** **

**UNITEDSTATES**

** SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20529**

 

**FORM 10-Q**

 

 

**MARKONE**

 
| ý

  | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                              |
|----------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           | ** **                                                                                                                                                                                                |
|           | **FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30,  2005**                                                                                                                                                    |
|           |                                                                                                                                                                                                      |
| o              | **TRANSITION  REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT**                                                                                                                                      |
|           |                                                                                                                                                                                                      |
|           | **FOR THE TRANSITION PERIOD**

**FROM                TO              ** |

 

**COMMISSIONFILE NUMBER  000-50771**

 

***BG FINANCIAL GROUP, INC.***

(ExactName of Registrant as Specified in Charter)

 

| **Tennessee**                    | ** ** | **20-0307691**          |
|----------------------------------|------------|-------------------------|
| (State  or Other Jurisdiction of |       | (I.R.S.  Employer       |
| Incorporation  or Organization)  |       | Identification  Number) |

 

| **3095 East Andrew Johnson Highway, Greeneville, Tennessee** | ** ** | **37745**   |
|--------------------------------------------------------------|------------|-------------|
| (Address  of Principal Executive Offices)                    |       | (Zip  Code) |

 

Registrant’stelephone number, including area code:         **(423) 636-1555**

 

 

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

YES ý    NO o

 

Indicateby check mark whether the registrant is an accelerated filer (as defined inRule 12b-2 of the Act).

YES o    NO ý

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

 YES o    NO ý

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date:

 

Common Stock, $1.00 par value, outstanding: 2,310,771 at November 1,2005

 

----

# *** ***

# ***PART I - FINANCIALINFORMATION***

| **Item 1.** | **Financial Statements.**

                                                                                            |
|-------------|-----------------------------------------------------------------------------------------------------------------------------|
|        | The unaudited consolidated  financial statements of the Registrant and its wholly owned subsidiary are as  follows:

  |
|        | Consolidated Balance Sheets—September 30, 2005 and  December 31, 2004.

                                          |
|        | Consolidated Statements of Income—For the nine months  ended September 30, 2005 and 2004

                        |
|        | Consolidated Statements of Income—For the three months  ended September 30, 2005 and 2004.

                      |
|        | Consolidated Statements of Cash Flows—For the nine  months ended September 30, 2005 and 2004.

                   |
|        | Notes to Consolidated Financial Statements.

                                                                          |
| **Item 2.** | **Management’s  Discussion and Analysis or Plan of Operation.**

                                                 |
| **Item 3.** | **Quantitative  and Qualitative Disclosures about Market Risk.**

                                                     |
| **Item 4.** | **Controls and  Procedures.**

                                                                                        |

 

 

**PART II - OTHER INFORMATION**
| **Item 1.**  | **Legal Proceedings.**

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

  |
| **Item 3.**  | **Defaults Upon  Senior Securities.**

                              |
| **Item 4.**  | **Submission of  Matters to a Vote of Security Holders.**

          |
| **Item 5.**  | **Other Information.**

                                             |
| **Item  6.** | **Exhibits.**

** **                                                 |

 

2

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**BG FINANCIAL GROUP, INC. ANDSUBSIDIARY**

**Greeneville,Tennessee**

**CONSOLIDATEDSTATEMENTS OF FINANCIAL CONDITION**

** **

**PartI. FINANCIAL INFORMATION**

** **

**Item1.  Financial Statements**

** **
| ** **                                                                                                                                                             | ** ** | **As of  September 30, 2005** | ** ** | **As of  December 31, 2004** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|------------------------------|------------|
|                                                                                                                                                                   |       |                          |       |                         |       |
| **ASSETS**                                                                                                                                                             |       |                          |       |                         |       |
| Cash and due from banks                                                                                                                                                |       | $                             | 4,805,544  |                         | $          | 5,538,897 |   |
| Federal funds sold                                                                                                                                                     |       | 6,872,360                     |       | 7,619,619                    |       |
| Cash and cash equivalents                                                                                                                                              |       | 11,677,904                    |       | 13,158,516                   |       |
| Federal Home Loan Bank  stock, at cost                                                                                                                                 |       | 241,100                       |       | 226,500                      |       |
| Loans, net of allowance for loan losses of $917,056 in 2005 and  $1,607,559 in 2004                                                                                    |       | 67,391,485                    |       | 72,355,286                   |       |
| Premises and equipment,  net                                                                                                                                           |       | 3,803,136                     |       | 3,895,500                    |       |
| Accrued income receivable                                                                                                                                              |       | 412,786                       |       | 389,308                      |       |
| Deferred tax benefit                                                                                                                                                   |       | 369,800                       |       | 601,307                      |       |
| Foreclosed assets                                                                                                                                                      |       | 762,958                       |       | 489,649                      |       |
| Prepaid expenses                                                                                                                                                       |       | 87,893                        |       | 58,302                       |       |
| Total Assets                                                                                                                                                           |       | $                             | 84,747,062 |                         | $          | 91,174,368 |   |
|                                                                                                                                                                   |       |                          |       |                         |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                          |       |                          |       |                         |       |
|                                                                                                                                                                   |       |                          |       |                         |       |
| **LIABILITIES**                                                                                                                                                        |       |                          |       |                         |       |
| Deposits:                                                                                                                                                              |       |                          |       |                         |       |
| Noninterest-bearing                                                                                                                                                    |       |                          |       |                         |       |
| Demand                                                                                                                                                                 |       | $                             | 7,471,732  |                         | $          | 6,755,994 |   |
| Interest-bearing                                                                                                                                                       |       |                          |       |                         |       |
| Money market, interest checking and savings                                                                                                                            |       | 18,923,061                    |       | 16,046,823                   |       |
| Time deposits                                                                                                                                                          |       | 45,589,204                    |       | 55,584,410                   |       |
| Total Deposits                                                                                                                                                         |       | 71,983,997                    |       | 78,387,227                   |       |
| Accrued interest                                                                                                                                                       |       | 299,460                       |       | 202,564                      |       |
| Other liabilities                                                                                                                                                      |       | 114,549                       |       | 482,134                      |       |
| Federal Home Loan Bank advances                                                                                                                                        |       | 4,224,643                     |       | 4,359,346                    |       |
| Total Liabilities                                                                                                                                                      |       | 76,622,649                    |       | 83,431,271                   |       |
|                                                                                                                                                                   |       |                          |       |                         |       |
| **STOCKHOLDERS’ EQUITY**                                                                                                                                          |       |                          |       |                         |       |
| Stock:                                                                                                                                                                 |       |                          |       |                         |       |
| Preferred stock, no par value; authorized 1,000,000 shares; none  issued and outstanding                                                                               |       | —                        |       | —                       |       |
| Common stock, $0.333 par value; authorized 6,000,000 shares; issued  and outstanding 2,310,771 shares at September 30, 2005 and 2,306,775 shares  at December 31, 2004 |       | 770,256                       |       | 768,925                      |       |
| Additional paid-in capital                                                                                                                                             |       | 6,932,307                     |       | 6,920,322                    |       |
| Retained earnings                                                                                                                                                      |       | 421,850                       |       | 53,850                       |       |
| Total Stockholders’ Equity                                                                                                                                        |       | 8,124,413                     |       | 7,743,097                    |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                        |       | $                             | 84,747,062 |                         | $          | 91,174,368 |   |

 

Theaccompanying notes are an integral part of these financial statements.

