**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**(MarkOne)**

 

ý           **ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**For thefiscal year ended December 31, 2005**

 

**OR**

 

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

 

**For thetransition period from                                          to                                **

 

**Commissionfile number  0-14289**

 

**GREENE COUNTY BANCSHARES, INC.**

(Exact name of registrant as specified in its charter)

 

| **Tennessee**                                     | ** ** | **62-1222567**                       |
|---------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of                   |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)                    |       |                                 |
|                                              |       |                                 |
| **100 North Main Street, Greeneville, Tennessee** | ** ** | **37743-4992**                       |
| (Address of principal executive offices)          |       | (Zip Code)                           |

 

Registrant’s telephone number, including area code:  **(423) 639-5111**.

 

Securities registered pursuant to Section 12(b) of the Act: **None**

 

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

 

**Common Stock - $2.00 par value**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405of the Securities Act      YES  o   NO  ý

 

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or 15(d) of the Act YES  o   NO  ý

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. YES  ý   NO  o

 

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

 

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

 

Largeaccelerated filer oAccelerated filer ý Non-accelerated filer o

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). YES  o   NO  ý

 

Theaggregate market value of the voting stock held by non-affiliates of theregistrant on June 30, 2005 was $185 million. The market value calculationwas determined using the closing sale price of the registrant’s common stock onJune 30, 2005, as reported on the Nasdaq National Market. For purposes of this calculation, the term “affiliate”refers to all directors, executive officers and 10% shareholders of theregistrant. As of the close of business on March 10, 2006 9,781,070 sharesof the registrant’s common stock were outstanding.

 

**DOCUMENTS INCORPORATED BYREFERENCE**

 

Thefollowing lists the documents incorporated by reference and the Part ofthe Form 10-K into which the document is incorporated:

 

1.             Portions of Proxy Statement for 2006 AnnualMeeting of Shareholders. (Part III)

 

 

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**PART I**

 

**Forward-LookingStatements**

 

**The information contained herein contains forward-lookingstatements that involve a number of risks and uncertainties. A number offactors, including those discussed herein, could cause results to differmaterially from those anticipated by such forward-looking statements which arewithin the meaning of that term in Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended. In addition, such forward-looking statements are necessarilydependent upon assumptions, estimates and data that may be incorrect orimprecise. Accordingly, any forward-looking statements included herein do notpurport to be predictions of future events or circumstances and may not berealized. Forward-looking statements can be identified by, among other things,the use of forward-looking terminology such as “intends,” “believes,” “expects,”“may,” “will,” “should,” “seeks,” “pro forma” or “anticipates,” or thenegatives thereof, or other variations thereon of comparable terminology, or bydiscussions of strategy or intentions. Such statements may include, butare not limited to, projections of income or loss, expenditures, acquisitions,plans for future operations, financing needs or plans relating to services ofthe Company, as well as assumptions relating to the foregoing. The Company’sactual results may differ materially from the results anticipated inforward-looking statements due to a variety of factors, including, but notlimited to those identified in “Item 1A. Risk Factors” in this Form 10-Kand (1) unanticipated deterioration in the financial condition ofborrowers resulting in significant increases in loan losses and provisions forthose losses; (2) lack of sustained growth in the economy in the marketsthat the Bank serves; (3) increased competition with other financialinstitutions in the markets that the Bank serves; (4) changes in thelegislative and regulatory environment; (5) the Company’s successfulimplementation of its growth strategy; and (6) the loss of key personnel.All forward-looking statements herein are based on information available to usas of the date this Annual Report on Form 10-K was filed with theSecurities and Exchange Commission (“SEC”).**

 

**ITEM 1. BUSINESS.**

** **

**Presentationof Amounts**

 

**Alldollar amounts set forth below, other than per-share amounts, are in thousandsunless otherwise noted.**

 

**The Company**

** **

GreeneCounty Bancshares, Inc. (the “Company”) was formed in 1985 and serves asthe bank holding company for Greene County Bank (the “Bank”), which is aTennessee-chartered commercial bank that conducts the principal business of theCompany. At December 31, 2005, and based on Federal Reserve Board (“FRB”)data as of September 30, 2005, the Company believes it was the secondlargest bank holding company headquartered in the state of Tennessee. At December 31,2005, the Company maintained a main office in Greeneville, Tennessee and 49full-service bank branches (of which eleven are in leased operating premises)and nine separate locations operated by the Bank’s subsidiaries.

 

The Company’s assets consist primarily of its investmentin the Bank and liquid investments. Its primary activities are conductedthrough the Bank. At December 31, 2005, the Company’s consolidated totalassets were $1,619,989, its consolidated net loans, including loans held forsale, were $1,361,589, its total deposits were $1,295,879 and its totalshareholders’ equity was $168,021.

 

The Company’s net income is dependent primarily on itsnet interest income, which is the difference between the interest income earnedon its loans, investment assets and other interest-earning assets and theinterest paid on deposits and other interest-bearing liabilities. To a lesserextent, the Company’s net income also is affected by its noninterest incomederived principally from service charges and fees as well as the level ofnoninterest expenses such as salaries and employee benefits.

 

1

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The operations of the Company are significantlyaffected by prevailing economic conditions, competition and the monetary,fiscal and regulatory policies of governmental agencies. Lending activities areinfluenced by the general credit needs of individuals and small andmedium-sized businesses in the Company’s market area, competition amonglenders, the level of interest rates and the availability of funds. Depositflows and costs of funds are influenced by prevailing market rates of interest,primarily the rates paid on competing investments, account maturities and thelevels of personal income and savings in the Company’s market area.

 

The principal executive offices of the Company arelocated at 100 North Main Street, Greeneville, Tennessee 37743-4992 andits telephone number is (423) 639-5111.

 

**The Bank and its Subsidiaries**

** **

The Bank is a Tennessee-chartered commercial bankestablished in 1890 which has its principal executive offices in Greeneville,Tennessee. The principal business of the Bank consists of attracting depositsfrom the general public and investing those funds, together with fundsgenerated from operations and from principal and interest payments on loans,primarily in commercial loans, commercial and residential real estate loans,and installment consumer loans. At December 31, 2005, the Bank had 48full-service banking offices located in Greene, Washington, Blount, Knox,Hamblen, McMinn, Loudon, Hawkins, Sullivan, Cocke and Monroe Counties in EastTennessee and in Sumner, Rutherford, Davidson, Lawrence, Montgomery andWilliamson Counties in Middle Tennessee. The Bank also operates two other fullservice branches–one located in nearby Madison County, North Carolina and theother in nearby Bristol, Virginia. Further, the Bank operates a trust and moneymanagement function doing business as President’s Trust from offices in WilsonCounty, Tennessee, and a mortgage banking operation in Knox County, Tennessee.

 

The Bank also offers other financial services throughthree wholly-owned subsidiaries. Through Superior Financial Services, Inc.(“Superior Financial”), the Bank operates eight consumer finance companyoffices located in Greene, Blount, Hamblen, Washington, Sullivan, Sevier, Knoxand Bradley Counties, Tennessee. Through GCB Acceptance Corporation (“GCBAcceptance”), the Bank operates a sub-prime automobile lending company with asole office in Johnson City, Tennessee. Through Fairway Title Co., the Bankoperates a title company headquartered in Knox County, Tennessee. At December 31,2005, these three subsidiaries had total combined assets of $31,083 and totalcombined loans, net of unearned interest, of $31,139.

 

Deposits of the Bank are insured by the Bank InsuranceFund (“BIF”) of the Federal Deposit Insurance Corporation (“FDIC”). The Bank issubject to supervision and regulation by the Tennessee Department of FinancialInstitutions (the “Banking Department”) and the FDIC. See “Regulation,Supervision and Governmental Policy.”

 

On November 21,2003, the Company entered the Middle Tennessee market by completing itsacquisition of Gallatin, Tennessee-based Independent Bankshares Corporation (“IBC”).IBC was the bank holding company for First Independent Bank, which had fouroffices in Gallatin and Hendersonville, Tennessee, in Sumner County, andRutherford Bank and Trust, with three offices in Murfreesboro and Smyrna,Tennessee in Rutherford County. First Independent Bank and Rutherford Bank andTrust were subsequently merged with the Bank, with the Bank as the survivingentity. Consideration in the transaction included the issuance of 836,114shares of the Company’s common stock and payment of approximately $9,060 incash and $198 in stock options in exchange for all outstanding IBC commonstock. 

 

On November 15,2004 the Company established banking operations in Nashville, Tennessee, withthe opening of its first full-service branch of Middle Tennessee Bank &Trust, which, like all of the Bank’s bank brands, operates within the Bank’sstructure. This new branch in Davidson County, Tennessee expanded the Company’spresence in the Middle Tennessee market and helped fill in the market betweenSumner and Rutherford Counties. 

 

TheCompany opened a new branch in Knoxville, Tennessee in late 2003 and expects toopen its second branch in that city during the first-half of 2006.

 

On December 10,2004 the Company purchased three full-service branches from National Bank ofCommerce located in Lawrence County Tennessee. This purchase (“NBC transaction”)added to the Bank’s presence in Middle Tennessee.

 

2

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On October 7,2005, the Company purchased five bank branches in Montgomery County, Tennessee.This purchase (the “Clarksville transaction”) also adds to the Bank’s presencein Middle Tennessee.

 

### **Growth and Business Strategy**

###  

The Company expects that, over the intermediate term,its growth from mergers and acquisitions, including acquisitions of both entirefinancial institutions and selected branches of financial institutions, willcontinue. De novo branching is also expected to be a method of growth,particularly in high-growth and other demographically-desirable markets. 

 

The Company’s strategic plan outlines geographicexpansion within a 300-mile radius of its headquarters in Greene County,Tennessee. This could result in the Company expanding westward and eastward upto and including Nashville, Tennessee and Roanoke, Virginia, respectively,east/southeast up to and including the Piedmont area of North Carolina andwestern North Carolina, southward to northern Georgia and northward intoeastern and central Kentucky. In particular, the Company believes the marketsin and around Knoxville, Nashville and Chattanooga, Tennessee are highlydesirable areas with respect to expansion and growth plans.

 

Whilethe Bank operates under a single bank charter, it conducts business under 18bank brands with a distinct community-based brand in almost every market. TheBank offers local decision making through the presence of its regionalexecutives in each of its markets, while at the same time maintaining a costeffective organizational structure in its back office and support areas. 

 

TheBank focuses its lending efforts predominately on individuals and small tomedium-sized businesses while it generates deposits primarily from individualsin its local communities. To aid in deposit generation efforts, the Bank offersits customers extended hours of operation during the week as well as Saturdaybanking. The Bank also offers free online banking and recently established itsHigh Performance Checking Program which it believes will allow it to generate asignificant number of core transaction accounts with significant balances.

 

In addition to the Company’sbusiness model, which is summarized in the paragraphs above entitled “TheCompany” and “The Bank and its Subsidiaries”, the Company is continuouslyinvestigating and analyzing other lines and areas of business. These include,but are not limited to, various types of insurance and real estate activities.Conversely, the Company frequently evaluates and analyzes the profitability,risk factors and viability of its various business lines and segments and, dependingupon the results of these evaluations and analyses, may conclude to exitcertain segments and/or business lines. Further, in conjunction with theseongoing evaluations and analyses, the Company may decide to sell, merge orclose certain branch facilities.

 

**Lending Activities**

** **

General. The loan portfolio of theCompany is comprised of commercial, commercial and residential real estate andconsumer loans. Such loans are primarily originated within the Company’s marketareas of East and Middle Tennessee and are generally secured by residential orcommercial real estate or business or personal property located in the countiesof Greene, Washington, Hamblen, Sullivan, Hawkins, Blount, Knox, McMinn,Loudon, Monroe, Cocke, Sumner, Rutherford, Davidson, Lawrence and MontgomeryCounties, Tennessee.

 

3

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Loan Composition. The followingtable sets forth the composition of the Company’s loans at December 31 foreach of the periods indicated.

 
| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003**  | ** ** | **2002** | ** ** | **2001** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|-----------|------------|----------|------------|----------|------------|
| Commercial                      |       | $        | 245,285    |     | $          | 165,975   |       | $        | 134,823    |     | $          | 93,836 |   | $ | 96,122 |   |
| Commercial real estate          |       | 729,254  |       | 484,088  |       | 445,104   |       | 342,407  |       | 295,002  |       |
| Residential real estate         |       | 319,797  |       | 319,713  |       | 295,528   |       | 233,128  |       | 210,489  |       |
| Loans held-for-sale             |       | 2,686    |       | 1,151    |       | 3,546     |       | 6,646    |       | 7,945    |       |
| Consumer                        |       | 90,682   |       | 82,532   |       | 81,624    |       | 77,644   |       | 80,314   |       |
| Other                           |       | 3,476    |       | 4,989    |       | 6,134     |       | 14,938   |       | 13,779   |       |
| Unearned interest               |       | (9,852   | )          | (10,430  | )          | (10,988   | )          | (11,696  | )          | (13,159  | )          |
| Loans, net of unearned interest |       | $        | 1,381,328  |     | $          | 1,048,018 |       | $        | 955,771    |     | $          | 756,903 |   | $ | 690,492 |   |
|                            |       |     |       |     |       |      |       |     |       |     |       |
| Allowance for loan losses       |       | $        | (19,739    | )        | $          | (15,721   | )          | $        | (14,564    | )        | $          | (12,586 | ) | $ | (11,221 | ) |

 

LoanMaturities. The following table reflects at December 31,2005 the dollar amount of loans maturing based on their contractual terms tomaturity. Demand loans, loans having no stated schedule of repayments andloans having no stated maturity are reported as due in one year or less. 

 
| ** **              | ** ** | **Due in One**   | ** ** | **Due After One Year** | ** ** | **Due After**  | ** ** | ** ** | ** ** |
|-------------------------|------------|----------------------------|------------|---------------------------------------|------------|---------------------|------------|------------|------------|
| ** **              | ** ** | **Year or Less** | ** ** | **Through Five Years**      | ** ** | **Five Years** | ** ** | **Total**  | ** ** |
| Commercial              |       | $                          | 137,299    |                                  | $          | 97,131              |       | $          | 10,855     |   | $ | 245,285 |   |
| Commercial real estate  |       | 300,439                    |       | 385,951                               |       | 42,864              |       | 729,254    |       |
| Residential real estate |       | 46,410                     |       | 107,054                               |       | 162,514             |       | 315,978    |       |
| Loans held for sale     |       | 2,686                      |       | —                                |       | —              |       | 2,686      |       |
| Consumer                |       | 25,111                     |       | 54,613                                |       | 4,925               |       | 84,649     |       |
| Other                   |       | 2,604                      |       | 681                                   |       | 191                 |       | 3,476      |       |
| Total                   |       | $                          | 514,549    |                                  | $          | 645,430             |       | $          | 221,349    |   | $ | 1,381,328 |   |

 

The following table sets forth the dollar amount ofthe loans maturing subsequent to the year ending December 31, 2006distinguished between those with predetermined interest rates and those withfloating, or variable, interest rates.

 
| ** **              | ** ** | **Fixed Rate** | ** ** | **Variable Rate** | ** ** | **Total** | ** ** |
|-------------------------|------------|---------------------|------------|------------------------|------------|-----------|------------|
| Commercial              |       | $                   | 51,253     |                   | $          | 56,733    |       | $ | 107,986 |   |
| Commercial real estate  |       | 288,624             |       | 140,190                |       | 428,814   |       |
| Residential real estate |       | 144,828             |       | 124,740                |       | 269,568   |       |
| Consumer                |       | 58,642              |       | 897                    |       | 59,539    |       |
| Other                   |       | 731                 |       | 141                    |       | 872       |       |
| Total                   |       | $                   | 544,078    |                   | $          | 322,701   |       | $ | 866,779 |   |

 

CommercialLoans. Commercial loans are made for a variety of business purposes,including working capital, inventory and equipment and capital expansion. At December 31,2005, commercial loans outstanding totaled $245,285, or 18.01%, of the Company’snet loan portfolio. Such loans are usually amortized over one to seven years andgenerally mature within five years. Commercial loan applications must besupported by current financial information on the borrower and, whereappropriate, by adequate collateral. Commercial loans are generallyunderwritten by addressing cash flow (debt service coverage), primary andsecondary sources of repayment, financial strength of any guarantor, liquidity,leverage, management experience, ownership structure, economic conditions andindustry-specific trends and collateral. The loan to value ratio depends on thetype of collateral. Generally speaking, accounts receivable are financedbetween 70% and 80% of accounts receivable less than 90 days past due. Ifother collateral is taken to support the loan, the loan to value of accountsreceivable may approach 85%. Inventory financing will range between 50%and 60% depending on the borrower and nature of inventory. The Company requiresa first lien position for such loans. These types of loans are generallyconsidered to be a higher credit risk than other loans originated by theCompany.

 

4

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CommercialReal Estate Loans. The Company originates commercial loans,generally to existing business customers, secured by real estate located in theCompany’s market area. At December 31, 2005, commercial real estate loanstotaled $729,254, or 53.56%, of the Company’s net loan portfolio. Commercialreal estate loans are generally underwritten by addressing cash flow (debtservice coverage), primary and secondary source of repayment, financialstrength of any guarantor, strength of the tenant (if any), liquidity,leverage, management experience, ownership structure, economic conditions andindustry specific trends and collateral. Generally, the Company will loan up to80-85% of the value of improved property, 65% of the value of raw land and 75%of the value of land to be acquired and developed. A first lien on the propertyand assignment of lease is required if the collateral is rental property, withsecond lien positions considered on a case-by-case basis.

 

Residential Real Estate. The Companyalso originates one-to-four family, owner-occupied residential mortgage loanssecured by property located in the Company’s primary market area. The majorityof the Company’s residential mortgage loans consists of loans secured byowner-occupied, single-family residences. At December 31, 2005, theCompany had $319,797, or 23.49%, of its net loan portfolio in residential realestate loans. Residential real estate loans generally have a loan-to-valueratio of 85% or less. These loans are underwritten by giving consideration tothe ability to pay, stability of employment or source of income, credit historyand loan-to-value ratio. Home equity loans make up approximately 27% ofresidential real estate loans. Home equity loans may have higherloan-to-value ratios when the borrower’s repayment capacity and credit historyconform to underwriting standards. Superior Financial extends sub-primemortgages to borrowers who generally have a higher risk of default thanmortgages extended by the Bank. Sub-prime mortgages totaled $10,980, or 3.43%,of the Company’s residential real estate loans at December 31, 2005.

 

The Company sells most of its one-to-four familymortgage loans in the secondary market to Freddie Mac and other mortgageinvestors through the Bank’s mortgage banking operation. Sales of such loans toFreddie Mac and other mortgage investors totaled $39,788 and $49,892 during2005 and 2004, respectively, and the related mortgage servicing rights weresold together with the loans.

 

Consumer Loans. At December 31,2005, the Company’s consumer loan portfolio totaled $90,682, or 6.66%, of theCompany’s total net loan portfolio. The Company’s consumer loan portfolio iscomposed of secured and unsecured loans originated by the Bank, SuperiorFinancial and GCB Acceptance. The consumer loans of the Bank have a higher riskof default than other loans originated by the Bank. Further, consumer loansoriginated by Superior Financial and GCB Acceptance, which are financecompanies rather than banks, generally have a greater risk of default than suchloans originated by commercial banks and, accordingly, carry a higher interestrate. Superior Financial and GCB Acceptance consumer loans totaledapproximately $30,011, or 33.10%, of the Company’s installment consumer loansat December 31, 2005. The performance of consumer loans will be affectedby the local and regional economy as well as the rates of personalbankruptcies, job loss, divorce and other individual-specific characteristics.

 

Past Due, Special Mention, Classified and NonaccrualLoans. The Company classifies its problem loans into threecategories: past due loans, special mention loans and classified loans (bothaccruing and non-accruing interest).

 

When management determines that a loan is no longerperforming and that collection of interest appears doubtful, the loan is placedon nonaccrual status. All loans that are 90 days past due are considerednonaccrual unless they are adequately secured and there is reasonable assuranceof full collection of principal and interest. Management closely monitors allloans that are contractually 90 days past due, treated as “special mention”or otherwise classified or on nonaccrual status. Nonaccrual loans that are120 days past due without assurance of repayment are charged off againstthe allowance for loan losses.

 

5

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The following table sets forth information withrespect to the Company’s nonperforming assets at the dates indicated. At thesedates, the Company did not have any troubled debt restructurings.

 
| ** **                                                                                            | ** ** | **At December, 31** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                            | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                                                  |       |                          |       |   |   |   |   |   |   |   |   |
| Loans accounted for on a nonaccrual basis                                                             |       | $                             | 5,915      |   | $ | 6,242 |   | $ | 4,305 |   | $ | 7,475 |   | $ | 5,857 |   |
| Accruing loans which are contractually past due 90  days or more as to interest or principal payments |       | 809                           |       | 664 |   | 224 |   | 307 |   | 871 |   |
| Total nonperforming loans                                                                             |       | 6,724                         |       | 6,906 |   | 4,529 |   | 7,782 |   | 6,728 |   |
| Real estate owned:                                                                                    |       |                          |       |   |   |   |   |   |   |   |   |
| Foreclosures                                                                                          |       | 2,920                         |       | 1,353 |   | 3,599 |   | 4,805 |   | 2,589 |   |
| Other real estate held and repossessed assets                                                         |       | 823                           |       | 213 |   | 627 |   | 767 |   | 623 |   |
| Total nonperforming assets                                                                            |       | $                             | 10,467     |   | $ | 8,472 |   | $ | 8,755 |   | $ | 13,354 |   | $ | 9,940 |   |

 

The Company’s continuing efforts to resolvenonperforming loans occasionally include foreclosures, which result in theCompany’s ownership of the real estate underlying the mortgage. If nonaccrual loans at December 31, 2005 hadbeen current according to their original terms and had been outstandingthroughout 2005, or since origination if originated during the year, interestincome on these loans would have been approximately $368. Interest actuallyrecognized on these loans during 2005 was not significant.

 

Foreclosed real estate increased $1,567, or 115.8%, to$2,920 at December 31, 2005 from $1,353 at December 31, 2004. Thereal estate consists of 29 properties, of which seven are commercialproperties with a carrying value of $1,932, 19 are single family residentialproperties with a carrying value of $883, one is a multi-family home with acarrying value of $25 and two are vacant lots with a carrying value of $80. Managementexpects to liquidate these properties during 2006. Management has recordedthese properties at fair value less estimated selling cost and the subsequentsale of such properties is not expected to result in any adverse effect on theCompany’s results of operations, subject to business and marketing conditionsat the time of sale. Other repossessed assets increased $610, or 286.38%, to$823 at December 31, 2005 from $213 at December 31, 2004. Theincrease is due primarily to the repossession and pending liquidation offoreclosed rental equipment of $240 and $225 of stock not traded on a publicmarket.

 

Total impaired loans increased by $2,469, or 20.22%,from $12,210 at December 31, 2004 to $14,679 at December 31, 2005. Thisincrease is primarily reflective of additional impaired loans in the Bankresulting from several commercial relationships placed on nonaccrual status andin the process of litigation or foreclosure action.

 

At December 31, 2005, the Company hadapproximately $8,764 in loans that are not currently classified as nonaccrualor 90 days past due or otherwise restructured but which known informationabout possible credit problems of borrowers caused management to have concernsas to the ability of the borrowers to comply with present loan repayment terms.Such loans were considered classified by the Company and were composedprimarily of various commercial, commercial real estate and consumer loans. TheCompany believes that these loans are adequately secured and management doesnot expect any material loss.

 

Allowance for Loan Losses. Theallowance for loan losses is maintained at a level which management believes isadequate to absorb all probable losses on loans then present in the loanportfolio. The amount of the allowance is affected by:  (1) loan charge-offs, which decrease theallowance; (2) recoveries on loans previously charged-off, which increasethe allowance; and (3) the provision of possible loan losses charged toincome, which increases the allowance. In determining the provision forpossible loan losses, it is necessary for management to monitor fluctuations inthe allowance resulting from actual charge-offs and recoveries, and toperiodically review the size and composition of the loan portfolio in light ofcurrent and anticipated economic conditions in an effort to evaluate portfoliorisks. If actual losses exceed the amount of the allowance for loan losses,earnings of the Company could be adversely affected. The amount of theprovision is based on management’s judgment of those risks. During the yearended December 31, 2005, the Company’s provision for loan losses increasedby $529, or 9.06%, to $6,365 from $5,836 for the year ended December 31,2004, while the allowance for loan losses increased by $4,018, or 25.56%, to$19,739 at

 

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December 31, 2005 from $15,721 at December 31,2004. The increase in the allowance for loan losses and provision for loanlosses is attributable to the organic loan growth the company experienced in2005. Also, the allowance for loan losses was increased by $1,467 in 2005 bythe allowance acquired in the Clarksville transaction. 

 

The following is a summary of activity in theallowance for loan losses for the periods indicated:

 
| ** **                                                                                       | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                       | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Balance at beginning of year                                                                     |       | $                                          | 15,721     |   | $ | 14,564 |   | $ | 12,586 |   | $ | 11,221 |   | $ | 11,728 |   |
| Reserve acquired in acquisition                                                                  |       | 1,467                                      |       | 363 |   | 1,340 |   | — |   | — |   |
| Subtotal                                                                                         |       | 17,188                                     |       | 14,927 |   | 13,926 |   | 11,221 |   | 11,728 |   |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Charge-offs:                                                                                     |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial                                                                                       |       | (1,500                                     | )          | (1,538 | ) | (1,007 | ) | (1,216 | ) | (411 | ) |
| Commercial real estate                                                                           |       | (189                                       | )          | (1,044 | ) | (664 | ) | (956 | ) | (997 | ) |
| Subtotal                                                                                         |       | (1,689                                     | )          | (2,582 | ) | (1,671 | ) | (2,172 | ) | (1,408 | ) |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Residential real estate                                                                          |       | (622                                       | )          | (424 | ) | (745 | ) | (740 | ) | (669 | ) |
| Consumer                                                                                         |       | (3,250                                     | )          | (3,962 | ) | (4,381 | ) | (4,736 | ) | (5,753 | ) |
| Other                                                                                            |       | (22                                        | )          | (12 | ) | — |   | — |   | — |   |
| Total charge-offs                                                                                |       | (5,583                                     | )          | (6,980 | ) | (6,797 | ) | (7,648 | ) | (7,830 | ) |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Recoveries:                                                                                      |       |                                       |       |   |   |   |   |   |   |   |   |
| Commercial                                                                                       |       | 160                                        |       | 304 |   | 195 |   | 239 |   | 11 |   |
| Commercial real estate                                                                           |       | 180                                        |       | 66 |   | 92 |   | 54 |   | 54 |   |
| Subtotal                                                                                         |       | 340                                        |       | 370 |   | 287 |   | 293 |   | 65 |   |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Residential real estate                                                                          |       | 166                                        |       | 63 |   | 92 |   | 141 |   | 102 |   |
| Consumer                                                                                         |       | 1,246                                      |       | 1,504 |   | 1,281 |   | 1,514 |   | 1,197 |   |
| Other                                                                                            |       | 17                                         |       | 1 |   | — |   | — |   | — |   |
| Total recoveries                                                                                 |       | 1,769                                      |       | 1,938 |   | 1,660 |   | 1,948 |   | 1,364 |   |
| Net charge-offs                                                                                  |       | (3,814                                     | )          | (5,042 | ) | (5,137 | ) | (5,700 | ) | (6,466 | ) |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Provision for loan losses                                                                        |       | 6,365                                      |       | 5,836 |   | 5,775 |   | 7,065 |   | 5,959 |   |
| Balance at end of year                                                                           |       | $                                          | 19,739     |   | $ | 15,721 |   | $ | 14,564 |   | $ | 12,586 |   | $ | 11,221 |   |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Ratio of net charge-offs to average loans  outstanding, net of unearned inome, during the period |       | 0.32                                       | %          | 0.51 | % | 0.64 | % | 0.80 | % | 0.94 | % |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Ratio of allowance for loan losses to nonperforming  loans                                       |       | 293.56                                     | %          | 227.64 | % | 321.57 | % | 161.73 | % | 166.78 | % |
|                                                                                             |       |                                       |       |   |   |   |   |   |   |   |   |
| Ratio of allowance for loan losses to total loans,  net of unearned income                       |       | 1.43                                       | %          | 1.50 | % | 1.53 | % | 1.68 | % | 1.64 | % |

 

7

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*Breakdownof allowance for loan losses by category.*The following tablepresents an allocation among the listed loan categories of the Company’sallowance for loan losses at the dates indicated and the percentage of loans ineach category to the total amount of loans at the respective year-ends: 

 
| ** **                                   | ** ** | **At December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|
| ** **                                   | ** ** | **2005**                 | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| **Balance  at end of period  applicable to** | ** ** | **Amount**               | ** ** | **Percent of  loan in  each  category  to total  loans** | ** ** | **Amount** | ** ** | **Percent of  loan in  each  category  to total  loans** | ** ** | **Amount** | ** ** | **Percent of  loan in  each  category  to total  loans** | ** ** | **Amount** | ** ** | **Percent of  loan in  each  category  to total  loans** | ** ** | **Amount(1)** | ** ** | **Percent of  loan in  each  category  to total  loans** | ** ** |
|                                         |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Commercial                                   |       | $                        | 4,797      |   | 17.76 | % | $ | 3,666 |   | 15.68 | % | $ | 3,001 |   | 13.95 | % | $ | 1,998 |   | 12.21 | % | $ | 2,072 |   | 13.66 | % |
| Commercial real  estate                      |       | 8,889                    |       | 52.80 | % | 5,939 |   | 45.73 | % | 4,737 |   | 46.04 | % | 3,961 |   | 44.56 | % | 3,144 |   | 41.93 | % |
| Residential real  estate                     |       | 2,035                    |       | 22.87 | % | 1,922 |   | 30.21 | % | 2,037 |   | 30.57 | % | 2,031 |   | 30.33 | % | 1,951 |   | 29.91 | % |
| Loans  held-for-sale                         |       | —                   |       | 0.19 | % | — |   | 0.11 | % | — |   | 0.37 | % | — |   | 0.86 | % | — |   | 1.13 | % |
| Consumer                                     |       | 3,960                    |       | 6.13 | % | 3,856 |   | 7.80 | % | 4,080 |   | 8.44 | % | 4,153 |   | 10.10 | % | 3,581 |   | 11.41 | % |
| Other                                        |       | 58                       |       | 0.25 | % | 338 |   | 0.47 | % | 709 |   | 0.63 | % | 443 |   | 1.94 | % | 473 |   | 1.96 | % |
|                                         |       |                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Totals                                       |       | $                        | 19,739     |   | 100.0 | % | $ | 15,721 |   | 100.0 | % | $ | 14,564 |   | 100.0 | % | $ | 12,586 |   | 100.0 | % | $ | 11,221 |   | 100.0 | % |

 

----

(1) Balances related tocertain loan categories have been reclassified in prior years to reflectrevised allocation methods used in 2002.

 

**Investment Activities**

** **

General. The Company maintains aportfolio of investments to provide liquidity and an additional source ofincome.

 

Securities by Category. Thefollowing table sets forth the carrying value of the securities, by majorcategories, held by the Company at December 31, 2005, 2004 and 2003:

 
| ** **                                                                              | ** ** | **At December 31,** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                              | ** ** | **2005**                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                    |       |                          |       |   |   |   |   |
| Securities Held to Maturity:                                                            |       |                          |       |   |   |   |   |
| U.S. Treasury securities and obligations of U.S.  Government, corporations and agencies |       | $                             | —     |   | $ | 250 |   | $ | 748 |   |
| Obligations of state and political subdivisions                                         |       | 2,630                         |       | 3,382 |   | 4,136 |   |
| Corporate Securities                                                                    |       | 749                           |       | 749 |   | 748 |   |
|                                                                                    |       |                          |       |   |   |   |   |
| Total                                                                                   |       | $                             | 3,379      |   | $ | 4,381 |   | $ | 5,632 |   |
|                                                                                    |       |                          |       |   |   |   |   |
| Securities Available for Sale:                                                          |       |                          |       |   |   |   |   |
| U.S. Treasury securities and obligations of U.S.  Government, corporations and agencies |       | $                             | 40,755     |   | $ | 26,989 |   | $ | 24,720 |   |
| Obligations of state and political subdivisions                                         |       | 1,700                         |       | 1,821 |   | 1,880 |   |
| Trust Preferred Securities                                                              |       | 6,413                         |       | 6,508 |   | 6,599 |   |
|                                                                                    |       |                          |       |   |   |   |   |
| Total                                                                                   |       | $                             | 48,868     |   | $ | 35,318 |   | $ | 33,199 |   |

 

8

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Maturity Distributions of Securities.The following table sets forth the distributions of maturities of securities atamortized cost as of December 31, 2005:

 
| ** **                                                                       | ** ** | **Due in One  Year or Less** | ** ** | **Due After One  Year through  Five Years** | ** ** | **Due After Five  Years through  10 Years** | ** ** | **Due After 10  Years** | ** ** | **Total** | ** ** |
|----------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------------------------------------|------------|-----------------------------------|------------|-----------|------------|
|                                                                             |       |                                             |       |                                                            |       |                                                            |       |                              |       |      |       |
| US Treasury securities and Federal agency  obligations – available for sale |       | $                                                | 17,044     |                                                            | $          | 11,821                                                          |       | $                                 | 1,839      |      | $          | 10,550 |   | $ | 41,254 |   |
| Federal agency obligations – held to maturity                               |       | —                                           |       | —                                                          |       | —                                                          |       | —                            |       | —    |       |
| Obligations of state and political subdivisions –  available for sale       |       | —                                           |       | 815                                                             |       | 896                                                             |       | —                            |       | 1,711     |       |
| Obligations of state and political subdivisions –  held to maturity         |       | 50                                               |       | 1,662                                                           |       | 918                                                             |       | —                            |       | 2,630     |       |
| Other securities – available for sale                                       |       | —                                           |       | —                                                          |       | —                                                          |       | 6,500                             |       | 6,500     |       |
| Other securities – held to maturity                                         |       | —                                           |       | 493                                                             |       | 256                                                             |       | —                            |       | 749       |       |
|                                                                             |       |                                             |       |                                                            |       |                                                            |       |                              |       |      |       |
| Subtotal                                                                         |       | $                                                | 17,094     |                                                            | $          | 14,791                                                          |       | $                                 | 3,909      |      | $          | 17,050 |   | $ | 52,844 |   |
|                                                                             |       |                                             |       |                                                            |       |                                                            |       |                              |       |      |       |
| Market value adjustment on available-for-sale  securities                        |       | (138                                             | )          | (178                                                            | )          | (13                                                             | )          | (268                              | )          | (597      | )          |
|                                                                             |       |                                             |       |                                                            |       |                                                            |       |                              |       |      |       |
| Total                                                                            |       | $                                                | 16,956     |                                                            | $          | 14,613                                                          |       | $                                 | 3,896      |      | $          | 16,782 |   | $ | 52,247 |   |
|                                                                             |       |                                             |       |                                                            |       |                                                            |       |                              |       |      |       |
| Weighted average yield (a)                                                  |       | 2.97                                             | %          | 3.94                                                            | %          | 4.77                                                            | %          | 6.08                              | %          | 4.37      | %          |

 

----

(a)           Actual yields ontax-exempt obligations do not differ materially from yields computed on a taxequivalent basis.

