**U.S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-K**

 

**(Mark One)**

 
| **x**  | ** ** | **Annual report  pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                             |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |       |                                                                                                                                                                                                                                                                                                                                                             |
|   |       | **For fiscal year ended****December 31,  2007**                                                                                                                                                                                                                                                                                                             |
|   |       |                                                                                                                                                                                                                                                                                                                                                             |
| **o**  | ** ** | **Transition  report under Section 13 or 15(d) of the Securities Exchange Act of  1934**                                                                                                                                                                                                                                                               |
|   |       |                                                                                                                                                                                                                                                                                                                                                             |
|   |       | **For the transition period from                              to                          ** |

 

**Commission File Number:  000-51147**

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

(Name of Small Business Issuer in Its Charter)

 

| **Georgia**                                                     | ** ** | **20-2198785**                    |
|-----------------------------------------------------------------|------------|-----------------------------------|
| (State or other jurisdiction of

incorporation or organization) |       | (IRS Employer Identification No.) |
|                                                            |       |                              |
| **120 Keys Ferry Street, McDonough, GA**                        | ** ** | **30253**                         |
| (Address of Principal Executive Offices)                        |       | (Zip Code)                        |

 

**(678) 583-2265**

(Issuer’s Telephone Number, Including Area Code)

 

Securities registeredpursuant to Section 12(b) of the Act: **None**.

 

Securities registeredpursuant to Section 12(g) of the Act: **Common Stock, Par Value $5.00 Per Share.**

 

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities

Act.  o  Yes  x  No

 

Indicate by check markwhether the registrant is not required to file reports pursuant to Section 13or 15(d) of the ExchangeAct.  o  Yes  x  No

 

Indicate by check markwhether the issuer: (1) filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for past 90 days.  x  Yes   No  o

 

Indicate by check mark ifdisclosure of delinquent filers in response to Item 405 of Regulation S-K isnot contained in this form, and no disclosure will be contained, to the best ofregistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

 

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-accelerated filer, or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer,” and “smaller reporting company” in Rule12b-2 of the Exchange Act.

 

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

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act):

o  Yes  x  No

 

State the issuer’srevenues for its most recent fiscal year: **$23,187,641**

 

State the aggregatemarket value of the voting and non-voting common equity held by non-affiliatescomputed by reference to the price at which the common equity was sold, or theaverage bid and asked price of such common equity, as of a specified datewithin the past 60 days:  **$4,538,540 as of April 3, 2008.**

 

APPLICABLE ONLY TOCORPORATE REGISTRANTS

 

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date:  **2,701,882 shares outstanding of common stock as of April 11, 2008.**

 

DOCUMENTSINCORPORATED BY REFERENCE

 

**Proxy Statement for 2008 AnnualMeeting of Shareholders**

 

 

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**SPECIAL CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS**

 

Someof the statements in this Report, including, without limitation, mattersdiscussed under the caption “Management’s Discussion and Analysis of FinancialCondition and Results of Operation,” of FirstBank Financial Services, Inc.(the “Company”) are “forward-looking statements” within the meaning of thefederal securities laws. Forward-looking statements include statements aboutthe competitiveness of the banking industry, potential regulatory obligations,our entrance and expansion into other markets, integration of recently acquiredbanks, pending or proposed acquisitions, our other business strategies, ourexpectations with respect to our allowance for loan losses and impaired loans,anticipated capital expenditures for our operations center, and otherstatements that are not historical facts. When we use words like “anticipate”, “believe”,“intend”, “expect”, “estimate”, “could”, “should”, “will”, and similarexpressions, you should consider them as identifying forward-lookingstatements, although we may use other phrasing. These forward-lookingstatements involve risks and uncertainties and are based on our beliefs andassumptions, and on the information available to us at the time that thesedisclosures were prepared. Factors that may cause actual results to differmaterially from those expressed or implied by such forward-looking statementsinclude, among others, the following possibilities: (1) competitivepressures among depository and other financial institutions may increasesignificantly; (2) changes in the interest rate environment may reducemargins; (3) general economic conditions may be less favorable thanexpected, resulting in, among other things, a deterioration in credit qualityand/or a reduction in demand for credit; (4) legislative or regulatorychanges, including changes in accounting standards, may adversely affect thebusinesses in which we are engaged; (5) costs or difficulties related tothe integration of our businesses, may be greater than expected; (6) depositattrition, customer loss or revenue loss following acquisitions may be greaterthan expected; (7) competitors may have greater financial resources anddevelop products that enable such competitors to compete more successfully thanus; and (8) adverse changes may occur in the equity markets.

 

Manyof such factors are beyond our ability to control or predict, and readers arecautioned not to put undue reliance on such forward-looking statements. Wedisclaim any obligation to update or revise any forward-looking statementscontained in this Report, whether as a result of new information, future eventsor otherwise.

 

TheCompany cautions that the foregoing list of important factors is notexclusive.  For further informationregarding the risk factors applicable to the Company, please see “Risk Factors.”

 

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**TABLE OFCONTENTS**

 
| ** **    | ** **                                                                                      | **Page**   |
|---------------|-------------------------------------------------------------------------------------------------|------------|
| ** **    | ** **                                                                                      | ** ** |
| PART I   |                                                                                            | 1          |
|          |                                                                                            |       |
| ITEM 1.       | BUSINESS                                                                                        | 1          |
| ITEM 1A.      | RISK FACTORS                                                                                    | 11         |
| ITEM 1B.      | UNRESOLVED  STAFF COMMENTS                                                                      | 19         |
| ITEM 2.       | DESCRIPTION OF  PROPERTY                                                                        | 19         |
| ITEM 3.       | LEGAL PROCEEDINGS                                                                               | 20         |
| ITEM 4.       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                            | 20         |
|          |                                                                                            |       |
| PART II  |                                                                                            | 21         |
|          |                                                                                            |       |
| ITEM 5.       | MARKET FOR  COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES                   | 21         |
| ITEM 6.       | SELECTED FINANCIAL  DATA                                                                        | 22         |
| ITEM 7.       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS     | 23         |
| ITEM 7A.      | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                     | 47         |
| ITEM 8.       | FINANCIAL  STATEMENTS AND SUPPLEMENTARY DATA                                                    | 47         |
| ITEM 9.       | CHANGES IN  AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE           | 47         |
| ITEM 9A.      | CONTROLS AND  PROCEDURES                                                                        | 47         |
| ITEM 9B.      | OTHER INFORMATION                                                                               | 48         |
|          |                                                                                            |       |
| PART III |                                                                                            | 49         |
|          |                                                                                            |       |
| ITEM 10.      | DIRECTORS,  EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE                                        | 49         |
| ITEM 11.      | EXECUTIVE  COMPENSATION                                                                         | 49         |
| ITEM 12.      | SECURITY OWNERSHIP  OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 49         |
| ITEM 13.      | CERTAIN  RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE                      | 50         |
| ITEM 14.      | PRINCIPAL  ACCOUNTANT FEES AND SERVICES                                                         | 50         |
|          |                                                                                            |       |
| PART IV  |                                                                                            | 51         |
|          |                                                                                            |       |
| ITEM 15.      | EXHIBITS,  FINANCIAL STATEMENT SCHEDULES                                                        | 51         |
|          |                                                                                            |       |
| SIGNATURES    | 52                                                                                              |

 

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**PART I**

 

**ITEM 1.****                            ****BUSINESS**

 

**General**

 

FirstBankFinancial Services, Inc. (the “Company”) is a bank holding company whoseprincipal activity is the ownership and management of its wholly-ownedsubsidiary, FirstBank Financial Services (formerly First Bank of Henry County)(the “Bank”).  On February 1, 2005,pursuant to an Agreement and Plan of Share Exchange approved by the Bank’sshareholders, the Company acquired all of the Bank’s common stock and the Bank’sshareholders received one share of the Company’s stock in exchange for eachshare of Bank stock that they held.

 

TheBank began its banking operations on January 28, 2002, after receivingfinal approval from the Georgia Department of Banking and Finance (“GDBF”) andthe Federal Deposit Insurance Corporation (“FDIC”) to organize the Bank as astate-chartered commercial bank with federally insured deposits.

 

TheBank is a full-service commercial bank specializing in meeting the needs ofindividuals and small- to medium-sized businesses and professional concerns inHenry County.  The Bank focuses oncommunity involvement and personal service while providing customers withsophisticated financial products.  TheBank offers a broad array of competitively priced deposit services, includinginterest-bearing and noninterest-bearing checking accounts, statement savingsaccounts, money market deposits, certificates of deposit and individualretirement accounts.  In addition, theBank complements its lending and deposit products by offering ATM and debitcards, travelers’ checks, official checks, credit cards, direct deposit, automatictransfers, savings bonds, night depository, stop payments, collections, wiretransfers and overdraft protection.

 

**Market Area and Competition**

 

Allphases of the Company’s banking activities are highly competitive.  The Company competes actively with commercialbanks, as well as finance companies, credit unions, and other financialinstitutions located within its primary market area of Henry County,Georgia.  The Bank competes with all ofthe super-regionals as well as national competitors, including:  Bank of America, SunTrust, Wachovia, TheFirst State Bank, Heritage Bank, First National Bank, Park Avenue Bank andBB&T.  Most of these institutionshave offices within two miles of the location of the Bank’s main office.  Presently, 21 commercial banks serve HenryCounty with a total of 56 branches.  The FDIC publishes market share data for theperiod ending June 30th of each year.  Based on the last reported dates, the Bankhas an approximately 11.05% market share in the Henry County market which is thethird largest in the county.

 

TheBank’s primary market is Henry County, as well as the adjoining portion ofClayton County.  The cities of McDonough,Stockbridge and Morrow, which are the focal points of the Bank’s currentprimary service area, are immediately accessible to traffic from all directionsvia Interstate 75.  Henry County islocated approximately 25 miles southeast of downtown Atlanta, in the southernportion of the Metropolitan Atlanta MSA, and 20 miles southeast ofHartsfield-Jackson Atlanta International Airport.  Clayton County is also the location ofHartsfield-Jackson Atlanta International Airport.

 

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**LendingServices**

 

**Lending Policy. **The Bank aggressively seeks creditworthy borrowerswithin its primary service area.  TheBank’s primary lending function is to make loans to small- to medium-sizedbusinesses.  In addition to commercialloans, the Bank makes installment loans, home equity loans, real estate loansand second mortgage loans to individual consumers.  Ourcurrent loan portfolio is comprised of the following:

 
| **Loan Category** | ** ** | **Ratio** | ** ** |
|------------------------|------------|-----------|------------|
|                   |       |      |       |
| Commercial Lending     |       | 7         | %          |
| Real Estate Lending    |       | 92        | %          |
| Consumer Lending       |       | 1         | %          |

** **

**Loan Approval and Review.**  TheBank’s loan approval provides for various levels of officer lendingauthority.  When the total amount ofloans to a single borrower exceeds an individual officer’s lending authority,an officer with a higher lending limit or the Bank’s Loan Committee determineswhether to approve the loan request.

 

**Lending Limits. **The Bank’s legal lending limits are 15% ofits unimpaired capital and surplus for unsecured loans and 25% of itsunimpaired capital and surplus for loans secured by readily marketablecollateral.  As of December 31,2007, the Bank’s legal lending limit for unsecured loans was approximately$3,806,000 and its legal lending limit for secured loans was approximately$6,343,000.****While the Bank generally employsmore conservative lending limits, the Board of Directors has discretion to lendup to its legal lending limits.

 

**Credit Risks**.  The principal economic risk associated witheach category of the loans that the Bank makes is the creditworthiness of theborrower.  General economic conditionsand the strength of the services and retail market segments affect borrowercreditworthiness.  Risks associated withreal estate loans also include fluctuations in the value of real estate, newjob creation trends, tenant vacancy rates and, in the case of commercialborrowers, the quality of the borrower’s management.  In addition, a commercial borrower’s abilityboth to evaluate properly changes in the supply and demand characteristicsaffecting its markets for products and services and to respond effectively tothese changes are significant factors in the creditworthiness of a commercialborrower.  General economic factorsaffecting a borrower’s ability to repay include interest, inflation andemployment rates, as well as other factors affecting a borrower’s customers,suppliers and employees.

 

Thewell-established banks in Henry County and Clayton County are likely to makeproportionately more loans to medium- to large-sized businesses than theBank.  Many of the commercial loans thatthe Bank makes are made to small- to medium-sized businesses, which may be lessable to withstand competitive, economic and financial pressures than largerborrowers.

 

**Commercial Loans**.  The Bank makes loans to small- tomedium-sized businesses whose demand for funds falls within the legal lendinglimits of the Bank.  This category ofloans includes loans made to individual, partnership or corporate borrowers,and obtained for a variety of business purposes.  Risks associated with these loans can besignificant and include but are not limited to fraud, bankruptcy, economicdownturn, deteriorated or non-existing collateral and changes in interestrates.

 

**Real Estate Loans**.  The Bank makes and holds realestate loans, consisting primarily of single-family residential constructionloans for one- to four-unit family structures. The Bank requires a first lien position on the land associated with theconstruction project and offers these loans to professional buildingcontractors and homeowners.  Loandisbursements require on-site inspections to assure the 

 

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projectis on budget and that the loan proceeds are being used for the constructionproject and not being diverted to another project.  The loan-to-value ratio for these loans ispredominantly 80% of the lower of the as-built appraised value or project cost,and is a maximum of 90% if the loan is amortized.  Loans for construction can present a highdegree of risk to the lender, depending upon, among other things, whether thebuilder can sell the home to a buyer, whether the buyer can obtain permanentfinancing, whether the transaction produces income in the interim and thenature of changing economic conditions.

 

**Consumer Loans**.  The Bank makes a variety of loans toindividuals for personal, family and household purposes, including secured andunsecured installment and term loans, home equity loans and lines ofcredit.  Consumer loan repayments dependupon the borrower’s financial stability and are more likely to be adverselyaffected by divorce, job loss, illness and personal hardships.  Because depreciable assets such as boats,cars and trailers secure many consumer loans, the Bank amortizes these loansover the useful life of the asset.  Tominimize the risk that the borrower cannot afford the monthly payments, fixedmonthly obligations are limited to no more than 40% of the borrower’s grossmonthly income.  The borrower should alsobe employed for at least 12 months prior to obtaining the loan.  The loan officer reviews the borrower’s pastcredit history, past income level, debt history and, when applicable, cash flowto determine the impact of all of these factors on the borrower’s ability tomake future payments as agreed.

 

**Investments**

 

Inaddition to loans, the Bank makes other investments primarily in obligations ofthe United States or obligations guaranteed as to principal and interest by theUnited States.  As of December 31,2007, investment securities comprised approximately 17% of the Bank’s assets,with net loans comprising approximately 72%. No investment in any of these instruments exceeds applicable limitationimposed by law or regulation.

 

**Deposits**

 

TheBank offers a wide range of commercial and consumer deposit accounts, includingchecking accounts, money market accounts, a variety of certificates of deposit,and IRA accounts.  The Bank attractsdeposits with an aggressive marketing plan, a broad product line andcompetitive products and services.  Theprimary sources of deposits are Henry County and Clayton County residents,local businesses and their employees and brokered deposits.

 

**Assetand Liability Management**

 

TheBank manages its assets and liabilities to provide an optimum and stable netinterest margin, a profitable after-tax return on assets and return on equity,and adequate liquidity.  These managementfunctions are conducted within the framework of the Bank’s written loan andinvestment policies.  The Bank attemptsto maintain a balanced position between rate-sensitive assets andrate-sensitive liabilities.  It chartsassets and liabilities on a matrix by maturity, effective duration, andinterest adjustment period, and endeavors to manage any gaps in maturityranges.

 

**Employees**

 

Asof December 31, 2007, the Bank had 61 full-time employees.  The Bank is not a party to any collectivebargaining agreement and, in the opinion of management, enjoys excellentrelations with its employees.

 

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**Website Address**

 

Ourcorporate website address is www.firstbankfinancialservices.com. From thiswebsite, select the “Investor Relations” link followed by the “SEC Filings”link. This is a direct link to our filings with the Securities and ExchangeCommission (SEC), including but not limited to our quarterly reports on Form 10-Q,current reports on Form 8-K and any amendments to these reports. Thesereports are accessible soon after we file them with the SEC.  Our Audit Committee Charter, Code of Conductand Ethics and Whistleblower Policy are posted under the “Corporate GovernanceDocuments” link.

 

**Supervisionand Regulation**

 

Boththe Company and the Bank are subject to extensive state and federal bankingregulations that impose restrictions on and provide for general regulatoryoversight of their operations.  Theselaws are generally intended to protect depositors and not shareholders.  Legislation and regulations authorized bylegislation influence, among other things:

 

·                  how,when and where we may expand geographically;

 

·                  intowhat product or service market we may enter;

 

·                  howwe must manage our assets; and

 

·                  underwhat circumstances money may or must flow between the parent bank holdingcompany and the subsidiary bank.

 

Setforth below is an explanation of the major pieces of legislation affecting ourindustry and how that legislation affects our actions.  The following summary is qualified byreference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations mayhave a material effect on our business and prospects, and legislative changes andthe policies of various regulatory authorities may significantly affect ouroperations.  We cannot predict the effectthat fiscal or monetary policies, or new federal or state legislation may haveon our business and earnings in the future.

 

**The Company**

 

Becausewe own all of the capital stock of the Bank, we are a bank holding companyunder the federal Bank Holding Company Act of 1956 (the “Bank Holding CompanyAct”). As a result, we are primarily subject to the supervision, examinationand reporting requirements of the Bank Holding Company Act and the regulationsof the Federal Reserve Board. As a bank holding company located in Georgia, theGeorgia Department of Banking and Finance also regulates and monitors allsignificant aspects of our operations.

 

***Acquisitions of Banks.***** **The Bank Holding Company Act requires every bank holding company toobtain the Federal Reserve Board’s prior approval before:

 

·                  acquiringdirect or indirect ownership or control of any voting shares of any bank if,after the acquisition, the bank holding company will directly or indirectly ownor control more than 5% of the bank’s voting shares;

 

·                  acquiringall or substantially all of the assets of any bank; or

 

·                  mergingor consolidating with any other bank holding company.

 

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Additionally,the Bank Holding Company Act provides that the Federal Reserve Board may notapprove any of these transactions if it would result in or tend to create amonopoly or, substantially lessen competition or otherwise function as arestraint of trade, unless the anti-competitive effects of the proposedtransaction are clearly outweighed by the public interest in meeting theconvenience and needs of the community to be served. The Federal Reserve Boardis also required to consider the financial and managerial resources and futureprospects of the bank holding companies and banks concerned and the convenienceand needs of the community to be served. The Federal Reserve Board’sconsideration of financial resources generally focuses on capital adequacy,which is discussed below.

 

Underthe Bank Holding Company Act, if adequately capitalized and adequately managed,we, as well as other banks located within Georgia, may purchase a bank locatedoutside of Georgia. Conversely, an adequately capitalized and adequatelymanaged bank holding company located outside of Georgia may purchase a banklocated inside Georgia. In each case, however, restrictions may be placed onthe acquisition of a bank that has only been in existence for a limited amountof time or will result in specified concentrations of deposits. Currently,Georgia law prohibits a bank holding company from acquiring control of afinancial institution until the target financial institution has beenincorporated for three years. Because the bank has been chartered for more thanthree years, this limitation would not limit our ability to sell.

 

***Change in Bank Control.****** ***Subject to various exceptions, the Bank Holding Company Act and theChange in Bank Control Act, together with related regulations, require FederalReserve Board approval prior to any person or company acquiring “control” of abank holding company. Control is conclusively presumed to exist if anindividual or company acquires 25% or more of any class of voting securities ofthe bank holding company. Control is rebuttably presumed to exist if a personor company acquires 10% or more, but less than 25%, of any class of votingsecurities and either:

 

·                  thebank holding company has registered securities under Section 12 of theSecurities Act of 1934; or

 

·                  noother person owns a greater percentage of that class of voting securitiesimmediately after the transaction.

 

Ourcommon stock is registered under Section 12 of the Securities Exchange Actof 1934. The regulations provide a procedure for challenging any rebuttablepresumption of control.

 

***Permitted Activities. ***The Bank Holding Company Act has generally prohibited a bank holdingcompany from engaging in activities other than banking or managing orcontrolling banks or other permissible subsidiaries and from acquiring orretaining direct or indirect control of any company engaged in any activitiesother than those determined by the Federal Reserve to be closely related tobanking or managing or controlling banks as to be a proper incidentthereto.  Provisions of theGramm-Leach-Bliley Act have expanded the permissible activities of a bankholding company that qualifies as a financial holding company.  Under the regulations implementing theGramm-Leach-Bliley Act, a financial holding company may engage in additionalactivities that are financial in nature or incidental or complementary tofinancial activity.  Those activitiesinclude, among other activities, certain insurance and securities activities.

 

Toqualify to become a financial holding company, the Bank and any otherdepository institution subsidiary of the Company must be well capitalized andwell managed and must have a Community Reinvestment Act rating of at least “satisfactory.”  Additionally, the Company must file anelection with the Federal Reserve to become a financial holding company andmust provide the Federal Reserve with 30 days’ written notice prior to engagingin a permitted financial activity. While the Company meets the 

 

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qualificationstandards applicable to financial holding companies, we have not elected tobecome a financial holding company at this time.

 

***Support of Subsidiary Institution. ***Under Federal Reserve Board policy, we are expected to act as a sourceof financial strength and commit resources to support the Bank. This supportmay be required at times when, without this Federal Reserve Board policy, wemight not be inclined to provide it. Accordingly, in connection with theformation of the bank holding company we made a commitment to the FederalReserve Board not to incur any debt without its approval. In addition, anycapital loans made by us to the Bank will be repaid only after its deposits andvarious other obligations are repaid in full. In the unlikely event of ourbankruptcy, any commitment we give to a federal bank regulatory agency tomaintain the capital of the Bank will be assumed by the bankruptcy trustee andentitled to a priority of payment.

 

**The Bank**

 

Sincethe Bank is a commercial bank chartered under the laws of the State of Georgia,we are primarily subject to the supervision, examination and reportingrequirements of the FDIC and the Georgia Department of Banking and Finance. TheFDIC and Department of Banking and Finance regularly examine the bank’soperations and have the authority to approve or disapprove mergers, theestablishment of branches and similar corporate actions. Both regulatoryagencies have the power to prevent the continuance or development of unsafe orunsound banking practices or other violations of law. Additionally, ourdeposits are insured by the FDIC to the maximum extent provided by law. We arealso subject to numerous state and federal statutes and regulations that affectour business, activities and operations.

 

***Branching.*******Under current Georgia law, we may open branchoffices throughout Georgia with the prior approval of the Department of Bankingand Finance. In addition, with prior regulatory approval, we may acquirebranches of existing banks located in Georgia. the Bank and any other nationalor state-chartered bank generally may branch across state lines only if allowedby the applicable states’ laws. Georgia law, with limited exceptions, currentlypermits branching across state lines only through interstate mergers.

 

Underthe Federal Deposit Insurance Act, states may “opt-in” and allow out-of-statebanks to branch into their state by establishing a new start-up branch in thestate. Currently, Georgia has not opted-in to this provision. Therefore,interstate merger is the only method through which a bank located outside ofGeorgia may branch into Georgia. This provides a limited barrier of entry intothe Georgia banking market, which protects us from an important segment ofpotential competition. However, because Georgia has elected not to opt-in, ourability to establish a new start-up branch in another state is limited. Manystates that have elected to opt-in have done so on a reciprocal basis, meaningthat an out-of-state bank may establish a new start-up branch only if theirhome state has also elected to opt-in. Consequently, until Georgia changes itselection, the only way we will be able to branch into states that have electedto opt-in on a reciprocal basis will be through interstate merger.

 

***Prompt Corrective Action. ***The Federal Deposit Insurance Corporation Improvement Act of 1991establishes a system of prompt corrective action to resolve the problems ofundercapitalized financial institutions. Under this system, the federal banking regulators have established fivecapital categories, well capitalized, adequately capitalized, undercapitalized,significantly undercapitalized and critically undercapitalized, in which allinstitutions are placed.  The federalbanking regulators have also specified by regulation the relevant capitallevels for each of the other categories.

 

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Federalbanking regulators are required to take various mandatory supervisory actionsand are authorized to take other discretionary actions with respect toinstitutions in the three undercapitalized categories.  The severity of the action depends upon thecapital category in which the institution is placed.  Generally, subject to a narrow exception, thebanking regulator must appoint a receiver or conservator for an institutionthat is critically undercapitalized.

 

***FDIC Insurance Assessments.*** TheFDIC has adopted a risk-based assessment system for insured depositoryinstitutions that takes into account the risks attributable to differentcategories and concentrations of assets and liabilities.  The system assesses higher rates on thoseinstitutions that pose greater risks to the Deposit Insurance Fund (the “DIF”).  The FDIC places each institution in one offour risk categories using a two-step process based first on capital ratios(the capital group assignment) and then on other relevant information (the supervisorygroup assignment).  Within the lower riskcategory, Risk Category I, rates will vary based on each institution’s CAMELScomponent ratings, certain financial ratios, and long-term debt issuer ratings.

 

Capitalgroup assignments are made quarterly and an institution is assigned to one ofthree capital categories: (1) well capitalized; (2) adequatelycapitalized; and (3) undercapitalized. These three categories are substantially similar to the promptcorrective action categories described above, with the “undercapitalized”category including institutions that are undercapitalized, significantlyundercapitalized and critically undercapitalized for prompt corrective actionpurposes.  The FDIC also assigns aninstitution to one of three supervisory subgroups based on a supervisoryevaluation that the institution’s primary federal banking regulator provides tothe FDIC and information that the FDIC determines to be relevant to theinstitution’s financial condition and the risk posed to the deposit insurancefunds.  Assessments range from 5 to 43cents per $100 of deposits, depending on the institution’s capital group andsupervisory subgroup.  Institutions thatare well capitalized will be charged a rate between 5 and 7 cents per $100 ofdeposits.

 

TheFDIC may terminate its insurance of deposits if it finds that the institutionhas engaged in unsafe and unsound practices, is in an unsafe or unsoundcondition to continue operations, or has violated any applicable law,regulation, rule, order or condition imposed by the FDIC.

 

***Community Reinvestment Act. ***The Community Reinvestment Act requires that, in connection withexaminations of financial institutions within their respective jurisdictions,the Federal Reserve, the FDIC or the OCC shall evaluate the record of eachfinancial institution in meeting the credit needs of its local community,including low and moderate-income neighborhoods.  These facts are also considered in evaluatingmergers, acquisitions and applications to open a branch or facility.  Failure to adequately meet these criteriacould impose additional requirements and limitations on the Bank.  Additionally, we must publicly disclose theterms of various Community Reinvestment Act-related agreements.

 

***Allowance for Loan and Lease Losses. ***The Allowance for Loan and Lease Losses (the “ALLL”) represents one ofthe most significant estimates in the Bank’s financial statements andregulatory reports.  Because of itssignificance, the Bank has developed a system by which it maintains anddocuments a comprehensive, systematic and consistently applied process fordetermining the amounts of the ALLL and the provision for loan and leaselosses.  The Interagency Policy Statementon the Allowance for Loan and Lease Losses, issued on December 13, 2006,encourages all banks to ensure controls are in place to consistently determinethe ALLL in accordance with generally accepted accounting principles, the bank’sstated policies and procedures, management’s best judgment and relevantsupervisory guidance.  Consistent withsupervisory guidance, the Bank maintains a prudent and conservative, but notexcessive, ALLL, that is at a level that is appropriate to cover estimatedcredit losses on individually evaluated loans determined to be impaired as wellas estimated credit losses inherent in the remainder of the loan and leaseportfolio.  The Bank’s estimate of creditlosses has always reflected 

 

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considerationof all significant factors that affect the collectibility of the portfolio asof the evaluation date and has been and is determined in accordance withgenerally accepted accounting principles. See “Management’s Discussion and Analysis – Critical AccountingPolicies.”

 

***Commercial Real Estate Lending***.  TheBank’s lending operations may be subject to enhanced scrutiny by federalbanking regulators based on its concentration of commercial real estateloans.  On December 6, 2006, thefederal banking regulators issued final guidance to remind financialinstitutions of the risk posed by commercial real estate (“CRE”) lendingconcentrations.  CRE loans generallyinclude land development, construction loans and loans secured by multifamilyproperty, and nonfarm, nonresidential real property where the primary source ofrepayment is derived from rental income associated with the property.

 

***Other Regulations. ***Interestand other charges collected or contracted for by the Bank are subject to stateusury laws and federal laws concerning interest rates. The Bank’s loan operationswill be subject to federal laws applicable to credit transactions, such as the:

 

·                  FederalTruth-In-Lending Act, governing disclosures of credit terms to consumerborrowers;

 

·                  HomeMortgage Disclosure Act of 1975, requiring financial institutions to provideinformation to enable the public and public officials to determine whether afinancial institution is fulfilling its obligation to help meet the housingneeds of the community it serves;

 

·                  EqualCredit Opportunity Act, prohibiting discrimination on the basis of race, creedor other prohibited factors in extending credit;

 

·                  FairCredit Reporting Act of 1978, as amended by the Fair and Accurate CreditTransactions Act, governing the use and provision of information to creditreporting agencies, certain identity theft protections, and certain credit andother disclosures;

 

·                  FairDebt Collection Act, governing the manner in which consumer debts may becollected by collection agencies;

 

·                  ServicemembersCivil Relief Act, which amended the Soldiers’ and Sailors’ Civil Relief Act of1940, governing the repayment terms of, and property rights underlying, securedobligations of persons in military service; and

 

·                  rules andregulations of the various federal agencies charged with the responsibility ofimplementing these federal laws.

 

The Bank’s deposit operations are subject to federallaws applicable to depository accounts, such as the:

 

·                  Rightto Financial Privacy Act, which imposes a duty to maintain confidentiality ofconsumer financial records and prescribes procedures for complying withadministrative subpoenas of financial records;

 

·                  ElectronicFunds Transfer Act and Regulation E issued by the Federal Reserve Board toimplement that act, which govern automatic deposits to and withdrawals fromdeposit accounts and customers’ rights and liabilities arising from the use ofautomated teller machines and other electronic banking services;

 

·                  Truth-In-SavingsAct, requiring certain disclosures for consumer deposit accounts; and

 

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·                  rules andregulations of the various federal banking regulators charged with theresponsibility of implementing these federal laws.

 

**Capital Adequacy**

 

Weare required to comply with the capital adequacy standards established by theFederal Reserve Board, in the case of the Company, and the FDIC, in the case ofthe Bank.  The Federal Reserve Board hasestablished a risk-based and a leverage measure of capital adequacy for bankholding companies.  Since the Company’sconsolidated total assets are less than $500 million, under the Federal Reserve’scapital guidelines, our capital adequacy is measured on a bank-only basis, asopposed to a consolidated basis.  TheBank is also subject to risk-based and leverage capital requirements adopted bythe FDIC, which are substantially similar to those adopted by the FederalReserve for bank holding companies.

