Table of Contents

** **

 

** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

 

**FORM 10-Q**

 

**(Mark One)**

 

| **x**                                                       | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
|                                                        |       |                                                                                                     |
| **For the  quarterly period ended September 30, 2008** |
|                                                        |       |                                                                                                     |
| **OR**                                                      |
|                                                        |       |                                                                                                     |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**CommissionFile Number 000-51281**

 

**TENNESSEE COMMERCE BANCORP, INC.**

(Exact name of registrant as specified in itscharter)

 

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

 

**(615) 599-2274**

(Registrant’s telephone number, includingarea code)

 

**NotApplicable**

(Former name, former address and formerfiscal year if changed since last report)

 

Indicateby check mark whether registrant (1) has filed reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.

 

Yes  x  No  o

 

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

 
| Large accelerated filer o                      |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a smaller  reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 

Yes  o  No  x

 

Asof November 06, 2008 there were 4,731,696 shares of common stock, $0.50par value per share, issued and outstanding.

 

 

 

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Tableof Contents

 

**TennesseeCommerce Bancorp, Inc.**

 

Table of Contents

 
| Part I  | Financial  Information                                                                                                                                                        |   |
|--------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|         |                                                                                                                                                                          |   |
| Item 1.      | Financial Statements                                                                                                                                                          |   |
|         |                                                                                                                                                                          |   |
|         | Consolidated  Balance Sheets at September  30, 2008 (unaudited) and December 31,  2007                                                                              | 3      |
|         |                                                                                                                                                                          |   |
|         | Consolidated  Statements of Income (unaudited) for the Nine Months Ended September   30, 2008 and 2007 and for the Three Months Ended September  30, 2008 and  2007 | 4      |
|         |                                                                                                                                                                          |   |
|         | Consolidated  Statements of Changes in Shareholders’ Equity (unaudited) for the Nine Months  Ended September  30, 2008 and 2007                                     | 5      |
|         |                                                                                                                                                                          |   |
|         | Consolidated  Statements of Cash Flows (unaudited) for the Nine Months Ended  September  30, 2008 and 2007                                                               | 6      |
|         |                                                                                                                                                                          |   |
|         | Notes to  Consolidated Financial Statements (unaudited)                                                                                                                       | 7      |
|         |                                                                                                                                                                          |   |
| Item 2.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                                                   | 15     |
|         |                                                                                                                                                                          |   |
| Item 3.      | Quantitative  and Qualitative Disclosures About Market Risk                                                                                                                   | 28     |
|         |                                                                                                                                                                          |   |
| Item 4.      | Controls and Procedures                                                                                                                                                       | 31     |
|         |                                                                                                                                                                          |   |
| Part II | Other Information                                                                                                                                                             | 31     |
|         |                                                                                                                                                                          |   |
| Item 1A.     | Risk Factors                                                                                                                                                                  | 31     |
|         |                                                                                                                                                                          |   |
| Item 6.      | Exhibits                                                                                                                                                                      | 32     |
|         |                                                                                                                                                                          |   |
| Signatures   |                                                                                                                                                                          | 33     |

 

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**PART I:FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS.**

 

TENNESSEE COMMERCE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2008 (UNAUDITED) AND DECEMBER 31,2007

 
| **(Dollars in thousands, except per share data)**                                                                                                                                                                  | ** ** | **September 30,  2008** | ** ** | **December 31,  2007 (1)** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|--------------------------------------|------------|
| **ASSETS**                                                                                                                                                                                                                                       |       |                         |       |                                 |       |
| Cash and due from financial institutions                                                                                                                                                                                                         |       | $                            | 5,251      |                                 | $          | 5,236 |   |
| Federal funds sold                                                                                                                                                                                                                               |       | —                       |       | 9,573                                |       |
| Cash and cash equivalents                                                                                                                                                                                                                        |       | 5,251                        |       | 14,809                               |       |
| Securities available for sale                                                                                                                                                                                                                    |       | 76,651                       |       | 73,753                               |       |
| Loans                                                                                                                                                                                                                                            |       | 997,839                      |       | 794,322                              |       |
| Allowance for loan losses                                                                                                                                                                                                                        |       | (12,191                      | )          | (10,321                              | )          |
| Net loans                                                                                                                                                                                                                                        |       | 985,648                      |       | 784,001                              |       |
|                                                                                                                                                                                                                                             |       |                         |       |                                 |       |
| Premises and equipment, net                                                                                                                                                                                                                      |       | 2,433                        |       | 1,413                                |       |
| Accrued interest receivable                                                                                                                                                                                                                      |       | 7,632                        |       | 5,901                                |       |
| Restricted equity securities                                                                                                                                                                                                                     |       | 1,376                        |       | 938                                  |       |
| Income tax receivable                                                                                                                                                                                                                            |       | —                       |       | 1,886                                |       |
| Other assets                                                                                                                                                                                                                                     |       | 27,067                       |       | 17,452                               |       |
|                                                                                                                                                                                                                                             |       |                         |       |                                 |       |
| Total assets                                                                                                                                                                                                                                     |       | $                            | 1,106,058  |                                 | $          | 900,153 |   |
|                                                                                                                                                                                                                                             |       |                         |       |                                 |       |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**                                                                                                                                                                                                    |       |                         |       |                                 |       |
| Liabilities                                                                                                                                                                                                                                      |       |                         |       |                                 |       |
| Deposits                                                                                                                                                                                                                                         |       |                         |       |                                 |       |
| Non-interest bearing                                                                                                                                                                                                                             |       | $                            | 30,573     |                                 | $          | 27,427 |   |
| Interest-bearing                                                                                                                                                                                                                                 |       | 958,091                      |       | 787,626                              |       |
| Total deposits                                                                                                                                                                                                                                   |       | 988,664                      |       | 815,053                              |       |
|                                                                                                                                                                                                                                             |       |                         |       |                                 |       |
| Federal funds purchased                                                                                                                                                                                                                          |       | 10,985                       |       | 2,000                                |       |
| Accrued interest payable                                                                                                                                                                                                                         |       | 3,099                        |       | 2,292                                |       |
| Short-term borrowings                                                                                                                                                                                                                            |       | 10,000                       |       | 7,000                                |       |
| Accrued bonuses                                                                                                                                                                                                                                  |       | 496                          |       | 1,700                                |       |
| Long-term subordinated debt                                                                                                                                                                                                                      |       | 23,198                       |       | 8,248                                |       |
| Deferred tax liabilities                                                                                                                                                                                                                         |       | 770                          |       | 139                                  |       |
| Other liabilities                                                                                                                                                                                                                                |       | 1,494                        |       | 600                                  |       |
| Total liabilities                                                                                                                                                                                                                                |       | 1,038,706                    |       | 837,032                              |       |
| Shareholders’ equity                                                                                                                                                                                                                        |       |                         |       |                                 |       |
| Preferred stock, no par value; 1,000,000  shares authorized; none issued                                                                                                                                                                         |       | —                       |       | —                               |       |
| Common stock, $0.50 par value, 10,000,000  shares authorized at September 30, 2008 and December 31, 2007;  4,731,696 and 4,724,196 shares issued and outstanding at September 30,  2008 and December 31, 2007, respectively. |       | 2,366                        |       | 2,362                                |       |
| Additional paid-in capital                                                                                                                                                                                                                       |       | 45,265                       |       | 45,024                               |       |
| Retained earnings                                                                                                                                                                                                                                |       | 20,533                       |       | 15,426                               |       |
| Accumulated other comprehensive  income/(loss)                                                                                                                                                                                                   |       | (812                         | )          | 309                                  |       |
| Total shareholders’ equity                                                                                                                                                                                                                  |       | 67,352                       |       | 63,121                               |       |
|                                                                                                                                                                                                                                             |       |                         |       |                                 |       |
| Total liabilities and shareholders’ equity                                                                                                                                                                                                  |       | $                            | 1,106,058  |                                 | $          | 900,153 |   |

 

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(1) Thebalance sheet at December 31, 2007 has been derived from the auditedconsolidated financial statements at that date but does not include all of theinformation and notes required by generally accepted accounting principles forcomplete financial statements.

 

Seeaccompanying notes to consolidated financial statements.

 

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TENNESSEE COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OFINCOME

NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

THREE MONTHS ENDED SEPTEMBER 30, 2008 AND2007

(UNAUDITED)

 
| ** **                                                                      | ** ** | **Nine Months Ended September 30,** | ** ** | **Three Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2008**                                                | ** ** | **2007**                                                 | ** ** | **2008** | ** ** | **2007** | ** ** |
| Interest income                                                                 |       |                                                    |       |                                                     |       |   |   |   |   |
| Loans, including fees                                                           |       | $                                                       | 52,125     |                                                     | $          | 41,252 |   | $ | 18,528 |   | $ | 15,267 |   |
| Securities                                                                      |       | 3,398                                                   |       | 2,507                                                    |       | 1,221 |   | 920 |   |
| Federal funds sold                                                              |       | 148                                                     |       | 435                                                      |       | 7 |   | 184 |   |
| Total interest income                                                           |       | 55,671                                                  |       | 44,194                                                   |       | 19,756 |   | 16,371 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Interest expense                                                                |       |                                                    |       |                                                     |       |   |   |   |   |
| Deposits                                                                        |       | 29,340                                                  |       | 24,411                                                   |       | 9,902 |   | 9,138 |   |
| Other                                                                           |       | 1,199                                                   |       | 462                                                      |       | 580 |   | 143 |   |
| Total interest expense                                                          |       | 30,539                                                  |       | 24,873                                                   |       | 10,482 |   | 9,281 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Net interest income                                                             |       | 25,132                                                  |       | 19,321                                                   |       | 9,274 |   | 7,090 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Provision for loan losses                                                       |       | 5,790                                                   |       | 4,300                                                    |       | 1,850 |   | 1,300 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Net interest income after provision for  loan losses                            |       | 19,342                                                  |       | 15,021                                                   |       | 7,424 |   | 5,790 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Non-interest income                                                             |       |                                                    |       |                                                     |       |   |   |   |   |
| Service charges on deposit accounts                                             |       | 89                                                      |       | 98                                                       |       | 40 |   | 30 |   |
| Securities gains (losses)                                                       |       | (67                                                     | )          | 10                                                       |       | (97 | ) | — |   |
| Gain on sale of loans                                                           |       | 1,419                                                   |       | 1,827                                                    |       | 1 |   | 547 |   |
| Other                                                                           |       | (13                                                     | )          | 71                                                       |       | 154 |   | (3 | ) |
| Total non-interest income                                                       |       | 1,428                                                   |       | 2,006                                                    |       | 98 |   | 574 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Non-interest expense                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Salaries and employee benefits                                                  |       | 6,151                                                   |       | 5,363                                                    |       | 2,058 |   | 2,125 |   |
| Occupancy and equipment                                                         |       | 1,037                                                   |       | 799                                                      |       | 315 |   | 287 |   |
| Data processing fees                                                            |       | 910                                                     |       | 729                                                      |       | 376 |   | 224 |   |
| Professional fees                                                               |       | 1,531                                                   |       | 543                                                      |       | 627 |   | 51 |   |
| Other                                                                           |       | 2,811                                                   |       | 1,749                                                    |       | 1,070 |   | 784 |   |
| Total non-interest expense                                                      |       | 12,440                                                  |       | 9,183                                                    |       | 4,446 |   | 3,471 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Income before income taxes                                                      |       | 8,330                                                   |       | 7,844                                                    |       | 3,076 |   | 2,893 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Income tax expense                                                              |       | 3,223                                                   |       | 3,050                                                    |       | 1,190 |   | 1,116 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Net income                                                                      |       | $                                                       | 5,107      |                                                     | $          | 4,794 |   | $ | 1,886 |   | $ | 1,777 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Earnings per share (EPS):                                                       |       |                                                    |       |                                                     |       |   |   |   |   |
| Basic EPS                                                                       |       | $                                                       | 1.08       |                                                     | $          | 1.05 |   | $ | 0.40 |   | $ | 0.38 |   |
| Diluted EPS                                                                     |       | $                                                       | 1.05       |                                                     | $          | 0.99 |   | $ | 0.39 |   | $ | 0.36 |   |
|                                                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Weighted average shares outstanding:                                            |       |                                                    |       |                                                     |       |   |   |   |   |
| Basic                                                                           |       | 4,731,039                                               |       | 4,578,930                                                |       | 4,731,696 |   | 4,700,509 |   |
| Diluted                                                                         |       | 4,878,150                                               |       | 4,857,681                                                |       | 4,851,831 |   | 4,979,260 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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TENNESSEE COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OFCHANGES IN SHAREHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(UNAUDITED)