 

Expected maturities may differ from contractualmaturities because borrowers may have the right to call or prepayobligations with or without call or prepayment penalties. 

 

9

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**Deposits**

 

Deposits are the primary source of funds for theCompany. Such deposits consist of checking accounts, regular savings deposits,NOW accounts, Money Market Accounts and market rate Certificates of Deposit. Depositsare attracted from individuals, partnerships and corporations in the Company’smarket area. In addition, the Company obtains deposits from state and localentities and, to a lesser extent, U.S. Government and other depositoryinstitutions. The Company’s policy permits the acceptance of limited amounts ofbrokered deposits.

 

The following table sets forth the average balancesand average interest rates based on daily balances for deposits for the periodsindicated:

 
| ** **                                   | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                   | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                   | ** ** | **Average**                                | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** | **Average** | ** ** |
| ** **                                   | ** ** | **Balance**                                | ** ** | **Rate Paid** | ** ** | **Balance** | ** ** | **Rate Paid** | ** ** | **Balance** | ** ** | **Rate Paid** | ** ** |
|                                         |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Types of deposits (all in domestic offices): |       |                                       |       |   |   |   |   |   |   |   |   |   |   |
| Noninterest-bearing demand deposits          |       | $                                          | 125,071    |   | — |   | $ | 105,763 |   | — |   | $ | 73,432 |   | — |   |
| Interest-bearing demand deposits             |       | 355,566                                    |       | 1.52 | % | 272,382 |   | 0.59 | % | 225,508 |   | 0.61 | % |
| Savings deposits                             |       | 68,053                                     |       | 0.36 | % | 63,732 |   | 0.26 | % | 54,857 |   | 0.36 | % |
| Time deposits                                |       | 591,608                                    |       | 3.01 | % | 466,392 |   | 2.24 | % | 384,836 |   | 2.87 | % |
| Total deposits                               |       | $                                          | 1,140,298  |   |   |   | $ | 908,269 |   |   |   | $ | 738,633 |   |   |   |

 

The following table indicates the amount of theCompany’s certificates of deposit of $100,000 or more by time remaining untilmaturity as of December 31, 2005:

 
| ** **                     | ** ** | **Certificates of** | ** ** |
|--------------------------------|------------|--------------------------|------------|
| **Maturity Period**       | ** ** | **Deposits**             | ** ** |
|                           |       |                     |       |
| Three months or less           |       | $                        | 66,426     |   |
| Over three through six months  |       | 45,422                   |       |
| Over six through twelve months |       | 51,361                   |       |
| Over twelve months             |       | 48,495                   |       |
| Total                          |       | $                        | 211,704    |   |

 

10

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**Competition**

 

To compete effectively, the Company reliessubstantially on local commercial activity; personal contacts by its directors,officers, other employees and shareholders; personalized services; and itsreputation in the communities it serves.

 

According to data as of June 30, 2005 publishedby SNL Financial LC and using information from the FDIC, the Bank ranked as thelargest independent commercial bank headquartered in East Tennessee, and itsmajor market areas include Greene, Hamblen, Hawkins, Sullivan, Washington,Madison, Loudon, Blount, Knox, McMinn, Sumner, Rutherford, Davidson,Montgomery, Lawrence and Williamson Counties, Tennessee and portions of Cocke,Monroe and Jefferson Counties, Tennessee. In Greene County, in which theCompany enjoyed its largest deposit share as of June 30, 2005, there wereseven commercial banks and one savings bank, operating 25 branches and holdingan aggregate of approximately $923 million in deposits as of June 30,2005. The following table sets forth the Bank’s deposit share, excluding creditunions, in each county in which it has a full-service branch(s) as of June 30,2005, according to data published by the FDIC: 

 
| **County**        | ** ** | **Deposit Share** | ** ** |
|-------------------|------------|------------------------|------------|
| Greene, TN        |       | 37.00                  | %          |
| Lawrence, TN      |       | 14.12                  | %          |
| Hawkins, TN       |       | 13.22                  | %          |
| Montgomery, TN(1) |       | 12.85                  | %          |
| Blount, TN        |       | 11.83                  | %          |
| Sumner, TN        |       | 7.31                   | %          |
| Cocke, TN         |       | 6.55                   | %          |
| McMinn, TN        |       | 6.16                   | %          |
| Hamblen, TN       |       | 5.46                   | %          |
| Madison, NC       |       | 5.13                   | %          |
| Washington, TN    |       | 5.02                   | %          |
| Loudon, TN        |       | 4.54                   | %          |
| Bristol, VA(2)    |       | 3.66                   | %          |
| Rutherford, TN    |       | 2.73                   | %          |
| Sullivan, TN      |       | 2.48                   | %          |
| Monroe, TN        |       | 1.16                   | %          |
| Knox, TN          |       | 0.23                   | %          |
| Davidson, TN      |       | 0.19                   | %          |
| Williamson, TN    |       | 0.01                   | %          |

 

----

(1) The Company acquired five full-servicebranches in Montgomery County on October 7, 2005.

(2) Bristol, VA is deemed a city.

 

**Employees**

** **

As of December 31, 2005 the Company employed 561full-time equivalent employees. None of the Company’s employees are presentlyrepresented by a union or covered under a collective bargaining agreement. Managementconsiders relations with employees to be good.

 

**Regulation, Supervision and Governmental Policy**

** **

The following is a brief summary of certain statutes, rules andregulations affecting the Company and the Bank. A number of other statutes andregulations have an impact on their operations. The following summary ofapplicable statutes and regulations does not purport to be complete and isqualified in its entirety by reference to such statutes and regulations.

 

11

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Bank Holding Company Regulation. TheCompany is registered as a bank holding company under the Bank Holding CompanyAct (the “Holding Company Act”) and, as such, is subject to supervision,regulation and examination by the Board of Governors of the FRB.

 

*Acquisitions and Mergers*. Underthe Holding Company Act, a bank holding company must obtain the prior approvalof the FRB before (1) acquiring direct or indirect ownership or control ofany voting shares of any bank or bank holding company if, after suchacquisition, the bank holding company would directly or indirectly own orcontrol more than 5% of such shares; (2) acquiring all or substantiallyall of the assets of another bank or bank holding company; or (3) mergingor consolidating with another bank holding company. Also, any company mustobtain approval of the FRB prior to acquiring control of the Company or theBank. For purposes of the Holding Company Act, “control” is defined asownership of more than 25% of any class of voting securities of theCompany or the Bank, the ability to control the election of a majority of thedirectors, or the exercise of a controlling influence over management orpolicies of the Company or the Bank.

 

The Change in Bank Control Act and the relatedregulations of the FRB require any person or persons acting in concert (exceptfor companies required to make application under the Holding Company Act), tofile a written notice with the FRB before such person or persons may acquirecontrol of the Company or the Bank. The Change in Bank Control Act defines “control”as the power, directly or indirectly, to vote 25% or more of any votingsecurities or to direct the management or policies of a bank holding company oran insured bank.

 

Bank holding companies like the Company are currentlyprohibited from engaging in activities other than banking and activities soclosely related to banking or managing or controlling banks as to be a properincident thereto. The FRB’s regulations contain a list of permissiblenonbanking activities that are closely related to banking or managing orcontrolling banks. A bank holding company must file an application or noticewith the FRB prior to acquiring more than 5% of the voting shares of a companyengaged in such activities. The Gramm-Leach-Bliley Act of 1999 (the “GLB Act”),however, greatly broadened the scope of activities permissible for bank holdingcompanies. The GLB Act permits bank holding companies, upon election andclassification as financial holding companies, to engage in a broad variety ofactivities “financial” in nature. The Company has not filed an election withthe FRB to be a financial holding company, but may chose to do so in the future.

 

*Capital Requirements*. The Companyis also subject to FRB guidelines that require bank holding companies tomaintain specified minimum ratios of capital to total assets and capital torisk-weighted assets. See “Capital Requirements.”

 

*Dividends*. The FRB has the powerto prohibit dividends by bank holding companies if their actions constituteunsafe or unsound practices. The FRB has issued a policy statement expressingits view that a bank holding company should pay cash dividends only to theextent that the company’s net income for the past year is sufficient to coverboth the cash dividends and a rate of earnings retention that is consistentwith the company’s capital needs, asset quality, and overall financialcondition. The Company does not believe compliance with this policy statementwill limit the Company’s ability to maintain its dividend payment rate.

 

*Support of Banking Subsidiaries*. UnderFRB policy, the Company is expected to act as a source of financial strength toits banking subsidiaries and, where required, to commit resources to supporteach of such subsidiaries. Further, if the Bank’s capital levels were to fallbelow minimum regulatory guidelines, the Bank would need to develop a capitalplan to increase its capital levels and the Company would be required toguarantee the Bank’s compliance with the capital plan in order for such plan tobe accepted by the federal regulatory authority.

 

Under the “cross guarantee” provisions of the FederalDeposit Insurance Act (the “FDI Act”), any FDIC-insured subsidiary of theCompany such as the Bank could be liable for any loss incurred by, orreasonably expected to be incurred by, the FDIC in connection with (i) thedefault of any other FDIC-insured subsidiary also controlled by the Company or (ii) anyassistance provided by the FDIC to any FDIC-insured subsidiary of the Companyin danger of default.

 

*Transactions with Affiliates*. TheFederal Reserve Act, as recently amended by Regulation W, imposes legalrestrictions on the quality and amount of credit that a bank holding company orits non-bank subsidiaries (“affiliates”) may obtain from bank subsidiariesof the holding company. For instance, these restrictions generally require thatany such extensions of credit by a bank to its affiliates be on nonpreferentialterms and be

 

12

----

 

secured by designated amounts of specified collateral.Further, a bank’s ability to lend to its affiliates is limited to 10% peraffiliate (20% in the aggregate to all affiliates) of the bank’s capital andsurplus.

 

Bank Regulation. As a Tennesseebanking institution, the Bank is subject to regulation, supervision and regularexamination by the Tennessee Department of Financial Institutions. Tennesseeand federal banking laws and regulations control, among other things, requiredreserves, investments, loans, mergers and consolidations, issuance ofsecurities, payment of dividends, and establishment of branches and otheraspects of the Bank’s operations. Supervision, regulation and examination ofthe Company and the Bank by the bank regulatory agencies are intended primarilyfor the protection of depositors rather than for holders of the Common Stock ofthe Company.

 

*Extensions of Credit*. Under jointregulations of the federal banking agencies, including the FDIC, banks mustadopt and maintain written policies that establish appropriate limits andstandards for extensions of credit that are secured by liens or interests inreal estate or are made for the purpose of financing permanent improvements toreal estate. These policies must establish loan portfolio diversificationstandards, prudent underwriting standards, including loan-to-value limits thatare clear and measurable, loan administration procedures and documentation,approval and reporting requirements. A bank’s real estate lending policy mustreflect consideration of the Interagency Guidelines for Real Estate LendingPolicies (the “Interagency Guidelines”) that have been adopted by the federalbanking regulators. The Interagency Guidelines, among other things, call upondepository institutions to establish internal loan-to-value limits for realestate loans that are not in excess of the loan-to-value limits specified inthe Guidelines for the various types of real estate loans. The InteragencyGuidelines state that it may be appropriate in individual cases tooriginate or purchase loans with loan-to-value ratios in excess of thesupervisory loan-to-value limits. The aggregate amount of loans in excess ofthe supervisory loan-to-value limits, however, should not exceed 100% of totalcapital, and the total of such loans secured by commercial, agricultural,multifamily and other non-one-to-four family residential properties should notexceed 30% of total capital.

 

*Federal Deposit Insurance*. Thedeposits of the Bank are insured by the FDIC to the maximum extent provided bylaw, and the Bank is subject to FDIC deposit insurance assessments. The FDIChas adopted a risk-based assessment system for insured depository institutionsthat takes into account the risks attributable to different categories andconcentrations of assets and liabilities. In early 2006, Congress passed theFederal Deposit Insurance Reform Act of 2005, which made certain changesto the Federal deposit insurance program. These changes included merging theBank Insurance Fund and the Savings Association Insurance Fund, increasingretirement account coverage to $250,000 and providing for inflationaryadjustments to general coverage beginning in 2010, providing the FDIC withauthority to set the fund’s reserve ratio within a specified range, andrequiring dividends to banks if the reserve ratio exceeds certain levels. Thenew statute grants banks an assessment credit based on their share of theassessment base on December 31, 1996, and the amount of the credit can beused to reduce assessments in any year subject to certain limitations. TheCompany does not anticipate this new assessment system will have a materialaffect on its operating results or financial condition.

 

*Safety and Soundness Standards*. TheFederal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”)required the federal bank regulatory agencies to prescribe, by regulation,non-capital safety and soundness standards for all insured depository institutionsand depository institution holding companies. The FDIC and the other federalbanking agencies have adopted guidelines prescribing safety and soundnessstandards pursuant to FDICIA. The safety and soundness guidelines establishgeneral standards relating to internal controls and information systems,internal audit systems, loan documentation, credit underwriting, interest rateexposure, asset growth, and compensation, fees and benefits. Among otherthings, the guidelines require banks to maintain appropriate systems andpractices to identify and manage risks and exposures identified in theguidelines.

 

Capital Requirements. The FRB hasestablished guidelines with respect to the maintenance of appropriate levels ofcapital by registered bank holding companies, and the FDIC has establishedsimilar guidelines for state-chartered banks, such as the Bank, that are notmembers of the FRB. The regulations of the FRB and FDIC impose two sets ofcapital adequacy requirements: minimum leverage rules, which require themaintenance of a specified minimum ratio of capital to total assets, andrisk-based capital rules, which require the maintenance of specified minimumratios of capital to “risk-weighted” assets. At December 31, 2005, theCompany and the Bank satisfied the minimum required regulatory capitalrequirements. See Note 11 of Notes to Consolidated Financial Statements.

 

13

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The FDIC has issued final regulations that classifyinsured depository institutions by capital levels and require the appropriatefederal banking regulator to take prompt action to resolve the problems of anyinsured institution that fails to satisfy the capital standards. Under suchregulations, a “well-capitalized” bank is one that is not subject to anyregulatory order or directive to meet any specific capital level and that hasor exceeds the following capital levels: a total risk-based capital ratio of10%, a Tier 1 risk-based capital ratio of 6%, and a leverage ratio of 5%. Asof December 31, 2005, the Bank was “well-capitalized” as defined by theregulations. See Note 11 of Notes to Consolidated Financial Statements forfurther information.

 

Legislative, Legal and Regulatory Developments:******The banking industry is generallysubject to extensive regulatory oversight. The Company, as a publicly held bankholding company, and the Bank, as a state-chartered bank with deposits insuredby the FDIC, are subject to a number of laws and regulations. Many of theselaws and regulations have undergone significant change in recent years. Theselaws and regulations impose restrictions on activities, minimum capitalrequirements, lending and deposit restrictions and numerous other requirements.Future changes to these laws and regulations, and other new financial serviceslaws and regulations, are likely and cannot be predicted with certainty. Futurelegislative or regulatory change, or changes in enforcement practices or courtrulings, may have a dramatic and potentially adverse impact on the Companyand its bank and other subsidiaries. 

 

*USA Patriot Act*. The President ofthe United States signed the Uniting and Strengthening America by ProvidingAppropriate Tools Required to Intercept and Obstruct Terrorism Act (the “PatriotAct”), into law on October 26, 2001. The Patriot Act establishes a widevariety of new and enhanced ways of combating international terrorism. Theprovisions that affect banks (and other financial institutions) most directlyare contained in Title III of the act. In general, Title III amended existinglaw - primarily the Bank Secrecy Act - to provide the Secretary of Treasury(the “Treasury”) and other departments and agencies of the federal governmentwith enhanced authority to identify, deter, and punish international moneylaundering and other crimes.

 

Among other things, the Patriot Act prohibitsfinancial institutions from doing business with foreign “shell” banks andrequires increased due diligence for private banking transactions andcorrespondent accounts for foreign banks. In addition, financial institutionswill have to follow new minimum verification of identity standards for all newaccounts and will be permitted to share information with law enforcementauthorities under circumstances that were not previously permitted. These andother provisions of the Patriot Act became effective at varying times and theTreasury and various federal banking agencies are responsible for issuingregulations to implement the new law.

 

**Additional Information**

 

The Company maintains a website atwww.mybankconnection.com and is notincluding the information contained on this website as a part of, orincorporating it by reference into, this Annual Report on Form 10-K. TheCompany makes available free of charge (other than an investor’s own internetaccess charges) through its website its Annual Report on Form 10-K,quarterly reports on Form 10-Q, and current reports on Form 8-K, andamendments to these reports, as soon as reasonably practicable after theCompany electronically files such material with, or furnishes such material to,the Securities and Exchange Commission. 

 

**ITEM1A.****              ****RISK FACTORS.**

 

***TheCompany’s business strategy includes the continuation of growth plans, and itsfinancial condition and results of operations could be affected if its businessstrategies are not effectively executed.***

 

TheCompany intends to continue pursuing a growth strategy for its business throughacquisitions and de novo branching. The Company’s prospects must be consideredin light of the risks, expenses and difficulties occasionally encountered byfinancial services companies in growth stages, which may include thefollowing:  

 

•      Maintainingloan quality; 

 

•      Maintainingadequate management personnel and information systems to oversee such growth;and

 

•      Maintainingadequate control and compliance functions. 

 

14

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*Operating Results*. There is no assurancethat existing offices or future offices will maintain or achieve depositlevels, loan balances or other operating results necessary to avoid losses orproduce profits. The Company’s growth and de novo branching strategynecessarily entails growth in overhead expenses as it routinely adds newoffices and staff. The Company’s historical results may not be indicativeof future results or results that may be achieved as the company continueto increase the number and concentration of its branch offices. 

 

*Development of Offices*. There areconsiderable costs involved in opening branches and new branches generally donot generate sufficient revenues to offset their costs until they have been inoperation for at least a year or more. Accordingly, the Company’s de novobranches may be expected to negatively impact its earnings during thisperiod of time until the branches reach certain economies of scale. 

 

*Expansion into New Markets*. Much of theCompany’s recent growth has been focused in the highly competitive Nashville,Knoxville and Clarksville metropolitan markets. The customer demographics andfinancial services offerings in these markets are unlike those found in theEast Tennessee markets that the Company has historically served. In theNashville, Knoxville and Clarksville markets the Company faces competition froma wide array of financial institutions. The Company’s expansion into these newmarkets may be impacted if it is unable to meet customer demands orcompete effectively with the financial institutions operating in these markets.

 

*Regulatory and Economic Factors*. TheCompany’s growth and expansion plans may be adversely affected by a numberof regulatory and economic developments or other events. Failure to obtainrequired regulatory approvals, changes in laws and regulations or otherregulatory developments and changes in prevailing economic conditions or otherunanticipated events may prevent or adversely affect the Company’scontinued growth and expansion. 

 

Failureto successfully address the issues identified above could have a materialadverse effect on the Company’s business, future prospects, financial conditionor results of operations, and could adversely affect the Company’s ability tosuccessfully implement its business strategy. 

 

***TheCompany could sustain losses if its asset quality declines.***

 

TheCompany’s earnings are affected by its ability to properly originate,underwrite and service loans. The Company could sustain losses if itincorrectly assesses the creditworthiness of its borrowers or fails to detector respond to deterioration in asset quality in a timely manner. Problems withasset quality could cause the Company’s interest income and net interest marginto decrease and its provisions for loan losses to increase, which couldadversely affect the Company’s results of operations and financial condition. 

 

## ***An inadequate allowance for loan losses wouldreduce the Company’s earnings.***

## ** **

Therisk of credit losses on loans varies with, among other things, generaleconomic conditions, the type of loan being made, the creditworthiness of theborrower over the term of the loan and, in the case of a collateralized loan,the value and marketability of the collateral for the loan. Managementmaintains an allowance for loan losses based upon, among other things,historical experience, an evaluation of economic conditions and regular reviewsof delinquencies and loan portfolio quality. Based upon such factors,management makes various assumptions and judgments about the ultimatecollectibility of the loan portfolio and provides an allowance for loan lossesbased upon a percentage of the outstanding balances and takes a charge againstearnings with respect to specific loans when their ultimate collectibility isconsidered questionable. If management’s assumptions and judgments prove to beincorrect and the allowance for loan losses is inadequate to absorb losses, orif the bank regulatory authorities require the Bank to increase the allowancefor loan losses as a part of their examination process, the Company’searnings and capital could be significantly and adversely affected. 

 

15

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***Liquidity needs could adversely affect theCompany’s results of operations and financial condition.***

 

The Company relies on dividends from the Bank as itsprimary source of funds. The primary source of funds of the Bank are customerdeposits and loan repayments. While scheduled loan repayments are a relativelystable source of funds, they are subject to the ability of borrowers to repaythe loans. The ability of borrowers to repay loans can be adversely affected bya number of factors, including changes in economic conditions, adverse trendsor events affecting business industry groups, reductions in real estate valuesor markets, business closings or lay-offs, inclement weather, natural disastersand international instability. Additionally, deposit levels may beaffected by a number of factors, including rates paid by competitors, generalinterest rate levels, returns available to customers on alternative investmentsand general economic conditions. Accordingly, the Company may be requiredfrom time to time to rely on secondary sources of liquidity to meet withdrawaldemands or otherwise fund operations. Such sources include Federal Home LoanBank advances and federal funds lines of credit from correspondent banks. Whilethe Company believes that these sources are currently adequate, there can be noassurance they will be sufficient to meet future liquidity demands. The Companymay be required to slow or discontinue loan growth, capital expendituresor other investments or liquidate assets should such sources not be adequate. 

 

***Competitionfrom financial institutions and other financial service providers may adverselyaffect the Company’s profitability.***

 

Thebanking business is highly competitive and the Company experiences competitionin each of its markets from many other financial institutions. The Companycompetes with commercial banks, credit unions, savings and loan associations,mortgage banking firms, consumer finance companies, securities brokerage firms,insurance companies, money market funds, and other mutual funds, as well asother community banks and super-regional and national financial institutionsthat operate offices in the Company’s primary market areas and elsewhere. 

 

Additionally,the Company faces competition from de novo community banks, including thosewith senior management who were previously affiliated with other local orregional banks or those controlled by investor groups with strong localbusiness and community ties. These de novo community banks may offerhigher deposit rates or lower cost loans in an effort to attract the Company’scustomers, and may attempt to hire the Company’s management and employees.

 

TheCompany competes with these other financial institutions both in attractingdeposits and in making loans. In addition, the Company has to attract itscustomer base from other existing financial institutions and from newresidents. The Company expects competition to increase in the future as aresult of legislative, regulatory and technological changes and the continuingtrend of consolidation in the financial services industry. The Company’sprofitability depends upon its continued ability to successfully compete withan array of financial institutions in its market areas. 

 

## ***The Company may face risks with respect tofuture expansion.***

## ** **

Fromtime to time the Company may engage in additional de novo branch expansionas well as the acquisition of other financial institutions or parts of thoseinstitutions. The Company may also consider and enter into new lines ofbusiness or offer new products or services. In addition, the Company may receivefuture inquiries and have discussions with potential acquirors of the Company.Acquisitions and mergers involve a number of risks, including: 

 

•      thetime and costs associated with identifying and evaluating potentialacquisitions and merger partners; 

 

•      inaccuraciesin the estimates and judgments used to evaluate credit, operations, managementand market risks with respect to the target institution; 

 

•      thetime and costs of evaluating new markets, hiring experienced local managementand opening new offices, and the time lags between these activities and thegeneration of sufficient assets and deposits to support the costs of theexpansion; 

 

•      theCompany’s ability to finance an acquisition and possible dilution to itsexisting shareholders; 

 

16

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•      thediversion of the Company’s management’s attention to the negotiation of atransaction, and the integration of the operations and personnel of thecombining businesses; 

 

•      entryinto new markets where the Company lacks experience; 

 

•      theintroduction of new products and services into the Company’s business; 

 

•      theincurrence and possible impairment of goodwill associated with an acquisitionand possible adverse short-term effects on the Company’s results of operations;and 

 

•      therisk of loss of key employees and customers. 

 

The Company may incur substantial costs to expand. There can be noassurance that integration efforts for any future mergers or acquisitions willbe successful. Also, the Company may issue equity securities, includingcommon stock and securities convertible into shares of the Company’s commonstock in connection with future acquisitions, which could cause ownership andeconomic dilution to the Company’s shareholders. There is no assurance that,following any future mergers or acquisitions, the Company’s integration effortswill be successful or the Company, after giving effect to the acquisition, willachieve profits comparable to or better than its historical experience. 

 

#### ***TheCompany’s business is subject to the success of the local economies where itoperates.***

####  

TheCompany’s success significantly depends upon the growth in population, incomelevels, deposits and housing starts in its market areas. If the communities inwhich the Company operates do not grow or if prevailing economic conditionslocally or nationally are unfavorable, the Company’s business may notsucceed. Adverse economic conditions in the Company’s specific market areascould reduce its growth rate, affect the ability of its customers to repaytheir loans to the Company and generally affect its financial condition andresults of operations. Moreover, the Company cannot give any assurance that itwill benefit from any market growth or favorable economic conditions in itsprimary market areas if they do occur. 

 

Anyadverse market or economic conditions in the state of Tennessee may increasethe risk that the Company’s borrowers will be unable to timely make their loanpayments. In addition, the market value of the real estate securing loans ascollateral could be adversely affected by unfavorable changes in market andeconomic conditions. As of December 31, 2005, approximately 75.82% of theCompany’s loans held for investment were secured by real estate. Of thisamount, approximately 41.87% were commercial real estate loans, 27.76% wereresidential real estate loans and 30.37% were construction and developmentloans. Any sustained period of increased payment delinquencies, foreclosures orlosses caused by adverse market or economic conditions in the state ofTennessee could adversely affect the value of the Company’s assets, revenues,results of operations and financial condition. 

 

***Changes in interest rates couldadversely affect the Company’s results of operations and financial condition.***

** **

Changesin interest rates may affect the Company’s level of interest income, theprimary component of its gross revenue, as well as the level of its interestexpense. Interest rates are highly sensitive to many factors that are beyondthe Company’s control, including general economic conditions and the policiesof various governmental and regulatory authorities. Accordingly, changes ininterest rates could decrease the Company’s net interest income. Changes in thelevel of interest rates also may negatively affect the Company’s abilityto originate real estate loans, the value of the Company’s assets and theCompany’s ability to realize gains from the sale of its assets, all of whichultimately affects the Company’s earnings. 

 

##### ***TheCompany relies heavily on the services of key personnel***. 

#####  

TheCompany depends substantially on the strategies and management services of R.Stan Puckett, its Chairman of the Board and Chief Executive Officer. Althoughthe Company has entered into an employment agreement with him, the loss of theservices of Mr. Puckett could have a material adverse effect on theCompany’s business, results of operations and financial condition. The Companyis also dependent on certain other key officers who have important customerrelationships or are instrumental to its operations. Changes in key personneland their responsibilities may be disruptive to the Company’s business andcould have a material adverse effect on the Company’s business, financialcondition and results of operations.

 

17

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TheCompany believes that its future results will also depend in part upon itsattracting and retaining highly skilled and qualified management and sales andmarketing personnel, particularly in those areas where the Company may opennew branches. Competition for such personnel is intense, and the Company cannotassure you that it will be successful in attracting or retaining suchpersonnel. 

 

##### ***TheCompany is subject to extensive regulation that could limit or restrict itsactivities.***

#####  

TheCompany operates in a highly regulated industry and is subject to examination,supervision, and comprehensive regulation by various federal and state agenciesincluding the Board of Governors of the FRB, the FDIC and the TennesseeDepartment of Financial Institutions. The Company’s regulatory compliance iscostly and restricts certain of its activities, including payment of dividends,mergers and acquisitions, investments, loans and interest rates charged,interest rates paid on deposits and locations of offices. The Company is alsosubject to capitalization guidelines established by its regulators, whichrequire it to maintain adequate capital to support its growth. 

 

Thelaws and regulations applicable to the banking industry could change at anytime, and the Company cannot predict the effects of these changes on itsbusiness and profitability. Because government regulation greatly affects thebusiness and financial results of all commercial banks and bank holdingcompanies, the Company’s cost of compliance could adversely affect its abilityto operate profitably. 

 

TheSarbanes-Oxley Act of 2002, and the related rules and regulationspromulgated by the Securities and Exchange Commission and Nasdaq that are nowapplicable to the Company, have increased the scope, complexity and cost ofcorporate governance, reporting and disclosure practices. As a result, theCompany has experienced, and may continue to experience, greatercompliance costs. 

 

#### ***TheCompany’s recent results may not be indicative of its future results.***

####  

TheCompany may not be able to sustain its historical rate of growth or may noteven be able to grow its business at all. In addition, the Company’s recentgrowth may distort some of its historical financial ratios and statistics.In the future, the Company may not have the benefit of several recentlyfavorable factors, such as a generally stable interest rate environment, astrong residential mortgage market, or the ability to find suitable expansionopportunities. Various factors, such as economic conditions, regulatory andlegislative considerations and competition, may also impede or prohibitthe Company’s ability to expand its market presence. 

 

***The Company is subject toTennessee anti-takeover statutes and certain charter provisions which coulddecrease its chances of being acquired even if the acquisition is in theCompany’s shareholders’ best interests.***

** **

As aTennessee corporation, the Company is subject to various legislative acts whichimpose restrictions on and require compliance with procedures designed toprotect shareholders against unfair or coercive mergers and acquisitions. Thesestatutes may delay or prevent offers to acquire the Company and increasethe difficulty of consummating any such offers, even if the acquisition of theCompany would be in its shareholders’ best interests. The Company’s amended andrestated charter also contains provisions which may make it difficult foranother entity to acquire it without the approval of a majority of thedisinterested directors on its board of directors. 

 

Theamount of common stock owned by, and other compensation arrangements with, theCompany’s officers and directors may make it more difficult to obtainshareholder approval of potential takeovers that they oppose. 

 

As of March 10,2006, directors and executive officers beneficially owned approximately 12.74%of the Company’s common stock. Agreements with the Company’s senior managementalso provide for significant payments under certain circumstances following achange in control. These compensation arrangements, together with the commonstock and option ownership of the Company’s board of directors and management,could make it difficult or expensive to obtain majority support for shareholderproposals or potential acquisition proposals of us that the Company’s directorsand officers oppose. 

 

TheCompany’s continued pace of growth may require it to raise additionalcapital in the future, but that capital may not be available when it isneeded. 

 

18

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TheCompany is required by federal and state regulatory authorities to maintainadequate levels of capital to support its operations. While the Company’scapital resources will satisfy its capital requirements for the foreseeablefuture, the Company may at some point, however, need to raise additionalcapital to support its continued growth. 

 

TheCompany’s ability to raise additional capital, if needed, will depend onconditions in the capital markets at that time, which are outside its control,and on its financial performance. Accordingly, the Company cannot assure itsshareholders that it will be able to raise additional capital if needed onterms acceptable to it. If the Company cannot raise additional capital whenneeded, its ability to further expand its operations through internal growthand acquisitions could be materially impaired. 