 

Therisk-based capital standards are designed to make regulatory capitalrequirements more sensitive to differences in risk profiles among banks andbank holding companies, to account for off-balance-sheet exposure, and tominimize disincentives for holding liquid assets. Assets and off-balance-sheetitems, such as letters of credit and unfunded loan commitments, are assigned tobroad risk categories, each with appropriate risk weights. The resultingcapital ratios represent capital as a percentage of total risk-weighted assetsand off-balance-sheet items.

 

Theminimum guideline for the ratio of total capital to risk-weighted assets is 8%.Total capital consists of two components, Tier 1 Capital and Tier 2 Capital.Tier 1 Capital generally consists of common stock, minority interests in theequity accounts of consolidated subsidiaries, noncumulative perpetual preferredstock and a limited amount of qualifying cumulative perpetual preferred stock,less goodwill and other specified intangible assets. Tier 1 Capital must equalat least 4% of risk-weighted assets. Tier 2 Capital generally consists ofsubordinated debt, other preferred stock and a limited amount of loan lossreserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1Capital. At December 31 2007, our ratio of total capital to risk-weightedassets was 11.68% and our ratio of Tier 1 Capital to risk-weighted assets was10.42%.

 

Inaddition, the Federal Reserve Board has established minimum leverage ratioguidelines for bank holding companies. These guidelines provide for a minimumratio of Tier 1 Capital to average assets, less goodwill and other specifiedintangible assets, of 3% for bank holding companies that meet specifiedcriteria, including having the highest regulatory rating and implementing theFederal Reserve Board’s risk-based capital measure for market risk. All otherbank holding companies generally are required to maintain a leverage ratio ofat least 4%.****At December 31, 2007,our leverage ratio was 9.82%. The guidelines also provide that bank holdingcompanies experiencing internal growth or making acquisitions will be expectedto maintain strong capital positions substantially above the minimumsupervisory levels without reliance on intangible assets. The Federal ReserveBoard considers the leverage ratio and other indicators of capital strength inevaluating proposals for expansion or new activities.

 

Failureto meet capital guidelines could subject a bank and a bank holding company to avariety of enforcement remedies, including issuance of a capital directive, thetermination of deposit insurance by the FDIC, a prohibition on acceptingbrokered deposits and certain other restrictions on its business. As describedabove, significant additional restrictions can be imposed on FDIC-insureddepository institutions that fail to meet applicable capital requirements.

 

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**Payment of Dividends**

 

The Company is a legal entity separate anddistinct from the Bank. The principal sources of our cash flow, including cashflow to pay dividends to its shareholders, are dividends that we receive fromthe Bank. Statutory and regulatory limitations apply to the payment ofdividends by a subsidiary bank to its bank holding company. These samelimitations apply to a bank holding company’s payment of dividends to itsshareholders. Our payment of dividends may also be affected by other factors,such as the requirement to maintain adequate capital above regulatoryguidelines.

 

Statutoryand regulatory limitations apply to our payment of dividends to ourshareholders. If, in the opinion of the federal banking regulator, we wereengaged in or about to engage in an unsafe or unsound practice, the federalbanking regulator could require, after notice and a hearing, that we cease anddesist from its practice. The federal banking agencies have indicated thatpaying dividends that deplete a depository institution’s capital base to aninadequate level would be an unsafe and unsound banking practice. Under theFederal Deposit Insurance Corporation Improvement Act of 1991, a depositoryinstitution may not pay any dividend if payment would cause it to becomeundercapitalized or if it already is undercapitalized. Moreover, the federalagencies have issued policy statements that provide that insured banks shouldgenerally only pay dividends out of current operating earnings

 

TheDepartment of Banking and Finance also regulates our dividend payments and mustapprove dividend payments that would exceed 50% of the bank’s net income forthe prior year. Our payment of dividends may also be affected or limited byother factors, such as the requirement to maintain adequate capital aboveregulatory guidelines**. **At December 31, 2007, theBank was unable to pay cash dividends to the Company without prior regulatoryapproval.

 

If,in the opinion of the federal banking regulator, the Bank was engaged in orabout to engage in unsafe or unsound practice, the federal banking regulatorcould require, after notice and a hearing, that the Bank stop or refrain fromengaging in the practice it considers unsafe or unsound.  The federal banking regulators have indicatedthat paying dividends that deplete a depository institution’s capital base toan inadequate level would be an unsafe and unsound banking practice.  Under the Federal Deposit InsuranceCorporation Improvement Act of 1991, a depository institution may not pay anydividend if payment would cause it to become undercapitalized or if it alreadyis undercapitalized.  Moreover, thefederal banking regulators have issued policy statements that provide that bankholding companies and insured banks should generally only pay dividends out ofcurrent operating earnings.

 

**Restrictions on Transactions with Affiliates**

 

TheCompany and the Bank are subject to the provisions of Section 23A of theFederal Reserve Act. Section 23A places limits on the amount of:

 

·                  abank’s loans or extensions of credit to affiliates;

 

·                  abank’s investment in affiliates;

 

·                  assetsa bank may purchase from affiliates, except for real and personal propertyexempted by the Federal Reserve Board;

 

·                  loansor extensions of credit to third parties collateralized by the securities orobligations of affiliates; and

 

·                  abank’s guarantee, acceptance or letter of credit issued on behalf of anaffiliate.

 

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Thetotal amount of the above transactions is limited in amount, as to any oneaffiliate, to 10% of a bank’s capital and surplus and, as to all affiliatescombined, to 20% of a bank’s capital and surplus. In addition to the limitationon the amount of these transactions, each of the above transactions must alsomeet specified collateral requirements. We must also comply with otherprovisions designed to avoid the taking of low-quality assets.

 

TheCompany and the Bank are also subject to the provisions of Section 23B ofthe Federal Reserve Act which, among other things, prohibit an institution fromengaging in the above transactions with affiliates unless the transactions areon terms substantially the same, or at least as favorable to the institution orits subsidiaries, as those prevailing at the time for comparable transactionswith nonaffiliated companies.

 

We are subject to restrictions on extensionsof credit to our executive officers, directors, principal shareholders andtheir related interests. These extensions of credit (1) must be made onsubstantially the same terms, including interest rates and collateral, as thoseprevailing at the time for comparable transactions with third parties and (2) mustnot involve more than the normal risk of repayment or present other unfavorablefeatures.

 

**Proposed Legislation and Regulatory Action**

 

Newregulations and statutes are regularly proposed that contain wide-rangingpotential changes to the structures, regulations and competitive relationshipsof financial institutions operating and doing business in the UnitedStates.  We cannot predict whether or inwhat form any proposed regulation or statute will be adopted or the extent towhich our business may be affected by any new regulation or statute.

 

**Effect of Governmental Monetary Policies**

 

Ourearnings are affected by domestic economic conditions and the monetary andfiscal policies of the United States government and its agencies.  The Federal Reserve Board’s monetary policieshave had, and are likely to continue to have, an important impact on theoperating results of commercial banks through its power to implement nationalmonetary policy in order, among other things, to curb inflation or combat arecession.  The monetary policies of theFederal Reserve Board affect the levels of bank loans, investments and depositsthrough its control over the issuance of United States government securities,its regulation of the discount rate applicable to member banks and itsinfluence over reserve requirements to which member banks are subject.  We cannot predict the nature or impact offuture changes in monetary and fiscal policies.

 

**ITEM 1A.****                   ****        RISKFACTORS**

 

*An investment in our common stock involves risks.  If any of the following risks or other risks,which have not been identified or which we may believe are immaterial orunlikely, actually occur, our business, financial condition and results ofoperations could be harmed.  In such acase, the trading price of our common stock could decline, and you may lose allor part of your investment.  The risksdiscussed below also include forward-looking statements, and our actual resultsmay differ substantially from those discussed in these forward-lookingstatements.*

 

***Current trends in the mortgage loan markets are adversely affecting ourcredit quality and profitability.***

 

Sincethe beginning of 2007, the market has seen several subprime lenders and hedgefunds that had invested in loans supported by real estate collateral declarebankruptcy and discontinue operations, 

 

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whileother lenders have continued to put in place more stringent underwritingcriteria.  Recent losses onmortgage-backed investment securities recorded by some larger financialinstitutions have resulted in reduced valuations, demand and liquidity forthese securities.

 

Thesechallenges have affected the mortgage loan marketplace by increasing theborrower’s cost of funds for loan supported by real estate.  More stringent loan underwriting standardscontinue to reduce the number of real estate borrowers who can find financingin the marketplace, and this continues to reduce the number of properties soldand refinanced.  The number ofresidential properties on the market has continued to increase, and in certain marketsincluding our own, there has been increasing downward pressure on the sellingprices of new and existing homes and also in the sales market values ofexisting properties, which are utilized as comparisons in valuing real estatecollateral.  This affects the ability ofsome borrowers, particularly those in construction and development, to sell theproperties securing their loans, which in turn makes it difficult for them tomake the scheduled repayments on those loans.

 

Theimpact of the described changes in the economy as a whole, and the real estatemarketplace specifically, has had a negative effect on our ability to grow ourloan levels and on the values of the collateral underlying our loans.  These changes could limit growth in interestincome and could also cause an increase in expenses associated with collectingon loans, foreclosing on real estate collateral, and selling properties thathave already been foreclosed.  Thepotential impact on the Company will depend on the duration and depth of thereal estate market downturn, which will also be affected by the financialmarket’s response to correcting the problems that have affected the market,including providing accommodations to borrowers in default or who areexperiencing financial difficulty.

 

***Declines in real estate values have adversely affected our creditquality and profitability.***

 

During2007, confidence in the credit market for residential housing finance eroded,which resulted in a reduction in financing available to buyers of new homes andborrowers wishing to refinance existing financing terms.  The tightening of credit availability for thepurchase of residential housing led to lower demand for residential housing andmore foreclosures, and has reduced the absorption rate for new and existingproperties.  In turn, this has causedmarket prices to fall as some property owners, including lenders who acquiredproperty by foreclosure, have accepted lower prices to reduce their exposure tothese real estate assets which has resulted in the reduction in the marketvalues for comparable real estate.** **The declines in values and theincreased level of marketing required to sell properties has reduced oreliminated the potential profits to many of the builders and developers ofproperties to whom we have extended loans. As a result, some of these borrowers have been unable to repay theirloans in accordance with their terms, which has led to an increase in our pastdue and non-performing loans.  If thesehousing trends continue or exacerbate, the Company expects that it willcontinue to experience increased delinquencies and credit losses.  Moreover, if a recession occurs thatnegatively impacts economic conditions in the United States as a whole or inspecific regions of the country, the Company would experience significantlyhigher delinquencies and credit losses. An increase in credit losses would reduce earnings and adversely affectthe Company’s financial condition. Furthermore, to the extent that real estate collateral is obtainedthrough foreclosure, the costs of holding and marketing the real estatecollateral, as well as the ultimate values obtained from disposition, couldreduce the Company’s earnings and adversely affect the Company’s financialcondition.

 

TheCompany’s business volume and growth is affected by the rate of growth anddemand for housing in specific geographic markets.  Based on the activity discussed above, theCompany expects that its level of historical growth could be significantlycurtailed and its assets may in fact shrink, depending on the duration and extentof the current disruption in the housing and mortgage markets.  The current disruption may expand andadversely impact the U.S. economy in general and the housing and mortgagemarkets in particular.  In addition, avariety of legislative, regulatory and other proposals have been 

 

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discussedor may be introduced in an effort to address the disruption.  Depending on the scope and nature oflegislative, regulatory or other initiatives, if any, that are adopted torespond to this disruption and applied to the Company, its financial condition,results of operations or liquidity could, directly or indirectly, benefit or beadversely affected in a manner that could be material to its business.

 

***If the value of real estate in our core market were todecline materially, a significant portion of our loan portfolio could becomeunder-collateralized, which could have a material adverse effect on ourbusiness, financial condition and results of operations.***

 

Withmost of our loans concentrated in Henry County, a decline in local economicconditions could adversely affect the values of our real estatecollateral.  Consequently, a decline inlocal economic conditions may have a greater effect on our earnings and capitalthan on the earnings and capital of larger financial institutions whose realestate loan portfolios are geographically diverse.

 

Inaddition to considering the financial strength and cash flow characteristics ofborrowers, we often secure loans with real estate collateral.  At December 31, 2007, approximately 92%of our loans had real estate as a primary or secondary component ofcollateral.  The real estate collateralin each case provides an alternate source of repayment in the event of defaultby the borrower and may deteriorate in value during the time the credit isextended.  If we are required toliquidate the collateral securing a loan to satisfy the debt during a period ofreduced real estate values, our earnings and capital could be adversely affected.

 

***We could suffer additional loan losses from a continuingdecline in credit quality.***

 

Wecould sustain losses if borrowers, guarantors and related parties fail toperform in accordance with the terms of their loans.  We have adopted underwriting and creditmonitoring procedures and policies, including the establishment and review ofthe allowance for credit losses that we believe are appropriate to minimizethis risk by assessing the likelihood of nonperformance, tracking loanperformance and diversifying our credit portfolio.  These policies and procedures, however, maynot prevent unexpected losses that could materially adversely affect ourresults of operations.

 

***Our profitability is vulnerable to interest ratefluctuations.***

 

Ourprofitability depends substantially upon our net interest income.  Net interest income is the difference betweenthe interest earned on assets, such as loans and investment securities, and theinterest paid for liabilities, such as savings and time deposits andout-of-market certificates of deposit. Market interest rates for loans, investments and deposits are highlysensitive to many factors beyond our control. Recently, interest rate spreads have generally narrowed due to changingmarket conditions, policies of various government and regulatory authoritiesand competitive pricing pressures, and we cannot predict whether these ratespreads will narrow even further.  Thisnarrowing of interest rate spreads could adversely affect our financialcondition and results of operations.

 

AtDecember 31, 2007 we were in a liability sensitive position, whichgenerally, means that changes in interest rates affect our interest paid forliabilities quicker than our interest earned on assets since the rates paid forour liabilities reset sooner than rates earned on our assets.  Accordingly, we anticipate that interest ratedecreases by the Federal Reserve Bank in the first quarter of 2008 will have anegative affect on our net interest income over the short term until theinterest rates paid on our liabilities reset.

 

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In addition, we cannot predict whetherinterest rates will continue to remain at present levels.  Changes in interest rates may causesignificant changes, up or down, in our net interest income.  Depending on our portfolio of loans andinvestments, our results of operations may be adversely affected by changes ininterest rates.

 

***Our access to additional short term funding to meetour liquidity needs is limited.***

 

Wemust maintain, on a daily basis, sufficient funds to cover withdrawals fromdepositors’ accounts and to supply new borrowers with funds. We routinelymonitor asset and liability maturities in an attempt to match maturities tomeet liquidity needs.  To meet our cash obligations,we rely on repayments as asset mature, keep cash on hand, maintain accountbalances with correspondent banks, purchase and sell federal funds, purchasebrokered deposits and maintain a line of credit with the Federal Home LoanBank.  If we are unable to meet ourliquidity needs through loan and other asset repayments and our cash on hand,we may need to borrow additional funds. Currently, our access to additional borrowed funds is limited and we maybe required to pay above market rates for additional borrowed funds, which mayadversely our results of operations.

 

***Additional growth may require us to raise additionalcapital in the future, but that capital may not be available when it is needed,which could adversely affect our financial condition and results of operations.***

 

Weare required by federal and state regulatory authorities to maintain adequatelevels of capital to support our operations. We anticipate that our current capital resources will satisfy ourcapital requirements for the foreseeable future.  We may at some point, however, need to raiseadditional capital to support our continued growth.

 

Ourability to raise additional capital, if needed, will depend on conditions inthe capital markets at that time, which are outside our control, and on ourfinancial performance.  Accordingly, wecannot assure you of our ability to raise additional capital, if needed, onterms acceptable to us.  If we cannotraise additional capital when needed, our ability to further expand ouroperations could be materially impaired.

 

***Our allowance for loan losses may not be adequate to cover actual loanlosses, which may require us to take a charge to our earnings and adverselyimpact our financial condition and results of operations.***

 

Wemaintain an allowance for estimated loan losses that we believe is adequate forabsorbing any probable losses in our loan portfolio.  Management determines the provision for loanlosses based upon an analysis of general market conditions, credit quality ofour loan portfolio, and performance of our customers relative to theirfinancial obligations with us.  We employan outside vendor specializing in credit risk management to evaluate our loanportfolio for risk grading, which can result in changes in our allowance forestimated loan losses.  The amount offuture losses is susceptible to changes in economic, operating, and otherconditions, including changes in interest rates, that may be beyond ourcontrol, and such losses may exceed the allowance for estimated loan losses.  Although management believes that theallowance for estimated loan losses is adequate to absorb any probable losseson existing loans that may become uncollectible, there can be no assurance thatthe allowance will prove sufficient to cover actual loan losses in thefuture.  Significant increases to theprovision for loan losses may be necessary if material adverse changes ingeneral economic conditions occur or the performance of our loan portfoliodeteriorates.  Additionally, federalbanking regulators, as an integral part of their supervisory function,periodically review the allowance for estimated loan losses.  If these regulatory agencies require us toincrease the allowance for estimated loan losses, it would have a negativeeffect on our results of operations and financial condition.

 

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***A continued economic downturn, especially oneaffecting our market areas, could continue to adversely affect our financialcondition, results of operations or cash flows.***

 

Oursuccess depends upon the growth in population, income levels, deposits andhousing starts in our primary market areas. If the communities in which we operate do not grow, or if prevailingeconomic conditions locally or nationally are unfavorable, our business may notsucceed.  Unpredictable economicconditions may have an adverse effect on the quality of our loan portfolio andour financial performance.  Economicrecession over a prolonged period or other economic problems in our marketareas could have a material adverse impact on the quality of the loan portfolioand the demand for our products and services. Future adverse changes in the economies in our market areas may have amaterial adverse effect on our financial condition, results of operations orcash flows.  Further, the bankingindustry in Georgia is affected by general economic conditions such asinflation, recession, unemployment and other factors beyond our control.  As a community bank, we are less able tospread the risk of unfavorable local economic conditions than larger or moreregional banks.  Moreover, we cannot giveany assurance that we will benefit from any market growth or favorable economicconditions in our primary market areas even if they do occur.

 

Themarket value of the real estate securing our loans as collateral has beenadversely affected by the slowing economy and unfavorable changes in economicconditions in our market areas and could be further adversely affected in thefuture. As of December 31, 2007, approximately 92% of our loans receivablewere secured by real estate. Any sustained period of increased paymentdelinquencies, foreclosures or losses caused by the adverse market and economicconditions, including the downturn in the real estate market, in our marketswill adversely affect the value of our assets, revenues, results of operationsand financial condition. Currently, we are experiencing such an economicdownturn, and if it continues, our operations could be further adverselyaffected.

 

***Changes in monetary policies may have an adverse effect onour business, financial condition and results of operations.***

 

Ourfinancial condition and results of operations are affected by credit policiesof monetary authorities, particularly the Federal Reserve Board.  Actions by monetary and fiscal authorities,including the Federal Reserve Board, could have an adverse effect on ourdeposit levels, loan demand or business and earnings.

 

***Our recent results may not be indicative of our futureresults, and may not provide guidance to assess the risk of an investment inour common stock.***

 

Wemay not be able to sustain our historical rate of growth or may not even beable to grow our business at all.  Inaddition, our recent and rapid growth may distort some of our historical financialratios and statistics.  In the future, wemay not have the benefit of several recently favorable factors, such as agenerally increasing interest rate environment, a strong residential mortgagemarket or the ability to find suitable expansion opportunities.  Various factors, such as economic conditions,regulatory and legislative considerations and competition, may also impede orprohibit our ability to expand our market presence.  If we experience a significant decrease inour historical rate of growth, our results of operations and financialcondition may be adversely affected due to a high percentage of our operatingcosts being fixed expenses.

 

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***If we fail to manage our past growth effectively, ourfinancial condition and results of operations could be negatively affected.***

 

Weexperienced significant growth in 2007, with our total assets increasing $68.5million, or 25.4%, from December 31, 2006. Our prospects must be considered in light of the risks, expenses anddifficulties frequently encountered by companies that have experienced thistype of growth.  Failure to manage ourpast growth effectively could have a material adverse effect on our business,financial condition, results of operations, or future prospects, and couldadversely affect our ability to successfully implement our business strategy.

 

***Our plans for future expansion depend, in some instances, onfactors beyond our control, and an unsuccessful attempt to achieve growth couldhave a material adverse effect on our business, financial condition, results ofoperations and future prospects.***

 

Weexpect to continue to engage in new branch expansion in the future.  We may also seek to acquire other financialinstitutions, or parts of those institutions, though we have no present plansin that regard.  Expansion involves anumber of risks, including:

 

·                  thetime and costs of evaluating new markets, hiring experienced local managementand opening new offices;

 

·                  thetime lags between these activities and the generation of sufficient assets anddeposits to support the costs of the expansion;

 

·                  wemay not be able to finance an acquisition without diluting the interests of ourexisting shareholders;

 

·                  thediversion of our management’s attention to the negotiation of a transaction maydetract from their business productivity;

 

·                  wemay enter into new markets where we lack experience; and

 

·                  wemay introduce new products and services with which we have no prior experienceinto our business.

 

***Our corporate culture has contributed to our success,and if we cannot maintain this culture as we grow, we could lose the teamworkand increased productivity fostered by our culture, which could harm ourbusiness.***

 

Webelieve that a critical contributor to our success has been our corporateculture, which we believe fosters teamwork and increased productivity.  As our organization grows and we are requiredto implement more complex organization management structures, we may find itincreasingly difficult to maintain the beneficial aspects of our corporateculture.  This could negatively impactour future success.

 

***We face intense competition in all of our currentand planned markets.***

 

Thefinancial services industry, including commercial banking, mortgage banking,consumer lending, and home equity lending, is highly competitive, and weencounter strong competition for deposits, loans, and other financial servicesin all of our market areas in each of our lines of business.  Our principal competitors include othercommercial banks, savings banks, savings and loan associations, mutual funds,money market funds, finance companies, trust companies, insurers, creditunions, and mortgage companies.  Many ofour non-bank competitors are not subject to the same degree of regulation 

 

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asus and have advantages over us in providing certain services.  Presently, 21 banks serve Henry County with atotal of 56 branches.  Many of ourcompetitors are significantly larger than us and have greater access to capitaland other resources.  Also, our abilityto compete effectively in our business is dependent on our ability to adaptsuccessfully to regulatory and technological changes within the banking andfinancial services industry generally. If we are unable to compete effectively, we will lose market share andour income from loans and other products may diminish.

 

Ourability to compete successfully depends on a number of factors, including,among other things:

 

·                  theability to develop, maintain, and build upon long-term customer relationshipsbased on top quality service and high ethical standards;

 

·                  thescope, relevance, and pricing of products and services offered to meet customerneeds and demands;

 

·                  therate at which we introduce new products and services relative to ourcompetitors;

 

·                  customersatisfaction with our level of service; and

 

·                  industryand general economic trends.

 

Failureto perform in any of these areas could significantly weaken our competitiveposition, which could adversely affect our growth and profitability, which, inturn, could have a material adverse effect on our financial condition andresults of operations.

 

***We are subject to extensive regulation that couldlimit or restrict our activities and impose financial requirements orlimitations on the conduct of our business, which limitations or restrictionscould adversely affect our profitability.***

 

Asa bank holding company, we are primarily regulated by the Board of Governors ofthe Federal Reserve System (“Federal Reserve Board”).  Our subsidiary bank is primarily regulated bythe Federal Deposit Insurance Corporation (the “FDIC”) and the GeorgiaDepartment of Banking and Finance.  Ourcompliance with Federal Reserve Board, FDIC and Department of Banking andFinance regulations is costly and may limit our growth and restrict certain ofour activities, including payment of dividends, mergers and acquisitions,investments, loans and interest rates charged, interest rates paid on depositsand locations of offices.  We are alsosubject to capital requirements of our regulators.

 

Thelaws and regulations applicable to the banking industry could change at anytime, and we cannot predict the effects of these changes on our business andprofitability.  Because governmentregulation greatly affects the business and financial results of all commercialbanks and bank holding companies, our cost of compliance could adversely affectour ability to operate profitably.

 

TheSarbanes-Oxley Act of 2002, the related rules and regulations promulgatedby the SEC that currently apply to us and the related exchange rules andregulations, have increased the scope, complexity and cost of corporategovernance, reporting and disclosure practices. As a result, we may experience greater compliance costs.

 

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***As a community bank, we have different lending risksthan larger banks.***

 

We provide services to our localcommunities.  Our ability to diversifyour economic risks is limited by our own local markets and economies.  We lend primarily to small to medium-sizedbusinesses, and, to a lesser extent, individuals which may expose us to greaterlending risks than those of banks lending to larger, better-capitalizedbusinesses with longer operating histories.

 

Wemanage our credit exposure through careful monitoring of loan applicants andloan concentrations in particular industries, and through loan approval andreview procedures.  We have establishedan evaluation process designed to determine the adequacy of our allowance forloan losses.  While this evaluation processuses historical and other objective information, the classification of loansand the establishment of loan losses is an estimate based on experience,judgment and expectations regarding our borrowers, the economies in which weand our borrowers operate, as well as the judgment of our regulators.  We cannot assure you that our loan lossreserves will be sufficient to absorb future loan losses or prevent a materialadverse effect on our business, financial condition, or results of operations.

 

***Opening new offices may not result in increased assets orrevenues for us.***

 

The investmentnecessary for branch expansion may negatively impact our efficiency ratio.  There is a risk that we will be unable tomanage our growth, as the process of opening new branches may divert our timeand resources.  There is also risk thatwe may fail to open any additional branches, and a risk that, if we do openthese branches, they may not be profitable which would negatively impact our resultsof operations.

 

***If we fail to retain our key employees, our growthand profitability could be adversely affected.***

 

Oursuccess is, and is expected to remain, highly dependent on our executivemanagement team, consisting of Thaddeus Williams, William Waller and LisaMaxwell.  This is particularly truebecause, as a community bank, we depend on our management team’s ties to thecommunity to generate business for us. Our growth will continue to place significant demands on our management,and the loss of any such person’s services may have an adverse effect upon ourgrowth and profitability.

 

***Our directors and executive officers own asignificant portion of our common stock and can influence stockholderdecisions.***

 

Ourdirectors and executive officers, as a group, beneficially owned approximately15.9% of our fully diluted outstanding common stock as of December 31,2007.  As a result of their ownership,the directors and executive officers will have the ability, if they voted theirshares in concert, to influence the outcome of all matters submitted to ourstockholders for approval, including the election of directors.

 

***Our ability to pay dividends is limited and we may beunable to pay future dividends.  As aresult, capital appreciation, if any, of our common stock may be your soleopportunity for gains on your investment for the foreseeable future.***

 

Wemake no assurances that we will pay any dividends in the future.  Any future determination relating to dividendpolicy will be made at the discretion of our Board of Directors and will dependon a number of factors, including our future earnings, capital requirements,financial condition, future prospects, regulatory restrictions and otherfactors that our Board of Directors may deem relevant.  The holders of our common stock are entitledto receive dividends when, and if declared by our Board of Directors out offunds legally available for that purpose. As part of our consideration to pay cash dividends, we intend to retainadequate funds from future earnings to support the development and growth 

 

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ofour business.  In addition, our abilityto pay dividends is restricted by federal policies and regulations.  It is the policy of the Federal Reserve Boardthat bank holding companies should pay cash dividends on common stock only outof net income available over the past year and only if prospective earningsretention is consistent with the organization’s expected future needs andfinancial condition. Further, our principal source of funds to pay dividends iscash dividends that we receive from the bank.

 

***Holders of our junior subordinated debentures haverights that are senior to those of our common stockholders.***

 

We have supported our continued growth by issuingtrust preferred securities from a special purpose trust and accompanying juniorsubordinated debentures. At December 31, 2007, we had outstanding trustpreferred securities totaling $8.2 million. We unconditionally guaranteed the payment of principal and interest onthe trust preferred securities.  Also,the junior debentures we issued to the special purpose trust that relate tothose trust preferred securities are senior to our common stock.  As a result, we must make payments on thejunior subordinated debentures before we can pay any dividends on our commonstock.  In the event of our bankruptcy,dissolution or liquidation, holders of our junior subordinated debentures mustbe satisfied before any distributions can be made on our common stock.  We do have the right to defer distributionson our junior subordinated debentures (and related trust preferred securities)for up to five years, but during that time we would not be able to paydividends on our common stock.

 

***Environmental liability associated with lendingactivities could result in losses.***

 

Inthe course of our business, we may foreclose on and take title to propertiessecuring our loans.  If hazardoussubstances are discovered on any of these properties, we may be liable togovernmental entities or third parties for the costs of remediation of thehazard, as well as for personal injury and property damage.  Many environmental laws can impose liabilityregardless of whether we knew of, or were responsible for, the contamination.  In addition, if we arrange for the disposalof hazardous or toxic substances at another site, we may be liable for thecosts of cleaning up and removing those substances from the site, even if weneither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and maymaterially limit the use of properties that we acquire through foreclosure,reduce their value or limit our ability to sell them in the event of a defaulton the loans they secure.  In addition,future laws or more stringent interpretations or enforcement policies withrespect to existing laws may increase our exposure to environmental liability.

 

**ITEM 1B.****              ****UNRESOLVEDSTAFF COMMENTS**

 

Thereare no written comments from the commission staff regarding our periodicreports or current reports under the Act which remain unresolved.

 

**ITEM 2.****                 ****DESCRIPTIONOF PROPERTY**

 

The Bank’s main office is located at 120 KeysFerry Street, McDonough, Georgia 30253. The main office is a one-story building of approximately 6,700 squarefeet and features traditional bank architecture.  The Bank’s main office includes a three-lanedrive-up facility, an external ATM and adequate parking.

 

19

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The Bank’s Stockbridge branch sits on 1.11acres and is located at 4421 N. Henry Boulevard, Stockbridge, Georgia30281.  The branch is a one-storybuilding of approximately 4,200 square feet and features traditional bankarchitecture.  The branch includes atwo-lane drive-up facility, an external ATM and adequate parking.

 

TheBank’s South Point Branch is situated on 1.25 acres and is located at 1375Highway 20 West, McDonough, Georgia 30253. The building is a two-story building of approximately 7,000 square feetand also features traditional bank architecture.  The branch includes a two-lane drive-upfacility, an external ATM and adequate parking.

 

The Bank’s Morrow branch is located at 6145 N. MainStreet, Morrow, Georgia 30260 which is in Clayton County.  The branch sits on 3.22 acres and is aone-story building of approximately 6,000 square feet.  The branch includes atwo-lane drive-up facility, an external ATM and adequate parking.

 

The Bank’s Operations Center is located at 1469Highway 20 West, McDonough, Georgia 30253 with approximately 8,100 square feetof leased office space.  The initial termof the lease is three years with two renewal options, each being for one year.