 
| **(Dollars in thousands)**                                                 | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Accumulated  Other  Comprehensive  Income  (Loss)** | ** ** | **Total  Shareholders’  Equity** | ** ** |
|--------------------------------------------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|------------------------|------------|-------------------------------------------------------|------------|---------------------------------------|------------|
| Balance at December 31, 2006                                                    |       | $                 | 2,226      |                             | $          | 40,755                 |       | $                                                     | 8,530      |                                  | $          | (287 | ) | $ | 51,224 |   |
| Comprehensive income                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Net income                                                                           |       | —            |       | —                           |       | 4,794                  |       | —                                                |       | 4,794                                 |       |
| Other comprehensive income, net of income  taxes                                     |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Unrealized losses on securities available  for sale during the period                |       | —            |       | —                           |       | —                 |       | 79                                                    |       | 79                                    |       |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Total comprehensive income                                                           |       |              |       |                             |       |                   |       |                                                  |       | 4,873                                 |       |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Exercise of stock options to purchase  255,522 common shares and related tax benefit |       | 128               |       | 3,844                            |       | —                 |       | —                                                |       | 3,972                                 |       |
| Stock-based compensation expense                                                     |       | —            |       | 124                              |       | —                 |       | —                                                |       | 124                                   |       |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Section 16 profit reimbursement                                                 |       | —            |       | 15                               |       | —                 |       | —                                                |       | 15                                    |       |
| Balance at September 30, 2007                                                   |       | $                 | 2,354      |                             | $          | 44,738                 |       | $                                                     | 13,324     |                                  | $          | (208 | ) | $ | 60,208 |   |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Balance at December 31, 2007                                                    |       | $                 | 2,362      |                             | $          | 45,024                 |       | $                                                     | 15,426     |                                  | $          | 309 |   | $ | 63,121 |   |
| Comprehensive income                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Net income                                                                           |       | —            |       | —                           |       | 5,107                  |       | —                                                |       | 5,107                                 |       |
| Other comprehensive income, net of income  taxes                                     |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Unrealized losses on securities available  for sale during the period                |       | —            |       | —                           |       | —                 |       | (1,121                                                | )          | (1,121                                | )          |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Total comprehensive income                                                           |       |              |       |                             |       |                   |       |                                                  |       | 3,986                                 |       |
|                                                                                 |       |              |       |                             |       |                   |       |                                                  |       |                                  |       |
| Stock-based compensation expense                                                     |       |              |       | 155                              |       |                   |       |                                                  |       | 155                                   |       |
| Exercise of stock options to purchase 7,500  common shares and related tax benefit   |       | 4                 |       | 86                               |       | —                 |       | —                                                |       | 90                                    |       |
| Balance at September 30, 2008                                                   |       | $                 | 2,366      |                             | $          | 45,265                 |       | $                                                     | 20,533     |                                  | $          | (812 | ) | $ | 67,352 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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TENNESSEE COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OFCASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007

(UNAUDITED)

 
| ** **                                                                                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)**                                                        | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
|                                                                                        |       |                                                |       |   |   |
| **Cash flows from operating activities**                                                    |       |                                                |       |   |   |
| Net income                                                                                  |       | $                                                   | 5,107      |   | $ | 4,794 |   |
| Adjustments to reconcile net income to net  cash provided by (used by) operating activities |       |                                                |       |   |   |
| Depreciation                                                                                |       | 295                                                 |       | 250 |   |
| Deferred loan fees                                                                          |       | (295                                                | )          | (563 | ) |
| Stock-based compensation expense                                                            |       | 155                                                 |       | 124 |   |
| Provision for loan losses                                                                   |       | 5,790                                               |       | 4,300 |   |
| Deferred income tax                                                                         |       | 1,319                                               |       | (1,506 | ) |
| Net amortization of investment securities                                                   |       | (45                                                 | )          | 11 |   |
| (Gain) loss on sales of securities                                                          |       | 67                                                  |       | (10 | ) |
| Change in:                                                                                  |       |                                                |       |   |   |
| Accrued interest receivable                                                                 |       | (1,731                                              | )          | (2,256 | ) |
| Accrued interest payable                                                                    |       | 807                                                 |       | 268 |   |
| Other assets                                                                                |       | (7,279                                              | )          | (5,887 | ) |
| Other liabilities                                                                           |       | 2,690                                               |       | 1,702 |   |
| Net cash provided by operating activities                                                   |       | 6,880                                               |       | 1,227 |   |
|                                                                                        |       |                                                |       |   |   |
| **Cash flows from investing activities**                                                    |       |                                                |       |   |   |
| Purchases of securities available for sale                                                  |       | (63,137                                             | )          | (24,434 | ) |
| Proceeds from sales of securities available  for sale                                       |       | 32,903                                              |       | 11,275 |   |
| Proceeds from maturities, prepayments and  calls of securities available for sale           |       | 25,505                                              |       | 1,488 |   |
| Net change in loans                                                                         |       | (207,142                                            | )          | (195,092 | ) |
| Purchases of FHLB stock                                                                     |       | (438                                                | )          | (305 | ) |
| Net purchases of premises and equipment                                                     |       | (1,315                                              | )          | (87 | ) |
| Net cash used by investing activities                                                       |       | (213,624                                            | )          | (207,155 | ) |
|                                                                                        |       |                                                |       |   |   |
| **Cash flows from financing activities**                                                    |       |                                                |       |   |   |
| Net change in deposits                                                                      |       | 173,611                                             |       | 205,723 |   |
| Net change in federal funds purchased and  repurchase agreements                            |       | 8,985                                               |       | — |   |
| Proceeds from long-term subordinated debt                                                   |       | 14,950                                              |       | — |   |
| Purchases of capital securities of  unconsolidated subsidiary                               |       | (450                                                | )          | — |   |
| Proceeds from exercise of common stock  options                                             |       | 38                                                  |       | 2,002 |   |
| Excess tax benefit from option exercises                                                    |       | 52                                                  |       | 1,970 |   |
| Section 16 profit reimbursement                                                        |       | —                                              |       | 15 |   |
| Net cash provided by financing activities                                                   |       | 197,186                                             |       | 209,710 |   |
|                                                                                        |       |                                                |       |   |   |
| **Net change in cash and cash equivalents**                                                 |       | (9,558                                              | )          | 3,782 |   |
|                                                                                        |       |                                                |       |   |   |
| Cash and cash equivalents at beginning of  period                                           |       | 14,809                                              |       | 13,997 |   |
|                                                                                        |       |                                                |       |   |   |
| **Cash and cash equivalents at end of period**                                              |       | $                                                   | 5,251      |   | $ | 17,779 |   |
|                                                                                        |       |                                                |       |   |   |
| **Supplemental cash flow information:**                                                     |       |                                                |       |   |   |
| Cash paid during period for interest                                                        |       | $                                                   | 29,732     |   | $ | 24,605 |   |
| Cash paid during period for income taxes                                                    |       | $                                                   | 228        |   | $ | 4,175 |   |

 

Seeaccompanying notes to consolidated financial statements.

 

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** **

TENNESSEECOMMERCE BANCORP, INC.

 

Notes to Consolidated Financial Statements(unaudited)

 

Note1 — Basis of Presentation

 

Tennessee Commerce Bancorp, Inc. (the “Corporation”) is the bankholding company for Tennessee Commerce Bank (the “Bank”).  In March 2005,the Corporation formed a wholly owned subsidiary, Tennessee Commerce BankStatutory Trust I (the “Trust I”).  In June 2008, the Corporationformed a wholly owned subsidiary, Tennessee Commerce Bank Statutory Trust II(the “Trust II”). In July 2008, the corporation formed a wholly ownedsubsidiary, TCB Commercial Assets Services. As of September 30, 2008, theBank, the Trust I, the Trust II and TCB Commercial Assets Services were theonly subsidiaries of the Corporation. The accompanying consolidated financialstatements include the accounts of the Corporation, the Bank and TCB CommercialAssets Services. The Trust I and the Trust II are not consolidated in accordancewith Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R) (revisedDecember 2003), “Consolidation of Variable Interest Entities.” Materialintercompany accounts and transactions have been eliminated.

 

The unaudited consolidated financial statements as of September 30,2008 and for the nine- and three-month periods ended September 30, 2008and 2007 have been prepared in accordance with accounting principles generallyaccepted in the United States of America and in accordance with theinstructions to Form 10-Q and Article 10 of Regulation S-X aspromulgated by the Securities and Exchange Commission (“SEC”), and in theopinion of management, include all adjustments, consisting of normal recurringadjustments, to present fairly the information included therein. They do notinclude all the information and notes required by generally accepted accountingprinciples for complete financial statements. Operating results for the nine-and three-month periods ended September 30, 2008 are not necessarilyindicative of the results that may be expected for the year ending December 31,2008. For further information, refer to the consolidated financial statementsand notes thereto included in the Corporation’s Annual Report on Form 10-Kfor the year ended December 31, 2007.

 

Note2 — Earnings per Share of Common Stock

 

The factors used in the earnings per sharecomputation follow:

 
| ** **                                                                      | ** ** | **Nine Months Ended  September 30,** | ** ** | **Three Months Ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in thousands, except per share data)** | ** ** | **2008**                                            | ** ** | **2007**                                             | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Basic                                                                           |       |                                                |       |                                                 |       |   |   |   |   |
| Net income                                                                      |       | $                                                   | 5,107      |                                                 | $          | 4,794 |   | $ | 1,886 |   | $ | 1,777 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Weighted average common shares outstanding                                      |       | 4,731,039                                           |       | 4,578,930                                            |       | 4,731,696 |   | 4,700,509 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Basic earnings per common share                                                 |       | $                                                   | 1.08       |                                                 | $          | 1.05 |   | $ | 0.40 |   | $ | 0.38 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Diluted                                                                         |       |                                                |       |                                                 |       |   |   |   |   |
| Net income                                                                      |       | $                                                   | 5,107      |                                                 | $          | 4,794 |   | $ | 1,886 |   | $ | 1,777 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Weighted average common shares outstanding  for basic earnings per common share |       | 4,731,039                                           |       | 4,578,930                                            |       | 4,731,696 |   | 4,700,509 |   |
| Add: Dilutive effects of assumed exercises  of stock options                    |       | 147,111                                             |       | 278,751                                              |       | 120,135 |   | 278,751 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Average shares and dilutive potential  common shares                            |       | 4,878,150                                           |       | 4,857,681                                            |       | 4,851,831 |   | 4,979,260 |   |
|                                                                            |       |                                                |       |                                                 |       |   |   |   |   |
| Diluted earnings per common share                                               |       | $                                                   | 1.05       |                                                 | $          | 0.99 |   | $ | 0.39 |   | $ | 0.36 |   |

 

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Note3 — Stock-Based Compensation

 

On January 1, 2006, the Corporation adopted Statement of FinancialAccounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFASNo. 123(R)”), which addresses the accounting for share-based paymenttransactions in which a company receives employee services in exchange forequity instruments. SFAS No. 123(R) eliminates the ability to accountfor share-based compensation transactions, as the Corporation formerly did,using the intrinsic value method as prescribed by Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” and generallyrequires that such transactions be accounted for using a fair-value-basedmethod and recognized as expense in the accompanying consolidated statement ofincome.

 

The Corporation adopted SFAS No. 123(R) using the modifiedprospective method which requires the application of the accounting standard asof January 1, 2006. The accompanying consolidated financial statements asof and for the periods ended September 30, 2008 reflect the impact of adoptingSFAS No. 123(R). In accordance with the modified prospective method, theconsolidated financial statements for prior periods have not been restated toreflect, and do not include, the impact of SFAS No. 123(R).

 

Stock-based compensation expense recognized during the period is basedon the value of the portion of stock-based payment awards that is ultimatelyexpected to vest. Stock-based compensation expense recognized in theaccompanying consolidated statements of income for the period ended September 30,2008 included any compensation expense for stock-based payment awards vestingduring the period based on the grant date fair value estimated in accordancewith SFAS No. 123(R). As stock-based compensation expense recognized inthe accompanying statement of income for the period ended September 30,2008 is based on awards ultimately expected to vest, it has been reduced forestimated forfeitures. SFAS No. 123(R) requires forfeitures tobe estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates.

 

For the nine months ended September 30, 2008, the Corporationgranted options to purchase 150,000 shares of Corporation common stock and10,955 restricted shares of Corporation common stock and there were 160,000non-vested options outstanding prior to that period with 40,000 forfeited.There was $155 stock-based expense recognized for the nine months ended September 30,2008.

