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

**Washington,D.C. 20549**

 

**FORM 10-KSB**

 

**ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OFTHE**

**SECURITIES EXCHANGE ACT OF 1934**

 

**For theFiscal Year ended December 31, 2005**

 

**CommissionFile Number:  0-50106**

 

**LEGENDS FINANCIAL HOLDINGS, INC.**

(Name of Small Business Issuerin its charter)

 
| **Tennessee**                                       | ** ** | **32-0008963**       |
|-----------------------------------------------------|------------|----------------------|
| (State or  other jurisdiction of                    |       | (I.R.S.  Employer    |
| incorporation  or organization)                     |       | Identification  No.) |
|                                                |       |                 |
| **310  North First Street, Clarksville, Tennessee** | ** ** | **37040**            |
| (Address of  principal executive offices)           |       | (Zip Code)           |

 

**(931)503-1234**

(Issuer’s telephone number)

 

**Securitiesregistered under Section 12(g) of the Exchange Act: Common Stock, $1.00 par value per share**(Title of Class)

 

Check whether the issuer (1) filed all reports required to befiled by Section 13 or 15(d) of the Exchange Act during the past 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

YES  ý   NO o

 

Check if there is no disclosure of delinquent filers in response toItem 405 of Regulation S-B contained in this form, and no disclosure will becontained, to the best of registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-KSBor any amendment to this Form 10-KSB o

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). 

YES  o   NO ý

 

The issuer’s revenues for the fiscal year ended December 31, 2005were $13,478,000.

 

The aggregate market value of the issuer’s voting common stock held bynon-affiliates, computed by reference to the price at which the stock was soldas of March 1, 2006, is $27,009,038 for 1,174,306 shares at an estimated$23.00 per share.

 

As of March 1, 2006, 1,469,619****sharesof the issuer’s common stock were outstanding.

 

DOCUMENTS INCORPORATED BYREFERENCE

 

Portions of the Registrant’s definitive proxy statement relating to itsannual meeting of shareholders are incorporated by reference into Part IIIof this annual report on Form 10-KSB.

 

 

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# **CROSS REFERENCE INDEXTOFORM 10-KSB**

#  

Certain information required by Form 10-KSB is incorporated byreference from the annual report to shareholders as indicated below. Only thatinformation expressly incorporated by reference is deemed filed with theCommission.

 
| PART I   |                                                                                                             |
|---------------|------------------------------------------------------------------------------------------------------------------|
|          |                                                                                                             |   |
| ITEM 1.       | DESCRIPTION OF BUSINESS                                                                                          | * |
| ITEM 2.       | DESCRIPTION OF PROPERTY                                                                                          | * |
| ITEM  3.      | LEGAL  PROCEEDINGS                                                                                               | * |
| ITEM 4.       | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                              | None |
|          |                                                                                                             |   |
| PART II  |                                                                                                             |
|          |                                                                                                             |   |
| ITEM 5.       | MARKET  FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER  PURCHASES OF EQUITY SECURITIES | * |
| ITEM 6.       | MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION                                                   | * |
| ITEM 7.       | FINANCIAL STATEMENTS                                                                                             | * |
| ITEM 8.       | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND  FINANCIAL DISCLOSURE                            | None |
| ITEM 8A.      | CONTROLS AND PROCEDURES                                                                                          | * |
| ITEM 8B.      | OTHER INFORMATION                                                                                                | None |
|          |                                                                                                             |   |
| PART III |                                                                                                             |
|          |                                                                                                             |   |
| ITEM 9.       | DIRECTORS AND EXECUTIVE OFFICERS OF THE  REGISTRANT                                                              | ** |
| ITEM 10.      | EXECUTIVE COMPENSATION                                                                                           | ** |
| ITEM 11.      | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL  OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS                  | ** |
| ITEM 12.      | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                   | ** |
| ITEM 13.      | EXHIBITS                                                                                                         | * |
| ITEM 14.      | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                           | ** |

 

- - - - - - - - - - - - - - - -- - - - -

 

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*This information is included in this annual report on Form 10-KSBand is not incorporated by reference from Legends Financial’s proxy statementto be filed with the SEC in connection with its annual meeting.

 

** The material required by Items 9 through 12 and 14 is incorporatedby reference from Legends Financial Holdings’ proxy statement pursuant toInstruction E(3) of Form 10-KSB to be filed with the SEC inconnection with its annual meeting.

 

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**CAUTIONARYSTATEMENT CONCERNING**

**FORWARD-LOOKINGINFORMATION**

 

This AnnualReport on Form 10-KSB of Legends Financial Holdings, Inc., aTennessee corporation (“Legends Financial” or the “Company”), contains orincorporates by reference certain “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended (the “SecuritiesAct”), and Section 21E of the Securities Exchange Act of 1934, as amended(the “Exchange Act”), which are intended to be covered by the “safe harbors”created thereby.  Those statementsinclude, but may not be limited to, the discussions of Legends Financial’sexpectations concerning its future profitability, operating performance, growthstrategy and its assumptions regarding other matters.  Also, when any of the words “believes,” “expects,”“anticipates,” “intends,” “estimates,” “plans,” or similar terms orexpressions, are used in this Annual Report on Form 10-KSB,forward-looking statements are being made.

 

You should beaware that, while Legends Financial believes the expectations reflected inthose forward-looking statements are reasonable, they are inherently subject torisks and uncertainties which could cause Legends Financial’s future resultsand stockholder values to differ materially from Legends Financial’sexpectations.  These factors aredisclosed in “Management’s Discussion and Analysis of Financial Condition andResults of Operation” set forth herein. Because of these factors, there can be no assurance that theforward-looking statements included or incorporated by reference herein willprove to be accurate.  In light of thesignificant uncertainties inherent in the forward-looking statements includedor incorporated by reference herein, you should not regard the inclusion ofsuch information as a representation by Legends Financial or any other personthat the objectives and plans of Legends Financial will be achieved.  In addition, Legends Financial does notintend to, and is not obligated to, update these forward-looking statementsafter the date of this Annual Report on Form 10-KSB, even if newinformation, future events or other circumstances have made them incorrect ormisleading as of any future date.

 

# **PART I**

#  

## **ITEM 1. DESCRIPTION OF BUSINESS**

##  

### **General**

###  

LegendsFinancial is a corporation formed on February 27, 2002 under the laws ofthe State of Tennessee for the purpose of acquiring Legends Bank, a Tennesseebanking corporation (“Legends Bank”), by means of a share exchange and becominga registered bank holding company under the Federal Reserve Act. On April 16,2002, the shareholders of Legends Bank approved a Plan of Share Exchange (the “Planof Share Exchange”) between Legends Financial and Legends Bank whereby thecommon shares of Legends Bank were exchanged, on a one for one basis, forshares of common stock of Legends Financial. The exchange became effective on July 1,2002.

 

Legends Bankis a banking corporation incorporated under the laws of Tennessee in 1998.Legends Bank’s deposit accounts are insured under the Federal Deposit InsuranceAct (“FDIA”), up to the maximum applicable limits thereof.  Legends Bank has its main office at 310 NorthFirst Street, Clarksville, Tennessee, and branch locations at 2250-O WilmaRudolph Boulevard, 1950 Madison Street, 140 Dover Crossing Road, each inClarksville, and 300 Donelson Parkway in Dover, Tennessee.

 

Legends Bankconsiders its primary market for loans and deposits to be individuals,small-to-medium size businesses, and professionals within Legends Bank’sprimary trade area.  Legends Bank offersa full range of depository products, including checking accounts; savingsaccounts; money market deposit accounts; various types of time deposits;individual retirement accounts; mobile branch services; lockbox services andsafe deposit services.  Legends Bank alsooffers its customers loans for consumer, commercial, and real estate purposes,and credit services.  Legends Bank’sprincipal source of income is from interest earned on personal, commercial andreal estate loans of various types. Legends Bank has correspondent banking relationships with a variety ofbanks, including certain regional banks.

 

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Legends Bankis subject to the regulatory authority of the Tennessee Department of FinancialInstitutions (“TDFI”) and the Federal Deposit Insurance Corporation (“FDIC”).  Legends Financial is regulated by the Boardof Governors of the Federal Reserve System (the “Federal Reserve Board”).

 

During 2002,Legends Bank formed a wholly owned subsidiary, Legends Financial Services, Inc.The subsidiary is affiliated with Linsco/Private Ledger and offers customers awide array of financial products. Through its subsidiary, Legends Bank is able to offer annuities, stock,bonds, mutual funds as well as other investment products.  These investment products are not federallyinsured and there is possibility of principal loss.

 

### **Market Area**

###  

Legends Bank’sprimary service area encompasses Clarksville, Montgomery County, Tennessee andthe surrounding counties in Tennessee and Kentucky.  Clarksville is situated on theTennessee-Kentucky border approximately 40 miles northwest of Nashville,Tennessee. Clarksville’s population is over 100,000, with the county totaling150,000 people.  Clarksville is home toAustin Peay State University, which is part of the Tennessee Regents highereducation system with an enrollment of 7,000. A factor effecting Clarksville’sgrowth is the proximity to Fort Campbell, Kentucky, home of the 101st AirborneDivision as well as other special forces outfits. There are over 23,000soldiers and 40,000 family members that reside at Fort Campbell. Based oncomparable data available on a statewide and national level, the local economyappears to be in better relative health than both Tennessee and the UnitedStates. The local retail, real estate and construction sectors are all showingpositive growth. The data indicates the local economy is experiencing overallmodest but stable growth. Today, Clarksville is Tennessee’s fifth largest city.

 

### **Employees**

###  

As of December 31,2005, Legends Bank had 65 full-time equivalent employees, of which 27 were Bankofficers, and****eight people employed on a part-timebasis. Legends Bank’s employees are not represented by any union or othercollective bargaining agreement and Legends Bank believes its employeerelations are satisfactory.

 

### **InvestmentPolicy**

###  

The objectiveof Legends Bank’s investment policy is to invest funds not otherwise needed tomeet the loan demand of its market area to earn the maximum return for LegendsBank, yet still maintain sufficient liquidity to meet fluctuations in LegendsBank’s loan demand and deposit structure. In doing so, Legends Bank balances the market and credit risks againstthe potential investment return, makes investments compatible with the pledgerequirements of Legends Bank’s deposits of public funds, maintains compliancewith regulatory investment requirements, and assists the various publicentities with their financing needs. Thomas Bates, Jr. and Lee Pedigo are authorized to execute securitytransactions for the investment portfolio based on the decisions of theinvestment committee.  All the investmenttransactions occurring since the previous board of directors’ meeting arereviewed by the board at its next monthly meeting, and the entire portfolio isreviewed on a semi-annual basis.  Theinvestment policy allows portfolio holdings to include short-term securitiespurchased to provide Legends Bank’s needed liquidity and longer term securitiespurchased to generate level income for Legends Bank over periods of interestrate fluctuations.

 

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### **Loan Portfolio**

###  

Legends Bankhad a total of $153.0 million in loans at December 31, 2005.  As the loan portfolio is concentrated inMontgomery County, there is a risk that the ability of borrowers to repay theloans could be affected by changes in local economic conditions.  The loan portfolio consists primarily of realestate, commercial and installment loans. Commercial loans consist of real estate loans, term loans, or lines ofcredit.  Maturity of term loans isnormally limited to three to five years. Conventional real estate loans may be made up to 89% of the appraised value or purchase cost of the real estate,with maturities generally 5 years or less and amortization not to exceed 30years.  Installment loans are based onthe earning capacity and vocational stability of the borrower.

 

### **Loan Policy**

###  

All lendingactivities of Legends Bank are under the direct supervision and control of theBoard of Directors through the Executive Credit Approval Committee.  The Executive Credit Approval Committeeenforces loan authorizations for each officer, decides on loans exceeding suchlimits, services all requests for officer credits to the extent allowable undercurrent laws and regulations, administers all problem credits, and determinesthe allocation of funds for each lending division.

 

The ExecutiveCredit Approval Committee approves loan relationships over $750,000 while thefull Board of Directors approves loan relationships of $2,000,000 or more andreviews all new loans made the preceding month. Loans which are 30 days or more past due are reviewed monthly by theBoard of Directors.

 

Real EstateLoans.  Commercial real estate loans aresecured primarily by office, industrial and retail properties located inClarksville.  Included in this categoryare loans secured by farmland.  Thesetypes of loans amounted to $53.0 million or 35% of the total loan portfolio asof December 31, 2005.  Commercialreal estate loans typically may be amortized up to 20 years, but frequentlyhave maturities at five years or less. Commercial real estate loans are originated with a loan-to-value ratiogenerally not exceeding 75%.  Commercial real estate loans are generallylarger and involve a greater degree of risk than mortgage loans.

 

Construction/Landdevelopment loans total $31.7 million or 21% of the total portfolio on December 31,2005.  These loans are primarily used tofund residential construction.  Loanstypically are set up for one to two years with adjustable rates and are repaidwith the sale of collateral. Construction loans for residential construction are originated with aloan-to-value ratio originally not exceeding 80%, and construction loans for non-residential construction andland development are originated with a loan-to-value ratio generally notexceeding 75%.  The Clarksville area continues to prosper inthe residential home market.

 

Residentialreal estate loans representing loans secured by 1-4 family and multi-familymortgages.  These loans, as of December 31,2005, including junior loans and home equity lines, total $33.0 million or 21%of the total loan portfolio.  Singlefamily residence loans are originated for terms up to 30-yearamortization.  Advances are typicallylimited to the lessor of 80% of appraised value or purchase price.  While amortization schedules may be for 30years, interest rates on real estate loans are generally not set for a periodlonger than three to five years. Residential real estate loans are originated with a loan-to-value ratiogenerally not exceeding 89.9%.

 

CommercialBusiness Loans. Commercial business loans are business loans that are notsecured by real estate and are dependent on business cash flows forrepayment.  At December 31, 2005,commercial loans amounted to $30.1 million or 20% of the total loanportfolio.  Half of the outstanding commercialloans are term loans, and half are commercial lines of credit.

 

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ConsumerLoans.  Consumer loans are made toprovide a wide range of financial services to customers and to create strongerties to customers.  Consumer loans aretypically five years or shorter and tend to carry higher yields, helpingmaintain a profitable spread between average loan yields and our cost of funds.Underwriting standards for consumer loans include assessment of the applicant’srepayment ability. Consumer loan repayment are dependent on the borrower’scontinuing financial stability and are likely to be adversely affected by jobloss, divorce and illness. As of December 31, 2005, consumer loansamounted to $5.2 million or 3% of the total loan portfolio.

 

Management ofLegends Bank reviews on a monthly basis the loan portfolio, particularlynon-accrual and renegotiated loans.  Thereview may result in a determination that a loan should be placed on anon-accrual status for income recognition. In addition, to the extent that management identifies potential lossesin the loan portfolio, it reduces the book value of such loans, throughcharge-offs, to their estimated collectible value.  Legends Bank’s policy is to classify as non-accrualany loan on which payment of principal or interest is 90 days or more past dueexcept where there is adequate collateral to cover principal and accruedinterest and the loan is in the process of collection.  Management defines “in the process of collection”as that point where the customer has agreed to an accelerated repayment plan tobring the loan current, which definition is in accordance with generallyaccepted accounting principles (“GAAP”) but is not in accordance withdefinition as contained in Banking Bulletin 91-19.  No concessions are granted and late fees arecollected.  In addition, a loan will beclassified as non-accrual if, in the opinion of the management, based upon areview of the borrower’s or guarantor’s financial condition, collateral valueor other factors, payment is questionable, even though payments are not 90 daysor more past due.

 

When a loan isclassified as non-accrual, any unpaid interest is reversed against currentincome.  Interest is included in incomethereafter only to the extent received in cash. The loan remains in a non-accrual classification until such time as theloan is brought current, when it may be returned to accrualclassification.  When principal orinterest on a non-accrual loan is brought current, if in management’s opinionfuture payments are questionable, the loan would remain classified asnon-accrual.  After a non-accrual orrenegotiated loan is charged off, any subsequent payments of either interest orprincipal are applied first to any remaining balance outstanding, then torecoveries and lastly to income.

 

The largenumber of consumer installment loans and the relatively small dollar amount ofeach makes an individual review impracticable. It is Legends Bank’s policy to charge off any consumer installment loan,which is past due 120 days or more.

 

In addition,mortgage loans secured by real estate are placed on non-accrual status when themortgagor is in bankruptcy, is 90 days delinquent, or foreclosure proceedingsare instituted.  Any accrued interestreceivable remains an obligation of the borrower.

 

Legends Bank’sunderwriting guidelines are applied to four major categories of loans:  (1) commercial, financial andagricultural; (2) installment; (3) real estate - mortgage; and (4) realestate - construction.  Legends Bankrequires its loan officers and loan committee to consider the borrower’scharacter, the borrower’s industry and the economic environment in which theloan will be repaid.  Before approving aloan, the loan officer or committee must determine that the borrower isbasically honest and creditworthy, determine that the borrower is a capablemanager, understand the specific purpose of the loans, understand the sourceand plan of repayment, determine that the purpose, plan and source of repaymentas well as collateral are acceptable, reasonable and practical given the normalframework within which the borrower operates.

 

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The accrual ofinterest income is discontinued when it is determined that the collection ofinterest is less probable or the collection of any amount of principal isdoubtful.  The decision to place a loanon a non-accrual status is based on an evaluation of the borrower’s financialcondition, collateral liquidation value, economic and business conditions andother factors that affect the borrower’s ability to pay.  At the time a loan is placed on a non-accrualstatus, the accrued but unpaid interest is also evaluated as tocollectability.  If collectability isdoubtful, the unpaid interest is charged off. Thereafter, interest on non-accrual loans is recognized only asreceived.  Legends Bank had $1,037,000loans on non-accrual status at December 31, 2005.

