposes as doubtful or substandard that have not been disclosedin the above table, which (i) represent or result from trends or uncertaintieswhich management reasonably expects will materially impact future operatingresults, liquidity, or capital resources, or (ii) represent material creditsabout which management is aware of any information which causes management tohave serious doubts as to the ability of such borrowers to comply with the loanrepayment terms.

36

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The Bank had no tax-exempt loans during the periodended December 31, 2006.  The Bank had no loans outstanding to foreignborrowers at December 31, 2006.

An analysis of the Bank’s loss experience is furnishedin the following table for December 31, 2006, 2005, 2004, 2003 and 2002, andthe periods then ended (dollars in thousands):
| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| **($ in thousands)**                    | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                              |       |                  |       |   |   |   |   |   |   |   |   |
| Allowance for  loan losses at beginning of period |       | $                     | 4,399      |   | $ | 2,841 |   | $ | 2,000 |   | $ | 1,103 |   | $ | 919 |   |
| Charge-offs:                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                      |       | —                |       | — |   | — |   | — |   | — |   |
| 1 to 4 family residential                         |       | —                |       | — |   | 101 |   | — |   | — |   |
| Other                                             |       | —                |       | — |   | 131 |   | — |   | — |   |
| Commercial, financial and agricultural            |       | 2,026                 |       | 2,379 |   | 1,366 |   | 235 |   | 105 |   |
| Consumer                                          |       | 11                    |       | 32 |   | 57 |   | 48 |   | 31 |   |
| Other                                             |       | —                |       | — |   | — |   | — |   | — |   |
| Total Charge-offs                                 |       | 2,037                 |       | 2,411 |   | 1,655 |   | 283 |   | 136 |   |
|                                              |       |                  |       |   |   |   |   |   |   |   |   |
| Recoveries:                                       |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                      |       | —                |       | — |   | — |   | — |   | — |   |
| 1 to 4 family residential                         |       | —                |       | 1 |   | — |   | — |   | — |   |
| Other                                             |       | —                |       | — |   | 3 |   | — |   | — |   |
| Commercial, financial and agricultural            |       | 234                   |       | 245 |   | 68 |   | 64 |   | 3 |   |
| Consumer                                          |       | 22                    |       | 23 |   | 5 |   | 1 |   | — |   |
| Other                                             |       | —                |       | — |   | — |   | — |   | — |   |
| Total Recoveries                                  |       | 256                   |       | 269 |   | 76 |   | 65 |   | 3 |   |
|                                              |       |                  |       |   |   |   |   |   |   |   |   |
| Net Charge-offs                                   |       | 1,781                 |       | 2,142 |   | 1,579 |   | 218 |   | 133 |   |
|                                              |       |                  |       |   |   |   |   |   |   |   |   |
| Provision for  loan losses charged to expense     |       | 4,350                 |       | 3,700 |   | 2,420 |   | 1,115 |   | 317 |   |
|                                              |       |                  |       |   |   |   |   |   |   |   |   |
| Allowance for loan  losses at end of period       |       | $                     | 6,968      |   | $ | 4,399 |   | $ | 2,841 |   | $ | 2,000 |   | $ | 1,103 |   |

 

37

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| ** **                                                                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                  | ** ** | **2006**              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Net charge-offs  as a percentage of average total loans outstanding during the year         |       | 0.41                  | %          | 0.76 | % | 0.89 | % | 0.20 | % | 0.23 | % |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Ending allowance for  loan losses as a percentage of total loans outstanding at end of year |       | 1.28                  | %          | 1.26 | % | 1.31 | % | 1.48 | % | 1.43 | % |

 

The allowance for loan losses is established bycharges to operations based on management’s evaluation of the loan portfolio,past due loan experience, collateral values, current economic conditions andother factors considered necessary to maintain the allowance at an adequatelevel. Management feels that the allowance is adequate at December 31, 2006.

At December 31, 2006, 2005, 2004, 2003 and 2002, theallowance was allocated as follows (dollars in thousands):
| ** **                             | ** ** | **2006**   | ** ** | **2005**                                                                        | ** ** | **2004**   | ** ** | **2003**                                                                        | ** ** | **2002**   | ** ** |
|----------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|
| **($ in thousands)**         | ** ** | **Amount** | ** ** | **Percentage  of loans in  each  category to  total loans** | ** ** | **Amount** | ** ** | **Percentage  of loans in  each  category to  total loans** | ** ** | **Amount** | ** ** | **Percentage  of loans in  each  category to  total loans** | ** ** | **Amount** | ** ** | **Percentage  of loans in  each  category to  total loans** | ** ** | **Amount** | ** ** | **Percentage  of loans in  each  category to  total loans** | ** ** |
| Real estate:                           |       |       |       |                                                                            |       |       |       |                                                                            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Construction                           |       | $          | 745        |                                                                            | 13.65      | %          | $          | 383                                                                             |       | 10.98      | %          | $ | 175 |   | 10.55 | % | $ | 71 |   | 7.68 | % | $ | 83 |   | 8.59 | % |
| 1 to 4 family residential              |       | 229        |       | 4.19                                                                            | %          | 225        |       | 5.27                                                                            | %          | 75         |       | 7.38 | % | 57 |   | 10.00 | % | 167 |   | 17.28 | % |
| Other                                  |       | 840        |       | 15.40                                                                           | %          | 504        |       | 14.45                                                                           | %          | 265        |       | 15.59 | % | 331 |   | 14.85 | % | 131 |   | 13.59 | % |
| Commercial, financial and agricultural |       | 5,048      |       | 64.89                                                                           | %          | 3,197      |       | 67.11                                                                           | %          | 2,272      |       | 64.68 | % | 1,510 |   | 65.03 | % | 697 |   | 58.00 | % |
| Consumer                               |       | 37         |       | 0.60                                                                            | %          | 45         |       | .90                                                                             | %          | 54         |       | 1.80 | % | 31 |   | 2.44 | % | 25 |   | 2.54 | % |
| Other                                  |       | 69         |       | 1.27                                                                            | %          | 45         |       | 1.29                                                                            | %          | —     |       | 0.00 | % | — |   | 0.00 | % | — |   | 0.00 | % |
|                                   |       |       |       |                                                                            |       |       |       |                                                                            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total                                  |       | $          | 6,968      |                                                                            | 100.00     | %          | $          | 4,399                                                                           |       | 100.00     | %          | $ | 2,841 |   | 100.00 | % | $ | 2,000 |   | 100.00 | % | $ | 1,103 |   | 100.00 | % |

 

**Non-interestIncome** - Non-interest income is income that is notrelated to interest-earning assets.  In a typical retail bank,non-interest income consists primarily of service charges and fees on depositaccounts and mortgage origination fees.  Due to the business focus of theBank and the lack of a large retail customer base, revenues from thesetraditional sources will remain modest.

The Bank earned $89 in mortgage origination fees in2006 compared to $105 earned in 2005, a decline of $16 or 15.24%. The declinein mortgage loan demand and mortgage origination income is attributed to thecontinued rising interest rates in 2006. Management believes that rates willnot continue in 2007 and that the mortgage unit will provide a value-addedservice with modest revenue results.

38

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The Bank earned $2,025 in 2006 on a series of loansale transactions compared to $1,106 in 2005. The Bank is located in a vibrantmarket area and can generate quality assets at a faster rate than it canadequately fund them. In addition to lending in the local marketplace, the Bankprovides collateral-based loans to business borrowers in other states throughtwo types of indirect funding programs. Management has identified a network ofcommunity banks eager to purchase quality assets. Management has installedappropriate systems and processes to sell assets to other banks located inslower growing markets and believes that loan sales will be a recurring sourceof revenue.

In 2005, the Bank earned $1,106 on a series of loansale transactions.  The Bank earned $105 in mortgage origination fees in2005 compared to $130 earned in 2004, a decline of $25 or 19.23%.  Thedecline in mortgage origination income is attributed to rising interest ratesstarting in mid-2004 and the slowing of refinancing activity.  Incomeearned in the form of service charges on deposits totaled $114, a gain of $90,or 375% above the $24 earned in 2004.  Gain on sales of securitiesdeclined by $29 or 87.88% from $33 in 2004 to $4 in 2005.  This declinewas due to the rise in interest rates in 2004 and the subsequent lack ofopportunities to recognize market gains in the investment portfolio.

**Non-interestExpense** - Non-interest expense includes salaries andbenefits expense, occupancy costs, and other operating expenses including data processing,professional fees, supplies, postage, telephone, and other items. Management views the control of operating expense as a critical element in thesuccess of the Business Bank strategy.  The Bank operates more efficientlythan peer banks because it conducts business from a single location and doesnot provide banking services for many retail customers with high transactionvolume.

Management targets $7.5 million in assets per fulltime employee as a measure of staffing efficiency. Management believes that thegrowth of the Bank will offer additional opportunities to leverage personnelresources.  The Bank does expect to hire employees in 2007 so salaries andbenefits expense will increase, but the target for Average Assets per Employeewill remain at $7.5 million per employee.

39

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Non-interest expense for 2006 was $9,056, an increaseof $2,810 or 44.99%, over the $6,246 expensed in 2005. Approximately 48% of theincrease was due to the addition of new employees during the year. The Bankended 2006 with 50 full time employees. Assets per employee were $12.5 millionat year-end 2006 compared to $9.8 million at year-end 2005.

Non-interest expense for 2005 was $6,246, an increaseof $1,694 or 37.21%, over the $4,552 expensed in 2004.  Approximately 65%of the increase was due to the addition of new employees during the year. The Bank ended 2005 with 41 full time employees.  Assets per employee were$9.8 million at year-end 2005 and $7.7 million at year-end 2004.

**IncomeTaxes** — Our effective tax rate in 2006 was 38.60%compared to 38.56% in 2005 and 39.37% in 2004. Management anticipates thattax rates in future years will approximate the rates paid in 2006.

**Changes in Financial Condition**

(dollars in thousands except share data)

**Assets-** Total assets at December 31, 2006, were $623,518, an increase of$219,478 or 54.32%, over total assets of $404,040 at December 31, 2005.Average assets for 2006 were $501,978, an increase of $186,004, or 58.87% overaverage assets in 2005. Loan growth was the primary reason for the increase.Year-end 2006 net loans were $538,550, up $194,363, or 56.47% over the year-end2005 total net loans of $344,187.

Total assets at December 31, 2005, were $404,040, anincrease of $158,123 or 64.29%, over total assets of $245,917 at December 31,2004.  Average assets for 2005 were $315,974, an increase of $114,835, or57.09% over average assets in 2004.  Loan growth was the primary reasonfor the increase.  Year-end 2005 net loans were $344,187, up $130,861, or61.34% over the year-end 2004 total net loans of $213,326.

The Bank’s Business Bank model of operation results ina higher level of earning assets than peer banks.  Earning assets aredefined as assets which earn interest income.  Earning assets includeshort-term investments, the investment portfolio, and net loans.  The Bankmaintains a higher level of earning assets because fewer assets are allocatedto facilities, cash, and due-from bank accounts used for transactionprocessing. Earning assets at December 31, 2006, were $610,322, or 97.88%of total assets of $623,518. Earning assets at December 31, 2005, were$388,714, or 96.20% of total assets of $404,040.  Management targets anearning asset to total asset ratio of 97% or higher. This ratio is expected togenerally continue at these levels although this may be affected by economicfactors beyond the Bank’s control.

**Liabilities-** The Bank relies on increasing its deposit base to fund loan and otherasset growth.  The Williamson County marketplace is highly competitivewith 26 financial institutions and 83 banking facilities (as of June 30, 2006).The Bank competes for local deposits by offering attractive products withpremium rates.  The Bank expects to have a higher average cost of fundsfor local deposits than competitor banks due to its single location and lack ofa branch network.  Management’s strategy is to offset the higher cost offunding with a lower level of operating expense and firm pricing discipline forloan products.  The Bank has promoted electronic banking services byproviding them without charge and by offering in-bank customer training.

40

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The Bank also obtains funding in the wholesale depositmarket which is accessed by means of an electronic bulletin board.  Thiselectronic market links banks and sellers of deposits to deposit purchaserssuch as credit unions, school districts, labor unions, and other organizationswith excess liquidity.  Deposits may be raised in ninety-nine thousanddollar ($99,000) or one hundred thousand dollar ($100,000) increments in maturitiesfrom two weeks to five years.  Management believes the utilization of theelectronic bulletin board is highly efficient and the average rate has beengenerally less than rates paid in the local market. Participants in theelectronic market pay a modest annual licensing fee and there are notransaction charges.  Management has established policies and proceduresto govern the acquisition of funding through the wholesale market. Wholesale deposits are categorized as “Purchased Time Deposits” on the detail ofdeposits shown in this Item 7. Management may also, from time to time, engagethe services of a deposit broker to raise a block of funding at a specifiedmaturity date.

Total average deposits in 2006 were $451,235, anincrease of $166,258, or 58.34% over the total average deposits of $284,977 in2005. Average non-interest bearing deposits decreased by $438, or 2.33%, from$18,763 in 2005 to $18,325 in 2006. Average savings deposits decreased by$10,107 from $22,785 in 2005 to $12,678 in 2006. Average purchased depositsincreased by $45,738, or 31.26%, from $146,326 in 2005 to $192,064 in 2006. Theaverage rate paid on purchased deposits in 2006 was 4.82% compared to 3.55% in2005. Purchased time deposit funding represented 42.56% of total funding in2006 compared to 51.34% in 2005.

Total average deposits in 2005 were $284,977, anincrease of $103,417, or 56.96% over the total average deposits of $181,560 in2004.  Average non-interest bearing deposits increased by $4,471, or31.28%, from $14,292 in 2004 to $18,763 in 2005.  Average savings depositsdecreased by $11,721 from $34,506 in 2004 to $22,785 in 2005.  Averagepurchased deposits increased by $47,811, or 48.53%, from $98,515 in 2004 to$146,326 in 2005.  The average rate paid on purchased time deposits in2005 was 3.55% compared to 2.68% in 2004.  Purchased time deposit fundingrepresented 51.34% of total funding in 2005 compared to 54.26% in 2004.

**Off-balancesheet arrangements** - The Bank is a party to financialinstruments with off-balance sheet risk in the normal course of business tomeet the financing needs of its customers.  These financial instrumentsinclude commitments to extend credit and standby letters of credit.  Thoseinstruments involve, to varying degrees, elements of credit risk in excess ofthe amount recognized in the balance sheet.  The contract or notionalamounts of those instruments reflect the extent of involvement the Bank has inthose particular financial instruments.

The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit and standby letters of credit is represented by thecontractual or notional amount of those instruments.  The Bank uses thesame credit policies in making commitments and conditional obligations as itdoes for on-balance sheet instruments.

Financial instruments whose contract amounts representcredit risk:
| ** **                                          | ** ** | **2006**        | ** ** | **2005**           | ** ** | **2004**        | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|--------------------|------------|-----------------|------------|
| **($ in thousands)**                      | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** |
|                                                |       |            |       |               |       |            |       |   |   |   |   |   |   |
| Commitments to  extend credit                       |       | $               | 9,601      |               | $          | 65,123          |       | $ | 2,404 |   | $ | 38,859 |   | $ | 4,014 |   | $ | 29,638 |   |
| Standby letters of  credit and financial guarantees |       | —          |       | 5,776              |       | —          |       | 5,686 |   | — |   | 2,139 |   |
|                                                     |            |                 |            |                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Commitments to make loans are generally made forperiods of one year or less.  The fixed rate loan commitments haveinterest rates ranging from 6.00% to 10.25% and maturities ranging from 6months to 6 years.

41

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Commitments to extend credit are agreements to lend toa customer as long as there is no violation of any condition established in thecontract.  Commitments generally have fixed expiration dates or othertermination clauses and may require payment of a fee.  Since many of thecommitments are expected to expire without being drawn upon, the total commitmentamounts do not necessarily represent future cash requirements.  The Bankevaluates each customer’s creditworthiness on a case—by-case basis.  Theamount of collateral obtained if deemed necessary by the Bank upon extension ofcredit is based on management’s credit evaluation. Collateral held varies butmay include accounts receivable, inventory, property, plant and equipment, andincome-producing commercial properties.

Standby letters of credit are conditional commitmentsissued by the Bank to guarantee the performance of a customer to a thirdparty.  Those guarantees are primarily issued to support public andprivate borrowing arrangements, including commercial paper, bond financing, andsimilar transactions.  All letters of credit are due within one year orless of the original commitment date.  The credit risk involved in issuingletters of credit is essentially the same as that involved in extending loanfacilities to customers.

**ContractualObligations** — At December 31, 2006, the Bank had certaincontractual obligations as shown below.
| ** **                               | ** ** | **Payments due by Period** | ** ** |
|------------------------------------------|------------|-------------------------------------------|------------|
| ** **                               | ** ** | **Total**                                 | ** ** | **LessThan  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than  5 Years** | ** ** |
| ** **                               | ** ** | **(dollars in thousands)**      | ** ** |
| Contractual  Obligations (1)             |       |                                      |       |   |   |   |   |   |   |   |   |
| Deposits without  a stated maturity |       | $                                         | 142,629    |   | $ | 142,629 |   | $ | — |   | $ | — |   | $ | — |   |
| Certificates of  deposit                 |       | 417,938                                   |       | 318,523 |   | 62,333 |   | 37,082 |   | — |   |
| Subordinated  long term debt             |       | 8,248                                     |       | — |   | — |   | — |   | 8,248 |   |
| Capital lease  obligations               |       | —                                    |       | — |   | — |   | — |   | — |   |
| Operating lease  obligations             |       | 1,400                                     |       | 353 |   | 694 |   | 353 |   | — |   |
| Purchase  obligations                    |       | —                                    |       | — |   | — |   | — |   | — |   |
| Other long term  liabilities             |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total                                    |       | $                                         | 570,215    |   | $ | 461,505 |   | $ | 63,027 |   | $ | 37,435 |   | $ | 8,248 |   |

 

----

(1)   excludes interest

42

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**Financial Tables**

The following financial information regarding us andthe Bank should be read in conjunction with our financial statements includedin Item 8 of this Report.

