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**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM 10-K**

 

**(MarkOne)**

 

| x      | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF  THE SECURITIES EXCHANGE ACT OF 1934**               |
|--------|------------|---------------------------------------------------------------------------------------------------------|
|   | ** ** | **For the fiscal year ended December 31, 2008**                                                    |
|   | ** ** |                                                                                                    |
|   | ** ** | **OR**                                                                                                  |
|   | ** ** |                                                                                                    |
| o      | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR  15(D) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For thetransition period from                    to                   .**

 

**Commissionfile number 000-51281**

 

**Tennessee Commerce Bancorp, Inc.**

(Exact name ofregistrant as specified in its charter)

 

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

 

Registrant’s telephonenumber, including area code**(615) 599-2274**

 

Securities registeredpursuant 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)         |

 

Securities registered pursuant to Section 12(g) of the Act:

 

 

(Title of eachclass)

 

Indicate by check mark ifthe registrant is a well-known, seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes  o   No  x

 

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yes  o   No  x

 

Indicate by check markwhether registrant (1) has filed reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.  Yes   x   No   o

 

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K is notcontained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

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

(Do not check if asmaller reporting company)

 

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

 

The aggregate marketvalue of the registrant’s voting stock held by non-affiliates of the registrantat June 30, 2008 was $65.8 million, based upon the average sale price onthat date.

 

As of March 14,2009, there were 4,731,696 shares of the registrant’s common stock outstanding.

 

Documents Incorporated by Reference:

 

Part III informationis incorporated herein by reference, pursuant to Instruction G of Form 10-K,to registrant’s Definitive Proxy Statement for its 2009 Annual Meeting ofshareholders to be held on May 19, 2009, which will be filed with theCommission no later than April 29, 2009 (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                                                                                                        | 11     |
| ITEM 1B.          |   | UNRESOLVED  STAFF COMMENTS                                                                                          | 17     |
| ITEM 2.           |   | PROPERTIES                                                                                                          | 17     |
| ITEM 3.           |   | LEGAL PROCEEDINGS                                                                                                   | 17     |
| ITEM 4.           |   | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                | 17     |
|              |   |                                                                                                                |   |
| **PART II**  |   |                                                                                                                |   |
|              |   |                                                                                                                |   |
| ITEM 5.           |   | MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES | 18     |
| ITEM 6.           |   | SELECTED FINANCIAL  DATA                                                                                            | 19     |
| ITEM 7.           |   | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION                          | 20     |
| ITEM 7A.          |   | QUANTITATIVE AND QUALITATIVE  DISCLOSURES ABOUT MARKET RISK                                                         | 40     |
| ITEM 8.           |   | FINANCIAL STATEMENTS AND SUPPLEMENTARY  DATA                                                                        | 42     |
| ITEM 9.           |   | CHANGES IN AND DISAGREEMENTS WITH  ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE                               | 42     |
| ITEM 9A.          |   | CONTROLS AND PROCEDURES                                                                                             | 42     |
| ITEM 9B.          |   | OTHER INFORMATION                                                                                                   | 43     |
|              |   |                                                                                                                |   |
| **PART III** |   |                                                                                                                |   |
|              |   |                                                                                                                |   |
| ITEM 10.          |   | DIRECTORS, EXECUTIVE OFFICERS AND  CORPORATE GOVERNANCE                                                             | 43     |
| ITEM 11.          |   | EXECUTIVE COMPENSATION                                                                                              | 43     |
| ITEM 12.          |   | SECURITY OWNERSHIP OF CERTAIN  BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS                     | 44     |
| ITEM 13.          |   | CERTAIN RELATIONSHIPS AND RELATED  TRANSACTIONS, AND DIRECTOR INDEPENDENCE                                          | 44     |
| ITEM 14.          |   | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                              | 44     |
|              |   |                                                                                                                |   |
| **PART IV**  |   |                                                                                                                |   |
|              |   |                                                                                                                |   |
| ITEM 15.          |   | EXHIBITS AND  FINANCIAL STATEMENT SCHEDULES                                                                         | 45     |

 

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**PART I**

 

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

 

**General**

 

TennesseeCommerce Bancorp, Inc. (the “Corporation” or “we” or “us”) is a bankholding company formed as a Tennessee corporation to own the shares ofTennessee 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, 2008 of $1.2 billion.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.

 

TheBank does not compete based on the traditional definition of “convenience” anddoes not have a branch network for that purpose. Business is conducted from asingle 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.

 

TheBank offers a full range of competitive retail and commercial bankingservices.  The deposit services offered include various types of checkingaccounts, savings accounts, money market investment accounts, certificates ofdeposits and retirement accounts.  Lending services include consumerinstallment loans, various types of mortgage loans, personal lines of credit,home equity loans, credit cards, real estate construction loans, commercialloans to small-and-medium size businesses and professionals, and letters ofcredit. The Bank issues VISA credit cards and is a merchant depository forcardholder drafts under VISA credit cards.  The Bank also offers checkcards and debit cards.  The Bank offers its local customers courierservices, access to third-party ATMs and state of the art electronic banking.The Bank has trust powers but does not have a trust department.

 

TheBusiness Bank strategy is evident in differences between the financialstatements of the Bank and more traditional financial institutions.  The Business Bank model creates a high degree of leverage.  Byavoiding the investment and maintenance costs of a typical branch network, theBank is able to maintain earning assets at a higher level than peerinstitutions.  Management targets a minimum earning asset ratio of 97%compared to the average of 85%, as of September 30, 2008, for all banksinsured by the Federal Deposit Insurance Corporation (“FDIC”). Assets of theBank are centered in the loan portfolio which consists primarily of commercialand industrial loans.  Management targets a loan mix of 60% commercialloans and 40% real estate.  At December 31, 2008, the composition ofthe $1.04 billion loan portfolio was 56.86% commercial, 37.68% secured by realestate (both commercial and consumer) and 5.46% in consumer and credit cardloans.

 

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Inaddition to lending in the local marketplace, the Bank generates assets in thenational market by providing collateral-based loans to business borrowerslocated in other states through two types of indirect funding programs. In bothprograms, 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 31.06% of the total loanportfolio at December 31, 2008.

 

Thetwo national market funding programs fund different size loans through twodifferent networks. In the first type, the Bank uses an established network offinancial service companies and vendor partners that provide the Bank fundingopportunities to national middle-market and investment grade companies. At December 31,2008, the average size of this type of loan in the loan portfolio wasapproximately $322,000 and earned an average yield of 7.60%. Funding under thisprogram represents approximately 14.33% of the $1.04 billion total loanportfolio.  In the second program, the Bank partners with a second networkof financial service companies and vendors located in Tennessee, Alabama,Georgia, California and Michigan. This program is for smaller transactions.These loans that finance business assets are less than $125,000 at origination.Management has installed a standardized credit approval process that deliversquick responsive service. At December 31, 2008, the average size of thistype of loan in the loan portfolio was approximately $46,000, and the averageyield on these loans was 8.05%. Funding under this program represents 16.94% ofthe $1.04 billion total loan portfolio.

 

Managementbelieves the Business Bank model is highly efficient.  The Bank targetsthe non-retail sector of the commercial market, which is characterized by lowerlevels of transactions and processing costs.  The commercial customer mixand the strategic outsourcing of certain administrative functions, such as dataprocessing, allow the Bank to operate with a smaller, more highly trainedstaff.  Management targets an average asset per employee ratio of $7.5million compared to the average of less than $4.50 million in assets per employeefor Tennessee state-chartered banks at the end of September 30, 2008, asreported by the FDIC. The Bank also promotes the use of technology, bothinternally and externally, to maximize the efficiency of operations. Management targets an operating efficiency ratio (total operating expensedivided by total revenue) of 40% to 45%.

 

TheBank is subject to the regulatory authority of the Department of FinancialInstitutions of the State of Tennessee (“TDFI”) and the FDIC.

 

TheBank’s principal executive offices are located at 381 Mallory Station Road, Suite 207,Franklin, Tennessee 37067, and its telephone number is (615) 599-2274.

 

TheCorporation was 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 Corporation’sactivities are subject to the supervision of the Board of Governors of theFederal Reserve System (“Federal Reserve Board”).  The Corporation’soffices are the same as the principal office of the Bank.  On March 29,2005, the Corporation formed a wholly owned subsidiary, Tennessee Commerce BankStatutory Trust I (the “Trust I”).  In June 2008, the Corporationformed a wholly owned subsidiary, Tennessee Commerce Bank Statutory Trust II(the “Trust II”) and in July 2008, the Corporation formed a wholly ownedsubsidiary, TCB Commercial Asset Services, Inc (“TCB”). As of December 31,2008, the Bank, the Trust I, the Trust II and TCB were the only subsidiaries ofthe Corporation. The accompanying consolidated financial statements include theaccounts of the Corporation, the Bank and TCB. The Trust I and the Trust II arenot consolidated in accordance with Financial Accounting Standards Board (“FASB”)Interpretation No. 46(R) (revised December 2003), “Consolidationof Variable Interest Entities.” Material intercompany accounts and transactionshave been eliminated. The Bank commenced operations as a Tennessee statechartered bank on January 14, 2000, and is headquartered in Franklin,Tennessee.

 

**Corporation Overview**

 

The Corporation,headquartered in Franklin, Tennessee, is the bank holding company for theBank.  Organized in January 2000, the Bank has a focused strategythat serves the banking needs of small to medium-sized businesses,entrepreneurs and professionals in the Nashville metropolitan statistical area,or the Nashville MSA, as well as the funding needs of certain national andregional equipment vendors and financial services companies.  TheCorporation calls this strategy its Business Bank strategy. The Corporationprimarily conducts business from a single location in the Cool Springscommercial area of Franklin, Tennessee, 15 miles south of Nashville. TheCorporation also operates three loan production offices - one in each ofBirmingham, Alabama, Minneapolis, Minnesota and Atlanta, Georgia, the lattertwo of which were opened in April and May 2008, respectively. Each ofthe two new offices is staffed with one senior lending officer.

 

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The Corporation offers afull range of competitive retail and commercial banking services to localcustomers in the Nashville MSA.  The Corporation’s deposit servicesinclude a broad offering of checking accounts, savings accounts, money marketinvestment accounts, certificates of deposits and retirement accounts. Lending services include consumer installment loans, various types of mortgageloans, personal lines of credit, home equity loans, credit cards, real estateconstruction loans, commercial loans to small and medium-sized businesses andprofessionals, and letters of credit. The Corporation issues VISA credit cardsand is a merchant depository for cardholder drafts under VISA creditcards.  The Corporation also offers check cards and debit cards and offersits local customers free courier services, access to third-party automatedteller machines, or ATMs, and state-of-the-art electronic banking. TheCorporation has trust powers but does not have a trust department.

 

**Employees**

 

At December 31,2008, the Corporation employed no persons and the Bank employed 83 persons on afull-time basis. The Bank’s employees are not represented by any union or othercollective bargaining agreement and management of the Bank believes itsemployee relations are satisfactory.

 

**Supervision and Regulation**

 

**Bank Holding Company Regulation**

 

TheCorporation is a bank holding company within the meaning of the Bank HoldingCompany Act of 1956, as amended (the “Holding Company Act”), and is registeredwith the Federal Reserve Board. The Corporation’s banking subsidiary issubject to restrictions under federal law which limit the transfer of funds bythe Bank to the Corporation, whether in the form of loans, extensions ofcredit, investments or asset purchases. Such transfers by any subsidiarybank to its holding company or any non-banking subsidiary are limited in amountto 10% of the subsidiary bank’s capital and surplus and, with respect to 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 abank holding company, the Corporation is 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 the Corporation at its discretion.

 

Accordingto Federal Reserve Board policy, bank holding companies are expected to act asa source of financial strength to each subsidiary bank and to commit resourcesto support each such subsidiary.  This support may be required at timeswhen a bank holding company may not be able to provide such support. Furthermore, in the event of a loss suffered or anticipated by the FDIC —either as a result of default of the Bank or related to FDIC assistanceprovided to a subsidiary in danger of default — the Bank may be assessed forthe FDIC’s loss, subject to certain exceptions.

 

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Variousfederal and state statutory provisions limit the amount of dividends thesubsidiary banks can pay to their holding companies without regulatoryapproval.  The payment of dividends by any bank also may be affected byother factors, such as the maintenance of adequate capital for such subsidiarybank.  In addition to the foregoing restrictions, the Federal ReserveBoard has the power to prohibit dividends by bank holding companies if theiractions constitute unsafe or unsound practices.  The Federal Reserve Boardhas issued a policy statement on the payment of cash dividends by bank holdingcompanies, which expresses the Federal Reserve Board’s view that a bank holdingcompany experiencing earnings weaknesses should not pay cash dividends thatexceed its net income or that could only be funded in ways that weaken the bankholding 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 bankholding company and its subsidiaries are also prohibited from acquiring anyvoting shares of, or interest in, any banks located outside of the state inwhich the operations of the bank holding company’s subsidiaries are located,unless the acquisition is specifically authorized by the statutes of the statein which the target is located.  Further, a bank holding company and itssubsidiaries are prohibited from engaging in certain tie-in arrangements inconnection with the extension of credit or provision of any property orservice.  Thus, an affiliate of a bank holding company may not extendcredit, lease or sell property, or furnish any services or fix or vary theconsideration for these on the condition that (i) the customer must obtainor provide some additional credit, property or services from or to its bankholding 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.

 

Inapproving acquisitions by bank holding companies of banks and companies engagedin the banking-related activities described above, the Federal Reserve Boardconsiders a number of factors, including the expected benefits to the publicsuch as greater convenience, increased competition, or gains in efficiency, asweighed against the risks of possible adverse effects such as undueconcentration of resources, decreased or unfair competition, conflicts ofinterest, or unsound banking practices.  The Federal Reserve Board is alsoempowered to differentiate between new activities and activities commencedthrough the acquisition of a going concern.

 

TheAttorney General of the United States may, within 30 days after approval by theFederal Reserve Board of an acquisition, bring an action challenging suchacquisition under the federal antitrust laws, in which case the effectivenessof such approval is stayed pending a final ruling by the courts.  Failureof the Attorney General to challenge an acquisition does not, however, exemptthe holding company from complying with both state and federal antitrust lawsafter the acquisition is consummated or immunize the acquisition from futurechallenge under the anti-monopolization provisions of the Sherman Act.

 

**Bank Regulation**

 

TheBank is a Tennessee state-chartered bank and is subject to the regulations ofand supervision by the FDIC as well as the Commissioner of the TDFI (the “Commissioner”),Tennessee’s state banking authority.  The Bank is also subject to variousrequirements and restrictions under federal and state law, including withoutlimitation restrictions on permitted activities, requirements to maintainreserves against deposits, restrictions on the types and amounts of loans thatmay be granted and the interest that may be charged thereon and limitations onthe types of investments that may be made and the types of services that may beoffered.  Various consumer laws and regulations also affect the operationsof the Bank.  In addition to the impact of regulation, commercial banksare affected significantly by the actions of the Federal Reserve Board as itattempts to control the money supply and credit availability in order toinfluence the economy.

 

TheFDIC and the Commissioner periodically conduct examinations of the Bank. If, as a result of an examination of the Bank, the FDIC determines that thefinancial condition, capital resources, asset quality, earnings prospects,management, liquidity or other aspects of the Bank’s operations areunsatisfactory or that the Bank or its management is violating or has violatedany law or regulation, various remedies are available to the FDIC.  Suchremedies include the power to enjoin “unsafe or unsound” practices, to requireaffirmative action to correct any conditions resulting from any violation orpractice, to issue an administrative order that can be judicially enforced, todirect an increase in capital, to restrict the growth of the Bank, to assesscivil monetary penalties, to remove officers and directors and ultimately toterminate a Bank’s deposit insurance.  The Commissioner has many of thesame remedial powers, including the power to take possession of a bank whosecapital becomes impaired.  As of December 31, 2008, the Bank was notthe subject of any such action by the FDIC or the Commissioner.

 

Thedeposits of the Bank are insured by the FDIC in the manner and to the extentprovided by law.  For this protection, the Bank pays a quarterly statutoryassessment.

 

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Althoughthe Bank is not a member of the Federal Reserve System, it is neverthelesssubject to certain regulations of the Federal Reserve Board.

 

Tennesseelaw contains limitations on the interest rates that may be charged on varioustypes of loans and restrictions on the nature and amount of loans that may begranted and on the types of investments that may be made.  The operationsof banks are also affected by various consumer laws and regulations, includingthose relating to equal credit opportunity and regulation of consumer lendingpractices.  All Tennessee banks must become and remain insured banks underthe Federal Deposit Insurance Act (the “FDIA”).

 

CapitalRequirements

 

TheFederal Reserve Board has risk-based capital requirements for bank holdingcompanies 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 for holdingliquid assets.  Assets and off-balance sheet items are assigned to broadrisk categories each with appropriate weights.  The resulting capitalratios represent capital as a percentage of total risk-weighted assets andoff-balance sheet items.  The guidelines require all federally regulatedbanks to maintain a minimum risk-based total capital ratio of 8%, of which atleast 4% must be Tier I Capital (as defined below).  Under the guidelines,the minimum ratio of total capital to risk-weighted assets (including certainoff-balance sheet items, such as standby letters of credit) is 8%.  To beconsidered a “well capitalized” bank or bank holding company under theguidelines, a bank or bank holding company must have a total risk based capitalratio in excess of 10% (in addition to meeting other requirements).

 

Atleast half of the total capital of a bank is to be comprised of common equity,retained earnings and a limited amount of perpetual preferred stock, aftersubtracting goodwill and certain other adjustments (“Tier I Capital”). The remainder may consist of perpetual debt, mandatory convertible debtsecurities, a limited amount of subordinated debt, other preferred stock notqualifying for Tier I Capital and a limited amount of loan loss reserves (“TierII Capital”).  Under the risk-based capital requirements, total capitalconsists of Tier I Capital, which is generally common shareholders’ equity lessgoodwill, and Tier II Capital, which is primarily a portion of the allowancefor loan losses and certain qualifying debt instruments.  In determiningrisk-based capital requirements, assets are assigned risk-weights of 0% to100%, depending primarily on the regulatory assigned levels of credit riskassociated with such assets.  Off-balance sheet items are considered inthe calculation of risk-adjusted assets through conversion factors establishedby the regulators.  The framework for calculating risk-based capitalrequires banks and bank holding companies to meet the regulatory minimums of 4%Tier I Capital and 8% total risk-based capital.

 

TheFederal Reserve Board and the FDIC have adopted a minimum leverage ratio of4%.  Generally, banking organizations are expected to operate well abovethe minimum required capital level of 4% unless they meet certain specifiedcriteria, including having the highest regulatory ratings. Most bankingorganizations are required to maintain a leverage ratio of 4%, 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 4% 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 suchinstitution would have well-diversified risk, no undue rate risk exposure,excellent asset quality, high liquidity and good earnings.  In general,the Bank would have to be considered a strong banking organization, rated inthe highest category under the bank rating system and have no significant plansfor expansion.  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 guidelinesalso provide that banking organizations experiencing internal growth or makingacquisitions will be expected to maintain strong capital positionssubstantially above the minimum supervisory levels without significant relianceupon intangible assets.  The Bank’s Tier I leverage capital ratio at December 31,2008 was 9.26%.

 

Underthe Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”),failure to meet the capital guidelines could subject a banking institution to avariety of enforcement remedies available to federal regulatory authorities,including the termination of deposit insurance by the FDIC.  Institutionsnot in compliance with the capital guidelines are expected to be operating incompliance with a capital plan or agreement with the regulator.  If theydo not do so, they are deemed to be engaging in an unsafe and unsound practiceand may be subject to enforcement action.  In addition, failure by aninstitution to maintain capital of at least 2% of assets constitutes an unsafe andunsound practice and may subject the institution to enforcement action andtermination of FDIC insurance.

 

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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, theBasel Committee issued its final framework.  The new capital framework (“BaselII”) consists of minimum capital requirements, a supervisory review process andthe effective use of market discipline.  Basel II seeks to ensure that abank’s capital position is consistent with its overall risk profile andstrategy, encourages early supervisory intervention when a bank’s capitalposition deteriorates and calls for detailed disclosure of a bank’s capitaladequacy and how 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 on Advanced Capital AdequacyFramework—Basel II (the “Final Rule”), has been approved by all regulatoryagencies and took effect on April 1, 2008. The Final Rule currentlyapplies only to certain core banks with total assets of $250 billion or more,but allows non-core banks to opt in.  Under the Final Rule, the Bank isconsidered to be a non-core bank. For those non-core banks that do not opt in,a NPR was issued in December 2006, known as Basel IA, which proposedcertain revisions to the current Basel I capital rules.

 

Theagencies have proposed a NPR that would provide non-core banks the option ofadopting the Standardized Approach of the Basel II Framework.  The BaselII Standardized NPR is expected to replace the Basel IA NPR.

 

Paymentof Dividends

 

TheCorporation is a legal entity separate and distinct from its banking and othersubsidiaries.  The principal source of cash flow of the Corporation,including cash flow to pay dividends to holders of trust preferred securitiesof the Corporation’s trusts, holders of the Fixed Rate Cumulative PerpetualPreferred Stock of the Corporation Series A (“Series A PreferredStock”) and to the Corporation’s common stock shareholders, will be dividendsthat the Bank pays to the Corporation as its sole shareholder. Under Tennesseelaw, the Corporation is not permitted to pay dividends if, after giving effectto such payment, the Corporation would not be able to pay the Corporation’s debtsas they become due in the usual course of business or the Corporation’s totalassets would be less than the sum of the Corporation’s total liabilities plusany amounts needed to satisfy any preferential rights if the Corporation weredissolving. In addition, in deciding whether or not to declare a dividend ofany particular size, the Corporation’s board of directors must consider theCorporation’s current and prospective capital, liquidity, and other needs.

 

Inaddition to the limitations on the Corporation’s ability to pay dividends underTennessee law, the Corporation’s ability to pay dividends on the Corporation’scommon stock is also limited by the Corporation’s participation in the TroubledAsset Relief Program (“TARP”) Capital Purchase Program (“CPP”) and by certainstatutory or regulatory limitations. Prior to December 19, 2011, unlessthe Corporation has redeemed the Series A Preferred Stock or U.S.Department of the Treasury (“Treasury”) has transferred the Series A Preferred Stock to a third party, theconsent of the Treasury must be received before the Corporation can declare orpay any dividend or make any distribution on the Corporation’s common stock.Furthermore, if the Corporation is not current in the payment of quarterlydividends on the Series A Preferred Stock, the Corporation cannot paydividends on the Corporation’s common stock.

 

Moreover,the terms of the Series A Preferred Stock include a restriction againstincreasing the Corporation’s common stock dividends from levels at the time ofthe initial investment by Treasury and prevent the Corporation from redeeming,purchasing or otherwise acquiring its common stock other than for certainstated exceptions. Historically, the Corporation has paid no dividends on itscommon stock. Therefore, the Corporation would have to seek Treasury’s consentto pay any dividends on shares of Corporation common stock. These restrictionswill terminate on the earlier of the third anniversary of the date of issuanceof the Series A Preferred Stock to Treasury and the date on which the Series APreferred Stock issued to Treasury has been redeemed in whole or Treasury hastransferred all of its Series A Preferred Stock to third parties.  In addition, the Corporation will be unableto declare or pay dividends or distributions on, or repurchase, redeem orotherwise acquire for consideration, shares of its common stock or other stockranking junior to, or in parity with, the Series A Preferred Stock if theCorporation fails to declare and pay full dividends (or declare and set aside asum sufficient for payment thereof) on its Series A Preferred Stock.

 

Thereare state and federal statutory and regulatory limitations on the payment ofdividends by the Bank to the Corporation, as well as by the Corporation to itsshareholders. 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.  In addition, the Bank is restrictedfrom paying dividends under certain circumstance by the Tennessee Banking Act.The payment of dividends by any bank is dependent upon its earnings andfinancial condition and subject to the statutory power of certain federal andstate regulatory agencies to act to prevent what they deem unsafe or unsoundbanking practices.  The payment of dividends could, depending upon thefinancial condition of the Bank, be deemed to constitute such an unsafe or unsoundbanking practice.  Under Tennessee law, the board of directors of a statebank may not declare dividends in any calendar year that exceeds the total ofits retained net income of the preceding two (2) years without the priorapproval of the TDFI.  The FDIA prohibits a state bank, the deposits ofwhich are insured by the FDIC, from paying dividends if it is in default in thepayment of any assessments due the FDIC.  The Bank is also subject to theminimum capital requirements of the FDIC which impact the Bank’s ability to paydividends.  If the Bank fails to meet these standards, it may not be ableto pay dividends or to accept additional deposits because of regulatoryrequirements.

 

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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 Federal Reserve Board have indicatedthat paying dividends that deplete a depository institution’s or holdingcompany’s capital base to an inadequate level would be such an unsafe andunsound banking practice. Moreover, the Federal Reserve Board and the FDIC haveissued policy statements which provide that bank holding companies and insureddepository institutions generally should only pay dividends out of currentoperating earnings.

 

UnderTennessee law, the Corporation is not permitted to pay dividends if, after givingeffect to such payment, it would not be able to pay its debts as they becomedue in the usual course of business or the Corporation’s total assets would beless than the sum of its total liabilities plus any amounts needed to satisfyany preferential rights if the Corporation was dissolving.  In addition,in deciding whether or not to declare a dividend of any particular size, theCorporation’s Board must consider the Corporation’s current and prospectivecapital, liquidity, and other needs.

 

Thepayment of dividends by the Corporation and the Bank may also be affected orlimited by other factors, such as the requirement to maintain adequate capitalabove regulatory guidelines and debt covenants.

 

FIRREA

 

FIRREAprovides that a depository institution insured by the FDIC can be held liablefor any loss incurred by, or reasonably expected to be incurred by, the FDICafter August 9, 1989 in connection with (i) the default of a commonlycontrolled FDIC-insured depository institution or (ii) any assistance providedby the FDIC to a commonly controlled FDIC-insured depository institution indanger of default.  FIRREA provides that certain types of personsaffiliated with financial institutions can be fined by the federal regulatoryagency having jurisdiction over a depository institution with federal depositinsurance (such as the Bank) up to $1 million per day for each violation ofcertain regulations related (primarily) to lending to and transactions withexecutive officers, directors, principal shareholders and the interests ofthese individuals.  Other violations may result in civil money penaltiesof $5,000 to $30,000 per day or in criminal fines and penalties.  Inaddition, the FDIC has been granted enhanced authority to withdraw or tosuspend deposit insurance in certain cases.

 

FDICIA

 

TheFederal 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 examinationrating.

 

Thecapital-based prompt corrective action provisions of FDICIA and theirimplementing regulations apply to FDIC-insured depository institutions and arenot 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.

 

Undercapitalizeddepository institutions are subject to restrictions on borrowing from theFederal Reserve System.  In addition, undercapitalized depositoryinstitutions are subject to growth limitations and are required to submitcapital restoration plans.  A depository institution’s holding companymust guarantee the capital plan, up to an amount equal to the lesser of 5% ofthe depository institution’s assets at the time it becomes undercapitalized orthe amount of the capital deficiency when the institution fails to comply withthe plan.  The federal banking agencies may not accept a capital planwithout determining, among other things, that the plan is based on realisticassumptions and is likely to succeed in restoring the depository institution’scapital.  If a depository institution fails to submit an acceptable plan,it is treated as if it is significantly undercapitalized.

 

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Significantlyundercapitalized depository institutions may be subject to a number ofrequirements and restrictions, including orders to sell sufficient voting stockto become adequately capitalized, requirements to reduce total assets andcessation of receipt of deposits from correspondent banks.  Criticallyundercapitalized depository institutions are subject to appointment of areceiver or conservator generally within 90 days of the date on which theybecame critically undercapitalized.

 

FDICIAcontains numerous other provisions, including accounting, audit and reportingrequirements, termination of the “too big to fail” doctrine except in specialcases, limitations on the FDIC’s payment of deposits at foreign branches, newregulatory standards in such areas as asset quality, earnings and compensationand revised regulatory standards for, among other things, powers of statebanks, real estate lending and capital adequacy.  FDICIA also requiresthat a depository institution provide 90 days prior notice of the closing ofany branches.

 

Riegle-NealInterstate Banking and Branching Efficiency Act

 

TheRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“InterstateAct”), among other things and subject to certain conditions and exceptions,permits on an interstate basis (i) bank holding company acquisitionscommencing one year after enactment of banks of a minimum age of up to fiveyears as established by state law in any state, (ii) mergers of nationaland state banks after May 31, 1997 unless the home state of either bankhas opted out of the interstate bank merger provision, (iii) branching denovo by national and state banks if the host state has opted-in to thisprovision of the Interstate Act, and (iv) certain bank agency activitiesone year after enactment.  The Interstate Act contains a 30% intrastatedeposit cap, except for the initial acquisition in the state, a restrictionthat applies to certain interstate acquisitions unless a different intrastatecap has been adopted by the applicable state pursuant to the provisions of theInterstate Act and a 10% national deposit cap restriction.  Tennessee hasopted-in to the Interstate Act.  Management cannot predict the extent towhich the business of the Bank may be affected by the Interstate Act. Tennessee has also adopted legislation allowing banks to acquire branchesacross state lines subject to certain conditions, including the availability ofsimilar legislation in the other state.

 

BrokeredDeposits and Pass-Through Insurance

 

TheFDIC has adopted regulations under FDICIA governing the receipt of brokereddeposits and pass-through insurance.  Under the regulations, a bank cannotaccept or rollover or renew brokered deposits unless (i) it is wellcapitalized or (ii) it is adequately capitalized and receives a waiverfrom the FDIC.  A bank that cannot receive brokered deposits also cannotoffer “pass-through” insurance on certain employee benefit accounts. Whether or not it has obtained such a waiver, an adequately capitalized bankmay not pay an interest rate on any deposits in excess of 75 basis points overcertain index prevailing market rates specified by regulation.  There areno such restrictions on a bank that is well capitalized.  The FDIC hasproposed an amendment to this regulation that would change the comparison ratefrom a specific market rate to a prevailing national average rate, as publishedby the FDIC.  Because it believes thatthe Bank was well capitalized as of December 31, 2008, management of theBank believes the brokered deposits regulation will have no material effect onthe funding or liquidity of the Bank.

 

FDICInsurance Premiums

 

TheBank is required to pay semiannual FDIC deposit insurance assessments to theDeposit Insurance Fund (“DIF”).  The FDIC merged the Bank Insurance Fundand the Savings Association Insurance Fund to form the DIF on March 31,2006 in accordance with the Federal Deposit Insurance Reform Act of 2005. The FDIC maintains the DIF by assessing depository institutions an insurancepremium.  The amount each institution is assessed is based upon statutoryfactors that include the balance of insured deposits as well as the degree ofrisk the institution poses to the insurance fund.  The FDIC uses arisk-based premium system that assesses higher rates on those institutions thatpose greater risks to the DIF.

 

As of January 1,2007, the previous nine risk categories utilized in the risk matrix werecondensed into four risk categories which continue to be distinguished bycapital levels and supervisory ratings. In an effort to restore capitalizationlevels and to ensure the DIF will adequately cover projected losses from futurebank failures, the FDIC, in October 2008, proposed a rule to alterthe way in which it differentiates for risk in the risk-based assessment systemand to revise deposit insurance assessment rates, including base assessmentrates.  The FDIC also proposed tointroduce three adjustments that could be made to an institution’s initial baseassessment rate, including (i) a potential decrease of up to two basispoints for long-term unsecured debt, including senior and subordinated debt, (ii) apotential increase for secured liabilities in excess of 15% of domesticdeposits and (iii) for certain institutions, a potential increase forbrokered deposits in excess of 10% of domestic deposits. In addition, the FDICproposed raising the current rates uniformly by seven basis points for theassessment for the first quarter of 2009. The proposal for first quarter 2009assessment rates was adopted as a final rule in December 2008.  Effective April 1, 2009, the FDIC willmake additional changes to assessment rates. In addition, on February 27, 2009, the FDIC adopted an interim rule imposinga 20 basis point emergency special assessment on June 30, 2009, to becollected on September 30, 2009. The interim rule also permits an emergency special assessment afterJune 30, 2009 of up to ten basis points. The interim rule is subject to public comment.  The increases in deposit insurance describedabove, as well as the recent increase and anticipated additional increase inthe number of bank failures, is expected to result in an increase in depositinsurance assessments for all banks.

 

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Underthe FDIA, insurance of deposits may be terminated by the FDIC upon a findingthat the institution has engaged in unsafe or unsound practices, is in an unsafeor unsound condition to continue operations or has violated any applicable law,regulation, rule, order or condition imposed by a federal bank regulatoryagency.