 

At December 31,2005, there were loans totaling $3,768,000 which were included in Legends Bank’sinternal classified loans list.  Loansare listed as classified when information obtained about possible creditproblems of the borrower has prompted management to question the ability of theborrower to comply with the repayment terms of the loan agreement.  The loan classifications do not represent orresult from trends or uncertainties which management expects will be materiallyimpacted by economic or other conditions.

 

At December 31,2005 there were no loan concentrations that exceeded ten percent of totalloans.  Loan concentrations are amountsloaned to a multiple number of borrowers engaged in similar activities whichwould cause them to be similarly impacted by economic or other conditions.

 

There were nomaterial amounts of other interest-bearing assets (interest-bearing depositswith other banks, municipal bonds, etc.) at December 31, 2005, which wouldbe required to be disclosed as past due, non-accrual, restructured or potentialproblem loans, if such interest-bearing assets were loans.

 

### **Credit RiskManagement and Reserve for Loan Losses**

###  

Credit risksand exposure to loss are inherent parts of Legends Bank’s business.  Management seeks to manage and minimize theserisks through its loan and investment policies and loan review procedures.  Management establishes and continuallyreviews lending and investment criteria and approval procedures that itbelieves reflect the risk sensitive nature of Legends Bank.  The loan review procedures are set to monitoradherence to the established criteria and to ensure that on a continuing basissuch standards are endorsed and maintained.

 

The allowancefor possible loan losses is an amount that management believes will be adequateto absorb possible losses on existing loans that may become uncollectible.  The provision for possible loan lossescharged to operating expense is based on past loan loss experience and otherfactors, which, in management’s judgment, deserve current recognition inestimating possible loan losses.  Suchother factors considered by management include growth and composition of theloan portfolio, review of specific loan problems, the relationship of theallowance for possible loan losses to outstanding loans, adverse situationsthat may affect the borrower’s ability to repay, the estimated value of anyunderlying collateral and current economic conditions that may affect theborrower’s ability to pay.

 

Managementconducts a continuous review of all loans that are delinquent, previouslycharged down or loans which are determined to be potentiallyuncollectible.  Loan classifications arereviewed periodically by a person independent of the lending function.  The Board of Directors periodically reviewsthe adequacy of the allowance for possible loan loss.

 

The loanportfolio is reviewed on a monthly basis and management determines the amountof loans to be charged off.  In addition,such factors as Legends Bank’s previous loan loss experience, prevailing andanticipated economic conditions, industry concentrations and the overallquality of the loan portfolio are considered. While management uses available information to recognize losses on loansand real estate owned, future additions to the allowance may be necessary basedon changes in economic conditions.  In addition,various regulatory agencies, as an integral part of their examination process,periodically review the allowances for losses on loans and real estateowned.  Such agencies may require LegendsBank to recognize additions to the allowances based on their judgments aboutinformation available at the time of their examination.  In addition, any loan or portion thereofwhich is classified as a “loss” by regulatory examiners is charged off.

 

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The reserve for loan losses is increased by provisions charged tooperating expense.  The reserve isreduced by charging off loans or portions of loans at the time that are deemedby management to be uncollectible and increased when loans previously chargedoff are recovered.  The resulting reservefor loan losses is viewed by management as a single, unallocated reserveavailable for all loans and, in management’s opinion, is adequate to providefor reasonably foreseeable potential loan losses.   Rules and formulas relative to theadequacy of the reserve, although useful as guidelines to management, are notrigidly applied.  The reserve for loanlosses was $1.758 million at year-end 2005 or 1.2% of loans outstanding, net ofunearned income.

 

### **Competition**

###  

Legends Bankencounters strong competition in making loans, acquiring deposits and offeringother services.  Competition amongfinancial institutions is based upon interest rates offered on depositaccounts, interest rates charged on loans, other credit and service chargesrelating to loans, the quality and scope of the services rendered, theconvenience of banking facilities and, in the case of loans to commercialborrowers, relative lending limits. Legends Bank competes with other commercial banks, savings and loan associations,credit unions and finance companies, mutual funds, insurance companies,brokerage and investment banking companies, and other financialintermediaries.  Many of thesecompetitors, some of which are affiliated with large bank holding companies, havesubstantially greater resources and lending limits, and may offer certainservices that Legends Bank does not currently provide.  In addition, many of Legends Bank’s non-bankcompetitors are not subject to the same extensive federal regulations that governbank holding companies and federally insured banks.

 

TheRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Riegle-Neal”)authorized bank holding companies to acquire banks and other bank holdingcompanies without geographic limitations beginning September 30,1995.  The arrival of interstate bankinghas further increased the competitiveness of Legends Banking industry.

 

In addition,beginning June 1, 1997, Riegle-Neal authorized interstate mergers andconsolidations of existing banks, provided that neither bank’s home state hadopted out of interstate branching by May 31, 1997.  Tennessee did not opt out of interstatebranching.  Interstate branching providesthat once a bank has established branches in a state through an interstate merger,Legends Bank may establish and acquire additional branches at any location inthe state where any bank involved in the interstate merger could haveestablished or acquired branches under applicable federal or state law.

 

The continuedderegulation of the financial services industry may have a detrimental effecton Legends Bank’s long-term growth and profitability.

 

### **Supervisionand Regulation**

###  

Bank HoldingCompany Regulation

 

LegendsFinancial is a bank holding company within the meaning of the Bank HoldingCompany Act of 1956, as amended (the “Holding Company Act”), and is registeredwith the Federal Reserve Board.  Itsbanking subsidiary, Legends Bank, is subject to restrictions under federal lawwhich limit the transfer of funds by it to Legends Financial and nonbankingsubsidiaries, whether in the form of loans, extensions of credit, investments,or asset purchases.  Such transfers byany subsidiary bank to its holding company or any non-banking subsidiary arelimited in amount to 10% of the subsidiary bank’s capital and surplus and, withrespect to Legends Financial and all such nonbanking subsidiaries, to anaggregate of 20% of such bank’s capital and surplus.  Furthermore, such loans and extensions ofcredit are required to be secured in specified amounts.  The Holding Company Act also prohibits,subject to certain exceptions, a bank holding company from engaging in oracquiring direct or indirect control of more than 5% of the voting stock of anycompany engaged in non banking activities. An exception to this prohibition is for activities expressly found bythe Federal Reserve Board to be so closely related to banking or managing orcontrolling banks as to be a proper incident thereto or financial in nature.

 

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As a bankholding company, Legends Financial is required to file with the Federal ReserveBoard semi-annual reports and such additional information as the FederalReserve Board may require.  The FederalReserve Board also makes examinations of Legends Financial.

 

According toFederal Reserve Board policy, bank holding companies are expected to act as asource of financial strength to each subsidiary bank and to commit resources tosupport each such subsidiary.  Thissupport may be required at times when a bank holding company may not be able toprovide such support.

 

A bank holdingcompany and its subsidiaries are also prohibited from acquiring any votingshares of, or interest in, any banks located outside of the state in which theoperations of the bank holding company’s subsidiaries are located, unless theacquisition is specifically authorized by the statutes of the state in whichthe target is located.  Further, a bankholding company and its subsidiaries are prohibited from engaging in certaintie-in arrangements in connection with the extension of credit or provision ofany property or service.  Thus, anaffiliate of a bank holding company may not extend credit, lease or sellproperty, or furnish any services or fix or vary the consideration for these onthe condition that (i) the customer must obtain or provide some additionalcredit, property or services from or to its bank holding company orsubsidiaries thereof or (ii) the customer may not obtain some othercredit, property, or services from a competitor, except to the extentreasonable conditions are imposed to assure the soundness of the creditextended.

 

In approvingacquisitions by bank holding companies of banks and companies engaged in thebanking-related activities described above, the Federal Reserve Board considersa number of factors, including the expected benefits to the public such asgreater convenience, increased competition, or gains in efficiency, as weighedagainst the risks of possible adverse effects such as undue concentration ofresources, decreased or unfair competition, conflicts of interest, or unsoundbanking practices.  The Federal ReserveBoard is also empowered to differentiate between new activities and activitiescommenced through the acquisition of a going concern.

 

The AttorneyGeneral of the United States may, within 30 days after approval by the FederalReserve Board of an acquisition, bring an action challenging such acquisitionunder the federal antitrust laws, in which case the effectiveness of such approvalis stayed pending a final ruling by the courts. Failure of the Attorney General to challenge an acquisition does not,however, exempt the holding company from complying with both state and federalantitrust laws after the acquisition is consummated or immunize the acquisitionfrom future challenge under the anti-monopolization provisions of the ShermanAct.

 

Sarbanes-OxleyAct of 2002

 

On July 30,2002, President Bush signed into law the Sarbanes-Oxley Act of 2002.  This legislation represents a comprehensiverevision of laws affecting corporate governance, accounting obligations andcorporate reporting. The Sarbanes-Oxley Act is applicable to all companies withequity securities registered, or that file reports under, the SecuritiesExchange Act of 1934.  In particular, theSarbanes-Oxley Act establishes (i) new requirements for audit committees,including independence, expertise and responsibilities; (ii) additionalresponsibilities regarding financial statements for the chief executive officerand chief financial officer of the reporting company and new requirements forthem to certify the accuracy of periodic reports; (iii) new standards forauditors and regulation of audits; (iv) increased disclosure and reportingobligations for the reporting company and its directors and executive officers,including an accelerated time frame for reporting of insider transactions; and (v) newand increased civil and criminal penalties for violations of the federalsecurities laws. The legislation also established a new accounting oversightboard to enforce auditing standards and restrict the scope of services thataccounting firms may provide to their public company audit clients.  Because Legends Financial’s common stock isregistered with the SEC, it is subject to the requirements of this legislation.

 

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TennesseeBanking Act; Federal Deposit Insurance Act

 

Legends Bankis a Tennessee state-chartered bank and is subject to the regulations of andsupervision by the FDIC as well as the TDFI, Tennessee’s state bankingauthority.  Legends Bank is also subjectto various requirements and restrictions under federal and state law, includingrequirements to maintain reserves against deposits, restrictions on the types andamounts of loans that may be granted and the interest that may be chargedthereon and limitations on the types of investments that may be made and thetypes of services that may be offered. Various consumer laws and regulations also affect the operations of LegendsBank.  In addition to the impact ofregulation, commercial banks are affected significantly by the actions of theFederal Reserve Board as it attempts to control the money supply and creditavailability in order to influence the economy.

 

From time totime, legislation is enacted which has the effect of increasing the cost ofdoing business, limiting or expanding permissible activities or affecting thecompetitive balance between banks and other financial institutions.  Proposals to change the laws and regulationsgoverning the operations and taxation of banks, bank holding companies andother financial institutions are frequently made in Congress, in the Tennesseelegislature and before various bank regulatory and other professional agencies.  The likelihood of any major legislativechanges and the impact such changes might have on Legends Bank are impossibleto predict.

 

Legends Bank,as a Tennessee state chartered bank, is subject to primary supervision,periodic examination and regulation by the Commissioner of the TDFI (“Commissioner”)and the FDIC.  If, as a result of anexamination of a bank, the FDIC should determine that the financial condition,capital resources, asset quality, earnings prospects, management, liquidity orother aspects of Legends Bank’s operations are unsatisfactory or that LegendsBank or its management is violating or has violated any law or regulation,various remedies are available to the FDIC. Such remedies include the power to enjoin “unsafe or unsound” practices,to require affirmative action to correct any conditions resulting from anyviolation or practice, to issue an administrative order that can be judiciallyenforced, to direct an increase in capital, to restrict the growth of LegendsBank, to assess civil monetary penalties, to remove officers and directors andultimately to terminate Legends Bank’s deposit insurance.  The Commissioner has many of the sameremedial powers, including the power to take possession of a bank whose capitalbecomes impaired.  As of March 1,2005, Legends Bank is not the subject of any such action by the FDIC or theCommissioner.

 

The depositsof Legends Bank are insured by the FDIC in the manner and to the extentprovided by law.  For this protection,Legends Bank pays a semiannual statutory assessment.  Although Legends Bank is not a member of theFederal Reserve System, it is nevertheless subject to certain regulations ofthe Federal Reserve Board.

 

Variousrequirements and restrictions under the laws of the State of Tennessee and theUnited States affect the operations of Legends Bank.  State and federal statutes and regulationsrelate to many aspects of Legends Bank’s operations, including reserves againstdeposits, interest rates payable on deposits, loans, investments, mergers andacquisitions, borrowings, dividends, locations of branch offices and capitalrequirements.  Further, Legends Bank isrequired to maintain certain levels of capital.

 

8

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Tennessee lawcontains limitations on the interest rates that may be charged on various typesof loans and restrictions on the nature and amount of loans that may be grantedand on the types of investments which may be made.  The operations of banks are also affected byvarious consumer laws and regulations, including those relating to equal creditopportunity and regulation of consumer lending practices.  All Tennessee banks must become and remaininsured banks under the FDIA. (See 12 U.S.C. §1811, et seq.).

 

FIRREA

 

Congressenacted the Financial Institutions Reform, Recovery and Enforcement Act of 1989(“FIRREA”) on August 9, 1989. FIRREA provides that a depository institution insured by the FDIC can beheld liable for any loss incurred by, or reasonable expected to be incurred by,the FDIC in connection with (i) the default of a commonly controlled FDICinsured depository institution or (ii) any assistance provided by the FDICto a commonly controlled FDIC insured depository institution in danger ofdefault.  FIRREA provides that certaintypes of persons affiliated with financial institutions can be fined by thefederal regulatory agency having jurisdiction over a depository institutionwith federal deposit insurance (such as Legends Bank) up to $1 million per dayfor each violation of certain regulations related (primarily) to lending to andtransactions with executive officers, directors, principal shareholders and theinterests of these individuals.  Otherviolations may result in civil money penalties of $5,000 to $30,000 per day orin criminal fines and penalties.  Inaddition, the FDIC has been granted enhanced authority to withdraw or tosuspend deposit insurance in certain cases.

 

FDICIA

 

The FederalDeposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) which wasenacted on December 19, 1991, substantially revised the depositoryinstitution regulatory and funding provisions of the FDIA and made revisions toseveral other federal banking statutes. Among other things, FDICIA requires the federal banking regulators totake “prompt corrective action” in respect of FDIC-insured depositoryinstitutions that do not meet minimum capital requirements. FDICIA establishesfive capital tiers: “well capitalized,” “adequately capitalized,” “undercapitalized,”“significantly undercapitalized” and “critically undercapitalized.”  Under applicable regulations, a FDIC-insureddepository institution is defined to be well capitalized if it maintains aLeverage Ratio of at least 5%, a risk adjusted Tier 1 Capital Ratio of at least6% and a Total Capital Ratio of at least 10% and is not subject to a directive,order or written agreement to meet and maintain specific capital levels.  An insured depository institution is definedto be adequately capitalized if it meets all of its minimum capital requirementsas described above.  In addition, aninsured depository institution will be considered undercapitalized if it failsto meet any minimum required measure, significantly undercapitalized if it issignificantly below such measure and critically undercapitalized if it fails tomaintain a level of tangible equity equal to not less than 2% of totalassets.  An insured depositoryinstitution may be deemed to be in a capitalization category that is lower thanis indicated by its actual capital position if it receives an unsatisfactoryexamination rating.

 

Thecapital-based prompt corrective action provision of FDICIA and theirimplementing regulations apply to FDIC-insured depository institutions and arenot directly applicable to holding companies which control suchinstitutions.  However, the FederalReserve Board has indicated that, in regulating bank holding companies, it willtake appropriate action at the holding company level based on an assessment ofthe effectiveness of supervisory actions imposed upon subsidiary depositoryinstitutions pursuant to such provisions and regulations.

 

9

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FDICIAgenerally prohibits an FDIC-insured depository institution from making anycapital distribution (including payment of dividends) or paying any managementfee to its holding company if the depository institution would thereafter beundercapitalized.  Undercapitalizeddepository institutions are subject to restrictions on borrowing from theFederal Reserve System.  In addition,undercapitalized depository institutions are subject to growth limitations andare required to submit capital restoration plans.  A depository institution’s holding companymust guarantee the capital plan, up to an amount equal to the lesser of 5% of thedepository institution’s assets at the time it becomes undercapitalized or theamount of the capital deficiency when the institution fails to comply with theplan.  The federal banking agencies maynot accept a capital plan without determining, among other things, that theplan is based on realistic assumptions and is likely to succeed in restoringthe depository institution’s capital.  Ifa depository institution fails to submit an acceptable plan, it is treated asif it is significantly undercapitalized.

 

Significantlyundercapitalized depository institutions may be subject to a number ofrequirements and restrictions, including orders to sell sufficient voting stockto become adequately capitalized, requirements to reduce total assets andcessation of receipt of deposits from correspondent banks.  Critically undercapitalized depositoryinstitutions are subject to appointment of a receiver or conservator generallywithin 90 days of the date on which they became critically undercapitalized.

 

Legends Bank believesthat at March 1, 2005, Legends Bank was well capitalized under thecriteria discussed above.

 

FDICIAcontains numerous other provisions, including accounting, audit and reportingrequirements, termination of the “too big to fail” doctrine except in specialcases, limitations on the FDIC’s payment of deposits at foreign branches, newregulatory standards in such areas as asset quality, earnings and compensationand revised regulatory standards for, among other things, powers of statebanks, real estate lending and capital adequacy.  FDICIA also requires that a depositoryinstitution provide 90 days prior notice of the closing of any branches.

 

Various otherlegislation, including proposals to revise the bank regulatory system and tolimit the investments that a depository institution may make with insuredfunds, is from time to time introduced in Congress.  The TDFI and FDIC will examine Legends Bankperiodically for compliance with various regulatory requirements.  Such examinations, however, are for theprotection of the Bank Insurance Fund (“BIF”) and for depositors, and not forthe protection of investors and shareholders.