**Average Balance Sheets, Net InterestIncome and Changes in Interest Income and Interest Expense**

The following tables show the average monthly balancesof each principal category of assets, liabilities and stockholders’ equity ofthe Bank, and an analysis of net interest revenue, and the change in interestincome and interest expense segregated into amount attributable to changes involume and changes in rates.  The table is presented on taxable equivalentbasis, if applicable.
| ** **                           | ** ** | **12 months Ended December 31, 2006** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------|------------|
| **(dollars in thousands)** | ** ** | **Average  Balance**                                           | ** ** | **Interest** | ** ** | **Average  Rate** | ** ** |
| **ASSETS**                           |       |                                                           |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Interest earning assets              |       |                                                           |       |   |   |   |   |
| Securities                           |       |                                                           |       |   |   |   |   |
| Taxable (1)                          |       | $                                                              | 44,317     |   | $ | 2,216 |   | 4.91 | % |
| Tax-exempt                           |       | —                                                         |       | — |   | — |   |
| Total securities                     |       | 44,317                                                         |       | 2,216 |   | 4.91 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Loans (2) (3)                        |       | 428,186                                                        |       | 38,382 |   | 8.96 | % |
| Federal funds sold                   |       | 14,165                                                         |       | 647 |   | 4.57 | % |
| Total interest earning  assets       |       | 486,668                                                        |       | 41,245 |   | 8.46 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Non-interest earning  assets         |       |                                                           |       |   |   |   |   |
| Cash and due  from banks             |       | 4,268                                                          |       |   |   |   |   |
| Net fixed assets  and equipment      |       | 1,146                                                          |       |   |   |   |   |
| Accrued interest  and other assets   |       | 9,896                                                          |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Total assets                         |       | $                                                              | 501,978    |   |   |   |   |   |
|                                      |            |                                                                |            |  |  |  |  |  |  |

 

43

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| **LIABILITIES AND SHAREHOLDERS’  EQUITY**  |   |    |    |   |   |   |   |
|-------------------------------------------------|--------|---------|---------|--------|--------|--------|--------|
|                                            |   |    |    |   |   |   |   |
| Interest bearing  liabilities                   |   |    |    |   |   |   |   |
| Deposits (other  than demand)                   |   | $       | 432,910 |   | 21,216 |   | 4.90   | % |
| Federal funds  purchased                        |   | 990     |    | 55     |   | 5.56   | %      |
| Subordinated  debt                              |   | 8,804   |    | 597    |   | 6.78   | %      |
| Total interest  bearing liabilities             |   | 442,704 |    | 21,868 |   | 4.94   | %      |
|                                            |   |    |    |   |   |   |   |
| Non-interest bearing  liabilities               |   |    |    |   |   |   |   |
| Non-interest  bearing demand deposits           |   | 18,325  |    |   |   |   |   |
| Other  liabilities                              |   | 3,508   |    |   |   |   |   |
| Shareholders’  equity                      |   | 37,441  |    |   |   |   |   |
|                                            |   |    |    |   |   |   |   |
| Total liabilities and shareholders’ equity |   | $       | 501,978 |   |   |   |   |   |

 
| Net Interest Spread |   | 3.52   | %      |
|---------------------|--------|--------|--------|
|                |   |   |   |
| Net Interest Margin |   | 3.98   | %      |

 

----

(1)   Unrealized loss of $803 isexcluded from yield calculation.

(2)   Non-accrual loans areincluded in average loan balances and loan fees of $2,774 are included ininterest income.

(3)   Loans are presented net ofallowance for loan loss
| ** **                           | ** ** | **12 months Ended December 31, 2005** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                           | ** ** | **Average**                                                    | ** ** | **Average** | ** ** | ** ** | ** ** |
| **(dollars in thousands)** | ** ** | **Balance**                                                    | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                           |       |                                                           |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Interest earning  assets             |       |                                                           |       |   |   |   |   |
| Securities                           |       |                                                           |       |   |   |   |   |
| Taxable (1)                          |       | $                                                              | 23,034     |   | $ | 980 |   | 4.19 | % |
| Tax-exempt                           |       | —                                                         |       | — |   | — |   |
| Total securities                     |       | 23,034                                                         |       | 980 |   | 4.19 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Loans (2) (3)                        |       | 277,821                                                        |       | 22,488 |   | 8.09 | % |
| Federal funds  sold                  |       | 5,910                                                          |       | 165 |   | 2.79 | % |
| Total interest  earning assets       |       | 306,765                                                        |       | 23,633 |   | 7.70 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Non-interest  earning assets         |       |                                                           |       |   |   |   |   |
| Cash and due from banks              |       | 4,097                                                          |       |   |   |   |   |
| Net fixed assets and equipment       |       | 731                                                            |       |   |   |   |   |
| Accrued interest and other assets    |       | 4,381                                                          |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Total assets                         |       | $                                                              | 315,974    |   |   |   |   |   |
|                                      |            |                                                                |            |  |  |  |  |  |  |

 

44

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| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**   |   |    |    |   |   |   |   |
|--------------------------------------------------|--------|---------|---------|--------|--------|--------|--------|
|                                             |   |    |    |   |   |   |   |
| Interest bearing  liabilities                    |   |    |    |   |   |   |   |
| Deposits (other than demand)                     |   | $       | 266,214 |   | 9,568  |   | 3.59   | % |
| Federal funds purchased                          |   | 589     |    | 22     |   | 3.74   | %      |
| Subordinated debt                                |   | 6,237   |    | 416    |   | 6.68   | %      |
| Total interest bearing liabilities               |   | 273,040 |    | 10,006 |   | 3.66   | %      |
|                                             |   |    |    |   |   |   |   |
| Non-interest  bearing liabilities                |   |    |    |   |   |   |   |
| Non-interest bearing demand deposits             |   | 16,489  |    |   |   |   |   |
| Other liabilities                                |   | 1,481   |    |   |   |   |   |
| Shareholders’ equity                        |   | 24,964  |    |   |   |   |   |
|                                             |   |    |    |   |   |   |   |
| Total liabilities and  shareholders’ equity |   | $       | 315,974 |   |   |   |   |   |

 
| Net Interest Spread |   | 4.03   | %      |
|---------------------|--------|--------|--------|
|                |   |   |   |
| Net Interest Margin |   | 4.44   | %      |

 

----

(1)   Unrealized loss of $357 isexcluded from yield calculation.

(2)   Non-accrual loans areincluded in average loan balances and loan fees of $1,438 are included ininterest income.

(3)   Loans are presented net ofallowance for loan loss
| ** **                           | ** ** | **12 months Ended December 31, 2004** | ** ** |
|--------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                           | ** ** | **Average**                                                    | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(dollars in thousands)** | ** ** | **Balance**                                                    | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                           |       |                                                           |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Interest earning  assets             |       |                                                           |       |   |   |   |   |
| Securities                           |       |                                                           |       |   |   |   |   |
| Taxable (1)                          |       | $                                                              | 15,987     |   | $ | 616 |   | 3.79 | % |
| Tax-exempt                           |       | —                                                         |       | — |   | — |   |
| Total securities                     |       | 15,987                                                         |       | 616 |   | 3.79 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Loans (2) (3)                        |       | 174,296                                                        |       | 12,496 |   | 7.17 | % |
| Federal funds  sold                  |       | 5,166                                                          |       | 73 |   | 1.41 | % |
| Total interest  earning assets       |       | 195,449                                                        |       | 13,185 |   | 6.74 | % |
|                                 |       |                                                           |       |   |   |   |   |
| Non-interest  earning assets         |       |                                                           |       |   |   |   |   |
| Cash and due from banks              |       | 3,045                                                          |       |   |   |   |   |
| Net fixed assets and equipment       |       | 644                                                            |       |   |   |   |   |
| Accrued interest and other assets    |       | 2,001                                                          |       |   |   |   |   |
|                                 |       |                                                           |       |   |   |   |   |
| Total assets                         |       | $                                                              | 201,139    |   |   |   |   |   |
|                                      |            |                                                                |            |  |  |  |  |  |  |

 

45

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| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**   |   |    |    |   |   |   |   |
|--------------------------------------------------|--------|---------|---------|--------|--------|--------|--------|
|                                             |   |    |    |   |   |   |   |
| Interest bearing  liabilities                    |   |    |    |   |   |   |   |
| Deposits (other than demand)                     |   | $       | 167,268 |   | 4,257  |   | 2.55   | % |
| Federal funds purchased                          |   | 379     |    | 8      |   | 2.11   | %      |
| Total interest bearing liabilities               |   | 167,647 |    | 4,265  |   | 2.54   | %      |
|                                             |   |    |    |   |   |   |   |
| Non-interest  bearing liabilities                |   |    |    |   |   |   |   |
| Non-interest bearing demand deposits             |   | 14,292  |    |   |   |   |   |
| Other liabilities                                |   | 525     |    |   |   |   |   |
| Shareholders’ equity                        |   | 18,675  |    |   |   |   |   |
|                                             |   |    |    |   |   |   |   |
| Total liabilities and  shareholders’ equity |   | $       | 201,139 |   |   |   |   |   |

 
| Net Interest Spread |   | 4.20   | %      |
|---------------------|--------|--------|--------|
|                |   |   |   |
| Net Interest Margin |   | 4.56   | %      |

 

----

(1)   Unrealized loss of $253 isexcluded from yield calculation.

(2)   Non-accrual loans areincluded in average loan balances and loan fees of $858 are included ininterest income.

(3)   Loans are presented net ofallowance for loan loss

The following Tables outline the components of the netinterest margin for the years 2006, 2005, and 2004 and identifies the impact ofchanges in volume and the changes in rate.
| ** **                           | ** ** | **December 31, 2006 change from** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2005 due to:**     | ** ** |
| **(dollars in thousands)** | ** ** | **Volume**                                            | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest income                      |       |                                                  |       |   |   |   |   |
| Loans                                |       | $                                                     | 13,262     |   | $ | 2,632 |   | $ | 15,894 |   |
| Securities – taxable            |       | 1,021                                                 |       | 215 |   | 1,236 |   |
| Federal funds sold                   |       | 331                                                   |       | 151 |   | 482 |   |
| Total interest  income               |       | 14,614                                                |       | 2,998 |   | 17,612 |   |
|                                 |       |                                                  |       |   |   |   |   |
| Interest expense                     |       |                                                  |       |   |   |   |   |
| Deposits (other than demand)         |       | 7,369                                                 |       | 4,279 |   | 11,648 |   |
| Federal funds purchased              |       | 19                                                    |       | 14 |   | 33 |   |
| Subordinated debt                    |       | 174                                                   |       | 7 |   | 181 |   |
| Total interest  expense              |       | 7,562                                                 |       | 4,300 |   | 11,862 |   |
|                                 |       |                                                  |       |   |   |   |   |
| Net interest income                  |       | $                                                     | 7,052      |   | $ | (1,302 | ) | $ | 5,750 |   |

 

46

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| ** **                           | ** ** | **December 31, 2005 change from** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2004 due to:**     | ** ** |
| **(dollars in thousands)** | ** ** | **Volume**                                            | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest income                      |       |                                                  |       |   |   |   |   |
| Loans                                |       | $                                                     | 8,209      |   | $ | 1,783 |   | $ | 9,992 |   |
| Securities – taxable            |       | 290                                                   |       | 74 |   | 364 |   |
| Federal funds sold                   |       | 12                                                    |       | 80 |   | 92 |   |
| Total interest  income               |       | 8,511                                                 |       | 1,937 |   | 10,448 |   |
|                                 |       |                                                  |       |   |   |   |   |
| Interest expense                     |       |                                                  |       |   |   |   |   |
| Deposits (other than demand)         |       | 3,130                                                 |       | 2,181 |   | 5,311 |   |
| Federal funds purchased              |       | 6                                                     |       | 8 |   | 14 |   |
| Subordinated debt                    |       | 416                                                   |       | — |   | 416 |   |
| Total interest  expense              |       | 3,552                                                 |       | 2,189 |   | 5,741 |   |
|                                 |       |                                                  |       |   |   |   |   |
| Net interest income                  |       | $                                                     | 4,959      |   | $ | (252 | ) | $ | 4,707 |   |

 

**Liability and Asset Management**

The matching of assets and liabilities may be analyzedby examining the extent to which such assets and liabilities are “interest ratesensitive” and by monitoring an institution’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specifictime period if it will mature or reprice within that time period.  Theinterest rate sensitivity gap is defined as the difference between the dollaramount of rate sensitive assets repricing during a period and the volume ofrate sensitive liabilities repricing during the same period. A gap isconsidered positive when the amount of interest rate sensitive assets exceedsthe amount of interest rate sensitive liabilities.  A gap is considerednegative when the amount of interest rate sensitive liabilities exceeds theamount of interest rate sensitive assets.  During a period of risinginterest rates, a negative gap would tend to adversely affect net interestincome while a positive gap would tend to result in an increase in net interestincome.  During a period of falling interest rates, a negative gap wouldtend to result in an increase in net interest income while a positive gap wouldtend to adversely affect net interest income.

The Bank’s asset liability and investment committee,which consists of the Executive Officers, Arthur F. Helf, Michael R. Sapp, H.Lamar Cox and George W. Fort, is charged with monitoring the liquidity andfunds position of the Bank.  The Committee regularly reviews (a) therate sensitivity position on a three-month, six-month, and one-year timehorizon; (b) loans to deposit ratios; and (c) average maturity forcertain categories of liabilities.  The Bank operates an asset/liabilitymanagement model.  At December 31, 2006, the Bank had a negativecumulative repricing gap within one year of approximately $(33,908) orapproximately 5.49% of total year end earning assets. See Quantitative andQualitative Analysis of Market Risk for additional information.

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**Deposits**

The Bank’s primary sources of funds areinterest-bearing deposits. The following tables present the average amount ofand average rate paid on each of the following deposit categories for 2006,2005 and 2004:

Deposits
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                            | ** ** | ** **                                 | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(dollars in thousands)**  | ** ** | **Average  Balance**                       | ** ** | **Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Rate  Paid** | ** ** | **Average  Balance** | ** ** | **Rate  Paid** | ** ** |
| Types of  Deposits                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing  demand deposits |       | $                                          | 18,325     |   | — |   | $ | 18,763 |   | — |   | $ | 14,292 |   | — |   |
| Interest-bearing  demand deposits     |       | 5,119                                      |       | 3.64 | % | 3,097 |   | 1.90 | % | 1,640 |   | 0.24 | % |
| Money market  accounts                |       | 72,866                                     |       | 5.23 | % | 39,485 |   | 3.88 | % | 16,316 |   | 2.07 | % |
| Savings accounts                      |       | 12,678                                     |       | 2.67 | % | 22,785 |   | 2.61 | % | 34,506 |   | 2.43 | % |
| IRA accounts                          |       | 5,450                                      |       | 4.91 | % | 2,183 |   | 4.31 | % | 1,040 |   | 3.56 | % |
| Purchased time  deposits              |       | 192,064                                    |       | 4.82 | % | 146,326 |   | 3.55 | % | 98,515 |   | 2.68 | % |
| Time deposits                         |       | 144,733                                    |       | 5.09 | % | 52,338 |   | 4.00 | % | 15,251 |   | 2.65 | % |
| Total deposits                        |       | $                                          | 451,235    |   |   |   | $ | 284,977 |   |   |   | $ | 181,560 |   |   |   |

 

The following table indicates amount outstanding oftime certificates of deposit of $100,000 or more and respective maturities asof December 31, 2006 (in thousands):
|                                   | ** ** | **2006** | ** ** |
|-----------------------------------|------------|----------|------------|
|                              |       |     |       |
| Three months or  less             |       | $        | 58,229     |   |
|                              |       |     |       |
| Over three  through twelve months |       | 97,206   |       |
|                              |       |     |       |
| More than twelve  months          |       | 72,482   |       |
| Total                             |       | $        | 227,917    |   |

 

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**Investment Portfolio**

The Bank’s investment portfolio at December 31, 2006,2005 and 2004 consisted of the following (dollars in thousands):
| ** **                    | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|-------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                    | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market**    | ** ** |
| ** **                    | ** ** | **Cost**      | ** ** | **Gain**       | ** ** | **Loss**       | ** ** | **Value**     | ** ** |
| As of December  31, 2006      |       |          |       |           |       |           |       |          |       |
| Securities available for sale |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies      |       | $             | 45,859     |           | $          | 134            |       | $             | (514       | ) | $ | 45,479 |   |
| Mortgage-backed securities    |       | 6,672         |       | —         |       | (207           | )          | 6,465         |       |
| Corporate debt securities     |       | 4,495         |       | —         |       | (50            | )          | 4,445         |       |
| Other                         |       | 380           |       | 174            |       | —         |       | 554           |       |
| Total                         |       | $             | 57,406     |           | $          | 308            |       | $             | (771       | ) | $ | 56,943 |   |
|                          |       |          |       |           |       |           |       |          |       |
| As of December  31, 2005      |       |          |       |           |       |           |       |          |       |
| Securities available for sale |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies      |       | $             | 22,195     |           | $          | 7              |       | $             | (411       | ) | $ | 21,791 |   |
| Mortgage-backed securities    |       | 8,059         |       | —         |       | (254           | )          | 7,805         |       |
| Corporate debt securities     |       | 1,958         |       | —         |       | (22            | )          | 1,936         |       |
| Other                         |       | 380           |       | 80             |       | —         |       | 460           |       |
| Total                         |       | $             | 32,592     |           | $          | 87             |       | $             | (687       | ) | $ | 31,992 |   |
|                          |       |          |       |           |       |           |       |          |       |
| As of December  31, 2004      |       |          |       |           |       |           |       |          |       |
| Securities available for sale |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies      |       | $             | 9,958      |           | $          | 5              |       | $             | (111       | ) | $ | 9,852 |   |
| Mortgage-backed securities    |       | 8,569         |       | —         |       | (111           | )          | 8,458         |       |
| Other                         |       | 380           |       | —         |       | —         |       | 380           |       |
| Total                         |       | $             | 18,907     |           | $          | 5              |       | $             | (222       | ) | $ | 18,690 |   |

 

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The following schedule presents the estimatedmaturities and weighted average yields of investment securities of the Bank atDecember 31, 2006:
| ** **                                     | ** ** | ** **    | ** ** | **Estimated** | ** ** | **Weighted** | ** ** |
|------------------------------------------------|------------|---------------|------------|---------------|------------|--------------|------------|
| ** **                                     | ** ** | **Amortized** | ** ** | **Market**    | ** ** | **Average**  | ** ** |
| ** **                                     | ** ** | **Cost**      | ** ** | **Value**     | ** ** | **Yield**    | ** ** |
| Obligations of  U.S. Government agencies       |       |          |       |          |       |         |       |
| Due in one year or less                        |       | $             | 500        |          | $          | 499          |       | 3.02 | % |
| Due after one through five years               |       | 13,738        |       | 13,503        |       | 4.48         | %          |
| Due after five through ten years               |       | 16,891        |       | 16,752        |       | 5.31         | %          |
| Due after ten years                            |       | 14,730        |       | 14,725        |       | 5.99         | %          |
| Total  obligations of U.S. Government agencies |       | 45,859        |       | 45,479        |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Mortgage-backed  securities                    |       | 6,672         |       | 6,465         |       | 4.00         | %          |
|                                           |       |          |       |          |       |         |       |
| Corporate debt  securities                     |       |          |       |          |       |         |       |
| Due in one year or less                        |       | —        |       | —        |       |         |       |
| Due after one through five years               |       | 335           |       | 319           |       | 4.01         | %          |
| Due after five through ten years               |       | 4,160         |       | 4,126         |       | 4.97         | %          |
| Due after ten years                            |       | —        |       | —        |       |         |       |
| Total corporate  debt securities               |       | 4,495         |       | 4,445         |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Other securities                               |       | 380           |       | 554           |       | 2.19         | %          |
| Total securities  available for sale           |       | $             | 57,406     |          | $          | 56,943       |       |   |   |

 

The Bank owned no tax-exempt securities during theperiod ended December 31, 2006.