 

Gramm-Leach-BlileyAct

 

TheGramm-Leach-Bliley Act of 1999 (the “GLBA”) ratified new powers for banks andbank 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.  Theregulatory agencies have been adopting many new regulations to implement theGLBA.

 

USA Patriot Act

 

The Unitingand Strengthening America by Providing Appropriate Tools Required to Interceptand Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) contains theInternational Money Laundering Abatement and Financial Anti-Terrorism Act of2001 (the “IMLAFA”).  The IMLAFA substantially broadened existinganti-money laundering legislation and the extraterritorial jurisdiction of theUnited States, imposed new compliance and due diligence obligations, creatednew crimes and penalties, compelled the production of documents located bothinside and outside the United States, including those of foreign institutionsthat have a correspondent relationship in the United States, and clarified thesafe harbor from civil liability to customers.  The U.S. Treasury Departmenthas issued a number of regulations implementing the USA Patriot Act that applycertain of its requirements to financial institutions such as theBank. The regulations imposed new obligations on financial institutions tomaintain appropriate policies, procedures and controls to detect, prevent andreport money laundering and terrorist financing.

 

TheIMLAFA required all “financial institutions,” as defined therein, to establishanti-money laundering compliance and due diligence programs no later than April 2003. Such programs must include, among other things, adequate policies, thedesignation of a compliance officer, employee training programs, and anindependent audit function to review and test the program.  The Bank hasestablished anti-money laundering compliance and due diligence programs whichmanagement believes comply with the IMLAFA.

 

DepositorPreference

 

TheOmnibus Budget Reconciliation Act of 1993 provides that deposits and certainclaims for administrative expenses and employee compensation against an insureddepositary institution would be afforded a priority over other generalunsecured claims against such an institution, including federal funds andletters of credit, in the “liquidation or other resolution” of such aninstitution by any receiver.

 

Emergency EconomicStabilization Act

 

Inresponse to recent, unprecedented market turmoil, Congress enacted theEmergency Economic Stabilization Act (“EESA”) on October 3, 2008. EESAauthorizes the Secretary of Treasury (the “Secretary”) to purchase up to $700billion in troubled assets from financial institutions under TARP. Troubledassets include residential or commercial mortgages and related instrumentsoriginated prior to March 14, 2008 and any other financial instrument thepurchase of which the Secretary determines, after consultation with theChairman of the Board of Governors of the Federal Reserve System, is necessaryto promote financial stability.  TheSecretary was authorized to purchase up to $250 billion in troubled assetsimmediately and up to $350 billion upon request by the President, subject toaction by Congress.  EESA also increasedthe maximum deposit insurance amount up to $250,000 until December 31,2009.  Pursuant to his authority underEESA, the Secretary created the TARP CPP under which Treasury is investing upto $250 billion in senior preferred stock of U.S. banks and savingsassociations or their holding companies.

 

TheCorporation applied for, and Treasury approved, a capital purchase in theamount of $30 million under the CPP.  TheCorporation entered into a Letter Agreement with Treasury, pursuant to whichthe Corporation issued and sold to Treasury, for an aggregate purchase price of$30 million in cash, (i) 30,000 shares of Series A Preferred Stockhaving a liquidation preference of $1,000, and (ii) a ten-year warrant topurchase up to 461,538 shares of common stock, at an exercise price of $9.75per share, subject to certain anti-dilution and other adjustments.  The Series A Preferred Stock will paycumulative dividends at a rate of 5% per annum for the first five years and 9%per annum thereafter.  The CCPtransaction closed on December 19, 2008.

 

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On November 21,2008, the Board of Directors of the FDIC adopted a final rule relating tothe Temporary Liquidity Guarantee Program (“TLG Program”). The TLG Program wasannounced by the FDIC on October 14, 2008, preceded by the determinationof systemic risk by the Secretary (after consultation with the President), asan initiative to counter the system-wide crisis in the nation’s financialsector. Under the TLG Program, the FDIC will (i) guarantee, through theearlier of maturity or June 30, 2012, certain newly issued seniorunsecured debt issued by participating institutions on or after October 14,2008, and before June 30, 2009 and (ii) provide full FDIC depositinsurance coverage for non-interest bearing transaction deposit accounts heldat participating FDIC-insured institutions through December 31, 2009. Thefee assessment for coverage of senior unsecured debt ranges from 50 basispoints to 100 basis points per annum, depending on the initial maturity of thedebt. The fee assessment for deposit insurance coverage is ten basis points perquarter on amounts in covered accounts exceeding $250,000. The TLG Program isin effect for all eligible entities that did not opt out on or before December 5,2008.  The Corporation did not opt out ofthe TLG Program.

 

American Recovery andReinvestment Act of 2009

 

TheAmerican Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law on February 17,2009.  ARRA contains a wide variety ofprograms intended to stimulate the economy and provide for extensiveinfrastructure, energy, health and education needs.  In addition, ARRA imposes certain newexecutive compensation and corporate expenditure limits on all current andfuture TARP recipients until they have repaid Treasury, which is permittedunder ARRA without the need to raise new capital, subject to Treasuryconsulting with the recipient’s appropriate regulatory agency.

 

Effect ofGovernmental Policies

 

TheCorporation and the Bank are affected by the policies of regulatoryauthorities, including the Federal Reserve System. An important function of theFederal Reserve System is to regulate the national money supply.  Amongthe 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.

 

Themonetary policies of the Federal Reserve System and other governmental policieshave had a significant effect on the operating results of commercial banks inthe past and are expected to continue to do so in the future.  Because ofchanging conditions in the national economy and in the money market, as well asthe result of actions by monetary and fiscal authorities, it is not possible topredict with certainty future changes in interest rates, deposit levels, loandemand or the business and earnings of the Bank or whether the changingeconomic conditions will have a positive or negative effect on operations andearnings.

 

Billsare pending before the United States Congress and the Tennessee GeneralAssembly and proposed regulations are pending before the various state andfederal regulatory agencies that could affect the business of the Corporationand 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 Corporation and the Bank may be affectedthereby.

 

**Sarbanes-Oxley Act of 2002**

 

TheSarbanes-Oxley Act of 2002 represents a comprehensive revision of lawsaffecting corporate governance, accounting obligations and corporate reporting.The Sarbanes-Oxley Act is applicable to all companies with equity securitiesregistered, or that file reports, under the Securities Exchange Act of 1934, asamended.  In particular, the act established (i) requirements foraudit 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

 

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**Availabilityof Information**

 

TheCorporation files periodic reports with the SEC. The SEC maintains an internetwebsite, www.sec.gov that contains reports, proxy and information statements,and other information regarding the Corporation that it files electronicallywith the SEC.  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.

 

**ITEM1A.          RISK FACTORS**

 

**Recentnegative developments in the financial services industry and U.S. and globalcredit markets may adversely impact our operations and results.**

 

Negativedevelopments in the latter half of 2007 and throughout 2008 in the capitalmarkets have resulted in uncertainty in the financial markets in general withthe expectation of the general economic downturn continuing into 2009. Loanportfolio performances have deteriorated at many institutions resulting from,among other factors, a weak economy and a decline in the value of thecollateral supporting their loans. The competition for our deposits hasincreased significantly as a result of liquidity concerns at many of these sameinstitutions. Stock prices of bank holding companies, like ours, have beennegatively affected by the current condition of the financial markets, as hasour ability, if needed, to raise capital or borrow in the debt markets comparedto recent years. As a result, there is a potential for new federal or statelaws and regulations regarding lending and funding practices and liquiditystandards, and financial institution regulatory agencies are expected to bevery aggressive in responding to concerns and trends identified in examinations,including the expected issuance of many formal enforcement actions.

 

Negativedevelopments in the financial services industry and the impact of newlegislation in response to those developments could negatively impact ourfinancial performance by restricting our operations, including our ability tooriginate or sell loans.

 

Dramaticdeclines in the housing market, with decreasing home prices and increasingdelinquencies and foreclosures, have negatively impacted the credit performanceof mortgage and construction loans and resulted in significant write-downs ofassets by many financial institutions. In addition, the values of real estate collateral supporting many loanshave declined and may continue to decline. General downward economic trends, reducedavailability of commercial credit and increasing unemployment have negativelyaffected the credit performance of commercial and consumer credit, resulting inadditional write-downs.  Concerns overthe stability of the financial markets and the economy have resulted indecreased lending by financial institutions to their customers and to eachother.  This market turmoil andtightening of credit has led to increased commercial and consumerdelinquencies, lack of customer confidence, increased market volatility andwidespread reduction in general business activity.  Competition among depository institutions fordeposits has increased significantly. Financial institutions have experienceddecreased access to deposits and/or borrowings. The resulting economic pressure on consumers and businesses and the lackof confidence in the financial markets may adversely affect our business,financial condition and results of operations.

 

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

 

Theprimary source of our funds is customer deposits and loan repayments. Whilescheduled loan repayments are a relatively stable source of funds, they aresubject to the ability of borrowers to repay the loans. The ability ofborrowers to repay loans can be adversely affected by a number of factors,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 be affected bya number of factors, including rates paid by competitors, general interest ratelevels, returns available to customers on alternative investments and generaleconomic conditions. Accordingly, we may be required from time to time to relyon secondary sources of liquidity to meet withdrawal demands or otherwise fundoperations. These sources include Federal Home Loan Bank advances and federalfunds lines of credit from correspondent banks. While our management believesthat these sources are currently adequate, there can be no assurance they willbe sufficient to meet future liquidity demands. We may be required to slow ordiscontinue loan growth, capital expenditures or other investments or liquidateassets should these sources not be adequate.

 

Ourability to borrow could also be impaired by factors that are not specific tous, such as a disruption in the financial markets or negative views andexpectations about the prospects for the financial services industry in lightof the recent turmoil faced by banking organizations and the continueddeterioration in credit markets.

 

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**Aninadequate allowance for loan losses would reduce our earnings.**

 

Therisk of credit losses on loans varies with, among other things, generaleconomic conditions, the type of loan being made, the creditworthiness of theborrower over the term of the loan and, in the case of a collateralized loan,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.

 

**Ourability to maintain adequate capital may restrict our activities.**

 

Ourcontinued pace of growth may require us to raise additional capital in thefuture, but that capital may not be available when it is needed.  We arerequired by federal and state regulatory authorities to maintain adequatelevels of capital to support our operations, so we may at some point need toraise additional capital to support any continued growth.

 

Ourability to raise additional capital, if needed, will depend on conditions inthe capital markets at that time, which are outside our control, and on ourfinancial performance. Accordingly, we cannot assure our shareholders that wewill be able to raise additional capital if needed on terms acceptable to us.If we cannot raise additional capital when needed, our ability to continue ourgrowth could be materially impaired.

 

**We may be required to paysignificantly higher FDIC premiums in the future.**

 

Recentinsured institution failures, as well as deterioration in banking and economicconditions, have significantly increased FDIC loss provisions, resulting in adecline in the designated reserve ratio to historical lows. The FDIC expects ahigher rate of insured institution failures in the next few years compared torecent years.  Therefore, thus, thereserve ratio may continue to decline. In addition, EESA temporarily increasedthe limit on FDIC coverage to $250,000 through December 31, 2009. Thesedevelopments will cause the premiums assessed to us by the FDIC to increase.

 

EffectiveApril 1, 2009, the FDIC will modify the way its assessment systemdifferentiates risk, making corresponding changes to assessment rates beginningwith the second quarter of 2009. Potentially higher FDIC assessment rates andspecial assessments could have an adverse impact on our results of operations.

 

**Recentlegislative and regulatory initiatives to address difficult market and economicconditions may not stabilize the U.S. banking system.**

 

EESAand ARRA followed, and have been followed by, numerous actions by the Board ofGovernors of the Federal Reserve System, Congress, Treasury, the FDIC, the SECand others to address the current liquidity and credit crisis that has followedthe sub-prime meltdown that commenced in 2007. These measures include homeowner relief that encourages loanrestructuring and modification; the establishment of significant liquidity andcredit facilities for financial institutions and investment banks; the loweringof the federal funds rate; emergency action against short selling practices; atemporary guaranty program for money market funds; the establishment of acommercial paper funding facility to provide back-stop liquidity to commercialpaper issuers; and coordinated international efforts to address illiquidity andother weaknesses in the banking sector. The purpose of these legislative andregulatory actions is to stabilize the U.S. banking system. These initiativesmay not have their desired effects.  Ifthe volatility in the markets continues and economic conditions fail to improveor worsen, our business, financial condition and results of operations could bematerially and adversely affected.

 

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**Ourissuance of securities to the Treasury may limit our ability to return capitalto our shareholders and is dilutive to the holders of our common stock and mayresult in other restrictions to our operations.**

 

Inconnection with our sale of $30 million of Series A Preferred Stock to theTreasury on December 19, 2008, we also issued to the Treasury a warrant topurchase 461,538 shares of our common stock. The terms of the transaction withthe Treasury will result in limitations on our ability to pay dividends andrepurchase our shares. Until December 19, 2011 or until the Treasury nolonger holds any shares of the Series A Preferred Stock, we will not beable to pay dividends nor repurchase any of our shares without the approval ofthe Treasury, with limited exceptions. In addition, we will not be able to payany dividends at all on our common stock unless we are current on our dividendpayments on the Series A Preferred Stock. These restrictions, as well as thedilutive impact of the warrant, may have a negative effect on the market priceof our common stock and may be dilutive of our earnings per share.  In addition, we are required to paycumulative dividends at a rate of 5% per annum for the first five years, andthereafter at a rate of 9% per annum. Depending on our financial condition atthe time, these dividends could have a negative effect on our liquidity. Theshares of Series A Preferred Stock will receive preferential treatment inthe event of our liquidation, dissolution or winding up. The transaction alsosubjects us to additional executive compensation restrictions.

 

**Holdersof the Series A Preferred Stock may, under certain circumstances, have theright to elect two directors to our board of directors.**

 

In theevent that we fail to pay dividends on the Series A Preferred Stock for anaggregate of six quarterly dividend periods or more (whether or notconsecutive), the authorized number of directors then constituting our board ofdirectors will be increased by two. Holders of the Series A PreferredStock, together with the holders of any outstanding parity stock with likevoting rights voting as a single class, will then be entitled to elect the twoadditional members of our board of directors at the next annual meeting (or ata special meeting called for the purpose of electing such directors prior tothe next annual meeting) and at each subsequent annual meeting until allaccrued and unpaid dividends for all past dividend periods have been paid in full.

 

**Holdersof the Series A Preferred Stock have limited voting rights.**

 

Except as otherwise required by law and inconnection with the election of directors to our board of directors in theevent that we fail to pay dividends on the Series A Preferred Stock for anaggregate of at least six quarterly dividend periods (whether or notconsecutive), holders of the Series A Preferred Stock have limited votingrights. So long as shares of the Series A Preferred Stock are outstanding,in addition to any other vote or consent of shareholders required by law or ouramended and restated charter, the vote or consent of holders owning at least 662/3% of the shares of Series A Preferred Stock outstanding is required for(i) any authorization or issuance of shares ranking senior to the Series APreferred Stock, (2) any amendment to the rights of the Series APreferred Stock so as to adversely affect the rights, preferences, privilegesor voting power of the Series A Preferred Stock or (3) consummationof any merger, share exchange or similar transaction unless the shares of Series APreferred Stock remain outstanding, or if we are not the surviving entity insuch transaction, such shares are converted into or exchanged for preferencesecurities of the surviving entity and the shares of Series A PreferredStock remaining outstanding or such preference securities have such rights,preferences, privileges and voting power as are not materially less favorableto the holders than the rights, preferences, privileges and voting power of theshares of Series A Preferred Stock.

 

**Ourbusiness is subject to the success of the local economies where we operate.**

 

Our success significantly depends upon the growth inpopulation, income levels, deposits and new businesses in the Nashville MSA andour other market areas. If the communities in which we operate do not grow orif prevailing economic conditions locally or nationally are unfavorable, ourbusiness may not succeed. Adverse economic conditions in our specific marketareas could reduce our growth rate, affect the ability of our customers torepay their loans to us and generally affect our financial condition andresults of operations. Moreover, we cannot give any assurance that we willbenefit from any market growth or favorable economic conditions in our primarymarket areas if they do occur.

 

**Nationalmarket funding outside of the Nashville MSA has different risks.**

 

Approximately 31.06% of our loan portfolio iscomposed of national market funding loans to non-Middle Tennessee businessesreferred to us by a small network of equipment vendors and financial servicecompanies. These loans account for approximately 38.74% and 32.72%,respectively, of the increase in total loans at December 31, 2008 and2007, over the prior year. This lending causes us to have somewhat differentrisks than those typical for community banks generally. Our loan portfolio ismore geographically diverse, and as a result the loan collateral is also morewidely dispersed geographically. This may result in longer time periods tolocate collateral and higher costs to dispose of collateral in the event thatthe collateral is used to satisfy the loan obligation. This part of ourportfolio also provides geographic risk diversification by reducing the adverseimpact of a regional downturn in the economy.

 

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**Ourability to attract deposits may restrict growth.**

 

We derive a substantial portion of our depositsthrough internet-based wholesale funding alternatives. In the event that we areno longer able to sell our deposits easily to institutional and retailinvestors, our ability to fund our loan portfolio could be adversely affected.We post rates to an internet-based program that retail and institutionalinvestors nationwide subscribe to in order to invest funds. Our wholesalefunding portfolio is therefore geographically dispersed and generally made upof deposits in FDIC insured amounts of $100,000 or less.

 

**Changesin monetary policy could adversely affect operating results.**

 

Like all regulated financial institutions, we areaffected by monetary policies implemented by the Federal Reserve Board andother federal instrumentalities.  Aprimary instrument of monetary policy employed by the Federal Reserve Board isthe restriction or expansion of the money supply through open marketoperations.  This instrument of monetarypolicy frequently causes volatile fluctuations in interest rates, and it canhave a direct, adverse effect on the operating results of financialinstitutions.  Borrowings by the UnitedStates government to finance the government debt may also cause fluctuations ininterest rates and have similar effects on the operating results of suchinstitutions.

 

**Changesin interest rates could adversely affect our results of operations andfinancial condition.**

 

Changes in interest rates may affect our level ofinterest income, the primary component of our gross revenue, as well as thelevel of our interest expense. Interest rates are highly sensitive to manyfactors that are beyond our control, including general economic conditions andthe policies of various governmental and regulatory authorities.  Accordingly, changes in interest rates coulddecrease our net interest income. Changes in the level of interest rates also may negatively affect ourability to originate loans, the value of our assets and our ability to realizegains from the sale of our assets, all of which ultimately affects ourearnings.

 

**Wecould sustain losses if our asset quality declines.**

 

Ourearnings are affected by our ability to properly originate, underwrite andservice loans.  We could sustain losses if we incorrectly assess thecreditworthiness of our borrowers or fail to detect or respond to deteriorationin asset quality in a timely manner.  Problems with asset quality couldcause our interest income and net interest margin to decrease and our provisionfor loan losses to increase, which could adversely affect our results ofoperations and financial condition.

 

**We aresubject to extensive regulation that could limit or restrict our activities.**

 

We operate in a highly regulated industry and aresubject to examination, supervision and comprehensive regulation by variousfederal and state agencies including the Federal Reserve Board, the FDIC andthe TDFI. Our regulatory compliance is costly and restricts certain of ouractivities, including payment of dividends, mergers and acquisitions,investments, loans and interest rates charged, and interest rates paid ondeposits. We are also subject to capitalization guidelines established by ourregulators, which require us to maintain adequate capital to support ourgrowth.

 

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

 

The Sarbanes-Oxley Act of2002, and the related rules and regulations promulgated by the Securitiesand Exchange Commission and The NASDAQ Stock Market that are applicable to us,have increased the scope, complexity and cost of our corporate governance,reporting and disclosure practices. As a result, we have experienced, and maycontinue to experience, greater compliance costs.

 

As aresult of the recent global financial crisis, the potential exists for newfederal or state laws and regulations regarding lending and funding practicesand liquidity standards to be promulgated, and bank regulatory agencies areexpected to be active in responding to concerns and trends identified inexaminations, including the expected issuance of many formal enforcementorders. Negative developments in the financial industry and the domestic andinternational credit markets, and the impact of new legislation in response tothose developments, may adversely affect our operations by restricting ourbusiness operations, including our ability to originate or sell loans, and mayadversely impact our financial condition.

 

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**Holdersof our subordinated debentures have rights that are senior to those of ourcommon shareholders.**

 

In2005 and 2008, we supported our continued growth through the issuance of trustpreferred securities from an affiliated special purpose trust and accompanyingsubordinated debentures. At December 31, 2008, we had outstanding trustpreferred securities and accompanying subordinated debentures totaling $23.2million. Our board of directors may also decide to issue additional tranches oftrust preferred securities in the future. We conditionally guarantee paymentsof the principal and interest on the trust preferred securities. Further, theaccompanying subordinated debentures we issued to the trust are senior to ourshares of common stock. As a result, we must make payments on the subordinateddebentures before any dividends can be paid on our common stock and, in theevent of our bankruptcy, dissolution or liquidation, the holders of the subordinateddebentures must be satisfied before any distributions can be made on our commonstock. We have the right to defer distributions on our subordinated debentures(and the related trust preferred securities) for up to five years (from thedate of issuance) during which time we may not pay dividends on our commonstock.

 

**We rely heavily on the servicesof key personnel.**

 

Wedepend substantially on the strategies and management services of our executiveofficers – Arthur F. Helf, Chairman and Chief Executive Officer, Michael R.Sapp, President, Frank Perez, Chief Financial Officer, and H. Lamar Cox, ChiefAdministrative Officer. The loss of the services of any of these executiveofficers could have a material adverse effect on our business, results ofoperations and financial condition. We are also dependent on certain other keyofficers who have important customer relationships or are instrumental to ouroperations. Changes in key personnel and their responsibilities may bedisruptive to our business and could have a material adverse effect on ourbusiness, financial condition and results of operations.  We believe that our future results will alsodepend in part 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.

 

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

 

Our ability to continue to grow the national marketfunding portion of our portfolio is dependent upon our retaining those membersof our senior management and those loan officers who have experience andrelationships with those equipment vendors and financial services companies who originate the underlying leasetransactions. In the event that any of these members of senior management,particularly President Mike Sapp, were to terminate his or her employment withus, or in the event that our relationships with any of these vendor/brokerswere to be discontinued, our ability to continue to increase our nationalmarket funding portfolio could be adversely affected.

 

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

 

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

 

**Ourbusiness strategy includes the continuation of growth plans, and our financialcondition and results of operations could be negatively affected if ourbusiness strategies are not effectively executed.**

 

We intend to continue pursuing a growth strategy forour business through organic growth of the loan portfolio. Our prospects mustbe considered in light of the risks, expenses and difficulties that can beencountered by financial service companies in rapid growth stages, whichinclude the risks associated with the following:

 

·      maintainingloan quality;

 

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

 

·      maintainingadequate control and compliance functions; and

 

·      securingcapital and liquidity needed to support our anticipated growth.

 

There can be no assurance that we will maintain orachieve deposit levels, loan balances or other operating results necessary toavoid losses or produce profits. Our growth will cause growth in overheadexpenses as we routinely add staff. As a result, historical results may not beindicative of future results. Failure to successfully address these issuesidentified above could have a material adverse effect on our business, futureprospects, financial condition or results of operations.

 

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**Competitionfrom financial institutions and other financial service providers may adverselyaffect our profitability.**

 

The banking business is highly competitive and weexperience competition in our markets from many other financialinstitutions.  We compete with commercialbanks, 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 as other community banksand super-regional and national financial institutions that operate in theNashville MSA and elsewhere.  We not onlycompete with these companies in the Nashville MSA, but also in the regional andnational markets in which we engage in our indirect funding programs.

 

Additionally, in the Nashville MSA, we facecompetition from de novo community banks, including those with senior managementwho were previously affiliated with other local or regional banks or thosecontrolled by investor groups with strong local business and community ties.These de novo community banks may offer higher deposit rates or lower costloans in an effort to attract our customers, and may attempt to hire ourmanagement and employees.

 

We compete with these other financial institutionsboth in attracting deposits and in making loans. In addition, we have toattract our customer base in the Nashville MSA from consumers with an existingrelationship with other financial institutions and from new residents.  We expect competition to increase in thefuture as a result of legislative, regulatory and technological changes and thecontinuing trend of consolidation in the financial services industry. Ourprofitability depends upon our continued ability to successfully compete withan array of financial institutions in the Nashville MSA and regionally andnationally with respect to our indirect funding programs.

 

**Materialfluctuations in non-interest income may occur.**

 

A substantial portion of our non-interest income isderived from the sale of loans, particularly loans generated for our nationalmarket funding portfolio. 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.

 

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

 

Wederive our income solely from dividends on the shares of common stock of thebank. The bank’s ability to declare and pay dividends to us is limited by itsobligations to maintain sufficient capital and by other general restrictions onits dividends that are applicable to banks that are regulated by the FDIC andthe TDFI. The Federal Reserve Board may also impose restrictions on our abilityto pay dividends on our common stock. In addition, we must make payments on thesubordinated debentures before any dividends can be paid on our common stock,and we may not pay dividends while we are deferring interest payments on ourtrust preferred securities and the related subordinated debentures. As aresult, we cannot assure our shareholders that we will declare or pay dividendson shares of our common stock in the future.

 

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

 

Thebanking industry and the ability to deliver financial services is becoming moredependent on technological advancement, such as the ability to process loanapplications over the Internet, accept electronic signatures, provide processstatus updates instantly and offer on-line banking capabilities and othercustomer expected conveniences that are cost efficient to our businessprocesses. As these technologies are improved in the future, we may, in orderto remain competitive, be required to make significant capital expenditures.

 

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

 

Whileour common stock is listed on The NASDAQ Global Market, the trading volume ofour common stock is relatively low and we cannot be certain when a more activeand liquid trading market for our common stock will develop or be sustained.Because of this, our shareholders may not be able to sell their shares atthe volumes, prices or times that they desire.

 

Wecannot predict the effect, if any, that future sales of our common stock in themarket, or availability of shares of our common stock for sale in the market,will have on the market price of our common stock. We, therefore, can give noassurance that sales of substantial amounts of our common stock in the market,or the potential for large amounts of sales in the market, would not cause theprice of our common stock to decline or impair our ability to raise capitalthrough sales of our common stock.

 

Themarket price of our common stock may fluctuate in the future, and thesefluctuations may be unrelated to our performance. General market pricedeclines or overall market volatility in the future could adversely affect theprice of our common stock, and the current market price may not beindicative of future market prices.

 

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**We mayissue additional common stock or other equity securities in the future whichcould dilute the ownership interest of existing shareholders.**

 

Inorder to maintain our capital at desired levels or required regulatory levels,or to fund future growth, our board of directors may decide from time to timeto issue additional shares of common stock, or securities convertible into,exchangeable for or representing rights to acquire shares of our common stock.The sale of these securities may significantly dilute our shareholders’ ownershipinterest as a shareholder and the market price of our common stock. Newinvestors of other equity securities issued by us in the future may also haverights, preferences and privileges senior to our current shareholders which mayadversely impact our current shareholders.

 

**Ourrecent results may not be indicative of our future results.**

 

Wemay not be able to sustain our historical rate of growth or may noteven be able to grow our business at all. In addition, our recent growthmay distort some of our historical financial ratios and statistics. In thefuture, we may not have the benefit of several recently favorable factors,a strong local business environment, and relationships with an extensive groupof equipment vendors and financial services companies. Various factors, such aseconomic conditions, regulatory and legislative considerations and competition,may also impede or prohibit our ability to grow.

 

**ITEM1B.              UNRESOLVED STAFF COMMENTS**

 

None.

 

**ITEM2.               PROPERTIES**

 

TheCorporation’s main office is located in Williamson County at 381 MalloryStation Road, Suite 207, Franklin, Tennessee 37067, which is also the mainoffice of the Bank.  This location is centrally located and in a hightraffic/exposure area. The Bank leases 34,956 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 also operatesloan production offices located at One Chase Corporate Center, Suite 400,Birmingham, Alabama 35244, at 7900 International Drive, Suite 200,Bloomington, Minnesota 55425 and at 125 TownPark Drive, Suite 300,Kennesaw, Georgia 30144. Allthree loan production office facilities are leased.

 

**ITEM3.               LEGAL PROCEEDINGS**

 

TheCorporation is party to proceedings arising from the May 6, 2008termination of its former Chief Financial Officer, George Fort. Thoseproceedings include a complaint filed by Mr. Fort under the Sarbanes-OxleyAct of 2002 (“SOX”) with the United States Department of Labor (the “SOXComplaint”) and a lawsuit styled *George Fort v. TennesseeCommerce Bancorp, Inc. and Tennessee Commerce Bank* (Case No. 3:08-cv-0668),filed on July 9, 2008 in the United States District Court for the MiddleDistrict of Tennessee (the “Federal Litigation”).

 

In theSOX Complaint, Mr. Fort alleges that his March 7, 2008 placement onadministrative leave and his subsequent termination on May 6, 2008 were inretaliation for his raising various alleged weaknesses in the Company’sinternal controls to the Audit Committee of the Company’s Board of Directors.In the Federal Litigation, Mr. Fort alleges that his terminationconstituted a breach of his Employment Agreement (the “Employment Agreement”)with the Bank and retaliation under the Tennessee Public Protection Act and theFederal Deposit Insurance Corporation Improvement Act. Mr. Fort alsoasserts a claim for libel based upon certain press releases issued by theCompany in connection with his former employment. The Company has brought acounter-claim against Mr. Fort that he engaged in misfeasance andmalfeasance as the Company’s Chief Financial Officer, in breach of hisfiduciary duty as an officer of the Company under Tennessee law.

 

TheCompany denies any liability to Mr. Fort or violation of any law, contractor otherwise and intends to contest all matters brought by Mr. Fortvigorously. In summary, the Company maintains that (i) Mr. Fort didnot engage in protected activity, because his report did not involve any of thespecific activities enumerated in Section 806 of SOX, (ii) it placed Mr. Forton administrative leave so that he could focus his attention on addressing theissues he raised to the Audit Committee after he refused to participate in goodfaith in such efforts and (iii) Mr. Fort grossly neglected his dutiesin the implementation of the Company’s SOX program based on reports fromexternal auditors that revealed that, despite Mr. Fort’s assurances thatSOX implementation was “on track,” it was not. The Company further maintainsthat the terms of the Employment Agreement created an at-will employmentrelationship as a matter of law and that, regardless, Mr. Fort’s grossneglect of his duties constituted cause for termination under the EmploymentAgreement.

 

**ITEM4.               SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Nomatter was submitted to a vote of security holders during the fourth quarter of2008 through the solicitation of proxies or otherwise.

 

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**PART II**

 

**ITEM5.               MARKET FOR REGISTRANT’SCOMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITYSECURITIES**

 

TheCorporation’s common stock has been listed on The NASDAQ Global Market since June 2006.Prior to that,  it was traded on theOver-The-Counter Bulletin Board from December 16, 2005, and prior to thattime, it was not traded through an organized exchange. The number ofshareholders of record at March 14, 2009, was 411. The table below showsthe quarterly range of high and low sale prices for our common stock during thefiscal years 2008 and 2007. These sale prices represent known transactions anddo not necessarily represent all trading transactions for the periods.

 
| **Year** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------|------------|----------------|------------|----------|------------|---------|------------|
|     |       |           |       |     |       |    |       |
| 2007:    |       | First Quarter  |       | $        | 31.25      |    | $          | 26.89 |   |
|     |       | Second Quarter |       | $        | 30.47      |    | $          | 23.32 |   |
|     |       | Third Quarter  |       | $        | 28.50      |    | $          | 21.01 |   |
|     |       | Fourth Quarter |       | $        | 27.10      |    | $          | 18.70 |   |
| 2008:    |       | First Quarter  |       | $        | 26.23      |    | $          | 13.72 |   |
|     |       | Second Quarter |       | $        | 19.94      |    | $          | 15.67 |   |
|     |       | Third Quarter  |       | $        | 17.25      |    | $          | 10.35 |   |
|     |       | Fourth Quarter |       | $        | 14.48      |    | $          | 5.00 |   |

 

**Dividends**

 

TheCorporation has never declared or paid dividends on its common stock. Thepayment of cash dividends is subject to the discretion of the Board ofDirectors, the Bank’s ability to pay dividends and the priority of holders ofthe Corporation’s subordinated debentures and Series A PreferredStock.  The Bank’s ability to pay dividends is restricted by applicableregulatory requirements. For more information on these restrictions, see ITEM 1“BUSINESS – Supervision and Regulation – Payment of Dividends” of thisAnnual Report on Form 10-K.  Noassurances can be given that any dividend will be declared or, if declared,what the amount of such dividend would be or whether such dividends wouldcontinue in the future.