 

Interstate Act

 

TheRiegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“InterstateAct”), which was enacted on September 29, 1994, among other things andsubject to certain conditions and exceptions, permits on an interstate basis (i) bankholding company acquisitions commencing one year after enactment of banks of aminimum age of up to five years as established by state law in any state, (ii) mergersof national and state banks after May 31, 1997 unless the home state ofeither bank has opted out of the interstate bank merger provision, (iii) branchingde novo by national and state banks if the host state has opted-in to thisprovision of the Interstate Act, and (iv) certain bank agency activitiesafter one year after enactment.  TheInterstate Act contains a 30% intrastate deposit cap, except for the initialacquisition in the state, restriction that applies to certain interstateacquisitions unless a different intrastate cap has been adopted by theapplicable state pursuant to the provisions of the Interstate Act and a 10%national deposit cap restriction. Tennessee has opted-in to the Interstate Act.  Management cannot predict the extent to whichthe business of Legends Bank may be affected. Tennessee has also adopted legislation allowing banks to acquirebranches across state lines subject to certain conditions, including theavailability of similar legislation in the other state.

 

10

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BrokeredDeposits and Pass-Through Insurance

 

The FDIC hasadopted regulations under FDICIA governing the receipt of brokered deposits andpass-through insurance.  Under the regulations,a bank cannot accept or rollover or renew brokered deposits unless (i) itis well capitalized or (ii) it is adequately capitalized and receives awaiver from the FDIC.  A bank that cannotreceive brokered deposits also cannot offer “pass-through” insurance on certainemployee benefit accounts.  Whether ornot it has obtained such a waiver, an adequately capitalized bank may not payan interest rate on any deposits in excess of 75 basis points over certain indexprevailing market rates specified by regulation.  There are no such restrictions on a bank thatis well capitalized.  Because it believesthat Legends Bank was well capitalized as of March 1, 2005, Legends Bankbelieves the brokered deposits regulation will have no material effect on thefunding or liquidity of Legends Bank.

 

FDIC InsurancePremiums

 

Legends Bankis required to pay semiannual FDIC deposit insurance assessments.  As required by FDICIA, the FDIC adopted arisk-based premium schedule which increased the assessment rates for mostFDIC-insured depository institutions. Under the schedule, the premiums initially range from $.00 to $.27 forevery $100 of deposits.  Each financialinstitution is assigned to one of three capital groups - well capitalized,adequately capitalized or undercapitalized - and further assigned to one ofthree subgroups within a capital group, on the basis of supervisory evaluationsby the institution’s primary federal and, if applicable, state supervisors andother information relevant to the institution’s financial condition and therisk posed to the applicable FDIC deposit insurance fund.  The actual assessment rate applicable to aparticular institution will, therefore, depend in part upon the risk assessmentclassification so assigned to the institution by the FDIC.  Recently the FDIC has passed a resolution tolower premiums.

 

Under theFDIA, insurance of deposits may be terminated by the FDIC upon a finding thatthe institution has engaged in unsafe and unsound practices, is in an unsafe orunsound condition to continue operations or has violated any applicable law,regulation, rule, order or condition imposed by a federal bank regulatoryagency.

 

Gramm-Leach-BlileyAct

 

TheGramm-Leach-Bliley Act adopted in November 1999 has been referred to asthe most important banking bill in over 60 years.  The most significant provisions ratify newpowers for banks and bank holding companies, especially in the areas ofsecurities and insurance.  The Act alsoincludes requirements regarding the privacy and protection of customerinformation held by financial institutions, as well as many other providers offinancial services.  There are provisionsproviding for functional regulation of the various services provided byinstitutions among different regulators. There are other provisions which limit the future expansion of unitarythrift holding companies which now prevent companies like Wal-Mart from owninga thrift institution.  Finally, amongmany other sections of the Act, there is some relief for small banks from theregulatory burden of the Community Reinvestment Act.  The regulatory agencies have been adoptingmany new regulations to implement the Act.

 

USA PatriotAct

 

On October 26,2001, President Bush signed the USA PATRIOT Act of 2001 into law.  This act contains the International MoneyLaundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”).  The IMLAFA substantially broadens existinganti-money laundering legislation and the extraterritorial jurisdiction of theUnited States, imposes new compliance and due diligence obligations, createsnew crimes and penalties, compels the production of documents located bothinside and outside the United States, including those of foreign institutionsthat have a correspondent relationship in the United States, and clarifies thesafe harbor from civil liability to customers. The U.S. Treasury Department has issued a number of regulationsimplementing the USA PATRIOT Act that apply certain of its requirements tofinancial institutions such as our banking and broker-dealer subsidiaries.  The regulations impose new obligations onfinancial institutions to maintain appropriate policies, procedures andcontrols to detect, prevent and report money laundering and terrorist financing.  The Treasury Department is expected to issuea number of additional regulations which will further clarify the USA PATRIOTAct’s requirements.

 

11

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The IMLAFArequires all “financial institutions,” as defined, to establish anti-moneylaundering compliance and due diligence programs no later than April 2003.  Such programs must include, among otherthings, adequate policies, the designation of a compliance officer, employeetraining programs, and an independent audit function to review and test theprogram.  Legends Bank has establishedanti-money laundering compliance and due diligence programs to comply withIMLAFA.

 

### **CapitalAdequacy**

###  

Under theFederal Reserve Board’s risk-based capital guidelines applicable to LegendsBank, the minimum ratio of capital to risk-weighted assets (including certainoff-balance sheet items, such as standby letters of credit) is 8%.  To be considered a “well-capitalized” bankunder the guidelines, a bank must have a total risk-based capital ratio inexcess of 10%.  Under these guidelines,at least half of the total capital is to be comprised of common equity,retained earnings and a limited amount of perpetual preferred stock, aftersubtracting certain intangibles, and certain other adjustments (“Tier 1 capital”). The remainder may consist of perpetualdebt, mandatory convertible debt securities, a limited amount of subordinateddebt, other preferred stock, after subtracting certain intangibles, and certainamount of loan loss reserve (“Tier 2 capital”). Banks are subject to similar capital requirements adopted by theFDIC.  In addition, the Federal ReserveBoard, the FDIC and the Office of the Comptroller of the Currency have adopteda minimum leverage ratio (Tier 1 capital to adjusted quarter average assets) of4%.  Generally, banking organizations areexpected to operate well above the minimum required capital level of 4% unlessthey meet certain specified criteria, including that they have the highestregulatory ratings.  Most banking  organizations are required to maintainleverage ratio of 4% plus an additional cushion of at least 1% to 2%.  The guidelines also provide that bankingorganizations experiencing internal growth or making acquisitions will beexpected to maintain strong capital positions substantially above the minimumsupervisory levels without significant reliance upon intangible assets.  Failure to meet capital guidelines couldsubject a banking institution to a variety of enforcement remedies available tofederal regulatory authorities, including the termination of deposit insuranceby the FDIC, issuance of a capital directive, prohibition on brokered depositsand certain other restrictions.

 

On December 31,2005, Legends Bank had a Tier 1 capital ratio of 10.1% a total risk-basedcapital ratio of 11.2% and a leverage ratio of 8.3%.

 

### **Payment ofDividends**

###  

The payment ofdividends by Legends Financial depends to a great extent on the ability ofLegends Bank to pay dividends to Legends Financial.  Legends Bank is subject to the TennesseeBanking Act, which provides that Legends Bank may not declare dividends in anycalendar year that exceeds the total of its net income of that year combinedwith its retained net income of the preceding two years without the approval ofthe TDFI.  Thereafter, 10% of net profitsmust be transferred to capital surplus prior to payment of dividends untilcapital surplus equals capital stock. Legends Bank is also subject to the minimum capital requirements of theFDIC which impact Legends Bank’s ability to pay dividends.  If Legends Bank fails to meet thesestandards, it may not be able to pay dividends or to accept additional depositsbecause of regulatory requirements.

 

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If, in theopinion of the applicable federal bank regulatory authority, a depositoryinstitution is engaged in or is about to engage in an unsafe or unsoundpractice (which, depending on the financial condition of the depositoryinstitution, could include the payment of dividends), such authority may requirethat such institution cease and desist from such practice.  The federal banking agencies have indicatedthat paying dividends that deplete a depository institution’s capital base toan inadequate level would be such an unsafe and unsound banking practice.  Moreover, the Federal Reserve Board, theComptroller of the Currency and the FDIC have issued policy statements whichprovide that bank holding companies and insured depository institutionsgenerally should only pay dividends out of current earnings.

 

The payment ofdividends by Legends Financial may also be affected or limited by otherfactors, such as the requirement of Legends Bank to maintain adequate capitalabove regulatory guidelines.  LegendsFinancial’s board of directors declared a $0.30 per share dividend on theoutstanding shares of its common stock on January 18, 2005 and declared a$0.20 per share dividend on the outstanding shares of its common stock on February 27,2004.

 

## **ITEM 2. DESCRIPTION OF PROPERTY**

##  

Legends Bank’smain banking office was completed and opened for full operations in January 2000.  This facility also serves as the principaloffice of Legends Financial and of Legends Bank.  The 14,000 square foot facility is located at310 North First Street in the central business district of Clarksville.  Legends Bank owns the property on whichLegends Financial’s principal office is located.

 

Legends Bankcurrently operates six full service banking locations at 310 North FirstStreet, 1950 Madison Street, 2250-O Wilma Rudolph Blvd., 140 Dover CrossingRoad and 1814 Tiny Town Road in Clarksville, Tennessee and 300 Donelson Parkwayin Dover, Tennessee.  Legends Bank leasesthe property for the offices located on Madison Street and Wilma Rudolph Blvd.  Legends Bank owns its mobile branch.

 

## **ITEM 3.  LEGAL PROCEEDINGS**

##  

From time totime Legends Bank is named as a defendant in suits arising from the ordinaryconduct of its affairs. In the opinion of management, the ultimate outcome ofthe litigation to which Legends Bank is a party as of the date of this Form 10-KSBwill not adversely affect its financial condition.

 

## **ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

##  

No matter wassubmitted to a vote of security holders during the fourth quarter of LegendsFinancial’s fiscal year ended December 31, 2005.

 

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# **PART II**

#  

## **ITEM 5.  MARKET FOR COMMON EQUITYAND RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITYSECURITIES**

##  

### **Market forCommon Stock**

###  

The commonstock of Legends Financial is not traded through an organized exchange nor isthere a known active trading market.  At December 31,2005, the number of shareholders of record was 952 and there was alsooutstanding options to purchase 247,904 shares of common stock, all of whichare currently exercisable.

 

The followingtable shows the quarterly range of high and low sale prices for LegendsFinancial’s stock during the fiscal years 2005, 2004 and 2003.  These sale prices represent knowntransactions and do not necessarily represent all trading transactions for theperiods.

 
| **Year** | ** ** | ** **      | ** ** | **High** | ** ** | **Low** | ** ** |
|----------|------------|-----------------|------------|----------|------------|---------|------------|
|     |       |            |       |     |       |    |       |
| 2003:    |       | First  Quarter  |       | $        | 17.00      |    | $          | 17.00 |   |
|     |       | Second  Quarter |       | $        | 17.00      |    | $          | 17.00 |   |
|     |       | Third  Quarter  |       | $        | 17.00      |    | $          | 17.00 |   |
|     |       | Fourth  Quarter |       | $        | 18.00      |    | $          | 17.00 |   |
|     |       |            |       |     |       |    |       |
| 2004:    |       | First  Quarter  |       | $        | 18.00      |    | $          | 18.00 |   |
|     |       | Second  Quarter |       | $        | 19.00      |    | $          | 18.00 |   |
|     |       | Third  Quarter  |       | $        | 19.00      |    | $          | 19.00 |   |
|     |       | Fourth  Quarter |       | $        | 20.00      |    | $          | 19.00 |   |
|     |       |            |       |     |       |    |       |
| 2005:    |       | First  Quarter  |       | $        | 21.00      |    | $          | 20.00 |   |
|     |       | Second  Quarter |       | $        | 20.00      |    | $          | 20.00 |   |
|     |       | Third  Quarter  |       | $        | 22.00      |    | $          | 20.00 |   |
|     |       | Fourth  Quarter |       | $        | 23.00      |    | $          | 22.00 |   |

 

### **Dividends**

###  

The payment ofdividends is subject to the discretion of Legends Financial’s board ofdirectors. Legends Financial’s ability to pay dividends is dependent on cash dividendspaid to it by Legends Bank.  The abilityof Legends Bank to pay dividends to Legends Financial is restricted byapplicable regulatory requirements. For more information on these restrictions,please see PART I, ITEM 1 “DESCRIPTION OF BUSINESS — Payment of Dividends.”  Legends Financial’s board of directorsdeclared a $0.30 per share dividend on the outstanding shares of its commonstock on January 18, 2005 and declared a $0.20 per share dividend on theoutstanding shares of its common stock on February 27, 2004.  No assurances can be given that any dividendwill be declared or, if declared, what the amount of such dividend would be orwhether such dividends would continue in future periods.

 

### **SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

###  

In December 1998,the board of directors of Legends Bank approved the Legends Bank 1998 StockOption Arrangement (the “1998 Arrangement”). In April 2001, the board of directors of Legends Bank approved the2001 Stock Option Plan (the “2001 Plan”). Legends Financial’s stockholders have also approved Legends Bank 1998Stock Option Arrangement and 2001 Stock Option Plan.  Legends Financial exchanged its options withthe holders of Legends Bank stock options under the 1998 Arrangement and the2001 Plan on an option-for-option basis. Thus, options that were outstanding under the 1998 Arrangement and the2001 Plan have been exchanged for options under Legends Financial’s StockOption Plan.

 

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The followingtable reflects the number of shares to be issued upon the exercise of optionsgranted under the 1998 Arrangement and the 2001 Plan, the weighted-averageexercise price of all such options, and the total number of shares of commonstock reserved for issuance upon the exercise of authorized, not-yet-grantedoptions as of December 31, 2005:

 
| **Plan Category**                                               | ** ** | **# of Securities to be   Issued Upon Exercise of   Outstanding Options,   Warrants and Rights** | ** ** | **Weighted-average   Exercise Price of   Outstanding Options,   Warrants, and Rights** | ** ** | **# of Equity Securities   Remaining Available for Future Issuance Under   Equity Compensation   Plans** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| **Equity Compensation Plans Approved by  Security Holders**     |       |                                                                                             |       |                                                                                   |       |                                                                                                     |       |
| ** **                                                      |       |                                                                                             |       |                                                                                   |       |                                                                                                     |       |
| **1998 Arrangement**                                            |       | 46,084                                                                                           |       | $                                                                                      | 8.33       |                                                                                                     | -0-        |   |
| ** **                                                      |       |                                                                                             |       |                                                                                   |       |                                                                                                     |       |
| **2001 Plan**                                                   |       | 201,820                                                                                          |       | $                                                                                      | 18.42      |                                                                                                     | 4,978      |   |
| ** **                                                      |       |                                                                                             |       |                                                                                   |       |                                                                                                     |       |
| **Equity Compensation Plans Not Approved by  Security Holders** | ** ** | **—**                                                                                       | ** ** | **—**                                                                             | ** ** | **—**                                                                                               | ** ** |
| ** **                                                      | ** ** | ** **                                                                                       | ** ** | ** **                                                                             | ** ** | ** **                                                                                               | ** ** |
| **TOTAL**                                                       |       | 247,904                                                                                          |       | $                                                                                      | 16.54      |                                                                                                     | 4,978      |   |

 

### **Recent Salesof Unregistered Securities**

###  

From January 1,2003 through December 31, 2005, Legends Financial has not sold anysecurities without registration under the Securities Act of 1933, except for:

 

•                  On December 29, 2005, DirectorBob Patel exercised the option to purchase 1,000 shares of common stock at anexercise price of $17.00 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On December 27, 2005, EmployeeKellie McCullough exercised the option to purchase 500 shares of common stockat an exercise price of $17.00 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On December 20, 2005, DirectorBilly Atkins exercised the option to purchase 1,400 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On November 2, 2005, DirectorMark R. Barnett exercised the option to purchase 548 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

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•                  On August 1, 2005, Employee JohnW. Wallace exercised the option to purchase 500 shares of common stock at anexercise price of $17.00 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On February 24, 2005, DirectorBilly Atkins exercised the option to purchase 1,000 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On February 23, 2005, DirectorThomas Bates, Jr. exercised the option to purchase 6,000 shares of commonstock at an exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On February 14, 2005, DirectorBilly Atkins exercised the option to purchase 1,549 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On January 27, 2005, DirectorRonnie Goad exercised the option to purchase 6,000 shares of common stock at anexercise price of $18.75 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On January 12, 2005, EmployeeJeanette Kramer exercised the option to purchase 105 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On December 15, 2004, DirectorBilly Atkins exercised the option to purchase 200 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of the SecuritiesAct of 1933.

 

•                  On December 6, 2004, DirectorPravin Patel exercised the option to purchase 1,200 shares of common stock atan exercise price of $18.75 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On December 1, 2004, DirectorPravin Patel exercised the option to purchase 700 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On June 10, 2004, Director MarkBarnett exercised the option to purchase 2,000 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On June 9, 2004, Director PravinPatel exercised the option to purchase 308 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On June 8, 2004, Director PravinPatel exercised the option to purchase 700 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On June 7, 2004, Director DwightDickson exercised the option to purchase 700 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

16

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•                  On June 2, 2004, Director JamesAmos exercised the option to purchase 1,952 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On May 25, 2004, Director DickLittleton exercised the option to purchase 3,020 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On March 31, 2004, Senior VicePresident Janet Roberts exercised the option to purchase 9,000 shares of commonstock at an exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On March 25, 2004, DirectorDavid Nussbaumer exercised the option to purchase 2,548 shares of common stockat an exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On March 1, 2004, DirectorDwight Dickson exercised the option to purchase 700 shares of common stock atan exercise price of $8.33 per share. The Company relied on the exemption provided by Section 4(2) ofthe Securities Act of 1933.

