Tableof Contents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C.  20549**

 

**FORM 10-Q**

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

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------------------|

 

**For the Transition Period From                                    To**

 

**Commission file number 000-50645**

 

**THE BANKHOLDINGS**

(Exact name of Registrant as specified in itscharter)

 

| **NEVADA**               | ** ** | **90-0071778**                   |
|--------------------------|------------|----------------------------------|
| (State of Incorporation) |       | (IRS Employer Identification No) |

 

**9990 Double R Boulevard, Reno, Nevada 89521**

(Address of principal executive offices)   (Zip Code)

 

**775-853-8600**

(Registrant’s telephone number, includingarea code)

 

**Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports) and (2) has been subject to such filing requirements for thepast 90 days.**

 

| ** ** | **YES     ****x** | **NO     ****o** |
|------------|--------------------------------------------|-------------------------------------------|

 

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

 

**Largeaccelerated filer    ****o****  Accelerated Filer   ****x****  Non-accelerated filer    ****o****  Smaller Reporting Company  ****o**

 

**Indicate by check mark whether the registrant is an Shell Company (asdefined in Rule 12b-2 of the Act)**

 

| ** ** | **YES     ****o** | **NO     ****x** |
|------------|--------------------------------------------|-------------------------------------------|

 

**Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date.**

 

**Common stock, $0.01 par value, 5,830,099shares outstanding as of November 7, 2008**

 

 

 

----

Table of Contents

 

Table of Contents

 
| PART I. FINANCIAL INFORMATION |      |
|------------------------------------|-----------|
|                               |      |   |   |
|                               | Item 1.   | Financial Statements (unaudited) |   |
|                               |      | Consolidated Statements of  Condition |   |
|                               |      | Consolidated Statements of  Operations |   |
|                               |      | Consolidated  Statements of Changes in Shareholders’ Equity and Comprehensive Income |   |
|                               |      | Consolidated Statements of Cash Flows |   |
|                               |      | Notes to Consolidated Financial Statements |   |
|                               |      |   |   |
|                               | Item 2.   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|                               |      | Summary |   |
|                               |      | Results  of Operations |   |
|                               |      |   | Net Interest Income |   |
|                               |      |   | Provision and Allowance for Loan Losses |   |
|                               |      |   | Non-interest  Income |   |
|                               |      |   | Non-Interest  Expense |   |
|                               |      |   | Provision  for Income Taxes |   |
|                               |      |   | Comprehensive  Income |   |
|                               |      | Financial  Condition |   |
|                               |      |   | Securities and Other Earning Assets |   |
|                               |      |   | Loans |   |
|                               |      |   | Deposits |   |
|                               |      |   | Other  Funding Sources |   |
|                               |      |   | Off Balance Sheet Arrangements |   |
|                               |      | Risk  Management |   |
|                               |      |   | Credit  Risk Management |   |
|                               |      |   | Nonperforming  Assets |   |
|                               |      | Asset  Liability Management |   |
|                               |      |   | Market Risk |   |
|                               |      |   | Interest  Rate Risk |   |
|                               |      | Liquidity |   |
|                               |      | Capital  Resources |   |
|                               |      |   |   |
|                               | Item 3.   | Quantitative and Qualitative Disclosures  about Market Risk |   |
|                               |      |   |   |
|                               | Item 4.   | Controls and Procedures |   |
|                               |      |   |   |
| PART II. OTHER  INFORMATION   |      |
|                               |      |   |   |
|                               | Item 1.   | Legal Proceedings |   |
|                               | Item  1A. | Risk Factors |   |
|                               | Item 2.   | Unregistered  Sales of Equity Securities and Use of Proceeds – none |   |
|                               | Item 3.   | Defaults Upon  Senior Securities – none |   |
|                               | Item 4.   | Submission of  Matters to a Vote of Security Holders – none |   |
|                               | Item 5.   | Other Information – none |   |
|                               | Item  6.  | Exhibits |   |
|                               |      |   |
| Signatures                         |      |
| Exhibits                           |      |
|                                    |           |  |  |  |  |

 

2

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Tableof Contents

 

**PART I – FINANCIALSTATEMENTS**

**Item 1**

THE BANK HOLDINGS AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFCONDITION

(Dollars in thousands)

 
| ** **                                                                                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                           | ** ** | **2008 (1)**      | ** ** | **2007 (2)**     | ** ** |
| **ASSETS**                                                                                                                                                           |       |                   |       |                  |       |
| Cash and due from banks                                                                                                                                              |       | $                      | 6,347      |                  | $          | 13,857 |   |
| Liquid money market funds                                                                                                                                            |       | 510                    |       | 323                   |       |
| Federal funds sold                                                                                                                                                   |       | 560                    |       | —                |       |
| Cash and cash equivalents                                                                                                                                            |       | 7,417                  |       | 14,180                |       |
| Securities available for sale, at fair  value                                                                                                                        |       | 3,924                  |       | 17,996                |       |
| Securities held to maturity, at amortized  cost                                                                                                                      |       | 61,637                 |       | 62,280                |       |
| Securities - trading, at market value                                                                                                                                |       | 84                     |       | 4,729                 |       |
| Other equity securities, at cost                                                                                                                                     |       | 7,728                  |       | 6,214                 |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| USDA loans (at fair value, unpaid principal  $893)                                                                                                                   |       | 866                    |       | 897                   |       |
| Loans, gross                                                                                                                                                         |       | 453,639                |       | 473,872               |       |
| Allowance for loan losses                                                                                                                                            |       | (7,198                 | )          | (7,276                | )          |
| Deferred loan fees, net                                                                                                                                              |       | (1,002                 | )          | (1,255                | )          |
| Loans, net                                                                                                                                                           |       | 446,305                |       | 466,238               |       |
|                                                                                                                                                                 |       |                   |       |                  |       |
| Premises and equipment, net                                                                                                                                          |       | 6,897                  |       | 7,512                 |       |
| Other real estate owned                                                                                                                                              |       | 2,910                  |       | 800                   |       |
| Bank owned life insurance                                                                                                                                            |       | 9,749                  |       | 9,473                 |       |
| Intangible assets                                                                                                                                                    |       | 986                    |       | 1,091                 |       |
| Goodwill                                                                                                                                                             |       | 3,153                  |       | 29,612                |       |
| Other assets                                                                                                                                                         |       | 7,426                  |       | 6,515                 |       |
| **TOTAL  ASSETS**                                                                                                                                                    |       | $                      | 558,216    |                  | $          | 626,640 |   |
|                                                                                                                                                                 |       |                   |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                                       |       |                   |       |                  |       |
| Deposits:                                                                                                                                                            |       |                   |       |                  |       |
| Non-interest bearing demand                                                                                                                                          |       | $                      | 53,082     |                  | $          | 65,400 |   |
| Interest bearing demand                                                                                                                                              |       | 11,728                 |       | 9,432                 |       |
| Savings                                                                                                                                                              |       | 22,032                 |       | 39,439                |       |
| Money Market                                                                                                                                                         |       | 71,497                 |       | 97,988                |       |
| IRA’s                                                                                                                                                           |       | 4,253                  |       | 4,123                 |       |
| Time deposits < $100,000                                                                                                                                          |       | 240,014                |       | 175,620               |       |
| Time deposits > $100,000                                                                                                                                          |       | 58,428                 |       | 59,333                |       |
| Total deposits                                                                                                                                                       |       | 461,034                |       | 451,335               |       |
| Liabilities:                                                                                                                                                         |       |                   |       |                  |       |
| Short term borrowed funds                                                                                                                                            |       | 27,500                 |       | 62,610                |       |
| Long term borrowed funds                                                                                                                                             |       | 7,000                  |       | 8,000                 |       |
| Junior subordinated debt                                                                                                                                             |       | 20,619                 |       | 20,619                |       |
| Exchange liabilities                                                                                                                                                 |       | 900                    |       | 4,101                 |       |
| Minority shareholder interest in subsidiaries                                                                                                                        |       | —                 |       | 1,095                 |       |
| Accrued interest payable and other  liabilities                                                                                                                      |       | 1,533                  |       | 4,043                 |       |
| Total Liabilities                                                                                                                                                    |       | 518,586                |       | 551,803               |       |
| Shareholders’ equity:                                                                                                                                           |       |                   |       |                  |       |
| Preferred stock, $.01 par value, 20,000,000  shares authorized; no shares issued or outstanding                                                                      |       | —                 |       | —                |       |
| Common stock, $.01 par value, 10,000,000  shares authorized; 5,830,099 issued and outstanding as of September 30,  2008 and 5,831,099 at December 31, 2007 |       | 58                     |       | 58                    |       |
| Surplus                                                                                                                                                              |       | 73,977                 |       | 73,766                |       |
| Retained (deficit)/earnings                                                                                                                                          |       | (33,445                | )          | 2,139                 |       |
| Treasury Stock                                                                                                                                                       |       | (9                     | )          | —                |       |
| Accumulated other comprehensive loss                                                                                                                                 |       | (951                   | )          | (1,126                | )          |
| Total shareholders’ equity                                                                                                                                      |       | 39,630                 |       | 74,837                |       |
| **TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                 |       | $                      | 558,216    |                  | $          | 626,640 |   |

 

----

(1) September 30,2008 information is unaudited.

(2) The condensed balance sheet as of December 31,2007 have been derived from audited financial statements.

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

3

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Tableof Contents

 

THE BANK HOLDINGS AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFOPERATIONS

(Dollars in thousands)

 
| ** **                                                                                        | ** ** | **For the Three-Month  Period**  | ** ** | **For the Nine-Month Period** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                        | ** ** | **Ended September 30, (1)** | ** ** | **Ended September 30, (1)**   | ** ** |
| ** **                                                                                        | ** ** | **2008**                                   | ** ** | **2007**                                     | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Interest,  fees and dividend income:**                                                          |       |                                       |       |                                         |       |   |   |   |   |
| Federal funds sold and other                                                                      |       | $                                          | 10         |                                         | $          | 242 |   | $ | 47 |   | $ | 707 |   |
| Debt securities, taxable                                                                          |       | 823                                        |       | 683                                          |       | 2,932 |   | 2,239 |   |
| Debt securities, non-taxable                                                                      |       | 322                                        |       | 206                                          |       | 955 |   | 566 |   |
| Dividends                                                                                         |       | 82                                         |       | 44                                           |       | 214 |   | 151 |   |
| Loans, including fees                                                                             |       | 7,734                                      |       | 10,368                                       |       | 24,542 |   | 30,444 |   |
| **Total  interest, fees and dividend income**                                                     |       | 8,971                                      |       | 11,543                                       |       | 28,690 |   | 34,107 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Interest  expense:**                                                                            |       |                                       |       |                                         |       |   |   |   |   |
| Deposits                                                                                          |       | 3,327                                      |       | 5,011                                        |       | 10,740 |   | 14,587 |   |
| Other borrowed funds, notes payable and  debt                                                     |       | 735                                        |       | 912                                          |       | 2,475 |   | 2,912 |   |
| **Total  interest expense**                                                                       |       | 4,062                                      |       | 5,923                                        |       | 13,215 |   | 17,499 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Net  interest income**                                                                          |       | 4,909                                      |       | 5,620                                        |       | 15,475 |   | 16,608 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| Provision for loan losses                                                                         |       | 150                                        |       | 346                                          |       | 1,440 |   | 760 |   |
| Net interest income, after provision for  loan losses                                             |       | 4,759                                      |       | 5,274                                        |       | 14,035 |   | 15,848 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Non-interest  income:**                                                                         |       |                                       |       |                                         |       |   |   |   |   |
| Service charges on deposit accounts                                                               |       | 178                                        |       | 155                                          |       | 459 |   | 315 |   |
| Other service charges, commissions and fees                                                       |       | 61                                         |       | 99                                           |       | 214 |   | 306 |   |
| Income on bank owned life insurance                                                               |       | 91                                         |       | 93                                           |       | 276 |   | 303 |   |
| Exchange fee income                                                                               |       | 15                                         |       | 45                                           |       | 73 |   | 124 |   |
| Unrealized (loss) gain on trading  securities                                                     |       | (802                                       | )          | (240                                         | )          | (987 | ) | 196 |   |
| Unrealized gain (loss) gain on fair value  loans                                                  |       | —                                     |       | 9                                            |       | 1 |   | (76 | ) |
| Realized gain on sale of fair value loans                                                         |       | —                                     |       | 5                                            |       | — |   | 5 |   |
| Realized (loss) gain on sale of fixed  assets                                                     |       | (14                                        | )          | —                                       |       | (55 | ) | 11 |   |
| Realized (loss) gain on the sale and  impairment of investments, net                              |       | (13,613                                    | )          | (3                                           | )          | (13,996 | ) | 6 |   |
| **Total  non-interest income**                                                                    |       | (14,084                                    | )          | 163                                          |       | (14,015 | ) | 1,190 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Non-interest  expense:**                                                                        |       |                                       |       |                                         |       |   |   |   |   |
| Salaries and employee benefits                                                                    |       | 2,243                                      |       | 2,161                                        |       | 7,272 |   | 7,139 |   |
| Occupancy and equipment                                                                           |       | 682                                        |       | 698                                          |       | 1,988 |   | 2,214 |   |
| Marketing                                                                                         |       | 127                                        |       | 191                                          |       | 402 |   | 675 |   |
| Data processing                                                                                   |       | 132                                        |       | 178                                          |       | 390 |   | 490 |   |
| Deposit and loan servicing costs                                                                  |       | 346                                        |       | 384                                          |       | 941 |   | 912 |   |
| Accounting, legal and tax                                                                         |       | 101                                        |       | 205                                          |       | 801 |   | 597 |   |
| Other professional services                                                                       |       | 41                                         |       | 109                                          |       | 174 |   | 442 |   |
| Goodwill impairment                                                                               |       | 26,911                                     |       | —                                       |       | 26,911 |   | — |   |
| Other                                                                                             |       | 211                                        |       | 337                                          |       | 1,036 |   | 1,406 |   |
| **Total  non-interest expense**                                                                   |       | 30,794                                     |       | 4,263                                        |       | 39,915 |   | 13,875 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Net  (loss)/income before income tax (benefit) provision and minority shareholder  allocation** |       | (40,119                                    | )          | 1,174                                        |       | (39,895 | ) | 3,163 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **(Benefit)  provision for income taxes**                                                         |       | (5,073                                     | )          | 413                                          |       | (5,383 | ) | 1,180 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **Gain  (loss) attributable to minority shareholders**                                            |       | —                                     |       | 11                                           |       | — |   | (28 | ) |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| **NET  LOSS/INCOME**                                                                              |       | $                                          | (35,046    | )                                            | $          | 750 |   | $ | (34,512 | ) | $ | 2,011 |   |
|                                                                                              |       |                                       |       |                                         |       |   |   |   |   |
| Net (loss)/earnings per share:                                                                    |       |                                       |       |                                         |       |   |   |   |   |
| Basic                                                                                             |       | (6.01                                      | )          | 0.13                                         |       | (5.92 | ) | 0.34 |   |
| Diluted                                                                                           |       | (6.01                                      | )          | 0.13                                         |       | (5.92 | ) | 0.34 |   |

 

----

(1) Theperiod ending data for September 30, 2008 and 2007 are unaudited.

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

4

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Tableof Contents

 

THE BANK HOLDINGS AND SUBSIDIARIES

Consolidated Statements ofShareholders’ Equity and Comprehensive Income

For the nine month periods ending September 30, 2008, and September 30,2007 (1) (2)

 
| ** **                                                                               | ** ** | **Comprehensive  Income(Loss)** | ** ** | **Shares of  Common  Stock** | ** ** | **Common  Stock** | ** ** | **Surplus** | ** ** | **Retained  Earnings/  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income/Loss** | ** ** | **Treasury  Stock** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------------------------------|------------|-------------------|------------|-------------|------------|----------------------------------|------------|----------------------------------------------------|------------|---------------------|------------|-----------|------------|
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| **Balance  at December 31, 2006**                                                   |       |                            |       | 5,831,099                         |       | $                 | 54         |        | $          | 73,345                           |       | $                                                  | 878        |                | $          | (709      | )          | $ | — |   | $ | 73,568 |   |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Stock Dividend  February 15, 2007                                                   |       |                            |       |                              |       | 4                 |       | (4          | )          |                             |       |                                               |       |                |       |      |       |
| Cumulative effect  of FAS 159 adoption adjustment                                        |       |                            |       |                              |       |              |       |        |       | (464                             | )          |                                               |       |                |       | (464      | )          |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Net Income                                                                               |       | $                               | 2,011      |                              | —     |              | —     |        | —     |                             | 2,011      |                                               | —     |                |       |      | 2,011      |   |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Compensation  expense related to stock options                                           |       |                            |       | —                            |       | —            |       | 326         |       | —                           |       | —                                             |       |                |       | 326       |       |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Other  comprehensive income:                                                             |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Unrealized  holding losses on securities available for sale arising during the period    |       | (216                            | )          |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Less  reclassification adjustment for losses included in net income                      |       | (22                             | )          |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Net unrealized  holding losses                                                           |       | (238                            | )          |                              |       | —            |       | —      |       | —                           |       | (238                                               | )          |                |       | (238      | )          |
| Comprehensive  Income                                                                    |       | $                               | 1,741      |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |   |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| **Balance  at September 30, 2007**                                                  |       |                            |       | 5,831,099                         |       | $                 | 58         |        | $          | 73,671                           |       | $                                                  | 2,421      |                | $          | (947      | )          | $ | — |   | $ | 74,203 |   |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| **Balance  at December 31, 2007**                                                   |       |                            |       | 5,831,099                         |       | 58                |       | 73,766      |       | 2,139                            |       | (1,126                                             | )          |                |       | 74,837    |       |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Cumulative effect  of adoption of   EITF 06-04                                           |       |                            |       |                              |       |              |       |        |       | (1,071                           | )          |                                               |       |                |       | (1,071    | )          |
| Purchase of  Treasury Stock                                                              |       |                            |       | (1,000                            | )          |              |       |        |       |                             |       |                                               |       | (9                  | )          | (9        | )          |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Net Loss                                                                                 |       | $                               | (34,512    | )                                 | —     |              | —     |        | —     |                             | (34,512    | )                                                  | —     |                |       |      | (34,512    | ) |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Compensation  expense related to stock options                                           |       |                            |       | —                            |       | —            |       | 211         |       | —                           |       | —                                             |       |                |       | 211       |       |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Amortization of  unrealized minimum projected benefit obligation of defined benefit plan |       |                            |       |                              |       |              |       |        |       |                             |       | 49                                                 |       |                |       | 49        |       |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Other  comprehensive income/(loss):                                                      |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Unrealized  holding losses on securities available for sale arising during the period    |       | (13,870                         | )          |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Less  reclassification adjustment for losses included in net income                      |       | 13,996                          |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| Net unrealized  holding Income                                                           |       | 126                             |       |                              |       | —            |       | —      |       | —                           |       | 126                                                |       |                |       | 126       |       |
| Comprehensive  Loss                                                                      |       | $                               | (34,386    | )                                 |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |   |
|                                                                                     |       |                            |       |                              |       |              |       |        |       |                             |       |                                               |       |                |       |      |       |
| **Balance at September 30, 2008**                                                   |       | ** **                      |       | 5,830,099                         |       | $                 | 58         |        | $          | 73,977                           |       | $                                                  | (33,445    | )                   | $          | (951      | )          | $ | (9 | ) | $ | 39,630 |   |

 

----

(1) Theperiods September 30, 2008 and 2007 are unaudited.

(2) The periods as of December 31, 2007and 2006 have been derived from audited financial statements.

 

The accompanying notes are an integral part of theseunaudited consolidated financial statements.

 

5

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Table of Contents

 

THE BANK HOLDINGS AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OFCASH FLOWS

(Dollars in thousands)

 
| ** **                                                                               | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **September 30, (1)** | ** ** |
| ** **                                                                               | ** ** | **2008**                        | ** ** | **2007** | ** ** |
|                                                                                     |       |                            |       |   |   |
| **Cash flows from operating activities:**                                                |       |                            |       |   |   |
| Net Loss/Income                                                                          |       | $                               | (34,512    | ) | $ | 2,011 |   |
| Adjustments to reconcile net income to cash  provided by (used in) operating activities: |       |                            |       |   |   |
| Provision for loan losses                                                                |       | 1,440                           |       | 760 |   |
| Stock option compensation expense                                                        |       | 211                             |       | 326 |   |
| Net amortization of securities                                                           |       | 201                             |       | 313 |   |
| Depreciation                                                                             |       | 647                             |       | 939 |   |
| Amortization of intangible assets, net                                                   |       | 105                             |       | — |   |
| Amortization of split dollar benefit plan,  net                                          |       | 50                              |       | — |   |
| Activity of trading securities, net                                                      |       | (4,645                          | )          | (447 | ) |
| Unrealized loss/(gain) on trading  securities                                            |       | 987                             |       | (196 | ) |
| Loss attributable to minority shareholders                                               |       | —                          |       | (28 | ) |
| Unrealized (gain) on loans carried at fair  value                                        |       | (1                              | )          | 76 |   |
| Activity of exchange assets, net                                                         |       | (3,201                          | )          | (8,163 | ) |
| Realized (gain) on sales of fixed assets,  net                                           |       | 55                              |       | (11 | ) |
| Realized loss (gain) on sales and  impairment of investment securities, net              |       | 13,996                          |       | (6 | ) |
| Impairment of goodwill                                                                   |       | 26,911                          |       | — |   |
| Net change in:                                                                           |       |                            |       |   |   |
| Other assets and liabilities, net                                                        |       | (1,507                          | )          | (343 | ) |
| **Net cash provided by (used in) operating  activities**                                 |       | 737                             |       | (4,769 | ) |
|                                                                                     |       |                            |       |   |   |
| **Cash flows from investing activities:**                                                |       |                            |       |   |   |
| Activity in available for sale securities:                                               |       |                            |       |   |   |
| Proceeds from sales, maturities,  prepayments and calls                                  |       | 19,989                          |       | 5,358 |   |
| Purchases                                                                                |       | (16,679                         | )          | (2,074 | ) |
| Activity in securities held to maturity:                                                 |       |                            |       |   |   |
| Proceeds from maturities, prepayments and  calls                                         |       | 32,409                          |       | 15,384 |   |
| Purchases                                                                                |       | (32,912                         | )          | (6,814 | ) |
| Activity in non-marketable equity  securities, net                                       |       | (1,515                          | )          | 277 |   |
| Investment in non-bank subsidiaries, net                                                 |       | (1,040                          | )          | (370 | ) |
| (Increase) decrease in bank owned life  insurance                                        |       | (276                            | )          | 2,485 |   |
| Loan originations and principal  collections, net                                        |       | 18,808                          |       | (25,979 | ) |
| Purchases of premises and equipment, net                                                 |       | 127                             |       | (434 | ) |
| **Net cash provided by (used in) investing  activities**                                 |       | 18,911                          |       | (12,167 | ) |
|                                                                                     |       |                            |       |   |   |
| **Cash flows from financing activities:**                                                |       |                            |       |   |   |
| Net increase in deposits                                                                 |       | 9,699                           |       | 19,844 |   |
| Activity in other borrowed funds, net                                                    |       | (36,110                         | )          | (11,030 | ) |
| **Net cash (used in) provided by financing  activities**                                 |       | (26,411                         | )          | 8,814 |   |
|                                                                                     |       |                            |       |   |   |
| **Net change in cash and cash equivalents**                                              |       | (6,763                          | )          | (8,122 | ) |
|                                                                                     |       |                            |       |   |   |
| **Cash and cash equivalents at beginning of  period**                                    |       | 14,180                          |       | 33,723 |   |
| **Cash and cash equivalents at end of period**                                           |       | $                               | 7,417      |   | $ | 25,601 |   |

 

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(1) Theperiods ending September 30, 2008 and 2007 are unaudited.