**Investment Policy**

The objective of the Bank’s investment policy is toinvest funds not otherwise needed to meet the loan demand of its market area toearn the maximum return for the Bank, yet still maintain sufficient liquidityto meet fluctuations in the Bank’s loan demand and deposit structure.  Indoing so, the Bank balances the market and credit risks against the potentialinvestment return, makes investments compatible with the pledge requirements ofthe Bank’s deposits of public funds, maintains compliance with regulatoryinvestment requirements, and assists the various public entities with theirfinancing needs.  The asset liability and investment committee has fullauthority over the investment portfolio and makes decisions on purchases andsales of securities.  The entire portfolio, along with all investment transactionsoccurring since the previous Board of Director’s meeting, is reviewed by theBoard at its next monthly meeting.  The investment policy allows portfolioholdings to include short-term securities purchased to provide the Bank’sneeded liquidity and longer term securities purchased to generate level incomefor the Bank over periods of interest rate fluctuations.

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**Loan Portfolio**

The Bank had total loans of $539 million at December31, 2006.  As the loan portfolio is concentrated in Davidson County and WilliamsonCounty, there is risk that the borrowers’ ability to repay the loans could beaffected by changes in local economic conditions. The following scheduledetails the loans of the Bank at December 31, 2006, 2005, 2004, 2003 and 2002:
| **(dollars in thousands)**    | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Real estate                             |       |     |       |     |       |     |       |     |       |     |       |
| Construction                            |       | $        | 74,482     |     | $          | 38,279   |       | $        | 22,813     |     | $          | 10,386 |   | $ | 6,646 |   |
| 1-4 family residential                  |       | 22,873   |       | 18,358   |       | 15,963   |       | 13,520   |       | 13,372   |       |
| Other                                   |       | 83,985   |       | 50,371   |       | 33,694   |       | 20,072   |       | 10,513   |       |
| Commercial, financial  and agricultural |       | 353,996  |       | 233,948  |       | 139,799  |       | 87,908   |       | 44,867   |       |
| Consumer                                |       | 3,246    |       | 3,149    |       | 3,898    |       | 3,301    |       | 1,963    |       |
| Other                                   |       | 6,936    |       | 4,481    |       | —   |       | —   |       | —   |       |
|                                    |       |     |       |     |       |     |       |     |       |     |       |
| Total loans                             |       | 545,518  |       | 348,586  |       | 216,167  |       | 135,187  |       | 77,361   |       |
| Less: allowance  for loan losses        |       | (6,968   | )          | (4,399   | )          | (2,841   | )          | (2,000   | )          | (1,103   | )          |
|                                    |       |     |       |     |       |     |       |     |       |     |       |
| Net loans                               |       | $        | 538,550    |     | $          | 344,187  |       | $        | 213,326    |     | $          | 133,187 |   | $ | 76,258 |   |

 

Compositionof loan portfolio by type
| ** **                              | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| **(dollars in thousands)**    | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| Real estate:                            |       |                                  |       |   |   |   |   |   |   |   |   |
| Construction                            |       | 13.65                                 | %          | 10.98 | % | 10.55 | % | 7.68 | % | 8.59 | % |
| 1 to 4 family residential               |       | 4.19                                  | %          | 5.27 | % | 7.38 | % | 10.00 | % | 17.28 | % |
| Other                                   |       | 15.40                                 | %          | 14.45 | % | 15.59 | % | 14.85 | % | 13.59 | % |
| Commercial,  financial and agricultural |       | 64.89                                 | %          | 67.11 | % | 64.68 | % | 65.03 | % | 58.00 | % |
| Consumer                                |       | 0.60                                  | %          | 0.90 | % | 1.80 | % | 2.44 | % | 2.54 | % |
| Other                                   |       | 1.27                                  | %          | 1.29 | % | 0.00 | % | 0.00 | % | 0.00 | % |
| Total                                   |       | 100                                   | %          | 100 | % | 100 | % | 100 | % | 100 | % |

 

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Compositionof commercial loan portfolio by sourcing program type
| ** **                               | ** ** | **As of December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------|------------|
| ** **                               | ** ** | **2006**                              | ** ** | **2005** | ** ** | **2004** | ** ** |
| **(dollars in thousands)**     | ** ** | **Amount**                            | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial and agricultural: |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Direct                                   |       | $                                     | 151,692    |   | 42.85 | % | $ | 94,742 |   | 40.50 | % | $ | 60,471 |   | 43.26 | % |
| Indirect                                 |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Large                                    |       | 88,569                                |       | 25.02 | % | 52,144 |   | 22.29 | % | 29,010 |   | 20.75 | % |
| Small                                    |       | 113,735                               |       | 32.13 | % | 87,062 |   | 37.21 | % | 50,318 |   | 35.99 | % |
| Total                                    |       | 353,996                               |       | 100.00 | % | 233,948 |   | 100.00 | % | 139,799 |   | 100.00 | % |
|                                          |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following schedule details maturities andsensitivity to interest rates changes for loans of the Bank at December 31,2005:
| ** **                              | ** ** | **Due in 1**         | ** ** | **Due in 1**   | ** ** | **Due after** | ** ** | ** ** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|--------------------------|------------|--------------------|------------|------------|------------|
| **Type of Loan (1)**     | ** ** | **year or less**     | ** ** | **to 5 years** | ** ** | **5 Years**   | ** ** | **Total**  | ** ** |
| ** **                              | ** ** | **($ in thousands)** | ** ** |
| Real estate:                            |       |                           |       |                     |       |               |       |       |       |
| Construction                            |       | $                              | 55,824     |                     | $          | 18,208             |       | $          | 450        |   | $ | 74,482 |   |
| 1 to 4 family residential               |       | 6,743                          |       | 15,885                   |       | 245                |       | 22,873     |       |
| Other                                   |       | 17,260                         |       | 48,102                   |       | 18,623             |       | 83,985     |       |
| Commercial,  financial and agricultural |       | 88,555                         |       | 262,559                  |       | 2,882              |       | 353,996    |       |
| Consumer                                |       | 1,696                          |       | 1,518                    |       | 32                 |       | 3,246      |       |
| Other                                   |       | —                         |       | —                   |       | 6,936              |       | 6,936      |       |
| Total                                   |       | $                              | 170,078    |                     | $          | 346,272            |       | $          | 29,168     |   | $ | 545,518 |   |
|                                    |       |                           |       |                     |       |               |       |       |       |
| Less: allowance  for loan loss          |       |                           |       |                     |       |               |       | (6,968     | )          |
|                                    |       |                           |       |                     |       |               |       |       |       |
| Net loans                               |       |                           |       |                     |       |               |       | $          | 538,550    |   |
|                                    |       |                           |       |                     |       |               |       |       |       |
| Interest rate  sensitivity:             |       |                           |       |                     |       |               |       |       |       |
| Fixed interest rates                    |       | 16,956                         |       | 345,064                  |       | 29,168             |       | 391,188    |       |
| Floating or adjustable rates            |       | 153,122                        |       | 1,208                    |       | —             |       | 154,330    |       |
|                                    |       |                           |       |                     |       |               |       |       |       |
| Total                                   |       | $                              | 170,078    |                     | $          | 346,272            |       | $          | 29,168     |   | $ | 545,518 |   |

 

----

(1) includes non-accrual loans

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**Recent Accounting Pronouncements**

InSeptember 2006, the Financial Accounting Standards Board (FASB) issued SFAS No.158, *Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans – an amendment of FASB Statements No. 87, 88,106 and 132(R)*.  ThisStatement requires an employer to recognize the overfunded or underfundedstatus of a defined benefit postretirement plan (other than a multiemployerplan) as an asset or liability in its balance sheet, beginning with year end2006, and to recognize changes in the funded status in the year in which thechanges occur through comprehensive income beginning in 2007.  Additionally, defined benefit plan assets andobligations are to be measured as of the date of the employer’s fiscalyear-end, starting in 2008.  Adoption didnot have a material impact on our 2006 consolidated financial statements.

InSeptember 2006, the Securities and Exchange Commission (SEC) released StaffAccounting Bulletin No. 108, Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements (SAB 108), which is effective for fiscal years ending on or afterNovember 15, 2006.  SAB 108 provides guidanceon how the effects of prior-year uncorrected financial statement misstatementsshould be considered in quantifying a current year misstatement.  SAB 108 requires public companies to quantifymisstatements using both an income statement (rollover) and balance sheet (ironcurtain) approach and evaluate whether either approach results in amisstatement that, when all relevant quantitative and qualitative factors areconsidered, is material.  If prior yearerrors that had been previously considered immaterial now are consideredmaterial based on either approach, no restatement is required so long asmanagement properly applied its previous approach and all relevant facts andcircumstances were considered. Adjustments considered immaterial in prior years under the methodpreviously used, but now considered material under the dual approach requiredby SAB 108, are to be recorded upon initial adoption of SAB 108.  The amount so recorded is shown as acumulative effect adjustment is recorded in opening retained earnings as ofJanuary 1, 2006.  The adoption of SAB 108had no material effect on our financial statements for the year ending December31, 2006.

InMarch 2006, the FASB issued Statement No. 156, *Accountingfor Servicing of Financial Assets-an amendment of FASB Statement No. 140.*  This Statement provides the following: 1)revised guidance on when a servicing asset and servicing liability should berecognized; 2) requires all separately recognized servicing assets andservicing liabilities to be initially measured at fair value, if practicable;3) permits an entity to elect to measure servicing assets and servicingliabilities at fair value each reporting date and report changes in fair valuein earnings in the period in which the changes occur; 4) upon initial adoption,permits a onetime reclassification of available-for-sale securities to tradingsecurities for securities which are identified as offsetting the entity’sexposure to changes in the fair value of servicing assets or liabilities that aservicer elects to subsequently measure at fair value; and 5) requires separatepresentation of servicing assets and servicing liabilities subsequentlymeasured at fair value in the statement of financial position and additionalfootnote disclosures.  This standard iseffective as of the beginning of an entity’s first fiscal year that beginsafter September 15, 2006 with the effects of initial adoption being reported asa cumulative-effect adjustment to retained earnings.  Management does not expect the adoption ofthis statement will have a material impact on our consolidated financialstatements.

InSeptember 2006, the FASB issued Statement No. 157, *Fair ValueMeasurements*.  This Statementdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements.  This Statement establishes a fair valuehierarchy about the assumptions used to measure fair value and clarifiesassumptions about risk and the effect of a restriction on the sale or use of anasset.  The standard is effective forfiscal years beginning after November 15, 2007. Management is currently evaluating the impact of the adoption of thisstandard on our consolidated financial statements.

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InJuly 2006, the FASB issued FASB Interpretation No. 48, *Accountingfor Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109*(FIN 48), which prescribes a recognition threshold and measurement attributefor a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure and transition.  FIN48 is effective for fiscal years beginning after December 15, 2006.  Management has determined that the adoptionof FIN 48 will not have a material effect on our consolidated financialstatements.

InSeptember 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, *Accounting for Deferred Compensation and Postretirement Benefit Aspectsof Endorsement Split-Dollar Life Insurance Arrangements*.  This issue requires that a liability berecorded during the service period when a split-dollar life insurance agreementcontinues after participants’ employment or retirement.  The required accrued liability will be basedon either the post-employment benefit cost for the continuing life insurance orbased on the future death benefit depending on the contractual terms of theunderlying agreement.  This issue iseffective for fiscal years beginning after December 15, 2007. Managementis currently evaluating the impact of the adoption of this standard on ourconsolidated financial statements.

InSeptember 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-5, *Accounting for Purchases of Life Insurance - Determining the AmountThat Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4(Accounting for Purchases of Life Insurance).*This issue requiresthat a policyholder consider contractual terms of a life insurance policy indetermining the amount that could be realized under the insurance contract.  It also requires that if the contractprovides for a greater surrender value if all individual policies in a groupare surrendered at the same time, that the surrender value be determined basedon the assumption that policies will  besurrendered on an individual basis. Lastly, the issue discusses whether the cash surrender value should bediscounted when the policyholder is contractually limited in its ability tosurrender a policy.  This issue iseffective for fiscal years beginning after December 15, 2006.  Management is currently evaluating theimpact of the adoption of this standard on our consolidated financialstatements.

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**ITEM7A.****                                            QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

**Quantitative and Qualitative Analysisof Market Risk**

Like all financial institutions, we are subject tomarket risk from changes in interest rates.  Interest rate risk isinherent in the balance sheet due to the mismatch between the maturities ofrate sensitive assets and rate sensitive liabilities.  If rates arerising, and the level of rate sensitive liabilities exceed the level of ratesensitive assets, the net interest margin will be negatively impacted. Conversely, if rates are falling, and the level of rate sensitive liabilitiesis greater than the level of rate sensitive assets, the impact on the netinterest margin will be favorable.  Managing interest rate risk is furthercomplicated by the fact that all rates do not change at the same pace, in otherwords, short term rates may be rising while longer term rates remainstable.  In addition, different types of rate sensitive assets and ratesensitive liabilities react differently to changes in rates.

To manage interest rate risk, we must take a positionon the expected future trend of interest rates.  Rates may rise, fall, orremain the same.  The Asset-Liability Committee develops its view offuture rate trends by monitoring economic indicators, examining the views ofeconomists and other experts, and understanding the current status of ourBalance Sheet.   Our annual budget reflects the anticipated rateenvironment for the next twelve months.  The Asset Liability Committeeconducts a quarterly analysis of the rate sensitivity position.  Theresults of the analysis are reported to the board.

The Asset Liability Committee uses a computer model toanalyze the maturities of rate sensitive assets and liabilities.  Themodel measures the “gap” which is defined as the difference between the dollaramount of rate sensitive assets repricing during a period and the volume ofrate sensitive liabilities repricing during the same period. Gap is alsoexpressed as the ratio of rate sensitive assets divided by rate sensitiveliabilities.  If the ratio is greater than “one”, the dollar value ofassets exceeds the dollar value of liabilities; the balance sheet is “assetsensitive”.

Conversely, if the value of liabilities exceeds thevalue of assets, the ratio is less than one and the balance sheet is “liabilitysensitive”.  Policy requires management to maintain the gap within a rangeof 0.75 to 1.25.

The model measures scheduled maturities in periods ofthree months, four to twelve months, one to five years, and over five years.The chart below illustrates our rate sensitive position at December 31, 2006.Management uses the one year gap as the appropriate time period for settingstrategy.

