**UNITED STATES SECURITIES ANDEXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**QUARTERLY REPORT PURSUANT TOSECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005**

 

**CommissionFile Number 000-51281**

 

**TENNESSEE COMMERCE BANCORP,  INC.**

(Exact Name of Registrant AsSpecified in Its Charter)

 
| **Tennessee**                                                    |   | **62-1815881**                     |
|------------------------------------------------------------------|--------|------------------------------------|
| (State or  Other Jurisdiction of  Incorporation or Organization) |   | (IRS  Employer Identification No.) |
|                                                             |   |                               |
| **381  Mallory Station Rd., Suite 207**                     |   | **Franklin,  Tennessee 37067**     |

(Address of Principal ExecutiveOffices and Zip Code)

 

**(615) 599-2274**

(Registrant’s Telephone Number,Including Area Code)

 

Indicate by check mark whether the Registrant(1) has filed all reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the Registrant was required to file such reports), and(2) has been subject to such filing requirements for the past90 days.

 

YES ý      NO o

 

Indicate by check mark whether the Registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

 

YES o      NO ý

 

Indicate by check mark whether the Registrantis a shell company (as defined by Rule 12b-2 of the Exchange Act)

 

YES o      NO ý

 

Indicate the number of shares outstanding ofeach of the issuer’s classes of common stock as of the latest practicabledate:  Common stock outstanding (parvalue $0.50 per share): 3,238,674 shares at November 1, 2005.

 

 

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**Tennessee Commerce Bancorp, Inc.**

 

Table of Contents

 
| **Part I**  | **Financial  Information**                                                                                                                                                                          |   |
|------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|             |                                                                                                                                                                                                |   |
| Item  1.         | Financial  Statements                                                                                                                                                                               |   |
|             |                                                                                                                                                                                                |   |
|             | Consolidated Balance Sheets at September 30, 2005 (unaudited)  and December 31, 2004                                                                                                      |   |
|             |                                                                                                                                                                                                |   |
|             | Consolidated Statements of Income and Comprehensive Income  (unaudited) for the Nine Months Ended September 30, 2005 and 2004 and  for the Three Months Ended September 30, 2005 and 2004 |   |
|             |                                                                                                                                                                                                |   |
|             | Consolidated Statements of Changes in Shareholders’ Equity  (unaudited) for the Nine Months Ended September 30, 2005 and 2004                                                             |   |
|             |                                                                                                                                                                                                |   |
|             | Consolidated Statements of Cash Flows (unaudited) for the Nine Months  Ended September 30, 2005 and 2004                                                                                       |   |
|             |                                                                                                                                                                                                |   |
|             | Notes to Consolidated Financial Statements (unaudited)                                                                                                                                              |   |
|             |                                                                                                                                                                                                |   |
| Item 2.          | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                                                                                                         |   |
|             |                                                                                                                                                                                                |   |
| Item 3.          | Quantitative and Qualitative Disclosures  About Market Risk                                                                                                                                         |   |
|             |                                                                                                                                                                                                |   |
| Item 4.          | Controls and Procedures                                                                                                                                                                             |   |
|             |                                                                                                                                                                                                |   |
| **Part II** | **Other Information**                                                                                                                                                                               |   |
|             |                                                                                                                                                                                                |   |
| Item 1.          | Legal Proceedings                                                                                                                                                                                   |   |
|             |                                                                                                                                                                                                |   |
| Item 2.          | Unregistered Sales of Equity Securities and  Use of Proceeds                                                                                                                                        |   |
|             |                                                                                                                                                                                                |   |
| Item 3.          | Defaults Upon Senior Securities                                                                                                                                                                     |   |
|             |                                                                                                                                                                                                |   |
| Item 4.          | Submission of Matters to a Vote of Security  Holders                                                                                                                                                |   |
|             |                                                                                                                                                                                                |   |
| Item 5.          | Other Information                                                                                                                                                                                   |   |
|             |                                                                                                                                                                                                |   |
| Item 6.          | Exhibits                                                                                                                                                                                            |   |
|             |                                                                                                                                                                                                |   |
| Signatures       |                                                                                                                                                                                                |

 

----

 

**PART I: FINANCIAL INFORMATION**

 

**ITEM 1: FINANCIAL STATEMENTS**

 

TENNESSEE COMMERCE BANCORP,INC.

CONSOLIDATEDBALANCE SHEETS

SEPTEMBER 30, 2005(UNAUDITED) AND DECEMBER 31, 2004

 

(dollars in thousands except share data)
| ** **                                                                                                                                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| **ASSETS**                                                                                                                                           |       |                   |       |                  |       |
| Cash and due  from financial institutions                                                                                                            |       | $                      | 2,575      |                  | $          | 3,838 |   |
| Federal  funds sold                                                                                                                                  |       | 5,855                  |       | 6,582                 |       |
| Cash and cash equivalents                                                                                                                            |       | 8,430                  |       | 10,420                |       |
| Securities  available for sale                                                                                                                       |       | 25,278                 |       | 18,610                |       |
| Loans held  for sale                                                                                                                                 |       | 682                    |       | —                |       |
| Loans                                                                                                                                                |       | 319,891                |       | 216,167               |       |
| Allowance  for loan losses                                                                                                                           |       | (4,175                 | )          | (2,841                | )          |
| Net loans                                                                                                                                            |       | 316,398                |       | 213,326               |       |
|                                                                                                                                                 |       |                   |       |                  |       |
| Premises and  equipment, net                                                                                                                         |       | 778                    |       | 609                   |       |
| Accrued  interest receivable                                                                                                                         |       | 1,760                  |       | 1,104                 |       |
| Restricted  equity securities                                                                                                                        |       | 457                    |       | 321                   |       |
| Deferred tax  asset                                                                                                                                  |       | 652                    |       | 597                   |       |
| Other assets                                                                                                                                         |       | 2,256                  |       | 930                   |       |
|                                                                                                                                                 |       |                   |       |                  |       |
| Total assets                                                                                                                                         |       | $                      | 356,009    |                  | $          | 245,917 |   |
|                                                                                                                                                 |       |                   |       |                  |       |
| **LIABILITIES  AND SHAREHOLDERS’ EQUITY**                                                                                                       | ** ** | ** **             | ** ** | ** **            | ** ** |
| ** **                                                                                                                                           | ** ** | ** **             | ** ** | ** **            | ** ** |
| Liabilities                                                                                                                                          |       |                   |       |                  |       |
| Deposits                                                                                                                                             |       |                   |       |                  |       |
| Noninterest-bearing                                                                                                                                  |       | $                      | 18,148     |                  | $          | 15,239 |   |
| Interest-bearing                                                                                                                                     |       | 302,864                |       | 206,155               |       |
| Total deposits                                                                                                                                       |       | 321,012                |       | 221,394               |       |
|                                                                                                                                                 |       |                   |       |                  |       |
| Accrued interest payable                                                                                                                             |       | 860                    |       | 445                   |       |
| Accrued bonuses                                                                                                                                      |       | 249                    |       | 125                   |       |
| Long-term subordinated debt                                                                                                                          |       | 8,248                  |       | —                |       |
| Other liabilities                                                                                                                                    |       | 125                    |       | 353                   |       |
| Total liabilities                                                                                                                                    |       | 330,494                |       | 222,317               |       |
|                                                                                                                                                 |       |                   |       |                  |       |
| Shareholders’  equity                                                                                                                           |       |                   |       |                  |       |
| Preferred stock, no par value. Authorized  1,000,000 shares; none issued or outstanding at September 30, 2005 and  December 31, 2004       |       | —                 |       | —                |       |
| Common stock, $0.50 par value. Authorized  5,000,000 shares; issued and outstanding 3,238,674 at September 30, 2005  and December 31, 2004 |       | 1,619                  |       | 1,619                 |       |
| Additional paid-in capital                                                                                                                           |       | 21,401                 |       | 21,401                |       |
| Retained earnings                                                                                                                                    |       | 2,717                  |       | 714                   |       |
| Accumulated other comprehensive income  (loss)                                                                                                       |       | (222                   | )          | (134                  | )          |
| Total shareholders’ equity                                                                                                                      |       | 25,515                 |       | 23,600                |       |
|                                                                                                                                                 |       |                   |       |                  |       |
| Total liabilities and shareholders’ equity                                                                                                      |       | $                      | 356,009    |                  | $          | 245,917 |   |

 

Note : The balance sheet presented above at December 31,2004 has been derived from the audited consolidated financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.

 

See accompanying notes to consolidatedfinancial statements.

 

1

----

 

TENNESSEE COMMERCE BANCORP,INC.

CONSOLIDATED STATEMENTS OF INCOME ANDCOMPREHENSIVE INCOMENINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004(UNAUDITED)

 

(dollars in thousandsexcept share data)
| ** **                                           | ** ** | **Nine Months Ended**  | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                           | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                           | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Interest  income                                     |       |                   |       |                   |       |   |   |   |   |
| Loans, including fees                                |       | $                      | 15,827     |                   | $          | 8,503 |   | $ | 6,075 |   | $ | 3,321 |   |
| Securities                                           |       | 649                    |       | 450                    |       | 243 |   | 172 |   |
| Federal funds sold                                   |       | 118                    |       | 47                     |       | 55 |   | 21 |   |
| Total interest income                                |       | 16,594                 |       | 9,000                  |       | 6,373 |   | 3,514 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Interest  expense                                    |       |                   |       |                   |       |   |   |   |   |
| Deposits                                             |       | 6,309                  |       | 2,907                  |       | 2,628 |   | 1,143 |   |
| Other                                                |       | 289                    |       | 5                      |       | 139 |   | 3 |   |
| Total interest expense                               |       | 6,598                  |       | 2,912                  |       | 2,767 |   | 1,146 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Net interest  income                                 |       | 9,996                  |       | 6,088                  |       | 3,606 |   | 2,368 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Provision  for loan losses                           |       | 2,800                  |       | 1,530                  |       | 1,000 |   | 625 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Net interest  income after provision for loan losses |       | 7,196                  |       | 4,558                  |       | 2,606 |   | 1,743 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Non interest  income                                 |       |                   |       |                   |       |   |   |   |   |
| Service charges on deposit accounts                  |       | 79                     |       | 96                     |       | 25 |   | 29 |   |
| Mortgage banking                                     |       | 75                     |       | 97                     |       | 36 |   | 43 |   |
| Securities gains                                     |       | 4                      |       | 33                     |       | — |   | 22 |   |
| Gain on sale of loans                                |       | 624                    |       | 261                    |       | 184 |   | 122 |   |
| Other                                                |       | 2                      |       | 21                     |       | (36 | ) | (10 | ) |
| Total non interest income                            |       | 784                    |       | 508                    |       | 209 |   | 206 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Non interest  expense                                |       |                   |       |                   |       |   |   |   |   |
| Salaries and employee benefits                       |       | 2,644                  |       | 1,910                  |       | 856 |   | 666 |   |
| Occupancy and equipment                              |       | 447                    |       | 346                    |       | 159 |   | 115 |   |
| Data processing fees                                 |       | 337                    |       | 247                    |       | 111 |   | 96 |   |
| Professional fees                                    |       | 275                    |       | 240                    |       | 113 |   | 90 |   |
| Other                                                |       | 828                    |       | 590                    |       | 304 |   | 204 |   |
| Total non interest expense                           |       | 4,531                  |       | 3,333                  |       | 1,543 |   | 1,171 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Income  before income taxes                          |       | 3,449                  |       | 1,733                  |       | 1,272 |   | 778 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Income tax  expense                                  |       | 1,446                  |       | 682                    |       | 552 |   | 305 |   |
|                                                 |       |                   |       |                   |       |   |   |   |   |
| Net income                                           |       | $                      | 2,003      |                   | $          | 1,051 |   | $ | 720 |   | $ | 473 |   |