 

Theaccompanying notes are an integral part of these unaudited consolidatedfinancial statements.

 

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**THE BANK HOLDINGS AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements (Unaudited)**

**September 30, 2008**

 

**NOTE – 1 THE BUSINESS OF THE BANK HOLDINGS**

 

***Nature of Banking Activities***

 

The Bank Holdings is a bank holding company, which provides a fullrange of banking services to commercial and consumer customers through itswholly owned subsidiary, Nevada Security Bank (“the Bank”).  At March 31, 2008, the Bank had sixbanking offices in northern Nevada.  The Bank closed the temporarySparks, Nevada branch effective March 31, 2008, leaving five open northernNevada branch offices. There are two offices in California, separately brandedas Silverado Bank.

 

The Company, during the first quarter of 2006 acquired two qualifiedintermediary companies; Rocky Mountain Exchange (formerly known as Big SkyProperty Exchange) and Granite Exchange, Inc., which facilitatetax-deferred real estate transactions under Section 1031 of the InternalRevenue Code.  The Company closed theRocky Mountain Exchange office located in Bozeman Montana effective July 31,2008.  As a result, the Company recordedan impairment charge to goodwill in the amount of $120,000 during the thirdquarter of 2008, for the closing of Rocky Mountain.  Granite Exchange is headquartered inRoseville, California.  Qualified intermediaries select the financialinstitution to hold the depositor accounts created as part of the exchangetransactions.  These subsidiaries havebeen consolidated on the Company’s books.

 

The Company’s other direct subsidiaries are The Bank Holdings StatutoryTrust I, a Connecticut statutory trust which was formed in November 2005,to solely facilitate the issuance of variable rate capital trust pass throughsecurities and NNB Holdings Statutory Trust I which was formed in June 2005as a subsidiary of NNB Holdings, Inc., and was acquired by the Company inthe merger with NNB Holdings, Inc. NNB Holdings Statutory Trust I is a Delaware Statutory Trust also formedto facilitate the issuance of capital trust pass through securities.  Pursuant to FASB Interpretation No. 46R *Consolidation of Variable Interest Entities* (FIN 46R), TheBank Holdings Statutory Trust I and NNB Holdings Statutory Trust I are notreflected on a consolidated basis in the financial statements of the Company.

 

These entities are collectively referred to herein as the Company.  The accounting and reporting policies of theCompany conform to accounting principles generally accepted in the UnitedStates of America and general practices within the banking industry.

 

**NOTE 2 – BASIS OF PRESENTATION**

 

***Principles of Consolidation and Basis ofPresentation***

 

On July 9, 2003, the stockholders of Nevada Security Bank approvedthe exchange of their common stock in Nevada Security Bank for common stock inthe newly formed holding company, The Bank Holdings.  This transaction was consummated on August 29,2003 and was accounted for at historical cost. Nevada Security Bank wasorganized on February 26, 2001 and opened for business on December 27,2001.  The consolidated financialstatements include the accounts of The Bank Holdings and its wholly-ownedsubsidiaries, Nevada Security Bank, Rocky Mountain Exchange, and GraniteExchange. All significant inter-company balances and transactions have beeneliminated in consolidation.

 

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***Use of Estimates***

 

The accompanying unaudited consolidated financial statements of theBank Holding and its majority-owned subsidiaries have been prepared in acondensed format, and therefore do not include all of the information andfootnotes required by generally accepted accounting principles for completefinancial statements.  The informationfurnished in these interim statements reflects all adjustments which are, inthe opinion of management, necessary for a fair statement of the results foreach respective period presented.  Suchadjustments are of a normal recurring nature, unless otherwise disclosed inthis Form 10-Q.

 

Operating results for the nine month period ended September 30,2008, are not necessarily indicative of the results that may be expected infuture periods. The balance sheet at December 31, 2007 is from the auditedfinancial statements at that date, but this Form 10-Q document does notinclude all of the information and footnotes required by generally acceptedaccounting principles for complete annual financial statements.  The interim financial information should beread in conjunction with the Company’s 2007 Annual Report on Form 10-K.

 

Analysis of certain interim financial information has been presentedfor both end-of-period and reporting period average balances.  It is anticipated that for historical review,average balances may be more pertinent to eliminate seasonality, quarter-endgrowth anomalies, and computational rounding.

 

In preparing consolidated financial statements in conformity withaccounting principles generally accepted in the United States of America andgeneral practices within the banking industry, management is required to makeestimates and assumptions that affect the reported amount of assets andliabilities as of the date of the balance sheet and reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Material estimates that areparticularly susceptible to significant change in the near term relate to thedetermination of the allowance for loan losses, loan origination costs,equity-based compensation, goodwill and income taxes.

 

***Operating Segment Information***

 

Wemanage our operations and prepare management reports and other information witha primary focus on lines of business.  Asof September 30, 2008, we operated one bank located in two distinctiveregional markets in two states, and one qualified intermediary company.  The operating segments are separated intoparent, bank, and non-bank financial services. Such segment reporting eliminates transactions between noted operatingareas, and the accounting policies of the individual segments are the same asthose of the Company.  Transactionsbetween operating segments are conducted at fair value, resulting in profitsthat are eliminated for reporting consolidated results of operations.  Operating segments pay for centrally providedservices based upon estimated or actual usage of those services.

 

Table8 presents selected operating segment information for the three and nine monthperiods ended September 30, 2008 and 2007.

 

***Loans***

 

The Company grants real estate, commercial, and consumer loans tocustomers.  A substantial portion of theloan portfolio is represented by real estate loans throughout northern Nevadaand northern California.  The ability ofthe Company’s borrowers to honor their contracts is dependent upon the realestate market and general economic conditions in these areas.  Both of these areas have been severelyimpacted by the substantial downturn in national, regional and state economicconditions, the continued effects of which management believes have not yetbeen made fully apparent.  Such aneconomic cycle may last for more than one year, and bring about furtherdeterioration in loan quality as exhibited in Table 5.

 

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Loans are reported at their outstanding unpaid principal balancesreduced by the allowance for loan losses, and any deferred fees or costs onoriginated loans.  Interest income isaccrued on the unpaid principal balance. The Company has adopted Financial Accounting Standards Board (“FAS”)159, *Fair Value Option of Financial Assets and FinancialLiabilities*and FAS 157, *Fair Value Measurement*for those SBA/USDA loans which were purchased by the Company during 2003 and2004 when the loan portfolio was smaller than the investment portfolio.  The Company recorded $1,000 of mark to marketgains on these loans during the first nine months of 2008.  For purposes of discussion the Companyincludes these fair value loans in its gross loan totals even though they areshown separately in the statement of condition.

 

We manage asset quality and control credit risk through the applicationof policies, practices and procedures designed to promote sound underwritingand loan monitoring, and the diversification of the loan portfolio.  The loan administration function is chargedwith monitoring asset quality and establishing credit policies, practices andprocedures which are thorough and consistently enforced.

 

***Income Taxes***

 

FAS Interpretation 48, *Accounting for Uncertaintyin Income Taxes*(FIN 48), clarifies FAS 109, *Accountingfor Income Taxes*, to indicate criteria that an individual taxposition would have to meet for some or all of the income tax benefit to berecognized in a taxable entity’s financial statements.  Under the FIN 48 guidelines an entity shouldrecognize the financial statement benefit of a tax position it determines is *more likely than not* to be sustained on examination.

 

The Company files its income taxes on a consolidated basis with itssubsidiaries.  The allocation of incometax expense represents each entity’s proportionate share of the consolidatedprovision for taxes.  Deferred income taxassets and liabilities are determined using the liability (or balance sheet)method.  Under this method, the net deferredtax asset or liability is determined based on the tax effects of the temporarydifferences between the book and tax bases of the various balance sheet assetsand liabilities and gives current recognition to changes in tax rates and laws.  Therefore, deferred taxes are recognized forthe tax consequences of temporary differences by applying enacted statutory taxrates applicable to future years to differences between tax financial statementcarrying amounts and the basis of existing assets and liabilities.  The effect on deferred taxes of a change intax rates would be recognized in income in the period that includes theenactment date.  The Company uses anestimate of future earnings to support its position that the benefit of itsdeferred tax assets will be realized.  Iffuture income should prove non-existent or not sufficient to recover the amountof the deferred tax assets within the tax years to which they may be applied,the assets may not be realized and the Company’s net income could be reduced.

 

The Company sets aside a provision for income taxes on a monthlybasis.  The amount of the tax provisionis determined by applying the Company’s statutory income tax rates to pre-taxbook income, adjusted for permanent differences between pre-tax book income andactual taxable income.  Such permanentdifferences include but are not limited to tax-exempt interest income;increases in the cash surrender value of bank-owned life insurance, certainexpenses that are not allowed as tax deductions, and tax credits.  For the first nine months, the reduction ofincome tax expense was related to permanent book tax differences which wereapproximately $1.3 million.

 

***Reclassification***

 

Various reclassifications may have been made in prior periods in orderto be consistent with the presentation as of September 30, 2008.  Further, certain captions may have minorrevisions to more 

 

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accurately reflect current activities of the Company.  There were no changes to previously reportedshareholders’ equity, net income or earnings per share.

 

**NOTE 3 – FAIR VALUE OPTIONS FOR FINANCIAL ASSETS FAS - 159**

 

Effective January 1, 2007, the Company adopted FAS 159, *The Fair Value Option for Financial Assets and Financial Liabilities*concurrent with its early adoption of FAS 157, *Fair ValueMeasurements. * FAS 159 allows entities to irrevocably electfair value as the initial and subsequent measurement attribute for certainfinancial assets and financial liabilities that are not otherwise required tobe measured at fair value, with changes in fair value recognized in earnings asthey occur.  FAS 159 also requiresentities to report those financial assets and liabilities that are measured atfair value in a manner that separates those reported fair values from thecarrying amounts of similar assets and liabilities measured using anothermeasurement attribute on the face of the statement of financial condition.  FAS 159 establishes presentation anddisclosure requirements designed to improve comparability between entities thatelect different measurement attributes for similar assets and liabilities.  The Company elected early adoption of FAS 159effective January 1, 2007 concurrent with the early adoption of FAS 157for certain USDA/SBA loans purchased during 2003 and early 2004.

 

The Company believed its adoption of FAS 159 would have a positiveimpact on its ability to better manage the balance sheet and interest raterisks which were associated with this group of specifically acquired assetswhile potentially benefiting the net interest margin, net interest income, netincome and earnings per common share in 2008. These loan purchases were initiated when the Company’s sole subsidiaryNevada Security Bank was just two years old and suffered from a lack ofsubstantive loan growth.  Further,interest rates were at a very low ebb and these loans were purchased at a yieldof approximately 5%.  While this yieldwas approximately 150 basis points greater than the Bank’s investment portfolioyield at the time, current loan portfolio yields for internally generated loansare in the range of 6%, due to changing market conditions.  With a lower than market coupon rate, andsubstantial premiums paid at acquisition, the Company’s cost basis of thepurchased loans recorded on the statement of condition does not properlyreflect the true opportunity costs to the Company.

 

FAS 157 requires the fair value of the assets or liabilities to bedetermined based on the assumptions that market participants use in pricing thefinancial instrument.  In developingthose assumptions, the Company identified characteristics that distinguish marketparticipants generally, and considered factors specific to (a) the assettype, (b) the principal (or most advantageous) market for the asset group,and (c) market participants with whom the reporting entity would transactin that market.  These loans may be soldin a secondary market with a limited number of active market participants.  An active market quote to determine pricingand the current market value of these loans in the secondary market wascompleted as of December 31, 2007 and September 30, 2008 and obtainedfrom a recognized investment brokerage house. These factors meet the definition of the most advantageous market andform the basis of the determination of a precise method for determining thevalue of these loans.  During the firstnine months of 2008 and 2007, pre-tax unrealized gains of $1,000 and losses of$76,000, respectively, were recorded in earnings.  The fair value at September 30, 2008 wascalculated using fair value hierarchy level two and in the same manner as thevaluation at December 31, 2007.

 

**NOTE 4 – FAIR VALUE MEASUREMENT FAS 157**

 

Effective January 1, 2007, the Company adopted FAS 157, *Fair Value Measurements,* concurrent with its early adoptionof FAS 159.  FAS 157 clarifies thedefinition of fair value and describes methods available 

 

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to appropriately measure fair value in accordance with generallyaccepted accounting principles.  Thisstatement applies whenever other accounting pronouncements require or permitfair value measurements.

 

The fair value hierarchy under FAS 157 prioritizes the inputs tovaluation techniques used to measure fair value into three broad levels (Levels1, 2 and 3).  Level 1 inputs are unadjustedquoted prices in active markets for identical assets or liabilities that thereporting entity has the ability to access at the measurement date.  Level 2 inputs are inputs other than quotedprices included within Level 1 that are observable for the asset or liability,either directly or indirectly.   Level 3inputs are unobservable inputs for the asset or liability and reflect thereporting entity’s own evaluation about the assumptions that marketparticipants would use in pricing the asset or liability.

 

Available for sale securities are valued based upon open-market quotesobtained from reputable third-party brokers. Market pricing is based upon specific CUSIP identification for eachindividual security.  Changes in fairvalue are recorded in other comprehensive income.  Trading securities are valued based on openmarket quotes obtained from reputable third party brokers and pricing is basedupon specific identification for each individual security.  Changes in fair value are reported in thestatement of operations.

 

The fair value measurements for impaired loans are performed pursuantto FAS 114 and are based upon either collateral values supported by appraisals,or discounted cash flow assumptions.  Allof the impaired loans at September 30, 2008 have collateral to supporttheir fair values.  Adjustments for fairvalue of impaired loans are a component in determining the overall adequacy ofthe loan loss reserve.  Consequently,adjustments to the estimated fair value of impaired loans may result in increasesor decreases to the provision for loan losses recorded in current earnings.

 

Fair value measurements for other real estate owned (OREO) are basedupon collateral values supported by appraisals. Changes in the estimated fair value of OREO are recorded in thestatement of operations.  FAS 157disclosures for impaired loans require that the practical expedient in FAS 114(observable market price or the fair value of collateral if the loan iscollateral dependent) is a fair value measurement, and therefore, is includedin the scope of the non-recurring disclosure requirements of FAS 157.

 

The Company performs fair value measurements on certain assets as theresult of the application of accounting guidelines and pronouncements that wererelevant prior to the adoption of FAS 157. Some fair value measurements, such as for available-for-sale and tradingsecurities and USDA loans are performed on a recurring basis, while other, suchas impairment of loans and goodwill, are performed on a non-recurring basis.

 

The following table summarizes the Company’s financial instruments thatwere measured at fair value as of September 30, 2008.

 

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| **Description of Financial Instrument** | ** ** | **September 30,  2008**         | ** ** | **Quoted Prices in  Active Markets  for Individual  Assets Level 1** | ** ** | **Significant  Other  Observable  Inputs  Level 2** | ** ** | **Significant  Unobservable  Inputs Level 3** | ** ** |
|--------------------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                             | ** ** | **(Dollars in thousands)** | ** ** |
|                                                   |       |                                 |       |                                                                                               |       |                                                     |       |                                                    |       |
| Securities Available for Sale                          |       | $                                    | 3,924      |                                                                                               | $          | —                                                   |       | $                                                       | 3,924      |   | $ | — |   |
| Trading Account                                        |       | 84                                   |       | 84                                                                                                 |       | —                                                   |       | —                                                  |       |
| Impaired Loans (non-recurring)                         |       | 9,714                                |       |                                                                                               |       | 9,714                                                    |       | —                                                  |       |
| OREO                                                   |       | 2,910                                |       | —                                                                                             |       | 2,910                                                    |       | —                                                  |       |
| USDA Loans at fair value                               |       | 866                                  |       | —                                                                                             |       | 866                                                      |       | —                                                  |       |
|                                                   |       |                                 |       |                                                                                               |       |                                                     |       |                                                    |       |
| Total                                                  |       | $                                    | 17,498     |                                                                                               | $          | 84                                                       |       | $                                                       | 17,414     |   | $ | — |   |

 

**NOTE 5 – SHARE BASED COMPENSATION**

 

***Stock Option Plan***

 

The Company has a stock based employee compensation plan, which is morefully described in Note 14 of the Company’s 2007 annual report on Form 10-K.  On January 1, 2006 the Company adoptedFAS Statement No. 123(R), *Accounting for Share BasedPayments.*  FAS 123(R) requiresall share-based payments to employees, including grants of employee stockoptions to be recognized in the financial statements based on the grant-datefair value of the award.  The fair valueis amortized over the implied service period (generally the vestingperiod).  The Company previouslyaccounted for stock-based awards to employees under the intrinsic valueprovisions of APB 25 in which no compensation cost was required to berecognized for options granted that had an exercise price equal to the marketvalue of the underlying common stock on the date of the grant.

 

Included in salaries and benefits for the nine months ending September 30,2008 and 2007, there was $211,000 and $326,000 of share-based compensation,respectively.  The related tax benefit onshare-based compensation was not material to either quarter.  The following table summarizes the Company’soptions and changes for the three and nine month periods ending September 30,2008.

 
| ** **                                 | ** ** | **Quarter Ended September 30, 2008** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                 | ** ** | **Number of  Shares**                               | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Aggregate  Intrinsic Value** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** |
| Options outstanding at beginning of period |       | 724,478                                                  |       | 13.59 |   |   |   |   |   |
| Granted                                    |       | —                                                   |       | — |   |   |   |   |   |
| Cancelled/Forfeited                        |       | 34,505                                                   |       | 9.53 |   |   |   |   |   |
| Exercised                                  |       | —                                                   |       | — |   |   |   |   |   |
| Options outstanding at end of period       |       | 689,973                                                  |       | 13.80 |   | $ | -0- |   | 5.72 Years |   |
|                                       |       |                                                     |       |   |   |   |   |   |   |
| Exercisable (vested) at end of period      |       | 593,539                                                  |       | 13.09 |   | $ | -0- |   | 5.35 Years |   |

 

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| ** **                                 | ** ** | **Nine months Ended September 30, 2008** | ** ** |
|--------------------------------------------|------------|-------------------------------------------------------------------|------------|
| ** **                                 | ** ** | **Number of   Shares**                                  | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Aggregate   Intrinsic Value** | ** ** | **Weighted Average  Remaining  Contractual Term** | ** ** |
| Options outstanding at beginning of period |       | 731,310                                                           |       | 13.63 |   |   |   |   |   |
| Granted                                    |       | —                                                            |       | — |   |   |   |   |   |
| Cancelled/Forfeited                        |       | 41,337                                                            |       | 10.85 |   |   |   |   |   |
| Exercised                                  |       | —                                                            |       | — |   |   |   |   |   |
| Options outstanding at end of period       |       | 689,973                                                           |       | 13.80 |   | $ | -0- |   | 5.72 Years |   |
|                                       |       |                                                              |       |   |   |   |   |   |   |
| Exercisable (vested) at end of period      |       | 593,539                                                           |       | 13.09 |   | $ | -0- |   | 5.35 Years |   |

 
| ** **                | ** ** | **Nine months Ended September 30, 2007** | ** ** |
|---------------------------|------------|-------------------------------------------------------------------|------------|
| Risk free interest rate   |       | 3.64%                                                             |       |
| Expected dividend yield   |       | 0.0%                                                              |       |
| Expected life in years    |       | 7.0                                                          |       |
| Expected price volatility |       | 38.9%                                                             |       |

 

TheBlack Scholes option valuation model requires the input of highly subjectiveassumptions, including the expected life of the stock based award and stockprice volatility.  The assumptions listedabove represent management’s best estimates, but these estimates involveinherent uncertainties and the application of management judgment.  As a result, if other assumptions had beenused, the Company’s recorded compensation expense could have been materiallydifferent from that depicted above.  Inaddition, the Company is required to estimate the expected forfeiture rate andonly recognize expense for those shares expected to vest.  If the Company’s actual forfeiture rate ismaterially different from the estimate, the share-based compensation expensecould be materially different.

 

**NOTE 6 – DEFERRED COMPENSATION**

 

InSeptember 2006 the Emerging Issues Task Force (“EITF”) ratified EITF issue06-04, “*Accounting for Deferred Compensation andPostretirement Benefit Aspect of Endorsement Split-Dollar Life InsuranceArrangements”.*   This rulingprovides that the Company should recognize a liability for future benefitsbased on the agreements held with employees. The issue was effective for fiscal years beginning after December 17,2007.  The Company adopted thispronouncement effective January 1, 2008 and has recorded an initialliability of $1.6 million with an offsetting adjustment to retained earnings of$1.1 million and deferred taxes of $0.5 million, pursuant to this accountingpronouncement.

 

**NOTE 7 – EARNINGS/LOSS PER SHARE**

 

Income/loss per share for all periods presented in the unauditedConsolidated Statements of Operations are computed based on the weighted averagenumber of shares outstanding during each period.  Options outstanding as of September 30,2008 totaled 689,973. The computation of basic and diluted loss/earnings perweighted average share outstanding is as follows:

 

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| ** **                                                                                       | ** ** | **Quarter Ending  September 30,** | ** ** | **Nine months Ending  September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|------------------------------------------------------|------------|
|                                                                                             |       | **2008**                                    | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** |   |
|                                                                                             |       |                                        |       |                                                 |       |   |   |   |   |
| Average number of common shares outstanding                                                      |       | 5,830,099                                   |       | 5,831,099                                            |       | 5,830,437 |   | 5,831,099 |   |
| Effect of dilutive options (1)                                                                   |       | -0-                                         |       | 163,064                                              |       | 2,736 |   | 155,066 |   |
| Average number of common shares outstanding  used to calculate diluted earnings per common share |       | 5,830,099                                   |       | 5,994,163                                            |       | 5,833,173 |   | 5,986,165 |   |
|                                                                                             |       |                                        |       |                                                 |       |   |   |   |   |
| Net (loss)/income                                                                                |       | $                                           | (35,046    | )                                                    | $          | 750 |   | $ | (34,512 | ) | $ | 2,011 |   |
| Basic net (loss)/income per share                                                                |       | $                                           | (6.01      | )                                                    | $          | 0.13 |   | $ | (5.92 | ) | $ | 0.34 |   |
| Diluted net (loss)/income per share                                                              |       | $                                           | (6.01      | )                                                    | $          | 0.13 |   | $ | (5.92 | ) | $ | 0.34 |   |

 

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(1) There were 711,529 anti-dilutive weighted shares which havebeen excluded from the diluted weighted shares outstanding calculation.

 

**NOTE 8 – INCOME TAXES**

 

FASBStatement 109 and FIN 48 provide guidance for the recognition, derecognitionand measurement in financial statements of tax positions taken in previouslyfiled tax returns or tax positions expected to be taken in tax returns. FIN 48requires an entity to recognize the financial statement impact of a taxposition when it is more likely than not that the position will be sustainedupon examination. If the tax position meets the more-likely-than-notrecognition threshold, the tax effect is recognized at the largest amount ofthe benefit that is greater than fifty percent likely of being realized uponultimate settlement. FIN 48 requires that a liability created for unrecognizedtax benefits shall be presented as a liability and not combined with deferredtax liabilities or assets. The application of FIN 48 may also affect the taxbasis of assets and liabilities and therefore may change or create deferred taxliabilities or assets.

 

TheCompany has not previously been examined by any income tax authority.  Management believes that in the event of anexamination by the taxing authority that it is more likely than not that thereported tax positions will be upheld. Accordingly, because management expectsthe taxing authority to allow the reported positions when and if examined, themore-likely-than-not recognition threshold has been met.

 

**NOTE 9 – OTHER BORROWED FUNDS**

 

The Company has entered into two agreements with correspondent banksunder which it may purchase federal funds up to $17.0 million.  The interest charged on borrowings isdetermined by the lending institution at the time of the borrowing.  These lines of credit are for short-term use,are unsecured and are renewed on an annual basis.  There were no balances outstanding underthese agreements at September 30, 2008, and $110,000 was outstanding at December 31,2007.