 

***The success and growth of the Company’sbusiness will depend on its ability to adapt to technological changes.***

** **

Thebanking industry and the ability to deliver financial services is becoming moredependent on technological advancement, such as the ability to process loanapplications over the Internet, accept electronic signatures, provide processstatus updates instantly and on-line banking capabilities and other customerexpected conveniences that are cost efficient to the Company’s businessprocesses. As these technologies are improved in the future, the Company may,in order to remain competitive, be required to make significant capitalexpenditures. 

 

***Even though the Company’s commonstock is currently traded on The Nasdaq National Market, the trading volume inits common stock has been thin and the sale of substantial amounts of theCompany’s common stock in the public market could depress the price of itscommon stock.***

** **

TheCompany cannot say with any certainty when a more active and liquid tradingmarket for its common stock will develop or be sustained. Because of this, theCompany’s shareholders may not be able to sell their shares at thevolumes, prices, or times that they desire. 

 

TheCompany cannot predict the effect, if any, that future sales of its commonstock in the market, or availability of shares of its common stock for sale inthe market, will have on the market price of the Company’s common stock. TheCompany, therefore, can give no assurance that sales of substantial amounts ofits common stock in the market, or the potential for large amounts of sales inthe market, would not cause the price of its common stock to decline or impairits ability to raise capital through sales of its common stock. 

 

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

 

***The Company may issueadditional common stock or other equity securities in the future which coulddilute the ownership interest of existing shareholders.***

** **

Inorder to maintain its capital at desired levels or required regulatory levels,or to fund future growth, the Company’s board of directors may decide fromtime to time to issue additional shares of common stock, or securitiesconvertible into, exchangeable for or representing rights to acquire shares ofits common stock. The sale of these shares may significantly dilute theCompany’s shareholders ownership interest as a shareholder and the per sharebook value of its common stock. New investors in the future may also haverights, preferences and privileges senior to its current shareholders which may adverselyimpact its current shareholders. 

 

***The Company’s ability to declareand pay dividends is limited by law and it may be unable to pay futuredividends.***

** **

TheCompany derives its income solely from dividends on the shares of common stockof the Bank. The Bank’s ability to declare and pay dividends is limited by itsobligations to maintain sufficient capital and by other general restrictions onits dividends that are applicable to banks that are regulated by the FDIC andthe Department of Financial Institutions. In addition, the FRB may imposerestrictions on the Company’s ability to pay dividends on its common stock. Asa result, the Company cannot assure its shareholders that it will declare orpay dividends on shares of its common stock in the future. 

 

19

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***Holdersof the Company’s junior subordinated debentures have rights that are senior tothose of its common shareholders.***

 

TheCompany has supported its continued growth through the issuance of trustpreferred securities from special purpose trusts and accompanying juniorsubordinated debentures. At December 31, 2005, the Company had outstandingtrust preferred securities and accompanying junior subordinated debenturestotaling $13.4 million. Payments of the principal and interest on the trustpreferred securities of these trusts are conditionally guaranteed by theCompany. Further, the accompanying junior subordinated debentures the Companyissued to the trusts are senior to its shares of common stock. As a result, theCompany must make payments on the junior subordinated debentures before anydividends can be paid on its common stock and, in the event of its bankruptcy,dissolution or liquidation, the holders of the junior subordinated debenturesmust be satisfied before any distributions can be made on its common stock. TheCompany has the right to defer distributions on its junior subordinateddebentures (and the related trust preferred securities) for up to five years,during which time no dividends may be paid on its common stock. 

 

**ITEM 1B.**               **UNRESOLVED STAFF COMMENTS.**

 

None.

 

**ITEM 2.**  PROPERTIES.

** **

At December 31, 2005, the Company maintained amain office in Greeneville, Tennessee in a building it owns, 49 full-servicebank branches (of which 38 are owned premises and 11 are leased premises) and aleased office for trust and money management functions. In addition, the Bank’ssubsidiaries operate from nine separate locations, all of which are leased.

 

**ITEM 3.**  LEGAL PROCEEDINGS.

** **

TheCompany and its subsidiaries are subject to claims and suits arising in theordinary course of business. In the opinion of management, the ultimateresolution of these pending claims and legal proceedings will not have amaterial adverse effect on the Company’s results of operations.

 

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

** **

No matters were submitted during the fourth quarter of2005 to a vote of security holders of the Company through a solicitation ofproxies or otherwise.

 

20

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**PART II**

 
| **ITEM 5.** | **MARKET FOR  REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES  OF EQUITY SECURITIES.** |
|-------------|--------------------------------------------------------------------------------------------------------------------------|

** **

On March 10,2006, Greene County Bancshares had 9,781,070 shares of common stock outstanding.The Company’s shares are traded on The Nasdaq National Market, under the symbol“GCBS”. As of March 10, 2006, the Company estimates that it hadapproximately 3,200 shareholders, including approximately 2,000 shareholders ofrecord and approximately 1,200 beneficial owners holding shares in nominee or “street”name.

 

Thefollowing table shows the high and low sales price for the Company’s commonstock as reported by The Nasdaq National Market for 2005 and 2004. The tablealso sets forth the dividends per share paid each quarter during 2005 and 2004.

 
| ** **     | ** ** | **High/Low Sales Price** | ** ** | **Dividends Paid** | ** ** |
|----------------|------------|------------------------------------|------------|-------------------------|------------|
| ** **     | ** ** | **During Quarter**            | ** ** | **Per Share**      | ** ** |
| **2005:**      |       |                               |       |                    |       |
| First quarter  |       | $28.50 / 25.88                     |       | $                       | 0.12       |   |
| Second quarter |       | 29.75 / 23.75                      |       | 0.12                    |       |
| Third quarter  |       | 29.50 / 25.09                      |       | 0.12                    |       |
| Fourth quarter |       | 28.32 / 25.65                      |       | 0.26                    |       |
|           |       |                               |       | $                       | 0.62       |   |
|           |       |                               |       |                    |       |
| **2004:**      |       |                               |       |                    |       |
| First quarter  |       | $24.64 / 21.11                     |       | $                       | 0.12       |   |
| Second quarter |       | 23.86 / 20.47                      |       | 0.12                    |       |
| Third quarter  |       | 24.02 / 22.25                      |       | 0.12                    |       |
| Fourth quarter |       | 27.70 / 23.50                      |       | 0.25                    |       |
|           |       |                               |       | $                       | 0.61       |   |

 

Holdersof the Company’s common stock are entitled to receive dividends when, as and ifdeclared by the Company’s board of directors out of funds legally available fordividends. Historically, the Company has paid quarterly cash dividends on itscommon stock, and its board of directors presently intends to continue to payregular quarterly cash dividends. The Company’s ability to pay dividends to itsshareholders in the future will depend on its earnings and financial condition,liquidity and capital requirements, the general economic and regulatoryclimate, the Company’s ability to service any equity or debt obligations seniorto its common stock, including its outstanding trust preferred securities andaccompanying junior subordinated debentures, and other factors deemed relevantby the Company’s board of directors. In order to pay dividends to shareholders,the Company must receive cash dividends from the Bank. As a result, the Company’sability to pay future dividends will depend upon the earnings of the Bank, itsfinancial condition and its need for funds. 

 

21

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Moreover,there are a number of federal and state banking policies and regulations thatrestrict the Bank’s ability to pay dividends to the Company and the Company’sability to pay dividends to its shareholders. In particular, because the Bankis a depository institution and its deposits are insured by the FDIC, it may notpay dividends or distribute capital assets if it is in default on any assessmentdue to the FDIC. In addition, the Tennessee Banking Act prohibits the Bank fromdeclaring dividends in excess of net income for the calendar year in which thedividend is declared plus retained net income for the preceding two yearswithout the approval of the Commissioner of the Department of FinancialInstitutions. Also, the Bank is subject to regulations which impose certainminimum regulatory capital and minimum state law earnings requirements thataffect the amount of cash available for distribution to the Company. Lastly,under Federal Reserve policy, the Company is required to maintain adequateregulatory capital, is expected to serve as a source of financial strength tothe Bank and to commit resources to support the Bank. These policies and regulationsmay have the effect of reducing or eliminating the amount of dividendsthat the Company can declare and pay to its shareholders in the future. Forinformation regarding restrictions on the payment of dividends by the Bank tothe Company, see “MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONS – Liquidity and Capital Resources” in this AnnualReport. See also Note 11 of Notes to Consolidated Financial Statements.

 

The Company made norepurchases of its common stock during the quarter ended December 31,2005.

 

22

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**ITEM 6.****  SELECTEDFINANCIAL DATA.**

 
| ** **                                                                 | ** ** | **At and for the Fiscal Years Ended December 31,** | ** ** |
|----------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2005**                                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| ** **                                                                 | ** ** | **(Dollars in Thousands)**                                                       | ** ** |
|                                                                       |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| Total interest income                                                      |       | $                                                                                          | 87,191     |   | $ | 65,076 |   | $ | 56,737 |   | $ | 59,929 |   | $ | 67,964 |   |
| Total interest expense                                                     |       | 28,405                                                                                     |       | 16,058 |   | 15,914 |   | 18,680 |   | 28,463 |   |
| Net interest income                                                        |       | 58,786                                                                                     |       | 49,018 |   | 40,823 |   | 41,249 |   | 39,501 |   |
| Provision for loan losses                                                  |       | (6,365                                                                                     | )          | (5,836 | ) | (5,775 | ) | (7,065 | ) | (5,959 | ) |
| Net interest income after provision for loan losses                        |       | 52,421                                                                                     |       | 43,182 |   | 35,048 |   | 34,184 |   | 33,542 |   |
| Noninterest income:                                                        |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| Investment securities gains                                                |       | —                                                                                     |       | — |   | — |   | 46 |   | — |   |
| Other income                                                               |       | 14,756                                                                                     |       | 13,028 |   | 11,588 |   | 10,484 |   | 9,593 |   |
| Noninterest expense                                                        |       | (44,340                                                                                    | )          | (36,983 | ) | (30,618 | ) | (29,199 | ) | (28,665 | ) |
| Income before income taxes                                                 |       | 22,837                                                                                     |       | 19,227 |   | 16,018 |   | 15,515 |   | 14,470 |   |
| Income tax expense                                                         |       | (8,674                                                                                     | )          | (7,219 | ) | (5,781 | ) | (5,702 | ) | (5,047 | ) |
| Net income                                                                 |       | $                                                                                          | 14,163     |   | $ | 12,008 |   | $ | 10,237 |   | $ | 9,813 |   | $ | 9,423 |   |
|                                                                       |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| **Per Share Data:**                                                        |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| Net income, basic                                                          |       | $                                                                                          | 1.73       |   | $ | 1.57 |   | $ | 1.48 |   | $ | 1.44 |   | $ | 1.38 |   |
| Net income, assuming dilution                                              |       | $                                                                                          | 1.71       |   | $ | 1.55 |   | $ | 1.47 |   | $ | 1.43 |   | $ | 1.38 |   |
| Dividends declared                                                         |       | $                                                                                          | 0.62       |   | $ | 0.61 |   | $ | 0.59 |   | $ | 0.58 |   | $ | 0.56 |   |
| Book value                                                                 |       | $                                                                                          | 17.20      |   | $ | 14.22 |   | $ | 13.31 |   | $ | 10.94 |   | $ | 10.06 |   |
| Tangible book value(1)                                                     |       | $                                                                                          | 13.15      |   | $ | 11.12 |   | $ | 10.57 |   | $ | 10.53 |   | $ | 9.64 |   |
|                                                                       |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| **Financial Condition Data:**                                              |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| Assets                                                                     |       | $                                                                                          | 1,619,989  |   | $ | 1,233,403 |   | $ | 1,108,522 |   | $ | 899,396 |   | $ | 811,612 |   |
| Loans, net of unearned interest                                            |       | $                                                                                          | 1,378,642  |   | $ | 1,046,867 |   | $ | 952,225 |   | $ | 750,257 |   | $ | 682,547 |   |
| Cash and investments                                                       |       | $                                                                                          | 104,872    |   | $ | 76,637 |   | $ | 80,910 |   | $ | 61,980 |   | $ | 57,470 |   |
| Federal funds sold                                                         |       | $                                                                                          | 28,387     |   | $ | 39,921 |   | $ | 5,254 |   | $ | 39,493 |   | $ | 25,621 |   |
| Deposits                                                                   |       | $                                                                                          | 1,295,879  |   | $ | 988,022 |   | $ | 907,115 |   | $ | 719,323 |   | $ | 653,913 |   |
| FHLB advances and notes payable                                            |       | $                                                                                          | 105,146    |   | $ | 85,222 |   | $ | 63,030 |   | $ | 82,359 |   | $ | 67,978 |   |
| Subordinated debentures                                                    |       | $                                                                                          | 13,403     |   | $ | 10,310 |   | $ | 10,310 |   | $ | — |   | $ | — |   |
| Federal funds purchased and repurchase agreements                          |       | $                                                                                          | 17,498     |   | $ | 13,868 |   | $ | 12,896 |   | $ | 10,038 |   | $ | 10,375 |   |
| Shareholders’ equity                                                  |       | $                                                                                          | 168,021    |   | $ | 108,718 |   | $ | 101,935 |   | $ | 74,595 |   | $ | 68,627 |   |
| Tangible shareholders’ equity(1)                                      |       | $                                                                                          | 128,399    |   | $ | 85,023 |   | $ | 80,965 |   | $ | 71,799 |   | $ | 65,721 |   |
|                                                                       |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| **Selected Ratios:**                                                       |       |                                                                                       |       |   |   |   |   |   |   |   |   |
| Interest rate spread                                                       |       | 4.30                                                                                       | %          | 4.53 | % | 4.59 | % | 4.99 | % | 4.98 | % |
| Net interest margin(2)                                                     |       | 4.61                                                                                       | %          | 4.75 | % | 4.83 | % | 5.29 | % | 5.41 | % |
| Return on average assets                                                   |       | 1.02                                                                                       | %          | 1.06 | % | 1.12 | % | 1.17 | % | 1.20 | % |
| Return on average equity                                                   |       | 11.09                                                                                      | %          | 11.23 | % | 12.59 | % | 13.40 | % | 13.96 | % |
| Return on average tangible equity(1)                                       |       | 14.04                                                                                      | %          | 13.95 | % | 13.38 | % | 13.93 | % | 14.30 | % |
| Average equity to average assets                                           |       | 9.20                                                                                       | %          | 9.47 | % | 8.87 | % | 8.72 | % | 8.59 | % |
| Dividend payout ratio                                                      |       | 37.38                                                                                      | %          | 38.86 | % | 41.20 | % | 40.31 | % | 40.53 | % |
| Ratio of nonperforming assets to total assets                              |       | 0.65                                                                                       | %          | 0.69 | % | 0.79 | % | 1.48 | % | 1.22 | % |
| Ratio of allowance for loan losses to nonperforming  loans                 |       | 293.56                                                                                     | %          | 227.64 | % | 321.70 | % | 161.73 | % | 166.78 | % |
| Ratio of allowance for loan losses to total loans,  net of unearned income |       | 1.43                                                                                       | %          | 1.50 | % | 1.53 | % | 1.68 | % | 1.64 | % |

 

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(1)   Tangible shareholders’ equity is shareholders’equity less goodwill and intangible assets. 

(2)   Net interest margin is the net yield oninterest earning assets and is the difference between the interest yield earnedon interest-earning assets less the interest rate paid on interest bearingliabilities.

 

23

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**GAAP Reconciliation and Management Explanation of Non-GAAPFinancial Measures**

 

Certain financial information included in our summaryconsolidated financial data is determined by methods other than in accordancewith accounting principles generally accepted within the United States, orGAAP. These non-GAAP financial measures are “tangible book value per share,” “tangibleshareholders’ equity,” and “return on average tangible equity.” The Company’smanagement uses these non-GAAP measures in its analysis of the Company’sperformance. 

 

•   “Tangiblebook value per share” is defined as total equity reduced by recorded goodwilland other intangible assets divided by total common shares outstanding. Thismeasure is important to investors interested in changes from period-to-periodin book value per share exclusive of changes in intangible assets. Goodwill, anintangible asset that is recorded in a purchase business combination, has theeffect of increasing total book value while not increasing the tangible assetsof a company. For companies such as the Company that have engaged in businesscombinations, purchase accounting can result in the recording of significantamounts of goodwill related to such transactions. 

•   “Tangibleshareholders’ equity” is shareholders’ equity less goodwill and otherintangible assets.

•   “Returnon average tangible equity” is defined as earnings for the period divided byaverage equity reduced by average goodwill and other intangible assets.

 

These disclosures should not be viewed as a substitutefor results determined in accordance with GAAP, and are not necessarilycomparable to non-GAAP performance measures which may be presented byother companies. The following reconciliation table provides a more detailedanalysis of these non-GAAP performance measures: 

 
| ** **                            | ** ** | **At and for the Fiscal Years Ended December 31,** | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                                                                   | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
| Book value per share                  |       | $                                                                                          | 17.20      |   | $ | 14.22 |   | $ | 13.31 |   | $ | 10.94 |   | $ | 10.06 |   |
| Effect of intangible assets per share |       | $                                                                                          | (4.05      | ) | $ | (3.10 | ) | $ | (2.74 | ) | $ | (.0.41 | ) | $ | (0.42 | ) |
| Tangible book value per share         |       | $                                                                                          | 13.15      |   | $ | 11.12 |   | $ | 10.57 |   | $ | 10.53 |   | $ | 9.64 |   |
| Return on average equity              |       | 11.09                                                                                      | %          | 11.23 | % | 12.59 | % | 13.40 | % | 13.96 | % |
| Effect of intangible assets           |       | 2.95                                                                                       | %          | 2.72 | % | 0.79 | % | 0.53 | % | 0.34 | % |
| Return on average tangible equity     |       | 14.04                                                                                      | %          | 13.95 | % | 13.38 | % | 13.93 | % | 14.30 | % |

 

24

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**ITEM 7.****  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Overview**

 

Net income increased by almost 18% over 2004 levelsand totaled $14,163 for the full year 2005. The rise in net income was drivenby an increase in earning assets, primarily loans. On a diluted per sharebasis, net income was $1.71 for 2005 compared with $1.55 for the same period ayear ago, an increase of 10.3%. The lower percentage increase for dilutedearnings per share is primarily a result of the issuance of 2.1 million sharesof common stock at the end of the third quarter of 2005. 

 

Net interest income for 2005, totaled $58,786, animprovement of 19.9% over the same period a year ago. The increase in netinterest income was due to the increase in average earning assets, primarilyloans, throughout 2005 and was partially offset by a reduction in the netinterest margin from 4.75% in 2004 to 4.61% in 2005. The narrowing in the netinterest margin was heavily influenced by the actions taken by the Federal OpenMarket Committee (“FOMC”) during 2005 to increase market rates eight timeswhich sharply increased market interest rates by 200 basis points during theyear and placed significant pressures on funding costs. Noninterest income grewby $1,728, or 13.3%, and totaled $14,756 for 2005. The successfulimplementation of a deposit gathering program plus the carryover effect ofexpansion initiatives in 2004 and the fourth quarter 2005 acquisition of theClarksville branches all contributed to this improvement. Noninterest expenses,which were impacted by some assimilation costs associated with the Clarksvillebranch acquisition, totaled $44,340 for the year, up $7,357 from the prior year.Similarly with noninterest income, the Company’s expansion activity in 2004 andin 2005 has impacted the comparisons between years. 

 

**CriticalAccounting Policies and Estimates**

 

TheCompany’s consolidated financial statements and accompanying notes have beenprepared in accordance with accounting principles generally accepted in theUnited States of America. The preparation of these financial statementsrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, the disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenue and expenses during the reported periods. 

 

Managementcontinually evaluates the Company’s accounting policies and estimates it usesto prepare the consolidated financial statements. In general, management’sestimates are based on current and projected economic conditions, historicalexperience, information from regulators and third party professionals andvarious assumptions that are believed to be reasonable under the then existingset of facts and circumstances. Actual results could differ from thoseestimates made by management.

 

TheCompany believes its critical accounting policies and estimates include thevaluation of the allowance for loan losses and the fair value of financialinstruments and other accounts. Based on management’s calculation, an allowanceof $19,739, or 1.43%, of total loans, net of unearned interest was an adequateestimate of losses inherent in the loan portfolio as of December 31, 2005.This estimate resulted in a provision for loan losses on the income statementof $6,365 during 2005. If the mix and amount of future charge-off percentagesdiffer significantly from those assumptions used by management in making itsdetermination, the allowance for loan losses and provision for loan losses onthe income statement could be materially affected. For further discussion ofthe allowance for loan losses and a detailed description of the methodology managementuses in determining the adequacy of the allowance, see “BUSINESS – LendingActivities – Allowance for Loan Losses” located earlier, and “Changes inResults of Operations – Provision for Loan Losses” located below. 

 

The consolidatedfinancial statements include certain accounting and disclosures that requiremanagement to make estimates about fair values. Estimates of fair value areused in the accounting for securities available for sale, loans held for sale,goodwill, other intangible assets, and acquisition purchase accountingadjustments. Estimates of fair values are used in disclosures regardingsecurities held to maturity, stock compensation (in 2006 the fair valueestimates will affect the accounting for stock options), commitments, and thefair values of financial instruments. Fair values are estimated using relevantmarket information and other assumptions such as interest rates, credit risk,prepayments and other factors. The fair values of financial instruments aresubject to change as influenced by market conditions.

 

25

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**Changes in Results of Operations**

 

Netincome. Net income for 2005 was $14,163, an increase of2,155, or 17.95%, as compared to net income of $12,008 for 2004. The increaseis primarily attributable to an increase in net interest income of $9,768, or19.93%, to $58,786 in 2005 from $49,018 in 2004 and resulted principally fromhigher average balances of loans. In addition, total noninterest incomeincreased by $1,728, or 13.26%, to $14,756 in 2005 from $13,028 in 2004. Theincrease in noninterest income can be primarily attributed to higher fee incomeassociated with additional volume of deposit-related activity. Offsetting, inpart, these positive effects on net income was an increase in noninterestexpense of $7,357, or 19.89%, to $44,340 in 2005 from $36,983 in 2004. Theincrease in noninterest expense resulted primarily as a result of the Company’sde novo branching initiatives into Davidson County and Williamson County, Tennessee,the NBC transaction in late-2004, the Clarksville transaction during the first part ofthe fourth quarter-2005 and the advertising cost associated with the Bank’sHigh Performance Checking Program. 

 

Netincome for 2004 was $12,008, an increase of $1,771, or 17.30%, as compared tonet income of $10,237 for 2003. The increase is primarily attributable to anincrease in net interest income of $8,195, or 20.07%, to $49,018 in 2004 from$40,823 in 2003 and resulted principally from higher average balances of loans.In addition, total noninterest income increased by $1,440, or 12.43%, to$13,028 in 2004 from $11,588 in 2003. The increase in noninterest income can beprimarily attributed to a significant gain on the sale of OREO property, thegain on the sale of the Company’s credit card portfolio and higher fee incomeassociated with additional volume of deposit-related activity. Offsetting, inpart, these positive effects on net income was an increase in noninterestexpense of $6,365, or 20.79%, to $36,983 in 2004 from $30,618 in 2003. Theincrease in noninterest expense resulted principally from the Company’s growthstrategy reflected in the first full year of operations in Sumner andRutherford Counties, Tennessee, resulting from the Company’s acquisition ofGallatin-based IBC in November, 2003, as well as the de novo branchinginitiative into Davidson County, Tennessee and the NBC transaction in LawrenceCounty, Tennessee, both of which occurred in the fourth quarter of 2004. 

 

NetInterest Income. The largest source of earnings for theCompany is net interest income, which is the difference between interest incomeon interest-earning assets and interest paid on deposits and otherinterest-bearing liabilities. The primary factors that affect net interestincome are changes in volume and yields of earning assets and interest-bearingliabilities, which are affected in part by management’s responses tochanges in interest rates through asset/liability management. During 2005, netinterest income was $58,786 as compared to $49,018 in 2004, an increase of19.93%. The Company experienced good growth in average balances ofinterest-earning assets, with average total interest-earning assets increasingby $244,151, or 23.67%, to $1,275,791 in 2005 from $1,031,640 in 2004. Most ofthe growth occurred in loans, with average loan balances increasing by$204,271, or 20.70%, to $1,191,077 in 2005 from $986,806 in 2004. Averagebalances of total interest-bearing liabilities also increased in 2005 from2004, with average total interest-bearing deposit balances increasing by$212,721, or 26.51%, to $1,015,227 in 2005 from $802,506 in 2004, as theCompany emphasized various types of deposits as a loan funding source. TheClarksville transaction, which closed on October 7, 2005 and in which theCompany acquired approximately $112,000 in loans and $173,000 in deposits, hada slight effect on full year average balances of loans and deposits. Most ofthe increase in net interest income in 2005 compared to 2004 related to the increasedloan volume resulting primarily from the Company’s organic loan growth, as wellas the late-2004 NBC transaction. The positive net interest income impact ofthe increase in average loan volumes was partially offset by rising costsassociated with both deposits and borrowed funds as the FOMC continued itstrend of increasing market interest rates throughout the year.

 

Beginningin the second half of 2004, the FOMC embarked upon a program to increaseshort-term interest rates at, according to the FOMC’s statements, a “pace thatis likely to be measured.”  As of December 31,2004, the FOMC had increased short-term interest rates by 100 basis points.While the Company continues to maintain an interest rate risk position which isasset sensitive, a situation in which rate-sensitive assets reprice quickerthan rate-sensitive liabilities, the FOMC’s commencement of increases inshort-term interest rates in mid-2004 was not sufficient to compensate theCompany for significant and sustained reductions in short-term interest ratesbeginning in early 2001, and the Company was unable to achieve upward momentumin the repricing of its major interest-earning assets. The Company’s aggressiveloan pricing in 2004 in order to obtain market share in new markets and increaseshare in existing markets further exacerbated this situation. In addition,management had been controlling the growth of higher-yielding subprime loans inthe Bank’s subsidiaries and focusing on increasing the balances of itstraditional commercial, commercial real estate and residential real estateloans, thus reducing the percentage of subprime loans in the Company’sportfolio. This trend in the loan portfolio mix also placed pressure on loanyields. Consequently, the

 

26

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Company’s yield onaverage loans declined to 6.44% in 2004 from 6.92% in 2003, and the Company’snet interest margin declined to 4.75% in 2004 from 4.83% in 2003. This declinerepresented the sixth consecutive year of net interest margin declines. 

 

*Average Balances, Interest Rates and Yields.*Netinterest income is affected by (i) the difference between yields earned oninterest-earning assets and rates paid on interest-bearing liabilities (“interestrate spread”) and (ii) the relative amounts of interest-earning assets andinterest-bearing liabilities. The Company’s interest rate spread is affected byregulatory, economic and competitive factors that influence interest rates,loan demand and deposit flows. When the total of interest-earning assetsapproximates or exceeds the total of interest-bearing liabilities, any positiveinterest rate spread will generate net interest income. An indication of theeffectiveness of an institution’s net interest income management is its “netyield on interest-earning assets,” which is net interest income divided byaverage interest-earning assets.

 

27

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Thefollowing table sets forth certain information relating to the Company’sconsolidated average interest-earning assets and interest-bearing liabilitiesand reflects the average yield on assets and average cost of liabilities forthe periods indicated. Such yields and costs are derived by dividing income orexpense by the average daily balance of assets or liabilities, respectively,for the periods presented. 

 
| ** **                                 | ** ** | **2005**    | ** ** | **2004**     | ** ** | **2003**    | ** ** |
|--------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                 | ** ** | **Average** | ** ** | ** **   | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                 | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-earning assets:**               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans(1)                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Real estate loans                          |       | $           | 896,485    |         | $          | 58,968      |       | 6.58 | % | $ | 759,657 |   | $ | 44,124 |   | 5.81 | % | $ | 612,528 |   | $ | 37,311 |   | 6.09 | % |
| Commercial loans                           |       | 208,964     |       | 13,651       |       | 6.53        | %          | 145,870 |   | 7,685 |   | 5.27 | % | 105,629 |   | 5,532 |   | 5.24 | % |
| Consumer and other loans-net(2)       |       | 85,628      |       | 9,319        |       | 10.88       | %          | 81,279 |   | 9,081 |   | 11.17 | % | 82,702 |   | 9,516 |   | 11.51 | % |
| Fees on loans                              |       | —      |       | 2,136        |       |        |       | — |   | 2,690 |   |   |   | — |   | 3,085 |   |   |   |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total loans (including fees)               |       | $           | 1,191,077  |         | $          | 84,074      |       | 7.06 | % | $ | 986,806 |   | $ | 63,580 |   | 6.44 | % | $ | 800,859 |   | $ | 55,444 |   | 6.92 | % |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment securities(3)                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                                    |       | $           | 48,774     |         | $          | 1,920       |       | 3.94 | % | $ | 29,382 |   | $ | 1,040 |   | 3.54 | % | $ | 28,297 |   | $ | 946 |   | 3.34 | % |
| Tax-exempt(4)                              |       | 3,668       |       | 138          |       | 3.76        | %          | 4,569 |   | 164 |   | 3.59 | % | 1,189 |   | 40 |   | 3.37 | % |
| FHLB, Bankers Bank and other stock at cost |       | 6,308       |       | 282          |       | 4.47        | %          | 6,073 |   | 230 |   | 3.79 | % | 5,378 |   | 193 |   | 3.59 | % |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total investment securities                |       | $           | 58,750     |         | $          | 2,340       |       | 3.98 | % | $ | 40,024 |   | $ | 1,434 |   | 3.58 | % | $ | 34,864 |   | $ | 1,179 |   | 3.38 | % |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Other short-term investments               |       | 25,964      |       | 777          |       | 2.99        | %          | 4,810 |   | 62 |   | 1.29 | % | 9,769 |   | 114 |   | 1.17 | % |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-earning assets              |       | $           | 1,275,791  |         | $          | 87,191      |       | 6.83 | % | $ | 1,031,640 |   | $ | 65,076 |   | 6.31 | % | $ | 845,492 |   | $ | 56,737 |   | 6.71 | % |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Noninterest-earning assets:**            |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from banks                    |       | $           | 32,971     |         |       |        |       |   | $ | 32,430 |   |   |   |   |   | $ | 26,926 |   |   |   |   |   |
| Premises and equipment                     |       | 38,891      |       |         |       |        |       | 34,795 |   |   |   |   |   | 27,879 |   |   |   |   |   |
| Other, less allowance for loan losses      |       | 40,943      |       |         |       |        |       | 31,156 |   |   |   |   |   | 16,190 |   |   |   |   |   |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total noninterest-earning assets           |       | $           | 112,805    |         |       |        |       |   | $ | 98,381 |   |   |   |   |   | $ | 70,995 |   |   |   |   |   |
|                                       |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                               |       | $           | 1,388,596  |         |       |        |       |   | $ | 1,130,021 |   |   |   |   |   | $ | 916,487 |   |   |   |   |   |

 

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(1) Average loanbalances include nonaccrual loans. Interest income collected on nonaccrualloans has been included.

(2) Installment loansare stated net of unearned income.

(3) The average balanceof and the related yield associated with securities available for sale arebased on the cost of such securities.

(4) Tax exempt incomehas not been adjusted to tax-equivalent basis since it is not material.

