** **

**UNITED STATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

** **

**FORM 10-K**

** **

**(Mark One)**

 

| x      | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**     |
|--------|------------|---------------------------------------------------------------------------------------------------------|
|   | ** ** | **For  the fiscal year ended December 31, 2007**                                                   |
|   | ** ** | ** **                                                                                              |
|   | ** ** | **OR**                                                                                                  |
|   | ** ** | ** **                                                                                              |
| o      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

** **

**For thetransition period from                    to                   .**

 

**Commission file number 000-51281**

 

**TennesseeCommerce Bancorp, Inc.**

(Exact name of registrant as specified in itscharter)

 

| **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**

** **

Securitiesregistered pursuant to Section 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)         |

 

Securitiesregistered pursuant to Section 12(g) of the Act:

 

 
| (Title of each class) |
|-----------------------|

 

Indicateby check mark if the registrant is a well-known, seasoned issuer, as defined inRule 405 of the Securities Act. Yes  o  No   x

 

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

 

Indicateby check mark whether registrant (1) has filed reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.  Yes   x  No   o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, a non-accelerated filer, or a smallerreporting company. See definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.(Check one):

Large accelerated filer   o      Acceleratedfiler   x       Non-acceleratedfiler   o         Smallerreporting company   o

(Do not check if asmaller reporting company)

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes  o  No   x

 

Theaggregate market value of the registrant’s voting stock held by non-affiliatesof the registrant at June 30, 2007 was $96.5 million, based upon theaverage sale price on that date.

 

As of March 14,2008, there were 4,731,696 shares of the registrant’s common stock outstanding.

 

Documents Incorporated by Reference:

 

Part IIIinformation is incorporated herein by reference, pursuant to Instruction G of Form 10-K,to registrant’s Definitive Proxy Statement for its 2008 Annual Meeting ofshareholders to be held on June 25, 2008, which will be filed with theCommission no later than April 29, 2008 (the Proxy Statement). Certain Part IIinformation 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 | 10 |
| ITEM 1B.          |   | UNRESOLVED  STAFF COMMENTS | 15 |
| ITEM 2.           |   | PROPERTIES | 15 |
| ITEM 3.           |   | LEGAL PROCEEDINGS | 15 |
| ITEM 4.           |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS | 15 |
|              |   |   |   |
| **PART II**  |   |
|              |   |   |   |
| ITEM 5.           |   | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES | 16 |
| ITEM 6.           |   | SELECTED FINANCIAL  DATA | 17 |
| ITEM 7.           |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION | 18 |
| ITEM 7A.          |   | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK | 38 |
| ITEM 8.           |   | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA | 40 |
| ITEM 9.           |   | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 40 |
| ITEM 9A.          |   | CONTROLS AND  PROCEDURES | 40 |
| ITEM 9B.          |   | OTHER INFORMATION | 41 |
|              |   |   |   |
| **PART III** |   |
|              |   |   |   |
| ITEM 10.          |   | DIRECTORS,  EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE | 42 |
| ITEM 11.          |   | EXECUTIVE  COMPENSATION | 42 |
| ITEM 12.          |   | SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS | 43 |
| ITEM 13.          |   | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE | 43 |
| ITEM 14.          |   | PRINCIPAL  ACCOUNTING FEES AND SERVICES | 43 |
|              |   |   |   |
| **PART IV**  |   |
|              |   |   |   |
| ITEM 15.          |   | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES | 44 |

 

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**PART I**

 

**ITEM 1.****                                                    ****BUSINESS**

 

**General**

 

Tennessee Commerce Bancorp, Inc. (the “Corporation” or “we” or “us”)is a bank holding company formed as a Tennessee corporation to own the sharesof Tennessee Commerce Bank (the “Bank”). The Bank commenced operations January 14,2000, and is a full service financial institution located in Franklin,Tennessee, 15 miles south of Nashville. Franklin is in Williamson County, oneof the most affluent and rapidly growing counties in the nation and the Bankconducts business from a single location in the Cool Springs commercial area ofFranklin. The Bank had total assets at December 31, 2007 of $900 million.Although the Bank offers a full range of banking services and products, itoperates with a focused “Business Bank” strategy.  The Business Bankstrategy emphasizes banking services for small- to medium-sized businesses,entrepreneurs and professionals in the local market. The Bank competes bycombining the personal service and appeal of a community bank institution withthe sophistication and flexibility of a larger bank. This strategydistinguishes the Bank from its competitors in efforts to attract loans anddeposits of local businesses. In addition, the Bank accesses a national marketthrough a network of financial service companies and vendor partners thatprovide indirect funding opportunities for the Bank nationwide.

 

The Bank does not compete based on the traditional definition of “convenience”and does not have a branch network for that purpose. Business is conducted froma single office with no teller line, drive-through window or extended bankinghours.  The Bank competes by providing responsive and personalized serviceto meet customer needs.  Convenience is created by technology and by afree courier service which transports deposits directly from the local businesslocation to the Bank.  The Bank provides free electronic banking and cashmanagement tools and on-site training for business customers.  The Bankcompetes for local consumer business by providing superior products, attractivedeposit rates, free Internet Banking services and access to a third partyregional automated teller machine (“ATM”) network. The Bank targets service,manufacturing and professional customers and avoids retail businesses with hightransaction volume.

 

The Bank offers a full range of competitive retail and commercialbanking services.  The deposit services offered include various types ofchecking 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 ATMs and state of the art electronicbanking. The Bank has trust powers but does not have a trust department.

 

The Business Bank strategy is evident in differences between thefinancial 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 banks insured by theFederal Deposit Insurance Corporation (“FDIC”). Assets of the Bank are centeredin the loan portfolio which consists primarily of commercial and industrialloans.  Management targets a loan mix of 60% commercial loans and 40% realestate.  At December 31, 2007, the composition of the $794 millionloan portfolio was 60.14% commercial, 36.50% secured by real estate (bothcommercial and consumer) and 0.50% in consumer and credit card loans.

 

The Bank offers a full range of loan products to local consumers andbusinesses.  Consumer products include secured and unsecured lines ofcredit, term loans and credit cards.  Loans secured by real estate includeconstruction and acquisition loans in the form of 1st and 2nd mortgage term loans and home equity lines. The Bank specializes in lending to businesses.  Customized business loansinclude lines of credit and term loans secured by accounts receivable,inventory, equipment, and real estate.  Commercial real estate productsinclude acquisition and construction loans for business properties and termloan financing of commercial real estate.

 

1

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In addition to lending in the local marketplace, the Bank generatesassets in the national market by providing collateral-based loans to businessborrowers located in other states through two types of indirect funding programs.In both programs, the transactions are originated by a third party, such as anequipment vendor or financial services company, who provides the Bank with aborrower’s financial information and arranges for a borrower’s execution ofloan documentation. The Bank funds these transactions earning strong yields andhas no servicing expense or residual risk in any transaction originated bythese financial service companies and vendors. The Bank has management andpersonnel who are experienced in this type of transaction and are able toevaluate and partner effectively with the companies who originate thesetransactions. All indirect funding is secured by the business asset financed,and is subject to the Bank’s minimum credit score and documentationstandards.  These national market transactions provide geographic andcollateral diversity for the portfolio and represent approximately 35.72% ofthe total loan portfolio at December 31, 2007.

 

The two national market funding programs fund different size loansthrough two different networks. In the first type, the Bank uses an establishednetwork of financial service companies and vendor partners that provide theBank funding opportunities to national middle-market and investment gradecompanies. At December 31, 2007, the average size of this type of loan inthe loan portfolio was $289,000 and earned an average yield of 7.91%. Fundingunder this program represents approximately 16.44% of the $794 million totalloan portfolio.  In the second program, the Bank partners with a secondnetwork of financial service companies and vendors located in Tennessee,Alabama, Georgia, California and Michigan. This program is for smallertransactions. These loans that finance business assets are less than $125,000at origination. Management has installed a standardized credit approval processthat delivers quick responsive service. At December 31, 2007, the averagesize of this type of loan in the loan portfolio was $45,000, and the averageyield on these loans was 8.75%. Funding under this program representsapproximately 19.28% of the $794 million total loan portfolio.

 

Management believes the Business Bank model is highly efficient. The Bank targets the non-retail sector of the commercial market, which ischaracterized by lower levels of transactions and processing costs.  Thecommercial customer mix and the strategic outsourcing of certain administrativefunctions, such as data processing, allow the Bank to operate with a smaller,more highly trained staff.  Management targets an average asset peremployee ratio of $7.5 million compared to the average of less than $3.4million in assets per employee for Tennessee state-chartered banks at the endof September 30, 2007, as reported by SNL. The Bank also promotes the useof technology, both internally and externally, to maximize the efficiency ofoperations.  Management targets an operating efficiency ratio (totaloperating expense divided by total revenue) of 40% to 45%.

 

The Bank is subject to the regulatory authority of the Department ofFinancial Institutions of the State of Tennessee (“TDFI”) and the FDIC.

 

The Bank’s principal executive offices are located at 381 MalloryStation Road, Suite 207, Franklin, Tennessee 37067, and its telephonenumber is (615) 599-2274.

 

We were incorporated on March 22, 2000, for the purpose ofacquiring 100% of the shares of the Bank by means of a share exchange, andbecoming a registered bank holding company under the Federal Reserve Act. The share exchange was completed on May 31, 2000.  The activities ofthe Corporation are subject to the supervision of the Board of Governors of theFederal Reserve System (“Federal Reserve Board”).  Our offices are thesame as the principal office of the Bank.  On March 29, 2005, weformed a wholly owned subsidiary, Tennessee Commerce Bank Statutory Trust I(the “Trust”). The Bank and the Trust are our only subsidiaries. At this time,we have no plans to conduct any business apart from the activities of the Bank.The Bank commenced operations as a Tennessee state chartered bank on January 14,2000, and is headquartered in Franklin, Tennessee.

 

# **MarketArea and Competition**

# ** **

All phases of the Bank’s business are highly competitive.  TheBank is subject to intense competition from various financial institutions andother companies or firms that offer financial services.  The Bank competesfor deposits with other commercial banks, savings and loan associations, creditunions and issuers of commercial paper and other securities, such asmoney-market and mutual funds.  In making loans, the Bank is expected tocompete with other commercial banks, savings and loan associations, consumerfinance companies, credit unions, leasing companies and other lenders.

 

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The Bank’s primary market area is Davidson County and Williamson Countyin Tennessee.  In Davidson County, as of June 30, 2007, there were 25banks and no savings and loan institutions, with at least 205 offices activelyengaged in banking activities, including eight major state-wide financialinstitutions, according to SNL.  Total deposits held by banks in DavidsonCounty as of June 30, 2007, were approximately $16.7 billion.  InWilliamson County, as of June 30, 2007, there were 22 banks and twosavings and loan institutions, with at least 83 offices actively engaged inbanking activities, including eight major state-wide financialinstitutions.  Total deposits held by banks and savings and loanassociations in Williamson County as of June 30, 2007, were approximately$4.6 billion, according to SNL.  In addition, there are numerous creditunions, finance companies, and other financial services providers.

 

Demographic information published by SNL Financial shows a totalestimated population of 164,410 for Williamson County in 2007, which is a29.83% increase from 126,638 in 2000. The estimated number of households in thecounty in 2007 was 58,965, up from 44,725 in 2000, averaging 2.79 persons perhousehold. In 2007, the median household income was $88,854, while per capitaincome was $44,942.  At the end of 2007, the unemployment rate was 3.6%.

 

Demographic information published by SNL Financial shows an estimatedpopulation of 599,512 for Davidson County in 2007, which is a 5.2% increaseover the population of 569,891 in 2000. The estimated number of households inthe county in 2007 was 253,891, averaging 2.36 persons per household. In 2007,the median household income was $51,811, while per capita income was$30,129.  At the end of 2007, the unemployment rate was 4.1%.

 

**Employees**

 

At December 31, 2007, the Corporation employed no persons and theBank employed 64 persons on a full-time basis. The Bank’s employees are notrepresented by any union or other collective bargaining agreement andmanagement of the Bank believes its employee relations are satisfactory.

 

**Supervisionand Regulation**

** **

**BankHolding Company Regulation**

** **

We are a bank holding company within the meaning of the Bank HoldingCompany Act of 1956, as amended (the “Holding Company Act”), and are registeredwith the Federal Reserve Board. Our banking subsidiary is subject torestrictions under federal law which limit the transfer of funds by the Bank tothe Corporation, whether in the form of loans, extensions of credit,investments or asset purchases. Such transfers by any subsidiary bank toits holding company or any non-banking subsidiary are limited in amount to 10%of the subsidiary bank’s capital and surplus and, with respect to theCorporation and the Bank, to an aggregate of 20% of the Bank’s capital andsurplus.  Furthermore, such loans and extensions of credit are required tobe secured in specified amounts.  The Holding Company Act also prohibits,subject to certain exceptions, a bank holding company from engaging in oracquiring direct or indirect control of more than 5% of the voting stock of anycompany 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 file with the FederalReserve Board semiannual reports and such additional information as the FederalReserve Board may require.  The Federal Reserve Board also makesexaminations of us at its discretion.

 

According to Federal Reserve Board policy, bank holding companies areexpected to act as a source of financial strength to each subsidiary bank andto commit resources to support each such subsidiary.  This support may berequired at times when a bank holding company may not be able to provide suchsupport.  Furthermore, in the event of a loss suffered or anticipated bythe FDIC – either as a result of default of our banking subsidiary or relatedto FDIC assistance provided to a subsidiary in danger of default – our bankingsubsidiary may be assessed for the FDIC’s loss, subject to certain exceptions.

 

3

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Various federal and state statutory provisions limit the amount ofdividends the subsidiary banks can pay to their holding companies withoutregulatory approval.  The payment of dividends by any bank also may beaffected by other factors, such as the maintenance of adequate capital for suchsubsidiary bank.  In addition to the foregoing restrictions, the FederalReserve Board has the power to prohibit dividends by bank holding companies iftheir actions constitute unsafe or unsound practices.  The Federal ReserveBoard has issued a policy statement on the payment of cash dividends by bankholding companies, which expresses the Federal Reserve Board’s view that a bankholding company experiencing earnings weaknesses should not pay cash dividendsthat exceed its net income or that could only be funded in ways that weaken thebank holding company’s financial health, such as by borrowing.  Furthermore,the TDFI also has authority to prohibit the payment of dividends by a Tennesseebank when it determines such payment to be an unsafe and unsound bankingpractice.

 

A bank holding company and its subsidiaries are also prohibited fromacquiring any voting shares of, or interest in, any banks located outside ofthe state in which the operations of the bank holding company’s subsidiariesare located, unless the acquisition is specifically authorized by the statutesof the state in which the target is located.  Further, a bank holdingcompany and its subsidiaries are prohibited from engaging in certain tie-inarrangements in connection with the extension of credit or provision of anyproperty or service.  Thus, an affiliate of a bank holding company may notextend credit, lease or sell property, or furnish any services or fix or varythe consideration for these on the condition that (i) the customer mustobtain or provide some additional credit, property or services from or to itsbank holding company or subsidiaries thereof or (ii) the customer may notobtain some other credit, property or services from a competitor, except to theextent reasonable conditions are imposed to assure the soundness of the creditextended.

 

In approving acquisitions by bank holding companies of banks andcompanies engaged in the banking-related activities described above, theFederal 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, within 30 days afterapproval by the Federal Reserve Board of an acquisition, bring an actionchallenging such acquisition under the federal antitrust laws, in which casethe 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.

 

**Bank Regulation**

** **

The Bank is a Tennessee state-chartered bank and is subject to theregulations of and supervision by the FDIC as well as the Commissioner of theTDFI (the “Commissioner”), Tennessee’s state banking authority.  The Bankis also subject to various requirements and restrictions under federal andstate law, including without limitation restrictions on permitted activities,requirements to maintain reserves against deposits, restrictions on the typesand amounts 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.

 

The FDIC and the Commissioner periodically conduct examinations of theBank.  If, as a result of an examinationof the Bank, the FDIC determines that the financial condition, capitalresources, asset quality, earnings prospects, management, liquidity or otheraspects of the Bank’s operations are unsatisfactory or that the Bank or itsmanagement is violating or has violated any law or regulation, various remediesare available to the FDIC.  Such remedies include the power to enjoin “unsafeor unsound” practices, to require affirmative action to correct any conditionsresulting from any violation or practice, to issue an administrative order thatcan be judicially enforced, to direct an increase in capital, to restrict thegrowth of the Bank, to assess civil monetary penalties, to remove officers anddirectors and ultimately to terminate a Bank’s deposit insurance.  TheCommissioner has many of the same remedial powers, including the power to takepossession of a bank whose capital becomes impaired.  As of December 31,2007, the Bank was not the subject of any such action by the FDIC or theCommissioner.

 

The deposits of the Bank are insured by the FDIC in the manner and tothe extent provided by law.  For this protection, the Bank pays asemiannual statutory assessment.

 

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Although the Bank is not a member of the Federal Reserve System, it isnevertheless subject to certain regulations of the Federal Reserve Board.

 

Tennessee law contains limitations on the interest rates that may becharged on various types of loans and restrictions on the nature and amount ofloans that may be granted and on the types of investments that may bemade.  The operations of banks are also affected by various consumer lawsand regulations, including those relating to equal credit opportunity andregulation of consumer lending practices.  All Tennessee banks must becomeand remain insured banks under the Federal Deposit Insurance Act (the “FDIA”).

 

## **Capital Requirements**

## ** **

The Federal Reserve Board has risk-based capital requirements for bankholding companies and member banks, and the FDIC adopted risk-based capitalrequirements for banks and bank holding companies effective after December 31,1990. The risk-based capital guidelines are designed to make regulatorycapital requirements more sensitive to differences in risk profile among banksto account for off-balance sheet exposure and to minimize disincentives forholding liquid assets.  Assets and off-balance sheet items are assigned tobroad risk categories each with appropriate weights.  The resultingcapital ratios represent capital as a percentage of total risk-weighted assetsand off-balance sheet items.  The guidelines require all federallyregulated banks to maintain a minimum risk-based total capital ratio of 8%, ofwhich at least 4% must be Tier I Capital (as defined below).  Under the guidelines, the minimum ratio oftotal capital to risk-weighted assets (including certain off-balance sheetitems, such as standby letters of credit) is 8%.  To be considered a “wellcapitalized” bank or bank holding company under the guidelines, a bank or bankholding company must have a total risk based capital ratio in excess of 10% (inaddition to meeting other requirements).

 

At least half of the total capital of a bank is to be comprised ofcommon equity, retained earnings and a limited amount of perpetual preferredstock, after subtracting goodwill and certain other adjustments (“Tier ICapital”).  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”).  Under the risk-based capitalrequirements, total capital consists of Tier I Capital, which is generallycommon shareholders’ equity less goodwill, and Tier II Capital, which isprimarily 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 Capital and 8% total risk-basedcapital.

 

The Federal Reserve Board and the FDIC have adopted a minimum leverageratio of 3%.  Generally, banking organizations are expected to operatewell above the minimum required capital level of 3% unless they meet certainspecified criteria, including having the highest regulatory ratings. Mostbanking organizations are required to maintain a leverage ratio of 3%, plus anadditional cushion of at least 1% to 2%.  State regulatory authorities andthe FDIC encourage most community banks to maintain a leverage ratio of 6.5% to7.0%. The FDIC has a regulation requiring certain banking organizations tomaintain additional capital of 1% to 2% above a 3% minimum Tier I leveragecapital ratio (ratio of Tier I Capital, less intangible assets, to totalassets).  In order for an institution to operate at or near the minimumTier I leverage capital requirement of 3%, the FDIC expects that such institutionwould have well-diversified risk, no undue rate risk exposure, excellent assetquality, high liquidity and good earnings.  In general, the Bank wouldhave to be considered a strong banking organization, rated in the highestcategory under the bank rating system and have no significant plans forexpansion.  Higher Tier I leverage capital ratios of up to 5% willgenerally be required if all of the above characteristics are not exhibited orif the institution is undertaking expansion, seeking to engage in newactivities or otherwise faces unusual or abnormal risks.  The guidelines also provide that bankingorganizations experiencing internal growth or making acquisitions will beexpected to maintain strong capital positions substantially above the minimumsupervisory levels without significant reliance upon intangible assets.  The Bank’s Tier I leverage capital ratio at December 31,2007 was 8.75%.

 

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Under the Financial Institutions Reform, Recovery and Enforcement Actof 1989 (“FIRREA”), failure to meet the capital guidelines could subject abanking institution to a variety of enforcement remedies available to federalregulatory authorities, including the termination of deposit insurance by theFDIC.  Institutions not in compliancewith the capital guidelines are expected to be operating in compliance with acapital plan or agreement with the regulator.  If they do not do so, theyare deemed to be engaging in an unsafe and unsound practice and may be subject toenforcement action.  In addition, failure by an institution to maintaincapital of at least 2% of assets constitutes an unsafe and unsound practice andmay subject the institution to enforcement action.  An institution’sfailure to maintain capital of at least 2% of assets constitutes an unsafe andunsound condition justifying termination of FDIC insurance.

 

In1999, the Basel Committee on Banking Supervision (“Basel Committee”) launchedits efforts to develop an improved capital adequacy framework by issuing itsproposals to revise the 1988 Basel Capital Accord.  In June 2004, the Basel Committee issuedits final framework.  The new capitalframework (“Basel II”) consists of minimum capital requirements, a supervisoryreview process and the effective use of market discipline.  Basel II seeks to ensure that a bank’scapital position is consistent with its overall risk profile and strategy,encourages early supervisory intervention when a bank’s capital positiondeteriorates and calls for detailed disclosure of a bank’s capital adequacy andhow it evaluates its own capital adequacy.

 

In September 2006,the U.S. regulators published a revised Notice of Proposed Rulemaking (“NPR”)for Basel II.  The Final Rule onAdvanced Capital Adequacy Framework—Basel II (the “Final Rule”), has beenapproved by all regulatory agencies and took effect on April 1, 2008. TheFinal Rule currently applies only to certain core banks with total assetsof $250 billion or more, but allows non-core banks to opt in.  Under the Final Rule, the Bank is consideredto be a non-core bank. For those non-core banks that do not opt in, a NPR wasissued in December 2006, known as Basel IA, which proposed certainrevisions to the current Basel I capital rules.

 

Theagencies are currently developing a NPR that would provide non-core banks theoption of adopting the Standardized Approach of the Basel II Framework.  The Basel II Standardized NPR is expected toreplace the Basel IA NPR.

 

## **Payment of Dividends**

## ** **

TheCorporation is a legal entity separate and distinct from its banking and othersubsidiaries.  The principal source ofcash flow of the Company, including cash flow to pay dividends on its stock orprincipal (premium, if any) and interest on debt securities, is dividends fromthe Bank.  There are state and federalstatutory and regulatory limitations on the payment of dividends by the Bank tothe Company, as well as by the Company to its shareholders.

 

Under the FDIA, the Bank may not make any capital distributions(including the payment of dividends) or pay any management fees to its holdingcompany or pay any dividend if it is undercapitalized or if such payment wouldcause it to become undercapitalized.  Inaddition, the Bank is restricted from paying dividends under certaincircumstance by the Tennessee Banking Act. The payment of dividends by any bankis dependent upon its earnings and financial condition and subject to thestatutory power of certain federal and state regulatory agencies to act toprevent what they deem unsafe or unsound banking practices.  The paymentof dividends could, depending upon the financial condition of the Bank, bedeemed 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.  TheFDIA prohibits a state bank, the deposits of which are insured by the FDIC,from paying dividends if it is in default in the payment of any assessments duethe FDIC.  The Bank is also subject to the minimum capital requirements ofthe FDIC which impact the Bank’s ability to pay dividends.  If the Bankfails to meet these standards, it may not be able to pay dividends or to acceptadditional deposits because of regulatory requirements.

 

If, inthe opinion of the FDIC or the Federal Reserve Board, a depository institutionor a holding company is engaged in or is about to engage in an unsafe orunsound practice (which, depending on the financial condition of the depositoryinstitution or holding company, could include the payment of dividends), suchauthority may require that such institution or holding company cease and desistfrom such practice.  The FDIC and the FederalReserve Board have indicated that paying dividends that deplete a depositoryinstitution’s or holding company’s capital base to an inadequate level would besuch an unsafe and unsound banking practice. Moreover, the Federal ReserveBoard and the FDIC have issued policy statements which provide that bankholding companies and insured depository institutions generally should only paydividends out of current operating earnings.

 

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Under Tennessee law, the Corporation is not permitted to pay dividendsif, after giving effect to such payment, it would not be able to pay its debtsas they become due in the usual course of business or the Corporation’s totalassets would be less than the sum of its total liabilities plus any amountsneeded to satisfy any preferential rights if the Corporation wasdissolving.  In addition, in decidingwhether or not to declare a dividend of any particular size, the Corporation’sBoard must consider the Corporation’s current and prospective capital,liquidity, and other needs.

 

The payment of dividends by the Corporation and the Bank may also beaffected or limited by other factors, such as the requirement to maintainadequate capital above regulatory guidelines and debt covenants.

 

## **FIRREA**

## ** **

FIRREA provides that a depository institution insured by the FDIC canbe held liable for any loss incurred by, or reasonably expected to be incurredby, the FDIC after August 9, 1989 in connection with (i) the defaultof a commonly controlled FDIC-insured depository institution or (ii) anyassistance provided by the FDIC to a commonly controlled FDIC-insureddepository institution in danger of default.  FIRREA provides that certaintypes of persons affiliated with financial institutions can be fined by thefederal regulatory agency having jurisdiction over a depository institutionwith federal deposit insurance (such as the Bank) up to $1 million per day foreach violation of certain regulations related (primarily) to lending to andtransactions with executive officers, directors, principal shareholders and theinterests of these individuals.  Other violations may result in civilmoney penalties of $5,000 to $30,000 per day or in criminal fines andpenalties.  In addition, the FDIC has been granted enhanced authority towithdraw or to suspend deposit insurance in certain cases.

 

## **FDICIA**

## ** **

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)requires, among other things, 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 well capitalized if itmaintains a Leverage Ratio of at least 5%, a risk adjusted Tier 1 Capital Ratioof at least 6% and a Total Capital Ratio of at least 10% and is not subject toa directive, order or written agreement to meet and maintain specific capitallevels.  An insured depository institution is adequately capitalized if itmeets all of the minimum capital requirements as described above.  Inaddition, an insured depository institution will be considered undercapitalizedif it fails to meet any minimum required measure, significantlyundercapitalized if it is significantly below such measure and criticallyundercapitalized if it fails to maintain a level of tangible equity equal tonot less than 2% of total assets.  An insured depository institution maybe deemed to be in a capitalization category that is lower than is indicated byits actual capital position if it receives an unsatisfactory examination rating.

 

The capital-based prompt corrective action provisions of FDICIA andtheir implementing regulations apply to FDIC-insured depository institutionsand are not directly applicable to holding companies that control suchinstitutions.  However, the Federal Reserve Board has indicated that, inregulating 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.

 

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.

 

7

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Significantly undercapitalized depository institutions may be subjectto a number of requirements and restrictions, including orders to sellsufficient voting stock to become adequately capitalized, requirements toreduce 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.