 

The Company also has an agreement with the Federal Home Loan Bank ofSan Francisco (FHLB) to borrow funds. Advances are collateralized by qualifying assets pursuant to collateralagreements with FHLB.  Under such agreementsthere were overnight advances of $27.5 million and $62.5 million outstanding asof September 30, 2008, and December 31, 2007, respectively.  In addition to the overnight advances therewere term advances in the amount of $7.0 million outstanding as of September 30,2008 

 

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and $8.0 million outstanding at December 31, 2007.  There was $33 million in securitiescollateral and $87 million in loan collateral available as of September 30,2008, for a total of $120 million, as compared to $100 million available as of December 31,2007.

 

Other borrowed funds include $20.6 million of subordinated debentures.The Company originally issued $15.5 million of these debentures and theadditional $5.1 million in debentures were acquired in the merger with NNBHoldings, Inc.

 

**NOTE 10 – GOODWILL**

 

Goodwill represents the excess of purchase price over the fair value ofnet assets acquired because of various business acquisitions.  In accordance with FAS 142, “*Goodwill and Other Intangible Assets*” goodwill must be evaluatedat the reporting unit level.  Reportingunits are defined as an operating segment. FAS 142 prohibits the amortization of goodwill, but requires that it betested for impairment at least annually, or more frequently if events orcircumstances change, such as adverse changes in the business climate, thatwould more likely than not reduce the reporting unit’s fair value below itscarrying amount.  Like most publiclytraded financial institutions, the Company experienced a significant decline inits stock price and market capitalization during 2008.  In conjunction with these declines and theongoing turmoil in the financial markets, the Company has elected to reduce thecarrying value of its goodwill resulting from the 2006 acquisitions of NorthernNevada Bank, Granite Exchange and Rocky Mountain 1031 Exchange.  In the past the analysis of goodwill occurredduring the fourth quarter, however, given the volatile trading patterns andvalues seen in NYSE and NASDAQ activities, it was believed that the goodwillevaluation was best performed before year end.

 

The Company contracted with an independent valuation firm to assist inthe valuation of the Company’s goodwill: they utilized three general approachesin its evaluation: 1) the asset-based approach, 2) the market approach and 3)the income approach.  The Company usedone method within the market approach and one method within the incomeapproach.  The method within the incomeapproach was the discounted cash flow method, which relies upon the perceptionof a future stream of benefits, the present value of which represents theindication of value of the Company.  Themethod within the market approach was the merger and acquisition method.  After analysis the various indications ofvalue were then weighted to derive a conclusion as to the fair value of thereporting units.

 

 The Company is taking a $27million non-recurring, non-cash goodwill impairment charge for the goodwillresulting from the NNB, Granite and Rocky Mountain acquisitions in 2006.  This goodwill write down will more closelyalign the Company’s book value and tangible equity.  This one time, non-cash impairment charge isa non-taxable event that does not affect the Bank’s liquidity, operations, orregulatory capital.

 

**NOTE 11 – RECENT ACCOUNTING PRONOUNCEMENTS**

 

**FASB162**

 

InMay 2008, the FASB issued SFAS No 162, *The Hierarchy of GenerallyAccepted Accounting Principles.* This statement identifies the sources of accounting principles andframework for selecting the principles to be used in the preparation offinancial statements of nongovernmental entities that are presented inconformity with generally accepted accounting principles in the United States.

 

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**FASB157**

 

InSeptember 2006, the FASB issued SFAS No. 157, *Fair Value Measurements*. The statementdefines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. The statement emphasizesthat fair value is a market-based measurement, not an entity-specificmeasurement and establishes a fair value hierarchy. This statement alsoclarifies how the assumptions of risk and the effect of restrictions on salesor use of an asset effect the valuation. SFAS 157 was effective for financialstatements issued for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years. Early adoption was permitted.Management adopted this statement effective as of January 1, 2007.

 

**FSP FAS157-3**

 

OnOctober 10, 2008, FASB staff position (FSP) was issued clarifying theapplication of SFAS No 157, *Fair Value Measurements,*ina market that is not active and provides an example to illustrate keyconsiderations in determining the fair value of a financial asset when themarket for that financial asset is not active. This FSP provides guidance on how to deal with issues in the applicationof FAS 157 when the market for financial assets is not active.  Application issues addressed include: 1) howthe reporting entity’s own assumptions should be considered when measuring fairvalue when relevant observable inputs do not exist, 2) how available observableinputs in a market that is not active should be considered when measuring fairvalue, and 3) how the use of market quotes should be considered when assessingthe relevance of observable and unobservable inputs available to measure fairvalue.  This FSP was effective uponissuance, including prior period for which financial statements had not beenissued.

 

**FASB159**

 

InFebruary 2007, the FASB issued SFAS No. 159, *Fair Value Option for Financial Assets and FinancialLiabilities, including an amendment of FASB Statement No. 115.*SFAS 159 permits entities to choose to measure many financial instruments andcertain other items at fair value at specified election dates. The fair valueoption may be applied instrument by instrument with certain exceptions and isapplied generally on an irrevocable basis to the entire instrument. SFAS 159was effective for financial statements issued for fiscal years beginning after November 15,2007. Early adoption was permitted under certain circumstances. Managementadopted this Statement effective as of January 1, 2007.

 

**EITF06-04**

 

InSeptember 2006, the Emerging Issues Task Force (“EITF”) of the FASBratified EITF Issue No. 06-4, *Accountingfor Deferred Compensation and Postretirement Benefit Aspects of EndorsementSplit-Dollar Life Insurance Arrangements*, and EITF Issue No. 06-5,*Accounting for Purchases of Life Insurance –Determining the Amount That Could Be Realized in Accordance with FASB TechnicalBulletin No. 85-4, Accounting for Purchases of Life Insurance*.EITF 06-4 provides that an employer should recognize a liability for futurebenefits based on the substantive agreement with the employee. The Issue shouldbe applied to fiscal years beginning after December 15, 2007, with earlierapplication permitted. EITF 06-5 provides that in determining the amountrecognized as an asset, a policyholder should consider the cash surrender valueas well as any additional amounts included in the contractual terms of thepolicy that will be paid upon surrender. The amount that could be realizedshould be calculated at the individual policy level and consider any probablecontractual limitations, including the exclusion of any additional amounts paidfor the surrender of an entire group of policies. The Issue is effective forfiscal years beginning after December 15, 2007. The banking subsidiary ofthe Company has life insurance arrangements. The Company has evaluated the impact of adoption of this rule onthe Company’s financial statements and results of operations and it has beendetermined by outside benefits administrators that $1.1 million would beadjusted to retained earnings pursuant to this accounting pronouncement,effective January 1, 2008.

 

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**Summary**

 

Thelist of recent accounting pronouncements noted above, while not an exhaustivelist, includes those which we believe will, or may, have the greatestlikelihood of application to the Company’s consolidated balance sheets and/orconsolidated statements of income.  Webelieve that adoption of these standards will not have a material impact on ourfinancial condition or results of income, earnings per share or cash flowunless otherwise noted, however no absolute assurance can be given that this infact, will occur.

 

**NOTE 12 – SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION**

 

During the nine months ended September 30, 2008 and 2007, cashpaid for interest expense on interest bearing liabilities was $12.5 million and$18.1 million, respectively.  There wasno real estate acquired in the settlement of loans for the three month periodending September 30, 2008, $3.5 million for the YTD period ending September 30,2008 and none for the corresponding periods of 2007, respectively.  During the nine month periods ended September 30,2008 and 2007, cash paid for income taxes was $864,000 and $684,000,respectively.

 

**NOTE 13 – COMMON STOCK REPURCHASE PLAN**

 

During December 2007, the Company’s Board of Directors approved aplan to repurchase, as conditions warrant, up to $3.0 million of the Company’scommon stock on the open market or in privately negotiated transactions.  The duration of the program is open ended andthe timing of the purchases will depend upon market conditions.  One thousand shares of common stock wererepurchased during the quarter ended June 30, 2008 at a total cost of ninethousand dollars, and there have been no subsequent purchases.

 

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**Selected Financial Data**

 
| ** **                                 | ** ** | **Nine months Ended September 30,**                         | ** ** | **Year Ended** | ** ** |
|--------------------------------------------|------------|---------------------------------------------------------------------------------|------------|---------------------|------------|
| ** **                                 | ** ** | **2008**                                                                        | ** ** | **2007**            | ** ** | **December 31, 2007** | ** ** |
| ** **                                 | ** ** | **(Dollars in thousands, except per share data)** | ** ** |
| **Condensed Statement of Operations**      |       |                                                                            |       |                |       |   |   |
| Interest Income                            |       | $                                                                               | 28,690     |                | $          | 34,107 |   | $ | 45,183 |   |
| Interest Expense                           |       | 13,215                                                                          |       | 17,499              |       | 22,964 |   |
| Net Interest Income                        |       | 15,475                                                                          |       | 16,608              |       | 22,219 |   |
| Provision for Loan Losses                  |       | 1,440                                                                           |       | 760                 |       | 3,007 |   |
| Non-interest income                        |       | (14,015                                                                         | )          | 1,190               |       | 1,422 |   |
| Non-interest expense                       |       | 39,915                                                                          |       | 13,875              |       | 18,307 |   |
| Loss attributable to minority shareholders |       | —                                                                          |       | (28                 | )          | (27 | ) |
| (Benefit) provision for income taxes       |       | (5,383                                                                          | )          | 1,180               |       | 625 |   |
| Net Loss/Income                            |       | $                                                                               | (34,512    | )                   | $          | 2,011 |   | $ | 1,729 |   |
|                                       |       |                                                                            |       |                |       |   |   |
| **Period End Data**                        |       |                                                                            |       |                |       |   |   |
| Assets                                     |       | 558,216                                                                         |       | 653,347             |       | 626,640 |   |
| Loans, gross (1)                           |       | 454,506                                                                         |       | 489,931             |       | 474,769 |   |
| Securities                                 |       | 65,560                                                                          |       | 79,987              |       | 80,276 |   |
| Deposits                                   |       | 461,034                                                                         |       | 516,841             |       | 451,335 |   |
| Other borrowed funds                       |       | 55,119                                                                          |       | 49,119              |       | 91,229 |   |
| Shareholders’ Equity                  |       | 39,630                                                                          |       | 75,203              |       | 74,837 |   |
|                                       |       |                                                                            |       |                |       |   |   |
| **Average Balance Sheet**                  |       |                                                                            |       |                |       |   |   |
| Assets                                     |       | 632,795                                                                         |       | 652,789             |       | 649,110 |   |
| Loans (1)                                  |       | 462,527                                                                         |       | 476,267             |       | 478,461 |   |
| Securities                                 |       | 108,375                                                                         |       | 87,583              |       | 85,306 |   |
| Deposits                                   |       | 450,901                                                                         |       | 497,151             |       | 492,347 |   |
| Shareholders’ Equity                  |       | 74,872                                                                          |       | 74,133              |       | 74,696 |   |
|                                       |       |                                                                            |       |                |       |   |   |
| **Asset Quality**                          |       |                                                                            |       |                |       |   |   |
| Non-performing assets (2)                  |       | 27,369                                                                          |       | 5,660               |       | 6,433 |   |
| Allowance for loan loss                    |       | 7,198                                                                           |       | 5,480               |       | 7,276 |   |
| Net Charge-offs                            |       | 1,518                                                                           |       | 710                 |       | 1,161 |   |
| Non-performing assets to total assets      |       | 4.90                                                                            | %          | 0.87                | %          | 1.03 | % |
| Allowance for loan loss to loans           |       | 1.58                                                                            | %          | 1.12                | %          | 1.53 | % |
| Net Charge-offs to average loans           |       | 0.33                                                                            | %          | 0.15                | %          | 0.24 | % |
|                                       |       |                                                                            |       |                |       |   |   |
| **Per Common Share**                       |       |                                                                            |       |                |       |   |   |
| Basic loss/income per share                |       | (5.92                                                                           | )          | 0.34                |       | 0.30 |   |
| Diluted loss/income per share              |       | (5.92                                                                           | )          | 0.34                |       | 0.29 |   |
| Book value per share                       |       | 6.80                                                                            |       | 12.90               |       | 12.83 |   |
| Period end common shares outstanding       |       | 5,830,099                                                                       |       | 5,831,099           |       | 5,831,099 |   |
| Average shares outstanding - basic         |       | 5,830,437                                                                       |       | 5,831,099           |       | 5,831,099 |   |
| Average shares outstanding - diluted       |       | 5,833,173                                                                       |       | 5,986,165           |       | 5,968,687 |   |
|                                       |       |                                                                            |       |                |       |   |   |
| **Financial Ratios**                       |       |                                                                            |       |                |       |   |   |
| Return on average assets (4)               |       | (7.29                                                                           | )%         | 0.41                | %          | 0.27 | % |
| Return on average equity (4)               |       | (61.57                                                                          | )%         | 3.61                | %          | 2.31 | % |
| Net interest margin (3)                    |       | 3.62                                                                            | %          | 3.77                | %          | 3.79 | % |
| Tier 1 leverage capital ratio              |       | 6.94                                                                            | %          | 10.40               | %          | 10.39 | % |

 

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| (1) | Includes USDA loans  carried at fair value.                                                                                                                                       |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Non-performing assets  consists of loans 90 days or more delinquent and still accruing interest,  investments or loans placed on non-accrual status and other real estate  owned. |
| (3) | Net interest income is  divided by average interest-earning assets.                                                                                                               |
| (4) | Annualized.                                                                                                                                                                       |

 

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**THE BANK HOLDINGS AND SUBSIDIARIES**

**Item 2**

**MANAGEMENT’S DISCUSSION AND ANALYSIS OF**

**FINANCIALCONDITION AND RESULTS OF OPERATIONS**

 

**FORWARD LOOKING STATEMENTS**

 

Certainstatements contained herein are not based on historical facts and are “forward-lookingstatements” within the meaning of Section 21A of the Securities ExchangeAct of 1934.  Forward-looking statements,which are based on various assumptions, may be identified by reference to afuture period or periods, or by the use of forward-looking terminology, such as“may,” “will,” “believe,” “expect,” “estimate,” “anticipate,” “continue” orsimilar terms or variations on those terms or the negative of those terms.  Forward-looking statements are subject tovarious factors (some of which are beyond our control), which could causeactual results to differ materially from these estimates.  These factors include, but are not limitedto, changes in general economic conditions, interest rates, deposit flows, loandemand, competition, legislation or regulation and accounting principles,policies or guidelines, as well as other economic, competitive, governmental,regulatory and technological factors affecting the Company’s operations.  We do not undertake, and specificallydisclaim any obligation, to publicly release the result of any revisions whichmay be made to any forward-looking statements to reflect the occurrence ofevents or circumstances after the date of such statements.

 

**CRITICAL ACCOUNTING POLICIES**

 

TheCompany’s financial statements are prepared in accordance with accountingprinciples generally accepted in the United States.  The financial information contained withinthese statements is, to a significant extent, based on approximate measures ofthe financial effects of transactions and events that have alreadyoccurred.  Critical accounting policiesare those that involve the most complex and subjective decision andassessments, and have the greatest potential impact on the Company’s statedresults of operations.  We consider theallowance for loan losses to be a critical accounting policy due to thepotential impact on our results of operations and the carrying value of certainof our assets based on any changes in judgments and assumptions required to bemade by us in the application of this policy. The Company has made no substantive changes in its critical accountingpolicies and assumptions compared to the disclosures made in The Bank HoldingsAnnual Report on Form 10-K for the year ended December 31, 2007.

 

***Allowance for Loan Losses***

 

Wemaintain an allowance for loan losses at a level which we believe is sufficientto cover probable losses on loans deemed to be uncollectible based on ourcontinuous review of a variety of factors. These factors consist of the character and size of the loan portfolio, businessand economic conditions, loan growth, delinquency trends, nonperforming loantrends, portfolio migration data (when appropriate), historical charge-offs,peer data, and other asset quality factors. The primary means of adjusting the level of this allowance is throughthe provision for loan losses, which is established and charged to income on amonthly basis.  Although we use availableinformation to establish the appropriate level of the allowance for loan losses,future additions to the allowance may be necessary because our estimates of thepotential losses in our loan portfolio are susceptible to change as a result ofchanges in the factors noted above.  Anysuch increase would adversely affect our results of operations.  Our allowance for loan losses was $7.2million and $5.5 million at September 30, 2008 and 2007, respectively. Theprovision for loan losses 

 

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was$150,000 for the quarter ended September 30, 2008 and $346,000 for thequarter ended September 30, 2007.

 

The Company grants real estate, commercial, and consumer loans tocustomers.  A substantial portion of theloan portfolio is represented by real estate loans throughout northern Nevadaand northern California.  The ability ofthe Company’s borrowers to honor their contracts is dependent upon the realestate market and general economic conditions in these areas.  Both of these areas have been severelyimpacted by the substantial downturn in national, regional and state economicconditions, the continued effects of which management believes have not yetbeen made fully apparent.  Such aneconomic cycle may last for more than one year, and bring about furtherdeterioration in loan quality as exhibited in Table 5.

 

Forthe commercial and real estate loan portfolios, we evaluate specific loanstatus reports on all “watch” and classified loans, including certain loanswhich may have been classified as impaired. On an ongoing basis an independent loan review function reviews a sampleof new loans as well as “watch” and any classified loans to ensure the accuracyof the loan classifications.  Estimatedreserves for classified loans are determined by reviewing current collateralvalue, financial information, cash flow, payment history and trends and otherrelevant facts surrounding the particular credit.  Provisions for losses on any remaining loansare based on pools of similar loans using a combination of historical loss fromthe Bank and its peers.  Table 5 setsforth the allocation of the allowance for loan losses as of September 30,2008, and September 30, 2007.

 

**OVERVIEW**

 

TheCompany earns income from two primary sources; net interest income generated bythe successful employment of earning assets less the costs of interest-bearingliabilities, and net non-interest income, which is generated by service chargeson deposit accounts and other service charges, commissions and fees charged forother services provided, less the operating costs of providing the full rangeof banking and exchange services to our customers.  Gains or losses on sale of securities, orother assets, exchange fees on real estate 1031 transactions, increase in cashsurrender value of bank owned life insurance and unrealized gains or losses onthe Company’s trading account comprise other areas of non-interest income.

 

**SUMMARY: Results of Operations – 3rd Quarter**

 

Netloss for the quarter ended September 30, 2008 was $35.0 million ascompared with earnings of $750,000 for the quarter ended September 30,2007.  Losses per share for the thirdquarter of 2008 was $6.01 compared with basic and diluted earnings per share of$0.13 respectively, for the same quarter of 2007.  The Company’s quarterly return on averageequity was (219.56)% and quarterly return on average assets was (22.25)% forthe quarter ended September 30, 2008, compared to 3.97% and 0.45%respectively, for the quarter ended September 30, 2007.  The primary drivers behind the variance innet income for the third quarter of 2008 relative to the same quarter of 2007are as follows:

 

·                  Exclusiveof investment losses and impairments, related tax provisions and the one-timenon-cash goodwill impairments, pre tax operating income for the quarter was$405,000.

 

·                  Thechallenging economic conditions starting in 2007 with the deterioration of thereal estate markets have expanded during the third quarter of 2008 into severeturmoil in credit markets and the general economy nationally, regionally andlocally.  Federal Open Market Committeeactions and consumer flight to safety concerns have placed increased pressureon the Company’s net interest margins. This turmoil and daily headlinesconcerning the financial crisis have affected the entire financial industry’smarket value 

 

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including the Company’s the result of which has led us to conduct anearly impairment analysis of the Company’s goodwill.  For the third quarter we recognized aone-time, non-cash goodwill impairment of $26.9 million or $4.62 per sharebased on the decline in the market value of our common stock.  This one-time non-cash impairment charge is anon-taxable event that does not affect the Company’s cash balances, liquidity,or operations.

 

·                  Theactions of the Treasury Department’s placement of Freddie Mac (FHLMC) andFannie Mae (FNMA) into conservatorship has rendered the preferred securitiesthe Company owned nearly worthless, and therefore the Company has recorded another than temporary impairment of $7.8 million net of taxes or $1.34 pershare.

 

·                  Theturmoil in the credit markets led the Company to recognize a one time $626,000charge in other than temporary impairment for several trust preferredsecurities held by the Company issued by other bank holding companies.

 

·                  Managementdoes not believe that the recognition of these impairment charges noted abovehas any further implication for the Company’s business fundamentals or itsoutlook in future quarters.

 

·                  TheCompany has reduced the number of offices by closing the exchange office inBozeman, Montana.

 

·                  TheCompany’s staff continues to be reduced through attrition.

 

·                  Interestincome decreased $2.6 million or 22%.

 

·                  Interestexpense decreased $1.9 million or about 31%.

 

·                  Netinterest income before the provision for loan losses decreased $711,000 or 13%.

 

·                  Forthe quarter ended September 30, 2008 $150,000 was added to the provisionfor loan losses.

 

·                  Non-interestloss was $14.1 million for the third quarter of 2008, a reduction from earningsof $163,000 for the same period in 2007.  This was caused by a $562,000 increase in trading asset losses and $13.6million net change in losses and impairments on investments.

 

·                  Non-interestexpense decreased $380,000 or 9%, exclusive of the $26.9 million goodwillimpairment charge.

 

·                  Thebenefit for taxes was increased by the effects of investment losses andimpairments as well as the permanent book/tax differences including $260,000 ofnon-taxable interest and dividends.

 

QuarterlyAverage balances and rates are provided in Table 1.

 

**SUMMARY: Results of Operations – YTD**

 

Netloss for the nine months ended September 30, 2008 was $34.5 million ascompared with earnings of $2.0 million for the quarter ended September 30,2007.  Basic and diluted losses per sharefor the first nine months of 2008 were $5.92 compared with basic and dilutedearnings per share of $0.34 respectively, for the same period of 2007.  The Company’s YTD return on average equitywas (61.57)% and YTD return on average assets was (7.29)% for the nine monthsended September 30, 2008, compared to 3.61% and 0.41% respectively, forthe same period ended September 30, 2007. The primary drivers behind the variance in net income for the first ninemonths of 2008 relative to the same period of 2007 are as follows:

 

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·                  Theeconomic downturn in the national, state, and regional economies which isexpected to continue to impact earnings for the balance of 2008 and likelybeyond.

 

·                  Thecontinuing turmoil in the money markets and attendant credit crises hasimpacted the stock prices of many financial companies, including theCompany.  This resulted in impairment ofthe Company’s goodwill which was reflected in a one time, non-cash charge inthe amount of $26.9 million.

 

·                  TheTreasury Department’s conservatorship of FNMA and FHLMC rendered the preferredsecurities the Company owned nearly worthless, resulting in a loss of $7.8million net of taxes.

 

·                  Interestincome decreased $5.4 million or 16%.

 

·                  Interestexpense decreased $4.3 million or about 24%.

 

·                  Netinterest income before the provision for loan losses decreased $1.1 million orabout 7%.

 

·                  Theprovision for loan losses increased $680,000 or 89% over September 30,2007.

 

·                  Non-interestloss was $14.0 million for the first nine months of 2008 compared with incomeof $1.2 million for the same period in 2007, as a result of unrealized andrealized losses in the trading and investments accounts amounting to $15.0million.

 

·                  Non-interestexpense decreased $871,000 or 6%, not including the non-cash goodwillimpairment costs.

 

·                  Thebenefit for taxes was increased by the investment losses and impairments and bythe effects of permanent book/tax differences including $1.2 million ofnon-taxable interest and dividends.

 

YTDAverage balances and rates are provided in Table 1a.