 

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A summary of the activity in the Corporation’s stock-based compensationplan is as follows:

 
| ** **                                                                      | ** ** | **Number** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Contractual  Remaining  Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value (1)  (000’s)** | ** ** |
|---------------------------------------------------------------------------------|------------|------------|------------|----------------------------------------|------------|----------------------------------------------------------------------|------------|--------------------------------------------------------|------------|
| Stock-based awards outstanding at  December 31, 2007                       |       | 798,570    |       | $                                      | 13.14      |                                                                 |       |                                                   |       |   |
| Options granted                                                                 |       | 150,000    |       | 22.15                                  |       |                                                                 |       |                                                   |       |
| Shares of restricted stock granted                                              |       | 10,955     |       | —                                 |       |                                                                 |       |                                                   |       |
| Options exercised                                                               |       | (7,500     | )          | 5.00                                   |       |                                                                 |       |                                                   |       |
| Options forfeited or expired                                                    |       | (100,000   | )          | 23.58                                  |       |                                                                 |       |                                                   |       |
| Stock-based awards outstanding at  September 30, 2008                      |       | 852,025    |       | $                                      | 13.58      |                                                                 | 4.90       |                                                   | $          | 395 |   |
| Stock-based awards outstanding and expected  to vest at September 30, 2008 |       | 852,025    |       | $                                      | 13.58      |                                                                 | 4.90       |                                                   | $          | 395 |   |
| Options exercisable at September 30,  2008                                 |       | 621,070    |       | $                                      | 9.99       |                                                                 | 4.01       |                                                   | $          | 2,522 |   |

 

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| (1) | The  aggregate intrinsic value is calculated as the difference between the  exercise price of each option and the closing price per share of Corporation  common stock of $14.05 for the 852,025 options outstanding and 621,070  options exercisable at September 30, 2008. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The estimated fair values are computed using the Black-Scholes optionvaluation model, using the following weighted-average assumptions as of thegrant date shown below:

 
| ** **              | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|-------------------------|------------|-----------|------------|-----------|------------|
|                    |       |      |       |      |       |
| Risk-free interest rate |       | 3.27      | %          | 4.94      | %          |
| Expected option life    |       | 3.5 years |       | 3.5 years |       |
| Dividend yield          |       | 0.0       | %          | 0.0       | %          |

 

The Corporation granted options to purchase 150,000 shares ofCorporation common stock and 10,955 restricted shares of Corporation commonstock in the first nine months of 2008. The options granted in 2008 had anestimated fair value of $4.45. The options granted in 2007 had an estimatedfair value of $5.75. The weighted average fair value of options granted duringthe year was $4.45 for 2008 and $5.75 for 2007.

 

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Note4 — Trust Preferred Securities

 

InMarch 2005, the Trust I issued and sold 8,000 of its fixed/floating ratecapital securities, with a liquidation amount of $1,000 per capital security,to First Tennessee Bank National Association. The securities pay a fixed rateof 6.73% payable quarterly for the first five years and a floating rate basedon a three-month LIBOR rate plus 1.98% thereafter. At the same time, theCorporation issued to the Trust I $8,248,000 of fixed/floating rate juniorsubordinated deferrable interest debentures due 2035. The Corporationguarantees the payment of distributions and payments for redemptions orliquidation of the capital securities. The fixed/floating rate capitalsecurities qualify as “Tier I Capital” for the Corporation under currentregulatory definitions subject to certain limitations.

 

Thedebentures pay a fixed rate of 6.73% payable quarterly for the first five yearsand a floating rate based on a three-month LIBOR rate plus 1.98% thereafter.The distributions on the capital securities are accounted for as interestexpense by the Corporation. Interest payments on the debentures and thecorresponding distributions on the capital securities may be deferred at anytime at the election of the Corporation for up to 20 consecutive quarterlyperiods (five years). The capital securities and debentures are redeemable atany time commencing after June 2010 at par. The Corporation reports asliabilities the subordinated debentures issued by the Corporation and held bythe Trust I.

 

InJune 2008, the Trust II issued and sold 14,500 of its floating ratecapital securities, with a liquidation amount of $1,000 per capital security,in a private placement. The securities pay a floating rate per annum, resetquarterly, equal to the prime rate of interest published in *The Wall Street Journal* on the firstbusiness day of each distribution period plus 50 basis points (but in no eventgreater than 8.0% or less than 5.75%). At the same time, the Corporation issuedto the Trust II $14.95 million of floating rate junior subordinated deferrableinterest debentures due 2038. The Corporation guarantees the payment ofdistributions and payments for redemptions or liquidation of the capitalsecurities. The floating rate capital securities qualify as “Tier I Capital”for the Corporation under current regulatory definitions subject to certainlimitations.

 

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

 

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Note5 – New Accounting Standards

 

In September 2006, the FASB released Statement of FinancialAccounting Standards No. 157 (“SFAS No. 157”), “Fair ValueMeasurements.” This statement defines fair value, establishes a framework formeasuring fair value and expands disclosures about fair value measurements.SFAS No. 157 clarifies the exchange price notion in the fair valuedefinition to mean the price that would be received to sell the asset or paidto transfer the liability (an exit price), not the price that would be paid toacquire the asset or received to assume the liability (an entry price). Thisstatement also clarifies that market participant assumptions should includeassumptions about risk, should include assumptions about the effect of a restrictionon the sale or use of an asset and should reflect its nonperformance risk (therisk that the obligation will not be fulfilled). Nonperformance risk shouldinclude the reporting entity’s credit risk. SFAS No. 157 is effective forfinancial statements issued for fiscal years beginning after November 15,2007. In February 2008, the FASB issued FASB Staff Position (“FSP”) FAS157-2, “Effective Date of FASB Statement No. 157,” which delays theeffective date of SFAS 157 for non-financial assets and non-financialliabilities that are recognized or disclosed in the financial statements on anon-recurring basis. The Corporation and the Bank both adopted SFAS No. 157on January 1, 2008 and the adoption did not have a material impact on thefinancial statements.

 

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

 

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Note6 — Fair Value Measurement

 

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

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

 

The methods described abovemay produce a fair value calculation that may not be indicative of netrealizable value or reflective of future fair values. Furthermore, while theBank believes its valuation methods are appropriate and consistent with othermarket participants, the use of different methodologies, or assumptions, todetermine the fair value of certain financial instruments could result in adifferent estimate of fair value at the reporting date.

 

**Valuation Hierarchy**

 

SFAS No.157 establishes athree-level valuation hierarchy for disclosure of fair value measurements. Thevaluation hierarchy is based upon the transparency of inputs to the valuationof an asset or liability as of the measurement date. The three levels aredefined as follows:

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

 

A financial instrument’scategorization within the valuation hierarchy is based upon the lowest level ofinput that is significant to the fair value measurement.  Below is adescription of the valuation methodologies used for instruments measured atfair value, as well as the general classification of such instruments pursuantto the valuation hierarchy.

 

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**Assets**

 

*Securities-*Available-for-salesecurities are recorded at fair value on a recurring basis.  Where quotedprices are available in an active market, securities are classified withinlevel 1 of the valuation hierarchy.  Level 1 securities include highlyliquid government bonds, federal funds sold and certain other products. Fair value measurement is based upon quoted prices, if available.  Ifquoted prices are not available, securities would generally be classifiedwithin level 2, and fair value would be determined by matrix pricing, which isa mathematical technique widely used in the industry to value debt securitieswithout relying exclusively on quoted prices for the specific securities but relyingon the securities’ relationship to other benchmark quoted securities. Incertain cases where there is limited activity or less transparency aroundinputs to the valuation, securities are classified within level 3 of thevaluation hierarchy. For the nine months ended September 30, 2008, theentire Bank’s available-for-sale securities were valued using matrix pricingand were classified within level 2 of the valuation hierarchy.  At September 30,2008, the Bank had no securities classified within level 3.

 

*Servicing Assets -* All separately recognized servicing assetsand servicing liabilities are initially measured at fair value. Subsequentmeasurement methods include the amortization method, whereby servicing assetsor servicing liabilities are amortized over the period of estimated netservicing income or net servicing loss, or the fair value method, wherebyservicing assets or servicing liabilities are measured at fair value at eachreporting date and changes in fair value are reported in earnings in the periodin which they occur. Because of the unique nature of the Bank’s servicingassets, quoted market prices may not be available. If no quoted market pricesare available, the amortization method is used. The Bank assesses servicingassets or servicing liabilities for impairment or increased obligation based onthe fair value at each reporting date.  At September 30,2008, the Bank had servicing assets measured at fair value on a recurringbasis classified within level 3 of the valuation hierarchy.

 

*Interest-Only Strips -* When the Bank sells loans to others, it mayhold interest-only strips, which is an interest that continues to be held bythe transferor in the securitized receivable. It may also obtain servicingassets or assume servicing liabilities that are initially measured at fairvalue. Gain or loss on sale of the receivables depends in part on both (a) theprevious carrying amount of the financial assets involved in the transfer,allocated between the assets sold and the interests that continue to be held bythe transferor based on their relative fair value at the date of transfer, and (b) theproceeds received. To obtain fair values, quoted market prices are used ifavailable. However, quotes are generally not available for interests thatcontinue to be held by the transferor, so the Bank generally estimates fairvalue based on the future expected cash flows estimated using management’s bestestimates of the key assumptions – credit losses and discount ratescommensurate with the risks involved. At September 30, 2008, the Bankhad interest-only strips measured at fair value on a recurring basis classifiedwithin level 3 of the valuation hierarchy.

 

*Impaired Loans –* A loan is considered to be impaired when itis probable the Bank will be unable to collect all principal and interestpayments due in accordance with the contractual terms of the loan agreement.Individually identified impaired loans are measured based on the present valueof expected payments using the loan’s original effective rate as the discountrate, the loan’s observable market price, or the fair value of the collateralif the loan is collateral dependent. If the recorded investment in the impairedloan exceeds the measure of fair value, a valuation allowance may beestablished as a component of the allowance for loan losses. At September 30,2008, the Bank had impaired loans measured on a nonrecurring basis classifiedwithin level 3 of the valuation hierarchy.

 

*OtherAssets*— Included inother assets are certain assets carried at fair value, including repossessionsand other real estate owned (“OREO”). The carrying amount is based on anobservable market price or appraisal value. The Bank reflects these assetswithin level 3 of the valuation hierarchy. At September 30, 2008, theBank had repossessions and OREO measured at fair value on a nonrecurring basisclassified within level 3 of the valuation hierarchy

 

**Liabilities**

 

*RecourseObligations* - Themaximum extent of the Bank’s recourse obligations on loans transferred is 10%of the amount transferred adjusted for any early payoffs or terminations, basedon the Bank’s payment history on loans of the type transferred. At September 30,2008, the Bank had recourse obligations measured at fair value on arecurring basis classified within level 3 of the valuation hierarchy.

 

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The following table presentsthe financial instruments carried at fair value as of September 30, 2008,by caption on the consolidated balance sheets and by SFAS No. 157valuation hierarchy (as described above) (dollars in thousands):

 

**Assets andliabilities measured at fair value on a recurring basis as of September 30,2008**

 
| ** **                          | ** ** | **Total  carrying  value in the  consolidated  balance** | ** ** | **Quoted  market  prices in an  active  market** | ** ** | **Internal  models with  significant  observable  market  parameters** | ** ** | **Internal  models with  significant  unobservable  market  parameters** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **sheet**                                                          | ** ** | **(Level 1)**                                         | ** ** | **(Level 2)**                                                          | ** ** | **(Level 3)**                                                            | ** ** |
| Securities available for sale       |       | 76,651                                                             |       | —                                                     |       | 76,651                                                                      |       | —                                                                        |       |
| Servicing assets                    |       | 161                                                                |       | —                                                     |       | —                                                                      |       | 161                                                                           |       |
| Interest-only strips                |       | 3,505                                                              |       | —                                                     |       | —                                                                      |       | 3,505                                                                         |       |
| **Total assets at fair value**      |       | $                                                                  | 80,317     |                                                       | $          | —                                                                      |       | $                                                                             | 76,651     |   | $ | 3,666 |   |
|                                |       |                                                               |       |                                                       |       |                                                                        |       |                                                                          |       |
| Recourse obligations                |       | 319                                                                |       | —                                                     |       | —                                                                      |       | 319                                                                           |       |
| **Total liabilities at fair value** |       | $                                                                  | 319        |                                                       | $          | —                                                                      |       | $                                                                             | —     |   | $ | 319 |   |

 

The Corporation may berequired, from time to time, to measure certain assets at fair value on anonrecurring basis in accordance with generally accepted accounting principles.These include assets that are measured at the lower of cost or market that wererecognized at fair value below the cost at the end of the period. The followingtable presents the financial instruments carried at fair value as of September 30,2008, by caption on the consolidated balance sheets and by SFAS No. 157valuation hierarchy (as described above) (dollars in thousands):

 