 

FDICIA contains numerous other provisions, including accounting, auditand reporting requirements, termination of the “too big to fail” doctrineexcept in special cases, limitations on the FDIC’s payment of deposits atforeign branches, new regulatory standards in such areas as asset quality,earnings and compensation and revised regulatory standards for, among otherthings, powers of state banks, real estate lending and capital adequacy. FDICIA also requires that a depository institution provide 90 days prior noticeof the closing of any branches.

 

## **Riegle-Neal Interstate Banking and Branching Efficiency Act**

## ** **

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994(“Interstate Act”), among other things and subject to certain conditions andexceptions, permits on an interstate basis (i) bank holding companyacquisitions commencing one year after enactment of banks of a minimum age ofup to five years as established by state law in any state, (ii) mergers ofnational and state banks after May 31, 1997 unless the home state ofeither bank has opted out of the interstate bank merger provision, (iii) branchingde novo by national and state banks if the host state has opted-in to thisprovision of the Interstate Act, and (iv) certain bank agency activitiesafter one year after enactment.  The Interstate Act contains a 30%intrastate deposit cap, except for the initial acquisition in the state,restriction that applies to certain interstate acquisitions unless a differentintrastate cap has been adopted by the applicable state pursuant to the provisionsof the Interstate Act and a 10% national deposit cap restriction. Tennessee has opted-in to the Interstate Act.  Management cannot predictthe extent to which the business of the Bank may be affected by the InterstateAct.  Tennessee has also adopted legislation allowing banks to acquirebranches across state lines subject to certain conditions, including theavailability of similar legislation in the other state.

 

## **Brokered Deposits and Pass-Through Insurance**

## ** **

The FDIC has adopted regulations under FDICIA governing the receipt ofbrokered deposits and pass-through insurance.  Under the regulations, abank cannot accept or rollover or renew brokered deposits unless (i) it iswell capitalized or (ii) it is adequately capitalized and receives awaiver from the FDIC.  A bank that cannot receive brokered deposits alsocannot 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 byregulation.  There are no such restrictions on a bank that is wellcapitalized.  Because it believes that the Bank was well capitalized as ofDecember 31, 2007, management of the Bank believes the brokered depositsregulation will have no material effect on the funding or liquidity of theBank.

 

## **FDIC Insurance Premiums**

## ** **

The Bank is required to pay semiannual FDIC deposit insuranceassessments to the Deposit Insurance Fund (“DIF”).  The FDIC merged theBank Insurance Fund and the Savings Association Insurance Fund to form the DIFon March 31, 2006 in accordance with the Federal Deposit Insurance ReformAct of 2005.  The FDIC maintains the DIF by assessing depository institutionsan insurance premium.  The amount each institution is assessed is basedupon statutory factors that include the balance of insured deposits as well asthe degree of risk the institution poses to the insurance fund.  The FDICuses a risk-based premium system that assesses higher rates on thoseinstitutions that pose greater risks to the DIF.

 

Under the FDIA, insurance of deposits may be terminated by the FDICupon a finding that the institution has engaged in unsafe or unsound practices,is in an unsafe or unsound condition to continue operations or has violated anyapplicable law, regulation, rule, order or condition imposed by a federal bankregulatory agency.

 

8

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## **Gramm-Leach-BlileyAct**

## ** **

The Gramm-Leach-Bliley Act of 1999 (the “GLBA”) ratified new powers forbanks and bank holding companies, especially in the areas of securities andinsurance.  The GLBA also includes requirements regarding the privacy andprotection of customer information held by financial institutions, as well asmany other providers of financial services.  There are provisionsproviding for functional regulation of the various services provided byinstitutions among different regulators.  There are other provisions whichlimit the future expansion of unitary thrift holding companies.  Finally,among many other sections of the GLBA, there is some relief for small banksfrom the regulatory burden of the Community Reinvestment Act.  The regulatoryagencies have been adopting many new regulations to implement the GLBA.

 

## **USAPatriot Act**

## ** **

The Uniting and Strengthening America by Providing Appropriate ToolsRequired to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”)contains the International Money Laundering Abatement and FinancialAnti-Terrorism Act of 2001 (the “IMLAFA”).  The IMLAFA substantiallybroadened existing anti-money laundering legislation and the extraterritorialjurisdiction of the United States, imposed new compliance and due diligenceobligations, created new crimes and penalties, compelled the production ofdocuments located both inside and outside the United States, including those offoreign institutions that have a correspondent relationship in the UnitedStates, and clarified 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 imposed 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 required all “financial institutions,” as defined therein,to establish anti-money laundering compliance and due diligence programs nolater than April 2003.  Such programs must include, among otherthings, adequate policies, the designation of a compliance officer, employeetraining programs, and an independent audit function to review and test theprogram.  The Bank has established anti-money laundering compliance anddue diligence programs which management believes comply with the IMLAFA.

 

## **DepositorPreference**

## ** **

The Omnibus Budget Reconciliation Act of 1993 provides that depositsand certain claims for administrative expenses and employee compensationagainst an insured depositary institution would be afforded a priority overother general unsecured claims against such an institution, including federalfunds and letters of credit, in the “liquidation or other resolution” of suchan institution by any receiver.

 

## **Effectof Governmental Policies**

## ** **

The Company and the Bank are 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: (i) purchasesand sales of U.S. Government securities in the marketplace; (ii) changesin the discount rate, which is the rate any depository institution must pay toborrow from the Federal Reserve; (iii) and changes in the reserverequirements of depository institutions.  These instruments are effectivein influencing economic and monetary growth, interest rate levels andinflation.

 

The monetary policies of the Federal Reserve System and othergovernmental policies have had a significant effect on the operating results ofcommercial banks in the past and are expected to continue to do so in thefuture.  Because of changing conditions in the national economy and in themoney 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.

 

9

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Bills are pending before the United States Congress and the TennesseeGeneral Assembly and proposed regulations are pending before the various stateand federal regulatory agencies that could affect the business of the Companyand the Bank, and there are indications that other similar bills and proposedregulations may be introduced in the future.  It cannot be predictedwhether or in what form any of these or future proposals will be adopted or theextent to which the business of the Company and the Bank may be affectedthereby.

 

## **Sarbanes-Oxley Act of 2002**

## ** **

The Sarbanes-Oxley Act of 2002 represents a comprehensive revision oflaws affecting corporate governance, accounting obligations and corporatereporting. The Sarbanes-Oxley Act is applicable to all companies with equitysecurities registered, or that file reports, under the Securities Exchange Actof 1934, as amended.  In particular, the act established (i) requirementsfor audit committees, including independence, expertise and responsibilities; (ii) responsibilitiesregarding financial statements for the chief executive officer and chieffinancial officer of the reporting company and new requirements for them tocertify the accuracy of periodic reports; (iii) standards for auditors andregulation of audits; (iv) disclosure and reporting obligations for thereporting company and its directors and executive officers; and (v) civiland criminal 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.

 

**Availability of Information**

 

We file periodic reports with the SEC. The SEC maintains an internetwebsite, www.sec.gov, that contains reports, proxy and information statements,and other information regarding us that we file electronically with theSEC.  The Corporation makes its annual reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K and allamendments to those reports available free of charge on the Bank’s website atwww.tncommercebank.com under the “Investor Relations” heading.

 

**ITEM 1A.****          ****RISK FACTORS**

 

**Changes in interest rates couldadversely affect our results of operations and financial condition.**

 

Changes in interest rates may affect our level of interest income,the primary component of our gross revenue, as well as the level of ourinterest expense. Interest rates are highly sensitive to many factors that arebeyond our control, including general economic conditions and the policies ofvarious governmental and regulatory authorities.  Accordingly, changes ininterest rates could decrease our net interest income.  Changes in thelevel of interest rates also may negatively affect our ability tooriginate loans, the value of our assets and our ability to realize gains fromthe sale of our assets, all of which ultimately affects our earnings.

 

**Our business is subject to thesuccess of the local economies where we operate.**

 

Our success significantly depends upon the growth in population, incomelevels, deposits and new businesses in the Nashville MSA and our other marketareas. If the communities in which we operate do not grow or if prevailingeconomic conditions locally or nationally are unfavorable, our businessmay not succeed. Adverse economic conditions in our specific market areascould reduce our growth rate, affect the ability of our customers to repaytheir loans to us and generally affect our financial condition and results ofoperations. Moreover, we cannot give any assurance that we will benefit fromany market growth or favorable economic conditions in our primary market areasif they do occur.

 

**Our business strategy includes thecontinuation of growth plans, and our financial condition and results ofoperations could be negatively affected if our business strategies are noteffectively executed.**

 

We intend to continue pursuing a growth strategy for our businessthrough organic growth of the loan portfolio. Our prospects must be consideredin light of the risks, expenses and difficulties that can be encountered byfinancial service companies in rapid growth stages, which include the risksassociated with the following:

 

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·                  maintaining loan quality;

 

·                  maintaining adequate management personnel andinformation systems to oversee such growth;

 

·                  maintaining adequate control and compliancefunctions; and

 

·                  securing capital and liquidity needed tosupport our anticipated growth.

 

There can be no assurance that we will maintain or achieve depositlevels, loan balances or other operating results necessary to avoid losses orproduce profits. Our growth will cause growth in overhead expenses as weroutinely add staff. As a result, historical results may not be indicativeof future results. Failure to successfully address these issues identified abovecould have a material adverse effect on our business, future prospects,financial condition or results of operations.

 

**We rely heavily on the services ofkey personnel.**

 

We depend substantially on the strategies and management services ofour executive officers – Arthur F. Helf, Chairman and Chief Executive Officer,Michael R. Sapp, President, George W. Fort, Chief Financial Officer, and H.Lamar Cox, Chief Administrative Officer and acting Chief Financial Officer. Theloss of the services of any of these executive officers could have a materialadverse effect on our business, results of operations and financial condition.We are also 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 our future results will also depend inpart upon our attracting and retaining highly skilled and qualifiedmanagement, as well as sales and marketing personnel. Competition for suchpersonnel is intense, and we cannot assure you that we will be successful inattracting or retaining such personnel.

 

**National market funding outside ofthe Nashville MSA has different risks.**

 

Approximately 35.72% of our loan portfolio is composed of nationalmarket funding loans to non-Middle Tennessee businesses referred to us by asmall network of equipment vendors and financial service companies. These loansaccount for approximately 32.72% and 32.04%, respectively, of the increase intotal loans at December 31, 2007 and 2006, over the prior year. Thislending causes us to have somewhat different risks than those typical for communitybanks generally. Our loan portfolio is more geographically diverse, and as aresult the loan collateral is also more widely dispersed geographically. Thismay result in longer time periods to locate collateral and higher costs todispose of collateral in the event that the collateral is used to satisfy theloan obligation. This part of our portfolio also provides geographic riskdiversification by reducing the adverse impact of a regional downturn in theeconomy.

 

**Our ability to attract deposits mayrestrict growth.**

 

We derive a substantial portion of our deposits through internet-basedwholesale funding alternatives. In the event that we were no longer able tosell our deposits easily to institutional and retail investors, our ability tofund our loan portfolio could be adversely affected. We post rates to aninternet-based program that retail and institutional investors nationwidesubscribe to in order to invest funds. Our wholesale funding portfolio istherefore geographically dispersed and generally made up of deposits in FDICinsured amounts of $100,000 or less.

 

**An inadequate allowance for loanlosses would reduce our earnings.**

 

The risk of credit losses on loans varies with, among other things,general economic conditions, the type of loan being made, the creditworthinessof the borrower over the term of the loan and, in the case of a collateralizedloan, the value and marketability of the collateral for the loan. Managementmaintains an allowance for loan losses based upon, among other things, historicalexperience, an evaluation of economic conditions and regular reviews ofdelinquencies and loan portfolio quality. Based upon such factors, managementmakes various assumptions and judgments about the ultimate collectability ofthe loan portfolio and provides an allowance for loan losses based upon apercentage of the outstanding balances and takes a charge against earnings withrespect to specific loans when their ultimate collectability is consideredquestionable. If management’s assumptions and judgments prove to be incorrectand the allowance for loan losses is inadequate to absorb losses, or if thebank regulatory authorities require us to increase the allowance for loanlosses as a part of their examination process, our earnings and capitalcould be significantly and adversely affected.

 

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**Our ability to maintain adequatecapital may restrict our activities.**

 

Our continued pace of growth may require us to raise additional capitalin the future, but that capital may not be available when it is needed. We are required by federal and state regulatory authorities to maintainadequate levels of capital to support our operations, so we may at some pointneed to raise additional capital to support any continued growth.

 

Our ability to raise additional capital, if needed, will depend onconditions in the capital markets at that time, which are outside our control,and on our financial performance. Accordingly, we cannot assure ourshareholders that we will be able to raise additional capital if needed onterms acceptable to us. If we cannot raise additional capital when needed, ourability to continue our growth could be materially impaired.

 

**Competition from financialinstitutions and other financial service providers may adversely affectour profitability.**

 

The banking business is highly competitive and we experiencecompetition in our markets from many other financial institutions.  Wecompete with commercial banks, credit unions, savings and loan associations,mortgage banking 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 in the Nashville MSA and elsewhere.  We not only compete withthese companies in the Nashville MSA, but also in the regional and nationalmarkets in which we engage in our indirect funding programs.

 

Additionally, in the Nashville MSA, we face competition from de novocommunity banks, including those with senior management who were previouslyaffiliated with other local or regional banks or those controlled by investorgroups with strong local business and community ties. These de novo communitybanks may offer higher deposit rates or lower cost loans in an effort toattract our customers, and may attempt to hire our management andemployees.

 

We compete with these other financial institutions both in attractingdeposits and in making loans. In addition, we have to attract our customer basein the Nashville MSA from consumers with an existing relationship with otherfinancial institutions and from new residents.  We expect competition toincrease in the future as a result of legislative, regulatory and technologicalchanges and the continuing trend of consolidation in the financial servicesindustry. Our profitability depends upon our continued ability to successfullycompete with an array of financial institutions in the Nashville MSA andregionally and nationally with respect to our indirect funding programs.

 

**Liquidity needs could adverselyaffect our results of operations and financial condition.**

 

The primary source of our funds is customer deposits and loanrepayments. While scheduled loan repayments are a relatively stable source offunds, they are subject to the ability of borrowers to repay the loans. Theability of borrowers to repay loans can be adversely affected by a number offactors, including changes in general economic conditions, adverse trends or eventsaffecting business industry groups, reductions in real estate values ormarkets, business closings or lay-offs, inclement weather, natural disastersand international instability. Additionally, deposit levels may beaffected by a number of factors, including rates paid by competitors, generalinterest rate levels, returns available to customers on alternative investmentsand general economic conditions. Accordingly, we may be required from timeto time to rely on secondary sources of liquidity to meet withdrawal demands orotherwise fund operations. These sources include Federal Home Loan Bankadvances and federal funds lines of credit from correspondent banks. While ourmanagement believes that these sources are currently adequate, there can be noassurance they will be sufficient to meet future liquidity demands. Wemay be required to slow or discontinue loan growth, capital expendituresor other investments or liquidate assets should these sources not be adequate.

 

12

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**We are subject to extensiveregulation that could limit or restrict our activities.**

 

We operate in a highly regulated industry and are subject toexamination, supervision and comprehensive regulation by various federal andstate agencies including the Federal Reserve Board, the FDIC and the TDFI. Ourregulatory compliance is costly and restricts certain of our activities,including payment of dividends, mergers and acquisitions, investments, loansand interest rates charged, and interest rates paid on deposits. We are alsosubject to capitalization guidelines established by our regulators, whichrequire us to maintain adequate capital to support our growth.

 

The laws and regulations applicable to the banking industry couldchange at any time, and we cannot predict the effects of these changes on ourbusiness and profitability. Because government regulation greatly affects thebusiness and financial results of all commercial banks and bank holdingcompanies, our cost of compliance could adversely affect our ability to operateprofitably.

 

The Sarbanes-Oxley Act of 2002, and the related rules andregulations promulgated by the Securities and Exchange Commission and TheNASDAQ Stock Market that are applicable to us, have increased the scope, complexityand cost of our corporate governance, reporting and disclosure practices. As aresult, we have experienced, and may continue to experience, greatercompliance costs.

 

**Our ability to continue to engagein and grow our national market funding programs depends on stable businessrelationships.**

 

Our ability to continue to grow the national market funding portion ofour portfolio is dependent upon our retaining those members of our seniormanagement and those loan officers who have experience and relationships withthose equipment vendors and financial services companies who originate theunderlying lease transactions. In the event that any of these members of seniormanagement, particularly President Mike Sapp, were to terminate his or heremployment with us, or in the event that our relationships with any of thesevendor/brokers were to be discontinued, our ability to continue to increase ournational market funding portfolio could be adversely affected.

 

**Material fluctuations innon-interest income may occur.**

 

A substantial portion of our non-interest income is derived from thesale of loans, particularly loans generated for our national market fundingportfolio. The timing and extent of these loan sales may not be predictable,and could cause material variation in our non-interest income on a quarter toquarter basis.

 

**The success and growth of ourbusiness will depend on our ability to adapt to technological changes.**

 

The banking industry and the ability to deliver financial services isbecoming more dependent on technological advancement, such as the ability toprocess loan applications over the Internet, accept electronic signatures,provide process status updates instantly and offer on-line banking capabilitiesand other customer expected conveniences that are cost efficient to ourbusiness processes. As these technologies are improved in the future, we may,in order to remain competitive, be required to make significant capitalexpenditures.

 

**We could sustain losses if ourasset quality declines.**

 

Our earnings are affected by 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 assetquality could cause our interest income and net interest margin to decrease andour provision for loan losses to increase, which could adversely affect ourresults of operations and financial condition.

 

**We may issue additional common stock or other equitysecurities in the future which could dilute the ownership interest of existingshareholders.**

 

In order to maintain our capital at desired levels or requiredregulatory levels, or to fund future growth, our board of directors may decidefrom time to time to issue additional shares of common stock, or securitiesconvertible into, exchangeable for or representing rights to acquire shares ofour common stock. The sale of these securities may significantly diluteour shareholders’ ownership interest as a shareholder and the market price ofour common stock. New investors of other equity securities issued by us in thefuture may also have rights, preferences and privileges senior to ourcurrent shareholders which may adversely impact our current shareholders.

 

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**Holders of our subordinated debentures have rights that aresenior to those of our common shareholders.**

 

In 2005, we supported our continued growth through the issuance oftrust preferred securities from an affiliated special purpose trust andaccompanying subordinated debentures. At December 31, 2007, we hadoutstanding trust preferred securities and accompanying subordinated debenturestotaling $8.2 million. Our board of directors may also decide to issueadditional tranches of trust preferred securities in the future. Weconditionally guarantee payments of the principal and interest on the trustpreferred securities. Further, the accompanying subordinated debentures weissued to the trust are senior to our shares of common stock. As a result, wemust make payments on the subordinated debentures before any dividends can bepaid on our common stock and, in the event of our bankruptcy, dissolution orliquidation, the holders of the subordinated debentures must be satisfiedbefore any distributions can be made on our common stock. We have the right todefer distributions on our subordinated debentures (and the related trustpreferred securities) for up to five years (from the date of issuance) duringwhich time we may not pay dividends on our common stock.

 

**Changes in monetary policy couldadversely affect operating results.**

 

Like all regulated financial institutions, we are affected by monetarypolicies implemented by the Federal Reserve Board and other federalinstrumentalities.  A primary instrument of monetary policy employed bythe Federal Reserve Board is the restriction or expansion of the money supplythrough open market operations.  This instrument of monetary policy frequentlycauses volatile fluctuations in interest rates, and it can have a direct,adverse effect on the operating results of financial institutions. Borrowings by the United States government to finance the government debt mayalso cause fluctuations in interest rates and have similar effects on theoperating results of such institutions.

 

**Our ability to declare and pay dividends on our common stockis limited by law and we may be unable to pay future dividends.**

 

We derive our income solely from dividends on the shares of commonstock of the bank. The bank’s ability to declare and pay dividends to us islimited by its obligations to maintain sufficient capital and by other generalrestrictions on its dividends that are applicable to banks that are regulatedby the FDIC and the TDFI. The Federal Reserve Board may also imposerestrictions on our ability to pay dividends on our common stock. In addition,we must make payments on the subordinated debentures before any dividends canbe paid on our common stock, and we may not pay dividends while we aredeferring interest payments on our trust preferred securities and the relatedsubordinated debentures. As a result, we cannot assure our shareholders that wewill declare or pay dividends on shares of our common stock in the future.

 

**Even though our common stock is currently traded on TheNASDAQ Global Market, the trading volume of our common stock has been low andthe sale of substantial amounts of our common stock in the public market coulddepress the price of our common stock.**

 

While we believe that because we are listed on The NASDAQ GlobalMarket, the trading volume of our common stock should increase, we cannot becertain when a more active and liquid trading market for our common stock willdevelop or be sustained. Because of this, our shareholders may not be ableto sell their shares at the volumes, prices or times that they desire.

 

We cannot predict the effect, if any, that future sales of our commonstock in the market, or availability of shares of our common stock for sale inthe market, will have on the market price of our common stock. We, therefore,can give no assurance that sales of substantial amounts of our common stock inthe market, or the potential for large amounts of sales in the market, wouldnot cause the price of our common stock to decline or impair our ability toraise capital through sales of our common stock.

 

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The market price of our common stock may fluctuate in the future,and these fluctuations may be unrelated to our performance. General marketprice declines or overall market volatility in the future could adverselyaffect the price of our common stock, and the current market price may notbe indicative of future market prices.

 

**Our recent results may not beindicative of our future results.**

 

We may not be able to sustain our historical rate of growth ormay not even be able to grow our business at all. In addition, our recentgrowth may distort some of our historical financial ratios and statistics.In the future, we may not have the benefit of several recently favorablefactors, a strong local business environment, and relationships with anextensive group of equipment vendors and financial services companies. Variousfactors, such as economic conditions, regulatory and legislative considerationsand competition, may also impede or prohibit our ability to grow.

 

**ITEM 1B.              UNRESOLVED STAFF COMMENTS**

 

None

 

**ITEM 2.               PROPERTIES**

 

Our main office is located in Williamson County at 381 Mallory StationRoad, Suite 207, Franklin, Tennessee 37067, which is also the main officeof the Bank.  This location is centrally located and in a hightraffic/exposure area. The Bank leases 32,711 square feet at a competitive rateand the term of the lease expires in December 2017.  The Bankprovides services throughout the community by use of a network of couriers,third party ATMs and state-of-the-art electronic banking. The Bank alsooperates a loan production office located in Jefferson County at One ChaseCorporate Center, Suite 400, Birmingham, Alabama 35244, where the Bankleases 560 square feet at a competitive rate under the terms of a lease.

 

**ITEM 3.               LEGAL PROCEEDINGS**

 

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

 

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

 

No matter was submitted to a vote of security holders during the fourthquarter of 2007 through the solicitation of proxies or otherwise.

 

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**PART II**

 

**ITEM 5.****                                   ****MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES**

 

Our common stock has been listed on The NASDAQ Global Market since June 9,2006. Before that date, it was traded on the Over-The-Counter Bulletin Boardfrom December 16, 2005, and prior to that time, it was not traded throughan organized exchange. The number of shareholders of record at March 14,2008, was 411. The table below shows the quarterly range of high and low saleprices for our common stock during the fiscal years 2007 and 2006. These sale pricesrepresent known transactions and do not necessarily represent all tradingtransactions for the periods.

 
| **Year** | ** ** | **High**       | ** ** | **Low** | ** ** |
|----------|------------|----------------|------------|---------|------------|
|     |       |           |       |    |       |   |   |
| 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 |   |
| 2007:    |       | First Quarter  |       | $       | 31.00      |   | $ | 26.89 |   |
|     |       | Second Quarter |       | $       | 30.00      |   | $ | 23.52 |   |
|     |       | Third Quarter  |       | $       | 28.19      |   | $ | 21.04 |   |
|     |       | Fourth Quarter |       | $       | 27.10      |   | $ | 19.75 |   |

 

**Dividends**

 

We have never declared or paid dividends on our common stock. Ourpayment of cash dividends is subject to the discretion of our Board ofDirectors and the Bank’s ability to pay dividends.  The Bank’s ability topay dividends is restricted by applicable regulatory requirements. For more informationon these restrictions, please see PART I, ITEM 1 “BUSINESS – Supervisionand Regulation – Payment of Dividends.”  No assurances can be given thatany dividend will be declared or, if declared, what the amount of such dividendwould be or whether such dividends would continue in the future.

 

**Recent Sales of Unregistered Securities**

 

At various times during 2007, options to purchase 272,522 shares of ourcommon stock were exercised by employees of the Bank, in 38 differenttransactions, at exercise prices ranging from $5.00 to $16.00 per share for anaggregate price of $2.1 million. We issued these shares of our common stock inreliance upon the exemption from the registration requirements of theSecurities Act of 1933, as amended, as set forth in Section 4(2) underthe Securities Act and Rule 701 of Regulation D promulgated thereunderrelating to sales by an issuer not involving any public offering, to the extentan exemption from such registration was required.

 

**Purchases of Equity Securities by the Registrant andAffiliated Purchasers**

 

The Corporation made no repurchases of its equity securities, and noAffiliated Purchasers (as defined in Rule 10b-18(a)(3) under theSecurities Exchange Act of 1934) purchased any shares of the Corporation’sequity securities during the fourth quarter of the fiscal year ended December 31,2007.