 

**SUMMARY:Financial Condition**

 

TheCompany’s total assets were $558 million at September 30, 2008 a decreaseof $69 million or 11%, from total assets of $627 million reported at December 31,2007.  The most significantcharacteristics of and changes in the Company’s balance sheet during the firstnine months of 2008 are outlined below:

 

·                  Acontinuing emphasis on restructuring the balance sheet to alleviate substantialreductions in rates earned on asset portfolios and shrinking the volume ofcapital intensive assets held to maintain the Company at well capitalized:

 

·                  Forthe nine months ended September 30, 2008 investment securities decreasednearly $15 million from December 31, 2007 or 19%.  Average investment securities increased $20million or 23% for the nine months ended September 30, 2008 as compared tothe same period in 2007.

 

·                  Grossloans decreased $20 million to $455 million at September 30, 2008 comparedto December 31, 2007.  Average grossloans as of September 30, 2008 showed a decrease of $13 million or about3% from the average at September 30, 2007.

 

·                  Forthe nine months ended September 30, 2008 total assets decreased $69million or 11% to $558 million from December 31, 2007.  Compared with the YTD period ending September 30,2007 average assets decreased $20 million or 3%.

 

·                  Totaldeposits increased by $10 million or 2% during the nine month period ending September 30,2008 to $461 million.  YTD averagedeposits decreased $46 million to $451 million or 9% at September 30, 2008compared with the same period in 2007.

 

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·                  Shortterm borrowings from FHLB decreased by $40 million.

 

·                  Exchangedeposits at non-affiliated financial institutions decreased $3 million.

 

**RESULTS OF OPERATIONS**

 

**Net Interest Income**

 

Netinterest income is the difference between interest income on earning assetssuch as loans and securities, and interest expense paid on liabilities such asdeposits and borrowings, and continues to be our largest revenue source.  Net interest income is affected by the levelof interest rates, changes in interest rates and by changes in the amount andcomposition of interest-earning assets and interest-bearing liabilities.

 

***Quarterly Analysis***

 

Netinterest income for the third quarter of 2008 was $4.9 million, a decrease of$0.7 million or about 13% compared to the third quarter of 2007.  This decrease was primarily due to thedecreases in rates earned on interest earning assets coupled with lower ratespaid on interest bearing liabilities. Average loans were $27.2 million less, or 5.6% for the quarter ended September 30,2008 compared to the same period in the prior year. Average deposits were $44.9million lower, or 10.2% for the quarter ended September 30, 2008 comparedto September 30, 2007.  Averageinvestments increased by $1.7 million or 1.6% during the third quarter of 2008compared to the third quarter 2007. Average gross loans, net of deferred feesand costs, as a percent of average assets was 73.3% and 74.1% for the quartersended September 30, 2008 and 2007, respectively.

 

Continuedconcern about loan quality has been the focus of the Bank during the thirdquarter of 2008.  Deteriorating realestate market conditions appeared in the third quarter of 2007 and havecontinued into 2008.  Managementattention to increases in non-performing assets and concern about real estatevalues led the Company to substantially increase the provision for loan lossesfor the year ended December 31, 2007 and the second quarter of 2008.  Management believes that the allowance forloan losses adequately covers the inherent losses in the loan portfolio;however no assurance can be given that further additions will not be required,especially in light of overriding economic uncertainties.

 

Table1 sets forth, for the periods indicated, information regarding, (i) thetotal dollar amount of interest income from interest earning assets and theresultant average yields, (ii) the total dollar amount of interest expenseon interest bearing liabilities and the resultant average cost; (iii) netinterest income; (iv) interest rate spread; and (v) net interestmargin (net interest income divided by average interest-earning assets).  Average balances are based on average dailybalances during the indicated periods and rates are annualized based on thenumber of days in the period subject to review, and the number of days in theyear.

 

TheCompany’s net interest margin, which represents net interest income as apercentage of average interest earning assets, decreased to 3.45% from 3.77%during the three months ended September 30, 2008 as compared to the sameperiod in 2007, respectively, a decrease of thirty two basis points or 8.5%.

 

Thedecrease in the Company’s net interest margin is largely a result of a greaterdecrease in interest earning asset rates and volumes than the changes in ratesand volumes of interest bearing liabilities. The dramatic changes in the interest rate environment brought about bythe FOMC’s activities of the last year have impacted both the asset andliability side of the balance sheet, however, the majority of the change hasbeen felt in the rates earned on the Company’s loan portfolio, with depositinterest rates generally 

 

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“sticky”in a downward rate environment.  TheCompany’s weighted average prime rate for the third quarter of 2008 was 5.00%as compared to 8.23% for the third quarter of 2007.

 

Thechange in the mix of both assets and liabilities has had a lesser impact on theCompany’s net interest margin.  TheCompany increased its use of short term average borrowed funds to $71.4 millionduring the third quarter of 2008 when compared to $27.9 million for the sameperiod in 2007.  Given the current stateof the financial markets, borrowings have been less costly than trying toattract a greater volume of interest bearing deposits.  The Company allowed certain high costexchange deposits to run off which caused average savings accounts to decrease$52.5 million to $26.25 million as of September 30, 2008 compared with thethird quarter of 2007.

 

***YTD Analysis***

 

Netinterest income for the first nine months of 2008 was $15.5 million, a decreaseof $1.1 million or about 7% compared to the first nine months of 2007.  This decrease was primarily due to thedecreases in rates earned on interest earning assets coupled with lower ratespaid on interest bearing liabilities. Average loans decreased about $14 million, or 2.9% for the nine monthsended September 30, 2008 compared to the same period in the prior year.While average investments decreased by $5 million or 4% during the first ninemonths of 2008 compared to the first nine months 2007, shorter term investmentsdecreased at a faster rate.  Averagegross loans, net of deferred fees and costs, as a percent of average assets was73.1% and 73.0% for the nine months ended September 30, 2008 and 2007,respectively.

 

Continuedconcern about loan quality has been the focus of the Bank during the first ninemonths of 2008.  Deteriorating real estatemarket conditions appeared in the third quarter of 2007, have continued into2008, and are likely to continue into 2009. Management attention to increases in non-performing assets and concernabout real estate values led the Company to substantially increase theprovision for loan losses for the year ended December 31, 2007 and thesecond quarter of 2008.  Managementbelieves that the allowance for loan losses adequately covers the inherentlosses in the loan portfolio; however given the state of the economy and thereal estate markets, no assurance can be given that further additions will notbe required.

 

Table1(a) reflects the Company’s net interest margin, which represents netinterest income as a percentage of average interest earning assets, decreasedto 3.62% from 3.77% during the nine months ended September 30, 2008 ascompared to the same period in 2007, respectively, a decrease of fifteen basispoints or 4.0%.

 

Thechange in the mix of both assets and liabilities has had an impact on theCompany’s net interest margin.  TheCompany increased its use of short term average borrowed funds to $75.1 millionduring the first nine months of 2008 when compared to $35.7 million for thesame period in 2007.  Given the currentstate of the financial markets, borrowings have been less costly than trying toattract a greater volume of interest bearing deposits.  The Company allowed high cost exchangedeposits to run off which caused average savings accounts to decrease $44.1million to $30.6 million as of September 30, 2008 compared with the samenine month period of 2007.

 

TheCompany’s weighted average prime rate for the first nine months of 2008 was5.64% compared with 8.05% for the full year of 2007.

 

**Provision and Allowance for Loan Losses**

 

Theallowance for loan losses is maintained at a level determined by management tobe adequate to absorb losses inherent in the loan portfolio.  This allowance is increased by the provisioncharged to 

 

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incomeand by recoveries on loans previously charged off.  Arriving at an appropriate level of allowancefor loan losses necessarily involves a high degree of judgment and isdetermined based on management’s ongoing evaluation.  As discussed under “Critical AccountingPolicies”, we believe that the methods we utilize to determine the allowancefor loan losses constitute a critical accounting policy.  Although we utilize judgment in providing forlosses, for the reasons discussed under “Critical Accounting Policies” and “CreditRisk Management” there can be no assurance that we will not have to increasethe amount of our historical provisions for loan losses in future periods.  Please see Table 5.

 

***Quarterly Analysis***

 

Weprovided $150,000 and $346,000 for probable loan losses in the quarters ended September 30,2008, and 2007, respectively.  At September 30,2008 the Company’s allowance for loan and lease loses was 1.58% of outstandingloans.  The Company had eighteennon-accrual loans amounting to $21.8 million at September 30, 2008, andten non-accrual loans amounting to $5.7 million at September 30,2007.  The Company charged-off $195,000in loans for the quarter ended September 30, 2008 and $450,000 for thethird quarter of 2007.  Including thenon-accrual loans, there were twenty-four 30 day or more past due loans as of September 30,2008, and thirteen during the same period of 2007.  The Company also estimates an allowance forpotential losses associated with off-balance-sheet loan commitments and standbyletters of credit.  This allowance at September 30,2008 was $157,000 or 0.41% of outstanding loan commitments and is included withother liabilities on the Company’s balance-sheet and any related increases ordecreases in the allowance are included in other expense.

 

***YTD Analysis***

 

Weprovided $1.4 million and $760,000 for probable loan losses in the nine monthsended September 30, 2008, and 2007, respectively.  The Company charged-off $1.5 million in loansfor the nine months ended September 30, 2008 and $735,000 for the sameperiod in 2007.  The Company also estimatesan allowance for potential losses associated with off-balance-sheet loancommitments and standby letters of credit. At September 30, 2008 and 2007 this allowance was $157,000 or 0.41%and $229,000 or 0.29% of outstanding loan commitments, respectively.  This allowance is included with otherliabilities on the Company’s balance-sheet and any related increases ordecreases in the allowance are included in other expense.

 

**Non-interest Income**

 

***Quarterly Analysis***

 

Thirdquarter non-interest income (excluding realized and unrealized investment andasset gains and losses) totaled $345,000, a decrease of $47,000 or 12% from thesame quarter of 2007.  The Company’sunrealized losses in trading securities were $802,000; an increase of $562,000over the same period in 2007 wherein reported losses were $240,000.   Realized losses on the sale of investmentsand other than temporary impairment charges were $14.4 million for the thirdquarter of 2008 compared with losses of $243,000 for the same period in2007.  Losses on the sale of assetsamounted to $41,000 for the quarter ending September 30, 2008.  There were no asset sales for the same periodin 2007.

 

Gainsand losses from the sale of securities are subject to market and economicconditions and, as a result, there can be no assurance that gains or lossesreported in any period will continue in the future.  Such gains or losses are not a factor in thecomputation of the Company’s efficiency ratio.

 

Servicecharges on deposit accounts and other service charges, commissions and feesincreased $11,000 to $239,000 from the same period in 2007.  Exchange fee income decreased $30,000 to$15,000 for the quarter ending September 30, 2008 as compared to the sameperiod in 2007.

 

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***YTD Analysis***

 

YTDnon-interest income (excluding realized and unrealized investment and assetgains and losses) totaled $1.0 million, a decrease of $26,000 or 2.5% from thesame period of 2007.  The Company’sunrealized losses in trading securities were $987,000; an increase of $1.2million over the same period in 2007 wherein were reported gains of$196,000.  Realized losses on the sale ofinvestments and OTTI impairment charges were $15.0 million for the first ninemonths of 2008 compared with gains of $202,000 for the same period in2007.  Losses on the sale of assetsamounted to $55,000 for the nine months ending September 30, 2008 ascompared to gains of $11,000 for the same period in 2007.

 

Gainsand losses from the sale of securities are subject to market and economicconditions and, as a result, there can be no assurance that gains or lossesreported in any period will continue in the future.  Such gains or losses are not a factor in thecomputation of the Company’s efficiency ratio.

 

Overthe past nine months, there has been substantial volatility in the agencypreferred market.  As the Companyrestructured its balance sheet it added agency preferred securities to itsinvestment portfolio and the extreme volatility for these assets has causedrealized and unrealized losses to accelerate. In order to ensure that a tax benefit is recognized for theseinvestments it is likely that the Company will sell them by the end of 2008,into an uncertain market.  If this is thecase, there would be additional other than temporary reductions in the value ofsuch assets held in the Company’s investment portfolio for the fourth quarterof 2008, than those represented in the current quarter.

 

Servicecharges on deposit accounts and other service charges, commissions and feesincreased $78,000 to $673,000 from the same period in 2007.  Exchange fee income decreased $51,000 to$73,000 for the nine months ending September 30, 2008 as compared to thesame period in 2007, reflecting fewer transactions completed during the currentreal estate malaise.

 

**Non-interest Expense**

 

***Quarterly Analysis***

 

Exclusiveof goodwill impairment charges of $26.9 million, non-interest expense was $3.8million and $4.3 million for the quarters ended September 30, 2008 and2007, respectively, which represented a decrease of approximately $380,000 or8.9%.  Expense categories that decreasedthe most include advertising and marketing, legal and accounting, depositservicing costs and other professional costs. These decreases amounted to $295,000 and were partially offset by anincrease in salary and benefit costs of $82,000.  The efficiency ratio was 692% and 73.7% forthe quarters ended September 30, 2008 and 2007, respectively.  For a description of the methodology we usedto calculate the efficiency ratio, please see Note (a) to Table 3.

 

Salaryand employee benefit expense for the quarter ended September 30, 2008 was$2.2 million, essentially unchanged from the same quarter 2007.  The full time equivalent (FTE) staffing levelis 102 at September 30, 2008 and was 120 as of September 30, 2007, adecrease of 13%.  For the quarter ended September 30,2008, such salary costs approximated 1.58% of average earning assets, ascompared to 1.45% for the same period in 2007. With a lower volume of new loans, salary expense reductions under FASB91 have decreased from previous periods and thereby have caused increases insalary and benefit expense accordingly

 

Occupancyand equipment expense amounted to $682,000 for the quarter ended September 30,2008, a decrease of $16,000 or 11.1% from the same quarter in 2007.  The Company now has five Nevada 

 

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bankingoffices, two banking offices in California, a data operations center and oneexchange company office.  Occupancyexpenses for the quarter ended September 30, 2008 approximated 0.48% ofaverage earning assets, as compared to 0.47% for the same period in 2007.

 

Depositand loan servicing costs amounted to $346,000 for the quarter ending September 30,2008 compared to $384,000 for the same period in 2007, a decrease of $38,000 or9.9%.  Deposit and loan servicing costsrepresent 0.24% of average earning assets for the quarter ending September 30,2008 compared with 0.23% for the same period in 2007.

 

Marketingexpenses amounted to $127,000 for the quarter ended September 30, 2008, adecrease of $64,000 or 33.5% over the same period in 2007.  Marketing and advertising represented 0.09%of average earning assets for the quarter ended September 30, 2008compared with 0.13% for the same period in 2007.

 

Accountingand legal costs amounted to $101,000 for the quarter ended September 30,2008 a decrease of $104,000 or 50.7% over the same period in 2007.  Legal and accounting costs for September 30,2008 represent 0.07% of average earning assets compared with 0.14% for the sameperiod during 2007, and are primarily comprised of reductions in Sarbanes-Oxleycompliance costs, as well as other audit costs relating to internal routinesand controls reviews.

 

Otherprofessional services expense totaled $41,000 and $109,000 at September 30,2008 and 2007, respectively, a decrease of $68,000 or 62.4%.  Other professional service costs represent0.03% of average earning assets compared with 0.07% for the same period in2007.

 

Animpairment charge to goodwill amounted to $26.9 million at September 30,2008 which represented 18.9% of average earning assets.  There was no corresponding charge during2007.

 

Theremainder of expenses which were not noted separately above amounted to$343,000 and $604,000 at September 30, 2008 and 2007, respectively, a $261,000decrease or 43.2%.  For the quarter endedSeptember 30, 2008 these other expenses represented 0.24% of averageearning assets, as compared to 0.40% for the same period of 2007.

 

Table3 sets forth the various non-interest income and expense items for the periodsindicated.

 

***YTD Analysis***

 

Non-interestexpense was $13.0 million, (exclusive of goodwill impairment charges of $26.9million for the YTD period ending September 30, 2008) and $13.9 millionfor the YTD periods ended September 30, 2008 and 2007, respectively, whichrepresented a decrease of approximately $900,000 or 6.5%.  Expense categories that decreased the mostinclude occupancy, advertising and marketing, data processing, and otherprofessional costs.  These decreasesamounted to $867,000 and were partially offset by an increase in accounting andlegal costs of $204,000.  The efficiencyratio was 257% and 78.03% for the nine months ended September 30, 2008 and2007, respectively which relates primarily to the reduction in non-interestincome for the periods noted.  For adescription of the methodology we used to calculate the efficiency ratio,please see Note (a) to Table 3.

 

Salaryand employee benefit expense for the nine months ended September 30, 2008was $7.3 million, compared with $7.1 for the same period 2007.  For the nine months ended September 30,2008, such salary costs approximated 1.70% of average earning assets, ascompared to 1.62% for the same period in 2007. In addition to certain severance payments made during 2008, salary expensereductions under 

 

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FASB91 have decreased from previous periods. This change in FASB 91 salary expense reductions increased salaryexpense for the nine months ended September 30, 2008 by $354,000 whencompared to the same period in 2007. Increases in group insurance costs have also been a major part ofincreased salary and benefit costs during 2008. Included in salaries and benefits for the nine months ending September 30,2008 and 2007, there was $211,000 and $326,000 of share-based compensation,respectively.  The related tax benefit onshare-based compensation was not material to either quarter.  These costs continue to be reflected in theCompany’s Consolidated Statements of Operations although no economic benefithas been transmitted to the option holders. At the current time, the market value of the Company’s stock asreflected on NASDAQ approximates 15% of the weighted average exercise price ofthe options granted by the Company.  As aresult, there is no economic Aggregate Intrinsic Value, only a valueestablished through an accounting rule that has no current economic valueto recipients of the options granted. Total accounting costs to date, since the required adoption of FAS123(R), approximate $1.2 million,although almost no benefit has been recognized by any of the Company’s officersor directors.

 

Occupancyand equipment expense amounted to $2.0 million for the YTD period ended September 30,2008, a decrease of $226,000 or 9.1% from the same period in 2007.  Occupancy expenses for the nine months ended September 30,2008 approximated 0.47% of average earning assets, as compared to 0.50% for thesame period in 2007.  The temporarySparks branch office was closed effective March 31, 2008, and the RockyMountain Exchange office was closed during July 2008.

 

Depositand loan servicing costs amounted to $941,000 for the nine months ending September 30,2008 compared to $912,000 for the same period in 2007, an increase of $29,000or 3.2%.  Deposit and loan servicingcosts represent 0.22% of average earning assets for the YTD period ending September 30,2008 compared with 0.19% for the same period in 2007.  FDIC insurance costs have risen dramaticallyover the past year, and are expected to substantially increase as a result ofincreases in coverage recently announced, during the rest of 2008 and into2009.

 

Marketingexpenses amounted to $402,000 for the YTD period ended September 30, 2008,a decrease of $273,000 or 40.4% over the same period in 2007.  It is anticipated that such expenditures willbe at a lower level for the remainder of 2008, when compared to such costs for2007.  Marketing and advertisingrepresented 0.09% of average earning assets for the nine months ended September 30,2008 compared with 0.15% for the same period in 2007.

 

Accountingand legal costs amounted to $801,000 for the nine months ended September 30,2008 an increase of $204,000 or 34.2% over the same period in 2007.  Legal and accounting costs for September 30,2008 represent 0.19% of average earning assets compared with 0.14% for the sameperiod during 2007, and are primarily comprised of Sarbanes-Oxley compliancecosts, as well as additional auditor costs relating to internal routines andcontrols reviews.  Such costs have becomean ever larger portion of overall Company expenses, and are unlikely to abateduring the rest of 2008.

 

Otherprofessional services expense totaled $174,000 and $442,000 at September 30,2008 and 2007, respectively, a decrease of $268,000 or 60.6%.  Other professional service costs represent0.04% of average earning assets compared with 0.10% for the same period in2007.

 

Goodwillimpairment charges for the nine month period ending September 30, 2008were $26.9 million and represented 6.30% of average earning assets.  There were no corresponding charges in 2007.

 

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Theremainder of expenses which were not separately noted amounted to $1.4 millionand $2.0 million at September 30, 2008 and 2007, respectively, a $600,000decrease or 30.0%.  For the nine months endedSeptember 30, 2008 these other expenses represented 0.33% of averageearning assets, as compared to 0.45% for the same period of 2007.

 

**Provision for Income Taxes**

 

Forthe nine months ending September 30, 2008 the Company had a net benefitfor income taxes in the amount of $5.4 million and a provision of $1.2 millionfor the same period in 2007.  Thesechanges are primarily due to the impairment charges on investments andpermanent book tax differences of approximately $1.2 million in non-taxableinterest and dividend income during the first nine months of 2008.  In addition to these differences we recorded$17,000 in a tax benefit for the first nine months with the adoption of EITF06-04.

 

**Comprehensive Income/Loss**

 

Ouravailable for sale investment portfolio had net unrealized losses of $478,000at September 30, 2008 and $604,000 at December 31, 2007.  At September 30, 2008 the unrealizedloss net of deferred taxes represented 12.2% of securities available for sale,which is included in comprehensive income. Comprehensive income or loss differs from our net income during therespective periods as a result of changes in the amount of unrealized gains andlosses on our portfolio of securities available for sale.  However, the change in value of our liabilities,which tend to fall in rising interest rate environments and rise in fallinginterest rate environments, is not included in “other comprehensive income”.  We quantify, monitor, and actively manage theinterest rate risk of interest earning assets with interest bearing liabilitiesbased on budgetary assumptions, anticipated balance sheet modifications andchanges in rates earned and rates paid. The Company believes that the comprehensive loss reported under FAS 115in the financial statements is due to changes in interest rates and does notreflect an impairment in the quality of the securities contained in theinvestment portfolio, nor a permanent impairment in value.  However, as financial rates fluctuate overthe term based on expectations of future FOMC actions, and credit marketscontinue to change, it is entirely possible that the AFS investment portfolio could further depreciate in value over theremainder of the year.

 

Anothercomponent of comprehensive income is the result of the adoption of FAS 158 *“Employers Accounting for Defined Benefit Pension and OtherPostretirement Plans”* by the Company in 2006.  As part of the Company’s accounting forcertain postretirement plans, there was recognition of a prior service costwhich is amortized over an estimated eleven year life from the date of the Planin 2005.  This prior service cost net ofdeferred taxes amounted to $473,000 at September 30, 2008, compared with$522,000 at September 30, 2007.

 

**FINANCIAL CONDITION**

 

Ourconsolidated total assets were $558 million and $627 million at September 30,2008 and December 31, 2007, respectively. Total average assets were $633 million and $653 million for the ninemonths ended September 30, 2008 and 2007, respectively, a decrease of 3%.

 

**Securities and Other Earning Assets**

 

***Quarterly Analysis***

 

Thesecurities portfolio, excluding trading securities was $65.6 million at September 30,2008 and averaged $108.4 million during the third quarter of 2008 as comparedto $80.8 million and an average of $82.1 million in the third quarter of2007.  The securities portfolio consistsprimarily of Mortgage-backed securities, Municipal securities, Preferred Stockand U.S. Government agency securities. The average 

 

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yieldon investments was 4.53% for the quarter ended September 30, 2008 and4.37% for the quarter ended September 30, 2007.  Securities available for sale had a netunrealized loss of $478,000 at September 30, 2008 as compared to the netunrealized loss of $604,000 at December 31, 2007.  These unrealized gains and losses do notimpact net income or regulatory capital but are recorded as adjustments toshareholders’ equity.  Unrealized gainsand losses are a component of “Comprehensive Income”.