 

•                  On March 1, 2004, Director BillyAtkins exercised the option to purchase 2,500 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On January 26, 2004, DirectorRonnie Goad exercised the option to purchase 1,220 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On December 29, 2003, DirectorJimmy Terry exercised the option to purchase 600 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

•                  On November 20, 2003, anemployee of the Company, Lynn Williams, exercised the option to purchase 120shares of common stock at an exercise price of $8.33 per share.  The Company relied on the exemption providedby Section 4(2) of the Securities Act of 1933.

 

•                  On October 27, 2003, an employeeof the Company, Merritt Bradley, exercised the option to purchase 726 shares ofcommon stock at an exercise price of $8.33 per share.  The Company relied on the exemption providedby Section 4(2) of the Securities Act of 1933.

 

•                  On July 24, 2003, Director JimmyTerry exercised the option to purchase 1,220 shares of common stock at anexercise price of $8.33 per share.  TheCompany relied on the exemption provided by Section 4(2) of theSecurities Act of 1933.

 

### **Purchases ofEquity Securities by Legends Financial**

###  

Legends Financial did not make any purchases of its common stock duringthe fourth quarter of 2005.

 

17

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## **ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**

##  

### **ProposedCommon Stock Share Reclassification**

###  

On December 20,2005, the Company’s Board of Directors voted to reclassify common stock toreduce the number of record holders of common stock below 300 for the purposeof going private.

 

To facilitatethis transaction a proposal to amend the Company charter and to reclassifycommon stock will be presented to Company shareholders for a vote.  Under the proposal, shares of existing commonstock held by shareholders who own between 500 and 1,500 shares will bereclassified into shares of Class A common stock.  Shares of existing common stock held byshareholders who own less than 500 shares will be reclassified into shares of Class Bcommon stock.  The reclassifications willbe made on the basis of one share of Class A or Class B common stockfor each share of common stock held.  Theproposal is subject to shareholder and regulatory approval.

 

The primary effect of this transaction willbe to reduce the Company’s total number of record holders of common stock tobelow 300.  As a result, the registrationof the Company’s common stock under federal securities laws will be terminatedand Legends Financial will no longer be considered a “public” company.

 

The Company is proposing the amendments toits charter because its Board of Directors has concluded, after carefulconsideration, that the costs and other disadvantages associated with being anSEC-reporting company outweigh any of the advantages.  The reasons for reaching this conclusion arebased on:

 

•                  the administrative burden and expenseof making periodic filings with the SEC;

 

•                  thefact that operating as a non-SEC reporting company will reduce the burden onmanagement and employees which arises from increasingly stringent SEC reportingrequirements, thus allowing management to focus more of its attention oncustomers and the community in which the Company operate;

 

•                  thefact that management will have increased flexibility to consider and initiateactions that may produce long-term benefits and growth;

 

•                  thelow trading volume of the Company’s common stock and the resulting lack of anactive market for the Company’s shareholders;

 

•                  thefact that a going-private transaction could be structured in a manner that allshareholders would still retain an equity interest in the Company, and wouldnot be forced out by means of a cash reverse stock split or other transaction;

 

•                  theestimated expense of a going private transaction; and

 

•                  thefact that the reclassification transaction allows the Company to discontinuereporting obligations with the SEC, while still allowing those shareholdersreceiving shares of Class A and Class B common stock to retain anequity interest in Legends Financial at the same value per share as holders ofcommon stock in the event of any sale of Legends Financial.

 

18

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### **General**

###  

LegendsFinancial Holdings, Inc. is a bank holding company within the meaning ofthe Bank Holding Company Act of 1956, as amended.  Management believes that the holding companystructure provides greater flexibility in the expansion of the Company’spresent business and will allow the Company to be more responsive to itscustomers broadening and changing financial needs.

 

Legends Bankis a state chartered bank which began operations on November 12,1998.  The Company offers a wide range ofbanking services, including checking, savings, and money market depositaccounts, certificates of deposit, individual retirement accounts and loans forconsumer, commercial and real estate purposes and investment products throughits wholly-owned subsidiary, Legends Financial Services, Inc.  The area served by the Company is MontgomeryCounty, Tennessee and surrounding counties of Middle Tennessee.  Services are provided at the main office,four branches in Clarksville, Tennessee and a branch in Dover, Tennessee.  The Company serves as a financialintermediary whereby its profitability is determined to a large degree by theinterest spread it achieves and the successful measurement of risks.  The Company’s management believes that itsmarket area offers an environment for continued growth and  the Company’s target market  is local consumers,professionals and small businesses.

 

The followingdiscussion and analysis is designed to assist readers in their analysis of theCompany’s financial statements and should be read in conjunction with suchconsolidated financial statements.

 

### **FinancialCondition**

###  

***Balance Sheet Summary:***  The Company’s total assets were $229,761,000and $185,124,000 at December 31, 2005 and 2004, respectively, an increaseof 24.1%.  Loans, net of allowance forpossible loan losses, totaled $151,225,000 and $128,334,000 at December 31,2005 and 2004, respectively, an increase of 17.8% and investment securitiestotaled $46,623,000 and $37,580,000, respectively, an increase of 24.1%.  The increase in loans and securities wasprimarily funded by an increase in deposits. There was $11,616,000 outstanding Federal funds sold as of December 31,2005 and no outstanding Federal funds sold balance as of December 31,2004.

 

Totalliabilities were $212,411,000 and $169,411,000 at December 31, 2005 and2004, respectively, an increase of 25.4%. Stockholders’ equity was $17,350,000 and $15,713,000 at December 31,2005 and 2004, respectively, an increase of 10.4%.  The increase in liabilities was primarilyfunded by an increase in deposits of $44,703,000 or 28.8% from December 31,2004 to December 31, 2005, an increase in advances from the Federal HomeLoan Bank of $876,000 or 9.8% for the same period and an increase in securitiessold under repurchase agreements of $1,343,000. A more detailed discussion of assets, liabilities and capital follows.

 

19

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### **Loans**

###  

Loan categories are as follows:

 
| ** **                              | ** **   | **December 31,** | ** ** |
|-----------------------------------------|--------------|-----------------------|------------|
| ** **                              | ** **   | **2005**              | ** ** | **2004** | ** ** |
| ** **                              | ** **   | **Amount**            | ** ** | **Percentage** | ** ** | **Amount** | ** ** | **Percentage** | ** ** |
| *** ***                            | *** *** | **(In Thousands)**    | ** ** | **(In Thousands)** | *** *** |
|                                    |         |                  |       |   |   |   |   |   |   |
| Commercial,  financial and agricultural |         | $                     | 30,059     |   | 19.7 | % | $ | 24,481 |   | 18.8 | % |
| Installment                             |         | 5,204                 |       | 3.4 |   | 5,307 |   | 4.1 |   |
| Real estate –  mortgage            |         | 85,999                |       | 56.2 |   | 77,646 |   | 59.8 |   |
| Real estate –  construction        |         | 31,721                |       | 20.7 |   | 22,417 |   | 17.3 |   |
| Total                                   |         | $                     | 152,983    |   | 100.0 | % | $ | 129,851 |   | 100.0 | % |

 

Loans are alarge component of the Company’s assets and are a primary source ofincome.  The loan portfolio is composedof four primary loan categories: commercial, financial and agricultural;installment; real estate - mortgage; and real estate - construction. The tableabove sets forth the loan categories and the percentage of such loans in theportfolio at December 31, 2005 and 2004.

 

As representedin the table, primary loan growth was in real estate mortgage, construction andcommercial loans. Management is increasing loans in an orderly fashion tomaintain quality.

 

Bankingregulators define highly leveraged transactions to include leveraged buy-outs,acquisition loans, and recapitalization loans of an existing business.  Under the regulatory definition, at December 31,2005 and 2004, the Company had no highly leveraged transactions, and there wereno foreign loans outstanding.

 

The Companyfollows the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 114,“Accounting by Creditors for Impairment of a Loan” and SFAS No. 118, “Accountingby Creditors for Impairment of a Loan - Income Recognition and Disclosures”.  These pronouncements apply to impaired loansexcept for large groups of smaller-balance homogeneous loans that arecollectively evaluated for impairment including credit card, residentialmortgage, and consumer installment loans.

 

A loan isimpaired when it is probable that the Company will be unable to collect thescheduled payments of principal and interest due under the contractual terms ofthe loan agreement.  Impaired loans aremeasured at the present value of expected future cash flows discounted at theloan’s effective interest rate, at the loan’s observable market price, or thefair value of the collateral if the loan is collateral dependent.  If the measure of the impaired loan is lessthan the recorded investment in the loan, the Company shall recognize animpairment by creating a valuation allowance with a corresponding charge to theprovision for loan losses or by adjusting an existing valuation allowance forthe impaired loan with a corresponding charge or credit to the provision forloan losses.

 

The Company’sfirst mortgage single family residential and installment loans, which totalapproximately $28,831,000 and $25,322,000 and $5,224,000 and $4,895,000,respectively at December 31, 2005 and 2004, are divided into variousgroups of smaller-balance homogeneous loans that are collectively evaluated forimpairment and thus are not subject to the provisions of SFAS Nos. 114 and118.  Substantially all other loans ofthe Company are evaluated for impairment under the provisions of SFAS Nos. 114and 118.

 

20

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The Companyconsiders all loans subject to the provisions of SFAS Nos. 114 and 118 that areon nonaccrual status to be impaired. Loans are placed on nonaccrual status when doubt as to timely collectionof principal or interest exists, or when principal or interest is past due 90days or more unless such loans are well-secured and in the process ofcollection.  Delays or shortfalls in loanpayments are evaluated with various other factors to determine if a loan isimpaired.  Generally, delinquencies under90 days are considered insignificant unless certain other factors are presentwhich indicate impairment is probable. The decision to place a loan on nonaccrual status is also based on anevaluation of the borrower’s financial condition, collateral, liquidationvalue, and other factors that affect the borrower’s ability to pay.

 

Generally, atthe time a loan is placed on nonaccrual status, all interest accrued on theloan in the current fiscal year is reversed from income, and all interestaccrued and uncollected from the prior year is charged off against the allowancefor loan losses.  Thereafter, interest onnonaccrual loans is recognized as interest income only to the extent that cashis received and future collection of principal is not in doubt.  If the collectibility of outstandingprincipal is doubtful, such interest received is applied as a reduction ofprincipal.  A nonaccrual loan may berestored to accruing status when principal and interest are no longer past dueand unpaid and future collection of principal and interest on a timely basis isnot in doubt.  At December 31, 2005and 2004 Legends Bank had $1,037,000 and $420,000, respectively, of loans onnonaccrual status.

 

Other loansmay be classified as impaired when the current net worth and financial capacityof the borrower or of the collateral pledged, if any, is viewed asinadequate.  In those cases, such loanshave a well-defined weakness or weaknesses that jeopardize the liquidation ofthe debt, and if such deficiencies are not corrected, there is a probabilitythat the Company will sustain some loss. In such cases, interest income continues to accrue as long as the loandoes not meet the Company’s criteria for nonaccrual status.

 

Generally theCompany also classifies as impaired any loans the terms of which have beenmodified in a troubled debt restructuring. Interest is accrued on such loans that continue to meet the modifiedterms of their loan agreements.  At December 31,2005 and 2004, the Company had no loans that have had the terms modified in atroubled debt restructuring.

 

The Company’scharge-off policy for impaired loans is similar to its charge-off policy forall loans in that loans are charged-off in the month when they are considereduncollectible.

 

As of December 31,2005 the Company had impaired loans totaling $2,010,000.  As of December 31, 2004 the Company hadimpaired loans totaling $3,052,000.  Aspecific reserve of $225,000 and $196,000 has been established by managementrelated to these loans for December 31, 2005 and 2004, respectively.  The total amount of interest recognized onimpaired loans was $167,000 in 2005.  Thetotal amount of interest recognized during 2004 on impaired loans was$195,000.  The impaired loans aregenerally commercial loans and have been classified as substandard bymanagement’s internal grading system. The total value of the collateral securing these loans is approximately$2,628,000 and $3,853,000 for December 31, 2005 and December 31,2004, respectively.

 

Non-performingloans, which include non-accrual loans and loans 90 days past due, at December 31,2005, totaled $1,037,000.  There were$420,000 of non-performing loans at December 31, 2004.

 

21

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The following schedule detailsselected information as to non-performing loans of Legends Bank at December 31,2005 and 2004:

 
| ** **          | ** **   | **2005**           | ** **   | **2004**           | ** **   |
|---------------------|--------------|--------------------|--------------|--------------------|--------------|
| ** **          | ** **   | **Past Due**       | ** **   | ** **         | ** **   | **Past Due** | ** ** | ** ** | ** ** |
| ** **          | ** **   | **90 Days**        | ** **   | **Non-Accrual**    | ** **   | **90 Days** | ** ** | **Non-Accrual** | ** ** |
| *** ***        | *** *** | **(In Thousands)** | *** *** | **(In Thousands)** | *** *** |
|                |         |               |         |               |         |   |   |   |   |
| Real estate  loans  |         | $                  | —       |               | $            | 994 |   | $ | — |   | $ | 350 |   |
| Consumer  loans     |         | —             |         | 2                  |         | — |   | 25 |   |
| Commercial          |         | —             |         | 41                 |         | — |   | 45 |   |
|                |         | $                  | —       |               | $            | 1,037 |   | $ | — |   | $ | 420 |   |
|                |         |               |         |               |         |   |   |   |   |
| Renegotiated  loans |         | $                  | —       |               |         |   | $ | — |   |   |   |

 

The allowancefor possible loan losses is discussed under “Provision for Possible Loan Losses”below.  The Company maintains itsallowance for possible loan losses at an amount considered by management to beadequate to provide for the possibility of loan losses in the loanportfolio.  Management has in place asystem of quality controls to identify and monitor problem loans.  Management believes the allowance forpossible loan losses at December 31, 2005 to be adequate.

 

Essentiallyall of the Company’s loans originate from Montgomery and adjacent Tennesseecounties.  The Company seeks to exerciseprudent risk management in lending, including diversification by loan categoryand industry segment, as well as by identification of credit risks.

 

The Company’smanagement believes there is a significant opportunity to continue to increasethe loan portfolio in the Company’s primary market area.  The Company has targeted commercial businesslending, commercial and residential real estate lending and consumerlending.  The Company seeks to build aloan portfolio which is capable of adjusting to swings in the interest rate market,and it is the Company’s policy to maintain a diverse loan portfolio notdependent on any particular market or industrial segment.  Management has set a goal for loans to rangebetween 80% and 85% of deposits.

 

### **Securities**

###  

Securitiesincreased 24.1% from $37,580,000 at December 31, 2004 to $46,623,000 at December 31,2005 and was a primary component of the Company’s earning assets.  At December 31, 2005, the market valueof the Company’s securities portfolio was less than its amortized cost by$712,000 or 1.5%.  At December 31,2004, the market value of the Company’s securities was less than its amortizedcost by $297,000 or 0.8%.  The weightedaverage yield (stated on a tax-equivalent basis, assuming a Federal income taxrate of 34%) of the securities at December 31, 2005 was 4.8% as comparedto an average yield of 4.50% at December 31, 2004.

 

The Companyhas adopted the provisions of Statement of Financial Accounting Standards No. 115(SFAS No. 115), “Accounting for Certain Investments in Debt and EquitySecurities”.  Under the provisions of theStatement, securities are to be classified in three categories and accountedfor as follows:

 

22

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•      Debtsecurities that the enterprise has the positive intent and ability to hold tomaturity are classified as held-to-maturity securities and reported atamortized costs.

 

•      Debtand equity securities that are bought and held principally for the purpose ofselling them in the near term are classified as trading securities and reportedat fair value, with unrealized gains and losses included in earnings.

 

•      Debtand equity securities not classified as either held-to-maturity securities ortrading securities are classified as available-for-sale securities and reportedat fair value, with unrealized gains and losses excluded from earnings andreported in a separate component of stockholders’ equity.

 

The Company’sclassification of securities as of December 31, 2005 and 2004 is asfollows:

 

 
| ** **                                                         | ** ** | **Available-For-Sale** | ** ** |
|--------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                         | ** ** | **2005**               | ** ** | **2004** | ** ** |
| ** **                                                         | ** ** | ** **             | ** ** | **Estimated** | ** ** | ** ** | ** ** | **Estimated** | ** ** |
| ** **                                                         | ** ** | **Amortized**          | ** ** | **Market** | ** ** | **Amortized** | ** ** | **Market** | ** ** |
| ** **                                                         | ** ** | **Cost**               | ** ** | **Value** | ** ** | **Cost** | ** ** | **Value** | ** ** |
| ** **                                                         | ** ** | **(In Thousands)**     | ** ** | **(In Thousands)** | ** ** |
|                                                               |       |                   |       |   |   |   |   |   |   |
| U.S. Treasury and other U.S. Government agencies  and corporations |       | $                      | 4,904      |   | $ | 4,782 |   | $ | 4,070 |   | $ | 4,001 |   |
| Obligations of states and political subdivisions                   |       | 16,589                 |       | 16,554 |   | 12,123 |   | 12,104 |   |
| Domestic corporate bonds                                           |       | 2,520                  |       | 2,490 |   | 2,750 |   | 2,731 |   |
| Mortgage-backed securities                                         |       | 23,322                 |       | 22,797 |   | 18,934 |   | 18,744 |   |
|                                                               |       | $                      | 47,335     |   | $ | 46,623 |   | $ | 37,877 |   | $ | 37,580 |   |

 

No securities have been classified as trading or held-to-maturitysecurities.