55

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Rate Sensitivity Gap Analysis

Maturities:
| **(dollars in thousands)**             | ** ** | **Floating** | ** ** | **1-3  Months** | ** ** | **4-12  Months** | ** ** | **1-5  Years** | ** ** | **Over  5 years** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|--------------|------------|-----------------|------------|------------------|------------|----------------|------------|------------------------|------------|-----------|------------|
| Interest  Earnings Assets                        |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Federal Funds  sold                              |       | $            | 13,820     |            | $          | —           |       | $              | —     |                   | $          | —    |       | $ | — |   | $ | 13,820 |   |
| Interest bearing  deposits in banks              |       |         |       |            |       | 1,009            |       |           |       |                   |       | 1,009     |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Securities                                       |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| U.S. government agencies                         |       | —       |       | 499             |       | —           |       | 13,503         |       | 36,157                 |       | 50,159    |       |
| Mortgage-backed and corporate debt securities    |       | —       |       | 805             |       | 2,404            |       | 2,615          |       | 960                    |       | 6,784     |       |
| Total securities                                 |       | —       |       | 1,304           |       | 2,404            |       | 16,118         |       | 37,117                 |       | 56,943    |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total loans                                      |       | 149,541      |       | 59,349          |       | 153,140          |       | 168,861        |       | 14,626                 |       | 545,517   |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total Interest  Earning Assets                   |       | 163,361      |       | 60,653          |       | 156,553          |       | 184,979        |       | 51,743                 |       | 617,289   |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other Assets                                     |       | —       |       | —          |       | —           |       | —         |       | 6,229                  |       | 6,229     |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total Assets                                     |       | $            | 163,361    |            | $          | 60,653           |       | $              | 156,553    |                   | $          | 184,979   |       | $ | 57,972 |   | $ | 623,518 |   |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest Bearing  Liabilities                    |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Deposits                                         |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest checking                                |       | $            | 6,925      |            | $          | —           |       | $              | —     |                   | $          | —    |       | $ | — |   | $ | 6,925 |   |
| Money market and savings                         |       | 89,027       |       | —          |       | —           |       | 29,676         |       | —                 |       | 118,703   |       |
| Time deposits                                    |       | —       |       | 96,482          |       | 222,041          |       | 99,415         |       | —                 |       | 417,938   |       |
| Total deposits                                   |       | 95,952       |       | 96,482          |       | 222,041          |       | 129,091        |       | —                 |       | 543,566   |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Subordinated  long term debt                     |       | —       |       | —          |       | —           |       | —         |       | 8,248                  |       | 8,248     |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total Interest  Bearing Liabilities              |       | 95,952       |       | 96,482          |       | 222,041          |       | 129,091        |       | 8,248                  |       | 551,814   |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other  Liabilities                               |       | —       |       | —          |       | —           |       | —         |       | 20,480                 |       | 20,480    |       |
| Shareholders’  Equity                       |       | —       |       | —          |       | —           |       | —         |       | 51,224                 |       | 51,224    |       |
|                                             |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total Liabilities and  Shareholders’ Equity |       | $            | 95,952     |            | $          | 96,482           |       | $              | 222,041    |                   | $          | 129,091   |       | $ | 79,952 |   | $ | 623,518 |   |

 

56

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| Rate Sensitive  Gap by Period                                  |   | $      | 67,409 |   | $      | (35,829 | )      | $       | (65,488 | )      | $      | 55,888 |   | $      | 43,495 |   |   |   |
|----------------------------------------------------------------|--------|--------|--------|--------|--------|---------|--------|---------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
|                                                           |   |   |   |   |   |    |   |    |    |   |   |   |   |
| Cumulative Gap                                                 |   |   |   | $      | 31,580 |    | $      | (33,908 | )       | $      | 21,980 |   | $      | 65,475 |   |   |   |
|                                                           |   |   |   |   |   |    |   |    |    |   |   |   |   |
| Cumulative Gap  as a Percent of Total Assets                   |   |   |   | 5.06   | %      | (5.44   | )%     | 3.53    | %       | 10.50  | %      |   |   |
|                                                           |   |   |   |   |   |    |   |    |    |   |   |   |   |
| Rate sensitive  assets/Rate sensitive liabilities (cumulative) |   | 1.70   |   | 1.16   |   | 0.92    |   | 1.04    |    | 1.12   |   |   |   |

 

In mid-2004, the Federal Reserve Open Market Committeebegan a series of interest rate increases which the FOMC indicated wouldcontinue “at a measured pace”.  From mid year 2004 to the end of 2006,short term interest rates had increased by 425 basis points.  We are nowpositioned for a falling rate environment by maintaining a moderately “liabilitysensitive” balance sheet in which more liabilities will reprice thanassets.  At year-end 2006, our one year GAP ratio was 0.92.

The interest rate risk model that defines the gapposition also performs a “rate shock” test of the balance sheet.  The rateshock procedure measures the impact on the economic value of equity (EVE) whichis a measure of long term interest rate risk. EVE is the difference between themarket value of the assets and the liabilities and is the liquidation value ofthe bank. In this analysis, the model calculates the discounted cash flow ormarket value of each category on the balance sheet. The percent change in EVEis a measure of the volatility of risk. Regulatory guidelines specify a maximumchange of 30% for a 200bps rate change. At December 31, 2006, the percentchange at plus or minus 200bps is well within that range at (20.4)% and 16.1%respectively.

The chart below identifies the EVE impact of a shiftin rates of 100, 200 and 300 basis points in either direction.

Economic Value of EquityUnder Rate Shock

(dollars in thousands)

At December 31, 2006
| **Rate Change**      | ** ** | **-300bp** | ** ** | **-200bp** | ** ** | **-100bp** | ** ** | **0bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** | **+300bp** | ** ** |
|---------------------------|------------|------------|------------|------------|------------|------------|------------|---------|------------|------------|------------|------------|------------|------------|------------|
|                      |       |       |       |       |       |       |       |    |       |       |       |       |       |       |       |
| Economic value  of equity |       | $          | 63,900     |       | $          | 60,118     |       | $       | 56,173     |       | $          | 51,770     |       | $          | 46,671     |   | $ | 41,231 |   | $ | 35,740 |   |
|                      |       |       |       |       |       |       |       |    |       |       |       |       |       |       |       |
| Actual dollar  change     |       | 12,130     |       | 8,348      |       | 4,403      |       | —  |       | (5,099     | )          | (10,539    | )          | (16,030    | )          |
|                      |       |       |       |       |       |       |       |    |       |       |       |       |       |       |       |
| Percent change            |       | 23.4       | %          | 16.1       | %          | 8.5        | %          | —  |       | (9.8       | )%         | (20.4      | )%         | (31.0      | )%         |
|                           |            |            |            |            |            |            |            |         |            |            |            |            |            |            |            |  |  |  |  |  |  |  |

 

The one year gap of 0.92 indicates that the Bank wouldshow an increase in net interest income in a falling rate environment, and theEVE rate shock shows that the EVE would rise in a falling rate environment. TheEVE simulation model is a static model which provides information only at acertain point in time. For example, in a rising rate environment, the modeldoes not take into account actions which management might take to change theimpact of rising rates on the Bank. Given that limitation, it is still usefulis assessing the impact of an unanticipated movement in interest rates.

The above analysis may not on its own be an entirelyaccurate indicator of how net interest income or EVE will be affected bychanges in interest rates. Income associated with interest earning assets andcosts associated with interest bearing liabilities may not be affecteduniformly by changes in interest rates. In addition, the magnitude and durationof changes in interest rates may have a significant impact on net interestincome. Interest rates on certain types of assets and liabilities fluctuate inadvance of changes in general market rates, while interest rates on other typesmay lag behind changes in general market rates. The Asset-Liability Committeedevelops its view of future rate trends by monitoring economic indicators,examining the views of economists and other experts, and understanding thecurrent status of our Balance Sheet and conducts a quarterly analysis of therate sensitivity position.  The results of the analysis are reported tothe board.

57

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**ITEM8.**                                                     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The report of Independent Accountants, ConsolidatedFinancial Statements and supplementary data required by Item 8 are set forth onpages F-1 through F-28 of this Report and are incorporated herein by reference.

Index to Financial Statements
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM         | F-1    |
|------------------------------------------------------------------|--------|
|                                                             |   |
| FINANCIAL  STATEMENTS                                            |   |
|                                                             |   |
| CONSOLIDATED BALANCE  SHEETS                                     | F-2    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF INCOME                               | F-3    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY | F-4    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS                           | F-5    |
|                                                             |   |
| NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS                      | F-6    |

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

 

None.

**ITEM9A.**                                            CONTROLS AND PROCEDURES

a)             Evaluation of Disclosure Controls and Procedures.The Corporation maintains disclosure controls and procedures, as defined inRule 13a-15(a) promulgated under the Securities Exchange Act of 1934 (the “ExchangeAct”), that are designed to ensure that information required to be disclosed byit in the reports that it files or submits under the Exchange Act is recorded,processed, summarized and reported within the time period specified in the SEC’srules and forms and that such information is accumulated and communicated tothe Corporation’s management, including its Chief Executive Officer and ChiefFinancial Officer. The Corporation carried out an evaluation, under thesupervision and with the participation of its management, including its ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of its disclosure controls and procedures as of the end ofthe period covered by this report.  Basedon the evaluation of these disclosure controls and procedures, the ChiefExecutive Officer and Chief Financial Officer concluded that the Corporation’sdisclosure control and procedures were effective.

b)            Changes in Internal Controls and Procedures. Therewere no changes in the Corporation’s internal control over financial reportingduring the Corporation’s fiscal quarter ended December 31, 2006 that havematerially affected, or are reasonably likely to materially affect, itsinternal control over financial reporting.

**ITEM9B.**                                            OTHER INFORMATION

None

58

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**PART III**

**ITEM10.**                                              DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Information relating toour directors, executive officers and our corporate governance will becontained in a definitive Proxy Statement involving the election of directorsat the annual meeting of shareholders to be held June 8, 2007, and suchinformation is incorporated herein by reference.

**ITEM11.**                                              EXECUTIVE COMPENSATION

Information relating toexecutive compensation will be contained in the Proxy Statement referred toabove in Item 10, and such information is incorporated herein by reference.
| **ITEM 12.** | **SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS** |
|--------------|-----------------------------------------------------------------------------------------------------|

 

Information relating tosecurity ownership of certain beneficial owners and management will becontained in the Proxy Statement referred to above in Item 10, and suchinformation is incorporated herein by reference.

**ITEM 13.**                                              CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Information relating tocertain relationships and related transactions, and director independence willbe contained in the Proxy Statement referred to above in Item 10, and suchinformation is incorporated herein by reference.

**ITEM14.**                                              PRINCIPAL ACCOUNTING FEES AND SERVICES

Informationrelating to the principal accounting fees and services will be contained in theProxy Statement referred to above in Item 10, and such information isincorporated herein by reference.

59

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**PART IV**

**ITEM15.**                                              EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a)(1)       Financial Statements:

(2)           Schedules required by Article 12 ofRegulation S-X are either omitted because they are not applicable or becausethe required information is shown in the financial statements or the notesthereto.

(3)           Exhibits:
| Exhibit No. | ** ** | **Description** |
|-------------|------------|-----------------|
|        |       |            |
| 2.1         |       |            | Articles of Share Exchange of Tennessee Commerce  Bank and Tennessee Commerce Bancorp, Inc.* |
|        |       |            |   |
| 2.2         |       |            | Plan of Share Exchange of Tennessee Commerce Bank  and Tennessee Commerce Bancorp, Inc.* |
|        |       |            |   |
| 3.1         |       |            | Charter of Tennessee Commerce Bancorp, Inc.* |
|        |       |            |   |
| 3.2         |       |            | Bylaws of Tennessee Commerce Bancorp, Inc.* |
|        |       |            |   |
| 4.1         |       |            | Shareholders’ Agreement* |
|        |       |            |   |
| 10.1        |       |            | Tennessee Commerce Bancorp, Inc. Stock Option Plan -  Employees* |
|        |       |            |   |
| 10.2        |       |            | Tennessee Commerce Bancorp, Inc. 1999 Stock Option -  Directors* |
|        |       |            |   |
| 10.3        |       |            | Tennessee Commerce Bancorp, Inc. 1999 Stock Option -  Incorporators* |
|        |       |            |   |
| 10.4        |       |            | Tennessee commerce Bancorp, Inc. 2003 Stock Option -  Directors* |
|        |       |            |   |
| 10.5        |       |            | Tennessee Commerce Bancorp, Inc. 1999 Stock Option  Agreement with Arthur F. Helf* |
|        |       |            |   |
| 10.6        |       |            | Tennessee Commerce Bancorp, Inc. 1999 Stock Option  Agreement with Michael R. Sapp* |

 

60

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| 10.7   |   | Tennessee Commerce Bancorp, Inc. 1999 Stock Option  Agreement with H. Lamar Cox*    |
|--------|--------|-------------------------------------------------------------------------------------|
|   |   |                                                                                |
| 10.8   |   | Employment Agreement between Tennessee Commerce  Bancorp, Inc. and Arthur F. Helf*  |
|   |   |                                                                                |
| 10.9   |   | Employment Agreement between Tennessee Commerce Bancorp,  Inc. and Michael R. Sapp* |
|   |   |                                                                                |
| 10.10  |   | Employment Agreement between Tennessee Commerce  Bancorp, Inc. and H. Lamar Cox*    |
|   |   |                                                                                |
| 10.11  |   | Employment Agreement between Tennessee Commerce  Bancorp, Inc. and George W. Fort** |
|   |   |                                                                                |
| 21.1   |   | Subsidiaries*                                                                       |
|   |   |                                                                                |
| 23.1   |   | Report of Independent Registered Public Accounting  Firm                            |
|   |   |                                                                                |
| 31.1   |   | Certification pursuant to Rule 13a-14a/15d-14(a)                                    |
|   |   |                                                                                |
| 31.2   |   | Certification pursuant to Rule 13a-14a/15d-14(a)                                    |
|   |   |                                                                                |
| 32.1   |   | Certification pursuant to Rule 18 USC Section  1350-Sarbanes-Oxley Act of 2002      |
|   |   |                                                                                |
| 32.2   |   | Certification pursuant to Rule 18 USC Section  1350-Sarbanes-Oxley Act of 2002      |

 

----

*   Previously filed as anexhibit to Tennessee Commerce Bancorp, Inc.’s Registration Statement on Form10, as filed with the Securities and Exchange Commission on April 29, 2005 andincorporated herein by reference.

** Previouslyfiled as an exhibit to Tennessee Commerce Bancorp, Inc.’s RegistrationStatement on Form S-1, as filed with the Securities and Exchange Commission onApril 25, 2006 and incorporated herein by reference.

61

----

**Signatures**

Pursuant to therequirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, theregistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.
|        | TENNESSEE COMMERCE BANCORP, INC.                     |
|--------|------------------------------------------------------|
|   |                                                 |
|   | By:                                                  | /s/ Arthur F. Helf |   |
|   | Arthur F. Helf, Chairman and Chief Executive Officer |   |
|   | Date:     March 30, 2007    |   |
|        |                                                      |  |  |  |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant in theircapacities as directors.
| By:    |  /s/ Dorris E.  (Eli) Bennett |   | By:    |  /s/ H. Lamar  Cox         |
|--------|------------------------------------|--------|--------|---------------------------------|
|   | Dorris E. (Eli) Bennett            |   |   | H. Lamar Cox                    |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Paul W.  Dierksen        |   | By:    |  /s/ Dennis L.  Grimaud    |
|   | Paul W. Dierksen                   |   |   | Dennis L. Grimaud               |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Arthur F.  Helf          |   | By:    |  /s/ Winston  C. Hickman   |
|   | Arthur F. Helf                     |   |   | Winston C. Hickman              |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Fowler H.  Low           |   | By:    |  /s/ William  W. McInnes   |
|   | Fowler H. Low                      |   |   | William W. McInnes              |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Thomas R.  Miller        |   | By:    |  /s/ Darrel  Reifschneider |
|   | Thomas R. Miller                   |   |   | Darrel Reifschneider            |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Michael  R. Sapp         |   | By:    |  /s/ Regg E.  Swanson      |
|   | Michael R. Sapp                    |   |   | Regg E. Swanson                 |
| Date:  | March 30, 2007                     |   | Date:  | March 30, 2007                  |
|   |                               |   |   |                            |
|   |                               |   |   |                            |
| By:    |  /s/ Dr. Paul  A. Thomas      |   |   |                            |
|   | Dr. Paul A. Thomas                 |   |   |                            |
| Date:  | March 30, 2007                     |   |   |                            |
|        |                                    |        |        |                                 |  |  |

 

----

**TENNESSEE COMMERCE BANCORP, INC.**

##### **CONSOLIDATED FINANCIAL STATEMENTS**

### **December 31, 2006 and 2005**

----

##### **CONSOLIDATED FINANCIAL STATEMENTS**

**December 31, 2006 and 2005**

CONTENTS
| REPORT OF INDEPENDENT  REGISTERED PUBLIC ACCOUNTING FIRM         | F-1    |
|------------------------------------------------------------------|--------|
|                                                             |   |
| FINANCIAL  STATEMENTS                                            |   |
|                                                             |   |
| CONSOLIDATED BALANCE  SHEETS                                     | F-2    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF INCOME                               | F-3    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY | F-4    |
|                                                             |   |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS                           | F-5    |
|                                                             |   |
| NOTES TO  CONSOLIDATED FINANCIAL STATEMENTS                      | F-6    |

 

----

**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

The Board of Directors

Tennessee CommerceBancorp, Inc.

Franklin, Tennessee

We have audited the consolidated balance sheets ofTennessee Commerce Bancorp, Inc. (the “Corporation”) and subsidiaries as ofDecember 31, 2006 and 2005, and the related consolidated statements of income,changes in shareholders’ equity and cash flows for the years then ended. Thesefinancial statements are the responsibility of the Corporation’s management.Our responsibility is to express an opinion on these financial statements basedon our audits. The consolidated statements of income, changes in shareholders’equity and cash flows of the Corporation for the year ended December 31, 2004were audited by other auditors whose report, dated March 31, 2005, expressed anunqualified opinion on those statements.

We conducted our audits of the 2006 and 2005consolidated financial statements in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance aboutwhether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.

In our opinion, the 2006and 2005 financial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Tennessee Commerce Bancorp,Inc. and subsidiaries as of December 31, 2006 and 2005, and the consolidatedresults of their operations and their cash flows for the years then ended inconformity with accounting principles generally accepted in the United Statesof America.