**Assets andliabilities measured at fair value on a nonrecurring basis as of September 30,2008**

 
| ** **                          | ** ** | **Total  carrying  value in the  consolidated  balance** | ** ** | **Quoted  market  prices in an  active  market** | ** ** | **Internal  models with  significant  observable  market  parameters** | ** ** | **Internal  models with  significant  unobservable  market  parameters** | ** ** |
|-------------------------------------|------------|--------------------------------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------|------------|
| ** **                          | ** ** | **sheet**                                                          | ** ** | **(Level 1)**                                    | ** ** | **(Level 2)**                                                          | ** ** | **(Level 3)**                                                            | ** ** |
| Impaired loans                      |       | 9,834                                                              |       | —                                                |       | —                                                                      |       | 9,834                                                                         |       |
| Other Assets                        |       | 12,221                                                             |       | —                                                |       | —                                                                      |       | 12,221                                                                        |       |
|                                |       |                                                               |       |                                                  |       |                                                                        |       |                                                                          |       |
| **Total assets at fair value**      |       | $                                                                  | 22,055     |                                                  | $          | —                                                                      |       | $                                                                             | —     |   | $ | 22,055 |   |
|                                |       |                                                               |       |                                                  |       |                                                                        |       |                                                                          |       |
| Liabilities                         |       | —                                                             |       | —                                                |       | —                                                                      |       | —                                                                        |       |
| **Total liabilities at fair value** |       | $                                                                  | —     |                                                  | $          | —                                                                      |       | $                                                                             | —     |   | $ | — |   |

 

**Changes in level 3 fair value measurements**

 

     Thetable below includes a roll-forward of the balance sheet amounts for the secondquarter of 2008 (including the change in fair value) for financial instrumentsclassified by the Bank within level 3 of the valuation hierarchy for assets andliabilities measured at fair value on a recurring basis. When a determinationis made to classify a financial instrument within level 3 of the valuationhierarchy, the determination is based upon the significance of the unobservablefactors to the overall fair value measurement. However, since level 3 financialinstruments typically include, in addition to the unobservable or level 3components, observable components (that is, components that are actively quotedand can be validated to external sources), the gains and losses in the tablebelow include changes in fair value due in part to observable factors that arepart of the valuation methodology.

 
| **Nine months ended September 30, 2008 (in thousands)**                                                            | ** ** | **Assets** | ** ** | **Liabilities** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------|------------|
| Fair value, January 1, 2008                                                                                                                      |       | $          | 3,564      |            | $          | 319 |   |
| Total realized and unrealized gains/losses  included in income                                                                                        |       | (2,225     | )          | —          |       |
| Purchases, issuances and settlements, net                                                                                                             |       | 2,328      |       | —          |       |
| Transfers in and/or out of level 3                                                                                                                    |       | —     |       | —          |       |
| Fair value, September 30, 2008                                                                                                                   |       | $          | 3,666      |            | $          | 319 |   |
| Total unrealized gains included in income  related to financial assets and liabilities still on the consolidated balance  sheet at September 30, 2008 |       | $          | 2,238      |            | $          | — |   |

 

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**ITEM 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.**

 

**Forward-Looking Statements**

 

Certain statements contained in this report may not be based onhistorical facts and are “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933, as amended, and Section 21E of theSecurities Exchange Act of 1934, as amended. These forward-looking statementsmay be identified by reference to a future period or by the use offorward-looking terminology, such as “expect,” “anticipate,” “believe,” “estimate,”“foresee,” “may,” “might,” “will,” “intend,” “could,” “would,” “plan,” “forecast”or future or conditional verb tenses and variations or negatives of suchterms. These forward-looking statements include, without limitation, thoserelating to our operating results, vesting of stock-based awards, recentlyadopted accounting standards, fair value measurements, allowance for loanlosses, business bank strategy, management’s review of the loan portfolio, loanclassifications, loan commitments, interest rate risk, economic value of equitymodel, loan sale transactions, tax rates, liquidity, inflation,  internal control over financial reporting andour future growth and profitability. We caution you not to place undue relianceon the forward-looking statements contained in this report because actualresults could differ materially from those indicated in such forward-lookingstatements as a result of a variety of factors. These factors include, but arenot limited to, changes in economic conditions, competition for loans,mortgages and other financial services and products, changes in interest rates,concentrations within our loan portfolio, our ability to maintain creditquality, the effectiveness of our risk monitoring systems, changes in consumerpreferences, the ability of our borrowers to repay loans, the availability ofand costs associated with maintaining and/or obtaining adequate and timelysources of liquidity, changes in our operating strategy, our ability to meetregulatory capital adequacy requirements, our ability to collect amounts dueunder loan agreements and to attract deposits, our ability to attract, trainand retain qualified personnel, the geographic concentration of our assets, ourability to operate and integrate new technology, our ability to provide marketcompetitive products and services, our ability to diversify revenue, ourability to fund growth with lower cost liabilities, laws and regulationsaffecting financial institutions in general and other factors detailed fromtime to time in our press releases and filings with the Securities and ExchangeCommission. We undertake no obligation to update these forward-lookingstatements to reflect the occurrence of changes or unanticipated events,circumstances or results that occur after the date of this report.

 

**Overview**

(Dollarsin thousands, except per share data, throughout this Item 2)

 

The results of operations for the quarter ended September 30, 2008compared to the quarter ended September 30, 2007 reflected a 6.13%increase in net income and an 8.33% increase in diluted earnings per share. Theincrease in earnings resulted primarily from a 30.80% increase in net interestincome because of higher average loan balances. Increased net interest incomewas partially offset by increases in non-interest expense. For the three monthsended September 30, 2008, net income was $1,886, an increase of $109 or6.13% compared to net income of $1,777 for the same period in 2007. Dilutedearnings per share increased $0.03 per share or 8.33% for the three monthsended September 30, 2008 compared to the same period in 2007. The ninemonths ended September 30, 2008 reflected a continuation of our bank’strend of rapid asset growth, increasing by $205,905 or 22.87% from $900,153 at December 31,2007 to $1,106,058 at September 30, 2008. Net loans increased by 25.72% or$201,647 from December 31, 2007 to September 30, 2008, while totaldeposits increased by 21.30% or $173,611 during that same period.

 

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**Corporation Overview**

 

Tennessee Commerce Bancorp, Inc.,headquartered in Franklin, Tennessee, is the bank holding company for TennesseeCommerce Bank (the “Bank”).  Organized in January 2000, TennesseeCommerce Bank has a focused strategy that serves the banking needs of small tomedium-sized businesses, entrepreneurs and professionals in the Nashvillemetropolitan statistical area, or the Nashville MSA, as well as the fundingneeds of certain national and regional equipment vendors and financial servicescompanies.  We call this strategy our “business bank” strategy. Weprimarily conduct business from a single location in the Cool Springscommercial area of Franklin, Tennessee, 15 miles south of Nashville. Wealso operate three loan production offices-one in Birmingham, Alabama, and twonew offices in Minneapolis, Minnesota and Atlanta, Georgia, both of which weopened in April and May 2008, respectively. Each of the two newoffices is staffed with one senior lending officer.

 

We offer a full range ofcompetitive retail and commercial banking services to local customers in theNashville MSA.  Our deposit services include a broad offering of checkingaccounts, savings accounts, money market investment accounts, certificates ofdeposits and retirement accounts.  Lending services include consumerinstallment loans, various types of mortgage loans, personal lines of credit,home equity loans, credit cards, real estate construction loans, commercialloans to small and medium-sized businesses and professionals, and letters ofcredit. We issue VISA credit cards and are a merchant depository for cardholderdrafts under VISA credit cards.  We also offer check cards and debitcards.  We offer our local customers free courier services, access tothird-party automated teller machines, or ATMs, and state-of-the-art electronicbanking. We have trust powers but do not have a trust department.

 

**Our Business Strategy**

 

We execute our business bankstrategy by combining the personal service and appeal of a community bankinginstitution with the sophistication of a larger bank.  We believe thisstrategy distinguishes us from our competitors in efforts to attract loans anddeposits of local small to medium-sized businesses and national and regionalequipment vendors and financial services companies.  Further, the rapidgrowth within the Nashville MSA, along with several bank mergers andacquisitions, has left many business owners without significant bankingrelationships. We seek to take advantage of this opportunity.

 

We do not compete based onthe traditional definition of “convenience” and currently have no plans todevelop a comprehensive branch bank network.  For us, convenience iscreated by technology and by a free courier service for local customers whichtransports deposits directly from the business location to the bank.  Weconduct business primarily from a single banking office with no teller line,drive-through window or extended banking hours.  We compete by providingresponsive and personalized service to meet customer needs.  We providefree electronic banking and cash management tools and on-site training forbusiness customers.  We compete for consumer business by providingsuperior products, attractive deposit rates, free internet banking services andaccess to a third-party regional ATM network.

 

The business bank strategyis highlighted by differences between the financial statements of our bank andmore traditional financial institutions. The business bank model creates a highdegree of leverage.  By avoiding the investment and maintenance costs of atypical branch network, we are able to maintain earning assets at a higherlevel than peer institutions.  Management targets a minimum earning assetratio of 97%, compared to the average of 85% to 95% for all FDIC-insured banksat the end of the second quarter of 2008. At September 30, 2008, we had anearning asset ratio of 96.04%.

 

The business bank model isalso highly efficient.  We primarily target the non-retail (service,manufacturing and professional) sector of the commercial market, which ischaracterized by lower levels of transactions and processing costs.  Thecommercial customer mix and the strategic outsourcing of non-customerfunctions, such as data processing, information technology and internal audit,allow us to operate with a small, highly-trained staff.  Managementtargets a minimum asset per employee ratio of $10,000 compared to the averageratio of approximately $4,341 assets per employee for Tennessee banks at theend of the third quarter of 2008. At September 30, 2008, our assets peremployee were $13,826.

 

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In addition to our NashvilleMSA focus, we have developed expertise in indirect lending that allows us toaccess a national market. Our indirect lending transactions are fixed-ratemonthly installment loans originated through a third-party equipment vendor orfinancial services company. Our national market lending is divided into twoprograms based on loan size. In the first program, through an establishednetwork of vendors and financial service companies, we have opportunities tofinance business asset secured loan transactions nationally for middle-marketand investment grade companies. In the second program, a different network ofvendors and financial service companies located in Tennessee, Alabama, Georgia,California and Michigan partner with us in financing smaller transactions(generally $150 or less per transaction). Both national market programs providegeographic and collateral diversity for our portfolio.

 

 **Comparison of Operating Results for the Three MonthsEnded September 30, 2008 and September 30, 2007**

 

**Net Income** - Net income for the three months ended September 30,2008 was $1,886, an increase of $109 or 6.13% compared to net income of $1,777for the three months ended September 30, 2007.  The increase isattributable to a $3,385 increase in interest income from $16,371 for the threemonths ended September 30, 2007 to $19,756 for the same period in 2008. Weexperienced an increase of $975 in operating expense which was the result ofour overall growth, including a $48 increase in FDIC assessment at September 30,2008 compared to the same date in 2007, as well as an increase in personnel andgeneral operating expenses because of our growth.

 
| ** **                                    | ** ** | **Three Months Ended  September 30,** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|------------------------------------------------------|------------|------------|------------|
| **(Dollars in thousands)**          | ** ** | **2008**                                             | ** ** | **2007**   | ** ** | **% Change** | ** ** |
|                                          |       |                                                 |       |       |       |   |   |
| Interest income                               |       | $                                                    | 19,756     |       | $          | 16,371 |   | 20.68 | % |
| Interest expense                              |       | 10,482                                               |       | 9,281      |       | 12.94 |   |
| Net interest income                           |       | 9,274                                                |       | 7,090      |       | 30.80 |   |
| Provision for loan losses                     |       | 1,850                                                |       | 1,300      |       | 42.31 |   |
| Net interest after provision for loan  losses |       | 7,424                                                |       | 5,790      |       | 28.22 |   |
| Non-interest income                           |       | 98                                                   |       | 574        |       | (82.93 | ) |
| Non-interest expense                          |       | 4,446                                                |       | 3,471      |       | 28.09 |   |
| Net income before taxes                       |       | 3,076                                                |       | 2,893      |       | 6.33 |   |
| Income tax expense                            |       | 1,190                                                |       | 1,116      |       | 6.63 |   |
| Net income                                    |       | $                                                    | 1,886      |       | $          | 1,777 |   | 6.13 | % |

 

**Provision for Loan Losses** - The provision for loan losses for thethree months ended September 30, 2008 was $1,850, an increase of$550, or 42.31%, above the provision of $1,300 expensed in the same period in2007.  This increase was primarily a result of the increase in loanvolume. At September 30, 2008, the loan loss reserve of $12,191 was 1.22%of gross loans of $997,839.

 

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**Non-interest Income** - Non-interest income decreased by 82.93% or$476, from $574 in the quarter ended September 30, 2007 to $98 for thesame period in 2008. The decrease was primarily a result of lower gains on loansales due to the freeze in the financial markets significantly reducing loansales to other banks. The gain on loan sales was $1 and $547 for thethree-month periods ended September 30, 2008 and 2007, respectively.

 

We earned $4 in mortgage origination fees during the three months endedSeptember 30, 2008 compared to $20 earned during the same period in 2007,a decrease of $16 or 80.00%, primarily as a result of a slower market.  Werecognized a $97 loss on the sale of securities in the three months ended September 30,2008 and no gain or loss in the same period in 2007.