 

3

----

 

**BGFINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville, Tennessee**

**CONSOLIDATED STATEMENTS OF INCOME**

 
| ** **                                           | ** ** | **Nine Months Ended**  | ** **       |                   |
|------------------------------------------------------|------------|------------------------|------------------|------------------------|
| ** **                                           | ** ** | **September 30, 2005** | ** **       | **September 30, 2004** | ** ** |   |
| **Interest and dividend income:**                    | ** ** | ** **             | ** **       | ** **             | ** ** |   |
| Loans, including fees                                |       | $                      | 3,862,213        |                   | $ | 4,009,382 |   |
| Dividends on Federal Home Loan Bank stock            |       | 8,286                  |             | 25,738                 |   |   |
| Federal funds sold and other                         |       | 220,913                |             | 58,063                 |   |   |
| Total interest and dividend income                   |       | 4,091,412              |             | 4,093,183              |   |   |
|                                                 |       |                   |             |                   |   |   |
| **Interest expense:**                                | ** ** | ** **             | ** **       | ** **             | ** ** |   |
| Deposits                                             |       | 1,439,974              |             | 1,029,821              |   |   |
| Borrowed funds                                       |       | 105,153                |             | 109,606                |   |   |
| Total interest expense                               |       | 1,545,127              |             | 1,139,427              |   |   |
| Net interest income before provision for loan losses | ** ** | 2,546,285              | ** **  | 2,953,756              | ** **  |   |
| ** **                                           | ** ** | ** **             | ** **       | ** **             | ** ** |   |
| **Provision for (benefit from)  loan losses**        |       | (367,819               | )                | 554,112                |   |   |
| Net interest income after provision for loan losses  | ** ** | 2,914,104              | ** **  | 2,399,644              | ** **  |   |
|                                                 |       |                   |             |                   |   |   |
| **Noninterest income:**                              |       |                   |             |                   |   |   |
| Service charges on deposit accounts                  |       | 202,471                |             | 213,498                |   |   |
| Fees from origination of mortgage loans              |       | 105,958                |             | 104,798                |   |   |
| Investment sales commissions                         |       | 78,039                 |             | 81,378                 |   |   |
| Other                                                |       | 28,704                 |             | 19,203                 |   |   |
| Total noninterest income                             |       | 415,172                |             | 418,877                |   |   |
|                                                 |       |                   |             |                   |   |   |
| **Noninterest expenses:**                            |       |                   |             |                   |   |   |
| Compensation and benefits                            |       | 1,402,042              |             | 1,170,628              |   |   |
| Occupancy expenses                                   |       | 355,977                |             | 293,705                |   |   |
| Marketing                                            |       | 143,697                |             | 126,815                |   |   |
| Data processing                                      |       | 141,102                |             | 147,997                |   |   |
| Other operating expenses                             |       | 709,734                |             | 596,216                |   |   |
| Total noninterest expense                            |       | 2,752,552              |             | 2,335,361              |   |   |
| **Income before income taxes**                       |       | 576,724                |             | 483,160                |   |   |
|                                                 |       |                   |             |                   |   |   |
| Income tax expense  (benefit)                        |       | 208,724                |             | 192,740                |   |   |
|                                                 |       |                   |             |                   |   |   |
| **Net income**                                       |       | $                      | 368,000          |                   | $ | 290,420 |   |
|                                                 |       |                   |             |                   |   |   |
| Earnings per share                                   |       | $                      | .16              |                   | $ | .13 |   |
|                                                      |            |                        |                  |                        |  |  |  |  |  |  |

 

The accompanying notesare an integral part of these financial statements.

 

4

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**BGFINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville, Tennessee**

**CONSOLIDATED STATEMENTS OF INCOME**

 
| ** **                                           | ** ** | **Three**** ****Months****Ended** | ** ** |
|------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                           | ** ** | **September 30, 2005**                 | ** ** | **September 30, 2004** | ** ** |
| **Interest and dividend income:**                    | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Loans, including fees                                |       | $                                      | 1,328,172  |   | $ | 1,366,899 |   |
| Dividends on Federal Home Loan Bank stock            |       | 2,927                                  |       | 10,550 |   |
| Federal funds sold and other                         |       | 86,370                                 |       | 23,334 |   |
| Total interest and dividend income                   |       | 1,417,469                              |       | 1,400,783 |   |
|                                                 |       |                                   |       |   |   |
| **Interest expense:**                                | ** ** | ** **                             | ** ** | ** ** | ** ** |
| Deposits                                             |       | 520,455                                |       | 362,903 |   |
| Borrowed funds                                       |       | 34,826                                 |       | 36,837 |   |
| Total interest expense                               |       | 555,281                                |       | 399,740 |   |
| Net interest income before provision for loan losses | ** ** | 862,188                                | ** ** | 1,001,043 | ** ** |
| ** **                                           | ** ** | ** **                             | ** ** | ** ** | ** ** |
| **Provision for loan losses**                        |       | 873                                    |       | 483,513 |   |
| Net interest income after provision for loan losses  | ** ** | 861,315                                | ** ** | 517,530 | ** ** |
|                                                 |       |                                   |       |   |   |
| **Noninterest income:**                              |       |                                   |       |   |   |
| Service charges on deposit accounts                  |       | 70,302                                 |       | 66,961 |   |
| Fees from origination of mortgage loans              |       | 50,220                                 |       | 30,951 |   |
| Investment sales commissions                         |       | 28,982                                 |       | 23,235 |   |
| Other                                                |       | 15,994                                 |       | 1,707 |   |
| Total noninterest income                             |       | 165,498                                |       | 122,854 |   |
|                                                 |       |                                   |       |   |   |
| **Noninterest expenses:**                            |       |                                   |       |   |   |
| Compensation and benefits                            |       | 459,844                                |       | 481,945 |   |
| Occupancy expenses                                   |       | 120,461                                |       | 110,666 |   |
| Marketing                                            |       | 36,874                                 |       | 55,573 |   |
| Data processing                                      |       | 48,558                                 |       | 57,093 |   |
| Other operating expenses                             |       | 236,722                                |       | 264,454 |   |
| Total noninterest expense                            |       | 902,459                                |       | 969,731 |   |
| **Income (loss) before income taxes**                |       | 124,354                                |       | (329,347 | ) |
|                                                 |       |                                   |       |   |   |
| Income tax expense  (benefit)                        |       | 17,337                                 |       | (105,940 | ) |
|                                                 |       |                                   |       |   |   |
| **Net income (loss)**                                |       | $                                      | 107,017    |   | $ | (223,407 | ) |
|                                                 |       |                                   |       |   |   |
| Earnings (loss) per share                            |       | $                                      | .05        |   | $ | (.10 | ) |
|                                                      |            |                                        |            |  |  |  |  |  |