 

### **Deposits**

###  

Totaldeposits, which in the future are expected to be the principal source of fundsfor the Company, totaled $199,678,000 and $154,975,000 at December 31,2005 and 2004, respectively, representing an increase of $44,703,000 or28.8%.  Demand deposits increased 57.2%from $26,965,000 at December 31, 2004 to $42,384,000 at December 31,2005.  A portion of the increase relatesto one customer whose balances increased $14,953,000 from December 31, 2004to December 31, 2005.  Negotiableorder of withdrawal, savings deposits and money market demand accountsincreased $15,216,000 or 22.7%. Certificates of deposit and individual retirement accounts increased$14,068,000 or 23.1%.  The Company hastargeted local consumers, professionals, local governments and commercialbusinesses as its central clientele; therefore, deposit instruments in the formof demand deposits, savings accounts, money market demand accounts,certificates of deposits and individual retirement accounts are offered tocustomers.

 

Management believes the Montgomery andStewart County areas in Tennessee are a growing economic market offering growthopportunities for the Company; however, the Company competes with several ofthe larger bank holding companies that have branch offices in this area, andtherefore, no assurances of market growth can be given.  Even though the Company is in a verycompetitive market, management currently believes that it is possible toincrease Legends Bank’s deposit and asset size. Management believes that itsposition as a locally oriented financial institution that offers personalizedservice will contribute significantly to loan and deposit growth and eventuallyto overall profitability.

 

23

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### **Acquisition**

### ** **

Effective March 24, 2003,the Company acquired certain assets and liabilities of NBC Bank in theClarksville, Tennessee area. The acquisition was accounted for as a purchase. Goodwillarising from this transaction will be evaluated on an annual basis.

 

### **Liquidityand Asset Management**

### ** **

The Company’s managementseeks to maximize net interest income by managing the Company’s assets andliabilities within appropriate constraints on capital, liquidity and interestrate risk. Liquidity is the ability to maintain sufficient cash levelsnecessary to fund operations, meet the requirements of depositors and borrowersand fund attractive investment opportunities. A company has liquidity potentialwhen it has the ability to obtain sufficient funds in a timely manner at areasonable cost. The Company’s primary source of liquidity is expected to be astable core deposit base. In addition, short-term investments, loan payments,investment security maturities and Federal Home Loan Bank advances provide asecondary source. The Company’s loan to deposit ratio was approximately 76.6%and 83.8% at December 31, 2005 and December 31, 2004, respectively.

 

The Company’s investmentportfolio, as represented above, consists of earning assets that provideinterest income.

 

Funds management decisionsmust reflect management’s intent to maintain profitability in both theimmediate and long-term earnings. The Company’s rate sensitivity position hasan important impact on earnings. Senior management of the Company meets monthlyto analyze the rate sensitivity position of the Company. These meetings focuson the spread between the subsidiary bank’s cost of funds and interest yieldsgenerated primarily through loans and investments.

 

The Company presentlymaintains a liability sensitive position over the 2006 year or a negative gap. Liabilitysensitivity means that more of the Company’ liabilities are capable ofrepricing over certain time frames than assets. The interest rates associatedwith these liabilities may not actually change over this period but are capableof changing.

 
| **Interest-rate sensitivity  gaps:**             | ** ** | **0-30** | ** ** | **31-90** | ** ** | **91-180** | ** ** | **181-365** | ** ** | **One Year  and** | ** ** | ** ** | ** ** |
|-------------------------------------------------------|------------|----------|------------|-----------|------------|------------|------------|-------------|------------|------------------------|------------|------------|------------|
| **(In Thousands)**                               | ** ** | **Days** | ** ** | **Days**  | ** ** | **Days**   | ** ** | **Days**    | ** ** | **Longer**             | ** ** | **Total**  | ** ** |
|                                                  |       |     |       |      |       |       |       |        |       |                   |       |       |       |
| Interest-earning assets                               |       | $        | 77,814     |      | 4,510      |       | 5,731      |        | 14,350     |                   | 109,598    |       | 212,003    |   |
| Interest-bearing liabilities                          |       | 90,672   |       | 12,658    |       | 9,457      |       | 29,010      |       | 27,271                 |       | 169,068    |       |
|                                                  |       |     |       |      |       |       |       |        |       |                   |       |       |       |
| Interest rate sensitivity                             |       | $        | (12,858    | )         | (8,148     | )          | (3,726     | )           | (14,660    | )                      | 82,327     |       | 42,935     |   |
|                                                  |       |     |       |      |       |       |       |        |       |                   |       |       |       |
| Cumulative gap                                        |       | $        | (12,858    | )         | (21,006    | )          | (24,732    | )           | (39,392    | )                      | 42,935     |       |       |   |
|                                                  |       |     |       |      |       |       |       |        |       |                   |       |       |       |
| Interest rate sensitivity gap as a % of  total assets |       | (5.60    | )%         | (3.55     | )%         | (1.62      | )%         | (6.38       | )%         | 35.84                  | %          |       |       |
|                                                  |       |     |       |      |       |       |       |        |       |                   |       |       |       |
| Cumulative gap as a % of total assets                 |       | (5.60    | )%         | (9.15     | )%         | (10.77     | )%         | (17.15      | )%         | 18.69                  | %          |       |       |

 

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Historically, there has beenno significant reduction in immediately withdrawable accounts such asnegotiable order of withdrawal, money market demand, demand deposit and regularsavings accounts. Management does not anticipate that there will be significantwithdrawals from these accounts in the future.

 

The Company completed andopened its main office in January of 2000. In addition to the main office, abranch was opened in April, 1999, a second branch was opened in February, 2001,a third branch was opened in April, 2003, a fourth branch was opened in Dover,Tennessee in November, 2003 and a fifth branch was opened in July, 2005. Capitalinvestments can be detrimental to a bank’s earnings thus management evaluatesthe potential growth and profitability at making such expenditures beforeproceeding. As previously discussed certain assets and liabilities of an NBCBank branch were acquired in 2003 but other than the ATM, the branch location,which was inside a grocery store, was not maintained. Other than the itemsdiscussed below, there are no known trends or any known commitments, demands,events or uncertainties that will result in or that are reasonably likely toresult in the Company’s liquidity changing in any material way. It isanticipated that with present maturities, the anticipated growth in depositbase, and the efforts of management in its asset/liability management program,liquidity will not pose a problem in the foreseeable future.

 

Currently, the Companymaintains nearly all deposit accounts for local municipalities and relateddepartments. As of December 31, 2005, such deposits approximated$37,232,000. The loss of these deposits or some portion thereof, could have anegative impact on deposit growth and liquidity.

 

The Company also maintains asignificant deposit relationship with a customer in Clarksville, MontgomeryCounty, Tennessee. As of December 31, 2005, this deposit relationship totaled$16,339,000. Subsequent to December 31, 2005, this deposit relationship hasincreased significantly by approximately $45 million in part due to the matterdiscussed below.

 

In the normal course ofbusiness, Legends Bank provides ACH services for its customers. As a result, acertain level of liability is incurred that is mitigated through agreements,activity level limits, financial review of participating parties, and even bankheld reserves when determined necessary. One of those customers utilizing ACHservices is an online payment processor. Subsequent to year-end, one of theclients of the online payment processor was determined to be operating a ponzischeme. The ponzi operation grew rapidly and exponentially, dramaticallyincreasing exposure levels for the Bank. After the resulting payments werecredited, a large level of ACH returns were initiated, which Legends Bank isrequired to honor for a period of 60 days from the initial transaction. ThroughMarch 24, 2006, Legends Bank has honored $15.5 million of returns, inaccordance with the ACH agreement signed with Legends’ customer. Legends Bankcontinues to hold sufficient funds of its customer as of March 24, 2006 tocover any remaining liability from ACH return activity. Legends Bank institutedpolicy and procedure allowed the exposure to be effectively managed. By virtueof honoring its ACH returns and preventing returns from other processors,Legends Bank may have some potential future liability to those parties. However,it is the opinion of both management and legal counsel that any furtherliabilities arising from the aforementioned information are currently unknownand indeterminable from existing facts.

 

The Company has committed tothe construction of a facility in Clarksville Montgomery County, Tennesseeduring 2006 at an estimated cost of $2,000,000. The facility will accommodatethe Company’s mortgage department, administrative offices and the relocation ofan existing branch.

 

### **CapitalPosition and Dividends**

### ** **

At December 31, 2005 and2004, total stockholders’ equity was $17,350,000 and $15,713,000 or 7.6% and8.5% of total assets. The increase in stockholders’ equity results from netearnings of $2,085,000, and proceeds from sales of common stock totaling$235,000 issued in connection with the Company’s stock option plan which wereoffset by an increase in unrealized losses of $256,000, and a dividend paid of$427,000.

 

25

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The Company’s principalregulators have established minimum risk-based capital requirements andleverage capital requirements for the Company. These guidelines classifycapital into two categories of Tier I and Total risk-based capital. Totalrisk-based capital consists of Tier I (or core) capital (essentially commonequity less intangible assets) and Tier II capital (essentially qualifyinglong-term debt, of which the Company has none, and a part of the allowance forpossible loan losses). In determining risk-based capital requirements,  assets are assigned risk-weights of 0% to100%, depending on regulatory assigned levels of credit risk associated withsuch assets. The risk-based capital guidelines require the Company to have atotal risk-based capital ratio of 8.0% and a Tier I risk-based capital ratio of4.0%. At December 31, 2005 and 2004, the Company’s total risk-basedcapital ratio was 11.2% and 12.1%, respectively, and its Tier I risk-basedcapital ratio was 10.1% and 11.0%, respectively. At December 31, 2005 and 2004,the Company had a leverage ratio of 8.3% and 8.7%, respectively.

 

It is management’s objectiveto leverage the Company to approximately a 7.5% capital ratio. The emphasiswill be on asset quality and growth in core deposits both of which should beaided by the large stockholder base.

 

There is no establishedtrading market for the Company’s stock. From time to time the Company mayacquire shares of its stock to provide some liquidity in the shares. During theyear ended December 31, 2005 and 2004, the Company did not redeem anyshares of its voting common stock and issued 18,602 (10,602 at $8.33 per share,2,000 at $17.00 per share and 6,000 at $18.75 per share) and 26,748 (25,548 at$8.33 per share and 1,200 at $18.75 per share) shares, respectively, inconjunction with its stock option plan. Privately negotiated trades may involvethe Company, its directors and officers and, accordingly, may not be reliableindicators of value.

 

On January 18, 2005, theCompany’s Board of Directors recommended a dividend be declared at the annualshareholders meeting on April 19, 2005. The recommendation was to set thedividend rate for 2005 at 23% of 2004 earnings. On April 29, 2005, thedividends were paid in the amount of $427,000 or $.30 per share of votingcommon stock. On February 17, 2004, the Company’s Board of Directors recommendeda dividend be declared at the annual shareholders meeting on April 20, 2004. Therecommendation was to set the dividend rate for 2004 at 33% of 2003 earnings. OnMay 28, 2004, the dividends were paid in the amount of $279,000 or $.20 pershare of voting common stock.

 

### **Results of Operations**

### ** **

Net earnings for the yearended December 31, 2005 increased by $479,000 or 29.8% from net earnings of$1,606,000 in 2004. Net earnings for the year ended December 31, 2004 were$1,606,000 an increase of $777,000 or 93.7% from net earnings of $829,000 forthe year ended December 31, 2003. The earnings in 2005, 2004 and 2003 are aresult of net interest income increasing as a result of Company’s growth whichoffset the overhead costs required to facilitate growth. Basic and dilutedearnings per common share were $1.47 and $1.42, respectively, in 2005, $1.15and $1.12 in 2004 and $.60 and $.59 in 2003.

 

26

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### **NetInterest Income**

### ** **

Net interest incomerepresents the amount by which interest earned on various earning assetsexceeds interest paid on deposits and other interest-bearing liabilities and isthe most significant component of the Company’s earnings. Total interest incomewas $11,543,000, $8,854,000 and $6,954,000 for the years ended December 31,2005, 2004 and 2003, respectively, and total interest expense was $3,942,000,$2,162,000 and $1,748,000, respectively. Net interest income for the sameperiods netted $7,601,000, $6,692,000 and $5,206,000, respectively. Interestrates increased during 2005 and are expected to increase slightly in 2006. Thecontinued growth in interest income and expense are a direct result of growthin earning assets and deposits consistent with the growth of the Company andthe opening of additional branches. The increases in interest income andinterest expense primarily relate to volume increases. Management believes thata satisfactory level of loans and deposits can be originated or repriced in2006 to maintain a stable net interest margin.

 

### **Provision for Possible LoanLosses**

### ** **

The provision for loanlosses represents a charge to earnings necessary to establish an allowance forpossible loan losses that, in management’s evaluation, is adequate to providecoverage for estimated losses on outstanding loans and to provide foruncertainties in the economy. The provision for loan losses for the years endedDecember 31, 2005, 2004 and 2003 were $305,000, $440,000 and $361,000,respectively. The allowance for possible loan losses were $1,758,000 and$1,517,000 at December 31, 2005 and 2004, respectively. The level of theallowance and the amount of the provision involve evaluation of uncertaintiesand matters of judgment. This is not an exact science. Management believes theallowance for possible loan losses at December 31, 2005 and 2004 to be adequate.The allowance for loan losses was 1.15% and 1.17% of loans at December 31, 2005and 2004, respectively.

 

### **Non-Interest Income**

### ** **

The Company’s non-interestincome consists of service charge on deposit accounts, other fees andcommissions and gain and fees on sale of loans. Total non-interest income forthe year ended December 31, 2005 was $1,935,000 and $1,582,000 for the yearended December 31, 2004, an increase of $353,000 or 22.3%. Non-interest income increased$584,000 or 58.5% for the year ended December 31, 2004 from $998,000 forthe year ended December 31, 2003. Included in the year ended December 31, 2004earnings was security gains of $67,000. There were no security gains for theyear ended December 31, 2005 or 2003. The increase in non-interest income forthe year ended December 31, 2005, was primarily due to an increase in servicecharge on deposit accounts of $123,000 and an increase on gain and fees on saleof small business administration and mortgage loans of $211,000. During 2004,the Company began receiving fees related to origination of mortgage loans asopposed to originating funding and selling mortgage loans. During 2005, theCompany earned fees related to the origination of mortgage loans of $115,000and fees related to the sale of small business association loans of $340,000. Managementprojects that other fees and commissions and service charges on depositaccounts will increase in 2006 due to growth of the Company.

 

### **Non-Interest Expense**

### ** **

Non-interest expensesconsist primarily of employee costs, occupancy expenses, furniture andequipment expenses, data processing expense, advertising expense, directorsfees and expenses, public relations and donations, printing and supplies,professional fees, freight and postage, loss on sale of fixed assets, loss onsale of other real estate, loss on sale of securities and other operatingexpenses. Total non-interest expense for the year ended December 31, 2005 was$6,135,000 and was $5,532,000 for the year ended December 31, 2004, an increaseof $603,000 or 10.9%. Non-interest expense increased $927,000 or 20.1% for theyear ended December 31, 2004 from $4,605,000 for the year ended December 31,2003. The increases in 2005 and 2004 were primarily the result of increases insalaries and benefits due to the addition of personnel to facilitate Companygrowth, and an increase in other costs associated with opening new branches andservices, the opening of an investment division and expansion of mortgage lendingservices.

 

27

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### **MonetaryPolicy**

### ** **

The Company is affected bycommercial bank credit policies of regulatory authorities, including the Boardof Governors. An important function of the Board is to regulate the nationalsupply of bank credit in order to attempt to combat recessionary and curbinflationary pressures. Among the instruments of monetary policy used by theBoard to implement these objectives are: open market operations in U.S. government securities, changes indiscount rates on member borrowings, changes in reserve requirements againstbank deposits and limitations on interest rates which member banks may pay ontime and savings deposits. These means are used in varying combinations toinfluence overall growth of bank loans, investments and deposits, and may alsoaffect interest rates charged on loans or paid on deposits. The monetarypolicies of the Board have had a significant effect on the operating results ofcommercial banks, including nonmembers as well as members, in the past and areexpected to continue to do so in the future.

 

### **ContractualObligations**

### ** **

The Company has thefollowing contractual obligations as of December 31, 2005:

 
| ** **              | ** ** | **Less**        | ** ** | ** **          | ** ** | ** **          | ** ** | **More**        | ** ** | ** ** | ** ** |
|-------------------------|------------|-----------------|------------|---------------------|------------|---------------------|------------|-----------------|------------|------------|------------|
| ** **              | ** ** | **than 1** | ** ** | **1 - 3** | ** ** | **3 - 5** | ** ** | **than 5** | ** ** | ** ** | ** ** |
| **(In Thousands)** | ** ** | **Year**        | ** ** | **Years**           | ** ** | **Years**           | ** ** | **Years**       | ** ** | **Total**  | ** ** |
|                    |       |            |       |                |       |                |       |            |       |       |       |
| Long-term debt          |       | $               | 1,000      |                | 7,460      |                | 980        |            | 355        |       | 9,795      |   |
| Purchases               |       | 2,000           |       | —              |       | —              |       | —          |       | 2,000      |       |
| Operating leases        |       | 117             |       | 100                 |       | 9                   |       | —          |       | 226        |       |
|                    |       |            |       |                |       |                |       |            |       |       |       |
| Total                   |       | $               | 3,117      |                | 7,560      |                | 989        |            | 355        |       | 12,021     |   |

 

### **Off BalanceSheet Arrangements**

### ** **

At December 31, 2005, theCompany had unfunded loan commitments outstanding of $32.7 million andoutstanding standby letters of credit of $3.8 million. Because thesecommitments generally have fixed expiration dates and many will expire withoutbeing drawn upon, the total commitment level does not necessarily representfuture cash requirements. If needed to fund these outstanding commitments, theCompany has the ability to liquidate securities available-for-sale or on ashort-term basis to borrow and purchase Federal funds from other financialinstitutions. Additionally, the Company could sell participations in these orother loans to correspondent banks. As mentioned above, the Company has beenable to fund its ongoing liquidity needs through its stable core deposit base,loan payments, its investment security maturities and short-term borrowings.