 

AtSeptember 30, 2008 debt securities had an aggregate depreciation of about3.37% from the Company’s amortized cost basis as compared to 1.4% at December 31,2007.  In the available for saleportfolio three securities have an unrealized loss as of September 30,2008.  In one of those securities theunrealized loss has exceeded one year. There are ninety-two securities in the held to maturity portfolio thathave an unrealized loss as of September 30, 2008.  For twenty-five of those securities, the losshas exceeded one year.  In analyzing anissuer’s financial condition, management considers whether the securities areissued by the federal government or its agencies, whether downgrades by bondrating agencies have occurred, and industry analysts’ reports.  In analyzing the market value of the pooledtrust preferred securities held by the Company and the inactive market forthese securities, management determined that an other than temporary (OTTI)impairment existed related to these securities and consequently recorded a$626,000 charge to losses on investments. In addition, given the Treasury’s action in placing Freddie Mac andFannie Mae into conservatorship, management deemed that an OTTI impairmentexisted and recorded a loss of $12.0 million on investments.  Regarding the remainder of the investmentportfolio; as management has the ability and intent to hold debt securitiesuntil maturity, or for the foreseeable future if classified as available forsale, no declines are deemed to be other than temporary, there are no declinesin value that are not related to the current interest rate environment andthere are no declines that may not be related to recent credit market turmoil.

 

Effectiveduration is a measure of duration which considers changes in cash flows and isbased on the expected price volatility of a security.  Generally the greater the duration of thesecurity, the greater will be its percentage price volatility.  The effective duration is presented in yearsand is equal to the approximate percentage change in price per 100 basis pointchange in rates.  The effective durationof the Bank’s investment securities portfolio at September 30, 2008 is3.63, as compared with 2.78 as of September 30, 2007.  The change is primarily due to the additionof state, county and municipal securities with longer maturities, and changingmoney market conditions.  At December 31,2007 the portfolio’s effective duration was 2.62.  The Company’s investment securities portfolioduration does not substantially differ from that of the Bank, sinceapproximately 97% of the Company’s securities portfolio is held in thesubsidiary bank.

 

Managementevaluates securities for other-than-temporary impairment on a quarterly basis,or more frequently when economic or market concerns warrant suchevaluation.  Consideration is given to (1) thelength of time and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value.

 

Theratio of average total investments to average total assets was 17.4%, 16.7% and16.3% at the quarter ended September 30, 2008, the year ended December 31,2007 and the quarter ended September 30, 2007, respectively.

 

TheCompany currently has $84,000 in an equity trading portfolio which is beingaccounted for as trading securities.  TheCompany adjusts the value of this portfolio monthly through the ConsolidatedStatement of Operations.  For the quarterending September 30, 2008 the Company had unrealized losses of $802,000from trading equities as compared to unrealized losses of $240,000 for the sameperiod in 2007.

 

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***YTD Analysis***

 

Thesecurities portfolio, excluding trading securities was $65.6 million at September 30,2008 and averaged $108.4 million during the first nine months of 2008 ascompared to an average of $87.6 million in the first nine months of 2007.  The average yield on investments was 5.11%for the nine months ended September 30, 2008 and 4.32% for the same periodended September 30, 2007.

 

Theratio of average total investments to average total assets was 17.1%, 16.7% and17.4% at the nine months ended September 30, 2008, the year ended December 31,2007 and the nine months ended September 30, 2007, respectively.

 

Asnoted above, the Company has $84,000 in an equity trading portfolio which isaccounted for as trading securities and for which the value is adjusted monthlythrough the Consolidated Statement of Operations.  For the YTD period ending September 30,2008 the Company had unrealized losses of $987,000 from trading equities ascompared to unrealized gains of $196,000 for the same period in 2007.

 

**Loans**

 

***Quarterly Analysis***

 

Grossloans including fair value loans amounted to $454.5 million at September 30,2008, $474.8 million at December 31, 2007, and $489.9 million at September 30,2007.  Total loans, before allowance forloan losses, averaged $457.9 million for the third quarter of 2008, a decreaseof $27.2 million or 5.6% from the average amount of such loans during the thirdquarter of 2007.  With slowing economicactivity in our local markets, loan growth has slowed as well.  Management believes it is unlikely that thiswill substantially change during the rest of 2008.

 

Asnoted in Table 4 “Composition of the Loan Portfolio”, real estate constructionloans amounted to $113.5 million and $171.3 million at September 30, 2008and September 30, 2007, respectively. These loans decreased $57.8 million or 33.7% from the amount of suchloans at September 30, 2007. Commercial construction loans decreased the most at $28.9 millionfollowed by single family construction which decreased $22.6 million.  These items taken together represents themajority of the decreases over September 30, 2007 balances.  The decreases in construction loans aresomewhat seasonal and due to the general economic decline in the local,regional and national real estate markets.

 

Theyield on average loans for the quarter ending September 30, 2008 was 6.72%as compared to 8.48% for the same period in 2007.  This one hundred and seventy-six basis pointdeterioration in yield was largely due to rate decreases as noted in Table 2,and can be somewhat characterized by the over 275 basis point drop in the primerate from September 30, 2007 to September 30, 2008.

 

Termreal estate loans amounted to $251.1 million as of September 30, 2008compared to $223.6 million for the quarter ending September 30, 2007, anincrease of $27.5 million or 12.3%. Commercial term loans increased $17.5 million or 7.7% to $243.8 millionover the first nine months of 2007 and represent the majority of the year toyear increase.

 

Commercialand industrial loans approximated $79.6 million and $84.0 million at September 30,2008 and September 30, 2007, respectively. Commercial and industrial loans decreased about $4.4 million or 5.2%over the balances at September 30, 2007.

 

Consumerloans amounted to $8.2 million and $9.0 million at September 30, 2008 and September 30,2007, respectively.  Consumer loansdecreased $800,000 or 8.9%.

 

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Theratio of average total loans to average total assets for the third quarter of2008 was 73.3% and 74.1% at September 30, 2008 and September 30,2007, respectively.   Of loan totalsoutstanding, approximately $170.6 million or 37.5% are prime rate basedloans.  The rest are tied to otherindices or are fixed rate.  TheCompany has eighteen non-accrual loans totaling $21.8 million as of September 30,2008.  The Company had ten loans onnon-accrual totaling $5.6 million as of December 31, 2007 and ten loanstotaling $5.7 million for the period ending September 30, 2007.

 

The Company has eighteen loans on non-accrual are considered impairedloans and five impaired loans which are not on non-accrual.  Of the twenty-three non-performing loans, 9were real estate construction loans which represented 39% of the total notedloans and 54% of the dollar amount, while 3 term real estate loans representedan additional 13% of the non-performing loans and 23% of the dollaramount.  Estimated collateral values forthese real estate construction and term loans as of September 30, 2008were $12.8 million and $6.5 million respectively.  At September 30, 2008 impaired loansamounted to $22.4 million of which $9.7 million had a specific relatedallowance for loan and lease losses of $1.6 million. Loans are placed on non-accrualstatus when it becomes likely that the obligor may be unable to fully repaycontracted principal and interest.  Thesecurity, or lack thereof, for any obligation of a borrower is not a factor inthe determination of the time a particular loan may be found to be impaired, orwhen a related valuation allowance may be established.    The following table outlines the Company’snonperforming assets as of September 30, 2008 and 2007.

 

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| ** **                               | ** ** | **September 30, 2008** | ** ** | **September 30, 2007** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                               | ** ** | **Balance**                      | ** ** | **Estimated  Inherent  Loss**    | ** ** | **Balance** | ** ** | **Estimated  Inherent  Loss** | ** ** |
| **Non-Performing Assets**                |       |                             |       |                             |       |   |   |   |   |
| Non-accrual impaired loans               |       |                             |       |                             |       |   |   |   |   |
| Commercial and revolving lines of credit |       | $                                | 3,990      |                             | $          | — |   | $ | 122 |   | $ | — |   |
| SBA guaranteed                           |       | 620                              |       | 40                               |       | 597 |   | — |   |
| Real Estate Construction                 |       | 12,041                           |       | 1,426                            |       | 4,935 |   | — |   |
| Real Estate Term                         |       | 5,146                            |       | —                           |       | — |   | — |   |
| Consumer                                 |       | —                           |       | —                           |       | — |   | — |   |
| Total non-accrual impaired loans         |       | 21,798                           |       | 1,466                            |       | 5,654 |   | — |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Accruing impaired loans                  |       |                             |       |                             |       |   |   |   |   |
| Commercial and revolving lines of credit |       | 180                              |       | 58                               |       | — |   | — |   |
| SBA loans                                |       | 434                              |       | 87                               |       | — |   | — |   |
| Real Estate Construction                 |       | —                           |       | —                           |       | — |   | — |   |
| Real Estate Term                         |       | —                           |       | —                           |       | — |   | — |   |
| Consumer                                 |       | —                           |       | —                           |       | — |   | — |   |
| Total accruing impaired loans            |       | 614                              |       | 145                              |       | — |   | — |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| **Total Impaired Loans**                 |       | $                                | 22,412     |                             | $          | 1,611 |   | $ | 5,654 |   | $ | — |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| OTTI Investments                         |       |                             |       |                             |       |   |   |   |   |
| Preferred Stock                          |       | 1,448                            |       | —                           |       | — |   | — |   |
| Trust Preferred Securities               |       | 599                              |       | —                           |       | — |   | — |   |
| Total Impaired investments               |       | 2,047                            |       | —                           |       | — |   | — |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| Other Real Estate Owned                  |       |                             |       |                             |       |   |   |   |   |
| OREO                                     |       | 2,910                            |       | —                           |       | — |   | — |   |
|                                     |       |                             |       |                             |       |   |   |   |   |
| **Total Non-performing assets**          |       | $                                | 27,369     |                             | $          | 1,611 |   | $ | 5,654 |   | $ | — |   |

 

***YTD Analysis***

 

Totalloans, before allowance for loan losses, averaged $462.5 million for the firstnine months of 2008, a decrease of $13.8 million or 2.9% from the averageamount of such loans during the first nine months of 2007.

 

Theyield on average loans for the nine months ending September 30, 2008 was7.09% as compared to 8.55% for the same period in 2007.  This one hundred and forty-six basis pointdeterioration in yield or 17.1% was largely due to rate decreases as noted inTable 2.

 

Theratio of average total loans to average total assets for the nine month periodwas 73.1% and 73.0% at September 30, 2008 and September 30, 2007,respectively.

 

**OREO**

 

TheCompany has three properties in other real estate owned (“OREO”) totaling $2.9million at September 30, 2008 as compared to one property at $800,000 at December 31,2007.  There was no OREO at September 30,2007.  For the nine months ending September 30,2008 a net $2.1 million was added to OREO.

 

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**Deposits**

 

Totaldeposits were $461 million and $451 million as of September 30, 2008 and December 31,2007 respectively, an increase of $10 million or 2.2%.  Core deposits (deposits excludingcertificates of deposit greater than $100,000), have decreased about $10.6million or 2.7% since December 31, 2007. The ratio of gross loans to deposits was 98.6% and 105.2% at September 30,2008 and December 31, 2007, respectively.

 

***Quarterly Analysis***

 

Non-interestbearing deposits amounted to approximately $53.1 million at September 30,2008, $65.4 million at December 31, 2007, and $56.9 million at September 30,2007, respectively.  Average non-interestbearing deposits totaled $60.2 million during the third quarter of 2008, whichrepresented 13.2% of average total deposits. This compares with $61.0 millionand 12.2%, respectively for the third quarter of 2007.  This is a decrease of $800,000 or 1.3% fornon-interest bearing deposits for the 12 month period ending September 30,2008.  Such accounts are now fullyinsured by the FDIC.

 

Interestbearing deposits amounted to approximately $408.0 million, $385.9 million and$460.0 million at September 30, 2008, December 31, 2007, and September 30,2007, respectively.  Averageinterest-bearing deposits were $395.4 million, a decrease of approximately$44.9 million during the quarter ended September 30, 2008, as compared tothe average of $440.3 million in interest-bearing deposits during the quarterended September 30, 2007.  Suchaccounts are now guaranteed to $250,000 by the FDIC.

 

Thecost of interest bearing deposits for the quarter ended September 30, 2008was 3.35% as compared to 4.51% for the same period in 2007 or a decrease of25.7%.  This one hundred and sixteenbasis point decrease in cost was the primary result of rate decreases with somevolume decreases, as noted in Table 2.

 

Includedin the deposit categories above are public deposits, which averaged $7.9million for the quarter ending September 30, 2008 and $7.7 million for thesame period of 2007.  Public depositsinclude deposits received from state and local governments, school districts,and other public entities in our market area. Many of these deposits exceed the FDIC insurance coverage amounts andrequire us to pledge specific collateral or maintain private insurance tosupport such deposit accounts.

 

***YTD Analysis***

 

Averagenon-interest bearing deposits totaled $58.4 million during the first ninemonths of 2008, which represented 13.0% of average total deposits. Thiscompares with $60.1 million and 12.1%, respectively for the first nine monthsof 2007.  This is a decrease of $1.7million or 2.8% for non-interest bearing deposits for the 12 month YTD periodending September 30, 2008.

 

Averageinterest-bearing deposits were $392.5 million, a decrease of approximately$44.5 million during the nine months ended September 30, 2008 or 10.2%, ascompared to the average of $437.0 million in interest-bearing deposits during thesame period ended September 30, 2007.

 

Thecost of interest bearing deposits for the quarter ended September 30, 2008was 3.65% as compared to 4.46% for the same period in 2007.  This eighty-one basis point decrease in costwas primarily rate decreases.

 

Includedin the deposit categories above are public deposits, which averaged $7.8million for the nine months ending September 30, 2008 and $7.7 million forthe quarter ending September 30, 2007. Public 

 

 

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depositsinclude deposits received from state and local governments, school districts,and other public entities in our market area. Many of these deposits exceed the FDIC insurance coverage amounts andrequire us to pledge specific collateral or maintain private insurance tosupport such deposit accounts.

 

Inthe current period, non-interest bearing deposits have declined.  This decline was brought about by the FDIC’stakeover of IndyMac Bank and the US Treasury Department’s guarantee ofbroker/dealer money market accounts.  Asa result, there was a “flight to safety” of customer deposits, towardsperceived “too big to fail” national competitors such as Wells Fargo and Bankof America, as well as certain investment banks.  It is only with recent FDIC actions to fullyguarantee non-interest bearing transaction accounts, and to guarantee up to$250,000 in interest bearing accounts that some faith in community banking mayhave been restored.  We are hopeful thatfurther governmental action does not place community banking in a continuallydisadvantageous position vis a vis our larger, national brethren.  In our local markets, credit unions, andlarger regional banks have been aggressively targeting customers with offers offree consumer and/or business accounts, as well as with relatively high shortterm interest rates on deposits to slow deposit outflows brought about byunfavorable media attention surrounding specific financial institution’sreported credit difficulties.  Managementbelieves it is important to monitor net interest margin and is currentlyunwilling to pay high rates to acquire interest sensitive deposits withoutappropriately higher earning asset rates and therefore, for the immediatefuture, deposit growth may likely be difficult to obtain.

 

**Other Funding Sources**

 

Weuse short-term and long-term borrowings to fund the growth of earning assets inexcess of deposit growth.  Short-termborrowings, which include federal funds purchased and overnight FHLB advances,amounted to $25.7 million at September 30, 2008 and $62.6 million at December 31,2007, respectively.  The Company hasavailable federal funds borrowing lines amounting to $17.0 million as of September 30,2008.  The Company has a Federal HomeLoan Bank (FHLB) advance line of credit in the amount of $120 million which ispredicated on the value of collateral held, and on September 30, 2008, thegross amount of all collateral was about $190 million.  At September 30, 2008 the Company had$103 million of borrowing capacity from all sources.

 

Longterm other borrowed funds includes FHLB term advances, subordinated debt,capital lease obligations and other debt with maturities greater than one year.  The Company had $7.0 million in FHLB termadvances, and $20.6 million in subordinated debt as of September 30, 2008and $8.0 million and $20.6 million, respectively as of December 31, 2007.

 

TheCompany’s 1031 qualified intermediaries during their course of business mayplace exchange liability deposits with non-affiliated financialinstitutions.  There were no suchdeposits at September 30, 2008 and $4.1 million as of December 31,2007.

 

***Off-Balance Sheet Arrangements***

*** ***

Inthe usual course of business, the Company makes commitments to extend credit aslong as there are no violations of any conditions established in theoutstanding contractual arrangement. Commitments to extend credit were $37.9 million at September 30,2008 as compared to $62.9 million at December 31, 2007.  These commitments represented 8% and 13% ofoutstanding gross loans at each of the periods noted, respectively.  The Company’s stand-by letters-of-credittotaled $2.2 million as of September 30, 2008 and $714,000 at December 31,2007.

 

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Theimportance to and effect on the Company’s revenues, expenses, cash flows,liquidity, capital resources and market risk support from the unused portion ofthe commitments to provide credit cannot be reasonably predicted because thereis no guarantee that the lines of credit will ever be used.

 

**RISK MANAGEMENT**

 

Theprimary goal of our risk management program is to determine how certainexisting or emerging issues in the financial services industry affect thenature and extent of the risks faced by the Company.  Based on a periodic self-evaluation, wedetermine key issues and develop plans and/or objectives to address risk.  Our board of directors and management believethat the nine applicable “risk categories” consist of compliance, credit,foreign exchange, interest rate, liquidity, price, strategic, reputation andtransaction risk.  Each risk category isviewed from a quantity of risk perspective (high, medium or low) coupled with aquality of risk perspective review.  Inaddition, an aggregate level of risk is assigned as a whole, and the directionof risk (stable, increasing or decreasing) is determined.  Each risk category and the overall risk levelis compared to regulatory views and internal criteria on a regular basis andthen reported to the board with an accompanying explanation as to the existenceof any differences.   The risk programincludes risk identification, measurement, control and monitoring.  However, we did not adequately anticipate the“unintended consequences” risk of bank failures or GSE takeovers in the currentenvironment, nor governmental guarantees of broker/dealer money market accountsand our customer’s “flight to safety”. We found that “reputation risk” extends beyond our own reputation to theindustry of community banks in relation to forces (governmental and otherwise)over which we have absolutely no control. As a result our risk management program will receive substantialrevision over the next six months.

 

Ourboard of directors has established the overall strategic direction of theCompany.  It approves our overall riskpolicies and oversees our overall risk management process.  The board has established an asset/liabilitymanagement committee which has been charged with overseeing certain keyinterest rate risks.  In addition, thereis a management risk committee comprised of senior officers which identify andmonitor key operational risks.

 

**Credit Risk Management**

 

Ourstrategy for credit risk management includes a loan administration emphasizingcentralized policies and uniform underwriting criteria for all loans, based oncertain categorizations.  The strategyalso includes diversification on a geographic, (to the extent possible),industry and customer level, regular credit examinations and quarterlymanagement review of large loans and loans with a deterioration of creditquality.  We maintain an internal ratingsystem that provides a mechanism to regularly monitor the credit quality of ourloan portfolio.  The rating system isintended to identify and measure the credit quality of lending relationships.  We strive to identify potential problem loansearly, place loans on non-accrual promptly and maintain adequate reservelevels.

 

Ourreal estate loan portfolio accounted for 80.4% of the total loan portfolio asof September 30, 2008 and 79.6% at December 31, 2007.  This portfolio consists primarily of loanssecured by commercial property and construction and land development loans.

 

Commercialloans accounted for 17.5% of the total loan portfolio as of September 30,2008 as compared to 18.5% at December 31, 2007.  Commercial loans are generally made to smalland medium size businesses located within our market areas.  These loans are not concentrated in anyparticular industry, but reflect the economies of our market areas.  Commercial loans consist primarily of loanssecured by various pieces of equipment or machinery and other corporate assetsincluding real property.  USDA 

 

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purchasedloans outstanding were $866,000 and $897,000 respectively, as of September 30,2008 and December 31, 2007.

 

Consumerloans accounted for 1.8% of our total loan portfolio as of September 30,2008 as compared to 1.8% at December 31, 2007.

 

**ASSET LIABILITY MANAGEMENT**

 

Thegoal of asset liability management is the prudent control of market risk,liquidity and capital.  Asset-liabilitymanagement is governed by policies reviewed and approved annually by our boardof directors and monitored periodically by a board committee.  The board delegates responsibility forasset-liability management to the Asset Liability Management Committee (“ALCO”),which sets strategic directives that guide the day-to-day asset-liabilitymanagement of our activities.  The ALCOalso reviews and approves all major interest rate risk, liquidity and capitalmanagement programs.

 

**Market Risk**

 

Marketrisk is the sensitivity of income to changes in interest rates, commodityprices and other market driven rates or prices. We have a small equity trading portfolio, and therefore we are primarilyexposed to non-trading market risk in our investment and loan portfolios.  The volatility of financial markets in therecent past has exacerbated any market risk previously noted, and it is notcertain that such volatility will be dampened as the economy continues to slow.

 

**Interest Rate Risk**

 

Interestrate risk, including mortgage prepayment risk, is one of the most significantnon-credit risks to which we are exposed. Interest rate risk is the sensitivity of income to changes in interestrates.  Changes in interest rates as wellas fluctuations in the level and duration of assets and liabilities, affect netinterest income, our primary source of revenue. This risk arises directly from our core banking activities – lending anddeposit gathering.  In addition todirectly impacting net interest income, changes in the level of interest ratescan also affect (i) the amount of loans originated and sold by us, (ii) theability of borrowers to repay adjustable or variable rate loans, (iii) theaverage maturity of loans, (iv) the rate of amortization of premiums paidon securities, (v) the fair value of our saleable assets, (vi) theamount of unrealized gains and losses on securities available for sale underthe requirements of  SFAS 115, the volumeof interest bearing non-maturity deposits and (vii) the early withdrawallikelihood of customer originated certificates of deposit.

 

Theprimary objective of interest-rate risk management is to control our exposureto interest-rate risk both within limits approved by our board and guidelinesestablished by the ALCO.  These limitsand guidelines reflect our tolerance for interest-rate risk over bothshort-term and long-term horizons.  Weattempt to control interest-rate risk by identifying, quantifying, and whereappropriate, changing our exposure.

 

Wequantify and measure interest-rate exposure using an outsourced BancWare modelto dynamically simulate net interest income under various interest ratescenarios over a 12 month period. Simulated scenarios include deliberately extreme interest rate “shocks”and more gradual interest rate “ramps”. Key assumptions in these simulation analyses relate to behavior ofinterest rates and spreads, increases or decreases of product balances and thebehavior of our deposit and loan customers. The most material assumptions relate to the prepayment of mortgageassets (including term real estate loans and mortgage-backed securities).  The risk of prepayment tends to increase wheninterest rates fall, as long as credit markets are not frozen and customershave sufficient cash to prepay outstanding obligations.  Since future 

 

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prepaymentbehavior of loan customers is uncertain, the resultant interest ratesensitivity of loan assets cannot be precisely determined.  Complicating our efforts to measure interestrate risk is the uncertainty of the maturity, repricing and/or runoff of someof our assets and liabilities.

 

Tocope with these uncertainties, we give careful attention to ourassumptions.  For example, in the case ofprepayment of real estate secured assets, the majority of assumptions arederived from vendor supported models that are periodically tested usingobserved loan prepayment behavior. Further, we rate shock our lending portfolio based on risk ratingsassigned to each loan by type, to more accurately determine likely net interestmargins for subsequent periods.  Thesemodified rate shocks are meant to provide support guidelines for subsequentloan loss reserve adequacy tests, so that we may track historical rates earnedon weighted risk factors apparent in our loan portfolio.

 

Ourpolicy on interest-rate risk simulation specifies that if interest rates wereto shift gradually up or down 100 basis points and 200 basis points, estimatednet interest income for the subsequent 12 months should change by less than 7%and 14%, respectively.

 

**LIQUIDITY**

 

Liquidityrepresents the ability to fund asset growth and accommodate deposit withdrawalsand meet other funding requirements. Liquidity risk is the danger that the Company cannot meet anticipated orunexpected funding requirements or can meet them only at excessive cost.  Liquidity is measured by the ability to raisecash when needed at a reasonable cost. Many factors affect a company’s ability to meet liquidity needs,including variations in the markets served, its asset-liability mix, itsreputation and credit standing in the market and general economic conditions.