 

The accompanying notesare an integral part of these financial statements.

 

5

----

 

**BGFINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville, Tennessee**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                                | ** ** | **Nine Months Ended**  | ** **   |
|-------------------------------------------------------------------------------------------|------------|------------------------|--------------|
| ** **                                                                                | ** ** | **September 30, 2005** | ** **   | **September 30, 2004** | ** ** |
|                                                                                      |       |                   |         |   |   |
| **CASH FLOWS FROM OPERATING  ACTIVITIES:**                                                |       |                   |         |   |   |
| Net income                                                                                |       | $                      | 368,000      |   | $ | 290,420 |   |
| Adjustments to reconcile net income to net cash provided (used) by  operating activities: |       |                   |    |   |    |
| Provision for loan losses                                                                 |       | (367,819               | )            | 554,112 |   |
| Depreciation                                                                              |       | 228,909                |         | 177,792 |   |
| Realized (gain) loss on sales of foreclosed assets                                        |       | 5,347                  |         | (8,919 | ) |
| Deferred income tax benefit                                                               |       | 231,508                |         | 16,437 |   |
| Net change in:                                                                            |       |                   |         |   |   |
| Accrued income receivable                                                                 |       | (23,478                | )            | 18,274 |   |
| Other assets                                                                              |       | (29,591                | )            | 78,913 |   |
| Other liabilities                                                                         |       | (270,691               | )            | 299,491 |   |
| Net cash provided by operating activities                                                 |       | 142,185                |         | 1,426,520 |   |
|                                                                                      |       |                   |         |   |   |
| **CASH FLOWS FROM INVESTING  ACTIVITIES:**                                                |       |                   |         |   |   |
| Federal Home Loan Bank stock purchases                                                    |       | (14,600                | )            | (52,500 | ) |
| Proceeds from sales of foreclosed assets                                                  |       | 525,265                |         | 255,109 |   |
| Loan originations and principal collections, net                                          |       | 4,527,699              |         | (7,156,933 | ) |
| Additions to premises and equipment                                                       |       | (136,544               | )            | (1,261,781 | ) |
| Net cash provided (used) by investing activities                                          |       | 4,901,820              |    | (8,216,105 | ) |
|                                                                                      |       |                   |         |   |   |
| **CASH FLOWS FROM FINANCING  ACTIVITIES:**                                                |       |                   |         |   |   |
| Net change in deposits                                                                    |       | 3,591,975              |         | 4,046,487 |   |
| Net change in certificates of deposit                                                     |       | (9,995,205             | )            | 1,393,693 |   |
| Issuance of stock                                                                    |       | 13,316                 |         | 34,000 |   |
| Proceeds from short-term borrowings                                                       |       | —                 |         | 41,000 |   |
| Federal Home Loan Bank advances                                                           |       | —                 |         | 276,462 |   |
| Federal Home Loan Bank repayments                                                         |       | (134,703               | )            | (127,000 | ) |
| Net cash provided (used) by financing activities                                          |       | (6,524,617             | )            | 5,664,642 |   |
|                                                                                      |       |                   |         |   |   |
| Net change in cash and  cash equivalents                                                  |       | (1,480,612             | )            | (1,124,943 | ) |
|                                                                                      |       |                   |         |   |   |
| Cash and cash equivalents  at beginning of year                                           |       | 13,158,516             |         | 12,298,970 |   |
|                                                                                      |       |                   |         |   |   |
| Cash and cash equivalents  at end of year                                                 |       | $                      | 11,677,904   |   | $ | 11,174,027 |   |
| ** **                                                                                |       |                   |         |   |   |
| **SUPPLEMENTARY CASH FLOW  INFORMATION:**                                                 |       |                   |         |   |   |
| Interest paid on deposits and borrowed funds                                              |       | $                      | 1,343,077    |   | $ | 1,010,276 |   |
| Income taxes paid                                                                         |       | $                      | 126,000      |   | $ | — |   |
|                                                                                      |       |                   |         |   |   |
| **SUPPLEMENTARY DISCLOSURE OF  NONCASH INVESTING ACTIVITY:**                              |       |                   |         |
| Acquisition of foreclosed real estate                                                     |       | $                      | 803,921      |   | $ | 490,532 |   |
|                                                                                           |            |                        |              |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these financialstatements.

 

6

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**BGFINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville, Tennessee**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

**Note 1.   Summary of Significant Accounting Policies**

 

*Nature of Business*:

 

BGFinancial Group, Inc. (the “Company”) is a bank holding company whose businessis conducted through its wholly-owned subsidiary, Bank of Greeneville (the “Bank”).  Bank of Greeneville is engaged in thebusiness of originating loans within its lending area, Greeneville and GreeneCounty in Tennessee.  The Bank obtainsdeposits both inside and outside of its primary lending area.  The Company was organized in October2003.  The Company had minimal assets,liabilities or operations until January, 2004, when it acquired the Bank in aPlan of Share Exchange whereby the stockholders exchanged their shares ofownership in the Bank for shares of ownership in the Company on a one-for-onebasis.  As a part of the Plan of ShareExchange, the Bank became a wholly owned subsidiary of the Company.

 

Thefollowing is a description of the significant policies used in the preparationof the accompanying consolidated financial statements.

 

*Basis of Presentation:*

 

Theseconsolidated financial statements include the accounts of the BG FinancialGroup, Inc.  Significant intercompanytransactions and accounts are eliminated in consolidation.