 

### **Impact of Inflation**

### ** **

The primary impact whichinflation has on the results of the Company’s operations is evidenced by itseffects on interest rates. Interest rates tend to reflect, in part, thefinancial market’s expectations of the level of inflation and, therefore, willgenerally rise or fall as the level of expected inflation fluctuates. To theextent interest rates paid on deposits and other sources of funds rise or fallat a faster rate than the interest income earned on funds, loans orinvestments, net interest income will vary. Inflation also impacts onnon-interest expenses as goods and services are purchased, although this hasnot had a significant effect on net earnings. If the inflation rate stays flator increases slightly, management believes that the effect on earnings will notbe significant.

 

28

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### **Quantitativeand Qualitative Disclosures About Market Risk**

### ** **

The Company’s primarycomponent of market risk is interest rate volatility. Fluctuations in interestrates will ultimately impact both the level of income and expense recorded on alarge portion of the Bank’s assets and liabilities, and the market value of allinterest-earning assets and interest-bearing liabilities, other than thosewhich possess a short term to maturity. Based upon the nature of the Company’soperations, the Company is not subject to foreign currency exchange orcommodity price risk.

 

Interest rate risk(sensitivity) management focuses on the earnings risk associated with changinginterest rates. Management seeks to maintain profitability in both immediateand long term earnings through funds management/interest rate risk management. TheCompany’s rate sensitivity position has an important impact on earnings. Seniormanagement of the Company meets monthly to analyze the rate sensitivityposition. These meetings focus on the spread between the cost of funds andinterest yields generated primarily through loans and investments.

 

29

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I.              Distribution ofAssets, Liabilities and Stockholders’ Equity:

Interest Rates and Interest Differential

 

The Schedule which followsindicates the average balances for each major balance sheet item, an analysisof net interest income and the change in interest income and interest expenseattributable to changes in volume and changes in rates.

 

The difference between interestincome on interest-earning assets and interest expense on interest-bearingliabilities is net interest income, which is the Company’s gross margin. Analysisof net interest income is more meaningful when income from tax-exempt earningassets is adjusted to a tax equivalent basis. Accordingly, the followingschedule includes a tax equivalent adjustment of tax-exempt earning assets,assuming a weighted average Federal income tax rate of 34%.

 

In the following Schedule “changedue to volume” is the change in volume multiplied by the interest rate for theprior year. “Change due to rate” is the change in interest rate multiplied bythe volume for the prior year. Changes in interest income and expense not duesolely to volume or rate changes are allocated between volume change and ratechange at the ratio of how much each component bears to the absolute value oftheir total.

 

Non-accrual loans have beenincluded in the loan category. Loan fees of $438,000, $368,000 and $318,000 for2005, 2004 and 2003, respectively, are included in loan income and represent anadjustment of the yield on these loans.

 

30

----

 
| ** **                              | ** ** | **In Thousands, Except Interest Rates** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                              | ** ** | **2005**                                                    | ** ** | **2004** | ** ** | **2005/2004 Change** | ** ** |
| ** **                              | ** ** | **Average**                                                 | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Average** | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Balance**                                                 | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans, net of  unearned interest        |       | $                                                           | 139,180    |   | 7.03 | % | 9,788 |   | 116,340 |   | 6.44 | % | 7,495 |   | 1,564 |   | 729 |   | 2,293 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment  securities - taxable        |       | 28,148                                                      |       | 4.08 |   | 1,148 |   | 26,584 |   | 3.57 |   | 950 |   | 58 |   | 140 |   | 198 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment  securities - tax-exempt     |       | 13,458                                                      |       | 3.78 |   | 509 |   | 8,442 |   | 4.39 |   | 371 |   | 195 |   | (57 | ) | 138 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable  equivalent adjustment          |       | —                                                      |       | 1.95 |   | 262 |   | — |   | 2.27 |   | 191 |   | 102 |   | (31 | ) | 71 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total tax-exempt investment  securities |       | 13,458                                                      |       | 5.73 |   | 771 |   | 8,442 |   | 6.66 |   | 562 |   | 297 |   | (88 | ) | 209 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total investment securities             |       | 41,606                                                      |       | 4.61 |   | 1,919 |   | 35,026 |   | 4.32 |   | 1,512 |   | 299 |   | 108 |   | 407 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale                    |       | —                                                      |       | — |   | — |   | 34 |   | 5.88 |   | 2 |   | (2 | ) | — |   | (2 | ) |
| Federal funds  sold                     |       | 1,821                                                       |       | 3.62 |   | 66 |   | 1,317 |   | 1.21 |   | 16 |   | 8 |   | 42 |   | 50 |   |
| Restricted equity  securities           |       | 738                                                         |       | 4.34 |   | 32 |   | 569 |   | 3.51 |   | 20 |   | 7 |   | 5 |   | 12 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total earning  assets                   |       | 183,345                                                     |       | 6.44 | % | 11,805 |   | 153,286 |   | 5.90 | % | 9,045 |   | 1,881 |   | 879 |   | 2,760 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                |       | 7,645                                                       |       |   |   |   |   | 6,589 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Allowance for  possible loan losses     |       | (1,603                                                      | )          |   |   |   |   | (1,389 | ) |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Bank premises and  equipment            |       | 5,982                                                       |       |   |   |   |   | 5,617 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other assets                            |       | 2,735                                                       |       |   |   |   |   | 2,471 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                            |       | $                                                           | 198,104    |   |   |   |   |   | 166,574 |   |   |   |   |   |   |   |   |   |   |   |

 

31

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| ** **                                       | ** ** | **In Thousands, Except Interest Rates** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2005**                                                    | ** ** | **2004** | ** ** | **2005/2004 Change** | ** ** |
| ** **                                       | ** ** | **Average**                                                 | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Average** | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                                       | ** ** | **Balance**                                                 | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                        |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Negotiable order  of withdrawal accounts         |       | $                                                           | 35,851     |   | 2.04 | % | 732 |   | 34,696 |   | 1.01 | % | 350 |   | 12 |   | 370 |   | 382 |   |
| Money market  demand accounts                    |       | 29,811                                                      |       | 2.22 |   | 662 |   | 25,562 |   | 1.07 |   | 273 |   | 52 |   | 337 |   | 389 |   |
| Individual  retirement accounts                  |       | 3,621                                                       |       | 3.56 |   | 129 |   | 2,464 |   | 2.76 |   | 68 |   | 38 |   | 23 |   | 61 |   |
| Other savings  deposits                          |       | 3,447                                                       |       | 0.93 |   | 32 |   | 2,976 |   | 0.67 |   | 20 |   | 3 |   | 9 |   | 12 |   |
| Certificates of  deposit, $100,000 and over      |       | 43,080                                                      |       | 3.15 |   | 1,356 |   | 36,103 |   | 2.41 |   | 871 |   | 187 |   | 298 |   | 485 |   |
| Certificates of  deposit under $100,000          |       | 20,854                                                      |       | 3.05 |   | 636 |   | 16,698 |   | 2.43 |   | 406 |   | 113 |   | 117 |   | 230 |   |
| Total  interest-bearing deposits                 |       | 136,664                                                     |       | 2.60 |   | 3,547 |   | 118,499 |   | 1.68 |   | 1,988 |   | 341 |   | 1,218 |   | 1,559 |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds  purchased                         |       | 663                                                         |       | 3.32 |   | 22 |   | 1,251 |   | 1.20 |   | 15 |   | (10 | ) | 17 |   | 7 |   |
| Securities sold  under repurchase agreements     |       | 1,452                                                       |       | 3.17 |   | 46 |   | 565 |   | 0.53 |   | 3 |   | 11 |   | 32 |   | 43 |   |
| Advances from  Federal Home Loan Bank            |       | 10,619                                                      |       | 3.08 |   | 327 |   | 7,685 |   | 2.03 |   | 156 |   | 73 |   | 98 |   | 171 |   |
| Total deposits  and borrowed funds               |       | 149,398                                                     |       | 2.64 |   | 3,942 |   | 128,000 |   | 1.69 |   | 2,162 |   | 408 |   | 1,372 |   | 1,780 |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand                                           |       | 31,523                                                      |       |   |   |   |   | 23,442 |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                                |       | 873                                                         |       |   |   |   |   | 501 |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stockholders’  equity                       |       | 16,310                                                      |       |   |   |   |   | 14,631 |   |   |   |   |   |   |   |   |   |   |   |
| Total liabilities  and stockholders’ equity |       | $                                                           | 198,104    |   |   |   |   |   | 166,574 |   |   |   |   |   |   |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                             |       |                                                        |       |   |   | 7,863 |   |   |   |   |   | 6,883 |   |   |   |   |   | 980 |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net yield on  earning assets                     |       |                                                        |       | 4.29 | % |   |   |   |   | 4.49 | % |   |   |   |   |   |   |   |   |
|                                             |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  spread                             |       |                                                        |       | 3.80 | % |   |   |   |   | 4.21 | % |   |   |   |   |   |   |   |   |

 

32

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| ** **                              | ** ** | **In Thousands, Except Interest Rates** | ** ** |
|-----------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                              | ** ** | **2004**                                                    | ** ** | **2003** | ** ** | **2004/2003 Change** | ** ** |
| ** **                              | ** ** | **Average**                                                 | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Average** | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Balance**                                                 | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans, net of  unearned interest        |       | $                                                           | 116,340    |   | 6.44 | % | 7,495 |   | 85,872 |   | 6.76 | % | 5,803 |   | 1,978 |   | (286 | ) | 1,692 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment  securities - taxable        |       | 26,584                                                      |       | 3.57 |   | 950 |   | 25,400 |   | 3.51 |   | 893 |   | 44 |   | 13 |   | 57 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Investment  securities - tax-exempt     |       | 8,442                                                       |       | 4.39 |   | 371 |   | 5,572 |   | 3.66 |   | 204 |   | 120 |   | 47 |   | 167 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Taxable  equivalent adjustment          |       | —                                                      |       | 2.27 |   | 191 |   | — |   | 1.89 |   | 105 |   | 62 |   | 24 |   | 86 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total tax-exempt investment  securities |       | 8,442                                                       |       | 6.66 |   | 562 |   | 5,572 |   | 5.55 |   | 309 |   | 182 |   | 71 |   | 253 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total investment securities             |       | 35,026                                                      |       | 4.32 |   | 1,512 |   | 30,972 |   | 3.88 |   | 1,202 |   | 166 |   | 144 |   | 310 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans held for  sale                    |       | 34                                                          |       | 5.88 |   | 2 |   | 288 |   | 5.21 |   | 15 |   | (15 | ) | 2 |   | (13 | ) |
| Federal funds  sold                     |       | 1,317                                                       |       | 1.21 |   | 16 |   | 2,316 |   | 1.08 |   | 25 |   | (12 | ) | 3 |   | (9 | ) |
| Restricted equity  securities           |       | 569                                                         |       | 3.51 |   | 20 |   | 429 |   | 3.26 |   | 14 |   | 5 |   | 1 |   | 6 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total earning  assets                   |       | 153,286                                                     |       | 5.90 |   | 9,045 |   | 119,877 |   | 5.89 |   | 7,059 |   | 1,974 |   | 12 |   | 1,986 |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and due from  banks                |       | 6,589                                                       |       |   |   |   |   | 5,043 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Allowance for  possible loan losses     |       | (1,389                                                      | )          |   |   |   |   | (1,019 | ) |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Bank premises and  equipment            |       | 5,617                                                       |       |   |   |   |   | 4,602 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other assets                            |       | 2,471                                                       |       |   |   |   |   | 2,083 |   |   |   |   |   |   |   |   |   |   |   |
|                                    |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total assets                            |       | $                                                           | 166,574    |   |   |   |   |   | 130,586 |   |   |   |   |   |   |   |   |   |   |   |

 

33

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| ** **                                          | ** ** | **In Thousands, Except Interest Rates** | ** ** |
|-----------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2004**                                                    | ** ** | **2003** | ** ** | **2004/2003 Change** | ** ** |
| ** **                                          | ** ** | **Average**                                                 | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Average** | ** ** | **Interest** | ** ** | **Income/** | ** ** | **Due to** | ** ** | **Due to** | ** ** | ** ** | ** ** |
| ** **                                          | ** ** | **Balance**                                                 | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Balance** | ** ** | **Rate** | ** ** | **Expense** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Total** | ** ** |
| ** **                                          | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits:                                           | ** ** | ** **                                                  | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Negotiable order of  withdrawal accounts  |       | $                                                           | 34,696     |   | 1.01 | % | 350 |   | 28,982 |   | 1.05 | % | 304 |   | 58 |   | (12 | ) | 46 |   |
| Money market  demand accounts                       |       | 25,562                                                      |       | 1.07 |   | 273 |   | 20,663 |   | 1.12 |   | 231 |   | 52 |   | (10 | ) | 42 |   |
| Individual  retirement accounts                     |       | 2,464                                                       |       | 2.76 |   | 68 |   | 1,977 |   | 3.14 |   | 62 |   | 14 |   | (8 | ) | 6 |   |
| Other savings  deposits                             |       | 2,976                                                       |       | 0.67 |   | 20 |   | 2,220 |   | 0.90 |   | 20 |   | 6 |   | (6 | ) | — |   |
| Certificates of  deposit, $100,000 and over         |       | 36,103                                                      |       | 2.41 |   | 871 |   | 26,324 |   | 2.49 |   | 655 |   | 237 |   | (21 | ) | 216 |   |
| Certificates of  deposit under $100,000             |       | 16,698                                                      |       | 2.43 |   | 406 |   | 14,367 |   | 2.71 |   | 390 |   | 59 |   | (43 | ) | 16 |   |
| Total  interest-bearing deposits                    |       | 118,499                                                     |       | 1.68 |   | 1,988 |   | 94,533 |   | 1.76 |   | 1,662 |   | 405 |   | (79 | ) | 326 |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Federal funds purchased                             |       | 1,251                                                       |       | 1.20 |   | 15 |   | 1,022 |   | 1.57 |   | 16 |   | 3 |   | (4 | ) | (1 | ) |
| Securities sold  under repurchase agreements        |       | 565                                                         |       | 0.53 |   | 3 |   | 1,444 |   | 0.90 |   | 13 |   | (6 | ) | (4 | ) | (10 | ) |
| Advances from  Federal Home Loan Bank               |       | 7,685                                                       |       | 2.03 |   | 156 |   | 3,751 |   | 1.52 |   | 57 |   | 75 |   | 24 |   | 99 |   |
| Total  interest-bearing deposits and borrowed funds |       | 128,000                                                     |       | 1.69 |   | 2,162 |   | 100,750 |   | 1.73 |   | 1,748 |   | 455 |   | (41 | ) | 414 |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand                                              |       | 23,442                                                      |       |   |   |   |   | 15,438 |   |   |   |   |   |   |   |   |   |   |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Other liabilities                                   |       | 501                                                         |       |   |   |   |   | 503 |   |   |   |   |   |   |   |   |   |   |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Stockholders’  equity                          |       | 14,631                                                      |       |   |   |   |   | 13,895 |   |   |   |   |   |   |   |   |   |   |   |
| Total liabilities  and stockholders’ equity    |       | $                                                           | 166,574    |   |   |   |   |   | 130,586 |   |   |   |   |   |   |   |   |   |   |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  income                                |       |                                                        |       |   |   | 6,883 |   |   |   |   |   | 5,311 |   |   |   |   |   | 1,572 |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net yield on  earning assets                        |       |                                                        |       | 4.49 | % |   |   |   |   | 4.43 | % |   |   |   |   |   |   |   |   |
|                                                |       |                                                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest  spread                                |       |                                                        |       | 4.21 | % |   |   |   |   | 4.16 | % |   |   |   |   |   |   |   |   |

 

34

----

 

II.            InvestmentPortfolio:

 

A.            Securities at December31, 2005 consist of the following:

 
| ** **                                                         | ** ** | **Securities Available-For-Sale** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                         | ** ** | **(In Thousands)**                | ** ** |
| ** **                                                         | ** ** | ** **                             | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                                         | ** ** | **Amortized**                          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market** | ** ** |
| ** **                                                         | ** ** | **Cost**                               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                                               |       |                                   |       |   |   |   |   |   |   |
| U.S. Treasury and other U.S. Government  agencies and corporations |       | $                                      | 4,904      |   | — |   | 122 |   | 4,782 |   |
| Obligations of states and political  subdivisions                  |       | 16,589                                 |       | 109 |   | 144 |   | 16,554 |   |
| Domestic corporate bonds                                           |       | 2,520                                  |       | — |   | 30 |   | 2,490 |   |
| Mortgage-backed securities                                         |       | 23,322                                 |       | 2 |   | 527 |   | 22,797 |   |
|                                                               |       | $                                      | 47,335     |   | 111 |   | 823 |   | 46,623 |   |

 

Securities at December 31, 2004 consist of the following:

 
| ** **                                                         | ** ** | **Securities Available-For-Sale** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                         | ** ** | **(In Thousands)**                | ** ** |
| ** **                                                         | ** ** | ** **                             | ** ** | **Gross** | ** ** | **Gross** | ** ** | **Estimated** | ** ** |
| ** **                                                         | ** ** | **Amortized**                          | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | **Market** | ** ** |
| ** **                                                         | ** ** | **Cost**                               | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Value** | ** ** |
|                                                               |       |                                   |       |   |   |   |   |   |   |
| U.S. Treasury and other U.S. Government  agencies and corporations |       | $                                      | 4,070      |   | 2 |   | 71 |   | 4,001 |   |
| Obligations of states and political  subdivision                   |       | 12,123                                 |       | 102 |   | 121 |   | 12,104 |   |
| Domestic corporate bonds                                           |       | 2,750                                  |       | — |   | 19 |   | 2,731 |   |
| Mortgage-backed securities                                         |       | 18,934                                 |       | 34 |   | 224 |   | 18,744 |   |
|                                                               |       | $                                      | 37,877     |   | 138 |   | 435 |   | 37,580 |   |