 

2

----

 

(dollars in thousandsexcept share data)
| ** **                                    | ** ** | **Nine Months Ended**  | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Unrealized  gains (losses) on securities, net |       | (88                    | )          | 18                     |       | (149 | ) | 235 |   |
| Comprehensive  income (loss)                  |       | $                      | 1,915      |                   | $          | 1,069 |   | $ | 571 |   | $ | 708 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Earnings per  share (EPS):                    |       |                   |       |                   |       |   |   |   |   |
| Basic EPS                                     |       | $                      | .62        |                   | $          | .38 |   | $ | .22 |   | $ | .15 |   |
| Diluted EPS                                   |       | .57                    |       | .36                    |       | .21 |   | .15 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Weighted  average shares outstanding:         |       |                   |       |                   |       |   |   |   |   |
| Basic                                         |       | 3,238,674              |       | 2,749,511              |       | 3,238,674 |   | 3,108,358 |   |
| Diluted                                       |       | 3,485,719              |       | 2,891,194              |       | 3,497,201 |   | 3,249,593 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

3

----

 

TENNESSEE COMMERCE BANCORP,INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITYNINE MONTHS ENDED SEPTEMBER 30, 2005 and 2004

(UNAUDITED)

 

(dollars in thousandsexcept share data)
| ** **                                                                       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | **Accumulated**   | ** ** | ** **             | ** ** |
|----------------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|---------------|------------|-------------------|------------|------------------------|------------|
| ** **                                                                       | ** ** | ** ** | ** ** | ** **      | ** ** | ** **    | ** ** | **Other**         | ** ** | ** **             | ** ** |
| ** **                                                                       | ** ** | ** ** | ** ** | **Additional**  | ** ** | **Retained**  | ** ** | **Comprehensive** | ** ** | **Total**              | ** ** |
| ** **                                                                       | ** ** | **Common** | ** ** | **Pai****d-In** | ** ** | **Earnings**  | ** ** | **Income**        | ** ** | **Shareholders’** | ** ** |
| ** **                                                                       | ** ** | **Stock**  | ** ** | **Capital**     | ** ** | **(Deficit)** | ** ** | **(Loss)**        | ** ** | **Equity**             | ** ** |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Balance at  December 31, 2003                                               |       | $          | 1,230      |            | $          | 13,245        |       | $                 | (952       | )                      | $          | (125 | ) | $ | 13,398 |   |
| Comprehensive  income                                                            |       |       |       |            |       |          |       |              |       |                   |       |
| Net income                                                                       |       | —     |       | —          |       | 1,051         |       | —            |       | 1,051                  |       |
| Other comprehensive income, net of income  taxes                                 |       |       |       |            |       |          |       |              |       |                   |       |
| Unrealized losses on securities available  for sale during the period            |       | —     |       | —          |       | —        |       | (2                | )          | (2                     | )          |
| Reclassification adjustment for gains  included in net income, net of $13 in tax |       | —     |       | —          |       | —        |       | 20                |       | 20                     |       |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Total  comprehensive income                                                      |       |       |       |            |       |          |       |              |       | 1,069                  |       |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Issuance of  778,000 common shares                                               |       | 389        |       | 8,156           |       | —        |       | —            |       | 8,545                  |       |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Balance at  September 30, 2004                                              |       | $          | 1,619      |            | $          | 21,401        |       | $                 | 99         |                   | $          | (107 | ) | $ | 23,012 |   |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Balance at  December 31, 2004                                               |       | $          | 1,619      |            | $          | 21,401        |       | $                 | 714        |                   | $          | (134 | ) | $ | 23,600 |   |
| Comprehensive income                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Net income                                                                       |       | —     |       | —          |       | 2,003         |       | —            |       | 2,003                  |       |
| Other comprehensive income, net of income  taxes                                 |       |       |       |            |       |          |       |              |       |                   |       |
| Unrealized losses on securities available  for sale during the period            |       | —     |       | —          |       | —        |       | (91               | )          | (91                    | )          |
| Reclassification adjustment for gains  included in net income, net of $1 in tax  |       | —     |       | —          |       | —        |       | 3                 |       | 3                      |       |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Total  comprehensive income                                                      |       |       |       |            |       |          |       |              |       | 1,915                  |       |
|                                                                             |       |       |       |            |       |          |       |              |       |                   |       |
| Balance at  September 30, 2005                                              |       | $          | 1,619      |            | $          | 21,401        |       | $                 | 2,717      |                   | $          | (222 | ) | $ | 25,515 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

4

----

 

TENNESSEE COMMERCE BANCORP,INC.

CONSOLIDATED STATEMENTS OF CASH FLOWSNINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004

(UNAUDITED)

 

(dollars in thousandsexcept share data)
| ** **                                                                        | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                        | ** ** | **September 30,** | ** ** |
| ** **                                                                        | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                                                                              |       |                   |       |   |   |
| **Cash  flows from operating activities**                                         |       |                   |       |   |   |
| Net income                                                                        |       | $                      | 2,003      |   | $ | 1,051 |   |
| Adjustments to reconcile net income to net cash  used by operating activities     |       |                   |       |   |   |
| Depreciation                                                                      |       | 124                    |       | 121 |   |
| Deferred loan fees                                                                |       | (3                     | )          | (1 | ) |
| Provision for loan losses                                                         |       | 2,800                  |       | 1,530 |   |
| FHLB stock dividends                                                              |       | (11                    | )          | (6 | ) |
| Net amortization of investment securities                                         |       | 35                     |       | 41 |   |
| Gain on sales of securities                                                       |       | (4                     | )          | (18 | ) |
| Change in:                                                                        |       |                   |       |   |   |
| Accrued interest payable                                                          |       | 415                    |       | 173 |   |
| Accrued interest receivable                                                       |       | (656                   | )          | (270 | ) |
| Other assets and liabilities                                                      |       | (1,183                 | )          | (495 | ) |
| Net cash from operating activities                                                |       | 3,520                  |       | 2,126 |   |
|                                                                              |       |                   |       |   |   |
| **Cash  flows from investing activities**                                         |       |                   |       |   |   |
| Purchases of securities available for sale                                        |       | (9,920                 | )          | (10,962 | ) |
| Proceeds from sales of securities available  for sale                             |       | 1,489                  |       | 5,446 |   |
| Proceeds from maturities, prepayments and  calls of securities available for sale |       | 1,590                  |       | 2,249 |   |
| Investment in unconsolidated subsidiary                                           |       | (248                   | )          | — |   |
| Net change in loans                                                               |       | (105,869               | )          | (68,352 | ) |
| Purchases of Federal Home Loan Bank Stock                                         |       | (125                   | )          | (81 | ) |
| Net purchases of premises and equipment                                           |       | (293                   | )          | (90 | ) |
| Net cash from investing activities                                                |       | (113,376               | )          | (71,790 | ) |
|                                                                              |       |                   |       |   |   |
| **Cash  flows from financing activities**                                         |       |                   |       |   |   |
| Net change in deposits                                                            |       | 99,618                 |       | 65,050 |   |
| Proceeds from long-term subordinated debt                                         |       | 8,248                  |       | — |   |
| Proceeds from issuance of common stock                                            |       | —                 |       | 8,545 |   |
| Net cash from financing activities                                                |       | 107,866                |       | 73,595 |   |
|                                                                              |       |                   |       |   |   |
| **Net  change in cash and cash equivalents**                                      |       | (1,990                 | )          | 3,931 |   |
|                                                                              |       |                   |       |   |   |
| Cash and  cash equivalents at beginning of period                                 |       | 10,420                 |       | 7,723 |   |
|                                                                              |       |                   |       |   |   |
| **Cash and  cash equivalents at end of period**                                   |       | $                      | 8,430      |   | $ | 11,654 |   |
|                                                                              |       |                   |       |   |   |
| **Supplemental  cash flow information:**                                          |       |                   |       |   |   |
| Cash paid during period for interest                                              |       | $                      | 6,182      |   | $ | 2,739 |   |
| Cash paid during period for income taxes                                          |       | 1,789                  |       | 515 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

5

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TENNESSEE COMMERCE BANCORP, INC.

 

Notes to Consolidated Financial Statements

 

Note 1 – Basis of Presentation

 

Tennessee Commerce Bancorp, Inc.(the “Corporation”) is the holding company for Tennessee Commerce Bank (the “Bank”).  In March 2005, the Corporation formed awholly owned subsidiary, Tennessee Commerce Bank Statutory Trust I, (the “TrustI”). The Bank and the Trust I are the only subsidiaries of the Corporation. Theaccompanying consolidated financial statements include the accounts of theCorporation and the Bank. The Trust I is not consolidated in accordance withFASB Interpretation No. 46 (revised December 2003) Consolidation ofVariable Interest Entities (FIN46R). Material intercompany accounts andtransactions have been eliminated.

 

The unaudited consolidatedfinancial statements as of September 30, 2005 and for the nine and threemonth periods ended September 30, 2005 and 2004 have been prepared inaccordance with accounting principles generally accepted in the United Statesof America and in accordance with the instructions to Form 10-Q and Article 10of Regulation S-X as promulgated by the Securities and Exchange Commission (“SEC”),and in the opinion of management, include all adjustments, consisting of normalrecurring adjustments, to present fairly the information. They do not includeall the information and footnotes required by generally accepted accountingprinciples for complete financial statements. Operating results for the nine andthree month periods ended September 30, 2005, are not necessarilyindicative of the results that may be expected for the year ending December 31,2005. For further information, refer to the 2004 consolidated financialstatements and footnotes thereto included in the Corporation’s Form 10 asfiled with the Securities and Exchange Commission.