 

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with accounting principles generally accepted in the United Statesfor interim financial information and in accordance with the instructions toForm 10-Q and Article 10 of Regulation S-X as promulgated by the Securities andExchange Commission (“SEC”). Accordingly, they do not include all the information and footnotesrequired by accounting principles generally accepted in the United States forcomplete financial statements.  In theopinion of management, all adjustments (none of which were other than normalrecurring accruals) considered necessary for a fair presentation of thefinancial position and results of operations for the periods presented havebeen included.  Operating results for thethree and nine months ended September 30, 2005 are not necessarily indicativeof the results that may be expected for the year ending December 31, 2005.  For further information, refer to theconsolidated financial statements and notes thereto included in the Company’sAnnual Report on Form 10-K for the year ended December 31, 2004.  Certain amounts from prior period financialstatements have been reclassified to conform to current year’s presentation.

 

*Use of Estimates:*

 

Thepreparation of consolidated financial statements in conformity with accountingprinciples generally accepted in the United States requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities as of thebalance sheet date and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.  The mostsignificant management accounting estimate is the appropriate level for theallowance for loan losses.  The allowancefor loan losses is evaluated on a regular basis by management and is based uponmanagement’s periodic review of the collectibility of the loans in light ofhistorical experience, the nature and volume of the loan portfolio, adversesituations that may affect the borrower’s ability to repay, estimated value ofany underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

7

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**Note 2.****           ****Stock Options and Awards**

 

                                                  In December 2002, the FASB issued SFASNo. 148, “*Accounting for Stock-BasedCompensation — Transition and Disclosure, an amendment of FASB Statement No.123.*”  This Statement amendsStatement No. 123, Accounting for Stock-Based Compensation, to providealternative methods of transition for a voluntary change to the fair valuemethod of accounting for stock-based employee compensation.  In addition, this Statement amends thedisclosure requirements of Statement No. 123 to require prominent disclosuresin both annual and interim financial statements.  Certain of the disclosure modifications arerequired for fiscal years ending after December 15, 2003 and are includedbelow.

 

                                                  The Company applies APB Opinion 25 andrelated interpretations in accounting for the stock option plan.  All option grants carry exercise prices equalto or above the fair value of the common stock on the date of the grant.  Accordingly, no compensation cost has beenrecognized.  On May 17, 2005 the Board ofDirectors approved for all non-vested employee stock options granted to becomefully vested and exercisable as of that date. Any stock options granted after May 17, 2005 are fully exercisable onthe date granted.  All stock optionsgranted that are not exercised expire ten (10) years from the date granted. Thepurpose of the acceleration of vesting was to enable the Company to recognizecompensation expense on a pro forma basis associated with these options in ourConsolidated Statements of Income before adoption of SFAS 123R in January 2006.  The following table illustrates the effect onnet income and earnings per share if the Company had applied the fair value recognitionprovisions of SFAS No. 123 to stock-based employee compensation.  

 
| ** **                                                                                                                                     | ** ** | **Three-Month Period** | ** ** | **Nine-Month Period**  | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                                                     | ** ** | **Ended September 30** | ** ** | **Ended September 30** | ** ** |
| ** **                                                                                                                                     | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                                                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income, as reported                                                                                                                        |       | $                      | 107,017    |                   | $          | (223,407 | ) | $ | 368,000 |   | $ | 290,420 |   |
| ** **                                                                                                                                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deduct: Total stock-based employee  compensation expense determined  under fair value based method for  all awards, net of related tax effects | ** ** | —                 | ** ** | 15,300                 | ** ** | 125,675 | ** ** | 45,900 | ** ** |
| ** **                                                                                                                                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Pro forma net income                                                                                                                           |       | $                      | 107,017    |                   | $          | (238,707 | ) | $ | 242,325 |   | $ | 244,520 |   |
| ** **                                                                                                                                     | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Earnings per share                                                                                                                             | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Basic — as reported                                                                                                                       |       | $                      | .05        |                   | $          | .(10 | ) | $ | .16 |   | $ | .13 |   |
|                                                                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Basic — pro forma                                                                                                                         |       | $                      | .05        |                   | $          | .(10 | ) | $ | .10 |   | $ | .11 |   |
|                                                                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Diluted — as reported                                                                                                                     |       | $                      | .04        |                   | $          | .(09 | ) | $ | .15 |   | $ | .12 |   |
|                                                                                                                                           |       |                   |       |                   |       |   |   |   |   |
| Diluted — pro forma                                                                                                                       |       | $                      | .04        |                   | $          | .(10 | ) | $ | .10 |   | $ | .10 |   |

** **

 

8

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**Note 3.****           ****Earnings Per Share of CommonStock**

 

**                                                 **Basic earningsper share (EPS) of common stock is computed by dividing net income by theweighted average number of common shares outstanding during the period.  Diluted earnings per share of common stock iscomputed by dividing net income by the weighted average number of common sharesand potential common shares outstanding during the period.  Stock options are regarded as potentialcommon shares.  Potential common sharesare computed using the treasury stock method. For the three and nine months ended September 30, 2005, 82,656options are excluded from the effect of dilutive securities because they areanti-dilutive; 19,948 options are similarly excluded from the effect ofdilutive securities for the three and nine months ended September 30,2004.

 

                                                  The followingis a reconciliation of the numerators and denominators used in the basic anddiluted earnings per share computations for the three and nine months endedSeptember 30, 2005 and 2004:

 
| ** **                                                       | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **Income**                           | ** ** | **Shares** | ** ** | **Income** | ** ** | **Shares** | ** ** |
| ** **                                                       | ** ** | **(Numerator)**                      | ** ** | **(Denominator)** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** |
|                                                             |       |                                 |       |   |   |   |   |   |   |
| Basic EPS                                                        |       |                                 |       |   |   |   |   |   |   |
| Income available to common stockholders                          |       | $                                    | 107,017    |   | 2,307,881 |   | $ | (223,407 | ) | 2,297,309 |   |
|                                                             |       |                                 |       |   |   |   |   |   |   |
| Effect of dilutive securities Stock options outstanding          |       | —                               |       | 159,973 |   | — |   | 84,217 |   |
|                                                             |       |                                 |       |   |   |   |   |   |   |
| Diluted EPS                                                      |       |                                 |       |   |   |   |   |   |   |
| Income available to common shareholders plus assumed conversions |       | $                                    | 107,017    |   | 2,467,854 |   | $ | (223,407 | ) | 2,381,526 |   |