As discussed in Note 1 tothe consolidated financial statements, the Corporation adopted Statement ofFinancial Accounting Standards No. 123(R), *Share-Based Payment*,as revised, effective January 1, 2006.
| /s/ KraftCPAs PLLC   |   |
|----------------------|--------|
| Nashville, Tennessee |
| March 28, 2007       |

 

555 Great Circle Road, Suite 200 ·Nashville, TN 37228 · Phone 615-242-7351·Fax 615-256-1952 · www.kraftcpas.com610 North Garden St. Suite 200, Columbia, Tennessee 38401 ·Phone 931-388-3711105 Bay Court, Lebanon, Tennessee 37087 ·Phone 615-449-2334An independently owned member of the RSM McGladrey Network

F-1

----

**TENNESSEE COMMERCE BANCORP, INC.CONSOLIDATED BALANCE SHEETSDecember 31, 2006 and 2005**
| **(dollars in thousands except share data)**                                                                                                                                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **ASSETS**                                                                                                                                                                                                            |       |     |       |     |       |
| Cash and due from  financial institutions                                                                                                                                                                             |       | $        | 177        |     | $          | 6,877 |   |
| Federal funds sold                                                                                                                                                                                                    |       | 13,820   |       | 12,535   |       |
| Cash and cash  equivalents                                                                                                                                                                                            |       | 13,997   |       | 19,412   |       |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| Securities available  for sale                                                                                                                                                                                        |       | 56,943   |       | 31,992   |       |
| Loans                                                                                                                                                                                                                 |       | 545,518  |       | 348,586  |       |
| Allowance for loan  losses                                                                                                                                                                                            |       | (6,968   | )          | (4,399   | )          |
| Net loans                                                                                                                                                                                                             |       | 538,550  |       | 344,187  |       |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| Premises and equipment,  net                                                                                                                                                                                          |       | 1,633    |       | 769      |       |
| Accrued interest  receivable                                                                                                                                                                                          |       | 4,116    |       | 2,148    |       |
| Restricted equity  securities                                                                                                                                                                                         |       | 633      |       | 383      |       |
| Deferred tax asset                                                                                                                                                                                                    |       | 635      |       | 490      |       |
| Other assets                                                                                                                                                                                                          |       | 7,011    |       | 4,659    |       |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| Total assets                                                                                                                                                                                                          |       | $        | 623,518    |     | $          | 404,040 |   |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                                                                                                                                                        |       |     |       |     |       |
| Liabilities                                                                                                                                                                                                           |       |     |       |     |       |
| Deposits                                                                                                                                                                                                              |       |     |       |     |       |
| Noninterest-bearing                                                                                                                                                                                                   |       | $        | 17,001     |     | $          | 33,372 |   |
| Interest-bearing                                                                                                                                                                                                      |       | 543,566  |       | 334,333  |       |
| Total deposits                                                                                                                                                                                                        |       | 560,567  |       | 367,705  |       |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| Accrued interest  payable                                                                                                                                                                                             |       | 1,728    |       | 1,126    |       |
| Long-term  subordinated debt                                                                                                                                                                                          |       | 8,248    |       | 8,248    |       |
| Accrued bonuses                                                                                                                                                                                                       |       | 623      |       | 430      |       |
| Other  liabilities                                                                                                                                                                                                    |       | 1,128    |       | 101      |       |
| Total  liabilities                                                                                                                                                                                                    |       | 572,294  |       | 377,610  |       |
| Shareholders’ equity                                                                                                                                                                                             |       |     |       |     |       |
| Preferred stock,  no par value. Authorized 1,000,000 shares; none issued                                                                                                                                              |       | —   |       | —   |       |
| Common stock,  $0.50 par value. Authorized 10,000,000 shares at December 31, 2006 and  5,000,000 at December 31, 2005; Issued and outstanding 4,451,674 at December  31, 2006 and 3,238,674 at December 31, 2005 |       | 2,226    |       | 1,619    |       |
| Additional  paid-in capital                                                                                                                                                                                           |       | 40,755   |       | 21,401   |       |
| Retained  earnings                                                                                                                                                                                                    |       | 8,530    |       | 3,781    |       |
| Accumulated  other comprehensive loss                                                                                                                                                                                 |       | (287     | )          | (371     | )          |
| Total  shareholders’ equity                                                                                                                                                                                      |       | 51,224   |       | 26,430   |       |
|                                                                                                                                                                                                                  |       |     |       |     |       |
| Total liabilities and  shareholders’ equity                                                                                                                                                                      |       | $        | 623,518    |     | $          | 404,040 |   |

 

See accompanying notes to consolidated financialstatements.

F-2

----

**TENNESSEE COMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF INCOMEYears Ended December 31, 2006, 2005, and 2004**
| **(dollars in thousands except share data)** | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Interest income                                                       |       |      |       |      |       |      |       |
| Loans, including  fees                                                |       | $         | 38,382     |      | $          | 22,488    |       | $ | 12,497 |   |
| Securities                                                            |       | 2,216     |       | 980       |       | 616       |       |
| Federal funds  sold                                                   |       | 647       |       | 165       |       | 72        |       |
| Total interest  income                                                |       | 41,245    |       | 23,633    |       | 13,185    |       |
|                                                                  |       |      |       |      |       |      |       |
| Interest expense                                                      |       |      |       |      |       |      |       |
| Deposits                                                              |       | 21,216    |       | 9,567     |       | 4,257     |       |
| Other                                                                 |       | 652       |       | 439       |       | 8         |       |
| Total interest  expense                                               |       | 21,868    |       | 10,006    |       | 4,265     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest income                                                   |       | 19,377    |       | 13,627    |       | 8,920     |       |
|                                                                  |       |      |       |      |       |      |       |
| Provision for loan  losses                                            |       | 4,350     |       | 3,700     |       | 2,420     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest income  after provision for loan losses                  |       | 15,027    |       | 9,927     |       | 6,500     |       |
|                                                                  |       |      |       |      |       |      |       |
| Non interest income                                                   |       |      |       |      |       |      |       |
| Service charges  on deposit accounts                                  |       | 202       |       | 114       |       | 24        |       |
| Mortgage banking                                                      |       | 89        |       | 105       |       | 130       |       |
| Securities gains                                                      |       | —    |       | 4         |       | 33        |       |
| Gain on sale of  loans                                                |       | 2,025     |       | 1,106     |       | 504       |       |
| Loss on  repossessions                                                |       | (538      | )          | (86       | )          | (46       | )          |
| Other                                                                 |       | (15       | )          | 68        |       | 155       |       |
| Total non  interest income                                            |       | 1,763     |       | 1,311     |       | 800       |       |
|                                                                  |       |      |       |      |       |      |       |
| Non interest expense                                                  |       |      |       |      |       |      |       |
| Salaries and  employee benefits                                       |       | 5,047     |       | 3,700     |       | 2,604     |       |
| Occupancy and  equipment                                              |       | 844       |       | 629       |       | 473       |       |
| Data processing  fees                                                 |       | 701       |       | 474       |       | 350       |       |
| Professional  fees                                                    |       | 786       |       | 398       |       | 314       |       |
| Other                                                                 |       | 1,678     |       | 1,045     |       | 811       |       |
| Total non  interest expense                                           |       | 9,056     |       | 6,246     |       | 4,552     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income before income  taxes                                           |       | 7,734     |       | 4,992     |       | 2,748     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income tax expense                                                    |       | 2,985     |       | 1,925     |       | 1,082     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net income                                                            |       | $         | 4,749      |      | $          | 3,067     |       | $ | 1,666 |   |
|                                                                  |       |      |       |      |       |      |       |
| Earnings per share  (EPS):                                            |       |      |       |      |       |      |       |
| Basic EPS                                                             |       | $         | 1.24       |      | $          | 0.95      |       | $ | 0.57 |   |
| Diluted EPS                                                           |       | 1.14      |       | 0.87      |       | 0.53      |       |
|                                                                  |       |      |       |      |       |      |       |
| Weighted average shares  outstanding:                                 |       |      |       |      |       |      |       |
| Basic                                                                 |       | 3,822,655 |       | 3,238,674 |       | 2,933,818 |       |
| Diluted                                                               |       | 4,157,338 |       | 3,517,408 |       | 3,166,794 |       |

 

See accompanying notes to consolidated financialstatements.

F-3

----

**TENNESSEE COMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYYears Ended December 31, 2006, 2005, and 2004**
| ** **                                                                          | ** ** | ** ** | ** ** | ** **     | ** ** | ** **    | ** ** | **Accumulated**        | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|---------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                          | ** ** | ** ** | ** ** | **Additional** | ** ** | **Retained**  | ** ** | **Other**              | ** ** | **Total**              | ** ** |
| ** **                                                                          | ** ** | **Common** | ** ** | **Paid-In**    | ** ** | **Earnings**  | ** ** | **Comprehensive**      | ** ** | **Shareholders’** | ** ** |
| **(dollars in thousands except share data)**               | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **(Deficit)** | ** ** | **Income (Loss)** | ** ** | **Equity**             | ** ** |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Balance at  December 31, 2003                                                  |       | $          | 1,230      |           | $          | 13,246        |       | $                      | (952       | )                      | $          | (126 | ) | $ | 13,398 |   |
| Comprehensive income                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Net income                                                                          |       | —     |       | —         |       | 1,666         |       | —                 |       | 1,666                  |       |
| Other  comprehensive income, net of income taxes                                    |       |       |       |           |       |          |       |                   |       |                   |       |
| Unrealized gains  on securities available for sale during the period                |       | —     |       | —         |       | —        |       | 12                     |       | 12                     |       |
| Reclassification  adjustment for gains included in net income, net of $13 in tax    |       | —     |       | —         |       | —        |       | (20                    | )          | (20                    | )          |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Total comprehensive  income                                                         |       | —     |       | —         |       | —        |       | —                 |       | 1,658                  |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Issuance of 775,000  common shares                                                  |       | 388        |       | 8,137          |       | —        |       | —                 |       | 8,525                  |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Exercise of stock  options to purchase 3,000 common shares                          |       | 1          |       | 18             |       | —        |       | —                 |       | 19                     |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Balance at December 31,  2004                                                       |       | 1,619      |       | 21,401         |       | 714           |       | (134                   | )          | 23,600                 |       |
| Comprehensive income                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Net income                                                                          |       | —     |       | —         |       | 3,067         |       | —                 |       | 3,067                  |       |
| Other  comprehensive income, net of income taxes                                    |       |       |       |           |       |          |       |                   |       |                   |       |
| Unrealized gains  on securities available for sale during the period                |       | —     |       | —         |       | —        |       | (234                   | )          | (234                   | )          |
| Reclassification  adjustment for gains included in net income, net of $1 in tax     |       | —     |       | —         |       | —        |       | (3                     | )          | (3                     | )          |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Total comprehensive  income                                                         |       |       |       |           |       |          |       |                   |       | 2,830                  |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Balance at December 31,  2005                                                       |       | 1,619      |       | 21,401         |       | 3,781         |       | (371                   | )          | 26,430                 |       |
| Comprehensive income                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Net income                                                                          |       | —     |       | —         |       | 4,749         |       | —                 |       | 4,749                  |       |
| Other  comprehensive income, net of income taxes                                    |       |       |       |           |       |          |       |                   |       |                   |       |
| Unrealized gains  on securities available for sale during the period                |       | —     |       | —         |       | —        |       | 84                     |       | 84                     |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Total comprehensive  income                                                         |       | —     |       | —         |       | —        |       | —                 |       | 4,833                  |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Issuance of 1,150,000  common shares                                                |       | 575        |       | 18,452         |       | —        |       | —                 |       | 19,027                 |       |
| Exercise of stock  options to purchase 63,000 common shares and related tax benefit |       | 32         |       | 820            |       | —        |       | —                 |       | 852                    |       |
| Stock based  compensation expense                                                   |       | —     |       | 82             |       | —        |       | —                 |       | 82                     |       |
|                                                                                |       |       |       |           |       |          |       |                   |       |                   |       |
| Balance at December 31, 2006                                                        |       | $          | 2,226      |           | $          | 40,755        |       | $                      | 8,530      |                   | $          | (287 | ) | $ | 51,224 |   |

 

See accompanying notes to consolidated financialstatements.

F-4

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**TENNESSEE COMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31, 2006, 2005, and 2004**
| **(dollars in thousands except share data)**             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from operating  activities**                                         |       |     |       |     |       |     |       |
| Net income                                                                        |       | $        | 4,749      |     | $          | 3,067    |       | $ | 1,666 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities |       |     |       |     |       |     |       |
| Depreciation                                                                      |       | 259      |       | 171      |       | 165      |       |
| Provision for  loan losses                                                        |       | 4,350    |       | 3,700    |       | 2,420    |       |
| FHLB stock  dividends                                                             |       | (32      | )          | (17      | )          | (9       | )          |
| Stock-based  compensation expense                                                 |       | 82       |       | —   |       | —   |       |
| Deferred income  tax                                                              |       | (198     | )          | 254      |       | 56       |       |
| Net amortization  of investment securities                                        |       | 14       |       | 40       |       | 52       |       |
| Gain on sales of  securities                                                      |       | —   |       | (4       | )          | (33      | )          |
| Change in:                                                                        |       |     |       |     |       |     |       |
| Accrued interest  receivable                                                      |       | (1,968   | )          | (1,045   | )          | (481     | )          |
| Accrued interest  payable                                                         |       | 602      |       | 681      |       | 276      |       |
| Other assets                                                                      |       | (2,118   | )          | (3,481   | )          | (837     | )          |
| Other  liabilities                                                                |       | 1,220    |       | 53       |       | 264      |       |
| Net cash from  operating activities                                               |       | 6,960    |       | 3,419    |       | 3,539    |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from investing  activities**                                         |       |     |       |     |       |     |       |
| Purchases of  securities available for sale                                       |       | (26,781  | )          | (17,315  | )          | (13,938  | )          |
| Proceeds from  sales of securities available for sale                             |       | —   |       | 1,489    |       | 4,909    |       |
| Proceeds from  maturities, prepayments and calls of securities available for sale |       | 1,953    |       | 2,104    |       | 3,284    |       |
| Investment in  unconsolidated subsidiary                                          |       | —   |       | (248     | )          | —   |       |
| Net change in  loans                                                              |       | (198,947 | )          | (134,561 | )          | (82,559  | )          |
| Purchases of  Federal Home Loan Bank Stock                                        |       | (218     | )          | (125     | )          | (82      | )          |
| Net purchases of  premises and equipment                                          |       | (1,123   | )          | (330     | )          | (101     | )          |
| Net cash used by  investing activities                                            |       | (225,116 | )          | (148,986 | )          | (88,487  | )          |
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from financing  activities**                                         |       |     |       |     |       |     |       |
| Net change in  deposits                                                           |       | 192,862  |       | 146,311  |       | 79,101   |       |
| Proceeds from  long-term subordinated debt                                        |       | —   |       | 8,248    |       | —   |       |
| Proceeds from  issuance of common stock                                           |       | 19,027   |       | —   |       | 8,525    |       |
| Proceeds from  exercise of common stock options                                   |       | 596      |       | —   |       | 19       |       |
| Excess tax  benefit from option exercises                                         |       | 256      |       | —   |       | —   |       |
| Net cash  provided by financing activities                                        |       | 212,741  |       | 154,559  |       | 87,645   |       |
|                                                                              |       |     |       |     |       |     |       |
| **Net change in cash and cash  equivalents**                                      |       | (5,415   | )          | 8,992    |       | 2,697    |       |
|                                                                              |       |     |       |     |       |     |       |
| Cash and cash  equivalents at beginning of period                                 |       | 19,412   |       | 10,420   |       | 7,723    |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash and cash equivalents at  end of period**                                   |       | $        | 13,997     |     | $          | 19,412   |       | $ | 10,420 |   |
|                                                                              |       |     |       |     |       |     |       |
| **Supplemental cash flow  information:**                                          |       |     |       |     |       |     |       |
| Cash paid during  period for interest                                             |       | $        | 21,266     |     | $          | 9,325    |       | $ | 3,989 |   |
| Cash paid during period  for income taxes                                         |       | 2,075    |       | 2,089    |       | 780      |       |

 

See accompanying notes toconsolidated financial statements.

F-5

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**TENNESSEECOMMERCE BANCORP, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

**NOTE 1 - SUMMARY OF SIGNIFICANTACCOUNTING POLICIES**

The accounting principles followed and the methods ofapplying those principles conform with accounting principles generally acceptedin the United States of America and to general practices in the bankingindustry. The significant policies are summarized as follows:

Principles of Consolidation: The accompanying consolidated financial statements include the accounts ofTennessee Commerce Bancorp, Inc. (the Corporation) and its wholly-ownedsubsidiary, Tennessee Commerce Bank (the Bank). Tennessee Commerce StatutoryTrust I is not consolidated and is accounted for under the equity method.Material intercompany accounts and transactions have been eliminated.

Nature of Operations: Tennessee Commerce Bancorp, Inc. was formed in July 2000. Tennessee CommerceBank received its charter as a state bank and opened for business in January2000. Substantially all of the assets, liabilities, and operations presented inthe consolidated financial statements are attributable to Tennessee CommerceBank. The Bank provides a variety of banking services to individuals andbusinesses in Middle Tennessee. Its primary deposit products are demand andsavings deposits and certificates of deposit, and its primary lending productsare commercial, lease financing, real estate mortgage and installment loans.

The Bank’s loans are generally secured by specificitems of collateral including real property, consumer assets, and businessassets. Although the Bank has a diversified loan portfolio, a substantialportion of its debtors’ ability to honor their contracts is dependent on localeconomic conditions.

Use of Estimates:  To preparefinancial statements in conformity with accounting principles generallyaccepted in the United States of America, management makes estimates andassumptions based on available information. These estimates and assumptionsaffect the amounts reported in the financial statements and the disclosuresprovided, and future results could differ. The allowance for loan losses andfair value of financial instruments are particularly subject to change.

Statement of Cash Flows:  Forpurposes of presentation in the statements of cash flows, cash and cashequivalents include amounts due from financial institutions and federal fundssold. Net cash flows are reported for loan and deposit transactions.

Securities:  In accordance withStatement of Financial Accounting Standards No. 115, *Accounting for Certain Debt and Equity Securities* (SFAS115), all securities are classified as available for sale. The Corporationcurrently has no trading securities or held to maturity securities.

Securities classified as available for sale may besold in response to changes in interest rates, liquidity needs, and for otherpurposes. Available for sale securities are reported at fair value and includesecurities not classified as held to maturity or trading.

F-6

----

Unrealized holding gains and losses for available forsale securities are reported in other comprehensive income. Realized gains(losses) on securities available for sale are included in other income(expense) and, when applicable, are reported as a reclassification adjustment,net of tax, in other comprehensive income. Gains and losses on sales of securitiesare determined on the specific-identification method.

Interest income includes amortization of purchasepremium or discount. Gains and losses on sales are based on the amortized costof the security sold. Securities are written down to fair value when a declinein fair value is not temporary. Any such losses are charged to earnings.

###### Mortgage Banking Activities:  The Bankoriginates mortgage loans for sale and these loans are carried at the lower ofcost or fair value, determined on an aggregate basis. Generally, a commitmentis obtained from investors at origination in order to minimize market riskdirectly related to interest rate movements. Origination fees are recorded asincome when the loans are sold to third party investors. At the end of the yearfor each period presented there were no loans held for sale.

Loans:  Loans that the Bank hasthe positive intent and ability to hold to maturity are stated at the principalamount outstanding. Interest on loans is computed daily based on the principalamount outstanding. Loan origination fees are deferred, to the extent theyexceed direct origination costs, and recognized over the life of the relatedloans as yield adjustments.