 

28

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| ** **                                                             | ** ** | **2005**    | ** ** | **2004**     | ** ** | **2003**    | ** ** |
|------------------------------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                                             | ** ** | **Average** | ** ** | ** **   | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                             | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate**    | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest-bearing liabilities:**                                      |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits                                                               |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW accounts and money markets                                |       | $           | 423,619    |         | $          | 5,654       |       | 1.33 | % | $ | 336,114 |   | $ | 1,762 |   | 0.52 | % | $ | 280,365 |   | $ | 1,576 |   | 0.56 | % |
| Time deposits                                                          |       | 591,608     |       | 17,827       |       | 3.01        | %          | 466,392 |   | 10,437 |   | 2.24 | % | 384,836 |   | 11,055 |   | 2.87 | % |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total deposits                                                         |       | $           | 1,015,227  |         | $          | 23,481      |       | 2.31 | % | $ | 802,506 |   | $ | 12,199 |   | 1.52 | % | $ | 665,201 |   | $ | 12,631 |   | 1.90 | % |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Securities sold under repurchase agreements and  short-term borrowings |       | 15,695      |       | 414          |       | 2.64        | %          | 15,903 |   | 162 |   | 1.02 | % | 14,055 |   | 112 |   | 0.80 | % |
| Subordinated debentures                                                |       | 11,878      |       | 729          |       | 6.14        | %          | 10,310 |   | 466 |   | 4.52 | % | 2,768 |   | 111 |   | 4.01 | % |
| FHLB advances and notes payable                                        |       | 77,551      |       | 3,781        |       | 4.88        | %          | 75,311 |   | 3,231 |   | 4.29 | % | 68,735 |   | 3,060 |   | 4.45 | % |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest-bearing liabilities                                     |       | $           | 1,120,351  |         | $          | 28,405      |       | 2.54 | % | $ | 904,030 |   | $ | 16,058 |   | 1.78 | % | $ | 750,759 |   | $ | 15,914 |   | 2.12 | % |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Non-interest-bearing liabilities:**                                  |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                                        |       | $           | 125,071    |         |       |        |       |   | $ | 105,763 |   |   |   |   |   | $ | 73,432 |   |   |   |   |   |
| Other liabilities                                                      |       | 15,460      |       |         |       |        |       | 13,271 |   |   |   |   |   | 10,991 |   |   |   |   |   |
| Total non-interesting bearing liabilities                              |       | $           | 140,531    |         |       |        |       |   | $ | 119,034 |   |   |   |   |   | $ | 84,423 |   |   |   |   |   |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Shareholders’ equity                                              |       | 127,714     |       |         |       |        |       | 106,957 |   |   |   |   |   | 81,305 |   |   |   |   |   |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity                        |       | $           | 1,388,596  |         |       |        |       |   | $ | 1,130,021 |   |   |   |   |   | $ | 916,487 |   |   |   |   |   |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                                                    |       |        |       | $            | 58,786     |        |       |   |   |   | $ | 49,018 |   |   |   |   |   | $ | 40,823 |   |   |   |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Margin analysis:**                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest rate spread                                                   |       |        |       |         |       | 4.29        |  %    |   |   |   |   | 4.53 | % |   |   |   |   | 4.59 | % |
|                                                                   |       |        |       |         |       |        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net yield on interest-earning assets (net interest  margin)            |       |        |       |         |       | 4.61        | %          |   |   |   |   | 4.75 | % |   |   |   |   | 4.83 | % |

 

29

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*Rate/Volume Analysis*. Thefollowing table analyzes net interest income in terms of changes in the volumeof interest-earning assets and interest-bearing liabilities and changes inyields and rates. The table reflects the extent to which changes in theinterest income and interest expense are attributable to changes in volume(changes in volume multiplied by prior year rate) and changes in rate (changesin rate multiplied by prior year volume). Changes attributable to the combinedimpact of volume and rate have been separately identified.

 
| ** **                                       | ** ** | **2005 vs. 2004** | ** ** | **2004 vs. 2003** | ** ** |
|--------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                       | ** ** | ** **                  | ** ** | ** **                  | ** ** | **Rate/** | ** ** | **Total** | ** ** | ** ** | ** ** | ** ** | ** ** | **Rate/** | ** ** | **Total** | ** ** |
| ** **                                       | ** ** | **Volume**                  | ** ** | **Rate**                    | ** ** | **Volume** | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Change** | ** ** |
| **Interest income:**                             |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income                    |       | $                           | 13,161     |                        | $          | 6,075 |   | $ | 1,258 |   | $ | 20,494 |   | $ | 12,873 |   | $ | (3,844 | ) | $ | (893 | ) | 8,136 |   |
| Investment securities:                           |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable                                          |       | 687                         |       | 115                         |       | 76 |   | 878 |   | 36 |   | 55 |   | 2 |   | 93 |   |
| Tax - exempt                                     |       | (32                         | )          | 9                           |       | (2 | ) | (25 | ) | 113 |   | 3 |   | 8 |   | 124 |   |
| FHLB, Bankers Bank and other stock, at cost      |       | 10                          |       | 41                          |       | 2 |   | 53 |   | 25 |   | 12 |   | 1 |   | 38 |   |
| Other short-term investments                     |       | 273                         |       | 82                          |       | 360 |   | 715 |   | (58 | ) | 12 |   | (6 | ) | (52 | ) |
|                                             |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest income                            |       | 14,099                      |       | 6,322                       |       | 1,694 |   | 22,115 |   | 12,989 |   | (3,762 | ) | (888 | ) | 8,339 |   |
|                                             |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| **Interest expense:**                            |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Savings, NOW accounts, and money market accounts |       | 560                         |       | 2,506                       |       | 826 |   | 3,892 |   | 331 |   | (123 | ) | (22 | ) | 186 |   |
| Time deposits                                    |       | 2,802                       |       | 3,617                       |       | 971 |   | 7,390 |   | 2,343 |   | (2,443 | ) | (518 | ) | (618 | ) |
| Short-term borrowings                            |       | (11                         | )          | 219                         |       | 44 |   | 252 |   | 2 |   | 41 |   | 7 |   | 50 |   |
| Subordinated debentures                          |       | 71                          |       | 167                         |       | 25 |   | 263 |   | 303 |   | 14 |   | 38 |   | 355 |   |
| Notes payable                                    |       | 96                          |       | 440                         |       | 14 |   | 550 |   | 295 |   | (113 | ) | (11 | ) | 171 |   |
|                                             |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Total interest expense                           |       | 3,518                       |       | 6,949                       |       | 1,880 |   | 12,347 |   | 3,274 |   | (2,624 | ) | (506 | ) | 144 |   |
|                                             |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                              |       | $                           | 10,581     |                        | $          | (627 | ) | $ | (186 | ) | $ | 9,768 |   | $ | 9,715 |   | $ | (1,138 | ) | $ | (382 | ) | $ | 8,195 |   |
|                                                  |            |                             |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

At December 31,2005, loans outstanding, net of unearned income, were $1,378,642 compared to$1,046,867 at 2004 year end. The increase is, in part, due to the approximate$112,000 in loans acquired via the Clarksville transaction, as well as thecombination of our expansion into new markets, increased loan demand, ourcommunity-focused banking philosophy and competitive loan rates. Averageoutstanding loans, net of unearned interest, for 2005 were $1,191,077, anincrease of 20.70% from the 2004 average of $986,806. Average outstanding loansfor 2003 were $941,207. The growth in average loans for the past three yearscan be attributed to the Company’s continuing market expansion through theCompany’s branch network, the IBC acquisition, the NBC transaction, theClarksville transaction and aggressive programs with respect to loan productionand pricing. The Company continued its branch expansion with the opening of newfull-service branches in Williamson County, Davidson County and Hamblen County,Tennessee during 2005.

 

Averageinvestment securities for 2005 were $58,750 compared to $40,024 in 2004 and$34,864 in 2003. The increase of $18,726, or 46.79%, from 2004 to 2005 resultedprimarily from the decision to move excess funds from the NBC transaction tohigher yielding investment securities. The increase of $5,160, or 14.80%, from2003 to 2004 resulted primarily from the additional investment securitiesreceived via the IBC acquisition in the fourth quarter of 2003. In 2005, theaverage yield on investments was 3.98%, an increase from the 3.58% yield in2004 and 3.38% yield in 2003. The increase in investment yield in 2005 comparedto 2004 primarily reflects the positive effect of higher rates on the Company’sadjustable-rate investment securities, as well as the purchase of investmentsecurities in a rising rate environment. Management believes this trend willcontinue if short-term interest rates continue to increase. Income provided bythe investment portfolio in 2005 was $2,340 as compared to $1,434 in 2004 and$1,179 in 2003.

 

30

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Provisionfor Loan Losses. Management assesses the adequacy of theallowance for loan losses by considering a combination of regulatory and creditrisk criteria. The entire loan portfolio is graded and potential loss factorsare assigned accordingly. The potential loss factors for impaired loans areassigned based on regulatory guidelines. The regulatory criteria are set forthin the *Interagency Policy Statement on the Allowance forLoan and Lease Losses.*The potential loss factors associated withunimpaired loans are based on a combination of both internal and industry netloss experience, as well as management’s review of trends within the portfolioand related industries. 

 

Generally, commercial, commercial real estate andresidential real estate loans are assigned a level of risk at inception. Thereafter,these loans are reviewed on an ongoing basis. The review includes loan paymentand collateral status, borrowers’ financial data and borrowers’ internaloperating factors such as cash flows, operating income, liquidity, leverage andloan documentation, and any significant change can result in an increase ordecrease in the loan’s assigned risk grade. Aggregate dollar volume by riskgrade is monitored on an ongoing basis. The establishment of and any changes torisk grades for consumer loans are generally based upon payment performance.

 

The Bank’s loan loss allowance is increased ordecreased based on management’s assessment of the overall risk of its loanportfolio. Occasionally, a portion of the allowance may be allocated to aspecific loan to reflect unusual circumstances associated with that loan.

 

Management reviews certain key loan quality indicatorson a monthly basis, including current economic conditions, delinquency trendsand ratios, portfolio mix changes and other information management deemsnecessary. This review process provides a degree of objective measurement thatis used in conjunction with periodic internal evaluations. To the extent thatthis process yields differences between estimated and actual observed losses,adjustments are made to provisions and/or the level of the allowance for loanlosses.

 

Increases and decreases in the allowance for loanlosses due to changes in the measurement of impaired loans are reflected in theprovision for loan losses. Loans continue to be classified as impaired unlesspayments are brought fully current and management also considers the collectionof scheduled interest and principal to be probable.

 

The Company’s provision for loan losses increased$529, or 9.06%, to $6,365 in 2005 from $5,836 in 2004. In 2005, managementdetermined that loss experience throughout the Company had essentially stabilized.In 2005, net charge-offs in the Bank, Superior Financial and GCB Acceptancewere $2,490, $440 and $884, respectively, totaling $3,814. In 2004, these netcharge-offs were $3,418, $524 and $1,100, respectively, totaling $5,042.Management attributes the decrease in net charge-offs to improved underwritingpolicies and management controls and an increase in loan quality and animprovement in the local and regional economy. Assuming no change in currenteconomic trends, and based on information presently available, managementanticipates that net charge-offs within the Company’s overall loan portfoliosshould continue at approximately the same rate and, in terms of percentages oftotal loans, may slightly decline over the twelve months ended December 31,2006. 

 

The ratio of nonperforming assets to total assets was0.65% at December 31, 2005 and 0.69% at December 31, 2004. The ratioof the Company’s allowance for loan losses to nonperforming assets increased in2005 to 188.58% from 185.56% in 2004. Total nonperforming loans decreased $182,or 2.64%, to $6,724 at December 31, 2005 from $6,906 at December 31,2004. Nonaccrual loans, which are nonperforming loans as to which the Bank nolonger recognizes interest income, decreased $327, or 5.24%, to $5,915 at December 31,2005 from $6,242 at December 31, 2004. Management believes that theseloans are adequately secured and does not anticipate any material losses. Note,however, that total impaired loans, which include substandard as well asnonaccrual loans, increased by $2,469, or 20.22%, from $12,210 at December 31,2004 to $14,679 at December 31, 2005. The Company records a riskallocation allowance for loan losses on all loans in this category; further,the Company specifically records additional allowance amounts for individualloans when the circumstances so warrant. For further discussion ofnonperforming assets as it relates to foreclosed real estate and impairedloans, see “BUSINESS – Lending Activities – Past Due, Special Mention,Classified and Nonaccrual Loans” located earlier.

 

31

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To further manage its credit risk on loans, theCompany maintains a “watch list” of loans that, although currently performing,have characteristics that require closer supervision by management. At December 31,2005, the Company had identified approximately $20,913 in loans that wereplaced on its “watch list,” compared to $37,556 as of December 31, 2004.

 

Noninterest Income. The generationof noninterest income, which is income that is not related to interest-earningassets and consists primarily of service charges, commissions and fees, hasbecome more important as increases in levels of interest-bearing deposits andother liabilities make it more difficult to maintain interest rate spreads.

 

Totalnoninterest income for 2005 increased to $14,756 as compared to $13,028 in 2004and $11,588 in 2003. The largest components of noninterest income are servicecharges, commissions and fees, which totaled $11,019 in 2005, $9,074 in 2004and $7,898 in 2003. The increase in 2005 primarily reflects additional feesgenerated from higher volume of deposit-related products especially highervolume of NSF Fees generated as a result of the Bank’s High PerformanceChecking Program. The increase for 2005 was offset, in part, by no net gains onthe sale of other real estate owned (“OREO”) during the year. The Company had$400 net gains on OREO during 2004.

 

NoninterestExpense. Control of noninterest expense also is an importantaspect in managing net income. Noninterest expense includes, among others,personnel, occupancy, and other expenses such as data processing, printing andsupplies, legal and professional fees, postage and FDIC assessments. Totalnoninterest expense was $44,340 in 2005 compared to $36,983 in 2004 and $30,618in 2003. The increase of $7,357, or 19.89%, in 2005 as compared to 2004principally reflects increases in all categories primarily as a result of theCompany’s de novo branching initiatives into Davidson County and WilliamsonCounty, Tennessee, the NBC transaction in late-2004, the Clarksvilletransaction during the first part of the fourth quarter-2005 and theadvertising cost associated with the Bank’s High Performance Checking Program. 

 

Personnel costs are the primary element of the Company’snoninterest expenses. For the years ended December 31, 2005 and 2004,salaries and benefits represented $22,185, or 50.03%, and $19,189, or 51.89%,respectively, of total noninterest expense. This was an increase of $2,996, or15.61%. Including Bank branches and non-Bank office locations, the Company had60 locations at December 31, 2005, as compared to 53 at December 31,2004, and the number of full-time equivalent employees increased 18.35% from474 at December 31, 2004 to 561 at December 31, 2005. These increasesin personnel costs, number of branches and employees are primarily the resultof the Company’s expansion initiatives. 

 

Advertisingincreased by $1,558, or 160.45%, to $2,529 in 2005 from $971 in 2004. TheCompany implemented the Bank’s High Performance Checking Account program at thebeginning of 2005 to generate significant numbers and balances of coretransaction accounts. The Company will continue this program through 2006.

 

IncomeTaxes. The Company’s effective income tax rate was 38.0% in2005 compared to 37.5% in 2004 and 36.1% in 2003. The increased 2005 effectiveincome tax rate relates to higher state income tax expense. 

 

**Changes in Financial Condition**

 

Totalassets at December 31, 2005 were $1,619,989, an increase of $386,586, or31.34%, over total assets of $1,233,403 at December 31, 2004. Thisincrease reflects an increase in loans, net of unearned interest, of $331,775,or 31.69%, to $1,378,642 at December 31, 2005 from $1,046,867 at December 31,2004. The increase in loans can be attributed to the Clarksville transactionand the full year impact of Middle Tennessee Bank and Trust, as well as theCompany’s continued focus on generating good credit quality loans, competitiveloan pricing and the addition of experienced lenders to the Company’s lendingstaff. Average assets for 2005 also increased to $1,388,596, an increase of$258,575, or 22.88%, from the average asset balance of $1,130,021 for 2004. Theincrease in average assets is due primarily to the continued increase oforganic loan growth through 2005 and the limited impact of the loans acquiredin the Clarksville transaction which occurred in the fourth quarter. Dueprimarily to the additional noninterest expense incurred as a result of theCompany’s expansion strategies carried out during 2005 and the attendantincrease in average assets, the Company’s return on average assets decreased in2005 to 1.02% from 1.06% in 2004.

 

32

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Totalassets at December 31, 2004 were $1,233,403, an increase of $124,881, or11.27%, over total assets of $1,108,522 at December 31, 2003. Thisincrease reflects an increase in loans, net, of $93,485, or 9.97%, to$1,031,146 at December 31, 2004 from $937,661 at December 31, 2003.The increase in loans can be attributed to the Company’s continued focus ongenerating good credit quality loans, competitive loan pricing and the additionof experienced lenders to the Company’s lending staff, as well as the NBCtransaction and the Davidson County, Tennessee branch opening in late 2004.Average assets for 2004 also increased to $1,130,021, an increase of $213,534,or 23.30%, from the average asset balance of $916,487 for 2003. The increase inaverage assets is due primarily to the effect of the IBC acquisition thatoccurred late in 2003. Due primarily to the additional noninterest expenseincurred as a result of the Company’s expansion strategies carried out during2004 and the attendant increase in average assets, along with the continued declinein net interest margin, the Company’s return on average assets decreased in2004 to 1.06% from 1.12% in 2003.

 

Earning assets consist of loans, investment securitiesand short-term investments that earn interest. Average earning assets during2005 were $1,275,791, an increase of 23.67% from an average of $1,031,640 in2004. The increase in average earnings assets is due primarily to the continuedincrease of organic loan growth through 2005 and the loans acquired from theClarksville transaction. 

 

Nonperforming loans include nonaccrual and classifiedloans. The Company has a policy of placing loans 90 days delinquent innonaccrual status and charging them off at 120 days past due. Other loanspast due that are well secured and in the process of collection continue to becarried on the Company’s balance sheet. For further information, see Note 1 ofthe Notes to Consolidated Financial Statements. The Company has aggressivecollection practices in which senior management is significantly and directlyinvolved.

 

TheCompany maintains an investment portfolio to provide liquidity and earnings. Investmentsat December 31, 2005 had an amortized cost of $52,844 and a market valueof $52,202 as compared to an amortized cost of $39,742 and market value of$39,824 at December 31, 2004. The Company invests principally inshorter-term, callable federal agency securities which, while usuallygenerating a higher yield than non-callable securities, are at risk of beingcalled in a declining interest rate environment. If the securities are called,the proceeds are typically invested at lower yields than those existing on thecalled securities. In 2005, the Company purchased $12,000 in federal agencysecurities, $8,310 in mortgage-backed securities and $1,000 in U.S. Treasurysecurities. The majority of the purchases, $14,763, occurred in the firstquarter of 2005 as a result of the Company’s decision to move excess funds fromthe NBC transaction to higher yielding investment securities. Also in 2005, theCompany received $2,093 from the pay down of SBA and mortgage-backed securities.The Company also received $5,100 on the maturity of various U.S. Treasury,agency and municipal securities held for sale. 

 

TheCompany’s deposits were $1,295,879 at December 31, 2005, which representsan increase of $297,857, or 29.84%, from the $998,022 of deposits at December 31, 2004.Noninterest bearing demand deposit balances increased 31.16% to $144,216 at December 31,2005 from $109,956 at December 31, 2004. Average interest-bearing depositsincreased $212,721, or 26.51%, to $1,015,227 in 2005 from $802,506 in 2004. Theincrease in average deposits is due primarily to the effect of the NBCacquisition that occurred late in 2004, the Clarksville transaction during thefirst part of the fourth quarter-2005 and the Bank’s High PerformanceChecking Program. In 2004, average interest-bearing deposits increased$137,305, or 20.64%, over 2003. The increase in average deposits is dueprimarily to the effect of the IBC acquisition that occurred late in 2003. TheNBC transaction occurred late in the fourth quarter of 2004 and had animmaterial affect on average deposits for 2004. 

 

TheCompany’s continued ability to fund its loan and overall asset growth remainsprincipally dependent upon the availability of core deposits in the Company’sexisting markets of East and Middle Tennessee. According to FDIC data, as of September 30,2005, the total deposit base of Tennessee commercial banks had a weightedaverage rate of 1.53%. Based on data from SNL Financial LC, during 2005, thepremiums charged in Tennessee by selling financial institutions for depositaccounts ranged from 6.00% to 8.50%. If the Company takes action to increaseits deposit base by either offering above-market interest rates on targeted productsor by acquiring deposits from other financial institutions and therebyincreases its overall cost of deposits, its net interest income could beadversely affected if it is unable to redeploy these funds at appropriatespreads. Should loan demand exceed deposit growth, the Company most likely willincrease its borrowings as a funding source. For further information see “MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS -Liquidity and Capital Resources” located below. 

 

33

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Interestpaid on deposits in 2005 totaled $23,481, reflecting a 2.31% cost on averageinterest-bearing deposits of $1,015,227. In 2004, interest of $12,199 was paidat a cost of 1.52% on average deposits of $802,506. In 2003, interest of$12,631 was paid at a cost of 1.90% on average deposits of $665,201. 

 

**Liquidity and Capital Resources**

** **

Liquidity. Liquidity refers to theability or the financial flexibility to manage future cash flows to meet the needsof depositors and borrowers and fund operations. Maintaining appropriate levelsof liquidity allows the Company to have sufficient funds available for reserverequirements, customer demand for loans, withdrawal of deposit balances andmaturities of deposits and other liabilities. The Company’s primary source ofliquidity is dividends paid by the Bank. Applicable Tennessee statutes andregulations impose restrictions on the amount of dividends that may bedeclared by the Bank. Further, any dividend payments are subject to thecontinuing ability of the Bank to maintain compliance with minimum federalregulatory capital requirements and to retain its characterization underfederal regulations as a “well-capitalized” institution. In addition, theCompany maintains borrowing availability with the Federal Home Loan Bank ofCincinnati (“FHLB”) approximating $22,370 at December 31, 2005. TheCompany also maintains federal funds lines of credit totaling $116,000 at ninecorrespondent banks of which $116,000 was available at December 31, 2005.The Company believes it has sufficient liquidity to satisfy its currentoperating needs.

 

On August 30, 2005, the Company entered into arevolving credit agreement with SunTrust Bank pursuant to which SunTrust agreedto loan the Company up to $35,000, with this amount being reduced to $15,000after November 30, 2005. SunTrust’s obligation to make advances to theCompany under the credit agreement terminates on August 29, 2006, unlessthe loan is extended or earlier terminated. The fee for maintaining this creditagreement is 0.15% per annum on unused commitment.

 

In 2005, operating activities of the Company provided$21,140 of cash flows, reflecting net income of $14,163 after taking intoaccount non-cash operating expenses including $6,365 in provision for loanlosses and amortization and depreciation of $3,740, and non-cash operatingincome, including $2,115 in the net change in accrued interest payable andother liabilities, offset by $2,339 in the net change in other assets. Cashflows from operating activities were increased by the proceeds from the sale ofheld-for-sale loans of $39,788, offset by cash used to originate held-for-saleloans of $40,823. 

 

Investing activities, including lending, used $214,316of the Company’s cash flows in 2005, an increase of $176,553 from $37,763 in2004. The Clarksville transaction provided $33,191 in net cash flows which wasa factor in reducing the cash used in investing activities in 2005. Cash flowsfrom investing activities also increased from the sale of OREO in the amount of$2,955. These cash inflows were reduced by the cash used in the net increase inloans in the amount of $229,042. This use of cash increased $157,445 from the$71,597 used in 2004, reflecting an increase in organic loan demand in 2005compared to 2004. In order to effectively utilize the excess liquidityexperienced earlier in the year, the Company increased its net holdings ofavailable for sale securities by $13,114. Investments in premises and equipmentof $4,657 were also undertaken in 2005 reflecting the Company’s continuedexpansion initiatives.

 

Net additional cash flows of $197,051 were provided byfinancing activities, an increase of $157,892 from $39,159 in 2004. Thefinancing cash flow activity in 2005 and 2004 with respect to notes payablereflected a net source of funds in the amounts of $19,925 and $22,192,respectively, reflecting the Company’s continued election to rely more on FHLBadvances to fund lending activity. Cash flows provided by the net change indeposits, excluding deposits totaling approximately $173,000 acquired in theClarksville transaction during the first part of the fourth quarter-2005was $124,921, an increase of $103,896 from $21,025 in 2004. During 2005, theCompany successfully completed a public offering of the Company’s common stockproviding $50,635 in funds and the Company issued an additional $3,093 ofsubordinated debentures described below. As in prior years, the Company’s cashflow from financing activities was decreased by the Company’s dividend paymentsduring 2005 of $5,294.

 

Capital Resources. The Company’scapital position is reflected in its shareholders’ equity, subject to certainadjustments for regulatory purposes. Shareholders’ equity, or capital, is ameasure of the Company’s net worth, soundness and viability. The Company’scapital continued to exceed regulatory requirements at December 31, 2005and its record of paying dividends to its stockholders continued uninterruptedduring 2005. Management believes the capital base of the Company allows it totake advantage of business opportunities while maintaining the level ofresources deemed appropriate by management of the Company to address businessrisks inherent in the Company’s daily operations.

 

34

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On September 25, 2003, the Company issued $10,310of subordinated debentures, as part of a privately placed pool of trustpreferred securities. The securities, due in 2033, bear interest at a floatingrate of 2.85% above the three-month LIBOR rate, reset quarterly, and arecallable in five years without penalty. The Company used the proceeds of theoffering to support its acquisition of IBC, and the capital raised from theoffering qualified as Tier I capital for regulatory purposes.

 

On June 28,2005, the Company issued an additional $3,093 of subordinated debentures, as part ofa privately placed pool of trust preferred securities. The securities, due in2035, bear interest at a floating rate of 1.68% above the three-month LIBORrate, reset quarterly, and are callable in five years from the date of issuancewithout penalty. The Company used the proceeds to augment its capital positionin connection with its significant asset growth, and the capital raised fromthe offering qualifies as Tier 1 capital for regulatory purposes.

 

The FRB has recently issued regulations which will allow continued inclusion of outstanding and prospective issuances of trust preferred securities as Tier 1 capital subject to stricter quantitative and qualitative limits than allowed under prior regulations. The new limits will phase in over a five-year transition period and would permit the Company’s trust preferred securities to continue to be treated as Tier 1 capital. 

 

Shareholders’ equity on December 31, 2005 was$168,021, an increase of $59,303, or 54.55%, from $108,718 on December 31,2004. The increase in shareholders’ equity arises primarily from the Company’ssuccessful public offering of 2,108,000 shares of common stock during 2005 fornet proceeds of $50,635. Net income for 2005 of $14,163 ($1.71 per share,assuming dilution) also contributed to the increase. This increase was offsetin part by dividend payments during 2005 that totaled $5,294 ($.62 pershare).

 

On September 18, 2002 the Company announced thatits Board of Directors had authorized the repurchase of up to $2,000 of theCompany’s outstanding shares of common stock beginning in October 2002.The repurchase plan was renewed by the Board of Directors in September 2003.On June 4, 2004 the Company announced that its Board of Directors hadapproved an increase in the amount authorized to be repurchased from $2,000 to$5,000. The repurchase plan is dependent upon market conditions and there is noguarantee as to the exact number of shares to be repurchased by the Company. Todate, the Company has purchased 25,700 shares at an aggregate cost ofapproximately $538 under this program which was renewed by the Company’s Boardof Directors on November 14, 2005. The repurchase program will terminateon the earlier to occur of the Company’s repurchase of the total authorizeddollar amount of the Company’s common stock or December 1, 2006.

 

35

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Risk-basedcapital regulations adopted by the FRB and the FDIC require both bank holdingcompanies and banks to achieve and maintain specified ratios of capital torisk-weighted assets. The risk-based capital rules are designed to measure“Tier 1” capital (consisting of stockholders’ equity, less goodwill) and totalcapital in relation to the credit risk of both on- and off-balance sheet items.Under the guidelines, one of four risk weights is applied to the differenton-balance sheet items. Off-balance sheet items, such as loan commitments, arealso subject to risk weighting after conversion to balance sheet equivalentamounts. All bank holding companies and banks must maintain a minimum totalcapital to total risk-weighted assets ratio of 8.00%, at least half of whichmust be in the form of core, or Tier 1, capital. At December 31,2005, the Company and the Bank each satisfied their respective minimumregulatory capital requirements, and the Bank was “well-capitalized” within themeaning of federal regulatory requirements. Actual capital levels and minimumlevels (in millions) were:

 
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **            | ** ** | **Minimum Amounts to**  | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|-----------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **            | ** ** | **be Well Capitalized** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **Minimum Required**  | ** ** | **Under Prompt** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **for Capital**       | ** ** | **Corrective**        | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Ratio (%)**         | ** ** | **Actual**                 | ** ** | **Ratio (%)**    | ** ** | **Actual**                        | ** ** | **Ratio (%)** | ** ** |
| 2005                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Total Capital (to Risk Weighted Assets)  |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 159.2      |                       | 11.5       |                       | $          | 111.2                 |       | 8.0                               |       | $ | 139.0 |   | 10.0 |   |
| Bank                                     |       | 157.1      |       | 11.3                       |       | 111.2                      |       | 8.0                   |       | 139.0                             |       | 10.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Risk Weighted Assets) |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 141.8      |                       | 10.2       |                       | $          | 55.6                  |       | 4.0                               |       | $ | 83.4 |   | 6.0 |   |
| Bank                                     |       | 139.7      |       | 10.1                       |       | 55.6                       |       | 4.0                   |       | 83.4                              |       | 6.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Average Assets)       |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 141.8      |                       | 9.3        |                       | $          | 61.2                  |       | 4.0                               |       | $ | 76.5 |   | 5.0 |   |
| Bank                                     |       | 139.7      |       | 9.1                        |       | 61.2                       |       | 4.0                   |       | 76.4                              |       | 5.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| 2004                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Total Capital (to Risk Weighted Assets)  |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 108.4      |                       | 10.5       |                       | $          | 83.0                  |       | 8.0                               |       | $ | 103.7 |   | 10.0 |   |
| Bank                                     |       | 109.5      |       | 10.6                       |       | 83.0                       |       | 8.0                   |       | 103.7                             |       | 10.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Risk Weighted Assets) |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 95.4       |                       | 9.2        |                       | $          | 41.5                  |       | 4.0                               |       | $ | 62.2 |   | 6.0 |   |
| Bank                                     |       | 96.5       |       | 9.3                        |       | 41.5                       |       | 4.0                   |       | 62.2                              |       | 6.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Average Assets)       |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 95.4       |                       | 8.5        |                       | $          | 45.1                  |       | 4.0                               |       | $ | 56.4 |   | 5.0 |   |
| Bank                                     |       | 96.5       |       | 8.6                        |       | 45.1                       |       | 4.0                   |       | 56.4                              |       | 5.0 |   |

 

36

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**Off-BalanceSheet Arrangements**

 

At December 31, 2005, the Company had outstanding unused lines of credit and standby letters of credit totaling $577,017 and unfunded loan commitments outstanding of $65,051. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If needed to fund these outstanding commitments, the Company has the ability to liquidate federal funds sold or securities available-for-sale or, on a short-term basis, to borrow from the FHLB and/or purchase federal funds from other financial institutions. At December 31, 2005, the Company had accommodations with upstream correspondent banks for unsecured federal funds lines. These accommodations have various covenants related to their term and availability, and in most cases must be repaid within less than a month. The following table presents additional information about the Company’s commitments as of December 31, 2005, which by their terms have contractual maturity dates subsequent to December 31, 2005:

 
| ** **                                | ** ** | **Less than 1** | ** ** | ** **         | ** ** | ** **         | ** ** | **More than 5** | ** ** | ** ** | ** ** |
|-------------------------------------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|---------------------------|------------|------------|------------|
| ** **                                | ** ** | **Year**                  | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **Years**                 | ** ** | **Total**  | ** ** |
|                                      |       |                      |       |               |       |               |       |                      |       |       |       |
| Commitments to make loans – fixed    |       | $                         | 11,008     |               | $          | —             |       | $                         | —     |       | $          | — |   | $ | 11,008 |   |
| Commitments to make loans – variable |       | 54,043                    |       | —             |       | —             |       | —                    |       | 54,043     |       |
| Unused lines of credit                    |       | 350,028                   |       | 90,125             |       | 23,255             |       | 83,770                    |       | 547,178    |       |
| Letters of credit                         |       | 13,366                    |       | 16,473             |       | —             |       | —                    |       | 29,839     |       |
| Total                                     |       | $                         | 428,445    |               | $          | 106,598            |       | $                         | 23,255     |       | $          | 83,770 |   | $ | 642,068 |   |

 

**Asset/Liability Management**

** **

The Company’s Asset/Liability Committee (“ALCO”)actively measures and manages interest rate risk using a process developed bythe Bank. The ALCO is also responsible for approving the Company’sasset/liability management policies, overseeing the formulation andimplementation of strategies to improve balance sheet positioning and earnings,and reviewing the Company’s interest rate sensitivity position.

 

The primary tool that management uses to measureshort-term interest rate risk is a net interest income simulation modelprepared by an independent national consulting firm and reviewed by anotherseparate and independent national consulting firm. These simulations estimatethe impact that various changes in the overall level of interest rates overone- and two-year time horizons would have on net interest income. The resultshelp the Company develop strategies for managing exposure to interest raterisk.

 

Like any forecasting technique, interest ratesimulation modeling is based on a large number of assumptions. In this case,the assumptions relate primarily to loan and deposit growth, asset andliability prepayments, interest rates and balance sheet management strategies. Managementbelieves that both individually and in the aggregate the assumptions are reasonable.Nevertheless, the simulation modeling process produces only a sophisticatedestimate, not a precise calculation of exposure.

 

The Company’s current guidelines for risk managementcall for preventive measures if a gradual 200 basis point increase or decreasein short-term rates over the next 12 months would affect net interest incomeover the same period by more than 18.5%. The Company has been operating wellwithin these guidelines. As of December 31, 2005 and 2004, based on theresults of the independent consulting firm’s simulation model, the Companycould expect net interest income to increase by approximately 10.25% and11.32%, respectively, if short-term interest rates gradually increase by 200basis points. Conversely, if short-term interest rates gradually decrease by200 basis points, net interest income could be expected to decrease byapproximately 12.50% and 14.26%, respectively. 

 

Thescenario described above, in which net interest income increases when interestrates increase and decreases when interest rates decline, is typically referredto as being “asset sensitive” because interest-earning assets exceedinterest-bearing liabilities. At December 31, 2005, approximately 50% ofthe Company’s gross loans had adjustable rates. While management believes,based on its asset/liability modeling, that the Company is asset sensitive, italso believes that a rapid, significant and prolonged increase or decrease inrates could have a substantial adverse impact on the Company’s net interestmargin.

 

37

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TheCompany’s net interest income simulation model incorporates certain assumptionswith respect to interest rate floors on certain deposits and other liabilities.Further, given the relatively low interest rate environment, a 200 basis pointdownward shock could very well reduce the costs on some liabilities below zero.In these cases, the Company’s model incorporates constraints which prevent sucha shock from simulating liability costs to zero.