 
| ** **                                                       | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                       | ** ** | **2005**                            | ** ** | **2004** | ** ** |
| ** **                                                       | ** ** | **Income**                          | ** ** | **Shares** | ** ** | **Income** | ** ** | **Shares** | ** ** |
| ** **                                                       | ** ** | **(Numerator)**                     | ** ** | **(Denominator)** | ** ** | **(Numerator)** | ** ** | **(Denominator)** | ** ** |
|                                                             |       |                                |       |   |   |   |   |   |   |
| Basic EPS                                                        |       |                                |       |   |   |   |   |   |   |
| Income available to common stockholders                          |       | $                                   | 368,000    |    | 2,307,881 |   | $ | 290,420 |   | 2,297,309 |   |
|                                                             |       |                                |       |   |   |   |   |   |   |
| Effect of dilutive securities Stock options outstanding          |       | —                              |       | 159,973 |   | — |   | 84,217 |   |
|                                                             |       |                                |       |   |   |   |   |   |   |
| Diluted EPS                                                      |       |                                |       |   |   |   |   |   |   |
| Income available to common shareholders plus assumed conversions |       | $                                   | 368,000    |   | 2,467,854 |   | $ | 290,420 |   | 2,381,526 |   |
|                                                                  |            |                                     |            |  |  |  |  |  |  |  |  |  |

 

9

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**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**Impact of Inflation**

 

**               **The financial statements and relatedfinancial data presented herein have been prepared in accordance withaccounting principles generally accepted in the United States and practiceswithin the banking industry which require the measurement of financial positionand operating results in terms of historical dollars without considering the changesin the relative purchasing power of money over time due to inflation.  Unlike most industrial companies, virtuallyall the assets and liabilities of a financial institution are monetary innature.  As a result, interest rates havea more significant impact on a financial institution’s performance than theeffects of general levels of inflation.

 

**Critical Accounting Estimates**

 

**               **The Companyfollows generally accepted accounting principles that are recognized in theUnited States, along with general practices within the banking industry.  In connection with the application of thoseprinciples and practices, we have made judgments and estimates which, in thecase of our allowance for loan and lease losses (ALL), are material to thedetermination of our financial position and results of operation.

 

**Recent Accounting Pronouncements**

 

                                                In March 2004,the SEC issued Staff Accounting Bulletin No. 105, Application of AccountingPrinciples to Loan Commitments.  Currentaccounting guidance requires the commitment to originate mortgage loans to beheld for sale be recognized on the balance sheet at fair value from inceptionthrough expiration or funding.  SAB 105requires that the fair-value measurement include only differences between theguaranteed interest rate in the loan commitment and a market interest rate,excluding any expected future cash flows related to the customer relationshipor loan servicing.  SAB 105 iseffective for commitments to originate mortgage loans to be held for sale that areentered into after March 31, 2004. Its adoption did not have a materialimpact on the consolidated financial position or results of operations of theCompany.

 

In March 2004, the FinancialAccounting Standards Board’s (“FASB”) Emerging Issues Task Force reached aconsensus on EITF Issue No. 03-1, *TheMeaning of Other-Than-Temporary Impairment and Its Application to CertainInvestments. *EITF 03-1provides guidance for determining when an investment is considered impaired,whether impairment is other-than-temporary, and measurement of an impairmentloss.  An investment is consideredimpaired if the fair value of the investment is less than its cost.  Generally, an impairment is consideredother-than temporary unless:  (i) theinvestor has the ability and intent to hold an investment for a reasonableperiod of time sufficient for an anticipated recovery of fair value up to (orbeyond) the cost of the investment; and (ii) evidence indicating that thecost of the investment is recoverable within a reasonable period of time outweighsevidence to the contrary.  If impairmentis determined to be other-than-temporary, then an impairment loss should berecognized equal to the difference between the investment’s cost and its fairvalue.  The recognition and measurementprovisions were initially effective for other-than-temporary impairmentevaluations in reporting periods beginning after June 15, 2004.  However, in September 2004, the effectivedate of these provisions was delayed until the finalization of a FASB StaffPosition (FSP) to provide additional implementation guidance.  Due to the recognition and measurementprovisions being suspended and the final rule delayed, the Company is not ableto determine whether the adoption of these new provisions will have a materialimpact on the consolidated financial position or results of income.

 

10

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                 Statement of Position 03-03, *Accounting for Certain Loans or Debt SecuritiesAcquired in a Transfer* (SOP 03-03) addresses accounting fordifferences between contractual cash flows and cash flows expected to becollected from an investor’s initial investment in loans or debt securities(loans) acquired in a transfer if those differences are attributable, at leastin part, to credit quality.  It includesloans acquired in purchase business combinations and applies to allnongovernmental entities, including not-for-profit organizations.  The SOP does not apply to loans originated bythe entity.  The SOP is effective forloans acquired in fiscal years beginning after December 15, 2004.  Early adoption is encouraged.  Specific transition guidance applies to certainloans that currently are within the scope of Practice Bulletin 6, Amortizationof Discounts on Certain Acquired Loans. Its adoption has****not had amaterial impact on the consolidated financial position or results of operationsof the Company.

 

                InDecember 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”)No. 123 (revised 2004), *Share-Based Payment*(“SFAS No. 123R”), which revised SFAS No. 123, “Accounting for Stock-BasedCompensation.” This statement supersedes APB Opinion No. 25, “Accounting forStock Issued to Employees.”  The revisedstatement addresses the accounting for share-based payment transactions withemployees and other third parties, eliminates the ability to account forshare-based compensation transactions using APB 25, and requires that thecompensation costs relating to such transactions be recognized in theconsolidated statement of income.  OnApril 14, 2005, the Securities and Exchange Commission deferred implementationof SFAS No. 123R for registrants until the next fiscal year following June 15,2005.  We are currently evaluating theprovisions of SFAS No. 123R and will adopt it on January 1, 2006 as required.

 

                InDecember 2004, the FASB issued Statement No. 153, “Exchanges of NonmonetaryAssets” which amends APB Opinion No. 29, Accounting for NonmonetaryTransactions.  The Statement amendsOpinion 29 to eliminate the exception for nonmonetary exchanges of similarproductive assets and replaces it with a general exception for exchanges ofnonmonetary assets that do not have commercial substance.  This Statement is effective for nonmonetaryasset changes occurring in fiscal periods beginning after June 15, 2005.  The Company does not anticipate thisstatement having any material impact on their consolidated financialstatements.