 

Inaddition to traditional retail deposits, the Company has various otherliquidity sources, including proceeds from maturities of securities and loansand the use of borrowed funds such as FHLB advances and brokered deposits.  We continually monitor and forecast ourliquidity position.  There are severalmethods we use for this purpose, including daily review of cash and due frombalances, federal funds sold or borrowed positions, monthly review of balancesheet changes, liquidity ratios, periodic liquidity forecasts and review ofcontingent funding plans.

 

Asof September 30, 2008 the Company had about $103 million of immediatelyaccessible liquidity, defined as cash that could be raised within 1-3 daysthrough available cash, securities and borrowings.  This represented approximately 22% of totaldeposits and 65% of non-maturity deposits. We believe that the level of our liquidity is sufficient to meet currentand future funding requirements. Further, should loan growth outstrip local deposit acquisitionactivities, out-of-area deposits could be acquired from external sources.

 

**CAPITAL RESOURCES**

 

AtSeptember 30, 2008, shareholders’ equity amounted to $39.6 million orapproximately 7% of total assets. Capital guidelines issued by The Federal Deposit Insurance Corporation(FDIC) and Federal Reserve Board require us and our banking subsidiary tomaintain certain ratios, as set forth in Table 6.  As indicated in such table, the Company and Bankcurrently exceed all minimum regulatory capital requirements, and areconsidered well capitalized.

 

TheFDIC has promulgated risk-based capital guidelines for all state non-memberbanks such as the Bank.  These guidelinesestablish a risk-adjusted ratio relating capital to different categories ofassets and 

 

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off-balance-sheetexposures.  There are two categories ofcapital under the guidelines.  The firstis Tier 1 Capital which includes common stockholders’ equity and qualifyingminority interest in consolidated subsidiaries, less goodwill and certain otherdeductions, notably the unrealized net gains or losses (after tax adjustments)on available for sale investment securities carried at fair market value.  The second is Tier 2 Capital which includespreferred stock, certain types of debt equity, and the allowance for loanlosses, subject to certain limitations.

 

TheCompany uses a variety of measures to evaluate its capital adequacy, withrisk-based capital ratios calculated separately for the Company and theBank.  Management reviews these capitalmeasurements on a quarterly basis and takes appropriate action to ensure thatthey are within established internal and external guidelines.  We believe that the Company has an adequatelevel of capital in relation to its balance sheet size, business mix and levelsof risk and, as a result, we do not presently anticipate that the capitalratios will materially change from their present levels, unless the Company isa recipient of the recently enacted Treasury TARP CPP Preferred Fundingprogram.  The Company’s current capitalposition exceeds minimum thresholds established by industry regulators.  Based on current regulatory definitions, theBank and Company are well capitalized, which is the highest rating of thecategories defined under Federal Deposit Insurance Corporation Improvement Act(FDICIA) of 1991.

 

**Troubled Asset Relief Program (TARP) – Capital Purchase Program (CPP)**

 

OnOctober 14, Secretary of the Treasury Henry Paulson announced decisiveactions to protect the US economy, among which was the announcement that theTreasury would purchase equity stakes in a wide array of financialinstitutions. These Qualifying Financial Institutions (“QFI’s”), such as NevadaSecurity Bank and the Company, may participate in selling senior preferredshares to the Treasury in order to raise additional capital so that they maystrengthen their capital position and make more loans to businesses andconsumers in the markets that they serve. Nine large financial institutionshave already agreed to participate in this program and will sell seniorpreferred shares to the US government, on the same terms that have been made availableto us. We believe that this program has substantial merit and have prepared andsent the application required to participate in the sale of preferred shares tothe US Treasury. There are certain rights that are granted to the Treasury,including the issuance of warrants having a market price of 15% of the value ofthe senior preferred shares placed if accepted into the program. Such issuancemay cause the Company to request that our shareholders approve that additionalcommon stock shares be made available than those currently allowed by ourby-laws, and there are certain restrictions placed on the Company as well,including executive compensation, and the granting of dividends. We haveapplied to issue an amount from $5 to $15 million in senior preferred stock,and believe that such amount if any as may be granted through the process willsubstantially enhance our capital ratios and ability to lend additional fundsin the markets that we serve so as to facilitate an economic recovery asenvisioned by Secretary Paulson. The Treasury has said that such seniorpreferred share purchases will be funded by the end of this calendar year, andwill add to the computation of Tier 1 capital for regulatory purposes,enhancing an institution’s risk based capital ratios.

 

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**The BANK HOLDING AND SUBSIDIARIES**

**Item 3.**

**QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

Referto the discussion on “Market Risk” contained in Management’s Discussion andAnalysis section of this 10-Q.

 

**Item 4.**

**  CONTROLS AND PROCEDURES**

 

**Evaluationof Disclosure Controls and Procedures**

 

TheCompany’s Chief Executive Officer and its Chief Financial Officer, afterevaluating the effectiveness of the Company’s disclosure controls andprocedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e))as of the end of the period covered by this report have concluded that, theCompany’s disclosure controls and procedures were adequate and effective toensure that material information relating to the Company and its consolidatedsubsidiaries would be made known to them by others within those entities,particularly during the period in which this quarterly report was beingprepared.

 

Toassure that financial information is reliable and assets are safeguarded,management maintains an effective system of internal controls and procedures,important elements of which include: careful selection, training and development of operating and financialmanagers; an organization that provides appropriate division of responsibility;and communications aimed at ensuring that Company policies and procedures areunderstood throughout the organization. In establishing internal controls, management weighs the costs of suchsystems against the benefits it believes such systems will provide.

 

Itshould be noted that in designing and evaluating the disclosure controls andprocedures, management recognized that any controls and procedures, no matterhow well designed and operated, can provide only reasonable assurance ofachieving the desired control objectives, and management necessarily wasrequired to apply its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.  The Company hasdesigned its disclosure controls and procedures to reach a level of reasonableassurance of achieving desired control objectives and, based on the evaluationdescribed above, the Company’s Chief Executive Officer and Chief FinancialOfficer (Principal Accounting Officer) concluded that the Company’s disclosurecontrols and procedures were effective at reaching that level of reasonableassurance.

 

Disclosurecontrols and procedures are designed to ensure that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Securities and Exchange Commission’s rules and forms.  Disclosure controls and procedures include,without limitation, controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file under the ExchangeAct is accumulated and communicated to our management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate to allow timelydecisions regarding required disclosure.

 

TheCompany’s assessment of the effectiveness of its internal control overfinancial reporting has been completed. Such assessments have been documentedand made a part of the permanent record of Sarbanes-Oxley Act Section 404compliance.

 

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**Changesin Internal Controls**

 

Therewere no substantive changes in the Company’s internal controls or in otherfactors that could significantly affect the Company’s internal controlssubsequent to the end of the period covered by this report.  While the Company believes the present designof its disclosure controls and procedures are effective to achieve its goal,future events affecting its business may cause the Company to modify itsdisclosure controls and procedures.

 

TheCompany does not expect that its disclosure controls and procedures andinternal control over financial reporting will prevent all error andfraud.  A control procedure, no matterhow well conceived and operated, can provide only reasonable, not absolute,assurance that the objectives of the control procedure are met.  Because of the inherent limitations in allcontrol procedures, no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, within the Company havebeen detected.  These inherentlimitations include the realities that judgments in decision-making can befaulty, and that breakdowns in controls or procedures can occur because ofsimple error or mistake.  Additionally,controls can be circumvented by the individual acts of some persons, bycollusion of two or more people, or by management override of the control.  The design of any control procedure is basedin part upon certain assumptions about the likelihood of future events, andthere can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions; over time, controls becomeinadequate because of changes in conditions, or the degree of compliance withthe policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective controlprocedure, misstatements due to error or fraud may occur and not be detected.

 

**Part II – Other Information**

 

**Item 1.  Legal Proceedings**

 

Inthe normal course of business, the Company is involved in various legal proceedings.  In the opinion of management, any liabilityresulting from such proceeding would not have a material adverse effect on theCompany’s financial condition or results of operations.

 

**Item 1A.  Risk Factors**

 

This Quarterly Report on Form 10-Q includes forward-lookingstatements and information and is subject to the “safe harbor” provisions of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  These forward-lookingstatements (which involve The Bank Holdings’ (the “Company’s”) plans, beliefsand goals, refer to estimates or use similar terms) involve certain risks anduncertainties that could cause actual results to differ materially from thosein the forward-looking statements.

 

Our business exposes us to certain risks.  The factors contained below, among others,could cause our financial condition and results of operations to be materiallyand adversely affected.  If this were tohappen, the value of our common stock could decline, perhaps significantly.  The factors that could cause actual resultsto differ from forward-looking statements include, but are not limited to thefollowing, as well as those discussed elsewhere herein:

 

·                  acts or threats of terrorism or actions takenby the United States or other governments as a result of such acts or threats,including possible military action, could further adversely affect business andeconomic conditions in the United States generally and in our principalmarkets, which could 

 

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have an adverse effect on our financial performance and that of ourborrowers and on the financial markets and the price of our common stock;

 

·                  changes in the extensive laws, regulationsand policies governing financial institution holding companies and theirsubsidiaries has substantially and is like to continue to alter the currentbusiness environment and affect our operations;

 

·                  general economic or industry conditions havebeen and  could continue to be lessfavorable than expected, resulting in a deterioration in credit quality, achange in the allowance for loan losses or a reduced demand for credit orfee-based products and services;

 

·                  concentrations of real estate loans couldfurther subject us to increased risk in the event of a real estate recession ornatural disaster;

 

·                  changes in the domestic interest rateenvironment could further reduce net interest income and could increase creditlosses;

 

·                  the conditions of the securities marketscould change, which could adversely affect, among other things, the value orcredit quality of our assets, the availability and terms of funding necessaryto meet our liquidity needs and our ability to originate loans and leases;

 

·                  competitive pressures could intensify andaffect our profitability, including as a result of continued industryconsolidation, the increased availability of financial services from non—banks,technological developments such as the internet, or bank regulatory reform;

 

·                  loss of key personnel, social or demographicdisplacements;

 

·                  the potential need to adapt to industrychanges in information technology systems, on which we are highly dependent,could present operational issues or require significant capital spending;

 

·                  operational risks and interruptions includingdata processing systems failure or fraud;

 

·                  our investments in our businesses and inrelated technology could require additional incremental spending, and might notproduce expected deposit and loan growth and anticipated contributions to ourearnings;

 

·                  acquisitions may result in large one—timecharges to income, may not produce revenue enhancements or cost savings atlevels or within time frames originally anticipated and may result inunforeseen integration difficulties;

 

·                  a substantial decline in the price of ourcommon stock has subjected and could further subject the Company to reductionsin the values of acquisitions completed during prior periods;

 

·                  we may have difficulty managing our growth,which depends on monitoring and managing expanded operations, staffing, andcustomer relations;

 

·                  we operate in a competitive environmentdominated by larger financial service providers which have lower cost structuresand offer a wider panoply of services;

 

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The price of our common stock may fluctuate significantly and this maymake it difficult for you to resell common stock when you want or at prices youfind attractive. The price of our common stock on the Nasdaq Global SelectMarket constantly changes.  We expectthat the market price of our common stock will continue to fluctuate.  Our stock price may fluctuate as a result ofa variety of factors, many of which are beyond our control.  These factors include:

 

·                  developments related to the financialservices industry;

 

·                  regulatory developments;

 

·                  fluctuations in the stock price and operatingresults of our competitors;

 

·                  actions of our current stockholders,including sales of common stock by existing stockholders and our directors andexecutive officers;

 

·                  changes in financial estimates andrecommendations by financial analysts;

 

·                  dispositions, acquisitions and financings;

 

·                  developments related to investigations,proceedings or litigations that involve us; and

 

·                  actual or anticipated quarterly fluctuationsin our operating and financial results.

 

The market price of our common stock may also be affected by marketconditions affecting the stock markets in general, including price and tradingfluctuations on the Nasdaq Global Select Market.  These conditions may results in (i) volatilityin the level of, and fluctuations in, the market prices of stocks generallyand, in turn, our common stock and (ii) sale of substantial amounts of ourcommon stock in the market, in each case that could be unrelated ofdisproportionate to changes in our operating performance.

 

You should not place undue reliance on any forward-lookingstatements.  Forward-looking statementsspeak only as of the date they are made, and we undertake no obligation toupdate them in light of new information or future events except to the extentrequired by federal securities laws. Additional factors that could cause actual results to differ materiallyfrom those expressed in the forward-looking statements are discussed in the2007 Annual Report on Form 10-K of The Bank Holdings filed with theSecurities and Exchange Commission (“SEC”) and available at the SEC’s internetsite (http://www.sec.gov).

 

***Nonperforming Assets***

 

Nonperformingassets consists of nonperforming loans, (which do not include accruing loans 90days or more overdue, none for all periods under review), other real estateowned, repossessed assets and certain securities available for sale.  The Company had eighteen non-accrual loanstotaling $21.8 million at September 30, 2008, $2.0 million in other thantemporary investment impairment and $2.9 million in OREO.  The Company had ten non-accrual loanstotaling $5.6 million, no impaired investments and $800,000 in OREO in December 31,2007 compared with ten non-accrual loans totaling $5.7 million and no impairedinvestments or OREO as of September 30, 2007, respectively.

 

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

 

**·****  None**

 

**Item 3.  Defaults Upon SeniorSecurities**

 

**·****  not applicable.**

 

**Item 4.  Submission of Matters toa Vote of Security Holders**

 

**·**** None**

 

**Item 5.  Other Information**

 

**·**** None**

 

**Item 6.  Exhibits**

 

(a)           The following documents are included or incorporated by reference in thisQuarterly Report on Form 10-Q.

 
| **Exhibit Number** | ** ** | **Description**                                                                                                                                           |
|-------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|
|                    |       |                                                                                                                                                      |
| Exhibit 11         |       | Computation  of Per Share Earnings (1)                                                                                                                    |
| Exhibit No.31.1    |       | Certification  of Hal Giomi Pursuant to Rules 13a-14(a) and 15d – 14(a) under  the Securities Exchange Act of 1934, as amended (2)    |
| Exhibit No.31.2    |       | Certification  of Jack Buchold Pursuant to Rules 13a-14(a) and 15d –  14(a) under the Securities Exchange Act of 1934, as amended (2) |
| Exhibit No.32.1    |       | Certification  of Hal Giomi Pursuant to 18 U.S.C. § 1350 (2)                                                                                         |
| Exhibit No.32.2    |       | Certification  of Jack Buchold Pursuant to 18 U.S.C. § 1350 (2)                                                                                      |

 

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| (1) |   | Data  required by Statement of Financial Accounting Standards No. 128, *Earnings per Share,* is provided in Note 7 to the  condensed, consolidated financial statements in this report. |
|-----|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | Filed  herewith.                                                                                                                                                                             |

 

44

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Table of Contents

 

**FINANCIALTABLES**

 

**Table 1 - QUARTERLY Average Balances and Rates**

 

The following table sets forth, for the periods indicated, informationregarding (i) the total dollar amount of interest income and the interest-earningassets resultant average yields; (ii) the total dollar amount of interestexpense on interest-bearing liabilities and the resultant average cost; (iii) netinterest income; (iv) interest rate spread; and (v) net interestmargin.

 
| ** **                                          |   | **For the Quarter Ended September 30,** |       | **For the Quarter Ended September 30,** |       |
|-----------------------------------------------------|--------|------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|
| ** **                                          |   | **2008 (a),(b)**                                            |       | **2007 (a),(b)**                                            |       |
| ** **                                          |   | **Average**                                                      | ** ** | ** **                                                       | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** |   |
| ** **                                          |   | **Balance**                                                      | ** ** | **Interest**                                                     | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** |   |
| ** **                                          |   | **(Dollars in thousands)**                             |       |
| **Assets**                                          |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Investments:                                        |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Federal Funds Sold and Interest Bearing  Deposits   |   | $                                                                | 2,552      |                                                             | $          | 10 |   | 1.56 | % | $ | 19,699 |   | $ | 242 |   | 4.87 | % |
| Securities                                          |   | 98,158                                                           |       | 1,145                                                            |       | 4.64 | % | 82,063 |   | 890 |   | 4.30 | % |
| Equity                                              |   | 7,686                                                            |       | 82                                                               |       | 4.24 | % | 4,977 |   | 43 |   | 3.43 | % |
| Total Investments                                   |   | 108,396                                                          |       | 1,237                                                            |       | 4.53 | % | 106,739 |   | 1,175 |   | 4.37 | % |
|                                                |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Loans: (c)                                          |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Agriculture                                         |   | 1,109                                                            |       | 11                                                               |       | 3.95 | % | 5,966 |   | 112 |   | 7.45 | % |
| Commercial                                          |   | 78,895                                                           |       | 1,224                                                            |       | 6.17 | % | 76,788 |   | 1,901 |   | 9.82 | % |
| Real Estate Construction                            |   | 118,133                                                          |       | 1,793                                                            |       | 6.04 | % | 171,027 |   | 3,644 |   | 8.45 | % |
| Real Estate Term                                    |   | 250,495                                                          |       | 4,577                                                            |       | 7.27 | % | 221,973 |   | 4,674 |   | 8.35 | % |
| Consumer                                            |   | 7,662                                                            |       | 116                                                              |       | 6.02 | % | 8,857 |   | 25 |   | 1.12 | % |
| Credit Card and Overdraft Protection                |   | 335                                                              |       | 13                                                               |       | 15.44 | % | 358 |   | 12 |   | 13.30 | % |
| Other                                               |   | 1,258                                                            |       | —                                                           |       | 0.00 | % | 133 |   | — |   | 0.00 | % |
| Total Loans                                         |   | 457,887                                                          |       | 7,734                                                            |       | 6.72 | % | 485,102 |   | 10,368 |   | 8.48 | % |
| Total Earning Assets                                |   | 566,283                                                          |       | 8,971                                                            |       | 6.30 | % | 591,841 |   | 11,543 |   | 7.74 | % |
| Non-Earning Assets                                  |   | 58,552                                                           |       |                                                             |       |   |   | 62,503 |   |   |   |   |   |
| **Total Assets**                                    |   | $                                                                | 624,835    |                                                             |       |   |   |   | $ | 654,344 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**      |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Interest Bearing Deposits:                          |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| NOW                                                 |   | $                                                                | 12,385     |                                                             | $          | 18 |   | 0.58 | % | $ | 10,838 |   | $ | 24 |   | 0.88 | % |
| Savings Accounts                                    |   | 26,205                                                           |       | 101                                                              |       | 1.53 | % | 78,705 |   | 803 |   | 4.05 | % |
| Money Market                                        |   | 88,464                                                           |       | 484                                                              |       | 2.18 | % | 113,168 |   | 1,163 |   | 4.08 | % |
| IRA’s                                          |   | 4,132                                                            |       | 43                                                               |       | 4.14 | % | 4,286 |   | 53 |   | 4.91 | % |
| Certificates of Deposit<$100,000                 |   | 199,608                                                          |       | 2,123                                                            |       | 4.23 | % | 170,070 |   | 2,230 |   | 5.20 | % |
| Certificates of Deposit>$100,000                 |   | 64,562                                                           |       | 558                                                              |       | 3.44 | % | 63,183 |   | 737 |   | 4.63 | % |
| Total Interest Bearing Deposits                     |   | 395,356                                                          |       | 3,327                                                            |       | 3.35 | % | 440,250 |   | 5,010 |   | 4.51 | % |
| Borrowed Funds:                                     |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Short term debt                                     |   | 71,401                                                           |       | 423                                                              |       | 2.36 | % | 27,908 |   | 487 |   | 6.92 | % |
| Long term debt                                      |   | 27,619                                                           |       | 312                                                              |       | 4.49 | % | 28,619 |   | 426 |   | 5.91 | % |
| Total Borrowed Funds                                |   | 99,020                                                           |       | 735                                                              |       | 2.95 | % | 56,527 |   | 913 |   | 6.41 | % |
| Total Interest Bearing Liabilities                  |   | 494,376                                                          |       | 4,062                                                            |       | 3.27 | % | 496,777 |   | 5,923 |   | 4.73 | % |
| Demand Deposits                                     |   | 60,150                                                           |       |                                                             |       |   |   | 61,010 |   |   |   |   |   |
| Other Liabilities                                   |   | 6,982                                                            |       |                                                             |       |   |   | 21,603 |   |   |   |   |   |
| Shareholders’ Equity                           |   | 63,327                                                           |       |                                                             |       |   |   | 74,954 |   |   |   |   |   |
| **Total Liabilities and Shareholders’ Equity** |   | $                                                                | 624,835    |                                                             |       |   |   |   | $ | 654,344 |   |   |   |   |   |
|                                                |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| **Interest Rate Spread (d)**                        |   |                                                             |       |                                                             |       | 3.03 | % |   |   |   |   | 3.01 | % |
|                                                |   |                                                             |       |                                                             |       |   |   |   |   |   |   |   |   |
| Interest Income/Earning Assets                      |   |                                                             |       |                                                             |       | 6.30 | % |   |   |   |   | 7.74 | % |
| Interest Expense/Earning Assets                     |   |                                                             |       |                                                             |       | 2.85 | % |   |   |   |   | 3.97 | % |
| **Net Interest Income and Margin (e)**              |   |                                                             |       | $                                                                | 4,909      |   | 3.45 | % |   |   | $ | 5,620 |   | 3.77 | % |

 

----

(a)  Average balances are obtained from the best available dailyor monthly data.

(b)  Yields are not reflected on a tax equivalent basis.

(c)  Loans are gross of the allowance for possible loan losses,and net of deferred fees and related direct costs.

(d)  Represents the difference between the yield oninterest-earning assets and the cost of interest-bearing liabilities.

(e)  Net interest margin represents net interest income as apercentage of average interest-earning assets.