 

The Company also uses an economic value of equitymodel, prepared and reviewed by the same independent national consulting firm,to complement its short-term interest rate risk analysis. The benefit of thismodel is that it measures exposure to interest rate changes over time frameslonger than the two-year net interest income simulation. The economic value ofthe Company’s equity is determined by calculating the net present value ofprojected future cash flows for current asset and liability positions based onthe current yield curve.

 

Economic value analysis has several limitations. Forexample, the economic values of asset and liability balance sheet positions donot represent the true fair values of the positions, since economic valuesreflect an analysis at one particular point in time and do not consider thevalue of the Company’s franchise. In addition, we must estimate cash flow forassets and liabilities with indeterminate maturities. Moreover, the model’spresent value calculations do not take into consideration future changes in thebalance sheet that will likely result from ongoing loan and deposit activitiesconducted by the Company’s core business. Finally, the analysis requiresassumptions about events which span several years. Despite its limitations, theeconomic value of equity model is a relatively sophisticated tool forevaluating the longer-term effect of possible interest rate movements.

 

The Company’s current guidelines for risk managementcall for preventive measures if an immediate 200 basis point increase ordecrease in interest rates would reduce the economic value of equity by morethan 23%. The Company has been operating well within these guidelines. As of December 31,2005 and 2004, based on the results of the independent national consulting firm’ssimulation model and reviewed by the separate and independent nationalconsulting firm, the Company could expect its economic value of equity toincrease by approximately 11.14% and 12.77%, respectively, if short-terminterest rates immediately increased by 200 basis points. Conversely, ifshort-term interest rates immediately decrease by 200 basis points, economicvalue of equity could be expected to decrease by approximately 16.50% and17.06%, respectively. The lower percentage changes in economic value of equityas of December 31, 2005, compared to December 31, 2004, are primarilydue to a combination of extending asset durations and further reflects customerliability preferences of remaining short in a rising rate environment.

 

**Disclosure of ContractualObligations**

 

In the ordinary course of operations, the Companyenters into certain contractual obligations. Such obligations include thefunding of operations through debt issuances as well as leases for premises andequipment. The following table summarizes the Company’s significant fixed anddeterminable contractual obligations as of December 31, 2005: 

 
| ** **                         | ** ** | **Less than 1** | ** ** | ** **         | ** ** | ** **         | ** ** | **More than 5** | ** ** | ** ** | ** ** |
|------------------------------------|------------|---------------------------|------------|--------------------|------------|--------------------|------------|---------------------------|------------|------------|------------|
| ** **                         | ** ** | **Year**                  | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **Years**                 | ** ** | **Total**  | ** ** |
|                               |       |                      |       |               |       |               |       |                      |       |       |       |
| Deposits without a stated maturity |       | $                         | 658,670    |               | $          | —             |       | $                         | —     |       | $          | — |   | $ | 658,670 |   |
| Certificate of deposits            |       | 455,179                   |       | 124,549            |       | 52,101             |       | 5,380                     |       | 637,209    |       |
| Repurchase agreements              |       | 17,498                    |       | —             |       | —             |       | —                    |       | 17,498     |       |
| FHLB advances and notes payable    |       | 35,382                    |       | 7,612              |       | 55,358             |       | 6,794                     |       | 105,146    |       |
| Subordinated debentures            |       | —                    |       | —             |       | —             |       | 13,403                    |       | 13,403     |       |
| Operating lease obligations        |       | 462                       |       | 693                |       | 397                |       | 1,136                     |       | 2,688      |       |
| Deferred compensation              |       | 524                       |       | 1,242              |       | —             |       | 866                       |       | 2,632      |       |
| Purchase obligations               |       | 237                       |       | —             |       | —             |       | —                    |       | 237        |       |
| Total                              |       | $                         | 1,167,952  |               | $          | 134,096            |       | $                         | 107,856    |       | $          | 27,579 |   | $ | 1,437,483 |   |

 

38

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Additionally, the Company routinely enters intocontracts for services. These contracts may require payment for servicesto be provided in the future and may also contain penalty clauses forearly termination of the contract. Management is not aware of any additionalcommitments or contingent liabilities which may have a material adverseimpact on the liquidity or capital resources of the Company. 

 

**Inflation**

** **

The effect of inflation on financial institutionsdiffers from its impact on other types of businesses. Since assets andliabilities of banks are primarily monetary in nature, they are more affectedby changes in interest rates than by the rate of inflation.

 

Inflation generates increased credit demand andfluctuation in interest rates. Although credit demand and interest rates arenot directly tied to inflation, each can significantly impact net interestincome. As in any business or industry, expenses such as salaries, equipment,occupancy, and other operating expenses also are subject to the upwardpressures created by inflation.

 

Since the rate of inflation has been stable during thelast several years, the impact of inflation on the earnings of the Company hasbeen insignificant.

 

**Effect of New Accounting Standards**

** **

In December 2004,the FASB issued SFAS No. 123(R), *Accounting for Stock-BasedCompensation* (SFAS No. 123(R)). SFAS No. 123(R)establishes standards for the accounting for transactions in which an entity exchangesits equity instruments for goods or services. This Statement focuses primarilyon accounting for transactions in which an entity obtains employee services inshare-based payment transactions. SFAS No. 123(R) requires that the fairvalue of such equity instruments be recognized as an expense in the historicalfinancial statements as services are performed. Prior to SFAS No. 123(R),only certain pro forma disclosures of fair value were required. The provisionsof this Statement are effective for fiscal years beginning after June 15,2005. Accordingly, the Company will adopt SFAS No. 123(R) commencing withthe quarter ending March 31, 2006. If the Company had included the cost ofemployee stock option compensation in our consolidated financial statements,its net income for the fiscal years ended December 31, 2005, 2004 and 2003would have decreased by approximately $193, $148, and $106, respectively. 

 

In March 2005, theSEC released Staff Accounting Bulletin (SAB) No. 107, *Share-Based Payment.* SAB No. 107expresses views of the SEC staff regarding the application of SFAS No. 123(R).Among other things, SAB No. 107 provides interpretive guidance related tothe interaction between SFAS No. 123(R) and certain SEC rules andregulations, as well as provides the staff’s view regarding the valuation ofshare-based payment arrangements for public companies.

 

In May 2005, theFASB issued SFAS No. 154, *AccountingChanges and Error Corrections.*This statement replaces APB Opinion No. 20,*Accounting Changes*and SFAS No. 3,*Reporting Accounting Changes in InterimFinancial Statements.*SFAS No. 154 changes the requirements forthe accounting for and reporting of a voluntary change in accounting principle.SFAS No. 154 requires retrospective application to prior periods forchanges in accounting principles or error corrections, unless it is impracticalto determine the period-specific effects or when a pronouncement includesspecific transition provisions. This Statement is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company does not expect the adoption of SFAS No. 154 (revised2004) will have a material impact on its financial condition or result ofoperations.

 

In November 2005, the FASB issued Staff Position(FSP) FAS 115-1 and FAS 124-1, *the Meaningof Other-Than-Temporary Impairment and Its Application to Certain Investments,*whichamends SFAS No. 115, *Accounting forCertain Investments in Debt and Equity Securities,*and SFAS No. 124,*Accounting for Certain Investments Held byNot-for-Profit Organizations,* and APB Opinion No. 18, *The Equity Method of Accounting for Investments inCommon Stock.* This FSP addresses the determination as to when aninvestment is considered impaired, whether the impairment is other thantemporary, and the measurement of an impairment loss. FSP FAS 115-1 and FAS124-1 also includes accounting considerations subsequent to the recognition ofan other-than-temporary impairment and requires certain disclosures about unrealizedlosses that have not been recognized as other-than-temporary impairments. Theguidance in this FSP is effective for reporting periods beginning after December 15,2005. The Company does not expect the adoption of FSP FAS 115-1 and FAS 124-1will have a material impact on its financial condition or results ofoperations. 

 

39

----

 

**ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

** **

Theinformation set forth on pages 25 through 39 of Item 7, “MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS –Asset/Liability Management” is incorporated herein by reference.

 

40

----

 

**Management Report on Internal Control OverFinancial Reporting**

 

Management of Greene County Bancshares, Inc. andsubsidiaries (the “Company”) is responsible for establishing and maintainingeffective internal control over financial reporting as defined in Rules 13a-15(f) and15d-15(d) under the Securities Exchange Act of 1934. Internal control overfinancial reporting is a process designed to provide reasonable assuranceregarding the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with U.S. generallyaccepted accounting principles. 

 

Under the supervision and with the participation ofmanagement, including the principal executive officer and principal financialofficer, the Company conducted an evaluation of the effectiveness of internalcontrol over financial reporting based on the framework in Internal Control –Integrated Framework issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on this evaluation under the framework in InternalControl – Integrated Framework, management of the Company has concluded theCompany maintained effective internal control over financial reporting as of December 31,2005. 

 

Internal control over financial reporting cannotprovide absolute assurance of achieving financial reporting objectives becauseof its inherent limitations. Internal control over financial reporting is aprocess that involves human diligence and compliance and is subject to lapsesin judgment and breakdowns resulting from human failures. Internal control overfinancial reporting can also be circumvented by collusion or impropermanagement override. Because of such limitations, there is a risk that materialmisstatements may not be prevented or detected on a timely basis byinternal control over financial reporting. 

 

Dixon Hughes PLLC, an independent, registered publicaccounting firm, has audited the Company’s consolidated financial statements asof and for the year ended December 31, 2005, and has issued an attestationreport on the Company’s assessment of the effectiveness of the Company’sinternal control over financial reporting as of December 31, 2005, whichis included herein on page 42.

 

41

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**ITEM 8.****                  FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

 

**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

THE BOARD OF DIRECTORS 

GREENE COUNTY BANCSHARES, INC.

 

We have audited management’s assessment, included inthe accompanying Greene County Bancshares, Inc. and Subsidiaries *Management Report on Internal Control over Financial Reporting*,that Greene County Bancshares, Inc. maintained effective internal controlover financial reporting as of December 31, 2005, based on criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (“COSO”). Greene CountyBancshares, Inc.’s management is responsible for maintaining effectiveinternal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting. Our responsibilityis to express an opinion on management’s assessment and an opinion on theeffectiveness of the Company’s internal control over financial reporting basedon our audit. 

 

We conducted our audit in accordance with the standardsof the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether effective internal control over financial reporting wasmaintained in all material respects. Our audit included obtaining anunderstanding of internal control over financial reporting, evaluatingmanagement’s assessment, testing and evaluating the design and operatingeffectiveness of internal control, and performing such other procedures as weconsidered necessary in the circumstances. We believe that our audit provides areasonable basis for our opinion. 

 

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

 

Because of its inherent limitations, internal controlover financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes inconditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that GreeneCounty Bancshares, Inc. maintained effective internal control overfinancial reporting as of December 31, 2005, is fairly stated, in allmaterial respects, based on criteria established in Internal Control—IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission (“COSO”). Also, in our opinion, Greene County Bancshares, Inc.maintained, in all material respects, effective internal control over financialreporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (“COSO”). 

 

We also have audited, in accordance with the standardsof the Public Company Accounting Oversight Board (United States), theconsolidated balance sheets of Greene County Bancshares, Inc. andsubsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of income, changes in shareholders’ equity, and cashflows for the years then ended, and our report dated March 10, 2006,expressed an unqualified opinion on those consolidated financial statements. 

 
|                 | /s/ Dixon Hughes  PLLC |   |
|----------------------|------------------------|--------|
|                 |
| Atlanta, Georgia     |
| March 10,  2006 |

 

42

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**REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

 

BOARD OF DIRECTORS ANDSHAREHOLDERS 

GREENE COUNTY BANCSHARES, INC.

 

We have audited theaccompanying consolidated balance sheets of Greene County Bancshares, Inc.and subsidiaries as of December 31, 2005 and 2004, and the relatedconsolidated statements of income, changes in shareholders’ equity and cashflows for the years then ended. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits. 

 

We conducted our auditsin accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by Management, as well as evaluating the overall financialstatement presentation. We believe that our audits provide a reasonable basisfor our opinion. 

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the financial position of Greene County Bancshares, Inc.and subsidiaries as of December 31, 2005 and 2004, and the results oftheir operations and their cash flows for the years then ended, inconformity with accounting principles generally accepted in the United Statesof America. 

 

We have also audited, inaccordance with the standards of the Public Company Accounting Oversight Board(United States), the effectiveness of Greene County Bancshares’ internalcontrol over financial reporting as of December 31, 2005, based on criteria established in InternalControl—Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission, and our report dated March 10,2006 expressed unqualified opinions on both management’s**assessment of the Company’s internalcontrol over**financial reportingand the effectiveness of the Company’s internal control over**financial reporting. 

 

 
|                 | /s/ Dixon Hughes  PLLC |   |
|----------------------|------------------------|--------|
|                 |
| Atlanta, Georgia     |
| March 10,  2006 |

 

43

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# **REPORT OF INDEPENDENT REGISTEREDPUBLIC ACCOUNTING FIRM**

# ** **

Board of Directors andShareholders

Greene County Bancshares, Inc.

Greeneville, Tennessee

 

We have audited theaccompanying consolidated statements of income, changes in shareholders’equity, and cash flows of Greene County Bancshares, Inc. for the yearended December 31, 2003. These financial statements are the responsibilityof the Company’s management. Our responsibility is to express an opinion onthese financial statements based on our audit.

 

We conducted our audit inaccordance with standards of the Public Company Accounting Oversight Board(United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. An audit includes examining, on a test basis,evidence supporting the amounts and disclosures in the financial statements. Anaudit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financialstatement presentation. We believe our audit provides a reasonable basis forour opinion.

 

In our opinion, theconsolidated financial statements referred to above present fairly, in allmaterial respects, the results of operations and cash flows of Greene CountyBancshares, Inc. for the year ended December 31, 2003, in conformitywith U.S. generally accepted accounting principles.

 

 
|                   |   | /s/ Crowe Chizek  and Company LLC |   |
|------------------------|--------|-----------------------------------|--------|
|                   |
| Oak Brook,  Illinois   |
| January 16,  2004 |

 

44

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**GREENE COUNTY BANCSHARES, INC.**

**CONSOLIDATED BALANCE SHEETS**

**December 31, 2005 and 2004**

**(Amounts in thousands, except share and per sharedata)**

 
| ** **                                                                                      | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|
| **ASSETS**                                                                                      |       |      |       |      |       |
| Cash and due from banks                                                                         |       | $         | 46,136     |      | $          | 30,727 |   |
| Federal funds sold                                                                              |       | 28,387    |       | 39,921    |       |
| Cash and cash equivalents                                                                       |       | 74,523    |       | 70,648    |       |
| Securities available for sale                                                                   |       | 48,868    |       | 35,318    |       |
| Securities held to maturity (with a market value of  $3,335 and $4,506)                         |       | 3,379     |       | 4,381     |       |
| Loans held for sale                                                                             |       | 2,686     |       | 1,151     |       |
| Loans, net of unearned interest                                                                 |       | 1,378,642 |       | 1,046,867 |       |
| Allowance for loan losses                                                                       |       | (19,739   | )          | (15,721   | )          |
| Premises and equipment, net                                                                     |       | 49,985    |       | 35,591    |       |
| FHLB, Bankers Bank, and other stock, at cost                                                    |       | 6,489     |       | 6,211     |       |
| Cash surrender value of life insurance                                                          |       | 19,764    |       | 15,471    |       |
| Goodwill                                                                                        |       | 31,327    |       | 18,282    |       |
| Core deposit intangible                                                                         |       | 8,295     |       | 5,413     |       |
| Other assets                                                                                    |       | 15,770    |       | 9,791     |       |
|                                                                                            |       |      |       |      |       |
| Total assets                                                                                    |       | $         | 1,619,989  |      | $          | 1,233,403 |   |
|                                                                                            |       |      |       |      |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                   |       |      |       |      |       |
| Liabilities                                                                                     |       |      |       |      |       |
| Noninterest-bearing deposits                                                                    |       | $         | 144,216    |      | $          | 109,956 |   |
| Interest-bearing deposits                                                                       |       | 1,151,663 |       | 888,066   |       |
| Total deposits                                                                                  |       | 1,295,879 |       | 998,022   |       |
|                                                                                            |       |      |       |      |       |
| Repurchase agreements                                                                           |       | 17,498    |       | 13,868    |       |
| FHLB advances and notes payable                                                                 |       | 105,146   |       | 85,222    |       |
| Subordinated debentures                                                                         |       | 13,403    |       | 10,310    |       |
| Accrued interest payable and other liabilities                                                  |       | 20,042    |       | 17,263    |       |
|                                                                                            |       |      |       |      |       |
| Total liabilities                                                                               |       | 1,451,968 |       | 1,124,685 |       |
|                                                                                            |       |      |       |      |       |
| Shareholders’ equity                                                                       |       |      |       |      |       |
| Common stock: $2 par, 15,000,000 shares authorized,  9,766,336 and 7,647,740 shares outstanding |       | 19,533    |       | 15,296    |       |
| Additional paid in capital                                                                      |       | 70,700    |       | 24,160    |       |
| Retained earnings                                                                               |       | 78,158    |       | 69,289    |       |
| Accumulated other comprehensive loss                                                            |       | (370      | )          | (27       | )          |
|                                                                                            |       |      |       |      |       |
| Total shareholders’ equity                                                                 |       | 168,021   |       | 108,718   |       |
|                                                                                            |       |      |       |      |       |
| Total liabilities and shareholders’ equity                                                 |       | $         | 1,619,989  |      | $          | 1,233,403 |   |

 

See accompanying notes.

 

45

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**GREENE COUNTY BANCSHARES, INC.**

**CONSOLIDATED STATEMENTS OF INCOME**

**Years ended December 31, 2005, 2004 and 2003**

**(Amounts in thousands, except share and per sharedata)**

 
| ** **                                          | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest income                                     |       |     |       |     |       |     |       |
| Interest and fees on loans                          |       | $        | 84,074     |     | $          | 63,580   |       | $ | 55,444 |   |
| Taxable securities                                  |       | 1,920    |       | 1,040    |       | 947      |       |
| Nontaxable securities                               |       | 138      |       | 164      |       | 40       |       |
| FHLB, Bankers Bank and other stock                  |       | 282      |       | 230      |       | 192      |       |
| Federal funds sold and other                        |       | 777      |       | 62       |       | 114      |       |
| Total interest income                               |       | 87,191   |       | 65,076   |       | 56,737   |       |
|                                                |       |     |       |     |       |     |       |
| Interest expense                                    |       |     |       |     |       |     |       |
| Deposits                                            |       | 23,481   |       | 12,199   |       | 12,631   |       |
| Federal funds purchased and repurchase agreements   |       | 414      |       | 162      |       | 112      |       |
| Notes payable and subordinated debentures           |       | 4,510    |       | 3,697    |       | 3,171    |       |
| Total interest expense                              |       | 28,405   |       | 16,058   |       | 15,914   |       |
|                                                |       |     |       |     |       |     |       |
| Net interest income                                 |       | 58,786   |       | 49,018   |       | 40,823   |       |
|                                                |       |     |       |     |       |     |       |
| Provision for loan losses                           |       | 6,365    |       | 5,836    |       | 5,775    |       |
|                                                |       |     |       |     |       |     |       |
| Net interest income after provision for loan losses |       | 52,421   |       | 43,182   |       | 35,048   |       |
|                                                |       |     |       |     |       |     |       |
| Noninterest income                                  |       |     |       |     |       |     |       |
| Service charges and fees                            |       | 11,019   |       | 9,074    |       | 7,898    |       |
| Mortgage banking income                             |       | 664      |       | 704      |       | 1,389    |       |
| Gain on sales of OREO and repossessed assets        |       | —   |       | 400      |       | 96       |       |
| Other                                               |       | 3,073    |       | 2,850    |       | 2,205    |       |
| Total noninterest income                            |       | 14,756   |       | 13,028   |       | 11,588   |       |
|                                                |       |     |       |     |       |     |       |
| Noninterest expense                                 |       |     |       |     |       |     |       |
| Salaries and employee benefits                      |       | 22,185   |       | 19,189   |       | 16,664   |       |
| Occupancy expense                                   |       | 3,570    |       | 2,948    |       | 2,337    |       |
| Equipment expense                                   |       | 3,703    |       | 3,075    |       | 2,365    |       |
| Professional services                               |       | 1,241    |       | 1,645    |       | 966      |       |
| Advertising                                         |       | 2,529    |       | 971      |       | 473      |       |
| Loss on OREO and repossessed assets                 |       | 109      |       | —   |       | —   |       |
| Core deposit intangible amortization                |       | 854      |       | 624      |       | 254      |       |
| Other                                               |       | 10,149   |       | 8,531    |       | 7,559    |       |
| Total noninterest expense                           |       | 44,340   |       | 36,983   |       | 30,618   |       |
|                                                |       |     |       |     |       |     |       |
| Income before income taxes                          |       | 22,837   |       | 19,227   |       | 16,018   |       |
|                                                |       |     |       |     |       |     |       |
| Provision for income taxes                          |       | 8,674    |       | 7,219    |       | 5,781    |       |
|                                                |       |     |       |     |       |     |       |
| Net income                                          |       | $        | 14,163     |     | $          | 12,008   |       | $ | 10,237 |   |
|                                                |       |     |       |     |       |     |       |
| Earnings per share:                                 |       |     |       |     |       |     |       |
| Basic                                               |       | $        | 1.73       |     | $          | 1.57     |       | $ | 1.48 |   |
| Diluted                                             |       | $        | 1.71       |     | $          | 1.55     |       | $ | 1.47 |   |

 

See accompanying notes.

 

46

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**GREENE COUNTY BANCSHARES, INC.**

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’EQUITY**

**Years ended December 31, 2005, 2004 and 2003**

**(Amounts in thousands, except share and per sharedata)**

 
| ** **                                                              | ** ** | ** ** | ** ** | ** **     | ** ** | ** **   | ** ** | **Accumulated**        | ** ** | ** **             | ** ** |
|-------------------------------------------------------------------------|------------|------------|------------|----------------|------------|--------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                              | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **   | ** ** | **Other**              | ** ** | **Total**              | ** ** |
| ** **                                                              | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Retained** | ** ** | **Comprehensive**      | ** ** | **Shareholders’** | ** ** |
| ** **                                                              | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Earnings** | ** ** | **Income (loss)** | ** ** | **Equity**             | ** ** |
|                                                                    |       |       |       |           |       |         |       |                   |       |                   |       |
| **Balance, January 1, 2003**                                       |       | $          | 13,641     |           | $          | 4,870        |       | $                      | 55,928     |                   | $          | 156 |   | $ | 74,595 |   |
|                                                                    |       |       |       |           |       |         |       |                   |       |                   |       |
| Issuance of 3,275 shares under stock option plan                        |       | 7          |       | 37             |       | —       |       | —                 |       | 44                     |       |
| Issuance of 836,114 shares and stock options in an  acquisition         |       | 1,672      |       | 19,575         |       | —       |       | —                 |       | 21,247                 |       |
| Dividends paid ($.59 per share)                                         |       | —     |       | —         |       | (4,218       | )          | —                 |       | (4,218                 | )          |
| Comprehensive income:                                                   |       |       |       |           |       |         |       |                   |       |                   |       |
| Net income                                                              |       | —     |       | —         |       | 10,237       |       | —                 |       | 10,237                 |       |
| Change in unrealized gains (losses), net of  reclassification and taxes |       | —     |       | —         |       | —       |       | 30                     |       | 30                     |       |
| Total comprehensive income                                              |       |       |       |           |       |         |       |                   |       | 10,267                 |       |
| **Balance, December 31, 2003**                                     |       | 15,320     |       | 24,482         |       | 61,947       |       | 186                    |       | 101,935                |       |
|                                                                    |       |       |       |           |       |         |       |                   |       |                   |       |
| Common stock transactions:                                              |       |       |       |           |       |         |       |                   |       |                   |       |
| Issuance of 13,511 shares under stock option plan                       |       | 27         |       | 147            |       | —       |       | —                 |       | 174                    |       |
| Repurchase of common stock, 25,700 shares                               |       | (51        | )          | (487           | )          | —       |       | —                 |       | (538                   | )          |
| Tax benefit from exercise of nonincentive stock  options                |       |       |       | 18             |       | —       |       | —                 |       | 18                     |       |
| Dividends ($.61 per share)                                              |       | —     |       | —         |       | (4,666       | )          | —                 |       | (4,666                 | )          |
| Comprehensive income:                                                   |       |       |       |           |       |         |       |                   |       |                   |       |
| Net income                                                              |       | —     |       | —         |       | 12,008       |       | —                 |       | 12,008                 |       |
| Change in unrealized gains (losses), net of  reclassification and taxes |       | —     |       | —         |       | —       |       | (213                   | )          | (213                   | )          |
| Total comprehensive income                                              |       |       |       |           |       |         |       |                   |       | 11,795                 |       |
| **Balance, December 31, 2004**                                     |       | 15,296     |       | 24,160         |       | 69,289       |       | (27                    | )          | 108,718                |       |
|                                                                    |       |       |       |           |       |         |       |                   |       |                   |       |
| Common stock transactions:                                              |       |       |       |           |       |         |       |                   |       |                   |       |
| Issuance of 10,596 shares under stock option plan                       |       | 21         |       | 121            |       | —       |       | —                 |       | 142                    |       |
| Issuance of 2,108,000 shares in public offering                         |       | 4,216      |       | 46,419         |       | —       |       | —                 |       | 50,635                 |       |
| Dividends ($.62 per share)                                              |       | —     |       | —         |       | (5,294       | )          | —                 |       | (5,294                 | )          |
| Comprehensive income:                                                   |       |       |       |           |       |         |       |                   |       |                   |       |
| Net income                                                              |       | —     |       | —         |       | 14,163       |       | —                 |       | 14,163                 |       |
| Change in unrealized gains (losses), net of  reclassification and taxes |       | —     |       | —         |       | —       |       | (343                   | )          | (343                   | )          |
| Total comprehensive income                                              |       |       |       |           |       |         |       |                   |       | 13,820                 |       |
| **Balance, December 31, 2005**                                     |       | $          | 19,533     |           | $          | 70,700       |       | $                      | 78,158     |                   | $          | (370 | ) | $ | 168,021 |   |

 

See accompanying notes.

 

47

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**GREENE COUNTY BANCSHARES, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**Years ended December 31, 2005, 2004 and 2003**

**(Amounts in thousands)**

 
| ** **                                                                 | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|
| **Cash flows from operating activities**                                   |       |       |       |       |       |       |       |
| Net income                                                                 |       | $          | 14,163     |       | $          | 12,008     |       | $ | 10,237 |   |
| Adjustments to reconcile net income to net cash from  operating activities |       |       |       |       |       |       |       |
| Provision for loan losses                                                  |       | 6,365      |       | 5,836      |       | 5,775      |       |
| Depreciation and amortization                                              |       | 3,740      |       | 3,120      |       | 2,199      |       |
| Security amortization and accretion, net                                   |       | 13         |       | 153        |       | 76         |       |
| FHLB stock dividends                                                       |       | (278       | )          | (219       | )          | (191       | )          |
| Net gain on sale of mortgage loans                                         |       | (501       | )          | (515       | )          | (1,066     | )          |
| Originations of mortgage loans held for sale                               |       | (40,823    | )          | (46,982    | )          | (74,313    | )          |
| Proceeds from sales of mortgage loans                                      |       | 39,789     |       | 49,892     |       | 78,478     |       |
| Increase in cash surrender value of life insurance                         |       | (635       | )          | (521       | )          | (469       | )          |
| Net losses from sales of fixed assets                                      |       | 20         |       | 41         |       | 40         |       |
| Net loss (gain) on OREO and repossessed assets                             |       | 109        |       | (400       | )          | (96        | )          |
| Deferred tax (benefit) expense                                             |       | (767       | )          | 572        |       | 182        |       |
| Net changes:                                                               |       |       |       |       |       |       |       |
| Other assets                                                               |       | (2,170     | )          | 1,101      |       | (75        | )          |
| Accrued interest payable and other liabilities                             |       | 2,115      |       | 3,825      |       | (1,200     | )          |
| Net cash provided from operating activities                                |       | 21,140     |       | 27,911     |       | 19,577     |       |
| **Cash flows from investing activities**                                   |       |       |       |       |       |       |       |
| Purchase of securities available for sale                                  |       | (21,310    | )          | (13,500    | )          | (30,842    | )          |
| Proceeds from maturities of securities held for sale                       |       | 7,193      |       | 11,232     |       | 41,401     |       |
| Proceeds from maturities of securities held to  maturity                   |       | 1,003      |       | 903        |       | 102        |       |
| Purchase of life insurance                                                 |       | (3,657     | )          | (2,500     | )          | (2,750     | )          |
| Net change in loans                                                        |       | (229,042   | )          | (71,597    | )          | (100,551   | )          |
| Net cash received in acquisitions                                          |       | 33,191     |       | 38,003     |       | 28,390     |       |
| Proceeds from sale of other real estate                                    |       | 2,955      |       | 3,714      |       | 5,641      |       |
| Improvement to other real estate                                           |       | —     |       | (6         | )          | (71        | )          |
| Proceeds from sale of fixed assets                                         |       | 8          |       | 32         |       | 81         |       |
| Premises and equipment expenditures                                        |       | (4,657     | )          | (4,044     | )          | (4,268     | )          |
| Net cash used in investing activities                                      |       | (214,316   | )          | (37,763    | )          | (62,867    | )          |
| **Cash flows from financing activities**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in deposits                                                     |       | 124,920    |       | 21,025     |       | 33,757     |       |
| Net change in repurchase agreements                                        |       | 3,630      |       | 972        |       | 1,108      |       |
| Proceeds from FHLB advances and notes payable                              |       | 303,755    |       | 219,950    |       | 234,064    |       |
| Proceeds from subordinated debentures                                      |       | 3,093      |       | —     |       | 10,310     |       |
| Repayments of FHLB advances and notes payable                              |       | (283,830   | )          | (197,758   | )          | (253,393   | )          |
| Dividends paid                                                             |       | (5,294     | )          | (4,666     | )          | (4,218     | )          |
| Proceeds from issuance of common stock                                     |       | 50,777     |       | 174        |       | 44         |       |
| Repurchase of common stock                                                 |       | —     |       | (538       | )          | —     |       |
| Net cash provided from financing activities                                |       | 197,051    |       | 39,159     |       | 21,672     |       |
| **Net change in cash and cash equivalents**                                |       | 3,875      |       | 29,307     |       | (21,618    | )          |
| Cash and cash equivalents, beginning of year                               |       | 70,648     |       | 41,341     |       | 62,959     |       |
| **Cash and cash equivalents, end of year**                                 |       | $          | 74,523     |       | $          | 70,648     |       | $ | 41,341 |   |
| **Supplemental disclosures – cash and noncash**                       |       |       |       |       |       |       |       |
| Interest paid                                                              |       | $          | 27,937     |       | $          | 16,681     |       | $ | 15,822 |   |
| Income taxes paid                                                          |       | 7,694      |       | 5,524      |       | 4,375      |       |
| Loans converted to other real estate                                       |       | 6,403      |       | 5,102      |       | 6,529      |       |
| Unrealized (loss) gain on available for sale  securities, net of tax       |       | (343       | )          | (213       | )          | 186        |       |
| Fair value of assets acquired                                              |       | 141,300    |       | 32,641     |       | 188,779    |       |
| Fair value of liabilities acquired                                         |       | 173,600    |       | 70,104     |       | 158,476    |       |

 

See accompanying notes.

 

48

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**GREENE COUNTY BANCSHARES, INC.**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

**(Amounts in thousands, exceptshare and per share data)**

**December 31, 2005, 2004 and2003**

 

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

 

Principles of Consolidation: Theconsolidated financial statements include the accounts of Greene CountyBancshares, Inc. (the “Company”) and its wholly owned subsidiary, GreeneCounty Bank (the “Bank”), and the Bank’s wholly owned subsidiaries, SuperiorFinancial Services, Inc., GCB Acceptance Corp., Inc., and FairwayTitle Company, Inc. All significant inter-company balances and transactionshave been eliminated in consolidation.

 

Nature ofOperations: The Company primarily provides financial servicesthrough its offices in Eastern, Middle and Southeastern Tennessee, WesternNorth Carolina and Southwestern Virginia. Its primary deposit products arechecking, savings, and term certificate accounts, and its primary lendingproducts are residential mortgage, commercial, and installment loans. Substantiallyall loans are secured by specific items of collateral including businessassets, consumer assets and real estate. Commercial loans are expected to berepaid from cash flow from operations of businesses. Real estate loans aresecured by both residential and commercial real estate. Other financialinstruments that potentially represent concentrations of credit risk includedeposit accounts in other financial institutions.

 

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

 

Cash Flows:  Cash and cash equivalents includes cash,deposits with other financial institutions under 90 days, and federal fundssold. Net cash flows are reported for loan, deposit and other borrowing transactions.

 

Securities:  Securities are classified as held to maturityand carried at amortized cost when management has the positive intent andability to hold them to maturity. Securities are classified as available forsale when they might be sold before maturity. Securities available for sale arecarried at fair value, with unrealized holding gains and losses reported inaccumulated other comprehensive income. 

 

Interest income includesamortization of purchase premium or discount and is recognized based upon thestraight-line method. Gains and losses on sales are based on the amortized costof the security sold. Securities are written down to fair value when a declinein fair value is other than temporary.