 

**Forward-LookingStatements**

 

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

 

11

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**General**

 

                OnJanuary 23, 2004, BG Financial Group, Inc. (“Company”), a Tennessee corporationbecame a bank holding company as it acquired all of the outstanding shares ofBank of Greeneville (“Bank”) in a one for one share****exchange.  The Bank is a Tennessee-chartered, FDICinsured, non-Member commercial bank offering a wide range of banking services,including checking, savings, and money market deposit accounts, certificates ofdeposit and loans for consumers, commercial and real estate purposes, and isthe principal business of the Company.  The Company and the Bank are located at 3095 East Andrew JohnsonHighway, Greeneville, Tennessee  37745.

 

                Management’sdiscussion and analysis of financial condition and results of operations arebased on Bank only statements for the three and nine months ended September 30,2004, whereas, the three and nine months ended September 30, 2005, are based onthe consolidated statements of the Company and the Bank.

 

**Liquidity**

 

                AtSeptember 30, 2005, the Company had liquid assets of $11.7 million in the formof cash and federal funds sold compared to $13.2 million on December 31,2004.  Management believes that theliquid assets are adequate at September 30, 2005. Additional liquidity shouldbe provided by the growth in deposit accounts and loan repayments.  The Company also has the ability to purchasefederal funds and is a member of the Federal Home Loan Bank of Cincinnati thatwill provide a credit line if necessary. Management is not aware of any trends, events or uncertainties that arereasonably likely to have a material impact on the Company’s short term or longterm liquidity.

 

**Results of Operations**

 

                TheCompany had net income of $107,017 or $.05 per share for the quarter endedSeptember 30, 2005 compared to a net loss of $223,407 or $.10 per share for thesame period in 2004.   Net income for thenine months ended September 30, 2005 was $368,000 as compared to a net incomeof $290,420 for the same period in 2004. The increase in net income is due inpart to the benefit received from loans considered impaired during the firsttwo quarters of 2005, being settled with little or no loss.

 

*Net Interest Income/Margin*

 

                Netinterest income represents the amount by which interest earned on variousassets exceeds interest paid on deposits and other interest-bearing liabilitiesand is the most significant component of the Company’s earnings.  Net interest income for the quarter endedSeptember 30, 2005 was $862,188 compared to $1,001,043 for the same period in2004.  Net interest income for the ninemonths ended September 30, 2005 was $2,546,285, compared to $2,953,756 for thesame period in 2004.  In addition to areduction in the total loan portfolio, the Company pursues local deposits aggressively,which has resulted in compression of net interest margin.  Based on the Company’s mix of interestearning assets and interest bearing liabilities, management believes that netinterest margin should begin to increase for the remainder of the year.  This assumption is based on a continuedrising interest rate environment.  If interestrates remain stable or begin to decline, net interest margin could decline dueto competitive pricing of both loans and interest bearing deposits.

 

12

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*Benefit from / Provision for LoanLosses*

 

                Theprovision for loan losses represents a charge to operations necessary toestablish an allowance for possible loan losses, which in management’sevaluation, is adequate to provide coverage for estimated losses on outstandingloans and to provide for uncertainties in the economy. There was a smallprovision for the estimate for loan losses during the three months endedSeptember 30, 2005, and a benefit from the estimate for loan losses for thenine months ended September 30, 2005**,**due to achange in the methodology used to evaluate impaired loans to identify specificreserves needed.  The benefit fromestimated losses was also a result of certain loans, which were considered impairedduring the first quarter, being settled with minimal losses. The provision(benefit) was $873 and $(367,819), for the three****monthsand nine months ended September 30, 2005**,** respectively,as compared to the provision of $483,513 and $554**,**112for the same periods in 2004.  Thebenefit from loan losses for the nine months ending September 30, 2005 has apositive effect on income and represents an improvement in the overall qualityof the loan portfolio, as well as a more detailed review of specific loans bymanagement.  This benefit is due also inpart to a reduction in the loan portfolio. During the three and nine monthsended September 30, 2005, loan charge-offs were $57,682 and $332,106respectively as compared to $750,748 and $776,070 for the same periods in2004.  The recoveries for the three andnine month periods ended September 30, 2005 were $3,248 and $9,422 respectivelyas compared to $396,877 and $450,874 for the same periods in 2004.  The benefit from loan losses lowered thetotal allowance for loan losses to $917,056 at September 30, 2005 from theDecember 31, 2004 total of $1,607,559, a decrease of 43.0%. Management believesthe allowance for possible loan losses at September 30, 2005 to be adequate andwill increase during the year**,**if necessary,to match normal loan growth.

 

*Provisions for Income Taxes*

 

                In2002, the Company posted pre-tax income of $130,109 causing management tobelieve that it is more likely than not that it will generate future taxableincome to utilize its net deferred tax asset.  As a result, the valuation allowance was eliminated and a net deferredtax asset was recorded for the deductible temporary differences andcarryforwards that are expected to be available to reduce future taxableincome.  The Company’s provision/(benefit)for income tax expense for the three months and nine months ended September 30,2005, was $17,337 and $208,724, respectively, when compared to $(105,940) and$192,740 for the same periods in 2004. Management believes the provision for income taxes at September 30, 2005to be adequate.

 

*Noninterest Income*

 

                TheCompany’s noninterest income consists of service charges on deposit accountsand other fees and commissions.  Totalnoninterest income for three months and nine months ended September 30, 2005was $165,498 and $415,172, respectively when compared to $122,354 and $418,877,for the same periods in 2004.  Managementbelieves that other fees and commissions and service charges will continue toincrease during the remainder of 2005. Although the noninterest income for the nine months ended September 30,2005 is $3,705 less than for the same period in 2004, the noninterest incomefor the three months ended September 30, 2005 shows an increase of $42,644 overthe same period in 2004.

 

13

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*Noninterest Expense*

 

                Noninterest expenses for the three months and ninemonths ended September 30, 2005, were $902,459 and $2,752,552, respectively ascompared to $969,731 and $2,335,361 for the same periods in 2004.  These expenses consisted of increasedemployee costs due to additions in senior management as well as otherdepartments, and annual review of other employees. Occupancy expenses increaseddue to the addition of the Company’s Operations Center, which caused greatercosts in maintenance, utilities and depreciation expense. Other operatingexpenses increased also, with the greatest single increase in marketingcosts.  Salaries and employee benefitsfor the three and nine months ended September 30, 2005, were $459,844 and$1,402,042 respectively compared to $481,945 and $1,170,628 for the sameperiods in 2004.