 

The Bank owns all four of its branch locations andleases its operations center.

 

**ITEM 3.****                 ****LEGALPROCEEDINGS**

 

Weare aware of no material pending legal proceedings to which the Company is aparty or of which any of its properties are subject; nor are we aware of anymaterial proceedings to be contemplated by any governmental authority; nor dowe know of any material proceedings, pending or contemplated, in which any director,officer or affiliate or any principal security holder of the Company or anyassociate of any of the foregoing, is a party or has an interest adverse to theCompany.

 

**ITEM 4.****                 ****SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

Nomatter was submitted to a vote of security holders during the fourth quarter of2007.

 

20

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**PART II**

 

**ITEM 5.****                 ****MARKETFOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER REPURCHASES**

 

TheCompany’s common stock began trading on the OTC Bulletin Board under the symbol“FBHC” in the second quarter of 2004.  OnDecember 12, 2005, NASDAQ changed the symbol to “FBFS”, in connection withthe formation of the bank holding company. There is a low volume of trading in the market for our commonstock.  The following table sets forthfor the periods indicated the quarterly high and low bid quotation per share asreported by the OTC Bulletin Board or as have come to the attention ofmanagement.  These quotations alsoreflect inter-dealer prices without retail markups, markdowns or commissions,and may not necessarily represent actual transactions.

 
| ** **                                | ** ** | **High** | ** ** | **Low** | ** ** |
|-------------------------------------------|------------|----------|------------|---------|------------|
| Fiscal year  ended December 31, 2007 |       |     |       |    |       |
| First Quarter                             |       | 16.00    |       | 13.75   |       |
| Second Quarter                            |       | 13.90    |       | 11.75   |       |
| Third Quarter                             |       | 11.90    |       | 8.10    |       |
| Fourth Quarter                            |       | 10.10    |       | 5.27    |       |
| Fiscal year  ended December 31, 2006 |       |     |       |    |       |
| First Quarter                             |       | 14.79    |       | 12.50   |       |
| Second Quarter                            |       | 15.42    |       | 13.96   |       |
| Third Quarter                             |       | 14.42    |       | 13.75   |       |
| Fourth Quarter                            |       | 16.95    |       | 13.96   |       |

 

Asof March 31, 2008, 2,701,882 shares of common stock were outstanding andwere held of record by approximately 539 persons (not including the number ofpersons or entities holding stock in nominee or street name through variousbrokerage houses.)

 

Nodividends were paid by the Company during 2007.

 

TheCompany repurchased 32,824 shares of its stock during the fourth quarter of2007 at prices ranging from $5.88 per share to $9.95 per share.  The following table provides additionalinformation regarding these repurchases:

 
| **Period**                                     | ** ** | **Total Number  of Shares  Purchased** | ** ** | **Average  Price Paid  per Share** | ** ** | **Total Number of  Shares Purchased as  Part of Publicly  Announced Plans or  Programs** | ** ** | **Maximum Number (or  Approximate Dollar  Value) of Shares that May  Yet Be Purchased Under  the Plans or Programs** | ** ** |
|------------------------------------------------|------------|--------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| October 1 –  October 31, 2007   |       | 14,760                                           |       | $                                            | 9.27       |                                                                                                                             | 14,760     |                                                                                                                                                                                  | 24,854     |   |
| November 1  – November 30, 2007 |       | 18,064                                           |       | 7.52                                         |       | 32,824                                                                                                                           |       | 6,790                                                                                                                                                                                 |       |
| December 1  – December 31, 2007 |       | —                                           |       | —                                       |       | —                                                                                                                           |       | —                                                                                                                                                                                |       |
| Total                                          |       | 32,824                                           |       | $                                            | 8.31       |                                                                                                                             | 32,824     |                                                                                                                                                                                  | —     |   |

 

OnAugust 16, 2007, the Board of Directors of FirstBank Financial Services, Inc.(the “Company”) approved a stock repurchase program to repurchase up to 5%, or141,583 shares of outstanding shares of common stock.  The Company entered into a Rule 10b5-1Plan for Share Repurchases for the period September 1, 2007 through March 31,2008 with a maximum repurchase price of $10.00 per share. The agreement wassubsequently terminated on January 10, 2008.

 

21

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

 

This information is not required since the Companyqualifies as a smaller reporting company.

 

22

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

 

Thefollowing is a discussion of our financial condition at December 31, 2007and 2006 and the results of operations for the years then ended. The purpose ofthis discussion is to focus on information about our financial condition andour results of operations that are not otherwise apparent from our auditedconsolidated financial statements. Reference should be made to those statements and the selected financialdata presented elsewhere in this report for an understanding of the followingdiscussion and analysis.

 

**Forward-LookingStatements**

 

Wemay from time to time make written or oral forward-looking statements,including statements contained in our filings with the Securities and ExchangeCommission and reports to stockholders. Statements made in this annual report, other than those concerninghistorical information, should be considered forward-looking and subject tovarious risks and uncertainties.  Suchforward-looking statements are made based upon management’s belief as well asassumptions made by, and information currently available to, management pursuantto “safe harbor” provisions of the Private Securities Litigation Reform Act of1995.  Our actual results may differmaterially from the results anticipated in forward-looking statements due to avariety of factors, including governmental monetary and fiscal policies,deposit levels, loan demand, loan collateral values, securities portfoliovalues, interest rate risk management, the effects of competition in thebanking business from other commercial banks, thrifts, mortgage banking firms,consumer finance companies, credit unions, securities brokerage firms, insurancecompanies, money market funds and other financial institutions operating in ourmarket area and elsewhere, including institutions operating through theInternet, changes in governmental regulation relating to the banking industry,including regulations relating to branching and acquisitions, failure ofassumptions underlying the establishment of allowance for loan losses,including the value of collateral underlying delinquent loans and otherfactors.  We caution that such factorsare not exclusive.  We do not undertaketo update any forward-looking statement that may be made from time to time by,or on behalf of us.

 

**Critical Accounting Policies**

 

Wehave adopted various accounting policies which govern the application ofaccounting principles generally accepted in the United States of America in thepreparation of our consolidated financial statements.  Our significant accounting policies aredescribed in the footnotes to the consolidated financial statements at December 31,2007 which are made a part of this annual report.

 

Certainaccounting policies involve significant judgments and assumptions by us whichhave a material impact on the carrying value of certain assets andliabilities.  We consider theseaccounting policies to be critical accounting policies.  The judgments and assumptions we use arebased on historical experience and other factors, which we believe to bereasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actualresults could differ from these judgments and estimates which could have amaterial impact on our carrying values of assets and liabilities and ourresults of operations.

 

*Allowance for loan losses*:  The allowance for loan losses represents management’s estimate of probable credit losses expected in the loan portfolio.  Estimating the amount of the allowance of loan losses required significant judgment and the use of estimates related to the fair market value or the estimated net realizable value of the underlying collateral on impaired loans, estimated losses on unimpaired loans based on historical loss experience, management’s evaluation of the current loan portfolio, and consideration of current economic trends and conditions.  Loan losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance.  A provision for loan losses is charged to operations based upon management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

 

23

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Theallowance for loan losses consists of specific, general and unallocatedcomponents.  The components of theallowance for loan losses represent an estimate to either Statement ofFinancial Accounting Standards (“SFAS”) No. 5, *Accountingfor Contingencies,* or SFAS No. 114, *Accountingby Creditors for Impairment of a Loan. *Theallocated component of the allowance for loan losses reflects expected lossesfrom analyses developed through specific credit allocations for individualproblem or potential problem loans and historical loss experience for each loancategory.  These analyses involve judgmentin estimating the amount of loss associated with the specific loans, includingestimating the underlying collateral values. Due to our limited loss history, the historical loss experience isdetermined using the average of actual losses of peer banks in the Atlanta MSAincurred over the prior five years for each loan category.  The historical loss experience is adjustedfor known changes in economic conditions as well as other qualitativefactors.  The resulting loss allocationfactors are applied to the balance of each loan category after removing thebalance of impaired loans from each category. The unallocated component reflects management’s estimate of potentialinherent but undetected losses within the portfolio due to uncertainties ineconomic conditions as well as a component that accounts for the inherentimprecision in the underlying assumptions used in the methodologies used forestimating specific and general losses in the loan portfolio.

 

Althoughmanagement believes its processes for determining the allowance adequately considerall the potential factors that could potentially result in credit losses, theprocesses include subjective elements and may be susceptible to significantchange.  In addition, there could bepotential problem loans in the portfolio that have not been identified asproblems because they continue to perform as set forth in the loanagreements.  Continued weakness in ourmarket area could cause currently performing credits to deteriorate.  To the extent the outcomes differ frommanagement estimates, additional provision for loan losses could be requiredthat could adversely affect earnings or financial position in future periods.

 

Additionalinformation on the Bank’s loan portfolio and allowance for loan losses can befound in the sections of Management’s Discussion and Analysis titled “RiskElements” and “Allowance for Loan Losses” and in Note 1 to the ConsolidatedFinancial Statements.

 

*Stock-based compensation**:*  The assumptions used in the determination ofthe fair value of stock options granted ultimately determine the recognition ofstock-based compensation expense.  Theshort-cut method was used to determine the expected life of the options.  This method, as prescribed by SAB Topic14.D.2, calculates the expected term based on the midpoint between the vestingdate of the option and the end of the contractual term.  Expected volatility was based upon thehistorical volatility of the Company’s stock. Risk-free interest rates for periods within the contractual life of theoption are based upon the U.S. Treasury yield curve in effect at the time ofthe grant.  Because of the need to retaincapital for expected growth and past history, the expected dividend rate is0%.  These assumptions have a significantimpact on the amount of expense recognized for stock-based compensation.

 

**Overview**

 

Duringthe second half of 2007, we experienced a significant downturn in our localreal estate market, as well as the overall metro Atlanta real estatemarket.  As a result, our operatingresults were below those of 2006.  Weanticipate that 2008 will also be a challenging year for earnings as wecontinue to see decreased construction and development loan activity.  Because of an increase in our average cost offunds, a 100 basis point drop in the Prime lending rate during the latter partof 2007, and a sharp increase in non-earning assets during the third and fourthquarters of 2007, our net interest margin decreased to 2.91% for 2007 ascompared to 4.00% in 2006.  Our netinterest margin was also affected by a dramatic increase in non-earning assetsduring the third and fourth quarters of 2007. Our ongoing analysis of the Bank’s loans, considering the currenteconomic environment and the level of impaired loans, has resulted in asignificant increase in our allowance for loan losses which has been calculatedin accordance with generally accepted accounting principles.

 

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Aftera consistent pattern of growth in the Company’s primary trade area over thelast few years, we anticipate a significant slowdown of housing sales, alongwith a corresponding negative impact on related economic sectors.  Indications of this slowdown are apparent inthe declining housing sales, as well as the significant drop in housing permitsissued by local governments.  Creditquality has become a major concern, with the Bank experiencing a substantialincrease in problem assets.  As thehousing market has slowed considerably, we anticipate that the Bank willexperience far less overall loan growth than in past years.  Flat or possibly negative growth, coupledwith compressed interest rate margins may negatively impact earnings in 2008.

 

**FinancialCondition at December 31, 2007 and 2006**

 

Following is asummary of our balance sheets for the periods indicated:

 
| ** **                     | ** ** | **December 31,**                | ** ** |
|--------------------------------|------------|--------------------------------------|------------|
| ** **                     | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                     | ** ** | **(Dollars in Thousands)** | ** ** |
|                           |       |                                 |       |   |   |
| Cash and due  from banks       |       | $                                    | 2,358      |   | $ | 5,838 |   |
| Federal funds  sold            |       | 14,620                               |       | 11,614 |   |
| Securities  available for sale |       | 54,645                               |       | 39,559 |   |
| Restricted  equity securities  |       | 2,517                                |       | 2,014 |   |
| Loans, net                     |       | 249,724                              |       | 208,005 |   |
| Premises and  equipment        |       | 7,565                                |       | 6,013 |   |
| Other real  estate owned       |       | 2,556                                |       | — |   |
| Other assets                   |       | 11,673                               |       | 4,037 |   |
|                           |       |                                 |       |   |   |
|                           |       | $                                    | 345,658    |   | $ | 277,080 |   |
|                           |       |                                 |       |   |   |
| Total deposits                 |       | $                                    | 274,946    |   | $ | 216,412 |   |
| Other borrowings               |       | 34,000                               |       | 22,000 |   |
| Subordinated  debentures       |       | 8,248                                |       | 8,248 |   |
| Other  liabilities             |       | 2,597                                |       | 2,667 |   |
| Stockholders’  equity     |       | 25,867                               |       | 27,753 |   |
|                           |       |                                 |       |   |   |
|                           |       | $                                    | 345,658    |   | $ | 277,080 |   |

 

Asof December 31, 2007, we had total assets of $346 million. Our totalassets grew by 25% in 2007.   Depositgrowth of $59 million, consisting of a $41 million increase in brokereddeposits and an $18 million increase in local deposits, were used to fund netloan growth of $42 million with the remainder being primarily invested insecurities.  Our loan to availablefunding ratio has remained steady since December 31, 2006, holding in the83-89% range.  Advances from the FederalHome Loan Bank increased by $12 million in 2007.  The net increase is the result of $6 millionin advances being called, $6 million in advances maturing, $4.9 million inadvance repayment and the subsequent borrowings of an additional $28.9 million.

 

Stockholders’equity has decreased by $1,885,805 due to net loss of $1,282,360, proceeds froma stock repurchase of $1,280,022, unrealized gains on securities available forsale, net of tax, of $385,776, reclassification adjustment for losses onsecurities available for sale recognized in net income, net of tax benefit, of$27,768, unrealized gains on interest rate floors, net of tax, of $172,364, andincluding recognition of share based compensation payments transactions asrequired by SFAS 123(R) of $90,669. We have not identified any permanent impairment in the securitiesportfolio, and no loss will be recognized in our income statement if thosesecurities with unrealized losses are held to maturity or for the foreseeablefuture.

 

25

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Securities

 

Oursecurities portfolio, consisting of U.S. Government sponsored agencysecurities, mortgage-backed securities and municipal securities, amounted to$54.6 million at December 31, 2007.  Netunrealized gains on securities amounted to $169,197 at December 31, 2007.  Management has not specifically identifiedany securities for sale in future periods that, if so designated, would requirea charge to operations if the market value would not be reasonably expected torecover prior to the time of sale.

 

Loans

 

Wehave 92% of our loan portfolio collateralized by real estate located in ourprimary market area of Henry County, Georgia and surrounding counties.  Our real estate mortgages and constructionportfolio consists of loans collateralized by one- to four-family residentialproperties (6%), construction loans to build one- to four-family residentialproperties (81%), and nonresidential properties consisting primarily of smallbusiness commercial properties (13%).  Wegenerally require that loans collateralized by real estate not exceed thecollateral values by the following percentages for each type of real estateloan as follows.

 
| One- to  four-family residential properties                       |   | 80 | % |
|-------------------------------------------------------------------|--------|----|---|
| Construction  loans on one- to four-family residential properties |   | 80 | % |
| Nonresidential  property                                          |   | 90 | % |

 

Theremaining 8% of the loan portfolio consists of commercial, consumer, and otherloans.  We require collateralcommensurate with the repayment ability and creditworthiness of the borrower.

 

Thespecific economic and credit risks associated with our loan portfolio,especially the real estate portfolio, include, but are not limited to, ageneral downturn in the economy which could affect unemployment rates in ourmarket area, general real estate market deterioration, interest ratefluctuations, deteriorated or non-existing collateral, title defects,inaccurate appraisals, financial deterioration of borrowers, fraud, and anyviolation of banking protection laws. Construction lending can also present other specific risks to the lendersuch as whether developers can find builders to buy lots for home construction,whether the builders can obtain financing for the construction, whether thebuilders can sell the home to a buyer, and whether the buyer can obtainpermanent financing.  Currently, realestate values and employment trends in our market area continue to show signsof downward pressure as a result of a slowdown in the general economy.

 

Weattempt to reduce these economic and credit risks not only by adhering to loanto value guidelines, but also by investigating the creditworthiness of theborrower and monitoring the borrower’s financial position.  Also, we establish and periodically reviewour lending policies and procedures. Banking regulations limit exposure by prohibiting loan relationshipsthat exceed 25% of the Bank’s statutory capital, as defined by the State ofGeorgia.

 

**Liquidityand Capital Resources**

 

Thepurpose of liquidity management is to ensure that there are sufficient cashflows to satisfy demands for credit, deposit withdrawals, and our otherneeds.  Traditional sources of liquidityinclude asset maturities and growth in core deposits.  A company may achieve its desired liquidityobjectives from the management of assets and liabilities and through funds providedby operations.  Funds invested inshort-term marketable instruments and the continuous maturing of other earningassets are sources of liquidity from the asset perspective.  The liability base provides sources ofliquidity through deposit growth, the maturity structure of liabilities, andaccessibility to market sources of funds.

 

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Scheduledloan payments are a relatively stable source of funds, but loan payoffs anddeposit flows fluctuate significantly, being influenced by interest rates andgeneral economic conditions andcompetition.  We attempt to price deposits to meetasset/liability objectives consistent with local market conditions.

 

Ourliquidity and capital resources are monitored on a periodic basis by managementand regulatory authorities.  Asdetermined under guidelines established by regulatory authorities and internalpolicy, our liquidity was considered satisfactory.

 

AtDecember 31, 2007 we had loan commitments and letters of creditoutstanding of $30.5 million.  Becausethese commitments generally have fixed expiration dates and many will expirewithout being drawn upon, the total commitment amounts do not necessarilyrepresent future cash requirements.

 

Dueto the recent turmoil in the real estate and financial markets, our financialstatements reflect weaker operating results than in previous periods. Because of this, we anticipate our ranking to be lowered by rating agencies inthe coming quarters.  At December 31, 2007, brokered certificates ofdeposit totaled $127.2 million with $91.7 million maturing within the nexttwelve months.  Subsequent to December 31,2007, management implemented a funding plan to mitigate the exposure to theuncertainties of the brokered CD market by pre-funding some of the futurematurities into longer term certificates.

 

Ifneeded, we have the ability on a short-term basis to borrow and purchase Federalfunds from other financial institutions. At December 31, 2007, we had arrangements with two commercial banksfor short-term unsecured lines of credit of $14.4 million.  We also had a remaining credit availabilityof $32 million at the Federal Home Loan Bank of Atlanta that could be drawnagainst with adequate collateral. Subsequent to December 31, 2007, the bank has secured a $4.6million collateralized line at the Federal Discount Window as another source ofliquidity.

 

AtDecember 31, 2007, our capital ratios were considered adequate based onregulatory minimum capital requirements. Banking regulations limit the amount of the dividends that may be paidwithout prior approval of the Bank’s regulatory agency.  Currently, no dividends could be paid by theBank to the Company.

 

Theminimum capital requirements to be considered well capitalized under promptcorrective action provisions and the actual capital ratios for the Company asof December 31, 2007 are as follows:

 
| ** **                  | ** ** | **Company** | ** ** | **Bank**   | ** ** | **Regulatory**   | ** ** |
|-----------------------------|------------|-------------|------------|------------|------------|------------------|------------|
| ** **                  | ** ** | **Actual**  | ** ** | **Actual** | ** ** | **Requirements** | ** ** |
|                        |       |        |       |       |       |             |       |
| Leverage capital  ratio     |       | 9.82        | %          | 8.99       | %          | 5.00             | %          |
| Risk-based  capital ratios: |       |        |       |       |       |             |       |
| Core capital                |       | 11.57       | %          | 10.42      | %          | 6.00             | %          |
| Total capital               |       | 12.84       | %          | 11.68      | %          | 10.00            | %          |

 

These ratios may decline due to anticipated increases in impairedloans, but are expected to exceed the regulatory minimum requirements.  During 2006, the Company issued $8,248,000 oftrust preferred securities which were invested in subordinated debenturesissued by the Company.  Thesesubordinated debentures qualify as Tier 1 capital subject to regulatorylimitations.  See Note 8 to the Notes toConsolidated Financial Statements for additional details.

 

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*ContractualObligations*

 

Summarizedbelow are our contractual obligations as of December 31, 2007.

 
| ** **                       | ** ** | ** ** | ** ** | **Less than** | ** ** | **1 to 3** | ** ** | **3 to 5** | ** ** | **More than** | ** ** |
|----------------------------------|------------|------------|------------|--------------------|------------|----------------------|------------|----------------------|------------|--------------------|------------|
| **Contractual Obligations** | ** ** | **Total**  | ** ** | **1 year**    | ** ** | **years**            | ** ** | **years**            | ** ** | **5 years**   | ** ** |
| **(Dollars  in Thousands)**      | ** ** | ** ** | ** ** | ** **         | ** ** | ** **           | ** ** | ** **           | ** ** | ** **         | ** ** |
|                             |       |       |       |               |       |                 |       |                 |       |               |       |
| FHLB advances                    |       | $          | 34,000     |               | $          | 10,000               |       | $                    | 5,000      |               | $          | 14,000 |   | $ | 5,000 |   |
| Lease  commitments               |       | 1,610      |       | 169                |       | 289                  |       | 192                  |       | 960                |       |
| Subordinated  debentures         |       | 8,248      |       | —             |       | —               |       | —               |       | 8,248              |       |
|                             |       |       |       |               |       |                 |       |                 |       |               |       |
|                             |       | $          | 43,858     |               | $          | 10,169               |       | $                    | 5,289      |               | $          | 14,192 |   | $ | 14,208 |   |

 

*Off-Balance-SheetFinancing*

 

Our financial statements do not reflect various commitments andcontingent liabilities that arise in the normal course of business.  These off-balance-sheet financial instrumentsinclude commitments to extend credit and standby letters of credit.  These financial instruments are included inthe financial statements when funds are distributed or the instruments becomepayable.  We use the same credit policiesin making commitments as we do for on-balance-sheet instruments.  Our exposure to credit loss in the event ofnonperformance by the other party to the financial instrument for commitmentsto extend credit and standby letters of credit is represented by thecontractual amount of those instruments. At December 31, 2007, we had outstanding commitments to extendcredit through open lines of $29.6 million and outstanding standby letters ofcredit of approximately $.9 million.

 

Subsequentto December 31, 2007, we had commitments for capital expenditures ofapproximately $1.6 million to construct our Covington branch facility locatedat 5220 Highway 278, Covington, Georgia. Due to current economic conditions, the construction of the branch hasbeen temporarily postponed as provided for in the terms of the agreement.

 

We believe that our liquidity and capital resources are adequate atthis time.  We may face challenges as wemeet our foreseeable short and long-term liquidity and capital needs in lightof current economic conditions.  Weanticipate that we will have sufficient funds available to meet current loancommitments and to fund or refinance, on a timely basis, our other materialcommitments and liabilities.

 

Management is not aware of any known trends, events or uncertaintiesother than those discussed above that will have or that are reasonably likelyto have a material effect on our liquidity, capital resources oroperations.  Management is also not awareof any current recommendations by the regulatory authorities that, if they wereimplemented, would have such an effect.

 

Effects of Inflation

 

The impact of inflation on banks differs from its impact onnon-financial institutions.  Banks, asfinancial intermediaries, have assets that are primarily monetary in nature andthat tend to fluctuate in concert with inflation.  A bank can reduce the impact of inflation ifit can manage its rate sensitivity gap. This gap represents the difference between rate sensitive assets andrate sensitive liabilities.  We, throughour asset-liability management strategies, attempt to structure the assets andliabilities and manage the rate sensitivity gap, thereby seeking to minimizethe potential effects of inflation.  Forinformation on the management of our interest rate sensitive assets andliabilities, see “Asset/Liability Management.”

 

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**Results of Operations****For TheYears Ended December 31, 2007 and 2006**

 

The following is a summary of our operations for the periods indicated.

 
| ** **                         | ** ** | **Years Ended**                 | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                         | ** ** | **(Dollars in Thousands)** | ** ** |
|                               |       |                                 |       |   |   |
| Interest income                    |       | $                                    | 22,587     |   | $ | 18,881 |   |
|                               |       |                                 |       |   |   |
| Interest expense                   |       | (14,030                              | )          | (9,272 | ) |
|                               |       |                                 |       |   |   |
| Net interest  income               |       | 8,557                                |       | 9,609 |   |
|                               |       |                                 |       |   |   |
| Provision for  loan losses         |       | (5,080                               | )          | (480 | ) |
|                               |       |                                 |       |   |   |
| Other income                       |       | 600                                  |       | 315 |   |
|                               |       |                                 |       |   |   |
| Other expenses                     |       | (6,333                               | )          | (5,385 | ) |
|                               |       |                                 |       |   |   |
| Income (loss)  before income taxes |       | (2,256                               | )          | 4,059 |   |
|                               |       |                                 |       |   |   |
| Income tax  benefit (expense)      |       | 974                                  |       | (1,497 | ) |
|                               |       |                                 |       |   |   |
| Net income  (loss)                 |       | $                                    | (1,282     | ) | $ | 2,562 |   |

 

The net loss for 2007 was influenced by a sharp decline in loan demand,particularly in the residential construction and housing markets.  Although the Bank does not participate insub-prime lending, the slowdown in the housing market resulted in a buildup offinished home inventories as well as a surplus of finished lot inventories.  This put stress on many residential real estatebuilders and developers who depend on an active housing market to sell theirinventories.  As a result, loan demanddecreased while the Bank experienced a sharp increase in credit losses andnonperforming loans.  The soft housingmarket also affected deposit pricing as large mortgage banks and localcommunity banks, needing liquidity, aggressively competed for certificates ofdeposit, driving rates significantly above wholesale borrowings with similarterms.  Competitive deposit pricing andthe carrying cost of a larger base on nonperforming assets compressed the netinterest margin further affecting 2007 earnings.

 

Net Interest Income

 

Our results of operations are determined by our ability to manageinterest income and expense effectively, to minimize loan and investmentlosses, to generate non-interest income, and to control operatingexpenses.  Because interest rates aredetermined by market forces and economic conditions beyond our control, ourability to generate net interest income is dependent upon our ability to obtainan adequate net interest spread between the rate we pay on interest-bearingliabilities and the rate we earn on interest-earning assets.

 

Ournet interest income decreased by $1,052,000 in 2007 as compared to the sameperiod in 2006.  The decrease wasprimarily due to interest income reversed on nonaccrual loans totalingapproximately $1,343,000 in 2007.  Ournet interest margin was 2.91% for the year ended 2007 as compared to 4.00% in2006. Our cost of funds increased to 5.19% for 2007 as compared to 4.46% in2006.  Average loans were $238.7 million,average securities were $50.1 million, and average federal funds sold were $7.8million.  Average interest-bearing liabilitieswere $270.4 million.  The rate earned onaverage interest-earning assets was 7.56% in 2007 compared to 7.86% in 2006.

 

29

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Provision for Loan Losses

 

The provision for loan losses was $5,080,000 in 2007 as compared to$480,000 in 2006.  The amount providedwas due primarily to our assessment of expected risk in the loan portfolio andthe increase in problem and potential problem loans. Please see the sectiontitled “Allowance for Loan Losses” for a more detailed explanation of ourassessment criteria as it relates to providing for loan losses.  We believe that the $7.1 million in theallowance for loan losses at December 31, 2007, or 2.78% of total netoutstanding loans is adequate to absorb known risks in the loan portfolio. Ournet charge-offs increased to $330,000 for the year ended 2007 as compared to$5,000 in 2006.  Our charge-offs wereminimal in 2007 and 2006 as the ratio of charged-off loans to average loansoutstanding was .14% and .003%, respectively. No assurance can be given that increased nonperforming loan volume andadverse economic conditions or other circumstances will not result in increasedlosses in our loan portfolio.

 

Noninterest Income

 

The following table represents the principal components of noninterestincome for the years ended December 31, 2007 and 2006.

 
| ** **                                                      | ** ** | **2007**                             | ** ** | **2006** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                                                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Income from  bank-owned life insurance                          |       | $                                    | 34         |     | $          | — |   |
| Service charge  income related to deposit accounts and ATM fees |       | 467                                  |       | 255      |       |
| Gain on sale of  other real estate owned                        |       | 21                                   |       | —   |       |
| Other                                                           |       | 78                                   |       | 60       |       |
| Total  noninterest income                                       |       | $                                    | 600        |     | $          | 315 |   |

 

Noninterest income consists of service charges on deposit accounts,other miscellaneous service charges, fees and income.  Noninterest income increased by $285,000, or91% to $600,000 in 2007 as compared to $315,000 in 2006.  The primary reason for the increase was theimplementation of an overdraft privilege program which increased NSF charges by$197,000, or 89% to $362,000 as compared to $165,000 in 2006.  Service charges related to ATM servicesincreased $35,000, or 60% to $93,000 in 2007 as compared to $58,000 in2006.  Bank owned life insurance waspurchased in October 2007 to offset current and future employee benefitcosts which increased other income $34,000 in 2007.  Additionally, the gain on sale of other realestate owned totaling $21,000 offset a marginal decrease in other income of$2,000.

 

Noninterest Expense

 

The following table represents the principal components of noninterestexpense for the years ended December 31, 2007 and 2006.

 

30

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| ** **                                     | ** ** | **2007**                             | ** ** | **2006** | ** ** |
|------------------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                                     | ** ** | **(Dollars in Thousands)** | ** ** |
| Salaries and  employee benefits                |       | $                                    | 3,142      |     | $          | 3,052 |   |
| Equipment and  occupancy                       |       | 975                                  |       | 716      |       |
| Data processing                                |       | 333                                  |       | 267      |       |
| Directors’ fees                           |       | 147                                  |       | 134      |       |
| Accounting and  audit fees                     |       | 148                                  |       | 96       |       |
| Regulatory fees                                |       | 187                                  |       | 53       |       |
| Other real  estate owned expense               |       | 109                                  |       | —   |       |
| Advertising and  marketing                     |       | 103                                  |       | 152      |       |
| Computer  software and maintenance             |       | 120                                  |       | 84       |       |
| Loss on sale of  securities available for sale |       | 45                                   |       | —   |       |
| Other                                          |       | 1,025                                |       | 831      |       |
| Total  noninterest expense                     |       | $                                    | 6,334      |     | $          | 5,385 |   |

 

Noninterest expenses increased 18% to $6.3 million in 2007 from $5.4million in 2006.  Salaries and employeebenefits increased $90,000.  Totalfull-time equivalent employees increased during the current year to 61 from 48at December 31, 2006.  The majorityof the additions to staff were due to the opening of our Morrow branch and toprovide additional support in the branch and operations areas of the bank.  Other annual salary increases, therecognition of stock compensation expense of $91,000 as required by FAS 123(R) andbonuses contributed to the increase in salaries and employee benefits.  Bonuses paid to executive officers underemployment agreements for 2007 and 2006 were $89,000 and $228,000, respectively.