 

**RecentSales of Unregistered Securities**

 

During2008, an employee of the Bank exercised options to purchase 7,500 shares ofCorporation common stock in one transaction, at an exercise price of $5.00 pershare for an aggregate price of $37,500. The Corporation issued these shares ofour common stock in reliance upon the exemption from the registrationrequirements of the Securities 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.

 

**Purchasesof Equity Securities by the Registrant and Affiliated Purchasers**

 

TheCorporation made no repurchases of its equity securities, and no AffiliatedPurchasers (as defined in Rule 10b-18(a)(3) under the SecuritiesExchange Act of 1934) purchased any shares of the Corporation’s equitysecurities during the fourth quarter of the fiscal year ended December 31,2008.

 

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

 

Thefollowing selected financial data for the years ended December 31, 2008,2007, 2006, 2005 and 2004 should be read in conjunction with the financialstatements included in Item 8 of this Annual Report on Form 10-K:

 
|                                                            | ** ** | **2008**                                                              | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                                                      | ** ** | **(Dollars in thousands except share data)** | ** ** |
| **Operating  Data:**                                            |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Total interest  income                                          |       | $                                                                     | 75,978     |     | $          | 62,206   |       | $        | 41,245     |     | $          | 23,633 |   | $ | 13,185 |   |
| Total interest  expense                                         |       | 41,027                                                                |       | 34,934   |       | 21,868   |       | 10,006   |       | 4,265    |       |
| Net interest  income                                            |       | 34,951                                                                |       | 27,272   |       | 19,377   |       | 13,627   |       | 8,920    |       |
| Provision for  loan losses                                      |       | (9,111                                                                | )          | (6,350   | )          | (4,350   | )          | (3,700   | )          | (2,420   | )          |
| Net interest  income after provision for loan losses            |       | 25,840                                                                |       | 20,922   |       | 15,027   |       | 9,927    |       | 6,500    |       |
| Non-interest  income:                                           |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Investment  securities gains                                    |       | 447                                                                   |       | 26       |       | —   |       | 4        |       | 33       |       |
| Gain on sale of  loans                                          |       | 3,750                                                                 |       | 2,687    |       | 2,025    |       | 1,106    |       | 504      |       |
| Other income                                                    |       | 97                                                                    |       | 167      |       | (262     | )          | 201      |       | 263      |       |
| Non-interest  expense                                           |       | (17,608                                                               | )          | (13,263  | )          | (9,056   | )          | (6,246   | )          | (4,552   | )          |
| Income before  income taxes                                     |       | 12,526                                                                |       | 10,539   |       | 7,734    |       | 4,992    |       | 2,748    |       |
| Income tax  expense                                             |       | (4,772                                                                | )          | (3,643   | )          | (2,985   | )          | (1,925   | )          | (1,082   | )          |
| Net income                                                      |       | $                                                                     | 7,754      |     | $          | 6,896    |       | $        | 4,749      |     | $          | 3,067 |   | $ | 1,666 |   |
|                                                            |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Per  Share Data :**                                           |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Net income,  basic                                              |       | $                                                                     | 1.64       |     | $          | 1.49     |       | $        | 1.24       |     | $          | 0.95 |   | $ | 0.57 |   |
| Net income,  diluted                                            |       | $                                                                     | 1.60       |     | $          | 1.41     |       | $        | 1.14       |     | $          | 0.87 |   | $ | 0.53 |   |
| Book value                                                      |       | $                                                                     | 21.50      |     | $          | 13.36    |       | $        | 11.51      |     | $          | 8.16 |   | $ | 7.29 |   |
|                                                            |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Financial  Condition Data:**                                  |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Assets                                                          |       | $                                                                     | 1,218,084  |     | $          | 900,153  |       | $        | 623,518    |     | $          | 404,040 |   | $ | 245,917 |   |
| Loans, net                                                      |       | 1,023,271                                                             |       | 784,001  |       | 538,550  |       | 344,187  |       | 213,326  |       |
| Investments                                                     |       | 101,290                                                               |       | 73,753   |       | 56,943   |       | 31,992   |       | 18,690   |       |
| Cash and due  from financial institutions                       |       | 5,260                                                                 |       | 5,236    |       | 177      |       | 6,877    |       | 3,838    |       |
| Federal funds  sold                                             |       | 35,538                                                                |       | 9,573    |       | 13,820   |       | 12,535   |       | 6,582    |       |
| Premises and  equipment, net                                    |       | 2,330                                                                 |       | 1,413    |       | 1,633    |       | 769      |       | 609      |       |
| Deposits                                                        |       | 1,069,143                                                             |       | 815,053  |       | 560,567  |       | 367,705  |       | 221,394  |       |
| Federal funds  purchased                                        |       | —                                                                |       | 2,000    |       | —   |       | —   |       | —   |       |
| Long term debt                                                  |       | 23,198                                                                |       | 8,248    |       | 8,248    |       | 8,248    |       | —   |       |
| Other  liabilities                                              |       | 15,100                                                                |       | 11,592   |       | 3,479    |       | 1,657    |       | 923      |       |
| Shareholders’  equity                                      |       | 101,747                                                               |       | 63,121   |       | 51,224   |       | 26,430   |       | 23,600   |       |
|                                                            |       |                                                                  |       |     |       |     |       |     |       |     |       |
| **Selected  Ratios:**                                           |       |                                                                  |       |     |       |     |       |     |       |     |       |
| Overhead ratio  (1)                                             |       | 1.52                                                                  | %          | 1.76     | %          | 1.80     | %          | 1.98     | %          | 2.26     | %          |
| Efficiency ratio  (2)                                           |       | 44.87                                                                 | %          | 43.99    | %          | 42.84    | %          | 41.81    | %          | 46.83    | %          |
| Net yield on  earning assets                                    |       | 7.45                                                                  | %          | 8.50     | %          | 8.46     | %          | 7.70     | %          | 6.74     | %          |
| Cost of funds                                                   |       | 4.16                                                                  | %          | 5.18     | %          | 4.94     | %          | 3.66     | %          | 2.54     | %          |
| Net Interest  margin                                            |       | 3.43                                                                  | %          | 3.72     | %          | 3.98     | %          | 4.44     | %          | 4.56     | %          |
| Operating  expenses to average earning assets                   |       | 1.73                                                                  | %          | 1.81     | %          | 1.86     | %          | 2.03     | %          | 2.33     | %          |
| Return on  average assets                                       |       | 0.73                                                                  | %          | 0.91     | %          | 0.95     | %          | 0.97     | %          | 0.83     | %          |
| Return on average  equity                                       |       | 11.34                                                                 | %          | 12.13    | %          | 12.68    | %          | 12.29    | %          | 8.92     | %          |
| Average equity  to average assets                               |       | 6.48                                                                  | %          | 7.53     | %          | 7.46     | %          | 7.90     | %          | 9.28     | %          |
| Ratio of  nonperforming assets to average assets                |       | 3.42                                                                  | %          | 1.14     | %          | 0.94     | %          | 1.40     | %          | 1.90     | %          |
| Ratio of  allowance for loan losses to average assets           |       | 1.27                                                                  | %          | 1.37     | %          | 1.39     | %          | 1.39     | %          | 1.41     | %          |
| Ratio of  allowance for loan losses to nonperforming assets (3) |       | 37.21                                                                 | %          | 119.94   | %          | 146.91   | %          | 99.43    | %          | 74.45    | %          |

 

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(1) Operatingexpenses divided by average assets.

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

(3) Nonperformingassets are made up of non-accruing loans, accruing loans 90 days past due andother real estate owned.

 

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

 

**Forward-LookingStatements**

 

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,” “target,” “predict,” “should,”or future or conditional verb tenses and variations or negatives of suchterms. These forward-looking statements include, without limitation, thoserelating to our operating results and financial condition, our earning asssetsratio, recent developments in the financial services industry, vesting of stock-basedawards, recently adopted accounting standards, fair value measurements,allowance for loan losses, asset quality, Business Bank strategy, management’sreview of the loan portfolio, loan classifications, loan commitments, interestrate risk, economic value of equity model, loan sale transactions, fluctuationsin non-interest income, tax rates, liquidity, inflation, legislative andregulatory changes affecting banks or bank holding companies, FDIC insurancepremiums, monetary policies of the Federal Reserve, rate sensitivity gapanalysis, maturities of debt securities, growth of our market area, the impactof the economic environment, competition for loans, non-interest income,revenue provided by our mortgage unit, hiring of employees, ratio of earning assetsto total assets, cost of funds, loan loss reserve, capital adequacy, netinterest margin, cash flows, lease payments, tax benefits and credits, internalcontrol over financial reporting and our future growth and profitability. Wecaution you not to place undue reliance on the forward-looking statementscontained in this report because actual results could differ materially fromthose indicated in such forward-looking statements as a result of a variety offactors. These factors include, but are not limited to, changes in economicconditions, competition for loans, mortgages and other financial services andproducts, changes in interest rates, concentrations within our loan portfolio,our ability to maintain credit quality, the effectiveness of our risk monitoringsystems, changes in consumer preferences, the ability of our borrowers to repayloans, the availability of and costs associated with maintaining and/orobtaining adequate and timely sources of liquidity, changes in our operatingstrategy, our ability to meet regulatory capital adequacy requirements, ourability to collect amounts due under loan agreements and to attract deposits,our ability to attract, train and retain qualified personnel, the geographicconcentration of our assets, our ability to operate and integrate newtechnology, our ability to provide market competitive products and services,our ability to diversify revenue, our ability to fund growth with lower costliabilities, laws and regulations affecting financial institutions in generaland other factors detailed from time to time in our press releases and filingswith the Securities and Exchange Commission. We undertake no obligation toupdate these forward-looking statements to reflect the occurrence of changes orunanticipated events, circumstances or results that occur after the date ofthis report.

 

**Overview**

 

**(Dollarsin thousands except share data in this Item 7.)**

 

Theresults of operations for the year 2008 compared to 2007 reflected a 12.44%increase in net income and a 13.48% increase in diluted earnings pershare.  The increase in earnings resulted primarily from a 28.16% increasein net interest income because of higher average loan balances.  The netinterest margin for 2008 was 3.43%. The increased revenue was partially offsetby increases in non-interest expense and the provision for loan losses. The year 2008 reflected a continuation of the Bank’s trend of rapid assetgrowth, increasing by $317,931 or 35.32% from $900,153 at December 31,2007 to $1,218,084 at December 31, 2008. Net loans increased by 30.52% or$239,270 from December 31, 2007 to December 31, 2008, while totaldeposits increased by 31.17% or $254,090 during that same period.

 

TheCorporation’s growth in assets was a result of growth in the market area and effectivemarketing. The improvement in results including net income and earnings pershare was a result of the business focus of the Bank. From 2000 to 2008, theBank’s market area experienced explosive growth. In Williamson County,demographic information shows a 34.75% growth in the number of households from2000 to 2008.  Estimates from SNL Financial LC show that by 2013 thenumber of households in this county will have grown by another 21.89%. Althoughestimates of growth are not guaranteed and actual growth may be affected byfactors beyond the Corporation’s control, management believes that theprojected growth of the Bank’s market area will positively impact the Bank’sfuture growth.

 

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TheBank has also grown by marketing to business owners that have been left withouta long standing banking relationship. The Middle Tennessee area has experiencedseveral bank mergers or acquisitions in the last ten years resulting in thetermination of many long standing relationships. These acquisitions alsoresulted in loan funding decisions being made out-of-state, creatingunpredictability 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 positively impactresults from operations.

 

TheBusiness Bank operating strategy has enabled management to focus on managingresults. Rather than focusing on building a multi-branch infrastructureincluding hiring and construction of buildings, management focuses on managingnet interest margin aggressively and controlling non-interest expense. This hasresulted in a 1.13% decrease in the net interest margin from 2004 to 2008.Non-interest expense is controlled by efficiently staffing the Bank’soperations. In 2008, that resulted in $14.7 in assets per employee at year end.Management believes that the Business Bank operating strategy will continue tobe an effective model in the future.

 

**Changesin Results of Operations**

 

**Net Income** - Net income for 2008 was $7,754, an increase of$858, or 12.44%, compared to $6,896 for 2007. The increase was primarilyattributable to a 28.16% increase in net interest income from $27,272 in 2007to $34,951 in 2008. The increase of $7,679 in net interest income was theresult of higher average loan balances. Non-interest income increased by $1,414from $2,880 to $4,294, or 49.10%, primarily a result of gains on loan sales.These positive effects were partially offset by a 43.48% increase in theprovision for loan losses, from $6,350 in 2007 to $9,111 in 2008, and anincrease of $4,345 in non-interest expense, up 32.76% to $17,608 in 2008compared to $13,263 in 2007. The increase in the provision for loan losses wasthe result of funding the loan loss reserve to match the growth in the loan portfolioand loan charge-offs. The increase in non-interest expense was a result of theincrease in personnel and general operating expenses attributable to theCorporation’s growth.

 

Netincome for 2007 was $6,896, an increase of $2,147, or 45.21%, compared to the$4,749 earned in 2006. The increase was attributable to a 40.74% increase innet interest income from $19,377 in 2006 to $27,272 in 2007. The increase of$7,895 in net interest income was the result of higher average loan balances.Non-interest income increased by $1,117, from $1,763 to $2,880, or 63.36%,primarily a result of gains on loan sales. These positive effects werepartially offset by a 45.98% increase in the provision for loan losses, from$4,350 in 2006 to $6,350 in 2007, and an increase of $4,207 in non-interestexpense, up 46.46% to $13,263 in 2007 compared to $9,056 in 2006. The increasein the provision for loan losses was the result of funding the loan lossreserve to match the growth in the loan portfolio and loan charge-offs. Theincrease in non-interest expense was a result of the increase in personnel andgeneral operating expenses attributable to the Corporation’s growth.

 

**Net Interest Income** - The primary source of earnings for the Bank is netinterest income, which is the difference between the interest earned oninterest earning assets and the interest paid on interest bearingliabilities.  The major factors which affect net interest income arechanges in volumes and yield on earning assets as well as the volumes and thecost of interest bearing liabilities.  Management’s ability to respond tochanges in interest rates by effective asset-liability management techniques iscritical to maintaining the stability of the net interest margin and themomentum of the Bank’s primary source of earnings.

 

During2008, the Federal Reserve Open Market Committee (“FOMC”) decreased short-terminterest rates by 400 basis points. During 2008, $52,293 of the Corporation’snet loan growth occurred in floating rate construction loans and approximately39.46% of the $132,520 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.

 

Netinterest income for 2008 was $34,951 compared to $27,272 for 2007, a gain of$7,679 or 28.16%. The increase in net interest income was largely attributableto strong loan growth. Net loans increased from $784,001 at December 31,2007 to $1,023,271 at December 31, 2008, an increase of $239,270 or30.52%.  Net interest income was favorably impacted by the increase in theBank’s indirect funding program for small transactions. These loans, which arepurchased at a minimum rate of 8%, increased from $153,140 at year-end 2007 to $173,438at the end of 2008. The loan growth was matched by an increase in deposits from$815,053 at December 31, 2007 to $1,069,143 in 2008, an increase of$254,090 or 31.17%.

 

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Netinterest income for 2007 was $27,272 compared to $19,377, a gain of $7,895 or40.74%. The increase in net interest income was largely attributable to strongloan 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 by the increase in the Bank’sindirect funding program for small transactions. These loans, which are purchasedat a minimum rate of 8%, increased from $113,400 at year-end 2006 to $153,100at the end of 2007. The loan growth was matched by an increase in deposits from$560,567 at December 31, 2006 to $815,053 in 2007, an increase of $254,486or 45.40%.

 

**Investments** - The Bank views the investment portfolio as a sourceof income and liquidity. Management’s investment strategy is to accept a lowerimmediate yield in the investment portfolio by targeting shorter terminvestments.   The Bank’s investment policy requires a minimumportfolio level equal to 7% of total assets and a maximum portfolio level of20% of total assets.  Management has maintained the portfolio at the lowerend of the policy guidelines with the portfolio at 8.32%, 8.19% and 9.13% of totalassets at year-end in 2008, 2007 and 2006, respectively.

 

Theinvestment portfolio at December 31, 2008 was $101,290 compared to $73,753at year-end 2007. The interest earned on investments rose from $3,492 in 2007to $4,717 in 2008, as a result of higher average portfolio balances as well asincreased yields. The average yield on the investment portfolio investmentsrose from 5.43% in 2007 to 5.59% in 2008, or 16 basis points.

 

Theinvestment portfolio at December 31, 2007 was $73,753, compared to $56,943at year-end 2006. The average yield on the investment portfolio was 5.43%in 2007 compared to 4.91% in 2006.

 

**Net Interest Margin Analysis** - The net interest margin is impacted bythe average volumes of interest sensitive assets and interest sensitive liabilitiesand by the difference between the yield on interest sensitive assets and thecost of interest sensitive liabilities (spread).  Loan fees collected atorigination represent an additional adjustment to the yield on loans. The Bank’sspread can be affected by economic conditions, the competitive environment,loan demand and deposit flows.  The net yield on earning assets is anindicator of the effectiveness of a bank’s ability to manage the net interestmargin by managing the overall yield on assets and the cost of funding thoseassets.

 

Thetwo factors that make up the spread are the interest rates received on loansand the interest rates paid on deposits. The Bank has been disciplined inraising 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.

 

Thenet interest margin declined from 3.72% in 2007 to 3.43% in 2008 because theyield on earning assets decreased faster than the cost of funds, resulting in acompression on the yield on earning assets during 2008. Interest incomeincreased by $13,772, or 22.14%, from $62,206 in 2007 to $75,978 in 2008. Theincrease was primarily a result of increased loan volume. Average earningassets increased from $731,749 in 2007 to $1,019,887 in 2008, an increase of$288,138 or 39.38%. The increase in earning assets was a result of loan growth.Average loans increased $272,298 or 41.50% from 2007 to 2008. The average yieldon earning assets decreased from 8.50% in 2007 to 7.45% in 2008, or 105 basispoints. The decrease in the Bank’s federal funds sold unfavorably impacted theaverage yield on earning assets. The average yield on this type of asset in2008 was 2.17%. These federal funds sold decreased 36.98% from $11,701 atyear-end 2007 to $7,374 at the end of 2008.   Interest expenseincreased from $34,934 in 2007 to $41,027 in 2008. The $6,093, or 17.44%,increase in expense was a result of increases in the volume of deposits.Average deposits increased from $685,063 in 2007 to $949,005 in 2008, anincrease of $263,942 or 38.53%. The cost of funds decreased from 5.18% in 2007to 4.17% in 2008, or 101 basis points.

 

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Thenet interest margin declined from 3.98% in 2006 to 3.72% in 2007 because thecost of funds rose faster than the yield on earning assets during 2007. 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 loanvolume.  Average earning assets increased from $486,668 in 2006 to$731,749 in 2007, an increase of $245,081 or 50.36%. The increase in earningassets was a result of loan growth. Average loans increased $228,024 or 53.25%from 2006 to 2007.  The average yield on earning assets increased from8.46% in 2006 to 8.50% in 2007, or 4 basis points. The net interest margin wasfavorably impacted by the expansion of the Bank’s indirect funded small loanportfolio.  The average yield 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 theend of 2007.   Interest expense increased from $21,868 in 2006 to$34,934 in 2007. The $13,066, or 59.75%, increase in expense was a result ofincreases in the volume of deposits as well as an increase in the cost offunds. Average deposits increased from $451,235 in 2006 to $685,063 in 2007, anincrease of $233,828 or 51.82%. The cost of funds increased from 4.94% in 2006to 5.18% in 2007, or 24 basis points.

 

**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”credit, and RR4 designates an “Average” credit.  The assignment of a riskrating is based on an evaluation of the credit risk in the transaction.  Theevaluation includes consideration of the borrower’s financial capacity,collateral, cash flows, liquidity, and alternative sources of repayment. If a loan deteriorates and the level of risk increases, management downgradesthe loan to RR5–“Watch,” RR6–“Criticized,” or RR7–“Substandard,” depending onthe circumstances.  A review by an independent accounting firm of theassigned risk ratings is an integral part of the Bank’s external loan reviewprogram.

 

Managementreviews the loan portfolio regularly to determine if loans should be placed onnon-accrual for revenue recognition. If a loan is placed on non-accrual, allinterest earned since the last current payment is immediately reversed. Loans may remain on non-accrual status until the underlying collateral isrepossessed and valued or until the amount of loss in the credit can bereasonably determined.  Once collateral is repossessed and appraised, thecollateral is recorded as a repossession at the lower of fair value or theinvestment in the related loan.  Any difference between the estimated fairvalue of the collateral and the loan balance is charged off.  Variances infair value estimates are recorded as a gain or loss on sale when the collateralis sold.   Non-accrual loans totaled $11,603, $6,465 and $2,689 atyear-end 2008, 2007 and 2006, respectively.  These amounts represented1.13%, 0.82% and 0.50%, respectively, of net loans at the end of each year.

 

Managementuses the weighted average risk rating to monitor the overall credit quality andtrends in the loan portfolio. At December 31, 2008, the weighted averagerisk rating of the $1,023,271 net loan portfolio was 3.49. At December 31,2007, the weighted average risk rating of the $784,001 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 reviewsmonthly all credits classified RR5 or higher.  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, 2008, the loan lossreserve of $13,454 was 1.30% of gross loans of $1,036,725.

 

Theprovision for loan losses in 2008 was $9,111, an increase of $2,761, or 43.48%,above the provision of $6,350 expensed in 2007. Of this provision, $3,133, or34.39%, was attributable to loan growth recorded during 2008. The remainder ofthe loan loss provision in 2008 funded net charge-offs of $5,978.

 

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Theprovision 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 this provision, $3,353, or52.80%, was attributable to loan growth recorded during 2007. The remainder ofthe loan loss provision in 2007 funded net charge offs of $2,997.

 

TheBank targets small and medium sized businesses as loan customers. Because oftheir size, these borrowers may be less able to withstand competitive oreconomic pressures than larger borrowers in periods of economic weakness. Ifloan losses occur to a level where the loan loss reserve is not sufficient tocover actual loan losses, the Bank’s earnings will decrease. The Bank uses anindependent accounting firm to review its loans quarterly for quality inaddition to the reviews that may be conducted by bank regulatory agencies aspart of their usual examination process.

 

Thefollowing table presents information regarding non-accrual, past due andrestructured loans at December 31, 2008, 2007, 2006, 2005 and 2004:

 
| ** **                                                                                              | ** ** | **December 31,**                | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                              | ** ** | **2008**                             | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                              | ** ** | **(Dollars in thousands)** | ** ** |
| Non-accrual  loans                                                                                      |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                  |       | 188                                  |       | 130 |   | 60 |   | 46 |   | 17 |   |
| Amount                                                                                                  |       | $                                    | 11,603     |   | $ | 6,465 |   | $ | 2,689 |   | $ | 2,928 |   | $ | 2,161 |   |
|                                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Accruing loans  which are contractually past due 90 days or more as to principal and interest  payments |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                  |       | 51                                   |       | 44 |   | 18 |   | 9 |   | 4 |   |
| Amount (1)                                                                                              |       | $                                    | 18,788     |   | $ | 1,992 |   | $ | 940 |   | $ | 352 |   | $ | 111 |   |
|                                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Loans defined as  “troubled debt restructurings”                                              |       |                                 |       |   |   |   |   |   |   |   |   |
| Number                                                                                                  |       | 5                                    |       | 1 |   | 3 |   | 3 |   | 2 |   |
| Amount                                                                                                  |       | $                                    | 668        |   | $ | 148 |   | $ | 1,144 |   | $ | 1,144 |   | $ | 1,544 |   |
|                                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Gross interest income  lost on the non-accrual loans                                                    |       | $                                    | 870        |   | $ | 436 |   | $ | 174 |   | $ | 133 |   | $ | 82 |   |
|                                                                                                    |       |                                 |       |   |   |   |   |   |   |   |   |
| Interest income  included in net income on the accruing loans                                           |       | $                                    | 1,674      |   | $ | 605 |   | $ | 73 |   | $ | 31 |   | $ | 48 |   |

 

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(1)          Accruing loans that are contractuallypast due 90 days or more as to principal and interest payments are inflated by$16,500, because of three loans 92 days past due. Management has resolved thisissue in the first quarter of 2009. The ratio of allowance for loan losses tonon-performing assets, less these three loans, would have been 68.45% versusthe ratio of 37.21% reported in Item 6 of this Annual Report on Form 10-K.

 

As of December 31,2008, 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.

 

TheBank had no tax-exempt loans during the years ended December 31, 2008 and December 31,2007. The Bank had no loans outstanding to foreign borrowers at December 31,2008 and December 31, 2007.

 

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Ananalysis of the Bank’s loss experience is furnished in the following table for December 31,2008, 2007, 2006, 2005 and 2004, and the years then ended:

 
| ** **                                                                                  | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| **(Dollars in thousands)**                                                        | ** ** | **2008**              | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Allowance for  loan losses at beginning of period                                           |       | $                     | 10,321     |   | $ | 6,968 |   | $ | 4,399 |   | $ | 2,841 |   | $ | 2,000 |   |
| Charge-offs:                                                                                |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                                                                |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                                                                |       | 288                   |       | 32 |   | — |   | — |   | — |   |
| 1 to 4 family  residential                                                                  |       | 9                     |       | — |   | — |   | — |   | 101 |   |
| Other                                                                                       |       | 102                   |       | — |   | — |   | — |   | 131 |   |
| Commercial,  financial and agricultural                                                     |       | 5,620                 |       | 3,262 |   | 2,026 |   | 2,379 |   | 1,366 |   |
| Consumer                                                                                    |       | 80                    |       | 16 |   | 11 |   | 32 |   | 57 |   |
| Other                                                                                       |       | —                |       | — |   | — |   | — |   | — |   |
| Total  Charge-offs                                                                          |       | 6,099                 |       | 3,310 |   | 2,037 |   | 2,411 |   | 1,655 |   |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Recoveries:                                                                                 |       |                  |       |   |   |   |   |   |   |   |   |
| Real estate:                                                                                |       |                  |       |   |   |   |   |   |   |   |   |
| Construction                                                                                |       | —                |       | — |   | — |   | — |   | — |   |
| 1 to 4 family  residential                                                                  |       | —                |       | — |   | — |   | 1 |   | — |   |
| Other                                                                                       |       | —                |       | — |   | — |   | — |   | 3 |   |
| Commercial,  financial and agricultural                                                     |       | 118                   |       | 313 |   | 234 |   | 245 |   | 68 |   |
| Consumer                                                                                    |       | 3                     |       | — |   | 22 |   | 23 |   | 5 |   |
| Other                                                                                       |       | —                |       | — |   | — |   | — |   | — |   |
| Total Recoveries                                                                            |       | 121                   |       | 313 |   | 256 |   | 269 |   | 76 |   |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Net Charge-offs                                                                             |       | 5,978                 |       | 2,997 |   | 1,781 |   | 2,142 |   | 1,579 |   |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Provision for  loan losses charged to expense                                               |       | 9,111                 |       | 6,350 |   | 4,350 |   | 3,700 |   | 2,420 |   |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Allowance for  loan losses at end of period                                                 |       | $                     | 13,454     |   | $ | 10,321 |   | $ | 6,968 |   | $ | 4,399 |   | $ | 2,841 |   |
|                                                                                        |       |                  |       |   |   |   |   |   |   |   |   |
| Net charge-offs  as a percentage of average total loans outstanding during the year         |       | 0.64                  | %          | 0.45 | % | 0.41 | % | 0.76 | % | 0.89 | % |
| Ending allowance  for loan losses as a percentage of total loans outstanding at end of year |       | 1.30                  | %          | 1.30 | % | 1.28 | % | 1.26 | % | 1.31 | % |

 

Theallowance for loan losses is established by charges to operations based onmanagement’s evaluation of the loan portfolio, past due loan experience,collateral values, current economic conditions and other factors considerednecessary to maintain the allowance at an adequate level. Management believesthat the allowance was adequate at December 31, 2008.

 

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At December 31, 2008,2007, 2006, 2005 and 2004, the allowance for loan losses was allocated asfollows:

 
| ** **                              | ** ** | **2008**   | ** ** | **2007**                                                            | ** ** | **2006**   | ** ** | **2005**                                                            | ** ** | **2004**   | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------------------|------------|------------|------------|
| **(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                            |       | $          | 1,816      |                                                                | 17.52      | %          | $          | 1,132                                                               |       | 14.15      | %          | $ | 745 |   | 13.65 | % | $ | 383 |   | 10.98 | % | $ | 175 |   | 10.55 | % |
| 1 to 4 family  residential              |       | 384        |       | 3.65                                                                | %          | 335        |       | 4.22                                                                | %          | 229        |       | 4.19 | % | 225 |   | 5.27 | % | 75 |   | 7.38 | % |
| Other                                   |       | 1,919      |       | 16.51                                                               | %          | 1,440      |       | 18.13                                                               | %          | 840        |       | 15.40 | % | 504 |   | 14.45 | % | 265 |   | 15.59 | % |
| Commercial,  financial and agricultural |       | 8,766      |       | 56.86                                                               | %          | 7,130      |       | 60.14                                                               | %          | 5,048      |       | 64.89 | % | 3,197 |   | 67.11 | % | 2,272 |   | 64.68 | % |
| Consumer                                |       | 39         |       | 0.35                                                                | %          | 56         |       | 0.50                                                                | %          | 37         |       | 0.60 | % | 45 |   | 0.90 | % | 54 |   | 1.80 | % |
| Other                                   |       | 530        |       | 5.11                                                                | %          | 228        |       | 2.86                                                                | %          | 69         |       | 1.27 | % | 45 |   | 1.29 | % | — |   | 0.00 | % |
|                                    |       |       |       |                                                                |       |       |       |                                                                |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Total                                   |       | $          | 13,454     |                                                                | 100.00     | %          | $          | 10,321                                                              |       | 100.00     | %          | $ | 6,968 |   | 100.00 | % | $ | 4,399 |   | 100.00 | % | $ | 2,841 |   | 100.00 | % |

 

**Non-interest Income** - Non-interestincome is income that is not related to interest-earning assets.  In a typical retail bank, non-interest incomeconsists primarily of service charges and fees on deposit accounts and mortgageorigination fees.  Because of thebusiness focus of the Bank and its lack of a large retail customer base,revenues from these traditional sources will remain modest.

 

TheBank earned $31 in mortgage origination fees in 2008 compared to $76 earned in2007, a decline of $45 or 59.21%. The decline in mortgage loan demand andmortgage origination income was attributed to the disruption in the mortgagemarket in 2008. Management believes that in 2009 the mortgage unit will providea value-added service with modest revenue results.

 

TheBank earned $3,750 in 2008 on a series of loan sale transactions compared to$2,687 in 2007. In addition to lending in the local marketplace, the Bankprovides collateral-based loans to business borrowers in other states throughtwo types of indirect funding programs. Management has identified a network ofcommunity banks eager to purchase quality assets. Management has installedappropriate systems and processes to sell assets to other banks located inslower growing markets and believes that loan sales will be a recurring sourceof revenue.

 

In2007, the Bank earned $2,687 on a series of loan sale transactions.  The Bank earned $76 in mortgage originationfees in 2007 compared to $89 earned in 2006, a decline of $13 or 14.61%.  The decline in mortgage origination income wasattributed to rising interest rates in 2007.  Income earned in the form of service chargeson deposits totaled $132, a gain of $20, or 17.86% above the $112 earned in2006.  Gain on sales of securitiesincreased by $662 or 32.69% from $2,025 in 2006 to $2,687 in 2007.

 

**Non-interest Expense** - Non-interestexpense includes salaries and benefits expense, occupancy costs and otheroperating expenses including data processing, professional fees, supplies,postage, telephone and other items. Management views the control of operatingexpense as a critical element in the success of the Business Bank strategy.  The Bank operates more efficiently than mostpeer banks because it conducts business from a single location and does notprovide banking services for many retail customers with high transactionvolume.

 

Managementtargets $10,000 in assets per full-time employee as a measure of staffingefficiency. Management believes that the growth of the Bank will offeradditional opportunities to leverage personnel resources.  The Bank does not expect to hire employees in2009, so salaries and benefits expense may increase slightly, but the targetfor assets per employee will remain at $10,000.