 

**Financial Condition**

 

                Total assets at September 30, 2005, were $84,747,062,a decrease of $6,427,306 or 7.0% compared to 2004 year-end assets of $91,174,368.  The decrease in total assets is mainly due tomanagement’s aggressive efforts to improve the quality of the loan portfolio byrecognizing troubled loans and taking appropriate action to have the loaneither paid and moved or charged off. Competitive pressures in the localinterest rate environment for fixed rate loans have also contributed to theloan portfolio reduction. Deposits decreased to $71,983,997 at September 30,2005, a decrease of $6,403,230 or 8.2% from $78,387,227 at December 31, 2004.  The decrease in deposits was mainly due tomanagement’s efforts through Asset/Liability Committee meetings to best matchliquidity and profitability.  Securitieswere $241,100 at September 30, 2005 compared to $226,500 at December 31, 2004.

**               **The Company placesan emphasis on an integrated approach to its balance sheet management.  Significant balance sheet components ofinvestment securities, loans and sources of funds are managed in an integratedmanner with the management of interest rate risk, liquidity, and capital.  These components are discussed below.

 

*Loans*

 

                Net loansoutstanding totaled $67,391,485 at September 30, 2005 compared to $72,355,286at December 31, 2004.  Commercial andreal estate loan declines accounted for almost all of the approximately $5.0million decrease in the loan portfolio for the first three quarters of 2005.This negative growth is in part attributable to potential customers seekingfixed rate loans with longer terms than the Company presently offers.

 

Management feels the overallquality of loans remains solid, as problem loans have been identified andeither charged off or adequate provision has been made for any potential lossthat might occur.  In the event that aloan is 90 days or more past due the accrual of income is generallydiscontinued when the full collection of principal or interest is in doubtunless the obligations are both well secured and in the process ofcollection.  At September 30, 2005, totalloans 90 days or more past due and still accruing interest were $0 while totalloans 90 days or more past due and in non-accrual status equaled $1,950,326.

 

14

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*Securities*

 

                Federal Home Loan Bank (FHLB)stock at September 30, 2005 had an amortized cost of $241,100 and a marketvalue of $241,100 as compared to an amortized cost of $226,500 and a marketvalue of $226,500 at December 31, 2004.  As a member of the FHLB, the Company is required to maintain stock in anamount equal to 0.15% of total assets. Federal Home Loan Bank stock is carried at cost under theavailable-for-sale category.  FederalHome Loan Bank stock is maintained by the Company at par value of one hundreddollars per share

 

*Deposits*

 

                Total deposits,which are the principal source of funds for the Company, were $71,983,997 atSeptember 30, 2005, compared to $78,387,227 at December 31, 2004 representing adecrease of 8.2%.  As previously stated thedecline in total deposits is mainly due to management’s efforts through theAsset/Liability Committee to best match liquidity and profitability. TheCompany has targeted local consumers, professional and commercial businesses asits central clientele, therefore, deposit instruments in the form of demanddeposits, savings accounts, money market demand accounts, NOW accounts,certificates of deposit and individual retirement accounts are offered tocustomers.   The Company established aline of credit with the Federal Home Loan Bank secured by a blanket-pledge of1-4 family residential mortgage loans.  At September 30, 2005 the Company had outstanding advances of $4,224,643at the Federal Home Loan Bank.

 

*Capital*

 

                Equity capital at September 30, 2005 was $8,124,413,an increase of $381,316 from $7,743,097 at December 31, 2004, due to a netprofit of $368,000 for the first three quarters of 2005 and the issuance of3,996 shares of common stock pursuant to the exercise of stock options for$13,316.

 

                AtSeptember 30, 2005, both the Company’s and Bank’s capital ratios were in excessof the regulatory minimums.  Those ratiosare as follows:

* *
| ** **                       | ** ** | **Required  Minimum  Ratio** | ** ** | **To Be Well  Capitalized  Ratio** | ** ** | **Bank** | ** ** | **Company** | ** ** |
|----------------------------------|------------|------------------------------|------------|------------------------------------|------------|----------|------------|-------------|------------|
| Tier 1 Leverage ratio            |       | 4.00                         | %          | 5.00                               | %          | 9.42     | %          | 9.51        | %          |
| Tier 1 risk-based capital  ratio |       | 4.00                         | %          | 6.00                               | %          | 11.32    | %          | 11.36       | %          |
| Total risk-based capital  ratio  |       | 8.00                         | %          | 10.00                              | %          | 12.57    | %          | 12.61       | %          |

 

The Company’s primary sourceof liquidity is dividends paid by the Bank. The Bank is subject to theTennessee Banking Act, which limits a bank’s ability to pay dividends.  The payment of dividends by any bank isdependent upon its earnings and financial condition and subject to thestatutory power of certain federal and state regulatory agencies to act to preventwhat they deem unsafe or unsound banking practices.  The payment of dividends could, dependingupon the financial condition of the Bank, be deemed to constitute such anunsafe or unsound banking practice. Under Tennessee law, the board of directors of a state bank may notdeclare dividends in any calendar year that exceeds the total of its retainednet income of the preceding two (2) years without the prior approval of theTDFI.  The FDIA prohibits a state bank,the deposits of which are insured by the FDIC, from paying dividends if it isin default in the payment of any assessments due the FDIC.  The Bank is also subject to the minimumcapital requirements of the FDIC which impact the Bank’s ability to paydividends.  If the Bank fails to meetthese standards, it may not be able to pay dividends or to accept additionaldeposits because of regulatory requirements.

 

15

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If, in the opinion of theapplicable federal bank regulatory authority, a depository institution is engagedin or is about to engage in an unsafe or unsound practice (which, depending onthe financial condition of the depository institution, could include thepayment of dividends), such authority may require that such institution ceaseand desist from such practice.  Thefederal banking agencies have indicated that paying dividends that deplete adepository institution’s capital base to an inadequate level would be an unsafeand unsound banking practice.  Moreover,the Federal Reserve Board, the Comptroller of the Currency and the FDIC haveissued policy statements which provide that bank holding companies and insureddepository institutions generally should only pay dividends out of currentoperating earnings.

 

The payment of dividends bythe Bank may also be affected or limited by other factors, such as therequirement to maintain adequate capital above regulatory guidelines.

 

*Liability and Asset Management*

 

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

 

The primary tool thatmanagement uses to measure short-term interest rate risk is a net interestincome simulation model prepared by an independent correspondentinstitution.  These simulations estimatethe impact that various changes in the overall level of interest rates overone- and two-year time horizons would have on net interest income.  The results help the Company developstrategies for managing exposures to interest rate risk.