 

Equipment and occupancy expenses increased $259,000, or 36% in 2007primarily due to branch expansion which increased depreciation and occupancyexpense, additional equipment needs for employees, other occupancy expensesrelated to the operations center and the new ground lease of$8,000 permonth for our Covington branch.  TheCompany leases it operations center facilities under an operating leaseagreement for approximately $70,000 a year in rental expense.

 

Data processing fees increased $66,000, or 25% compared to 2006.  This increase was attributed to the openingof our Morrow branch, bill pay product implementation and the overall growth ofthe bank.  The increase of $13,000 indirectors’ fees was due in part to a new director added to the Board of theBank and Company designated as the Company’s financial expert. The increase of$52,000 in audit and accounting fees was due to the implementation of the firstphase of SOX 404 which required management to test internal controls in orderto assess their effectiveness in 2007. Regulatory fees increased $134,000, or 253% as compared to 2006 whichwas due to the new FDIC assessment methodology implemented in 2007. Expensesrelated to the increase in other real estate owned totaled $109,000 in 2007.Advertising and marketing expenses decreased $49,000, or 32% compared to2006.  This decrease was due to a changein the Bank’s marketing plan to maximize the benefit of our outdoor messageboards as opposed to billboards. Computer software and maintenance increased$36,000, or 43% compared to 2006.  Thisincrease was mainly due to overall growth and branch expansion in 2007.  Loss on sale of securities increased $45,000as compared to 2006 in an effort to protect the long-term earnings of the Bankby actively managing the Bank’s interest rate risk sensitivity.  Other noninterest expenses also increased$194,000, or 23% compared to 2006. Included in this amount are expenses totaling $68,000 related to thechange of the Bank’s name effective January 1, 2007.

 

Income Tax

 

Income tax benefit was $974,000 for 2007 as compared to income taxexpense of $1,497,000 in 2006.  Thedecrease in our income tax provision was $2,471,000 as compared to 2006.  The effective tax rate for the year ended December 31,2007 was 0% as compared to 37% to 2006. The decrease in our effective tax rate is due primarily to the decreasein net income, decrease of expense related to the permanent non-deductibilityof

 

31

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incentive stock options that have been expensed in the amount of$81,000 for 2007 as compared to $144,000 for 2006, income from bank owned lifeinsurance totaling $34,000 and an increase in tax exempt interest incometotaling $109,000.

 

Asset/Liability Management

 

Our objective is to manage assets and liabilities to provide asatisfactory, consistent level of profitability within the framework ofestablished cash, loan, investment, borrowing, and capital policies.  Certain officers are charged with theresponsibility for monitoring policies and procedures that are designed toensure acceptable composition of the asset/liability mix.  Our management’s overall philosophy is tosupport asset growth primarily through growth of core deposits of allcategories made by local individuals, partnerships, and corporations.

 

Our asset/liability mix is monitored on a regular basis with a reportreflecting the interest rate-sensitive assets and interest rate-sensitiveliabilities being prepared and presented to the Board of Directors on a periodicbasis.  The objective of this policy isto monitor interest rate-sensitive assets and liabilities so as to minimize theimpact of substantial movements in interest rates on earnings.  An asset or liability is considered to beinterest rate-sensitive if it will reprice or mature within the time periodanalyzed, usually one year or less. The interest rate-sensitivity gap is thedifference between the interest-earning assets and interest-bearing liabilitiesscheduled to mature or reprice within such time period.  A gap is considered positive when the amountof interest rate-sensitive assets exceeds the amount of interest rate-sensitiveliabilities.  A gap is considerednegative when the amount of interest rate-sensitive liabilities exceeds theinterest rate-sensitive assets.  During aperiod of rising interest rates, a negative gap would tend to affect netinterest income adversely, while a positive gap would tend to result in anincrease in net interest income. Conversely, during a period of falling interestrates, a negative gap would tend to result in an increase in net interestincome, while a positive gap would tend to affect net interest incomeadversely.  If our assets and liabilitieswere equally flexible and moved concurrently, the impact of any increase or decreasein interest rates on net interest income would be minimal.

 

A simple interest rate “gap” analysis by itself may not be an accurateindicator of how net interest income will be affected by changes in interestrates.  Accordingly, we also evaluate howthe repayment of particular assets and liabilities is impacted by changes ininterest rates.  Income associated withinterest-earning assets and costs associated with interest-bearing liabilitiesmay not be affected uniformly by changes in interest rates.  In addition, the magnitude and duration ofchanges in interest rates may have a significant impact on net interestincome.  For example, although certainassets and liabilities may have similar maturities or periods of repricing,they may react in different degrees to changes in market interest rates.  Interest rates on certain types of assets andliabilities fluctuate in advance of changes in general market rates, whileinterest rates on other types may lag behind changes in general market rates.  In addition, certain assets, such asadjustable rate mortgage loans, have features (generally referred to as “interestrate caps and floors”) that limit changes in interest rates.  Prepayment and early withdrawal levels alsocould deviate significantly from those assumed in calculating the interest rategap.  The ability of many borrowers toservice their debts also may decrease during periods of rising interest rates.

 

Changes in interest rates also affect our liquidity position.  We currently price deposits in response tomarket rates and it is management’s intention to continue this policy.  If deposits are not priced in response tomarket rates, a loss of deposits could occur that would negatively affect ourliquidity position.

 

At December 31, 2007, our cumulative one year interestrate-sensitivity gap ratio was (93%). Our targeted ratio is 90% to 120% in this time horizon.  This indicates that our interest-bearingliabilities will reprice during this period at a rate faster than our interest-earningassets.

 

The following table sets forth the distribution of the repricing of ourinterest-earning assets and interest-bearing liabilities as of December 31,2007, the interest rate-sensitivity gap,

 

32

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the cumulative interest rate-sensitivity gap, the interestrate-sensitivity gap ratio and the cumulative interest rate-sensitivity gapratio.  The table also sets forth thetime periods in which interest-earning assets and interest-bearing liabilitieswill mature or may reprice in accordance with their contractual terms.  However, the table does not necessarilyindicate the impact of general interest rate movements on the net interestmargin as the repricing of various categories of assets and liabilities issubject to competitive pressures and the needs of our customers.  In addition, various assets and liabilitiesindicated as repricing within the same period may in fact, reprice at differenttimes within this period and at different rates.

 
| ** **                                      | ** ** | ** **                           | ** ** | **After**         | ** ** | **After**         | ** ** | ** ** | ** ** | ** ** | ** ** |
|-------------------------------------------------|------------|--------------------------------------|------------|-------------------|------------|-------------------|------------|------------|------------|------------|------------|
| ** **                                      | ** ** | ** **                           | ** ** | **Three**         | ** ** | **One**           | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | ** **                           | ** ** | **Months**        | ** ** | **Year but** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Within**                           | ** ** | **But**           | ** ** | **Within**        | ** ** | **After**  | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Three**                            | ** ** | **Within**        | ** ** | **Five**          | ** ** | **Five**   | ** ** | ** ** | ** ** |
| ** **                                      | ** ** | **Months**                           | ** ** | **One Year** | ** ** | **Years**         | ** ** | **Years**  | ** ** | **Total**  | ** ** |
| ** **                                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Interest-earning  assets:                       |       |                                 |       |              |       |              |       |       |       |       |       |
| Federal funds  sold                             |       | $                                    | 14,620     |              | $          | —            |       | $          | —     |       | $          | — |   | $ | 14,620 |   |
| Interest-bearing  due from                      |       | 701                                  |       | —            |       | 80                |       | —     |       | 781        |       |
| Securities                                      |       | —                               |       | 498               |       | 17,123            |       | 37,025     |       | 54,646     |       |
| Loans (1)                                       |       | 173,905                              |       | 15,575            |       | 18,240            |       | 498        |       | 208,218    |       |
|                                            |       | $                                    | 189,226    |              | $          | 16,073            |       | $          | 35,443     |       | $          | 37,523 |   | $ | 278,265 |   |
|                                            |       |                                 |       |              |       |              |       |       |       |       |       |
| Interest-bearing  liabilities:                  |       |                                 |       |              |       |              |       |       |       |       |       |
| Interest-bearing  demand deposits               |       | $                                    | 13,036     |              | $          | —            |       | $          | 25,305     |       | $          | — |   | $ | 38,341 |   |
| Savings                                         |       | 6,110                                |       | —            |       | 6,109             |       | —     |       | 12,219     |       |
| Certificates,  less than $100,000               |       | 49,001                               |       | 93,169            |       | 34,146            |       | —     |       | 176,316    |       |
| Certificates,  $100,000 and over                |       | 7,664                                |       | 27,694            |       | 2,859             |       | —     |       | 38,217     |       |
| Other borrowings                                |       | 15,000                               |       | —            |       | 14,000            |       | 5,000      |       | 34,000     |       |
| Trust preferred  securities                     |       | 8,248                                |       | —            |       | —            |       | —     |       | 8,248      |       |
|                                            |       | $                                    | 99,059     |              | $          | 120,863           |       | $          | 82,419     |       | $          | 5,000 |   | $ | 307,341 |   |
|                                            |       |                                 |       |              |       |              |       |       |       |       |       |
| Interest rate  sensitivity gap                  |       | $                                    | 98,415     |              | $          | (104,790          | )          | $          | (46,976    | )          | $          | 32,523 |   | $ | (29,076 | ) |
|                                            |       |                                 |       |              |       |              |       |       |       |       |       |
| Cumulative  interest rate gap                   |       | $                                    | 98,415     |              | $          | (14,623           | )          | $          | (61,599    | )          | $          | (29,076 | ) |   |   |
|                                            |       |                                 |       |              |       |              |       |       |       |       |       |
| Interest rate  sensitivity gap ratio            |       | 191                                  | %          | (13               | )%         | (43               | )%         | 750        | %          |       |       |
|                                            |       |                                 |       |              |       |              |       |       |       |       |       |
| Cumulative  interest rate sensitivity gap ratio |       | 191                                  | %          | (93               | )%         | (80               | )%         | (91        | )%         |       |       |

 

----

(1) Excludesnonaccrual loans of approximately $48,804,000.

 

33

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**SELECTED FINANCIAL INFORMATION AND STATISTICAL DATA**

 

The tables and schedules on the following pages set forth certainsignificant financial information and statistical data with respect to thedistribution of assets, liabilities and shareholders’ equity, the interestrates we experienced; our investment portfolio; our loan portfolio, includingtypes of loans, maturities, and sensitivities of loans to changes in interestrates and information on nonperforming loans; summary of the loan lossexperience and allowance for loan losses; types of deposits and the return onequity and assets.

 

**DISTRIBUTION OF ASSETS, LIABILITIES, AND**

**SHAREHOLDERS’ EQUITY:**

**INTEREST RATES AND INTEREST DIFFERENTIALS**

 

**Average Balances**

 

The condensed average balance sheet for the period indicated ispresented below. (1)

 
| ** **                                          | ** ** | **December 31, 2007**      | ** ** | **December 31, 2006** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                          | ** ** | **(Dollars in Thousands)** | ** ** |
| ASSETS                                              |       |                                 |       |                            |       |
|                                                |       |                                 |       |                            |       |
| Cash and due  from banks                            |       | $                                    | 3,392      |                            | $          | 2,585 |   |
| Interest bearing  due from                          |       | 1,427                                |       | 1,205                           |       |
| Federal funds  sold                                 |       | 7,821                                |       | 14,032                          |       |
| Taxable securities  available for sale, at cost     |       | 44,687                               |       | 34,968                          |       |
| Tax-exempt  securities available for sale, at cost  |       | 6,127                                |       | 3,416                           |       |
| Unrealized  losses on securities available for sale |       | (583                                 | )          | (905                            | )          |
| Loans (2)                                           |       | 238,652                              |       | 186,728                         |       |
| Allowance for  loan losses                          |       | (2,951                               | )          | (2,100                          | )          |
| Other assets                                        |       | 14,682                               |       | 8,821                           |       |
|                                                |       | $                                    | 313,254    |                            | $          | 248,750 |   |
|                                                |       |                                 |       |                            |       |
| Total  interest-earning assets                      |       | $                                    | 294,014    |                            | $          | 240,349 |   |
|                                                |       |                                 |       |                            |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY           |       |                                 |       |                            |       |
|                                                |       |                                 |       |                            |       |
| Deposits:                                           |       |                                 |       |                            |       |
| Noninterest-bearing  demand                         |       | $                                    | 11,304     |                            | $          | 13,038 |   |
| Interest-bearing  demand and savings                |       | 37,067                               |       | 22,635                          |       |
| Time                                                |       | 196,252                              |       | 160,694                         |       |
| Total deposits                                      |       | 244,623                              |       | 196,367                         |       |
|                                                |       |                                 |       |                            |       |
| Other borrowed  funds                               |       | 28,791                               |       | 22,377                          |       |
| Subordinated  debentures                            |       | 8,248                                |       | 2,011                           |       |
| Other  liabilities                                  |       | 3,049                                |       | 1,903                           |       |
| Total  liabilities                                  |       | 284,711                              |       | 222,658                         |       |
| Stockholders’  equity                          |       | 28,543                               |       | 26,092                          |       |
|                                                |       | $                                    | 313,254    |                            | $          | 248,750 |   |
|                                                |       |                                 |       |                            |       |
| Total  interest-bearing liabilities                 |       | $                                    | 270,358    |                            | $          | 207,717 |   |

 

----

(1)                                  Average balances were determined usingthe daily average balances for the years ended December 31, 2007 and 2006.

 

(2)                                  There were $4,700,000 of nonaccrual loansincluded in average loans in 2007 and $305,000 in 2006.

 

34

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**Interest Income and Interest Expense**

 

Thefollowing tables set forth the amount of our interest income and interestexpense for each category of interest-earning assets and interest-bearingliabilities and the average interest rate for total interest-earning assets andtotal interest-bearing liabilities, net interest spread and net yield onaverage interest-earning assets.

 
| ** **                                                | ** ** | **Year Ended**                  | ** ** | **Year Ended**             | ** ** |
|-----------------------------------------------------------|------------|--------------------------------------|------------|---------------------------------|------------|
| ** **                                                | ** ** | **December 31, 2007**      | ** ** | **December 31, 2006** | ** ** |
| ** **                                                | ** ** | ** **                           | ** ** | **Average**                     | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                                | ** ** | **Interest**                         | ** ** | **Yields**                      | ** ** | **Interest** | ** ** | **Yields** | ** ** |
| ** **                                                | ** ** | **(Dollars in Thousands)** | ** ** |
|                                                      |       |                                 |       |                            |       |   |   |   |   |
| INTEREST INCOME:                                          |       |                                 |       |                            |       |   |   |   |   |
| Interest and  fees on loans (1)                           |       | $                                    | 19,696     |                            | 8.25       | % | $ | 16,487 |   | 8.83 | % |
| Interest on  taxable securities                           |       | 2,182                                |       | 4.88                            | %          | 1,506 |   | 4.31 | % |
| Interest on  tax-exempt securities                        |       | 248                                  |       | 4.05                            | %          | 139 |   | 4.07 | % |
| Interest on  federal funds sold                           |       | 389                                  |       | 4.97                            | %          | 693 |   | 4.94 | % |
| Interest on due  from banks                               |       | 72                                   |       | 5.05                            | %          | 56 |   | 4.65 | % |
| Total interest  income                                    |       | $                                    | 22,587     |                            | 7.56       | % | $ | 18,881 |   | 7.86 | % |
|                                                      |       |                                 |       |                            |       |   |   |   |   |
| INTEREST  EXPENSE:                                        |       |                                 |       |                            |       |   |   |   |   |
| Interest on  interest-bearing demand deposits and savings |       | $                                    | 1,615      |                            | 4.36       | % | $ | 770 |   | 3.40 | % |
| Interest on time  deposits                                |       | 10,472                               |       | 5.34                            | %          | 7,450 |   | 4.64 | % |
| Interest on  other borrowed funds                         |       | 1,350                                |       | 4.69                            | %          | 908 |   | 4.06 | % |
| Interest on  subordinated debentures                      |       | 593                                  |       | 7.19                            | %          | 144 |   | 7.16 | % |
| Total interest  expense                                   |       | $                                    | 14,030     |                            | 5.19       | % | $ | 9,272 |   | 4.46 | % |
|                                                      |       |                                 |       |                            |       |   |   |   |   |
| NET INTEREST  INCOME                                      |       | $                                    | 8,557      |                            |       |   | $ | 9,609 |   |   |   |
|                                                      |       |                                 |       |                            |       |   |   |   |   |
| Net interest  spread                                      |       |                                 |       | 2.49                            | %          |   |   | 3.40 | % |
| Net yield on  average interest-earning assets             |       |                                 |       | 2.91                            | %          |   |   | 4.00 | % |

 

----

(1)          Interest and fees on loans includes$1,019,135 and $928,853 of loan fee income for the years ended December 31,2007 and 2006, respectively.  There wasno interest income recognized on nonaccrual loans during 2007 or 2006.

 

35

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**Rate and Volume Analysis**

 

The following table describes the extent to which changes in interestrates and changes in volume of interest-earning assets and interest-bearingliabilities have affected our interest income and expense during the yearsindicated.  For each category ofinterest-earning assets and interest-bearing liabilities, information isprovided on changes attributable to (1) change in volume (change in volumemultiplied by old rate); (2) change in rate (change in rate multiplied byold volume); and (3) a combination of change in rate and change involume.  The changes in interest incomeand interest expense attributable to both volume and rate have been allocatedproportionately to the change due to volume and the change due to rate.

 
| ** **                                                         | ** ** | **Year Ended December 31,**                    | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                         | ** ** | **2007 to 2006**                                    | ** ** |
| ** **                                                         | ** ** | **Increase (decrease)  due to change in** | ** ** |
| ** **                                                         | ** ** | **Rate**                                                      | ** ** | **Volume** | ** ** | **Net** | ** ** |
| ** **                                                         | ** ** | **(Dollars in Thousands)**                          | ** ** |
| Income from  interest-earning assets:                              |       |                                                          |       |   |   |   |   |
| Interest and  fees on loans                                        |       | $                                                             | (1,133     | ) | $ | 4,342 |   | $ | 3,209 |   |
| Interest on  taxable securities                                    |       | 220                                                           |       | 456 |   | 676 |   |
| Interest on  tax-exempt securities                                 |       | (1                                                            | )          | 110 |   | 109 |   |
| Interest on  federal funds sold                                    |       | 5                                                             |       | (309 | ) | (304 | ) |
| Interest on  interest-bearing deposits in banks                    |       | 5                                                             |       | 11 |   | 16 |   |
| Total interest  income                                             |       | (904                                                          | )          | 4,610 |   | 3,706 |   |
| ** **                                                         | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Expense from  interest-bearing liabilities:                        | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest on  interest-bearing demand deposits and savings deposits | ** ** | 258                                                           |       | 587 |   | 845 |   |
| Interest on time  deposits                                         |       | 1,226                                                         |       | 1,796 |   | 3,022 |   |
| Interest on  borrowings                                            |       | 155                                                           |       | 287 |   | 442 |   |
| Interest on  subordinated debentures                               |       | 1                                                             |       | 448 |   | 449 |   |
| Total interest  expense                                            |       | 1,640                                                         |       | 3,118 |   | 4,758 |   |
|                                                               |       |                                                          |       |   |   |   |   |
| Net interest  income                                               |       | $                                                             | (2,544     | ) | $ | 1,492 |   | $ | (1,052 | ) |

 

36

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**INVESTMENT PORTFOLIO**

 

**Types of Investments**

 

Thecarrying amounts of securities at the dates indicated, which are all classifiedas available for sale, are summarized as follows:

 
| ** **                                   | ** ** | **December 31,**                | ** ** |
|----------------------------------------------|------------|--------------------------------------|------------|
| ** **                                   | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                                   | ** ** | **(Dollars in Thousands)** | ** ** |
| U.S. Government  sponsored agency securities |       | $                                    | 37,051     |   | $ | 24,141 |   |
| Mortgage-backed  securities                  |       | 8,472                                |       | 9,354 |   |
| Municipal  securities                        |       | 9,122                                |       | 6,064 |   |
| Restricted  equity securities                |       | 2,517                                |       | 2,014 |   |
|                                         |       | $                                    | 57,162     |   | $ | 41,573 |   |

 

**Maturities**

 

The amounts of debt securities, including the weighted average yield ineach category as of December 31, 2007 are shown in the following tableaccording to contractual maturity classifications (1) one year or less, (2) afterone through five years, (3) after five through ten years and (4) afterten years.  Restricted equity securitiesare not included in the table because they have no contractual maturity.

 
| ** **                                   | ** ** | ** **                          | ** ** | ** **                       | ** ** | **After one year**    | ** ** | **After five years** | ** ** |
|----------------------------------------------|------------|-------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|--------------------------------|------------|
| ** **                                   | ** ** | **One year or less** | ** ** | **through five years** | ** ** | **through ten years** | ** ** |
| ** **                                   | ** ** | **Amount**                          | ** ** | **Yield (1)**               | ** ** | **Amount**                      | ** ** | **Yield (1)**             | ** ** | **Amount** | ** ** | **Yield (1)** | ** ** |
|                                         |       |                                |       |                             |       |                            |       |                           |       |   |   |   |   |
| U.S. Government  sponsored agency securities |       | $                                   | 498        |                             | 4.00       | %                               | $          | 13,962                         |       | 4.68 | % | $ | 16,945 |   | 5.34 | % |
| Mortgage-backed  securities                  |       | —                              |       |                             |       | 1,794                           |       | 3.78                           | %          | 1,085 |   | 3.93 | % |
| Municipal  securities                        |       | —                              |       |                             |       | 1,016                           |       | 3.75                           | %          | 1,471 |   | 4.15 | % |
|                                         |       | $                                   | 498        |                             | 4.00       | %                               | $          | 16,772                         |       | 4.26 | % | $ | 19,501 |   | 4.45 | % |

 
| ** **                                   | ** ** | **After ten years** | ** ** | **Total**          | ** ** |
|----------------------------------------------|------------|-------------------------------|------------|--------------------|------------|
| ** **                                   | ** ** | **Amount**                    | ** ** | **Yield (1)** | ** ** | **Amount** | ** ** | **Yield (1)** | ** ** |
|                                         |       |                          |       |               |       |   |   |   |   |
| U.S. Government  sponsored agency securities |       | $                             | 5,646      |               | 6.30       | % | $ | 37,051 |   | 5.22 | % |
| Mortgage-backed  securities                  |       | 5,594                         |       | 4.44               | %          | 8,472 |   | 4.24 | % |
| Municipal  securities                        |       | 6,635                         |       | 4.55               | %          | 9,122 |   | 4.39 | % |
|                                         |       | $                             | 17,875     |               | 4.49       | % | $ | 54,645 |   | 4.33 | % |

 

----

| (1) |   | The weighted average  yields were computed using coupon interest, adding discount accretion or  subtracting premium amortization, as appropriate, on a ratable basis over the  life of each security. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

37

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**LOAN PORTFOLIO**

 

**Types of Loans**

 

Theamount of loans outstanding at the indicated dates are shown in the followingtable according to the type of loan.

 
| ** **                      | ** ** | **December 31,**                | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                      | ** ** | ** **                           | ** ** | ** ** | ** ** |
| Commercial                      |       | $                                    | 18,109     |   | $ | 17,325 |   |
| Real  estate-construction       |       | 191,182                              |       | 145,712 |   |
| Real  estate-mortgage           |       | 45,294                               |       | 44,344 |   |
| Consumer  installment and other |       | 2,437                                |       | 3,330 |   |
|                            |       | 257,022                              |       | 210,711 |   |
| Less deferred  loan fees        |       | (156                                 | )          | (314 | ) |
| Less allowance  for loan losses |       | (7,142                               | )          | (2,392 | ) |
| Net loans                       |       | $                                    | 249,724    |   | $ | 208,005 |   |

 

**Maturities and Sensitivities of Loans to Changes in Interest Rates**

 

Totalloans as of December 31, 2007 are shown in the following table accordingto contractual maturity classifications one year or less, after one yearthrough five years, and after five years.

 
| ** **                         | ** ** | **(Dollars in Thousands)** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|
| Commercial                         |       |                                 |       |
| One year or less                   |       | $                                    | 13,099     |   |
| After one year  through five years |       | 5,010                                |       |
| After five years                   |       | —                               |       |
|                               |       | 18,109                               |       |
| Construction                       |       |                                 |       |
| One year or less                   |       | 181,851                              |       |
| After one year  through five years |       | 9,324                                |       |
| After five years                   |       | 7                                    |       |
|                               |       | 191,182                              |       |
| Other                              |       |                                 |       |
| One year or less                   |       | 22,942                               |       |
| After one year  through five years |       | 22,174                               |       |
| After five years                   |       | 2,615                                |       |
|                               |       | 47,731                               |       |
|                               |       |                                 |       |
|                               |       | $                                    | 257,022    |   |

 

The following table summarizes loans at December 31, 2007 with thedue dates after one year that have predetermined and floating or adjustableinterest rates.

 
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|
| Predetermined  interest rates          |       | $                                    | 18,567     |   |
| Floating or  adjustable interest rates |       | 20,563                               |       |
|                                   |       | $                                    | 39,130     |   |

 

38

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**Risk Elements**

 

A major key to long-term earnings growth is themaintenance of a high-quality loan portfolio. The Bank’s directive in thisregard is carried out through its policies and procedures for extending creditto the Bank’s customers.  The goal andresult of these policies and procedures is to provide a sound basis for newcredit extensions and an early recognition of problem assets to allow the mostflexibility in their timely disposition. Additions to the allowance for loan losses will be made periodically tomaintain the allowance at an appropriate level based upon management’s analysisof potential risk in the loan portfolio. While risk of loss in the Bank’s portfolio is primarily tied to thecredit quality of the various borrowers, risk of loss may increase due tofactors beyond the Bank’s control such as local, regional and/or nationaleconomic downturns.  General conditionsin the real estate market may also impact the relative risk in the real estateportfolio.

 

Thefollowing table presents the aggregate of nonperforming assets for thecategories indicated.

 
| ** **                                                                                                 | ** ** | **December 31,**                | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                 | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                                                                                                 | ** ** | **(Dollars in Thousands)** | ** ** |
| Nonaccrual loans                                                                                           |       | $                                    | 48,804     |   | $ | 1,022 |   |
| Loans  contractually past due ninety days or more as to interest or principal  payments and still accruing |       | 1,637                                |       | 17 |   |
| Restructured  loans                                                                                        |       | —                               |       | — |   |
| Total  nonperforming loans                                                                                 |       | 50,441                               |       | 1,039 |   |
|                                                                                                       |       |                                 |       |   |   |
| Other real  estate                                                                                         |       | 2,556                                |       | — |   |
| Total  nonperforming assets                                                                                |       | $                                    | 52,997     |   | $ | 1,039 |   |

 

The reduction in interest income associated with nonaccrual loansduring 2007 is as follows:

 
| ** **                                                                                                | ** ** | **(Dollars in** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                                | ** ** | **Thousands)**       | ** ** |
| Interest income  that would have been recorded on nonaccrual and restructured loans under  original terms |       | $                    | 1,694      |   |
| Interest income  that was recorded on nonaccrual and restructured loans                                   |       | $                    | —     |   |

 

Our policy is to discontinue the accrual of interest income when, inthe opinion of management, collection of interest becomes doubtful. We willgenerally discontinue the accrual of interest when (1) there is asignificant deterioration in the financial condition of the borrower and fullrepayment of principal and interest is not expected; or (2) the principalor interest is more than ninety days past due, unless the loan is bothwell-secured and in the process of collection. Accrual of interest on such loans is resumed when, in management’sjudgment, the collection of interest and principal becomes probable.

 

Potentialproblem loans are defined as loans about which we have serious doubts as to theability of the borrower to comply with the present loan repayment terms andwhich may cause the loan to be placed on nonaccrual status, to become past duemore than ninety days or to be restructured.

 

39

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Informationwith respect to potential problem loans is as follows:

 
| ** **                                                                                          | ** ** | **(Dollars in  Thousands)** | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| Loans  contractually past due 30 - 89 days as to interest or principal payments and  still accruing |       | $                                | 7,306      |   |
| Loans  contractually current as to interest or principal payments                                   |       | 210                              |       |
|                                                                                                |       | $                                | 7,516      |   |

 

Other criticized /watch loans are defined as loans that may possesscredit deficiencies which may require management’s attention to monitor theborrower’s ability to comply with the present loan repayment terms and todetect any further credit deterioration of the borrower.

 

Informationwith respect to other criticized /watch loans is as follows:

 
| ** **                                                                                               | ** ** | **(Dollars in  Thousands)** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| Loans  contractually past due 30 – 89 days as to interest or principal payments and  still accruing |       | $                                | 4,707      |   |
| Loans  contractually past due 1 – 29 days as to interest or principal payments and  still accruing  |       | 495                              |       |
| Loans  contractually current as to interest or principal payments                                        |       | 12,844                           |       |
|                                                                                                     |       | $                                | 18,046     |   |

 

Nonperforming assets at December 31, 2007 totaled approximately$53 million or 20.40% of total loans and other real estate.  This compares to approximately $1 million or..50% of total loans and other real estate at December 31, 2006.

 

Summarizedbelow is a list of other real estate totaling $2,556,000 as of December 31,2007 detailed by collateral type and location:

 
|  

  | · |   | $901,000  secured by three completed new construction single family detached homes in  Stockbridge, Henry County, Georgia; |
|----------------|--------|--------|----------------------------------------------------------------------------------------------------------------------------|

 
|   | · |   | $879,000  secured by two new construction single family detached homes in various  stages of completion in Oxford, Newton County, Georgia. |
|--------|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------|

 
|   | · |   | $525,000  secured by four new construction single family detached homes in various  stages of completion in Jackson, Butts County, Georgia; |
|--------|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------|

 
|   | · |   | $195,000  secured by five developed residential lots in Jackson, Butts County, Georgia; |
|--------|--------|--------|-----------------------------------------------------------------------------------------|

 
|   | · |   | $56,000  secured by two developed residential lots in Riverdale, Clayton County,  Georgia; |
|--------|--------|--------|--------------------------------------------------------------------------------------------|

 

Subsequent to December 31, 2007, other real estate totalingapproximately $455,000 was sold with a loss on the sale of approximately$71,000.  Other real estate acquiredthrough foreclosure subsequent to December 31, 2007 totaled approximately$7,354,000 with writedowns on the acquired other real estate of approximately$1,347,000.  We have made provisions forthese writedowns and losses in the December 31, 2007 allowance for loanloss.

 

The majority of nonaccrual loans are represented by approximatelytwenty-three separate loan relationships with aggregate balances over $250,000which involve construction loans and residential development loans located inour local trade area.  These loanscomprise over 89% of the $48.8 million in loans in nonaccrual as of December 31,2007.  The ten largest nonaccrual loanscomprise $23.1 million, or 47.4% of total nonaccrual loans.  Of these ten loans, eight are residential developmentloans, one is a commercial real estate loan and one is a real estate loan fortwo residential lake lots.