 

Non-interestexpense for 2008 was $17,608, an increase of $4,345 or 32.76%, over the $13,263expensed in 2007. Approximately 28.38% of the increase was attributable to theincrease in professional fees (audit, legal, and accounting), and approximately25.85% of the increase was attributable to the addition of new employees duringthe year. The Bank ended 2008 with 83 full-time employees. Assets per employeewere $14,676 at year-end 2008 compared to $14,060 at year-end 2007.

 

Non-interestexpense for 2007 was $13,263, an increase of $4,207 or 46.46%, over the $9,056expensed in 2006. Approximately 70% of the increase was attributable to theaddition of new employees during the year. The Bank ended 2007 with 64full-time employees. Assets per employee were $14,060 at year-end 2007 comparedto $12,500 at year-end 2006.

 

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**Income Taxes** — The Corporation’seffective tax rate in 2008 was 38.10% compared to 34.57% in 2007 and 38.60% in2006. Management anticipates that tax rates in future years will approximatethe rates paid in 2008.

 

**Changes in Financial Condition**

 

**Assets -** Total assets at December 31,2008 were $1,218,084, an increase of $317,931 or 35.32%, over total assets of$900,153 at December 31, 2007. Average assets for 2008 were $1,055,859, anincrease of $300,605, or 39.80% over average assets in 2007. Loan growth wasthe primary reason for these increases. Year-end 2008 net loans were$1,023,271, up $239,270, or 30.52% over the year-end 2007 total net loans of$784,001.

 

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

 

TheBank’s Business Bank model of operation results in a higher level of earningassets than most peer banks.  Earningassets are defined as assets that earn interest income.  Earning assets include short-term investments,the investment portfolio and net loans.  The Bank maintains a relatively high level ofearning assets because few assets are allocated to facilities, cash anddue-from bank accounts used for transaction processing. Earning assets at December31, 2008 were $1,160,099, or 95.24% of total assets of $1,218,084. Earningassets at December 31, 2007 were $867,327, or 96.35% of total assets of$900,153.  Management targets an earningasset to total asset ratio of 97% or higher. This ratio is expected togenerally continue at these levels, although it may be affected by economicfactors beyond the Bank’s control.

 

**Liabilities -** The Bank relies onincreasing its deposit base to fund loan and other asset growth.  The Williamson County marketplace is highlycompetitive with 28 financial institutions and 91 banking facilities (as of June30, 2008). The Bank competes for local deposits by offering attractive productswith premium rates.  The Bank expects tohave a higher average cost of funds for local deposits than most competitorbanks because of its single location and lack of a branch network.  Management’s strategy is to offset the highercost of funding with a lower level of operating expense and firm pricingdiscipline for loan products.  The Bankhas promoted electronic banking services by providing them without charge andby offering in-bank customer training.

 

TheBank also obtains funding in the wholesale deposit market which is accessed bymeans of an electronic bulletin board.  This electronic market links banks and sellersof deposits to deposit purchasers such as credit unions, school districts, laborunions, and other organizations with excess liquidity.  Deposits may be raised in $99 or $100increments in maturities from 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 hasestablished policies and procedures to govern the acquisition of fundingthrough the wholesale market.  Wholesaledeposits are categorized as “Purchased Time Deposits” on the detail of depositsshown in this Item 7. Management may also, from time to time, engage theservices of a deposit broker to raise a block of funding at a specifiedmaturity date.

 

Totalaverage deposits in 2008 were $949,005, an increase of $263,942, or 38.53% overthe total average deposits of $685,063 in 2007. Average non-interest bearingdeposits increased by $2,097, or 9.87%, from $21,247 in 2007 to $23,344 in2008. Average savings deposits decreased by $724 from $7,255 in 2007 to $6,531in 2008. Average purchased deposits increased by $200,443, or 78.73%, from$254,611 in 2007 to $455,054 in 2008. The average rate paid on purchaseddeposits in 2008 was 4.50% compared to 5.28% in 2007. Purchased time depositfunding represented 47.95% of total funding in 2008 compared to 37.27% in 2007.

 

Totalaverage deposits in 2007 were $685,063, an increase of $233,828, or 51.82% overthe total average deposits of $451,235 in 2006. Average non-interest bearingdeposits increased by $2,922, or 15.95%, from $18,325 in 2006 to $21,247 in2007. 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 rate paid on purchaseddeposits in 2007 was 5.28% compared to 4.82% in 2006. Purchased time depositfunding represented 37.27% of total funding in 2007 compared to 33.96% in 2006.

 

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**Informationregarding the Corporation’s return on assets, return on equity and equity toasset ratio is located in Item 6 of this Annual Report on Form 10-K.**

 

**Loan Policy** - Lending activity isconducted under guidelines defined in the Bank’s Loan Policy.  The Loan Policy establishes guidelines foranalyzing financial transactions including an evaluation of a borrower’s credithistory, repayment capacity, collateral value, and cash flow.  Loans may be at a fixed or variable rate, withthe maximum maturity of fixed rate loans set at five years.

 

Alllending activities of the Bank are under the direct supervision and control ofthe Officers Loan Committee, the Executive Committee of the Board and, in somecases, the full Board of Directors. The Officers Loan Committee consists ofArthur F. Helf, Michael R. Sapp and H. Lamar Cox, and approves loans up to$1,000. The Executive Committee consists of Arthur F. Helf, Michael R. Sapp andH. Lamar Cox and two outside directors, and approves loans up to 15% of Tier ICapital. The full Board of Directors approves all loans above those limits. Thefull Board of Directors also approves loan authorizations, if any, for anyexecutive officer. The Bank’s established maximum loan volume to deposits is100%. The Executive Committee of the Board makes a monthly review of loans thatare 90 days or more past due and the full Board of Directors makes a quarterlyreview of loans that are 90 days or more past due.

 

Managementof the Bank periodically reviews the loan portfolio, particularly non-accrualand renegotiated loans.  The review mayresult in a determination that a loan should be placed on a non-accrual statusfor income recognition.  In addition, tothe extent that management identifies potential losses in the loan portfolio,it reduces the book value of such loans, through charge-offs, to theirestimated collectible value.  The Bank’spolicy is that accrual of interest is discontinued on a loan when management ofthe Bank determines that collection of interest is doubtful based onconsideration of economic and business factors affecting collection efforts.

 

When aloan is classified as non-accrual, any unpaid interest is reversed againstcurrent income.  Interest is included inincome thereafter only to the extent received in cash.  The loan remains in a non-accrualclassification until such time as the loan is brought current, when it may bereturned to accrual classification.  Whenprincipal or interest on a non-accrual loan is brought current, if inmanagement’s opinion future payments are questionable, the loan would remainclassified as non-accrual.  After anon-accrual or renegotiated loan is charged off, any subsequent payments ofeither interest or principal are applied first to any remaining balanceoutstanding, then to recoveries and lastly to income.

 

TheBank’s underwriting guidelines are applied to four major categories of loans,commercial and industrial, consumer, agricultural and real estate whichincludes residential, construction and development and certain other realestate loans.  The Bank requires its loanofficers and loan committee to consider the borrower’s character, the borrower’sfinancial condition, the economic environment in which the loan will be repaid,as well as, for commercial loans, the borrower’s management capability and theborrower’s industry. Before approving a loan, the loan officer or committeemust determine that the borrower is creditworthy, is a capable manager,understands the specific purpose of the loan, understands the source and planof repayment, and determine that the purpose, plan and source of repayment aswell as collateral are acceptable, reasonable and practical given the normalframework within which the borrower operates.

 

Themaintenance of an adequate loan loss reserve is one of the fundamental conceptsof risk management for every financial institution.  Management is responsible for ensuring thatcontrols are in place to monitor the adequacy of the loan loss reserve inaccordance with generally accepted accounting principles (“GAAP”), the Bank’sstated policies and procedures, and regulatory guidance.  Quantification of the level of reserve whichis prudently conservative, but not excessive, involves a high degree ofjudgment.

 

Management’sassessment of the adequacy of the loan loss reserve considers a wide range offactors including portfolio growth, mix, collateral and geographic diversity,and terms and structure.  Portfolioperformance trends, including past dues and charge-offs, are monitored closely. Management’s assessment includes acontinuing evaluation of current and expected market conditions and thepotential impact of economic events on borrowers.  Management’s assessment program is monitoredby an ongoing loan review program conducted by an independent accounting firmand periodic examinations by bank regulators.

 

Managementuses a variety of financial methods to quantify the level of the loan lossreserve.  At inception, each loantransaction is assigned a risk rating that ranges from “RR1—Excellent” to “RR4—Average.” The risk rating is determined by ananalysis of the borrower’s credit history and capacity, collateral, and cashflow.  The weighted average risk ratingof the portfolio provides an indication of overall risk and identifies trends.  The portfolio is additionally segmented byloan type, collateral, and purpose.  Loantransactions that have exhibited signs of increased risk are downgraded to a “Watch,”“Critical,” or “Substandard” classification, i.e., RR5, RR6 and RR7,respectively.  These loans are closelymonitored for rehabilitation or potential loss and the loan loss reserve isadjusted accordingly.

 

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It ismanagement’s intent to maintain a loan loss reserve that is adequate to absorbcurrent and estimated losses which are inherent in a loan portfolio.  The historical loss ratio (net charge-offs asa percentage of average loans) was 0.64%, 0.45% and 0.41% for the years ended December31, 2008, 2007 and 2006, respectively.  The year-end loan loss reserve as a percentageof the end of period loans was 1.30%, 1.30% and 1.28%, respectively, for thesame years.  Because of the commercialemphasis of the Bank’s operation, management has kept a reserve level in excessof historical results.

 

Theprovision for loan losses for 2008 was $9,111, an increase of $2,761 over the$6,350 provision for 2007.  In 2008,expenses reflected the impact of $5,978 in charge-offs during the year and theincremental provision required as a result of the $239,270 increase in loanvolume.

 

CreditRisk Management and Reserve for Loan Losses

 

Creditrisk and exposure to loss are inherent parts of the banking business.  Management seeks to manage and minimize theserisks through its loan and investment policies and loan review procedures.  Management establishes and continually reviewslending and investment criteria and approval procedures that it believesreflect the risk sensitive nature of the Bank.  The loan review procedures are set to monitoradherence to the established criteria and to ensure that on a continuing basissuch standards are enforced and maintained.  Management’s objective in establishing lendingand investment standards is to manage the risk of loss and provide for incomegeneration through pricing policies.

 

TheBank targets small- and medium-sized businesses as loan customers. Because oftheir size, these borrowers may be less able to withstand competitive oreconomic pressures than larger borrowers in periods of economic weakness. Ifloan losses occur to a level where the loan loss reserve is not sufficient tocover actual loan losses, the Bank’s earnings will decrease. The Bank uses anindependent accounting firm to review its loans for quality in addition to thereviews that may be conducted by bank regulatory agencies as part of theirusual examination process.

 

Managementregularly reviews the loan portfolio and determines the amount of loans to becharged-off.  In addition, managementconsiders such factors as the Bank’s previous loan loss experience, prevailingand anticipated economic conditions, industry concentrations and the overallquality of the loan portfolio. While management uses available information torecognize losses on loans and real estate owned, future additions to theallowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, asan integral part of their examination process, periodically review theallowances for losses on loans and real estate owned.  Such agencies may require the Bank torecognize additions to the allowances based on their judgments aboutinformation available at the time of their examinations.  In addition, any loan or portion thereof whichis classified as a “loss” by regulatory examiners is charged-off.

 

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**Financial Tables**

 

Thefinancial information below regarding the Corporation and the Bank should beread in conjunction with the Corporation’s financial statements included inItem 8 of this Annual Report on Form 10-K.

 

AverageBalance Sheets, Net Interest Income and Changes in Interest Income and InterestExpense

 

Thefollowing tables present the average yearly balances of each principal categoryof assets, liabilities and stockholders’ equity of the Corporation and theBank. The tables are presented on a taxable equivalent basis, as applicable.

 
| ** **                                       | ** ** | **12 Months Ended December 31, 2008** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                       | ** ** | **Average**                                                    | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(Dollars in thousands)**             | ** ** | **Balance**                                                    | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                       |       |                                                           |       |   |   |   |   |
|                                             |       |                                                           |       |   |   |   |   |
| Interest earning  assets                         |       |                                                           |       |   |   |   |   |
| Securities                                       |       |                                                           |       |   |   |   |   |
| Taxable (1)                                      |       | $                                                              | 84,005     |   | $ | 4,717 |   | 5.59 | % |
| Tax-exempt                                       |       | —                                                         |       | — |   | — |   |
| Total securities                                 |       | 84,005                                                         |       | 4,717 |   | 5.59 | % |
|                                             |       |                                                           |       |   |   |   |   |
| Loans (2) (3)                                    |       | 928,508                                                        |       | 71,101 |   | 7.66 | % |
| Federal funds  sold                              |       | 7,374                                                          |       | 160 |   | 2.17 | % |
| Total interest  earning assets                   |       | 1,019,887                                                      |       | 75,978 |   | 7.45 | % |
|                                             |       |                                                           |       |   |   |   |   |
| Non-interest  earning assets                     |       |                                                           |       |   |   |   |   |
| Cash and due  from banks                         |       | 3,732                                                          |       |   |   |   |   |
| Net fixed assets  and equipment                  |       | 1,918                                                          |       |   |   |   |   |
| Accrued interest  and other assets               |       | 30,322                                                         |       |   |   |   |   |
|                                             |       |                                                           |       |   |   |   |   |
| Total assets                                     |       | $                                                              | 1,055,859  |   |   |   |   |   |
|                                             |       |                                                           |       |   |   |   |   |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**   |       |                                                           |       |   |   |   |   |
|                                             |       |                                                           |       |   |   |   |   |
| Interest bearing  liabilities                    |       |                                                           |       |   |   |   |   |
| Deposits (other  than demand)                    |       | $                                                              | 925,661    |   | 39,271 |   | 4.24 | % |
| Federal funds  purchased                         |       | 10,380                                                         |       | 269 |   | 2.59 | % |
| Subordinated  debt                               |       | 25,268                                                         |       | 1,487 |   | 5.88 | % |
| Total interest  bearing liabilities              |       | 961,309                                                        |       | 41,027 |   | 4.27 | % |
|                                             |       |                                                           |       |   |   |   |   |
| Non-interest  bearing liabilities                |       |                                                           |       |   |   |   |   |
| Non-interest  bearing demand deposits            |       | 23,344                                                         |       |   |   |   |   |
| Other  liabilities                               |       | 2,825                                                          |       |   |   |   |   |
| Shareholders’  equity                       |       | 68,381                                                         |       |   |   |   |   |
|                                             |       |                                                           |       |   |   |   |   |
| Total  liabilities and shareholders’ equity |       | $                                                              | 1,055,859  |   |   |   |   |   |
|                                                  |            |                                                                |            |  |  |  |  |  |  |

 
| Net  interest spread |   | 3.18   | %      |
|----------------------|--------|--------|--------|
|                 |   |   |   |
| Net  interest margin |   | 3.43   | %      |

 

----

(1)   Unrealizedloss of $318 is excluded from yield calculation.

(2)   Non-accrualloans are included in average loan balances and loan fees of $5,730 areincluded in interest income.

(3)   Loansare presented net of allowance for loan loss.

 

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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.

 

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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.

 

Thefollowing tables outline the components of the net interest margin for theyears 2008, 2007 and 2006 and identify the impact of changes in volume andrate.

 

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| ** **                           | ** ** | **December 31, 2008 change from**               | ** ** |
|--------------------------------------|------------|---------------------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2007 as a result of:** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume**                                                          | ** ** | **Rate** | ** ** | **Total** | ** ** |
| Interest income                      |       |                                                                |       |   |   |   |   |
| Loans                                |       | $                                                                   | 21,654     |   | $ | (8,667 | ) | $ | 12,987 |   |
| Securities –  taxable           |       | 1,125                                                               |       | 100 |   | 1,225 |   |
| Federal funds  sold                  |       | (172                                                                | )          | (268 | ) | (440 | ) |
| Total interest  income               |       | 22,607                                                              |       | (8,835 | ) | 13,772 |   |
|                                 |       |                                                                |       |   |   |   |   |
| Interest expense                     |       |                                                                |       |   |   |   |   |
| Deposits (other  than demand)        |       | 11,854                                                              |       | (6,828 | ) | 5,026 |   |
| Federal funds  purchased             |       | 265                                                                 |       | (53 | ) | 212 |   |
| Subordinated  debt                   |       | 946                                                                 |       | (91 | ) | 855 |   |
|                                 |       |                                                                |       |   |   |   |   |
| Total interest  expense              |       | 13,065                                                              |       | (6,972 | ) | 6,093 |   |
|                                 |       |                                                                |       |   |   |   |   |
| Net interest  income                 |       | $                                                                   | 9,542      |   | $ | (1,863 | ) | $ | 7,679 |   |

 
| ** **                           | ** ** | **December 31, 2007 change from**                   | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **December 31, 2006 as** **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 |   |

 

Liabilityand Asset Management

 

Thematching of assets and liabilities may be analyzed by examining the extent towhich such assets and liabilities are “interest rate sensitive” and bymonitoring an institution’s interest rate sensitivity “gap.”  An asset orliability is said to be interest rate sensitive within a specific time periodif it will mature or reprice within that time period.  The interest ratesensitivity gap is defined as the difference between the dollar amount of ratesensitive assets re-pricing during a period and the volume of rate sensitiveliabilities re-pricing during the same period. A gap is considered positivewhen the amount of interest rate sensitive assets exceeds the amount ofinterest rate sensitive liabilities.  A gap is considered negative whenthe amount of interest rate sensitive liabilities exceeds the amount ofinterest rate sensitive assets.  During a period of rising interest rates,a negative gap would tend to adversely affect net interest income while apositive gap would tend to result in an increase in net interest income. During a period of falling interest rates, a negative gap would tend to resultin an increase in net interest income while a positive gap would tend toadversely affect net interest income.

 

TheBank’s Asset Liability and Investment Committee, which consists of theCorporation’s executive officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Coxand Frank Perez, is charged with monitoring the liquidity and funds position ofthe Bank.  The committee regularly reviews (a) the rate sensitivityposition on a three-month, six-month and one-year time horizon; (b) loansto deposit ratios; and (c) average maturity for certain categories ofliabilities.  The Bank operates an asset/liability management model. At December 31, 2008, the Bank had a negative cumulative re-pricing gapwithin one year of approximately $(138,952) or approximately 11.84% of totalyear-end earning assets. See Item 7A of this Annual Report on Form 10-Kfor additional information.

 

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Deposits

 

TheBank’s primary source of funds is interest-bearing deposits. The followingtables present the average amount of and average rate paid on each of thefollowing deposit categories for 2008, 2007 and 2006:

 
| ** **                            | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------|------------|
| ** **                            | ** ** | **2008**                                   | ** ** | **2007** | ** ** | **2006** | ** ** |
| ** **                            | ** ** | ** **                                 | ** ** | **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 |       | $                                          | 23,344     |   | — |   | $ | 21,247 |   | — |   | $ | 18,325 |   | — |   |
| Interest-bearing  demand deposits     |       | 6,517                                      |       | 0.74 | % | 6,659 |   | 3.36 | % | 5,119 |   | 3.64 | % |
| Money market  accounts                |       | 65,269                                     |       | 2.04 | % | 111,747 |   | 4.84 | % | 72,866 |   | 5.23 | % |
| Savings accounts                      |       | 6,531                                      |       | 2.71 | % | 7,255 |   | 2.66 | % | 12,678 |   | 2.67 | % |
| IRA accounts                          |       | 25,363                                     |       | 4.66 | % | 17,522 |   | 5.88 | % | 5,450 |   | 4.91 | % |
| Purchased time  deposits              |       | 455,054                                    |       | 4.50 | % | 254,611 |   | 5.28 | % | 192,064 |   | 4.82 | % |
| Time deposits                         |       | 366,926                                    |       | 4.37 | % | 266,022 |   | 5.29 | % | 144,733 |   | 5.09 | % |
| Total deposits                        |       | $                                          | 949,004    |   |   |   | $ | 685,063 |   |   |   | $ | 451,235 |   |   |   |

 

Thefollowing table indicates amount outstanding of time certificates of deposit of$100,000 or more and respective maturities as of December 31, 2008 (inthousands):

 
| ** **                     | ** ** | **2008**   | ** ** |
|--------------------------------|------------|------------|------------|
| ** **                     | ** ** | ** ** | ** ** |
| Three months or  less          |       | $          | 137,282    |   |
|                           |       |       |       |
| Over three  through six months |       | 133,615    |       |
|                           |       |       |       |
| Over six through  12 months    |       | 232,625    |       |
|                           |       |       |       |
| More than 12  months           |       | 57,432     |       |
| Total                          |       | $          | 560,954    |   |

 

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InvestmentPortfolio

 

The Bank’s investmentportfolio at December 31, 2008, 2007 and 2006 consisted of the following(dollars in thousands):

 
| ** **                     | ** ** | ** **    | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | **Estimated** | ** ** |
|--------------------------------|------------|---------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                     | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market**    | ** ** |
| ** **                     | ** ** | **Cost**      | ** ** | **Gain**       | ** ** | **Loss**       | ** ** | **Value**     | ** ** |
| As of December 31,  2008       |       |          |       |           |       |           |       |          |       |
| Securities  available for sale |       |          |       |           |       |           |       |          |       |
| U.S. Government  agencies      |       | $             | 94,049     |           | $          | 1,197          |       | $             | (51        | ) | $ | 95,195 |   |
| Mortgage-backed  securities    |       | —        |       | —         |       | —         |       | —        |       |
| Corporate debt  securities     |       | 730           |       | 2              |       | (82            | )          | 650           |       |
| Other                          |       | 5,217         |       | 228            |       | —         |       | 5,445         |       |
| Total                          |       | $             | 99,996     |           | $          | 1,427          |       | $             | (133       | ) | $ | 101,290 |   |
|                           |       |          |       |           |       |           |       |          |       |
| 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 |   |

 

Thefollowing table presents the estimated maturities and weighted average yieldsof investment securities of the Bank at December 31, 2008:

 
| ** **                                     | ** ** | ** **    | ** ** | **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              |       | —        |       | —        |       | —       | %          |
| Due after five  through ten years              |       | 26,957        |       | 27,191        |       | 5.07         | %          |
| Due after ten  years                           |       | 67,092        |       | 68,004        |       | 5.38         | %          |
| Total  obligations of U.S. Government agencies |       | 94,049        |       | 95,195        |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Mortgage-backed  securities                    |       | —        |       | —        |       | —       | %          |
|                                           |       |          |       |          |       |         |       |
| Corporate debt  securities                     |       |          |       |          |       |         |       |
| Due in one year  or less                       |       | —        |       | —        |       | —       |       |
| Due after one  through five years              |       | 730           |       | 650           |       | 4.71         | %          |
| Due after five  through ten years              |       | —        |       | —        |       | —       | %          |
| Due after ten  years                           |       | —        |       | —        |       | —       |       |
| Total corporate  debt securities               |       | 730           |       | 650           |       |         |       |
|                                           |       |          |       |          |       |         |       |
| Other securities                               |       | 5,217         |       | 5,445         |       | 10.38        | %          |
| Total securities  available for sale           |       | $             | 99,996     |          | $          | 101,290      |       |   |   |

 

The Bank owned notax-exempt securities during the period ended December 31, 2008.

 

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InvestmentPolicy

 

Theobjective of the Bank’s investment policy is to invest funds not otherwiseneeded to meet the loan demand of its market area to earn the maximum returnfor the Bank, yet still maintain sufficient liquidity to meet fluctuations inthe Bank’s loan demand and deposit structure.  In doing so, the Bank balances the market andcredit risks against the potential investment return, makes investmentscompatible with the pledge requirements of the Bank’s deposits of public funds,maintains compliance with regulatory investment requirements and assists thevarious public entities with their financing needs.  The asset liability and investment committeehas full authority over the investment portfolio and makes decisions on purchasesand sales of securities.  The entireportfolio, along with all investment transactions occurring since the previousBoard of Director’s meeting, is reviewed by the Board at each monthly meeting.  The investment policy allows portfolioholdings to include short-term securities purchased to provide the Bank’sneeded liquidity and longer term securities purchased to generate level incomefor the Bank over periods of interest rate fluctuations.

 

LoanPortfolio

 

TheBank had net loans of $1,023,271 at December 31, 2008.  As the loan portfolio is concentrated inDavidson County and Williamson County, there is a risk that the borrowers’ability to repay the loans could be affected by changes in local economicconditions. The following schedule details the loans of the Bank at December 31,2008, 2007, 2006, 2005 and 2004:

 
| **(Dollars  in thousands)**             | ** ** | **2008**  | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|-----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| Real estate                             |       |      |       |     |       |     |       |     |       |     |       |
| Construction                            |       | $         | 181,638    |     | $          | 112,405  |       | $        | 74,482     |     | $          | 38,279 |   | $ | 22,813 |   |
| 1 to 4 family  residential              |       | 37,822    |       | 33,560   |       | 22,873   |       | 18,358   |       | 15,963   |       |
| Other                                   |       | 171,150   |       | 143,973  |       | 83,985   |       | 50,371   |       | 33,694   |       |
| Commercial,  financial and agricultural |       | 589,518   |       | 477,666  |       | 353,996  |       | 233,948  |       | 139,799  |       |
| Consumer                                |       | 3,572     |       | 3,966    |       | 3,246    |       | 3,149    |       | 3,898    |       |
| Other                                   |       | 53,025    |       | 22,752   |       | 6,936    |       | 4,481    |       | —   |       |
|                                    |       |      |       |     |       |     |       |     |       |     |       |
| Total loans                             |       | 1,036,725 |       | 794,322  |       | 545,518  |       | 348,586  |       | 216,167  |       |
| Less: allowance  for loan losses        |       | (13,454   | )          | (10,321  | )          | (6,968   | )          | (4,399   | )          | (2,841   | )          |
|                                    |       |      |       |     |       |     |       |     |       |     |       |
| Net loans                               |       | $         | 1,023,271  |     | $          | 784,001  |       | $        | 538,550    |     | $          | 344,187 |   | $ | 213,326 |   |

 

Thefollowing table reflects the composition of loan portfolio by type:

 
| ** **                              | ** ** | **As of December 31,** | ** ** |
|-----------------------------------------|------------|------------------------|------------|
| **(Dollars  in thousands)**             | ** ** | **2008**               | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
| Real estate:                            |       |                   |       |   |   |   |   |   |   |   |   |
| Construction                            |       | 17.52                  | %          | 14.15 | % | 13.65 | % | 10.98 | % | 10.55 | % |
| 1 to 4 family  residential              |       | 3.65                   | %          | 4.22 | % | 4.19 | % | 5.27 | % | 7.38 | % |
| Other                                   |       | 16.51                  | %          | 18.13 | % | 15.40 | % | 14.45 | % | 15.59 | % |
| Commercial,  financial and agricultural |       | 56.86                  | %          | 60.14 | % | 64.89 | % | 67.11 | % | 64.68 | % |
| Consumer                                |       | 0.34                   | %          | 0.50 | % | 0.60 | % | 0.90 | % | 1.80 | % |
| Other                                   |       | 5.12                   | %          | 2.86 | % | 1.27 | % | 1.29 | % | 0.00 | % |
| Total                                   |       | 100                    | %          | 100 | % | 100 | % | 100 | % | 100 | % |

 

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Thefollowing table reflects the composition of commercial loan portfolio bysourcing program type:

 
| ** **                               | ** ** | **As of  December 31,** | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2008**                | ** ** | **2007** | ** ** | **2006** | ** ** |
| **(Dollars  in thousands)**              | ** ** | **Amount**              | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** | **Amount** | ** ** | **%** | ** ** |
| Commercial,  financial and agricultural: |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Direct                                   |       | $                       | 267,542    |   | 45.38 | % | $ | 193,943 |   | 40.60 | % | $ | 151,692 |   | 42.85 | % |
| Indirect                                 |       |                    |       |   |   |   |   |   |   |   |   |   |   |
| Large                                    |       | 148,538                 |       | 25.20 | % | 130,583 |   | 27.34 | % | 88,569 |   | 25.02 | % |
| Small                                    |       | 173,438                 |       | 29.42 | % | 153,140 |   | 32.06 | % | 113,735 |   | 32.13 | % |
| Total                                    |       | $                       | 589,518    |   | 100.00 | % | $ | 477,666 |   | 100.00 | % | $ | 353,996 |   | 100.00 | % |

 

Thefollowing table details maturities and sensitivity to interest rates changesfor loans of the Bank at December 31, 2008:

 
| ** **                              | ** ** | **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                            |       | $                          | 87,631     |           | $          | 75,535        |       | $          | 18,472     |   | $ | 181,638 |   |
| 1 to 4 family  residential              |       | 9,374                      |       | 23,436         |       | 5,012         |       | 37,822     |       |
| Other                                   |       | 47,058                     |       | 117,646        |       | 6,446         |       | 171,150    |       |
| Commercial,  financial and agricultural |       | 134,932                    |       | 433,966        |       | 20,620        |       | 589,518    |       |
| Consumer                                |       | 1,371                      |       | 2,201          |       | —        |       | 3,572      |       |
| Other                                   |       | —                     |       | —         |       | 53,025        |       | 53,025     |       |
| Total                                   |       | $                          | 280,366    |           | $          | 652,784       |       | $          | 103,575    |   | $ | 1,036,725 |   |
|                                    |       |                       |       |           |       |          |       |       |       |
| Less: allowance  for loan loss          |       |                       |       |           |       |          |       | (13,454    | )          |
|                                    |       |                       |       |           |       |          |       |       |       |
| Net loans                               |       |                       |       |           |       |          |       | $          | 1,023,271  |   |
|                                    |       |                       |       |           |       |          |       |       |       |
| Interest rate  sensitivity:             |       |                       |       |           |       |          |       |       |       |
| Fixed interest  rates                   |       | 84,141                     |       | 619,153        |       | 20,842        |       | 724,136    |       |
| Floating or  adjustable rates           |       | 196,225                    |       | 33,631         |       | 82,733        |       | 312,589    |       |
|                                    |       |                       |       |           |       |          |       |       |       |
| Total                                   |       | $                          | 280,366    |           | $          | 652,784       |       | $          | 103,575    |   | $ | 1,036,725 |   |

 

----

(1) Includes non-accrualloans.

 

**CapitalResources / Liquidity**

 

**Liquidity**

 

Ofprimary importance to depositors, creditors and regulators is the ability tohave readily available funds sufficient to repay fully maturing liabilities.  The Bank’s liquidity, represented by cash andcash due from banks, is a result of its operating, investing and financingactivities.  In order to ensure funds areavailable 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.  Liquidity requirements can also be met throughshort-term borrowings or the disposition of short-term assets which aregenerally matched to correspond to the maturity of liabilities.

 

Althoughthe Bank has no formal liquidity policy, in the opinion of management, itsliquidity levels are considered adequate. The Bank is subject to general FDIC guidelines which do not require aminimum level of liquidity.  Managementbelieves its liquidity ratios meet or exceed these guidelines.  Management does not know of any trends ordemands that are reasonably likely to result in liquidity increasing ordecreasing in any material manner.

 

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**Impact of Inflation and Changing Prices**

 

Thefinancial statements and related financial data presented herein have beenprepared in accordance with GAAP which require the measurement of financialposition and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time anda result of inflation.  The impact ofinflation on operations of the Bank is reflected in increased operating costs.  Unlike most industrial companies, virtuallyall of the assets and liabilities of the Bank are monetary in nature.  As a result, interest rates have a moresignificant impact on the Bank’s performance than the effects of general levelsof inflation.  Interest rates do notnecessarily move in the same direction or in the same magnitude as the price ofgoods and services.

 

**CapitalAdequacy**

 

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

 

Theobjective of the Bank’s management is to maintain a level of capitalizationthat is sufficient to take advantage of profitable growth opportunities whilemeeting regulatory requirements including remaining well capitalized. This isachieved by improving profitability through effectively allocating resources tomore profitable businesses, improving asset quality, strengthening servicequality 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.

 

TheFederal Reserve Board has adopted capital guidelines governing the activitiesof 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 lower risk.  In addition, banks and bank holding companiesare required to maintain capital to support, on a risk-adjusted basis, certainoff-balance sheet activities such as loan commitments.