 

Investments inEquity Securities Carried at Cost:  Investment in Federal Home Loan Bank (“FHLB”)stock, which is carried at cost because it can only be redeemed at par, is arequired investment based on the Bank’s amount of borrowing. The Bank alsocarries certain other equity investments at cost, which approximates fairvalue.

 

Loans:  Loans are reported at the principal balanceoutstanding, net of unearned interest, deferred loan fees and costs, andallowance for loan losses.

 

Interest income isreported on the interest method over the loan term. Interest income on mortgageand commercial loans is discontinued at the time the loan is 90 days delinquentunless the loan is well secured and in process of collection. Most consumerloans are charged off no later than 120 days past due. In all cases, loans areplaced on nonaccrual or charged off at an earlier date if collection ofprincipal and interest is doubtful. Interest accrued but not collected isreversed against interest income when a loan is placed on nonaccrual status.

 

49

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Interest received isrecognized on the cash basis or cost recovery method until qualifying forreturn to accrual status. Accrual is resumed when all contractually duepayments are brought current and future payments are reasonably assured.

 

Allowance for LoanLosses: The allowance for loan losses is a valuationallowance for probable incurred credit losses, increased by the provision forloan losses and decreased by charge-offs less recoveries. Management estimatesthe allowance balance required using past loan loss experience, known andinherent risks in the nature and volume of the portfolio, information aboutspecific borrower situations and estimated collateral values, economicconditions, and other factors. Allocations of the allowance may be madefor specific loans, but the entire allowance is available for any loan that, inmanagement’s judgment, should be charged-off. Loan losses are charged againstthe allowance when management believes the uncollectibility of a loan isconfirmed.

 

The Bank uses severalfactors in determining if a loan is impaired. The internal asset classificationprocedures include a thorough review of significant loans and lendingrelationships and include the accumulation of related data. This data includesloan payment and collateral status, borrowers’ financial data and borrowers’operating factors such as cash flows, operating income, liquidity, leverage andloan documentation, and any significant changes. A loan is considered impaired,based on current information and events, if it is probable that the Bank willbe unable to collect the scheduled payments of principal or interest when dueaccording to the contractual terms of the loan agreement. Uncollateralizedloans are measured for impairment based on the present value of expected futurecash flows discounted at the historical effective interest rate, while allcollateral-dependent loans are measured for impairment based on the fair valueof the collateral. Larger groups of smaller balance, homogeneous loans, such asconsumer and residential real estate loans, are collectively evaluated forimpairment, and accordingly, they are not separately identified for impairmentdisclosures.

 

Foreclosed Assets:Assets acquired through or instead of loan foreclosure are initially recordedat the lower of cost or market when acquired, establishing a new cost basis. Iffair value declines, a valuation allowance is recorded through expense. Costsafter acquisition are expensed. 

 

Premises andEquipment: Premises and equipment are stated at cost lessaccumulated depreciation. Depreciation is computed over the asset useful liveson a straight-line basis. Buildings and related components have useful livesranging from 10 to 40 years, while furniture, fixtures and equipment haveuseful lives ranging from 3 to 10 years. Leasehold improvements are amortizedover the lesser of the life of the asset or lease term.

 

Mortgage BankingActivities: Mortgage loans originated and intended for salein the secondary market are carried at the lower of aggregate cost or marketvalue. The Company controls its interest rate risk with respect to mortgageloans held for sale and loan commitments expected to close by usually enteringinto agreements to sell loans. The Company records loan commitments related tothe origination of mortgage loans held for sale as derivative instruments. TheCompany’s commitments are for fixed rated mortgage loans, generally last 60 to90 days and are at market rates when initiated. The Company had $16,138 inoutstanding loan commitment derivatives at December 31, 2005. Salescontract derivatives are entered into for amounts and terms offsetting theinterest rate risk of loan commitment derivatives, and both are carried attheir fair value with changes included in earnings. Substantially all of thegain on sale generated from mortgage banking activities continues to berecorded when closed loans are delivered into the sales contracts. Theaggregate market value of mortgage loans held for sale considers the salesprices of such agreements. The Company also provides currently for any losseson uncovered commitments to lend or sell. The Company sells mortgage loansservicing released.

 

Bank Owned Life Insurance: The Company has purchased life insurance policies on certain keyexecutives. Company owned life insurance is recorded at its cash surrendervalue or the amount that can be realized.

 

50

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Goodwill and Other Intangible Assets:Goodwill results from prior business acquisitions and represents the excess ofthe purchase price over the fair value of acquired tangible assets andliabilities and identifiable intangible assets. Upon adopting new accountingguidance on January 1, 2002, the Company ceased amortizing goodwill. Goodwillis assessed at least annually for impairment and any such impairment will berecognized in the period identified. 

 

Other intangible assets consist of core depositintangibles arising from whole bank and branch acquisitions. They are initiallymeasured at fair value and then are amortized on a straight line method overtheir estimated useful lives, which range from seven to 15 years and aredetermined by an independent consulting firm. Other intangible assets will beassessed at least annually for impairment and any such impairment will berecognized in the period identified. 

 

Long-term Assets:****Premises and equipment and other long-term assets arereviewed for impairment when events indicate their carrying amount may notbe recoverable from future undiscounted cash flows. If impaired, the assets arerecorded at fair value.

 

Repurchase Agreements: Substantiallyall repurchase agreement liabilities represent amounts advanced by variouscustomers. Securities are pledged to cover these liabilities, which are notcovered by federal deposit insurance.

 

Benefit Plans: Retirement planexpense is the amount contributed to the plan as determined by Board decision. Deferredcompensation expense is recognized during the year the benefit is earned.

 

Stock Compensation: Employeecompensation expense under stock option plans is reported if options aregranted below market price at grant date, whereas no expense is recorded foroptions granted at market price. Pro forma disclosures of net income andearnings per share are shown below using the fair value method of SFAS No. 123to measure expense for options using the Black-Scholes option pricing model toestimate fair value.

 

The fair value of eachoption grant is estimated on the date of grant with the following weighted-averageassumptions used for grants in 2005, 2004 and 2003: dividend yield of 2.3%,2.5% and 3.0%, risk-free interest rate of 4.20%, 4.11% and 4.10%, expectedlives of eight years, and estimated volatility of 23.30%, 24.24% and 19.53%.

 

51

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The following tableillustrates the effect on net income and earnings per share if the fair valuebased method, using an option pricing model, had been applied to alloutstanding and unvested awards in each period: 

 
| ** **                                                                                                                                    | ** ** | **Year ended December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |                                       |       |   |   |   |   |
| Net income, as reported                                                                                                                       |       | $                                          | 14,163     |   | $ | 12,008 |   | $ | 10,237 |   |
|                                                                                                                                          |       |                                       |       |   |   |   |   |
| Add: Stock-based employee compensation expense  included in reported net income, net of related tax effects                                   |       | —                                     |       | 24 |   | 23 |   |
|                                                                                                                                          |       |                                       |       |   |   |   |   |
| Deduct: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of  related tax effects |       | (207                                       | )          | (172 | ) | (129 | ) |
|                                                                                                                                          |       |                                       |       |   |   |   |   |
| Pro forma net income                                                                                                                          |       | $                                          | 13,956     |   | $ | 11,860 |   | $ | 10,131 |   |
|                                                                                                                                          |       |                                       |       |   |   |   |   |
| Earnings per share:                                                                                                                           |       |                                       |       |   |   |   |   |
| Basic - as reported                                                                                                                           |       | $                                          | 1.73       |   | $ | 1.57 |   | $ | 1.48 |   |
| Basic - pro forma                                                                                                                             |       | $                                          | 1.71       |   | $ | 1.54 |   | $ | 1.46 |   |
| Diluted - as reported                                                                                                                         |       | $                                          | 1.71       |   | $ | 1.55 |   | $ | 1.47 |   |
| Diluted - pro forma                                                                                                                           |       | $                                          | 1.69       |   | $ | 1.53 |   | $ | 1.44 |   |

 

Income Taxes: Income tax expense isthe total of the current year income tax due or refundable and the change indeferred tax assets and liabilities. Deferred tax assets and liabilities arethe expected future tax amounts for the temporary differences between carryingamounts and tax bases of assets and liabilities, computed using enacted taxrates. A valuation allowance, if needed, reduces deferred tax assets to theamount expected to be realized.

 

Loan Commitments and Related Financial Instruments:Financial instruments include credit instruments, such as commitments to makeloans and standby letters of credit, issued to meet customer financing needs. Theface amount for these items represents the exposure to loss before consideringcustomer collateral or ability to repay. Such financial instruments arerecorded when they are funded. Instruments such as standby letters of creditare considered financial guarantees in accordance with Financial AccountingStandards Board (“FASB”) Interpretation No. 45. The fair value of thesefinancial guarantees is not material.

 

Earnings Per Common Share: Basicearnings per common share are net income divided by the weighted average numberof common shares outstanding during the period. Diluted earnings per commonshare includes the dilutive effect of additional potential common sharesissuable under stock options.

 

Comprehensive Income: Comprehensiveincome consists of net income and other comprehensive income. Othercomprehensive income includes unrealized gains and losses on securitiesavailable for sale which are also recognized as a separate component of equity.Comprehensive income is presented in the consolidated statements of changes inshareholders’ equity. 

 

New Accounting Pronouncements: In December 2004,the FASB issued SFAS No. 123(R), *Accounting for Stock-BasedCompensation* (SFAS No. 123(R)). SFAS No. 123(R)establishes standards for the accounting for transactions in which an entityexchanges its equity instruments for goods or services. This Statement focusesprimarily on accounting for transactions in which an entity obtains employeeservices in share-based payment transactions. SFAS No. 123(R) requiresthat the fair value of such equity instruments be recognized as an expense inthe historical financial statements as services are performed. Prior to SFAS No. 123(R),only certain 

 

52

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pro forma disclosures of fair value were required. Theprovisions of this Statement are effective for fiscal years beginning after June 15,2005. Accordingly, the Company will adopt SFAS No. 123(R) commencing withthe quarter ending March 31, 2006. If the Company had included the cost ofemployee stock option compensation in our consolidated financial statements,its net income for the fiscal years ended December 31, 2005, 2004 and 2003would have decreased by approximately $193, $148, and $106, respectively. 

 

In March 2005, the SEC released Staff AccountingBulletin (SAB) No. 107, *Share-BasedPayment*, SAB No. 107 expresses views of the SEC staff regardingthe application of SFAS No. 123(R). Among other things, SAB No. 107provides interpretive guidance related to the interaction between SFAS No. 123(R)and certain SEC rules and regulations, as well as provides the staff’sview regarding the valuation of share-based payment arrangements for publiccompanies.

 

In May 2005,the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections.*This statement replaces APB Opinion No. 20,*Accounting Changes*and SFAS No. 3,*Reporting Accounting Changes in InterimFinancial Statements.*SFAS No. 154 changes the requirements forthe accounting for and reporting of a voluntary change in accounting principle.SFAS No. 154 requires retrospective application to prior periods forchanges in accounting principles or error corrections, unless it is impracticalto determine the period-specific effects or when a pronouncement includesspecific transition provisions. This Statement is effective for accountingchanges and corrections of errors made in fiscal years beginning after December 15,2005. The Company does not expect the adoption of SFAS No. 154 (revised2004) will have a material impact on its financial condition or result ofoperations. 

 

In November 2005,the FASB issued Staff Position (FSP) FAS 115-1 and FAS 124-1, *the Meaning of Other-Than-Temporary Impairment andIts Application to Certain Investments,*which amends SFAS No. 115,*Accounting for Certain Investments in Debtand Equity Securities,*and No. 124, *Accounting for Certain Investments Held by Not-for-ProfitOrganizations,* and APB Opinion No. 18, *The Equity Method of Accounting for Investments inCommon Stock.* This FSP addresses the determination as to when aninvestment is considered impaired, whether the impairment is other thantemporary, and the measurement of an impairment loss. FSP FAS 115-1 and FAS124-1 also includes accounting considerations subsequent to the recognition ofan other-than-temporary impairment and requires certain disclosures aboutunrealized losses that have not been recognized as other-than-temporary impairments.The guidance in this FSP is effective for reporting periods beginning after December 15,2005. The Company does not expect the adoption of FSP FAS 115-1 and FAS 124-1will have a material impact on its financial condition or results of operations.

 

Loss Contingencies: Losscontingencies, including claims and legal actions arising in the ordinarycourse of business, are recorded as liabilities when the likelihood of loss isprobable and an amount or range of loss can be reasonably estimated. Managementdoes not believe there are any such matters that will have a material effect onthe financial statements.

 

Restrictions on Cash: Cash on handor on deposit with the Federal Reserve Bank of $14,341 and $8,376 was requiredto meet regulatory reserve and clearing requirements at year-end 2005 and 2004.These balances do not earn interest.

 

Segments: Internal financialreporting is primarily reported and aggregated in five lines of business:banking, mortgage banking, consumer finance, subprime automobile lending, andtitle insurance. Banking accounts for 92.6% of revenues for 2005.

 

Fair Value of Financial Instruments:Fair values of financial instruments are estimated using relevant marketinformation and other assumptions, as more fully disclosed in a separate note. Fairvalue estimates involve uncertainties and matters of significant judgmentregarding interest rates, credit risk, prepayments, and other 

 

53

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factors, especially in the absence of broad marketsfor particular items. Changes in assumptions or in market conditions couldsignificantly affect the estimates.

 

Reclassifications: Certain items inprior year financial statements have been reclassified to conform to the2005 presentation. These reclassifications had no effect on net income orshareholders’ equity as previously reported.

 

54

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# **NOTE 2 - SECURITIES**

 

Securitiesare summarized as follows:

 
| ** **                                       | ** ** | ** ** | ** ** | **Gross**      | ** ** | **Gross**      | ** ** | ** **    | ** ** |
|--------------------------------------------------|------------|------------|------------|----------------|------------|----------------|------------|---------------|------------|
| ** **                                       | ** ** | **Fair**   | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Amortized** | ** ** |
| ** **                                       | ** ** | **Value**  | ** ** | **Gains**      | ** ** | **Losses**     | ** ** | **Cost**      | ** ** |
| Available for Sale                               |       |       |       |           |       |           |       |          |       |
|                                             |       |       |       |           |       |           |       |          |       |
| 2005                                             |       |       |       |           |       |           |       |          |       |
| U. S. Treasury and government agency             |       | $          | 31,279     |           | $          | 10             |       | $             | (344       | ) | $ | 31,613 |   |
| Obligations of states and political subdivisions |       | 1,700      |       | —         |       | (11            | )          | 1,711         |       |
| Mortgage-backed                                  |       | 9,476      |       | 22             |       | (187           | )          | 9,641         |       |
| Trust preferred securities                       |       | 6,413      |       | 20             |       | (107           | )          | 6,500         |       |
|                                             |       |       |       |           |       |           |       |          |       |
|                                             |       | $          | 48,868     |           | $          | 52             |       | $             | (649       | ) | $ | 49,465 |   |
|                                             |       |       |       |           |       |           |       |          |       |
| 2004                                             |       |       |       |           |       |           |       |          |       |
| U. S. Treasury and government agency             |       | $          | 21,594     |           | $          | 5              |       | $             | (109       | ) | $ | 21,698 |   |
| Obligations of states and political subdivisions |       | 1,821      |       | 10             |       | (1             | )          | 1,812         |       |
| Mortgage-backed                                  |       | 5,395      |       | 57             |       | (13            | )          | 5,351         |       |
| Trust preferred securities                       |       | 6,508      |       | 37             |       | (29            | )          | 6,500         |       |
|                                             |       |       |       |           |       |           |       |          |       |
|                                             |       | $          | 35,318     |           | $          | 109            |       | $             | (152       | ) | $ | 35,361 |   |

 
| ** **                                       | ** ** | ** **   | ** ** | **Gross**        | ** ** | **Gross**        | ** ** | ** ** | ** ** |
|--------------------------------------------------|------------|--------------|------------|------------------|------------|------------------|------------|------------|------------|
| ** **                                       | ** ** | **Carrying** | ** ** | **Unrecognized** | ** ** | **Unrecognized** | ** ** | **Fair**   | ** ** |
| ** **                                       | ** ** | **Amount**   | ** ** | **Gains**        | ** ** | **Losses**       | ** ** | **Value**  | ** ** |
| Held to Maturity                                 |       |         |       |             |       |             |       |       |       |
| 2005                                             |       |         |       |             |       |             |       |       |       |
| U. S. Treasury and government agency             |       | $            | —     |             | $          | —           |       | $          | —     |   | $ | — |   |
| Obligations of states and political subdivisions |       | 2,630        |       | 25               |       | (5               | )          | 2,650      |       |
| Other securities                                 |       | 749          |       | —           |       | (64              | )          | 685        |       |
|                                             |       |         |       |             |       |             |       |       |       |
|                                             |       | $            | 3,379      |             | $          | 25               |       | $          | (69        | ) | $ | 3,335 |   |
|                                             |       |         |       |             |       |             |       |       |       |
| 2004                                             |       |         |       |             |       |             |       |       |       |
| U. S. Treasury and government agency             |       | $            | 250        |             | $          | 1                |       | $          | —     |   | $ | 251 |   |
| Obligations of states and political subdivisions |       | 3,382        |       | 97               |       | —           |       | 3,479      |       |
| Other securities                                 |       | 749          |       | 27               |       | —           |       | 776        |       |
|                                             |       |         |       |             |       |             |       |       |       |
|                                             |       | $            | 4,381      |             | $          | 125              |       | $          | —     |   | $ | 4,506 |   |

 

55

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Contractual maturities of securities at year-end 2005are shown below. Securities not due at a single maturity date, primarilymortgage-backed securities, are shown separately.

 
| ** **                             | ** ** | **Available for Sale** | ** ** | **Held to Maturity** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                             | ** ** | **Fair**                         | ** ** | **Carrying**                   | ** ** | **Fair** | ** ** |
| ** **                             | ** ** | **Value**                        | ** ** | **Amount**                     | ** ** | **Value** | ** ** |
|                                   |       |                             |       |                           |       |   |   |
| Due in one year or less                |       | $                                | 16,905     |                           | $          | 50 |   | $ | 51 |   |
| Due after one year through five years  |       | 12,459                           |       | 2,154                          |       | 2,119 |   |
| Due after five years through ten years |       | 2,722                            |       | 1,175                          |       | 1,165 |   |
| Due after ten years                    |       | 7,306                            |       | —                         |       | — |   |
| Mortgage-backed securities             |       | 9,476                            |       | —                         |       | — |   |
|                                   |       |                             |       |                           |       |   |   |
| Total maturities                       |       | $                                | 48,868     |                           | $          | 3,379 |   | $ | 3,335 |   |

 

There were no securitysales during 2005, 2004 and 2003.

 

Securities with a carrying value of $24,025 and$20,477 at year-end 2005 and 2004 were pledged for public deposits andsecurities sold under agreements to repurchase.

 

Securities with unrealized losses at year-end 2005 and2004 not recognized in income are as follows:

 
| ** **                                       | ** ** | **Less than 12 months** | ** ** | **12 months or more** | ** ** | **Total** | ** ** |
|--------------------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|-----------|------------|
| ** **                                       | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| ** **                                       | ** ** | **Value**                              | ** ** | **Loss**                             | ** ** | **Value** | ** ** | **Loss** | ** ** | **Value** | ** ** | **Loss** | ** ** |
| 2005                                             |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U. S. Treasury and government agency             |       | $                                      | 16,968     |                                 | $          | (139      | )          | $ | 13,598 |   | $ | (200 | ) | $ | 30,566 |   | $ | (339 | ) |
| Obligations of states and political subdivisions |       | —                                 |       | —                               |       | 2,060     |       | (21 | ) | 2,060 |   | (21 | ) |
| Trust preferred securities                       |       | —                                 |       | —                               |       | 4,500     |       | (107 | ) | 4,500 |   | (107 | ) |
| Other Securities                                 |       | —                                 |       | —                               |       | 749       |       | (64 | ) | 749 |   | (64 | ) |
| Mortgage-backed securities                       |       | —                                 |       | —                               |       | 8,699     |       | (187 | ) | 8,699 |   | (187 | ) |
| Total temporarily impaired                       |       | $                                      | 16,968     |                                 | $          | (139      | )          | $ | 29,606 |   | $ | (579 | ) | $ | 46,574 |   | $ | (718 | ) |
|                                             |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| 2004                                             |       |                                   |       |                                 |       |      |       |   |   |   |   |   |   |
| U. S. Treasury and government agency             |       | $                                      | 16,616     |                                 | $          | (104      | )          | $ | 745 |   | $ | (5 | ) | $ | 17,361 |   | $ | (109 | ) |
| Obligations of states and political subdivisions |       | 994                                    |       | (1                                   | )          | —    |       | — |   | 994 |   | (1 | ) |
| Trust preferred securities                       |       | 4,472                                  |       | (29                                  | )          | —    |       | — |   | 4,472 |   | (29 | ) |
| Mortgage-backed securities                       |       | 2,115                                  |       | (8                                   | )          | 207       |       | (5 | ) | 2,322 |   | (13 | ) |
| Total temporarily impaired                       |       | $                                      | 24,197     |                                 | $          | (142      | )          | $ | 952 |   | $ | (10 | ) | $ | 25,149 |   | $ | (152 | ) |

 

Unrealized losses onsecurities have not been recognized into income because management has theintent and ability to hold for the foreseeable future, and the decline in fairvalue is largely due to increases in market interest rates. The fair value isexpected to recover as the securities approach their maturity date and/ormarket rates decline.

 

56

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**NOTE 3 - LOANS**

 

Loans at year-end were asfollows:

 
| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |
| Commercial                      |       | $        | 245,285    |     | $          | 165,975 |   |
| Commercial real estate          |       | 729,254  |       | 484,088  |       |
| Residential real estate         |       | 319,797  |       | 319,713  |       |
| Consumer                        |       | 90,682   |       | 82,532   |       |
| Other                           |       | 3,476    |       | 4,989    |       |
| Unearned interest               |       | (9,852   | )          | (10,430  | )          |
| Loans, net of unearned interest |       | $        | 1,378,642  |     | $          | 1,046,867 |   |
|                            |       |     |       |     |       |
| Allowance for loan losses       |       | $        | (19,739    | )        | $          | (15,721 | ) |

 

Activity in the allowancefor loan losses is as follows:

 
| ** **                      | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                            |       |     |       |     |       |     |       |
| Beginning balance               |       | $        | 15,721     |     | $          | 14,564   |       | $ | 12,586 |   |
| Reserve acquired in acquisition |       | 1,467    |       | 363      |       | 1,340    |       |
| Provision for loan losses       |       | 6,365    |       | 5,836    |       | 5,775    |       |
| Loans charged off               |       | (5,583   | )          | (6,980   | )          | (6,797   | )          |
| Recoveries of loans charged off |       | 1,769    |       | 1,938    |       | 1,660    |       |
|                            |       |     |       |     |       |     |       |
| Balance, end of year            |       | $        | 19,739     |     | $          | 15,721   |       | $ | 14,564 |   |

 

Impaired loans were asfollows:

 
| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                             |       |     |       |     |       |     |       |
| Loans with allowance allocated                   |       | $        | 14,679     |     | $          | 12,210   |       | $ | 10,632 |   |
| Amount of allowance allocated                    |       | 2,202    |       | 1,832    |       | 1,595    |       |
| Average balance during the year                  |       | 11,964   |       | 11,971   |       | 10,028   |       |
| Interest income not recognized during impairment |       | 368      |       | 244      |       | 166      |       |
|                                                  |            |          |            |          |            |          |            |  |  |  |

 

Interest income actuallyrecognized on these loans during 2005, 2004 and 2003 was not significant.

 

57

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Nonperforming loans wereas follows:

 
| ** **                              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------------|------------|----------|------------|----------|------------|
|                                    |       |     |       |     |       |
| Loans past due 90 days still on accrual |       | $        | 809        |     | $          | 664 |   |
| Nonaccrual loans                        |       | 5,915    |       | 6,242    |       |
|                                    |       |     |       |     |       |
| Total                                   |       | $        | 6,724      |     | $          | 6,906 |   |

 

Nonperforming loans andimpaired loans are defined differently. Some loans may be included in bothcategories, whereas other loans may only be included in one category.

 

The aggregate amount ofloans to executive officers and directors of the Company and their relatedinterests was approximately $13,011 and $9,813 at year-end 2005 and 2004,respectively. During 2005 and 2004, new loans aggregating approximately $19,689and $19,384, respectively, and amounts collected of approximately $16,491 and$16,677, respectively, were transacted with such parties.

 

**NOTE 4 -PREMISES AND EQUIPMENT**

 

Year-end premises andequipment follows:

 
| ** **                        | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|
|                              |       |     |       |     |       |
| Land                              |       | $        | 10,226     |     | $          | 6,480 |   |
| Premises                          |       | 34,748   |       | 24,232   |       |
| Leasehold improvements            |       | 2,518    |       | 1,749    |       |
| Furniture, fixtures and equipment |       | 16,911   |       | 15,245   |       |
| Automobiles                       |       | 127      |       | 134      |       |
| Construction in progress          |       | 449      |       | 128      |       |
|                              |       | 64,979   |       | 47,968   |       |
| Accumulated depreciation          |       | (14,994  | )          | (12,377  | )          |
|                              |       |     |       |     |       |
|                              |       | $        | 49,985     |     | $          | 35,591 |   |

 

Rent expense for operating leases was $587 for 2005,$537 for 2004, and $477 for 2003. Rent commitments under noncancelableoperating leases were as follows, before considering renewal options thatgenerally are present:

 
| 2006       |   | $      | 462    |   |
|------------|--------|--------|--------|--------|
| 2007       |   | 384    |   |
| 2008       |   | 309    |   |
| 2009       |   | 248    |   |
| 2010       |   | 149    |   |
| Thereafter |   | 1,136  |   |
|       |   |   |   |
| Total      |   | $      | 2,688  |   |

 

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**NOTE 5 – GOODWILL AND OTHER INTANGIBLE ASSETS**

 

**Goodwill**

 

The change in the amount of goodwill is as follows:

 
| ** **                             | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------|------------|----------|------------|----------|------------|
| Beginning of year                      |       | $        | 18,282     |     | $          | 15,885 |   |
| Goodwill from acquisitions during year |       | 13,045   |       | 2,397    |       |
| End of year                            |       | $        | 31,327     |     | $          | 18,282 |   |

 

Goodwill was no longer amortized starting in 2002;however, it is periodically evaluated for impairment and no impairment wasrecognized in 2005, 2004, or 2003.

 

**Core deposit intangibles**

 

Core deposit intangibles had a gross carrying amountof $11,056 and $7,320 for years ended 2005 and 2004 and accumulatedamortization of $2,761 and $1,907 for the same periods, respectively. Aggregateamortization expense was $854 for year ended 2005, $624 for year-ended 2004 and$254 for year ended 2003. Core deposit intangibles of $3,736 and $953 wererecorded during 2005 and 2004, respectively, from acquisition transactions.

 

Estimated amortization expense for each of the nextfive years is as follows:

 
| 2006  |   | $     | 1,082  |   |
|-------|--------|-------|--------|--------|
| 2007  |   | 1,082 |   |
| 2008  |   | 1,082 |   |
| 2009  |   | 1,082 |   |
| 2010  |   | 1,077 |   |
| Total |   | $     | 5,405  |   |

 

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**NOTE 6 – DEPOSITS**

 

Deposits at year-end wereas follows:

 
| ** **                          | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Noninterest-bearing demand deposits |       | $        | 144,216    |     | $          | 109,956 |   |
| Interest-bearing demand deposits    |       | 438,321  |       | 306,239  |       |
| Savings deposits                    |       | 76,133   |       | 66,284   |       |
| Time deposits                       |       | 637,209  |       | 515,543  |       |
| Total deposits                      |       | $        | 1,295,879  |     | $          | 998,022 |   |

 

Time deposits of $100thousand or more were $211,704 and $146,255 at year-end 2005 and 2004.

 

Scheduled maturities ofall time deposits for the next five years and thereafter were as follows:

 
| 2006       |   | $      | 455,293 |   |
|------------|--------|--------|---------|--------|
| 2007       |   | 93,309 |    |
| 2008       |   | 31,240 |    |
| 2009       |   | 43,945 |    |
| 2010       |   | 8,157  |    |
| Thereafter |   | 5,265  |    |

 

The aggregate amount of deposits of executive officersand directors of the Company and their related interests was approximately$3,879 and $5,170 at year-end 2005 and 2004.

 

**NOTE 7 - BORROWINGS**

** **

Federal funds purchased,securities sold under agreements to repurchase and treasury tax and loandeposits are financing arrangements. Securities involved with the agreementsare recorded as assets and are held by a safekeeping agent and the obligationsto repurchase the securities are reflected as liabilities. Securities soldunder agreements to repurchase consist of short-term excess funds and overnightliabilities to deposit customers arising from a cash management program. 

 

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Information concerning securities sold under agreements torepurchase at year-end 2005, 2004 and 2003 is as follows:

 
| ** **                                 | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                       |       |     |       |     |       |     |       |
| Average balance during the year            |       | $        | 15,687     |     | $          | 14,460   |       | $ | 11,232 |   |
| Average interest rate during the year      |       | 2.64     | %          | 0.97     | %          | 0.66     | %          |
| Maximum month-end balance during the year  |       | $        | 19,931     |     | $          | 19,305   |       | $ | 14,381 |   |
| Weighted average interest rate at year-end |       | 3.37     | %          | 1.74     | %          | 0.62     | %          |

 

### FHLB advances and notespayable consist of the following at year-end:

###  

| ** **                                                                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| **Short-term borrowings**                                                                    |       |     |       |     |       |
| Fixed rate FHLB advance, 4.12%,                                                              |       |     |       |     |       |
| Maturing January 2006                                                                   |       | $        | 35,000     |     | $          | — |   |
|                                                                                         |       |     |       |     |       |
| Fixed rate FHLB advance, 2.32%                                                               |       |     |       |     |       |
| Matured January 2005                                                                    |       | —   |       | 20,000   |       |
| Total short-term borrowings                                                                  |       | 35,000   |       | 20,000   |       |
|                                                                                         |       |     |       |     |       |
| **Long-term borrowings**                                                                     |       |     |       |     |       |
| Fixed rate FHLB advances, from 2.85% to 6.35%,                                               |       |     |       |     |       |
| Various maturities through July 2022                                                    |       | 18,846   |       | 13,922   |       |
|                                                                                         |       |     |       |     |       |
| Variable rate FHLB advances, from 4.56% to 5.76%,                                            |       |     |       |     |       |
| Maturities from November 2008 to January 2010                                      |       | 49,500   |       | 49,500   |       |
|                                                                                         |       |     |       |     |       |
| Fixed rate notes payable, interest due quarterly at  3.80%, principal due October 2006. |       | 1,800    |       | 1,800    |       |
| Total long-term borrowings                                                                   |       | 70,146   |       | 65,222   |       |
|                                                                                         |       |     |       |     |       |
| Total borrowings                                                                             |       | $        | 105,146    |     | $          | 85,222 |   |

 

Each advance is payable at its maturity date; however,prepayment penalties are required if paid before maturity. The variable rateadvances are convertible to a 3-month LIBOR rate at the discretion of the FHLB.The advances are collateralized by a required blanket pledge of qualifyingmortgage, commercial, agricultural, and home equity lines of credit loanstotaling $426,153 and $378,563 at year-end 2005 and 2004. 

 

61

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Scheduled maturities of long-term FHLB advances and notespayable over the next five years and thereafter are as follows:

 
| ** ** | ** ** | **Total** | ** ** |
|------------|------------|-----------|------------|
|       |       |      |       |
| 2006       |       | $         | 383        |   |
| 2007       |       | 2,201     |       |
| 2008       |       | 5,411     |       |
| 2009       |       | 29,919    |       |
| 2010       |       | 25,439    |       |
| Thereafter |       | 6,793     |       |
|       |       | $         | 70,146     |   |

 

At year-end 2005, the Company had approximately $116,000 offederal funds lines of credit available from correspondent institutions,$22,370 in unused lines of credit with the FHLB, and $118,300 of letters ofcredit with the FHLB.

 

In September 2003,the Company formed Greene County Capital Trust I (“GC Trust I”). GC Trust Iissued $10,000 of variable rate trust preferred securities as part of apooled offering of such securities. The Company issued $10,310 subordinateddebentures to the GC Trust I in exchange for the proceeds of the offering,which debentures represent the sole asset of GC Trust I. The debentures payinterest quarterly at the three-month LIBOR plus 2.85% adjusted quarterly(7.00% and 4.92% at year-end 2005 and 2004, respectively). The Company may redeemthe subordinated debentures, in whole or in part, beginning October 2008at a price of 100% of face value. The subordinated debentures must be redeemedno later than 2033.

 

In June 2005,the Company formed Greene County Capital Trust II (“GC Trust II”). GC Trust IIissued $3,000 of variable rate trust preferred securities as part of apooled offering of such securities. The Company issued $3,093 subordinateddebentures to the GC Trust II in exchange for the proceeds of the offering,which debentures represent the sole asset of GC Trust II. The debentures payinterest quarterly at the three-month LIBOR plus 1.68% adjusted quarterly(5.55% at year-end 2005). The Company may redeem the subordinateddebentures, in whole or in part, beginning September 2010 at a price of100% of face value. The subordinated debentures must be redeemed no later than2035.