 

Note 2 – Earnings per Share of Common Stock

 

The factorsused in the earnings per share computation follow.

 

(dollars in thousandsexcept share data)

 
| ** **                                                                      | ** ** | **Nine Months Ended**  | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                      | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                      | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Basic                                                                           |       |                   |       |                   |       |   |   |   |   |
| Net income                                                                      |       | $                      | 2,003      |                   | $          | 1,051 |   | $ | 720 |   | $ | 473 |   |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Weighted average common shares outstanding                                      |       | 3,238,674              |       | 2,749,511              |       | 3,238,674 |   | 3,108,358 |   |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Basic earnings per common share                                                 |       | $                      | .62        |                   | $          | .38 |   | $ | .22 |   | $ | .15 |   |
| Diluted                                                                         |       |                   |       |                   |       |   |   |   |   |
| Net income                                                                      |       | $                      | 2,003      |                   | $          | 1,051 |   | $ | 720 |   | $ | 473 |   |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Weighted average common shares outstanding  for basic earnings per common share |       | 3,238,674              |       | 2,749,511              |       | 3,238,674 |   | 3,108,358 |   |
| Add: Dilutive effects of assumed exercises  of stock options                    |       | 247,045                |       | 141,683                |       | 258,527 |   | 141,235 |   |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Average shares and dilutive potential common  shares                            |       | 3,485,719              |       | 2,891,194              |       | 3,497,201 |   | 3,249,593 |   |
|                                                                            |       |                   |       |                   |       |   |   |   |   |
| Diluted earnings per common share                                               |       | $                      | .57        |                   | $          | .36 |   | $ | .21 |   | $ | .15 |   |

 

No options were antidilutive

 

6

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Note 3 – Stock Compensation

 

Employeecompensation expense under stock options is reported using the intrinsic valuemethod.  No stock-based compensation costis reflected in net income, as all options granted had an exercise price equalto or greater than the market price of the underlying common stock at date ofgrant.

 

The FinancialAccounting Standards Board (FASB) recently issued new accounting standards onshare-based payments (FAS 123R). FAS 123R requires all public companies torecord compensation cost for stock options provided to employees in return foremployee service. The cost is measured at the fair value of the options whengranted, and this cost is expensed over the employee service period, which isnormally the vesting period of the options. This will apply to awards grantedor modified after the first quarter or year beginning after December 15,2005. Compensation cost will also be recorded for prior option grants that vestafter the date of adoption. The effect on results of operations will depend onthe level of future option grants and the calculation of the fair value of theoptions granted at such future date, as well as the vesting periods provided,and so cannot be currently predicted. Existing options that will vest afteradoption date are expected to result in additional after tax compensation expenseof approximately $55,688 in 2006. There will be no significant effect on theCorporation’s financial position as total equity will not change.

 

7

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The followingtable illustrates the effect on net income and earnings per share if expensewas measured using the fair value recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation.

 

(dollars in thousandsexcept share data)
| ** **                                                                                     | ** ** | **Nine Months Ended**  | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                     | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Net income  as reported                                                                        |       | $                      | 2,003      |                   | $          | 1,051 |   | $ | 720 |   | $ | 473 |   |
| Deduct: Stock-based compensation expense, net  of tax determined under fair value based method |       | 191                    |       | 106                    |       | 166 |   | 35 |   |
|                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Pro forma  net income                                                                          |       | $                      | 1,812      |                   | $          | 945 |   | $ | 554 |   | $ | 438 |   |
|                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Basic  earnings per share as reported                                                          |       | $                      | .62        |                   | $          | .38 |   | $ | .22 |   | $ | .15 |   |
| Pro forma  basic earnings per share                                                            |       | .56                    |       | .34                    |       | .17 |   | .14 |   |
|                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Diluted  earnings per share as reported                                                        |       | .57                    |       | .36                    |       | .21 |   | .15 |   |
| Proforma  diluted earnings per share                                                           |       | .52                    |       | .33                    |       | .16 |   | .13 |   |

 

The pro forma effects are computed usingoption pricing models, using the following weighted-average assumptions as ofgrant date.

 
| ** **               | ** ** | **2005**  | ** ** | **2004** | ** ** |
|--------------------------|------------|-----------|------------|----------|------------|
|                     |       |      |       |     |       |
| Risk-free  interest rate |       | 3.17-3.48 | %          | 3.23     | %          |
| Expected  option life    |       | 5 years   |       | 7 years  |       |
| Dividend  yield          |       | 0.0       | %          | 0.0      | %          |
| Volatility               |       | 20        | %          | n/a      |       |

 

There were69,000 options granted to employees on July 1, 2005. There were 15,000options granted to employees on August 1, 2005. In each case, one halfvested immediately with the other half vesting in one year. The weightedaverage fair value of the options granted on July 1 and August 1 were$3.96 and $4.07 respectively. The risk free interest rate used to calculate theweighted average fair value of the options granted at July 1 and August 1was 3.17% and 3.48% respectively. The weighted average fair value of optionsgranted during the nine month period ending September 30, 2004 was$2.23.  There were no options grantedduring the three month period ending September 30, 2004.

 

Note 4 – Trust Preferred Securities

 

In March 2005,the Corporation formed a financing subsidiary, Tennessee Commerce StatutoryTrust I, a Delaware statutory trust (the “Trust I”). In March 2005, TrustI issued and sold 8,000 Fixed/Floating rate capital securities, with aliquidation amount of $1,000 per capital security, to First Tennessee BankNational Association. At the same time, the Corporation issued to Trust I$8,248,000 of Fixed/Floating rate junior subordinated deferrable interestdebentures due 2035. The debentures pay a 6.73% fixed rate payable quarterly for the first five years and afloating rate based on a 3 month Libor rate plus a margin thereafter.

 

8

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In accordancewith FASB Interpretation No. 46 (revised December 2003) Consolidationof Variable Interest Entities (FIN46R), the Trust I is not consolidated. TheCorporation will report as liabilities the subordinated debentures issued bythe Corporation and held by Trust I.

 

**ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS**

 

**Forward-LookingStatements**

 

Management’s discussion of theCorporation and management’s analysis of the Corporation’s operations andprospects, and other matters, may include forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 and otherprovisions of federal and state securities laws.  Although the Corporation believes that theassumptions underlying such forward-looking statements contained in this Reportare reasonable, any of the assumptions could be inaccurate and, accordingly,there can be no assurance that the forward-looking statements included hereinwill prove to be accurate.  The use ofsuch words as expect, anticipate, forecast, and comparable terms should beunderstood by the reader to indicate that the statement is “forward-looking”and thus subject to change in a manner that can be unpredictable.  Factors that could cause actual results todiffer from the results anticipated, but not guaranteed, in this Report,include (without limitation) economic and social conditions, competition forloans, mortgages, and other financial services and products, changes in interestrates, unforeseen changes in liquidity, results of operations, and financialconditions affecting the Corporation’s customers, as well as other risks thatcannot be accurately quantified or completely identified.  Many factors affecting the Corporation’sfinancial condition and profitability, including changes in economicconditions, the volatility of interest rates, political events and competitionfrom other providers of financial services simply cannot be predicted.  Because these factors are unpredictable andbeyond the Corporation’s control, earnings may fluctuate from period toperiod.  The purpose of this type ofinformation is to provide readers with information relevant to understandingand assessing the financial condition and results of operations of theCorporation, and not to predict the future or to guarantee results.  The Corporation is unable to predict thetypes of circumstances, conditions, and factors that can cause anticipatedresults to change.  The Corporationundertakes no obligation to publish revised forward-looking statements toreflect the occurrence of changes or unanticipated events, circumstances, orresults.

 

**CorporationOverview**

 

Tennessee Commerce Bancorp, Inc.(the “Corporation”) is a one-bank holding company formed as a Tennesseecorporation to own the shares of Tennessee Commerce Bank (the “Bank”).  The Corporation was incorporated on March 22,2000, for the purpose of acquiring 100% of the shares of the Bank and the shareexchange was completed on May 31, 2000. The Bank commenced operations as a Tennessee state chartered bank on January 14,2000, and both the Bank’s and Corporation’s principal executive offices arelocated at 381 Mallory Station Road, Suite 207, Franklin, Tennessee37067.  On March 29, 2005, theCorporation formed a wholly owned subsidiary, Tennessee Commerce Bank StatutoryTrust I, (the “Trust I”). The Bank and the Trust I are the only subsidiaries ofthe Corporation.

 

9

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The Bank offers a full range ofcompetitive retail and commercial banking services.  The deposit services offered include varioustypes of checking accounts, savings accounts, money market investment accounts,certificates of deposits, and retirement accounts.  Lending services include consumer installmentloans, various types of mortgage loans, personal lines of credit, home equityloans, credit cards, real estate construction loans, commercial loans to smalland medium size businesses and professionals, and letters of credit. The Bankissues VISA credit cards and is a merchant depository for cardholder draftsunder VISA credit cards.  The Bank alsooffers check cards and debit cards.  TheBank offers its customers courier services, access to third-party automatedteller machines (“ATMs”), and state of the art electronic banking. The Bank hastrust powers but does not have a trust department.

 

**BusinessBank Strategy**

 

The Bank is located inFranklin, Tennessee, fifteen miles south of Nashville. Franklin is inWilliamson County, one of the most affluent and rapidly growing counties in thenation and the Bank conducts business from a single location in the CoolSprings commercial area of Franklin. Although the Bank offers a full range ofbanking services and products, it operates with a focused “Business Bank”strategy.  The “Business Bank” strategyemphasizes banking services for small to medium sized businesses,entrepreneurs, and professionals.  TheBank competes by combining the personal service and appeal of a community bankinstitution with the sophistication and flexibility of a larger bank.  This strategy distinguishes the Bank from itscompetitors in efforts to attract loans and deposits of local businesses.

 

The Bank does not compete basedon the traditional definition of “convenience” and has no plans to develop abranch bank network.  Business isconducted from a single office with no teller line, drive-through window orextended banking hours.  The Bank competesby providing responsive and personalized service to meet customer needs.  Convenience is created by technology and by afree courier service which transports deposits directly from the customer’sbusiness location to the Bank.  The Bankprovides free electronic banking and cash management tools and on-site trainingfor business customers.  The Bankcompetes for consumer business by providing superior products, attractivedeposit rates, free Internet Banking services, and access to a third partyregional ATM network. The Bank targets service, manufacturing, and professionalcustomers and avoids retail businesses with high transaction volume.