 

We earned $1 on loan sale transactions in the three months ended September 30,2008, a 99.82% decrease compared to $547 during the same period in 2007. Thisdecrease was primarily as a result of timing differences. Management willcontinue to consider loan sale transactions if the opportunity for a reasonablereturn is available.

 

**Non-interest Expense** - Non-interest expense for the three monthsended September 30, 2008 was $4,446, an increase of $975 or 28.09%, overthe $3,471 expensed in the same period in 2007.  The increase is mainlyattributable to the increase in professional fees (audit, legal, andaccounting).

 

**Net Interest Margin******- The net interest margin decreased from3.67% for the three months ended September 30, 2007 to 3.46% for the sameperiod in 2008 because of a lower average yield from the loan portfolio thatwas not fully offset by a decrease in our cost for deposits.  Interestincome increased by $3,385 or 20.68%, from $16,371 during the three monthsended September 30, 2007 to $19,756 during the same period in 2008. Theincrease was primarily a result of increased loan volume.  Average earningassets increased from $764,886 in the three months ended September 30,2007 to $1,064,396 in the same period in 2008, an increase of $299,510 or39.16%.  The increase in earning assets was primarily a result of loan growth.Average loan balances increased by $289,806 or 42.27% for the three monthsended September 30, 2008, from the same period in 2007.  The averageyield on earning assets decreased from 8.48% in the three months ended September 30,2007 to 7.37% in the same period in 2008. The decrease in the cost of funds, asa percentage of average balances was primarily a result of decreases inshort-term interest rates paid on deposits that support our loan growth.Between September 30, 2007 and September 30, 2008, the FederalReserve Open Market Committee, or FOMC, lowered the federal funds rate by 275basis points.

 

**Interest Expense** – Interest expense increased from $9,281 inthe three months ended September 30, 2007 to $10,482 in the three monthsended September 30, 2008. The $1,201, or 12.94%, increase in expense was aresult of increases in the volume of deposits partially offset by adecrease in the cost of funds. Average interest earning liabilities increasedby $303,015 or 42.87%.  The cost of funds decreased from 5.07% in thethree months ended September 30, 2007 to 4.04% during the same threemonths in 2008, a decrease of 103 basis points.

 

**Income Taxes** - Our effective tax rate for the threemonths ended September 30, 2008 was 38.69% compared to 38.58% for thethree months ended September 30, 2007. Management anticipates that taxrates in future periods will approximate the rates paid in 2008.

 

**Efficiency Ratio** - Our efficiency ratio for the three monthsended September 30, 2008 and 2007 was 47.44% and 45.29%, respectively, anincrease of 215 basis points. The following table reflects the calculation ofthe efficiency ratio:

 
| ** **                           | ** ** | **Three Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2008**                                             | ** ** | **2007** | ** ** |
| Non-interest expense                 |       | $                                                    | 4,446      |   | $ | 3,471 |   |
|                                 |       |                                                 |       |   |   |
| Net interest income                  |       | 9,274                                                |       | 7,090 |   |
| Non-interest income                  |       | 98                                                   |       | 574 |   |
| Total Revenues                       |       | $                                                    | 9,372      |   | $ | 7,664 |   |
|                                 |       |                                                 |       |   |   |
| Efficiency Ratio                     |       | 47.44                                                | %          | 45.29 | % |

 

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**Net Interest Income** – Net interest income for the three monthsended September 30, 2008 was $9,274 compared to $7,090 for the same periodin 2007, an increase of $2,184 or 30.80%.  The increase in net interestincome was largely attributable to strong loan growth.  The average netloan balance for the three months ended September 30, 2008 increased by42.27% or $289,806 from $685,681 for that period in 2007 to $975,487 for thesame period in 2008. Loan growth was accompanied by an increase in averageinterest-bearing deposits from $706,875 for the three months ended September 30,2007, to $1,009,890 for the same period in 2008, an increase of $303,015 or42.87%.

 

 **Comparison of Operating Results for the Nine MonthsEnded September 30, 2008 and September 30, 2007**

 

**Net Income** - Net income for the nine months ended September 30,2008 was $5,107, an increase of $313 or 6.53% compared to net income of $4,794for the nine months ended September 30, 2007.  The increase isattributable to a 25.97% increase in interest income from $44,194 for the ninemonths ended September 30, 2007 to $55,671 for the same period in 2008. Weexperienced an increase of $3,257 in operating expense which was the result ofour overall growth, including a $331 increase in FDIC assessment at September 30,2008 compared to the same date in 2007, as well as an increase in personnel andgeneral operating expenses because of our growth.

 
| ** **                                    | ** ** | **Nine Months Ended  September 30,** | ** ** | ** ** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|------------|------------|
| **(Dollars in thousands)**          | ** ** | **2008**                                            | ** ** | **2007**   | ** ** | **% Change** | ** ** |
|                                          |       |                                                |       |       |       |   |   |
| Interest income                               |       | $                                                   | 55,671     |       | $          | 44,194 |   | 25.97 | % |
| Interest expense                              |       | 30,539                                              |       | 24,873     |       | 22.78 |   |
| Net interest income                           |       | 25,132                                              |       | 19,321     |       | 30.08 |   |
| Provision for loan losses                     |       | 5,790                                               |       | 4,300      |       | 34.65 |   |
| Net interest after provision for loan  losses |       | 19,342                                              |       | 15,021     |       | 28.77 |   |
| Non-interest income                           |       | 1,428                                               |       | 2,006      |       | (28.81 | ) |
| Non-interest expense                          |       | 12,440                                              |       | 9,183      |       | 35.47 |   |
| Net income before taxes                       |       | 8,330                                               |       | 7,844      |       | 6.20 |   |
| Income tax expense                            |       | 3,223                                               |       | 3,050      |       | 5.67 |   |
| Net income                                    |       | $                                                   | 5,107      |       | $          | 4,794 |   | 6.53 | % |

 

**Provision for Loan Losses** - The provision for loan losses for the ninemonths ended September 30, 2008 was $5,790, an increase of $1,490, or34.65%, above the provision of $4,300 expensed in the same period in2007.  This increase was primarily a result of the increase in loanvolume. At September 30, 2008, the loan loss reserve of $12,191 was 1.22%of gross loans of $997,839.

 

**Non-interest Income** - Non-interest income decreased by 28.81% or$578, from $2,006 in the nine months ended September 30, 2007 to $1,428for the same period in 2008. The decrease was primarily a result ofrepossessions in the transportation sector.  The gain on loan sales was$1,419 and $1,827 for the nine-month periods ended September 30, 2008 and2007, respectively.

 

We earned $28 in mortgage origination fees during the nine months endedSeptember 30, 2008 compared to $69 earned during the same period in 2007,a decrease of $41 or 59.42%, primarily as a result of a slower market.  Welost $67 on the sale of securities in the nine months ended September 30,2008 compared with a gain of $10 for the same period in 2007, primarily as aresult of the restructuring of portfolios in response to the current economicsituation.

 

We earned $1,419 on loan sale transactions in the nine months ended September 30,2008, a 22.33% decrease compared to $1,827 during the same period in 2007. Thisdecrease was primarily a result of the freeze in the financial markets, slowingloan sales to other banks. Management will continue to consider loan sale transactionsif the opportunity for a reasonable return is available.

 

**Non-interest Expense** - Non-interest expense for the nine monthsended September 30, 2008 was $12,440, an increase of $3,257 or 35.47%,over the $9,183 expensed in the same period in 2007.  Approximately 24.19%of the increase was a result of increases in personnel. At September 30,2008, the Bank had 80 full-time employees compared with 61 full-time employeesat September 30, 2007.

 

**Net Interest Margin******- The net interest margin decreased from3.73% for the nine months ended September 30, 2007 to 3.40% for the sameperiod in 2008 because of a lower average yield from the loan portfolio thatwas not fully offset by a decrease in our cost for deposits.  Interestincome increased by $11,477 or 25.97%, from $44,194 during the nine monthsended September 30, 2007 to $55,671 during the same period in 2008. Theincrease was primarily a result of increased loan volume.  Average earningassets increased from $692,219 in the nine months ended September 30, 2007to $986,080 in the same period in 2008, an increase of $293,861 or42.45%.  The increase in earning assets was primarily a result of loangrowth. Average loan balances increased by $276,317 or 44.57% for the ninemonths ended September 30, 2008, from the same period in 2007.  Theaverage yield on earning assets decreased from 8.53% in the nine months ended September 30,2007 to 7.54% in the same period in 2008. The decrease in the cost of funds, asa percentage of average balances was primarily a result of decreases inshort-term interest rates paid on deposits that support our loan growth.Between September 30, 2007 and September 30, 2008, FOMC lowered thefederal funds rate by 275 basis points.

 

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**Interest Expense** – Interest expense increased from $24,873 inthe nine months ended September 30, 2007 to $30,539 in the nine monthsended September 30, 2008. The $5,666, or 22.78%, increase in expense was aresult of increases in the volume of deposits partially offset by adecrease in the cost of funds. Average interest earning liabilities increasedby $291,708 or 45.87%.  The cost of funds decreased from 5.06% in the ninemonths ended September 30, 2007 to 4.29% during the same nine months in2008, a decrease of 77 basis points.

 

**Income Taxes** – Our effective tax rate for the nine monthsended September 30, 2008 was 38.69% compared to 38.88% for the nine monthsended September 30, 2007. Management anticipates that tax rates in futureperiods will approximate the rates paid in 2008.

 

**Efficiency Ratio** – Our efficiency ratio for the nine monthsended September 30, 2008 and 2007 was 46.84% and 43.06%, respectively, anincrease of 378 basis points. The following table reflects the calculation ofthe efficiency ratio:

 
| ** **                           | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------|------------|-----------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **2008**                                            | ** ** | **2007** | ** ** |
| Non-interest expense                 |       | $                                                   | 12,440     |   |   | $ | 9,183 |   |   |
|                                 |       |                                                |       |   |   |
| Net interest income                  |       | 25,132                                              |       | 19,321 |   |
| Non-interest income                  |       | 1,428                                               |       | 2,006 |   |
| Total Revenues                       |       | $                                                   | 26,560     |   | $ | 21,327 |   |
|                                 |       |                                                |       |   |   |
| Efficiency Ratio                     |       | 46.84                                               | %          | 43.06 | % |
|                                      |            |                                                     |            |  |  |  |  |  |  |

 

**Net Interest Income** – Net interest income for the nine monthsended September 30, 2008 was $25,132 compared to $19,321 for the sameperiod in 2007, an increase of $5,811 or 30.08%.  The increase in netinterest income was largely attributable to strong loan growth.  Theaverage net loan balance for the nine months ended September 30, 2008increased by 44.57% or $276,317 from $619,924 for that period in 2007 to$896,241 for the same period in 2008. Loan growth was accompanied by anincrease in average interest-bearing deposits from $635,881 for the nine monthsended September 30, 2007, to $927,589 for the same period in 2008, anincrease of $291,708 or 45.87%.