 

16

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**ITEM 6.****                                          ****SELECTED FINANCIAL DATA**

 

The following selected financial data for the years ended December 31,2007, 2006, 2005, 2004 and 2003 should be read in conjunction with thefinancial statements included in Item 8:

 
| ** **                                                  | ** ** | **2007**                                                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                  | ** ** | **(Dollars in Thousands except share data)** | ** ** |
| **Operating  Data:**                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Total  interest income                                      |       | $                                                                     | 62,206     |     | $          | 41,245   |       | $        | 23,633     |     | $          | 13,185 |   | $ | 8,205 |   |
| Total  interest expense                                     |       | 34,934                                                                |       | 21,868   |       | 10,006   |       | 4,265    |       | 2,976    |       |
| Net interest  income                                        |       | 27,272                                                                |       | 19,377   |       | 13,627   |       | 8,920    |       | 5,229    |       |
| Provision  for loan losses                                  |       | (6,350                                                                | )          | (4,350   | )          | (3,700   | )          | (2,420   | )          | (1,115   | )          |
| Net interest  income after provision for loan losses        |       | 20,922                                                                |       | 15,027   |       | 9,927    |       | 6,500    |       | 4,114    |       |
| Non-interest  income:                                       |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Investment  securities gains                                |       | 26                                                                    |       | —   |       | 4        |       | 33       |       | 132      |       |
| Gain on sale  of loans                                      |       | 2,687                                                                 |       | 2,025    |       | 1,106    |       | 504      |       | —   |       |
| Other income                                                |       | 167                                                                   |       | (262     | )          | 201      |       | 263      |       | 300      |       |
| Non-interest  expense                                       |       | (13,263                                                               | )          | (9,056   | )          | (6,246   | )          | (4,552   | )          | (3,459   | )          |
| Income  before income taxes                                 |       | 10,539                                                                |       | 7,734    |       | 4,992    |       | 2,748    |       | 1,087    |       |
| Income tax  (expense) benefit                               |       | (3,643                                                                | )          | (2,985   | )          | (1,925   | )          | (1,082   | )          | (188     | )          |
| Net income                                                  |       | $                                                                     | 6,896      |     | $          | 4,749    |       | $        | 3,067      |     | $          | 1,666 |   | $ | 899 |   |
|                                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Per  Share Data :**                                       |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Net income,  basic                                          |       | $                                                                     | 1.49       |     | $          | 1.24     |       | $        | 0.95       |     | $          | 0.57 |   | $ | 0.40 |   |
| Net income,  diluted                                        |       | $                                                                     | 1.41       |     | $          | 1.14     |       | $        | 0.87       |     | $          | 0.53 |   | $ | 0.38 |   |
| Book value                                                  |       | $                                                                     | 13.36      |     | $          | 11.51    |       | $        | 8.16       |     | $          | 7.29 |   | $ | 5.44 |   |
|                                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Financial  Condition Data:**                              |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Assets                                                      |       | $                                                                     | 900,153    |     | $          | 623,518  |       | $        | 404,040    |     | $          | 245,917 |   | $ | 156,075 |   |
| Loans, net                                                  |       | 784,001                                                               |       | 538,550  |       | 344,187  |       | 213,326  |       | 133,187  |       |
| Investments                                                 |       | 73,753                                                                |       | 56,943   |       | 31,992   |       | 18,690   |       | 12,978   |       |
| Cash and due  from financial institutions                   |       | 5,236                                                                 |       | 177      |       | 6,877    |       | 3,838    |       | 5,224    |       |
| Federal  funds sold                                         |       | 9,573                                                                 |       | 13,820   |       | 12,535   |       | 6,582    |       | 2,498    |       |
| Premises and  equipment, net                                |       | 1,413                                                                 |       | 1,633    |       | 769      |       | 609      |       | 673      |       |
| Deposits                                                    |       | 815,053                                                               |       | 560,567  |       | 367,705  |       | 221,394  |       | 142,293  |       |
| Federal  funds purchased                                    |       | 2,000                                                                 |       | —   |       | —   |       | —   |       | —   |       |
| Long term  debt                                             |       | 8,248                                                                 |       | 8,248    |       | 8,248    |       | —   |       | —   |       |
| Other  liabilities                                          |       | 11,592                                                                |       | 3,479    |       | 1,657    |       | 923      |       | 384      |       |
| Shareholders’  equity                                  |       | 63,121                                                                |       | 51,224   |       | 26,430   |       | 23,600   |       | 13,398   |       |
|                                                        |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Selected  Ratios:**                                       |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Overhead  ratio (1)                                         |       | 1.76                                                                  | %          | 1.80     | %          | 1.98     | %          | 2.26     | %          | 2.70     | %          |
| Efficiency  ratio (2)                                       |       | 43.99                                                                 | %          | 42.84    | %          | 41.81    | %          | 46.83    | %          | 61.11    | %          |
| Net yield on  earning assets                                |       | 8.50                                                                  | %          | 8.46     | %          | 7.70     | %          | 6.74     | %          | 6.62     | %          |
| Cost of  funds                                              |       | 5.18                                                                  | %          | 4.94     | %          | 3.66     | %          | 2.54     | %          | 2.75     | %          |
| Net Interest  margin                                        |       | 3.72                                                                  | %          | 3.98     | %          | 4.44     | %          | 4.56     | %          | 4.22     | %          |
| Operating  expenses to average earning assets               |       | 1.81                                                                  | %          | 1.86     | %          | 2.03     | %          | 2.33     | %          | 2.79     | %          |
| Return on  average assets                                   |       | 0.91                                                                  | %          | 0.95     | %          | 0.97     | %          | 0.83     | %          | 0.70     | %          |
| Return on  average equity                                   |       | 12.13                                                                 | %          | 12.68    | %          | 12.29    | %          | 8.92     | %          | 8.00     | %          |
| Average  equity to average assets                           |       | 7.53                                                                  | %          | 7.46     | %          | 7.90     | %          | 9.28     | %          | 8.78     | %          |
| Ratio of  nonperforming assets to average assets            |       | 1.14                                                                  | %          | 0.94     | %          | 1.40     | %          | 1.90     | %          | 1.99     | %          |
| Ratio of  allowance for loan losses to average assets       |       | 1.37                                                                  | %          | 1.39     | %          | 1.39     | %          | 1.41     | %          | 1.56     | %          |
| Ratio of  allowance for loan losses to nonperforming assets |       | 119.94                                                                | %          | 146.91   | %          | 99.43    | %          | 74.45    | %          | 78.59    | %          |

 

----

(1) Operatingexpenses divided by average assets.

(2) Operatingexpenses divided by net interest income and noninterest income.

 

17

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| **ITEM  7.** | ** ** | **MANAGEMENT’S DISCUSSION AND  ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION** |
|--------------|------------|------------------------------------------------------------------------------------------------|

 

**Forward-Looking Statements**

 

Certainstatements contained in this report may not be based on historical facts andare “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These forward-looking statements may beidentified by reference to a future period or by the use of forward-lookingterminology, such as “expect,” “anticipate,” “believe,” “estimate,” “foresee,” “may,”“might,” “will,” “intend,” “could,” “would,” “plan,” “forecast” or future orconditional verb tenses and variations or negatives of such terms. Theseforward-looking statements include, without limitation, those relating to theefficiency and efficacy of the business bank model, the conduct of businessapart from the activities of the Bank, competition, employee relations of theBank, legislative changes affecting banks or bank holding companies, thepayment of dividends, the Bank’s capitalization under FDICIA, the impact of theInterstate Act on the Bank, brokered deposits regulation, FDIC insurancepremiums, monetary policies of the Federal Reserve System, liquidity, capitaladequacy and the Bank’s ability to raise additional capital, growth of ourmarket area, an acquisitive banking environment, our practice of competing forloans based on superior service rather than lowest price, loan loss reserve,loans classified as doubtful or substandard, allowance for loan losses,non-interest income, revenue results from our mortgage unit, loan sales,opportunities offered by Bank growth, the hiring of additional employees,salaries and benefits expense, tax rates, earning asset to total asset ratio,the cost of funds for local deposits, utilization of an electronic bulletinboard for funding in the wholesale deposit market, engagement of a depositbroker, borrowers’ ability to repay loans, the impact of recent accountingpronouncements, rate sensitivity gap analysis, economic value of equity,maturities of debt securities, fair value of debt securities, unrecognized taxbenefits and the issuance of preferred stock. We caution you not to place unduereliance on the forward-looking statements contained in this report becauseactual results could differ materially from those indicated in suchforward-looking statements as a result of a variety of factors. These factorsinclude, but are not limited to, changes in economic conditions, competitionfor loans, mortgages and other financial services and products, changes ininterest rates, concentrations within our loan portfolio, our ability tomaintain credit quality, the effectiveness of our risk monitoring systems,changes in consumer preferences, the ability of our borrowers to repay loans,the availability of and costs associated with maintaining and/or obtainingadequate and timely sources of liquidity, changes in our operating strategy,our ability to meet regulatory capital adequacy requirements, our ability tocollect amounts due under loan agreements and to attract deposits, our abilityto attract, train and retain qualified personnel, the geographic concentrationof our assets, our ability to operate and integrate new technology, our abilityto provide market competitive products and services, our ability to diversifyrevenue, our ability to fund growth with lower cost liabilities, laws andregulations affecting financial institutions in general and other factorsdetailed from time to time in our press releases and filings with theSecurities and Exchange Commission. We undertake no obligation to updatethese forward-looking statements to reflect the occurrence of changes orunanticipated events, circumstances or results that occur after the date ofthis report.

 

**Overview**

 

**(Dollars in thousands except share data in the remainder ofthis Item 7.)**

 

The results of operations for the year 2007 compared to 2006 reflecteda 45.21% increase in net income and a 23.68% increase in diluted earnings per share. The increase in earnings resulted primarily from a 40.74% increase in netinterest income because of higher average loan balances.  The net interestmargin for 2007 was 3.72%. The increased revenue was partially offset byincreases in non-interest expense and the provision for loan losses.  Theyear 2007 reflected a continuation of the Bank’s trend of rapid assetgrowth.  The asset growth was a result of the strength of the MiddleTennessee economy and the success of our Business Bank operating strategy.

 

Our growth in assets was a result of growth in the market area andeffective marketing. The improvement in results including net income andearnings per share was a result of the business focus of the Bank. From 2000 to2007, the Bank’s market area experienced explosive growth. In WilliamsonCounty, demographic information shows a 31.84% growth in the number ofhouseholds from 2000 to 2007.  Estimates from SNL show that by 2012 thenumber of households will have grown by another 20.63%. Although estimates ofgrowth are not guaranteed and actual growth may be affected by factors beyondour control, management believes that the projected growth of our market areawill positively impact the Bank’s future growth.

 

18

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The Bank has also grown by marketing to business owners that have beenleft without a long standing banking relationship. The Middle Tennessee areahas experienced several bank mergers or acquisitions in the last ten yearsresulting in the termination of many long standing relationships. Theseacquisitions also resulted in loan funding decisions being made out-of-state,creating unpredictability for local lending personnel and uncertainty for localbusinesses. The Bank has taken advantage of this uncertainty by offering loansat a fair rate and funded locally in a timely manner. Management believes thecompetitive advantage created by this environment will continue to positivelyimpact results from operations.

 

The Business Bank operating strategy has enabled management to focus onmanaging results. Rather than focusing on building a multi-branchinfrastructure including hiring and construction of buildings, managementfocuses on managing net interest margin aggressively and controlling non-interestexpense. This has resulted in a 11.85% decrease in the net interest margin from2003 to 2007. Non-interest expense is controlled by efficiently staffing theBank’s operations. In 2007, that resulted in $14,060 in assets per employee atyear end. Management believes that the Business Bank operating strategy willcontinue to be an effective model in the future.

 

**Changes in Results of Operations**

 

**Net Income** - Net income for 2007 was $6,896, anincrease of $2,147, or 45.21%, compared to the $4,749 earned in 2006. Theincrease was attributable to a 40.74% increase in net interest income from$19,377 in 2006 to $27,272 in 2007. The increase of $7,895 in net interestincome was the result of higher average loan balances. Non-interest incomeincreased by $1,117, from $1,763 to $2,880, or 63.36%, primarily a result ofgains on loan sales. These positive effects were partially offset by a 45.98%increase in the provision for loan losses, from $4,350 in 2006 to $6,350 in2007, and an increase of $4,207 in non-interest expense, up 46.46% to $13,263in 2007 compared to $9,056 in 2006. The increase in the provision for loanlosses was the result of funding the loan loss reserve to match the growth inthe loan portfolio and loan charge-offs. The increase in non-interest expensewas a result of the increase in personnel and general operating expensesattributable to the Corporation’s growth.

 

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 was attributable to a42.20% increase in net interest income from $13,627 in 2005 to $19,377 in2006.  The increase of $5,750 in net interest income was the result ofhigher average loan balances.  Non-interest income increased by $452, from$1,311 to $1,763, or 34.48%, primarily as a result of to gains on loansales. These positive effects were partially offset by a 17.57% increasein the provision for loan losses, from $3,700 in 2005 to $4,350 in 2006 and anincrease of $2,810 in non-interest expense, up 44.99% to $9,056 in 2006compared to $6,246 in 2005.  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 wasa result of the increase in personnel and general operating expensesattributable to the Corporation’s growth.

 

**Net Interest Income** - The primary source of earnings for theBank is net interest income, which is the difference between the interestearned on 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 aseries of increases in short-term interest rates.  By year-end 2007, theFOMC had increased rates by 300 basis points. During 2007, $20,656 of our netloan growth occurred in floating rate construction loans and approximately14.63% of the $141,156 increase in commercial loans was related to floatingrate transactions. Management expects to continue its practice of competing forloans based on providing superior service rather than the lowest price.

 

Net interest income for 2007 was $27,272 compared to $19,377, a gain of$7,895 or 40.74%. The increase in net interest income was largely attributableto strong loan growth. Net loans increased from $538,550 at December 31,2006 to $784,001 at December 31, 2007, an increase of $245,451 or 45.58%.  Net interest income was favorably impacted bythe increase in the Bank’s indirect funding program for small transactions.These loans, which are purchased at a minimum rate of 8%, increased from$113,400 at year-end 2006 to $153,100 at the end of 2007. The loan growth wasmatched by an increase in deposits from $560,567 at December 31, 2006 to$815,053 in 2007, an increase of $254,486 or 45.40%.

 

19

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Net interest income for 2006 was $19,377 compared to $13,627 in 2005, again of $5,750 or 42.20%.  The increase in net interest income was largelyattributable to strong loan growth.  Net loans increased from $344,187 at 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 expansion of the Bank’sindirect funding program for small transactions. These loans, which arepurchased at a minimum rate of 8%, increased from $87,000 at year-end 2005 to$113,400 at the end of 2006.  This high yielding portfolio was a keycomponent in the stability and strength of net interest income.  The loangrowth was matched by an increase in deposits from $367,705 at December 31,2005 to $560,567 in 2006 – an increase of $192,862 or 52.45%.

 

**Investments** - The Bank views the investmentportfolio as a source of income and liquidity. Management’s investment strategyis to accept a lower immediate yield in the investment portfolio by targetingshorter term investments.   The Bank’s investment policy requires aminimum portfolio level equal to 7.00% of total assets and a maximum portfoliolevel of 20.00% of total assets.  Management has maintained the portfolioat the lower end of the policy guidelines with the portfolio at 8.19%, 9.13%and 7.91% of total assets at year-end in 2007, 2006 and 2005, respectively.

 

The investment portfolio at December 31, 2007 was $73,753 comparedto $56,943 at year-end 2006. The interest earned on investments rose from$2,216 in 2006 to $3,492 in 2007, as a result of higher average portfoliobalances as well as increased yields. The average yield on the investmentportfolio investments rose from 4.91% in 2006 to 5.43% in 2007, or 52 basispoints.

 

The investment portfolio at December 31, 2006 was $56,943,compared to $31,992 at year-end 2005. The average yield on the investmentportfolio was 4.91% in 2006 compared to 4.19% in 2005.

 

**Net Interest Margin Analysis** - The net interest margin is impacted bythe average volumes of interest sensitive assets and interest sensitiveliabilities and by the difference between the yield on interest sensitiveassets and the cost of interest sensitive liabilities (spread).  Loan feescollected at origination represent an additional adjustment to the yield onloans. 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 the interest rates receivedon loans and the interest rates paid on deposits. The Bank has been disciplinedin raising interest rates on deposits only as the market demands and therebymanaging the cost of funds. Also, the Bank has not competed for new loans oninterest rate alone but has relied on effective marketing to businesscustomers. Business customers are not influenced by interest rates alone butare influenced by other factors such as timely funding.

 

The net interest margin declined from 3.98% in 2006 to 3.72% in 2007because the cost of funds rose faster than the yield on earning assets during2007. Interest income increased by $20,961, or 50.82%, from $41,245 in 2006 to$62,206 in 2007. The increase was primarily a result of increased loan volume.Average earning assets increased from $486,668 in 2006 to $731,749 in 2007, anincrease of $245,081 or 50.36%. The increase in earning assets was a result ofloan growth. Average loans increased $228,024 or 53.25% from 2006 to 2007. Theaverage yield on earning assets increased from 8.46% in 2006 to 8.50% in 2007,or 4 basis points. The increase in the Bank’s indirect funded small loanportfolio favorably impacted the average yield on earning assets. The averageyield on this type of loan in 2007 was 8.75%. These loans increased 35.01% from$113,400 at year-end 2006 to $153,100 at the end of 2007.   Interestexpense increased from $21,868 in 2006 to $34,934 in 2007. The $13,066, or59.75%, increase in expense was a result of increases in the volume of depositsas well as an increase in the cost of funds. Average deposits increased from$451,235 in 2006 to $685,063 in 2007, an increase of $233,828 or 51.82%. Thecost of funds increased from 4.94% in 2006 to 5.18% in 2007, or 24 basispoints.

 

20

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The net interest margin declined from 4.44% in 2005 to 3.98% in 2006because of the cost of funds rose faster than the yield on earning assetsduring 2006.  Interest income increased by $17,612, or 74.52%, from$23,633 in 2005 to $41,245 in 2006.  The increase was primarily a resultof increased loan volume.  Average earning assets increased from $306,765in 2005 to $486,668 in 2006, an increase of $179,903 or 58.65%.  Theincrease in earning assets was a result of loan growth. Average loans increased$150,365 or 54.12%.  The average yield on earning assets increased from7.70% in 2005 to 8.46% in 2006, or 76 basis points. The net interest margin wasfavorably impacted by the expansion of the Bank’s indirect funded small loanportfolio.  These loans increased from $87,100****atyear-end 2005 to $113,400 at the end of 2006.  This high yieldingportfolio is a key component in the strength of the net interest margin.

 

Interest expense increased from $21,868 in 2006 to $34,934 in2007.  The $13,066, or 59.75%, increase in expense was a result ofincreases in the volume of deposits as well as interest rates. Average interestbearing deposits increased from $432,910 in 2006 to $663,816 in 2007, anincrease of $230,906 or 53.34%. Additionally, the cost of funds increased from4.94% in 2006 to 5.18% in 2007.

 

Interest expense increased from $10,006 in 2005 to $21,868 in2006.  The $11,862, or 118.55%, increase in expense was a result ofincreases in the volume of deposits.   Average interest bearingdeposits increased from $266,214 in 2005 to $432,910 in 2006, an increase of$166,696 or 62.62%.  Despite the fact that rates started increasing in thelast half of 2006, management was aggressive in lowering interest rates onsavings accounts and other products during the year.  As a result, thecost of funds increased from 3.66% in 2005 to 4.94% in 2006, an increase of 128basis 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.

 

**Provision for Loan Losses** - Management assesses the adequacy ofthe allowance for loan losses with a combination of qualitative andquantitative factors.  At inception, each loan is assigned a risk ratingthat ranges from “RR1 to RR4.”  An RR1 assignment indicates a “Superior”credit, RR2 represents an “Excellent” credit, RR3 represents an “Above-Average”loan, and RR4 designates an “Average” credit.  The assignment of a riskrating is based on an evaluation of the credit risk in the transaction. The evaluation 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.

 

Management reviews the loan portfolio regularly to determine if loansshould be placed on non-accrual for revenue recognition. If a loan is placed onnon-accrual, all interest earned since the last current payment is immediatelyreversed.  Loans may remain on non-accrual status until the underlyingcollateral is repossessed and valued or until the amount of loss in the creditcan be reasonably determined.  Once collateral is repossessed andappraised, the collateral is recorded as a repossession at the lower of fairvalue or the investment in the related loan.  Any difference between theestimated 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 $6,465,$2,689 and $2,928 at year-end 2007, 2006 and 2005, respectively.  Theseamounts represented 0.82%, 0.50% and 0.85%, respectively, of net loans at theend of each year.

 

Management uses the weighted average risk rating to monitor the overallcredit quality and trends in the loan portfolio. At December 31, 2007, theweighted average risk rating of the $784,001 net loan portfolio was 3.56. At December 31,2006, the weighted average risk rating of the $538,550 net loan portfolio was3.56.  The Board of Directors reviews the weighted average risk rating ofloans booked during the previous month.  In addition, the Board reviewsall credits classified RR5 or higher monthly.  Management closely monitorsother key loan quality indicators including delinquencies, changes in theportfolio mix and general economic conditions.  These actions provide adegree of objectivity in assessing the risk in the portfolio and establishingan adequate loan loss reserve.  To the extent that actual and anticipatedlosses differ, adjustments are made to the loan loss provision or to the levelof the allowance for loan losses. At December 31, 2007, the loan lossreserve of $10,321 was 1.30% of gross loans of $794,322.

 

The provision for loan losses in 2007 was $6,350, an increase of$2,000, or 45.98%, above the provision of $4,350 expensed in 2006. Of thisprovision, $3,353, or 52.80%, was attributable to loan growth recorded during2007. The remainder of the loan loss provision in 2007 funded net charge offsof $2,997.

 

21

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The provision for loan losses in 2006 was $4,350, an increase of $650,or 17.57%, above the provision expensed in 2005. Of this provision,$2,569, or 59.06%, was attributable to maintaining a general reserve for theloan growth recorded during 2006.  The remainder of the loan lossprovision in 2006 funded net charge offs of $1,781.

 

The Bank targets small and medium sized businesses as loan customers.Because of their size, these borrowers may be less able to withstandcompetitive or economic pressures than larger borrowers in periods of economicweakness. If loan losses occur to a level where the loan loss reserve is notsufficient to cover actual loan losses, the Bank’s earnings will decrease. TheBank uses an independent accounting firm to review our loans quarterly forquality in addition to the reviews that may be conducted by bank regulatoryagencies as part of their usual examination process.

 

The following table presents information regarding non-accrual, pastdue and restructured loans at December 31, 2007, 2006, 2005, 2004 and2003:

 
| ** **                                                                                             | ** ** | **December 31,**                | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                             | ** ** | **2007**                             | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                             | ** ** | **(Dollars in thousands)** | ** ** |
| Non-accrual loans                                                                                      |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                 |       | 130                                  |       | 60 |   | 46 |   | 17 |   | 12 |   |
| Amount                                                                                                 |       | $                                    | 6,465      |   | $ | 2,689 |   | $ | 2,928 |   | $ | 2,161 |   | $ | 1,136 |   |
|                                                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Accruing loans which are contractually past due 90 days or more as to  principal and interest payments |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                 |       | 44                                   |       | 18 |   | 9 |   | 4 |   | 6 |   |
| Amount                                                                                                 |       | $                                    | 1,992      |   | $ | 940 |   | $ | 352 |   | $ | 111 |   | $ | 308 |   |
|                                                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Loans defined as “troubled debt restructurings”                                              |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                 |       | 1                                    |       | 3 |   | 3 |   | 2 |   | 1 |   |
| Amount                                                                                                 |       | $                                    | 148        |   | $ | 1,114 |   | $ | 1,144 |   | $ | 1,544 |   | $ | 1,101 |   |
|                                                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Gross interest income lost on the non-accrual loans                                                    |       | $                                    | 436        |   | $ | 174 |   | $ | 133 |   | $ | 82 |   | $ | 193 |   |
|                                                                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Interest income included in net income on the accruing loans                                           |       | $                                    | 605        |   | $ | 73 |   | $ | 31 |   | $ | 48 |   | $ | 29 |   |

 

As of December 31,2007, there were no loans classified for regulatory purposes as doubtful orsubstandard that have not been disclosed in the above table, which (i) representor result from trends or uncertainties that management reasonably expects willmaterially impact future operating results, liquidity, or capital resources, or(ii) represent material credits about which management is aware of anyinformation which causes management to have serious doubts as to the ability ofsuch borrowers to comply with the loan repayment terms.

 

The Bank had no tax-exempt loans during the years ended December 31,2007 and December 31, 2006. The Bank had no loans outstanding toforeign borrowers at December 31, 2007 and December 31, 2006.

 

22

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An analysis of the Bank’s loss experience is furnished in the followingtable for December 31, 2007, 2006, 2005, 2004 and 2003, and the years thenended:

 
| ** **                                       | ** ** | **December 31,** | ** ** |
|--------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**             | ** ** | **2007**              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Allowance for loan losses at beginning of period |       | $                     | 6,968      |   | $ | 4,399 |   | $ | 2,841 |   | $ | 2,000 |   | $ | 1,103 |   |
| Charge-offs:                                     |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                     |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                     |       | 32                    |       | — |   | — |   | — |   | — |   |
| 1 to 4 family residential                        |       | —                |       | — |   | — |   | 101 |   | — |   |
| Other                                            |       | —                |       | — |   | — |   | 131 |   | — |   |
| Commercial, financial and agricultural           |       | 3,262                 |       | 2,026 |   | 2,379 |   | 1,366 |   | 235 |   |
| Consumer                                         |       | 16                    |       | 11 |   | 32 |   | 57 |   | 48 |   |
| Other                                            |       | —                |       | — |   | — |   | — |   | — |   |
| Total Charge-offs                                |       | 3,310                 |       | 2,037 |   | 2,411 |   | 1,655 |   | 283 |   |
|                                             |       |                  |       |   |   |   |   |   |   |   |   |
| Recoveries:                                      |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                     |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                     |       | —                |       | — |   | — |   | — |   | — |   |
| 1 to 4 family residential                        |       | —                |       | — |   | 1 |   | — |   | — |   |
| Other                                            |       | —                |       | — |   | — |   | 3 |   | — |   |
| Commercial, financial and agricultural           |       | 313                   |       | 234 |   | 245 |   | 68 |   | 64 |   |
| Consumer                                         |       | —                |       | 22 |   | 23 |   | 5 |   | 1 |   |
| Other                                            |       | —                |       | — |   | — |   | — |   | — |   |
| Total Recoveries                                 |       | 313                   |       | 256 |   | 269 |   | 76 |   | 65 |   |
|                                             |       |                  |       |   |   |   |   |   |   |   |   |
| Net Charge-offs                                  |       | 2,997                 |       | 1,781 |   | 2,142 |   | 1,579 |   | 218 |   |
|                                             |       |                  |       |   |   |   |   |   |   |   |   |
| Provision for loan losses charged to expense     |       | 6,350                 |       | 4,350 |   | 3,700 |   | 2,420 |   | 1,115 |   |
|                                             |       |                  |       |   |   |   |   |   |   |   |   |
| Allowance for loan losses at end of period       |       | $                     | 10,321     |   | $ | 6,968 |   | $ | 4,399 |   | $ | 2,841 |   | $ | 2,000 |   |

 
| ** **                                                                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                  | ** ** | **2007**              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net charge-offs as a percentage of average total loans outstanding  during the year         |       | 0.45                  | %          | 0.41 | % | 0.76 | % | 0.89 | % | 0.20 | % |
| Ending allowance for loan losses as a percentage of total loans  outstanding at end of year |       | 1.30                  | %          | 1.28 | % | 1.26 | % | 1.31 | % | 1.48 | % |

 

The allowance for loan losses is established by charges to operationsbased on management’s evaluation of the loan portfolio, past due loanexperience, collateral values, current economic conditions and other factorsconsidered necessary to maintain the allowance at an adequate level. Managementbelieves that the allowance was adequate at December 31, 2007.

 

23

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At December 31, 2007, 2006, 2005, 2004 and 2003, the allowance forloan losses was allocated as follows:

 
| ** **                              | ** ** | **2007**   | ** ** | **2006**                                                                        | ** ** | **2005**   | ** ** | **2004**                                                                        | ** ** | **2003**   | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------------------|------------|------------|------------|
| **(Dollars 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                            |       | $          | 1,132      |                                                                            | 14.15      | %          | $          | 745                                                                             |       | 13.65      | %          | $ | 383 |   | 10.98 | % | $ | 175 |   | 10.55 | % | $ | 71 |   | 7.68 | % |
| 1 to 4 family  residential              |       | 335        |       | 4.22                                                                            | %          | 229        |       | 4.19                                                                            | %          | 225        |       | 5.27 | % | 75 |   | 7.38 | % | 57 |   | 10.00 | % |
| Other                                   |       | 1,440      |       | 18.13                                                                           | %          | 840        |       | 15.40                                                                           | %          | 504        |       | 14.45 | % | 265 |   | 15.59 | % | 331 |   | 14.85 | % |
| Commercial,  financial and agricultural |       | 7,130      |       | 60.14                                                                           | %          | 5,048      |       | 64.89                                                                           | %          | 3,197      |       | 67.11 | % | 2,272 |   | 64.68 | % | 1,510 |   | 65.03 | % |
| Consumer                                |       | 56         |       | 0.50                                                                            | %          | 37         |       | 0.60                                                                            | %          | 45         |       | 0.90 | % | 54 |   | 1.80 | % | 31 |   | 2.44 | % |
| Other                                   |       | 228        |       | 2.86                                                                            | %          | 69         |       | 1.27                                                                            | %          | 45         |       | 1.29 | % | — |   | 0.00 | % | — |   | 0.00 | % |
|                                    |       |       |       |                                                                            |       |       |       |                                                                            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total                                   |       | $          | 10,321     |                                                                            | 100.00     | %          | $          | 6,968                                                                           |       | 100.00     | %          | $ | 4,399 |   | 100.00 | % | $ | 2,841 |   | 100.00 | % | $ | 2,000 |   | 100.00 | % |

 

**Non-interest Income** - Non-interest income is income that isnot related 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.  Because of the business focus ofthe Bank and its lack of a large retail customer base, revenues from thesetraditional sources will remain modest.