 

Like any forecastingtechnique, interest rate simulation modeling is based on a large number ofassumptions.  In this case, theassumptions relate primarily to loan and deposit growth, asset and liabilityprepayments, interest rates and balance sheet management strategies.  Management believes that both individuallyand in the aggregate the assumptions are reasonable.  Nevertheless, the simulation modeling processproduces only a sophisticated estimate, not a precise calculation of exposure.

 

At September 30, 2005, approximately56.3% of the Company’s gross loans had adjustable rates.  Based on the asset/liability modelingmanagement believes that these loans reprice at a faster pace than liabilitiesheld at the institution.  Because themajority of the Company’s liabilities are 12 months and under and the gap inrepricing is asset sensitive, management believes that a rising rateenvironment would have a positive impact on the Company’s net interestmargin.  Conversely, floors in themajority of the institutions adjustable rate assets also mitigate interest ratesensitivity in a decreasing rate environment.

 

16

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**Off-Balance Sheet Arrangements**

 

TheCompany, at September 30, 2005, had outstanding unused lines of credit and standbyletters of credit that totaled approximately $9,265,000.  These commitments have fixed maturity datesand many will mature without being drawn upon, meaning that the totalcommitment does not necessarily represent the future cash requirements.  The Company has the ability to liquidateFederal funds sold or, on a short-term basis, to purchase Federal funds fromother banks and to borrow from the Federal Home Loan Bank.  At September 30, 2005, the Company had establishedthe ability to purchase Federal funds if needed with correspondent banks.

 

**Item 3. Quantitative and Qualitative Disclosures about Market Risk**

 

The information set forth on pages 10 through 17 of Item 2, “MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS isincorporated herein by reference.

 

**Item 4.  Controls andProcedures**

 

**               **a)             Evaluation of DisclosureControls and Procedures

 

                                TheCompany maintains disclosure controls and procedures, as defined in Rule13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934(the “Exchange Act”), that are designed to ensure that information required tobe disclosed by it in the reports that it files or submits under the ExchangeAct is recorded, processed, summarized and reported within the time periodspecified in the SEC’s rules and forms and that such information is accumulatedand communicated to the Company’s management, including its Chief ExecutiveOfficer and Chief Financial Officer.  TheCompany carried out an evaluation, under the supervision and with theparticipation of its management, including its Chief Executive Officer andChief Financial Officer, of the effectiveness of the design and operation ofits disclosure controls and procedures as of the end of the period covered bythis report.  Based on the evaluation ofthese disclosure controls and procedures, the Chief Executive Officer and ChiefFinancial Officer concluded that the Company’s disclosure control andprocedures were effective.

 

                b)            Changes in Internal Controls andProcedures

 

                                Therewere no changes in our internal controls over financial reporting during thequarter ended September 30, 2005, that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting.

 

17

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**PART II - OTHER INFORMATION**

 

**Item 1.     LEGAL PROCEEDINGS**

 

 None.

 

**Item 2.  UNREGISTEREDSALES OF EQUITY SECURITIES AND USE OF PROCEEDS**

 

(a)        3,996 shares of the Company’scommon stock were issued during the quarter ended September 30, 2005 as aresult of the exercise of the following stock options:

 
| **Date Exercised** | ** ** | **Number of Shares** | ** ** | **Exercise Price** | ** ** |
|--------------------|------------|----------------------|------------|--------------------|------------|
|               |       |                 |       |               |       |
| July 6, 2005       |       | 1,000                |       | $                  | 3.33       |   |
| July 8, 2005       |       | 900                  |       | $                  | 3.33       |   |
| July 12, 2005      |       | 1,334                |       | $                  | 3.33       |   |
| July 26, 2005      |       | 162                  |       | $                  | 3.33       |   |
| August 23, 2005    |       | 600                  |       | $                  | 3.33       |   |

 

The aggregate proceeds ofthe shares sold were $13,316.

 

There were no underwritersand no underwriting discounts or commissions. All sales were for cash.

 

The Company believes that an exemption from registration of theseshares was available to the Company in that the issuance thereof did notconstitute a public offering of securities within the meaning of the SecuritiesAct of 1933, as amended, pursuant to Section 4(2) of the Securities Act.

 

The securities sold are not convertible or exchangeable into any otherequity security.

 

The proceeds of the sales are being used by the Company for generalcorporate purposes.

 

(b)       Not applicable.

 

(c)        No repurchasesof Company securities were made during the quarter ended September 30, 2005.

 

Theonly restrictions on working capital and/or the payment of dividends are thosereported in Part I.

 

**Item 3.    DEFAULTS UPONSENIOR SECURITIES**

 

(a)          None.

 

(b)         None.

 

**Item 4.    SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS**

 

None.

 

18

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**Item 5.    OTHER INFORMATION**

 

(a)    None.

 

(b)    None.

 

**Item 6.    EXHIBITS.**

 

**               **Index to Exhibits.

 
| **Exhibit No.** | ** ** | **Description**                                                                      |
|-----------------|------------|--------------------------------------------------------------------------------------|
| 2.1*            |       | Articles of Share Exchange  between BG Financial Group, Inc. and Bank of Greeneville |
| 2.2*            |       | Plan of Share Exchange between  BG Financial Group, Inc. and Bank of Greeneville     |
| 3.1*            |       | Charter of BG Financial  Group, Inc.                                                 |
| 3.2*            |       | Bylaws of BG Financial  Group, Inc.                                                  |
| 10.1*           |       | Stock Option Agreement  between BG Financial Group, Inc. and J.Robert Grubbs         |
| 10.2*           |       | Stock Option Agreement  between BG Financial Group, Inc and T. Don Waddell           |
| 31.1            |       | Certification pursuant to  Rule 13a-14a/15d-14(a)                                    |
| 31.2            |       | Certification pursuant to  Rule 13a-14a/15d-14(a)                                    |
| 32.1            |       | Certification pursuant to  Rule 18 USC Section 1350-Sarbanes-Oxley Act of 2002       |
| 32.2            |       | Certification pursuant to  Rule 18 USC Section 1350-Sarbanes-Oxley Act of 2002       |

----

* Previously filed as an exhibit to BGFinancial Group, Inc.’s Form 8-K, as filed with the Securities and ExchangeCommission on May 21, 2004.

 

19

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***SIGNATURES***

 

In accordance with the requirements of the ExchangeAct, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

BG FINANCIAL GROUP, INC.(Registrant)

 

 
| DATE:  | November 16 , 2005 |   | /s/ J. Robert Grubbs                     |   |
|-------------|--------------------|--------|------------------------------------------|--------|
|        |               |   | J. Robert Grubbs                         |
|        |               |   | President & Chief  Executive Officer |

 

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