 

40

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Summarizedbelow are nonaccrual loans totaling $48,804,000 as of December 31,2007.  This information is provided togive detail as to the collateral type and location of our nonaccrual loans andto assist in the assessment of possible collateral concentrations.

 
| · |   | $8,895,000  in loans secured by three residential A & D projects in various stages  of completion located in McDonough, Henry County, Georgia;                  |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                     |
| · |   | $7,733,000  in loans secured by fifty new construction single family detached homes in  various stages of completion located in McDonough, Henry County, Georgia;        |
|   |   |                                                                                                                                                                     |
| · |   | $4,529,000  in loans secured by one residential A & D project located in  Lovejoy, Clayton County, Georgia;                                                     |
|   |   |                                                                                                                                                                     |
| · |   | $3,567,000  in loans secured by two residential A & D projects in various stages  of completion located in Stockbridge, Henry County, Georgia;                  |
|   |   |                                                                                                                                                                     |
| · |   | $2,507,000  in loans secured by six new construction single family detached homes in  various stages of completion located in Forsyth, Monroe County, Georgia;           |
|   |   |                                                                                                                                                                     |
| · |   | $1,808,000  in loans secured by commercial property in Covington, Newton County, Georgia;                                                                                |
|   |   |                                                                                                                                                                     |
| · |   | $1,687,000  in loans secured by seventeen new construction single family detached homes  in various stages of completion located in Covington, Newton County, Georgia;   |
|   |   |                                                                                                                                                                     |
| · |   | $1,686,000  in loans secured by commercial property in Forsyth, Monroe County, Georgia;                                                                                  |
|   |   |                                                                                                                                                                     |
| · |   | $1,644,000  in loans secured by various developed residential lots in McDonough, Henry  County, Georgia;                                                                 |
|   |   |                                                                                                                                                                     |
| · |   | $1,565,000  in loans secured by developed residential lots located in Hampton, Henry  County, Georgia;                                                                   |
|   |   |                                                                                                                                                                     |
| · |   | $1,500,000  in loans secured by two developed residential lots on Lake Spivey in  Jonesboro, Clayton County, Georgia;                                                    |
|   |   |                                                                                                                                                                     |
| · |   | $1,020,000  in loans secured by eleven new construction single family detached homes in  various stages of completion located in Griffin, Spalding County, Georgia;      |
|   |   |                                                                                                                                                                     |
| · |   | $1,000,000  in loans secured by a car wash facility located in Stockbridge, Henry County,  Georgia;                                                                      |
|   |   |                                                                                                                                                                     |
| · |   | $934,000  in loans secured by commercial equipment;                                                                                                                      |
|   |   |                                                                                                                                                                     |
| · |   | $915,000  in loans secured by twenty new construction single family detached homes in  various stages of completion located in Palmetto, Fulton County, Georgia;         |
|   |   |                                                                                                                                                                     |
| · |   | $749,000  in loans secured by six new construction single family detached homes in  various stages of completion in Hampton, Clayton County, Georgia;                    |
|   |   |                                                                                                                                                                     |
| · |   | $714,000  in loans secured by six new construction single family detached homes in  various stages of completion in College Park, Fulton County, Georgia;                |
|   |   |                                                                                                                                                                     |
| · |   | $610,000  in loans secured by nine developed residential lots in Forsyth, Monroe  County, Georgia;                                                                       |
|   |   |                                                                                                                                                                     |
| · |   | $558,000  in loans secured by seven new construction single family detached homes in  various stages of completion located in Morrow, Clayton County, Georgia;           |
|   |   |                                                                                                                                                                     |
| · |   | $525,000  in loans secured by a condo unit at the Atlanta Motor Speedway in Hampton,  Henry County, Georgia;                                                             |
|   |   |                                                                                                                                                                     |
| · |   | $520,000  in loans secured by commercial property in McDonough, Henry County, Georgia;                                                                                   |
|   |   |                                                                                                                                                                     |
| · |   | $505,000  in loans secured by nine new construction single family detached homes in  various stages of completion located in Luthersville, Meriweather County,  Georgia; |

 

41

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| · |   | $490,000  in loans secured by four new construction single family detached homes in  various stages of completion located in Barnesville, Lamar County, Georgia; |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                             |
| · |   | $465,000  in loans secured by commercial property in Lithonia, DeKalb County, Georgia;                                                                           |
|   |   |                                                                                                                                                             |
| · |   | $445,000  in loans secured by three new construction single family detached homes in  various stages of completion located in Hampton, Henry County, Georgia;    |
|   |   |                                                                                                                                                             |
| · |   | $368,000  in loans secured by three new construction single family detached homes in  various stages of completion located in Jackson, Butts County, Georgia;    |
|   |   |                                                                                                                                                             |
| · |   | $334,000  in loans secured by three single family rental properties located in Griffin,  Spalding County, Georgia;                                               |
|   |   |                                                                                                                                                             |
| · |   | $301,000  in loans secured by two single family detached homes in various stages of  completion located in Monticello, Jasper County, Georgia;                   |
|   |   |                                                                                                                                                             |
| · |   | $188,000  in loans secured by two single family rental properties located in Morrow,  Clayton County, Georgia;                                                   |
|   |   |                                                                                                                                                             |
| · |   | $143,000  in loans secured by other bank stock;                                                                                                                  |
|   |   |                                                                                                                                                             |
| · |   | $130,000  in loans secured by a single family home located in Lawrenceville, Gwinnett  County, Georgia;                                                          |
|   |   |                                                                                                                                                             |
| · |   | $129,000  in loans secured by a single family detached home under construction located  in Barnesville, Lamar County, Georgia;                                   |
|   |   |                                                                                                                                                             |
| · |   | $93,000  in loans secured by a single family rental property located in McDonough,  Henry County, Georgia;                                                       |
|   |   |                                                                                                                                                             |
| · |   | $92,000  in loans secured by a single family rental property located in Riverdale,  Clayton County, Georgia;                                                     |
|   |   |                                                                                                                                                             |
| · |   | $91,000  in loans secured by assignments on accounts receivables contracts;                                                                                      |
|   |   |                                                                                                                                                             |
| · |   | $84,000  in loans secured by a single family detached home located in Covington,  Newton County, Georgia;                                                        |
|   |   |                                                                                                                                                             |
| · |   | $73,000  in home equity loans secured by a single family detached home located in  Henry County, Georgia;                                                        |
|   |   |                                                                                                                                                             |
| · |   | $59,000  in loans secured by a single family detached home under construction located  in Stockbridge, Henry County, Georgia;                                    |
|   |   |                                                                                                                                                             |
| · |   | $55,000  in loans secured by five vehicles;                                                                                                                      |
|   |   |                                                                                                                                                             |
| · |   | $49,000  in loans secured by a single family detached home located in McDonough, Henry  County, Georgia;                                                         |
|   |   |                                                                                                                                                             |
| · |   | $41,000  in loans secured by a single family detached home under construction located  in Locust Grove, Henry County, Georgia;                                   |
|   |   |                                                                                                                                                             |
| · |   | $3,000  in three unsecured loans.                                                                                                                                |

 

The Company has performed an extensive analysis of these loans and theunderlying collateral values and has made provisions to the allowance for loanlosses under FAS 114 guidelines totaling $4.4 million.

 

The Bank’s primary trade area is Henry County and Clayton County,Georgia and those portions of adjoining counties that are natural extension ofthese communities.  Henry County has beennoted as one of the top 10 counties in the nation for growth.  Consistent with the Atlanta metropolitanarea, the growth provided a significant portion of the Bank’s loanportfolio.  While home sales slowed inearly 2007, the sales activity declined dramatically during the third andfourth quarters.  While the Bank did not engagein sub-prime 

 

42

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mortgage lending, either as a direct investor or as a holder ofsecurities, it has not been immune to the economic impacts.  A number of the Bank’s loan customers areinvolved in the development of residential housing lots or the construction forresale of residential housing units. Prior to August 2007, the absorption rate of single family housesand lots supported a significant buildup of inventory of houses for sale aswell as a constant supply of lots for future home construction.  The significant downturn in home sales as aresult of the sub-prime mortgage crisis has exacerbated the cash flow problemsof individual borrowers.  Experienceddevelopers and builders have found their inventories of homes and lots beingexposed to a market that was no longer able to absorb these properties in atimeframe consistent with the production of inventory.  The properties in these inventories nowgenerally require sales concessions or buyer incentives to sell.  The sudden change in absorption patterns hasleft many borrowers with standing inventories that require significant levelsof cash to support the carrying cost of servicing the related debts.  Unfortunately, this comes at a time when manyof their assets are held in relatively illiquid form.  As a result of these issues, the Bank hasseen a sudden spike in nonperforming assets which the borrower does not havethe current ability to meet the obligations of the loan upon thepre-established terms.

 

We can make no assurances that the Bank will not see a furtherdeterioration in credit quality which would require additional reserves forthose problem loans.  The Bank isactively working with those borrowers impacted by the economic downturn to developplans for repayment and programs to liquidate the underlying properties throughsales.  We recognize the possibility thatnonperforming assets may increase in future periods.

 

43

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**SUMMARY OF LOAN LOSS EXPERIENCE**

 

The following table summarizes average loan balances for the yeardetermined using the daily average balances during the period of bankingoperations; changes in the allowance for loan losses arising from loans chargedoff and recoveries on loans previously charged off; additions to the allowancewhich have been charged to operating expense; and the ratio of net charge-offsduring the period to average loans.

 
| ** **                                                                     | ** ** | **2007**                             | ** ** | **2006** | ** ** |
|--------------------------------------------------------------------------------|------------|--------------------------------------|------------|----------|------------|
| ** **                                                                     | ** ** | **(Dollars in Thousands)** | ** ** |
| Average amount  of loans outstanding                                           |       | $                                    | 238,652    |     | $          | 186,728 |   |
|                                                                           |       |                                 |       |     |       |
| Balance of  allowance for loan losses at beginning of period                   |       | 2,392                                |       | 1,917    |       |
|                                                                           |       |                                 |       |     |       |
| Loans charged  off:                                                            |       |                                 |       |     |       |
| Construction,  land development, and other land loans                          |       | (137                                 | )          | —   |       |
| Commercial                                                                     |       | (122                                 | )          | —   |       |
| Consumer  installment and other                                                |       | (77                                  | )          | (13      | )          |
|                                                                           |       | (336                                 | )          | (13      | )          |
|                                                                           |       |                                 |       |     |       |
| Loans recovered:                                                               |       |                                 |       |     |       |
| Commercial                                                                     |       | —                               |       | 6        |       |
| Consumer  installment and other                                                |       | 6                                    |       | 2        |       |
|                                                                           |       | 6                                    |       | 8        |       |
|                                                                           |       |                                 |       |     |       |
| Net charge-off                                                                 |       | (330                                 | )          | (5       | )          |
|                                                                           |       |                                 |       |     |       |
| Additions to the  allowance charged to operating expense during period         |       | 5,080                                |       | 480      |       |
|                                                                           |       |                                 |       |     |       |
| Balance of  allowance for loan losses at end of period                         |       | $                                    | 7,142      |     | $          | 2,392 |   |
|                                                                           |       |                                 |       |     |       |
| Ratio of net  loans charged off during the period to average loans outstanding |       | 0.138                                | %          | 0.003    | %          |

 

**Allowance for Loan Losses**

 

The allowance isan amount that management believes will be adequate to absorb estimated lossesrelating to specifically identified loans as well as probable credit lossesexpected in the balance of the loan portfolio, based on an evaluation of thecollectibility of existing loans and prior loss experience.  This evaluation also takes into considerationsuch factors as changes in the nature and volume of the loan portfolio, overallportfolio quality, and review of specific problem loans, concentrations andcurrent economic conditions that may affect the borrower’s ability to pay.  This evaluation does not include the effectsof expected losses on specific loans or groups of loans that are related tofuture events or expected changes in economic conditions.  While management uses the best informationavailable to make its evaluation, future adjustments to the allowance may benecessary if there are significant changes in economic conditions.  Impaired loans are individually assessedunder Statement of Financial Accounting Standards (“SFAS”) No. 114 andassigned specific allocations.  Inaddition, regulatory agencies, as an integral part of their examinationprocess, periodically review the Bank’s allowance for loan losses, and mayrequire the Bank to make additions to the allowance based on their judgmentabout information available to them at the time of their examinations.

 

44

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Aprovision for loan losses was made for the year ended December 31, 2007 inthe amount of $5,080,000 as compared to $480,000 in 2006.  The amounts provided are due primarily to ourassessment of expected risk in the loan portfolio, the increase in problem andpotential problem loans and the increase in loan growth as compared to 2006. Wecan make no assurances that the Company will not see a further deterioration incredit quality which would require additional reserves for those problem loans.The allowance for loan losses as a percentage of total loans was 2.78% at December 31, 2007 as compared to 1.14% at December 31,2006.  Based upon our evaluation of theloan portfolio, we believe the allowance for loan losses to be adequate toabsorb losses on existing loans that may become uncollectible.

 

As of December 31, 2007, we had made allocations of our allowancefor loan losses to specifically correspond to the categories of loans listedbelow.  Based on our best estimate, theallocation of the allowance for loan losses to types of loans, as of theindicated dates, is as follows:

 
| ** **                      | ** ** | **December 31,**                | ** ** |
|---------------------------------|------------|--------------------------------------|------------|
| ** **                      | ** ** | **2007**                             | ** ** | **2006** | ** ** |
| ** **                      | ** ** | ** **                           | ** ** | **Percent of loans in** | ** ** | ** ** | ** ** | **Percent of loans in** | ** ** |
| ** **                      | ** ** | ** **                           | ** ** | **each category** | ** ** | ** ** | ** ** | **each category** | ** ** |
| ** **                      | ** ** | **Amount**                           | ** ** | **to total loans** | ** ** | **Amount** | ** ** | **to total loans** | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial                      |       | $                                    |  500  |   | 7 | % | $ |  598 |   | 8 | % |
| Real estate -  construction     |       | 5,285                                |       | 74 | % | 1,076 |   | 69 | % |
| Real estate -  mortgage         |       | 1,286                                |       | 18 | % | 478 |   | 21 | % |
| Consumer  installment and other |       | 71                                   |       | 1 | % | 240 |   | 2 | % |
|                            |       | $                                    | 7,142      |   | 100 | % | $ | 2,392 |   | 100 | % |

** **

**DEPOSITS**

 

Average amount of deposits and average rates paid thereon, classifiedas to noninterest-bearing demand deposits, interest-bearing demand deposits,savings deposits, and time deposits, for the period of operations is presentedbelow.(1)

 
| ** **                                    | ** ** | **2007**                             | ** ** | **2006**    | ** ** |
|-----------------------------------------------|------------|--------------------------------------|------------|-------------|------------|
| ** **                                    | ** ** | **Amount**                           | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                                    | ** ** | **(Dollars in Thousands)** | ** ** |
| ** **                                    | ** ** | ** **                           | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Noninterest-bearing  demand deposits          |       | $                                    | 11,304     |        |       |   | $ | 13,038 |   |   |   |
| Interest-bearing  demand deposits and savings |       | 37,067                               |       | 4.36        | %          | 22,635 |   | 3.40 | % |
| Time deposits                                 |       | 196,252                              |       | 5.34        | %          | 160,694 |   | 4.64 | % |
| Total deposits                                |       | $                                    | 244,623    |        |       |   | $ | 196,367 |   |   |   |

 

----

(1)           Average balances were determined using the dailyaverage balances for the years ended December 31, 2007 and 2006.

 

45

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The amounts of time certificates of deposit issued in amounts of$100,000 or more as of December 31, 2007 are shown below by category,which is based on time remaining until maturity of (1) three months orless, (2) over three through six months, (3) over six through twelvemonths, and (4) over twelve months.

 
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|
| ** **                             | ** ** | ** **                           | ** ** |
| Three months or  less                  |       | $                                    | 7,695      |   |
| Over three  months through six months  |       | 14,993                               |       |
| Over six months  through twelve months |       | 12,670                               |       |
| Over twelve  months                    |       | 2,859                                |       |
| Total                                  |       | $                                    | 38,217     |   |

** **

**RETURN ON ASSETS AND STOCKHOLDERS’ EQUITY**

 

The following rate of return information for the year indicated ispresented below.

 
| ** **                  | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------|------------|----------|------------|----------|------------|
|                        |       |     |       |     |       |
| Return on assets  (1)       |       | (.41     | )%         | 1.03     | %          |
| Return on equity  (2)       |       | (4.49    | )%         | 9.82     | %          |
| Dividend payout  ratio (3)  |       | n/a      |       | n/a      |       |
| Equity to assets  ratio (4) |       | 9.11     | %          | 10.49    | %          |

 

----

| (1)    | Net income (loss)  divided by average total assets.                            |
|--------|--------------------------------------------------------------------------------|
|   |                                                                           |
| (2)    | Net income (loss)  divided by average equity.                                  |
|   |                                                                           |
| (3)    | Dividends declared per  share of common stock divided by net income per share. |
|   |                                                                           |
| (4)    | Average common equity  divided by average total assets.                        |

 

46

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**ITEM 7A.****                                     ****QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**

 

This information is notrequired since the Company qualifies as a smaller reporting company.

 

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

 

Theconsolidated financial statements, notes thereto and independent auditors’report thereon for year ended December 31, 2007 and attached heretobeginning at page F-1.

 

Thefollowing financial statements are attached on page F-1 of this Report:

 

Report of Independent Registered Public AccountingFirm

 

Consolidated Balance Sheets

 

Consolidated Statements of Operations

 

Consolidated Statements of Comprehensive Income (Loss)

 

ConsolidatedStatements of Changes in Stockholders’ Equity

 

ConsolidatedStatements of Cash Flows

 

Notesto Consolidated Financial Statements

 

**ITEM 9.****                                              ****CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Not applicable.

 

**ITEM 9A.****                                     ****CONTROLSAND PROCEDURES**

 

**Evaluation of DisclosureControls and Procedures**

 

Pursuantto Section 302 of the Sarbanes-Oxley Act of 2002, as of the end of theperiod covered by this Annual Report on Form 10-K, our principal executiveofficer and principal financial officer have evaluated the effectiveness of our“disclosure controls and procedures” (“Disclosure Controls”). DisclosureControls, as defined in Rule 13a-15(e) of the Securities Exchange Actof 1934, as amended (the “Exchange Act”), are procedures that are designed withthe objective of ensuring that information required to be disclosed in ourreports filed under the Exchange Act, such as this annual report, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms. Disclosure Controlsare also designed with the objective of ensuring that such information isaccumulated and communicated to our management, including our principalexecutive officer and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

 

Ourmanagement, including our principal executive officer and principal financialofficer, does not expect that our Disclosure Controls will prevent all errorand all fraud. A control system, no matter how well conceived and operated, canprovide only reasonable, not absolute, assurance that the objectives of thecontrol system are met. Further, the design of a control system must reflectthe fact that there are resource constraints, and the benefits of controls mustbe considered relative to their costs. Because of the inherent limitations inall control systems, no evaluation of controls can provide absolute assurancethat all control issues and instances of fraud, if any, within the Company havebeen detected. These inherent 

 

47

----

 

limitations include the realities thatjudgments in decision-making can be faulty, and that breakdowns can occurbecause of simple error or mistake. The design of any system of controls alsois based in part upon certain assumptions about the likelihood of futureevents, and there can be no assurance that any design will succeed in achievingits stated goals under all potential future conditions.

 

Basedupon this evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that such disclosure controls and procedures are adequate to ensurethat material information relating to the Company, including its consolidatedsubsidiary, that is required to be included in its periodic filings with theSecurities Exchange Commission, is timely made known to them.

 

**Management’s Report on Internal Control Over Financial Reporting**

 

Ourmanagement is responsible for establishing and maintaining adequate internalcontrol over financial reporting as defined in Rules 13a-15(f) and15d-15(f) under the Securities Exchange Act of 1934.  Our internal control over financial reportingis a process designed to provide reasonable assurance that assets aresafeguarded against loss from unauthorized use or disposition, transactions areexecuted in accordance with appropriate management authorization and accountingrecords are reliable for the preparation of financial statements in accordancewith generally accepted accounting principles.

 

Inthe fourth quarter of 2007, a review was performed by an independent thirdparty firm which identified significant deficiencies in the systems andprocesses that are used to identify problem credits.  These deficiencies, coupled with rapid growthand the recent slowdown in acquisition, development and construction activity,where our loan portfolio is heavily concentrated, resulted in an increase ofpotential problem credits identified and augmented the allowance for loanlosses.  We have hired additionalqualified staff to assist in the elimination of these deficiencies in internalcontrols.  The Company has enhanced itsrisk rating methodology and has taken steps to strengthen the internal controlsover financial reporting with regard to problem asset identification,appropriate classification and adequate loan loss provision.  As we continue to review and document ourdisclosure controls and procedures, including our internal controls andprocedures for financial reporting we may from time to time make changesdesigned to enhance their effectiveness and to ensure that our systems evolve withour business as discussed below.

 

Managementassessed the effectiveness of our internal control over financial reporting asof December 31, 2007.  Managementbased this assessment on criteria for effective internal control over financialreporting described in Internal Control—Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission.  Management’s assessment included anevaluation of the design of our internal control over financial reporting andtesting of the operational effectiveness of its internal control over financialreporting.  Management reviewed theresults of its assessment with the Audit Committee of our Board of Directors.

 

Basedon this assessment, management believes that FirstBank Financial Services, Inc.maintained effective internal control over financial reporting as of December 31,2007.

 

ThisAnnual Report on Form 10-K does not include an attestation report of theCompany’s independent public accounting firm regarding internal control over financialreporting.  Management’s report was notsubject to attestation by the Company’s independent public accounting firmpursuant to temporary rules of the Securities and Exchange Commission thatpermit the Company to provide only management’s report in this annual report.

 

**ITEM 9B.****                                      ****OTHERINFORMATION**

 

Not applicable.

 

48

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**PART III**

 

**ITEM 10.****                                        ****DIRECTORS,EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE**

 

Theinformation required by this Item is partially included in the Company’s ProxyStatement for the Annual Meeting of Shareholders to be held on June 19,2008 under the headings “Proposal — Election of Directors — Director Nomineesand Continuing Directors,” “Executive Officers,” “Meetings and Committees ofthe Board” and “Filings Under Section 16(a)” and is incorporated herein byreference.

 

TheCompany has adopted a Code of Business Conduct and Ethics that is applicable toall of our executive officers and employees. The Code of Business Conduct and Ethics is posted on the Company’s website at www.firstbankfinancialservices.com. A copy of the Code of Business Conduct and Ethics may be obtainedwithout charge upon written request addressed to the FirstBank FinancialServices, Inc., 120 Keys Ferry Street, McDonough , Georgia 30253.

 

Therehave been no material changes to the procedures by which shareholders mayrecommend nominees to the Company’s board of directors.

 

**ITEM 11.****                                        ****EXECUTIVECOMPENSATION**

 

Theinformation required by this Item is included in the Company’s Proxy Statementfor the Annual Meeting of Shareholders to be held on June 19, 2008 underthe heading “Executive Compensation” and is incorporated herein by reference.

 

**ITEM 12.****                                        ****SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS**

 

Theother information required by this item is included in the Company’s ProxyStatement for the Annual Meeting of Shareholders to be held on June 19,2008 under the heading “Security Ownership of Certain Beneficial Owners andManagement and Related Matters” and is incorporated herein by reference.

 

**2000 Stock Incentive Plan Information**

 

The following table sets forth information regardingthe number of shares subject to options issued and reserved for future issuanceunder the 2000 Stock Incentive Plan.  The2000 Stock Incentive Plan was adopted by the Board of Directors on December 10,2001 and approved by the shareholders on June 20, 2002.  On May 19, 2005, the shareholdersamended the Plan to increase the number of shares reserved under the Plan from100,000 to 250,000 and to provide that shares issued pursuant to awards underthe Plan would be shares of FirstBank Financial Services, Inc. The numberof shares reserved under the Plan has been adjusted to 330,000 due to theCompany’s subsequent stock dividend and stock split.  The Company does not maintain any otherequity compensation plan.

 

49

----

 
| ** **                                                  | ** ** | **Number of securities to  be issued upon exercise  of outstanding options** | ** ** | **Weighted-average  exercise price of  outstanding options** | ** ** | **Number of shares  remaining available for  future issuance under  the Plan (excludes  outstanding options)** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
|                                                        |       |                                                                                                                 |       |                                                                        |       |                                                                                                                                                        |       |
| Equity  compensation plans approved by security holders     |       | 219,984                                                                                                              |       | $                                                                           | 11.51      |                                                                                                                                                        | 110,016    |   |
|                                                        |       |                                                                                                                 |       |                                                                        |       |                                                                                                                                                        |       |
| Equity compensation  plans not approved by security holders |       | N/A                                                                                                                  |       | N/A                                                                         |       | N/A                                                                                                                                                         |       |
|                                                        |       |                                                                                                                 |       |                                                                        |       |                                                                                                                                                        |       |
| TOTAL                                                       |       | 219,984                                                                                                              |       | $                                                                           | 11.51      |                                                                                                                                                        | 110,016    |   |

 

**ITEM 13.****                                        ****CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

 

The information requiredby this Item is included in the Company’s Proxy Statement for the AnnualMeeting of Shareholders to be held on June 19, 2008 under the headings “Certain Relationshipsand Related Transactions with Management” and is incorporated herein byreference.

 

**ITEM 14.****                                        ****PRINCIPAL ACCOUNTANT FEES ANDSERVICES**

 

The information requiredby this Item is included in the Company’s Proxy Statement for the AnnualMeeting of Shareholders to be held on June 19, 2008 under the heading “Audit and Other FeesPaid to Independent Accountants” and is incorporated herein by reference.

 

50

----

 

**PART IV**

 

**ITEM 15.****                                          ****EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

 

| 3.1    |   | Articles of  Incorporation of FirstBank Financial Services, Inc. (1)                                                                              |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                   |
| 3.2    |   | Bylaws of FirstBank  Financial Services, Inc.                                                                                                     |
|   |   |                                                                                                                                                   |
| 4.1    |   | Instruments Defining  the Rights of Security Holders. See Articles of Incorporation at  Exhibit 3.1 hereto and Bylaws at Exhibit 3.2 hereto. |
|   |   |                                                                                                                                                   |
| 10.1*  |   | Amended and Restated  Employment Agreement by and between First Bank of Henry County and Thaddeus  M. Williams. (2)                                    |
|   |   |                                                                                                                                                   |
| 10.2*  |   | Employment Agreement by  and between FirstBank Financial Services, Inc. and Lisa J. Maxwell.  (3)                                            |
|   |   |                                                                                                                                                   |
| 10.3*  |   | Employment Agreement by  and between First Bank of Henry County and William M. Waller. (4)                                                             |
|   |   |                                                                                                                                                   |
| 10.4*  |   | First  Bank of Henry County 2000 Stock Incentive Plan. (5)                                                                                             |
|   |   |                                                                                                                                                   |
| 10.5*  |   | First  Amendment to First Bank of Henry County 2000 Stock Incentive Plan. (6)                                                                          |
|   |   |                                                                                                                                                   |
| 21.1   |   | Subsidiaries of  FirstBank Financial Services, Inc. (7)                                                                                           |
|   |   |                                                                                                                                                   |
| 24.1   |   | Power of Attorney  (appears on the signature pages to this Annual Report on 10-K).                                                                |
|   |   |                                                                                                                                                   |
| 31.1   |   | Certification of Chief  Executive Officer.                                                                                                             |
|   |   |                                                                                                                                                   |
| 31.2   |   | Certification of Chief  Financial Officer.                                                                                                             |
|   |   |                                                                                                                                                   |
| 32.1   |   | Certifications  pursuant to 18 U.S.C. Section 1350, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                   |

 

----

| *      |   | Compensatory plan or  warrant                                                                                                             |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                      |
| (1)    |   | Incorporated herein by  reference to Exhibit of the same number in the Company’s Form 8-K  filed January 23, 2006.    |
|   |   |                                                                                                                                      |
| (2)    |   | Incorporated herein by  reference to Exhibits 10.1 in the Company’s Form 8-K filed  January 4, 2008.                       |
|   |   |                                                                                                                                      |
| (3)    |   | Incorporated herein by  reference to Exhibit 10.3 of the Company’s Form 8-K filed  February 28, 2007.                 |
|   |   |                                                                                                                                      |
| (4)    |   | Incorporated herein by  reference to Exhibit 10.4 of the Company’s Form 10-KSB for the year  ended December 31, 2006. |
|   |   |                                                                                                                                      |
| (5)    |   | Incorporated herein by  reference to Exhibit 10.7 of the Company’s Form 8-K filed  January 23, 2006.                  |
|   |   |                                                                                                                                      |
| (6)    |   | Incorporated herein by  reference to Exhibit 10.8 of the Company’s Form 8-K filed  January 23, 2006.                  |
|   |   |                                                                                                                                      |
| (7)    |   | FirstBank Financial  Services, Inc. has only one subsidiary, FirstBank Financial Services.                                           |

 

51

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**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this Report to be signed on its behalf by theundersigned, thereunto duly authorized.

 

 
|   | FIRSTBANK  FINANCIAL SERVICES, INC. |
|--------|-------------------------------------|
|   |                                |   |
|   |                                |   |
|   | By:                                 |      /s/  Thaddeus M. Williams |
|   |                                |      Thaddeus  M. Williams |
|   |                                |      President  and Chief Executive Officer |
|   |                                |   |
|   |                                |   |
|   | Date:                               |    April 15,  2008 |
|        |                                     |  |  |

 

 

POWER OF ATTORNEY

 

KNOW ALL MEN BY THESEPRESENTS, that each person whose signature appears on the signature page tothis Report constitutes and appoints Thaddeus Williams his true and lawfulattorney-in-fact and agent, with full power of substitution and resubstitution,for him and in his name, place, and stead, in any and all capacities, to signany and all amendments to this Report, and to file the same, with all exhibitshereto, and other documents in connection herewith with the Securities andExchange Commission, granting unto said attorney-in-fact and agent full powerand authority to do and perform each and every act and thing requisite andnecessary to be done in and about the premises, as fully to all intents and purposesas he might or could do in person, hereby ratifying and confirming all thatsaid attorney-in-fact and agent or his substitute or substitutes, may lawfullydo or cause to be done by virtue hereof.