 

The Bank earned $76 in mortgage origination fees in 2007 compared to$89 earned in 2006, a decline of $13 or 14.61%. The decline in mortgage loandemand and mortgage origination income was attributed to the disruption in themortgage market in 2007. Management believes that in 2008 the mortgage unitwill provide a value-added service with modest revenue results.

 

The Bank earned $2,687 in 2007 on a series of loan sale transactionscompared to $2,025 in 2006. The Bank is located in a vibrant market area andcan generate quality assets at a faster rate than it can adequately fund them.In addition to lending in the local marketplace, the Bank providescollateral-based loans to business borrowers in other states through two typesof indirect funding programs. Management has identified a network of communitybanks eager to purchase quality assets. Management has installed appropriate systemsand processes to sell assets to other banks located in slower growing marketsand believes that loan sales will be a recurring source of revenue.

 

In 2006, the Bank earned $2,025 on a series of loan saletransactions.  The Bank earned $89 in mortgage origination fees in 2006compared to $105 earned in 2005, a decline of $16 or 15.24%.  The declinein mortgage origination income was attributed to rising interest rates in2006.  Income earned in the form of service charges on deposits totaled $112,a loss of $2, or 1.75% below the $114 earned in 2005.  Gain on sales ofsecurities declined by $4 or 100% from $4 in 2005 to $0 in 2006.

 

**Non-interest Expense** - Non-interest expense includes salariesand benefits expense, occupancy costs and other operating expenses includingdata processing, professional fees, supplies, postage, telephone and otheritems. Management views the control of operating expense as a criticalelement in the success of the Business Bank strategy.  The Bank operatesmore efficiently than most peer banks because it conducts business from asingle location and does not provide banking services for many retail customerswith high transaction volume.

 

Management targets $7,500 in assets per full-time employee as a measureof staffing efficiency. Management believes that the growth of the Bank willoffer additional opportunities to leverage personnel resources.  The Bankdoes expect to hire employees in 2008, so salaries and benefits expense willincrease, but the target for Average Assets per Employee will remain at $7,500per employee.

 

Non-interest expense for 2007 was $13,263, an increase of $4,207 or46.46%, over the $9,056 expensed in 2006. Approximately 70% of the increase wasattributable to the addition of new employees during the year. The Bank ended2007 with 64 full-time employees. Assets per employee were $14,060 at year-end2007 compared to $12,500 at year-end 2006.

 

Non-interest expense for 2006 was $9,056, an increase of $2,810 or44.99%, over the $6,246 expensed in 2005.  Approximately 48% of theincrease was attributable to the addition of new employees during theyear.  The Bank ended 2006 with 50 full-time employees.  Assets peremployee were $12,500 at year-end 2006 and $9,800 at year-end 2005.

 

24

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**Income Taxes** — Our effective tax rate in 2007 was34.57% compared to 38.60% in 2006 and 38.56% in 2005. Managementanticipates that tax rates in future years will approximate the rates paid in2007.

 

**Changes in Financial Condition**

 

**Assets****-** Total assets at December 31, 2007were $900,153, an increase of $276,635 or 44.37%, over total assets of $623,518at December 31, 2006. Average assets for 2007 were $755,254, an increaseof $253,276, or 50.46% over average assets in 2006. Loan growth was the primaryreason for the increases. Year-end 2007 net loans were $784,001, up $245,451,or 45.58% over the year-end 2006 total net loans of $538,550.

 

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, or58.87% over average assets in 2005.  Loan growth was the primary reasonfor the increases.  Year-end 2006 net loans were $538,550, up $194,363, or56.47% over the year-end 2005 total net loans of $344,187.

 

The Bank’s Business Bank model of operation results in a higher levelof earning assets than most peer banks.  Earning assets are defined asassets that earn interest income.  Earning assets include short-terminvestments, the investment portfolio and net loans.  The Bank maintains arelatively high level of earning assets because few assets are allocated tofacilities, cash and due-from bank accounts used for transaction processing.Earning assets at December 31, 2007 were $867,327, or 96.35% of totalassets of $900,153. Earning assets at December 31, 2006 were $610,322, or97.88% of total assets of $623,518.  Management targets an earning assetto total asset ratio of 97% or higher. This ratio is expected to generallycontinue at these levels, although it may be affected by economic factorsbeyond the Bank’s control.

 

**Liabilities****-** The Bank relies on increasing itsdeposit base to fund loan and other asset growth.  The Williamson Countymarketplace is highly competitive with 24 financial institutions and 83 bankingfacilities (as of June 30, 2007). The Bank competes for local deposits byoffering attractive products with premium rates.  The Bank expects to havea higher average cost of funds for local deposits than most competitor banksbecause of its single location and lack of a branch network.  Management’sstrategy is to offset the higher cost of funding with a lower level ofoperating expense and firm pricing discipline for loan products.  The Bankhas promoted electronic banking services by providing them without charge andby offering in-bank customer training.

 

The Bank also obtains funding in the wholesale deposit market which isaccessed by means of an electronic bulletin board.  This electronic marketlinks banks and sellers of deposits to deposit purchasers such as creditunions, school districts, labor unions, and other organizations with excessliquidity.  Deposits may be raised in $99 or $100 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 detailof deposits shown in this Item 7. Management may also, from time to time,engage the services of a deposit broker to raise a block of funding at aspecified maturity date.

 

Total average deposits in 2007 were $685,063, an increase of $233,828,or 51.82% over the total average deposits of $451,235 in 2006. Averagenon-interest bearing deposits increased by $2,922, or 15.95%, from $18,325 in2006 to $21,247 in 2007. Average savings deposits decreased by $5,423 from$12,678 in 2006 to $7,255 in 2007. Average purchased deposits increased by$62,547, or 32.57%, from $192,064 in 2006 to $254,611 in 2007. The average ratepaid on purchased deposits in 2007 was 5.28% compared to 4.82% in 2006.Purchased time deposit funding represented 37.27% of total funding in 2007compared to 33.96% in 2006.

 

Total average deposits in 2006 were $451,235, an increase of $168,532,or 59.61% over the total average deposits of $282,703 in 2005.  Averagenon-interest bearing deposits increased by $1,836 or 11.13%, from $16,489 in2005 to $18,325 in 2006. Average savings deposits decreased by $10,107 from$22,785 in 2005 to $12,678 in 2006.  Average purchased deposits increasedby $45,738, or 31.26%, from $146,326 in 2005 to $192,064 in 2006.  Theaverage rate paid on purchased time deposits in 2006 was 4.82% compared to3.55% in 2005.  Purchased time deposit funding represented 42.56% of totalfunding in 2006 compared to 51.34% in 2005.

 

25

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**Loan Policy** - Lending activity is conducted underguidelines defined in the Bank’s Loan Policy.  The Loan Policy establishesguidelines for analyzing financial transactions including an evaluation of aborrower’s credit history, repayment capacity, collateral value, and cashflow.  Loans may be at a fixed or variable rate, with the maximum maturityof fixed rate loans set at five years.

 

All lending activities of the Bank are under the direct supervision andcontrol of the Officers Loan Committee, the Executive Committee of the Boardand, in some cases, the full Board of Directors. The Officers Loan Committeeconsists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox, and approvesloans up to $1,000. The Executive Committee consists of Arthur F. Helf, MichaelR. Sapp and H. Lamar Cox and two outside directors, and approves loans up to15% of Tier I Capital. The full Board of Directors approves all loans abovethose limits. The full Board of Directors also approves loan authorizations, ifany, for any executive officer. The Bank’s established maximum loan volume todeposits is 100%. The Executive Committee of the Board makes a monthly reviewof loans which are 90 days or more past due and the full Board of Directorsmakes a quarterly review of loans which are 90 days or more past due.

 

Management of the Bank periodically reviews the loan portfolio,particularly non-accrual and renegotiated loans.  The review may result ina determination that a loan should be placed on a non-accrual status for incomerecognition.  In addition, to the extent that management identifies potentiallosses in the loan portfolio, it reduces the book value of such loans, throughcharge-offs, to their estimated collectible value.  The Bank’s policy isthat accrual of interest is discontinued on a loan when management of the Bankdetermines that collection of interest is doubtful based on consideration ofeconomic and business factors affecting collection efforts.

 

When a loan is classified as non-accrual, any unpaid interest isreversed against current income.  Interest is included in incomethereafter only to the extent received in cash.  The loan remains in anon-accrual classification until such time as the loan is brought current, whenit may be returned to accrual classification.  When principal or intereston a non-accrual loan is brought current, if in management’s opinion futurepayments 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 four major categoriesof loans, commercial and industrial, consumer, agricultural and real estatewhich includes residential, construction and development and certain other realestate loans.  The Bank requires its loan officers and loan committee toconsider the borrower’s character, the borrower’s financial condition, theeconomic environment in which the loan will be repaid, as well as, for commercialloans, the borrower’s management capability and the borrower’s industry. Beforeapproving a loan, the loan officer or committee must determine that theborrower is creditworthy, is a capable manager, understands the specificpurpose of the loan, understands the source and plan of repayment, anddetermine that the purpose, plan and source of repayment as well as collateralare acceptable, reasonable and practical given the normal framework withinwhich the borrower operates.

 

The maintenance of an adequate loan loss reserve is one of thefundamental concepts of risk management for every financial institution. Management is responsible for ensuring that controls are in place to monitorthe adequacy of the loan loss reserve in accordance with generally acceptedaccounting principles (“GAAP”), the Bank’s stated policies and procedures, andregulatory guidance.  Quantification of the level of reserve which isprudently conservative, but not excessive, involves a high degree of judgment.

 

Management’s assessment of the adequacy of the loan loss reserveconsiders a wide range of factors including portfolio growth, mix, collateraland geographic diversity, and terms and structure.  Portfolio performancetrends, 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 to quantify the level ofthe loan loss reserve.  At inception, each loan transaction is assigned arisk rating that ranges from “RR1—Excellent” to “RR4—Average.”  The riskrating is determined by an analysis of the borrower’s credit history andcapacity, collateral, and cash flow.  The weighted average risk rating ofthe portfolio provides an indication of overall risk and identifiestrends.  The portfolio is additionally segmented by loan type, collateral,and purpose.  Loan transactions that 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.

 

26

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It is management’s intent to maintain a loan loss reserve that is adequateto absorb current and estimated losses which are inherent in a loanportfolio.  The historical loss ratio (net charge-offs as a percentage ofaverage loans) was 0.76%, 0.41% and 0.45% for the years ended December 31,2005, 2006 and 2007, respectively.  The year end loan loss reserve as apercentage of end of period loans was 1.26%, 1.28% and 1.30%, respectively, forthe same years.  Because of the commercial emphasis of the bank’soperation, management has kept a reserve level in excess of historical results.

 

The provision for loan losses for 2007 was $6,350,000, an increase of$2,000,000 over the $4,350,000 provision for 2006.  In 2007, expensereflected the impact of $3,310,000 in charge-offs during the year and theincremental provision required as a result of the $249,000 increase in loanvolume.

 

CreditRisk Management and Reserve for Loan Losses

 

Credit risk and exposure to loss are inherent parts of the bankingbusiness.  Management seeks to manage and minimize these risks through itsloan and investment policies and loan review procedures.  Managementestablishes and continually reviews lending and investment criteria andapproval procedures that it believes reflect the risk sensitive nature of theBank.  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 as loan customers.Because of their size, these borrowers may be less able to withstandcompetitive or economic pressures than larger borrowers in periods of economic weakness.If loan losses occur to a level where the loan loss reserve is not sufficientto cover actual loan losses, the Bank’s earnings will decrease. The Bank usesan independent accounting firm to review its loans for quality in addition tothe reviews that may be conducted by bank regulatory agencies as part of theirusual examination process.

 

Management regularly reviews the loan portfolio and determines theamount of loans to be charged-off.  In addition, management considers suchfactors as the Bank’s previous loan loss experience, prevailing and anticipatedeconomic conditions, industry concentrations and the overall quality of theloan portfolio. While management uses available information to recognizelosses on loans and real estate owned, future additions to the allowance may benecessary based on changes in economic conditions.  In addition, variousregulatory agencies, as an integral part of their examination process,periodically review the allowances for losses on loans and real estate owned. Such agencies may require the Bank to recognize additions to the allowancesbased on their judgments about information available at the time of theirexaminations.  In addition, any loan or portion thereof which isclassified as a “loss” by regulatory examiners is charged-off.

 

**Financial Tables**

 

The following financial information regarding the Corporation and theBank should be read in conjunction with our financial statements included inItem 8 of this Report.

 

Average Balance Sheets, Net Interest Income andChanges in Interest Income and Interest Expense

 

The following tables present the average yearly balances of eachprincipal category of assets, liabilities and stockholders’ equity of theCorporation and the Bank. The tables are presented on taxable equivalentbasis, as applicable.

 

27

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| ** **                                      | ** ** | **12 months Ended December 31, 2007** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Average**                                                    | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance**                                                    | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                      |       |                                                           |       |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| Interest earning assets                         |       |                                                           |       |   |   |   |   |
| Securities                                      |       |                                                           |       |   |   |   |   |
| Taxable (1)                                     |       | $                                                              | 63,838     |   | $ | 3,492 |   | 5.43 | % |
| Tax-exempt                                      |       | —                                                         |       | — |   | — |   |
| Total securities                                |       | 63,838                                                         |       | 3,492 |   | 5.43 | % |
|                                            |       |                                                           |       |   |   |   |   |
| Loans (2) (3)                              |       | 656,210                                                        |       | 58,114 |   | 8.86 | % |
| Federal funds sold                              |       | 11,701                                                         |       | 600 |   | 5.13 | % |
| Total interest earning assets                   |       | 731,749                                                        |       | 62,206 |   | 8.50 | % |
|                                            |       |                                                           |       |   |   |   |   |
| Non-interest earning assets                     |       |                                                           |       |   |   |   |   |
| Cash and due from banks                         |       | 5,057                                                          |       |   |   |   |   |
| Net fixed assets and equipment                  |       | 1,539                                                          |       |   |   |   |   |
| Accrued interest and other assets               |       | 16,909                                                         |       |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| Total assets                                    |       | $                                                              | 755,254    |   |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**   |       |                                                           |       |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| Interest bearing liabilities                    |       |                                                           |       |   |   |   |   |
| Deposits (other than demand)                    |       | $                                                              | 663,816    |   | 34,245 |   | 5.16 | % |
| Federal funds purchased                         |       | 889                                                            |       | 57 |   | 6.41 | % |
| Subordinated debt                               |       | 9,355                                                          |       | 632 |   | 6.76 | % |
| Total interest bearing liabilities              |       | 674,060                                                        |       | 34,934 |   | 5.18 | % |
|                                            |       |                                                           |       |   |   |   |   |
| Non-interest bearing liabilities                |       |                                                           |       |   |   |   |   |
| Non-interest bearing demand deposits            |       | 21,247                                                         |       |   |   |   |   |
| Other liabilities                               |       | 3,090                                                          |       |   |   |   |   |
| Shareholders’ equity                       |       | 56,857                                                         |       |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                                                              | 755,254    |   |   |   |   |   |
|                                                 |            |                                                                |            |  |  |  |  |  |  |

 
| Net interest spread |   | 3.32   | %      |
|---------------------|--------|--------|--------|
|                |   |   |   |
| Net interest margin |   | 3.72   | %      |

 

----

(1)  Unrealized loss of $463 is excluded from yield calculation.

(2)  Non-accrual loans are included in average loan balances and loan fees of $3,890are included in interest income.

(3)  Loans are presented net of allowance for loan loss.

 

28

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| ** **                                      | ** ** | **12 months Ended December 31, 2006** | ** ** |
|-------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Average**                                                    | ** ** | **Average** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance**                                                    | ** ** | **Interest** | ** ** | **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    |   |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| **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 is excluded from yield calculation.

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

(3)  Loans are presented net of allowance for loan loss.

 

29

----

 
| ** **                                      | ** ** | **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    |   |   |   |   |   |
|                                            |       |                                                           |       |   |   |   |   |
| **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 is excluded from yieldcalculation.

(2)   Non-accrual loans are included in average loan balancesand loan fees of $1,438 are included in interest income.

(3)   Loans are presented net of allowance for loan loss.

 

The following tables outlinethe components of the net interest margin for the years 2007, 2006 and 2005 andidentify the impact of changes in volume and rate.

 

30

----

 
| ** **                           | ** ** | **December 31, 2007 change from**       | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2006 a result of:** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume**                                                  | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest income                      |       |                                                        |       |   |   |   |   |
| Loans                                |       | $                                                           | 20,199     |   | $ | (467 | ) | $ | 19,732 |   |
| Securities – taxable            |       | 1,041                                                       |       | 235 |   | 1,276 |   |
| Federal funds sold                   |       | (121                                                        | )          | 74 |   | (47 | ) |
| Total interest income                |       | 21,119                                                      |       | (158 | ) | 20,961 |   |
|                                 |       |                                                        |       |   |   |   |   |
| Interest expense                     |       |                                                        |       |   |   |   |   |
| Deposits (other than demand)         |       | 11,858                                                      |       | 1,171 |   | 13,029 |   |
| Federal funds purchased              |       | (6                                                          | )          | 8 |   | 2 |   |
| Subordinated debt                    |       | 37                                                          |       | (2 | ) | 35 |   |
| Total interest expense               |       | 11,889                                                      |       | 1,177 |   | 13,066 |   |
|                                 |       |                                                        |       |   |   |   |   |
| Net interest income                  |       | $                                                           | 9,230      |   | $ | (1,335 | ) | $ | 7,895 |   |

 
| ** **                           | ** ** | **December 31, 2006 change from**       | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2005 a result of:** | ** ** |
| **(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 |   |

 

Liability and AssetManagement

 

The matching of assets and liabilities may beanalyzed by examining the extent to which such assets and liabilities are “interestrate sensitive” 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 re-pricing during a period and the volume ofrate sensitive liabilities re-pricing 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 InvestmentCommittee, which consists of our executive officers, Arthur F. Helf, Michael R.Sapp, H. Lamar Cox and George W. Fort, is charged with monitoring the liquidityand funds 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, 2007, the Bank had a negativecumulative re-pricing gap within one year of approximately $(59,608) orapproximately 6.79% of total year-end earning assets. See Part II, Item 7A“QUANTITATIVE AND QUALITATIVE ANALYSIS OF MARKET RISK” for additionalinformation.

 

31

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Deposits

 

The Bank’s primary source of funds isinterest-bearing deposits. The following tables present the average amount ofand average rate paid on each of the following deposit categories for 2007,2006 and 2005:

 
| ** **                           | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------|------------|--------------------------------------------|------------|
| ** **                           | ** ** | **2007**                                   | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                           | ** ** | ** **                                 | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                           | ** ** | **Average**                                | ** ** | **Rate** | ** ** | **Average** | ** ** | **Rate** | ** ** | **Average** | ** ** | **Rate** | ** ** |
| **(Dollars in thousands)** | ** ** | **Balance**                                | ** ** | **Paid** | ** ** | **Balance** | ** ** | **Paid** | ** ** | **Balance** | ** ** | **Paid** | ** ** |
| Types of Deposits                    |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-bearing demand deposits |       | $                                          | 21,247     |   | — |   | $ | 18,325 |   | — |   | $ | 16,489 |   | — |   |
| Interest-bearing demand deposits     |       | 6,659                                      |       | 3.36 | % | 5,119 |   | 3.64 | % | 3,097 |   | 1.90 | % |
| Money market accounts                |       | 111,747                                    |       | 4.84 | % | 72,866 |   | 5.23 | % | 39,485 |   | 3.88 | % |
| Savings accounts                     |       | 7,255                                      |       | 2.66 | % | 12,678 |   | 2.67 | % | 22,785 |   | 2.61 | % |
| IRA accounts                         |       | 17,522                                     |       | 5.88 | % | 5,450 |   | 4.91 | % | 2,183 |   | 4.31 | % |
| Purchased time deposits              |       | 254,611                                    |       | 5.28 | % | 192,064 |   | 4.82 | % | 146,326 |   | 3.55 | % |
| Time deposits                        |       | 266,022                                    |       | 5.29 | % | 144,733 |   | 5.09 | % | 52,338 |   | 4.00 | % |
| Total deposits                       |       | $                                          | 685,063    |   |   |   | $ | 451,235 |   |   |   | $ | 282,703 |   |   |   |

 

The following table indicates amountoutstanding of time certificates of deposit of $100,000 or more and respectivematurities as of December 31, 2007 (in thousands):

 
| ** **                   | ** ** | **2007**   | ** ** |
|------------------------------|------------|------------|------------|
| ** **                   | ** ** | ** ** | ** ** |
| Three months or less         |       | $          | 69,310     |   |
|                         |       |       |       |
| Over three through 12 months |       | 201,332    |       |
|                         |       |       |       |
| More than 12 months          |       | 94,155     |       |
| Total                        |       | $          | 364,797    |   |

 

Investment Portfolio

 

The Bank’s investment portfolio at December 31,2007, 2006 and 2005 consisted of the following (dollars in thousands):

 

32

----

 
| ** **                           | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|--------------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                           | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market**    | ** ** |
| ** **                           | ** ** | **Cost**      | ** ** | **Gain**       | ** ** | **Loss**       | ** ** | **Value**     | ** ** |
| As of December 31, 2007         |       |          |       |           |       |           |       |          |       |
| Securities available for sale   |       |          |       |           |       |           |       |          |       |
| U.S. Government agencies             |       | $             | 63,622     |           | $          | 504            |       | $             | (36        | ) | $ | 64,090 |   |
| Mortgage-backed securities           |       | 5,410         |       | —         |       | (104           | )          | 5,306         |       |
| Corporate debt securities            |       | 3,841         |       | 1              |       | (66            | )          | 3,776         |       |
| Other                                |       | 380           |       | 201            |       | —         |       | 581           |       |
| Total                                |       | $             | 73,253     |           | $          | 706            |       | $             | (206       | ) | $ | 73,753 |   |
|                                 |       |          |       |           |       |           |       |          |       |
| 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 |   |

 

The following schedule presents the estimatedmaturities and weighted average yields of investment securities of the Bank at December 31,2007:

 
| ** **                                     | ** ** | ** **    | ** ** | **Estimated** | ** ** | **Weighted** | ** ** |
|------------------------------------------------|------------|---------------|------------|---------------|------------|--------------|------------|
| ** **                                     | ** ** | **Amortized** | ** ** | **Market**    | ** ** | **Average**  | ** ** |
| ** **                                     | ** ** | **Cost**      | ** ** | **Value**     | ** ** | **Yield**    | ** ** |
| Obligations of U.S. Government agencies        |       |          |       |          |       |         |       |
| Due in one year or less                        |       | $             | —     |          | $          | —       |       | — | % |
| Due after one through five years               |       | 8,757         |       | 8,776         |       | 4.60         | %          |
| Due after five through ten years               |       | 22,459        |       | 22,582        |       | 5.25         | %          |
| Due after ten years                            |       | 32,406        |       | 32,732        |       | 5.99         | %          |
| Total obligations of U.S. Government  agencies |       | 63,622        |       | 64,090        |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Mortgage-backed securities                     |       | 5,410         |       | 5,306         |       | 4.03         | %          |
|                                           |       |          |       |          |       |         |       |
| Corporate debt securities                      |       |          |       |          |       |         |       |
| Due in one year or less                        |       | —        |       | —        |       | —       |       |
| Due after one through five years               |       | 3,209         |       | 3,179         |       | 4.52         | %          |
| Due after five through ten years               |       | 632           |       | 597           |       | 4.53         | %          |
| Due after ten years                            |       | —        |       | —        |       | —       |       |
| Total corporate debt securities                |       | 3,841         |       | 3,776         |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Other securities                               |       | 380           |       | 581           |       | 2.31         | %          |
| Total securities available for sale            |       | $             | 73,253     |          | $          | 73,753       |       |   |   |

 

The Bank owned no tax-exempt securities during theperiod ended December 31, 2007.

 

33

----

 

Investment Policy

 

The objective of the Bank’s investment policyis to invest funds not otherwise needed to meet the loan demand of its marketarea to earn the maximum return for the Bank, yet still maintain sufficientliquidity to meet fluctuations in the Bank’s loan demand and depositstructure.  In doing so, the Bank balances the market and credit risksagainst the potential investment return, makes investments compatible with thepledge requirements of the Bank’s deposits of public funds, maintainscompliance with regulatory investment requirements and assists the variouspublic entities with their financing needs.  The asset liability andinvestment committee has full authority over the investment portfolio and makesdecisions on purchases and sales of securities.  The entire portfolio,along with all investment transactions occurring since the previous Board ofDirector’s meeting, is reviewed by the Board at each monthly meeting.  Theinvestment policy allows portfolio holdings to include short-term securitiespurchased to provide the Bank’s needed liquidity and longer term securities purchasedto generate level income for the Bank over periods of interest ratefluctuations.