 

The Business Bank strategy isevident in differences in the financial statements of the Bank and moretraditional financial institutions. The Business Bank model creates a highdegree of leverage.  By avoiding theinvestment and maintenance costs of a typical branch network, the Bank is ableto maintain Earning Assets at a higher level than peer institutions.  Assets of the Bank are centered in the loanportfolio which consists primarily of commercial and industrial loans.

 

The Business Bank model ishighly efficient.  The Bank targets thenon-retail sector of the commercial market which is characterized by lowerlevels of transactions and processing costs. The commercial customer mix and the strategic outsourcing ofnon-customer functions, such as data processing, allow the Bank to operate witha smaller, more highly trained staff. Management targets an average asset per employee ratio of $7 millioncompared to the average of less than $2.5 million in assets per employee forTennessee state chartered banks.  TheBank also promotes the use of technology, both internally and externally, tomaximize the efficiency of operations.

 

10

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**Overviewof Operating Results for the Three and Nine Months ended September 30,2005 and September 30, 2004 and Financial Condition at September 30,2005 and December 31, 2004.**

 

(dollars inthousands except share data in the remainder of this Item 2)

 

The results of operations forthe quarter ended September 30, 2005 compared to the quarter ended September 30,2004 reflected a 52.22% increase in net income and a 40.00% increase inearnings per share, assuming dilution. The increase in earnings resultedprimarily from a 52.28% increase in net interest income due to higher averageloan balances. Noninterest income increased by $3 between the two quarterlyperiods while noninterest expense increased by $372 and the provision for loanlosses increased by $375. For the nine months ended September 30, 2005,net income was $2,003, an increase of $952 or 90.58% compared to net income of$1,051 for the same period in 2004. Diluted earnings per share increased $.21per share or 58.33% for the nine months ended September 30, 2005 comparedto the same period in 2004. The nine months ended September 30, 2005,reflected a continuation of the Bank’s trend of rapid asset growth increasingby $110,092 or 44.77% from $245,917 at December 31, 2004 to $356,009 at September 30,2005.  Net loans increased by 48.32% or$103,072 from December 31, 2004 to September 30, 2005, while totaldeposits increased by 45.00% or $99,618 during that same period.

 

**Comparisonof Operating Results for the Three Months ended September 30, 2005 and September 30,2004**

 

(dollars inthousands except share data in this Item)

 

**Net Income**- Net income for the three months ended September 30, 2005 was $720 anincrease of $247 or 52.22%, compared to the net income of $473 for the threemonths ended September 30, 2004. The increase is primarily attributable to a 52.28% increase in netinterest income from $2,368 for the three months ended September 30, 2004to $3,606 for the same period in 2005. The increase of $1,238 in net interestincome was the result of overall growth of the Corporation, including a 58.19%increase in the ending net loan balance from September 30, 2004 to thesame date in 2005. Noninterest income increased $3, from $206 in the quarterended September 30, 2004 to $209 for the same period in 2005.  These increases were partially offset by a$375 increase in the provision for loan losses, from $625 during the threemonths ended September 30, 2004 to $1,000 for the same period in2005.  Also, noninterest expenseincreased by 31.77% to $1,543 for the three month period ended September 30,2005 compared to $1,171 for the same period in 2004. The increase in theprovision for loan losses was the result of funding the allowance for loanlosses to match the significant loan growth. The increase in noninterestexpense was due to the increase in personnel and general operating expenses dueto the Corporation’s growth.

 

**NetInterest Income** - Net interest income for thethree months ended September 30, 2005 was $3,606 compared to $2,368 forthe same period in 2004, a gain of $1,238 or 52.28%.  The increase in net interest income waslargely attributable to strong loan growth. The ending net loan balance at September 30 increased by 58.19% or$116,389 from $200,009 in 2004 to $316,398 for the same date in 2005. Loangrowth was matched by an increase in deposits from $207,344 at September 30,2004 to $321,012 for the same date in 2005 – an increase of $113,668 or 54.82%.

 

11

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**Provisionfor Loan Losses** - The provision for loan lossesfor the three months ended September 30, 2005 was $1,000, an increase of$375, or 60.00%, above the provision of $625 expensed in the same period in2004.  This increase was primarily due tosignificant loan growth. The provision is discussed as it relates to theallowance for loan losses in the following Comparison of Financial Conditionsection. At September 30, 2005, the loan loss reserve of $4,175 was 1.30%of gross loans of $320,573.

 

**NoninterestIncome** – Noninterest income increased by $3, from$206 in the quarter ended September 30, 2004 to $209 for the same periodin 2005. The increase was primarily due to an increase in net gains on loansales of $62 for the quarter ended September 30, 2005 compared to the samequarter in 2004. This increase was mostly offset by decreases in mortgage fees,and service charges on deposit accounts.

 

**NoninterestExpense** – Noninterest expense for the three monthsended September 30, 2005 was $1,543, an increase of $372 or 31.77%, overthe $1,171 expensed in the same period in 2004. Approximately 51.08% of the increase was due to the addition of ten newemployees during the period between the two quarter-end dates. At September 30,2005, the Corporation had forty full time employees.

 

**Comparisonof Operating Results for the Nine Months ended September 30, 2005 and September 30,2004**

 

(dollars inthousands except share data in this Item)

 

**Net Income**- Net income for the nine months ended September 30, 2005 was $2,003 anincrease of $952 or 90.58%, compared to the net income of $1,051 for the threequarters ended September 30, 2004. The increase is attributable to a 64.19% increase in net interest incomefrom $6,088 for the nine months ended September 30, 2004 to $9,996 for thesame period in 2005. The increase of $3,908 in net interest income was theresult of overall growth of the Corporation, including a 61.12% increase inaverage net loan balances in the nine months ended September 30, 2005compared to the same period in 2004. This positive effect was partially offsetby an 83.01% increase in the provision for loan losses, from $1,530 during thenine months ended September 30, 2004 to $2,800 for the same period in2005. Also, noninterest expense increased by 35.94% to $4,531 for the ninemonth period ended September 30, 2005 compared to $3,333 for the sameperiod in 2004. The increase in the provision for loan losses was the result offunding the allowance for loan losses to match the significant loan growth. Theincrease in noninterest expense was due to the increase in personnel andgeneral operating expenses due to the Corporation’s growth.

 

12

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(dollars inthousands)
| ** **                                    | ** ** | **Nine Months Ended**  | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------|------------|
| ** **                                    | ** ** | **September 30,** | ** ** | ** ** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**   | ** ** | **% Increase** | ** ** |
|                                          |       |                   |       |       |       |   |   |
| Interest  income                              |       | $                      | 16,594     |       | $          | 9,000 |   | 84.38 | % |
| Interest  expense                             |       | 6,598                  |       | 2,912      |       | 126.58 |   |
| Net interest income                           |       | 9,996                  |       | 6,088      |       | 64.19 |   |
| Provision  for loan losses                    |       | 2,800                  |       | 1,530      |       | 83.01 |   |
| Net interest after provision for loan  losses |       | 7,196                  |       | 4,558      |       | 57.88 |   |
| Noninterest  income                           |       | 784                    |       | 508        |       | 54.33 |   |
| Noninterest  expense                          |       | 4,531                  |       | 3,333      |       | 35.94 |   |
| Net income before taxes                       |       | 3,449                  |       | 1,733      |       | 99.02 |   |
| Income tax  expense                           |       | 1,446                  |       | 682        |       | 112.02 |   |
| Net income                                    |       | $                      | 2,003      |       | $          | 1,051 |   | 90.58 | % |

 

**NetInterest Income** - Net interest income for the ninemonths ended September 30, 2005 was $9,996 compared to $6,088 for the sameperiod in 2004, an increase of $3,908 or 64.19%.  The increase in net interest income waslargely attributable to strong loan growth. The average loan balance for the nine months ended September 30increased by 61.04% or $100,342 from $164,384 for that period in 2004 to$264,726 for the same period in 2005. Loan growth was matched by an increase inaverage deposits from $170,592 for the nine months ended September 30,2004 to $264,915 for the same period in 2005 – an increase of $94,323 or55.29%.

 

**NetInterest Margin**- The annualized net interestmargin improved from 4.44% for the nine months ended September 30, 2004 to4.63% for the same period in 2005 due to an improved yield on earning assetsoffset to a lesser degree by an increase in the cost of funding. Interestincome increased by $7,594 or 84.38%, from $9,000 during the nine months ended September 30,2004 to $16,594 during the same period in 2005. The increase was primarily dueto increased volume.  Average earningassets increased from $182,944 in the nine months ended September 30, 2004to $288,151 in the same period in 2005, an increase of $105,207 or 57.51%.  The increase in earning assets was due toloan growth. Average net loan balances increased by $99,134 or 61.12%.  The average yield on earning assets increasedfrom 6.56% in the nine months ended September 30, 2004 to 7.69% in thesame period in 2005. The increase in yield on earning assets and cost of funds,as a percentage of average balances was primarily due to increases in shortterm interest rates by the Federal Reserve Open Market Committee (FOMC).