 

35

----

 

II.            InvestmentPortfolio, Continued:

 

B.            Thefollowing schedule details the estimated maturities and weighted average yieldsof investment securities of the Company at December 31, 2005.

 
| ** **                                                                             | ** ** | ** **              | ** ** | **Estimated** | ** ** | **Weighted** | ** ** |
|----------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------|------------|--------------|------------|
| ** **                                                                             | ** ** | **Amortized**           | ** ** | **Market**    | ** ** | **Average**  | ** ** |
| **Available-For-Sale Securities**                                                 | ** ** | **Cost**                | ** ** | **Value**     | ** ** | **Yields**   | ** ** |
| ** **                                                                             | ** ** | **(In Thousands)** | ** ** |
| Obligations of U.S. Treasury and other U.S.  Government agencies and corporations:     |       |                    |       |          |       |         |       |
| Less than one year                                                                     |       | $                       | 1,001      |          | 979        |         | 3.523      | % |
| One to five years                                                                      |       | 2,908                   |       | 2,830         |       | 3.915        |       |
| Five to ten years                                                                      |       | 495                     |       | 495           |       | 5.284        |       |
| More than ten years                                                                    |       | 500                     |       | 478           |       | 4.600        |       |
| Total securities of U.S. Treasury and other  U.S. Government agencies and corporations |       | 4,904                   |       | 4,782         |       | 4.043        |       |
|                                                                                   |       |                    |       |          |       |         |       |
| Obligations of states and political subdivisions  (tax-exempt)*:                       |       |                    |       |          |       |         |       |
| Less than one year                                                                     |       | 200                     |       | 200           |       | 8.485        |       |
| One to five years                                                                      |       | 4,568                   |       | 4,518         |       | 5.017        |       |
| Five to ten years                                                                      |       | 7,029                   |       | 6,985         |       | 5.799        |       |
| More than ten years                                                                    |       | 4,792                   |       | 4,851         |       | 6.384        |       |
| Total obligations of states and political  subdivisions                                |       | 16,589                  |       | 16,554        |       | 5.785        |       |
|                                                                                   |       |                    |       |          |       |         |       |
| Domestic corporate bonds:                                                              |       |                    |       |          |       |         |       |
| Less than one year                                                                     |       | —                  |       | —        |       | —       |       |
| One to five years                                                                      |       | 270                     |       | 268           |       | 5.200        |       |
| Five to ten years                                                                      |       | —                  |       | —        |       | —       |       |
| More than ten years                                                                    |       | 2,250                   |       | 2,222         |       | 6.039        |       |
|                                                                                   |       | 2,520                   |       | 2,490         |       | 5.949        |       |
|                                                                                   |       |                    |       |          |       |         |       |
| Other:                                                                                 |       |                    |       |          |       |         |       |
| Mortgage backed securities                                                             |       | 23,322                  |       | 22,797        |       | 4.128        |       |
|                                                                                   |       |                    |       |          |       |         |       |
| Total investment securities                                                            |       | $                       | 47,335     |          | 46,623     |         | 4.797      | % |

 

----

| *Weighted average yield is stated on a  tax-equivalent basis assuming a weighted average Federal income tax rate of  34%. |
|---------------------------------------------------------------------------------------------------------------------------|

 

36

----

 

III.           Loan Portfolio:

 

A.            Loan Types

 

The following schedule details the loans of theCompany at December 31, 2005 and 2004.

 
| *** ***                            | *** *** | **(In Thousands)** | *** *** |
|-----------------------------------------|--------------|--------------------|--------------|
| ** **                              | ** **   | **2005**           | ** **   | **2004** | ** ** |
|                                    |         |               |         |   |   |
| Commercial, financial and agricultural  |         | $                  | 30,059       |   | 24,481 |   |
| Real estate - construction              |         | 31,721             |         | 22,417 |   |
| Real estate - mortgage                  |         | 85,999             |         | 77,646 |   |
| Installment                             |         | 5,204              |         | 5,307 |   |
| Total loans                             |         | 152,983            |         | 129,851 |   |
| Less allowance for possible loan losses |         | (1,758             | )            | (1,517 | ) |
| Net loans                               |         | $                  | 151,225      |   | 128,334 |   |

 

B.            Maturities and Sensitivitiesof Loans to Changes in Interest Rates

 

Thefollowing schedule details maturities and sensitivity to interest ratechanges for commercial and real estate construction loans of the Company at December 31,2005.

 
| *** ***                                                                               | *** *** | **(In Thousands)** | *** *** |
|--------------------------------------------------------------------------------------------|--------------|--------------------|--------------|
| ** **                                                                                 | ** **   | ** **         | ** **   | **1 Year to** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                                 | ** **   | **Less Than**      | ** **   | **Less Than** | ** ** | **After 5** | ** ** | ** ** | ** ** |
| ** **                                                                                 | ** **   | **1 Year**         | ** **   | **5 Years** | ** ** | **Years** | ** ** | **Total** | ** ** |
|                                                                                       |         |               |         |   |   |   |   |   |   |
| Maturity Distribution:                                                                     |         |               |         |   |   |   |   |   |   |
| Commercial,  financial and agricultural*                                                   |         | $                  | 13,099       |   | 15,791 |   | 1,169 |   | 30,059 |   |
| Real estate  – construction                                                           |         | 26,499             |         | 1,767 |   | 3,455 |   | 31,721 |   |
|                                                                                       |         | $                  | 39,598       |   | 17,558 |   | 4,624 |   | 61,780 |   |
|                                                                                       |         |               |         |   |   |   |   |   |   |
| Interest-Rate Sensitivity:                                                                 |         |               |         |   |   |   |   |   |   |
| Fixed  interest rates                                                                      |         | $                  | 3,988        |   | 17,212 |   | 4,624 |   | 25,824 |   |
| Floating or  adjustable interest rates                                                     |         | 35,610             |         | 346 |   | — |   | 35,956 |   |
| Total  commercial, financial and agricultural loans plus real estate - construction  loans |         | $                  | 39,598       |   | 17,558 |   | 4,624 |   | 61,780 |   |

 

----

*Includes demand loans, bankers acceptances, commercial paper anddeposit notes.

 

37

----

 

C.            Risk Elements

 

Thefollowing schedule details selected information as to non-performing loansof the Company at December 31, 2005 and 2004:

 
| *** ***                                                                                      | *** *** | **(In Thousands  except percentages)** | *** *** |
|---------------------------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                                        | ** **   | **2005**                               | ** **   | **2004** | ** ** |
|                                                                                              |         |                                   |         |   |   |
| Non accrual loans:                                                                                |         |                                   |         |   |   |
| Commercial,  financial and agricultural                                                           |         | $                                      | 41           |   | 45 |   |
| Real estate  – construction                                                                  |         | —                                 |         | — |   |
| Real estate  – mortgage                                                                      |         | 994                                    |         | 350 |   |
| Installment                                                                                       |         | 2                                      |         | 25 |   |
| Lease  financing receivable                                                                       |         | —                                 |         | — |   |
| Total  non-accrual                                                                                |         | $                                      | 1,037        |   | 420 |   |
|                                                                                              |         |                                   |         |   |   |
| Loans 90 days past due:                                                                           |         |                                   |         |   |   |
| Commercial,  financial and agricultural                                                           |         | $                                      | —       |   | — |   |
| Real estate  – construction                                                                  |         | —                                 |         | — |   |
| Real estate  – mortgage                                                                      |         | —                                 |         | — |   |
| Installment                                                                                       |         | —                                 |         | — |   |
| Lease  financing receivable                                                                       |         | —                                 |         | — |   |
| Total loans  90 days past due                                                                     |         | $                                      | —       |   | — |   |
|                                                                                              |         |                                   |         |   |   |
| Renegotiated loans:                                                                               |         |                                   |         |   |   |
| Commercial,  financial and agricultural                                                           |         | $                                      | —       |   | — |   |
| Real estate  – construction                                                                  |         | —                                 |         | — |   |
| Real estate  – mortgage                                                                      |         | —                                 |         | — |   |
| Installment                                                                                       |         | —                                 |         | — |   |
| Lease  financing receivable                                                                       |         | —                                 |         | — |   |
| Total  renegotiated loans past due                                                                |         | $                                      | —       |   | — |   |
|                                                                                              |         |                                   |         |   |   |
| Loans current - considered uncollectible                                                          |         | $                                      | —       |   | — |   |
|                                                                                              |         |                                   |         |   |   |
| Total  non-performing loans                                                                       |         | $                                      | 1,037        |   | 420 |   |
|                                                                                              |         |                                   |         |   |   |
| Total loans,  net of unearned interest                                                            |         | $                                      | 152,983      |   | 129,851 |   |
|                                                                                              |         |                                   |         |   |   |
| Total  non-performing loans as a percentage of total loans outstanding, net of  unearned interest |         | 0.68                                   | %            | 0.32 | % |
|                                                                                              |         |                                   |         |   |   |
| Other real estate                                                                                 |         | $                                      | 603          |   | $ | 281 |   |
|                                                                                                   |              |                                        |              |  |  |  |  |

 

38

----

 

The accrual of interestincome is discontinued when it is determined that collection of interest isless than probable or the collection of any amount of principal is doubtful. Thedecision to place a loan on non-accrual status is based on an evaluation of theborrower’s financial condition, collateral liquidation value, economic andbusiness conditions and other factors that affect the borrower’s ability topay. At the time a loan is placed on a non-accrual status, the accrued butunpaid interest is also evaluated as to collectibility. If collectibility isdoubtful, the unpaid interest is charged off. Thereafter, interest onnon-accrual loans is recognized only as received. The amount of interest incomerecognized related to non-accrual loans for the year ended December 31,2005 approximated $37,000.

 

At December 31, 2005loans totaling $3,768,000 were included in the Company’s watch list. Of theseloans $2,010,000 are commercial and $1,758,000 are installment. The collateralvalue related to these loans approximated $4,697,000 ($2,628,000 related tocommercial and $2,069,000 related to installment). At December 31, 2004loans totaling $3,912,000 were included in the Company’s internal watch loanlist. Of these loans $3,052,000 are commercial and $860,000 are installment andreal estate mortgage loans. The collateral value related to these loansapproximated $4,965,000 ($3,853,000 related to commercial and $1,112,000related to installment and real estate mortgage). Loans are listed asclassified when information obtained about possible credit problems of theborrower has prompted management to question the ability of the borrower tocomply with the repayment terms of the loan agreement. The loan classificationsdo not represent or result from trends or uncertainties which managementexpects will materially impact future operating results, liquidity or capitalresources.

 

At December 31, 2005and 2004 there were no loan concentrations that exceeded ten percent of totalloans other than as included in the preceding table of types of loans. Loanconcentrations are amounts loaned to a multiple number of borrowers engaged insimilar activities which would cause them to be similarly impacted by economicor other conditions.

 

At December 31, 2005and 2004 other real estate totaled $603,000 and $281,000, respectively.

 

There were no materialamounts of other interest-bearing assets (interest-bearing deposits with otherbanks, municipal bonds, etc.) at December 31, 2005 which would be requiredto be disclosed as past due, non-accrual, restructured or potential problemloans, if such interest-bearing assets were loans.

 

39

----

 

IV.           Summary of Loan LossExperience:

 

The following schedule detailsselected information related to the allowance for possible loan loss account ofthe Company at December 31, 2005 and 2004.

 
| *** ***                                                                                 | *** *** | **(In Thousands,  Except Percentages)** | *** *** |
|----------------------------------------------------------------------------------------------|--------------|-----------------------------------------|--------------|
| ** **                                                                                   | ** **   | **2005**                                | ** **   | **2004** | ** ** |
|                                                                                         |         |                                    |         |   |   |
| Allowance for loan losses at beginning of  year                                              |         | $                                       | 1,517        |   | 1,225 |   |
|                                                                                         |         |                                    |         |   |   |
| Less net loan charge offs:                                                                   |         |                                    |         |   |   |
| Charge-offs:                                                                                 |         |                                    |         |   |   |
| Commercial,  financial and agricultural                                                      |         | (42                                     | )            | (62 | ) |
| Real estate  construction                                                                    |         | —                                  |         | — |   |
| Real estate  – mortgage                                                                 |         | —                                  |         | (40 | ) |
| Installment                                                                                  |         | (30                                     | )            | (54 | ) |
| Lease  financing                                                                             |         | —                                  |         | (1 | ) |
|                                                                                         |         | (72                                     | )            | (157 | ) |
|                                                                                         |         |                                    |         |   |   |
| Recoveries:                                                                                  |         |                                    |         |   |   |
| Commercial,  financial and agricultural                                                      |         | —                                  |         | 1 |   |
| Real estate  construction                                                                    |         | —                                  |         | — |   |
| Real estate –  mortgage                                                                 |         | —                                  |         | — |   |
| Installment                                                                                  |         | 8                                       |         | 8 |   |
| Lease  financing                                                                             |         | —                                  |         | — |   |
|                                                                                         |         | 8                                       |         | 9 |   |
|                                                                                         |         |                                    |         |   |   |
| Net loan  charge offs                                                                        |         | (64                                     | )            | (148 | ) |
|                                                                                         |         |                                    |         |   |   |
| Provision  for loan losses charged to expense                                                |         | 305                                     |         | 440 |   |
|                                                                                         |         |                                    |         |   |   |
| Allowance  for loan losses at end of year                                                    |         | $                                       | 1,758        |   | 1,517 |   |
|                                                                                         |         |                                    |         |   |   |
| Total loans  at end of year                                                                  |         | $                                       | 152,983      |   | 129,851 |   |
|                                                                                         |         |                                    |         |   |   |
| Average  total loans outstanding during year                                                 |         | $                                       | 139,180      |   | 116,340 |   |
|                                                                                         |         |                                    |         |   |   |
| Net  charge-offs as a percentage of average total loans outstanding during year              |         | 0.05                                    | %            | 0.13 | % |
|                                                                                         |         |                                    |         |   |   |
| Ending  allowance for loan losses as a percentage of total loans outstanding at end  of year |         | 1.15                                    | %            | 1.17 | % |

 

40

----

 

Thefollowing detail provides a breakdown of the allocation of the allowance forpossible loan losses:

 
| ** **                             | ** ** | **December 31, 2005** | *** *** | **December 31, 2004**                                | *** *** |
|----------------------------------------|------------|----------------------------|--------------|-----------------------------------------------------------|--------------|
| ** **                             | ** ** | **In Thousands**      | ** **   | **Percent  of Loans  in Each  Category  to Total  Loans** | ** **   | **In Thousands** | ** ** | **Percent  of Loans  in Each  Category  to Total  Loans** | ** ** |
|                                   |       |                       |         |                                                      |         |   |   |   |   |
| Commercial, financial and agricultural |       | $                          | 949          |                                                      | 19.7         | % | 275 |   | 18.8 | % |
| Real estate – construction        |       | 268                        |         | 20.7                                                      |         | 178 |   | 17.3 |   |
| Real estate – mortgage            |       | 417                        |         | 56.2                                                      |         | 974 |   | 59.8 |   |
| Installment                            |       | 124                        |         | 3.4                                                       |         | 90 |   | 4.1 |   |
|                                   |       | $                          | 1,758        |                                                      | 100.0        | % | 1,517 |   | 100.0 | % |

 

The allowance for possibleloan losses is an amount that management believes will be adequate to absorbpossible losses on existing loans that may become uncollectible. Theprovision for possible loan losses charged to operating expense is based onpast loan loss experience and other factors which, in management’s judgment,deserve current recognition in estimating possible loan losses. Such otherfactors considered by management include growth and composition of the loanportfolio, review of specific loan problems, the relationship of the allowancefor possible loan losses to outstanding loans, adverse situations that may affectthe borrower’s ability to repay, the estimated value of any underlyingcollateral and current economic conditions that may affect the borrower’sability to pay.

 

Management conducts acontinuous review of all loans that are delinquent, previously charged down orloans which are determined to be potentially uncollectible. Loanclassifications are reviewed periodically by a person independent of thelending function. The Board of Directors periodically reviews the adequacy ofthe allowance for possible loan losses.

 

The Company maintains itsallowance for possible loan losses at an amount considered by management to beadequate to provide for the possibility of loan losses in the loan portfolio.