 

Loan Portfolio

 

The Bank had net loans of $784,001 at December 31,2007.  As the loan portfolio is concentrated in Davidson County andWilliamson County, there is a risk that the borrowers’ ability to repay theloans could be affected by changes in local economic conditions. The followingschedule details the loans of the Bank at December 31, 2007, 2006, 2005,2004 and 2003:

 
| **(Dollars in thousands)**   | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Real estate                            |       |     |       |     |       |     |       |     |       |     |       |
| Construction                           |       | $        | 112,405    |     | $          | 74,482   |       | $        | 38,279     |     | $          | 22,813 |   | $ | 10,386 |   |
| 1 to 4 family residential              |       | 33,560   |       | 22,873   |       | 18,358   |       | 15,963   |       | 13,520   |       |
| Other                                  |       | 143,973  |       | 83,985   |       | 50,371   |       | 33,694   |       | 20,072   |       |
| Commercial, financial and agricultural |       | 477,666  |       | 353,996  |       | 233,948  |       | 139,799  |       | 87,908   |       |
| Consumer                               |       | 3,966    |       | 3,246    |       | 3,149    |       | 3,898    |       | 3,301    |       |
| Other                                  |       | 22,752   |       | 6,936    |       | 4,481    |       | —   |       | —   |       |
|                                   |       |     |       |     |       |     |       |     |       |     |       |
| Total loans                            |       | 794,322  |       | 545,518  |       | 348,586  |       | 216,167  |       | 135,187  |       |
| Less: allowance for loan losses        |       | (10,321  | )          | (6,968   | )          | (4,399   | )          | (2,841   | )          | (2,000   | )          |
|                                   |       |     |       |     |       |     |       |     |       |     |       |
| Net loans                              |       | $        | 784,001    |     | $          | 538,550  |       | $        | 344,187    |     | $          | 213,326 |   | $ | 133,187 |   |

 

The following table reflects the composition of loanportfolio by type:

 
| ** **                             | ** ** | **As of December 31,** | ** ** |
|----------------------------------------|------------|---------------------------------------|------------|
| **(Dollars in thousands)**   | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
| Real estate:                           |       |                                  |       |   |   |   |   |   |   |   |   |
| Construction                           |       | 14.15                                 | %          | 13.65 | % | 10.98 | % | 10.55 | % | 7.68 | % |
| 1 to 4 family residential              |       | 4.22                                  | %          | 4.19 | % | 5.27 | % | 7.38 | % | 10.00 | % |
| Other                                  |       | 18.13                                 | %          | 15.40 | % | 14.45 | % | 15.59 | % | 14.85 | % |
| Commercial, financial and agricultural |       | 60.14                                 | %          | 64.89 | % | 67.11 | % | 64.68 | % | 65.03 | % |
| Consumer                               |       | 0.50                                  | %          | 0.60 | % | 0.90 | % | 1.80 | % | 2.44 | % |
| Other                                  |       | 2.86                                  | %          | 1.27 | % | 1.29 | % | 0.00 | % | 0.00 | % |
| Total                                  |       | 100                                   | %          | 100 | % | 100 | % | 100 | % | 100 | % |

 

34

----

 

The following table reflects the composition of commercial loanportfolio by sourcing program type:

 
| ** **                              | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------|------------|---------------------------------------|------------|
| ** **                              | ** ** | **2007**                              | ** ** | **2006** | ** ** | **2005** | ** ** |
| **(Dollars in thousands)**    | ** ** | **Amount**                            | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial, financial and agricultural: |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Direct                                  |       | $                                     | 193,943    |   | 40.60 | % | $ | 151,692 |   | 42.85 | % | $ | 94,742 |   | 40.50 | % |
| Indirect                                |       |                                  |       |   |   |   |   |   |   |   |   |   |   |
| Large                                   |       | 130,583                               |       | 27.34 | % | 88,569 |   | 25.02 | % | 52,144 |   | 22.29 | % |
| Small                                   |       | 153,140                               |       | 32.06 | % | 113,735 |   | 32.13 | % | 87,062 |   | 37.21 | % |
| Total                                   |       | 477,666                               |       | 100.00 | % | 353,996 |   | 100.00 | % | 233,948 |   | 100.00 | % |
|                                         |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following schedule details maturities andsensitivity to interest rates changes for loans of the Bank at December 31,2007:

 
| ** **                             | ** ** | **Due in 1**     | ** ** | **Due in 1**               | ** ** | **Due after** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|----------------------------|------------|--------------------------------------|------------|--------------------|------------|------------|------------|
| **Type of Loan (1)**    | ** ** | **year or less** | ** ** | **to 5 years**             | ** ** | **5 Years**   | ** ** | **Total**  | ** ** |
| ** **                             | ** ** | ** **                 | ** ** | **(Dollars in thousands)** | ** ** | ** **         | ** ** |
| Real estate:                           |       |                       |       |                                 |       |               |       |       |       |
| Construction                           |       | $                          | 47,059     |                                 | $          | 55,897             |       | $          | 9,449      |   | $ | 112,405 |   |
| 1 to 4 family residential              |       | 7,558                      |       | 19,729                               |       | 6,273              |       | 33,560     |       |
| Other                                  |       | 23,279                     |       | 116,807                              |       | 3,887              |       | 143,973    |       |
| Commercial, financial and agricultural |       | 94,669                     |       | 373,890                              |       | 9,107              |       | 477,666    |       |
| Consumer                               |       | 1,631                      |       | 2,022                                |       | 313                |       | 3,966      |       |
| Other                                  |       | —                     |       | —                               |       | 22,752             |       | 22,752     |       |
| Total                                  |       | $                          | 174,196    |                                 | $          | 568,345            |       | $          | 51,781     |   | $ | 794,322 |   |
|                                   |       |                       |       |                                 |       |               |       |       |       |
| Less: allowance for loan loss          |       |                       |       |                                 |       |               |       | (10,321    | )          |
|                                   |       |                       |       |                                 |       |               |       |       |       |
| Net loans                              |       |                       |       |                                 |       |               |       | $          | 784,001    |   |
|                                   |       |                       |       |                                 |       |               |       |       |       |
| Interest rate sensitivity:             |       |                       |       |                                 |       |               |       |       |       |
| Fixed interest rates                   |       | 29,760                     |       | 551,290                              |       | 17,529             |       | 598,579    |       |
| Floating or adjustable rates           |       | 144,436                    |       | 17,055                               |       | 34,252             |       | 195,743    |       |
|                                   |       |                       |       |                                 |       |               |       |       |       |
| Total                                  |       | $                          | 174,196    |                                 | $          | 568,345            |       | $          | 51,781     |   | $ | 794,322 |   |

 

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(1) Includes non-accrual loans.

 

**Capital Resources / Liquidity**

 

**Liquidity**

 

Of primary importance todepositors, creditors and regulators is the ability to have readily availablefunds sufficient to repay fully maturing liabilities.  The Bank’sliquidity, represented by cash and cash due from banks, is a result of itsoperating, investing and financing activities.  In order to ensure fundsare available at all times, the Bank devotes resources to projecting on a monthlybasis the amount of funds that will be required and maintains relationshipswith a diversified customer base so funds are accessible.  Liquidityrequirements can also be met through short-term borrowings or the dispositionof short-term assets which are generally matched to correspond to the maturityof liabilities.

 

Although the Bank has no formal liquiditypolicy, in the opinion of management, its liquidity levels are consideredadequate.   The Bank is subject to general FDIC guidelines which do notrequire a minimum level of liquidity.  Management believes its liquidityratios meet or exceed these guidelines.  Management does not know of anytrends or demands that are reasonably likely to result in liquidity increasingor decreasing in any material manner.

 

35

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**Impact of Inflation and ChangingPrices**

 

The financial statements and relatedfinancial data presented herein have been prepared in accordance with GAAPwhich require the measurement of financial position and operating results interms of historical dollars without considering the changes in the relativepurchasing power of money over time and a result of inflation.  The impactof inflation on operations of the Bank is reflected in increased operatingcosts.  Unlike most industrial companies, virtually all of the assets andliabilities of the Bank are monetary in nature.  As a result, interestrates have a more significant impact on the Bank’s performance than the effectsof general levels of inflation.  Interest rates do not necessarily move inthe same direction or in the same magnitude as the price of goods and services.

 

**Capital Adequacy**

 

Capital adequacy refers to the level ofcapital required to sustain asset growth over time and to absorb losses. To continue to grow, the Bank must increase capital by generating earnings,issuing equity securities, borrowing funds or a combination of thoseactivities. If growth exceeds expectations, the Bank may need to raise capitalin the capital markets. The Bank’s ability to raise capital will depend in parton conditions in the capital markets which are outside the Bank’s control. Ifthe Bank cannot raise capital on terms acceptable to it, the Bank’s ability tocontinue growing would be materially impaired.

 

The objective of the Bank’s management is tomaintain a level of capitalization that is sufficient to take advantage ofprofitable growth opportunities while meeting regulatory requirements includingremaining well 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.

 

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.

 

We and the Bank are required to maintaincertain capital ratios. These include Tier I, Total Capital and Leverage Ratios.Certain ratios for us and the Bank for 2007 and 2006 are set forth below:

 
| ** **             | ** ** | **Capital Level Meeting**    | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|------------------------|------------|----------------------------------------|------------|-----------------|------------|------------|------------|------------|------------|------------|------------|
| ** **             | ** ** | **Regulatory Definition of** | ** ** | **Corporation** | ** ** | **Bank**   | ** ** |
| ** **             | ** ** | **“Well Capitalized”**  | ** ** | **2007**        | ** ** | **2006**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
| ** **             | ** ** | **(%)**                                | ** ** | **(%)**         | ** ** | **(%)**    | ** ** | **(%)**    | ** ** | **(%)**    | ** ** |
| Tier I Capital Ratio   |       | 6.00                                   |       | 8.55            |       | 10.45      |       | 9.26       |       | 9.23       |       |
|                   |       |                                   |       |            |       |       |       |       |       |       |       |
| Total Risk-Based Ratio |       | 10.00                                  |       | 9.80            |       | 11.68      |       | 10.51      |       | 10.45      |       |
|                   |       |                                   |       |            |       |       |       |       |       |       |       |
| Leverage Ratio         |       | 5.00                                   |       | 8.09            |       | 9.94       |       | 8.75       |       | 8.78       |       |

 

Based solely on analysis of federal bankingregulatory categories, it appears on December 31, 2007 that we and theBank fall within the “well capitalized” categories under the regulations.

 

**Off-Balance Sheet Arrangements**

 

The Bank is a party to financial instrumentswith off-balance sheet risk in the normal course of business to meet thefinancing needs of its customers.  These financial instruments includecommitments 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.

 

36

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The Bank’s exposure to credit loss in theevent of nonperformance by the other party to the financial instrument isrepresented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditionalobligations as it does for on-balance sheet instruments.

 

Financial instruments for which contractamounts represented credit risk as of December 31:

 
| ** **                                          | ** ** | **2007**        | ** ** | **2006**           | ** ** | **2005**        | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|--------------------|------------|-----------------|------------|
| **(Dollars in thousands)**                | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** |
|                                                |       |            |       |               |       |            |       |   |   |   |   |   |   |
| Commitments to extend credit                        |       | $               | 18,380     |               | $          | 107,663         |       | $ | 9,601 |   | $ | 65,123 |   | $ | 2,404 |   | $ | 38,859 |   |
| Standby letters of credit and financial  guarantees |       | —          |       | 11,063             |       | —          |       | 5,776 |   | — |   | 5,686 |   |
|                                                     |            |                 |            |                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Commitments to make loans are generally madefor periods of one year or less.  The fixed rate loan commitments haveinterest rates ranging from 4.31% to 9.00% and maturities ranging from threemonths to six years.

 

Commitments to extend credit are agreementsto lend to a customer as long as there is no violation of any conditionestablished in the contract.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon,the total commitment amounts do not necessarily represent future cashrequirements.  The Bank evaluates each customer’s creditworthiness on acase-by-case basis.  The amount of collateral obtained if deemed necessaryby the Bank upon extension of credit is based on management’s creditevaluation. Collateral held varies but may include accounts receivable,inventory, property, plant and equipment, and income-producing commercialproperties.

 

Standby letters of credit are conditionalcommitments issued by the Bank to guarantee the performance of a customer to athird party.  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.

 

**Contractual Obligations**

 

At December 31, 2007, the Bank had certaincontractual obligations as shown below.

 
| ** **                                | ** ** | **Payments due by Period** | ** ** |
|-------------------------------------------|------------|-------------------------------------------|------------|
| **Contractual Obligations (1)** | ** ** | **Total**                                 | ** ** | **Less Than  1 Year** | ** ** | **1-3  Years** | ** ** | **3-5  Years** | ** ** | **More than 5  Years** | ** ** |
| ** **                                | ** ** | **(Dollars in thousands)**      | ** ** |
| Deposits without a stated maturity   |       | $                                         | 142,520    |   | $ | 142,520 |   | $ | — |   | $ | — |   | $ | — |   |
| Certificates of deposit                   |       | 672,533                                   |       | 526,017 |   | 141,225 |   | 5,291 |   | — |   |
| Subordinated long term debt               |       | 8,248                                     |       | — |   | — |   | — |   | 8,248 |   |
| Capital lease obligations                 |       | —                                    |       | — |   | — |   | — |   | — |   |
| Operating lease obligations               |       | 5,849                                     |       | 554 |   | 1,696 |   | 588 |   | 3,011 |   |
| Purchase obligations                      |       | —                                    |       | — |   | — |   | — |   | — |   |
| Other long term liabilities               |       | —                                    |       | — |   | — |   | — |   | — |   |
| Total                                     |       | $                                         | 829,150    |   | $ | 669,091 |   | $ | 142,921 |   | $ | 5,879 |   | $ | 11,259 |   |

 

----

(1)  Excludesinterest.

 

37

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**Recent Accounting Pronouncements**

 

In September 2006, the Financial AccountingStandards Board (the “FASB”) released Statement of Financial AccountingStandards No. 157 (“SFAS No. 157”), “Fair Value Measurements.” Thisstatement defines  fair value,establishes a framework for measuring fair value and expands disclosures aboutfair value measurements. SFAS No. 157 clarifies the exchange price notionin the fair value definition to mean the price that would be received to sellthe asset or paid to transfer the liability (an exit price), not the price thatwould be paid to acquire the asset or received to assume the liability (anentry price). This statement also clarifies that market participant assumptionsshould include assumptions about risk, should include assumptions about theeffect of a restriction on the sale or use of an asset and should reflect itsnonperformance risk (the risk that the obligation will not be fulfilled).Nonperformance risk should include the reporting entity’s credit risk. SFAS No. 157is effective for financial statements issued for fiscal years beginning after November 15,2007. The Corporation adopted SFAS No. 157 on January 1, 2008 andmanagement is still evaluating the impact on the Corporation’s consolidatedfinancial statements.

 

In March 2006, the FASBissued Statement No. 156, “Accountingfor Servicing of Financial Assets-an amendment of FASB Statement No. 140.” This statement provides the following: (i) revised guidance on when aservicing asset and servicing liability should be recognized; (ii) requiresall separately recognized servicing assets and servicing liabilities to beinitially measured at fair value, if practicable; (iii) permits an entityto elect to measure servicing assets and servicing liabilities at fair valueeach reporting date and report changes in fair value in earnings in the periodin which the changes occur; (iv) upon initial adoption, permits a onetimereclassification of available-for-sale securities to trading securities forsecurities which are identified as offsetting the entity’s exposure to changesin the fair value of servicing assets or liabilities that a servicer elects tosubsequently measure at fair value; and (v) requires separate presentationof servicing assets and servicing liabilities subsequently measured at fairvalue in the statement of financial position and additional footnotedisclosures.  This standard is effective as of the beginning of an entity’sfirst fiscal year that begins after September 15, 2006 with the effects ofinitial adoption being reported as a cumulative-effect adjustment to retainedearnings.  Management does not expect the adoption of this statement willhave a material impact on our consolidated financial statements.

 

**ITEM 7A.****                                           ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

**Quantitative and QualitativeAnalysis of Market Risk**

 

Like all financial institutions, we aresubject to market risk from changes in interest rates.  Interest rate riskis inherent in the balance sheet because of the mismatch between the maturitiesof rate 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 aposition on the expected future trend of interest rates.  Rates may rise,fall or remain the same.  The Asset-Liability Committee of the Bankdevelops 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.   Our annual budget reflects theanticipated rate environment for the next 12 months.  The Asset-LiabilityCommittee conducts a quarterly analysis of the rate sensitivity position. The results of the analysis are reported to the Board.

 

The Asset-Liability Committee uses a computermodel to analyze the maturities of rate sensitive assets and liabilities. The model measures the “gap,” which is the difference between the dollar amountof rate sensitive assets re-pricing during a period and the volume of ratesensitive liabilities re-pricing during the same period. Gap is also expressedas the ratio of rate sensitive assets divided by rate sensitiveliabilities.  If the ratio is greater than one, the dollar value of assetsexceeds the dollar value of liabilities and the balance sheet is “assetsensitive.”Conversely,if the value of liabilities exceeds the value of assets, the ratio is less thanone and the balance sheet is “liability sensitive.”  Policy requiresmanagement to maintain the gap within a range of 0.75 to 1.25.

 

The model measures scheduled maturities inperiods of three months, four to 12 months, one to five years and over fiveyears. The chart below illustrates our rate sensitive position at December 31,2007. Management uses the one year gap as the appropriate time period forsetting strategy.

 

38

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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                                             |       | $            | 9,573      |            | $          | —           |       | $              | —     |                   | $          | —    |       | $ | — |   | $ | 9,573 |   |
| Interest bearing deposits  in banks                            |       | —       |       | —          |       | —           |       | —         |       | —                 |       | —    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Securities                                                     |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| U.S. government agencies                                       |       | —       |       | 32,045          |       | —           |       | 6,259          |       | 29,796                 |       | 68,100    |       |
| Mortgage-backed and corporate debt securities                  |       | —       |       | 988             |       | 2,281            |       | 1,516          |       | 868                    |       | 5,653     |       |
| Total securities                                               |       | —       |       | 33,033          |       | 2,281            |       | 7,775          |       | 30,664                 |       | 73,753    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total loans                                                    |       | 213,600      |       | 90,128          |       | 221,245          |       | 247,042        |       | 22,307                 |       | 794,322   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total interest earning  assets                                 |       | 223,173      |       | 123,161         |       | 223,526          |       | 254,817        |       | 52,971                 |       | 877,648   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other assets                                                   |       | —       |       | —          |       | —           |       | —         |       | 22,505                 |       | 22,505    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total assets                                                   |       | $            | 223,173    |            | $          | 123,161          |       | $              | 223,526    |                   | $          | 254,817   |       | $ | 75,476 |   | $ | 900,153 |   |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest Bearing  Liabilities                                  |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Deposits                                                       |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest checking                                              |       | $            | 6,022      |            | $          | —           |       | $              | —     |                   | $          | 1,233     |       | $ | — |   | $ | 7,255 |   |
| Money market and savings                                       |       | 88,426       |       | —          |       | —           |       | 19,410         |       | —                 |       | 107,836   |       |
| Time deposits                                                  |       | —       |       | 136,597         |       | 389,423          |       | 146,515        |       | —                 |       | 672,535   |       |
| Total deposits                                                 |       | 94,448       |       | 136,597         |       | 389,423          |       | 167,158        |       | —                 |       | 787,626   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Federal funds purchased                                        |       | 2,000        |       | —          |       | —           |       | —         |       | —                 |       | 2,000     |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Short term debt                                                |       | —       |       | —          |       | 7,000            |       | —         |       | —                 |       | 7,000     |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Subordinated long term  debt                                   |       | —       |       | —          |       | —           |       | —         |       | 8,248                  |       | 8,248     |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total interest bearing  liabilities                            |       | 96,448       |       | 136,597         |       | 396,423          |       | 167,158        |       | 8,248                  |       | 804,874   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other liabilities                                              |       | —       |       | —          |       | —           |       | —         |       | 32,158                 |       | 32,158    |       |
| Shareholders’ equity                                      |       | —       |       | —          |       | —           |       | —         |       | 63,121                 |       | 63,121    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total liabilities and  shareholders’ equity               |       | $            | 96,448     |            | $          | 136,597          |       | $              | 396,423    |                   | $          | 167,158   |       | $ | 103,527 |   | $ | 900,153 |   |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Rate sensitive gap by  period                                  |       | $            | 126,725    |            | $          | (13.436          | )          | $              | (172,897   | )                      | $          | 87,659    |       | $ | 44,723 |   |   |   |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Cumulative gap                                                 |       | —       |       | $               | 113,289    |             | $          | (59,608        | )          | $                      | 28,051     |      | $          | 72,744 |   |   |   |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Cumulative gap as a  percent of total assets                   |       | —       |       | 12.59           | %          | (6.62            | )%         | 3.12           | %          | 8.08                   | %          |      |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Rate sensitive assets/rate  sensitive liabilities (cumulative) |       | 2.31         |       | 1.49            |       | 0.91             |       | 1.04           |       | 1.09                   |       |      |       |

 

39

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In mid-2004, the FOMC began a series of interest rate increases whichthe FOMC indicated would continue “at a measured pace.” From mid-year 2004to the end of 2007, short-term interest rates had increased by 325 basis  points.  We are now positioned for afalling rate environment by maintaining a moderately “liability sensitive”balance sheet in which more liabilities will reprice than assets.  Atyear-end 2007, our one-year ratio was 0.92.

 

The interest rate risk model that defines the gap position alsoperforms a “rate shock” test of the balance sheet.  The rate shockprocedure measures the impact on the economic value of equity (“EVE”) which isa 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, 2007, the percentchange in EVE for a plus or minus 200bps is well within that range at (20.9)%and 12.8%, respectively.

 

The one year gap of 0.91 indicates that the Bank would show an increasein net interest income in a falling rate environment, and the EVE rate shockshows that the EVE would rise in a falling rate environment. The EVE simulationmodel is a static model that provides information only at a certain point intime. For example, in a rising rate environment, the model does not take intoaccount actions that management might take to change the impact of rising rateson the Bank. Given that limitation, it is still useful is assessing the impactof an unanticipated movement in interest rates.

 

The above analysis may not on its own be an entirely accurate indicatorof how net interest income or EVE will be affected by changes in interestrates. Income associated with interest earning assets and costs associated withinterest bearing liabilities may not be affected uniformly by changes ininterest rates. In addition, the magnitude and duration of changes in interestrates may have a significant impact on net interest income. Interest rates oncertain types of assets and liabilities fluctuate in advance of changes ingeneral market rates, while interest rates on other types may lag behind changesin general market rates. 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, and conducts a quarterly analysis of the rate sensitivityposition.  The results of the analysis are reported to the Board.

 

**ITEM 8.****                                                    ****FINANCIAL STATEMENTS ANDSUPPLEMENTARY DATA**

 

The report of independent accountants, consolidated financialstatements and supplementary data required by Item 8 are set forth on pages F-1through F-28 of this Annual Report on Form 10-K and are incorporatedherein by reference.

 

**ITEM9.**                                                       **CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

None.

 

**ITEM 9A.****                                           ****CONTROLS AND PROCEDURES**

 

a)                                             Evaluation of Disclosure Controls andProcedures. TheCorporation maintains disclosure controls and procedures, as defined in Rule 13a-15(a) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”),that are designed to ensure that information required to be disclosed by it inthe 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 communicatedto the Corporation’s management, including its Chief Executive Officer andChief Financial 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.  Based on the evaluation of these disclosurecontrols and procedures, the Chief Executive Officer and Chief FinancialOfficer concluded that the Corporation’s disclosure control and procedures wereeffective.

 

40

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Pursuantto Section 404 of the Sarbanes-Oxley Act of 2002, the Corporation hasincluded a report of management’s assessment of the design and operatingeffectiveness of its internal controls as part of this Annual Report on Form 10-K.The Corporation’s independent registered public accounting firm reported on theeffectiveness of internal control over financial reporting. Management’s reportand the independent registered public  accountingfirm’s report are included with our 2007 consolidated financial statements inItem 8 of this Annual Report on Form 10-K under the captions entitled“Management’s Report on Internal Control Over Financial Reporting” and “Reportof Independent Registered Public Accounting Firm.”

 

b)            Changes inInternal Controls and Procedures. There were no changes in the Corporation’sinternal control over financial reporting during the Corporation’s fiscalquarter ended December 31, 2007 that have materially affected, or arereasonably likely to materially affect, its internal control over financialreporting.

 

**ITEM 9B.****              ****OTHER INFORMATION**

 

None.

 

41

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**PART III**

 

**ITEM 10.****              ****DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE GOVERNANCE**

 

**Directors**

 

Information relating to our directors is incorporated by reference tothe information contained under the caption “Proposal 1: Election of Directors”included in our proxy statement relating to our 2008 annual meeting ofshareholders.

 

**ExecutiveOfficers**

 

Information relating to our executive officers incorporated byreference to the information contained under the caption “Executive Officers”included in our proxy statement relating to our 2008 annual meeting ofshareholders.

 

**Compliancewith Section 16(a) of the Exchange Act**

 

Information with respect to compliance with Section 16(a) ofthe Securities Exchange Act of 1934, as amended, is  incorporated by reference to the informationcontained under the caption “General Information – Section 16(a) BeneficialOwnership Reporting Compliance” included in our proxy statement relating to our2008 annual meeting of shareholders.

 

**Code ofEthics**

 

Information with respect to our Code of Ethics is incorporated byreference to the information contained under the caption “Corporate Governance –Code of Ethics” included in our proxy statement relating to our 2008 annualmeeting of shareholders.

 

**ShareholderNominees**

 

Information with respect to procedures by which  shareholders may recommend nominees to theBoard of Directors is incorporated by reference to the information containedunder the caption “Corporate Governance – Shareholder Nomination of Directors”included in our proxy statement relating to our 2008 annual meeting ofshareholders.

 

**Audit andCompliance Committee**

 

Information relating to the Audit and Compliance Committee isincorporated by reference to the information contained under the caption “AuditCommittee Report” included in our proxy statement relating to our 2008 annualmeeting of shareholders.

 

**ITEM 11.****              ****EXECUTIVE COMPENSATION**

 

Information regarding the Executive Compensation is incorporated byreference to the information contained under the caption “CompensationDiscussion and Analysis,” “Executive Compensation,” “Director Compensation,” “CompensationCommittee Report” and “Compensation Committee Interlocks and InsideParticipation” included in our proxy statement relating to our 2008 annualmeeting of shareholders.

 

42

----

 

**ITEM 12.**                                         **SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

 

**SecurityOwnership of Certain Beneficial Owners and Management**

 

This information is incorporated is incorporated by reference to theinformation contained under the caption “Security Ownership of CertainBeneficial Owners and Management” included in our proxy statement relating toour 2008 annual meeting of shareholders.

 

**Equity Compensation Plan Information**

 

The following table provides information as of December 31, 2007,with respect to compensation plans under which shares of our common stock areauthorized for issuance:

 
| **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 (1)                                                                               |       | 200,000                                                                                                                                                   |       | $                                                                                                                     | 25.00      |                                                                                                                                                                                                                  | 800,000    |   |
| Equity Compensation Plans Not Approved by Shareholders (incentive  options for executive officers, directors, and incorporators) (2) |       | 598,570                                                                                                                                                   |       | $                                                                                                                     | 8.78       |                                                                                                                                                                                                                  | —     |   |
| Total                                                                                                                                |       | 798,570                                                                                                                                                   |       | $                                                                                                                     | 13.14      |                                                                                                                                                                                                                  | 800,000    |   |

 

----

|   | (1)    | Includes the Tennessee  Commerce Bancorp, Inc. 2007 Equity Plan.                                                                       |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                        |
|   | (2)    | Includes various stock  option agreements entered into with employees of the Bank between  January 14, 2000 and November 1, 2005. |

 

 

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

 

This information is incorporated is incorporated byreference to the information contained under the caption “Certain Relationshipsand Related Transactions” and “Corporate Governance-Director Independence”included in our proxy statement relating to our 2008 annual meeting ofshareholders.

 

**ITEM 14.****                     ****PRINCIPAL ACCOUNTING FEES ANDSERVICES**

 

This information is incorporated is incorporated byreference to the information contained under the caption “Proposal 2:Ratification of the Appointment of Independent Registered Accounting Firm”included in our proxy statement relating to our 2008 annual meeting ofshareholders.

 

43

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**PART IV**

 

**ITEM 15.****              ****EXHIBITS AND FINANCIALSTATEMENT SCHEDULES**

 

(a)(1)       Financial Statements:

 

(2)           Schedules required by Article 12 of RegulationS-X are either omitted because they are not applicable or because the requiredinformation is shown in the financial statements or the notes thereto.