 

TheCorporation and the Bank are required to maintain certain capital ratios. Theseinclude Tier I, Total Capital and Leverage Ratios. Certain ratios for theCorporation and the Bank for 2008 and 2007 are set forth below:

 
| ** **              | ** ** | **Capital Level Meeting**        | ** ** | ** **      | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------|------------|----------------------------------|------------|-----------------|------------|------------|------------|------------|------------|------------|------------|
| ** **              | ** ** | **Regulatory Definition of**     | ** ** | **Corporation** | ** ** | **Bank**   | ** ** |
| ** **              | ** ** | **“Well Capitalized”** | ** ** | **2008**        | ** ** | **2007**   | ** ** | **2008**   | ** ** | **2007**   | ** ** |
| ** **              | ** ** | **(%)**                          | ** ** | **(%)**         | ** ** | **(%)**    | ** ** | **(%)**    | ** ** | **(%)**    | ** ** |
| Tier I Capital  Ratio   |       | 6.00                             |       | 11.20           |       | 8.55       |       | 9.79       |       | 9.26       |       |
|                    |       |                             |       |            |       |       |       |       |       |       |       |
| Total Risk-Based  Ratio |       | 10.00                            |       | 12.42           |       | 9.80       |       | 11.01      |       | 10.51      |       |
|                    |       |                             |       |            |       |       |       |       |       |       |       |
| Leverage Ratio          |       | 5.00                             |       | 10.63           |       | 8.09       |       | 9.26       |       | 8.75       |       |

 

Basedsolely on analysis of federal banking regulatory categories, it appears on December31, 2008 that the Corporation and the Bank fall within the “well capitalized”categories under the regulations.

 

**Off-BalanceSheet Arrangements**

 

TheBank is a party to financial instruments with off-balance sheet risk in thenormal course of business to meet the financing needs of its customers.  These financial instruments includecommitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees,elements of credit risk in excess of the amount recognized in the balancesheet.  The contract or notional amountsof those instruments reflect the extent of involvement the Bank has in thoseparticular financial instruments.

 

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TheBank’s exposure to credit loss in the event of nonperformance by the otherparty to the financial instrument is represented by the contractual or notionalamount of those instruments.  The Bankuses the same credit policies in making commitments and conditional obligationsas it does for on-balance sheet instruments.

 

Financial instruments forwhich contract amounts represented credit risk as of December 31:

 
| ** **                                          | ** ** | **2008**        | ** ** | **2007**           | ** ** | **2006**        | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|--------------------|------------|-----------------|------------|
| **(Dollars  in thousands)**                         | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** | **Fixed  Rate** | ** ** | **Variable  Rate** | ** ** |
|                                                |       |            |       |               |       |            |       |   |   |   |   |   |   |
| Commitments to  extend credit                       |       | $               | 39,529     |               | $          | 137,950         |       | $ | 18,380 |   | $ | 107,663 |   | $ | 9,601 |   | $ | 65,123 |   |
| Standby letters  of credit and financial guarantees |       | —          |       | 16,239             |       | —          |       | 11,063 |   | — |   | 5,776 |   |
|                                                     |            |                 |            |                    |            |                 |            |  |  |  |  |  |  |  |  |  |  |  |  |

 

Commitmentsto make loans are generally made for periods of one year or less.  The fixed rate loan commitments have interestrates ranging from 4% to 11% and maturities ranging from two months to fiveyears.

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established 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 toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements.  The Bank evaluates each customer’screditworthiness on a case-by-case basis.  The amount of collateral obtained if deemednecessary by 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.

 

Standbyletters of credit are conditional commitments issued by the Bank to guaranteethe performance of a customer to a third party.  Those guarantees are primarily issued tosupport public and private borrowing arrangements, including commercial paper,bond financing and similar transactions.  All letters of credit are due within one yearor less of the original commitment date.  The credit risk involved in issuing letters ofcredit is essentially the same as that involved in extending loan facilities tocustomers.

 

**ContractualObligations**

 

At December 31, 2008, the Bank had certain contractualobligations 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 |       | $                          | 93,380     |   | $ | 93,380 |   | $ | — |   | $ | — |   | $ | — |   |
| Certificates of  deposit            |       | 975,763                    |       | 879,620 |   | 91,621 |   | 4,522 |   | — |   |
| Subordinated  long term debt        |       | 23,198                     |       | — |   | — |   | — |   | 23,198 |   |
| Capital lease  obligations          |       | —                     |       | — |   | — |   | — |   | — |   |
| Operating lease  obligations        |       | 6,293                      |       | 639 |   | 2,067 |   | 2,122 |   | 1,465 |   |
| Purchase  obligations               |       | —                     |       | — |   | — |   | — |   | — |   |
| Other long term  liabilities        |       | —                     |       | — |   | — |   | — |   | — |   |
| Total                               |       | $                          | 1,016,745  |   | $ | 108,273 |   | $ | 93,688 |   | $ | 6,644 |   | $ | 24,663 |   |

 

----

(1)  Excludes interest.

 

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**RecentAccounting Pronouncements**

 

In April 2008,the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination ofthe Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends thefactors an entity should consider in developing renewal or extensionassumptions used in determining the useful life of recognized intangible assetsunder FASB Statement No. 142, “Goodwill and Other Intangible Assets”. Thisnew guidance applies prospectively to intangible assets that are acquiredindividually or with a group of other assets in business combinations and assetacquisitions. FSP 142-3 is effective for financial statements issued for fiscalyears and interim periods beginning after December 15, 2008. Earlyadoption is prohibited. The Corporation is currently evaluating the impact, ifany, that FSP 142-3 will have on its consolidated financial statements.

 

In March 2008,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 161(“SFAS 161”), “Disclosures about Derivative Instruments and Hedging Activities”.SFAS 161 requires companies with derivative instruments to disclose informationthat should enable financial-statement users to understand how and why acompany uses derivative instruments, how derivative instruments and relatedhedged items are accounted for under FASB Statement No. 133, “Accountingfor Derivative Instruments and Hedging Activities,” and how derivativeinstruments and related hedged items affect a company’s financial position,financial performance and cash flows. SFAS 161 is effective for financialstatements issued for fiscal years and interim periods beginning after November 15,2008. The Corporation is currently evaluating the impact, if any, that SFAS 161will have on its consolidated financial statements.

 

In December 2007,the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS141R clarifies the definitions of both a business combination and a business.All business combinations will be accounted for under the acquisition method(previously referred to as the purchase method). This standard defines theacquisition date as the only relevant date for recognition and measurement ofthe fair value of consideration paid. SFAS 141R requires the acquirer toexpense all acquisition related costs. SFAS 141R will also require acquiredloans to be recorded net of the allowance for loan losses on the date ofacquisition. SFAS 141R defines the measurement period as the time after theacquisition date during which the acquirer may make adjustments to the “provisional”amounts recognized at the acquisition date. This period cannot exceed one year,and any subsequent adjustments made to provisional amounts are done retrospectivelyand restate prior period data. The provisions of this statement are effectivefor business combinations during fiscal years beginning after December 15,2008. The Corporation has not determined the impact that SFAS 141R will have onits financial position and results of operations and believes that suchdetermination will not be meaningful until the Corporation enters into abusiness combination.

 
| **ITEM  7A.** | **QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK** |
|---------------|----------------------------------------------------------------|

 

**Quantitativeand Qualitative Analysis of Market Risk**

 

Likeall financial institutions, the Corporation is subject to market risk fromchanges in interest rates.  Interest rate risk is inherent in the balancesheet because of the mismatch between the maturities of rate sensitive assetsand rate sensitive liabilities.  If rates are rising, and the level ofrate sensitive liabilities exceed the level of rate sensitive assets, the netinterest margin will be negatively impacted.  Conversely, if rates arefalling, and the level of rate sensitive liabilities is greater than the levelof rate sensitive assets, the impact on the net interest margin will befavorable.  Managing interest rate risk is further complicated by the factthat all rates do not change at the same pace; in other words, short-term ratesmay be rising while longer term rates remain stable.  In addition,different types of rate sensitive assets and rate sensitive liabilities reactdifferently to changes in rates.

 

Tomanage interest rate risk, the Corporation must take a position on the expectedfuture trend of interest rates.  Rates may rise, fall or remain thesame.  The Asset-Liability Committee of the Bank develops its view offuture rate trends by monitoring economic indicators, examining the views ofeconomists and other experts, and understanding the current status of theCorporation’s balance sheet.   The Corporation’s annual budgetreflects the anticipated rate environment for the next 12 months.  TheAsset-Liability Committee conducts a quarterly analysis of the rate sensitivityposition.  The results of the analysis are reported to the Board.

 

TheAsset-Liability Committee uses a computer model to analyze the maturities ofrate sensitive assets and liabilities.  The model measures the “gap,”which is the difference between the dollar amount of rate sensitive assetsre-pricing during a period and the volume of rate sensitive liabilitiesre-pricing during the same period. Gap is also expressed as the ratio of ratesensitive assets divided by rate sensitive liabilities.  If the ratio isgreater than one, the dollar value of assets exceeds the dollar value ofliabilities and the balance sheet is “asset sensitive.” Conversely, if thevalue of liabilities exceeds the value of assets, the ratio is less than oneand the balance sheet is “liability sensitive.”  Policy requiresmanagement to maintain the gap within a range of 0.75 to 1.25.

 

Themodel measures scheduled maturities in periods of three months, four to 12months, one to five years and over five years. The chart below illustrates theCorporation’s rate sensitive position at December 31, 2008. Managementuses the one year gap as the appropriate time period for setting strategy.

 

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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                                            |       | $            | 35,538     |            | $          | —           |       | $              | —     |                   | $          | —    |       | $ | — |   | $ | 35,538 |   |
| Interest bearing  deposits in banks                            |       | —       |       | —          |       | —           |       | —         |       | —                 |       | —    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Securities                                                     |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| U.S. government  agencies                                      |       | —       |       | 47,598          |       | —           |       | 217            |       | 53,158                 |       | 100,973   |       |
| Mortgage-backed  and corporate debt securities                 |       | —       |       | 32              |       | 99               |       | 107            |       | 79                     |       | 317       |       |
| Total securities                                               |       | —       |       | 47,630          |       | 99               |       | 324            |       | 53,237                 |       | 101,290   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total loans                                                    |       | 263,173      |       | 146,348         |       | 295,597          |       | 289,927        |       | 41,680                 |       | 1,036,725 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total interest  earning assets                                 |       | 298,711      |       | 193,978         |       | 295,696          |       | 290,251        |       | 94,917                 |       | 1,173,553 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other assets                                                   |       | —       |       | —          |       | —           |       | —         |       | 44,531                 |       | 44,531    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total assets                                                   |       | 298,711      |       | 193,978         |       | 295,696          |       | 290,251        |       | 139,448                |       | 1,218,084 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest Bearing  Liabilities                                  |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Deposits                                                       |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Interest  checking                                             |       | 3,021        |       | —          |       | —           |       | 4,348          |       | —                 |       | 7,369     |       |
| Money market and  savings                                      |       | 29,356       |       | —          |       | —           |       | 27,098         |       | —                 |       | 56,454    |       |
| Time deposits                                                  |       | —       |       | 249,414         |       | 635,546          |       | 96,143         |       | —                 |       | 981,103   |       |
| Total deposits                                                 |       | 32,377       |       | 249,414         |       | 635,546          |       | 127,589        |       | —                 |       | 1,044,926 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Federal funds  purchased                                       |       | —       |       | —          |       | —           |       | —         |       | —                 |       | —    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Short term  borrowings                                         |       | —       |       | —          |       | 10,000           |       | —         |       | —                 |       | 10,000    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Subordinated  long term debt                                   |       | —       |       | —          |       | —           |       | —         |       | 23,198                 |       | 23,198    |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total interest  bearing liabilities                            |       | 32,377       |       | 249,414         |       | 645,546          |       | 127,589        |       | 23,198                 |       | 1,078,124 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Other  liabilities                                             |       | —       |       | —          |       | —           |       | —         |       | 38,213                 |       | 38,213    |       |
| Shareholders’  equity                                     |       | —       |       | —          |       | —           |       | —         |       | 101,747                |       | 101,747   |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Total  liabilities and shareholders’ equity               |       | 32,377       |       | 249,414         |       | 645,546          |       | 127,589        |       | 163,158                |       | 1,218,084 |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Rate sensitive  gap by period                                  |       | 266,334      |       | (55,436         | )          | (349,850         | )          | 162,662        |       | 71,719                 |       |      |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Cumulative gap                                                 |       | $            | —     |            | $          | 210,898          |       | $              | (138,952   | )                      | $          | 23,710    |       | $ | 95,429 |   |   |   |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Cumulative gap  as a percent of total                          |       | —       |       | 17.31           | %          | (11.41           | )%         | 1.95           | %          | 7.83                   | %          |      |       |
|                                                           |       |         |       |            |       |             |       |           |       |                   |       |      |       |
| Rate sensitive assets/rate sensitive liabilities  (cumulative) |       | 9.23         |       | 1.75            |       | 0.85             |       | 1.02           |       | 1.09                   |       |      |       |
|                                                                |            |              |            |                 |            |                  |            |                |            |                        |            |           |            |  |  |  |  |  |  |

 

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In2008, the FOMC decreased short-term interest rates by 400 basis points. The Corporation is now positioned for a falling rate environment by maintaininga moderately “liability sensitive” balance sheet in which more liabilities willreprice than assets.  At year-end 2008, the Corporation’s one-year ratiowas 0.85.

 

Theinterest rate risk model that defines the gap position also performs a “rateshock” test of the balance sheet.  The rate shock procedure measures theimpact on the economic value of equity (“EVE”) which is a measure of long-terminterest rate risk. EVE is the difference between the market value of theassets and the liabilities and is the liquidation value of the bank. In thisanalysis, the model calculates the discounted cash flow or market value of eachcategory on the balance sheet. The percent change in EVE is a measure of thevolatility of risk. Regulatory guidelines specify a maximum change of 30% for a200bps rate change. At December 31, 2008, the percent change in EVE for aplus or minus 200bps was well within that range at (20.9) % and 12.8%,respectively.

 

Theone year gap of 0.85indicates that the Bank would show an increase in netinterest income in a falling rate environment, and the EVE rate shock showsthat the EVE would rise in a falling rate environment. The EVE simulation modelis a static model that provides information only at a certain point in time.For example, in a rising rate environment, the model does not take into accountactions that management might take to change the impact of rising rates on theBank. Given that limitation, it is still useful is assessing the impact of anunanticipated movement in interest rates.

 

Theabove analysis may not on its own be an entirely accurate indicator of how netinterest income or EVE will be affected by changes in interest rates. Incomeassociated with interest earning assets and costs associated with interestbearing liabilities may not be affected uniformly by changes in interest rates.In addition, the magnitude and duration of changes in interest rates may have asignificant impact on net interest income. Interest rates on certain types ofassets and liabilities fluctuate in advance of changes in general market rates,while interest rates on other types may lag behind changes in general market rates.The Asset-Liability Committee develops its view of future rate trends bymonitoring economic indicators, examining the views of economists and otherexperts, and understanding the current status of the Corporation’s balancesheet, and conducts a quarterly analysis of the rate sensitivityposition.  The results of the analysis are reported to the Board.

 
| **ITEM  8.** | **FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA** |
|--------------|-------------------------------------------------|

 

Thereport of independent accountants, consolidated financial statements andsupplementary data required by Item 8 are set forth on pages F-1 throughF-29 of this Annual Report on Form 10-K and are incorporated herein byreference.

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

 

None.

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

 

a)**          **Evaluation of Disclosure Controls andProcedures. The Corporation maintains disclosure controls and procedures,as defined in Rule 13a-15(a) promulgated under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), that are designed toensure that information required to be disclosed by it in the reports that itfiles or submits under the Exchange Act is recorded, processed, summarized andreported within the time period specified in the SEC’s rules and forms andthat such information is accumulated and communicated to the Corporation’smanagement, including its Chief Executive Officer and Chief Financial Officer.The Corporation carried out an evaluation, under the supervision and with theparticipation of its management, including its Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofits disclosure controls and procedures as of the end of the period covered bythis report.  Based on the evaluation of these disclosure controls andprocedures, the Chief Executive Officer and Chief Financial Officer concludedthat the Corporation’s disclosure control and procedures were effective.

 

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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 accounting firm’s report are includedwith the 2008 consolidated financial statements in Item 8 of this AnnualReport on Form 10-K under the captions entitled “Management’s Report onInternal Control Over Financial Reporting” and “Report of IndependentRegistered Public Accounting Firm.”

 

b)**          **Changes in Internal Controls andProcedures. There were no changes in the Corporation’s internal controlover financial reporting during the Corporation’s fiscal quarter ended December 31,2008 that have materially affected, or are reasonably likely to materiallyaffect, its internal control over financial reporting.

 
| **ITEM  9B.** | **OTHER INFORMATION** |
|---------------|-----------------------|

 

None.

 

**PART III**

 
| **ITEM  10.** | **DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE** |
|---------------|------------------------------------------------------------|

 

**Directors**

 

Informationrelating to our directors is incorporated by reference to the informationcontained under the caption “Proposal 1: Election of Directors” included in ourproxy statement relating to our 2009 annual meeting of shareholders.

 

**ExecutiveOfficers**

 

Informationrelating to our executive officers incorporated by reference to the informationcontained under the caption “Executive Officers” included in our proxystatement relating to our 2009 annual meeting of shareholders.

 

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

 

Informationwith respect to compliance with Section 16(a) of the SecuritiesExchange Act of 1934, as amended, is incorporated by reference to theinformation contained under the caption “General Information — Section 16(a) BeneficialOwnership Reporting Compliance” included in our proxy statement relating to our2009 annual meeting of shareholders.

 

**Codeof Ethics**

 

Informationwith respect to our Code of Ethics is incorporated by reference to theinformation contained under the caption “Corporate Governance — Code of Ethics”included in our proxy statement relating to our 2009 annual meeting ofshareholders.

 

**ShareholderNominees**

 

Informationwith 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 2009 annual meeting ofshareholders.

 

**Auditand Compliance Committee**

 

Informationrelating to the Audit and Compliance Committee is incorporated by reference tothe information contained under the caption “Audit Committee Report” includedin our proxy statement relating to our 2009 annual meeting of shareholders.

 
| **ITEM  11.** | **EXECUTIVE COMPENSATION** |
|---------------|----------------------------|

 

Informationregarding the Executive Compensation is incorporated by reference to theinformation contained under the caption “Compensation Discussion and Analysis,”“Executive Compensation,” “Director Compensation,” “Compensation CommitteeReport” and “Compensation Committee Interlocks and Insider Participation”included in our proxy statement relating to our 2009 annual meeting ofshareholders.

 

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| **ITEM  12.** | **SECURITY  OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER  MATTERS** |
|---------------|------------------------------------------------------------------------------------------------------|

 

**SecurityOwnership of Certain Beneficial Owners and Management**

 

Thisinformation is incorporated by reference to the information contained under thecaption “Security Ownership of Certain Beneficial Owners and Management”included in our proxy statement relating to our 2009 annual meeting ofshareholders.

 

**EquityCompensation Plan Information**

 

Thefollowing table provides information as of December 31, 2008, with respectto compensation plans under which shares of Corporation 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. For additional information  regarding the terms of these stock options, see note 12 to the Corporation’s  Consolidated Financial Statements included in Item 8 of this Annual Report on  Form 10-K. |

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

 

Thisinformation is incorporated by reference to the information contained under thecaption “Certain Relationships and Related Transactions” and “CorporateGovernance-Director Independence” included in our proxy statement relating toour 2009 annual meeting of shareholders.

 
| **ITEM  14.** | **PRINCIPAL ACCOUNTING FEES AND SERVICES** |
|---------------|--------------------------------------------|

 

Thisinformation is incorporated by reference to the information contained under thecaption “Proposal 2: Ratification of the Appointment of Independent RegisteredAccounting Firm” included in our proxy statement relating to our 2009 annualmeeting of shareholders.

 

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**PART IV**

 

**ITEM 15.****              EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

 

(a)(1)      FinancialStatements: See Part II, Item 8 “Financial Statements and Supplementary Data”of this Annual Report on Form 10-K.

 

(2)          Schedulesrequired by Article 12 of Regulation S-X are either omitted because theyare not applicable or because the required information is shown in thefinancial 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.(2)                                                                                                                                                                                                    |
| 3.3                  |       | Bylaws of  Tennessee Commerce Bancorp, Inc.(1)                                                                                                                                                                                                                                  |
| 3.4                  |       | Amendment to  Bylaws of Tennessee Commerce Bancorp, Inc.(3)                                                                                                                                                                                                                     |
| 4.1                  |       | Shareholders’  Agreement(1)                                                                                                                                                                                                                                                     |
| 4.2                  |       | Form of  Stock Certificate(4)                                                                                                                                                                                                                                                   |
| 4.3                  |       | Indenture, dated  as of June 20, 2008, between Tennessee Commerce Bancorp, Inc. and  Wilmington Trust Company, as trustee(5)                                                                                                                                               |
| 4.4                  |       | Amended and  Restated Declaration of Trust, dated as of June 20, 2008, among  Tennessee Commerce Bancorp, Inc. , as sponsor, Wilmington Trust Company,  as institutional and Delaware trustee, and Arthur F. Helf, H. Lamar Cox and  Michael R. Sapp, as administrators(5) |
| 4.5                  |       | Guarantee  Agreement, dated as of June 20, 2008, between Tennessee Commerce  Bancorp, Inc. and Wilmington Trust Company(5)                                                                                                                                                 |
| 4.6                  |       | Warrant for Purchase of Shares of Common Stock, dated  December 19, 2008(6)                                                                                                                                                                                                     |
| 10.1                 |       | Tennessee  Commerce Bancorp, Inc. Stock Option Plan - Employees(1)                                                                                                                                                                                                              |
| 10.2                 |       | Form of  Tennessee Commerce Bancorp, Inc. 1999 Stock Option - Directors(1)                                                                                                                                                                                                 |
| 10.3                 |       | Form of  Tennessee Commerce Bancorp, Inc. — 1999 Stock Option - Incorporators(1)                                                                                                                                                                                      |
| 10.4                 |       | Form of  Tennessee Commerce Bancorp, Inc. — 2003 Stock Option - Directors(1)                                                                                                                                                                                          |
| 10.5                 |       | Tennessee  Commerce Bancorp, Inc. — 1999 Stock Option Agreement with Arthur F.  Helf(1)                                                                                                                                                                                    |
| 10.6                 |       | Tennessee  Commerce Bancorp, Inc. — 1999 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                 |       | Amended and  Restated Employment Agreement, dated as of December 30, 2008, between  Tennessee Commerce Bank and Arthur F. Helf(7)                                                                                                                                               |
| 10.9                 |       | Amended and  Restated Employment Agreement, dated as of December 30, 2008, between  Tennessee Commerce Bank and Michael R. Sapp(7)                                                                                                                                              |
| 10.10                |       | Amended and  Restated Employment Agreement, dated as of December 30, 2008, between  Tennessee Commerce Bank and H. Lamar Cox(7)                                                                                                                                                 |
| 10.11                |       | Tennessee  Commerce Bancorp, Inc. 2007 Equity Plan(8)                                                                                                                                                                                                                           |
| 10.12                |       | Offer of  Employment, dated as of August 5, 2008, between Tennessee Commerce  Bancorp, Inc. and Frank Perez(9)                                                                                                                                                             |
| 10.13                |       | Letter Agreement  dated as of December 19, 2008, between the United States Department of  the Treasury and Tennessee Commerce Bancorp, Inc.(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 Annual Report on  Form 10-K, as filed with the Securities and Exchange Commission on  April 18, 2008, and incorporated herein by reference.                                                |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (3)    | 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.                                              |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (4)    | 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. |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (5)    | 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 23, 2008 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  December 23, 2008, and incorporated herein by reference.                                             |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (7)    | 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  January 6, 2009, and incorporated herein by reference.                                               |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (8)    | 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.                                            |
|   |   |                                                                                                                                                                                                                                                                                 |
|   | (9)    | 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 August 5, 2008 and incorporated  herein by reference.                                                 |

 

45

----

 

**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
|   | TENNESSEE COMMERCE BANCORP,  INC.                                                    |
|--------|--------------------------------------------------------------------------------------|
|   |                                                                                 |
|   | By:                                                                                  | /s/ Arthur F. Helf |   |
|   | Arthur F. Helf,  Chairman and Chief Executive  Officer (Principal Executive Officer) |
|   | Date:   March 16,  2009                                          |   |
|   |                                                                                 |
|   | By:                                                                                  | /s/ Frank Perez |   |
|   | Frank Perez, Chief  Financial Officer (Principal  Financial and Accounting Officer)  |
|   | Date:   March 16,  2009                                          |   |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant in theircapacities as directors.

 
| By:    | /s/ H. Lamar Cox             |   | By:                 | /s/ Paul W. Dierksen |
|--------|------------------------------|--------|---------------------|----------------------|
|   | H. Lamar Cox                 |   | Paul W. Dierksen    |
| Date:  | March 16, 2009          | Date:  | March 16, 2009 |
|   |                         |   |                |
|   |                         |   |                |
| By:    | /s/ Dennis L. Grimaud        |   | By:                 | /s/ Arthur F. Helf   |
|   | Dennis L. Grimaud            |   | Arthur F. Helf      |
| Date:  | March 16, 2009          | Date:  | March 16, 2009 |
|   |                         |   |                |
|   |                         |   |                |
| By:    | /s/ William W. McInnes       |   | By:                 | /s/ Thomas R. Miller |
|   | William W. McInnes           |   | Thomas R. Miller    |
| Date:  | March 16, 2009          | Date:  | March 16, 2009 |
|   |                         |   |                |
|   |                         |   |                |
| By:    | /s/ Darrel  Reifschneider    |   | By:                 | /s/ Michael R. Sapp  |
|   | Darrel Reifschneider         |   | Michael R. Sapp     |
| Date:  | March 16, 2009          | Date:  | March 16, 2009 |
|   |                         |   |
|   |                         |   |
| By:    | /s/ Dr. Paul A.  Thomas |   |                |
|   | Dr. Paul A. Thomas      |   |
| Date:  | March 16, 2009          |   |
|        |                              |        |                     |                      |  |  |

 

46

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Table of Contents

 

**TENNESSEE COMMERCE BANCORP, INC.**

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

**December 31, 2008, 2007 and 2006**

 

CONTENTS

 
| MANAGEMENT’S REPORT ON INTERNAL  CONTROL OVER FINANCIAL REPORTING | F-2    |
|------------------------------------------------------------------------|--------|
|                                                                   |   |
| REPORT OF INDEPENDENT REGISTERED  PUBLIC ACCOUNTING FIRM               | F-3    |
|                                                                   |   |
| FINANCIAL STATEMENTS                                                   |   |
|                                                                   |   |
| CONSOLIDATED BALANCE SHEETS                                            | F-5    |
|                                                                   |   |
| CONSOLIDATED STATEMENTS OF INCOME                                      | F-6    |
|                                                                   |   |
| CONSOLIDATED  STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY       | F-7    |
|                                                                   |   |
| CONSOLIDATED  STATEMENTS OF CASH FLOWS                                 | F-8    |
|                                                                   |   |
| NOTES TO CONSOLIDATED  FINANCIAL STATEMENTS                            | F-9    |

 

F-1

----

Tableof Contents

 

**Management’s Report on InternalControl Over Financial Reporting**

 

Management of theCorporation is responsible for establishing and maintaining adequate internalcontrol over financial reporting, (as defined in Rules 13a-15(f) and15d-15(f) of the Securities Exchange Act of 1934, as amended) that isdesigned to produce reliable financial statements in conformity with accountingprinciples generally accepted in the United States.  The Corporation’sinternal 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 Corporation; (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 Corporation are being madeonly in accordance with authorizations of management and directors of theCorporation; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use or disposition of theCorporation’s assets that could have a material effect on the financialstatements.

 

The system of internalcontrol over financial reporting as it relates to the financial statements isevaluated for effectiveness by management and tested for reliability through aprogram of internal audits. Actions are taken to correct potential deficienciesas they are identified. Any system of internal control, no matter how well designed,has inherent limitations, including the possibility that a control can becircumvented or overridden, and misstatements resulting from error or fraud mayoccur and not be detected. Also, because of changes in conditions, internalcontrol effectiveness may vary over time. Accordingly, even an effective systemof internal control will provide only reasonable assurance with respect tofinancial statement preparation.

 

Management, with theparticipation of the Corporation’s Chief Executive Officer and Chief FinancialOfficer, conducted an assessment of the effectiveness of the Corporation’ssystem of internal control over financial reporting as of December 31,2008, based on criteria for effective internal control over financial reportingdescribed in “Internal Control - Integrated Framework,” issued by the Committeeof Sponsoring Organizations of the Treadway Commission.  Based on thisassessment, management believes that the Corporation maintained effectiveinternal control over financial reporting as of December 31, 2008.

 

KraftCPAs PLLC, theCorporation’s independent registered public accounting firm, has issued anattestation report on the Corporation’s internal control over financialreporting which appears on page F-3 of this annual report.

 

F-2

----

Tableof Contents

 

**Report of Independent RegisteredPublic Accounting Firm**

 

Board of Directors

Tennessee CommerceBancorp, Inc.

 

We have audited theinternal control over financial reporting of Tennessee Commerce Bancorp, Inc.and subsidiaries (collectively, the “Company”) as of December 31, 2008,based on 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 internalcontrol over financial reporting is a process designed to provide reasonableassurance regarding the reliability of financial reporting and the preparationof financial 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 risk thatcontrols may become inadequate because of changes in conditions, or that thedegree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Tennessee Commerce Bancorp, Inc. andsubsidiaries maintained, in all material respects, effective internal controlover financial reporting as of December 31, 2008, based on criteriaestablished in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission (COSO).

 

We have also audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Tennessee Commerce Bancorp, Inc. andsubsidiaries as of December 31, 2008 and 2007, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for each of the three years in the period ended December 31, 2008,and our report dated March 13, 2009, expressed an unqualified opinion onthose consolidated financial statements.

 

 

/s/KraftCPAs PLLC

Nashville, Tennessee

March 13, 2009

 

F-3

----

Tableof Contents

 

**Reportof Independent Registered Public Accounting Firm**

 

To the Board of Directorsand Shareholders

Tennessee CommerceBancorp, Inc.

 

Wehave audited the accompanying consolidated balance sheets of Tennessee CommerceBancorp, Inc. and subsidiaries as of December 31, 2008 and 2007, andthe related consolidated statements of income, changes in shareholders’ equity,and cash flows for each of the three years in the period ended December 31,2008.  These consolidated financialstatements are the responsibility of the Company’s management.  Our responsibility is to express an opinion onthese consolidated financial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements.  An audit alsoincludes assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation.  We believe that our auditsprovide a reasonable basis for our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Tennessee CommerceBancorp, Inc. and subsidiaries as of December 31, 2008 and 2007, andthe consolidated results of their operations and their cash flows for each ofthe three years in the period ended December 31, 2008, in conformity withU.S. generally accepted accounting principles.

 

Asdiscussed in Note 1 to the consolidated financial statements, effective January 1,2008, the Company adopted Statement of Financial Accounting Standards No. 157,*Fair Value Measurements,*and Statementof Financial Accounting Standards No. 159, *The FairValue Option for Financial Assets and Financial Liabilities*.

 

Wehave also audited, in accordance with the standards of the Public CompanyAccounting Oversight Board (United States), Tennessee Commerce Bancorp, Inc.and subsidiaries’ internal control over financial reporting as of December 31,2008, based on criteria established in *InternalControl — Integrated Framework* issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 13,2009, expressed an unqualified opinion on the effectiveness of TennesseeCommerce Bancorp, Inc.’s internal control over financial reporting.