 

Inaccordance with FASB Interpretation No. 46R, GC Trust I and GC Trust IIare not consolidated with the Company. Accordingly, the Company does not reportthe securities issued by GC Trust I and GC Trust II as liabilities, and insteadreports as liabilities the subordinated debentures issued by the Company andheld by each Trust. However, the Company has fully and unconditionallyguaranteed the repayment of the variable rate trust preferred securities. Thesetrust preferred securities currently qualify as Tier 1 capital for regulatorycapital requirements of the Company. 

 

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**NOTE 8 - BENEFIT PLANS**

 

The Company has a profitsharing plan which allows employees to contribute from 1% to 20% of theircompensation. The Company contributes an additional amount at a discretionaryrate established annually by the Board of Directors. Company contributions tothe Plan were $856, $713 and $593 for 2005, 2004 and 2003 respectively.

 

Directors have deferred some of their fees for futurepayment, including interest. The amount accrued for deferred compensation was$2,306 and $2,068 at year-end 2005 and 2004. Amounts expensed under the Planwere $298, $294 and $269 during 2005, 2004, and 2003. The Bank paid interest onbalances in the Plan during 2005, 2004, and 2003, as follows: Interest iscredited on the account balances of the participating directors monthly at anannual rate of 10% compounded monthly until separation from service, and,thereafter, at an annual rate of 7.5% compounded monthly. Also certain officersof the Company are participants under a Supplemental Executive Retirement Plan.The amount accrued for future payments under this Plan was $326 and $150 atyear-end 2005 and 2004. Amounts expensed under the Plan were $176, $119 and $27during 2005, 2004 and 2003, respectively. Related to these plans, the Companypurchased single premium life insurance contracts on the lives of the relatedparticipants. The cash surrender value of these contracts is recorded as anasset of the Company.

 

**NOTE 9 - INCOME TAXES**

 

Income tax expense is summarized as follows:

 
| ** **             | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------|------------|----------|------------|----------|------------|----------|------------|
|                   |       |     |       |     |       |     |       |
| Current – federal |       | $        | 7,860      |     | $          | 5,656    |       | $ | 5,008 |   |
| Current – state   |       | 1,581    |       | 991      |       | 591      |       |
| Deferred - federal     |       | (640     | )          | 477      |       | 152      |       |
| Deferred - state       |       | (127     | )          | 95       |       | 30       |       |
|                   |       |     |       |     |       |     |       |
|                   |       | $        | 8,674      |     | $          | 7,219    |       | $ | 5,781 |   |

 

Deferred income taxes reflect the effect of “temporarydifferences” between values recorded for assets and liabilities for financialreporting purposes and values utilized for measurement in accordance with taxlaws. The tax effects of the primary temporary differences giving rise to theCompany’s net deferred tax assets and liabilities are as follows:

 

63

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| ** **                           | ** ** | **2005**   | ** ** | **2004**        | ** ** |
|--------------------------------------|------------|------------|------------|-----------------|------------|
| ** **                           | ** ** | **Assets** | ** ** | **Liabilities** | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
|                                 |       |       |       |            |       |   |   |   |   |
| Allowance for loan losses            |       | $          | 7,572      |            | $          | — |   | $ | 5,977 |   | $ | — |   |
| Deferred compensation                |       | 1,289      |       | —          |       | 1,116 |   | — |   |
| Purchase accounting adjustments      |       | —     |       | (788            | )          | — |   | (608 | ) |
| Depreciation                         |       | —     |       | (2,065          | )          | — |   | (2,215 | ) |
| FHLB dividends                       |       | —     |       | (933            | )          | — |   | (824 | ) |
| Core deposit intangible              |       | —     |       | (2,772          | )          | — |   | (1,887 | ) |
| Unrealized (gain) loss on securities |       | 227        |       | —          |       | 17 |   | — |   |
| Other                                |       | 1          |       | —          |       | 115 |   | — |   |
|                                 |       |       |       |            |       |   |   |   |   |
| Total deferred income taxes          |       | $          | 9,089      |            | $          | (6,558 | ) | $ | 7,225 |   | $ | (5,534 | ) |

 

No valuation allowanceswere required relating to deferred tax assets at December 31, 2005 and2004.

 

A reconciliation of expected income tax expense at thestatutory federal income tax rate of 35% with the actual effective income taxrates is as follows:

 
| ** **                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                     |       |     |       |     |       |     |       |
| Statutory federal tax rate               |       | 35.0     | %          | 35.0     | %          | 35.0     | %          |
| State income tax, net of federal benefit |       | 4.1      |       | 3.7      |       | 2.1      |       |
| Tax exempt income                        |       | (1.1     | )          | (1.2     | )          | (0.2     | )          |
| Other                                    |       | —   |       | —   |       | (0.8     | )          |
|                                     |       |     |       |     |       |     |       |
|                                     |       | 38.0     | %          | 37.5     | %          | 36.1     | %          |

 

64

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**NOTE 10 -COMMITMENTS AND FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK**

 

Some financialinstruments, such as loan commitments, credit lines, letters of credit, andoverdraft protection, are issued to meet customer-financing needs. These areagreements to provide credit or to support the credit of others, as long asconditions established in the contract are met, and usually have expirationdates. Commitments may expire without being used. Off-balance-sheet riskto credit loss exists up to the face amount of these instruments, althoughmaterial losses are not anticipated. The same credit policies are used to makesuch commitments as are used for loans, including obtaining collateral atexercise of the commitment. 

 

Financial instrumentswith off-balance-sheet risk were as follows at year-end:

 
| ** **                                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|----------|------------|----------|------------|
|                                      |       |     |       |     |       |
| Commitments to make loans – fixed    |       | $        | 11,008     |     | $          | 50,569 |   |
| Commitments to make loans – variable |       | 54,043   |       | 45,849   |       |
| Unused lines of credit                    |       | 547,178  |       | 206,714  |       |
| Letters of credit                         |       | 29,839   |       | 27,644   |       |
|                                           |            |          |            |          |            |  |  |

 

The fixed rate loancommitments have interest rates ranging from 6.49% to 10.25% and maturitiesranging from six-months to thirty years. Letters of credit are consideredfinancial guarantees under FASB Interpretation No. 45. These instrumentsare carried at fair value, which was immaterial at year-end 2005 and 2004.

 

**NOTE 11 -CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS**

 

Banksand bank holding companies are subject to regulatory capital requirementsadministered by federal banking agencies. Capital adequacy guidelines and,additionally for banks, prompt corrective action regulations involvequantitative measures of assets, liabilities, and certain off-balance-sheetitems calculated under regulatory accounting practices. Capital amounts andclassifications are also subject to qualitative judgments by regulators. Failureto meet capital requirements can initiate regulatory action.

 

Prompt corrective actionregulations provide five classifications: well capitalized, adequatelycapitalized, undercapitalized, significantly undercapitalized, and criticallyundercapitalized, although these terms are not used to represent overallfinancial condition. If adequately capitalized, regulatory approval is requiredto accept brokered deposits. If undercapitalized, capital distributions arelimited, as is asset growth and expansion, and capital restoration plans arerequired.

 

65

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**NOTE 11 -CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS (Continued)**

 

Based on the most recentnotifications from its regulators, the Bank is well capitalized under theregulatory framework for prompt corrective action. Management believes that asof December 31, 2005, the Company and the Bank met all capital adequacyrequirements to which they are subject and was not aware of any conditions orevents that would affect the Bank’s well capitalized status. Actual capitallevels and minimum required levels (in millions) were as follows:

 
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **            | ** ** | **Minimum Amounts to**  | ** ** |
|------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|-----------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **            | ** ** | **be Well Capitalized** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **Minimum Required**  | ** ** | **Under Prompt** | ** ** |
| ** **                               | ** ** | ** ** | ** ** | ** **                 | ** ** | **for Capital**       | ** ** | **Corrective**        | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                               | ** ** | **Actual** | ** ** | **Ratio (%)**         | ** ** | **Actual**                 | ** ** | **Ratio (%)**    | ** ** | **Actual**                        | ** ** | **Ratio (%)** | ** ** |
| 2005                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Total Capital (to Risk Weighted Assets)  |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 159.2      |                       | 11.5       |                       | $          | 111.2                 |       | 8.0                               |       | $ | 139.0 |   | 10.0 |   |
| Bank                                     |       | 157.1      |       | 11.3                       |       | 111.2                      |       | 8.0                   |       | 139.0                             |       | 10.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Risk Weighted Assets) |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 141.8      |                       | 10.2       |                       | $          | 55.6                  |       | 4.0                               |       | $ | 83.4 |   | 6.0 |   |
| Bank                                     |       | 139.7      |       | 10.1                       |       | 55.6                       |       | 4.0                   |       | 83.4                              |       | 6.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Average Assets)       |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 141.8      |                       | 9.3        |                       | $          | 61.2                  |       | 4.0                               |       | $ | 76.5 |   | 5.0 |   |
| Bank                                     |       | 139.7      |       | 9.1                        |       | 61.2                       |       | 4.0                   |       | 76.4                              |       | 5.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| 2004                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Total Capital (to Risk Weighted Assets)  |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 108.4      |                       | 10.5       |                       | $          | 83.0                  |       | 8.0                               |       | $ | 103.7 |   | 10.0 |   |
| Bank                                     |       | 109.5      |       | 10.6                       |       | 83.0                       |       | 8.0                   |       | 103.7                             |       | 10.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Risk Weighted Assets) |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 95.4       |                       | 9.2        |                       | $          | 41.5                  |       | 4.0                               |       | $ | 62.2 |   | 6.0 |   |
| Bank                                     |       | 96.5       |       | 9.3                        |       | 41.5                       |       | 4.0                   |       | 62.2                              |       | 6.0 |   |
|                                     |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Tier 1 Capital (to Average Assets)       |       |       |       |                       |       |                       |       |                  |       |                              |       |   |   |
| Consolidated                             |       | $          | 95.4       |                       | 8.5        |                       | $          | 45.1                  |       | 4.0                               |       | $ | 56.4 |   | 5.0 |   |
| Bank                                     |       | 96.5       |       | 8.6                        |       | 45.1                       |       | 4.0                   |       | 56.4                              |       | 5.0 |   |

 

The Company’s primarysource of funds to pay dividends to shareholders is the dividends it receivesfrom the Bank. Applicable state laws and the regulations of the Federal ReserveBank and the Federal Deposit Insurance Corporation regulate the payment ofdividends. Under the state regulations, the amount of dividends that may bepaid by the Bank to the Company is limited in any one year to an amount equalto the net income in the calendar year of declaration plus retained net incomefor the preceding two years.; however, future dividends will be dependent onthe level of earnings, capital and liquidity requirements and considerations ofthe Bank and Company.

 

66

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**NOTE 12 -STOCK OPTIONS**

 

The Company maintains a 2004 Long-Term Incentive Plan,whereby a maximum of 500,000 shares of common stock may be issued todirectors and employees of the Company and the Bank. The Plan provides for theissuance of awards in the form of stock options, stock appreciationrights, restricted shares, restricted share units, deferred share units andperformance awards. Stock options granted under the Plan are typically grantedat exercise prices equal to the fair market value of the Company’s common stockon the date of grant and typically have terms of ten years and vest at anannual rate of 20%. At year-end 2005, 428,772 shares remained available forfuture grant. 

 

The Company had a stock option plan that was part of akey executive’s employment agreement, pursuant to which the Company granted tothe key executive options to purchase 9,000 shares per year at one and one-halftimes year end book value. The options vested immediately on the grant date. Thisemployment agreement was amended during 2005 to provide that future optiongrants to the key executive would be made at no less than fair market value onthe date of grant in order to comply with Section 409A of the InternalRevenue Code of 1986, as amended. Compensation expense associated with theseoptions was $40 for 2004 and $38 for 2003. No expense for stock options toother key executives has been recorded, as the grant price equaled the marketprice of the stock at grant date. This plan was superceded by the new 2004Long-Term Incentive Plan.

 

A summary of the Company’soption activity and related information for the years ended 2005, 2004, and2003 is presented below:

 
| ** **                                        | ** ** | **2005**    | ** ** | **2004**     | ** ** | **2003**    | ** ** |
|---------------------------------------------------|------------|-------------|------------|--------------|------------|-------------|------------|
| ** **                                        | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** **  | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                                        | ** ** | ** **  | ** ** | **Average**  | ** ** | ** **  | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                        | ** ** | ** **  | ** ** | **Exercise** | ** ** | ** **  | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                        | ** ** | **Options** | ** ** | **Price**    | ** ** | **Options** | ** ** | **Price** | ** ** | **Options** | ** ** | **Price** | ** ** |
| Outstanding at beginning of year                  |       | 336,278     |       | $            | 20.28      |        | 299,273    |   | $ | 19.63 |   | 232,347 |   | $ | 20.47 |   |
| Granted                                           |       | 71,228      |       | 26.89        |       | 71,130      |       | 22.91 |   | 75,978 |   | 17.02 |   |
| Exercised                                         |       | (10,596     | )          | 13.47        |       | (13,511     | )          | 12.90 |   | (3,275 | ) | 13.36 |   |
| Forfeited                                         |       | —      |       | —       |       | (20,614     | )          | 24.75 |   | (5,777 | ) | 22.74 |   |
|                                              |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Outstanding at end of year                        |       | 396,910     |       | $            | 21.65      |        | 336,278    |   | $ | 20.28 |   | 299,273 |   | $ | 19.63 |   |
|                                              |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Options exercisable at year-end                   |       | 255,525     |       | $            | 20.47      |        | 223,437    |   | $ | 19.59 |   | 210,423 |   | $ | 19.01 |   |
|                                              |       |        |       |         |       |        |       |   |   |   |   |   |   |
| Fair value of each option granted during the year |       |        |       | $            | 7.12       |        |       |   | $ | 6.30 |   |   |   | $ | 4.80 |   |

 

67

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Options outstanding atyear-end 2005 were as follows:

 
| ** **                                  | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|---------------------------------------------|------------|-----------------|------------|-----------------|------------|
| ** **                                  | ** ** | ** **      | ** ** | **Average**     | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | ** **      | ** ** | **Weighted**    | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | ** **      | ** ** | **Remaining**   | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Remaining** | ** ** | **Weighted** | ** ** |
| ** **                                  | ** ** | **Number**      | ** ** | **Contractual** | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Contractual** | ** ** | **Exercise** | ** ** |
| **Range of Exercise Prices** | ** ** | **Outstanding** | ** ** | **Life**        | ** ** | **Price** | ** ** | **Outstanding** | ** ** | **Life** | ** ** | **Price** | ** ** |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| $10.13 - $15.00                             |       | 68,532          |       | 3.8             |       | $ | 12.47 |   | 68,532 |   | 3.9 |   | $ | 12.47 |   |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| $15.01 - $20.00                             |       | 117,035         |       | 6.1             |       | $ | 17.87 |   | 84,806 |   | 5.8 |   | $ | 17.69 |   |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| $20.01 - $25.00                             |       | 79,930          |       | 6.7             |       | $ | 23.25 |   | 33,002 |   | 4.8 |   | $ | 23.12 |   |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| $25.01- $30.00                              |       | 98,478          |       | 7.7             |       | $ | 27.75 |   | 36,250 |   | 5.2 |   | $ | 29.23 |   |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| $30.01 - $32.00                             |       | 32,935          |       | 5.0             |       | $ | 32.00 |   | 32,935 |   | 5.0 |   | $ | 32.00 |   |
|                                        |       |            |       |            |       |   |   |   |   |   |   |   |   |
| Total                                       |       | 396,910         |       |            |       |   |   | 255,525 |   |   |   |   |   |

 

68

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**NOTE 13 -EARNINGS PER SHARE**

 

A reconciliation of the numerators and denominators of theearnings per common share and earnings per common share assuming dilutioncomputations are presented below.

 
| ** **                                                                   | ** ** | **2005**  | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|------------------------------------------------------------------------------|------------|-----------|------------|-----------|------------|-----------|------------|
| **Basic Earnings Per Share**                                                 |       |      |       |      |       |      |       |
|                                                                         |       |      |       |      |       |      |       |
| Net income                                                                   |       | $         | 14,163     |      | $          | 12,008    |       | $ | 10,237 |   |
|                                                                         |       |      |       |      |       |      |       |
| Weighted average common shares outstanding                                   |       | 8,184,499 |       | 7,652,099 |       | 6,916,351 |       |
|                                                                         |       |      |       |      |       |      |       |
| Basic Earnings Per Share                                                     |       | $         | 1.73       |      | $          | 1.57      |       | $ | 1.48 |   |
|                                                                         |       |      |       |      |       |      |       |
| **Diluted Earnings Per Share**                                               |       |      |       |      |       |      |       |
|                                                                         |       |      |       |      |       |      |       |
| Net income                                                                   |       | $         | 14,163     |      | $          | 12,008    |       | $ | 10,237 |   |
|                                                                         |       |      |       |      |       |      |       |
| Weighted average common shares outstanding                                   |       | 8,184,499 |       | 7,652,099 |       | 6,916,351 |       |
|                                                                         |       |      |       |      |       |      |       |
| Add: Dilutive effects of assumed conversions and  exercises of stock options |       | 91,634    |       | 82,236    |       | 69,596    |       |
|                                                                         |       |      |       |      |       |      |       |
| Weighted average common and dilutive potential  common shares outstanding    |       | 8,276,133 |       | 7,734,335 |       | 6,985,947 |       |
|                                                                         |       |      |       |      |       |      |       |
| Diluted Earnings Per Share                                                   |       | $         | 1.71       |      | $          | 1.55      |       | $ | 1.47 |   |

 

Stock options of 118,321,62,463 and 69,602 were excluded from the 2005, 2004 and 2003 diluted earningsper share because their impact was antidilutive.

 

69

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**NOTE 14 -FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The carrying value and estimated fair value of the Company’sfinancial instruments are as follows at year-end 2005 and 2004.

 
| ** **                             | ** ** | **2005**     | ** ** | **2004**  | ** ** |
|----------------------------------------|------------|--------------|------------|-----------|------------|
| ** **                             | ** ** | **Carrying** | ** ** | **Fair**  | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                             | ** ** | **Value**    | ** ** | **Value** | ** ** | **Value** | ** ** | **Value** | ** ** |
| Financial assets:                      |       |         |       |      |       |   |   |   |   |
| Cash and cash equivalents              |       | $            | 74,523     |      | $          | 74,523 |   | $ | 70,648 |   | $ | 70,648 |   |
| Securities available for sale          |       | 48,868       |       | 48,868    |       | 35,318 |   | 35,318 |   |
| Securities held to maturity            |       | 3,379        |       | 3,335     |       | 4,381 |   | 4,506 |   |
| Loans held for sale                    |       | 2,686        |       | 2,726     |       | 1,151 |   | 1,165 |   |
| Loans, net of unearned interest        |       | 1,378,642    |       | 1,374,464 |       | 1,046,867 |   | 1,048,427 |   |
| Allowance for loan losses              |       | (19,739      | )          | (19,739   | )          | (15,721 | ) | (15,721 | ) |
| FHLB, Bankers Bank and other stock     |       | 6,489        |       | 6,489     |       | 6,211 |   | 6,211 |   |
| Cash surrender value of life insurance |       | 19,764       |       | 19,764    |       | 15,471 |   | 15,471 |   |
| Accrued interest receivable            |       | 6,913        |       | 6,913     |       | 4,413 |   | 4,413 |   |
|                                   |       |         |       |      |       |   |   |   |   |
| Financial liabilities:                 |       |         |       |      |       |   |   |   |   |
| Deposit accounts                       |       | $            | 1,295,879  |      | $          | 1,303,842 |   | $ | 998,022 |   | $ | 1,004,482 |   |
| Repurchase agreements                  |       | 17,498       |       | 17,498    |       | 13,868 |   | 13,868 |   |
| FHLB advances and notes payable        |       | 105,416      |       | 104,817   |       | 85,222 |   | 86,924 |   |
| Subordinated debentures                |       | 13,403       |       | 12,949    |       | 10,310 |   | 11,087 |   |
| Accrued interest payable               |       | 2,535        |       | 2,535     |       | 2,068 |   | 2,068 |   |

 

The following methods and assumptions were used toestimate the fair values for financial instruments. The carrying amount isconsidered to estimate fair value for cash and short-term instruments, demanddeposits, liabilities for repurchase agreements, variable rate loans ordeposits that reprice frequently and fully, and accrued interest receivable andpayable. Securities available for sale fair values are based on quoted marketprices or, if no quotes are available, on the rate and term of the security andon information about the issuer. For fixed rate loans or deposits and forvariable rate loans or deposits with infrequent repricing or repricing limits,the fair value is estimated by discounted cash flow analysis using currentmarket rates for the estimated life and credit risk. Fair values for impairedloans are estimated using discounted cash flow analyses or underlyingcollateral values, where applicable. Fair value of mortgage loans held for saleis based on current market price for such loans. Liabilities for FHLB advancesand notes payable are estimated using rates of debt with similar terms andremaining maturities. The fair value of off-balance sheet items is based on thecurrent fees or costs that would be charged to enter into or terminate sucharrangements which is not material. The fair value of commitments to sell loansis based on the difference between the interest rates committed to sell at andthe quoted secondary market price for similar loans, which is not material.

 

70

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**NOTE 15 -PARENT COMPANY CONDENSED FINANCIAL STATEMENTS**

 

**BALANCE SHEETS**

**Years ended December 31, 2005 and 2004**

 
| ** **                                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------|------------|----------|------------|----------|------------|
| ASSETS                                           |       |     |       |     |       |
| Cash and due from financial institutions         |       | $        | 4,072      |     | $          | 646 |   |
| Investment in subsidiary                         |       | 178,509  |       | 119,589  |       |
| Cash surrender value of life insurance contracts |       | 273      |       | 264      |       |
| Other                                            |       | 1,275    |       | 1,237    |       |
|                                             |       |     |       |     |       |
| Total assets                                     |       | $        | 184,129    |     | $          | 121,736 |   |
|                                             |       |     |       |     |       |
| LIABILITIES                                      |       |     |       |     |       |
| Subordinated debentures                          |       | $        | 13,403     |     | $          | 10,310 |   |
| Other liabilities                                |       | 2,705    |       | 2,708    |       |
|                                             |       |     |       |     |       |
| Total liabilities                                |       | 16,108   |       | 13,018   |       |
|                                             |       |     |       |     |       |
| Shareholders’ equity                        |       | 168,021  |       | 108,718  |       |
|                                             |       |     |       |     |       |
| Total liabilities and shareholders’ equity  |       | $        | 184,129    |     | $          | 121,736 |   |

 

**STATEMENTS OF INCOME**

**Years ended December 31, 2005, 2004, and 2003**

 
| ** **                                         | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
|                                               |       |     |       |     |       |     |       |
| Dividends from subsidiaries                        |       | $        | 3,511      |     | $          | 5,423    |       | $ | 4,218 |   |
| Other income                                       |       | 208      |       | 183      |       | 165      |       |
| Interest expense                                   |       | (781     | )          | (536     | )          | (182     | )          |
| Other expense                                      |       | (829     | )          | (965     | )          | (723     | )          |
| Income before income taxes                         |       | 2,109    |       | 4,105    |       | 3,478    |       |
| Income tax benefit                                 |       | (592     | )          | (548     | )          | (369     | )          |
| Equity in undistributed net income of subsidiaries |       | 11,462   |       | 7,355    |       | 6,390    |       |
|                                               |       |     |       |     |       |     |       |
| Net income                                         |       | $        | 14,163     |     | $          | 12,008   |       | $ | 10,237 |   |

 

71

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**STATEMENTS OF CASH FLOWS**

**Years ended December 31, 2005, 2004, and 2003**

 
| ** **                                                                           | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|--------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| **Operating activities**                                                             |       |     |       |     |       |     |       |
| Net income                                                                           |       | $        | 14,163     |     | $          | 12,008   |       | $ | 10,237 |   |
| Adjustments to reconcile net income to net cash  provided from operating activities: |       |     |       |     |       |     |       |
| Undistributed net income of subsidiaries                                             |       | (11,462  | )          | (7,355   | )          | (6,390   | )          |
| Depreciation and amortization                                                        |       | 110      |       | 110      |       | 110      |       |
| Change in assets                                                                     |       | (149     | )          | (82      | )          | (546     | )          |
| Change in liabilities                                                                |       | (3       | )          | 214      |       | 107      |       |
| Net cash provided from operating activities                                          |       | 2,659    |       | 4,895    |       | 3,518    |       |
|                                                                                 |       |     |       |     |       |     |       |
| **Investing activities**                                                             |       |     |       |     |       |     |       |
| Capital investment in bank subsidiary                                                |       | (47,800  | )          | —   |       | (944     | )          |
| Cash paid in acquisition                                                             |       | —   |       | —   |       | (9,056   | )          |
| Increase in cash surrender value of life insurance                                   |       | (9       | )          | (7       | )          | (12      | )          |
| Net cash used in investing activities                                                |       | (47,809  | )          | (7       | )          | (10,012  | )          |
|                                                                                 |       |     |       |     |       |     |       |
| **Financing activities**                                                             |       |     |       |     |       |     |       |
| Dividends paid                                                                       |       | (5,294   | )          | (4,666   | )          | (4,218   | )          |
| Proceeds from issuance of public offering                                            |       | 50,635   |       | —   |       | —   |       |
| Proceeds from exercise of common stock options                                       |       | 142      |       | 174      |       | 44       |       |
| Proceeds from subordinated debentures                                                |       | 3,093    |       | —   |       | 10,310   |       |
| Purchase of Treasury Stock                                                           |       | —   |       | (538     | )          | —   |       |
| Net cash provided from (used in) financing  activities                               |       | 48,576   |       | (5,030   | )          | 6,136    |       |
|                                                                                 |       |     |       |     |       |     |       |
| **Net change in cash and cash equivalents**                                          |       | 3,426    |       | (142     | )          | (358     | )          |
|                                                                                 |       |     |       |     |       |     |       |
| Cash and cash equivalents, beginning of year                                         |       | 646      |       | 788      |       | 1,146    |       |
|                                                                                 |       |     |       |     |       |     |       |
| **Cash and cash equivalents, end of year**                                           |       | $        | 4,072      |     | $          | 646      |       | $ | 788 |   |

 

72

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**NOTE 16 - OTHER COMPREHENSIVEINCOME**

 

**Other comprehensive income components were as follows.**

 
| ** **                                                                                                                  | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Unrealized holding gains and (losses) on securities  available for sale, net of tax of ($213), ($131) and $19, respectively |       | $        | (343       | )        | $          | (213     | )          | $ | 30 |   |
|                                                                                                                        |       |     |       |     |       |     |       |
| Other comprehensive income (loss)                                                                                           |       | $        | (343       | )        | $          | (213     | )          | $ | 30 |   |

** **

**NOTE 17 - SEGMENTINFORMATION**

** **

**The Company’s operating segments include banking, mortgagebanking, consumer finance, subprime automobile lending and title insurance. Thereportable segments are determined by the products and services offered, andinternal reporting. Loans, investments, and deposits provide the revenues inthe banking operation, loans and fees provide the revenues in consumer finance,mortgage banking, and subprime lending and insurance commissions providerevenues for the title insurance company. Mortgage banking, consumer finance,subprime automobile lending and title insurance do not meet the quantitativethreshold for disclosure on an individual basis, and are therefore shown belowin “other”. All operations are domestic.**

 

**The accounting policies used are the same as thosedescribed in the summary of significant accounting policies. Segmentperformance is evaluated using net interest income and noninterest income. Incometaxes are allocated based on income before income taxes and indirect expenses(includes management fees) are allocated based on time spent for each segment. Transactionsamong segments are made at fair value. Information reported internally forperformance assessment follows.**

 
| ** **                | ** ** | ** **  | ** ** | **Other**    | ** ** | **Holding** | ** ** | ** **       | ** ** | **Total**    | ** ** |
|---------------------------|------------|-------------|------------|--------------|------------|-------------|------------|------------------|------------|--------------|------------|
| **2005**                  | ** ** | **Banking** | ** ** | **Segments** | ** ** | **Company** | ** ** | **Eliminations** | ** ** | **Segments** | ** ** |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Net interest income       |       | $           | 53,805     |         | $          | 5,762       |       | $                | (781       | )            | $          | — |   | $ | 58,786 |   |
| Provision for loan losses |       | 5,055       |       | 1,310        |       | —      |       | —           |       | 6,365        |       |
| Noninterest income        |       | 13,332      |       | 2,035        |       | 209         |       | (820             | )          | 14,756       |       |
| Noninterest expense       |       | 39,980      |       | 4,351        |       | 829         |       | (820             | )          | 44,340       |       |
| Income tax expense        |       | 8,428       |       | 838          |       | (592        | )          | —           |       | 8,674        |       |
| Segment profit            |       | $           | 13,674     |         | $          | 1,298       |       | $                | (809       | )            | $          | — |   | $ | 14,163 |   |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Segment assets            |       | $           | 1,583,655  |         | $          | 31,083      |       | $                | 5,251      |         | $          | — |   | $ | 1,619,989 |   |

 

73

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| ** **                | ** ** | ** **  | ** ** | **Other**    | ** ** | **Holding** | ** ** | ** **       | ** ** | **Total**    | ** ** |
|---------------------------|------------|-------------|------------|--------------|------------|-------------|------------|------------------|------------|--------------|------------|
| ** **                | ** ** | **Banking** | ** ** | **Segments** | ** ** | **Company** | ** ** | **Eliminations** | ** ** | **Segments** | ** ** |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| 2004                      |       |        |       |         |       |        |       |             |       |         |       |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Net interest income       |       | $           | 43,361     |         | $          | 6,193       |       | $                | (536       | )            | $          | — |   | $ | 49,018 |   |
| Provision for loan losses |       | 4,578       |       | 1,258        |       | —      |       | —           |       | 5,836        |       |
| Noninterest income        |       | 12,243      |       | 1,661        |       | 183         |       | (1,059           | )          | 13,028       |       |
| Noninterest expense       |       | 32,557      |       | 4,520        |       | 965         |       | (1,059           | )          | 36,983       |       |
| Income tax expense        |       | 6,984       |       | 783          |       | (548        | )          | —           |       | 7,219        |       |
| Segment profit            |       | $           | 11,485     |         | $          | 1,293       |       | $                | (770       | )            | $          | — |   | $ | 12,008 |   |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Segment assets            |       | $           | 1,200,097  |         | $          | 31,186      |       | $                | 2,120      |         | $          | — |   | $ | 1,233,403 |   |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| 2003                      |       |        |       |         |       |        |       |             |       |         |       |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Net interest income       |       | $           | 34,506     |         | $          | 6,499       |       | $                | (182       | )            | $          | — |   | $ | 40,823 |   |
| Provision for loan losses |       | 3,957       |       | 1,818        |       | —      |       | —           |       | 5,775        |       |
| Noninterest income        |       | 10,453      |       | 2,086        |       | 165         |       | (1,116           | )          | 11,588       |       |
| Noninterest expense       |       | 26,202      |       | 4,808        |       | 724         |       | (1,116           | )          | 30,618       |       |
| Income tax expense        |       | 5,353       |       | 797          |       | (369        | )          | —           |       | 5,781        |       |
| Segment profit            |       | $           | 9,447      |         | $          | 1,162       |       | $                | (372       | )            | $          | — |   | $ | 10,237 |   |
|                      |       |        |       |         |       |        |       |             |       |         |       |
| Segment assets            |       | $           | 1,073,503  |         | $          | 32,541      |       | $                | 2,478      |         | $          | — |   | $ | 1,108,522 |   |

 

**AssetQuality Ratios**

 
| **As of and for the period ended December 31, 2005** | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
|                                                                                              |       |     |       |      |       |      |       |
| Nonperforming loans as a percentage of total loans,  net of unearned income                       |       | 0.45     | %          | 1.68      | %          | 0.49      | %          |
| Nonperforming assets as a percentage of total assets                                              |       | 0.59     | %          | 2.37      | %          | 0.65      | %          |
| Allowance for loan losses as a percentage of total  loans, net of unearned income                 |       | 1.26     | %          | 7.89      | %          | 1.43      | %          |
| Allowance for loan losses as a percentage of  nonperforming assets                                |       | 180.06   | %          | 282.74    | %          | 188.58    | %          |
| Net charge-offs to average total loans, net of  unearned income                                   |       | 0.21     | %          | 4.22      | %          | 0.32      | %          |

 
| **As of and for the period ended December 31, 2004**                         | ** ** | **Bank** | ** ** | **Other** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------|------------|-----------|------------|-----------|------------|
|                                                                              |       |     |       |      |       |      |       |
| Nonperforming loans as a percentage of total loans,  net of unearned income       |       | 0.60     | %          | 2.22      | %          | 0.66      | %          |
| Nonperforming assets as a percentage of total assets                              |       | 0.61     | %          | 2.90      | %          | 0.69      | %          |
| Allowance for loan losses as a percentage of total  loans, net of unearned income |       | 1.27     | %          | 7.77      | %          | 1.50      | %          |
| Allowance for loan losses as a percentage of  nonperforming assets                |       | 176.54   | %          | 255.69    | %          | 185.56    | %          |
| Net charge-offs to average total loans, net of  unearned income                   |       | 0.35     | %          | 5.04      | %          | 0.51      | %          |

 

74

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**NOTE 18 -SELECTED QUARTERLY FINANCIAL INFORMATION (UNAUDITED)**

 

Presented below is asummary of the consolidated quarterly financial data:

 
| ** **                                       | ** ** | **For the three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|
| **Summary of Operations**              | ** ** | **3/31/2005**                                      | ** ** | **6/30/2005** | ** ** | **9/30/2005** | ** ** | **12/31/2005** | ** ** |
|                                             |       |                                               |       |   |   |   |   |   |   |
| Interest income                                  |       | $                                                  | 18,735     |   | $ | 20,703 |   | $ | 22,115 |   | $ | 25,638 |   |
| Net interest income                              |       | 13,327                                             |       | 14,072 |   | 14,548 |   | 16,839 |   |
| Provision for loan losses                        |       | 1,622                                              |       | 1,060 |   | 1,704 |   | 1,979 |   |
| Income before income taxes                       |       | 4,606                                              |       | 6,053 |   | 5,949 |   | 6,229 |   |
| Net income                                       |       | 2,935                                              |       | 3,714 |   | 3,676 |   | 3,838 |   |
|                                             |       |                                               |       |   |   |   |   |   |   |
| Basic earnings per share                         |       | 0.38                                               |       | 0.49 |   | 0.48 |   | 0.40 |   |
| Diluted earning per share                        |       | 0.38                                               |       | 0.48 |   | 0.47 |   | 0.39 |   |
| Dividends per common share                       |       | 0.12                                               |       | 0.12 |   | 0.12 |   | 0.26 |   |
| Average common shares outstanding                |       | 7,649,070                                          |       | 7,650,884 |   | 7,710,871 |   | 9,709,731 |   |
| Average common shares outstanding – diluted |       | 7,744,181                                          |       | 7,745,985 |   | 7,805,458 |   | 9,799,609 |   |
|                                                  |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                                       | ** ** | **For the three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------|------------|
| **Summary of Operations**              | ** ** | **3/31/2004**                                      | ** ** | **6/30/2004** | ** ** | **9/30/2004** | ** ** | **12/31/2004** | ** ** |
|                                             |       |                                               |       |   |   |   |   |   |   |
| Interest income                                  |       | $                                                  | 15,930     |   | $ | 15,869 |   | $ | 16,142 |   | $ | 17,135 |   |
| Net interest income                              |       | 11,880                                             |       | 11,983 |   | 12,412 |   | 12,743 |   |
| Provision for loan losses                        |       | 1,523                                              |       | 1,162 |   | 1,062 |   | 2,089 |   |
| Income before income taxes                       |       | 4,500                                              |       | 5,317 |   | 5,159 |   | 4,251 |   |
| Net income                                       |       | 2,852                                              |       | 3,275 |   | 3,213 |   | 2,668 |   |
|                                             |       |                                               |       |   |   |   |   |   |   |
| Basic earnings per share                         |       | 0.37                                               |       | 0.43 |   | 0.42 |   | 0.35 |   |
| Diluted earning per share                        |       | 0.37                                               |       | 0.42 |   | 0.42 |   | 0.34 |   |
| Dividends per common share                       |       | 0.12                                               |       | 0.12 |   | 0.12 |   | 0.25 |   |
| Average common shares outstanding                |       | 7,660,578                                          |       | 7,656,832 |   | 7,644,544 |   | 7,656,509 |   |
| Average common shares outstanding – diluted |       | 7,731,176                                          |       | 7,713,966 |   | 7,710,335 |   | 7,735,834 |   |
|                                                  |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |

 

75

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**NOTE 19 –BUSINESS COMBINATION**

 

On October 7, 2005,the Company completed the acquisition of five branches in Montgomery County,Tennessee (“Clarksville transaction”). The primary reason for the acquisition was related to the Company’sdesire to expand its market share in the Middle Tennessee area. The Companypaid a deposit premium for the branches, which resulted in the Companyrecording intangible assets of $16,781, all of which are deductible for taxpurposes. The identifiable intangible asset associated with the fair value ofthe core deposit base, as determined by an independent consulting firm, wasdetermined to be $3,736 and is being amortized as an expense on a straight-linemethod over an eight and one-half-year period. The remaining intangible assetof $13,045 has been classified as goodwill, and, thus, will not besystematically amortized, but rather will be subject to an annual impairmenttest in accordance with SFAS No. 142, as described in Note 1 above. Theamortization of the identifiable intangible asset is included in theaccompanying Consolidated Statements of Income beginning on the acquisitiondate of October 7, 2005.