Loans are generally placed on nonaccrual when a loanis specifically determined to be impaired or when principal or interest isdelinquent for 90 days or more. Any unpaid interest previously accrued on thoseloans is reversed from income. Interest income generally is not recognized onspecific impaired loans unless the likelihood of further loss is remote.Interest payments received on such loans are applied as a reduction of the loanprincipal balance. Interest income on other nonaccrual loans is recognized onlyto the extent of interest payments received.

Tax leases: Tax leases comprised$6,936,000 and $4,481,000 of loans on the balance sheet at December 31, 2006and 2005 respectively. In accordance with the Statement of Financial AccountingStandards No. 140, *Accounting For Transfersand Servicing of Financial Assets and Extinguishments of Liabilities*,at the time of investment, the tax lease asset is recorded along with unearnedinterest income followed by periodic journal entries to record the interestincome and maintain an accurate representation of the investment balance. Thecurrent balance is part of “Loans” on the balance sheet and as “Other” on theSummary of Loans in Note 3. For 2006, the tax leases created a net timingdifference of $1,550,007.  Net deductions of $1,550,007 were allowed fortax, but not book. For 2005, the tax leases created a net timing difference of$787,948.  Net deductions of $787,948 were allowed for tax, but not book.

Allowance for Loan Losses:  Theallowance for loan losses is maintained at a level that, in management’sjudgment, is adequate to absorb credit losses inherent in the loan portfolio.The amount of the allowance is based on management’s evaluation of thecollectibility of the loan portfolio, including the nature of the portfolio,credit concentrations, trends in historical loss experience, impaired loans,and economic conditions. Allowances for impaired loans are generally determinedbased on collateral values or the present value of estimated cash flows.Because of uncertainties associated with the regional economic conditions, collateralvalues, and future cash flows on impaired loans, it is reasonably possible thatmanagement’s estimate of credit losses inherent in the loan portfolio and therelated allowance may change materially in the near term. The allowance isincreased by the provision for loan losses and reduced by charge-offs, net ofrecoveries.

F-7

----

The allowance consists of specific and generalcomponents. The specific component relates to loans that are individuallyclassified as impaired or loans otherwise classified as substandard ordoubtful. The general component covers non-classified loans and is based onhistorical loss experience adjusted for current factors.

Management periodically reviews the loan portfolio. Aloan is placed on non-accrual status when it is 90 days or more past due andimmediate collection is doubtful. The non-accrual loans are reviewedperiodically for impairment. A loan is impaired when full payment under theloan terms is not expected. Commercial and commercial real estate loans areindividually evaluated for impairment. If a loan is impaired, a portion of theallowance is allocated so that the loan is reported, net, at the present valueof estimated future cash flows using the loan’s existing rate or at the fairvalue of collateral if repayment is expected solely from the collateral. Largegroups of smaller balance homogeneous loans, such as consumer and residentialreal estate loans, are collectively evaluated for impairment, and accordingly,they are not separately identified for impairment disclosures.

Premises and Equipment: Premises and equipment are stated at cost, less accumulated depreciation andamortization. The provision for depreciation is computed principally on thestraight-line method over the estimated useful lives of the assets. Leaseholdimprovements are amortized over the shorter of the lease term or useful life ofthe asset. Costs of major additions and improvements are capitalized.Expenditures for maintenance and repairs are charged to operations as incurred.

Other Real Estate:  Real estateacquired by foreclosure is carried at the lower of the recorded investment inthe property or its fair value at the date of foreclosure, determined byappraisal. Declines in value indicated by reappraisals as well as lossesresulting from disposition are charged to operations.

Gain on Sale of Loans: The Bankrecords a transfer of financial assets as a sale when it surrenders controlover those financial assets to the extent that consideration other thanbeneficial interests in the assets is received in exchange. The Bank considerscontrol surrendered when all conditions prescribed by Statement of FinancialAccounting Standards No. 140, *Accounting ForTransfers and Servicing of Financial Assets and Extinguishments of Liabilities,*a replacement of SFAS No. 125, are met. These conditions focus on whether thetransferred financial assets are isolated beyond the reach of the Bank and itscreditors, the constraints on the transferee or beneficial interest holders,and the Bank’s rights or obligations to reacquire transferred financial assets.In accordance with SFAS No. 140, the Bank records the transfer by allocatingthe carrying amount of the financial asset between the assets sold, and theretained interests, if any, based on their relative fair values at the date oftransfer. Estimates of expected future cash flows are used to determine fairvalue on the date of transfer. The gain on sale is presented as a component ofnon-interest income.

F-8

----

Interest-Only Strips Receivable: Interest-only strips receivable are related to loans originated and sold toothers, and represent the difference between the loan’s coupon rate and therate “passed through” to investors. The initial amount recorded asinterest-only strips receivable (I/O) is computed by applying present valuefactors to the investors’ expected cash flows compared to expected cash flowsfrom the borrowers. I/Os are carried at fair value and unrealized losses orgains are recognized into income. I/Os are included in other assets on thebalance sheet.

Servicing Asset: In accordance withStatement of Financial Accounting Standards No. 140 - *Accounting for Transfers and Servicing of FinancialAssets and Extinguishment of Liabilities*, servicing assets arerecognized as separate assets when rights are acquired through purchase orthrough sale of financial assets. When the Bank sells loans to others that itcontinues to service, a servicing asset is recorded at fair value. Capitalizedservicing rights are reported in other assets and are amortized over the lifeof the loan being serviced.

Stock-BasedCompensation:  Effective January 1, 2006, theCorporation adopted Statement of Financial Accounting Standards (“SFAS”) No.123(R), *Share-based Payment*, using the modifiedprospective transition method. Accordingly, the Corporation has recorded stock-based employeecompensation cost using the fair value method starting in 2006.  For 2006, adopting this standard resulted ina reduction of income before income taxes of $82,000, a reduction in net incomeof $51,000, a decrease in basic and diluted earnings per share of $.01 and$.01.

Prior to January1, 2006, employee compensation expense under stock options was reported usingthe intrinsic value method; therefore, no stock-based compensation costis reflected in net income for the years ending December 31, 2005 and 2004, asall options granted had an exercise price equal to or greater than the marketprice of the underlying common stock at date of grant.

The followingtable illustrates the effect on net income and earnings per share if expensewas measured using the fair value recognition provisions of SFAS No. 123, *Accounting for Stock-Based Compensation,*for the yearsending December 31, 2005 and 2004.
| (dollars in thousands except share data)                  | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                               |       |     |       |     |       |
| Net income as  reported                                                            |       | $        | 3,067      |     | $          | 1,666 |   |
| Deduct:  Stock-based compensation expense determined under fair value based method |       | 245      |       | 141      |       |
|                                                                               |       |     |       |     |       |
| Pro forma net  income                                                              |       | $        | 2,822      |     | $          | 1,525 |   |
|                                                                               |       |     |       |     |       |
| Basic earnings  per share as reported                                              |       | $        | 0.95       |     | $          | 0.57 |   |
| Pro forma basic  earnings per share                                                |       | 0.87     |       | 0.52     |       |
|                                                                               |       |     |       |     |       |
| Diluted earnings  per share as reported                                            |       | 0.87     |       | 0.53     |       |
| Pro forma diluted  earnings per share                                              |       | 0.80     |       | 0.48     |       |

 

The pro forma effects are computed using optionpricing models, using the following weighted-average assumptions as of grantdate.
|                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
|                     |       |     |       |     |       |
| Risk-free  interest rate |       | 3.96     | %          | 3.23     | %          |
| Expected option  life    |       | 5years   |       | 7 years  |       |
| Dividend yield           |       | 0.0      | %          | 0.0      | %          |

 

The weighted average fair value of options grantedduring the year was $4.03 for 2005, and $2.23 for 2004.

F-9

----

Stock Issuance:On June 27, 2006, the Corporation’s Registration Statement on Form S-1 (FileNo. 333-133539) was declared effective by the SEC.  Pursuant to the Registration Statement, theCorporation registered 1,150,000 shares of its common stock at a price of$18.00 per share.  On July 3, 2006, theCorporation received $16,920,000 of net proceeds from the sale of 1,000,000shares of its common stock in connection with its public offering, and on July28, the Corporation received $2,538,000 of net proceeds from the sale of150,000 additional shares of its common stock issued in connection with theunderwriters’ over-allotment option.  Asof July 28, 2006, all 1,150,000 shares offered under the Registration Statementhad been fully subscribed. FTN Midwest Securities Corp. and Sterne, Agee &Leach, Inc. were the managing underwriters for the offering.  The total expenses incurred for theCorporation’s account in connection with the issuance and distribution of thesecurities were $431,000. The net offering proceeds to the Corporation afterdeducting the total expenses were $19,027,000. These net proceeds were used to repay the $5,000,000 outstanding balanceon our revolving line of credit, to fund the continued expansion of ourfranchise and for general corporate purposes in accordance with the Corporation’sRegistration Statement on Form S-1 as amended.

In 2004, the Corporation offered 775,000 shares forsale at a price of $11.00. The offering expired July 31, 2004 with all sharessold pursuant to the offering.

Income Taxes:  Income taxexpense is the total of the current year income tax due or refundable and thechange in deferred tax assets and liabilities. Deferred tax assets andliabilities are the expected future tax amounts for the temporary differencesbetween carrying amounts and tax bases of assets and liabilities, computedusing enacted tax rates. A valuation allowance, if needed, reduces deferred taxassets to the amount expected to be realized.

Advertising Costs:  Advertisingcosts are generally charged to operations in the year incurred and totaled$206,000, $140,000, and $35,000 in 2006, 2005, and 2004.

Off-Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such ascommitments to make loans and standby letters of credit, issued to meetcustomer financing needs. The face amount for these items represents theexposure to loss, before considering customer collateral or ability to repay.Such financial instruments are recorded when they are funded.

Restrictions on Cash:  Cash onhand or on deposit with other banks of $220,000 and $101,000 was required tomeet regulatory reserve and clearing requirements at year-end 2006 and 2005respectively. These balances do not earn interest.

Dividend Restrictions:  Bankingregulations require maintaining certain capital levels and may limit thedividends paid by the Bank.

Comprehensive Income: Comprehensive income consists of net income and other comprehensive income.Other comprehensive income includes unrealized gains and losses on securitiesavailable for sale which are also recognized as separate components of equity.

Fair Value of Financial Instruments: Fair values of financial instruments are estimated using relevant marketinformation and other assumptions, as more fully disclosed in a separate note.Fair value estimates involve uncertainties and matters of significant judgmentregarding interest rates, credit risk, prepayments, and other factors, especiallyin the absence of broad markets for particular items. Changes in assumptions orin market conditions could significantly affect the estimates.

F-10

----

Adoption of NewAccounting Standards: Effective January 1, 2006, theCorporation adopted Statement of Financial Accounting Standards (“SFAS”) No.123(R), *Share-based Payment*.  See “Stock-Based Compensation” above forfurther discussion of the effect of adopting this standard.

In September 2006, the Securities and Exchange Commission (SEC) releasedStaff Accounting Bulletin No. 108, *Considering the Effects ofPrior Year Misstatements when Quantifying Misstatements in Current YearFinancial Statements (SAB 108),*which is effective for fiscal yearsending on or after November 15, 2006. SAB 108 provides guidance on how the effects of prior-year uncorrectedfinancial statement misstatements should be considered in quantifying a currentyear misstatement.  SAB 108 requirespublic companies to quantify misstatements using both an income statement(rollover) and balance sheet (iron curtain) approach and evaluate whethereither approach results in a misstatement that, when all relevant quantitativeand qualitative factors are considered, is material.  If prior year errors that had been previouslyconsidered immaterial now are considered material based on either approach, norestatement is required so long as management properly applied its previousapproach and all relevant facts and circumstances were considered.  Adjustments considered immaterial in prioryears under the method previously used, but now considered material under thedual approach required by SAB 108, are to be recorded upon initial adoption ofSAB 108.  The amount so recorded is shownas a cumulative effect adjustment and is recorded in opening retained earningsas of January 1, 2006.  The adoption ofSAB 108 had no effect on the Corporation’s financial statements for the yearending December 31, 2006.

Recently IssuedAccounting Standards: New accounting standards have beenissued that the Corporation does not expect will have a material effect on thefinancial statements when adopted in future years or for which the Corporationhas not yet completed its evaluation of the potential effect uponadoption.  In general, these standardsrevise the accounting for derivatives embedded in other financial instrumentsfor 2007, revise the recognition and accounting for servicing of financialassets for 2007, establish a hierarchy about the assumptions used to measurefair value for 2008, change the recognition threshold and measurement guidancefor tax positions that contain significant uncertainty in 2007, revise theaccrual of post-retirement benefits associated with providing life insurancefor 2008, and revise the accounting for cash surrender value for 2007.

Operating Segments:  While thechief decision-makers monitor the revenue streams of the various products andservices, the identifiable segments are not material and operations are managedand financial performance is evaluated on a Corporation-wide basis. Accordingly,all of the financial service operations are considered by management to beaggregated in one reportable operating segment.

Reclassifications:  Some itemsin the prior year financial statements were reclassified to conform to thecurrent presentation.

F-11

----

**NOTE 2 - SECURITIES**

The fair value of available for sale securities andthe related gross unrealized gains and losses recognized in accumulated othercomprehensive income (loss) were as follows:
| ** **                           | ** ** | ** ** | ** ** | **Gross**      | ** ** | **Gross**      | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **                           | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** |
| **(dollars in thousands)** | ** ** | **Value**  | ** ** | **Gains**      | ** ** | **Losses**     | ** ** |
|                                 |       |       |       |           |       |           |       |
| 2006                                 |       |       |       |           |       |           |       |
|                                 |       |       |       |           |       |           |       |
| U.S. Government  agencies            |       | $          | 45,479     |           | $          | 134            |       | $ | (514 | ) |
| Mortgage-backed  securities          |       | 6,465      |       | —         |       | (207           | )          |
| Corporate debt  securities           |       | 319        |       | —         |       | (16            | )          |
| Corporate bonds                      |       | 4,126      |       | —         |       | (34            | )          |
| Other                                |       | 554        |       | 174            |       | —         |       |
|                                 |       |       |       |           |       |           |       |
|                                 |       | $          | 56,943     |           | $          | 308            |       | $ | (771 | ) |
|                                 |       |       |       |           |       |           |       |
| 2005                                 |       |       |       |           |       |           |       |
|                                 |       |       |       |           |       |           |       |
| U.S. Government  agencies            |       | $          | 21,791     |           | $          | 7              |       | $ | (411 | ) |
| Mortgage-backed  securities          |       | 7,805      |       | —         |       | (254           | )          |
| Corporate debt  securities           |       | 399        |       | —         |       | (18            | )          |
| Corporate bonds                      |       | 1,537      |       | —         |       | (4             | ))         |
| Other                                |       | 460        |       | 80             |       | —         |       |
|                                 |       |       |       |           |       |           |       |
|                                 |       | $          | 31,992     |           | $          | 87             |       | $ | (687 | ) |

 

Contractual maturities of debt securities at December31, 2006 are shown below. Expected maturities will differ from contractualmaturities because borrowers may have the right to call or prepay obligationswith or without prepayment penalties.
| **(dollars in thousands)** | ** ** | **Fair  Value** | ** ** |
|--------------------------------------|------------|-----------------|------------|
|                                 |       |            |       |
| Due in less than  one year           |       | $               | 499        |   |
| Due after one  through five years    |       | 13,822          |       |
| Due after five  through ten years    |       | 20,878          |       |
| Due after ten  years                 |       | 15,279          |       |
| Mortgage-backed  securities          |       | 6,465           |       |
|                                 |       |            |       |
|                                 |       | $               | 56,943     |   |

 

Gross gains of $0, $4,000, and $33,000 on sales ofsecurities were recognized in 2006, 2005, and 2004. Securities carried at$10,535,000 and $7,112,000 at December 31, 2006 and 2005 were pledged to securedeposits and for other purposes as required or permitted by law.

Restricted equity securities consist of securitieswhich are restricted as to transferability. These securities are recorded atcost.
| **(dollars in thousands)** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Federal Home Loan Bank  stock        |       | $        | 633        |     | $          | 383 |   |
|                                      |            |          |            |          |            |  |  |

 

F-12

----

Securities with unrealized losses at year-end 2006 and2005, and the length of time they have been in continuous loss positions are asfollows:
| ** **                           | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                           | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(dollars in thousands)** | ** ** | **Value**                              | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2006                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S.Government  agencies             |       | $                                      | 22,721     |                                 | $          | 94        |       | $ | 22,758 |   | $ | 420 |   | $ | 45,479 |   | $ | 514 |   |
| Corporate Bonds                      |       | —                                 |       | —                               |       | 4,126     |       | 34 |   | 4,126 |   | 34 |   |
| Corporate Debt  Securities           |       | —                                 |       | —                               |       | 319       |       | 16 |   | 319 |   | 16 |   |
| Mortgage-backed  securities          |       | —                                 |       | —                               |       | 6,465     |       | 207 |   | 6,465 |   | 207 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| Total  temporarily impaired          |       | $                                      | 22,721     |                                 | $          | 94        |       | $ | 33,668 |   | $ | 677 |   | $ | 56,389 |   | $ | 771 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2005                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S.Government  agencies             |       | $                                      | 14,558     |                                 | $          | 155       |       | $ | 7,233 |   | $ | 256 |   | $ | 21,791 |   | $ | 411 |   |
| Corporate Bonds                      |       | 1,537                                  |       | 4                                    |       | —    |       | — |   | 1,537 |   | 4 |   |
| Corporate Debt  Securities           |       | —                                 |       | —                               |       | 399       |       | 18 |   | 399 |   | 18 |   |
| Mortgage-backed  securities          |       | 1,873                                  |       | 35                                   |       | 5,932     |       | 219 |   | 7,805 |   | 254 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| Total temporarily  impaired          |       | $                                      | 17,968     |                                 | $          | 194       |       | $ | 13,564 |   | $ | 493 |   | $ | 31,532 |   | $ | 687 |   |

 

Unrealized losseson securities have not been recognized into income because the securities arebacked by the U.S. government or its agencies, management has the intent andability to hold for the foreseeable future, and the decline in fair value islargely due to increases in market interest rates. The unrealized losses onmortgage-backed securities and corporate securities have not been recognizedinto income because management has the intent and ability to hold for theforeseeable future, and the decline in fair value is largely due to increasesin market interest rates. The fair value of the securities above is expected torecover as the securities approach their maturity dates and/or market ratesdecline.