 

# **Interestexpense increased from $2,912 in the nine months ended September 30, 2004to $6,598 in the nine months ended September 30, 2005.  The $3,686 or 126.58%, increase in expensewas due largely to increases in the volume of deposits. Average interestbearing deposits increased by $91,758 or 58.34%.  Increase in rates was also a factor in theincrease in interest expense. The cost of funds increased from 2.47% in thenine months ended September 30, 2004 to 3.46% in the same period in 2005,an increase of 99 basis points.**

 

13

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# **Average Balance Sheets, Net Interest Income, and Changesin Interest Income and Interest Expense**

# ** **

The following table shows the average daily balances of each principalcategory of assets, liabilities and shareholders’ equity of the Corporation,and an analysis of net interest income, and the change in interest income andinterest expense segregated into amounts attributable to changes in volume andchanges in rates for the nine month periods ended September 30, 2004 and2005. The table is presented on a tax equivalent basis if applicable.

 
| ** **                                    | ** ** | **Nine Months Ended**       | ** ** | **Nine Months Ended**       | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                    | ** ** | **September 30, 2005** | ** ** | **September 30, 2004** | ** ** |
| ** **                                    | ** ** | **Average**                 | ** ** | ** **                  | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(dollars in thousands)**                    | ** ** | **Balance**                 | ** ** | **Interest**                | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                    |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Interest earning assets                       |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Securities (taxable) (1)                      |       | $                           | 21,244     |                        | $          | 657 |   | 4.08 | % | $ | 15,678 |   | $ | 450 |   | 3.78 | % |
| Loans (2) (3)                            |       | 261,319                     |       | 15,827                      |       | 8.10 | % | 162,185 |   | 8,503 |   | 7.00 | % |
| Federal funds sold                            |       | 5,588                       |       | 110                         |       | 2.63 | % | 5,081 |   | 47 |   | 1.24 | % |
| Total interest earning assets                 |       | 288,151                     |       | 16,594                      |       | 7.69 | % | 182,944 |   | 9,000 |   | 6.56 | % |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Noninterest earning assets                    |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Cash and due  from financial institutions     |       | 3,994                       |       |                        |       |   |   | 2,883 |   |   |   |   |   |
| Premises and  equipment, net                  |       | 715                         |       |                        |       |   |   | 650 |   |   |   |   |   |
| Accrued  interest and other assets            |       | 3,944                       |       |                        |       |   |   | 1,824 |   |   |   |   |   |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Total assets                                  |       | $                           | 296,804    |                        |       |   |   |   | $ | 188,301 |   |   |   |   |   |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY** |       |                        |       |                        |       |   |   |   |   |
| Interest  bearing liabilities                 |       |                        |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits  (other than demand)                 |       | $                           | 249,034    |                        | $          | 6,309 |   | 3.39 | % | $ | 157,276 |   | $ | 2,908 |   | 2.47 | % |
| Federal  funds purchased                      |       | 394                         |       | 12                          |       | 4.07 | % | 309 |   | 4 |   | 1.73 | % |
| Subordinated  debt                            |       | 5,559                       |       | 277                         |       | 6.66 | % | — |   | — |   | 0.00 | % |
| Total  interest bearing liabilities           |       | 254,987                     |       | 6,598                       |       | 3.46 | % | 157,585 |   | 2,912 |   | 2.47 | % |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Noninterest  bearing liabilities              |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Noninterest  bearing demand deposits          |       | 15,881                      |       |                        |       |   |   | 13,316 |   |   |   |   |   |
| Other  liabilities                            |       | 1,432                       |       |                        |       |   |   | 415 |   |   |   |   |   |
| Shareholders’  equity                    |       | 24,504                      |       |                        |       |   |   | 16,985 |   |   |   |   |   |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’      |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| equity                                        |       | $                           | 296,804    |                        |       |   |   |   | $ | 188,301 |   |   |   |   |   |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Net Interest Spread                           |       | 4.23                        | %          |                        |       |   |   | 4.09 | % |   |   |   |   |
|                                          |       |                        |       |                        |       |   |   |   |   |   |   |   |   |
| Net Interest Margin                           |       | 4.63                        | %          |                        |       |   |   | 4.44 | % |   |   |   |   |

 

----

(1)     Unrealizedloss of $307 and $227 is excluded from yield calculation for the nine monthsended September 30, 2005 and 2004 respectively.

(2)     Non-accrualloans are included in average loan balances and loan fees of $1,212 and $537are included in interest income for the nine months ended September 30,2005 and 2004 respectively.

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

 

14

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The following table outlines the componentsof the net interest margin for the nine month periods ended September 30,2005 and 2004 and identifies the impact of changes in volume and the changes inrate.

 
| ** **                     | ** ** | **September 30, 2005 change  from** | ** ** |
|--------------------------------|------------|------------------------------------------|------------|
| ** **                     | ** ** | **September 30, 2004 due to:**      | ** ** |
| **(dollars in thousands)**     | ** ** | **Volume**                               | ** ** | **Rate** | ** ** | **Total** | ** ** |
|                           |       |                                     |       |   |   |   |   |
| Interest income                |       |                                     |       |   |   |   |   |
| Loans                          |       | $                                        | 5,841      |   | $ | 1,483 |   | $ | 7,324 |   |
| Securities –  taxable (1) |       | 167                                      |       | 40 |   | 207 |   |
| Federal  funds sold            |       | 5                                        |       | 58 |   | 63 |   |
| Total interest income          |       | 6,013                                    |       | 1,581 |   | 7,594 |   |
|                           |       |                                     |       |   |   |   |   |
| Interest expense               |       |                                     |       |   |   |   |   |
| Deposits  (other than demand)  |       | 2,081                                    |       | 1,320 |   | 3,401 |   |
| Federal  funds purchased       |       | 1                                        |       | 7 |   | 8 |   |
| Subordinated  debt             |       | 277                                      |       | — |   | 277 |   |
| Total interest expense         |       | 2,359                                    |       | 1,327 |   | 3,686 |   |
|                           |       |                                     |       |   |   |   |   |
| Net interest income            |       | $                                        | 3,654      |   | $ | 254 |   | $ | 3,908 |   |

 

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(1)     Unrealized loss of $307 and $227 isexcluded from yield calculation for the nine months ended September 30,2005 and 2004 respectively.

 

**Provisionfor Loan Losses** - The provision for loan lossesfor the nine months ended September 30, 2005 was $2,800, an increase of$1,270, or 83.01%, above the provision of $1,530 expensed in the same period in2004.  This increase was primarily due tosignificant loan growth. The provision is discussed as it relates to theallowance for loan losses in the following Comparison of Financial Conditionsection. At September 30, 2005, the loan loss reserve of $4,175 was 1.30%of gross loans of $320,573.

 

**NoninterestIncome** - The Bank earned $75 in mortgageorigination fees during the nine months ended September 30, 2005 comparedto $97 earned in 2004, a decline of $22 or 22.68%.  The decline in mortgage origination income isattributed to rising interest rates from mid-2004 and the slowing ofrefinancing activity. Management believes that rates will continue to rise andthat the mortgage unit will provide a value-added service with modest revenueresults. Income earned in the form of service charges on deposits totaled $79for the nine months ended September 30, 2005, a decrease of $17 comparedto the same period in 2004.  Sale ofsecurities showed a gain of $4 for the nine months ended September 30,2005, compared with a gain of $33 for the same period in 2004. The Bank earned$624 on loan sale transactions in the nine months ended September 30,2005, a 139.08% increase compared to $261 during the same period in 2004. Thisincrease is largely due to loan sale transactions in the quarter ending June 30,2005 resulting in a gain of $295. Management will continue to consider loansale transactions if the opportunity for a reasonable return is available.

 

15

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**NoninterestExpense** – Noninterest expense for the nine monthsended September 30, 2005 was $4,531, an increase of $1,198 or 35.94%, overthe $3,333 expensed in the same period in 2004. Approximately 61.27% of the increase was due to the addition of ten newemployees during the period between the three quarter end dates. At September 30,2005, the Corporation had forty full time employees. Assets per employee were$7.7 million at September 30, 2004 and $8.9 million at September 30,2005.  Management targets $7.0 millionper full time employee as a measure of staffing efficiency.

 

Efficiency Ratio

(dollarsin thousands)

 
| ** **          | ** ** | **Nine Months Ended**  | ** ** |
|---------------------|------------|------------------------|------------|
| ** **          | ** ** | **September 30,** | ** ** |
| ** **          | ** ** | **2005**               | ** ** | **2004** | ** ** |
|                |       |                   |       |   |   |
| Noninterest expense |       | $                      | 4,531      |   | $ | 3,333 |   |
|                |       |                   |       |   |   |
| Net interest income |       | 9,996                  |       | 6,088 |   |
| Noninterest income  |       | 784                    |       | 508 |   |
| Total Revenues      |       | $                      | 10,780     |   | $ | 6,596 |   |
|                |       |                   |       |   |   |
| Efficiency Ratio    |       | 42.03                  | %          | 50.53 | % |

 

**IncomeTaxes** - The Corporation’s effective tax rate forthe nine months ended September 30, 2005 was 41.93% compared to 39.35% forthe nine months ended September 30, 2004. Management anticipates that taxrates in future periods will approximate the rates paid in 2004.

 

**Comparisonof Financial Condition at September 30, 2005 and December 31, 2004**

 

(dollars inthousands except share data in this Item)

 

**Assets-**Total assets at September 30, 2005 were $356,009, an increase of$100,092 or 44.77%, over total assets of $245,917 at December 31, 2004.Loan growth was the primary reason for the increase.  At September 30, 2005 net loans were$316,398, up $103,072, or 48.32% over the December 31, 2004 total netloans of $213,326.

 

The Corporation’s Business Bankmodel of operation generally results in a higher relative level of earningassets than peer banks.  Earning assetsare defined as assets which earn interest income.  Earning assets include short-term investments,the investment portfolio, and net loans. The Bank maintains a higher relative level of earning assets becausefewer assets are allocated to facilities, cash, and due-from bank accounts usedfor transaction processing.  Earningassets at September 30, 2005 were $347,531, or 97.62% of total assets of$356,009.  Earning assets at December 31,2004 were $238,518, or 96.99% of total assets of $245,917.

 

16

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**Loans**- The Bank had total net loans of $316.4 million at September 30, 2005. Atthat same date, loans held for sale were $682. The fair value of the loans heldfor sale was determined by an offer to purchase these loans. All loans held forsale at September 30, 2005 were sold in a loan sale transaction thatclosed October 3, 2005. The following table sets forth the composition of theBank’s loan portfolio at September 30, 2005 and December 31, 2004(dollars in thousands):

 
| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Real estate                             |       |                   |       |                  |       |
| Construction                            |       | $                      | 37,576     |                  | $          | 22,813 |   |
| 1-4  family residential                 |       | 15,942                 |       | 15,963                |       |
| Other                                   |       | 43,205                 |       | 33,694                |       |
| Commercial,  financial and agricultural |       | 219,922                |       | 139,799               |       |
| Consumer                                |       | 3,928                  |       | 3,898                 |       |
| Total loans                             |       | 320,573                |       | 216,167               |       |
| Less:  allowance for loan losses        |       | (4,175                 | )          | (2,841                | )          |
|                                    |       |                   |       |                  |       |
| Net loans  (1)                          |       | $                      | 316,398    |                  | $          | 213,326 |   |

 

----

(1) Includes loans held for sale at September 30, 2005

 

Compositionof loan portfolio by type

(dollarsin thousands)

 
| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Real estate:                            |       |                   |       |                  |       |
| Construction                            |       | 11.72                  | %          | 10.56                 | %          |
| 1 to 4  family residential              |       | 4.97                   | %          | 7.38                  | %          |
| Other                                   |       | 13.48                  | %          | 15.59                 | %          |
| Commercial,  financial and agricultural |       | 68.60                  | %          | 64.67                 | %          |
| Consumer                                |       | 1.23                   | %          | 1.80                  | %          |
|                                    |       |                   |       |                  |       |
| Total (1)                               |       | 100                    | %          | 100                   | %          |

 

----

(1) Includes loans held for sale at September 30,2005

 

Management of the Bankperiodically reviews the loan portfolio, particularly non-accrual andrenegotiated loans.  The review mayresult in a determination that a loan should be placed on a non-accrual statusfor income recognition. When a loan is classified as non-accrual, any unpaidinterest is reversed against current income. Interest is included in income thereafter only to the extent received incash.  The loan remains in a non-accrualclassification until such time as the loan is brought current, when it may bereturned to accrual classification.