 

/s/KraftCPAs PLLC

Nashville, Tennessee

March 13, 2009

 

F-4

----

Tableof Contents

 

**TENNESSEE COMMERCE BANCORP, INC.**

**CONSOLIDATED BALANCE SHEETS**

**December 31,2008 and 2007**

 
| **(Dollars in thousands except share data)**                                                                                                                                                                         | ** ** | **2008**  | ** ** | **2007** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|
| **ASSETS**                                                                                                                                                                                                                                    |       |      |       |     |       |
| Cash and due  from financial institutions                                                                                                                                                                                                     |       | $         | 5,260      |     | $          | 5,236 |   |
| Federal funds  sold                                                                                                                                                                                                                           |       | 35,538    |       | 9,573    |       |
| Cash and cash  equivalents                                                                                                                                                                                                                    |       | 40,798    |       | 14,809   |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Securities  available for sale                                                                                                                                                                                                                |       | 101,290   |       | 73,753   |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Loans                                                                                                                                                                                                                                         |       | 1,036,725 |       | 794,322  |       |
| Allowance for  loan losses                                                                                                                                                                                                                    |       | (13,454   | )          | (10,321  | )          |
| Net loans                                                                                                                                                                                                                                     |       | 1,023,271 |       | 784,001  |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Premises and  equipment, net                                                                                                                                                                                                                  |       | 2,330     |       | 1,413    |       |
| Accrued interest  receivable                                                                                                                                                                                                                  |       | 8,115     |       | 5,901    |       |
| Restricted  equity securities                                                                                                                                                                                                                 |       | 1,685     |       | 938      |       |
| Income tax  receivable                                                                                                                                                                                                                        |       | 4,430     |       | 1,886    |       |
| Other assets                                                                                                                                                                                                                                  |       | 36,165    |       | 17,452   |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Total assets                                                                                                                                                                                                                                  |       | $         | 1,218,084  |     | $          | 900,153 |   |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                |       |      |       |     |       |
| Liabilities                                                                                                                                                                                                                                   |       |      |       |     |       |
| Deposits                                                                                                                                                                                                                                      |       |      |       |     |       |
| Noninterest-bearing                                                                                                                                                                                                                           |       | $         | 24,217     |     | $          | 27,427 |   |
| Interest-bearing                                                                                                                                                                                                                              |       | 1,044,926 |       | 787,626  |       |
| Total deposits                                                                                                                                                                                                                                |       | 1,069,143 |       | 815,053  |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Federal funds  purchased                                                                                                                                                                                                                      |       | —    |       | 2,000    |       |
| Accrued interest  payable                                                                                                                                                                                                                     |       | 3,315     |       | 2,292    |       |
| Short-term  borrowings                                                                                                                                                                                                                        |       | 10,000    |       | 7,000    |       |
| Accrued bonuses                                                                                                                                                                                                                               |       | 917       |       | 1,700    |       |
| Deferred tax  liability                                                                                                                                                                                                                       |       | 8,695     |       | 139      |       |
| Other  liabilities                                                                                                                                                                                                                            |       | 1,069     |       | 600      |       |
| Long-term  subordinated debt                                                                                                                                                                                                                  |       | 23,198    |       | 8,248    |       |
| Total  liabilities                                                                                                                                                                                                                            |       | 1,116,337 |       | 837,032  |       |
| Shareholders’  equity                                                                                                                                                                                                                    |       |      |       |     |       |
| Preferred stock,  1,000,000 shares authorized; 30,000 shares of $0.50 par value Fixed Rate  Cumulative Perpetual, Series A issued and outstanding at  December 31, 2008: none at December 31, 2007                             |       | 15,000    |       | —   |       |
| Common stock,  $0.50 par value; 10,000,000 shares authorized at December 31, 2008 and  December 31, 2007; 4,731,696 and 4,724,196 shares issued and outstanding  at December 31, 2008 and December 31, 2007, respectively |       | 2,366     |       | 2,362    |       |
| Common stock  warrants                                                                                                                                                                                                                        |       | 453       |       | —   |       |
| Additional  paid-in capital                                                                                                                                                                                                                   |       | 59,946    |       | 45,024   |       |
| Retained  earnings                                                                                                                                                                                                                            |       | 23,180    |       | 15,426   |       |
| Accumulated  other comprehensive income                                                                                                                                                                                                       |       | 802       |       | 309      |       |
| Total  shareholders’ equity                                                                                                                                                                                                              |       | 101,747   |       | 63,121   |       |
|                                                                                                                                                                                                                                          |       |      |       |     |       |
| Total  liabilities and shareholders’ equity                                                                                                                                                                                              |       | $         | 1,218,084  |     | $          | 900,153 |   |

 

See accompanying notes to consolidated financialstatements.

 

F-5

----

Tableof Contents

 

**TENNESSEE COMMERCE BANCORP, INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**YearsEnded December 31, 2008, 2007 and 2006**

 
| **(Dollars in thousands except share data)** | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|-----------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Interest income                                                       |       |      |       |      |       |      |       |
| Loans, including  fees                                                |       | $         | 71,101     |      | $          | 58,114    |       | $ | 38,382 |   |
| Securities                                                            |       | 4,717     |       | 3,492     |       | 2,216     |       |
| Federal funds  sold                                                   |       | 160       |       | 600       |       | 647       |       |
| Total interest  income                                                |       | 75,978    |       | 62,206    |       | 41,245    |       |
|                                                                  |       |      |       |      |       |      |       |
| Interest expense                                                      |       |      |       |      |       |      |       |
| Deposits                                                              |       | 39,271    |       | 34,245    |       | 21,216    |       |
| Other                                                                 |       | 1,756     |       | 689       |       | 652       |       |
| Total interest  expense                                               |       | 41,027    |       | 34,934    |       | 21,868    |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest  income                                                  |       | 34,951    |       | 27,272    |       | 19,377    |       |
|                                                                  |       |      |       |      |       |      |       |
| Provision for  loan losses                                            |       | 9,111     |       | 6,350     |       | 4,350     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net interest  income after provision for loan losses                  |       | 25,840    |       | 20,922    |       | 15,027    |       |
|                                                                  |       |      |       |      |       |      |       |
| Non-interest  income                                                  |       |      |       |      |       |      |       |
| Service charges  on deposit accounts                                  |       | 122       |       | 132       |       | 112       |       |
| Gain on sale of  loans                                                |       | 3,750     |       | 2,687     |       | 2,025     |       |
| Other                                                                 |       | 422       |       | 61        |       | (374      | )          |
| Total  non-interest income                                            |       | 4,294     |       | 2,880     |       | 1,763     |       |
|                                                                  |       |      |       |      |       |      |       |
| Non-interest  expense                                                 |       |      |       |      |       |      |       |
| Salaries and  employee benefits                                       |       | 9,100     |       | 7,977     |       | 5,047     |       |
| Occupancy and  equipment                                              |       | 1,422     |       | 1,109     |       | 844       |       |
| Data processing  fees                                                 |       | 1,210     |       | 983       |       | 701       |       |
| Professional  fees                                                    |       | 2,012     |       | 779       |       | 786       |       |
| Other                                                                 |       | 3,864     |       | 2,415     |       | 1,678     |       |
| Total  non-interest expense                                           |       | 17,608    |       | 13,263    |       | 9,056     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income before  income taxes                                           |       | 12,526    |       | 10,539    |       | 7,734     |       |
|                                                                  |       |      |       |      |       |      |       |
| Income tax  expense                                                   |       | 4,772     |       | 3,643     |       | 2,985     |       |
|                                                                  |       |      |       |      |       |      |       |
| Net income                                                            |       | $         | 7,754      |      | $          | 6,896     |       | $ | 4,749 |   |
|                                                                  |       |      |       |      |       |      |       |
| Earnings per  share (EPS):                                            |       |      |       |      |       |      |       |
| Basic EPS                                                             |       | $         | 1.64       |      | $          | 1.49      |       | $ | 1.24 |   |
| Diluted EPS                                                           |       | 1.60      |       | 1.41      |       | 1.14      |       |
|                                                                  |       |      |       |      |       |      |       |
| Weighted average  shares outstanding:                                 |       |      |       |      |       |      |       |
| Basic                                                                 |       | 4,731,204 |       | 4,613,342 |       | 3,822,655 |       |
| Diluted                                                               |       | 4,852,065 |       | 4,892,167 |       | 4,157,338 |       |

 

See accompanying notes to consolidated financialstatements.

 

F-6

----

Table of Contents

 

**TENNESSEE COMMERCE BANCORP, INC.**

** CONSOLIDATED STATEMENTS OF CHANGES INSHAREHOLDERS’ EQUITY**

**YearsEnded December 31, 2008, 2007 and 2006**

 
| ** **                                                                               | ** ** | ** **    | ** ** | ** ** | ** ** | **Warrants to** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** **             | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------|------------|------------|------------|----------------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                               | ** ** | ** **    | ** ** | ** ** | ** ** | **Purchase**         | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**              | ** ** | **Total**              | ** ** |
| ** **                                                                               | ** ** | **Preferred** | ** ** | **Common** | ** ** | **Common**           | ** ** | **Paid-In**    | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | **Shareholders’** | ** ** |
| **(Dollars in thousands except share data)**                    | ** ** | **Stock**     | ** ** | **Stock**  | ** ** | **Stock**            | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (Loss)** | ** ** | **Equity**             | ** ** |
|                                                                                     |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| 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                 |       |
| Comprehensive  income                                                                    |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| Net income                                                                               |       | —        |       | —     |       | —               |       | —         |       | 7,754        |       | —                 |       | 7,754                  |       |
| Other  comprehensive income, net of income taxes                                         |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| Unrealized gains  on securities available for sale during the period, net of $477 in tax |       | —        |       | —     |       | —               |       | —         |       | —       |       | 770                    |       | 770                    |       |
| Reclassification  adjustment for gains included in net income, net of $170 in tax        |       |          |       |       |       |                 |       |           |       |         |       | (277                   | )          | (277                   | )          |
|                                                                                     |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| Total  comprehensive income                                                              |       | —        |       | —     |       | —               |       | —         |       | —       |       | —                 |       | 8,247                  |       |
|                                                                                     |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| Issuance of  preferred stock                                                             |       | 15,000        |       | —     |       | —               |       | 14,547         |       | —       |       | —                 |       | 29,547                 |       |
| Issuance of  common stock warrant                                                        |       | —        |       | —     |       | 453                  |       | —         |       | —       |       | —                 |       | 453                    |       |
| Exercise of  stock options to purchase 7,500 common shares and related tax benefit       |       | —        |       | 4          |       | —               |       | 86             |       | —       |       | —                 |       | 90                     |       |
| Stock-based  compensation expense                                                        |       | —        |       | —     |       | —               |       | 289            |       | —       |       | —                 |       | 289                    |       |
|                                                                                     |       |          |       |       |       |                 |       |           |       |         |       |                   |       |                   |       |
| Balance at  December 31, 2008                                                       |       | $             | 15,000     |       | $          | 2,366                |       | $              | 453        |         | $          | 59,946                 |       | $                      | 23,180     |   | $ | 802 |   | $ | 101,747 |   |
|                                                                                          |            |               |            |            |            |                      |            |                |            |              |            |                        |            |                        |            |  |  |  |  |  |  |  |

 

See accompanying notes to consolidated financialstatements.

 

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**TENNESSEE COMMERCE BANCORP, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**YearsEnded December 31, 2008, 2007 and 2006**

 
| **(Dollars in thousands except share data)**             | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                                                              |       |     |       |     |       |     |       |
| **Cash  flows from operating activities**                                         |       |     |       |     |       |     |       |
| Net income                                                                        |       | $        | 7,754      |     | $          | 6,896    |       | $ | 4,749 |   |
| Adjustments to  reconcile net income to net cash provided by operating activities |       |     |       |     |       |     |       |
| Depreciation                                                                      |       | 423      |       | 333      |       | 259      |       |
| Deferred loan  fees                                                               |       | (210     | )          | 919      |       | 234      |       |
| Provision for  loan losses                                                        |       | 9,111    |       | 6,350    |       | 4,350    |       |
| FHLB stock  dividends                                                             |       | —   |       | —   |       | (32      | )          |
| Stock-based  compensation expense                                                 |       | 289      |       | 259      |       | 82       |       |
| Deferred income  tax                                                              |       | 8,255    |       | 408      |       | (198     | )          |
| Net amortization  of investment securities                                        |       | (52      | )          | 11       |       | 14       |       |
| Gain on sales of  securities                                                      |       | (447     | )          | (26      | )          | —   |       |
| Change in:                                                                        |       |     |       |     |       |     |       |
| Accrued interest  receivable                                                      |       | (2,214   | )          | (1,785   | )          | (1,968   | )          |
| Accrued interest  payable                                                         |       | 1,023    |       | 564      |       | 602      |       |
| Income tax  receivable                                                            |       | (2,544   | )          | (1,886   | )          | —   |       |
| Other assets                                                                      |       | (18,263  | )          | (10,442  | )          | (2,352   | )          |
| Other  liabilities                                                                |       | (314     | )          | 549      |       | 1,220    |       |
| Net cash from  operating activities                                               |       | 2,811    |       | 2,150    |       | 6,960    |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash  flows from investing activities**                                         |       |     |       |     |       |     |       |
| Purchases of  securities available for sale                                       |       | (101,560 | )          | (43,898  | )          | (26,781  | )          |
| Proceeds from  sales of securities available for sale                             |       | 46,603   |       | 25,850   |       | —   |       |
| Proceeds from  maturities, prepayments and calls of securities available for sale |       | 28,713   |       | 2,216    |       | 1,953    |       |
| Net change in  loans                                                              |       | (248,171 | )          | (252,720 | )          | (198,947 | )          |
| Purchases of  FHLB Stock                                                          |       | (747     | )          | (305     | )          | (218     | )          |
| Net purchases of  premises and equipment                                          |       | (1,340   | )          | (113     | )          | (1,123   | )          |
| Net cash used by  investing activities                                            |       | (276,502 | )          | (268,970 | )          | (225,116 | )          |
|                                                                              |       |     |       |     |       |     |       |
| **Cash  flows from financing activities**                                         |       |     |       |     |       |     |       |
| Net change in  deposits                                                           |       | 254,090  |       | 254,486  |       | 192,862  |       |
| Net change in  federal funds purchased and repurchase agreements                  |       | (2,000   | )          | 2,000    |       | —   |       |
| Payments on  short-term debt                                                      |       | (7,000   | )          | —   |       | —   |       |
| Proceeds from  long-term subordinated debt                                        |       | 14,950   |       | —   |       | —   |       |
| Proceeds from  issuance of common stock                                           |       | —   |       | —   |       | 19,027   |       |
| Purchase of  capital securities of unconsolidated subsidiary                      |       | (450     | )          | —   |       | —   |       |
| Proceeds from  issuance of preferred stock and common stock warrant               |       | 30,000   |       | —   |       | —   |       |
| Proceeds from  exercise of common stock options                                   |       | 38       |       | 2,152    |       | 596      |       |
| Proceeds from  issuance of short-term debt                                        |       | 10,000   |       | 7,000    |       | —   |       |
| Excess tax  benefit from option exercises                                         |       | 52       |       | 1,979    |       | 256      |       |
| Section 16  profit reimbursement                                             |       | —   |       | 15       |       | —   |       |
| Net cash  provided by financing activities                                        |       | 299,680  |       | 267,632  |       | 212,741  |       |
|                                                                              |       |     |       |     |       |     |       |
| **Net  change in cash and cash equivalents**                                      |       | 25,989   |       | 812      |       | (5,415   | )          |
|                                                                              |       |     |       |     |       |     |       |
| Cash and cash  equivalents at beginning of period                                 |       | 14,809   |       | 13,997   |       | 19,412   |       |
|                                                                              |       |     |       |     |       |     |       |
| **Cash  and cash equivalents at end of period**                                   |       | $        | 40,798     |     | $          | 14,809   |       | $ | 13,997 |   |
|                                                                              |       |     |       |     |       |     |       |
| **Supplemental  cash flow information:**                                          |       |     |       |     |       |     |       |
| Cash paid during  period for interest                                             |       | $        | 40,004     |     | $          | 34,370   |       | $ | 21,266 |   |
| Cash paid during  period for income taxes                                         |       | 1,125    |       | 4,745    |       | 2,075    |       |

 

See accompanying notes to consolidated financialstatements.

 

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**TENNESSEE COMMERCE BANCORP, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

The accounting principlesfollowed and the methods of applying those principles conform with accountingprinciples generally accepted in the United States of America and to generalpractices in the banking industry. The significant policies are summarized asfollows:

 

Principles ofConsolidation: The accompanying consolidated financial statements include the accounts ofTennessee Commerce Bancorp, Inc. (the “Corporation”) and its wholly-ownedsubsidiaries, Tennessee Commerce Bank (the “Bank”) and TCB Commercial AssetServices, Inc. (“TCB”). Tennessee Commerce Statutory Trust I and TennesseeCommerce Statutory Trust II are not consolidated and are accounted for underthe equity method. Material intercompany accounts and transactions have beeneliminated.

 

Nature ofOperations: The Corporation was formed in July 2000. The Bank received its charter asa state bank and opened for business in January 2000. Substantially all ofthe assets, liabilities and operations presented in the consolidated financialstatements are attributable to the Bank. The Bank provides a variety of bankingservices to individuals and businesses in Middle Tennessee. Its primary depositproducts are demand and savings deposits and certificates of deposit, and itsprimary lending products are commercial, lease financing, real estate mortgageand installment loans. In July 2008, the Corporation formed a wholly ownedsubsidiary, TCB Commercial Asset Services, Inc. (“TCB”). This subsidiarypurchases, at fair market value, and then sells assets for the Bank.

 

The Bank’s loans aregenerally secured by specific items of collateral including real property, consumerassets and business assets. Although the Bank has a diversified loan portfolio,a substantial portion of its debtors’ ability to honor their contracts isdependent on local economic conditions.

 

Use of Estimates:  To prepare financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America, management makes estimates and assumptions based onavailable information. These estimates and assumptions affect the amountsreported in the financial statements and the disclosures provided, and futureresults could differ. The allowance for loan losses and fair value of financialinstruments are particularly subject to change.

 

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

 

Securities:  In accordance with Statement ofFinancial Accounting Standards (“SFAS”) No. 115, “Accounting for CertainDebt and Equity Securities,” all securities are classified as available forsale. The Bank has no trading securities or held to maturity securities as of December 31,2008.

 

Securities classified asavailable for sale may be sold in response to changes in interest rates,liquidity needs and for other purposes. Available for sale securities arereported at fair value and include securities not classified as held tomaturity or trading.

 

Unrealized holding gainsand losses for available for sale securities are reported in othercomprehensive income. Realized gains (losses) on securities available for saleare included in other income (expense) and, when applicable, are reported as areclassification adjustment, net of tax, in other comprehensive income. Gainsand losses on sales of securities are determined on the specific-identificationmethod.

 

Interest income includesamortization of purchase premiums or discounts. Gains and losses on sales arebased on the amortized cost of the security sold. Securities are written downto fair value when a decline in fair value is not temporary. Any such lossesare charged to earnings.In estimating other-than-temporary impairment losses, managementconsiders, among other things, (i) the length of time and the extent towhich the fair value has been less than cost, (ii) the financial conditionand near-term prospects of the issuer, and (iii) the intent and ability of theCorporation to retain its investment in the issuer for a period of timesufficient to allow for any anticipated recovery in fair value.

 

Mortgage BankingActivities: The Bank originates mortgage loans for sale and these loans are carried at thelower of cost or fair value, determined on an aggregate basis. Generally, acommitment is obtained from investors at origination in order to minimizemarket risk directly related to interest rate movements. Origination fees arerecorded as income when the loans are sold to third party investors. At the endof the year for each period presented there were no loans held for sale.

 

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

 

Loans are generallyplaced on nonaccrual when a loan is specifically determined to be impaired orwhen principal or interest is delinquent for 90 days or more. Any unpaidinterest previously accrued on those loans is reversed from income. Interestincome generally is not recognized on specific impaired loans unless thelikelihood of further loss is remote. Interest payments received on such loansare applied as a reduction of the loan principal balance. Interest income onother nonaccrual loans is recognized only to the extent of interest paymentsreceived.

 

Tax Leases: Tax leasescomprised approximately $52,805,000 and $22,752,000 of loans on the balancesheet at December 31, 2008 and 2007, respectively. In accordance with SFASNo. 140, “Accounting For Transfers and Servicing of Financial Assets andExtinguishments of Liabilities,” (“SFAS 140”), at the time of investment, thetax lease asset is recorded along with unearned interest income followed byperiodic journal entries to record the interest income and maintain an accuraterepresentation of the investment balance. The current balance is part of “Loans”on the balance sheet and as “Other” on the Summary of Loans in Note 3. For2008, the tax leases created a net timing difference of approximately$25,728,000.  Net deductions ofapproximately $18,833,000 were allowed for tax, but not book. For 2007, the taxleases created a net timing difference of approximately $4,800,000.  Net deductions of approximately $4,800,000 wereallowed for tax, but not book.

 

Allowance for LoanLosses:  Theallowance for loan losses is maintained at a level that, in management’sjudgment, is adequate to absorb credit losses inherent in the loan portfolio.The amount of the allowance is based on management’s evaluation of thecollectability of the loan portfolio, including the nature of the portfolio,credit concentrations, trends in historical loss experience, impaired loans andeconomic conditions. Allowances for impaired loans are generally determinedbased on collateral values or the present value of estimated cash flows.Because of uncertainties associated with the regional economic conditions,collateral values and future cash flows on impaired loans, it is reasonablypossible that management’s estimate of credit losses inherent in the loanportfolio and the related allowance may change materially in the near term. Theallowance is increased by the provision for loan losses and reduced bycharge-offs, net of recoveries.

 

The allowance consists ofspecific and general components. The specific component relates to loans thatare individually classified as impaired. The general component coversnon-classified loans and is based on historical loss experience and adjustedfor current factors including the economic environment. The allowance alsoincludes an unallocated component. Management believes that the unallocatedamount is warranted for inherent factors that cannot be practically assigned toindividual loan categories. An example is the imprecision in the overallmeasurement process, in particular the volatility of the national and globaleconomy.

 

Management periodicallyreviews the loan portfolio. A loan is placed on non-accrual status when it is90 days or more past due and immediate collection is doubtful. The non-accrualloans are reviewed periodically for impairment. A loan is impaired when fullpayment under the loan terms is not expected. Commercial and commercial realestate loans are individually evaluated for impairment. If a loan is impaired,a portion of the allowance is allocated so that the loan is reported, net, atthe present value of estimated future cash flows using the loan’s existing rateor at the fair value of collateral if repayment is expected solely from thecollateral. Large groups of smaller balance homogeneous loans, such as consumerand residential real estate loans are collectively evaluated for impairment,and accordingly, they are not separately identified for impairment disclosures.Loans are charged-off at a time when the collection efforts are reasonablydeemed uncollectable.

 

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

 

Other Real Estateand Repossessed Assets:  Real estate acquired by foreclosure is carried at the lower ofthe recorded investment in the property or its fair value, less costs to sell,at the date of foreclosure, determined by appraisal. Declines in valueindicated by reappraisals as well as losses resulting from disposition arecharged to operations. Subsequent expenses are expensed as they occur after anyre-acquisitions. Other real estate owned is included in other assets on thebalance sheet, with a carrying value of approximately $5,764,000 and $690,000in 2008 and 2007, respectively. Repossessed assets acquired by foreclosure arecarried at the lower of the recorded investment in the asset or its estimated fairvalue. Declines in value indicated by reappraisals as well as losses resultingfrom disposition are charged to operations. These repossessed assets are eitherdisposed of by the Bank or sold to TCB. Subsequent expenses are expensed asthey occur after any re-acquisitions. Repossessions are included in otherassets on the balance sheet, with a carrying value of approximately $10,694,000and $7,028,000 in 2008 and 2007, respectively. If a repossession of the Bank isnot resold within the six month holding period allowed by Tennessee law, it ispurchased by TCB at fair market value.  The sole purpose of TCB is theresale of assets repossessed by the Bank. At December 31, 2008, TCB hadpurchased approximately $4,701,000 and nothing in prior years; TCB carriesthese purchases as inventory.

 

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Gain on Sale ofLoans: Transfersof financial assets are accounted for as sales when control over the assets hasbeen surrendered. Control over transferred assets is deemed to be surrenderedwhen (1) the assets have been isolated from the Corporation, (2) thetransferee obtains the right (free of conditions that constrain it from takingadvantage of the right) to pledge or exchange the transferred assets, and (3) theCorporation does not maintain effective control over the transferred assetsthrough an agreement to repurchase them before maturity. The Bank records thetransfer by allocating the carrying amount of the financial asset between theassets sold, and the retained interests, if any, based on their relative fairvalues at the date of transfer. Estimates of expected future cash flows areused to determine fair value on the date of transfer. The gain on sale ispresented as a component of non-interest income.

 

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

 

When the Bank sells loansto others, it may hold interest-only strips, which is an interest that continuesto be held by the transferor in the securitized receivable.  It may also obtain servicing assets or assumeservicing liabilities that are initially measured at fair value.  Gain or loss on sale of the receivablesdepends in part on both (a) the previous carrying amount of the financialassets involved in the transfer, allocated between the assets sold and theinterests that continue to be held by the transferor based on their relativefair value at the date of transfer, and (b) the proceeds received.  To obtain fair values, quoted market pricesare used if available. Quotes are generally not available for interests thatcontinue to be held by the transferor, so the Bank generally estimates fairvalue based on the future expected cash flows estimated using management’s bestestimates of the key assumptions — credit losses and discount ratescommensurate with the risks involved.

 

Servicing Assets: Servicing assets are recognized asseparate assets 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. The Corporation values its servicingassets by allocating the carrying value of the financial asset between theassets sold and the retained interests, if any, based on their relative fairvalues at the date of transfer. Capitalized servicing rights are reported inother assets and are amortized over the life of the loan being serviced.Servicing assets totaled approximately $216,000, $210,000 and $128,000 for theyears ended 2008, 2007 and 2006, respectively. Servicing assets are included onthe balance sheet with other assets.

 

We initially measure allseparately recognized servicing assets and servicing liabilities at fair value.We subsequently measure such assets and liabilities using either theamortization method, where we amortize servicing assets or servicingliabilities in proportion to and over the period of estimated net servicingincome or net servicing loss, or the fair value method, where we measureservicing assets or servicing liabilities at fair value at each reporting date.We report fair value changes in our earnings during the period in which theyoccur. Because of the nature of our servicing assets, quoted market prices maynot be available, prohibiting us from using the fair value method. Therefore,if no quoted market prices are available, we use the amortization method. Weassess servicing assets or servicing liabilities for impairment or increasedobligation based on the fair value at each reporting date. Afterconsidering costs to service, we generally value the servicing assets atapproximately 0.20% of the assets’ fair value. As a result of the adoption ofSFAS 156, “Accounting for Servicing of Financial Assets” (“SFAS 156”), we did not have a materialchange in the valuation of our servicing assets or servicing liabilities forthe year ended December 31, 2008.

 

Income Per Common Share: Basic income per share available to commonstockholders (“EPS”) is computed by dividing net income available to commonstockholders by the weighted average common shares outstanding for the period.Diluted EPS reflects the dilution that could occur if securities or othercontracts to issue common stock were exercised or converted. The differencebetween basic and diluted weighted average shares outstanding was attributableto common stock options, common stock appreciation rights, warrants andrestricted shares. The dilutive effect of outstanding options, common stockappreciation rights, warrants and restricted shares is reflected in diluted EPSby application of the treasury stock method.

 

Stock-BasedCompensation: Effective January 1, 2006, the Corporation adopted SFAS No. 123(R), “Share-basedPayment,” using the modified prospective transition method.  Accordingly,the Corporation has recorded stock-based employee compensation cost based onthe fair value method using the Black-Scholes valuation model starting in2006.  For 2008, adopting this standard resulted in a reduction of incomebefore income taxes of $289,000, a reduction in net income of $110,000 and adecrease in basic and diluted earnings per share of $0.07 and $0.07. For 2007,adopting this standard resulted in a reduction of income before income taxes of$259,000, a reduction in net income of $169,000 and a decrease in basic anddiluted earnings per share of $0.04 and $0.03. For 2006, adopting this standardresulted in a reduction of income before income taxes of $82,000, a reductionin net income of $51,000, and a decrease in basic and diluted earnings pershare of $.01 and $.01.

 

In June of 2007, theTennessee Commerce Bancorp 2007 Equity Plan was adopted and the Corporationreserved authorized shares to be issued, and not repurchased, in accordancewith the provisions of the plan.

 

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Income Taxes:  Income tax expense is the totalof the 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 Corporation adoptedFASB Interpretation 48, “Accounting for Uncertainty in Income Taxes,” as of January 1,2007.  A tax position is recognized as a benefit only if it is “morelikely than not” that the tax position would be sustained in a tax examination,with a tax examination being presumed to occur.  The amount recognized isthe largest amount of tax benefit that is greater than 50% likely of beingrealized on examination.  For tax positions not meeting the “more likelythat not” test, no tax benefit is recorded.  The adoption had no effect onthe Corporation’s consolidated financial statements.

 

TheCorporation recognizes interest and/or penalties related to income tax mattersin income tax expense.

 

Advertising Costs:  Advertising costs are generallycharged to operations in the year incurred and totaled approximately $107,000,$73,000 and $206,000 in 2008, 2007 and 2006.

 

Off-Balance SheetFinancial Instruments:  Financial instruments include off-balance sheet creditinstruments, such as commitments to make loans, financial guarantees andstandby letters of credit, issued to meet customer financing needs. The faceamount for these items represents the exposure to loss, before consideringcustomer collateral or ability to repay. Such financial instruments arerecorded when they are funded.

 

Restrictions onCash:  Cashon hand or on deposit with other banks of approximately $294,000 and $227,000was required to meet regulatory reserve and clearing requirements at year-end2008 and 2007, respectively. These balances do not earn interest.

 

Dividend Restrictions:  Banking regulations require maintainingcertain capital levels and may limit the dividends paid by the Bank to theCorporation, which would limit dividends payable by the Corporation to itsshareholders. In addition, the Fixed Rate Cumulative PerpetualPreferred Stock, Series A, of the Corporation (“Series A PreferredStock”) includes certain restrictions regarding the payment of dividends on theCorporation’s common stock. For more information regarding these restrictions,see Note 15.

 

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

 

Fair Value ofFinancial Instruments:  Fair values of financial instruments are estimated usingrelevant market information and other assumptions, as more fully disclosed inNote 13. Fair value estimates involve uncertainties and matters of significantjudgment regarding interest rates, credit risk, prepayments and other factors,especially in the absence of broad markets for particular items. Changes inassumptions or in market conditions could significantly affect the estimates.

 

Recently IssuedAccounting Standards: In September 2006, the FASB released SFAS No. 157 (“SFAS 157”), “FairValue Measurements.” This statement defines fair value, establishes a frameworkfor measuring fair value and expands disclosures about fair value measurements.SFAS 157 clarifies the exchange price notion in the fair value definition tomean the price that would be received to sell the asset or paid to transfer theliability (an exit price), not the price that would be paid to acquire theasset or received to assume the liability (an entry price). This statement alsoclarifies that market participant assumptions should include assumptions aboutrisk, should include assumptions about the effect of a restriction on the saleor use of an asset and should reflect its nonperformance risk (the risk thatthe obligation will not be fulfilled). Nonperformance risk should include thereporting entity’s credit risk. SFAS 157 is effective for financial statementsissued for fiscal years beginning after November 15, 2007. The Corporationadopted SFAS 157 on January 1, 2008 and determined that it had no impacton the consolidated financial statements of the Corporation.

 

In February 2007,the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value Option forFinancial Assets and Financial Liabilities,” which gives entities the option tomeasure eligible financial assets and financial liabilities at fair value, onan instrument by instrument basis, that are otherwise not permitted to beaccounted for at fair value under other accounting standards. The election touse the fair value option is available when an entity first recognizes afinancial asset or financial liability. Subsequent changes in fair value mustbe recorded in earnings. This statement was effective as of January 1,2008; and had no impact on the consolidated financial statements of theCorporation because the Corporation did not elect the fair value option for anyfinancial instrument not presently being accounted for at fair value.

 

In October 2008, theFASB issued FSP No. FAS 157-3, “Determining the Fair Value of a FinancialAsset When the Market for That Asset Is Not Active.” This FSP clarifies theapplication of SFAS 157 in a market that is not active and provides an exampleto illustrate key considerations in determining the fair value of a financialasset when the market for that financial asset is not active. This FSP was effectivefor the Corporation upon issuance, including prior periods for which financialstatements have not been issued. Therefore, it was effective for theCorporation’s consolidated financial statements as of and for the year ended December 31,2008. Adoption of FSP No. FAS 157-3 did not have a significant impact onthe Corporation’s consolidated financial position or results of operations.