 

The following table outlines the components of net interest income forthe nine-month periods ended September 30, 2008 and 2007 and identifiesthe impact of changes in volume and rate:

 
| ** **                           | ** ** | **September 30, 2008 change from  September 30, 2007 due to:** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Volume**                                                                                             | ** ** | **Rate** | ** ** | **Total** | ** ** |
|                                 |       |                                                                                                   |       |   |   |   |   |
| Interest income                      |       |                                                                                                   |       |   |   |   |   |
| Loans                                |       | $                                                                                                      | 16,581     |   | $ | (5,708 | ) | $ | 10,873 |   |
| Securities (taxable) (1)             |       | 856                                                                                                    |       | 35 |   | 891 |   |
| Federal funds sold                   |       | (101                                                                                                   | )          | (186 | ) | (287 | ) |
| Total interest income                |       | 17,336                                                                                                 |       | (5,859 | ) | 11,477 |   |
|                                 |       |                                                                                                   |       |   |   |   |   |
| Interest expense                     |       |                                                                                                   |       |   |   |   |   |
| Deposits (other than demand)         |       | 9,269                                                                                                  |       | (4,340 | ) | 4,929 |   |
| Federal funds purchased              |       | 193                                                                                                    |       | (31 | ) | 162 |   |
| Subordinated debt                    |       | 636                                                                                                    |       | (61 | ) | 575 |   |
| Total interest expense               |       | 10,098                                                                                                 |       | (4,432 | ) | 5,666 |   |
|                                 |       |                                                                                                   |       |   |   |   |   |
| Net interest income                  |       | $                                                                                                      | 7,238      |   | $ | (1,427 | ) | $ | 5,811 |   |

 

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| (1) | Unrealized  losses of $31 and $705 are excluded from yield calculation for the nine  months ended September 30, 2008 and 2007, respectively. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------|

 

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*Average Balance Sheets, Net Interest Income, and Changes inInterest Income and Interest Expense*

 

Thetable below shows the average daily balances of each principal category of ourassets, liabilities and shareholders’ equity, and an analysis of net interestincome, and the change in interest income and interest expense segregated intoamounts attributable to changes in volume and changes in rates for thenine-month periods ended September 30, 2008 and 2007. The table ispresented on a tax equivalent basis, as applicable.

 
| ** **                                      | ** ** | **Nine Months Ended September 30,  2008** | ** ** | **Nine Months Ended September 30,  2007** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Average**                                                   | ** ** | ** **                                                    | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance**                                                   | ** ** | **Interest**                                                  | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| **ASSETS**                                      |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest earning assets                         |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Securities (taxable) (1)                        |       | $                                                             | 81,985     |                                                          | $          | 3,398 |   | 5.53 | % | $ | 61,298 |   | $ | 2,507 |   | 5.41 | % |
| Loans (2) (3)                              |       | 896,241                                                       |       | 52,125                                                        |       | 7.77 | % | 619,924 |   | 41,252 |   | 8.90 | % |
| Federal funds sold                              |       | 7,854                                                         |       | 148                                                           |       | 2.52 | % | 10,997 |   | 435 |   | 5.29 | % |
| Total interest earning assets                   |       | 986,080                                                       |       | 55,671                                                        |       | 7.54 | % | 692,219 |   | 44,194 |   | 8.53 | % |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Non-interest earning assets                     |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Cash and due from banks                         |       | 3,612                                                         |       |                                                          |       |   |   | 5,275 |   |   |   |   |   |
| Net fixed assets and equipment                  |       | 1,760                                                         |       |                                                          |       |   |   | 1,567 |   |   |   |   |   |
| Accrued interest and other assets               |       | 28,826                                                        |       |                                                          |       |   |   | 15,597 |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Total assets                                    |       | $                                                             | 1,020,278  |                                                          |       |   |   |   | $ | 714,658 |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS’ EQUITY**   |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities                    |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Deposits (other than demand)                    |       | $                                                             | 895,780    |                                                          | $          | 29,340 |   | 4.38 | % | $ | 626,592 |   | $ | 24,411 |   | 5.21 | % |
| Federal funds purchased                         |       | 9,204                                                         |       | 206                                                           |       | 2.99 | % | 1,012 |   | 44 |   | 5.81 | % |
| Subordinated debt                               |       | 22,605                                                        |       | 993                                                           |       | 5.87 | % | 8,277 |   | 418 |   | 6.75 | % |
| Total interest-bearing liabilities              |       | 927,589                                                       |       | $                                                             | 30,539     |   | 4.40 | % | 635,881 |   | $ | 24,873 |   | 5.23 | % |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Non-interest bearing liabilities                |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Non-interest bearing demand deposits            |       | 23,870                                                        |       |                                                          |       |   |   | 20,514 |   |   |   |   |   |
| Other liabilities                               |       | 3,749                                                         |       |                                                          |       |   |   | 2,944 |   |   |   |   |   |
| Shareholders’ equity                       |       | 65,070                                                        |       |                                                          |       |   |   | 55,319 |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | $                                                             | 1,020,278  |                                                          |       |   |   |   | $ | 714,658 |   |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net interest spread                             |       | 3.14                                                          | %          |                                                          |       |   |   | 3.30 | % |   |   |   |   |
|                                            |       |                                                          |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net interest margin                             |       | 3.40                                                          | %          |                                                          |       |   |   | 3.73 | % |   |   |   |   |

 

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| (1) | Unrealized  losses of $31 and $705 are excluded from yield calculation for the nine  months ended September 30, 2008 and 2007, respectively.                                                        |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | Non-accrual  loans are included in average loan balances, and loan fees of $3,698 and  $2,768 are included in interest income for the nine months ended September 30,  2008 and 2007, respectively. |
| (3) | Loans  are presented net of allowance for loan loss.                                                                                                                                                     |

 

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**Comparison of Financial Condition at September 30, 2008and December 31, 2007**

 

**Assets****–**Totalassets at September 30, 2008 were $1,106,058, an increase of $205,905, or22.87%, over total assets of $900,153 at December 31, 2007. Loan growthwas the primary reason for the increase.  At September 30, 2008, netloans equaled $985,648, up $201,647, or 25.72%, over the December 31, 2007total net loans of $784,001. The cash and cash equivalents balance decreased by$9,558 between December 31, 2007 and September 30, 2008, as fundswere used to fund loans made in the first three quarters of 2008.

 

Our business bank model of operation generally results in a higherlevel of earning assets than our peer banks.  Earning assets are definedas assets that earn interest income and include short-term investments, theinvestment portfolio and net loans.  We generally maintain a higher levelof earning assets than our peer banks because fewer assets are allocated tofacilities, cash and “due from” bank accounts used for transactionprocessing.  Earning assets at September 30, 2008 were $1,062,299 or96.04% of total assets of $1,106,058.  Earning assets at December 31,2007 were $867,327, or 96.35% of total assets of $900,153.

 

**Loans** – We had total net loans of $985,648 at September 30, 2008. Thefollowing table sets forth the composition of our loan portfolio at September 30,2008 and December 31, 2007:

 
| **(Dollars in thousands)**   | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Real estate                            |       |                         |       |                        |       |
| Construction                           |       | $                            | 165,511    |                        | $          | 112,405 |   |
| 1 to 4 family residential              |       | 38,128                       |       | 33,560                      |       |
| Other                                  |       | 162,283                      |       | 143,973                     |       |
| Commercial, financial and agricultural |       | 580,501                      |       | 477,666                     |       |
| Consumer                               |       | 3,479                        |       | 3,966                       |       |
| Other                                  |       | 47,937                       |       | 22,752                      |       |
|                                   |       |                         |       |                        |       |
| Total loans                            |       | 997,839                      |       | 794,322                     |       |
| Less: allowance for loan losses        |       | (12,191                      | )          | (10,321                     | )          |
|                                   |       |                         |       |                        |       |
| Net loans                              |       | $                            | 985,648    |                        | $          | 784,001 |   |

 

Thefollowing table sets forth the percentage composition of our loan portfolio bytype at September 30, 2008 and December 31, 2007:

 
| ** **                             | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Real estate:                           |       |                         |       |                        |       |
| Construction                           |       | 16.59                        | %          | 14.15                       | %          |
| 1 to 4 family residential              |       | 3.82                         |       | 4.22                        |       |
| Other                                  |       | 16.26                        |       | 18.13                       |       |
| Commercial, financial and agricultural |       | 58.18                        |       | 60.14                       |       |
| Consumer                               |       | 0.35                         |       | 0.50                        |       |
| Other                                  |       | 4.80                         |       | 2.86                        |       |
|                                   |       |                         |       |                        |       |
| Total                                  |       | 100.00                       | %          | 100.00                      | %          |

 

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The following table sets forth the composition of our commercial loanportfolio by source at September 30, 2008 and December 31, 2007:

 
| ** **                           | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|--------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **(Dollars in thousands)** | ** ** | **Amount**                   | ** ** | **%**                       | ** ** | **Amount** | ** ** | **%** | ** ** |
|                                 |       |                         |       |                        |       |   |   |   |   |
| Direct funding                       |       | $                            | 223,357    |                        | 38.48      | % | $ | 193,943 |   | 40.60 | % |
| Indirect funding:                    |       |                         |       |                        |       |   |   |   |   |
| Large                                |       | 157,613                      |       | 27.15                       |       | 130,583 |   | 27.34 |   |
| Small                                |       | 199,531                      |       | 34.37                       |       | 153,140 |   | 32.06 |   |
| Total                                |       | $                            | 580,501    |                        | 100.00     | % | $ | 477,666 |   | 100.00 | % |

 

Management periodically reviews our loan portfolio, particularlynon-accrual and renegotiated loans.  The review may result in adetermination that a loan should be placed on a non-accrual status for incomerecognition. When a loan is classified as non-accrual, any unpaid interest isreversed against current income.  Interest is included in incomethereafter only to the extent received in cash.  The loan remains in anon-accrual classification until such time as the loan is brought current, whenit may be returned to accrual classification.

 

The following table presents information regarding non-accrual, pastdue and restructured loans at September 30, 2008 and December 31,2007:

 
| **(Dollars in thousands)**                                                                    | ** ** | **September 30,  2008** | ** ** | **December 31,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Non-accrual loans:                                                                                      |       |                         |       |                        |       |
| Number                                                                                                  |       | 175                          |       | 130                         |       |
| Amount                                                                                                  |       | $                            | 9,834      |                        | $          | 6,465 |   |
|                                                                                                    |       |                         |       |                        |       |
| Accruing loans which are contractually past  due 90 days or more as to principal and interest payments: |       |                         |       |                        |       |
| Number                                                                                                  |       | 58                           |       | 44                          |       |
| Amount                                                                                                  |       | $                            | 4,398      |                        | $          | 1,992 |   |
|                                                                                                    |       |                         |       |                        |       |
| Loans defined as “troubled debt  restructurings”:                                             |       |                         |       |                        |       |
| Number                                                                                                  |       | 6                            |       | 1                           |       |
| Amount                                                                                                  |       | $                            | 2,488      |                        | $          | 148 |   |

 

As of September 30, 2008 and December 31, 2007, there were noloans classified for regulatory purposes as doubtful or substandard that arenot disclosed in the above table, which (i) represent or result fromtrends or uncertainties which management reasonably expects will materiallyimpact future operating results, liquidity or capital resources, or (ii) representmaterial credits about which management is aware of any information that causesmanagement to have serious doubts as to the ability of such borrowers to complywith the loan repayment terms. During the nine months ended September 30,2008, non-performing loans increased as a result of the restructuring of fourcredits in a total amount of $2,488.

 

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**Allowance for Loan Losses** – The maintenance of an adequate allowancefor loan losses, or ALL, is one of the fundamental concepts of risk managementfor every financial institution. Management is responsible for ensuring thatcontrols are in place to ensure the adequacy of the loan loss reserve inaccordance with generally accepted accounting principles, our stated policiesand procedures, and regulatory guidance.

 

It is management’s intent to maintain an ALL that is adequate to absorbcurrent and estimated losses which are inherent in a loan portfolio.  Thehistorical loss ratio (net charge-offs as a percentage of average loans) was0.43% for the nine months ended September 30, 2008, and 0.33% for the ninemonths ended September 30, 2007. The ALL as a percentage of theoutstanding loans at the end of the period was 1.22% at September 30,2008, and 1.25% at September 30, 2007.

 

An analysis of our ALL and net charge-offs is furnished in thefollowing table for the nine months ended September 30, 2008 and the sameperiod ended September 30, 2007:

 
| **(Dollars in thousands)**              | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
|---------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Allowance for loan losses at beginning of  period |       | $                            | 10,321     |                         | $          | 6,968 |   |
| Charge-offs:                                      |       |                         |       |                         |       |
| Real estate:                                      |       |                         |       |                         |       |
| Construction                                      |       | 205                          |       | —                       |       |
| 1 to 4 family residential                         |       | —                       |       | —                       |       |
| Other                                             |       | —                       |       | —                       |       |
| Commercial, financial and agricultural            |       | 3,685                        |       | 2,268                        |       |
| Consumer                                          |       | 77                           |       | 11                           |       |
| Total Charge-offs                                 |       | 3,967                        |       | 2,279                        |       |
|                                              |       |                         |       |                         |       |
| Recoveries:                                       |       |                         |       |                         |       |
| Real estate:                                      |       |                         |       |                         |       |
| Construction                                      |       | —                       |       | —                       |       |
| 1 to 4 family residential                         |       | —                       |       | —                       |       |
| Other                                             |       | —                       |       | —                       |       |
| Commercial, financial and agricultural            |       | 44                           |       | 261                          |       |
| Consumer                                          |       | 3                            |       | —                       |       |
| Total Recoveries                                  |       | 47                           |       | 261                          |       |
|                                              |       |                         |       |                         |       |
| Net Charge-offs                                   |       | 3,920                        |       | 2,018                        |       |
|                                              |       |                         |       |                         |       |
| Provision for loans charged to expense            |       | 5,790                        |       | 4,300                        |       |
| Allowance for loan losses at end of period        |       | $                            | 12,191     |                         | $          | 9,250 |   |

 
| ** **                                                                                        | ** ** | **September 30,  2008** | ** ** | **September 30,  2007** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| Net charge-offs as a percentage of average  total loans outstanding during the period             |       | 0.43                         | %          | 0.33                         | %          |
|                                                                                              |       |                         |       |                         |       |
| Ending allowance for loan losses as a  percentage of total loans outstanding at end of the period |       | 1.22                         | %          | 1.25                         | %          |

 

ALL is established by charges to operations based on management’sevaluation of the loan portfolio, past due loan experience, collateral values,current economic conditions and other factors considered necessary to maintainthe allowance at an adequate level. The increase in ALL was due to the Bank’sgrowth in the loan portfolio compared to December 31, 2007.