 

The following tablesummarizes the fair value of assets acquired and liabilities assumed at thedate of acquisition. 

 
| Cash                            |   | $       | 33,191  |   |
|---------------------------------|--------|---------|---------|--------|
| Loans, net of unearned interest |   | 111,788 |    |
| Allowance for loan losses       |   | (1,467  | )       |
| Premises and equipment          |   | 12,653  |    |
| Goodwill                        |   | 13,045  |    |
| Core deposit intangible         |   | 3,736   |    |
| Other assets                    |   | 654     |    |
| Total assets acquired           |   | $       | 173,600 |   |
|                            |   |    |    |
| Deposits                        |   | $       | 172,937 |   |
| Other liabilities               |   | 663     |    |
| Total liabilities assumed       |   | $       | 173,600 |   |

 

The following tablepresents pro forma information as if the acquisition had occurred at thebeginning of 2005. The pro forma information includes adjustments for interestincome on loans, amortization of intangibles arising from the transaction,depreciation expense on property acquired, interest expense on depositsassumed, and the related income tax effects. The pro forma financialinformation is not necessarily indicative of the results of operations as theywould have been had the transactions been effected on the assumed dates.

 
| ** **                 | ** ** | **2005** | ** ** |
|----------------------------|------------|----------|------------|
| Net interest income        |       | $        | 62,719     |   |
|                       |       |     |       |
| Net income                 |       | $        | 15,541     |   |
|                       |       |     |       |
| Basic earnings per share   |       | $        | 1.90       |   |
|                       |       |     |       |
| Diluted earnings per share |       | $        | 1.88       |   |

 

76

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On December 10,2004, the Company completed the acquisition of three branches from NationalBank of Commerce (“NBC”) located in Lawrence County, Tennessee. The primaryreason for the acquisition related to the Company’s desire to expand its marketshare in the Middle Tennessee area. The Company paid a deposit premium of 4.5%for the branches, which resulted in the Company recording intangible assets of$3,349, all of which are deductible for tax purposes. The identifiableintangible asset associated with the fair value of the core deposit base, asdetermined by an independent consulting firm, was determined to be $952 and isbeing amortized as an expense on a straight-line method over a seven-yearperiod. The remaining intangible asset of $2,397 has been classified asgoodwill, and, thus, will not be systematically amortized, but rather will besubject to an annual impairment test in accordance with SFAS No. 142, as describedin Note 1 above. The amortization of the identifiable intangible asset isincluded in the accompanying Consolidated Statements of Income beginning on theacquisition date of December 10, 2004. Historical financial informationrelated to the three branches while owned by NBC is not available, and thus proforma results of operations have not been presented. 

 

The following tablesummarizes the fair value of assets acquired and liabilities assumed at thedate of acquisition. 

 
| Cash                            |   | $      | 38,003 |   |
|---------------------------------|--------|--------|--------|--------|
| Loans, net of unearned interest |   | 28,734 |   |
| Allowance for loan losses       |   | (363   | )      |
| Premises and equipment          |   | 230    |   |
| Goodwill                        |   | 2,397  |   |
| Core deposit intangible         |   | 953    |   |
| Other assets                    |   | 150    |   |
| Total assets acquired           |   | $      | 70,104 |   |
|                            |   |   |   |
| Deposits                        |   | $      | 69,882 |   |
| Other liabilities               |   | 222    |   |
| Total liabilities assumed       |   | $      | 70,104 |   |

 

On November 21,2003, the Company acquired 100% of the outstanding shares of IndependentBankshares Corporation, parent of First Independent Bank and Rutherford CountyBank and Trust. Operating results of Independent Bankshares Corporation areincluded in the consolidated financial statements since the date of theacquisition. 

 

The aggregate purchaseprice was $30,303, including $9,056 in cash, $21,049 in common stock and $198in stock options. The purchase price resulted in $13,832 in goodwill and $4,596in core deposit and customer relationship intangible. The intangible asset willbe amortized over 10 years, using an accelerated method. Goodwill will not beamortized but instead evaluated periodically for impairment. Any future writedown of goodwill and the amortization of intangibles assets are not deductiblefor tax purposes. 

 

The following tablesummarizes the fair value of assets acquired and liabilities assumed at thedate of acquisition. 

 

77

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| Cash and due from banks         |   | $        | 7,951  |   |
|---------------------------------|--------|----------|--------|--------|
| Federal funds sold              |   | 29,495   |   |
| Securities                      |   | 16,354   |   |
| FHLB stock                      |   | 446      |   |
| Loans, net of unearned interest |   | 110,172  |   |
| Allowance for loan losses       |   | (1,340   | )      |
| Premises and equipment          |   | 5,316    |   |
| Goodwill                        |   | 13,832   |   |
| Core deposit intangible         |   | 4,596    |   |
| Other assets                    |   | 1,957    |   |
| Total assets acquired           |   | 188,779  |   |
| Deposits                        |   | (154,004 | )      |
| Other liabilities               |   | (4,472   | )      |
| Total liabilities assumed       |   | (158,476 | )      |
| Net assets acquired             |   | $        | 30,303 |   |

 

The following tablepresents pro forma information as if the acquisition had occurred at thebeginning of 2003. The pro forma information includes adjustments for interestincome on loans and securities acquired, amortization of intangibles arisingfrom the transaction, depreciation expense on property acquired, interestexpense on deposits assumed, and the related income tax effects. The pro formafinancial information is not necessarily indicative of the results ofoperations as they would have been had the transactions been effected on theassumed dates.

 
| ** **                 | ** ** | **2003** | ** ** |
|----------------------------|------------|----------|------------|
| Net interest income        |       | $        | 46,388     |   |
|                       |       |     |       |
| Net income                 |       | $        | 10,255     |   |
|                       |       |     |       |
| Basic earnings per share   |       | $        | 1.34       |   |
| Diluted earnings per share |       | $        | 1.33       |   |

 

78

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**ITEM 9.**         CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

None.

 

**ITEM 9A.**               CONTROLSAND PROCEDURES.

 

**Evaluation of Disclosure Controls andProcedures**

 

TheCompany maintains disclosure controls and procedures, as defined in Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934 (the “Exchange Act”), that aredesigned to ensure that information required to be disclosed by it in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules andforms and that such information is accumulated and communicated to the Company’smanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosure. TheCompany carried out an evaluation, under the supervision and with theparticipation of its management, including its Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofits disclosure controls and procedures as of the end of the period covered bythis report. Based on the evaluation of these disclosure controls andprocedures, the Chief Executive Officer and Chief Financial Officer concludedthat the Company’s disclosure controls and procedures were effective.

 

**Changes in Internal Control Over FinancialReporting**

 

Therewere no changes in the Company’s internal control over financial reportingduring the Company’s fiscal quarter ended December 31, 2005 that havematerially affected, or are reasonably likely to materially affect, the Company’sinternal control over financial reporting. 

 

**Management Report onInternal Control Over Financial Reporting**

 

Thereport of the Company’s management on the effectiveness of the Company’sinternal control over financial reporting is set forth on page 41 of thisAnnual Report on Form 10-K. The attestation of the Company’s registeredpublic accounting firm related to the report is set forth on page 42 ofthis Annual Report on Form 10-K. 

 

**ITEM 9B.**               OTHERINFORMATION.

** **

None.

 

79

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**PART III**

 
| **ITEM 10.** | **DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.** |
|--------------|---------------------------------------------------------|

** **

Forinformation concerning the Board of Directors of the Company, the informationcontained under the section captioned “Proposal 1 – Election of Directors”in the Company’s definitive Proxy Statement for the Company’s 2006 AnnualMeeting of Shareholders (the “ Proxy Statement”) is incorporated herein byreference.

 

Informationregarding executive officers of the Company contained under the section captioned“Proposal 1 – Election of Directors” in the Proxy Statement is incorporatedherein by reference.

 

Informationregarding delinquent Form 3, 4 or 5 filers is incorporated herein byreference to the section entitled “Section 16(a) BeneficialOwnership Reporting Compliance” in the Proxy Statement.

 

Informationregarding the Company’s code of ethics is incorporated herein by reference tothe section entitled “Proposal 1 – Election of Directors” in the ProxyStatement.

 

Informationregarding the Company’s “audit committee financial expert” and its auditcommittee is incorporated herein by reference to the section captioned “Proposal1 – Election of Directors - Meetings and Committees of the Board of Directors”in the Proxy Statement. 

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

 

Theinformation contained under the section captioned “Proposal 1 – Electionof Directors - Executive Compensation and Other Benefits” in the ProxyStatement is incorporated herein by reference.

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

** **

(a)           SecurityOwnership of Certain Beneficial Owners

 

Informationrequired by this item is incorporated herein by reference to the section captioned“Security Ownership of Certain Beneficial Owners and Management” in the ProxyStatement.

 

(b)           SecurityOwnership of Management

 

Informationrequired by this item is incorporated herein by reference to the sectionscaptioned “Security Ownership of Certain Beneficial Owners and Management” and “Proposal1 – Election of Directors” in the Proxy Statement.

 

(c)           Changes inControl

 

Managementof the Company knows of no arrangements, including any pledge by any person ofsecurities of the Company, the operation of which may at a subsequent dateresult in a change in control of the registrant.

 

(d)           EquityCompensation Plan Information

 

The following table sets forth certain informationwith respect to securities to be issued under the Company’s equity compensationplans as of December 31, 2005.

 

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| **Plan Category**                                           | ** ** | **(a)  Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **(b)  Weighted-average  exercise price of  outstanding  options, warrants  and rights** | ** ** | **(c)  Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  reflected in column (a))** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by security  holders     |       | 324,910                                                                                                  |       | $                                                                                        | 23.33      |                                                                                                                                                      | 428,772    |   |
| Equity compensation plans not approved by security  holders |       | 72,000                                                                                                   |       | $                                                                                        | 14.03      |                                                                                                                                                      |       | * |
|                                                        |       |                                                                                                     |       |                                                                                     |       |                                                                                                                                                      |       |
| Total                                                       |       | 396,910                                                                                                  |       | $                                                                                        | 21.65      |                                                                                                                                                      | 428,772    |   |

 

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*R. Stan Puckett, was thesole participant under this plan, which was a part of Mr. Puckett’semployment agreement. This employment agreement was amended during 2005 toprovide that future option grants to the key executive would be made at no lessthan fair market value on the date of grant in order to comply with Section 409Aof the Internal Revenue Code of 1986, as amended.

 

**ITEM13.**    CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

** **

Theinformation required by this item is incorporated herein by reference to thesections captioned “Proposal 1 – Election of Directors” and “CertainTransactions” in the Proxy Statement.

 

**ITEM14.**    PRINCIPAL ACCOUNTANT FEES AND SERVICES.

** **

Theresponses to this Item are incorporated herein by reference to the section captioned“Independent Registered Public Accounting Firm” in the Proxy Statement.

 

**PART IV**

 

**ITEM15.**    EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. 

** **
| (a)(1) | The following  consolidated financial statements of the Company included in the Company’s  2005 Annual Report to the Shareholders (the “Annual Report”) are incorporated  herein by reference from Item 8 of this Form 10-K. The remaining  information appearing in the Annual Report is not deemed to be filed as  part of this Form 10-K, except as expressly provided herein. |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

1.             Reportof Independent Registered Public Accounting Firm.

 

2.             ConsolidatedBalance Sheets – December 31, 2005 and 2004.

 

3.             ConsolidatedStatements of Income for the Years Ended December 31, 2005, 2004 and 2003.

 

4.             ConsolidatedStatements of Changes in Shareholders’ Equity for the Years Ended December 31,2005, 2004 and 2003.

 

5.             ConsolidatedStatements of Cash Flows for the Years Ended December 31, 2005, 2004 and2003.

 

6.             Notes toConsolidated Financial Statements.

 
| (a)(2) | All schedules for which provision is made in the  applicable accounting regulations of the Securities and Exchange Commission  are not required under the related instructions or are inapplicable and  therefore have been omitted. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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(a)(3)      Thefollowing exhibits either are filed as part of this Report or areincorporated herein by reference:

 

2.1           BranchPurchase and Assumption Agreement between Greene County Bank and Old NationalBank (Pursuant to Item 601(b)(2) of Regulation S-K the schedulesand exhibits to this agreement have been omitted from this filing) –incorporated herein by reference to the Company’s Quarterly Report on Form 10-Qfor the quarter ended June 30, 2005.

 

3.1           Amended and RestatedCharter – incorporated herein by reference to the Company’s RegistrationStatement on Form S-4 filed on August 11, 2003.

 

3.2           Amended and RestatedBylaws – incorporated herein by reference to the Company’s Current Report on Form 8-Kfiled on November 18, 2005.

 

10.1         Employment Agreement andAmendment to Employment Agreement between the Company and R. Stan Puckett –incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the years ended December 31, 1995 and December 31, 2003,respectively.*

 

10.2         Employment Agreementbetween the Company and Kenneth R. Vaught – incorporated herein by reference tothe Company’s Annual Report on Form 10-K for the year ended December 31,2003.* 

 

10.3         Employment Agreementbetween the Company and Ronald E. Mayberry – incorporated herein by referenceto the Company’s Annual Report on Form 10-K for the year ended December 31,2003.*

 

10.4         Non-competition Agreementbetween the Company and R. Stan Puckett – incorporated herein by reference tothe Company’s Annual Report on Form 10-K for the year ended December 31,2003.*

 

10.5         Non-competition Agreementbetween the Company and Kenneth R. Vaught – incorporated herein by reference tothe Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,2004.*

 

10.6         Greene County Bancshares, Inc.2004 Long-Term Incentive Plan – incorporated herein by reference to the Company’sRegistration Statement on Form S-8 filed on April 30, 2004.*

 

10.7         Greene County Bancshares, Inc.Amended and Restated Deferred Compensation Plan for Non-employee Directors –incorporated herein by reference to the Company’s Current Report on Form 8-Kfiled on December 17, 2004.*

 

10.8         Form of Stock OptionAward Agreement - incorporated herein by reference to the Company’s AnnualReport on Form 10-K for the year ended December 31, 2004.*

 

10.9         Deferred Fee Agreementbetween the Bank and John Tolsma dated December 13, 2004 - incorporatedherein by reference to the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.*

 

10.10       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreements dated March 11,1997, March 1, 1999 and November 15, 2004 between the Bank and PhilipM. Bachman dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

82

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10.11       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated March 1,1999 between the Bank and W.T. Daniels dated March 11, 2005 - incorporatedherein by reference to the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.*

 

10.12       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated March 1,1999 between the Bank and Terry Leonard dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.13       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,1999 between the Bank and Charles S. Brooks dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.14       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,1999 between the Bank and Jerald K. Jaynes dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.15       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,2003 between the Bank and Charles H. Whitfield, Jr. dated March 11,2005 - incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.16       Greene County BankExecutive Deferred Compensation Agreement between the Bank and R. Stan Puckettdated March 11, 2005 - incorporated herein by reference to the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.*

 

10.17       Greene County BankExecutive Deferred Compensation Agreement between the Bank and Kenneth R.Vaught dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

10.18       Greene County BankExecutive Deferred Compensation Agreement between the Bank and Ronald E.Mayberry dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

10.19       Greene County Bancshares, Inc.Change in Control Protection Plan – incorporated herein by reference to theCompany’s Current Report on Form 8-K filed on October 26, 2004.*

 

10.20       Greene County Bancshares, Inc.Change in Control Protection Plan Participation Agreement between the Companyand Steve L. Droke – incorporated herein by reference to the Company’s CurrentReport on Form 8-K filed on October 26, 2004.*

 

10.21       Greene County Bancshares, Inc.Change in Control Protection Plan Participation Agreement between the Companyand Ronald E. Mayberry – incorporated herein by reference to the Company’sCurrent Report on Form 8-K filed on October 26, 2004.*

 

10.22       FirstAmendment dated March 31, 2005 to Non-Competition Agreement dated August 10,2004, by and between the Company and Kenneth R. Vaught – incorporated herein byreference to the Company’s Quarterly Report on Form 10-Q for the quarter endedMarch 31, 2005.*

 

83

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10.23       FirstAmendment dated April 15, 2005 to Non-Competition Agreement dated November 24,2003, by and between the Company and R. Stan Puckett – incorporated herein byreference to the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2005.*

 

10.24       RevolvingCredit Agreement dated as of August 30, 2005, by and between the Companyand SunTrust Bank – incorporated herein by reference to the Company’s QuarterlyReport on Form 10-Q for the quarter ended September 30, 2005.

 

10.25       Form ofRevolving Credit Note – incorporated herein by reference to the Company’sQuarterly Report on Form 10-Q for the quarter ended September 30,2005.

 

10.26       Summaryof Compensation Arrangement for James E. Adams – incorporated herein byreference to the Company’s Current Report on Form 8-K filed on November 15,2005.*

 

10.27       SecondAmendment to Employment Agreement by and between Greene County Bancshares, Inc.and R. Stan Puckett dated as of December 20, 2005 – incorporated herein byreference to the Company’s Current Report on Form 8-K filed on December 21,2005.*

 

10.28       Amendedand Restated Deferred Compensation Plan for Nonemployee Directors –incorporated herein by reference to the Company’s Current Report on Form 8-Kfiled on December 21, 2005.*

 

10.29       Directorand Named Executive Officer Compensation Summary.*

 

11.1         Statement reComputation of Per Share Earnings – incorporated by reference to Note 13 of theNotes to Consolidated Financial Statements herein.

 

21.1         Subsidiariesof the Company

 

23.1         Consentof Dixon Hughes PLLC

 

23.2         Consentof Crowe Chizek and Company LLC

 

31.1         ChiefExecutive Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

 

31.2         ChiefFinancial Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

 

32.1         ChiefExecutive Officer Certification Pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

32.2         ChiefFinancial Officer Certification Pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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*Management contract or compensatory plan. 

 

TheCompany is a party to certain agreements entered into in connection with theoffering by Greene County Capital Trust I (“GC Trust”) and Greene CountyCapital Trust II (“GC Trust II”) of an aggregate of $13 million of variablerate trust preferred securities, as more fully described in this Annual Reporton Form 10-K. In accordance with Item 601(b)(4)(iii) of RegulationS-K, and because the total amount of the trust preferred securities is not inexcess of 10% of the Company’s total assets, the Company has not filed thevarious documents and agreements associated with the trust preferred securitiesherewith. The Company has, however, agreed to furnish copies the variousdocuments and agreements associated with the trust preferred securities to theSEC upon request.

 

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(b)           Exhibits.The exhibits required by Item 601 of Regulation S-K are either filed as part ofthis Annual Report on Form 10-K or incorporated herein by reference.

 

(c)           FinancialStatements and Financial Statement Schedules Excluded From Annual Report. Thereare no financial statements and financial statement schedules which wereexcluded from the Annual Report pursuant to Rule 14a-3(b)(1) whichare required to be included herein.

 

85

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**SIGNATURES**

 

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

 
|                            | GREENE COUNTY  BANCSHARES, INC. |
|---------------------------------|--------------------------------------|
|                            |                                 |
|                            |                                 |
| Date:  March 14, 2006 | By:                                  |  /s/ R.  Stan Puckett |
|                            |                                 |  R. Stan  Puckett |
|                            |                                 |  Chairman  of the Board and |
|                            |                                 |  Chief  Executive Officer |
|                            |                                 |  (Duly  Authorized Representative) |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant and inthe capacities indicated and on the dates indicated.

 
| **SIGNATURE AND TITLE:**                                                                                                   | ** ** | **DATE:** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------|
|                                                                                                                                 |       |      |
| /s/ R. Stan  Puckett                                                                                                                 |       |      | March 14,  2006 |
| R. Stan Puckett  Chairman of the Board and Chief Executive Officer  (Principal Executive Officer)                                    |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Kenneth R.  Vaught                                                                                                               |       |      | March 14,  2006 |
| Kenneth R.  Vaught  President, Chief Operating Officer, and Director                                                                 |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ James E.  Adams                                                                                                                  |       |      | March 14,  2006 |
| James E. Adams  Senior Vice President, Chief Financial Officer and Assistant Secretary  (Principal Financial and Accounting Officer) |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Ronald E.  Mayberry                                                                                                              |       |      | March 14,  2006 |
| Ronald E.  Mayberry  Regional President, Sumner, Rutherford and Lawrence Counties, and Director                                      |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Phil M.  Bachman                                                                                                                 |       |      | March 14,  2006 |
| Phil M. Bachman  Director and Secretary                                                                                              |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Martha M.  Bachman                                                                                                               |       |      | March 14,  2006 |
| Martha Bachman  Director                                                                                                             |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Charles S.  Brooks                                                                                                               |       |      | March 14,  2006 |
| Charles S.  Brooks  Director                                                                                                         |       |      |
|                                                                                                                                 |       |      |
|                                                                                                                                 |       |      |
| /s/ Bruce  Campbell                                                                                                                  |       |      | March 14,  2006 |
| Bruce Campbell  Director                                                                                                             |       |      |
|                                                                                                                                      |            |           |  |  |  |  |  |  |  |  |

 

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| /s/ W. T.  Daniels                        |   |   | March 14,  2006 |
|-------------------------------------------|--------|--------|----------------------|
| W.T. Daniels  Director                    |   |   |
|                                      |   |   |
| /s/ Robin Haynes                          |   |   | March 14,  2006 |
| Robin Haynes  Director                    |   |   |
|                                      |   |   |
|                                      |   |   |
| /s/ Jerald K.  Jaynes                     |   |   | March 14,  2006 |
| Jerald K. Jaynes  Director                |   |   |
|                                      |   |   |
|                                      |   |   |
| /s/ Robert K.  Leonard                    |   |   | March 14,  2006 |
| Robert K.  Leonard  Director              |   |   |
|                                      |   |   |
|                                      |   |   |
| /s/ Terry  Leonard                        |   |   | March 14,  2006 |
| Terry Leonard  Director                   |   |   |
|                                      |   |   |
|                                      |   |   |
| /s/ John Tolsma                           |   |   | March 14,  2006 |
| John Tolsma  Director                     |   |   |
|                                      |   |   |
|                                      |   |   |
| /s/ Charles H.  Whitfield, Jr.       |   |   | March 14,  2006 |
| Charles H.  Whitfield, Jr.  Director |   |   |
|                                           |        |        |                      |  |  |  |  |  |

 

87

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**EXHIBIT INDEX**

 

2.1           BranchPurchase and Assumption Agreement between Greene County Bank and Old NationalBank (Pursuant to Item 601(b)(2) of Regulation S-K the schedules andexhibits to this agreement have been omitted from this filing) – incorporatedherein by reference to the Company’s Quarterly Report on Form 10-Q for thequarter ended June 30, 2005.

 

3.1           Amended and RestatedCharter – incorporated herein by reference to the Company’s Registration Statementon Form S-4 filed on August 11, 2003.

 

3.2           Amended and RestatedBylaws – incorporated herein by reference to the Company’s Current Report Form 8-Kfiled on November 18, 2005.

 

10.1         Employment Agreement andAmendment to Employment Agreement between the Company and R. Stan Puckett –incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the years ended December 31, 1995 and December 31, 2003,respectively.*

 

10.2         Employment Agreementbetween the Company and Kenneth R. Vaught – incorporated herein by reference tothe Company’s Annual Report on Form 10-K for the year ended December 31,2003.*

 

10.3         Employment Agreementbetween the Company and Ronald E. Mayberry – incorporated herein by referenceto the Company’s Annual Report on Form 10-K for the year ended December 31,2003.*

 

10.4         Non-competition Agreementbetween the Company and R. Stan Puckett – incorporated herein by reference tothe Company’s Annual Report on Form 10-K for the year ended December 31,2003.*

 

10.5         Non-competition Agreementbetween the Company and Kenneth R. Vaught – incorporated herein by reference tothe Company’s Quarterly Report on Form 10-Q for the quarter ended September 30,2004.*

 

10.6         Greene County Bancshares, Inc.2004 Long-Term Incentive Plan – incorporated herein by reference to the Company’sRegistration Statement on Form S-8 filed on April 30, 2004.*

 

10.7         Greene County Bancshares, Inc.Amended and Restated Deferred Compensation Plan for Non-employee Directors –incorporated herein by reference to the Company’s Current Report on Form 8-Kfiled on December 17, 2004.*

 

10.8         Form of Stock OptionAward Agreement - incorporated herein by reference to the Company’s AnnualReport on Form 10-K for the year ended December 31, 2004.*

 

10.9         Deferred Fee Agreementbetween the Bank and John Tolsma dated December 13, 2004 - incorporatedherein by reference to the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.*

 

10.10       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreements dated March 11,1997, March 1, 1999 and November 15, 2004 between the Bank and PhilipM. Bachman dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

10.11       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated March 1,1999 between the Bank and W.T. Daniels dated March 11, 2005 - incorporatedherein by reference to the Company’s Annual Report on Form 10-K for theyear ended December 31, 2004.*

 

10.12       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated March 1,1999 between the Bank and Terry Leonard dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

88

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10.13       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,1999 between the Bank and Charles S. Brooks dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.14       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,1999 between the Bank and Jerald K. Jaynes dated March 11, 2005 -incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.15       Amendment and Restatementof the Greene County Bank Deferred Compensation Agreement dated May 1,2003 between the Bank and Charles H. Whitfield, Jr. dated March 11,2005 - incorporated herein by reference to the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2004.*

 

10.16       Greene County BankExecutive Deferred Compensation Agreement between the Bank and R. Stan Puckettdated March 11, 2005 - incorporated herein by reference to the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.*

 

10.17       Greene County BankExecutive Deferred Compensation Agreement between the Bank and Kenneth R.Vaught dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

10.18       Greene County BankExecutive Deferred Compensation Agreement between the Bank and Ronald E.Mayberry dated March 11, 2005 - incorporated herein by reference to theCompany’s Annual Report on Form 10-K for the year ended December 31,2004.*

 

10.19       Greene County Bancshares, Inc.Change in Control Protection Plan – incorporated herein by reference to theCompany’s Current Report on Form 8-K filed on October 26, 2004.*

 

10.20       Greene County Bancshares, Inc.Change in Control Protection Plan Participation Agreement between the Companyand Steve L. Droke – incorporated herein by reference to the Company’s CurrentReport on Form 8-K filed on October 26, 2004.*

 

10.21       Greene County Bancshares, Inc.Change in Control Protection Plan Participation Agreement between the Companyand Ronald E. Mayberry – incorporated herein by reference to the Company’sCurrent Report on Form 8-K filed on October 26, 2004.*

 

10.22       FirstAmendment dated March 31, 2005 to Non-Competition Agreement dated August 10,2004, by and between the Company and Kenneth R. Vaught – incorporated herein byreference to the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2005.*

 

10.23       FirstAmendment dated April 15, 2005 to Non-Competition Agreement dated November 24,2003, by and between the Company and R. Stan Puckett – incorporated herein byreference to the Company’s Quarterly Report on Form 10-Q for the quarterended March 31, 2005.*

 

10.24       RevolvingCredit Agreement dated as of August 30, 2005, by and between the Companyand SunTrust Bank – incorporated herein by reference to the Company’s QuarterlyReport on Form 10-Q for the quarter ended September 30, 2005.

 

10.25       Form ofRevolving Credit Note – incorporated herein by reference to the Company’sQuarterly Report on Form 10-Q for the quarter ended September 30,2005.

 

10.26       Summaryof Compensation Arrangement for James E. Adams – incorporated herein byreference to the Company’s Current Report on Form 8-K filed on November 15,2005.*

 

10.27       SecondAmendment to Employment Agreement by and between Greene County Bancshares, Inc.and R. Stan Puckett dated as of December 20, 2005 – incorporated herein byreference to the Company’s Current Report on Form 8-K filed on December 21,2005.*

 

89

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10.28       Amendedand Restated Deferred Compensation Plan for Nonemployee Directors –incorporated herein by reference to the Company’s Current Report on Form 8-Kfiled on December 21, 2005.*

 

10.29       Directorand Named Executive Officer Compensation Summary.*

 

11.1         Statement reComputation of Per Share Earnings – incorporated by reference to Note 13 of theNotes to Consolidated Financial Statements herein.

 

21.1         Subsidiariesof the Company

 

23.1         Consent ofDixon Hughes PLLC

 

23.2         Consent ofCrowe Chizek and Company LLC

 

31.1         ChiefExecutive Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

 

31.2         ChiefFinancial Officer Certification Pursuant to Rule 13a-14(a)/15d-14(a)

 

**32.1**         Chief Executive Officer Certification Pursuant to 18U.S.C. Section 1350, as Adopted Pursuant to Section 906 of theSarbanes-Oxley Act of 2002

** **

**32.2**         Chief Financial Officer Certification Pursuant to 18 U.S.C. Section 1350,as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

----

*Management contact or compensatory plan. 

 

90

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