 

52

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Pursuant to the requirementsof the Securities Exchange Act of 1934, this Report has been signed below bythe following persons on behalf of the Registrant and in the capacities and onthe dates indicated.

 
| **Signature**                       | ** ** | **Title**                             | ** ** | **Date**            |
|-------------------------------------|------------|---------------------------------------|------------|---------------------|
| ** **                          | ** ** | ** **                            | ** ** | ** **          |
| ** **                          | ** ** | ** **                            | ** ** | ** **          |
| /s/  Larry D. Adams                 |       |                                  |       | April 9,  2008 |
| Larry  D. Adams                     |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Wiley A. Brown, Jr.       |       |                                  |       | April 9,  2008 |
| Wiley  A. Brown, Jr.           |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Don H. Cagle                   |       |                                  |       | April 9,  2008 |
| Don  H. Cagle                       |       | Chairman  of the Board                |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  James Troy Chafin, III    |       |                                  |       | April 9,  2008 |
| James  Troy Chafin, III        |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  William Lee Craddock, Jr. |       |                                  |       | April 9,  2008 |
| William  Lee Craddock, Jr.     |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Luther Martin Denney, III |       |                                  |       | April 9,  2008 |
| Luther  Martin Denney, III     |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Milton Stanley Goggins         |       |                                  |       | April 9,  2008 |
| Milton  Stanley Goggins             |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Richard Allen Grimes           |       |                                  |       | April 9,  2008 |
| Richard  Allen Grimes               |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Robert J. McDonald             |       |                                  |       | April 9,  2008 |
| Robert  J. McDonald                 |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Larry Max Phillips             |       |                                  |       | April 9,  2008 |
| Larry  Max Phillips                 |       | Director                              |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Thaddeus M. Williams           |       | Director,  President, Chief Executive |       | April 9,  2008 |
| Thaddeus  M. Williams               |       | Officer                               |       |                |
|                                |       |                                  |       |                |
|                                |       |                                  |       |                |
| /s/  Lisa J. Maxwell                |       | Executive  Vice President,            |       | April 9,  2008 |
| Lisa  J. Maxwell                    |       | Chief  Financial Officer              |       |                |

 

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** **

**FIRSTBANK FINANCIALSERVICES, INC.**

**AND SUBSIDIARY**

** **

** **

**CONSOLIDATED FINANCIAL REPORT**

** **

**DECEMBER 31, 2007**

 

F-1

----

 

**FIRSTBANK FINANCIAL SERVICES,INC.**

**AND SUBSIDIARY**

 

**CONSOLIDATED FINANCIAL REPORT**

**DECEMBER 31, 2007**

 

**TABLE OF CONTENTS**

 
| ** **                                                   | **Page** |
|--------------------------------------------------------------|----------|
|                                                         |     |
| **REPORT  OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM** | **F-3**  |
|                                                         |     |
| **FINANCIAL STATEMENTS**                                     |     |
|                                                         |     |
| **Consolidated  balance sheets**                             | **F-4**  |
| **Consolidated  statements of operations**                   | **F-5**  |
| **Consolidated  statements of comprehensive income (loss)**  | **F-6**  |
| **Consolidated  statements of stockholders’ equity**    | **F-7**  |
| **Consolidated  statements of cash flows**                   | **F-8**  |
| **Notes to consolidated financial statements**               | **F-9**  |

 

F-2

----

 

 

**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

** **

To the Boardof Directors

FirstBankFinancial Services, Inc.

McDonough,Georgia

 

We haveaudited the consolidated balance sheets of FirstBank Financial Services, Inc.and subsidiary as of December 31, 2007 and 2006, and the relatedconsolidated statements of operations and other comprehensive income (loss),stockholders’ equity and cash flows for the years then ended. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

We conductedour audits in accordance with the standards of the Public Company AccountingOversight Board (United States).  Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

 

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of FirstBank FinancialServices, Inc. and subsidiary as of December 31, 2007 and 2006, andthe results of their operations and their cash flows for the years then ended,in conformity with U.S. generally accepted accounting principles.

 

We were notengaged to examine management’s assertion about the effectiveness of FirstBankFinancial Services, Inc. and subsidiary’s internal control over financialreporting as of December 31, 2007 included under Item 9A  “Controls and Procedures” in FirstBankFinancial Services, Inc. and subsidiary’s Annual Report on Form 10-Kand, accordingly, we do not express an opinion thereon.
|                |                           |
|---------------------|--------------------------------|
|                | /s/ MAULDIN & JENKINS, LLC |
| Atlanta, Georgia    |                           |
| April 14, 2008 |                           |

 

 

F-3

----

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

**AND SUBSIDIARY**

**CONSOLIDATEDBALANCE SHEETS**

**DECEMBER 31, 2007 AND 2006**

 
| ** **                                                                                                               | ** ** | **2007**        | ** **      | **2006**    | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------|-----------------|-------------|------------|
| **Assets**                                                                                                               |       |            |            |        |       |
| Cash and due from banks                                                                                                  | ** ** | **$**           | **1,576,976**   |        | $          | 4,047,726 |   |
| Interest-bearing deposits in banks                                                                                       | ** ** | **780,914**     |            | 1,790,278   |       |
| Federal funds sold                                                                                                       | ** ** | **14,620,000**  |            | 11,614,000  |       |
| Securities available for sale, at fair  value                                                                            | ** ** | **54,645,511**  |            | 39,559,041  |       |
| Restricted equity securities, at cost                                                                                    | ** ** | **2,516,856**   |            | 2,013,556   |       |
|                                                                                                                     |       |            |            |        |       |
| Loans, net of unearned income                                                                                            | ** ** | **256,865,762** |            | 210,397,450 |       |
| Less allowance for loan losses                                                                                           | ** ** | **7,141,996**   |            | 2,392,086   |       |
| Loans, net                                                                                                               | ** ** | **249,723,766** |            | 208,005,364 |       |
|                                                                                                                     |       |            |            |        |       |
| Premises and equipment                                                                                                   | ** ** | **7,565,255**   |            | 6,013,068   |       |
| Other real estate owned                                                                                                  | ** ** | **2,556,179**   |            | —      |       |
| Other assets                                                                                                             | ** ** | **11,672,636**  |            | 4,036,623   |       |
|                                                                                                                     |       |            |            |        |       |
| **Total assets**                                                                                                         | ** ** | **$**           | **345,658,093** |        | $          | 277,079,656 |   |
|                                                                                                                     |       |            |            |        |       |
| **Liabilities  and Stockholders’ Equity**                                                                           |       |            |            |        |       |
|                                                                                                                     |       |            |            |        |       |
| Deposits                                                                                                                 |       |            |            |        |       |
| Noninterest-bearing                                                                                                      | ** ** | **$**           | **9,852,593**   |        | $          | 11,571,364 |   |
| Interest-bearing                                                                                                         | ** ** | **265,093,731** |            | 204,840,106 |       |
| Total deposits                                                                                                           | ** ** | **274,946,324** |            | 216,411,470 |       |
| Other borrowings                                                                                                         | ** ** | **34,000,000**  |            | 22,000,000  |       |
| Subordinated debentures                                                                                                  | ** ** | **8,248,000**   |            | 8,248,000   |       |
| Other liabilities                                                                                                        | ** ** | **2,596,846**   |            | 2,667,458   |       |
| **Total liabilities**                                                                                                    | ** ** | **319,791,170** |            | 249,326,928 |       |
|                                                                                                                     |       |            |            |        |       |
| **Commitments and contingencies**                                                                                        |       |            |            |        |       |
|                                                                                                                     |       |            |            |        |       |
| **Stockholders’ equity**                                                                                            |       |            |            |        |       |
| Preferred stock, no par value per share,  2,000,000 shares authorized; -0- shares issued and outstanding                 |       | **—**      |            | —      |       |
| Common stock, par value $5; 10,000,000  shares authorized; 2,696,882 and 2,831,676 issued and outstanding,  respectively |       | **13,484,410**  |            | 14,158,380  |       |
| Surplus                                                                                                                  | ** ** | **11,139,662**  |            | 11,655,045  |       |
| Retained earnings                                                                                                        | ** ** | **1,046,207**   |            | 2,328,567   |       |
| Accumulated other comprehensive income  (loss)                                                                           | ** ** | **196,644**     |            | (389,264    | )          |
| **Total stockholders’ equity**                                                                                      | ** ** | **25,866,923**  |            | 27,752,728  |       |
|                                                                                                                     |       |            |            |        |       |
| **Total liabilities and stockholders’ equity**                                                                      | ** ** | **$**           | **345,658,093** |        | $          | 277,079,656 |   |

 

**See notes to consolidated financialstatements.**

 

F-4

----

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

**AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**YEARS ENDED DECEMBER 31, 2007 AND 2006**

 
| ** **                                               | ** ** | **2007**       | ** **     | **2006**   | ** ** |
|----------------------------------------------------------|------------|----------------|----------------|------------|------------|
| **Interest income:**                                     |       |           |           |       |       |
| Loans, including fees                                    | ** ** | **$**          | **19,696,420** |       | $          | 16,486,625 |   |
| Taxable securities                                       | ** ** | **2,181,636**  |           | 1,505,623  |       |
| Tax-exempt securities                                    | ** ** | **247,573**    |           | 138,897    |       |
| Deposits in banks                                        | ** ** | **72,256**     |           | 56,700     |       |
| Federal funds sold                                       | ** ** | **389,432**    |           | 692,918    |       |
| **Total interest income**                                | ** ** | **22,587,317** |           | 18,880,763 |       |
|                                                     |       |           |           |       |       |
| **Interest expense:**                                    |       |           |           |       |       |
| Deposits                                                 | ** ** | **12,086,679** |           | 8,220,794  |       |
| Other borrowings                                         | ** ** | **1,943,508**  |           | 1,051,415  |       |
| **Total interest expense**                               | ** ** | **14,030,187** |           | 9,272,209  |       |
|                                                     |       |           |           |       |       |
| **Net interest income**                                  | ** ** | **8,557,130**  |           | 9,608,554  |       |
| **Provision for loan losses**                            | ** ** | **5,080,183**  |           | 480,000    |       |
| **Net interest income after provision for loan  losses** |       | **3,476,947**  |           | 9,128,554  |       |
|                                                     |       |           |           |       |       |
| **Other income:**                                        |       |           |           |       |       |
| Service charges on deposit accounts                      | ** ** | **415,008**    |           | 223,169    |       |
| Gain on sale of other real estate owned                  | ** ** | **21,306**     |           | —     |       |
| Other operating income                                   | ** ** | **164,010**    |           | 91,494     |       |
| **Total other income**                                   | ** ** | **600,324**    |           | 314,663    |       |
|                                                     |       |           |           |       |       |
| **Other expenses:**                                      |       |           |           |       |       |
| Salaries and employee benefits                           | ** ** | **3,141,801**  |           | 3,052,128  |       |
| Equipment and occupancy expenses                         | ** ** | **974,986**    |           | 715,602    |       |
| Loss on sale of premises and equipment                   | ** ** | **6,991**      |           | 6,293      |       |
| Net losses on sales of securities available  for sale    | ** ** | **44,787**     |           | —     |       |
| Other operating expenses                                 | ** ** | **2,164,992**  |           | 1,610,582  |       |
| **Total other expenses**                                 | ** ** | **6,333,557**  |           | 5,384,605  |       |
|                                                     |       |           |           |       |       |
| **Income (loss) before income taxes**                    | ** ** | **(2,256,286** | **)**          | 4,058,612  |       |
|                                                     |       |           | ** **     |       |       |
| **Income tax (benefit) expense**                         | ** ** | **(973,926**   | **)**          | 1,496,899  |       |
|                                                     |       |           | ** **     |       |       |
| **Net income (loss)**                                    | ** ** | **$**          | **(1,282,360** | **)**      | $          | 2,561,713 |   |
|                                                     |       |           | ** **     |       |       |
| **Basic earnings (losses) per share**                    | ** ** | **$**          | **(0.46**      | **)**      | $          | 0.90 |   |
|                                                     |       |           | ** **     |       |       |
| **Diluted earnings (losses) per share**                  | ** ** | **$**          | **(0.44**      | **)**      | $          | 0.85 |   |

 

**See notes to consolidated financialstatements.**

 

F-5

----

** **

**FIRSTBANK FINANCIAL SERVICES, INC**

**AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOME (LOSS)**

**YEARS ENDED DECEMBER 31, 2007 AND 2006**

 
| ** **                                                                                                                                         | ** ** | **2007**    | ** **     | **2006** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|----------------|----------|------------|
|                                                                                                                                               |       |        |           |     |       |
| **Net income (loss)**                                                                                                                              | ** ** | **$**       | **(1,282,360** | **)**    | $          | 2,561,713 |   |
|                                                                                                                                               |       |        | ** **     |     |       |
| **Other comprehensive income (loss):**                                                                                                             |       |        | ** **     |     |       |
|                                                                                                                                               |       |        | ** **     |     |       |
| Net unrealized holding gains on securities  available for sale arising during period, net of tax of $236,443 and $54,616,  respectively            |       | **385,776** | ** **     | 164,583  |       |
|                                                                                                                                               |       |        | ** **     |     |       |
| Reclassification adjustment for losses on  securities available for sale realized in net income, net of tax benefit  $17,019 and $0, respectively  |       | **27,768**  | ** **     | —   |       |
|                                                                                                                                               |       |        | ** **     |     |       |
| Net unrealized holding gains (losses) on  interest rate floor arising during period, net of tax (benefit) of $105,642  and ($47,692), respectively |       | **172,364** | ** **     | (77,280  | )          |
|                                                                                                                                               |       |        | ** **     |     |       |
| **Other comprehensive income**                                                                                                                     | ** ** | **585,908** | ** **     | 87,303   |       |
|                                                                                                                                               |       |        | ** **     |     |       |
| **Comprehensive income (loss)**                                                                                                                    | ** ** | **$**       | **(696,452**   | **)**    | $          | 2,649,016 |   |

 

**See notes to consolidated financialstatements.**

 

F-6

----

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

**AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

**YEARS ENDED DECEMBER 31, 2007 AND 2006**

 
| ** **                          | ** ** | ** **            | ** ** | ** **         | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated**        | ** ** | ** ** | ** ** |
|-------------------------------------|------------|-----------------------|------------|--------------------|------------|--------------|------------|-------------------|------------|------------------------|------------|------------|------------|
| ** **                          | ** ** | ** **            | ** ** | ** **         | ** ** | ** **   | ** ** | ** **        | ** ** | **Other**              | ** ** | **Total**  | ** ** |
| ** **                          | ** ** | **Common Stock** | ** ** | ** **         | ** ** | **Retained** | ** ** | **Comprehensive** | ** ** | **Stockholders’** | ** ** |
| ** **                          | ** ** | **Shares**            | ** ** | **Par Value** | ** ** | **Surplus**  | ** ** | **Earnings**      | ** ** | **Income (Loss)** | ** ** | **Equity** | ** ** |
|                                |       |                  |       |               |       |         |       |              |       |                   |       |       |       |
| **Balance, December 31, 2005** |       | 2,145,250             |       | $                  | 10,726,250 |         | $          | 11,235,374        |       | $                      | 3,298,408  |       | $          | (476,567 | ) | $ | 24,783,465 |   |
| Net income                          |       | —                |       | —             |       | —       |       | 2,561,713         |       | —                 |       | 2,561,713  |       |
| 10% stock dividend                  |       | 214,503               |       | 1,072,515          |       | 2,458,204    |       | (3,531,081        | )          | —                 |       | (362       | )          |
| Six-for-five stock split            |       | 471,923               |       | 2,359,615          |       | (2,359,615   | )          | (473              | )          | —                 |       | (473       | )          |
| Other comprehensive income          |       | —                |       | —             |       | —       |       | —            |       | 87,303                 |       | 87,303     |       |
| Stock-based compensation            |       | —                |       | —             |       | 321,082      |       | —            |       | —                 |       | 321,082    |       |
| **Balance, December 31, 2006** |       | 2,831,676             |       | 14,158,380         |       | 11,655,045   |       | 2,328,567         |       | (389,264               | )          | 27,752,728 |       |
| Net loss                            |       | —                |       | —             |       | —       |       | (1,282,360        | )          | —                 |       | (1,282,360 | )          |
| Stock repurchase                    |       | (134,794              | )          | (673,970           | )          | (606,052     | )          | —            |       | —                 |       | (1,280,022 | )          |
| Other comprehensive income          |       | —                |       | —             |       | —       |       | —            |       | 585,908                |       | 585,908    |       |
| Stock-based compensation            |       | —                |       | —             |       | 90,669       |       | —            |       | —                 |       | 90,669     |       |
| **Balance, December 31, 2007** |       | 2,696,882             |       | $                  | 13,484,410 |         | $          | 11,139,662        |       | $                      | 1,046,207  |       | $          | 196,644 |   | $ | 25,866,923 |   |
|                                     |            |                       |            |                    |            |              |            |                   |            |                        |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

**See notes to consolidated financialstatements.**

 

F-7

----

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

**AND SUBSIDIARY**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**YEARS ENDED DECEMBER 31, 2007 AND 2006**

 
| ** **                                                                         | ** ** | **2007**        | ** **     | **2006**    | ** ** |
|------------------------------------------------------------------------------------|------------|-----------------|----------------|-------------|------------|
| **OPERATING ACTIVITIES**                                                           |       |            |           |        |       |
| Net income (loss)                                                                  | ** ** | **$**           | **(1,282,360** | **)**       | $          | 2,561,713 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |            | ** **     |        |       |
| Loss on sale of premises and equipment                                             | ** ** | **6,991**       | ** **     | 6,293       |       |
| Gain on sales of other real estate owned                                           | ** ** | **(21,306**     | **)**          | —      |       |
| Writedowns of other real estate owned                                              | ** ** | **98,648**      | ** **     | —      |       |
| Net losses on sales of securities available  for sale                              | ** ** | **44,787**      | ** **     | —      |       |
| Depreciation and amortization                                                      | ** ** | **492,233**     | ** **     | 363,178     |       |
| Stock compensation expense                                                         | ** ** | **90,669**      | ** **     | 321,082     |       |
| Deferred taxes                                                                     | ** ** | **(2,091,663**  | **)**          | (216,517    | )          |
| Provision for loan losses                                                          | ** ** | **5,080,183**   | ** **     | 480,000     |       |
| Increase in accrued interest receivable                                            | ** ** | **(1,004,606**  | **)**          | (617,871    | )          |
| Increase in accrued interest payable                                               | ** ** | **48,089**      | ** **     | 1,140,943   |       |
| Net other operating activities                                                     | ** ** | **(801,729**    | **)**          | 201,865     |       |
|                                                                               |       |            | ** **     |        |       |
| Net cash provided by operating activities                                          | ** ** | **659,936**     | ** **     | 4,240,686   |       |
|                                                                               |       |            | ** **     |        |       |
| **INVESTING ACTIVITIES**                                                           |       |            | ** **     |        |       |
| Net (increase) decrease in interest-bearing  deposits in banks                     | ** ** | **1,009,364**   | ** **     | (1,000,299  | )          |
| Purchases of securities available for sale                                         | ** ** | **(23,777,070** | **)**          | (11,338,842 | )          |
| Proceeds from sales of securities available  for sale                              | ** ** | **4,781,678**   | ** **     | —      |       |
| Proceeds from maturities of securities  available for sale                         | ** ** | **4,531,141**   | ** **     | 3,124,112   |       |
| Purchases of restricted equity securities                                          | ** ** | **(503,300**    | **)**          | (429,300    | )          |
| Net (increase) decrease in federal funds  sold                                     | ** ** | **(3,006,000**  | **)**          | 2,151,000   |       |
| Net increase in loans                                                              | ** ** | **(49,549,607** | **)**          | (41,728,117 | )          |
| Proceeds from sales of other real estate  owned                                    | ** ** | **155,267**     | ** **     | —      |       |
| Proceeds from sales of premises and  equipment                                     | ** ** | **22,000**      | ** **     | 3,491       |       |
| Purchase of premises, equipment and  software                                      | ** ** | **(2,052,491**  | **)**          | (2,235,575  | )          |
| Purchase of bank owned life insurance                                              | ** ** | **(3,000,000**  | **)**          | —      |       |
| Purchase of state tax credits                                                      | ** ** | **(996,500**    | **)**          | —      |       |
| Purchase of interest rate floor                                                    | ** ** | **—**      | ** **     | (298,500    | )          |
| Net cash used in investing activities                                              | ** ** | **(72,385,518** | **)**          | (51,752,030 | )          |
|                                                                               |       |            | ** **     |        |       |
| **FINANCING ACTIVITIES**                                                           |       |            | ** **     |        |       |
| Net increase in deposits                                                           | ** ** | **58,534,854**  | ** **     | 42,075,462  |       |
| Net increase in borrowings                                                         | ** ** | **12,000,000**  | ** **     | —      |       |
| Stock repurchase                                                                   | ** ** | **(1,280,022**  | **)**          | —      |       |
| Purchase of fractional shares                                                      | ** ** | **—**      | ** **     | (835        | )          |
| Proceeds from issuance of subordinated  debentures                                 | ** ** | **—**      | ** **     | 8,248,000   |       |
| Net cash provided by financing activities                                          | ** ** | **69,254,832**  | ** **     | 50,322,627  |       |
|                                                                               |       |            | ** **     |        |       |
| Net increase (decrease) in cash and due  from banks                                | ** ** | **(2,470,750**  | **)**          | 2,811,283   |       |
|                                                                               |       |            | ** **     |        |       |
| Cash and due from banks at beginning of  year                                      | ** ** | **4,047,726**   | ** **     | 1,236,443   |       |
|                                                                               | ** ** | ** **      | ** **     |        |       |
| Cash and due from banks at end of year                                             | ** ** | **$**           | **1,576,976**  | ** **  | $          | 4,047,726 |   |
|                                                                               |       |            | ** **     |        |       |
| **SUPPLEMENTAL DISCLOSURES**                                                       |       |            | ** **     |        |       |
| Cash paid for interest                                                             | ** ** | **$**           | **13,982,098** | ** **  | $          | 8,131,266 |   |
| Cash paid for income taxes                                                         | ** ** | **$**           | **1,721,384**  | ** **  | $          | 1,871,035 |   |
|                                                                               |       |            | ** **     |        |       |
| **NONCASH TRANSACTIONS**                                                           |       |            | ** **     |        |       |
| Foreclosed assets acquired in settlement of  loans                                 | ** ** | **$**           | **2,751,022**  | ** **  | $          | — |   |

 

**See notes to consolidated financialstatements.**

 

F-8

----

 

**FIRSTBANK FINANCIAL SERVICES, INC.**

**AND SUBSIDIARY**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

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

 

**Nature of Business**

 

FirstBankFinancial Services, Inc. (the “Company”) is a bank holding company whosebusiness is conducted by its wholly-owned commercial bank, FirstBank FinancialServices (the “Bank”).  The Bank islocated in McDonough, Henry County, Georgia with a branch in Stockbridge,Georgia, another branch also in McDonough known as the Bank’s South Pointbranch and a branch in Morrow, Clayton County, Georgia.  The Bank provides a full range of bankingservices in its primary market areas of Henry and Clayton County andsurrounding counties.

 

**Basis of Presentation**

 

Theconsolidated financial statements include the accounts of the Company and itssubsidiary.  Significant intercompanytransactions and balances have been eliminated in consolidation.

 

Inpreparing the consolidated financial statements in accordance with accountingprinciples generally accepted in the United States of America, management isrequired to make estimates and assumptions that affect the reported amounts ofassets and liabilities and the disclosure of contingent assets and liabilitiesas of the balance sheet date and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

Materialestimates that are particularly susceptible to significant change in the nearterm relate to the determination of the allowance for loan losses, deferredtaxes, and contingent assets and liabilities. The determination of the adequacy of theallowance for loan losses is based on estimates that are susceptible tosignificant changes in the economic environment and market conditions. Inconnection with the determination of the estimated losses on loans, managementobtains independent appraisals for significant collateral.

 

**Cash, Due from Banks and Cash Flows**

 

Forpurposes of reporting cash flows, cash and due from banks includes cash onhand, cash items in process of collection and amounts due from banks.  Cash flows from interest-bearing deposits inbanks, loans, federal funds sold, deposits and other borrowings are reportednet.

 

The Bank is required to maintain reserve balances in cash oron deposit with the Federal Reserve Bank, based on a percentage ofdeposits.  The total of those reservebalances was approximately $9,000 and $939,000 at December 31, 2007 and2006, respectively.  The decrease in reserve balances was due tothe implementation of a deposit reclassification program approved by theFederal Reserve Bank of Atlanta in November 2007.

 

**Securities**

 

Securitiesare classified as available for sale and recorded at fair value with unrealizedgains and losses excluded from earnings and reported in other comprehensiveincome, net of the related deferred tax effect. Restricted equity securities without a readily determinable fair valueare recorded at cost.

 

F-9

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1.****               ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES****(Continued)**

 

**Securities (Continued)**

 

The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the life of the securities.  Realized gains and losses, determined on the basis of the cost of specific securities sold, are included in earnings on the settlement date.  Declines in the fair value of available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses.  In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

 

**Loans**

 

Loansare reported at their outstanding principal balances less unearned income andthe allowance for loan losses.  Interestincome is accrued on the outstanding principal balance.

 

Nonrefundableloan fees and costs incurred for loans are deferred and recognized in incomeover the life of the loans using a method which approximates a level yield.

 

Theaccrual of interest on loans is discontinued when, in management’s opinion, theborrower may be unable to meet payments as they become due, unless the loan iswell-secured.  All interest accrued butnot collected for loans that are placed on nonaccrual or charged off isreversed against interest income, unless management believes that the accruedinterest is recoverable through the liquidation of collateral.  Interest income on nonaccrual loans is recognizedon the cost-recovery method, until the loans are returned to accrualstatus.  Loans are returned to accrualstatus when all the principal and interest amounts are brought current andfuture payments are reasonably assured.

 

Aloan is considered impaired when it is probable, based on current informationand events, the Company will be unable to collect all principal and interestpayments due in accordance with the contractual terms of the loanagreement.  Impaired loans are measuredby either the present value of expected future cash flows discounted at theloan’s effective interest rate, the loan’s obtainable market price, or the fairvalue of the collateral if the loan is collateral dependent.  The amount of impairment, if any, and any subsequentchanges are included in the allowance for loan losses.  Interest on accruing impaired loans isrecognized as long as such loans do not meet the criteria for nonaccrualstatus.

 

**Allowance for Loan Losses**

 

The allowance for loanlosses represents management’s estimate of probable credit losses expected inthe loan portfolio.  Estimating theamount of the allowance of loan losses required significant judgment and theuse of estimates related to the fair market value or the estimated netrealizable value of the underlying collateral on impaired loans, estimatedlosses on unimpaired loans based on historical loss experience, management’sevaluation of the current loan portfolio, and consideration of current economictrends and conditions.  Loan losses arecharged against the allowance, while recoveries of amounts previously chargedoff are credited to the allowance.  Aprovision for loan losses is charged to operations based upon management’speriodic evaluation of the factors previously mentioned, as well as otherpertinent factors.

 

F-10

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1.****               ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES****(Continued)**

 

**Allowance for Loan Losses(Continued)**

 

Theallowance for loan losses consists of specific, general and unallocatedcomponents.  The components of theallowance for loan losses represent an estimate to either Statement ofFinancial Accounting Standards (“SFAS”) No. 5, *Accountingfor Contingencies,* or SFAS No. 114, *Accountingby Creditors for Impairment of a Loan. *Theallocated component of the allowance for loan losses reflects expected lossesfrom analyses developed through specific credit allocations for individualproblem or potential problem loans and historical loss experience for each loancategory.  These analyses involvejudgment in estimating the amount of loss associated with the specific loans,including estimating the underlying collateral values.  Due to our limited loss history, thehistorical loss experience is determined using the average of actual losses ofpeer banks in the Atlanta MSA incurred over the prior five years for each loancategory.  The historical loss experienceis adjusted for known changes in economic conditions as well as otherqualitative factors.  The resulting lossallocation factors are applied to the balance each loan category after removingthe balance of impaired loans from each category.  The unallocated component reflects management’sestimate of potential inherent but undetected losses within the portfolio dueto uncertainties in economic conditions as well as a component that accountsfor the inherent imprecision in the underlying assumptions used in themethodologies used for estimating specific and general losses in the portfolio.

 

Althoughmanagement believes its processes for determining the allowance adequatelyconsider all the potential factors that could potentially result in creditlosses, the process include subjective elements and may be susceptible tosignificant change.  In addition, therecould be potential problem loans in the portfolio that have not been identifiedas problems because they continue to perform as set forth in the loanagreements.  Continued weakness in ourmarket area could cause currently performing credits to deteriorate.  To the extent the outcomes differ frommanagement estimates, additional provision for loan losses could be requiredthat could adversely affect earnings or financial position in future periods.

 

**Premises and Equipment**

 

Landis carried at cost.  Premises andequipment, including software costs, are carried at cost less accumulateddepreciation and amortization computed on the straight-line method over thefollowing estimated useful lives of the assets: Buildings, 40 years; equipment, 3-7 years; leasehold improvements andsoftware, 3 years.

 

**Other Real Estate Owned**

 

Other real estate ownedrepresents properties acquired through or in lieu of loan foreclosure and isrecorded at the lower of cost or fair value less estimated costs to sell.  Any write-down to fair value at the time oftransfer to other real estate owned is charged to the allowance for loanlosses.  Costs of improvements arecapitalized, whereas costs relating to holding other real estate owned andsubsequent adjustments to the value are expensed.  The Company had other real estate ownedtotaling $2,556,179 at December 31, 2007.

 

**Income Taxes**

 

Deferredincome tax assets and liabilities are determined using the balance sheetmethod.  Under this method, the netdeferred tax asset or liability is determined based on the tax effects of thetemporary differences between the book and tax bases of the various balancesheet assets and liabilities and gives current recognition to changes in taxrates and laws.

 

F-11

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1.****               ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES****(Continued)**

 

**Earnings Per Share**

 

Basicearnings per share are computed by dividing net income by the weighted-averagenumber of shares of common stock outstanding. Diluted earnings per share are computed by dividing net income by thesum of the weighted-average number of shares outstanding and potential commonshares.  Potential common shares consistof stock options and warrants.

 

**Stock-Based Compensation**

 

AtDecember 31, 2007, the Company has two stock-based compensation planswhich include certain employees and director, which are described more fully inNote 9.  The Company accounts for theseplans under FASB Statement No. 123(R), *Share-Based Payment,*usingthe modified-prospective-transition method. Under that transition method, compensation cost recognized in the yearsended December 31, 2007 and 2006 includes: (a) compensation cost forall share-based payments granted prior to, but not vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of Statement 123, and (b) compensation cost for allshare-based payments subsequent to January 31, 2006, based on the grantdate fair value estimated in accordance with the provisions of Statement123(R).

 

**Derivative Instruments and Hedging Activities**

 

Inaccordance with SFAS No. 133, *Accounting for DerivativeInstruments and Hedging Activities*, the Company recognizes the fairvalue of derivatives as assets or liabilities in the financial statements.  The accounting for the changes in the fairvalue of a derivative depends on the intended use of the derivative instrumentat inception.  The change in fair valueof instruments used as fair value hedges is accounted for in earnings of theperiod simultaneous with accounting for the fair value change of the item beinghedged.  The change in fair value of theeffective portion of cash flow hedges is accounted for in comprehensive income ratherthan income.  Changes in fair value ofderivative instruments that are not intended as a hedge are accounted for inearnings of the period of the change.  Asof December 31, 2007, the Company had two interest rate floors to offsetinterest rate risk in the floating rate loan portfolio, two interest rate swapsto offset interest rate risk of the fixed rate brokered certificates ofdeposit, and S&P call options and FHLB derivative contracts related to theissuance of certain certificates of deposits to customers.  These instruments are discussed in moredetail in Note 12.