 

**Securities** – The securities portfolio at September 30,2008 was $76,651 compared to $73,753 at December 31, 2007.  We viewthe securities portfolio as a source of income and liquidity.  Thesecurities portfolio was 6.93% of total assets at September 30, 2008 and8.19% of total assets at September 30, 2007.

 

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**Liabilities****–** We depend on a growing deposit base to fundloan and other asset growth. We compete for local deposits by offeringattractive products with premium rates.  We also obtain funding in thewholesale deposit market which is accessed by means of an electronic bulletinboard.  This electronic market links banks and acquirers of funds tocredit unions, school districts, labor unions and other organizations withexcess liquidity. The process is highly efficient and the average rate isgenerally less than rates paid in the local market. Wholesale deposits arecategorized as “Purchased time deposits” on the detail of deposits shown in thetable below.

 

**Deposits** – Total deposits at September 30, 2008 were $988,664, up $173,611or 21.30% over the December 31, 2007 total deposits of $815,053. Totalaverage deposits during the nine months ended September 30, 2008, was$919,650, an increase of $272,544, or 42.12% over the total average deposits of$647,106 during the nine months ended September 30, 2007. Averagenon-interest bearing deposits increased by $3,356, or 16.36%, from $20,514 inthe nine months ended September 30, 2007, to $23,870 in the nine monthsended September 30, 2008.

 

The following table sets forth average deposit balances for the ninemonths ended September 30, 2008 and 2007 and the average rates paid onthose balances:

 
| ** **                           | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                           | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **(Dollars in thousands)** | ** ** | **Average  Balance**                                    | ** ** | **Average  Rate  Paid (1)** | ** ** | **Average  Balance** | ** ** | **Average  Rate  Paid (1)** | ** ** |
| Types of Deposits:                   |       |                                                    |       |   |   |   |   |   |   |
| Non-interest-bearing demand deposits |       | $                                                       | 23,870     |   | — | % | $ | 20,514 |   | — | % |
| Interest-bearing demand deposits     |       | 6,704                                                   |       | 0.92 |   | 6,499 |   | 3.69 |   |
| Money market accounts                |       | 69,502                                                  |       | 2.30 |   | 116,090 |   | 5.09 |   |
| Savings accounts                     |       | 6,412                                                   |       | 2.72 |   | 7,481 |   | 2.68 |   |
| IRA accounts                         |       | 23,972                                                  |       | 4.80 |   | 15,616 |   | 5.21 |   |
| Purchased time deposits              |       | 428,489                                                 |       | 4.62 |   | 235,896 |   | 5.27 |   |
| Time deposits                        |       | 360,701                                                 |       | 4.55 |   | 245,010 |   | 5.32 |   |
| Total deposits                       |       | $                                                       | 919,650    |   |   |   | $ | 647,106 |   |   |   |

 

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(1)   Rate is annualized

 

**Short-Term Debt** – We have a $15,000 line of credit withFirst Tennessee Bank, National Association. The outstanding principal balanceon this line of credit at September 30, 2008 was $10,000, and this line ofcredit expires on April 30, 2009.

 

**Subordinated Debt** – In March 2005, we formed a financingsubsidiary, Tennessee Commerce Statutory Trust I, a Delaware statutory trust,or the Trust I. In March 2005, the Trust I issued and sold 8,000 of theTrust I’s fixed/floating rate capital securities, with a liquidation amount of$1 per capital security, to First Tennessee Bank, National Association. At thesame time, we issued to Trust I $8,248 of fixed/floating rate juniorsubordinated deferrable interest debentures due 2035. The debentures pay a6.73% fixed rate payable quarterly for the first five years and a floating ratebased on a three-month LIBOR rate plus a margin thereafter.

 

InApril 2008, we formed a financing subsidiary, Tennessee Commerce StatutoryTrust II, a Delaware statutory trust, or the Trust II. In June 2008, theTrust II issued and sold 14,500 of the Trust II’s floating rate capitalsecurities, with a liquidation amount of $1 per capital security, in a privateplacement. At the same time, we issued to Trust II $14,950 of floating ratejunior subordinated deferrable interest debentures due 2038. The debentures paya floating rate per annum, reset quarterly, equal to the prime rate of interestpublished in *The Wall Street Journal*on the first business day of each distribution period plus 50 basis points (butin no event greater than 8.0% or less than 5.75%).

 

Inaccordance with FASB Interpretation No. 46 (revised December 2003) “Consolidationof Variable Interest Entities,” neither the Trust I nor the Trust II isconsolidated. We report as liabilities the subordinated debentures issued by usand held by the Trust I and Trust II.

 

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**Off-Balance Sheet Arrangements**

 

We are a party to financial instruments with off-balance sheet risk inthe normal course of business to meet the financing needs of our customers. At September 30,2008, we had unfunded loan commitments outstanding of $174,009 and standbyletters of credit and financial guarantees of $13,049. Those instruments involve,to varying degrees, elements of credit risk in excess of the amount recognizedin the balance sheet.  The contract or notional amounts of thoseinstruments reflect the extent of our involvement in those particular financialinstruments. We use the same credit policies in making commitments andconditional obligations as we do for on-balance sheet instruments.

 

Because these commitments generally have fixed expiration dates andmany will expire without being drawn upon, the total commitment level does notnecessarily represent future cash requirements. If needed, we can liquidatefederal funds sold or securities available for sale or borrow and purchasefederal funds from other financial institutions, where we have availablefederal fund lines at September 30, 2008 totaling $33,700.

 

# **Liquidity/CapitalResources**

# ** **

**Liquidity** – Of primary importance to depositors, creditors and regulators is theability to have readily available funds sufficient to repay fully maturingliabilities.  We are subject to general FDIC guidelines, which do notrequire a minimum level of liquidity. Liquidity requirements can be met throughshort-term borrowings or the disposition of short-term assets which aregenerally matched to correspond to the maturity of liabilities. Managementbelieves our liquidity ratios meet the general FDIC guidelines and we haveassets and borrowing capacity to provide adequate liquidity. Management doesnot know of any trends or demands that are reasonably likely to result in ourliquidity increasing or decreasing in any material manner.

 

**Capital Resources****–**Our objective is to maintain a level ofcapitalization that is sufficient to take advantage of profitable growthopportunities while meeting regulatory requirements.****To continue to grow, we must increase capital by generatingearnings, issuing equities, borrowing funds or a combination of thoseactivities.

 

The Federal Reserve Board has adopted capital guidelines governing theactivities of bank holding companies.  These guidelines require the maintenanceof an amount of capital based on risk-adjusted assets so that categories ofassets with potentially higher credit risk will require more capital backingthan assets with lower risk.  In addition, banks and bank holdingcompanies are required to maintain capital to support, on a risk-adjustedbasis, certain off-balance sheet activities such as loan commitments.

 

The capital guidelines classify capital into two tiers, referred to asTier I and Tier II. Under risk-based capital requirements, totalcapital consists of Tier I capital which is generally common shareholders’equity less goodwill and Tier II capital which is primarily a portion of theallowance for loan losses and certain preferred stock and qualifying debtinstruments. In determining risk-based capital requirements, assets areassigned risk-weights of 0% to 100%, depending primarily on the regulatoryassigned levels of credit risk associated with such assets. Off-balance sheetitems are considered in the calculation of risk-adjusted assets throughconversion factors established by the regulators. The framework for calculatingrisk-based capital requires banks and bank holding companies to meet theregulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990,regulators added a leverage computation to the capital requirements, comparingTier I capital to total average assets less goodwill.

 

The Federal Deposit Insurance Corporation Improvement Act of 1991established five capital categories for banks and bank holding companies. The bankregulators adopted regulations defining these five capital categories in September 1992.Under these regulations, each bank is classified into one of the fivecategories based on its level of risk-based capital as measured by Tier Icapital, total risk-based capital, Tier I leverage ratios and itssupervisory ratings.

 

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At September 30, 2008 and December 31, 2007, the Bank’s andour risk-based capital ratios and the minimums for capital adequacy wereconsidered well-capitalized under the Federal Reserve Board’s prompt correctiveaction guidelines were as follows:

 
| ** **                                               | ** ** | ** **             | ** ** | ** **            | ** ** | ** **           | ** ** | **Minimum to**    | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|----------------------|------------|------------------------|------------|
| ** **                                               | ** ** | ** **             | ** ** | ** **            | ** ** | **Minimum**          | ** ** | **be considered** | ** ** |
| ** **                                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | **for capital** | ** ** | **well-**              | ** ** |
| ** **                                               | ** ** | **2008**               | ** ** | **2007**              | ** ** | **adequacy**         | ** ** | **capitalized**        | ** ** |
|                                                     |       |                   |       |                  |       |                 |       |                   |       |
| Tier 1 leverage ratio                                    |       |                   |       |                  |       |                 |       |                   |       |
| Tennessee Commerce Bank                                  |       | 8.52                   | %          | 8.75                  | %          | 4.00                 | %          | 5.00                   | %          |
| Tennessee Commerce Bancorp, Inc.                    |       | 8.22                   | %          | 8.09                  | %          | 4.00                 | %          | n/a                    |       |
|                                                     |       |                   |       |                  |       |                 |       |                   |       |
| Tier 1 “core” capital to risk-weighted  assets |       |                   |       |                  |       |                 |       |                   |       |
| Tennessee Commerce Bank                                  |       | 9.01                   | %          | 9.26                  | %          | 4.00                 | %          | 6.00                   | %          |
| Tennessee Commerce Bancorp, Inc.                    |       | 8.69                   | %          | 8.55                  | %          | 4.00                 | %          | n/a                    |       |
|                                                     |       |                   |       |                  |       |                 |       |                   |       |
| Total capital to risk-weighted assets                    |       |                   |       |                  |       |                 |       |                   |       |
| Tennessee Commerce Bank                                  |       | 10.18                  | %          | 10.51                 | %          | 8.00                 | %          | 10.00                  | %          |
| Tennessee Commerce Bancorp, Inc.                    |       | 9.86                   | %          | 9.80                  | %          | 8.00                 | %          | n/a                    |       |

 

Based solely on our analysis of federal banking regulatory categories,on September 30, 2008 and December 31, 2007, we and the Bank werewithin the “well capitalized” categories under the regulations.

 

**Impact of Inflation and Changing Prices** – The financial statements and relatedfinancial data presented herein have been prepared in accordance with U.S.generally accepted accounting principles which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time andresulting from inflation. The impact of inflation on operations of the Bank isreflected in increased operating costs. Unlike most industrial companies,almost all of the assets and liabilities of the Bank are monetary in nature. Asa result, interest rates have a more significant impact on the Bank’s performancethan the effects of general levels of inflation. Interest rates do notnecessarily move in the same direction or in the same magnitude as the price ofgoods and services.

 

**Recent Developments**

 

The subprime lending crisisand the rate of mortgage loan foreclosures during the past year have negativelyimpacted the banking industry specifically and financial markets generally. Inresponse to the financial crises affecting the financial markets and thebanking system, on October 3, 2008, the Emergency Economic StabilizationAct of 2008 (“EESA”) was enacted, under which the United States Department ofthe Treasury (“Treasury”) has authority, among other things, to purchasemortgages, mortgage-backed securities, capital stock and other financialinstruments from financial institutions for the purpose of stabilizing andproviding liquidity to the U.S. financial markets. On October 3, 2008, theTroubled Assets Relief Program (“TARP”) was adopted under EESA. TARP gives theTreasury authority to deploy up to $700 billion into the financial markets toaddress liquidity and related concerns. On October 14, 2008, the Treasuryannounced several initiatives under TARP intended to help stabilize the bankingindustry, including a voluntary capital purchase program (the “CPP”) designedto encourage qualifying financial institutions to build capital. Under the CPP,the Treasury will purchase up to $250 billion of senior preferred shares fromeligible financial institutions on standardized terms with attached warrants topurchase common stock with an aggregate market price equal to 15 percent of thesenior preferred investments. We are currently reviewing the details of the CPPas information is made available and are considering the effect ofparticipation in the program. If we choose to participate, the range of theTreasury’s preferred investment would be approximately $10 to $30 million.

 

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**ITEM 3. QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK.**

 

Like all financial institutions, we are subject to market risk fromchanges in interest rates. Interest rate risk is inherent in the balance sheetbecause of the mismatch between the maturities of rate sensitive assets andrate sensitive liabilities. If rates are rising, and the level of ratesensitive liabilities exceeds the level of rate sensitive assets, the netinterest margin will be negatively impacted. Conversely, if rates are falling,and the level of rate sensitive liabilities is greater than the level of ratesensitive assets, the impact on the net interest margin will be favorable. Managinginterest rate risk is further complicated by the fact that all rates do notchange at the same pace, in other words, short-term rates may be rising whilelonger term rates remain stable. In addition, different types of rate sensitiveassets and rate sensitive liabilities react differently to changes in rates.