 

17

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The following table presentsinformation regarding non-accrual, past due and restructured loans at September 30,2005 and December 31, 2004:

 
| ** **                                                                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| **(dollars in thousands)**                                                                               | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Non-accrual  loans                                                                                       |       |                   |       |                  |       |
| Number                                                                                                   |       | 29                     |       | 17                    |       |
| Amount                                                                                                   |       | $                      | 2,159      |                  | $          | 2,161 |   |
|                                                                                                     |       |                   |       |                  |       |
| Accruing  loans which are contractually past due 90 days or more as to principal and  interest payments: |       |                   |       |                  |       |
| Number                                                                                                   |       | 14                     |       | 4                     |       |
| Amount                                                                                                   |       | $                      | 1,755      |                  | $          | 111 |   |
| Loans  defined as “troubled debt restructurings”                                               |       |                   |       |                  |       |
| Number                                                                                                   |       | 4                      |       | 2                     |       |
| Amount                                                                                                   |       | $                      | 1,301      |                  | $          | 1,544 |   |
|                                                                                                     |       |                   |       |                  |       |
| Total  nonperforming loans and accruing loans past due 90 days or more                                   |       | $                      | 5,215      |                  | $          | 3,816 |   |

 

As of September 30, 2005and December 31, 2004, there are no loans classified for regulatory purposesas doubtful or substandard that have not been disclosed in the above table,which (i) represent or result from trends or uncertainties whichmanagement reasonably expects will materially impact future operating results,liquidity, or capital resources, or (ii) represent material credits aboutwhich management is aware of any information which causes management to haveserious doubts as to the ability of such borrowers to comply with the loanrepayment terms.

 

**Allowancefor loan losses** - The maintenance of an adequateallowance for loan losses (ALL) is one of the fundamental concepts of riskmanagement for every financial institution.

 

Management isresponsible for ensuring that controls are in place to insure the adequacy ofthe loan loss reserve in accordance with generally accepted accountingprincipals (GAAP), the Bank’s stated policies and procedures, and regulatoryguidance.

 

It ismanagement’s intent to maintain an ALL which is adequate to absorb current andestimated losses which are inherent in a loan portfolio.  The loss ratio (net charge-offs for theperiod as a percentage of average loans) was .55% for the nine months ended September 30,2005 and .59% for the nine months ended September 30, 2004. The ALL as apercentage of the outstanding loans at the end of the period was 1.30% at September 30,2005 and 1.26% at September 30, 2004.

 

18

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An analysis ofthe Bank’s loss experience is furnished in the following table for the ninemonths ended September 30, 2005 and the same period ended September 30,2004:

 
| **(dollars in thousands)**                                                                         | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
|                                                                                               |       |                         |       |                         |       |
| Allowance  for loan losses at beginning of period                                                  |       | $                            | 2,841      |                         | $          | 1,999 |   |
|                                                                                               |       |                         |       |                         |       |
| Loan  charge-offs:                                                                                 |       |                         |       |                         |       |
| Real estate:                                                                                       |       |                         |       |                         |       |
| Construction                                                                                       |       | —                       |       | —                       |       |
| 1 to 4  family residential                                                                         |       | —                       |       | —                       |       |
| Other                                                                                              |       | —                       |       | 131                          |       |
| Commercial,  financial and agricultural                                                            |       | 1,709                        |       | 865                          |       |
| Consumer                                                                                           |       | 15                           |       | 37                           |       |
| Total loan  charge-offs                                                                            |       | 1,724                        |       | 1,033                        |       |
|                                                                                               |       |                         |       |                         |       |
| Recoveries:                                                                                        |       |                         |       |                         |       |
| Real estate:                                                                                       |       |                         |       |                         |       |
| Construction                                                                                       |       | —                       |       | —                       |       |
| 1 to 4  family residential                                                                         |       | 1                            |       | —                       |       |
| Other                                                                                              |       | —                       |       | 2                            |       |
| Commercial,  financial and agricultural                                                            |       | 234                          |       | 54                           |       |
| Consumer                                                                                           |       | 23                           |       | 6                            |       |
| Total  recoveries                                                                                  |       | 258                          |       | 62                           |       |
|                                                                                               |       |                         |       |                         |       |
| Net  charge-offs                                                                                   |       | $                            | 1,466      |                         | $          | 971 |   |
|                                                                                               |       |                         |       |                         |       |
| Provision  for loans charged to expense                                                            |       | 2,800                        |       | 1,530                        |       |
|                                                                                               |       |                         |       |                         |       |
| Allowance  for loan losses at end of period                                                        |       | $                            | 4,175      |                         | $          | 2,558 |   |
|                                                                                               |       |                         |       |                         |       |
| Net  charge-offs as a percentage of average total loans outstanding during the  period             |       | .55                          | %          | .59                          | %          |
|                                                                                               |       |                         |       |                         |       |
| Ending  allowance for loan losses as a percentage of total loans outstanding at end  of the period |       | 1.30                         | %          | 1.26                         | %          |

 

The above table shows that netcharge offs increased by $495 or 50.97% from $971 for the nine month periodending September 30, 2004, to $1,466 for the same period in 2005. However,as a percentage of average total loans outstanding during the period, netcharge offs declined from .59% in the three quarters ending September 30,2004 to .55% during the same period in 2005. The allowance for loan losses isestablished by charges to operations based on management’s evaluation of theloan portfolio, past due loan experience, collateral values, current economicconditions and other factors considered necessary to maintain the allowance atan adequate level.

 

**Securities**- The securities portfolio at September 30, 2005 was $25,278 compared to$18,610 at December 31, 2004.  TheCorporation views the securities portfolio as a source of income andliquidity.  Management has maintained theportfolio at 7.10% of total assets at September 30, 2005 and 7.57% of totalassets at December 31, 2004.

 

19

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**Liabilities-** The Bank relies on a growing deposit base to fund loan and other assetgrowth. The Bank competes for local deposits by offering attractive productswith premium rates.  The Bank alsoobtains funding in the wholesale deposit market which is accessed by means ofan electronic bulletin board.  Thiselectronic market links banks and acquirers of funds to credit unions, schooldistricts, labor unions, and other organizations with excess liquidity. Theprocess is highly efficient and the average rate is generally less than ratespaid in the local market. Wholesale deposits are categorized as “Purchased TimeDeposits” on the detail of deposits shown in the table below.

 

Total depositsat September 30, 2005 were $321,012, up $99,618 or 45.00% over the December 31,2004 total deposits of $221,394. Total average deposits during the nine monthsending September 30, 2005 were $264,915, an increase of $94,323, or 55.29%over the total average deposits of $170,592 during the nine months ending September 30,2004. Average noninterest bearing deposits increased by $2,565, or 19.26%, from$13,316 in the nine months ending September 30, 2004 to $15,881 in thenine months ending September 30, 2005. Average deposit balances for thenine months ended September 30, 2005 and 2004 and the average rates paidon those balances are shown below.

 

Deposits

(dollars in thousands)

 
| ** **                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------|------------|
| ** **                           | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| ** **                           | ** ** | **Average  Balance**                     | ** ** | **Average  Rate  Paid (1)** | ** ** | **Average  Balance** | ** ** | **Average  Rate  Paid (1)** | ** ** |
|                                 |       |                                     |       |   |   |   |   |   |   |
| Types of  Deposits                   |       |                                     |       |   |   |   |   |   |   |
| Noninterest-bearing  demand deposits |       | $                                        | 15,881     |   | — |   | $ | 13,316 |   | — |   |
| Interest-bearing  demand deposits    |       | 2,519                                    |       | 1.42 | % | 1,464 |   | .08 | % |
| Money market  accounts               |       | 35,340                                   |       | 3.57 | % | 14,288 |   | 1.78 | % |
| Savings  accounts                    |       | 24,018                                   |       | 2.60 | % | 35,251 |   | 2.42 | % |
| IRA accounts                         |       | 1,535                                    |       | 4.07 | % | 1,043 |   | 3.57 | % |
| Purchased  time deposits             |       | 144,868                                  |       | 3.39 | % | 90,251 |   | 2.61 | % |
| Time  deposits                       |       | 40,754                                   |       | 3.76 | % | 14,979 |   | 2.58 | % |
|                                 |       |                                     |       |   |   |   |   |   |   |
| Total  deposits                      |       | $                                        | 264,915    |   |   |   | $ | 170,592 |   |   |   |

 

----

(1) Rateis annualized

 

**SubordinatedDebt** - In March 2005, the Corporation formeda financing subsidiary, Tennessee Commerce Statutory Trust I, a Delawarestatutory trust (the “Trust I”). In March 2005, Trust I issued and sold8,000 of Trust I’s Fixed/Floating rate capital securities, with a liquidationamount of $1,000 per capital security, to First Tennessee Bank NationalAssociation. At the same time, the Corporation issued to Trust I $8.248 millionof Fixed/Floating rate junior subordinated deferrable interest debentures due2035. The debentures pay a  6.73% fixedrate payable quarterly for the first five years and a floating rate based on a3 month Libor rate plus a margin thereafter. In accordance with FASBInterpretation No. 46 (revised December 2003) Consolidation ofVariable Interest Entities (FIN46R), the Trust I is not consolidated. Thesubordinated debentures are reported as a liability on the balance sheet of theCorporation.

 

20

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**Off-balance Sheet Arrangements**

 

The Bank is aparty to financial instruments with off-balance sheet risk in the normal courseof business to meet the financing needs of its customers. At September 30,2005, the Bank had unfunded loan commitments outstanding of $42.6 million andunfunded lines of credit and letters of credit of $4.6 million. These financialinstruments include commitments to extend credit and standby letters ofcredit.  Those instruments involve, tovarying degrees, elements of credit risk in excess of the amount recognized inthe balance sheet.  The contract ornotional amounts of those instruments reflect the extent of involvement theBank has in those particular financial instruments. The Bank uses the samecredit policies in making commitments and conditional obligations as it doesfor on-balance sheet instruments.