 

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-12

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Table of Contents

 

**NOTE2 - SECURITIES**

 

The fair value ofavailable for sale securities and the related gross unrealized gains and lossesrecognized in accumulated other comprehensive income (loss) were as follows:

 
| ** **                           | ** ** | ** ** | ** ** | **Gross**      | ** ** | **Gross**      | ** ** |
|--------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|
| ** **                           | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** |
| **(Dollars in thousands)** | ** ** | **Value**  | ** ** | **Gains**      | ** ** | **Losses**     | ** ** |
|                                 |       |       |       |           |       |           |       |
| 2008                                 |       |       |       |           |       |           |       |
|                                 |       |       |       |           |       |           |       |
| U.S. Government  agencies            |       | $          | 95,195     |           | $          | 1,197          |       | $ | (51 | ) |
| Corporate debt  securities           |       | 239        |       | 2              |       | —         |       |
| Corporate bonds                      |       | 411        |       | —         |       | (82            | )          |
| Other                                |       | 5,445      |       | 228            |       | —         |       |
|                                 |       |       |       |           |       |           |       |
|                                 |       | $          | 101,290    |           | $          | 1,427          |       | $ | (133 | ) |
|                                 |       |       |       |           |       |           |       |
| 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 | ) |

 

Contractual maturities ofdebt securities at December 31, 2008 are shown below. Expected maturitieswill differ from contractual maturities because borrowers may have the right tocall or prepay obligations with or without prepayment penalties.

 
| **(Dollars in thousands)** | ** ** | **Fair Value** | ** ** |
|--------------------------------------|------------|---------------------|------------|
|                                 |       |                |       |
| Due in less than  one year           |       | $                   | —     |   |
| Due after one  through five years    |       | 730                 |       |
| Due after five  through ten years    |       | 26,957              |       |
| Due after ten  years                 |       | 73,603              |       |
|                                 |       |                |       |
|                                 |       | $                   | 101,290    |   |

 

Gross gains of approximately$447,000, $26,000 and $0 on sales of securities were recognized in 2008, 2007and 2006, respectively Securities carried at approximately $74,979,000 and$11,735,000 at December 31, 2008 and 2007, respectively, were pledged. tosecure deposits and for other purposes as required or permitted by law.

 

Restrictedequity securities consist of securities which are restricted as to transferability.These securities are recorded at cost.

 
| **(Dollars in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Federal Home  Loan Bank stock        |       | $        | 1,685      |     | $          | 938 |   |
|                                      |            |          |            |          |            |  |  |

 

F-13

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Table of Contents

 

Securities withunrealized losses at year-end 2008 and 2007, and the length of time they havebeen in continuous loss positions were 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** | ** ** |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2008                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U.S. Government  agencies            |       | $                                      | —     |                                 | $          | —    |       | $ | 8,048 |   | $ | 51 |   | $ | 8,048 |   | $ | 51 |   |
| Corporate debt  securities           |       | —                                 |       | —                               |       | —    |       | — |   | — |   | — |   |
| Corporate bonds                      |       | —                                 |       | —                               |       | 411       |       | 82 |   | 411 |   | 82 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| Total                                |       | $                                      | —     |                                 | $          | —    |       | $ | 8,459 |   | $ | 133 |   | $ | 8,459 |   | $ | 133 |   |
|                                 |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 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 |   |

 

Unrealized losses on U.S.government agency securities have not been recognized into income because thesecurities are backed by the U.S. government or its agencies, management hasthe intent and ability to hold for the foreseeable future and the decline infair value is largely a result of increases in market interest rates. Theunrealized losses on corporate securities have not been recognized into incomebecause management has the intent and ability to hold for the foreseeablefuture, and the decline in fair value is largely a result of increases inmarket interest rates. The fair value of the securities above is expected torecover as the securities approach their maturity dates and/or market ratesdecline.

 

**NOTE3 - LOANS**

 

The following is asummary of loans outstanding by category at December 31:

 
| **(Dollars in thousands)**    | ** ** | **2008**  | ** ** | **2007** | ** ** |
|-----------------------------------------|------------|-----------|------------|----------|------------|
| Real estate:                            |       |      |       |     |       |
|                                    |       |      |       |     |       |
| Construction                            |       | $         | 181,638    |     | $          | 112,405 |   |
| 1 to 4 family  residential              |       | 37,822    |       | 33,560   |       |
| Other                                   |       | 171,150   |       | 143,973  |       |
| Commercial,  financial and agricultural |       | 589,518   |       | 477,666  |       |
| Consumer                                |       | 3,572     |       | 3,966    |       |
| Other                                   |       | 53,025    |       | 22,752   |       |
|                                    |       | 1,036,725 |       | 794,322  |       |
| Less: Allowance  for loan losses        |       | (13,454   | )          | (10,321  | )          |
|                                    |       |      |       |     |       |
| Net loans                               |       | $         | 1,023,271  |     | $          | 784,001 |   |

 

The Bank records atransfer of financial assets as a sale when it surrenders control over thosefinancial assets to the extent that consideration other than beneficialinterests in the assets is received in exchange. The maximum extent of ourrecourse obligations on loans transferred during the three-year period ended December 31,2008 was 10% of the amount transferred, adjusted for any early payoffs orterminations. The amount of the proceeds for loans that were transferred withrecourse, that were recorded as a sale for each period follows.

 

F-14

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Table of Contents

 
| **(Dollars in thousands)**           | ** ** | **2008**   | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from  loans transferred with recourse |       | $          | 27,045     |       | $          | 40,590     |       | $ | 26,022 |   |
|                                                |            |            |            |            |            |            |            |  |  |  |

 

The Bank services loansfor the benefit of others. The amount of loans being serviced for the benefitof others at year-end for each period follows:

 
| ** **                           | ** ** | **December  31,** | ** ** |
|--------------------------------------|------------|-------------------|------------|
| **(Dollars in thousands)** | ** ** | **2008**          | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                 |       |              |       |   |   |   |   |
| Amount of loans  being serviced      |       | $                 | 105,177    |   | $ | 86,489 |   | $ | 66,465 |   |
|                                      |            |                   |            |  |  |  |  |  |  |  |

 

Certain parties(principally executive officers and directors of the Bank, including theirrelated interests) were customers of, and had loans with the Bank in theordinary course of business. These loan transactions were made on substantiallythe same terms as those prevailing at the time for comparable loans to otherpersons. They did not involve more than the normal risk of collectability orpresent other unfavorable features.

 

Loansto principal officers, directors and their affiliates in 2008 were as follows:

 
| **(Dollars in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Beginning  balance                   |       | $        | 6,804      |     | $          | 8,724 |   |
| New loans                            |       | 11,888   |       | 4,475    |       |
| Repayments                           |       | (2,267   | )          | (6,395   | )          |
|                                 |       |     |       |     |       |
| Ending balance                       |       | $        | 16,425     |     | $          | 6,804 |   |

 

**NOTE4 — ALLOWANCE FOR LOAN LOSSES**

 

Changes in the allowancefor loan losses were as follows:

 
| **(Dollars in thousands)**     | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |     |       |
| Balance at  beginning of year            |       | $        | 10,321     |     | $          | 6,968    |       | $ | 4,399 |   |
| Provision  charged to operating expenses |       | 9,111    |       | 6,350    |       | 4,350    |       |
| Loans  charged-off                       |       | (6,099   | )          | (3,310   | )          | (2,037   | )          |
| Recoveries                               |       | 121      |       | 313      |       | 256      |       |
|                                     |       |     |       |     |       |     |       |
| Balance at end  of year                  |       | $        | 13,454     |     | $          | 10,321   |       | $ | 6,968 |   |

 

Impaired loans were as follows:

 
| **(Dollars in thousands)**                 | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                 |       |     |       |     |       |
| Loans with  allocated allowance for loan losses      |       | $        | 11,603     |     | $          | 6,492 |   |
|                                                 |       |     |       |     |       |
| Amount of the  allowance allocated to impaired loans |       | $        | 3,203      |     | $          | 2,442 |   |

 

F-15

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Table of Contents

 
| ** **                                 | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |     |       |
| Average of  impaired loans during the year |       | $        | 7,875      |     | $          | 3,783    |       | $ | 2,719 |   |
|                                            |            |          |            |          |            |          |            |  |  |  |

 

The amount of interestincome recognized for the time that these loans were impaired during 2008, 2007and 2006 was not material to the financial statements.

 

Nonperforming loans wereas follows:

 
| **(Dollars in thousands)**          | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                          |       |     |       |     |       |     |       |
| Loans past due  over 90 days still on accrual |       | $        | 18,788     |     | $          | 1,992    |       | $ | 940 |   |
| Nonaccrual loans                              |       | 11,603   |       | 6,465    |       | 2,689    |       |
|                                               |            |          |            |          |            |          |            |  |  |  |

 

Nonperforming loansinclude both smaller balance homogeneous loans that are collectively evaluatedfor impairment and individually classified impaired loans.

 

**NOTE5 — PREMISES AND EQUIPMENT**

 

Below is a summary ofpremises and equipment as of December 31, 2008 and 2007. Depreciationexpense for 2008, 2007 and 2006 was approximately $423,000, $333,000 and$259,000, respectively.

 
| **(Dollars in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |
| Leasehold improvements               |       | $        | 1,319      |     | $          | 903 |   |
| Furniture and  equipment             |       | 2,680    |       | 1,756    |       |
|                                 |       | 3,999    |       | 2,659    |       |
| Less: Allowance  for depreciation    |       | 1,669    |       | 1,246    |       |
|                                 |       |     |       |     |       |
|                                 |       | $        | 2,330      |     | $          | 1,413 |   |

 

The Bank leases officespace, furniture and equipment under operating leases. Rent expense recognizedin 2008, 2007 and 2006 amounted to approximately $660,000, $390,000 and$352,000, respectively. The remaining minimum lease payments related to theleases are as follows, before considering renewal options that generally arepresent:

 
| **(Dollars in thousands)** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
| 2009                                 |       | $          | 639        |   |
| 2010                                 |       | 675        |       |
| 2011                                 |       | 689        |       |
| 2012                                 |       | 703        |       |
| 2013                                 |       | 706        |       |
| 2014-2017                            |       | 2,881      |       |
|                                 |       |       |       |
|                                 |       | $          | 6,293      |   |

 

F-16

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Table of Contents

 

**NOTE6 - DEPOSITS**

 

Timedeposits greater than $100,000 amounted to approximately $566,084,000 in 2008and approximately $364,797,000 in 2007.

 

At December 31,2008, scheduled maturities of time deposits were as follows:

 
| **(Dollars in thousands)** | ** ** | ** ** | ** ** |
|--------------------------------------|------------|------------|------------|
|                                 |       |       |       |
| 2009                                 |       | $          | 879,830    |   |
| 2010                                 |       | 82,507     |       |
| 2011                                 |       | 8,276      |       |
| 2012                                 |       | 839        |       |
| 2013                                 |       | 4,522      |       |
|                                      |            |            |            |  |

 

Deposits held at the Bankby directors, executive officers and their related interests were approximately$14,706,000 and $3,960,000 at December 31, 2008 and 2007, respectively.

 

**NOTE7 - ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER DEBT**

 

The Federal Home LoanBank (“FHLB”) of Cincinnati advances funds to the Bank with the requirementthat the advances are secured by securities and qualifying loans, essentiallyhome mortgages (1-4 family residential). The Bank has an available line of$16,805,000 with the FHLB. To participate in this program, the Bank is requiredto be a member of the FHLB and own stock in the FHLB. The Corporation had$1,685,000 of such stock at December 31, 2008 to satisfy this requirement.

 

At December 31,2008, the Bank had received no advances from the FHLB and, therefore, hadpledged no securities or qualifying loans to the FHLB.

 

At December 31,2008, the Bank had approximately $48,700,000 in available federal funds lines(or the equivalent thereof) with correspondent banks.  At December 31,2008, the Bank had no federal funds purchased.

 

In September 2008,the Bank entered into a short-term revolving line of credit with FirstTennessee Bank, National Association, pursuant to which First Tennessee agreedto loan the Bank up to $15,000,000.  First Tennessee’s obligation to makeadvances to the Bank under this line of credit terminates on April 30,2009.  At December 31, 2008, the Bank had outstanding borrowings of$10,000,000 under this line of credit.

 

**NOTE8 — INCOME TAXES**

 

Income tax expense(benefit) recognized in each year is made up of current and deferred federaland state tax amounts shown below:

 
| **(Dollars in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |     |       |
| Current federal                      |       | $        | (3,466     | )        | $          | 2,897    |       | $ | 2,730 |   |
| Current state                        |       | (14      | )          | 338      |       | 453      |       |
| Deferred federal                     |       | 7,789    |       | 369      |       | (164     | )          |
| Deferred state                       |       | 463      |       | 39       |       | (34      | )          |
|                                 |       |     |       |     |       |     |       |
|                                 |       | $        | 4,772      |     | $          | 3,643    |       | $ | 2,985 |   |

 

F-17

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Tableof Contents

 

The tax effect of eachtype of temporary difference that results in net deferred tax assets andliabilities is as follows:

 
| **(Dollars in thousands)**     | ** ** | **2008** | ** ** | **2007** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|
| Assets                                   |       |     |       |     |       |
| Allowance for  loan losses               |       | $        | 4,852      |     | $          | 3,428 |   |
| Nonaccrual loan  interest                |       | 337      |       | 245      |       |
| Net deferred  loan fees                  |       | 556      |       | 641      |       |
| Federal net  operating loss carryforward |       | 778      |       | —   |       |
| Tax credit  carryforward                 |       | 463      |       | —   |       |
| Other                                    |       | 245      |       | —   |       |
| Total deferred  tax assets               |       | 7,231    |       | 4,314    |       |
|                                     |       |     |       |     |       |
| Liabilities                              |       |     |       |     |       |
| Tax leases                               |       | (12,593  | )          | (2,733   | )          |
| Unrealized  (gain) loss on securities    |       | (495     | )          | (191     | )          |
| SFAS 140 income  adjustments             | ** ** | (2,243   | )          | (1,476   | )          |
| Depreciation                             |       | (165     | )          | (31      | )          |
| Other                                    |       | (430     | )          | (22      | )          |
| Total deferred  tax asset (liability)    |       | (15,926  | )          | (4,453   | )          |
|                                     |       |     |       |     |       |
| Net deferred tax  asset (liability)      |       | $        | (8,695     | )        | $          | (139 | ) |

 

A reconciliation of theamount computed by applying the federal statutory rate (34%) to pretax incomewith income tax expense (benefit) follows:

 
| **(Dollars in thousands)** | ** ** | **2008** | ** ** | **2007** | ** ** | **2006** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                 |       |     |       |     |       |     |       |
| Tax expense at  statutory rate       |       | $        | 4,259      |     | $          | 3,583    |       | $ | 2,630 |   |
| State income tax  effect             |       | 296      |       | 249      |       | 277      |       |
| Other                                |       | 217      |       | (189     | )          | 78       |       |
|                                 |       |     |       |     |       |     |       |
| Income tax  expense                  |       | $        | 4,772      |     | $          | 3,643    |       | $ | 2,985 |   |

 

The Corporation had nounrecognized tax benefits as of December 31, 2007 and December 31,2008.  No significant increase is expected over the next 12 months.

 

Should the accrual of anyinterest or penalties relative to unrecognized tax benefits be necessary, it isthe Corporation’s policy to record such accruals in its income tax accounts. Nosuch accruals existed as of December 31, 2007 and December 31, 2008.

 

The Corporation and itssubsidiaries file a consolidated U.S. federal income tax return and various returnsin states where its banking offices are located. The Corporation’s filed incometax returns are no longer subject to examination by taxing authorities foryears before 2005.

 

The deferred taxliability itemized above as “SFAS 140 income adjustments” originated from thetransfers of both loans and leases in accordance with SFAS 140. The increase inthis deferred tax liability for the year ended December 31, 2008 comparedto the year ended December 31, 2007 was related to the transfer of leases.For more information, please see the discussion in the section above entitled “TaxLeases” in Note 1 on page F-10.

 

The Bank has a federalnet operating loss carryforward of $2.3 million that will expire in 2028, ifnot previously utilized.

 

The Bank has a federalalternative minimum tax credit carryforward of approximately $428,000 that willnot expire, and a federal general business tax credit carryforward ofapproximately $35,000 that will begin to expire in 2026, if not previouslyutilized.

 

**NOTE 9 – COMMITMENTS AND CONTINGENCIES**

 

The Bank is a party tofinancial instruments with off-balance sheet risk in the normal course ofbusiness to meet the financing needs of its customers. These financialinstruments include commitments to extend credit, standby letters of credit andfinancial guarantees. Those instruments involve, to varying degrees, elementsof credit risk in excess of the amount recognized in the balance sheet. Thecontract or notional amounts of those instruments reflect the extent ofinvolvement the Bank has in those particular financial instruments.

 

The Bank’s exposure tocredit loss in the event of nonperformance by the other party to the financialinstrument for commitments to extend credit, standby letters of credit andfinancial guarantees is represented by the contractual or notional amount ofthose instruments. The Bank uses the same credit policies in making commitmentsand conditional obligations as it does for on-balance sheet instruments.

 

F-18

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Table of Contents

 

The following tablereflects financial instruments for which contract amounts represented creditrisk as of December 31, for the following years:

 
| ** **                                          | ** ** | **2008**  | ** ** | **2007**     | ** ** |
|-----------------------------------------------------|------------|-----------|------------|--------------|------------|
| ** **                                          | ** ** | **Fixed** | ** ** | **Variable** | ** ** | **Fixed** | ** ** | **Variable** | ** ** |
| **(Dollars in thousands)**                | ** ** | **Rate**  | ** ** | **Rate**     | ** ** | **Rate** | ** ** | **Rate** | ** ** |
|                                                |       |      |       |         |       |   |   |   |   |
| Commitments to  extend credit                       |       | $         | 39,529     |         | $          | 137,950 |   | $ | 18,380 |   | $ | 107,663 |   |
| Standby letters  of credit and financial guarantees |       | —    |       | 12,045       |       | — |   | 11,063 |   |
|                                                     |            |           |            |              |            |  |  |  |  |  |  |  |  |

 

Commitments to make loansare generally made for periods of one year or less. The fixed rate loancommitments have interest rates ranging from 4% to 11% and maturities rangingfrom two months to five years.

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract. Commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.Because many of the commitments are expected to expire without being drawnupon, 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 necessary bythe Bank upon extension of credit, is based on management’s credit evaluation.Collateral held varies but may include accounts receivable, inventory,property, plant and equipment, and income-producing commercial properties.

 

Standby letters of creditare conditional commitments issued by the Bank to guarantee the performance ofa customer to a third party. Those guarantees are primarily issued to supportpublic and private borrowing arrangements, including commercial paper, bondfinancing, and similar transactions. All letters of credit are due within oneyear or less of the original commitment date. The credit risk involved inissuing letters of credit is essentially the same as that involved in extendingloan facilities to customers.

 

The Bank primarily servescustomers located in Middle Tennessee. As such, the Bank’s loans, commitmentsand letters of credit have been granted to customers in that area.Concentration of credit by type of loan is presented above in Note 3.

 

**NOTE 10 – EMPLOYEE BENEFITS**

 

The Bank maintains a 401(k) planfor all employees who have satisfied the minimum age and service requirements.The Bank may make discretionary contributions and employees vest in employercontributions over five years. The Bank made no contributions to the planduring 2008, 2007 or 2006.

 

**NOTE 11 – REGULATORY MATTERS**

 

Under capital adequacyguidelines and the regulatory framework for prompt corrective action, theCorporation and the Bank are required to meet specific capital adequacyguidelines that involve quantitative measures of a bank’s assets, liabilitiesand certain off-balance sheet items as calculated under regulatory accountingpractices. Failure to meet minimum capital requirements can initiate certainmandatory and possible additional discretionary actions by regulators that, ifundertaken, could have a material effect on the Bank’s financial condition.

 

The Corporation and theBank’s capital amounts and classifications are also subject to qualitativejudgments by the regulators about components, risk weightings and otherfactors. The risk-based guidelines are based on the assignment of risk weightsto assets and off-balance sheet items depending on the level of credit riskassociated with them. In addition to minimum capital requirements, under theregulatory framework for prompt corrective action, regulatory agencies havespecified certain ratios an institution must maintain to be considered “undercapitalized,”“adequately capitalized,” and “well capitalized.” As of December 31, 2008and 2007, the most recent notification from the Bank’s regulatory authoritycategorized the Corporation and the Bank as “well capitalized.” There are noconditions or events since that notification that management believes havechanged the Corporation and the Bank’s category.

 

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Table of Contents

 

The Bank and theCorporation’s capital amounts and ratios at December 31, 2008 and 2007 areas follows:

 
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|--------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                           | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                           | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)** | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 2008                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Total risk-based                     |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 120,746    |                       | 11.01      | %                          | $          | 87,716                     |       | 8.0                        | %          | $ | 109,645 |   | 10.0 | % |
| Corporation                          |       | $          | 136,900    |                       | 12.42      | %                          | $          | 88,207                     |       | 8.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 to  risk-based                |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 107,292    |                       | 9.79       | %                          | $          | 43,858                     |       | 4.0                        | %          | $ | 65,787 |   | 6.0 | % |
| Corporation                          |       | $          | 123,446    |                       | 11.20      | %                          | $          | 44,103                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Tier 1 leverage                      |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| Bank                                 |       | $          | 107,292    |                       | 9.26       | %                          | $          | 46,359                     |       | 4.0                        | %          | $ | 57,949 |   | 5.0 | % |
| Corporation                          |       | $          | 123,446    |                       | 10.62      | %                          | $          | 46,473                     |       | 4.0                        | %          | n/a |   |   |   |
|                                 |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |
| 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 |   |   |   |

 

**NOTE12 – STOCK OPTIONS**

 

Below is a summary ofcertain rights and provisions of the stock options the Corporation has issued.All stock options and the related strike price reflect the impact of thetwo-for-one stock split on December 31, 2003. All options expire ten yearsfrom the date of grant.

 

The original 14incorporators and members of the Board of Directors were granted an aggregateof options to purchase 122,500 shares of common stock at $5.00 per share inconnection with organization activities. Each of these options was immediatelyvested on the date of grant. In 2002, 2006 and 2007, options to purchase10,000, 11,000 and 65,900 shares of common stock, respectively, were exercised,leaving options to purchase 35,600 shares outstanding.

 

Pursuant to employmentagreements, executive officers received options equal to 14% of the shares soldin the original offering at an exercise price of $5.00 per share. Based on theinitial sale of 1,817,440 shares, executive officer received options topurchase 254,440 shares, which options vest over three years. Of this total,options to purchase 24,232 shares were exercised and options to purchase 12,116shares were forfeited in 2002, and options to purchase 2,000 shares wereexercised in 2004.  In August 2003,the Board of Directors approved an option plan for active directors andincorporators in recognition of their four years of service to the Bank withoutcompensation. An aggregate of options to purchase 320,000 shares at a price of$10.50 per share were included in this plan. These options were immediatelyvested on the date of grant. In 2006 and 2007, options to purchase 50,000 and60,000 shares, respectively, were exercised, leaving options to purchase210,000 shares outstanding.

 

In 2006, options to purchase 1,000 shares wereexercised and in 2007, options to purchase 93,372 shares were exercised leavingan outstanding balance of options to purchase 121,720 shares. In August 2005,one executive officer was granted options to purchase 5,000 shares. Of these,options to purchase 2,500 shares immediately vested and the remaining vestedone year later. In November 2005, one executive officer was grantedoptions to purchase 6,250 shares that immediately vested. Of these 2005 grants,all were exercised in 2007, leaving no options outstanding at December 31,2007. In June 2007, four executive officers were granted options topurchase 50,000 shares each at an exercise price of $25.00 per share to vestover five years based 20% on service and 80% on performance. Of these, optionsto purchase 200,000 shares were outstanding with options to purchase 40,000shares vested at December 31, 2007. In 2008, three executive officers weregranted options to purchase 50,000 shares at a an exercise price of $22.15 pershare to vest over five years based 20% on service and 80% on performance. Ofthese, options to purchase 150,000 shares were outstanding with options topurchase 23,000 shares vested at December 31, 2008.

 

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In2008, options to purchase 7,500 shares were exercised at an exercise price of$5.00 per share, and options to purchase 108,876 shares were forfeited.

 

TheBoard of Directors has granted incentive options to various employees who arenot executive officers. Incentive options are used for recruiting and retentionpurposes and to recognize performance. Employee incentive options includeoptions to purchase 13,000 shares at $5.00 per share granted in 2000 and 2001.An aggregate of options to purchase 5,000 shares have been forfeited by formeremployees, options to purchase 3,000 shares were exercised on December 31,2003, and options to purchase 1,000 shares were exercised in 2004. Options topurchase an additional 2,000 shares were exercised in 2007 leaving options topurchase 2,000 shares outstanding at December 31, 2007. None of theseoptions were exercised in 2008. In March 2003, options to purchase 9,000shares at $7.50 per share were granted. In 2007, options to purchase 4,000shares were exercised leaving options to purchase 5,000 shares outstanding at December 31,2007. None of these options were exercised in 2008. In December 2003,options to purchase 31,000 shares at $10.50 per share were granted. Of these,options to purchase 5,000 shares were forfeited in 2004. In 2006, options topurchase 1,000 shares were exercised and in 2007, options to purchase 12,000shares were exercised, leaving options to purchase 13,000 shares outstanding atDecember 31, 2007. None of these options were exercised in 2008. All ofthese incentive options vested in two years. In July 2005 and August 2005,options to purchase 69,000 and 10,000 shares respectively, were granted. Oneach grant date, half of all options immediately vested with the remainingoptions vesting one year later. In November 2005, options to purchase10,000 shares were granted to employees and were immediately vested. Of these2005 grants, options to purchase 3,750 shares were forfeited in 2006 and in2007, options to purchase 24,000 shares were exercised, leaving options topurchase 61,250 shares outstanding at December 31, 2007. In 2008, none ofthe awards granted in 2005 were exercised or forfeited, leaving options topurchase 61,250 shares outstanding at December 31, 2008.

 

The fair value of optionsgranted during 2008 was computed using option pricing models, using thefollowing weighted-average assumptions as of grant date:

 
| ** **               | ** ** | **2008**  | ** ** |
|--------------------------|------------|-----------|------------|
|                     |       |      |       |
| Risk-free  interest rate |       | 3.27      | %          |
| Expected option  life    |       | 3.5 years |       |
| Dividend yield           |       | 0.0       | %          |
| Volatility               |       | 20.0      | %          |

 

Theweighted average fair value of options granted during 2008 was $4.45.

 

A summary of the activityrelated to stock options is as follows:

 
| ** **                                               | ** ** | **2008**   | ** ** | **2007**     | ** ** | **2006**   | ** ** |
|----------------------------------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                                               | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                               | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                               | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                               | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                                                     |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding at  beginning of year                        |       | 798,570    |       | $            | 13.14      |       | 871,092    |   | $ | 8.78 |   | 937,842 |   | $ | 8.85 |   |
| Options granted                                          |       | 150,000    |       | 22.15        |       | 200,000    |       | 25.00 |   | — |   | — |   |
| Shares of  restricted stock granted                      |       | 10,955     |       | —       |       | —     |       | — |   | — |   | — |   |
| Options  exercised                                       |       | (7,500     | )          | 5.00         |       | (272,522   | )          | 7.91 |   | (63,000 | ) | 9.45 |   |
| Options  forfeited or expired                            |       | (108,000   | )          | 23.47        |       | —     |       | — |   | (3,750 | ) | 16.00 |   |
| Restricted stock  forfeited                              |       | (876       | )          |         |       | —     |       |   |   | — |   |   |   |
| Outstanding  at end of year                         |       | 843,149    |       | $            | 13.49      |       | 798,570    |   | $ | 13.14 |   | 871,092 |   | $ | 8.78 |   |
| Outstanding  at end of year (less restricted stock) |       | 833,070    |       | $            | 13.49      |       | 798,570    |   | $ | 13.14 |   | 871,092 |   | $ | 8.78 |   |
|                                                     |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options  exercisable at year-end                         |       | 669,470    |       |         |       | 638,570    |       |   |   | 871,092 |   |   |   |

 

At December 31,2008, options outstanding had a weighted average remaining contractual term of5.09 years and an aggregate intrinsic value of $6.00. At December 31,2008, options exercisable had a weighted average remaining contractual term of4.20 years and an aggregate intrinsic value of $6.00. During the years ended December 31,2008, 2007 and 2006, the aggregate intrinsic value of options exercised underthe Corporation’s stock option plans was $136,275, $5,404,895 and $667,500,respectively. As of December 31, 2008, there was $28,600 unrecognized compensationcosts related to nonvested stock options granted. This cost is expected to berecognized over a weighted average period of four years. Of the options topurchase 150,000 shares of common stock granted in 2008, 58,000 were forfeitedor exercised, and only 23,000 vested, leaving 69,000 shares unvested as of December 31,2008.  The respective weighted average fair values were approximately$117,000 and approximately $351,000 at December 31, 2007 and 2008,respectively.

 

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Options outstanding atyear-end 2008 were as follows:

 
| ** **               | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|--------------------------|------------|-----------------|------------|-----------------|------------|
| ** **               | ** ** | ** **      | ** ** | **Weighted**    | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **      | ** ** | **Average**     | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **               | ** ** | ** **      | ** ** | **Remaining**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Exercise**             | ** ** | ** **      | ** ** | **Contractual** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| **Prices**               | ** ** | **Number**      | ** ** | **Life**        | ** ** | **Number** | ** ** | **Price** | ** ** |
|                     |       |            |       |            |       |   |   |   |   |
| $5.00                    |       | 151,820         |       | 1.0 years       |       | 151,820 |   | $ | 5.00 |   |
| $7.50                    |       | 95,000          |       | 4.0 years       |       | 95,000 |   | $ | 7.50 |   |
| $10.50                   |       | 223,000         |       | 4.0 years       |       | 223,000 |   | $ | 10.50 |   |
| $11.00                   |       | 60,000          |       | 5.0 years       |       | 60,000 |   | $ | 11.00 |   |
| $16.00                   |       | 61,250          |       | 6.8 years       |       | 61,250 |   | $ | 16.00 |   |
| $25.00                   |       | 150,000         |       | 8.5 years       |       | 60,000 |   | $ | 25.00 |   |
| $22.15                   |       | 92,000          |       | 9.0 years       |       | 18,400 |   | $ | 22.15 |   |
|                     |       |            |       |            |       |   |   |   |   |
| Outstanding at  year-end |       | 833,070         |       | 5.1 years       |       | 669,470 |   | $ | 10.99 |   |

 

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

 

The methods andassumptions used to estimate fair value are described as follows:

 

Carrying amount is theestimated fair value for cash and due from financial institutions, federalfunds sold and purchased, accrued interest receivable and payable, demanddeposits and variable rate loans or deposits that reprice frequently and fully.Security fair values are based on market prices or dealer quotes, and if nosuch information is available, on the rate and term of the security andinformation about the issue. For fixed rate loans or deposits and for variablerate loans or deposits with infrequent re-pricing or re-pricing limits, fairvalue is based on discounted cash flows using current market rates applied to theestimated life and credit risk. The fair value of the subordinated long termdebt is based on discounted cash flows using current market rates applied tothe estimated life of the debt. Other assets and accrued liabilities arecarried at fair value. The fair value of off-balance-sheet loan commitments isconsidered nominal.

 

The estimated fair valuesof the Bank’s financial instruments at December 31, 2008 and 2007 were asfollows:

 
| ** **                                | ** ** | **2008**     | ** ** | **2007**  | ** ** |
|-------------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                                | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| **(Dollars in thousands)**      | ** ** | **Amount**   | ** ** | **Value** | ** ** | **Amount** | ** ** | **Value** | ** ** |
| Financial assets                          |       |         |       |      |       |   |   |   |   |
| Cash and due  from financial institutions |       | $            | 5,260      |      | $          | 5,260 |   | $ | 5,236 |   | $ | 5,236 |   |
| Federal funds  sold                       |       | 35,538       |       | 35,538    |       | 9,573 |   | 9,573 |   |
| Securities  available for sale            |       | 101,290      |       | 101,290   |       | 73,753 |   | 73,753 |   |
| Loans, net                                |       | 1,023,271    |       | 1,114,151 |       | 784,001 |   | 799,545 |   |
| Accrued interest  receivable              |       | 8,115        |       | 8,115     |       | 5,901 |   | 5,901 |   |
| Restricted  equity securities             |       | 1,685        |       | 1,685     |       | 938 |   | 938 |   |
| Financial  liabilities                    |       |         |       |      |       |   |   |   |   |
| Deposits                                  |       | $            | 1,069,143  |      | $          | 1,106,907 |   | $ | 815,053 |   | $ | 828,176 |   |
| Federal fund  purchased                   |       | —       |       | —    |       | 2,000 |   | 2,000 |   |
| Accrued interest  payable                 |       | 3,315        |       | 3,315     |       | 2,292 |   | 2,292 |   |
| Subordinated  long-term debt              |       | 23,198       |       | 24,897    |       | 8,248 |   | 8,221 |   |
| Short-term  borrowings                    |       | 10,000       |       | 10,000    |       | 7,000 |   | 7,000 |   |

 

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The Bank has an established process for determining fair values of thefinancial instruments, in accordance with SFAS No. 157. Fair value isbased upon quoted market prices, where available. If listed prices or quotesare not available, fair value is based upon internally developed models orprocesses that use primarily market-based or independently-sourced market data,including interest rate yield curves, option volatilities and third partyinformation. Valuation adjustments may be made to ensure that financialinstruments are recorded at fair value. These adjustments include amounts toreflect counterparty credit quality (for financial assets reflected at fairvalue), the Bank’s creditworthiness (for financial liabilities reflected atfair value), liquidity and other unobservable parameters that are appliedconsistently over time as follows:

 
| · | Credit valuation adjustments are necessary when the  market price (or parameter) is not indicative of the credit quality of the  counterparty;                                                                                                                                                                                                                                       |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                                                                                 |
| · | Debit valuation adjustments are necessary to reflect  the credit quality of the Bank in the valuation of liabilities measured at  fair value;                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                                                                                 |
| · | Liquidity valuation adjustments are necessary when  the Bank may not be able to observe a recent market price for a financial  instrument that trades in inactive (or less active) markets or to reflect the  cost of exiting larger- than-normal market-size risk positions; and                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                                                                                 |
| · | Unobservable parameter valuation adjustments are  necessary when positions are valued using internally developed models that  use as their basis unobservable parameters – that is, parameters that must be  estimated and are, therefore, subject to management judgment to substantiate  the model valuation. These financial instruments are normally traded less  actively. |

 

The methods described above may produce a fair valuecalculation that may not be indicative of net realizable value or reflective offuture fair values. Furthermore, while management believes its valuationmethods are appropriate and consistent with other market participants, the useof different methodologies, or assumptions, to determine the fair value ofcertain financial instruments could result in a different estimate of fairvalue at the reporting date.