 

**Comprehensive Income**

 

Accountingprinciples generally require that recognized revenue, expenses, gains andlosses be included in net income. Although certain changes in assets and liabilities, such as unrealizedgains and losses on available for sale securities and cash flow hedges, arereported as a separate component of the equity section of the balance sheet,such items, along with net income, are components of comprehensive income.

 

**Reclassification**

 

Certain items on the statements of operationsand cash flows for the year ended December 31, 2006 have been reclassifiedto be consistent with the classifications adopted for the year ended December 31,2007.

 

F-12

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 1.****               ****SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES****(Continued)**

 

**Recent Accounting Pronouncements**

 

InSeptember 2006, the FASB issued FAS 157, *Fair ValueMeasurements.*  The standard providesguidance for using fair value to measure assets and liabilities.  It defines fair value, establishes aframework for measuring fair value under generally accepted accountingprinciples and expands disclosures about fair value measurement.  Under the standard, fair value refers to theprice that would be received to sell an asset or paid to transfer a liabilityin an orderly transaction between market participants in the market in whichthe reporting equity transacts.  Itclarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing the asset or liability.  In support of this principle, the standardestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions.  Under thestandard, fair value measurements would be separately disclosed by level withinthe fair value hierarchy.  Statement 157is effective for financial statements issued for fiscal years beginning after November 15,2007.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS No. 159 permits entities to make an irrevocable election, at specified election dates, to measure eligible financial instruments and certain other items at fair value. This statement also establishes presentation and disclosure requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The provisions of this statement are effective as of the beginning of the first fiscal year that begins after November 15, 2007. The Company has not chosen to early adopt this statement.

 

In March 2008, the Financial Accounting Standards Board (FASB) issued Statement No. 161, **Disclosures   about Derivative Instruments and Hedging Activities** (SFAS 161) – an amendment of FASB Statement No. 133, **Accounting for Derivative Instruments and Hedging Activities**. SFAS 161 is intended to improve financial reporting transparency regarding derivative instruments and hedging activities by providing investors with a better understanding of their effects on financial position, financial performance, and cash flows. SFAS 161 applies to all entities and is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008 with early adoption encouraged.

 

F-13

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 2.****               ****SECURITIES AVAILABLE FOR SALE**

 

Theamortized cost and fair value of securities available for sale are summarizedas follows:

 
| ** **                                      | ** ** | **Amortized  Cost** | ** **     | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** **   |
|-------------------------------------------------|------------|---------------------|----------------|------------------------------|------------|-------------------------------|------------|-----------------|--------------|
| ** **                                      | ** ** | ** **          | ** **     | ** **                   | ** ** | ** **                    | ** ** | ** **      | ** **   |
| **December 31, 2007:**                     |       | ** **          | ** **     | ** **                   | ** ** | ** **                    | ** ** | ** **      | ** **   | ** ** | ** ** | ** ** | ** ** |
| **U.S. Government sponsored agency securities** |       | **$**               | **36,536,566** | ** **                   | **$**      | **515,499**                   | ** ** | **$**           | **(1,185**   | **)** | **$** | **37,050,880** | ** ** |
| **Mortgage-backed securities**                  | ** ** | **8,702,587**       | ** **     | **—**                   | ** ** | **(230,074**                  | **)**      | **8,472,513**   | ** **   |
| **Municipal securities**                        | ** ** | **9,237,161**       | ** **     | **62,275**                   | ** ** | **(177,318**                  | **)**      | **9,122,118**   | ** **   |
| ** **                                      | ** ** | **$**               | **54,476,314** | ** **                   | **$**      | **577,774**                   | ** ** | **$**           | **(408,577** | **)** | **$** | **54,645,511** | ** ** |
| ** **                                      | ** ** | ** **          | ** **     | ** **                   | ** ** | ** **                    | ** ** | ** **      | ** **   |
| December 31, 2006:                         |       |                |           |                         |       |                          |       |            |         |   |   |   |   |
| U.S. Government sponsored agency securities     |       | $                   | 24,340,355     |                         | $          | 26,450                        |       | $               | (225,850     | ) | $ | 24,140,955 |   |
| Mortgage-backed securities                      |       | 9,674,230           |           | —                       |       | (320,495                      | )          | 9,353,735       |         |
| Municipal securities                            |       | 6,042,265           |           | 65,791                       |       | (43,705                       | )          | 6,064,351       |         |
|                                            |       | $                   | 40,056,850     |                         | $          | 92,241                        |       | $               | (590,050     | ) | $ | 39,559,041 |   |

 

Securitieswith a carrying value of approximately $40,005,000 and $25,366,000 at December 31,2007 and 2006, respectively, were pledged to secure public deposits and forother purposes required or permitted by law.

 

The market value of securities is based onquoted market values and is significantly affected by the interest rateenvironment.  At December 31, 2007,unrealized losses represented 2.58% of the amortized cost.  These unrealized losses are consideredtemporary because of acceptable investment grades on each security.

 

Thefollowing tables show the gross unrealized losses and fair value of securities,aggregated by category and length of time that securities have been in acontinuous unrealized loss position at December 31, 2007 and 2006.

 

| ** **                                | ** ** | **December 31, 2007**        | ** **    |
|-------------------------------------------|------------|----------------------------------------|---------------|
| ** **                                | ** ** | **Less Than 12 Months** | ** **    | **12 Months or More** | ** ** | **Total** | ** ** |
| **Description of Securities:**  | ** ** | **Fair  Value**                        | ** **    | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** |
| **U.S. Government sponsored agencies**    | ** ** | **$**                                  | **—**    | ** ** | **$** | **—** | ** ** | **$** | **997,500** | ** ** | **$** | **(1,185** | **)** | **$** | **997,500** | ** ** | **$** | **(1,185** | **)** |
| **Mortgage-backed securities**            | ** ** | **939,085**                            | ** **    | **(2,648** | **)** | **7,533,428** | ** ** | **(227,426** | **)** | **8,472,513** | ** ** | **(230,074** | **)** |
| **Municipal securities**                  | ** ** | **4,447,695**                          | ** **    | **(143,655** | **)** | **1,502,762** | ** ** | **(33,663** | **)** | **5,950,457** | ** ** | **(177,318** | **)** |
| **Total temporarily impaired securities** | ** ** | **$**                                  | **5,386,780** | ** ** | **$** | **(146,303** | **)** | **$** | **10,033,690** | ** ** | **$** | **(262,274** | **)** | **$** | **15,420,470** | ** ** | **$** | **(408,577** | **)** |

 

| ** **                               | ** ** | **December 31, 2006**        | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **Less Than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| **Description of Securities:** | ** ** | **Fair  Value**                        | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Fair  Value** | **S** | **Gross  Unrealized  Losses** | ** ** |
| U.S. Government sponsored agencies       |       | $                                      | 4,931,835  |   | $ | (17,244 | ) | $ | 14,436,745 |   | $ | (208,606 | ) | $ | 19,368,580 |   | $ | (225,850 | ) |
| Mortgage-backed securities               |       | 1,051,032                              |       | (5,455 | ) | 8,302,702 |   | (315,040 | ) | 9,353,734 |   | (320,495 | ) |
| Municipal securities                     |       | 1,245,854                              |       | (11,342 | ) | 11,308,072 |   | (32,363 | ) | 2,553,926 |   | (43,705 | ) |
| Total temporarily impaired securities    |       | $                                      | 7,228,721  |   | $ | (34,041 | ) | $ | 24,047,519 |   | $ | (556,009 | ) | $ | 31,276,240 |   | $ | (590,050 | ) |

 

F-14

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 2.****               ****SECURITIES AVAILABLE FOR SALE****(Continued)**

 

Theamortized cost and fair value of debt securities as of December 31, 2007 bycontractual maturity are shown below. Maturities may differ from contractual maturities of mortgage-backedsecurities because the mortgages underlying the securities may be called orrepaid without penalty.  Therefore, thesesecurities are not included in the maturity categories in the followingsummary.

 
| ** **                      | ** ** | **Amortized  Cost** | ** ** | **Fair  Value** | ** ** |
|---------------------------------|------------|---------------------|------------|-----------------|------------|
| ** **                      | ** ** | ** **          | ** ** | ** **      | ** ** |
| Due in less than one year       |       | $                   | 499,000    |            | $          | 498,050 |   |
| Due from one to five years      |       | 14,817,597          |       | 14,978,577      |       |
| Due from five to ten years      |       | 18,200,946          |       | 18,415,494      |       |
| Due from greater than ten years |       | 12,256,184          |       | 12,280,877      |       |
| Mortgage-backed securities      |       | 8,702,587           |       | 8,472,513       |       |
|                            | ** ** | $                   | 54,476,314 | ** **      | $          | 54,645,511 |   |

 

Gainsand losses on sales of securities available for sale consist of the following:

 
| ** **          | ** ** | **For the Year ended  December 31, 2007** | ** **  |
|---------------------|------------|--------------------------------------------------------------------|-------------|
|                |       |                                                               |        |
| Gross gains         | ** ** | **$**                                                              | **8,779**   | ** ** |
| Gross losses        | ** ** | **(53,566**                                                        | **)**       |
| Net realized losses | ** ** | **$**                                                              | **(44,787** | **)** |

 

Therewere no sales of securities during the year ended December 31, 2006.

 

**NOTE 3.****               ****LOANS**

 

Thecomposition of loans is summarized as follows:

 
| ** **                      | ** ** | **December 31,** | ** **      |
|---------------------------------|------------|-----------------------|-----------------|
| ** **                      | ** ** | **2007**              | ** **      | **2006** | ** ** |
|                            |       |                  |            |   |   |
| Commercial                      | ** ** | **$**                 | **18,109,000**  |   | $ | 17,325,000 |   |
| Real estate – construction | ** ** | **191,182,000**       |            | 145,712,000 |   |
| Real estate – other        | ** ** | **45,294,000**        |            | 44,344,000 |   |
| Consumer                        | ** ** | **2,436,509**         |            | 3,330,613 |   |
| ** **                      |       | **257,021,509**       |            | 210,711,613 |   |
| Unearned income                 | ** ** | **(155,747**          | **)**           | (314,163 | ) |
| Allowance for loan losses       | ** ** | **(7,141,996**        | **)**           | (2,392,086 | ) |
| Loans, net                      | ** ** | **$**                 | **249,723,766** |   | $ | 208,005,364 |   |

 

F-15

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 3.****               ****LOANS (Continued)**

 

Changesin the allowance for loan losses are as follows:

 
| ** **                                 | ** ** | **Years Ended December 31,** | ** **    |
|--------------------------------------------|------------|---------------------------------------------|---------------|
| ** **                                 | ** ** | **2007**                                    | ** **    | **2006** | ** ** |
|                                       |       |                                        |          |   |   |
| Balance, beginning of year                 | ** ** | **$**                                       | **2,392,086** |   | $ | 1,917,216 |   |
| Provision for loan losses                  | ** ** | **5,080,183**                               |          | 480,000 |   |
| Loans charged off                          | ** ** | **(336,619**                                | **)**         | (12,723 | ) |
| Recoveries of loans previously charged off | ** ** | **6,346**                                   | ** **    | 7,593 |   |
| Balance, end of year                       | ** ** | **$**                                       | **7,141,996** |   | $ | 2,392,086 |   |

 

Thefollowing is a summary of information pertaining to nonperforming loans:

 
| ** **                                                     | ** ** | **As of and for the Years Ended  December 31,** | ** **     |
|----------------------------------------------------------------|------------|------------------------------------------------------------------------------------|----------------|
| ** **                                                     | ** ** | **2007**                                                                           | ** **     | **2006** | ** ** |
|                                                           |       |                                                                               |           |   |   |
| Impaired loans without a FAS 114 valuation allowance           | ** ** | **$**                                                                              | **18,576,827** |   | $ | 1,021,811 |   |
| Impaired loans with a FAS 114 valuation allowance              | ** ** | **30,227,013**                                                                     |           | — |   |
| Total impaired loans                                           | ** ** | **$**                                                                              | **48,803,840** |   | $ | 1,021,811 |   |
| FAS 114 valuation allowance related to impaired loans          | ** ** | **$**                                                                              | **4,352,921**  |   | $ | — |   |
| Average investment in impaired loans                           | ** ** | **$**                                                                              | **4,700,446**  |   | $ | 305,065 |   |
| Interest income recognized on impaired loans                   | ** ** | **$**                                                                              | **—**     |   | $ | — |   |
| Nonaccrual loans                                               | ** ** | **$**                                                                              | **48,803,840** |   | $ | 1,021,811 |   |
| Loans past due ninety days or more and still accruing interest | ** ** | **$**                                                                              | **1,637,465**  |   | $ | 17,000 |   |

 

When a loan is considered to be impaired, theamount of the impairment is measured based on the present value of expectedfuture cash flows discounted at the loan’s effective interest rate, or the fairvalue of the collateral less estimated selling costs if the loan is collateraldependent, or the observable market price of the collateral, to determine theamount of impairment. Impairment losses are included in the allowance for loanlosses through a charge to the provision for loan losses.  A majority of our impaired loans arecollateral dependent and most are secured by real estate.  The allowance for loan losses on these loansis determined based on fair value estimates (net of selling costs) of therespective collateral. The actual losses on these loans could differsignificantly if the fair value of the collateral is different from theestimates used in determining the allocated allowance. The fair value of thesereal estate properties is generally determined based on appraisals performed bya certified or licensed appraiser. Management also considers other factors or recent developments whichcould result in adjustments to the collateral value estimates indicated in theappraisals.

 

Inthe ordinary course of business, the Company has granted loans to certainrelated parties, including directors, executive officers and theiraffiliates.  The interest rates on theseloans were substantially the same as rates prevailing at the time of thetransaction and repayment terms are customary for the type of loan.  Changes in related party loans for the yearended December 31, 2007 are as follows:

 

F-16

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 3.****               ****LOANS (Continued)**

 
| Balance, beginning of year |   | $          | 3,462,100  |   |
|----------------------------|--------|------------|------------|--------|
| Changes in related parties |   | 7,159      |       |
| Advances                   |   | 13,976,173 |       |
| Repayments                 |   | (6,617,225 | )          |
| Balance, end of year       |   | $          | 10,828,207 |   |

 

**NOTE 4.****               ****PREMISES AND EQUIPMENT**

 

Premisesand equipment are summarized as follows:

 
| ** **               | ** ** | **December 31,** | ** **    |
|--------------------------|------------|-----------------------|---------------|
| ** **               | ** ** | **2007**              | ** **    | **2006** | ** ** |
| ** **               | ** ** | ** **            | ** **    | ** ** | ** ** |
| Land                     | ** ** | **$**                 | **1,784,006** |   | $ | 1,494,006 |   |
| Buildings                | ** ** | **4,632,648**         |          | 3,354,009 |   |
| Construction in progress | ** ** | **14,395**            |          | — |   |
| Leasehold improvements   | ** ** | **166,977**           |          | 166,977 |   |
| Equipment                | ** ** | **2,125,793**         |          | 1,789,815 |   |
| ** **               |       | **8,723,819**         |          | 6,804,807 |   |
| Accumulated depreciation | ** ** | **(1,158,564**        | **)**         | (791,739 | ) |
| ** **               |       | **$**                 | **7,565,255** |   | $ | 6,013,068 |   |

 

Subsequent to December 31, 2007, theCompany entered into a contractual agreement totaling $1.6 million to constructa new branch in Covington, Georgia.  At December 31,2007, capitalized expenses totaling $14,395 for surveying and land planningfees were related to the proposed Covington branch construction.  Due to current economic conditions, theconstruction of the branch has been temporarily postponed as provided for inthe terms of the agreement.

 

Softwarecosts of $149,158 and $130,327, net of accumulated amortization of $119,306 and$79,465, are included in other assets as of December 31, 2007 and 2006,respectively.

 

**Leases**

 

The Company leases itsoperations center facilities under an operating lease agreement forapproximately $70,000 a year in rental expense. The initial term of the lease is three years with two renewal options,each being for one year.

 

During 2007, the Companyentered into an operating ground lease agreement for its new Covington branchlocation for $96,000 a year in rental expense. The initial term of the lease is 15 years with a right to renew and anoption to purchase.

 

Rental expense for theyears ended December 31, 2007 and 2006 was $93,139 and $69,139,respectively.

 

F-17

----

** **

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 4.****                                            PREMISESAND EQUIPMENT (Continued)**

** **

Futureminimum lease payments on noncancelable operating leases are summarized asfollows:

 
| 2008       |   | $       | 169,000  |   |
|------------|--------|---------|---------------|--------|
| 2009       |   | 169,000 |          |
| 2010       |   | 120,000 |          |
| 2011       |   | 96,000  |          |
| 2012       |   | 96,000  |          |
| Thereafter |   | 960,000 |          |
|       |   | $       | 1,610,000     |   |

 

**NOTE 5.****                                            BANKOWNED LIFE INSURANCE**

 

****In 2007, the Companypurchased and is the beneficiary of life insurance policies on its executiveofficers.  The cash surrender values of   these policies included in other assets atDecember 31, 2007 was $3,033,980.

 

**NOTE 6.****                                            DEPOSITS**

** **

Theaggregate amount of time deposits in denominations of $100,000 or more atDecember 31, 2007 and 2006 was $38,217,150 and $41,348,232, respectively.  Total brokered time deposits at December 31,2007 and 2006 were $127,150,000 and $85,786,000, respectively.  The scheduled maturities of time deposits atDecember 31, 2007 are as follows:

 
| 2008   |   | $          | 174,460,322 |   |
|--------|--------|------------|-------------|--------|
| 2009   |   | 13,818,260 |        |
| 2010   |   | 4,806,203  |        |
| 2011   |   | 10,528,282 |        |
| 2012   |   | 10,920,426 |        |
|   |   | $          | 214,533,493 |   |

 

Overdraftdemand deposits reclassified to loans totaled $101,954 and $8,438 atDecember 31, 2007 and 2006, respectively.

 

**NOTE 7.****                                            OTHERBORROWINGS**

 

Other borrowingsconsist of the following:

 
| ** **                                                                                                                | ** ** | **December 31,** | ** **     |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------|----------------|
| ** **                                                                                                                | ** ** | **2007**         | ** **     | **2006** | ** ** |
| Adjustable rate  credit advances from Federal Home Loan Bank, with a weighted average rate of  5.14% at December 31, 2007 | ** ** | **$**            | **10,000,000** |   | $ | 2,000,000 |   |
|                                                                                                                      |       |             |           |   |   |
| Fixed rate  credit advances from Federal Home Loan Bank, with a weighted average rate of  5.24% at December 31, 2007      | ** ** | **5,000,000**    |           | 4,000,000 |   |
|                                                                                                                      |       |             |           |   |   |
| Convertible rate  credit advances from Federal Home Loan Bank, with a weighted average rate  4.26% at December 31, 2007   | ** ** | **19,000,000**   |           | 16,000,000 |   |
|                                                                                                                      | ** ** | **$**            | **34,000,000** |   | $ | 22,000,000 |   |

 

F-18

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 7.****                                            OTHERBORROWINGS (Continued)**

** **

The contractualmaturities of other borrowings as of December 31, 2007 are as follows:

 
| 2008   |   | $         | 10,000,000 |   |
|--------|--------|-----------|------------|--------|
| 2009   |   | 5,000,000 |       |
| 2011   |   | 5,000,000 |       |
| 2012   |   | 9,000,000 |       |
| 2014   |   | 3,000,000 |       |
| 2015   |   | 2,000,000 |       |
|   |   | $         | 34,000,000 |   |

 

All Federal HomeLoan Bank advances are secured by commercial real estate loans with a carryingvalue of $6,901,912, and securities with a carrying value of $36,288,139 atDecember 31, 2007.

 

**NOTE 8.****                                            SUBORDINATEDDEBENTURES**

** **

****In 2006, the Company formed awholly-owned grantor trust to issue floating rate cumulative trust preferredsecurities in a private placement offering. The grantor trust has invested the proceeds of the trust securities insubordinated debentures of the Company. The trust preferred securities can be redeemed, in whole or in part,from time to time, prior to maturity at the option of the Company on or afterOctober 7, 2011.  The sole assets of theguarantor trust are the floating rate subordinated debentures of the Company(the debentures).  The Company has theright to defer interest payments on the debentures up to ten consecutivesemi-annual periods (five years), so long as the Company is not in defaultunder the subordinated debentures.  Interestcompounds during the deferral period.  Nodeferral period may extend beyond the maturity date.

 

The preferred securitiesare subject to redemption, in whole or in part, upon repayment of thesubordinated debentures at maturity on October 7, 2036 or their earlierredemption.  The Company has the right toredeem the debentures, in whole or in part, from time to time, on or afterOctober 7, 2011, at a redemption price equal to 100% of the principal amount tobe redeemed plus any accrued and unpaid interest.

 

The Company hasguaranteed the payment of all distributions the Trust is obligated to make, butonly to the extent the Trust has sufficient funds to satisfy thosepayments.  The Company and the Trustbelieve that, taken together, the obligations of the Company under theguarantee agreement, the trust agreement, the subordinated debentures, and theindenture provide, in aggregate, a full, irrevocable and unconditionalguarantee of all of the obligations of the trust under the preferred securitieson a subordinated basis.

 

The Company is requiredby the Federal Reserve Board to maintain certain levels of capital for bankregulatory purposes.  The Federal ReserveBoard has determined that certain cumulative preferred securities having thecharacteristics of trust preferred securities qualify as minority interest,which is included in Tier 1 capital for bank and financial holdingcompanies.  In calculating the amount ofTier 1 qualifying capital, the trust preferred securities can only be includedup to the amount constituting 25% of total Tier 1 capital elements (includingtrust preferred securities).  Such Tier 1capital treatment provides the company with a more cost-effective means ofobtaining capital for bank regulatory purposes than if the Company were toissue preferred stock.

 

F-19

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 8.****                                            SUBORDINATEDDEBENTURES (Continued)**

** **

The trust preferredsecurities and the related debentures were issued on October 4, 2006.  Both financial instruments bear an identicalannual rate of interest of the London Interbank Offered Rate (LIBOR) plus1.67%, or 6.66% at December 31, 2007. Distributions on the trust preferred securities are paid quarterly onMarch 15, June 15, September 15 and December 15 of each year, beginningDecember 15, 2006.  Interest on thedebentures is paid on the corresponding dates. The aggregate principal amount of trust preferred certificatesoutstanding at December 31, 2007 was $8,000,000.  The aggregate principal amount of debenturesoutstanding at December 31, 2007 was $8,248,000.

 

**NOTE 9.****                                            EMPLOYEEAND DIRECTOR BENEFIT PLANS**

 

**Stock Compensation Plans**

 

The Company adopted astock option plan during 2005 which grants key employees options to purchaseshares of common stock of the Company. Option prices and terms are determined by a committee appointed by theBoard of Directors.  The plan providesfor a total of 330,000 options to purchase common stock of the Company.  As of December 31, 2007, 219,984 optionsunder the plan are outstanding.  TheCompany can grant up to 110,016 options under the existing plan.

 

Inrecognition of the efforts and financial risks undertaken by the Company’sorganizers, the Company granted each organizer an opportunity to purchase anumber of shares of the Company’s common stock. The warrants vest over a three year period from the date the Companycommenced operations and are exercisable in whole or in part during the tenyear period following the commencement date, at an exercise price equal to$7.58 per share.  The warrants arenontransferable, but shares issued pursuant to the exercise of warrants will betransferable, subject to compliance with applicable securities laws.  At December 31, 2007, there were 262,416warrants outstanding.

 

A summary of the statusof the fixed stock option and warrant plans is as follows:

 
| ** **                             | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------|------------|------------------------------|------------|
| ** **                             | ** ** | **2007**                     | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                   | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                             | ** ** | ** **                   | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                             | ** ** | ** **                   | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                             | ** ** | **Number**                   | ** ** | **Price** | ** ** | **Number** | ** ** | **Price** | ** ** |
|                                   |       |                         |       |   |   |   |   |   |   |
| Options outstanding, beginning of year | ** ** | **493,702**                  | ** ** | **$** | **9.58** |   | 428,615 |   | $ | 8.77 |   |
| Granted                                | ** ** | **8,500**                    | ** ** | **7.56** |   | 68,154 |   | 14.84 |   |
| Exercised                              | ** ** | **—**                   | ** ** | **—** |   | — |   | — |   |
| Forfeited                              | ** ** | **(14,238**                  | **)**      | **13.78** |   | (3,067 | ) | 13.71 |   |
| Expired                                | ** ** | **(5,564**                   | **)**      | **13.68** |   | — |   | — |   |
| Options outstanding, end of year       | ** ** | **482,400**                  | ** ** | **9.37** |   | 493,702 |   | 9.58 |   |
|                                   |       |                         |       |   |   |   |   |   |   |
| Exercisable, end of year               | ** ** | **458,200**                  | ** ** | **9.46** |   | 445,022 |   | 9.46 |   |
|                                        |            |                              |            |  |  |  |  |  |  |  |  |

 

F-20

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 9.****                                            EMPLOYEEAND DIRECTOR BENEFIT PLANS (Continued)**

 

**Stock Compensation Plans (Continued)**

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the weighted-average assumptions listed in the following table.  Expected volatility has been determined based upon the historical volatility of the Company’s stock.  The expected term of the options granted is based upon the short-cut method and represents the period of time that the options granted are expected to be outstanding.  Expected dividends are based on dividend trends and the market price of the Company’s stock price at grant.  Historical data is used to estimate option exercised and employee terminations within the model.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

 
| ** **                                                           | ** ** | **Year Ended  December 31,  2007** | ** ** |
|----------------------------------------------------------------------|------------|------------------------------------|------------|
|                                                                 |       |                               |       |
| Expected dividends (as a percentage of the fair  value of the stock) |       | 0%                                 |       |
| Expected life of the options                                         |       | 5 years                            |       |
| Expected volatility                                                  |       | 19.76%-27.43%                      |       |
| Weighted average expected volatility                                 |       | 25.17%                             |       |
| Risk-free interest rate                                              |       | 3.45%-4.59%                        |       |
| Weighted-average grant date fair value                               |       | $2.23                              |       |

 

At December 31, 2007,there was $19,678 of unrecognized compensation cost related to stock-basedpayments, which is expected to be recognized over a weighted-average period of1.50 years.  At December 31, 2007, theintrinsic value of outstanding options was $0 and the intrinsic value ofexercisable options was $0 because the market price of the stock was lower thanthe option exercise price.

 

A further summary of thestock options and warrants outstanding at December 31, 2007 follows:

 
| ** **          | ** ** | **Options and Warrants  Outstanding** | ** ** | **Options and Warrants** | ** ** |
|---------------------|------------|---------------------------------------|------------|--------------------------|------------|
| ** **          | ** ** | ** **                            | ** ** | **Weighted-**            | ** ** | ** ** | ** ** | **Exercisable** | ** ** |
| ** **          | ** ** | ** **                            | ** ** | **Average**              | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **          | ** ** | ** **                            | ** ** | **Remaining**            | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| **Range of**        | ** ** | **Number**                            | ** ** | **Contractual**          | ** ** | **Exercise** | ** ** | **Number** | ** ** | **Exercise** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**                       | ** ** | **Life (Years)**         | ** ** | **Price** | ** ** | **Exercisable** | ** ** | **Price** | ** ** |
| $5.30               |       | 6,000                                 |       | 10.00                    |       | $ | 5.30 |   | 6,000 |   | $ | 5.30 |   |
| 7.58                |       | 344,916                               |       | 3.67                     |       | 7.58 |   | 320,716 |   | 7.58 |   |
| 13.68               |       | 77,853                                |       | 5.14                     |       | 13.66 |   | 77,853 |   | 13.66 |   |
| 13.75 - 14.38       |       | 19,631                                |       | 1.88                     |       | 13.86 |   | 19,631 |   | 13.86 |   |
| 15.21               |       | 6,000                                 |       | 4.21                     |       | 15.21 |   | 6,000 |   | 15.21 |   |
| 16.00               |       | 28,000                                |       | 4.54                     |       | 16.00 |   | 28,000 |   | 16.00 |   |
|                |       | 482,400                               |       | 3.97                     |       | 9.37 |   | 458,200 |   | 9.46 |   |
|                     |            |                                       |            |                          |            |  |  |  |  |  |  |  |  |

 

**401(k)Profit Sharing Plan**

 

The Company has a 401(K)Profit Sharing Plan available to all eligible employees, subject to certainminimum age and service requirements. The contributions expensed were $61,208 and $52,538 for the years endedDecember 31, 2007 or 2006, respectively.