 

(3)           Exhibits:

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                    |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                               |
| 3.1                  |       | Charter of Tennessee  Commerce Bancorp, Inc., as amended(1)                                                                                   |
| 3.2                  |       | Articles of Amendment  to the Charter of Tennessee Commerce Bancorp, Inc.                                                                     |
| 3.3                  |       | Bylaws of Tennessee  Commerce Bancorp, Inc.(1)                                                                                                |
| 3.4                  |       | Amendment to Bylaws of  Tennessee Commerce Bancorp, Inc.(2)                                                                                   |
| 4.1                  |       | Shareholders’  Agreement(1)                                                                                                                   |
| 4.2                  |       | Form of Stock  Certificate(3)                                                                                                                 |
| 10.1                 |       | Tennessee Commerce  Bancorp, Inc. Stock Option Plan - Employees(1)                                                                            |
| 10.2                 |       | Form of Tennessee  Commerce Bancorp, Inc. – Director’s Common Stock Option(1)                                                  |
| 10.3                 |       | Form of Tennessee  Commerce Bancorp, Inc. – Incorporator’s Common Stock Option(1)                                              |
| 10.4                 |       | Form of Tennessee  Commerce Bancorp, Inc. - Stock Option Agreement(1)                                                                    |
| 10.5                 |       | Tennessee Commerce  Bancorp, Inc. - Stock Option Agreement with Arthur F. Helf(1)                                                             |
| 10.6                 |       | Tennessee Commerce  Bancorp, Inc. - Stock Option Agreement with Michael R. Sapp(1)                                                            |
| 10.7                 |       | Tennessee Commerce  Bancorp, Inc. 1999 Stock Option Agreement with H. Lamar Cox(1)                                                            |
| 10.8                 |       | Employment Agreement  between Tennessee Commerce Bancorp, Inc. and Arthur F. Helf(1)                                                          |
| 10.9                 |       | Employment Agreement  between Tennessee Commerce Bancorp, Inc. and Michael R. Sapp(1)                                                         |
|  10.10          |       | Employment Agreement  between Tennessee Commerce Bancorp, Inc. and H. Lamar Cox(1)                                                            |
|  10.11          |       | Employment Agreement  between Tennessee Commerce Bancorp, Inc. and George W. Fort(4)                                                          |
|  10.12          |       | Tennessee Commerce  Bancorp, Inc. 2007 Equity Plan(5)                                                                                         |
|  10.13          |       | Summary of Tennessee  commerce Bancorp, Inc. Executive Officer Compensation(6)                                                                |
|  21.1           |       | Subsidiaries                                                                                                                                       |
|  23.1           |       | Report of Independent  Registered Public Accounting Firm                                                                                           |
|  31.1           |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
|  31.2           |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
|  32.1           |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |
|  32.2           |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

----

|   | (1)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration  Statement on Form 10, as filed with the Securities and Exchange  Commission on April 29, 2005, and incorporated herein by reference.                                         |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (2)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form 8-K, as filed with the Securities and Exchange Commission on February 5,  2008, and incorporated herein by reference.                                              |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (3)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration  Statement on Form S-8, as filed with the Securities and Exchange  Commission on December 31, 2007 (Registration No. 333-148415), and  incorporated herein by reference. |

 

44

----

 
|   | (4)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration  Statement on Form S-1, as filed with the Securities and Exchange  Commission on April 25, 2006 (Registration No. 333-148415), and  incorporated herein by reference. |
|--------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                              |
|   | (5)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Quarterly  Report on Form 10-Q, as filed with the Securities and Exchange  Commission on August 14, 2007, and incorporated herein by reference.                                         |
|   |   |                                                                                                                                                                                                                                                                              |
|   | (6)    | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form 8-K, as filed with the Securities and Exchange Commission on  June 26, 2007, and incorporated herein by reference.                                              |

 

45

----

 

**TENNESSEECOMMERCE BANCORP, INC.**

 

##### **CONSOLIDATEDFINANCIAL STATEMENTS**

 

### **December 31, 2007and 2006**

 

 

CONTENTS

 
| MANAGEMENT’S  REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING | F-2    |
|------------------------------------------------------------------------|--------|
|                                                                   |   |
| REPORT  OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM               | F-4    |
|                                                                   |   |
| FINANCIAL  STATEMENTS                                                  |   |
|                                                                   |   |
| CONSOLIDATED  BALANCE SHEETS                                           | F-7    |
|                                                                   |   |
| CONSOLIDATED  STATEMENTS OF INCOME                                     | F-8    |
|                                                                   |   |
| CONSOLIDATED  STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY       | F-9    |
|                                                                   |   |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS                                 | F-10   |
|                                                                   |   |
| NOTES TO CONSOLIDATED FINANCIAL STATEMENTS                             | F-11   |

 

F-1

----

 

**Management’s Report on Internal Control Over Financial Reporting**

 

Management of the Company is responsible forestablishing and maintaining adequate internal control over financialreporting, (as defined in Rules 13a-15(f) and 15d-15(f) of theSecurities Exchange Act of 1934, as amended) that is designed to producereliable financial statements in conformity with accounting principlesgenerally accepted in the United States. The Company’s internal control over financial reporting includes thosepolicies and procedures that: (1) pertain to the maintenance of recordsthat, in reasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the Company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples and that receipts and expenditures of the Company are being madeonly in accordance with authorizations of management and directors of theCompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of the Company’sassets that could have a material effect on the financial statements.

 

The system of internal control over financialreporting as it relates to the financial statements is evaluated foreffectiveness by management and tested for reliability through a program ofinternal audits. Actions are taken to correct potential deficiencies as theyare identified. Any system of internal control, no matter how well designed,has inherent limitations, including the possibility that a control can be circumventedor overridden, and misstatements resulting from error or fraud may occur andnot be detected. Also, because of changes in conditions, internal controleffectiveness may vary over time. Accordingly, even an effective system ofinternal control will provide only reasonable assurance with respect tofinancial statement preparation.

 

Management, with the participation of the Company’sChief Executive Officer and acting Chief Financial Officer, conducted anassessment of the effectiveness of the Company’s system of internal controlover financial reporting as of December 31, 2007, based on criteria foreffective internal control over financial reporting described in “InternalControl - Integrated Framework,” issued by the Committee of SponsoringOrganizations of the Treadway Commission. Based on this assessment, management identified the following materialweaknesses in internal control over financial reporting as of December 31,2007:

 

Employee Accounts – Certain transactions related toemployee accounts were not appropriately processed, reviewed and approved inaccordance with Company policy; and

 

Asset/Liability Management Committee – While theCompany has an Asset/Liability Management Committee (the “ALCO”) that providesinformation to the Company’s Board of Directors, no meetings of the ALCO wereheld during 2007.

 

These control deficiencies had no known impact on theCompany’s financial reporting.

 

A material weakness is a deficiency, or combination ofdeficiencies, in internal control over financial reporting, such that there isa reasonable possibility that a material misstatement of the company’s annualor interim financial statements would not be prevented or detected on a timelybasis. As a result of the two material weaknesses described in the precedingparagraph, management has concluded that the Company’s internal control overfinancial reporting was not effective as of December 31, 2007 based on thecriteria described in the “Internal Control – Integrated Framework.”

 

KraftCPAs PLLC, the Company’s independent registeredpublic accounting firm, has issued an attestation report on the Company’sinternal control over financial reporting which appears on page F-4 ofthis annual report.

 

**Changes inInternal Control Over Financial Reporting**

 

Managementof the Company has evaluated, with the participation of the Company’s ChiefExecutive Officer and acting Chief Financial Officer, changes in the Company’sinternal control over financial reporting (as defined in Rule 13a-15(f) and15d-15(f) of the Securities Exchange Act of 1934, as amended) during thefourth quarter of 2007. In connection with such evaluation, the Company hasdetermined that there have been changes in internal control over financialreporting that are reasonably likely to materially affect the Company’sinternal control over financial reporting. As discussed in Management’s Reporton Internal Control Over Financial Reporting, the Company identified two control deficiencies it concluded were materialweaknesses in internal control over financial reporting.

 

F-2

----

 

Asof December 31, 2007, the Company had not fully remediated the material weaknesses in the Company’sinternal control over financial reporting. However, since January 15,2008, the Company has taken the following remedial actions:

 

·                  Employees have been informed that, inaccordance with Company policy, all personal transactions are to be handled inthe same manner as customer transactions.  Management has initiated a training program for all employees to ensureunderstanding of the necessity for adherence to policies governing personaltransactions.

 

·                  Management has established controls to ensurethat all employees sign acknowledgement forms regarding Company policies,including the Employee Financial Services Policy (relating to employees’personal transactions) and other key Company policies.

 

·                  In February 2008, the Chair of the AuditCommittee of the Company’s Board of Directors was appointed Chair of theALCO.  Also in February 2008, theALCO met, determined that the ALCO-related information provided to the Board ofDirectors during 2007 was accurate and complete, and ratified such informationas previously provided to the Board of Directors.

 

The ALCO has been directed to meet at leastquarterly during 2008 and provide reports of those meetings to the Board ofDirectors.

 

F-3

----

 

Report of Independent Registered PublicAccounting Firm

 

To the Board of Directorsand Shareholders

Tennessee Commerce Bancorp, Inc.

 

We have audited theconsolidated balance sheets of Tennessee Commerce Bancorp, Inc. andsubsidiaries (collectively, the “Company”) as of December 31, 2007 and2006, and the related consolidated statements of income, changes in shareholders’equity and cash flows for each of the three years in the period ended December 31,2007.  These consolidated financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these consolidated financialstatements based on our audits.

 

We conducted our audits inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement.  An audit includes examining, on a test basis,evidence supporting the amounts and disclosures 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 that our audits provide areasonable basis for our opinion.

 

In our opinion, thefinancial statements referred to above present fairly, in all materialrespects, the consolidated financial position of Tennessee Commerce Bancorp, Inc.and subsidiaries as of December 31, 2007 and 2006, and the consolidatedresults of their operations and their cash flows for each of the three years inthe period ended December 31, 2007, in conformity with U.S. generallyaccepted accounting principles.

 

We also have audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), Tennessee Commerce Bancorp, Inc. and subsidiaries’internal control over financial reporting as of December 31, 2007, basedon criteria establishedin*Internal Control—Integrated Framework*issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).  Ourreport dated April 17, 2008 expressed an opinion that Tennessee CommerceBancorp, Inc. had not maintained effective internal control over financialreporting as of December 31, 2007, based on criteria established in*InternalControl—Integrated Framework*issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO).

 

 

KraftCPAs PLLC

Nashville, Tennessee

April 17, 2008

 

F-4

----

 

REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Tothe Board of Directors and Shareholders

TennesseeCommerce Bancorp, Inc.

Franklin,Tennessee

 

We have audited the internalcontrol over financial reporting of Tennessee Commerce Bancorp, Inc. andsubsidiaries (collectively, the “Company”) as of December 31, 2007, basedon criteria established in *InternalControl—Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO*)*.  The Company’s management is responsible formaintaining effective internal control over financial reporting and for itsassessment of the effectiveness of internal control over financial reportingincluded in the accompanying Management Report on Internal Control OverFinancial Reporting.  Our responsibilityis to express an opinion on the Company’s internal control over financialreporting based on our audit.

 

We conducted our audit inaccordance with the standards of the Public Company Accounting Oversight Board(United States).  Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding of internalcontrol over financial reporting, assessing the risk that a material weaknessexists, and testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk. Our audit also included performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal controlover financial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generallyaccepted accounting principles.  Acompany’s internal control over financial reporting includes those policies andprocedures that (1) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (2) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements.  Also, projectionsof any evaluation of effectiveness to future periods are subject to the riskthat controls may become inadequate because of changes in conditions, or thatthe degree of compliance with the policies or procedures may deteriorate.

 

F-5

----

 

A material weakness is adeficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the Company’s annual or interim financial statementswill not be prevented or detected on a timely basis.

 

The following materialweaknesses have been identified and included in management’s assessment. (1) TheCompany’s policy prohibiting employees from initiating transactions affectingtheir own accounts without appropriate review was violated.  Numerous transactions processed on employeeaccounts were not appropriately reviewed and approved. (2) Formal meetingsof the Asset/Liability Management Committee did not occur during 2007.  Furthermore, items discussed during informalmeetings between members of the Asset/Liability Management Committee werepresented to the Board of Directors in the form of formal minutes.  These material weaknesses were considered indetermining the nature, timing, and extent of audit tests applied in our auditof the 2007 financial statements, and this report does not affect our reportdated April 17, 2007 on those financial statements.

 

In our opinion, because ofthe effects of the material weaknesses described above on the achievement ofthe objectives of the control criteria, Tennessee Commerce Bancorp, Inc.and subsidiaries has not maintained effective internal control over financialreporting as of December 31, 2007, based on criteria established in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the consolidated balance sheets of Tennessee Commerce Bancorp, Inc.and subsidiaries as of December 31, 2007 and 2006, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for each of the three years in the period ended December 31, 2007,and our report dated April 17, 2008 expressed an unqualified opinion onthose consolidated financial statements.

 

 

KraftCPAs PLLC

Nashville, Tennessee

April 17, 2008

 

F-6

----

 

**TENNESSEECOMMERCE BANCORP, INC.CONSOLIDATED BALANCE SHEETSDecember 31, 2007 and 2006**

 
| **(Dollars in thousands except share data)**                                                                                                                                                                         | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **ASSETS**                                                                                                                                                                                                                                    |       |     |       |     |       |
| Cash and due from financial institutions                                                                                                                                                                                                      |       | $        | 5,236      |     | $          | 177 |   |
| Federal funds sold                                                                                                                                                                                                                            |       | 9,573    |       | 13,820   |       |
| Cash and cash equivalents                                                                                                                                                                                                                     |       | 14,809   |       | 13,997   |       |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| Securities available for sale                                                                                                                                                                                                                 |       | 73,753   |       | 56,943   |       |
| Loans                                                                                                                                                                                                                                         |       | 794,322  |       | 545,518  |       |
| Allowance for loan losses                                                                                                                                                                                                                     |       | (10,321  | )          | (6,968   | )          |
| Net loans                                                                                                                                                                                                                                     |       | 784,001  |       | 538,550  |       |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| Premises and equipment, net                                                                                                                                                                                                                   |       | 1,413    |       | 1,633    |       |
| Accrued interest receivable                                                                                                                                                                                                                   |       | 5,901    |       | 4,116    |       |
| Restricted equity securities                                                                                                                                                                                                                  |       | 938      |       | 633      |       |
| Deferred tax asset                                                                                                                                                                                                                            |       | —   |       | 635      |       |
| Income tax receivable                                                                                                                                                                                                                         |       | 1,886    |       | —   |       |
| Other assets                                                                                                                                                                                                                                  |       | 17,452   |       | 7,011    |       |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| Total assets                                                                                                                                                                                                                                  |       | $        | 900,153    |     | $          | 623,518 |   |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                 |       |     |       |     |       |
| Liabilities                                                                                                                                                                                                                                   |       |     |       |     |       |
| Deposits                                                                                                                                                                                                                                      |       |     |       |     |       |
| Noninterest-bearing                                                                                                                                                                                                                           |       | $        | 27,427     |     | $          | 17,001 |   |
| Interest-bearing                                                                                                                                                                                                                              |       | 787,626  |       | 543,566  |       |
| Total deposits                                                                                                                                                                                                                                |       | 815,053  |       | 560,567  |       |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| Federal funds purchased                                                                                                                                                                                                                       |       | 2,000    |       | —   |       |
| Accrued interest payable                                                                                                                                                                                                                      |       | 2,292    |       | 1,728    |       |
| Short-term borrowings                                                                                                                                                                                                                         |       | 7,000    |       | —   |       |
| Accrued bonuses                                                                                                                                                                                                                               |       | 1,700    |       | 623      |       |
| Deferred tax liability                                                                                                                                                                                                                        |       | 139      |       | —   |       |
| Other liabilities                                                                                                                                                                                                                             |       | 600      |       | 1,128    |       |
| Long-term subordinated debt                                                                                                                                                                                                                   |       | 8,248    |       | 8,248    |       |
| Total liabilities                                                                                                                                                                                                                             |       | 837,032  |       | 572,294  |       |
| Shareholders’ equity                                                                                                                                                                                                                     |       |     |       |     |       |
| Preferred stock, no par value, 1,000,000  shares authorized; none issued                                                                                                                                                                      |       | —   |       | —   |       |
| Common stock, $0.50 par value; 10,000,000  shares authorized at December 31, 2007 and December 31, 2006;  4,724,196 and 4,451,674 shares issued and outstanding at December 31,  2007 and December 31, 2006, respectively |       | 2,362    |       | 2,226    |       |
| Additional paid-in capital                                                                                                                                                                                                                    |       | 45,024   |       | 40,755   |       |
| Retained earnings                                                                                                                                                                                                                             |       | 15,426   |       | 8,530    |       |
| Accumulated other comprehensive income  (loss)                                                                                                                                                                                                |       | 309      |       | (287     | )          |
| Total shareholders’ equity                                                                                                                                                                                                               |       | 63,121   |       | 51,224   |       |
|                                                                                                                                                                                                                                          |       |     |       |     |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                                               |       | $        | 900,153    |     | $          | 623,518 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-7

----

 

**TENNESSEECOMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF INCOMEYears Ended December 31, 2007, 2006 and 2005**

 
| **(Dollars in thousands except share data)** | ** ** | **2007**  | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Interest income                                                       |       |      |       |      |       |      |       |
| Loans, including fees                                                 |       | $         | 58,114     |      | $          | 38,382    |       | $ | 22,488 |   |
| Securities                                                            |       | 3,492     |       | 2,216     |       | 980       |       |
| Federal funds sold                                                    |       | 600       |       | 647       |       | 165       |       |
| Total interest income                                                 |       | 62,206    |       | 41,245    |       | 23,633    |       |
|                                                                  |       |      |       |      |       |      |       |
| Interest expense                                                      |       |      |       |      |       |      |       |
| Deposits                                                              |       | 34,245    |       | 21,216    |       | 9,567     |       |
| Other                                                                 |       | 689       |       | 652       |       | 439       |       |
| Total interest expense                                                |       | 34,934    |       | 21,868    |       | 10,006    |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest income                                                   |       | 27,272    |       | 19,377    |       | 13,627    |       |
|                                                                  |       |      |       |      |       |      |       |
| Provision for loan losses                                             |       | 6,350     |       | 4,350     |       | 3,700     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest income after provision for  loan losses                  |       | 20,922    |       | 15,027    |       | 9,927     |       |
|                                                                  |       |      |       |      |       |      |       |
| Non-interest income                                                   |       |      |       |      |       |      |       |
| Service charges on deposit accounts                                   |       | 132       |       | 112       |       | 114       |       |
| Gain on sale of loans                                                 |       | 2,687     |       | 2,025     |       | 1,106     |       |
| Other                                                                 |       | 61        |       | (374      | )          | 91        |       |
| Total non-interest income                                             |       | 2,880     |       | 1,763     |       | 1,311     |       |
|                                                                  |       |      |       |      |       |      |       |
| Non interest expense                                                  |       |      |       |      |       |      |       |
| Salaries and employee benefits                                        |       | 7,977     |       | 5,047     |       | 3,700     |       |
| Occupancy and equipment                                               |       | 1,109     |       | 844       |       | 629       |       |
| Data processing fees                                                  |       | 983       |       | 701       |       | 474       |       |
| Professional fees                                                     |       | 779       |       | 786       |       | 398       |       |
| Other                                                                 |       | 2,415     |       | 1,678     |       | 1,045     |       |
| Total non-interest expense                                            |       | 13,263    |       | 9,056     |       | 6,246     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income before income taxes                                            |       | 10,539    |       | 7,734     |       | 4,992     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income tax expense                                                    |       | 3,643     |       | 2,985     |       | 1,925     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net income                                                            |       | $         | 6,896      |      | $          | 4,749     |       | $ | 3,067 |   |
|                                                                  |       |      |       |      |       |      |       |
| Earnings per share (EPS):                                             |       |      |       |      |       |      |       |
| Basic EPS                                                             |       | $         | 1.49       |      | $          | 1.24      |       | $ | 0.95 |   |
| Diluted EPS                                                           |       | 1.41      |       | 1.14      |       | 0.87      |       |
|                                                                  |       |      |       |      |       |      |       |
| Weighted average shares outstanding:                                  |       |      |       |      |       |      |       |
| Basic                                                                 |       | 4,613,342 |       | 3,822,655 |       | 3,238,674 |       |
| Diluted                                                               |       | 4,892,167 |       | 4,157,338 |       | 3,517,408 |       |

 

See accompanying notes to consolidatedfinancial statements.

 

F-8

----

 

**TENNESSEECOMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYYears Ended December 31, 2007, 2006 and 2005**

 
| ** **                                                                                | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**              | ** ** | **Total**              | ** ** |
|-------------------------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                | ** ** | **Common** | ** ** | **Paid-In**    | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | **Shareholders’** | ** ** |
| **(Dollars in thousands except share data)**                     | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Equity**             | ** ** |
|                                                                                      |       |       |       |           |       |         |       |                   |       |                   |       |
| 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 loss on securities available for  sale during the period, net of $(146) in tax |       | —     |       | —         |       | —       |       | (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, net of $53 in tax   |       | —     |       | —         |       | —       |       | 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                 |       |
| Comprehensive income                                                                      |       |       |       |           |       |         |       |                   |       |                   |       |
| Net income                                                                                |       | —     |       | —         |       | 6,896        |       | —                 |       | 6,896                  |       |
| Other comprehensive income, net of income  taxes                                          |       |       |       |           |       |         |       |                   |       |                   |       |
| Unrealized gains on securities available  for sale during the period, net of $366 in tax  |       | —     |       | —         |       | —       |       | 596                    |       | 596                    |       |
|                                                                                      |       |       |       |           |       |         |       |                   |       |                   |       |
| Total comprehensive income                                                                |       | —     |       | —         |       | —       |       | —                 |       | 7,492                  |       |
|                                                                                      |       |       |       |           |       |         |       |                   |       |                   |       |
| Exercise of stock options to purchase  272,522 common shares and related tax benefit      |       | 136        |       | 3,995          |       | —       |       | —                 |       | 4,131                  |       |
| Stock-based compensation expense                                                          |       | —     |       | 259            |       | —       |       | —                 |       | 259                    |       |
| Section 16 profit reimbursement                                                      |       | —     |       | 15             |       | —       |       | —                 |       | 15                     |       |
|                                                                                      |       |       |       |           |       |         |       |                   |       |                   |       |
| Balance at December 31, 2007                                                         |       | $          | 2,362      |           | $          | 45,024       |       | $                      | 15,426     |                   | $          | 309 |   | $ | 63,121 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F-9

----

 

**TENNESSEECOMMERCE BANCORP, INC.CONSOLIDATED STATEMENTS OF CASH FLOWSYears Ended December 31, 2007, 2006 and 2005**

 
| **(Dollars in thousands except share data)**             | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from operating activities**                                          |       |     |       |     |       |     |       |
| Net income                                                                        |       | $        | 6,896      |     | $          | 4,749    |       | $ | 3,067 |   |
| Adjustments to reconcile net income to net  cash provided by operating activities |       |     |       |     |       |     |       |
| Depreciation                                                                      |       | 333      |       | 259      |       | 171      |       |
| Deferred loan fees                                                                |       | 919      |       | 234      |       | 86       |       |
| Provision for loan losses                                                         |       | 6,350    |       | 4,350    |       | 3,700    |       |
| FHLB stock dividends                                                              |       | —   |       | (32      | )          | (17      | )          |
| Stock-based compensation expense                                                  |       | 259      |       | 82       |       | —   |       |
| Deferred income tax                                                               |       | 408      |       | (198     | )          | 254      |       |
| Net amortization of investment securities                                         |       | 11       |       | 14       |       | 40       |       |
| Gain on sales of securities                                                       |       | (26      | )          | —   |       | (4       | )          |
| Change in:                                                                        |       |     |       |     |       |     |       |
| Accrued interest receivable                                                       |       | (1,785   | )          | (1,968   | )          | (1,045   | )          |
| Accrued interest payable                                                          |       | 564      |       | 602      |       | 681      |       |
| Income tax receivable                                                             |       | (1,886   | )          | —   |       | —   |       |
| Other assets                                                                      |       | (10,442  | )          | (2,352   | )          | (3,567   | )          |
| Other liabilities                                                                 |       | 549      |       | 1,220    |       | 53       |       |
| Net cash from operating activities                                                |       | 2,150    |       | 6,960    |       | 3,419    |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from investing activities**                                          |       |     |       |     |       |     |       |
| Purchases of securities available for sale                                        |       | (43,898  | )          | (26,781  | )          | (17,315  | )          |
| Proceeds from sales of securities available  for sale                             |       | 25,850   |       | —   |       | 1,489    |       |
| Proceeds from maturities, prepayments and  calls of securities available for sale |       | 2,216    |       | 1,953    |       | 2,104    |       |
| Investment in unconsolidated subsidiary                                           |       | —   |       | —   |       | (248     | )          |
| Net change in loans                                                               |       | (252,720 | )          | (198,947 | )          | (134,561 | )          |
| Purchases of FHLB Stock                                                           |       | (305     | )          | (218     | )          | (125     | )          |
| Net purchases of premises and equipment                                           |       | (113     | )          | (1,123   | )          | (330     | )          |
| Net cash used by investing activities                                             |       | (268,970 | )          | (225,116 | )          | (148,986 | )          |
|                                                                              |       |     |       |     |       |     |       |
| **Cash flows from financing activities**                                          |       |     |       |     |       |     |       |
| Net change in deposits                                                            |       | 254,486  |       | 192,862  |       | 146,311  |       |
| Net change in federal funds purchased and  repurchase agreements                  |       | 2,000    |       | —   |       | —   |       |
| Proceeds from long-term subordinated debt                                         |       | —   |       | —   |       | 8,248    |       |
| Proceeds from issuance of common stock                                            |       | —   |       | 19,027   |       | —   |       |
| Proceeds from exercise of common stock  options                                   |       | 2,152    |       | 596      |       | —   |       |
| Proceeds from issuance of short-term debt                                         |       | 7,000    |       | —   |       | —   |       |
| Excess tax benefit from option exercises                                          |       | 1,979    |       | 256      |       | —   |       |
| Section 16 profit reimbursement                                              |       | 15       |       | —   |       | —   |       |
| Net cash provided by financing activities                                         |       | 267,632  |       | 212,741  |       | 154,559  |       |
|                                                                              |       |     |       |     |       |     |       |
| **Net change in cash and cash equivalents**                                       |       | 812      |       | (5,415   | )          | 8,992    |       |
|                                                                              |       |     |       |     |       |     |       |
| Cash and cash equivalents at beginning of  period                                 |       | 13,997   |       | 19,412   |       | 10,420   |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash and cash equivalents at end of period**                                    |       | $        | 14,809     |     | $          | 13,997   |       | $ | 19,412 |   |
|                                                                              |       |     |       |     |       |     |       |
| **Supplemental cash flow information:**                                           |       |     |       |     |       |     |       |
| Cash paid during period for interest                                              |       | $        | 34,370     |     | $          | 21,266   |       | $ | 9,325 |   |
| Cash paid during period for income taxes                                          |       | 4,745    |       | 2,075    |       | 2,089    |       |

 

See accompanying notes to consolidated financial statements.