 

**Valuation Hierarchy**

 

SFAS No.157 establishes a three-level valuationhierarchy for disclosure of fair value measurements. The valuation hierarchy isbased upon the transparency of inputs to the valuation of an asset or liabilityas of the measurement date. The three levels are defined as follows:

 
| · | Level 1 – inputs to the valuation methodology are  quoted prices (unadjusted) for identical assets or liabilities in active  markets.                                                                                                                                              |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                         |
| · | Level 2 – inputs to the valuation methodology  include quoted prices for similar assets and liabilities in active markets,  and inputs that are observable for the asset or liability, either directly or  indirectly, for substantially the full term of the financial instrument, and |
|   |                                                                                                                                                                                                                                                                                         |
| · | Level 3 – inputs to the valuation methodology are  unobservable and significant to the fair value measurement.                                                                                                                                                                          |

 

A financial instrument’s categorization within thevaluation hierarchy is based upon the lowest level of input that is significantto the fair value measurement.  Below is a description of the valuationmethodologies used for instruments measured at fair value, as well as thegeneral classification of such instruments pursuant to the valuation hierarchy.

 

**Assets**

 

*Securities -*Available-for-sale securities arerecorded at fair value on a recurring basis.  Where quoted prices areavailable in an active market, securities are classified within Level 1 of thevaluation hierarchy.  Level 1 securities include highly liquid governmentbonds, federal funds sold and certain other products.  Fair valuemeasurement of these securities is based upon quoted prices, ifavailable.  If quoted prices are not available, securities would generallybe classified within Level 2, and fair value would be determined by matrixpricing, which is a mathematical technique widely used in the industry to valuedebt securities without relying exclusively on quoted prices for the specificsecurities but relying on the securities’ relationship to other benchmarkquoted securities. In certain cases where there is limited activity or lesstransparency around inputs to the valuation, securities are classified withinLevel 3 of the valuation hierarchy. For the year ended December 31, 2008,the entire Bank’s available-for-sale securities were valued using matrixpricing and were classified within Level 2 of the valuation hierarchy.  AtDecember 31, 2008, the Bank had no securities classified within Level 3.

 

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*Servicing Assets -* All separately recognized servicingassets and servicing liabilities are initially measured at fair value.Subsequent measurement methods include the amortization method, wherebyservicing assets or servicing liabilities are amortized over the period of estimatednet servicing income or net servicing loss, or the fair value method, wherebyservicing assets or servicing liabilities are measured at fair value at eachreporting date and changes in fair value are reported in earnings in the periodin which they occur. Because of the unique nature of the Bank’s servicingassets, quoted market prices may not be available.  If no quoted market prices are available, theamortization method is used.  The Bankassesses servicing assets or servicing liabilities for impairment or increasedobligation based on the fair value at each reporting date.  At December 31,2008, the Bank had servicing assets measured at fair value on a recurringbasis classified within Level 3 of the valuation hierarchy.

 

*Interest-Only Strips -* When the Bank sells loans to others, itmay hold interest-only strips, which is an interest that continues to be heldby the transferor in the securitized receivable.  It may also retain servicing assets or assumeservicing liabilities that are initially measured at fair value.  Gain or loss on sale of the receivablesdepends in part on both (a) the previous carrying amount of the financialassets involved in the transfer, allocated between the assets sold and theinterests that continue to be held by the transferor based on their relativefair value at the date of transfer, and (b) the proceeds received.  To obtain fair values, quoted market pricesare used if available.  Quotes aregenerally not available for interests that continue to be held by the transferor,so the Bank generally estimates fair value based on the future expected cashflows estimated using management’s best estimates of the key assumptions –credit losses and discount rates commensurate with the risks involved. At December 31,2008, the Bank had interest-only strips measured at fair value on arecurring basis classified within Level 3 of the valuation hierarchy.

 

*Impaired Loans –* A loan is considered to be impaired whenit is probable the Bank will be unable to collect all principal and interestpayments due in accordance with the contractual terms of the loan agreement.Individually identified impaired loans are measured based on the present valueof expected payments using the loan’s original effective rate as the discountrate, the loan’s observable market price, or the fair value of the collateralif the loan is collateral dependent.  Ifthe recorded investment in the impaired loan exceeds the measure of fair value,a valuation allowance may be established as a component of the allowance forloan losses.  At December 31, 2008,the Bank had impaired loans measured on a nonrecurring basis classified withinLevel 3 of the valuation hierarchy.

 

*Other Assets –* Included in other assets are certainassets carried at fair value, including repossessions and other real estateowned. The carrying amount of these assets is based on an observable marketprice or appraisal value. The Bank reflects these assets within Level 3 of thevaluation hierarchy. At December 31, 2008, the Bank had repossessionsand other real estate owned measured at fair value on a nonrecurring basisclassified within Level 3 of the valuation hierarchy. Repossessed assets areresold at retail prices as soon as practicable.  If a repossession of theBank is not resold within the six month holding period allowed by Tennesseelaw, it is purchased by a subsidiary of the Corporation at fair marketvalue.  The sole purpose of the subsidiary is the resale of assets reposedby the Bank.

 

**Liabilities**

 

*Recourse Obligations* – The maximum extent of the Bank’srecourse obligations on loans transferred is 10% of the amount transferredadjusted for any early payoffs or terminations, based on the Bank’s paymenthistory on loans of the type transferred. At December 31, 2008, theBank had recourse obligations measured at fair value on a recurring basisclassified within Level 3 of the valuation hierarchy.

 

The following table presents the financial instrumentscarried at fair value as of December 31, 2008, by caption on theconsolidated balance sheets and by SFAS No. 157 valuation hierarchy (asdescribed above) (dollars in thousands):

 

**Assets and liabilities measured atfair value on a recurring basis as of December 31, 2008**

 
| ** **                           | ** ** | **Total  carrying  value in the  consolidated  balance** | ** ** | **Quoted  market  prices in an  active  market** | ** ** | **Internal  models with  significant  observable  market  parameters** | ** ** | **Internal  models with  significant  unobservable  market  parameters** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **sheet**                                                          | ** ** | **(Level 1)**                                         | ** ** | **(Level 2)**                                                          | ** ** | **(Level 3)**                                                            | ** ** |
| Securities  available for sale       |       | $                                                                  | 101,290    |                                                       | $          | —                                                                      |       | $                                                                             | 101,290    |   | $ | — |   |
| Servicing assets                     |       | 216                                                                |       | —                                                     |       | —                                                                      |       | 216                                                                           |       |
| Interest-only  strips                |       | 5,244                                                              |       | —                                                     |       | —                                                                      |       | 5,244                                                                         |       |
| **Total  assets at fair value**      |       | $                                                                  | 106,750    |                                                       | $          | —                                                                      |       | $                                                                             | 101,290    |   | $ | 5,460 |   |
|                                 |       |                                                               |       |                                                       |       |                                                                        |       |                                                                          |       |
| Recourse  obligations                |       | 444                                                                |       | —                                                     |       | —                                                                      |       | 444                                                                           |       |
| **Total  liabilities at fair value** |       | $                                                                  | 444        |                                                       | $          | —                                                                      |       | $                                                                             | —     |   | $ | 444 |   |

 

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The Corporation may be required, from time to time, tomeasure certain assets at fair value on a nonrecurring basis in accordance withgenerally accepted accounting principles. These include assets that aremeasured at the lower of cost or market that were recognized at fair valuebelow the cost at the end of the period. The following table presents thefinancial instruments carried at fair value as of December 31, 2008, bycaption on the consolidated balance sheets and by SFAS No. 157 valuationhierarchy (as described above) (dollars in thousands):

 

**Assetsand liabilities measured at fair value on a nonrecurring basis as of December 31,2008**

 
| ** **                           |   | **Total  carrying  value in the  consolidated  balance** |   | **Quoted  market  prices in an  active  market** |   | **Internal  models with  significant  observable  market  parameters** |   | **Internal  models with  significant  unobservable  market  parameters** |   |
|--------------------------------------|--------|--------------------------------------------------------------------|--------|------------------------------------------------------------|--------|-----------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------|--------|
| ** **                           |   | **sheet**                                                          |   | **(Level 1)**                                         |   | **(Level 2)**                                                          |   | **(Level 3)**                                                            |   |
| Impaired loans                       |   | $                                                                  | 11,603 |                                                       | $      | —                                                                      |   | $                                                                             | — |   | $ | 11,603 |   |
| Inventory                            |   | 4,701                                                              |   | —                                                     |   | —                                                                      |   | 4,701                                                                         |   |
| Other Assets                         |   | 16,457                                                             |   | —                                                     |   | —                                                                      |   | 16,457                                                                        |   |
|                                 |   |                                                               |   |                                                       |   |                                                                        |   |                                                                          |   |
| **Total  assets at fair value**      |   | $                                                                  | 32,761 |                                                       | $      | —                                                                      |   | $                                                                             | — |   | $ | 32,761 |   |
|                                 |   |                                                               |   |                                                       |   |                                                                        |   |                                                                          |   |
| Liabilities                          |   | —                                                             |   | —                                                     |   | —                                                                      |   | —                                                                        |   |
| **Total  liabilities at fair value** |   | $                                                                  | — |                                                       | $      | —                                                                      |   | $                                                                             | — |   | $ | — |   |

 

**Changesin Level 3 Fair Value Measurements**

 

Thetable below includes a roll-forward of the balance sheet amounts for 2008(including the change in fair value) for financial instruments classified bythe Bank within Level 3 of the valuation hierarchy for assets and liabilitiesmeasured at fair value on a recurring basis. When a determination is made toclassify a financial instrument within Level 3 of the valuation hierarchy, thedetermination is based upon the significance of the unobservable factors to theoverall fair value measurement. Because, Level 3 financial instrumentstypically include, in addition to the unobservable or Level 3 components,observable components (that is, components that are actively quoted and can bevalidated to external sources), the gains and losses in the table below includechanges in fair value due in part to observable factors that are part of thevaluation methodology.

 
| **Twelve months ended December 31, 2008 (in thousands)**                                                               | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|
| Fair value,  January 1, 2008                                                                                                                         |       | $          | 3,564      |            | $          | 319 |   |
| Total realized  and unrealized gains/losses included in income                                                                                            |       | (2,897     | )          | 291             |       |
| Purchases,  issuances and settlements, net                                                                                                                |       | 4,793      |       | (166            | )          |
| Transfers in and/or  out of level 3                                                                                                                       |       | —     |       | —          |       |
| Fair value,  December 31, 2008                                                                                                                       |       | $          | 5,460      |            | $          | 444 |   |
| Total unrealized  gains included in income related to financial assets and liabilities still on  the consolidated balance sheet at December 31, 2008 |       | $          | —     |            | $          | — |   |

 

**NOTE 14 –EMPLOYMENT AGREEMENTS**

 

The Bank has entered into employment agreements withthree executive officers that have a term of two years and are automaticallyrenewable each day during their term for one additional day so that the term ofeach is always two years, unless and until either the Bank or the executiveprovides notice of its intent not to renew. In the event of a change in control of the Bank, each executive would beentitled to receive a lump sum payment equal to one dollar ($1) less than theamount that would constitute an “excess parachute payment,” as defined in Section 280Gof the Internal Revenue Code.

 

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**NOTE 15 –CAPITAL STOCK**

 

TheCorporation’s charter authorizes 1,000,000 shares of preferred stock, no parvalue. Shares of the preferred stock may be issued from time to time in one ormore series, each such series to be so designated as to distinguish the sharesfrom the shares of all other series and classes. The Board of Directors has theauthority to divide any or all classes of preferred stock into series and tofix and determine the relative rights and preferences of the shares of anyseries so established.

 

*Series A Preferred Stock andWarrants –* OnOctober 3, 2008, the Emergency Economic Stabilization Act of 2008 wasenacted. On October 14, 2008, the U.S. Department of the Treasury (“Treasury”)announced its intention to inject capital into nine large U.S. financialinstitutions under the Troubled Asset Relief Program Capital Purchase Program (“CPP”)  and since has injected capital into manyother financial institutions. On December 19, 2008, the Corporationentered into a Letter Agreement with Treasury pursuant to which, among otherthings, the Corporation sold to Treasury for an aggregate purchase price of $30million, 30,000 shares of Series A Preferred Stock and a warrant topurchase up to 461,538 shares of common stock (the “Warrant”), of the Corporation.As a condition under the CPP, the Corporation’s share repurchases are currentlylimited to purchases in connection with the administration of any employeebenefit plan, consistent with past practices, including purchases to offsetshare dilution in connection with any such plans. This restriction is effectiveuntil December 19, 2011, or until Treasury no longer owns any of the Series APreferred Stock.

 

The Series APreferred Stock ranks senior to the Corporation’s common shares. The Series APreferred Stock pays a compounding cumulative dividend, in cash, at a rate of5% per annum for the first five years, and 9% per annum thereafter on theliquidation preference of $1,000 per share. The Corporation is prohibited frompaying any dividend with respect to shares of common stock, other juniorsecurities or preferred stock ranking *paripassu* with the Series A Preferred Stock or repurchasing orredeeming any shares of the Corporation’s common shares, other juniorsecurities or preferred stock ranking *paripassu* with the Series A Preferred Stock in any quarter unlessall accrued and unpaid dividends are paid on the Series A Preferred Stockfor all past dividend periods (including the latest completed dividend period),subject to certain limited exceptions. The Series A Preferred Stock isnon-voting, other than class voting rights on matters that could adverselyaffect the Series A Preferred Stock. The Series A Preferred Stock iscallable at par after three years. Prior to the end of three years, the Series APreferred Stock may be redeemed with the proceeds from one or more qualifiedequity offerings of any Tier 1 perpetual preferred or common stock (each a “QualifiedEquity Offering”). Treasury may also transfer the Series A Preferred Stockto a third party at any time.

 

In addition, the terms of the Series A Preferred Stock include arestriction against increasing the Corporation’s common stock dividends fromlevels at the time of the initial investment by Treasury and prevent theCorporation from redeeming, purchasing or otherwise acquiring its common stockother than for certain stated exceptions. Historically, the Corporation haspaid no dividends on its common stock. Therefore, the Corporation would have toseek Treasury’s consent to pay any dividends on shares of Corporation commonstock. These restrictions will terminate on the earlier of the thirdanniversary of the date of issuance of the Series A Preferred Stock toTreasury and the date on which the Series A Preferred Stock issued toTreasury has been redeemed in whole or Treasury has transferred all of its Series APreferred Stock to third parties.  Inaddition, the Corporation will be unable to declare or pay dividends ordistributions on, or repurchase, redeem or otherwise acquire for consideration,shares of its common stock or other stock ranking junior to, or in parity with,the Series A Preferred Stock if the Corporation fails to declare and payfull dividends (or declare and set aside a sum sufficient for payment thereof)on its Series A Preferred Stock.

 

The Series APreferred Stock qualifies as Tier 1 capital in accordance with regulatorycapital requirements.

 

*Warrant –*The Warrant has a term of ten years andis exercisable at any time, in whole or in part, at an exercise price of $9.75per share (subject to certain anti-dilution adjustments). Based on the BlackScholes options pricing model, the Warrant has been assigned a fair value of$1.2 million in the aggregate, as of December 19, 2008. Treasury may notexercise the Warrant for, or transfer the Warrant with respect to, more thanhalf of the initial shares of common stock underlying the Warrant prior to theearlier of (i) the date on which the Corporation receives aggregate grossproceeds of not less than $30 million from one or more Qualified EquityOfferings and (ii) December 31, 2009. The number of shares of commonstock to be delivered upon settlement of the Warrant will be reduced by 50% ifthe Corporation receives aggregate gross proceeds of at least 100% of theaggregate liquidation preference of the Series A Preferred Stock ($30million) from one or more Qualified Equity Offerings prior to December 31,2009.

 

*StockIssuance: –*On June 27, 2006, the Corporation’s Registration Statement on Form S-1,as amended (Registration 333-133539), was declared effective by the SEC. Pursuant to the registration statement, the Corporation registered 1,150,000shares of its common stock at a price of $18.00 per share.  On July 3,2006, the Corporation received approximately $16,920,000 of net proceeds fromthe sale of 1,000,000 shares of its common stock in connection with its publicoffering, and on July 28, 2006, the Corporation received approximately$2,538,000 of net proceeds from the sale of 150,000 additional shares of itscommon stock issued in connection with the underwriters’ over-allotmentoption.  As of July 28, 2006, all 1,150,000 shares offered under theregistration statement had been fully subscribed. FTN Midwest Securities Corp.and Sterne, Agee & Leach, Inc. were the managing underwriters forthe offering.  The total expenses incurred for the Corporation’s accountin connection with the issuance and distributions of the securities wereapproximately $431,000. The net offering proceeds to the Corporation afterdeducting the total expenses were $19,027,000.  These net proceeds wereused to repay the approximately $5,000,000 outstanding balance on our revolvingline of credit, to fund the continued expansion of our franchise and forgeneral corporate purposes.

 

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**NOTE 16 –PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION**

 

Condensed financialinformation of the Corporation follows:

 

**CONDENSEDBALANCE SHEETS**

 
|                                 |   | **December 31,** |    |
|--------------------------------------|--------|-----------------------|---------|
| **(Dollars in thousands)** |   | **2008**              |    | **2007** |   |
| ASSETS                               |   |                  |    |   |   |
| Cash and cash  equivalents           |   | $                     | 17,427  |   | $ | 777 |   |
| Investment in  banking subsidiary    |   | 115,010               |    | 76,923 |   |
| Other                                |   | 2,782                 |    | 944 |   |
|                                 |   |                  |    |   |   |
| Total assets                         |   | $                     | 135,219 |   | $ | 78,644 |   |
|                                 |   |                  |    |   |   |
| LIABILITIES AND  EQUITY              |   |                  |    |   |   |
| Interest payable                     |   | $                     | 24      |   | $ | 25 |   |
| Other short term  payables           |   | 10,250                |    | 7,250 |   |
| Subordinated  long term debt         |   | 23,198                |    | 8,248 |   |
| Shareholders’  equity           |   | 101,747               |    | 63,121 |   |
|                                 |   |                  |    |   |   |
| Total  liabilities and equity        |   | $                     | 135,219 |   | $ | 78,644 |   |

 

**CONDENSEDSTATEMENTS OF INCOME**

 
| ** **                                                           | ** ** | **For Years ended December 31,** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                           | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
|                                                                 |       |                                                 |       |   |   |   |   |
| Dividend and  interest income                                        |       | $                                                    | 69         |   | $ | 17 |   | 17 |   |
| Interest expense                                                     |       | (1,487                                               | )          | (632 | ) | (597 | ) |
| Non-interest  expense                                                |       | (2,508                                               | )          | (1,261 | ) | (826 | ) |
|                                                                 |       |                                                 |       |   |   |   |   |
| Income (loss)  before income tax and undistributed subsidiary income |       | (3,926                                               | )          | (1,876 | ) | (1,406 | ) |
| Income tax  (expense) benefit                                        |       | 1,388                                                |       | 696 |   | 542 |   |
| Equity in  undistributed subsidiary income                           |       | 10,292                                               |       | 8,076 |   | 5,613 |   |
|                                                                 |       |                                                 |       |   |   |   |   |
| Net income                                                           |       | $                                                    | 7,754      |   | $ | 6,896 |   | $ | 4,749 |   |
|                                                                      |            |                                                      |            |  |  |  |  |  |  |  |

 

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**CONDENSEDSTATEMENTS OF CASH FLOWS**

 
| ** **                                                          | ** ** | **For Years ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2008**                                             | ** ** | **2007** | ** ** | **2006** | ** ** |
| Cash flows from  operating activities                               |       |                                                 |       |   |   |   |   |
| Net income                                                          |       | $                                                    | 7,754      |   | $ | 6,896 |   | $ | 4,749 |   |
| Adjustments:                                                        |       |                                                 |       |   |   |   |   |
| Change in other  assets and liabilities                             |       | (8,388                                               | )          | 234 |   | (507 | ) |
| Equity in  undistributed subsidiary income                          |       | (10,292                                              | )          | (8,076 | ) | (5,613 | ) |
| Net cash from  operating activities                                 |       | (10,926                                              | )          | (946 | ) | (1,371 | ) |
|                                                                |       |                                                 |       |   |   |   |   |
| Cash flows from  investing activities                               |       |                                                 |       |   |   |   |   |
| Investments in  subsidiaries                                        |       | (20,303                                              | )          | (15,990 | ) | (13,000 | ) |
| Other assets                                                        |       | —                                               |       | — |   | — |   |
|                                                                |       |                                                 |       |   |   |   |   |
| Net cash from  investing activities                                 |       | (20,303                                              | )          | (15,990 | ) | (13,000 | ) |
|                                                                |       |                                                 |       |   |   |   |   |
| Cash flows from  financing activities                               |       |                                                 |       |   |   |   |   |
| Proceeds from  long-term subordinated debt                          |       | 14,950                                               |       | — |   | — |   |
| Proceeds from  issuance of common stock                             |       | —                                               |       | — |   | 19,027 |   |
| Purchase of  capital securities of unconsolidated subsidiary        |       | (450                                                 | )          | — |   | — |   |
| Proceeds from  issuance of preferred stock and common stock warrant |       | 30,000                                               |       | — |   | — |   |
| Proceeds from  exercise of stock options and excess tax benefit     |       | 379                                                  |       | 4,405 |   | 852 |   |
| Proceeds from  issuance of short-term debt                          |       | 3,000                                                |       | 7,000 |   | — |   |
| Net cash from  financing activities                                 |       | 47,879                                               |       | 11,405 |   | 19,879 |   |
|                                                                |       |                                                 |       |   |   |   |   |
| Net change in  cash and cash equivalents                            |       | 16,650                                               |       | (5,531 | ) | 5,508 |   |
|                                                                |       |                                                 |       |   |   |   |   |
| Beginning cash  and cash equivalents                                |       | 777                                                  |       | 6,308 |   | 800 |   |
|                                                                |       |                                                 |       |   |   |   |   |
| Ending cash and  cash equivalents                                   |       | $                                                    | 17,427     |   | $ | 777 |   | $ | 6,308 |   |

 

**NOTE17 – EARNINGS PER SHARE**

 

The factors used in theearnings per share computation follow:

 
| **(Dollars in thousands except share data)**           | ** ** | **2008**  | ** ** | **2007**  | ** ** | **2006**  | ** ** |
|---------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| Basic                                                                           |       |      |       |      |       |      |       |
| Net income                                                                      |       | $         | 7,754      |      | $          | 6,896     |       | $ | 4,749 |   |
|                                                                            |       |      |       |      |       |      |       |
| Weighted average  common shares outstanding                                     |       | 4,731,204 |       | 4,613,342 |       | 3,822,655 |       |
|                                                                            |       |      |       |      |       |      |       |
| Basic earnings  per common share                                                |       | $         | 1.64       |      | $          | 1.49      |       | $ | 1.24 |   |
|                                                                            |       |      |       |      |       |      |       |
| Diluted                                                                         |       |      |       |      |       |      |       |
| Net income                                                                      |       | $         | 7,754      |      | $          | 6,896     |       | $ | 4,749 |   |
|                                                                            |       |      |       |      |       |      |       |
| Weighted average  common shares outstanding for basic earnings per common share |       | 4,731,204 |       | 4,613,342 |       | 3,822,655 |       |
| Add: Dilutive  effects of assumed exercises of stock options                    |       | 120,861   |       | 278,825   |       | 334,683   |       |
|                                                                            |       |      |       |      |       |      |       |
| Average shares  and dilutive potential common shares                            |       | 4,852,065 |       | 4,892,167 |       | 4,157,338 |       |
|                                                                            |       |      |       |      |       |      |       |
| Diluted earnings  per common share                                              |       | $         | 1.60       |      | $          | 1.41      |       | $ | 1.14 |   |

 

No options were anti-dilutive for 2006. For 2007, 40,000 vested optionsat a strike price of $25.00 were anti-dilutive and were excluded from thecalculation of diluted earnings per share. For 2008, 439,250 vested options and461,538 warrants were anti-dilutive.

 

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**NOTE 18 – TRUST PREFERRED SECURITIES**

 

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

 

The debentures pay a fixed rate of 6.73% payable quarterly for thefirst five years and a floating rate based on a three-month LIBOR rate plus1.98% thereafter. The distributions on the capital securities are accounted foras interest expense by the Corporation. Interest payments on the debentures andthe corresponding distributions on the capital securities may be deferred atany time at the election of the Corporation for up to 20 consecutive quarterlyperiods (five years). The capital securities and debentures are redeemable atany time commencing after June 2010 at par. The Corporation reports asliabilities the subordinated debentures issued by the Corporation and held byTrust I.

 

In June 2008,Tennessee Commerce Statutory Trust II, a Delaware statutory trust (“Trust II”),issued and sold 14,500 of its floating rate capital securities, with aliquidation amount of $1,000 per capital security, in a private placement. Thesecurities pay a floating rate per annum, reset quarterly, equal to the primerate of interest published in *The WallStreet Journal* on the first business day of each distribution periodplus 50 basis points (but in no event greater than 8.0% or less than 5.75%). Atthe same time, the Corporation issued to Trust II $14.95 million of floatingrate junior subordinated deferrable interest debentures due 2038. TheCorporation guarantees the payment of distributions and payments forredemptions or liquidation of the capital securities. The floating rate capitalsecurities qualify as “Tier I Capital” for the Corporation under currentregulatory definitions subject to certain limitations.

 

Thedebentures pay a floating rate per annum, reset quarterly, equal to the primerate of interest published in *The WallStreet Journal* on the first business day of each distribution periodplus 50 basis points (but in no event greater than 8.0% or less than 5.75%).The distributions on the capital securities are accounted for as interestexpense by the Corporation. Interest payments on the debentures and thecorresponding distributions on the capital securities may be deferred at anytime at the election of the Corporation for up to 20 consecutive quarterlyperiods (five years). The capital securities and debentures are redeemable atany time commencing after June 2013 at par. The Corporation reports asliabilities the subordinated debentures issued by the Corporation and held byTrust II.

 

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

 

A summary of selectedconsolidated quarterly financial data for the years ended December 31,2008 and 2007 follows:

 
| ** **                                               | ** ** | **First**   | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|----------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
| **(In thousands except share data)** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| 2008                                                     |       |        |       |        |       |        |       |        |       |
| Interest income                                          |       | $           | 17,486     |        | $          | 18,429      |       | $           | 19,756     |   | $ | 20,307 |   |
| Net interest  income                                     |       | 7,462       |       | 8,396       |       | 9,274       |       | 9,819       |       |
| Provision for  loan losses                               |       | 1,600       |       | 2,340       |       | 1,850       |       | 3,321       |       |
| Income before  taxes                                     |       | 2,245       |       | 3,009       |       | 3,076       |       | 4,196       |       |
| Net income                                               |       | 1,375       |       | 1,846       |       | 1,886       |       | 2,647       |       |
| Basic earnings  per share                                |       | $           | 0.29       |        | $          | 0.39        |       | $           | 0.40       |   | $ | 0.56 |   |
| Diluted earnings  per share                              |       | $           | 0.28       |        | $          | 0.38        |       | $           | 0.39       |   | $ | 0.55 |   |
|                                                     |       |        |       |        |       |        |       |        |       |
| 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 |   |

 

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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.(2)                                                                                                                                                                                                   |
| 3.3                  |       | Bylaws of Tennessee Commerce Bancorp, Inc.(1)                                                                                                                                                                                                                                  |
| 3.4                  |       | Amendment to Bylaws of Tennessee Commerce  Bancorp, Inc.(3)                                                                                                                                                                                                                    |
| 4.1                  |       | Shareholders’ Agreement(1)                                                                                                                                                                                                                                                     |
| 4.2                  |       | Form of Stock Certificate(4)                                                                                                                                                                                                                                                   |
| 4.3                  |       | Indenture, dated as of June 20, 2008, between  Tennessee Commerce Bancorp, Inc. and Wilmington Trust Company, as trustee(5)                                                                                                                                               |
| 4.4                  |       | Amended and Restated Declaration of Trust, dated as  of June 20, 2008, among Tennessee Commerce Bancorp, Inc. , as  sponsor, Wilmington Trust Company, as institutional and Delaware trustee, and  Arthur F. Helf, H. Lamar Cox and Michael R. Sapp, as administrators(5) |
| 4.5                  |       | Guarantee Agreement, dated as of June 20, 2008,  between Tennessee Commerce Bancorp, Inc. and Wilmington Trust Company(5)                                                                                                                                                 |
| 4.6                  |       | Warrant for Purchase of Shares of Common Stock,  dated December 19, 2008(6)                                                                                                                                                                                                    |
| 10.1                 |       | Tennessee Commerce Bancorp, Inc. Stock Option  Plan - Employees(1)                                                                                                                                                                                                             |
| 10.2                 |       | Form of Tennessee Commerce Bancorp, Inc.  1999 Stock Option – Directors(1)                                                                                                                                                                                           |
| 10.3                 |       | Form of Tennessee Commerce Bancorp, Inc.  1999 Stock Option - Incorporators(1)                                                                                                                                                                                            |
| 10.4                 |       | Form of Tennessee Commerce Bancorp, Inc.  2003 Stock Option - Directors(1)                                                                                                                                                                                                |
| 10.5                 |       | Tennessee Commerce Bancorp, Inc. 1999 Stock  Option Agreement with Arthur F. Helf(1)                                                                                                                                                                                           |
| 10.6                 |       | Tennessee Commerce Bancorp, Inc. 1999 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                 |       | Amended and Restated Employment Agreement, dated as  of December 30, 2008, between Tennessee Commerce Bank and Arthur F.  Helf(7)                                                                                                                                              |
| 10.9                 |       | Amended and Restated Employment Agreement, dated as  of December 30, 2008, between Tennessee Commerce Bank and Michael R.  Sapp(7)                                                                                                                                             |
|  10.10          |       | Amended and Restated Employment Agreement, dated as  of December 30, 2008, between Tennessee Commerce Bank and H. Lamar  Cox(7)                                                                                                                                                |
|  10.11          |       | Tennessee Commerce Bancorp, Inc. 2007 Equity Plan(8)                                                                                                                                                                                                                           |
| 10.12                |       | Offer of Employment, dated as of August 5,  2008, between Tennessee Commerce Bancorp, Inc. and Frank Perez(9)                                                                                                                                                             |
| 10.13                |       | Letter Agreement, dated as of December 19,  2008, between the United States Department of the Treasury and Tennessee  Commerce Bancorp, Inc.(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 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 Annual Report on Form 10-K, as filed with the Securities  and Exchange Commission on April 18, 2008 and incorporated herein by  reference.                                                |
|   |   |                                                                                                                                                                                                                                                                                |
|   | (3)    | 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.                                              |
|   |   |                                                                                                                                                                                                                                                                                |
|   | (4)    | 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. |

 

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Table ofContents

 
|   | (5)    | 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 23, 2008 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 December 23, 2008 and incorporated  herein by reference.  |
|   |   |                                                                                                                                                                                                                                     |
|   | (7)    | 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 January 6, 2009 and incorporated  herein by reference.    |
|   |   |                                                                                                                                                                                                                                     |
|   | (8)    | 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. |
|   |   |                                                                                                                                                                                                                                     |
|   | (9)    | 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 August 5, 2008 and incorporated  herein by reference.     |

 

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