 

45

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Tableof Contents

 

**FINANCIAL TABLES**

** **

**Table 1a - YTD Average Balances and Rates**

 

The following table sets forth, for the periods indicated, informationregarding (i) the total dollar amount of interest income on and the interest-earningassets resultant average yields; (ii) the total dollar amount of interestexpense on interest-bearing liabilities and the resultant average cost; (iii) netinterest income; (iv) interest rate spread; and (v) net interestmargin.

 
| ** **                                          | ** ** | **For the Nine Months Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2008 (a),(b)**                                                     | ** ** | **2007 (a),(b)**                                                     | ** ** |
| ** **                                          | ** ** | **Average**                                                               | ** ** | ** **                                                                | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| ** **                                          | ** ** | **Balance**                                                               | ** ** | **Interest**                                                              | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| ** **                                          | ** ** | **(Dollars in thousands)**                                      | ** ** |
| **Assets**                                          |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Investments:                                        |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Federal Funds Sold and Interest Bearing  Deposits   |       | $                                                                         | 2,993      |                                                                      | $          | 47 |   | 2.10 | % | $ | 21,329 |   | $ | 707 |   | 4.43 | % |
| Securities                                          |       | 98,068                                                                    |       | 3,887                                                                     |       | 5.29 | % | 87,583 |   | 2,806 |   | 4.28 | % |
| Equity                                              |       | 7,314                                                                     |       | 214                                                                       |       | 3.91 | % | 4,548 |   | 150 |   | 4.41 | % |
| Total Investments                                   |       | 108,375                                                                   |       | 4,148                                                                     |       | 5.11 | % | 113,460 |   | 3,663 |   | 4.32 | % |
|                                                |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Loans: (c)                                          |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Agriculture                                         |       | 1,022                                                                     |       | 1                                                                         |       | 0.13 | % | 9,461 |   | 390 |   | 5.51 | % |
| Commercial                                          |       | 80,776                                                                    |       | 4,020                                                                     |       | 6.65 | % | 73,635 |   | 4,850 |   | 8.81 | % |
| Real Estate Construction                            |       | 132,934                                                                   |       | 6,921                                                                     |       | 6.95 | % | 168,974 |   | 11,963 |   | 9.47 | % |
| Real Estate Term                                    |       | 239,264                                                                   |       | 13,226                                                                    |       | 7.38 | % | 213,871 |   | 12,738 |   | 7.96 | % |
| Consumer                                            |       | 7,605                                                                     |       | 338                                                                       |       | 5.94 | % | 9,304 |   | 460 |   | 6.61 | % |
| Credit Card and Overdraft Protection                |       | 318                                                                       |       | 36                                                                        |       | 15.12 | % | 374 |   | 43 |   | 15.36 | % |
| Other                                               |       | 608                                                                       |       | —                                                                    |       | 0.00 | % | 655 |   | — |   | 0.00 | % |
| Total Loans                                         |       | 462,527                                                                   |       | 24,542                                                                    |       | 7.09 | % | 476,274 |   | 30,444 |   | 8.55 | % |
| Total Earning Assets                                |       | 570,902                                                                   |       | 28,690                                                                    |       | 6.71 | % | 589,734 |   | 34,107 |   | 7.74 | % |
| Non-Earning Assets                                  |       | 61,893                                                                    |       |                                                                      |       |   |   | 63,055 |   |   |   |   |   |
| **Total Assets**                                    |       | $                                                                         | 632,795    |                                                                      |       |   |   |   | $ | 652,789 |   |   |   |   |   |
| **Liabilities  and Shareholders’ Equity**      |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Interest Bearing Deposits:                          |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| NOW                                                 |       | $                                                                         | 12,317     |                                                                      | $          | 72 |   | 0.78 | % | $ | 11,343 |   | $ | 75 |   | 0.88 | % |
| Savings Accounts                                    |       | 30,635                                                                    |       | 508                                                                       |       | 2.22 | % | 74,713 |   | 2,476 |   | 4.43 | % |
| Money Market                                        |       | 93,621                                                                    |       | 1,806                                                                     |       | 2.58 | % | 109,337 |   | 3,316 |   | 4.05 | % |
| IRA’s                                          |       | 4,091                                                                     |       | 134                                                                       |       | 4.38 | % | 4,352 |   | 153 |   | 4.70 | % |
| Certificates of Deposit<$100,000                 |       | 186,416                                                                   |       | 6,301                                                                     |       | 4.51 | % | 171,952 |   | 6,354 |   | 4.94 | % |
| Certificates of Deposit>$100,000                 |       | 65,469                                                                    |       | 1,919                                                                     |       | 3.92 | % | 65,332 |   | 2,213 |   | 4.53 | % |
| Total Interest Bearing Deposits                     |       | 392,549                                                                   |       | 10,740                                                                    |       | 3.65 | % | 437,029 |   | 14,587 |   | 4.46 | % |
| Borrowed Funds:                                     |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Short term debt                                     |       | 75,122                                                                    |       | 1,467                                                                     |       | 2.61 | % | 35,665 |   | 1,629 |   | 6.11 | % |
| Long term debt                                      |       | 27,725                                                                    |       | 1,008                                                                     |       | 4.86 | % | 37,947 |   | 1,283 |   | 4.52 | % |
| Total Borrowed Funds                                |       | 102,847                                                                   |       | 2,475                                                                     |       | 3.21 | % | 73,612 |   | 2,912 |   | 5.29 | % |
| Total Interest Bearing Liabilities                  |       | 495,396                                                                   |       | 13,215                                                                    |       | 3.56 | % | 510,641 |   | 17,499 |   | 4.58 | % |
| Demand Deposits                                     |       | 58,352                                                                    |       |                                                                      |       |   |   | 60,122 |   |   |   |   |   |
| Other Liabilities                                   |       | 4,175                                                                     |       |                                                                      |       |   |   | 7,616 |   |   |   |   |   |
| Shareholders’ Equity                           |       | 74,872                                                                    |       |                                                                      |       |   |   | 74,410 |   |   |   |   |   |
| **Total Liabilities and Shareholders’ Equity** |       | $                                                                         | 632,795    |                                                                      |       |   |   |   | $ | 652,789 |   |   |   |   |   |
| ** **                                          |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| **Interest Rate Spread (d)**                        |       |                                                                      |       |                                                                      |       | 3.15 | % |   |   |   |   | 3.16 | % |
|                                                |       |                                                                      |       |                                                                      |       |   |   |   |   |   |   |   |   |
| Interest Income/Earning Assets                      |       |                                                                      |       |                                                                      |       | 6.71 | % |   |   |   |   | 7.74 | % |
| Interest Expense/Earning Assets                     |       |                                                                      |       |                                                                      |       | 3.09 | % |   |   |   |   | 3.97 | % |
| **Net Interest Income and Margin (e)**              |       |                                                                      |       | $                                                                         | 15,475     |   | 3.62 | % |   |   | $ | 16,608 |   | 3.77 | % |

 

----

(a)  Average balances are obtained from the best available dailyor monthly data.

(b)  Yields are not reflected on a tax equivalent basis.

(c)  Loans are gross of the allowance for possible loan losses,and net of deferred fees and related direct costs.

(d)  Represents the difference between the yield oninterest-earning assets and the cost of interest-bearing liabilities.

(e)  Net interest margin represents net interest income as apercentage of average interest-earning assets.

 

46

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Tableof Contents

 

**Table 2 - Changes in Net Interest Income**

 

Thefollowing table presents certain information regarding changes in our interestincome and interest expense for the periods indicated. For each category ofinterest-earning assets and interest-bearing liabilities, information isprovided with respect to changes attributable to (i) changes in volume(change in volume multiplied by prior year rate), (ii) changes in rate(change in rate multiplied by prior year volume) and (iii) changes in rate/volume(change in rate multiplied by change in volume).

 
| ** **                                           | ** ** | **For the Quarter Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2008 vs. 2007**                                      | ** ** | **2008 vs. 2007**                                               | ** ** |
| ** **                                           | ** ** | **Increase (Decrease) Due to**                    | ** ** | **Increase (Decrease) Due to**                             | ** ** |
| ** **                                           | ** ** | ** **                                                       | ** ** | ** **                                                                | ** ** | **Rate and** | ** ** | **Total** | ** ** | ** ** | ** ** | ** ** | ** ** | **Rate and** | ** ** | **Total** | ** ** |
| ** **                                           | ** ** | **Volume**                                                       | ** ** | **Rate**                                                                  | ** ** | **Volume (1)** | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Volume (1)** | ** ** | **Change** | ** ** |
| ** **                                           | ** ** | **(Dollars in thousands)**                             | ** ** | **(Dollars in thousands)**                                      | ** ** |
| **Interest  Income**                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments:                                         |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds sold and other short term  investments |       | $                                                                | (210       | )                                                                         | $          | (164 | ) | $ | 142 |   | $ | (232 | ) | $ | (608 | ) | $ | (372 | ) | $ | 320 |   | $ | (660 | ) |
| Securities                                           |       | 174                                                              |       | 70                                                                        |       | 11 |   | 255 |   | 336 |   | 662 |   | 83 |   | 1,081 |   |
| Equity                                               |       | 23                                                               |       | 10                                                                        |       | 6 |   | 39 |   | 91 |   | (17 | ) | (10 | ) | 64 |   |
| Total Investment Income                              |       | (13                                                              | )          | (84                                                                       | )          | 159 |   | 62 |   | (181 | ) | 273 |   | 393 |   | 485 |   |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans:                                               |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Agriculture                                          |       | (91                                                              | )          | (52                                                                       | )          | 42 |   | (101 | ) | (348 | ) | (381 | ) | 340 |   | (389 | ) |
| Commerical                                           |       | 52                                                               |       | (705                                                                      | )          | (24 | ) | (677 | ) | 471 |   | (1,191 | ) | (110 | ) | (830 | ) |
| Real Estate Construction                             |       | (1,123                                                           | )          | (1,036                                                                    | )          | 308 |   | (1,851 | ) | (2,555 | ) | (3,188 | ) | 701 |   | (5,042 | ) |
| Real Estate Term                                     |       | 599                                                              |       | (603                                                                      | )          | (93 | ) | (97 | ) | 1,513 |   | (929 | ) | (96 | ) | 488 |   |
| Consumer                                             |       | (3                                                               | )          | 109                                                                       |       | (15 | ) | 91 |   | (84 | ) | (47 | ) | 9 |   | (122 | ) |
| Credit Card and Overdraft Protection                 |       | (1                                                               | )          | 2                                                                         |       | — |   | 1 |   | (6 | ) | (1 | ) | — |   | (7 | ) |
| Other                                                |       | —                                                           |       | —                                                                    |       | — |   | — |   | — |   | — |   | — |   | — |   |
| Total Loan Income                                    |       | (567                                                             | )          | (2,285                                                                    | )          | 218 |   | (2,634 | ) | (1,009 | ) | (5,737 | ) | 844 |   | (5,902 | ) |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total Interest Income**                            |       | (580                                                             | )          | (2,369                                                                    | )          | 377 |   | (2,572 | ) | (1,190 | ) | (5,464 | ) | 1,237 |   | (5,417 | ) |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest  Expense**                                |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Bearing Deposits:                           |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Now Accounts                                         |       | 3                                                                |       | (8                                                                        | )          | (1 | ) | (6 | ) | 6 |   | (8 | ) | (1 | ) | (3 | ) |
| Savings                                              |       | (534                                                             | )          | (499                                                                      | )          | 331 |   | (702 | ) | (1,462 | ) | (1,236 | ) | 730 |   | (1,968 | ) |
| Money market                                         |       | (253                                                             | )          | (540                                                                      | )          | 114 |   | (679 | ) | (477 | ) | (1,203 | ) | 170 |   | (1,510 | ) |
| IRA’s                                           |       | (2                                                               | )          | (8                                                                        | )          | — |   | (10 | ) | (9 | ) | (10 | ) | — |   | (19 | ) |
| Certificates of deposit<$100,000                  |       | 386                                                              |       | (415                                                                      | )          | (78 | ) | (107 | ) | 535 |   | (554 | ) | (34 | ) | (53 | ) |
| Certificates of deposit>$100,000                  |       | 16                                                               |       | (189                                                                      | )          | (6 | ) | (179 | ) | 5 |   | (298 | ) | (1 | ) | (294 | ) |
| Total interest-bearing deposits                      |       | (384                                                             | )          | (1,659                                                                    | )          | 360 |   | (1,683 | ) | (1,402 | ) | (3,309 | ) | 864 |   | (3,847 | ) |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Borrowed Funds                                       |       | 685                                                              |       | (492                                                                      | )          | (371 | ) | (178 | ) | 1,158 |   | (1,146 | ) | (449 | ) | (437 | ) |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Total interest expense**                           |       | 301                                                              |       | (2,151                                                                    | )          | (11 | ) | (1,861 | ) | (244 | ) | (4,455 | ) | 415 |   | (4,284 | ) |
|                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Net Interest Income**                              |       | $                                                                | (881       | )                                                                         | $          | (218 | ) | $ | 388 |   | $ | (711 | ) | $ | (946 | ) | $ | (1,009 | ) | $ | 822 |   | $ | (1,133 | ) |

 

----

(1) Includes changes in interest income and expense not due solelyto volume or rate changes.

 

47

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Tableof Contents

 

**Table 3 - Non-Interest Income and Non-Interest Expense**

 

The following table sets forth the variouscomponents of the Company’s non-interest income and expense for the periods indicated.

 
| ** **                                                                 | ** ** | **For the Quarter Ended September 30,** | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2008**                                                         | ** ** | **% of Total**                                                  | ** ** | **2007** | ** ** | **% of Total** | ** ** | **2008** | ** ** | **% of Total** | ** ** | **2007** | ** ** | **% of Total** | ** ** |
| ** **                                                                 | ** ** | **(Dollars in thousands)**                             | ** ** | ** **                                                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Other Operating Income**                                                 |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Service charges on deposit accounts                                        |       | $                                                                | 178        |                                                                      | -1.26      | % | $ | 155 |   | 95.09 | % | $ | 459 |   | -3.28 | % | $ | 315 |   | 26.47 | % |
| Other service charges, commissions and fees                                |       | 14                                                               |       | -0.10                                                                     | %          | 20 |   | 12.27 | % | 35 |   | -0.25 | % | 45 |   | 3.78 | % |
| Loan Charges and Fees                                                      |       | 47                                                               |       | -0.33                                                                     | %          | 79 |   | 48.47 | % | 179 |   | -1.28 | % | 261 |   | 21.93 | % |
| Income on bank owned life insurance                                        |       | 91                                                               |       | -0.65                                                                     | %          | 93 |   | 57.06 | % | 276 |   | -1.97 | % | 303 |   | 25.46 | % |
| Exchange fee income                                                        |       | 15                                                               |       | -0.11                                                                     | %          | 45 |   | 27.61 | % | 73 |   | -0.52 | % | 124 |   | 10.42 | % |
| Unrealized gains (loss) on trading  securities                             |       | (802                                                             | )          | 5.69                                                                      | %          | (240 | ) | -147.24 | % | (987 | ) | 7.04 | % | 196 |   | 16.47 | % |
| Unrealized (loss) on fair value loans                                      |       | —                                                           |       | 0.00                                                                      | %          | 9 |   | 5.52 | % | 1 |   | -0.01 | % | (76 | ) | -6.39 | % |
| (Loss)/gain on sale of fixed assets                                        |       | (14                                                              | )          | 0.10                                                                      | %          | — |   | 0.00 | % | (55 | ) | 0.39 | % | 11 |   | 0.92 | % |
| Gain on the sale of loans                                                  |       | —                                                           |       | 0.00                                                                      | %          | 5 |   | 3.07 | % | — |   | 0.00 | % | 5 |   | 0.42 | % |
| (Loss) gain on sale of investments                                         |       | (13,613                                                          | )          | 96.66                                                                     | %          | (3 | ) | -1.84 | % | (13,996 | ) | 99.86 | % | 6 |   | 0.50 | % |
| Total non-interest income                                                  |       | (14,084                                                          | )          | 100.00                                                                    | %          | 163 |   | 100.00 | % | (14,015 | ) | 100.00 | % | 1,190 |   | 100.00 | % |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As a percentage of average earning assets                                  |       |                                                             |       | -10.09                                                                    | %          |   |   | 0.11 | % |   |   | -4.95 | % |   |   | 0.41 | % |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Other Operating Expense:**                                               |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Salaries and employee benefits                                             |       | 2,243                                                            |       | 7.28                                                                      | %          | 2,161 |   | 50.69 | % | 7,272 |   | 18.22 | % | 7,139 |   | 51.45 | % |
| Occupancy costs                                                            |       | 682                                                              |       | 2.21                                                                      | %          | 698 |   | 16.37 | % | 1,988 |   | 4.98 | % | 2,214 |   | 15.96 | % |
| Advertising and marketing costs                                            |       | 127                                                              |       | 0.41                                                                      | %          | 191 |   | 4.48 | % | 402 |   | 1.01 | % | 675 |   | 4.86 | % |
| Data processing costs                                                      |       | 131                                                              |       | 0.43                                                                      | %          | 178 |   | 4.18 | % | 390 |   | 0.98 | % | 490 |   | 3.53 | % |
| Deposit services costs                                                     |       | 287                                                              |       | 0.93                                                                      | %          | 346 |   | 8.12 | % | 849 |   | 2.13 | % | 912 |   | 6.57 | % |
| Loan servicing costs                                                       |       | 62                                                               |       | 0.20                                                                      | %          | 5 |   | 0.12 | % | 135 |   | 0.34 | % | 26 |   | 0.19 | % |
| Recovery of undisbursed loan commitments                                   |       | (2                                                               | )          | -0.01                                                                     | %          | (56 | ) | -1.31 | % | (42 | ) | -0.11 | % | (115 | ) | -0.83 | % |
| Telephone and data communication costs                                     |       | 79                                                               |       | 0.26                                                                      | %          | 79 |   | 1.85 | % | 279 |   | 0.70 | % | 326 |   | 2.35 | % |
| Postage                                                                    |       | 26                                                               |       | 0.08                                                                      | %          | 46 |   | 1.08 | % | 83 |   | 0.21 | % | 102 |   | 0.74 | % |
| Legal and accounting costs                                                 |       | 101                                                              |       | 0.33                                                                      | %          | 205 |   | 4.81 | % | 801 |   | 2.01 | % | 597 |   | 4.30 | % |
| Other professional services                                                |       | 41                                                               |       | 0.13                                                                      | %          | 109 |   | 2.56 | % | 174 |   | 0.44 | % | 442 |   | 3.19 | % |
| Directors fees                                                             |       | 59                                                               |       | 0.19                                                                      | %          | 66 |   | 1.55 | % | 219 |   | 0.55 | % | 214 |   | 1.54 | % |
| Travel and education costs                                                 |       | 38                                                               |       | 0.12                                                                      | %          | 74 |   | 1.74 | % | 150 |   | 0.38 | % | 242 |   | 1.74 | % |
| Stationery and supplies                                                    |       | 45                                                               |       | 0.15                                                                      | %          | 48 |   | 1.13 | % | 126 |   | 0.32 | % | 193 |   | 1.39 | % |
| Goodwill Impairment                                                        |       | 26,911                                                           |       | 87.39                                                                     | %          | — |   | 0.00 | % | 26,911 |   | 67.42 | % | — |   | 0.00 | % |
| Other                                                                      |       | (36                                                              | )          | -0.12                                                                     | %          | 113 |   | 2.65 | % | 178 |   | 0.45 | % | 418 |   | 3.01 | % |
| Total non-interest expense                                                 |       | $                                                                | 30,794     |                                                                      | 100.00     | % | $ | 4,263 |   | 100.00 | % | $ | 39,915 |   | 100.00 | % | $ | 13,875 |   | 100.00 | % |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| As a percentage of average earning assets                                  |       |                                                             |       | 21.63                                                                     | %          |   |   | 2.86 | % |   |   | 9.34 | % |   |   | 3.15 | % |
| Net non-interest income/expense as a  percentage of average earning assets |       |                                                             |       | 31.53                                                                     | %          |   |   | 2.75 | % |   |   | 12.62 | % |   |   | 2.88 | % |
|                                                                       |       |                                                             |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Efficiency ratio (a)                                                       |       |                                                             |       | 691.69                                                                    | %          |   |   | 73.68 | % |   |   | 257.33 | % |   |   | 78.03 | % |

 

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(a)  Represents non-interest expense as a percentage of netinterest income and non-interest income excluding realized securities gains andlosses.

 

48

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**Table 4 - Composition of Loan Portfolio**

 

The following table sets forth the composition of our loan portfolio atthe dates indicated.

 
| ** **                            | ** ** | **As of**                       | ** ** | **As of**         | ** ** | **As of**        | ** ** |
|---------------------------------------|------------|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                            | ** ** | **September 30,**               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
| ** **                            | ** ** | **2008 (1)**                    | ** ** | **2007 (1)**      | ** ** | **2007 (1)**     | ** ** |
| ** **                            | ** ** | ** **                           | ** ** | **% of**          | ** ** | ** **            | ** ** | **% of** | ** ** | ** ** | ** ** | **% of** | ** ** |
| ** **                            | ** ** | **Amount**                           | ** ** | **Loans**              | ** ** | **Amount**            | ** ** | **Loans** | ** ** | **Amount** | ** ** | **Loans** | ** ** |
| ** **                            | ** ** | **(Dollars in thousands)** | ** ** |
| USDA Agriculture Loans                |       | $                                    | 1,103      |                   | 0.24       | %                     | $          | 905 |   | 0.19 | % | $ | 897 |   | 0.19 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Commercial and Industrial             |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Revolving Lines of Credit             |       | 46,287                               |       | 10.21                  | %          | 49,971                |       | 10.22 | % | 48,283 |   | 10.20 | % |
| Other Collateral                      |       | 34,207                               |       | 7.54                   | %          | 33,160                |       | 6.78 | % | 35,624 |   | 7.52 | % |
| Unsecured                             |       | 6,561                                |       | 1.45                   | %          | 10,047                |       | 2.06 | % | 13,059 |   | 2.76 | % |
| Participations                        |       | (7,500                               | )          | -1.65                  | %          | (9,200                | )          | -1.88 | % | (9,500 | ) | -2.01 | % |
| Total Commerical and Industrial Loans |       | 79,555                               |       | 17.54                  | %          | 83,978                |       | 17.18 | % | 87,466 |   | 18.47 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Real Estate Construction:             |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Acquisition and Land                  |       | 62,005                               |       | 13.67                  | %          | 63,177                |       | 12.93 | % | 63,252 |   | 13.36 | % |
| Single Family Residences              |       | 14,926                               |       | 3.29                   | %          | 37,459                |       | 7.66 | % | 26,866 |   | 5.67 | % |
| Multi-family                          |       | 2,603                                |       | 0.57                   | %          | 6,625                 |       | 1.36 | % | 4,599 |   | 0.97 | % |
| Commerical                            |       | 38,591                               |       | 8.51                   | %          | 67,512                |       | 13.81 | % | 52,094 |   | 11.00 | % |
| Government Guaranteed                 |       | 4,325                                |       | 0.95                   | %          | 8,206                 |       | 1.68 | % | 6,017 |   | 1.27 | % |
| Participations                        |       | (8,950                               | )          | -1.97                  | %          | (11,654               | )          | -2.38 | % | (7,371 | ) | -1.56 | % |
| Total Real Estate Construction        |       | 113,500                              |       | 25.04                  | %          | 171,325               |       | 35.06 | % | 145,457 |   | 30.73 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Real Estate Term:                     |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Single Family Residences              |       | 4,676                                |       | 1.03                   | %          | 1,714                 |       | 0.35 | % | 3,503 |   | 0.74 | % |
| Multi-family                          |       | 13,199                               |       | 2.91                   | %          | 6,967                 |       | 1.43 | % | 6,935 |   | 1.46 | % |
| Commerical                            |       | 243,763                              |       | 53.75                  | %          | 226,253               |       | 46.29 | % | 232,024 |   | 49.00 | % |
| Government Guaranteed                 |       | 2,226                                |       | 0.49                   | %          | 652                   |       | 0.13 | % | 1,863 |   | 0.39 | % |
| Participations                        |       | (12,746                              | )          | -2.81                  | %          | (11,986               | )          | -2.45 | % | (12,917 | ) | -2.73 | % |
| Total Real Estate Term                |       | 251,118                              |       | 55.37                  | %          | 223,600               |       | 45.75 | % | 231,408 |   | 48.87 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Total Real Estate Loans               |       | 364,618                              |       | 80.40                  | %          | 394,925               |       | 80.80 | % | 376,865 |   | 79.59 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Consumer Loans:                       |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Consumer                              |       | 1,761                                |       | 0.39                   | %          | 2,483                 |       | 0.51 | % | 2,273 |   | 0.48 | % |
| Home Equity Lines of Credit           |       | 6,125                                |       | 1.35                   | %          | 6,146                 |       | 1.26 | % | 5,710 |   | 1.21 | % |
| Credit Cards and Overdraft Protection |       | 333                                  |       | 0.07                   | %          | 337                   |       | 0.07 | % | 259 |   | 0.05 | % |
| Other                                 |       | 8                                    |       | 0.00                   | %          | 20                    |       | 0.00 | % | 44 |   | 0.01 | % |
| Total Consumer Loans                  |       | 8,227                                |       | 1.81                   | %          | 8,986                 |       | 1.84 | % | 8,286 |   | 1.75 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Total Loans, before allowance         |       | 453,503                              |       | 100.00                 | %          | 488,794               |       | 100.00 | % | 473,514 |   | 100.00 | % |
|                                  |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Less:                                 |       |                                 |       |                   |       |                  |       |   |   |   |   |   |   |
| Allowance for Loan Losses             |       | 7,198                                |       | 1.59                   | %          | 5,480                 |       | 1.12 | % | 7,276 |   | 1.54 | % |
| Net Loans                             |       | $                                    | 446,305    |                   |       |                  | $          | 483,314 |   |   |   | $ | 466,238 |   |   |   |

 

----

(1) Deferred fees and costs have beendeducted from loan totals.