 

F-21

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 10.****                                     INCOMETAXES**

 

Thecomponents of income tax expense are as follows:

 
| ** **                    | ** ** | **Years Ended December 31,** | ** **    |
|-------------------------------|------------|------------------------------|---------------|
| ** **                    | ** ** | **2007**                     | ** **    | **2006** | ** ** |
| Current                       | ** ** | **$**                        | **1,117,737** | ** ** | **$** | **1,713,416** | ** ** |
| Deferred                      | ** ** | **(2,091,663**               | **)**         | **(216,517** | **)** |
| Income tax  (benefit) expense | ** ** | **$**                        | **(973,926**  | **)** | **$** | **1,496,899** | ** ** |

 

TheCompany’s income tax expense differs from the amounts computed by applying thefederal income tax statutory rates to income before income taxes.  A reconciliation of the differences is asfollows:

 
| ** **                              | ** ** | **Years Ended December 31,** | ** **   |
|-----------------------------------------|------------|------------------------------|--------------|
| ** **                              | ** ** | **2007**                     | ** **   | **2006** | ** ** |
|                                    |       |                         |         |   |   |
| Tax provision at statutory federal rate | ** ** | **$**                        | **(767,137** | **)** | $ | 1,379,928 |   |
| State income  taxes                     | ** ** | **(147,778**                 | **)**        | 117,411 |   |
| Tax-free  interest                      | ** ** | **(66,022**                  | **)**        | (38,339 | ) |
| Stock based  compensation               | ** ** | **27,483**                   |         | 48,909 |   |
| Other items, net                        | ** ** | **(20,472**                  | **)**        | (11,010 | ) |
| Income tax (benefit) expense            | ** ** | **$**                        | **(973,926** | **)** | $ | 1,496,899 |   |

 

The components ofdeferred income taxes are as follows:

 
| ** **                          | ** ** | **December 31,** | ** **    |
|-------------------------------------|------------|------------------|---------------|
| ** **                          | ** ** | **2007**         | ** **    | **2006** | ** ** |
| Deferred tax assets:                | ** ** | ** **       | ** **    | ** ** | ** ** |
| Loan loss  reserves                 | ** ** | **$**            | **2,428,352** |   | $ | 692,744 |   |
| Preopening  expenses                | ** ** | **11,855**       |          | 15,729 |   |
| Unearned loan  fees                 | ** ** | **58,772**       |          | 118,553 |   |
| Non-qualified  stock option expense | ** ** | **70,593**       |          | 66,880 |   |
| Nonaccrual loan  interest           | ** ** | **459,793**      |          | **—** |   |
| Securities  available for sale      | ** ** | **—**       |          | 189,167 |   |
| Interest rate  derivatives          | ** ** | **—**       |          | 49,413 |   |
| ** **                          | ** ** | **3,029,365**    |          | 1,132,486 |   |
| Deferred tax liabilities:           | ** ** | ** **       | ** **    | ** ** | ** ** |
| Depreciation                        | ** ** | **109,613**      |          | 65,816 |   |
| Securities  available for sale      | ** ** | **64,295**       | ** **    | **—** | ** ** |
| Interest rate  derivatives          | ** ** | **56,229**       | ** **    | **—** | ** ** |
| ** **                          | ** ** | **230,137**      |          | 65,816 |   |
|                                |       |             |          |   |   |
| Net deferred tax assets             | ** ** | **$**            | **2,799,228** |   | $ | 1,066,670 |   |

 

F-22

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 11.****                                     EARNINGS(LOSSES) PER SHARE**

** **

Presented below isa summary of the components used to calculate basic and diluted earnings(losses) per common share:

 
| ** **                                                                                                                                     | ** ** | **Years Ended December 31,** | ** **     |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|----------------|
| ** **                                                                                                                                     | ** ** | **2007**                     | ** **     | **2006** | ** ** |
| Basic Earnings (Losses) Per Share:                                                                                                             |       |                         |           |   |   |
| Weighted average  common shares outstanding                                                                                                    | ** ** | **2,792,498**                |           | 2,831,676 |   |
|                                                                                                                                           |       |                         |           |   |   |
| Net income (loss)                                                                                                                              | ** ** | **$**                        | **(1,282,360** | **)** | $ | 2,561,713 |   |
|                                                                                                                                           |       |                         |           |   |   |
| Basic earnings (losses) per share                                                                                                              | ** ** | **$**                        | **(.46**       | **)** | $ | .90 |   |
|                                                                                                                                           |       |                         |           |   |   |
| Diluted Earnings (Losses) Per Share:                                                                                                           |       |                         |           |   |   |
| Weighted average  common shares outstanding                                                                                                    | ** ** | **2,792,498**                |           | 2,831,676 |   |
| Net effect of  the assumed exercise of stock options and warrants based on the treasury  stock method using average market prices for the year |       | **120,503**                  |           | 175,013 |   |
| Total weighted  average common shares and common stock equivalents outstanding                                                                 |       | **2,913,001**                |           | 3,006,689 |   |
|                                                                                                                                           |       |                         |           |   |   |
| Net income  (loss)                                                                                                                             | ** ** | **$**                        | **(1,282,360** | **)** | 2,561,713 |   |
|                                                                                                                                           |       |                         |           |   |   |
| Diluted earnings  (losses) per share                                                                                                           | ** ** | **$**                        | **(.44**       | **)** | $ | .85 |   |

** **

****On November 16, 2006, theCompany declared a six-for-five stock split payable to shareholders of recordon December 1, 2006 which was distributed on December 29, 2006.  The 2005 stock dividend and the 2006 stocksplit are accurately reflected in the weighted average common sharesoutstanding for the years ended December 31, 2007 and 2006.

 

**NOTE 12.****                                     COMMITMENTSAND CONTINGENCIES**

** **

**LoanCommitments**

** **

The Company is aparty to financial instruments with off-balancesheet risk in the normal course of business to meet the financing needsof its customers.  These financialinstruments include commitments to extend credit and standby letters ofcredit.  They involve, to varying degrees,elements of credit risk and interest rate risk in excess of the amount recognizedin the balance sheets.  The majority ofall commitments to extend credit and standby letters of credit are variablerate instruments.

 

The Company’sexposure to credit loss in the event of nonperformance by the other party tothe financial instrument for commitments to extend credit and standby lettersof credit is represented by the contractual amount of those instruments.  The Company uses the same credit policies inmaking commitments and conditional obligations as it does for on-balance sheetinstruments.

 

F-23

----

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

** **

**NOTE 12.****                                     COMMITMENTSAND CONTINGENCIES (Continued)**

 

**LoanCommitments (Continued)**

 

A summary of theCompany's commitments is as follows:

 
| ** **                   | ** ** | **December 31,** | ** **     |
|------------------------------|------------|------------------|----------------|
| ** **                   | ** ** | **2007**         | ** **     | **2006** | ** ** |
|                         |       |             |           |   |   |
| Commitments to extend credit | ** ** | **$**            | **29,592,199** |   | $ | 48,844,407 |   |
| Standby letters of credit    | ** ** | **913,147**      |           | 1,702,671 |   |
|                         | ** ** | **$**            | **30,505,346** |   | $ | 50,547,078 |   |

 

Commitmentsto extend credit are agreements to lend to a customer as long as there is noviolation of any condition established in the contract.  Commitments generally have fixed expirationdates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected toexpire without being drawn upon, the total commitment amounts do notnecessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Companyupon extension of credit, is based on management’s credit evaluation of theparty.  Collateral held varies, but mayinclude accounts receivable, inventory, property and equipment, residentialreal estate and income-producing commercial properties.

 

Standby letters ofcredit are conditional commitments issued by the Company to guarantee theperformance of a customer to a third party. Those guarantees are primarily issued to support public and privateborrowing arrangements.  The credit riskinvolved in issuing letters of credit is essentially the same as that involvedin extending loans to customers.  Collateralheld varies as specified above and is required in instances which the Companydeems necessary.

 

At December 31,2007 and 2006, the carrying amount of liabilities related to the Company’sobligation to perform under financial standby letters of credit wasinsignificant.  The Company has not beenrequired to perform on any financial standby letters of credit, and the Companyhas not incurred any losses on financial standby letters of credit for theyears ended December 31, 2007 and 2006.

 

**InterestRate Derivatives**

** **

The Companymaintains an overall interest rate risk-management strategy that incorporatesthe use of derivative instruments to minimize significant unplannedfluctuations in earnings that are caused by interest rate volatility.  The goal is to manage interest ratesensitivity by modifying the repricing characteristics of certain assets andliabilities so that certain movements in interest rates do not, on a materialbasis, adversely affect the net interest margin.  The Company views this strategy as prudentmanagement of interest rate sensitivity, such that earnings are not exposed toundue risk presented by changes in interest rates.  As a matter of policy, the Company does notuse speculative derivative instruments for interest rate risk management

 

By usingderivative instruments, the Company is potentially exposed to credit and marketrisk.  If the counter-party fails toperform, credit risk is equal to the extent of the fair value gain in aderivative.  When the fair value of aderivative contract is positive, this generally indicates that the counterpartyowes the Company, and, therefore, creates a repayment risk for theCompany.  When the fair value of aderivative contract is negative, the Company owes the counterparty and,therefore, has no repayment risk.  TheCompany minimizes the credit (or repayment) risk in derivative instruments byentering into transactions with high-quality counterparties that are reviewedperiodically.

 

F-24

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 12.****                                         ****COMMITMENTS AND CONTINGENCIES (Continued)**

 

**InterestRate Derivatives (Continued)**

 

The Company’s derivativeactivities are monitored by its asset/liability management committee as part ofthat committee’s oversight of the Company’s asset/liability management andtreasury functions. The Company’s asset/liability management committee isresponsible for implementing various hedging strategies that are developedthrough its analysis of data from financial simulation models and otherinternal and industry sources. The resulting hedging strategies are thenincorporated into the overall interest-rate risk management.

 

All of the Company’sderivative financial instruments are classified as highly effective cash flowhedges. For the year ended December 31, 2007, there were no materialamounts recognized which represented the ineffective portion of cash flowhedges. All components of each derivative’s gain or loss are included in theassessment of hedge effectiveness, unless otherwise noted.

 

Interest rate derivativeinstruments that are used as part of the Company’s interest raterisk-management strategy consist of S&P call options and FHLB derivativecontracts related to the issuance of certain certificates of deposit tocustomers. The Company offers to its customers a deposit product called IndexPowered Certificates of Deposit (IPCD) with the IPCD’s payoff at maturityconsisting of an S&P call option and the deposited principal. The Companypays a quarterly interest charge to the FHLB in return for a guarantee that theFHLB will give the Company the cash equivalent of 90% of the average growth ofthe last twelve quarters of the growth in the S&P 500 Index over the termof the IPCD (“FHLB Derivative Contract”). The Company remits this cashequivalent and the original deposited principal to the customer upon maturityof the IPCD.

 

Information pertainingto outstanding interest rate derivatives used to hedge variable-rate depositsis as follows:

 
| ** **                                                                              | ** ** | **December 31,** | ** **  |
|-----------------------------------------------------------------------------------------|------------|-----------------------|-------------|
| ** **                                                                              | ** ** | **2007**              | ** **  | **2006** | ** ** |
| Notional amount                                                                         | ** ** | **$**                 | **247,951** |   | $ | 247,951 |   |
| Weighted average maturity in years                                                      | ** ** | **.76 years**         |        | 1.66 years |   |
|                                                                                    |       |                  |        |   |   |
| Fair value of S&P call options included  in other liabilities                       | ** ** | **$**                 | **93,423**  |   | $ | 84,934 |   |
|                                                                                    |       |                  |        |   |   |
| Fair value of FHLB derivative contracts included  as a reduction of deposit liabilities |       | **$**                 | **3,505**   |   | $ | 10,490 |   |

 

The Company recognizednet expense for the year ended December 31, 2007 as a result of theseinterest rate derivatives in the amount of $8,500, of which $7,283 is includedin interest expense and $1,217 is included in other operating expenses ascompared to a net expense of $11,709, of which $7,443 is included in interestexpense and $4,266 is included in other operating expenses for the year ended December 31,2006.

 

Another component of theCompany’s interest rate risk management strategy is the implementation ofinterest rate floors. In addition to the 2005 interest rate floor purchase witha $40 million notional amount and a 7.50% strike, the Company purchased anadditional interest rate floor in 2006 with a $30 million notional amount andan 8.50% strike. These instruments are being used as a hedge for the Company’sprime-based loan portfolio.

 

F-25

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 12.****                                         ****COMMITMENTS AND CONTINGENCIES (Continued)**

 

**InterestRate Derivatives (Continued)**

 

Information pertainingto the interest rate floors is as follows:

 
| ** **                                                     | ** ** | **December 31,** | ** **     |
|----------------------------------------------------------------|------------|-----------------------|----------------|
| ** **                                                     | ** ** | **2007**              | ** **     | **2006** | ** ** |
| Notional amount                                                | ** ** | **$**                 | **70,000,000** |   | $ | 70,000,000 |   |
| Weighted average maturity in years                             | ** ** | **.49 years**         |           | 1.49 years |   |
|                                                           |       |                  |           |   |   |
| Fair value of the floor option value  included in other assets | ** ** | **$**                 | **353,422**    |   | $ | 400,000 |   |

 

The Company recognized anet expense for the year ended December 31, 2007 as a result of theinterest rate floors in the amount of $182,362 which is included as a reductionof loan interest income as compared to a net expense of $96,139 for the yearended December 31, 2006.

 

In December 2007,the Company also implemented interest rate swaps as another interest rate riskmanagement strategy. The Company receives a fixed rate of interest from thecounterparty and pays a floating rate tied to prime to the counterparty. Theseinstruments are being used as a hedge for the Company’s certificate of depositportfolio.

 

Information pertainingto the interest rate swaps is as follows:

 
| ** **                         | ** ** | **December 31,** | ** **     |
|------------------------------------|------------|-----------------------|----------------|
| ** **                         | ** ** | **2007**              | ** **     | **2006** | ** ** |
| Notional amount                    | ** ** | **$**                 | **20,000,000** |   | $ | — |   |
| Weighted average maturity in years | ** ** | **4.50 years**        |           | — |   |
|                                    |            |                       |                |  |  |  |  |

 

The Company recognized anet expense for the year ended December 31, 2007 as a result of theinterest rate swaps in the amount of $2,358 which is included as an increase ofdeposit interest.

 

**Contingencies**

 

In the normal course ofbusiness, the Company is involved in various legal proceedings. In the opinionof management, any liability resulting from such proceedings would not have amaterial adverse effect on the Company’s financial statements.

 

**Employment Agreements**

 

In 2004, the Companyentered into employment agreements with certain officers of the Company withinitial terms ranging from three to four years requiring annual salariestotaling $645,500. The agreements are automatically extended for an additionaltwelve months on the initial term date and each anniversary date thereafterunless proper notification is given. The officers are entitled to receiveannual salary increases, and are eligible to receive discretionary bonuses andstock option incentives as may be determined by the Company’s Board ofDirectors. The total annual salaries under these agreements for 2007 and 2006were $592,183 and $711,664, respectively, and bonuses paid under the employmentagreements for 2007 and 2006 were $88,639 and $227,666, respectively.

 

F-26

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**NOTE 13.****                                     ****CONCENTRATIONS OF CREDIT**

 

The Company originatesprimarily commercial, residential and consumer loans to customers in HenryCounty and surrounding counties. The ability of the majority of the Company’scustomers to honor their contractual loan obligations is dependent on theeconomy in these areas.

 

Ninety-two percent ofthe Company’s loan portfolio is concentrated in loans secured by real estate,of which a substantial portion is secured by real estate in the Company’sprimary market area. Accordingly, the ultimate collectibility of the loanportfolio is susceptible to changes in market conditions in the Company’sprimary market area. The other significant concentrations of credit by type ofloan are set forth in Note 3.

 

The Company, as a matterof policy, does not generally extend credit to any single borrower or group ofrelated borrowers in excess of 25% of the Bank’s statutory capital, orapproximately $6,343,000.

 

**NOTE 14.****                                     ****REGULATORY MATTERS**

 

The Company is subjectto certain restrictions on the amount of dividends that may be declared withoutprior regulatory approval. At December 31, 2007, no dividends wereavailable for declaration.

 

The Company and Bank arealso subject to various regulatory capital requirements administered by thefederal banking agencies. Failure to meet minimum capital requirements caninitiate certain mandatory, and possibly additional discretionary actions byregulators that, if undertaken, could have a direct material effect on theconsolidated financial statements. Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Company and the Bankmust meet specific capital guidelines that involve quantitative measures of theassets, liabilities and certain off-balance-sheet items as calculated underregulatory accounting practices. Capital amounts and classification are alsosubject to qualitative judgments by the regulators about components, riskweightings and other factors. If, in the opinion of the regulators, the Companyor the Bank engaged in unsafe or unsound practices, the regulators couldsubject the Company or the Bank to a variety of enforcement remedies, includingissuance of a capital directive, a prohibition on accepting brokered depositsand other restrictions.

 

Quantitative measuresestablished by regulation to ensure capital adequacy require the Company andthe Bank to maintain minimum amounts and ratios of total and Tier 1 capital torisk-weighted assets, as defined, and of Tier 1 capital to average assets, asdefined. Management believes, as of December 31, 2007, the Company and theBank met all capital adequacy requirements to which they are subject.

 

As of December 31,2007, the most recent notification from the Federal Deposit InsuranceCorporation categorized the Bank as well capitalized under the regulatoryframework for prompt corrective action. To be categorized as well capitalized,the Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1leverage ratios as set forth in the following table. There are no conditions orevents since that notification that management believes have changed the Bank’scategory. Prompt corrective action provisions are not applicable to bankholding companies.

 

F-27

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 14.****                                         ****REGULATORY MATTERS****(Continued)**

 

The Company’s actualcapital amounts and ratios are presented in the following table.

 
| ** **                             | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|--------------|------------|----------------------------|------------|----------------------------|------------|--------------------------|------------|
| ** **                             | ** ** | ** **                           | ** ** | ** **   | ** ** | **For Capital**       | ** ** | **Capitalized Under** | ** ** |
| ** **                             | ** ** | ** **                           | ** ** | ** **   | ** ** | **Adequacy**               | ** ** | **Prompt Corrective** | ** ** |
| ** **                             | ** ** | **Actual**                           | ** ** | **Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                             | ** ** | **Amount**                           | ** ** | **Ratio**    | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**               | ** ** | **Ratio** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
| **As of December 31, 2007:**      |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Total Capital to Risk Weighted Assets  | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **               | ** ** | ** ** | ** ** |
| Consolidated                           | ** ** | **$**                                | **37,350** | ** **   | **12.84**  | **%**                      | **$**      | **23,276**                 | ** ** | **8**                    | **%**      | **$** | N/A |   | N/A |   |
| Bank only                              | ** ** | **$**                                | **33,997** | ** **   | **11.68**  | **%**                      | **$**      | **23,276**                 | ** ** | **8**                    | **%**      | **$** | **29,095** | ** ** | **10** | **%** |
| Tier 1 Capital to Risk Weighted Assets | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **               | ** ** | ** ** | ** ** |
| Consolidated                           | ** ** | **$**                                | **33,670** | ** **   | **11.57**  | **%**                      | **$**      | **11,638**                 | ** ** | **4**                    | **%**      | **$** | N/A |   | N/A |   |
| Bank only                              | ** ** | **$**                                | **30,317** | ** **   | **10.42**  | **%**                      | **$**      | **11,638**                 | ** ** | **4**                    | **%**      | **$** | **17,457** | ** ** | **6** | **%** |
| Tier 1 Capital to Average Assets       | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **               | ** ** | ** ** | ** ** |
| Consolidated                           | ** ** | **$**                                | **33,670** | ** **   | **9.82**   | **%**                      | **$**      | **13,717**                 | ** ** | **4**                    | **%**      | **$** | N/A |   | N/A |   |
| Bank only                              | ** ** | **$**                                | **30,317** | ** **   | **8.99**   | **%**                      | **$**      | **13,495**                 | ** ** | **4**                    | **%**      | **$** | **16,868** | ** ** | **5** | **%** |
|                                   |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| **As of December 31, 2006:**      |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Total Capital to Risk Weighted Assets  | ** ** | ** **                           | ** ** | ** **   | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **               | ** ** | ** ** | ** ** |
| Consolidated                           |       | $                                    | 38,534     |         | 16.32      | %                          | $          | 18,887                     |       | 8                        | %          | $ | N/A |   | N/A |   |
| Bank only                              |       | $                                    | 30,579     |         | 12.95      | %                          | $          | 18,886                     |       | 8                        | %          | $ | 23,607 |   | 10 | % |
| Tier 1 Capital to Risk Weighted Assets |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Consolidated                           |       | $                                    | 36,142     |         | 15.31      | %                          | $          | 9,443                      |       | 4                        | %          | $ | N/A |   | N/A |   |
| Bank only                              |       | $                                    | 28,187     |         | 11.94      | %                          | $          | 9,443                      |       | 4                        | %          | $ | 14,164 |   | 6 | % |
| Tier 1 Capital to Average Assets       |       |                                 |       |         |       |                       |       |                       |       |                     |       |   |   |
| Consolidated                           |       | $                                    | 36,142     |         | 13.16      | %                          | $          | 10,989                     |       | 4                        | %          | $ | N/A |   | N/A |   |
| Bank only                              |       | $                                    | 28,187     |         | 10.26      | %                          | $          | 10,988                     |       | 4                        | %          | $ | 13,736 |   | 5 | % |

 

F-28

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 15.****                                         ****FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of afinancial instrument is the current amount that would be exchanged betweenwilling parties, other than in a forced liquidation. Fair value is bestdetermined based upon quoted market prices. However, in many instances, thereare no quoted market prices for the Company’s various financial instruments. Incases where quoted market prices are not available, fair value is based ondiscounted cash flows or other valuation techniques. Those techniques aresignificantly affected by the assumptions used, including the discount rate andestimates of future cash flows. Accordingly, the fair value estimates may notbe realized in an immediate settlement of the instrument. SFAS No. 107, *Disclosures about Fair Values of FinancialInstruments,* excludes certain financial instruments and allnonfinancial instruments from its disclosure requirements. Accordingly, theaggregate fair value amounts presented may not necessarily represent theunderlying fair value of the Company.

 

The following methodsand assumptions were used by the Company in estimating the fair value of itsfinancial instruments.

 

**Cash, Due From Banks,Interest-Bearing Deposits in Banks and Federal Funds Sold: **The carrying amounts of cash, due frombanks, interest-bearing deposits in banks and federal funds sold approximatefair values.

 

**Securities: **Fair values for securities are based onavailable quoted market prices. The carrying values of restricted equity securitieswith no readily determinable fair value approximate fair values.

 

**Loans: **The carrying amount of variable-rateloans that reprice frequently and have no significant change in credit riskapproximates fair value. The fair value of fixed-rate loans is estimated basedon discounted contractual cash flows, using interest rates currently beingoffered for loans with similar terms to borrowers with similar credit quality.The fair value of impaired loans is estimated based on discounted contractualcash flows or underlying collateral values, where applicable.

 

**Deposits:**  The carryingamount of demand deposits, savings deposits, and variable-rate certificates ofdeposit approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based ondiscounted contractual cash flows using interest rates currently being offeredfor certificates of similar maturities.

 

**Other Borrowings**:  The carrying amount ofadjustable and convertible rate borrowings approximates fair value. The fairvalue of fixed-rate borrowings is estimated based on discounted contractualcash flows using interest rates currently being offered for borrowings ofsimilar maturities.

 

**Subordinated Debentures: **The fair value of the Company’s variablerate subordinated debentures approximates the carrying value.

 

**Accrued Interest: **The carrying amount of accrued interestapproximates fair value.

 

**Interest Rate Derivatives**:  The fair value of interest rate derivativesis based on quoted market prices.

 

**Off-Balance-Sheet Instruments:**  The carrying amount of commitments to extendcredit and standby letters of credit approximates fair value. The carryingamount of the off-balance sheet financialinstruments is based on fees charged to enter into such agreements.

 

F-29

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 15.****                                         ****FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)**

 

The carrying amount andestimated fair value of the Company’s financial instruments were as follows:

 
| ** **                                                                       | ** ** | **December 31,** | ** **     |
|----------------------------------------------------------------------------------|------------|-----------------------|----------------|
| ** **                                                                       | ** ** | **2007**              | ** **     | **2006** | ** ** |
| ** **                                                                       | ** ** | **Carrying  Amount**  | ** **     | **Fair  Value** | ** ** | **Carrying  Amount** | ** ** | **Fair  Value** | ** ** |
| Financial assets:                                                                |       |                  |           |   |   |   |   |   |   |
| Cash, due from banks, interest-bearing  deposits in banks and federal funds sold |       | **$**                 | **16,977,890** | ** ** | **$** | **16,977,890** |   | $ | 17,452,004 |   | $ | 17,452,004 |   |
| Securities available for sale                                                    | ** ** | **54,645,511**        | ** **     | **54,645,511** |   | 39,559,041 |   | 39,559,041 |   |
| Restricted equity securities                                                     | ** ** | **2,516,856**         | ** **     | **2,516,856** |   | 2,013,556 |   | 2,013,556 |   |
| Loans                                                                            | ** ** | **249,723,766**       | ** **     | **249,770,591** |   | 208,005,364 |   | 209,791,903 |   |
| Accrued interest receivable                                                      | ** ** | **3,105,484**         | ** **     | **3,639,544** |   | 2,100,878 |   | 2,100,878 |   |
| Interest rate derivatives                                                        | ** ** | **353,422**           | ** **     | **353,422** |   | 400,000 |   | 400,000 |   |
|                                                                             |       |                  |           |   |   |   |   |   |   |
| Financial liabilities:                                                           |       |                  |           |   |   |   |   |   |   |
| Deposits                                                                         | ** ** | **274,946,324**       | ** **     | **261,880,359** |   | 216,411,470 |   | 202,291,281 |   |
| Other borrowings                                                                 | ** ** | **34,000,000**        | ** **     | **34,059,249** |   | 22,000,000 |   | 21,903,125 |   |
| Subordinated debentures                                                          | ** ** | **8,248,000**         | ** **     | **8,248,000** |   | 8,248,000 |   | 8,248,000 |   |
| Accrued interest payable                                                         | ** ** | **2,326,582**         | ** **     | **2,326,582** |   | 2,278,493 |   | 2,278,493 |   |
| Interest rate derivatives                                                        | ** ** | **89,918**            | ** **     | **89,918** |   | 74,444 |   | 74,444 |   |
|                                                                                  |            |                       |                |  |  |  |  |  |  |  |  |  |  |

 

**NOTE 16.****                                         ****SUPPLEMENTAL FINANCIAL DATA**

 

Components of otheroperating income and expenses in excess of 1% of total revenue are as follows:

 
| ** **                | ** ** | **Years Ended December 31,** | ** **  |
|---------------------------|------------|---------------------------------------------|-------------|
| ** **                | ** ** | **2007**                                    | ** **  | **2006** | ** ** |
| Other operating expenses: |       |                                        |        |   |   |
| Audit and accounting fees | ** ** | **$**                                       | **148,400** |   | $ | 96,293 |   |
| Data processing expense   | ** ** | **214,779**                                 |        | 175,047 |   |
|                           |            |                                             |             |  |  |  |  |

 

F-30

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 17.****                                          PARENTCOMPANY FINANCIAL INFORMATION**

 

The followinginformation presents the condensed balance sheet, statement of operation, andcash flows of FirstBank Financial Services, Inc. as of and for the yearsended December 31, 2007 and 2006.

 

**CONDENSED BALANCE SHEETS**

 
| ** **                                          | ** ** | **2007**       | ** **     | **2006**   | ** ** |
|-----------------------------------------------------|------------|----------------|----------------|------------|------------|
| **Assets**                                          |       |           |           |       |       |
| Cash                                                | ** ** | **$**          | **3,055,385**  |       | $          | 7,897,175 |   |
| Investment in subsidiary                            | ** ** | **30,583,819** |           | 27,798,420 |       |
| Restricted equity securities                        | ** ** | **248,000**    |           | 248,000    |       |
| Other assets                                        | ** ** | **250,607**    |           | 84,514     |       |
| **Total assets**                                    | ** ** | **$**          | **34,137,811** |       | $          | 36,028,109 |   |
|                                                |       |           |           |       |       |
| **Liabilities  and Stockholders’ Equity**      |       |           |           |       |       |
| Subordinated debentures                             | ** ** | **$**          | **8,248,000**  |       | $          | 8,248,000 |   |
| Other liabilities                                   | ** ** | **22,888**     |           | 27,381     |       |
| **Total liabilities**                               | ** ** | **8,270,888**  |           | 8,275,381  |       |
|                                                |       |           |           |       |       |
| **Stockholders’ equity**                       | ** ** | **25,866,923** |           | 27,752,728 |       |
| **Total liabilities and stockholders’ equity** | ** ** | **$**          | **34,137,811** |       | $          | 36,028,109 |   |

 

**CONDENSEDSTATEMENTS OF OPERATIONS**

 
| ** **                                                                               | ** ** | **2007**     | ** **     | **2006**  | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------|----------------|-----------|------------|
| **Income**                                                                               |       |         |           |      |       |
| Interest income                                                                          | ** ** | **$**        | **17,845**     |      | $          | 4,315 |   |
| Dividends from subsidiary                                                                | ** ** | **—**   |           | 50,000    |       |
| **Total income**                                                                         | ** ** | **17,845**   |           | 54,315    |       |
|                                                                                     |       |         |           |      |       |
| **Expenses**                                                                             |       |         |           |      |       |
| Interest expense                                                                         | ** ** | **593,478**  |           | 143,513   |       |
| Expenses, other                                                                          | ** ** | **52,630**   |           | 45,965    |       |
| **Total expenses**                                                                       | ** ** | **646,108**  |           | 189,478   |       |
| Loss before income tax benefits and equity  in undistributed income (loss) of subsidiary | ** ** | **(628,263** | **) **    | (135,163  | )     |
| **Income tax benefits**                                                                  | ** ** | **237,081**  |           | 69,873    |       |
| Loss before equity in undistributed loss of  subsidiary                                  | ** ** | **(391,182** | **) **    | (65,290   | )     |
| **Equity in undistributed income (loss) of  subsidiary**                                 | ** ** | **(891,178** | **)**          | 2,627,003 |       |
| **Net income (loss)**                                                                    | ** ** | **$**        | **(1,282,360** | **)**     | $          | 2,561,713 |   |

 

F-31

----

 

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS**

 

**NOTE 17.****                                          PARENTCOMPANY FINANCIAL INFORMATION (Continued)**

 

**CONDENSED STATEMENTS OF CASH FLOWS**

 
| ** **                                                                            | ** ** | **2007**       | ** **     | **2006**   | ** ** |
|---------------------------------------------------------------------------------------|------------|----------------|----------------|------------|------------|
| **OPERATING ACTIVITIES**                                                              |       |           |           |       |       |
| Net income (loss)                                                                     | ** ** | **$**          | **(1,282,360** | **)**      | $          | 2,561,713 |   |
| Adjustments to reconcile net income (loss)  to net cash used in operating activities: |       |           | ** **     |       |       |
| Undistributed (income) loss of subsidiary                                             | ** ** | **891,178**    | ** **     | (2,627,003 | )          |
| Other operating activities                                                            | ** ** | **(170,586**   | **)**          | (39,215    | )          |
|                                                                                  |       |           | ** **     |       |       |
| Net cash used in operating activities                                                 | ** ** | **(561,768**   | **)**          | (104,505   | )          |
|                                                                                  |       |           | ** **     |       |       |
| **INVESTING ACTIVITIES**                                                              |       |           | ** **     |       |       |
| Purchase of restricted equity securities                                              | ** ** | **—**     | ** **     | (248,000   | )          |
| Investment in subsidiary                                                              | ** ** | **(3,000,000** | **)**          |       |       |
|                                                                                  |       |           | ** **     |       |       |
| Net cash used in investing activities                                                 | ** ** | **(3,000,000** | **)**          | (248,000   | )          |
|                                                                                  |       |           | ** **     |       |       |
| **FINANCING ACTIVITIES**                                                              |       |           | ** **     |       |       |
| Proceeds from issuance of subordinated  debentures                                    | ** ** | **—**     | ** **     | 8,248,000  |       |
| Stock repurchase                                                                      | ** ** | **(1,280,022** | **)**          | —     |       |
| Payment for fractional shares                                                         | ** ** | **—**     | ** **     | (835       | )          |
|                                                                                  |       |           | ** **     |       |       |
| Net cash provided by (used in) financing  activities                                  | ** ** | **(1,280,022** | **)**          | 8,247,165  |       |
|                                                                                  |       |           | ** **     |       |       |
| Net increase (decrease) in cash                                                       | ** ** | **(4,841,790** | **)**          | 7,894,660  |       |
| Cash at beginning of year                                                             | ** ** | **7,897,175**  | ** **     | 2,515      |       |
| Cash at end of year                                                                   | ** ** | **$**          | **3,055,385**  | ** ** | $          | 7,897,175 |   |

 

F-32

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