F-13

----

## **NOTE 3 - LOANS**

A summary of loans outstanding by category at December31:
| **(dollars in thousands)**    | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
| Real estate:                            |       |     |       |     |       |
| Construction                            |       | $        | 74,482     |     | $          | 38,279 |   |
| 1 to 4 family residential               |       | 22,873   |       | 18,358   |       |
| Other                                   |       | 83,985   |       | 50,371   |       |
| Commercial,  financial and agricultural |       | 353,996  |       | 233,948  |       |
| Consumer                                |       | 3,246    |       | 3,149    |       |
| Other                                   |       | 6,936    |       | 4,481    |       |
|                                    |       | 545,518  |       | 348,586  |       |
| Less: Allowance  for loan losses        |       | (6,968   | )          | (4,399   | )          |
|                                    |       |     |       |     |       |
| Net loans                               |       | $        | 538,550    |     | $          | 344,187 |   |

 

The Bank records a transfer of financial assets as asale when it surrenders control over those financial assets to the extent thatconsideration other than beneficial interests in the assets is received inexchange. The amount of the proceeds for loans that were transferred withrecourse that were recorded as sales for each period follows.
| (dollars in thousands)               | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                           |       |     |       |     |       |     |       |
| Proceeds from  loans transferred with recourse |       | $        | 26,022     |     | $          | 19,571   |       | $ | 2,302 |   |
|                                                |            |          |            |          |            |          |            |  |  |  |

 

The Bank services loans for the benefit of others. Theamount of loans being serviced for the benefit of others at year end for eachperiod follows.
| ** **                           | ** ** | **December  31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|
| **(dollars in thousands)** | ** ** | **2006**          | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                 |       |              |       |   |   |   |   |
| Amount of loans being  serviced      |       | $                 | 66,465     |   | $ | 36,094 |   | $ | 19,157 |   |
|                                      |            |                   |            |  |  |  |  |  |  |  |

 

Certain parties (principally executive officers anddirectors of the Bank including their related interests) were customers of, andhad loans with the Bank in the ordinary course of business. These loantransactions were made on substantially the same terms as those prevailing atthe time for comparable loans to other persons. They did not involve more thanthe normal risk of collectibility or present other unfavorable features.

F-14

----

Loans to principal officers, directors, and theiraffiliates in 2006 were as follows.
| (dollars in thousands) | ** ** | **2006** | ** ** |
|----------------------------------|------------|----------|------------|
|                             |       |     |       |
| Beginning balance                |       | $        | 6,465      |   |
| New loans                        |       | 3,788    |       |
|                             |       |     |       |
| Repayments                       |       | (1,529   | )          |
|                             |       |     |       |
| Ending balance                   |       | $        | 8,724      |   |

 

**NOTE 4 – ALLOWANCE FOR LOAN LOSSES**

Changes in the allowance for loan losses were asfollows:
| (dollars in thousands)        | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |     |       |
| Balance at beginning of year            |       | $        | 4,399      |     | $          | 2,841    |       | $ | 2,000 |   |
| Provision charged to operating expenses |       | 4,350    |       | 3,700    |       | 2,420    |       |
| Loans charged-off                       |       | (2,037   | )          | (2,411   | )          | (1,655   | )          |
| Recoveries                              |       | 256      |       | 269      |       | 76       |       |
|                                    |       |     |       |     |       |     |       |
| Balance at end  of year                 |       | $        | 6,968      |     | $          | 4,399    |       | $ | 2,841 |   |

 

Impaired loans were as follows:
| (dollars in thousands)                     | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |
| Loans with  allocated allowance for loan losses      |       | $        | 2,689      |     | $          | 2,928 |   |
|                                                 |       |     |       |     |       |
| Amount of the allowance  for loan losses unallocated |       | $        | 1,539      |     | $          | 942 |   |

 
|                                            | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |     |       |
| Average of impaired  loans during the year |       | $        | 2,719      |     | $          | 4,444    |       | $ | 1,430 |   |
|                                            |            |          |            |          |            |          |            |  |  |  |

 

The amount of interest income recognized for the timethat these loans were impaired during 2006, 2005, and 2004 was not material tothe financial statements.

Nonperforming loans were as follows:
| (dollars in thousands)             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                         |       |     |       |     |       |     |       |
| Loans past due over 90 days still on accrual |       | $        | 940        |     | $          | 352      |       | $ | 111 |   |
| Nonaccrual loans                             |       | 2,689    |       | 2,928    |       | 2,161    |       |
|                                              |            |          |            |          |            |          |            |  |  |  |

 

Nonperforming loans include both smaller balancehomogeneous loans that are collectively evaluated for impairment andindividually classified impaired loans.

F-15

----

**NOTE 5 – PREMISES AND EQUIPMENT**

The following is a summary of premises and equipmentas of December 31, 2006 and 2005. Depreciation expense for 2006, 2005, and 2004was $259,000, $171,000, and $165,000.
| (dollars in thousands) | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
|                             |       |     |       |     |       |
| Leasehold improvements           |       | $        | 901        |     | $          | 440 |   |
| Furniture and equipment          |       | 1,645    |       | 983      |       |
|                             |       | 2,546    |       | 1,423    |       |
| Less: Allowance for depreciation |       | 913      |       | 654      |       |
|                             |       |     |       |     |       |
|                             |       | $        | 1,633      |     | $          | 769 |   |

 

The Bank leases office space, furniture and equipmentunder operating leases. Rent expense recognized in 2006, 2005, and 2004 amountedto $352,000, $268,000, and $226,000. The remaining minimum lease paymentsrelated to the leases are as follows, before considering renewal options thatgenerally are present.
| (dollars in thousands) | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|
| 2007                             |       | $          | 353        |   |
| 2008                             |       | 346        |       |
| 2009                             |       | 348        |       |
| 2010                             |       | 353        |       |
|                             |       |       |       |
|                             |       | $          | 1,400      |   |

 

## **NOTE 6 - DEPOSITS**

Time deposits greater than $100,000 amounted to$227,917,000 in 2006 and $122,798,000 in 2005.

At December 31, 2006, scheduled maturities of timedeposits are as follows:
| (dollars in thousands) | ** ** | ** ** | ** ** |
|----------------------------------|------------|------------|------------|
|                             |       |       |       |
| 2007                             |       | $          | 316,813    |   |
| 2008                             |       | 45,873     |       |
| 2009                             |       | 16,460     |       |
| 2010                             |       | 32,809     |       |
| 2011                             |       | 4,272      |       |
|                                  |            |            |            |  |

 

Deposits held at the Bank by directors, executiveofficers, and their related interests were approximately $7,958,000 and$8,867,000 at December 31, 2006 and 2005.

F-16

----

**NOTE 7 - ADVANCES FROM FEDERAL HOMELOAN BANK AND OTHER DEBT**

The Federal Home Loan Bank (FHLB) of Cincinnatiadvances funds to the Bank with the requirement that the advances are securedby securities and qualifying loans, essentially home mortgages (1-4 familyresidential). The Bank has an available line of $11,047,407 with FHLB. Toparticipate in this program, the Bank is required to be a member of the FederalHome Loan Bank and own stock in the FHLB. The Corporation has $633,000 of suchstock at December 31, 2006 to satisfy this requirement.

At December 31, 2006, the Bank had received noadvances from the FHLB and therefore had pledged no securities or qualifyingloans.

The Bank has approximately $25,400,000 in availablefederal funds lines (or the equivalent thereof) with correspondent banks.

**NOTE 8 – INCOME TAXES**

Income tax expense (benefit) recognized in each yearis made up of current and deferred Federal and State tax amounts shown below:
| (dollars in thousands) | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                             |       |     |       |     |       |     |       |
| Current Federal                  |       | $        | 2,730      |     | $          | 1,385    |       | $ | 852 |   |
| Current State                    |       | 453      |       | 286      |       | 174      |       |
| Deferred Federal                 |       | (164     | )          | 213      |       | 46       |       |
| Deferred State                   |       | (34      | )          | 41       |       | 10       |       |
|                             |       |     |       |     |       |     |       |
|                             |       | $        | 2,985      |     | $          | 1,925    |       | $ | 1,082 |   |

 

The tax effect of each type of temporary differencethat results in net deferred tax assets and liabilities is as follows:
| (dollars in thousands) | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Asset  (liability)               |       |     |       |     |       |
| Allowance for loan losses        |       | $        | 1,994      |     | $          | 936 |   |
| Tax leases                       |       | (895     | )          | (302     | )          |
| Unrealized loss on securities    |       | 175      |       | 228      |       |
| Depreciation                     |       | (47      | )          | (60      | )          |
| SFAS 140 income adjustments      |       | (792     | )          | (382     | )          |
| Other, net                       |       | 200      |       | 70       |       |
|                             |       |     |       |     |       |
| Balance at end  of year          |       | $        | 635        |     | $          | 490 |   |

 

F-17

----

A reconciliation of the amount computed by applyingthe federal statutory rate (34%) to pretax income with income tax expense(benefit) follows:
| (dollars in thousands) | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                             |       |     |       |     |       |     |       |
| Tax expense at statutory rate    |       | $        | 2,630      |     | $          | 1,698    |       | $ | 934 |   |
| State income tax effect          |       | 277      |       | 216      |       | 120      |       |
| Other                            |       | 78       |       | 11       |       | 28       |       |
|                             |       |     |       |     |       |     |       |
| Income tax  expense              |       | $        | 2,985      |     | $          | 1,925    |       | $ | 1,082 |   |

 

## **NOTE 9 – COMMITMENTS AND CONTINGENCIES**

The Bank is a party to financial instruments withoff-balance sheet risk in the normal course of business to meet the financingneeds of its customers. These financial instruments include commitments toextend credit, standby letters of credit and financial guarantees. Thoseinstruments involve, to varying degrees, elements of credit risk in excess ofthe amount recognized in the balance sheet. The contract or notional amounts ofthose instruments reflect the extent of involvement the Bank has in thoseparticular financial instruments.

The Bank’s exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit, standby letters of credit and financial guarantees isrepresented by the contractual or notional amount of those instruments. TheBank uses the same credit policies in making commitments and conditionalobligations as it does for on-balance sheet instruments.

Financial instruments whose contract amounts representcredit risk:
|                                                     | ** ** | **2006**  | ** ** | **2005**     | ** ** |
|-----------------------------------------------------|------------|-----------|------------|--------------|------------|
| ** **                                          | ** ** | **Fixed** | ** ** | **Variable** | ** ** | **Fixed** | ** ** | **Variable** | ** ** |
| **(dollars in thousands)**                | ** ** | **Rate**  | ** ** | **Rate**     | ** ** | **Rate** | ** ** | **Rate** | ** ** |
|                                                |       |      |       |         |       |   |   |   |   |
| Commitments to extend credit                        |       | $         | 9,601      |         | $          | 65,123 |   | $ | 2,404 |   | $ | 38,859 |   |
| Standby letters  of credit and financial guarantees |       | —    |       | 5,776        |       | — |   | 5,686 |   |
|                                                     |            |           |            |              |            |  |  |  |  |  |  |  |  |

 

Commitments to make loans are generally made forperiods of one year or less. The fixed rate loan commitments have interestrates ranging from 6.00% to 10.25% and maturities ranging from 6 months to 6years.

F-18

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## Commitments to extend credit are agreements tolend to a customer as long as there is no violation of any conditionestablished in the contract. Commitments generally have fixed expiration datesor other termination clauses and may require payment of a fee. Since many ofthe commitments are expected to expire without being drawn upon, the totalcommitment amounts do not necessarily represent future cash requirements. TheBank evaluates each customer’s creditworthiness on a case-by-case basis. Theamount of collateral obtained if deemed necessary by the Bank upon extension ofcredit is based on management’s credit evaluation. Collateral held varies butmay include accounts receivable, inventory, property, plant and equipment, andincome-producing commercial properties.

Standby letters of credit are conditional commitmentsissued by the Bank to guarantee the performance of a customer to a third party.Those guarantees are primarily issued to support public and private borrowingarrangements, including commercial paper, bond financing, and similartransactions. All letters of credit are due within one year or less of theoriginal commitment date. The credit risk involved in issuing letters of creditis essentially the same as that involved in extending loan facilities tocustomers.

The Bank primarily serves customers located in MiddleTennessee. As such, the Bank’s loans, commitments and letters of credit havebeen granted to customers in that area. Concentration of credit by type of loanis presented in Note 3.

## **NOTE 10 – EMPLOYEE BENEFITS**

The Bank maintains a 401(k) plan for all employees whohave satisfied the minimum age and service requirements. The Bank may makediscretionary contributions and employees vest in employer contributions overfive years. The Bank made no contributions to the plan during 2006, 2005 and2004.

F-19

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**NOTE 11 – REGULATORY MATTERS**

Under capital adequacy guidelines and the regulatoryframework for prompt corrective action, the Corporation and the Bank arerequired to meet specific capital adequacy guidelines that involve quantitativemeasures of a bank’s assets, liabilities, and certain off-balance sheet itemsas calculated under regulatory accounting practices. Failure to meet minimum capitalrequirements can initiate certain mandatory and possible additionaldiscretionary actions by regulators that, if undertaken, could have a materialeffect on the Bank’s financial condition.

The Corporation and the Bank’s capital amounts andclassifications are also subject to qualitative judgments by the regulatorsabout components, risk weightings, and other factors. The risk-based guidelinesare based on the assignment of risk weights to assets and off-balance sheetitems depending on the level of credit risk associated with them. In additionto minimum capital requirements, under the regulatory framework for promptcorrective action, regulatory agencies have specified certain ratios aninstitution must maintain to be considered “undercapitalized”, “adequatelycapitalized”, and “well capitalized”. As of December 31, 2006 and 2005, themost recent notification from the Bank’s regulatory authority categorized theCorporation and the Bank as “well capitalized”. There are no conditions orevents since that notification that management believes have changed theCorporation and the Bank’s category.

The Bank and the Corporation’s capital amounts andratios at December 31, 2006 and 2005 are as follows:
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                           | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(dollars in thousands)** | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 2006                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based                     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 59,514     |                       | 10.5       | %                          | $          | 45,561                     |       | 8.0                        | %          | $ | 56,951 |   | 10.0 | % |
| Corporation                          |       | $          | 66,478     |                       | 11.7       | %                          | $          | 45,561                     |       | 8.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 to  risk-based                |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 52,547     |                       | 9.2        | %                          | $          | 22,781                     |       | 4.0                        | %          | $ | 34,171 |   | 6.0 | % |
| Corporation                          |       | $          | 59,511     |                       | 10.5       | %                          | $          | 22,781                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 leverage                      |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 52,547     |                       | 8.8        | %                          | $          | 23,949                     |       | 4.0                        | %          | $ | 29,936 |   | 5.0 | % |
| Corporation                          |       | $          | 59,511     |                       | 9.9        | %                          | $          | 23,959                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 2005                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based                     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 38,250     |                       | 10.5       | %                          | $          | 29,132                     |       | 8.0                        | %          | $ | 36,415 |   | 10.0 | % |
| Corporation                          |       | $          | 39,201     |                       | 10.8       | %                          | $          | 29,111                     |       | 8.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 to  risk-based                |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 33,851     |                       | 9.3        | %                          | $          | 14,566                     |       | 4.0                        | %          | $ | 21,849 |   | 6.0 | % |
| Corporation                          |       | $          | 34,802     |                       | 9.6        | %                          | $          | 14,566                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 leverage                      |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 33,851     |                       | 9.1        | %                          | $          | 14,559                     |       | 4.0                        | %          | $ | 18,599 |   | 5.0 | % |
| Corporation                          |       | $          | 34,802     |                       | 9.3        | %                          | $          | 14,969                     |       | 4.0                        | %          | n/a |   |   |   |

 

F-20

----

 

**NOTE 12 – STOCK OPTIONS**

The following is a summary of certain rights andprovisions of the options the Corporation has issued. All options and therelated strike price reflect the impact of the two-for-one stock split onDecember 31, 2003. All options expire ten years from the date of grant.

The original fourteen incorporators and members of theBoard of Directors were granted an aggregate of 122,500 options to purchaseshares at $5.00 per share in connection with organization activities. Each ofthe 122,500 options were immediately vested on the date of grant. In 2002 and2006, 10,000 and 11,000 options respectively were exercised leaving 101,500options outstanding to purchase shares.

In August 2003, the Board of Directors approved anoption plan for active directors and incorporators in recognition of their fouryears of service to the Bank without compensation. An aggregate of 320,000options to purchase shares at a price of $10.50 per share were included in thisplan. The 320,000 options were immediately vested on the date of grant. In2006, 50,000 options were exercised leaving 270,000 options outstanding topurchase shares.

Pursuant to employment agreements, executive officersreceived options equal to 14% of the shares sold in the original offering at anexercise price of $5.00 per share. Based on the initial sale of 1,817,440shares, executive officer options totaled 254,440 and vest over three years. Ofthis total, 24,232 options were exercised and 12,116 options were forfeited in2002, and 2,000 options were exercised in 2004. In 2006, 1,000 options wereexercised leaving an outstanding balance of 215,092 options to purchase shares.In February 2003, three executive officers were granted 30,000 options each atan exercise price of $7.50 to vest over three years. In March 2004, threeexecutive officers were granted 20,000 options each at an exercise price of$11.00. These options were immediately vested on the date of grant. In August2005, one executive officer was granted 5,000 options. Of these 2,500 optionsimmediately vested and the remaining vested one year later. In November 2005,one executive officer was granted 6,250 options that immediately vested. Ofthese 2005 grants, all 11,250 options were outstanding at December 31, 2006.