 

F-10

----

 

 

**TENNESSEECOMMERCE BANCORP, INC.**

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

The accounting principles followed and the methodsof applying 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 consolidatedfinancial statements include the accounts of Tennessee Commerce Bancorp, Inc.(the “Corporation”) and its wholly-owned subsidiary, Tennessee Commerce Bank(the “Bank,” and, together with the Corporation, the “Company”). TennesseeCommerce Statutory Trust I is not consolidated and is accounted for under the equitymethod. Material intercompany accounts and transactions have been eliminated.

 

Nature of Operations:  The Corporation was formed in July 2000.The Bank received its charter as a state bank and opened for business in January 2000.Substantially all of the assets, liabilities and operations presented in theconsolidated financial statements are attributable to the Bank. The Bankprovides a variety of banking services to individuals and businesses in MiddleTennessee. Its primary deposit products are demand and savings deposits andcertificates of deposit, and its primary lending products are commercial, leasefinancing, 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 prepare financial statements inconformity with accounting principles generally accepted in the United Statesof America, management makes estimates and assumptions based on availableinformation. These estimates and assumptions affect the amounts reported in thefinancial statements and the disclosures provided, and future results coulddiffer. The allowance for loan losses and fair value of financial instrumentsare particularly subject to change.

 

Statement of Cash Flows:  For purposes of presentation in thestatements of cash flows, cash and cash equivalents include amounts due fromfinancial institutions and federal funds sold. Net cash flows are reported forloan and deposit transactions.

 

Securities:  In accordance with Statement of Financial Accounting Standards(“SFAS”) No. 115, “Accounting forCertain Debt and Equity Securities,” all securities are classified asavailable for sale. The Bank has no trading securities or held to maturitysecurities as of December 31, 2007.

 

Securities classified as available for sale may be soldin 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.

 

Unrealized holding gains and losses for availablefor sale 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 ofsecurities are 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.

 

F-11

----

 

###### **MortgageBanking Activities**:  The Bank originates mortgage loans for saleand these loans are carried at the lower of cost or fair value, determined onan aggregate basis. Generally, a commitment is obtained from investors atorigination in order to minimize market risk directly related to interest ratemovements. Origination fees are recorded as income when the loans are sold tothird party investors. At the end of the year for each period presented therewere no loans held for sale.

###### ** **

Loans:  Loans that the Bank has the positive intent and ability to holdto maturity are stated at the principal amount outstanding. Interest on loansis computed daily based on the principal amount outstanding. Loan originationfees are deferred, to the extent they exceed direct origination costs, andrecognized over the life of the related loans 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 $22,752,000 and $6,936,000 of loans on thebalance sheet at December 31, 2007 and 2006, respectively. In accordancewith the SFAS No. 140, “AccountingFor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities,” at the time of investment, the tax lease asset is recordedalong with unearned interest income followed by periodic journal entries torecord the interest income and maintain an accurate representation of theinvestment balance. The current balance is part of “Loans” on the balance sheetand as “Other” on the Summary of Loans in Note 3. For 2007, the tax leasescreated a net timing difference of $4,800,328.  Net deductions of$4,800,328 were allowed for tax, but not book. For 2006, the tax leases createda net timing difference of $1,550,007.  Net deductions of $1,550,007 wereallowed for tax, but not book.

 

Allowance for Loan Losses:  The allowance for loan losses ismaintained at a level that, in management’s judgment, is adequate to absorbcredit losses inherent in the loan portfolio. The amount of the allowance isbased on management’s evaluation of the collectability of the loan portfolio,including the nature of the portfolio, credit concentrations, trends inhistorical loss experience, impaired loans and economic conditions. Allowancesfor impaired loans are generally determined based on collateral values or thepresent value of estimated cash flows. Because of uncertainties associated withthe regional economic conditions, collateral values and future cash flows onimpaired loans, it is reasonably possible that management’s estimate of creditlosses inherent in the loan portfolio and the related allowance may changematerially in the near term. The allowance is increased by the provision forloan losses and reduced by charge-offs, net of recoveries.

 

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.A loan 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. Loans arecharged-off at a time when the collection efforts are reasonably deemeduncollectable.

 

Premises and Equipment:  Premises and equipment are stated atcost, less accumulated depreciation and amortization. The provision fordepreciation is computed principally on the straight-line method over theestimated useful lives of the assets. Leasehold improvements are amortized overthe shorter of the lease term or useful life of the asset. Costs of majoradditions and improvements are capitalized. Expenditures for maintenance andrepairs are charged to operations as incurred.

 

F-12

----

 

Other Real Estate:  Real estate acquired by foreclosureis carried at the lower of the recorded investment in the property or its fairvalue, less costs to sell, at the date of foreclosure, determined by appraisal.Declines in value indicated by reappraisals as well as losses resulting from dispositionare charged to operations. Subsequent expenses are expensed as they occur afterany re-acquisitions.

 

Gain on Sale of Loans: Transfers of financial assets are accountedfor as sales when control over the assets has been surrendered. Control over transferredassets is deemed to be surrendered when (1) the assets have been isolatedfrom the Corporation, (2) the transferee obtains the right (free ofconditions that constrain it from taking advantage of the right) to pledge orexchange the transferred assets, and (3) the Corporation does not maintaineffective over the transferred assets through an agreement to repurchase thembefore maturity. The Bank records the transfer by allocating the carryingamount of the financial asset between the assets sold, and the retainedinterests, if any, based on their relative fair values at the date of transfer.Estimates of expected future cash flows are used to determine fair value on thedate of transfer. The gain on sale is presented as a component of non-interestincome.

 

Interest-Only Strips Receivable:  Interest-only strips receivable arerelated to loans originated and sold to others, and represent the differencebetween the loan’s coupon rate and the rate “passed through” to investors. Theinitial amount recorded as interest-only strips receivable (“I/O”) is computedby applying present value factors to the investors’ expected cash flowscompared to expected cash flows from the borrowers. I/Os are carried at fairvalue and unrealized losses or gains are recognized into income. I/Os areincluded in other assets on the balance sheet.

 

Servicing Asset: Servicing assets are recognized as separateassets when rights are acquired through purchase or through sale of financialassets. When the Bank sells loans to others that it continues to service, aservicing asset is recorded at fair value. Capitalized servicing rights arereported in other assets and are amortized over the life of the loan beingserviced.

 

Stock-Based Compensation:  Effective January 1, 2006, theCorporation adopted SFAS No. 123(R), “Share-based Payment,” using the modified prospective transitionmethod.  Accordingly, the Corporation has recorded stock-based employeecompensation cost based on the fair value method using the Black-Scholesvaluation model starting in 2006.  For 2007, adopting this standardresulted in a reduction of income before income taxes of $259,000, a reductionin net income of $169,000 and a decrease in basic and diluted earnings pershare of $.04 and $.03. For 2006, adopting this standard resulted in areduction of income before income taxes of $82,000, a reduction in net incomeof $51,000, and a decrease in basic and diluted earnings per share of $.01 and$.01.

 

Prior to January 1, 2006, employee compensationexpense under stock options was reported using the intrinsic value method;therefore, no stock-based compensation cost is reflected in net income for theyear ending December 31, 2005, as all options granted had an exerciseprice equal to or greater than the market price of the underlying common stockat date of grant.

 

The following table illustrates the effect on netincome and earnings per share if expense was measured using the fair valuerecognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,”**for the year ending December 31, 2005:

 
| **(Dollars in thousands except share data)**              | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------|------------|----------|------------|
|                                                                               |       |     |       |
| Net income as reported                                                             |       | $        | 3,067      |   |
| Deduct: Stock-based compensation expense  determined under fair value based method |       | 245      |       |
|                                                                               |       |     |       |
| Pro forma net income                                                               |       | $        | 2,822      |   |
|                                                                               |       |     |       |
| Basic earnings per share as reported                                               |       | $        | 0.95       |   |
| Pro forma basic earnings per share                                                 |       | 0.87     |       |
|                                                                               |       |     |       |
| Diluted earnings per share as reported                                             |       | 0.87     |       |
| Pro forma diluted earnings per share                                               |       | 0.80     |       |

 

F-13

----

 

The pro forma effects are computed using optionpricing models, using the following weighted-average assumptions as of grantdate:

 
| ** **              | ** ** | **2005** | ** ** |
|-------------------------|------------|----------|------------|
|                    |       |     |       |
| Risk-free interest rate |       | 3.96     | %          |
| Expected option life    |       | 5 years  |       |
| Dividend yield          |       | 0.0      | %          |

 

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

 

In June of 2007, the Tennessee Commerce Bancorp2007 Equity Plan was adopted and the Corporation reserved authorized shares tobe issued, and not repurchased, in accordance with the provisions of the plan.

 

Stock Issuance: On June 27, 2006, the Corporation’sRegistration Statement on Form S-1, as amended (Registration 333-133539),was declared effective by the SEC.  Pursuant to the registrationstatement, the Corporation registered 1,150,000 shares of its common stock at aprice of $18.00 per share.  On July 3, 2006, the Corporation received$16,920,000 of net proceeds from the sale of 1,000,000 shares of its commonstock in connection with its public offering, and on July 28, 2006, theCorporation received $2,538,000 of net proceeds from the sale of 150,000additional shares of its common stock issued in connection with theunderwriters’ over-allotment option.  As of July 28, 2006, all1,150,000 shares offered under the registration statement had been fullysubscribed. FTN Midwest Securities Corp. and Sterne, Agee & Leach, Inc.were the managing underwriters for the offering.  The total expensesincurred for the Corporation’s account in connection with the issuance anddistributions of the securities were $431,000. The net offering proceeds to theCorporation after deducting the total expenses were $19,027,000.  Thesenet proceeds were used to repay the $5,000,000 outstanding balance on ourrevolving line of credit, to fund the continued expansion of our franchise andfor general corporate purposes.

 

Income Taxes:  Income tax expense is the total ofthe current year income tax due or refundable and the change in deferred taxassets and liabilities. Deferred tax assets and liabilities are the expectedfuture tax amounts for the temporary differences between carrying amounts andtax bases of assets and liabilities, computed using enacted tax rates. Avaluation allowance, if needed, reduces deferred tax assets to the amountexpected to be realized.

 

The Company adopted FASB Interpretation 48, “Accountingfor Uncertainty in Income Taxes,” as of January 1, 2007.  A tax position is recognized as a benefitonly if it is “more likely than not” that the tax position would be sustainedin a tax examination, with a tax examination being presumed to occur.  The amount recognized is the largest amountof tax benefit that is greater than 50% likely of being realized onexamination.  For tax positions notmeeting the “more likely that not” test, no tax benefit is recorded.  The adoption had no effect on the Company’sfinancial statements.

 

The Company recognizes interest and/or penaltiesrelated to income tax matters in income tax expense.

 

Advertising Costs:  Advertising costs are generallycharged to operations in the year incurred and totaled $73,000, $206,000, and$140,000 in 2007, 2006 and 2005.

 

Off-Balance Sheet Financial Instruments:  Financial instruments includeoff-balance sheet credit instruments, such as commitments to make loans,financial guarantees and standby letters of credit, issued to meet customerfinancing needs. The face amount for these items represents the exposure toloss, before considering customer collateral or ability to repay. Suchfinancial instruments are recorded when they are funded.

 

Restrictions on Cash:  Cash on hand or on deposit with otherbanks of $227,000 and $220,000 was required to meet regulatory reserve andclearing requirements at year-end 2007 and 2006, respectively. These balancesdo not earn interest.

 

F-14

----

 

Dividend Restrictions:  Banking regulations requiremaintaining certain capital levels and may limit the dividends paid by the Bankto the Corporation, which would limit dividends payable by the Corporation toits shareholders.

 

Comprehensive Income:  Comprehensive income consists of netincome and other comprehensive income. Other comprehensive income includesunrealized gains and losses on securities available for sale which are alsorecognized as separate components of equity.

 

Fair Value of Financial Instruments:  Fair values of financial instrumentsare estimated using relevant market information and other assumptions, as morefully disclosed in Note 13. Fair value estimates involve uncertainties andmatters of significant judgment regarding interest rates, credit risk,prepayments and other factors, especially in the absence of broad markets forparticular items. Changes in assumptions or in market conditions couldsignificantly affect the estimates.

 

Recently Issued Accounting Standards:  In September 2006,the FASB released SFAS No. 157 (“SFAS No. 157”), “Fair ValueMeasurements.” This statement defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements.SFAS No. 157 clarifies the exchange price notion in the fair valuedefinition to mean the price that would be received to sell the asset or paidto transfer the liability (an exit price), not the price that would be paid toacquire the asset or received to assume the liability (an entry price). Thisstatement also clarifies that market participant assumptions should includeassumptions about risk, should include assumptions about the effect of arestriction on the sale or use of an asset and should reflect itsnonperformance risk (the risk that the obligation will not be fulfilled).Nonperformance risk should include the reporting entity’s credit risk. SFAS No. 157is effective for financial statements issued for fiscal years beginning after November 15,2007. The Corporation adopted SFAS No. 157 on January 1, 2008, andmanagement is still evaluating the impact on the Corporation’s consolidatedfinancial statements.

 

Operating Segments:  While the chief decision-makersmonitor the revenue streams of the various products and services, theCorporation does not have any identifiable segments.

 

Reclassifications:  Some items in the prior yearfinancial statements were reclassified to conform to the current presentation.

 

F-15

----

** **

**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**     | ** ** |
|                                 |       |       |       |           |       |           |       |
| 2007                                 |       |       |       |           |       |           |       |
|                                 |       |       |       |           |       |           |       |
| U.S. Government agencies             |       | $          | 64,090     |           | $          | 504            |       | $ | (36 | ) |
| Mortgage-backed securities           |       | 5,306      |       | —         |       | (104           | )          |
| Corporate debt securities            |       | 268        |       | —         |       | (12            | )          |
| Corporate bonds                      |       | 3,508      |       | 1              |       | (54            | )          |
| Other                                |       | 581        |       | 201            |       | —         |       |
|                                 |       |       |       |           |       |           |       |
|                                 |       | $          | 73,753     |           | $          | 706            |       | $ | (206 | ) |
|                                 |       |       |       |           |       |           |       |
| 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 | ) |

 

Contractual maturities of debt securities at December 31,2007 are shown below. Expected maturities will differ from contractual maturitiesbecause borrowers may have the right to call or prepay obligations with orwithout prepayment penalties.

 
| **(Dollars in thousands)** | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|---------------------|------------|
|                                 |       |                |       |
| Due in less than one year            |       | $                   | —     |   |
| Due after one through five years     |       | 11,955              |       |
| Due after five through ten years     |       | 23,179              |       |
| Due after ten years                  |       | 33,313              |       |
| Mortgage-backed securities           |       | 5,306               |       |
|                                 |       |                |       |
|                                 |       | $                   | 73,753     |   |

 

Gross gains of $26,000, $0, and $4,000 on sales ofsecurities were recognized in 2007, 2006 and 2005, respectively. Securitiescarried at $11,735,000 and $10,535,000 at December 31, 2007 and 2006,respectively, were pledged to secure deposits and for other purposes asrequired or permitted by law.

 

Restricted equity securities consist of securitieswhich are restricted as to transferability. These securities are recorded atcost.

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Federal Home Loan Bank stock         |       | $        | 938        |     | $          | 633 |   |
|                                      |            |          |            |          |            |  |  |

 

F-16

----

 

Securitieswith unrealized losses at year-end 2007 and 2006, and the length of time theyhave been in continuous loss positions are as follows:

 
| ** **                           | ** ** | **Less than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
|--------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                           | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **(Dollars in thousands)** | ** ** | **Value**                              | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2007                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies             |       | $                                      | 60,119     |                                 | $          | 10        |       | $ | 3,971 |   | $ | 26 |   | $ | 64,090 |   | $ | 36 |   |
| Mortgage-backed securities           |       | —                                 |       | —                               |       | 5,234     |       | 104 |   | 5,234 |   | 104 |   |
| Corporate debt securities            |       | —                                 |       | —                               |       | 268       |       | 12 |   | 268 |   | 12 |   |
| Corporate bonds                      |       | 3,508                                  |       | 54                                   |       | —    |       | — |   | 3,508 |   | 54 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| Total                                |       | $                                      | 63,627     |                                 | $          | 64        |       | $ | 9,473 |   | $ | 142 |   | $ | 73,100 |   | $ | 206 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2006                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government agencies             |       | $                                      | 22,721     |                                 | $          | 94        |       | $ | 22,758 |   | $ | 420 |   | $ | 45,479 |   | $ | 514 |   |
| Mortgage-backed securities           |       | —                                 |       | —                               |       | 6,465     |       | 207 |   | 6,465 |   | 207 |   |
| Corporate debt securities            |       | —                                 |       | —                               |       | 319       |       | 16 |   | 319 |   | 16 |   |
| Corporate bonds                      |       | —                                 |       | —                               |       | 4,126     |       | 34 |   | 4,126 |   | 34 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| Total                                |       | $                                      | 22,721     |                                 | $          | 94        |       | $ | 33,668 |   | $ | 677 |   | $ | 56,389 |   | $ | 771 |   |

 

Unrealizedlosses on U.S. government agency securities have not been recognized intoincome because the securities are backed by the U.S. government or itsagencies, management has the intent and ability to hold for the foreseeablefuture and the decline in fair value is largely a result of increases in marketinterest rates. The unrealized losses on mortgage-backed securities andcorporate securities have not been recognized into income because managementhas the intent and ability to hold for the foreseeable future, and the declinein fair value is largely a result of increases in market interest rates. Thefair value of the securities above is expected to recover as the securitiesapproach their maturity dates and/or market rates decline.

 

## **NOTE3 - LOANS**

## ** **

Asummary of loans outstanding by category at December 31:

 
| **(Dollars in thousands)**   | ** ** | **2007** | ** ** | **2006** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Real estate:                           |       |     |       |     |       |
|                                   |       |     |       |     |       |
| Construction                           |       | $        | 112,405    |     | $          | 74,482 |   |
| 1 to 4 family residential              |       | 33,560   |       | 22,873   |       |
| Other                                  |       | 143,973  |       | 83,985   |       |
| Commercial, financial and agricultural |       | 477,666  |       | 353,996  |       |
| Consumer                               |       | 3,966    |       | 3,246    |       |
| Other                                  |       | 22,752   |       | 6,936    |       |
|                                   |       | 794,322  |       | 545,518  |       |
| Less: Allowance for loan losses        |       | (10,321  | )          | (6,968   | )          |
|                                   |       |     |       |     |       |
| Net loans                              |       | $        | 784,001    |     | $          | 538,550 |   |

 

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.

 

F-17

----

 
| **(Dollars in thousands)**           | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                           |       |     |       |     |       |     |       |
| Proceeds from loans transferred with  recourse |       | $        | 40,590     |     | $          | 26,022   |       | $ | 19,571 |   |
|                                                |            |          |            |          |            |          |            |  |  |  |

 

The Bank services loans for the benefit of others.The amount of loans being serviced for the benefit of others at year end foreach period follows.

 
| ** **                           | ** ** | **December  31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|
| **(Dollars in thousands)** | ** ** | **2007**          | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                 |       |              |       |   |   |   |   |
| Amount of loans being serviced       |       | $                 | 86,489     |   | $ | 66,465 |   | $ | 36,094 |   |
|                                      |            |                   |            |  |  |  |  |  |  |  |

 

Certain parties (principally executive officers anddirectors of the Bank, including their related interests) were customers of,and had loans with the Bank in the ordinary course of business. These loan transactionswere made on substantially the same terms as those prevailing at the time forcomparable loans to other persons. They did not involve more than the normalrisk of collectability or present other unfavorable features.

 

Loansto principal officers, directors and their affiliates in 2007 were as follows.

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Beginning balance                    |       | $        | 8,724      |     | $          | 6,465 |   |
| New loans                            |       | 4,475    |       | 3,788    |       |
|                                 |       |     |       |     |       |
| Repayments                           |       | (6,395   | )          | (1,529   | )          |
|                                 |       |     |       |     |       |
| Ending balance                       |       | $        | 6,804      |     | $          | 8,724 |   |

 

**NOTE 4 – ALLOWANCE FOR LOAN LOSSES**

 

Changesin the allowance for loan losses were as follows:

 
| **(Dollars in thousands)**    | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |     |       |
| Balance at beginning of year            |       | $        | 6,968      |     | $          | 4,399    |       | $ | 2,841 |   |
| Provision charged to operating expenses |       | 6,350    |       | 4,350    |       | 3,700    |       |
| Loans charged-off                       |       | (3,310   | )          | (2,037   | )          | (2,411   | )          |
| Recoveries                              |       | 313      |       | 256      |       | 269      |       |
|                                    |       |     |       |     |       |     |       |
| Balance at end of year                  |       | $        | 10,321     |     | $          | 6,968    |       | $ | 4,399 |   |

 

Impairedloans were as follows:

 
| **(Dollars in thousands)**                 | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |
| Loans with allocated allowance for loan  losses      |       | $        | 6,492      |     | $          | 2,689 |   |
|                                                 |       |     |       |     |       |
| Amount of the allowance allocated to  impaired loans |       | $        | 2,442      |     | $          | 1,539 |   |

 

F-18

----

 
| ** **                                | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |     |       |
| Average of impaired loans during the year |       | $        | 3,783      |     | $          | 2,719    |       | $ | 4,444 |   |
|                                           |            |          |            |          |            |          |            |  |  |  |

 

The amount of interest income recognized for thetime that these loans were impaired during 2007, 2006 and 2005 was not materialto the financial statements.

 

Nonperformingloans were as follows:

 
| **(Dollars in thousands)**          | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |     |       |
| Loans past due over 90 days still on  accrual |       | $        | 1,992      |     | $          | 940      |       | $ | 352 |   |
| Nonaccrual loans                              |       | 6,465    |       | 2,689    |       | 2,928    |       |
|                                               |            |          |            |          |            |          |            |  |  |  |

 

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

 

**NOTE 5 – PREMISES AND EQUIPMENT**

 

The following is a summary of premises and equipmentas of December 31, 2007 and 2006. Depreciation expense for 2007, 2006 and2005 was $333,000, $259,000 and $171,000, respectively.

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Leasehold improvements               |       | $        | 903        |     | $          | 901 |   |
| Furniture and equipment              |       | 1,756    |       | 1,645    |       |
|                                 |       | 2,659    |       | 2,546    |       |
| Less: Allowance for depreciation     |       | 1,246    |       | 913      |       |
|                                 |       |     |       |     |       |
|                                 |       | $        | 1,413      |     | $          | 1,633 |   |

 

The Bank leases office space, furniture andequipment under operating leases. Rent expense recognized in 2007, 2006 and2005 amounted to $390,000, $352,000 and $268,000, respectively. The remainingminimum lease payments related to the leases are as follows, before consideringrenewal options that generally are present:

 
| **(Dollars in thousands)** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2008                                 |       | $          | 554        |   |
| 2009                                 |       | 556        |       |
| 2010                                 |       | 564        |       |
| 2011                                 |       | 576        |       |
| 2012                                 |       | 588        |       |
| 2013-2017                            |       | 3,011      |       |
|                                 |       |       |       |
|                                 |       | $          | 5,849      |   |

 

F-19

----

 

## **NOTE 6 - DEPOSITS**

## ** **

Timedeposits greater than $100,000 amounted to $364,797,000 in 2007 and$227,917,000 in 2006.

 

AtDecember 31, 2007, scheduled maturities of time deposits were as follows:

 
| **(Dollars in thousands)** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
|                                 |       |       |       |
| 2008                                 |       | $          | 526,463    |   |
| 2009                                 |       | 103,383    |       |
| 2010                                 |       | 37,843     |       |
| 2011                                 |       | 4,678      |       |
| 2012                                 |       | 613        |       |
|                                      |            |            |            |  |

 

Deposits held at the Bank by directors, executiveofficers and their related interests were approximately $3,960,000 and$7,958,000 at December 31, 2007 and 2006, respectively.

 

**NOTE 7 - ADVANCES FROM FEDERAL HOME LOAN 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 $17,967,407 with FHLB. Toparticipate in this program, the Bank is required to be a member of the FHLBand own stock in the FHLB. The Corporation had $937,800 of such stock at December 31,2007 to satisfy this requirement.

 

At December 31, 2007, the Bank had received noadvances from the FHLB and, therefore, had pledged no securities or qualifyingloans to the FHLB.

 

The Bank has approximately $24,000,000 in availablefederal funds lines (or the equivalent thereof) with correspondent banks.  At December 31, 2007, the Bank had$2,000,000 of federal funds purchased.

 

In September 2007, we entered into a short-termrevolving line of credit with First Tennessee Bank, National Association,pursuant to which First Tennessee agreed to loan us up to $10,000,000.  First Tennessee’s obligation to make advancesto us under this line of credit terminates on October 1, 2008.  At December 31, 2007, we had outstandingborrowings of $7,000,000 under this line of credit.

 

**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)** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |     |       |
| Current federal                      |       | $        | 2,897      |     | $          | 2,730    |       | $ | 1,385 |   |
| Current state                        |       | 338      |       | 453      |       | 286      |       |
| Deferred federal                     |       | 369      |       | (164     | )          | 213      |       |
| Deferred state                       |       | 39       |       | (34      | )          | 41       |       |
|                                 |       |     |       |     |       |     |       |
|                                 |       | $        | 3,643      |     | $          | 2,985    |       | $ | 1,925 |   |

 

F-20

----

 

Thetax effect of each type of temporary difference that results in net deferredtax assets and liabilities is as follows:

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
| Asset (liability)                    |       |     |       |     |       |
| Allowance for loan losses            |       | $        | 3,428      |     | $          | 1,994 |   |
| Tax leases                           |       | (2,733   | )          | (895     | )          |
| Unrealized (gain) loss on securities |       | (191     | )     | 175      |       |
| Depreciation                         |       | (31      | )          | (47      | )          |
| SFAS 140 income adjustments          |       | (1,476   | )          | (792     | )          |
| Nonaccrual loan interest             |       | 245      |       | 178      |       |
| Net deferred loan fees               |       | 641      |       | 104      |       |
| Other, net                           |       | (22      | )     | (82      | )          |
|                                 |       |     |       |     |       |
| Balance  at end of year              |       | $        | (139       | )   | $          | 635 |   |

 

A reconciliation of the amount computed by applyingthe federal statutory rate (34%) to pretax income with income tax expense(benefit) follows:

 
| **(Dollars in thousands)** | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |     |       |
| Tax expense at statutory rate        |       | $        | 3,583      |     | $          | 2,630    |       | $ | 1,698 |   |
| State income tax effect              |       | 249      |       | 277      |       | 216      |       |
| Other                                |       | (189     | )     | 78       |       | 11       |       |
|                                 |       |     |       |     |       |     |       |
| Income  tax expense                  |       | $        | 3,643      |     | $          | 2,985    |       | $ | 1,925 |   |

 

The Corporation had no unrecognized tax benefits at January 1,2007 and December 31, 2007.  Nosignificant increase in expected over the next 12 months.

 

Should the accrual of any interest or penaltiesrelative to unrecognized tax benefits be necessary, it is the Corporation’spolicy to record such accruals in its income tax accounts; no such accrualsexisted as of January 1, 2007 and December 31, 2007.

 

The Corporation and its subsidiary file aconsolidated U.S. federal income tax return and various returns in states whereits banking offices are located. The Corporation’s filed income tax returns areno longer subject to examination by taxing authorities for years before 2004.