 

To manage interest rate risk, we must take a position on the expectedfuture trend of interest rates. Rates may rise, fall or remain the same. TheBank’s asset liability committee develops its view of future rate trends andstrives to manage rate risk within a targeted range by monitoring economicindicators, examining the views of economists and other experts, andunderstanding the current status of our balance sheet. Our annual budgetreflects the anticipated rate environment for the next twelve months. The assetliability committee conducts a quarterly analysis of the rate sensitivityposition and reports its results to the Bank’s board of directors.

 

The asset liability committee uses a computer model to analyze thematurities of rate sensitive assets and liabilities. The model measures the “gap”which is defined as the difference between the dollar amount of rate sensitiveassets re-pricing during a period and the volume of rate sensitive liabilitiesre-pricing during the same period. Gap is also expressed as the ratio of ratesensitive assets divided by rate sensitive liabilities. If the ratio is greaterthan one, the dollar value of assets exceeds the dollar value of liabilities,and the balance sheet is “asset sensitive.” Conversely, if the value ofliabilities exceeds the value of assets, the ratio is less than one and thebalance sheet is “liability sensitive.” Our internal policy requires managementto maintain the gap within a range of 0.75 to 1.25.

 

The model measures scheduled maturities in periods of three months,four to 12 months, one to five years and over five years. The chart belowillustrates our rate sensitive position at September 30, 2008. Managementuses the one-year gap as the appropriate time period for setting strategy.

 

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RateSensitivity Gap Analysis(Dollars in thousands)

 
| ** **                                                       | ** ** | ** **   | ** ** | **1-3**    | ** ** | **4-12**   | ** ** | **1-5**   | ** ** | **Over**         | ** ** | ** ** | ** ** |
|------------------------------------------------------------------|------------|--------------|------------|------------|------------|------------|------------|-----------|------------|------------------|------------|------------|------------|
| ** **                                                       | ** ** | **Floating** | ** ** | **Months** | ** ** | **Months** | ** ** | **Years** | ** ** | **5 years** | ** ** | **Total**  | ** ** |
| **Maturities :**                                            |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Interest-Earnings Assets                                         |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Federal funds sold                                               |       | $            | —     |       | $          | —     |       | $         | —     |             | $          | —     |       | $ | — |   | $ | — |   |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Securities                                                       |       |         |       |       |       |       |       |      |       |             |       |       |       |
| U.S. government agencies                                         |       | —       |       | 35,314     |       | —     |       | 183       |       | 40,839           |       | 76,336     |       |
| Mortgage-backed securities                                       |       | —       |       | 23         |       | 71         |       | 142       |       | 79               |       | 315        |       |
| Total securities                                                 |       | —       |       | 35,337     |       | 71         |       | 325       |       | 40,918           |       | 76,651     |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Total loans                                                      |       | 263,147      |       | 115,802    |       | 251,803    |       | 326,532   |       | 40,555           |       | 997,839    |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Total interest-earning assets                                    |       | 263,147      |       | 151,139    |       | 251,874    |       | 326,857   |       | 81,473           |       | 1,074,490  |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Other assets                                                     |       | —       |       | —     |       | —     |       | —    |       | 31,568           |       | 31,568     |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Total assets                                                     |       | $            | 263,147    |       | $          | 151,139    |       | $         | 251,874    |             | $          | 326,857    |       | $ | 113,041 |   | $ | 1,106,058 |   |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Interest-bearing liabilities                                     |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Deposits                                                         |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Interest checking                                                |       | $            | 2,622      |       | $          | —     |       | $         | —     |             | $          | 3,077      |       | $ | — |   | $ | 5,699 |   |
| Money market and savings                                         |       | 33,239       |       | —     |       | —     |       | 28,315    |       | —           |       | 61,554     |       |
| Time deposits                                                    |       | —       |       | 166,008    |       | 592,128    |       | 132,702   |       | —           |       | 890,838    |       |
| Total deposits                                                   |       | 35,861       |       | 166,008    |       | 592,128    |       | 164,094   |       | —           |       | 958,091    |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Federal funds purchased                                          |       | 10,985       |       | —     |       | —     |       | —    |       | —           |       | 10,985     |       |
| Short-term debt                                                  |       | —       |       | —     |       | 10,000     |       | —    |       | —           |       | 10,000     |       |
| Subordinated debt                                                |       | —       |       | —     |       | —     |       | —    |       | 23,198           |       | 23,198     |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Total interest-bearing liabilities                               |       | 46,846       |       | 166,008    |       | 602,128    |       | 164,094   |       | 23,198           |       | 1,002,274  |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Other liabilities                                                |       | —       |       | —     |       | —     |       | —    |       | 36,432           |       | 36,432     |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Shareholders’ equity                                        |       | —       |       | —     |       | —     |       | —    |       | 67,352           |       | 67,352     |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Total liabilities and shareholders’ equity                  |       | $            | 46,846     |       | $          | 166,008    |       | $         | 602,128    |             | $          | 164,094    |       | $ | 126,982 |   | $ | 1,106,058 |   |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Rate sensitive gap by period                                     |       | $            | 216,301    |       | $          | (14,869    | )          | $         | (350,254   | )                | $          | 162,763    |       | $ | 58,275 |   |   |   |
| Cumulative gap                                                   |       |         |       | $          | 201,432    |       | $          | (148,822  | )          | $                | 13,941     |       | $          | 72,216 |   |   |   |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Cumulative gap as a percentage of total  assets                  |       |         |       | 18.21      | %          | (13.46     | )%         | 1.26      | %          | 6.53             | %          |       |       |
|                                                             |       |         |       |       |       |       |       |      |       |             |       |       |       |
| Rate sensitive assets / rate sensitive  liabilities (cumulative) |       | 5.62         |       | 1.95       |       | 0.82       |       | 1.01      |       | 1.07             |       |       |       |

 

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From September 30, 2007 to September 30, 2008, the FOMCdecreased interest rates by 275 basis points. Management has positioned thebalance sheet to be essentially neutral for asset and liability sensitivity. AtSeptember 30, 2008, our one-year gap was 0.82.

 

The interest rate risk model that defines the gap position alsoperforms a “rate shock” test of the balance sheet using an earnings simulationmodel and an economic value of equity model. The rate shock test measures theimpact on the net interest margin and the economic value of equity of animmediate shift in interest rates in either direction.

 

Our earnings simulation model measures the impact of changes ininterest rates on net interest income. To limit interest rate risk, we have aguideline for our earnings at risk which sets a limit on the variance of netinterest income to less than a 5% percent decline for a 100-basis pointchange up or down in rates from management’s flat interest rate forecast overthe next twelve months. At September 30, 2008, we were in compliance withthis guideline.

 

Our economic value of equity model measures the extent that estimatedeconomic values of our assets, liabilities and off-balance sheet items willchange as a result of interest rate changes. To help limit interest rate risk,we have a guideline stating that for an instantaneous 100-basis point increaseor decrease in interest rates, the economic value of equity will not decreaseby more than 10% from the base case. At September 30, 2008, we were incompliance with this guideline.

 

The above analysis may not on its own be an entirely accurate indicatorof how net interest income or net interest margin will be affected by changesin interest rates. Income associated with interest-earning assets and costsassociated with interest-bearing liabilities may not be affected uniformly bychanges in interest rates. In addition, the magnitude and duration of changesin interest rates may have a significant impact on net interest income.Interest rates on certain types of assets and liabilities fluctuate in advanceof changes in general market rates, while interest rates on other types may lagbehind changes in general market rates. The asset liability committee developsits view of future rate trends by monitoring economic indicators, examining theviews of economists and other experts, and understanding the current status ofour balance sheet and conducts a quarterly analysis of the rate sensitivityposition. The results of the analysis are reported to the Bank’s board ofdirectors.

 

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**ITEM 4. CONTROLS AND PROCEDURES.**

 

Evaluationof Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures, as defined in Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the “Exchange Act”),that are designed to ensure that information required to be disclosed by us inthe reports that we file or submit under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms and that suchinformation is accumulated and communicated to our management, including ourChief Executive Officer and Chief Financial Officer, as appropriate, to allowtimely decisions regarding required disclosure. We carried out an evaluation,under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof the design and operation of our disclosure controls and procedures as of theend of the period covered by this report. Based on the evaluation of thesedisclosure controls and procedures, the Chief Executive Officer and ChiefFinancial Officer concluded that our disclosure controls and procedures areeffective to allow timely decisions regarding disclosure in the reports that wefile or submit to the Securities and Exchange Commission under the ExchangeAct.

 

InternalControl Over Financial Reporting

 

Therewere no changes in our internal control over financial reporting during thequarter ended September 30, 2008 that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

**PART II:OTHER INFORMATION**

 

**ITEM 1A. RISK FACTORS.**

 

There were no material changes to our risk factors included in Part I,Item 1A of our Annual Report on Form 10-K for the year ended December 31,2007, as filed with the Securities and Exchange Commission on April 18,2008.

 

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**ITEM 6. EXHIBITS.**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                                                                                                                      |
|----------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                                                                                                                                 |
| 3.1                  |       | Charter  of Tennessee Commerce Bancorp, Inc., as amended(1)                                                                                                                                                                                                                     |
| 3.2                  |       | Articles  of Amendment to the Charter of Tennessee Commerce Bancorp, Inc.(2)                                                                                                                                                                                                    |
| 3.3                  |       | Bylaws  of Tennessee Commerce Bancorp, Inc.(1)                                                                                                                                                                                                                                  |
| 3.4                  |       | Amendment  to Bylaws of Tennessee Commerce Bancorp, Inc.(3)                                                                                                                                                                                                                     |
| 4.1                  |       | Shareholders’  Agreement(1)                                                                                                                                                                                                                                                     |
| 4.2                  |       | Form of  Stock Certificate(4)                                                                                                                                                                                                                                                   |
| 4.3                  |       | Indenture,  dated as of June 20, 2008, between Tennessee Commerce Bancorp, Inc.  and Wilmington Trust Company, as trustee(5)                                                                                                                                               |
| 4.4                  |       | Amended  and Restated Declaration of Trust, dated as of June 20, 2008, among  Tennessee Commerce Bancorp, Inc. , as sponsor, Wilmington Trust Company,  as institutional and Delaware trustee, and Arthur F. Helf, H. Lamar Cox and  Michael R. Sapp, as administrators(6) |
| 4.5                  |       | Guarantee  Agreement, dated as of June 20, 2008, between Tennessee Commerce  Bancorp, Inc. and Wilmington Trust Company(5)                                                                                                                                                 |
| 10.1                 |       | Offer  of Employment, dated as of August 5, 2008, between Tennessee Commerce  Bancorp, Inc. and Frank Perez(7)                                                                                                                                                             |
| 31.1                 |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                   |
| 31.2                 |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                   |
| 32.1                 |       | Certification  of Chief Executive Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                   |
| 32.2                 |       | Certification  of Chief Financial Officer of Tennessee Commerce Bancorp, Inc. pursuant  to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                   |

 

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| (1)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration  Statement on Form 10, as filed with the Securities and Exchange  Commission on April 29, 2005, and incorporated herein by reference.                                         |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                 |
| (2)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Annual Report  on Form 10-K, as filed with the Securities and Exchange Commission on  April 18, 2008, and incorporated herein by reference.                                                |
|   |   |                                                                                                                                                                                                                                                                                 |
| (3)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form 8-K, as filed with the Securities and Exchange Commission on  February 5, 2008, and incorporated herein by reference.                                              |
|   |   |                                                                                                                                                                                                                                                                                 |
| (4)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration  Statement on Form S-8, as filed with the Securities and Exchange  Commission on December 31, 2007 (Registration No. 333-148415), and  incorporated herein by reference. |
|   |   |                                                                                                                                                                                                                                                                                 |
| (5)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form-8-K, as filed with the Securities and Exchange Commission on  June 23, 2008, and incorporated herein by reference.                                                      |
|   |   |                                                                                                                                                                                                                                                                                 |
| (6)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form-8-K/A, as filed with the Securities and Exchange Commission on  June 30, 2008, and incorporated herein by reference.                                                    |
|   |   |                                                                                                                                                                                                                                                                                 |
| (7)    |   | Previously  filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Current Report  on Form-8-K, as filed with the Securities and Exchange Commission on  August 5, 2008, and incorporated herein by reference.                                                     |

 

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SIGNATURES

 

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

 
|                    |   | Tennessee  Commerce      |
|-------------------------|--------|--------------------------|
|                    |   | Bancorp, Inc.       |
|                    |   | (Registrant)             |
|                    |   |                     |
|                    |   |                     |
| November 10,  2008 |   | /s/  Frank Perez         |
| (Date)                  |   | Frank  Perez             |
|                    |   | Chief  Financial Officer |

 

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