 

Because thesecommitments generally have fixed expiration dates and many will expire withoutbeing drawn upon, the total commitment level does not necessarily representfuture cash requirements. If needed, the Bank can liquidate Federal funds soldor securities available for sale or borrow and purchase Federal funds fromother financial institutions where the Bank has available federal fund linestotaling $12 million.

 

**Capital Resources/Liquidity**

 

**Liquidity**- Of primary importance to depositors, creditors and regulators is the abilityto have readily available funds sufficient to repay fully maturingliabilities.  The Bank is subject to generalFDIC guidelines which do not require a minimum level of liquidity. Liquidityrequirements can also be met through short-term borrowings or the dispositionof short-term assets which are generally matched to correspond to the maturityof liabilities. Management believes its liquidity ratios meet the general FDICguidelines and the Corporation has assets and borrowing capacity to provideadequate liquidity. Management does not know of any trends or demands which arereasonably likely to result in liquidity increasing or decreasing in anymaterial manner.

 

**CapitalAdequacy**- The objective of the Bank’s managementis to maintain a level of capitalization that is sufficient to take advantageof profitable growth opportunities while meeting regulatory requirements.****To continue to grow, the Bank must increase capital bygenerating earnings, issuing equities, borrowing funds, or a combination ofthose activities. If growth exceeds expectations, the Bank may need to raisecapital in the capital markets. For example, in 2004 the Corporation issuedequity securities increasing capital by $8.5 million.  In March 2005, the Corporation’ssubsidiary Trust I issued $8 million in Trust Preferred Securities that meetthe capital guidelines to be classified as Tier I capital as explained below.

 

The Federal Reserve Board hasadopted capital guidelines governing the activities of bank holding companies.These guidelines require the maintenance of an amount of capital based onrisk-adjusted assets so that categories of assets with potentially highercredit risk will require more capital backing than assets with lower risk.  In addition, banks and bank holding companiesare required to maintain capital to support, on a risk-adjusted basis, certainoff-balance sheet activities such as loan commitments.

 

21

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The capital guidelines classifycapital into two tiers, referred to as Tier I and Tier II.  Under risk-based capital requirements, totalcapital consists of Tier I capital which is generally common stockholders’equity less goodwill and Tier II capital which is primarily a portion of theallowance for loan losses and certain qualifying debt instruments.  In determining risk-based capitalrequirements, assets are assigned risk-weights of 0% to 100%, dependingprimarily on the regulatory assigned levels of credit risk associated with suchassets.  Off-balance sheet items areconsidered in the calculation of risk-adjusted assets through conversionfactors established by the regulators.  The framework for calculating risk-basedcapital requires banks and bank holding companies to meet the regulatoryminimums of 4% Tier I and 8% total risk-based capital.  In 1990 regulators added a leveragedcomputation to the capital requirements, comparing Tier I capital to totalaverage assets less goodwill.

 

The Federal Deposit InsuranceCorporation Improvement Act of 1991 (“FDICIA”) established five capitalcategories for banks and bank holding companies.  The bank regulators adopted regulationsdefining these five capital categories in September 1992.  Under these new regulations, each bank isclassified into one of the five categories based on its level of risk-basedcapital as measured by Tier I capital, total risk-based capital, andTier I leverage ratios and its supervisory ratings.

 

At September 30,2005 and December 31, 2004, The Bank’s and the Corporation’s risk-basedcapital ratios and the minimums to be considered well-capitalized under theFederal Deposit Insurance Corporation’s prompt corrective action guidelineswere as follows:

 
| ** **                                               | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** | **Minimum to   be considered   well-capitalized** | ** ** |
|----------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|---------------------------------------------------|------------|
|                                                     |       |                         |       |                        |       |                                              |       |
| Tier 1 “core”  capital to risk-weighted assets |       |                         |       |                        |       |                                              |       |
| Tennessee  Commerce Bank                                 |       | 9.33                         | %          | 10.71                       | %          | 6.00                                              | %          |
| Tennessee Commerce  Bancorp, Inc.                   |       | 10.22                        | %          | 10.81                       | %          | 6.00                                              | %          |
|                                                     |       |                         |       |                        |       |                                              |       |
| Total  capital to risk-weighted assets                   |       |                         |       |                        |       |                                              |       |
| Tennessee  Commerce Bank                                 |       | 10.58                        | %          | 11.96                       | %          | 10.00                                             | %          |
| Tennessee  Commerce Bancorp, Inc.                   |       | 11.47                        | %          | 12.06                       | %          | 10.00                                             | %          |
|                                                     |       |                         |       |                        |       |                                              |       |
| Tier 1  leverage ratio                                   |       |                         |       |                        |       |                                              |       |
| Tennessee  Commerce Bank                                 |       | 9.28                         | %          | 9.73                        | %          | 5.00                                              | %          |
| Tennessee  Commerce Bancorp, Inc.                   |       | 10.16                        | %          | 9.83                        | %          | 5.00                                              | %          |

 

On September 30, 2005 and December 31,2004, both the Bank and the Corporation exceeded the regulatory minimums andqualified as a well-capitalized institution under the regulations.

 

**Impact ofInflation and Changing Prices** - The financialstatements and related financial data presented herein have been prepared inaccordance with U.S. generally accepted accounting principles which require themeasurement of financial position and operating results in terms of historicaldollars without considering the changes in the relative purchasing power ofmoney over time and due to inflation. The impact of inflation on operations of the Bank is reflected inincreased operating costs.  Unlike mostindustrial companies, virtually all of the assets and liabilities of the Bankare monetary in nature.  As a result,interest rates have a more significant impact on the Bank’s performance thanthe effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in thesame magnitude as the price of goods and services.

 

22

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**ITEM 3: QUANTITATIVE AND QUALITATIVE ANALYSISOF MARKET RISK**

 

Like all financialinstitutions, the Corporation is subject to market risk from changes ininterest rates.  Interest rate risk isinherent in the balance sheet due to the mismatch between the maturities ofrate sensitive assets and rate sensitive liabilities.  Management develops its view of future ratetrends by monitoring economic indicators, examining the views of economists andother experts, and understanding the current status of the Corporation’sBalance Sheet. Management conducts a quarterly analysis of the rate sensitivityposition.  The results of the analysisare reported to the Corporation’s Board of Directors.

 

  Management uses a computer model to analyzethe maturities of rate sensitive assets and liabilities.  The model measures the “GAP” which is definedas the difference between the dollar amount of rate sensitive assets repricingduring a period and the volume of rate sensitive liabilities repricing duringthe same period. GAP is also expressed as the ratio of rate sensitive assetsdivided by rate sensitive liabilities. If the ratio is greater than “one”, the dollar value of assets exceedsthe dollar value of liabilities; the balance sheet is “asset sensitive”.  Conversely, if the value of liabilitiesexceeds the value of assets, the ratio is less than one and the balance sheetis “liability sensitive”. The model measures scheduled maturities in periods ofthree months, four to twelve months, one to five years, and over five years.

 

23

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The table below illustrates therate sensitive position of the Corporation at September 30, 2005.Management uses the one year GAP as the appropriate time period for settingstrategy.

 

Rate Sensitivity Gap Analysis

(dollars in thousands)

 
| **Maturities:**                                                  | ** ** | **Floating** | ** ** | **1-3  Months** | ** ** | **4-12  Months** | ** ** | **1-5  Years** | ** ** | **Over  5 Years** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|------------|--------------|------------|-----------------|------------|------------------|------------|----------------|------------|-------------------|------------|-----------|------------|
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Interest  Earning Assets                                         |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Federal  funds sold                                              |       | $            | 5,855      |            | $          | —           |       | $              | —     |              | $          | —    |       | $ | — |   | $ | 5,855 |   |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Securities                                                       |       |         |       |            |       |             |       |           |       |              |       |      |       |
| U.S.  government agencies                                        |       | —       |       | —          |       | —           |       | 5,891          |       | 11,193            |       | 17,084    |       |
| Mortgage-backed  securities                                      |       | —       |       | 961             |       | 2,929            |       | 2,902          |       | 1,402             |       | 8,194     |       |
| Total  securities                                                |       | —       |       | 961             |       | 2,929            |       | 8,793          |       | 12,595            |       | 25,278    |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Total loans                                                      |       | 104,993      |       | 36,125          |       | 87,278           |       | 86,359         |       | 5,818             |       | 320,573   |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Total  Interest Earning Assets                                   |       | 110,848      |       | 37,086          |       | 90,207           |       | 95,152         |       | 18,413            |       | 351,706   |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Other Assets                                                     |       | —       |       | —          |       | —           |       | —         |       | 4,303             |       | 4,303     |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Total Assets                                                     |       | $            | 110,848    |            | $          | 37,086           |       | $              | 90,207     |              | $          | 95,152    |       | $ | 22,716 |   | $ | 356,009 |   |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Interest  Bearing Liabilities                                    |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Deposits                                                         |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Interest  checking                                               |       | $            | 5,736      |            | $          | —           |       | $              | —     |              | $          | —    |       | $ | — |   | $ | 5,736 |   |
| Money market  and savings                                        |       | 59,019       |       | —          |       | —           |       | —         |       | —            |       | 59,019    |       |
| Time  deposits                                                   |       | —       |       | 27,701          |       | 116,475          |       | 93,933         |       | —            |       | 238,109   |       |
| Total  deposits                                                  |       | 64,755       |       | 27,701          |       | 116,475          |       | 93,933         |       | —            |       | 302,864   |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Subordinated  Debt                                               |       | —       |       | —          |       | —           |       | —         |       | 8,248             |       | 8,248     |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Total  Interest Bearing Liabilities                              |       | 64,755       |       | 27,701          |       | 116,475          |       | 93,933         |       | 8,248             |       | 311,112   |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Other  Liabilities                                               |       | —       |       | —          |       | —           |       | —         |       | 19,382            |       | 19,382    |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Shareholders’  Equity                                       |       | —       |       | —          |       | —           |       | —         |       | 25,515            |       | 25,515    |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Total  Liabilities and Shareholders’ Equity                 |       | $            | 64,755     |            | $          | 27,701           |       | $              | 116,475    |              | $          | 93,933    |       | $ | 53,145 |   | $ | 356,009 |   |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Rate  Sensitive Gap by period                                    |       | $            | 46,093     |            | $          | 9,385            |       | $              | (26,268    | )                 | $          | 1,219     |       | $ | 10,165 |   |   |   |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Cumulative  Gap                                                  |       |         |       | $               | 55,478     |             | $          | 29,210         |       | $                 | 30,429     |      | $          | 40,594 |   |   |   |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Cumulative  Gap as a percent Of Total Assets                     |       |         |       | 15.58           | %          | 8.20             | %          | 8.55           | %          | 11.40             | %          |      |       |
|                                                             |       |         |       |            |       |             |       |           |       |              |       |      |       |
| Rate  sensitive assets / Rate sensitive liabilities (cumulative) |       | 1.71         |       | 1.60            |       | 1.14             |       | 1.10           |       | 1.13              |       |      |       |

 

24

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In mid-2004, the FederalReserve Open Market Committee began a series of interest rate increases whichthe FOMC indicated would continue “at a measured pace”.  By September 30, 2005, short terminterest rates had been increased by 275 basis points.  Management has positioned the Bank for a risingrate environment by maintaining an “asset sensitive” balance sheet in whichmore assets will reprice than liabilities. Management achieved this position during fourth quarter, 2004, byoffering higher rates of interest on deposit liabilities in the two to threeyear maturity range.  At September 30,2005, the Corporation’s one year GAP was 1.14.