 

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**Table 5 - Table of Activity in the Allowancefor Loan Losses**

 

The following table sets forth information concerning the activity inour allowance for loan losses during the periods indicated.

 
| ** **                                   | ** ** | **For the Quarters Ended** | ** ** | **For the Nine Months Ended** | ** ** |
|----------------------------------------------|------------|-------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                   | ** ** | **September 30,**                    | ** ** | **September 30,**                            | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2008**                                  | ** ** | **2007**                                          | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                   | ** ** | **(Dollars in thousands)**      | ** ** | **(Dollars in thousands)**              | ** ** |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| **Allowance at the beginning of the period** |       | $                                         | 7,241      |                                              | $          | 5,584 |   | $ | 7,276 |   | $ | 5,430 |   |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| **Charge-offs:**                             |       |                                      |       |                                              |       |   |   |   |   |
| Agricultural                                 |       | —                                    |       | —                                            |       | — |   | — |   |
| Commercial & industrial loans       |       | —                                    |       | 150                                               |       | 98 |   | 428 |   |
| Real estate construction                     |       | 195                                       |       | 300                                               |       | 1,440 |   | 300 |   |
| Real estate term                             |       | —                                    |       | —                                            |       | — |   | — |   |
| Consumer loans                               |       | —                                    |       | —                                            |       | 2 |   | 7 |   |
| Total Loans Charged-Off                      |       | 195                                       |       | 450                                               |       | 1,540 |   | 735 |   |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| **Recoveries:**                              |       |                                      |       |                                              |       |   |   |   |   |
| Agricultural                                 |       | —                                    |       | —                                            |       | — |   | — |   |
| Commercial & industrial loans       |       | 2                                         |       | —                                            |       | 5 |   | 25 |   |
| Real estate construction                     |       | —                                    |       | —                                            |       | — |   | — |   |
| Real estate term                             |       | —                                    |       | —                                            |       | — |   | — |   |
| Consumer loans                               |       | —                                    |       | —                                            |       | 17 |   | — |   |
| Total Loans Recovered                        |       | 2                                         |       | —                                            |       | 22 |   | 25 |   |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| Net loan charge offs                         |       | (193                                      | )          | (450                                              | )          | (1,518 | ) | (710 | ) |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| Provision charged to expense                 |       | 150                                       |       | 346                                               |       | 1,440 |   | 760 |   |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| Balance                                      |       | $                                         | 7,198      |                                              | $          | 5,480 |   | $ | 7,198 |   | $ | 5,480 |   |
|                                         |       |                                      |       |                                              |       |   |   |   |   |
| Average loans outstanding during period *    |       | $                                         | 457,887    |                                              | $          | 485,102 |   | $ | 462,527 |   | $ | 476,274 |   |
| Total loans outstanding at end of period *   |       | $                                         | 453,503    |                                              | $          | 488,794 |   | $ | 453,503 |   | $ | 488,794 |   |

 

----

* Deferred fees and costs have been deductedfrom loan totals

 
| **RATIOS**                                                          |   |   |   |   |   |   |   |   |   |
|---------------------------------------------------------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|
| Net Charge-offs to Average Loans  (annualized)                      |   |   | 0.17   | %      |   | 0.37   | %      |   | 0.66   | % |   | 0.30 | % |
| Allowance for Loan Losses to Gross Loans at  End of Period          |   | 1.59   | %      | 1.12   | %      | 1.59   | %      | 1.12   | %      |
| Net Loan Charge-offs to Allowance for Loan  Losses at End of Period |   | 2.68   | %      | 8.21   | %      | 21.09  | %      | 12.96  | %      |
| Net Loan Charge-offs to Provision for Loan  Losses                  |   | 128.67 | %      | 130.06 | %      | 105.42 | %      | 93.42  | %      |
|                                                                     |        |        |        |        |        |        |        |        |        |  |  |  |  |

 

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**Table 6 - Capital Adequacy - Risk-based Ratios**

 
| ** **                             | ** ** | ** ** | ** ** | ** **      | ** ** | ** **                 | ** ** | ** **                            | ** ** | **Minimum to** | ** ** |
|----------------------------------------|------------|------------|------------|-----------------|------------|----------------------------|------------|---------------------------------------|------------|---------------------|------------|
| ** **                             | ** ** | ** ** | ** ** | ** **      | ** ** | **Minimum**                | ** ** | **be Well Capitalized**     | ** ** |
| ** **                             | ** ** | ** ** | ** ** | ** **      | ** ** | **Capital**                | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                             | ** ** | **Actual** | ** ** | **Requirement** | ** ** | **Action Provisions** | ** ** |
| **(Dollars in thousands)**   | ** ** | **Amount** | ** ** | **Ratio**       | ** ** | **Amount**                 | ** ** | **Ratio**                             | ** ** | **Amount**          | ** ** | **Ratio** | ** ** |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| **September 30, 2008**            |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Total Capital to Risk Weighted Assets  |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 59,044     |            | 12.03      | %                          | $          | 39,263                                |       | 8.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 51,775     |            | 10.59      | %                          | $          | 39,105                                |       | 8.00                | %          | $ | 48,881 |   | 10.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Risk Weighted Assets |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 42,856     |            | 8.73       | %                          | $          | 19,632                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 45,650     |            | 9.34       | %                          | $          | 19,552                                |       | 4.00                | %          | $ | 29,329 |   | 6.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Average Assets       |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 42,856     |            | 6.94       | %                          | $          | 24,697                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 45,650     |            | 7.59       | %                          | $          | 24,053                                |       | 4.00                | %          | $ | 24,441 |   | 5.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| **June 30, 2008**                 |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Total Capital to Risk Weighted Assets  |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 70,219     |            | 13.04      | %                          | $          | 43,090                                |       | 8.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 59,177     |            | 11.41      | %                          | $          | 41,488                                |       | 8.00                | %          | $ | 51,860 |   | 10.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Risk Weighted Assets |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 63,717     |            | 11.83      | %                          | $          | 21,545                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 52,675     |            | 10.16      | %                          | $          | 20,744                                |       | 4.00                | %          | $ | 31,116 |   | 6.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Average Assets       |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 63,717     |            | 10.38      | %                          | $          | 25,766                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 52,675     |            | 8.76       | %                          | $          | 24,889                                |       | 4.00                | %          | $ | 31,112 |   | 5.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| **March 31, 2008**                |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Total Capital to Risk Weighted Assets  |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 67,578     |            | 12.96      | %                          | $          | 41,702                                |       | 8.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 58,350     |            | 11.44      | %                          | $          | 40,791                                |       | 8.00                | %          | $ | 50,990 |   | 10.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Risk Weighted Assets |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 61,051     |            | 11.71      | %                          | $          | 20,851                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 51,974     |            | 10.19      | %                          | $          | 20,396                                |       | 4.00                | %          | $ | 30,593 |   | 6.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Average Assets       |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 61,051     |            | 10.28      | %                          | $          | 23,759                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 51,974     |            | 8.90       | %                          | $          | 23,357                                |       | 4.00                | %          | $ | 29,196 |   | 5.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| **December 31, 2007**             |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Total Capital to Risk Weighted Assets  |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 69,453     |            | 12.77      | %                          | $          | 43,496                                |       | 8.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 57,071     |            | 10.97      | %                          | $          | 41,632                                |       | 8.00                | %          | $ | 52,040 |   | 10.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Risk Weighted Assets |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 62,936     |            | 11.58      | %                          | $          | 32,622                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 50,554     |            | 9.71       | %                          | $          | 20,816                                |       | 4.00                | %          | $ | 31,224 |   | 6.00 | % |
|                                   |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| Tier 1 Capital to Average Assets       |       |       |       |            |       |                       |       |                                  |       |                |       |   |   |
| The Bank Holdings                      |       | $          | 62,936     |            | 10.39      | %                          | $          | 24,219                                |       | 4.00                | %          | NA |   | NA |   |
| Nevada Security Bank                   |       | $          | 50,554     |            | 8.60       | %                          | $          | 23,513                                |       | 4.00                | %          | $ | 29,392 |   | 5.00 | % |

 

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**Table 7 -QUARTERLY DATA (UNAUDITED)**

 
|   |   | **2008**    | ** ** | **2007**    | ** ** | **2006**    | ** ** | **2005**    | ** ** |
|--------|--------|-------------|------------|-------------|------------|-------------|------------|-------------|------------|
|   |   | **Third**   | ** ** | **Second**  | ** ** | **First**   | ** ** | **Fourth**  | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** | **Fourth** | ** ** | **Third** | ** ** | **Second** | ** ** | **First** | ** ** | **Fourth** | ** ** | **Third** | ** ** | **Second** | ** ** | **First** |   |
|   |   | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** |   |
|   |   |        |       |        |       |        |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income                                        |   | 8971    |   | $      | 9,411  |   | $      | 10,308 |   | $      | 11,076 |   | $      | 11,543 |   | $      | 11,222 |   | $      | 11,342 |   | $      | 10,203 |   | $      | 7,736  |   | $      | 6,916  |   | $      | 6,184 |   | $ | 5,293 |   | $ | 4,643 |   | $ | 3,864 |   | $ | 3,366 |   |
|--------------------------------------------------------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|-------|--------|---|-------|--------|---|-------|--------|---|-------|--------|---|-------|--------|
| Interest Expense                                       |   | 4,062   |   | 4,170  |   | 4,983  |   | 5,465  |   | 5,923  |   | 5,584  |   | 5,992  |   | 4,887  |   | 3,855  |   | 3,274  |   | 3,067  |   | 2,631  |   | 1,964  |   | 1,533  |   | 1,216  |   |
| Net interest income                                    |   | 4,909   |   | 5,241  |   | 5,325  |   | 5,611  |   | 5,620  |   | 5,638  |   | 5,350  |   | 5,316  |   | 3,881  |   | 3,642  |   | 3,117  |   | 2,662  |   | 2,679  |   | 2,331  |   | 2,150  |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision for Loan Losses                              |   | 150     |   | 1,140  |   | 150    |   | 2,247  |   | 346    |   | 234    |   | 180    |   | 175    |   | 247    |   | (124   | )      | 473    |   | 377    |   | 292    |   | 186    |   | 214    |   |
| Net interest income after Provision for  Loan Losses   |   | 4,759   |   | 4,101  |   | 5,175  |   | 3,364  |   | 5,274  |   | 5,404  |   | 5,170  |   | 5,141  |   | 3,634  |   | 3,766  |   | 2,644  |   | 2,285  |   | 2,387  |   | 2,145  |   | 1,936  |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Non-interest income                                    |   | (14,084 | )      | 151    |   | (82    | )      | 232    |   | 163    |   | 605    |   | 422    |   | 677    |   | 535    |   | 249    |   | 221    |   | 153    |   | 376    |   | 97     |   | 146    |   |
| Non-interest expenses                                  |   | 30,794  |   | 4,535  |   | 4,586  |   | 4,432  |   | 4,263  |   | 4,679  |   | 4,933  |   | 4,102  |   | 3,250  |   | 3,348  |   | 2,882  |   | 2,569  |   | 2,382  |   | 1,967  |   | 1,905  |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income (Loss) before taxes                             |   | (40,119 | )      | (283   | )      | 507    |   | (836   | )      | 1,174  |   | 1,330  |   | 659    |   | 1,716  |   | 919    |   | 667    |   | (17    | )      | (131   | )      | 381    |   | 275    |   | 177    |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income/(losses) attributable to Minority  Shareholders |   |    |   | — |   | — |   | 1      |   | 11     |   | (15    | )      | (24    | )      | 159    |   | 3      |   | (35    | )      | — |   | — |   | — |   | — |   | — |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision (Benefit) for taxes                          |   | (5,073  | )      | (308   | )      | (2     | )      | (555   | )      | 413    |   | 541    |   | 226    |   | 653    |   | 382    |   | 33     |   | 7      |   | (710   | )      | — |   | — |   | — |   |
|                                                   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net Income (Loss)                                                                            |   | $      | (35,046 | )      | $      | 25     |   | $      | 509    |   | $      | (282   | )      | $      | 750    |   | $      | 804    |   | $      | 457    |   | $      | 904    |   | $      | 534    |   | $      | 669    |   | $ | (24   | )      | $ | 579  |   | $ | 381  |   | $ | 275  |   | $ | 177  |   |
|----------------------------------------------------------------------------------------------|--------|--------|---------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|-------|--------|---|------|--------|---|------|--------|---|------|--------|---|------|--------|
|                                                                                         |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other Comprehensive income (loss),  unrealized gains/losses on securities available-for-sale |   | 791    |    | (510   | )      | (155   | )      | (179   | )      | (122   | )      | (154   | )      | 38     |   | (451   | )      | 186    |   | (83    | )      | 193    |   | (144   | )      | (88    | )      | 266    |   | (225   | )      |
|                                                                                         |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Comprehensive Income (Loss)                                                                  |   | $      | (34,255 | )      | $      | (485   | )      | $      | 354    |   | $      | (461   | )      | $      | 628    |   | $      | 650    |   | $      | 495    |   | $      | 453    |   | $      | 720    |   | $      | 586    |   | $ | 169   |   | $ | 435  |   | $ | 293  |   | $ | 541  |   | $ | (48  | )      |
|                                                                                         |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings (loss) per common share:                                                            |   |   |    |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                        |   | $      | (6.01   | )      | $      | 0.00   |   | $      | 0.09   |   | $      | (0.05  | )      | $      | 0.13   |   | $      | 0.13   |   | $      | 0.08   |   | $      | 0.18   |   | $      | 0.14   |   | $      | 0.20   |   | $ | (0.01 | )      | $ | 0.18 |   | $ | 0.12 |   | $ | 0.09 |   | $ | 0.06 |   |
| Diluted                                                                                      |   | $      | (6.01   | )      | $      | 0.00   |   | $      | 0.09   |   | $      | (0.05  | )      | $      | 0.13   |   | $      | 0.13   |   | $      | 0.08   |   | $      | 0.17   |   | $      | 0.13   |   | $      | 0.19   |   | $ | (0.01 | )      | $ | 0.15 |   | $ | 0.11 |   | $ | 0.09 |   | $ | 0.06 |   |

 

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**Table 8 - Operating Segment Information**

 

Segment information is divided into the Parent, Bank and non-banksegments.

Non-bank segments includes the Company’s 1031 qualified intermediarycompanies.

 
| ** **                                           | ** ** | **For the Nine Months Ending** | ** ** | **For the Nine Months Ending** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                           | ** ** | **September 30, 2008**                   | ** ** | **September 30, 2007**                   | ** ** |
| **Condensed Income Statement**             | ** ** | **Bank**                                           | ** ** | **1031**                                           | ** ** | **Parent** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** | **Bank** | ** ** | **1031** | ** ** | **Parent** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **(in thousands - unaudited)**                       | ** ** | ** **                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income                                      |       | $                                                  | 28,278     |                                               | $          | 558 |   | $ | 398 |   | $ | (544 | ) | $ | 28,690 |   | $ | 33,367 |   | $ | 1,351 |   | $ | 243 |   | $ | (854 | ) | $ | 34,107 |   |
| Interest Expense                                     |       | 12,673                                             |       | 310                                                |       | 776 |   | (544 | ) | 13,215 |   | 16,645 |   | 678 |   | 1,030 |   | (854 | ) | 17,499 |   |
| Provision for Loan Losses                            |       | 1,440                                              |       | —                                             |       | –– |   |   |   | 1,440 |   | 760 |   | –– |   | –– |   |   |   | 760 |   |
| Non-interest Income                                  |       | (7,999                                             | )          | 64                                                 |       | (6,080 | ) |   |   | (14,015 | ) | 856 |   | 132 |   | 202 |   |   |   | 1,190 |   |
| Non-interest Expense                                 |       | 27,935                                             |       | 772                                                |       | 11,208 |   |   |   | 39,915 |   | 10,926 |   | 1,255 |   | 1,695 |   |   |   | 13,876 |   |
| Net Income/(Loss) before taxes and other             |       | (21,769                                            | )          | (460                                               | )          | (17,666 | ) | –– |   | (39,895 | ) | 5,892 |   | (450 | ) | (2,280 | ) | –– |   | 3,162 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income/(Loss) attributable to minority  shareholders |       | —                                             |       | —                                             |       | –– |   |   |   | –– |   | –– |   | –– |   | (28 | ) |   |   | (28 | ) |
| Income Taxes/(Benefit)                               |       | (2,518                                             | )          | (169                                               | )          | (2,696 | ) |   |   | (5,383 | ) | 2,057 |   | (151 | ) | (727 | ) |   |   | 1,179 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **NET  INCOME/(LOSS)**                               |       | $                                                  | (19,251    | )                                                  | $          | (291 | ) | $ | (14,970 | ) | $ | –– |   | $ | (34,512 | ) | $ | 3,835 |   | $ | (299 | ) | $ | (1,525 | ) | $ | –– |   | $ | 2,011 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Statement  of Condition**                          |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| ASSETS                                               |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and Due from Banks                              |       | $                                                  | 6,138      |                                               | $          | 7,748 |   | $ | 77 |   | $ | (7,616 | ) | $ | 6,347 |   | $ | 9,889 |   | $ | 50,137 |   | $ | 859 |   | $ | (45,217 | ) | $ | 15,668 |   |
| Investments                                          |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investments in subsidiaries                          |       | —                                             |       | —                                             |       | 52,868 |   | (52,868 | ) | –– |   | –– |   | –– |   | 72,971 |   | (72,971 | ) | –– |   |
| Investment Portfolio                                 |       | 69,781                                             |       | 692                                                |       | 2,851 |   |   |   | 73,324 |   | 88,076 |   | –– |   | 11,813 |   |   |   | 99,889 |   |
| Loans (net)                                          |       | 446,305                                            |       | —                                             |       | –– |   |   |   | 446,305 |   | 483,314 |   | –– |   | –– |   |   |   | 483,314 |   |
| Fixed Assets                                         |       | 6,711                                              |       | 68                                                 |       | 118 |   |   |   | 6,897 |   | 7,093 |   | 114 |   | 144 |   |   |   | 7,351 |   |
| Intangibles                                          |       | 4,139                                              |       | —                                             |       | –– |   | –– |   | 4,139 |   | 21,552 |   | –– |   | 9,771 |   |   |   | 31,323 |   |
| Other Assets                                         |       | 19,035                                             |       | 70                                                 |       | 2,152 |   | (53 | ) | 21,204 |   | 14,949 |   | 395 |   | 797 |   | (339 | ) | 15,802 |   |
| Total Assets                                         |       | $                                                  | 552,109    |                                               | $          | 8,578 |   | $ | 58,066 |   | $ | (60,537 | ) | $ | 558,216 |   | $ | 624,873 |   | $ | 50,646 |   | $ | 96,355 |   | $ | (118,527 | ) | $ | 653,347 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| LIABILITIES                                          |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                             |       | 461,332                                            |       | —                                             |       | –– |   | (299 | ) | 461,033 |   | 517,162 |   | –– |   | –– |   | (321 | ) | 516,841 |   |
| Borrowing                                            |       | 34,500                                             |       | —                                             |       | 20,619 |   |   |   | 55,119 |   | 28,500 |   | –– |   | 20,619 |   |   |   | 49,119 |   |
| Other Liabilities                                    |       | 3,798                                              |       | 8,189                                              |       | (2,183 | ) | (7,370 | ) | 2,434 |   | 6,923 |   | 49,963 |   | 533 |   | (45,235 | ) | 12,184 |   |
| Total Liabilities                                    |       | 499,630                                            |       | 8,189                                              |       | 18,436 |   | (7,669 | ) | 518,586 |   | 552,585 |   | 49,963 |   | 21,152 |   | (45,556 | ) | 578,144 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                            |       | 52,479                                             |       | 389                                                |       | 39,630 |   | (52,868 | ) | 39,630 |   | 72,288 |   | 683 |   | 75,203 |   | (72,971 | ) | 75,203 |   |
|                                                 |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total Liabilities and Shareholders’ Equity      |       | $                                                  | 552,109    |                                               | $          | 8,578 |   | $ | 58,066 |   | $ | (60,537 | ) | $ | 558,216 |   | $ | 624,873 |   | $ | 50,646 |   | $ | 96,355 |   | $ | (118,527 | ) | $ | 653,347 |   |

 

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| ** **                                          | ** ** | **For the Nine Months Ending** | ** ** | **For the Nine Months Ending** | ** ** |
|-----------------------------------------------------|------------|----------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                          | ** ** | **September 30, 2008**                   | ** ** | **September 30, 2007**                   | ** ** |
| **Condensed Income Statement**            | ** ** | **Bank**                                           | ** ** | **1031**                                           | ** ** | **Parent** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** | **Bank** | ** ** | **1031** | ** ** | **Parent** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **(in thousands - unaudited)**                      | ** ** | ** **                                         | ** ** | ** **                                         | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                                                |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest Income                                     |       | $                                                  | 8,940      |                                               | $          | 82 |   | $ | 31 |   | $ | (82 | ) | $ | 8,971 |   | $ | 11,294 |   | $ | 588 |   | $ | 73 |   | $ | (412 | ) | $ | 11,543 |   |
| Interest Expense                                    |       | 3,882                                              |       | 26                                                 |       | 236 |   | (82 | ) | 4,062 |   | 5,691 |   | 308 |   | 336 |   | (412 | ) | 5,923 |   |
| Provision for Loan Losses                           |       | 150                                                |       | —                                             |       | — |   |   |   | 150 |   | 346 |   | — |   | — |   |   |   | 346 |   |
| Non-interest Income                                 |       | (8,574                                             | )          | 1                                                  |       | (5,511 | ) |   |   | (14,084 | ) | 353 |   | 53 |   | (244 | ) |   |   | 162 |   |
| Non-interest Expense                                |       | 20,227                                             |       | 248                                                |       | 10,319 |   |   |   | 30,794 |   | 3,395 |   | 351 |   | 517 |   |   |   | 4,263 |   |
| Net Income/(Loss) before taxes and other            |       | (23,893                                            | )          | (191                                               | )          | (16,035 | ) | — |   | (40,119 | ) | 2,215 |   | (18 | ) | (1,024 | ) | — |   | 1,173 |   |
|                                                |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Income/(Loss) attributable to minority shareholders |       | —                                             |       | —                                             |       | — |   |   |   | — |   | — |   | — |   | 11 |   |   |   | 11 |   |
| Income Taxes/(Benefit)                              |       | (2,863                                             | )          | (81                                                | )          | (2,129 | ) |   |   | (5,073 | ) | 754 |   | (4 | ) | (338 | ) |   |   | 412 |   |
|                                                |       |                                               |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **NET INCOME/(LOSS)**                               |       | $                                                  | (21,030    | )                                                  | $          | (110 | ) | $ | (13,906 | ) | $ | — |   | $ | (35,046 | ) | $ | 1,461 |   | $ | (14 | ) | $ | (697 | ) | $ | — |   | $ | 750 |   |

 

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**SIGNATURES**

 

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

 
|        | THE  BANK HOLDINGS      |
|-------------|-------------------------|
|        |                    |   |
| Date:  | November 10,  2008 |   | by: | /s/  Harold G. Giomi |
|        |                    | Harold  G. Giomi |
|        |                    | Chief  Executive Officer |
|        |                    |   |
| Date:       | November 10,  2008 |   | by: | /s/  Jack B. Buchold |
|        |                    | Jack  B. Buchold |
|        |                    | Chief  Financial Officer |
|        |                    | (principal  financial and |
|        |                    | accounting  officer) |

 

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