The Board of Directors has granted incentive optionsto various employees who are not executive officers. Incentive options are usedfor recruiting and retention purposes and to recognize performance. Employeeincentive options include 13,000 options to purchase shares at $5.00 per sharegranted in 2000 and 2001. 5,000 options to purchase shares have been forfeitedby former employees, 3,000 options were exercised on December 31, 2003, and1,000 options were exercised in 2004. The remaining 4,000 are fully vested. InMarch 2003, 9,000 options to purchase shares at $7.50 per share were granted.In December 2003, 31,000 options to purchase shares at $10.50 per share weregranted. Of these, 5,000 options were forfeited in 2004. In 2006, 1,000 optionswere exercised leaving 25,000 options to purchase shares. All of theseincentive options vested in two years. In July 2005 and August 2005, 69,000 and10,000 options respectively were granted. On each grant date half immediatelyvested with the remaining options vesting one year later. In November 2005,10,000 options were granted to employees and were immediately vested. Of these2005 grants, 3,750 options were forfeited leaving 85,250 options outstanding topurchase shares.

F-21

----

A summary of theactivity in the plan is as follows:
|                                   | ** ** | **2006**   | ** ** | **2005**     | ** ** | **2004**   | ** ** |
|-----------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                        | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                        | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                        | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                              |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding at  beginning of year |       | 937,842    |       | $            | 8.85       |       | 837,592    |   | $ | 7.99 |   | 785,592 |   | $ | 7.77 |   |
| Granted                           |       | —     |       | —       |       | 100,250    |       | 16.00 |   | 60,000 |   | 11.00 |   |
| Exercised                         |       | (63,000    | )          | 9.45         |       | —     |       | — |   | (3,000 | ) | 5.00 |   |
| Forfeited or  expired             |       | (3,750     | )          | 16.00        |       | —     |       | — |   | (5,000 | ) | 10.50 |   |
|                              |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding  at end of year  |       | 871,092    |       | $            | 8.78       |       | 937,842    |   | $ | 8.85 |   | 837,592 |   | $ | 7.99 |   |
|                              |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options exercisable at  year-end  |       | 871,092    |       |         |       | 865,842    |       |   |   | 757,592 |   |   |   |

 

At December 31, 2006, options outstanding had aweighted average remaining contractual term of 5.3 years and an aggregateintrinsic value of $19,573,437. At December 31, 2006, options exercisable had aweighted average remaining contractual term of 5.3 years and an aggregateintrinsic value of $19,573,437. During the years ended December 31, 2006, 2005and 2004, the aggregate intrinsic value of options exercised under our stockoption plans was $667,500, $0 and $18,000 respectively. As of December 31,2006, there was no unrecognized compensation costs related to nonvested stockoptions granted.

Options outstanding at year-end 2006 were as follows:
| ** **              | ** ** | **Outstanding** | ** ** | **Exerciseable** | ** ** |
|-------------------------|------------|-----------------|------------|------------------|------------|
| ** **              | ** ** | ** **      | ** ** | **Weighted**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **      | ** ** | **Average**      | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **      | ** ** | **Remaining**    | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Exercise**            | ** ** | ** **      | ** ** | **Contractual**  | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| **Prices**              | ** ** | **Number**      | ** ** | **Life**         | ** ** | **Number** | ** ** | **Price** | ** ** |
|                    |       |            |       |             |       |   |   |   |   |
| $5.00                   |       | 320,592         |       | 3.0 years        |       | 320,592 |   | $ | 5.00 |   |
| $7.50                   |       | 99,000          |       | 6.0 years        |       | 99,000 |   | $ | 7.50 |   |
| $10.50                  |       | 295,000         |       | 6.0 years        |       | 295,000 |   | $ | 10.50 |   |
| $11.00                  |       | 60,000          |       | 7.0 years        |       | 60,000 |   | $ | 11.00 |   |
| $16.00                  |       | 96,500          |       | 8.8 years        |       | 96,500 |   | $ | 16.00 |   |
|                    |       |            |       |             |       |   |   |   |   |
| Outstanding at year-end |       | 871,092         |       | 5.3 years        |       | 871,092 |   | $ | 8.78 |   |

 

F-22

----

**NOTE 13 –FAIR VALUES OF FINANCIAL INSTRUMENTS**

The methods and assumptions used to estimate fairvalue are described as follows:

Carrying amount is the estimated fair value for cashand due from financial institutions, federal funds sold and purchased, accruedinterest receivable and payable, demand deposits, and variable rate loans ordeposits that reprice frequently and fully. Security fair values are based onmarket prices or dealer quotes, and if no such information is available, on therate and term of the security and information about the issue. For fixed rateloans or deposits and for variable rate loans or deposits with infrequentrepricing or repricing limits, fair value is based on discounted cash flowsusing current market rates applied to the estimated life and credit risk. Thefair value of the subordinated long term debt is based on discounted cash flowsusing current market rates applied to the estimated life of the debt. Otherassets and accrued liabilities are carried at fair value. The fair value ofoff-balance-sheet loan commitments is considered nominal.

The estimated fair values of the Bank’s financialinstruments at December 31, 2006 and 2005 were as follows:
| ** **                               | ** ** | **2006**     | ** ** | **2005**  | ** ** |
|------------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                               | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(dollars in thousands)**     | ** ** | **Amount**   | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets                         |       |         |       |      |       |   |   |   |   |
| Cash and due from financial institutions |       | $            | 177        |      | $          | 177 |   | $ | 6,877 |   | $ | 6,877 |   |
| Federal funds sold                       |       | 13,820       |       | 13,820    |       | 12,535 |   | 12,535 |   |
| Securities available for sale            |       | 56,943       |       | 56,943    |       | 31,992 |   | 31,992 |   |
| Loans, net                               |       | 538,550      |       | 537,756   |       | 344,187 |   | 347,646 |   |
| Accrued interest receivable              |       | 4,116        |       | 4,116     |       | 2,148 |   | 2,148 |   |
| Restricted equity securities             |       | 633          |       | 633       |       | 383 |   | 383 |   |
| Financial  liabilities                   |       |         |       |      |       |   |   |   |   |
| Deposits                                 |       | $            | 560,567    |      | $          | 562,175 |   | $ | 367,705 |   | $ | 367,544 |   |
| Accrued interest payable                 |       | 1,728        |       | 1,728     |       | 1,126 |   | 1,126 |   |
| Subordinated  long term debt             |       | 8,248        |       | 8,066     |       | 8,248 |   | 8,316 |   |

 

F-23

----

**NOTE 14 – EMPLOYMENT AGREEMENTS**

The Corporation has entered into two-yearautomatically renewable employment agreements with four executive officers. Inthe event of a change in control of the Corporation, or an officer isterminated without cause, the Corporation has an obligation to pay 2.99 timesthe officer’s annual salary and bonus which combined is not to be less than theprevious year’s salary and bonus.

**NOTE 15 – SHAREHOLDERS’ EQUITY**

The Corporation’s charter authorizes 1,000,000 sharesof preferred stock, no par value. Shares of the preferred stock may be issuedfrom time to time in one or more series, each such series to be so designatedas to distinguish the shares from the shares of all other series and classes.The Board of Directors has the authority to divide any or all classes ofpreferred stock into series and to fix and determine the relative rights andpreferences of the shares of any series so established. The Board currently hasno intent to issue such preferred stock.

The Corporation’s charter authorizes 10,000,000 sharesof common stock at a $.50 par value (after two-for-one stock split). A two-for-onestock split was distributed to shareholders of record on December 31, 2003resulting in the issuance of 1,230,337 shares of common stock. The stock splitincreased the number of outstanding shares of Common Stock to 2,460,674 andreduced the par value per share to $0.50. Share data and all relevant portionsof the presented financial statements and notes have been adjusted to reflectthe stock split.

In January 2000, 1,819,440 common shares were issuedat $5.00 per share. In December 2002, 166,656 common shares were issued at$7.50 per share and 34,232 common shares were purchased through the exercise ofstock options. In June through August 2003, 437,346 common shares were issuedat $9.00 per share and 3,000 common shares were purchased through the exerciseof stock options. In March through August 2004, 775,000 common shares wereissued at $11.00 per share and 3,000 common shares were purchased through theexercise of stock options. On July 3, 2006, the Corporation issued 1,000,000shares of its common stock at a price of $18.00 per share in connection withits public offering, and on July 28, the Corporation issued 150,000 additionalshares of its common stock at a price of $18.00 per share in connection withthe underwriters’ over-allotment option. An additional 63,000 shares werepurchased in 2006 through the exercise of stock options. At December 31, 2006,4,451,674 common shares are outstanding.

F-24

----

**NOTE 16 – PARENT COMPANY ONLYCONDENSED FINANCIAL INFORMATION**

Condensed financial information of Tennessee CommerceBancorp, Inc. follows.

**CONDENSED BALANCE SHEETS**
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| **(dollars in thousands)** | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ASSETS                               |       |                  |       |   |   |
| Cash and cash  equivalents           |       | $                     | 6,308      |   | $ | 800 |   |
| Investment in  banking subsidiary    |       | 52,260                |       | 33,479 |   |
| Interest  receivable                 |       | 1                     |       | 1 |   |
| Other                                |       | 1,204                 |       | 421 |   |
|                                 |       |                  |       |   |   |
| Total assets                         |       | $                     | 59,773     |   | $ | 34,701 |   |
|                                 |       |                  |       |   |   |
| LIABILITIES AND  EQUITY              |       |                  |       |   |   |
| Interest Payable                     |       | $                     | 23         |   | $ | 23 |   |
| Other short term  payables           |       | 278                   |       | — |   |
| Subordinated  long term debt         |       | 8,248                 |       | 8,248 |   |
| Shareholders’  equity           |       | 51,224                |       | 26,430 |   |
|                                 |       |                  |       |   |   |
| Total liabilities and  equity        |       | $                     | 59,773     |   | $ | 34,701 |   |

 

**CONDENSED STATEMENTS OF INCOME**
| ** **                                                           | ** ** | **For Years ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                 |       |                                                 |       |   |   |   |   |
| Dividend and  interest income                                        |       | $                                                    | 17         |   | $ | 12 |   | — |   |
| Interest expense                                                     |       | (597                                                 | )          | (416 | ) | — |   |
| Non-interest  expense                                                |       | (826                                                 | )          | (46 | ) | (34 | ) |
|                                                                 |       |                                                 |       |   |   |   |   |
| Income (loss)  before income tax and undistributed subsidiary income |       | (1,406                                               | )          | (450 | ) | (34 | ) |
| Income Tax  (Expense) Benefit                                        |       | 542                                                  |       | 173 |   |   |   |
| Equity in  undistributed subsidiary income                           |       | 5,613                                                |       | 3,344 |   | 1,700 |   |
|                                                                 |       |                                                 |       |   |   |   |   |
| Net income                                                           |       | $                                                    | 4,749      |   | $ | 3,067 |   | $ | 1,666 |   |
|                                                                      |            |                                                      |            |  |  |  |  |  |  |  |

 

F-25

----

**CONDENSED STATEMENTS OF CASH FLOWS**
| ** **                                                      | ** ** | **For Years ended December 31,** | ** ** |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                      | ** ** | **2006**                                             | ** ** | **2005** | ** ** | **2004** | ** ** |
| Cash flows from  operating activities                           |       |                                                 |       |   |   |   |   |
| Net income                                                      |       | $                                                    | 4,749      |   | $ | 3,067 |   | $ | 1,666 |   |
| Adjustments:                                                    |       |                                                 |       |   |   |   |   |
| Change in other assets and liabilities                          |       | (507                                                 | )          | (150 | ) | — |   |
| Equity in undistributed subsidiary income                       |       | (5,613                                               | )          | (3,344 | ) | (1,700 | ) |
| Net cash from operating activities                              |       | (1,371                                               | )          | (427 | ) | (34 | ) |
|                                                            |       |                                                 |       |   |   |   |   |
| Cash flows from  investing activities                           |       |                                                 |       |   |   |   |   |
| Investments in subsidiaries                                     |       | (13,000                                              | )          | (7,000 | ) | (8,325 | ) |
| Other assets                                                    |       | —                                               |       | (248 | ) | — |   |
|                                                            |       |                                                 |       |   |   |   |   |
| Net cash from investing activities                              |       | (13,000                                              | )          | (7,248 | ) | (8,325 | ) |
|                                                            |       |                                                 |       |   |   |   |   |
| Cash flows from  financing activities                           |       |                                                 |       |   |   |   |   |
| Proceeds from subordinated long term debt                       |       | —                                               |       | 8,248 |   | — |   |
| Proceeds from stock issue                                       |       | 19,027                                               |       | — |   | 8,525 |   |
| Proceeds from exercise of stock options and excess  tax benefit |       | 852                                                  |       | — |   | 19 |   |
| Net cash from financing activities                              |       | 19,879                                               |       | 8,248 |   | 8,544 |   |
|                                                            |       |                                                 |       |   |   |   |   |
| Net change in  cash and cash equivalents                        |       | 5,508                                                |       | 573 |   | 185 |   |
|                                                            |       |                                                 |       |   |   |   |   |
| Beginning cash  and cash equivalents                            |       | 800                                                  |       | 227 |   | 42 |   |
|                                                            |       |                                                 |       |   |   |   |   |
| Ending cash and cash  equivalents                               |       | $                                                    | 6,308      |   | $ | 800 |   | $ | 227 |   |

 

F-26

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**NOTE 17 – EARNINGS PER SHARE**

The factors used in the earnings per share computationfollow.
| **(dollars in thousands except share data)**           | ** ** | **2006**  | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|---------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Basic                                                                           |       |      |       |      |       |      |       |
| Net income                                                                      |       | $         | 4,749      |      | $          | 3,067     |       | $ | 1,666 |   |
|                                                                            |       |      |       |      |       |      |       |
| Weighted average common shares outstanding                                      |       | 3,822,655 |       | 3,238,674 |       | 2,933,818 |       |
|                                                                            |       |      |       |      |       |      |       |
| Basic earnings per common share                                                 |       | $         | 1.24       |      | $          | 0.95      |       | $ | 0.57 |   |
|                                                                            |       |      |       |      |       |      |       |
| Diluted                                                                         |       |      |       |      |       |      |       |
| Net income                                                                      |       | $         | 4,749      |      | $          | 3,067     |       | $ | 1,666 |   |
|                                                                            |       |      |       |      |       |      |       |
| Weighted average common shares outstanding for basic  earnings per common share |       | 3,822,655 |       | 3,238,674 |       | 2,933,818 |       |
| Add: Dilutive effects of assumed exercises of stock  options                    |       | 334,683   |       | 278,734   |       | 232,976   |       |
|                                                                            |       |      |       |      |       |      |       |
| Average shares and dilutive potential common shares                             |       | 4,157,338 |       | 3,517,408 |       | 3,166,794 |       |
|                                                                            |       |      |       |      |       |      |       |
| Diluted earnings per common share                                               |       | $         | 1.14       |      | $          | 0.87      |       | $ | 0.53 |   |

 

No options were antidilutive for 2006, 2005 and 2004.

 

F-27

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**NOTE 18 – TRUST PREFERRED SECURITIES**

In March 2005, the Corporation formed a financing subsidiary,Tennessee Commerce Statutory Trust I, a Delaware statutory trust (the Trust).In March 2005, the Trust issued and sold 8,000 of the Trust’s fixed/floatingrate capital securities, with a liquidation amount of $1,000 per capitalsecurity, to First Tennessee Bank National Association. The securities pay afixed rate of 6.73% payable quarterly for the first five years and a floatingrate based on a 3 month Libor rate plus 1.98% thereafter. At the same time, theCorporation issued to the Trust $8,248,000 of fixed/floating rate juniorsubordinated deferrable interest debentures due 2035. The Corporationguarantees the payment of distributions and payments for redemptions orliquidation of the capital securities. The Trust Preferred Securities qualify as“Tier I Capital” under current regulatory definitions subject to certainlimitations.

The debentures pay a fixed rate of 6.73% payablequarterly for the first five years and a floating rate based on a 3 month Liborrate plus 1.98% thereafter. The distributions on the capital securities areaccounted for as interest expense by the Corporation. Interest payments on thedebentures and the corresponding distributions on the capital securities may bedeferred at any time at the election of the Corporation for up to 20consecutive quarterly periods (5 years). The capital securities and debenturesare redeemable at any time commencing in 2010 at par. The Corporation willreport as liabilities the subordinated debentures issued by the Corporation andheld by the Trust.

**NOTE 19 – QUARTERLY FINANCIAL RESULTS(UNAUDITED)**

A summary of selected consolidated quarterly financialdata for the years ended December 31, 2006 and 2005 follows:
| ** **                                               | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(in thousands except share data)** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| 2006                                                     |       |        |       |        |       |        |       |        |       |
| Interest income                                          |       | $           | 8,404      |        | $          | 9,354       |       | $           | 11,000     |   | $ | 12,487 |   |
| Net interest  income                                     |       | 4,255       |       | 4,443       |       | 5,126       |       | 5,553       |       |
| Provision for  loan losses                               |       | 1,000       |       | 1,000       |       | 1,150       |       | 1,200       |       |
| Income before  taxes                                     |       | 1,482       |       | 1,516       |       | 2,164       |       | 2,572       |       |
| Net income                                               |       | 909         |       | 932         |       | 1,330       |       | 1,578       |       |
| Basic earnings  per share                                |       | $           | .28        |        | $          | .29         |       | $           | .31        |   | $ | .36 |   |
| Diluted earnings  per share                              |       | $           | .25        |        | $          | .27         |       | $           | .29        |   | $ | .33 |   |
|                                                     |       |        |       |        |       |        |       |        |       |
| 2005                                                     |       |        |       |        |       |        |       |        |       |
| Interest income                                          |       | $           | 4,673      |        | $          | 5,548       |       | $           | 6,373      |   | $ | 7,039 |   |
| Net interest  income                                     |       | 3,048       |       | 3,342       |       | 3,606       |       | 3,631       |       |
| Provision for  loan losses                               |       | 650         |       | 1,150       |       | 1,000       |       | 900         |       |
| Income before  taxes                                     |       | 1,081       |       | 1,096       |       | 1,272       |       | 1,543       |       |
| Net income                                               |       | 662         |       | 621         |       | 720         |       | 1,064       |       |
| Basic earnings  per share                                |       | $           | .20        |        | $          | .19         |       | $           | .22        |   | $ | .34 |   |
| Diluted earnings  per share                              |       | $           | .19        |        | $          | .18         |       | $           | .21        |   | $ | .29 |   |

 

F-28

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