 

## **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.

 

F-21

----

 

The following table reflects financialinstruments for which contract amounts represented credit risk as of December 31,for the following years:

 
|                                                | ** ** | **2007**  | ** ** | **2006**     | ** ** |
|-----------------------------------------------------|------------|-----------|------------|--------------|------------|
| ** **                                          | ** ** | **Fixed** | ** ** | **Variable** | ** ** | **Fixed** | ** ** | **Variable** | ** ** |
| **(Dollars in thousands)**                | ** ** | **Rate**  | ** ** | **Rate**     | ** ** | **Rate** | ** ** | **Rate** | ** ** |
|                                                |       |      |       |         |       |   |   |   |   |
| Commitments to extend credit                        |       | $         | 18,380     |         | $          | 107,663 |   | $ | 9,601 |   | $ | 65,123 |   |
| Standby  letters of credit and financial guarantees |       | —    |       | 11,063       |       | — |   | 5,776 |   |
|                                                     |            |           |            |              |            |  |  |  |  |  |  |  |  |

 

Commitments to make loans are generally made forperiods of one year or less. The fixed rate loan commitments have interestrates ranging from 4.31% to 9.00% and maturities ranging from three months tosix years.

 

## **Commitments to extend credit are agreements to lend to acustomer 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 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 extensionof credit, is based on management’s credit evaluation. Collateral held variesbut may include accounts receivable, inventory, property, plant and equipment,and income-producing commercial properties.**

## ** **

Standby letters of credit are conditionalcommitments issued by the Bank to guarantee the performance of a customer to athird party. 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 or less ofthe original commitment date. The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loan facilities tocustomers.

 

The Bank primarily serves customers located inMiddle Tennessee. As such, the Bank’s loans, commitments and letters of credithave been granted to customers in that area. Concentration of credit by type ofloan is presented in Note 3.

 

## **NOTE 10 – EMPLOYEE BENEFITS**

## ** **

The Bank maintains a 401(k) plan for allemployees who have satisfied the minimum age and service requirements. The Bankmay make discretionary contributions and employees vest in employercontributions over five years. The Bank made no contributions to the planduring 2007, 2006 or 2005.

 

**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 items ascalculated under regulatory accounting practices. Failure to meet minimumcapital requirements 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, 2007 and 2006,the most recent notification from the Bank’s regulatory authority categorizedthe Corporation 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.

 

F-22

----

 

The Bank and the Corporation’s capital amounts andratios at December 31, 2007 and 2006 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** | ** ** |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 2007                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based                     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 86,935     |                       | 10.5       | %                          | $          | 66,204                     |       | 8.0                        | %          | $ | 82,755 |   | 10.0 | % |
| Corporation                          |       | $          | 81,133     |                       | 9.8        | %                          | $          | 66,240                     |       | 8.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 to risk-based                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 76,614     |                       | 9.3        | %                          | $          | 33,102                     |       | 4.0                        | %          | $ | 49,653 |   | 6.0 | % |
| Corporation                          |       | $          | 70,812     |                       | 8.6        | %                          | $          | 33,120                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 leverage                      |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 76,614     |                       | 8.8        | %                          | $          | 35,019                     |       | 4.0                        | %          | $ | 43,774 |   | 5.0 | % |
| Corporation                          |       | $          | 70,812     |                       | 8.1        | %                          | $          | 35,029                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 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 |   |   |   |

 

**NOTE 12 – STOCK OPTIONS**

 

The following is a summaryof certain rights and provisions of the stock options the Corporation hasissued. All stock options and the related strike price reflect the impact ofthe two-for-one stock split on December 31, 2003. All options expire tenyears from the date of grant.

 

The original 14incorporators 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, 2006 and 2007 10,000, 11,000 and 65,900 options,respectively, were exercised, leaving 35,600 options to purchase sharesoutstanding.

 

In August 2003, theBoard of Directors approved an option plan for active directors and incorporatorsin recognition of their four years of service to the Bank without compensation.An aggregate of 320,000 options to purchase shares at a price of $10.50 pershare were included in this plan. The 320,000 options were immediately vestedon the date of grant. In 2006 and 2007, 50,000 and 60,000 options,respectively, were exercised, leaving 210,000 options to purchase sharesoutstanding.

 

In 2006, 1,000 options wereexercised and in 2007, 93,372 options were exercised leaving an outstandingbalance of 121,720 options to purchase shares. In August 2005, oneexecutive 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 were exercised in 2007, leaving no options outstandingat December 31, 2007. In June 2007, four executive officers weregranted 50,000 options each at an exercise price of $25.00 per share to vestover five years based 20% on service and 80% on performance. Of these, 200,000options were outstanding with 40,000 options vested at December 31, 2007.

 

F-23

----

 

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. An aggregate of 5,000 options to purchase shares havebeen forfeited by former employees, 3,000 options were exercised on December 31,2003, and 1,000 options were exercised in 2004. An additional 2,000 optionswere exercised in 2007 leaving 2,000 outstanding at December 31, 2007. In March 2003,9,000 options to purchase shares at $7.50 per share were granted. In 2007,4,000 of these options were exercised leaving 5,000 options outstanding at December 31,2007. In December 2003, 31,000 options to purchase shares at $10.50 pershare were granted. Of these, 5,000 options were forfeited in 2004. In 2006,1,000 options were exercised and in 2007, 12,000 options were exercised,leaving 13,000 options outstanding at December 31, 2007. All of theseincentive options vested in two years. In July 2005 and August 2005,69,000 and 10,000 options respectively were granted. On each grant date, halfof all options immediately vested with the remaining options vesting one yearlater. In November 2005, 10,000 options were granted to employees and wereimmediately vested. Of these 2005 grants, 3,750 options were forfeited in 2006and in 2007, 24,000 options were exercised, leaving 61,250 options outstandingat December 31, 2007.

 

The fair value options granted during 2007 werecomputed using option pricing models, using the following weighted-averageassumptions as of grant date:

 
|                    | ** ** | **2007**  | ** ** |
|-------------------------|------------|-----------|------------|
|                    |       |      |       |
| Risk-free interest rate |       | 4.94      | %          |
| Expected option life    |       | 3.5 years |       |
| Dividend  yield         |       | 0.0       | %          |
| Volatility              |       | 20.0      | %          |

 

The weighted average fair value of options grantedduring the year was $5.75 for 2007.

 

Asummary of the activity related to stock options is as follows:

 
|                             | ** ** | **2007**   | ** ** | **2006**     | ** ** | **2005**   | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                             |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding at beginning of year |       | 871,092    |       | $            | 8.78       |       | 937,842    |   | $ | 8.85 |   | 837,592 |   | $ | 7.99 |   |
| Granted                          |       | 200,000    |       | 25.00        |       | —     |       | — |   | 100,250 |   | 16.00 |   |
| Exercised                        |       | (272,522   | )          | 7.91         |       | (63,000    | )          | 9.45 |   | — |   | — |   |
| Forfeited or expired             |       | —     |       | —       |       | (3,750     | )          | 16.00 |   | — |   | — |   |
|                             |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding at end of year  |       | 798,570    |       | $            | 13.14      |       | 871,092    |   | $ | 8.78 |   | 937,842 |   | $ | 8.85 |   |
|                             |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  exercisable at year-end |       | 638,570    |       |         |       | 871,092    |       |   |   | 865,842 |   |   |   |

 

At December 31, 2007, options outstanding had aweighted average remaining contractual term of 5.81 years and an aggregateintrinsic value of $9,894,282. At December 31, 2007, options exercisablehad a weighted average remaining contractual term of 4.89 years and anaggregate intrinsic value of $10,300,134. During the years ended December 31,2007, 2006 and 2005, the aggregate intrinsic value of options exercised underour stock option plans was $5,404,895, $667,500 and $0, respectively. As of December 31,2007, there was $86,188 unrecognized compensation costs related to nonvestedstock options granted. This cost is expected to be recognized over a weightedaverage period of four years. Of the 200,000 shares granted in 2007, none wereforfeited or exercised, and only 40,000 vested, leaving 160,000 shares unvestedas of December 31, 2007.  Therespected weighted average fair values were $230,000 and $920,000.

 

F-24

----

 

Options outstanding at year-end 2007 were asfollows:

 
| ** **              | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|-------------------------|------------|-----------------|------------|-----------------|------------|
| ** **              | ** ** | ** **      | ** ** | **Weighted**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **              | ** ** | ** **      | ** ** | **Average**     | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **              | ** ** | ** **      | ** ** | **Remaining**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Exercise**            | ** ** | ** **      | ** ** | **Contractual** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| **Prices**              | ** ** | **Number**      | ** ** | **Life**        | ** ** | **Number** | ** ** | **Price** | ** ** |
|                    |       |            |       |            |       |   |   |   |   |
| $5.00                   |       | 159,320         |       | 2.0 years       |       | 159,320 |   | $ | 5.00 |   |
| $7.50                   |       | 95,000          |       | 5.0 years       |       | 95,000 |   | $ | 7.50 |   |
| $10.50                  |       | 223,000         |       | 5.0 years       |       | 223,000 |   | $ | 10.50 |   |
| $11.00                  |       | 60,000          |       | 6.0 years       |       | 60,000 |   | $ | 11.00 |   |
| $16.00                  |       | 61,250          |       | 7.8 years       |       | 61,250 |   | $ | 16.00 |   |
| $25.00                  |       | 200,000         |       | 9.5 years       |       | 40,000 |   | $ | 25.00 |   |
|                    |       |            |       |            |       |   |   |   |   |
| Outstanding at year-end |       | 798,570         |       | 5.81 years      |       | 638,570 |   | $ | 10.16 |   |

 

**NOTE 13 – FAIR VALUES OF FINANCIALINSTRUMENTS**

 

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 infrequentre-pricing or re-pricing 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, 2007 and 2006 were as follows:

 
| ** **                               | ** ** | **2007**     | ** ** | **2006**  | ** ** |
|------------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                               | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(Dollars in thousands)**     | ** ** | **Amount**   | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets                         |       |         |       |      |       |   |   |   |   |
| Cash and due from financial institutions |       | $            | 5,236      |      | $          | 5,236 |   | $ | 177 |   | $ | 177 |   |
| Federal funds sold                       |       | 9,573        |       | 9,573     |       | 13,820 |   | 13,820 |   |
| Securities available for sale            |       | 73,753       |       | 73,753    |       | 56,943 |   | 56,943 |   |
| Loans, net                               |       | 784,001      |       | 799,545   |       | 538,550 |   | 537,756 |   |
| Accrued interest receivable              |       | 5,901        |       | 5,901     |       | 4,116 |   | 4,116 |   |
| Restricted equity securities             |       | 938          |       | 938       |       | 633 |   | 633 |   |
| Financial liabilities                    |       |         |       |      |       |   |   |   |   |
| Deposits                                 |       | $            | 815,053    |      | $          | 828,176 |   | $ | 560,567 |   | $ | 562,175 |   |
| Accrued interest payable                 |       | 2,292        |       | 2,292     |       | 1,728 |   | 1,728 |   |
| Subordinated  long-term debt             |       | 8,248        |       | 8,221     |       | 8,248 |   | 8,066 |   |
| Short-term  borrowings                   |       | 7,000        |       | 7,000     |       | — |   | — |   |

 

F-25

----

 

**NOTE 14 –EMPLOYMENT AGREEMENTS**

 

The Corporation has entered into two-year employmentagreements that are automatically renewable for indefinite duration, with fourexecutive officers. In the event of a change in control of the Corporation, theCorporation has an obligation to pay 2.99 times the officer’s annual salary andbonus which combined is not to be less than the previous year’s salary andbonus.

 

**NOTE 15 – PREFERRED STOCK**

 

The Corporation’s charter authorizes 1,000,000shares of preferred stock, no par value. Shares of the preferred stock may beissued from time to time in one or more series, each such series to be sodesignated as to distinguish the shares from the shares of all other series andclasses. The Board of Directors has the authority to divide any or all classesof preferred 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.

 

**NOTE 16 – PARENT COMPANY ONLY CONDENSEDFINANCIAL INFORMATION**

 

Condensed financial information of TennesseeCommerce Bancorp, Inc. follows:

 

**CONDENSED BALANCE SHEETS**

 
| ** **                           | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)** | ** ** | **2007**              | ** ** | **2006** | ** ** |
| ASSETS                               |       |                  |       |   |   |
| Cash and cash equivalents            |       | $                     | 777        |   | $ | 6,308 |   |
| Investment in banking subsidiary     |       | 76,923                |       | 52,260 |   |
| Interest receivable                  |       | —                |       | 1 |   |
| Other                                |       | 944                   |       | 1,204 |   |
|                                 |       |                  |       |   |   |
| Total assets                         |       | $                     | 78,644     |   | $ | 59,773 |   |
|                                 |       |                  |       |   |   |
| LIABILITIES AND EQUITY               |       |                  |       |   |   |
| Interest payable                     |       | $                     | 25         |   | $ | 23 |   |
| Other short term payables            |       | 7,250                 |       | 278 |   |
| Subordinated long term debt          |       | 8,248                 |       | 8,248 |   |
| Shareholders’ equity            |       | 63,121                |       | 51,224 |   |
|                                 |       |                  |       |   |   |
| Total  liabilities and equity        |       | $                     | 78,644     |   | $ | 59,773 |   |

 

**CONDENSED STATEMENTS OF INCOME**

 
| ** **                                                           | ** ** | **For Years ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **2005** | ** ** |
|                                                                 |       |                                                 |       |   |   |   |   |
| Dividend and interest income                                         |       | $                                                    | 17         |   | $ | 17 |   | 12 |   |
| Interest expense                                                     |       | (632                                                 | )          | (597 | ) | (416 | ) |
| Non-interest expense                                                 |       | (1,261                                               | )          | (826 | ) | (46 | ) |
|                                                                 |       |                                                 |       |   |   |   |   |
| Income (loss) before income tax and undistributed  subsidiary income |       | (1,876                                               | )          | (1,406 | ) | (450 | ) |
| Income tax (expense) benefit                                         |       | 696                                                  |       | 542 |   | 173 |   |
| Equity in undistributed subsidiary income                            |       | 8,076                                                |       | 5,613 |   | 3,344 |   |
|                                                                 |       |                                                 |       |   |   |   |   |
| Net income                                                           |       | $                                                    | 6,896      |   | $ | 4,749 |   | $ | 3,067 |   |
|                                                                      |            |                                                      |            |  |  |  |  |  |  |  |

 

F-26

----

 

**CONDENSEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                      | ** ** | **For Years ended December 31,** | ** ** |     |
|-----------------------------------------------------------------|------------|------------------------------------------------------|------------|----------|
| ** **                                                      | ** ** | **2007**                                             | ** ** | **2006** | ** ** | **2005** | ** ** |   |
| Cash flows from operating activities                            |       |                                                 |       |     |   |   |   |   |
| Net income                                                      |       | $                                                    | 6,896      |     | $ | 4,749 |   | $ | 3,067 |   |   |
| Adjustments:                                                    |       |                                                 |       |     |   |   |   |   |
| Change in other assets and liabilities                          |       | 234                                                  |       | (507     | ) | (150 | ) |   |
| Equity in undistributed subsidiary income                       |       | (8,076                                               | )          | (5,613   | ) | (3,344 | ) |   |
| Net cash from operating activities                              |       | (946                                                 | )          | (1,371   | ) | (427 | ) |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Cash flows from investing activities                            |       |                                                 |       |     |   |   |   |   |
| Investments in subsidiaries                                     |       | (15,990                                              | )          | (13,000  | ) | (7,000 | ) |   |
| Other assets                                                    |       | —                                               |       | —   |   | (248 | ) |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Net cash from investing activities                              |       | (15,990                                              | )          | (13,000  | ) | (7,248 | ) |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Cash flows from financing activities                            |       |                                                 |       |     |   |   |   |   |
| Proceeds from subordinated long term debt                       |       | —                                               |       | —   |   | 8,248 |   |   |
| Proceeds from stock issue                                       |       | —                                               |       | 19,027   |   | — |   |   |
| Proceeds from exercise of stock options and excess  tax benefit |       | 4,405                                                |       | 852      |   | — |   |   |
| Proceeds from issuance of short-term debt                       |       | 7,000                                                |       | —   |   | — |   |   |
| Net cash from financing activities                              |       | 11,405                                               |       | 19,879   |   | 8,248 |   |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Net change in cash and cash equivalents                         |       | (5,531                                               | )     | 5,508    |   | 573 |   |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Beginning cash and cash equivalents                             |       | 6,308                                                |       | 800      |   | 227 |   |   |
|                                                            |       |                                                 |       |     |   |   |   |   |
| Ending  cash and cash equivalents                               |       | $                                                    |  777  |     | $ | 6,308 |   | $ | 800 |   |
|                                                                 |            |                                                      |            |          |  |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 17 – EARNINGS PER SHARE**

 

The factors used in the earnings per sharecomputation follow:

 
| **(Dollars in thousands except share data)**           | ** ** | **2007**  | ** **  | **2006**  | ** ** | **2005**  | ** ** |
|---------------------------------------------------------------------------------|------------|-----------|-------------|-----------|------------|-----------|------------|
| Basic                                                                           |       |      |        |      |       |      |       |
| Net income                                                                      |       | $         |  6,896 |      | $          | 4,749     |       | $ |  3,067 |   |
|                                                                            |       |      |        |      |       |      |       |
| Weighted average common shares outstanding                                      |       | 4,613,342 |        | 3,822,655 |       | 3,238,674 |       |
|                                                                            |       |      |        |      |       |      |       |
| Basic earnings per common share                                                 |       | $         |  1.49  |      | $          | 1.24      |       | $ |  0.95 |   |
|                                                                            |       |      |        |      |       |      |       |
| Diluted                                                                         |       |      |        |      |       |      |       |
| Net income                                                                      |       | $         |  6,896 |      | $          | 4,749     |       | $ |  3,067 |   |
|                                                                            |       |      |        |      |       |      |       |
| Weighted average common shares outstanding for  basic earnings per common share |       | 4,613,342 |        | 3,822,655 |       | 3,238,674 |       |
| Add: Dilutive effects of assumed exercises of  stock options                    |       | 278,825   |        | 334,683   |       | 278,734   |       |
|                                                                            |       |      |        |      |       |      |       |
| Average shares and dilutive potential common  shares                            |       | 4,892,167 |        | 4,157,338 |       | 3,517,408 |       |
|                                                                            |       |      |        |      |       |      |       |
| Diluted earnings per common share                                               |       | $         |  1.41  |      | $          | 1.14      |       | $ |  0.87 |   |

 

F-27

----

 

No options were antidilutive for 2006 and 2005. For2007, 40,000 vested options at a strike price of $25.00 were antidilutive andwere excluded from the calculation of diluted earnings per share.

 

**NOTE 18 – TRUST PREFERREDSECURITIES**

 

In March 2005, the Corporation formed afinancing subsidiary, Tennessee Commerce Statutory Trust I, a Delawarestatutory trust (the “Trust”). In March 2005, the Trust issued and sold8,000 of the Trust’s fixed/floating rate capital securities, with a liquidationamount of $1,000 per capital security, to First Tennessee Bank NationalAssociation. The securities pay a fixed rate of 6.73% payable quarterly for thefirst five years and a floating rate based on a 3- month Libor rate plus 1.98%thereafter. At the same time, the Corporation issued to the Trust $8,248,000 offixed/floating rate junior subordinated deferrable interest debentures due2035. The Corporation guarantees the payment of distributions and payments forredemptions or liquidation of the capital securities. The Trust PreferredSecurities qualify as “Tier I Capital” under current regulatory definitionssubject to certain limitations.

 

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 (five years). The capital securities anddebentures are redeemable at any time commencing after June 2010 at par.The Corporation reports as liabilities the subordinated debentures issued bythe Corporation and held by the Trust.

 

**NOTE 19 – QUARTERLY FINANCIALRESULTS (UNAUDITED)**

 

A summary of selected consolidated quarterlyfinancial data for the years ended December 31, 2007 and 2006 follows:

 
| ** **                                               | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(In thousands except share data)** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| 2007                                                     |       |        |       |        |       |        |       |        |       |
| Interest income                                          |       | $           | 12,971     |        | $          | 14,852      |       | $           | 16,371     |   | $ | 18,012 |   |
| Net interest income                                      |       | 5,585       |       | 6,646       |       | 7,090       |       | 7,951       |       |
| Provision for loan losses                                |       | 1,500       |       | 1,500       |       | 1,300       |       | 2,050       |       |
| Income before taxes                                      |       | 2,292       |       | 2,659       |       | 2,893       |       | 2,695       |       |
| Net income                                               |       | 1,406       |       | 1,611       |       | 1,777       |       | 2,102       |       |
| Basic earnings per share                                 |       | $           | 0.31       |        | $          | 0.36        |       | $           | 0.38       |   | $ | 0.44 |   |
| Diluted earnings per share                               |       | $           | 0.29       |        | $          | 0.34        |       | $           | 0.36       |   | $ | 0.42 |   |
|                                                     |       |        |       |        |       |        |       |        |       |
| 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                                 |       | $           | 0.28       |        | $          | 0.29        |       | $           | 0.31       |   | $ | 0.36 |   |
| Diluted earnings per share                               |       | $           | 0.25       |        | $          | 0.27        |       | $           | 0.29       |   | $ | 0.33 |   |

 

F-28

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**SIGNATURES**

 

Pursuant to the requirements of Section 13or 15(d) of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 
|   | TENNESSEE  COMMERCE BANCORP, INC.                       |                |
|--------|---------------------------------------------------------|---------------------|
|   |                                                    |                |
|   | By:                                                     | /s/  Arthur F. Helf |   |
|   | Arthur  F. Helf, Chairman and Chief Executive Officer   |                |
|   |                                                    |                |
|   | Date:     April 17,  2008 |                |
|        |                                                         |                     |  |

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, this report has been signed below by thefollowing persons on behalf of the registrant in their capacities as directors.

 
| By:    | /s/  H. Lamar Cox            |   | By:                  |  /s/ Paul W. Dierksen |
|--------|------------------------------|--------|----------------------|----------------------------|
|   | H.  Lamar Cox                |   | Paul  W. Dierksen    |
| Date:  | April 17,  2008         | Date:  | April 17,  2008 |
|   |                         |   |                 |
|   |                         |   |                 |
| By:    | /s/  Dennis L. Grimaud       |   | By:                  |  /s/ Arthur F. Helf   |
|   | Dennis  L. Grimaud           |   | Arthur  F. Helf      |
| Date:  | April 17,  2008         | Date:  | April 17,  2008 |
|   |                         |   |                 |
|   |                         |   |                 |
| By:    | /s/  William W. McInnes      |   | By:                  |  /s/ Thomas R. Miller |
|   | William  W. McInnes          |   | Thomas  R. Miller    |
| Date:  | April 17,  2008         | Date:  | April 17,  2008 |
|   |                         |   |                 |
|   |                         |   |                 |
| By:    | /s/  Darrel Reifschneider    |   | By:                  |  /s/ Michael R. Sapp  |
|   | Darrel  Reifschneider        |   | Michael  R. Sapp     |
| Date:  | April 17,  2008         | Date:  | April 17,  2008 |
|   |                         |   |                 |
|   |                         |   |                 |
| By:    | /s/  Dr. Paul A. Thomas |   |                 |                       |
|   | Dr. Paul  A. Thomas     |   |                 |
| Date:  | April 17,  2008         |   |                 |
|        |                              |        |                      |                            |  |  |

 

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**INDEX TO EXHIBITS**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                    |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                               |
| 3.1                  |       | Charter  of Tennessee Commerce Bancorp, Inc., as amended(1)                                                                                   |
| 3.2                  |       | Articles  of Amendment to the Charter of Tennessee Commerce Bancorp, Inc.                                                                     |
| 3.3                  |       | Bylaws  of Tennessee Commerce Bancorp, Inc.(1)                                                                                                |
| 3.4                  |       | Amendment  to Bylaws of Tennessee Commerce Bancorp, Inc.(2)                                                                                   |
| 4.1                  |       | Shareholders’  Agreement(1)                                                                                                                   |
| 4.2                  |       | Form of  Stock Certificate(3)                                                                                                                 |
| 10.1                 |       | Tennessee  Commerce Bancorp, Inc. Stock Option Plan - Employees(1)                                                                            |
| 10.2                 |       | Form of  Tennessee Commerce Bancorp, Inc. – Director’s Common Stock Option(1)                                                  |
| 10.3                 |       | Form of  Tennessee Commerce Bancorp, Inc. – Incorporator’s Common Stock Option(1)                                              |
| 10.4                 |       | Form of  Tennessee Commerce Bancorp, Inc. - Stock Option Agreement(1)                                                                    |
| 10.5                 |       | Tennessee  Commerce Bancorp, Inc. - Stock Option Agreement with Arthur F. Helf(1)                                                             |
| 10.6                 |       | Tennessee  Commerce Bancorp, Inc. - Stock Option Agreement with Michael R. Sapp(1)                                                            |
| 10.7                 |       | Tennessee  Commerce Bancorp, Inc. 1999 Stock Option Agreement with H. Lamar Cox(1)                                                            |
| 10.8                 |       | Employment  Agreement between Tennessee Commerce Bancorp, Inc. and Arthur F. Helf(1)                                                          |
| 10.9                 |       | Employment  Agreement between Tennessee Commerce Bancorp, Inc. and Michael R.  Sapp(1)                                                        |
|  10.10          |       | Employment  Agreement between Tennessee Commerce Bancorp, Inc. and H. Lamar Cox(1)                                                            |
|  10.11          |       | Employment  Agreement between Tennessee Commerce Bancorp, Inc. and George W. Fort(4)                                                          |
|  10.12          |       | Tennessee  Commerce Bancorp, Inc. 2007 Equity Plan(5)                                                                                         |
|  10.13          |       | Summary  of Tennessee commerce Bancorp, Inc. Executive Officer Compensation(6)                                                                |
|  21.1           |       | Subsidiaries                                                                                                                                       |
|  23.1           |       | Report  of Independent Registered Public Accounting Firm                                                                                           |
|  31.1           |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
|  31.2           |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002 |
|  32.1           |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |
|  32.2           |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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(1)   Previously filed as an exhibit to TennesseeCommerce Bancorp, Inc.’s Registration Statement on Form 10, as filedwith the Securities and Exchange Commission on April 29, 2005, andincorporated herein by reference.

 

(2)   Previously filed as an exhibit to TennesseeCommerce Bancorp, Inc.’s Current Report on Form 8-K, as filed withthe Securities and Exchange Commission on February 5, 2008, andincorporated herein by reference.

 

(3)   Previously filed as an exhibit to TennesseeCommerce Bancorp, Inc.’s Registration Statement on Form S-8, as filedwith the Securities and Exchange Commission on December 31, 2007(Registration No. 333-148415), and incorporated herein by reference.

 

(4)   Previously filed as an exhibit to TennesseeCommerce Bancorp, Inc.’s Registration Statement on Form S-1, as filedwith the Securities and Exchange Commission on April 25, 2006(Registration No. 333-148415), and incorporated herein by reference.

 

(5)   Previously filed as an exhibit to TennesseeCommerce Bancorp, Inc.’s Quarterly Report on Form 10-Q, as filed withthe Securities and Exchange Commission on August 14, 2007, andincorporated herein by reference.

 

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(6)    Previously filed as an exhibit to Tennessee Commerce Bancorp, Inc.’sCurrent Report on  Form 8-K, asfiled with the Securities and Exchange Commission on June 26, 2007, andincorporated herein by reference.

 

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