 

The interest rate risk modelthat defines the GAP position also performs a “rate shock” test of the balancesheet.  The rate shock procedure measuresthe impact on the net interest margin and net income projected over the nextfour quarters of an immediate shift in interest rates in either direction.  Although this is a static model whichprovides information only at a certain point in time, it is useful is assessingthe impact of an unanticipated movement in interest rates. As shown below, thenet interest dollar amount decrease assuming a 200 basis point drop in interestrates is .14% of the average assets for 2005.

 

The chart below identifies thenet interest margin impact of a shift in rates of 50, 100 and 200 basis pointsin either direction.

 

Interest Income and Expense Under Rate Shock

(dollarsin thousands)

 
| **At September 30, 2005  Rate Change** | ** ** | **-200bp** | ** ** | **-100bp** | ** ** | **-50bp** | ** ** | **0bp** | ** ** | **+50bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|-----------|------------|---------|------------|-----------|------------|------------|------------|------------|------------|
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Net Interest  Income                        |       | $          | 14,737     |       | $          | 15,052    |       | $       | 15,201     |      | $          | 15,335     |       | $          | 15,457     |   | $ | 15,560 |   | $ | 15,743 |   |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Actual  dollar risk                         |       | (598       | )          | (283       | )          | (134      | )          | —  |       | 122       |       | 225        |       | 408        |       |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Percent of  risk                            |       | 3.90       | %          | 1.85       | %          | .87       | %          | —  |       | .80       | %          | 1.47       | %          | 2.66       | %          |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Percent of  average assets                  |       | .14        | %          | .07        | %          | .03       | %          | —  |       | .03       | %          | .05        | %          | .10        | %          |
|                                             |            |            |            |            |            |           |            |         |            |           |            |            |            |            |            |  |  |  |  |  |  |  |

 

The chartbelow identifies the net income impact of a shift in rates of 50, 100 and 200basis points in either direction.

 

NetIncome Under Rate Shock

(dollarsin thousands)

 
| **At September 30, 2005  Rate Change** | ** ** | **-200bp** | ** ** | **-100bp** | ** ** | **-50bp** | ** ** | **0bp** | ** ** | **+50bp** | ** ** | **+100bp** | ** ** | **+200bp** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|-----------|------------|---------|------------|-----------|------------|------------|------------|------------|------------|
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Net Income                                  |       | $          | 3,707      |       | $          | 3,902     |       | $       | 3,994      |      | $          | 4,076      |       | $          | 4,152      |   | $ | 4,215 |   | $ | 4,328 |   |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Actual  dollar risk                         |       | (369       | )          | (175       | )          | (83       | )          | —  |       | 75        |       | 139        |       | 252        |       |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Percent of  risk                            |       | 9.05       | %          | 4.28       | %          | 2.03      | %          | —  |       | 1.85      | %          | 3.41       | %          | 6.18       | %          |
|                                        |       |       |       |       |       |      |       |    |       |      |       |       |       |       |       |
| Percent of  average assets                  |       | .09        | %          | .04        | %          | .02       | %          | —  |       | .02       | %          | .03        | %          | .06        | %          |
|                                             |            |            |            |            |            |           |            |         |            |           |            |            |            |            |            |  |  |  |  |  |  |  |

 

25

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As shownabove, net interest income and net income should benefit from an increase inmarket interest rates. This reflects the asset sensitive bias of the balancesheet at September 30, 2005. The model simulates activity so that maturingbalances are replaced with new balances at the new rate level and repricingbalances are adjusted to the new rate shock level. In a rising rateenvironment, early withdrawal and repricing levels may increase. Because thebalance sheet is asset sensitive as shown by the positive one year GAP of 1.14,the net effect of the early withdrawals of the liabilities and the repricing ofthe assets will be a net increase in net interest income and net income.

 

The aboveanalysis may not on its own be an entirely accurate indicator of how netinterest income will be affected by changes in interest rates. Incomeassociated with interest earning assets and costs associated with interestbearing liabilities may not be affected uniformly by changes in interest rates.In addition, the magnitude and duration of changes in interest rates may have asignificant impact on net interest income. Although certain assets andliabilities may have similar maturities or periods of repricing, they may reactin different degrees to changes in market interest rates. Interest rates oncertain types of assets and liabilities fluctuate in advance of changes ingeneral market rates, while interest rates on other types may lag behindchanges in general market rates. The Asset-Liability Committee develops itsview of future rate trends by monitoring economic indicators, examining theviews of economists and other experts, and understanding the current status ofthe Corporation’s Balance Sheet and conducts a quarterly analysis of the ratesensitivity position.  The results of theanalysis are reported to the board.

 

**ITEM 4: CONTROLS AND PROCEDURES**

 

A. Evaluation of Disclosure Controls and Procedures

 

TheCorporation 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 Securities andExchange Commission’s rules and forms and that such information isaccumulated and communicated to the Corporation’s management, including itsChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. The Corporation carried out anevaluation, under the supervision and with the participation of its management,including it Chief Executive Officer and Chief Financial Officer, of theeffectiveness of the design and operation of its disclosure controls andprocedures as of the end of the period covered by this report. Based on theevaluation of these disclosure controls and procedures, the Chief ExecutiveOfficer and Chief Financial Officer concluded that the Corporation’s disclosurecontrols and procedures were effective.

 

B. Changes in Internal Controls and Procedures

 

There were no changes in our internal controls over financial reportingduring the quarter ended September 30, 2005, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

26

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**PART II: OTHER INFORMATION**

 

**ITEM 1: LEGAL PROCEEDINGS**

 

None

 

**ITEM 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

A.           None

 

B.             None

 

C.             None

 

The only working capitalrestrictions or other limitations upon the payment of dividends are thosereported in Part I.

 

**ITEM 3: DEFAULTS UPON SENIOR SECURITIES**

 

A.           None

 

B.             None

 

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

 

None

 

**ITEM 5:OTHER INFORMATION**

 

A.           None

 

B.             None

 

**ITEM 6:EXHIBITS**

 

Index to Exhibits

 
| **Exhibit No.** | ** ** | **Description**                                                                                  |
|----------------------|------------|--------------------------------------------------------------------------------------------------|
|                 |       |                                                                                             |
| 2.1 *                |       | Articles of Share Exchange of Tennessee  Commerce Bank and Tennessee Commerce Bancorp, Inc. |
|                 |       |                                                                                             |
| 2.2 *                |       | Plan of Share Exchange of Tennessee  Commerce Bank and Tennessee Commerce Bancorp, Inc.     |

 

27

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| 3.1*    |   | Charter of Tennessee Commerce Bancorp, Inc.                                                         |
|---------|--------|----------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                     |
| 3.2 *   |   | Bylaws of Tennessee Commerce Bancorp, Inc.                                                          |
|    |   |                                                                                                     |
| 10.1 *  |   | Tennessee Commerce Bancorp, Inc. Stock  Option Plan – Employees                                |
|    |   |                                                                                                     |
| 10.2 *  |   | Tennessee Commerce Bancorp, Inc. 1999  Stock Option Plan – Directors                           |
|    |   |                                                                                                     |
| 10.3 *  |   | Tennessee Commerce Bancorp, Inc. 1999  Stock Option Plan – Incorporators                       |
|    |   |                                                                                                     |
| 10.4 *  |   | Tennessee Commerce Bancorp, Inc. 2003  Stock Option Plan – Directors                           |
|    |   |                                                                                                     |
| 10.5 *  |   | Tennessee Commerce Bancorp, Inc. 1999  Stock Option Agreement with Arthur F. Helf                   |
|    |   |                                                                                                     |
| 10.6 *  |   | Tennessee Commerce Bancorp, Inc. 1999  Stock Option Agreement with Michael R. Sapp                  |
|    |   |                                                                                                     |
| 10.7 *  |   | Tennessee Commerce Bancorp, Inc. 1999  Stock Option Agreement with H. Lamar Cox                     |
|    |   |                                                                                                     |
| 10.8 *  |   | Employment Agreement between Tennessee  Commerce Bancorp, Inc. and Arthur F. Helf                   |
|    |   |                                                                                                     |
| 10.9 *  |   | Employment Agreement between Tennessee  Commerce Bancorp, Inc. and Michael R. Sapp                  |
|    |   |                                                                                                     |
| 10.10 * |   | Employment Agreement between Tennessee  Commerce Bancorp, Inc. and H. Lamar Cox                     |
|    |   |                                                                                                     |
| 11.1    |   | Computation of Per Share Earnings                                                                        |
|    |   |                                                                                                     |
| 31.1    |   | Certification of Chief Executive Officer  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|    |   |                                                                                                     |
| 31.2    |   | Certification of Chief Financial Officer  Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
|    |   |                                                                                                     |
| 32.1    |   | Certification of Chief Executive Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
|    |   |                                                                                                     |
| 32.2    |   | Certification of Chief Financial Officer  Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

----

* Previously filed as an Exhibit toTennessee Commerce Bancorp, Inc.’s Form 10 as filed with theSecurities Exchange Commission on April 29, 2005.

 

28

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SIGNATURES

 

In accordance with the requirements of theExchange Act, the Registrant caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 
|                   | Tennessee Commerce Bancorp, Inc. |                                 |
|------------------------|---------------------------------------|--------------------------------------|
|                   | (Registrant)                          |                                 |
|                   |                                  |                                 |
| November 10, 2005 |                                  | /s/ Arthur F. Helf                   |   |
| (Date)                 |                                  | Arthur F. Helf                       |   |
|                   |                                  | Chairman and Chief Executive Officer |
|                   |                                  |                                 |
| November 10, 2005 |                                  | /s/ George W. Fort                   |   |
| (Date)                 |                                  | George W. Fort                       |   |
|                   |                                  | Chief Financial Officer              |   |

 

29

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