 

41

----

 

V.            Deposits:

 

Theaverage amounts and average interest rates for deposits for 2005 and 2004 aredetailed in the following schedule:

 
| ** **                                | ** **   | **2005**         | ** ** | **2004**    | ** **   |
|-------------------------------------------|--------------|------------------|------------|-------------|--------------|
| ** **                                | ** **   | **Average**      | ** ** | ** **  | ** **   | **Average** | ** ** | ** ** | ** ** |
| ** **                                | ** **   | **Balance**      | ** ** | **Average** | ** **   | **Balance** | ** ** | **Average** | ** ** |
| *** ***                              | *** *** | **In Thousands** | ** ** | **Rate**    | *** *** | **In Thousands** | ** ** | **Rate** | ** ** |
| ** **                                | ** **   | ** **       | ** ** | ** **  | ** **   | ** ** | ** ** | ** ** | ** ** |
| Non-interest bearing deposits             |         | $                | 31,523     |        | —       | % | 23,442 |   | — | % |
| Negotiable order of withdrawal accounts   |         | 35,851           |       | 2.04        | %            | 34,696 |   | 1.01 | % |
| Money market demand accounts              |         | 29,811           |       | 2.22        | %            | 25,562 |   | 1.07 | % |
| Individual retirement accounts            |         | 3,621            |       | 3.56        | %            | 2,464 |   | 2.76 | % |
| Other savings                             |         | 3,447            |       | 0.93        | %            | 2,976 |   | 0.67 | % |
| Certificates of deposit $100,000 and over |         | 43,080           |       | 3.15        | %            | 36,103 |   | 2.41 | % |
| Certificates of deposit under $100,000    |         | 20,854           |       | 3.05        | %            | 16,698 |   | 2.43 | % |
|                                      |         |             |       |        |         |   |   |   |   |
|                                      |         | $                | 168,187    |        | 2.11         | % | 141,941 |   | 1.40 | % |

 

The following schedule detailsthe maturities of certificates of deposit and individual retirement accounts of$100,000 and over at December 31, 2005.

 
| *** ***            | *** *** | **In Thousands** | *** *** |
|-------------------------|--------------|------------------|--------------|
| ** **              | ** **   | **Certificates** | ** **   | **Individual** | ** ** | ** ** | ** ** |
| ** **              | ** **   | **of**           | ** **   | **Retirement** | ** ** | ** ** | ** ** |
| ** **              | ** **   | **Deposit**      | ** **   | **Accounts** | ** ** | **Total** | ** ** |
|                    |         |             |         |   |   |   |   |
| Less than three months  |         | $                | 12,655       |   | 100 |   | 12,755 |   |
|                    |         |             |         |   |   |   |   |
| Three to six months     |         | 3,668            |         | 323 |   | 3,991 |   |
|                    |         |             |         |   |   |   |   |
| Six to twelve months    |         | 19,766           |         | — |   | 19,766 |   |
|                    |         |             |         |   |   |   |   |
| More than twelve months |         | 11,605           |         | 1,422 |   | 13,027 |   |
|                    |         |             |         |   |   |   |   |
|                    |         | $                | 47,694       |   | 1,845 |   | 49,539 |   |

 

42

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VI.           Return on Equity andAssets:

 

Thefollowing schedule details selected key ratios of the Company at December 31,2005 and 2004.

 
| ** **                                                                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
|                                                                                                                                       |       |     |       |     |       |
| Return on assets                                                                                                                           |       | 1.05     | %          | 0.96     | %          |
| (Net income  divided by average total assets)                                                                                              |       |     |       |     |       |
|                                                                                                                                       |       |     |       |     |       |
| Return on equity                                                                                                                           |       | 12.78    | %          | 10.98    | %          |
| (Net income  divided by average equity)                                                                                                    |       |     |       |     |       |
|                                                                                                                                       |       |     |       |     |       |
| Dividend payout ratio                                                                                                                      |       | 20.41    | %          | 17.39    | %          |
| (Dividends  declared per share divided by net earnings per share)                                                                          |       |     |       |     |       |
|                                                                                                                                       |       |     |       |     |       |
| Equity to asset ratio                                                                                                                      |       | 8.23     | %          | 8.78     | %          |
| (Average  equity divided by average total assets)                                                                                          |       |     |       |     |       |
|                                                                                                                                       |       |     |       |     |       |
| Leverage capital ratio                                                                                                                     |       | 8.27     | %          | 8.71     | %          |
| (Equity  divided by fourth quarter average total assets, excluding the net unrealized  loss on available-for-sale securities and goodwill) |       |     |       |     |       |

 

Theminimum leverage capital ratio required by the regulatory agencies is 4%.

 

Beginning January 1,1991, new risk-based capital guidelines were adopted by regulatory agencies.Under these guidelines, a credit risk is assigned to various categories ofassets and commitments ranging from 0% to 100% based on the riskassociated with the asset.

 

43

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The following schedule detailsthe Company’s risk-based capital at December 31, 2005 excluding goodwilland the net unrealized loss on available-for-sale securities, which isshown as a deduction in stockholders’ equity in the consolidated financialstatements:

 
| *** ***                                                                                                       | *** *** | **In  Thousands  except  percentages** | *** *** |
|--------------------------------------------------------------------------------------------------------------------|--------------|----------------------------------------|--------------|
| ** **                                                                                                         | ** **   | **2005**                               | ** **   |
| Tier I capital:                                                                                                    |         |                                   |         |
| Stockholders’  equity, excluding the net unrealized gain/ loss on available-for-sale  securities and goodwill |         | $                                      | 17,636       |   |
|                                                                                                               |         |                                   |         |
| Total capital:                                                                                                     |         |                                   |         |
| Allowable  allowance for loan losses (limited to 1.25% of risk-weighted assets)                                    |         | 1,758                                  |         |
|                                                                                                               |         |                                   |         |
| Total  capital                                                                                                     |         | $                                      | 19,394       |   |
|                                                                                                               |         |                                   |         |
| Risk-weighted assets                                                                                               |         | $                                      | 173,870      |   |
|                                                                                                               |         |                                   |         |
| Risk-based capital ratios:                                                                                         |         |                                   |         |
| Tier I  capital ratio                                                                                              |         | 10.14                                  | %            |
|                                                                                                               |         |                                   |         |
| Total  risk-based capital ratio                                                                                    |         | 11.15                                  | %            |

 

The Company is required tomaintain a Total capital to risk-weighted asset ratio of 8% and a Tier Icapital to risk-weighted asset ratio of 4%. At December 31, 2005, theCompany was in compliance with these requirements.

 

44

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VI.           Return on Equity andAssets, Continued:

 

Thefollowing schedule details the Company’s interest rate sensitivity at December 31,2005:

 
| ** **                                         | ** ** | **Repricing Within** | ** ** |
|----------------------------------------------------|------------|----------------------|------------|
| **(In Thousands)**                                 | ** ** | **Total**            | ** ** | **0-30 Days** | ** ** | **31-90 Days** | ** ** | **91-180 Days** | ** ** | **181-365 Days** | ** ** | **Over 1 Year** | ** ** |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Earning  assets:                                   |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net  of unearned interest                   |       | $                    | 152,983    |   | 63,106 |   | 2,835 |   | 4,237 |   | 10,345 |   | 72,460 |   |
| Securities                                         |       | 46,623               |       | 2,311 |   | 1,675 |   | 1,494 |   | 4,005 |   | 37,138 |   |
| Restricted  equity securities                      |       | 781                  |       | 781 |   | — |   | — |   | — |   | — |   |
| Federal  funds sold                                |       | 11,616               |       | 11,616 |   | — |   | — |   | — |   | — |   |
| Total  earning assets                              |       | 212,003              |       | 77,814 |   | 4,510 |   | 5,731 |   | 14,350 |   | 109,598 |   |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                     |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Negotiable  order of withdrawal accounts           |       | 39,581               |       | 39,581 |   | — |   | — |   | — |   | — |   |
| Money market  demand accounts                      |       | 38,490               |       | 38,490 |   | — |   | — |   | — |   | — |   |
| Savings  deposits                                  |       | 4,155                |       | 4,155 |   | — |   | — |   | — |   | — |   |
| Certificates  of deposit, $100,000 and over        |       | 47,694               |       | 5,809 |   | 6,847 |   | 3,668 |   | 19,766 |   | 11,604 |   |
| Certificates  of deposit, under $100,000           |       | 23,036               |       | 1,130 |   | 5,066 |   | 5,014 |   | 7,565 |   | 4,261 |   |
| Individual  retirement accounts                    |       | 4,338                |       | 128 |   | 245 |   | 775 |   | 579 |   | 2,611 |   |
| Securities  sold under under repurchase agreements |       | 1,979                |       | 1,379 |   | — |   | — |   | 600 |   | — |   |
| Advances  from FHLB                                |       | 9,795                |       |   |   | 500 |   | — |   | 500 |   | 8,795 |   |
| Total  interest bearing liabilities                |       | 169,068              |       | 90,672 |   | 12,658 |   | 9,457 |   | 29,010 |   | 27,271 |   |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-sensitivity  gap                          |       | $                    | 42,935     |   | (12,858 | ) | (8,148 | ) | (3,726 | ) | (14,660 | ) | 82,327 |   |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Cumulative  gap                                    |       |                 |       | (12,858 | ) | (21,006 | ) | (24,732 | ) | (39,392 | ) | 42,935 |   |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Interest-sensitivity  gap as % of total assets     |       |                 |       | (5.60 | )% | (3.55 | ) | (1.62 | ) | (6.38 | ) | 35.84 |   |
|                                               |       |                 |       |   |   |   |   |   |   |   |   |   |   |
| Cumulative  gap as % of total assets               |       |                 |       | (5.60 | )% | (9.15 | ) | (10.77 | ) | (17.15 | ) | 18.69 |   |

 

The Company presentlymaintains a liability sensitive position over the next twelve months.Management expects that liabilities of a demand nature will renew and that itwill not be necessary to replace them with significantly higher cost funds.

 

45

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VI.           Return on Equity andAssets, Continued:

 

The Company’s primarycomponent of market risk is interest rate volatility. Fluctuations in interestrates will ultimately impact both the level of income and expense recorded on alarge portion of the Company’s assets and liabilities, and the market value ofall interest-earning assets and interest-bearing liabilities, other than thosewhich possess a short term to maturity. Based upon the nature of the Company’soperations, the Company is not subject to foreign currency exchange or commodityprice risk.

 

Interest rate risk(sensitivity) management focuses on the earnings risk associated with changinginterest rates. Management seeks to maintain profitability in both immediateand long term earnings through funds management/interest rate risk management.The Company’s rate sensitivity position has an important impact on earnings.Senior management of the Bank meets monthly to analyze the rate sensitivityposition. These meetings focus on the spread between the cost of funds andinterest yields generated primarily through loans and investments.

 

VII.          Short-TermBorrowings:

 

Informationrelated to short-term borrowings in excess of 30% of stockholders’ equity is asfollows:

 
| *** ***                                                                   | *** *** | **In Thousands, except  percentages** | *** *** |
|--------------------------------------------------------------------------------|--------------|---------------------------------------|--------------|
| ** **                                                                     | ** **   | **2005**                              | ** **   | **2004** | ** ** |
|                                                                           |         |                                  |         |   |   |
| Advances from Federal Home Loan Bank:                                          |         |                                  |         |   |   |
|                                                                           |         |                                  |         |   |   |
| Balance  outstanding - end of year                                             |         | $                                     | 9,795        |   | 8,919 |   |
|                                                                           |         |                                  |         |   |   |
| Weighted  average interest rate on balance outstanding at end of year          |         | 3.83                                  | %            | 2.41 | % |
|                                                                           |         |                                  |         |   |   |
| Maximum  amount of borrowings at any month end                                 |         | $                                     | 14,889       |   | 12,925 |   |
|                                                                           |         |                                  |         |   |   |
| Average  amounts outstanding during each year                                  |         | $                                     | 10,619       |   | 7,685 |   |
|                                                                           |         |                                  |         |   |   |
| Weighted  average interest rate on average amounts outstanding during the year |         | 3.08                                  | %            | 2.03 | % |

 

46

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## **ITEM7. FINANCIAL STATEMENTS**

 

**LEGENDS FINANCIAL HOLDINGS, INC.CONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2005 AND 2004(WITH INDEPENDENT AUDITOR’S REPORT THEREON)**

** **

**TABLE OF CONTENTS**

 
| Report of Independent Public  Accounts |                                                             |
|----------------------------------------|------------------------------------------------------------------|
|                                   |                                                             |
| Consolidated  Financial Statements     |                                                             |
|                                   |                                                             |
|                                   | Consolidated balance sheets                                      |   |
|                                   | Consolidated statements of  earnings                             |   |
|                                   | Consolidated statements of  comprehensive earnings               |   |
|                                   | Consolidated statements of changes  in stockholders’ equity |   |
|                                   | Consolidated statements of  cash flows                           |   |
|                                   | Notes to consolidated  financial statements                      |   |

 

47

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**INDEPENDENT AUDITOR’S REPORT**

 

TheBoard of Directors

LegendsFinancial Holdings, Inc.

 

Wehave audited the accompanying consolidated balance sheets of Legends FinancialHoldings, Inc. and Subsidiaries as of December 31, 2005 and 2004 and therelated consolidated statements of earnings, comprehensive earnings, changes instockholders’ equity and cash flows for each of the three years in the periodended December 31, 2005. These financial statements are the responsibility ofthe Company’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

 

Weconducted our audits in accordance with the standards of the Public AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether the financialstatements are free of material misstatement. An audit includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide areasonable basis for our opinion.

 

In ouropinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Legends Financial Holdings, Inc.and Subsidiaries as of December 31, 2005 and 2004, and the results of itsoperations and its cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with accounting principles generally acceptedin the United States of America.

 

 
| /s/  Maggart & Associates, P.C.       |   |
|-------------------------------------------|--------|
| January  25, 2006                         |
| (except for note 23, as to which the date |
| is March 24, 2006)                        |

 

48

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Consolidated Balance Sheets***

***December 31, 2005 and 2004***

 
| ** **                                                                                                                              | *** *** | **In Thousands** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------|------------|
| ** **                                                                                                                              | ** **   | **2005**         | ** ** | **2004** | ** ** |
| ASSETS                                                                                                                                  |         |             |       |   |   |
|                                                                                                                                    |         |             |       |   |   |
| Loans, less allowance for possible loan losses of $1,758,000 and $1,517,000,  respectively                                              |         | $                | 151,225    |   | 128,334 |   |
| Securities available-for-sale, at market (amortized cost of  $47,335,000 and $37,877,000, respectively)                                 |         | 46,623           |       | 37,580 |   |
| Restricted equity securities                                                                                                            |         | 781              |       | 655 |   |
| Federal funds sold                                                                                                                      |         | 11,616           |       | — |   |
| Total earning assets                                                                                                                    |         | 210,245          |       | 166,569 |   |
|                                                                                                                                    |         |             |       |   |   |
| Cash and due from banks                                                                                                                 |         | 10,522           |       | 11,052 |   |
| Bank premises and equipment, net                                                                                                        |         | 6,302            |       | 5,717 |   |
| Accrued interest receivable                                                                                                             |         | 1,006            |       | 765 |   |
| Other real estate owned                                                                                                                 |         | 603              |       | 281 |   |
| Deferred tax asset, net                                                                                                                 |         | 527              |       | 325 |   |
| Goodwill                                                                                                                                |         | 153              |       | 153 |   |
| Other assets                                                                                                                            |         | 403              |       | 262 |   |
|                                                                                                                                    |         |             |       |   |   |
| Total assets                                                                                                                            |         | $                | 229,761    |   | 185,124 |   |
|                                                                                                                                    |         |             |       |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                              |         |             |       |   |   |
|                                                                                                                                    |         |             |       |   |   |
| Deposits                                                                                                                                |         | $                | 199,678    |   | 154,975 |   |
| Securities sold under repurchase agreements                                                                                             |         | 1,979            |       | 636 |   |
| Accrued interest payable                                                                                                                |         | 708              |       | 282 |   |
| Accounts payable and other liabilities                                                                                                  |         | 251              |       | 795 |   |
| Advances from Federal Home Loan Bank                                                                                                    |         | 9,795            |       | 8,919 |   |
| Federal funds purchased                                                                                                                 |         | —           |       | 3,804 |   |
| Total liabilities                                                                                                                       |         | 212,411          |       | 169,411 |   |
|                                                                                                                                    |         |             |       |   |   |
| Stockholders’ equity:                                                                                                              |         |             |       |   |   |
| Preferred stock, no par value, authorized 1,000,000 shares, no shares  issued                                                           |         | —           |       | — |   |
| Common stock, par value $1 per share, authorized 2,000,000 shares,  1,427,099 and 1,408,497 shares issued and outstanding, respectively |         | 1,427            |       | 1,408 |   |
| Additional paid-in capital                                                                                                              |         | 12,711           |       | 12,495 |   |
| Retained earnings                                                                                                                       |         | 3,651            |       | 1,993 |   |
| Net unrealized losses on available-for-sale securities, net of income  taxes of $273,000 and $114,000, respectively                     |         | (439             | )          | (183 | ) |
| Total stockholders’ equity                                                                                                         |         | 17,350           |       | 15,713 |   |
|                                                                                                                                    |         |             |       |   |   |
| COMMITMENTS AND CONTINGENCIES                                                                                                           |         |             |       |   |   |
|                                                                                                                                    |         |             |       |   |   |
| Total liabilities and stockholders’ equity                                                                                         |         | $                | 229,761    |   | 185,124 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

49

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Consolidated Statements of Earnings***

***For the Years Ended December 31, 2005, 2004 and2003***

 
| ** **                                                            | ** ** | **In  Thousands  (except per share amounts)** | ** ** |
|-----------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                            | ** ** | **2005**                                      | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                  |       |                                          |       |   |   |   |   |
| Interest income:                                                      |       |                                          |       |   |   |   |   |
| Interest and fees on loans                                            |       | $                                             | 9,788      |   | 7,495 |   | 5,803 |   |
| Interest and dividends on taxable securities                          |       | 1,148                                         |       | 950 |   | 893 |   |
| Interest and dividends on securities exempt from Federal income taxes |       | 509                                           |       | 371 |   | 204 |   |
| Interest and dividends on restricted equity securities                |       | 32                                            |       | 20 |   | 14 |   |
| Interest on loans held for sale                                       |       | —                                        |       | 2 |   | 15 |   |
| Interest on Federal funds sold                                        |       | 66                                            |       | 16 |   | 25 |   |
| Total interest income                                                 |       | 11,543                                        |       | 8,854 |   | 6,954 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Interest expense:                                                     |       |                                          |       |   |   |   |   |
| Interest on negotiable order of withdrawal accounts                   |       | 732                                           |       | 350 |   | 304 |   |
| Interest on money market and savings accounts                         |       | 694                                           |       | 293 |   | 251 |   |
| Interest on certificates of deposits over $100,000                    |       | 1,408                                         |       | 891 |   | 670 |   |
| Interest on certificates of deposits - other                          |       | 713                                           |       | 454 |   | 437 |   |
| Interest on Federal funds purchased                                   |       | 22                                            |       | 15 |   | 16 |   |
| Interest on advances from Federal Home Loan Bank                      |       | 327                                           |       | 156 |   | 57 |   |
| Interest on securities sold under repurchase agreements               |       | 46                                            |       | 3 |   | 13 |   |
| Total interest expense                                                |       | 3,942                                         |       | 2,162 |   | 1,748 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Net interest income before provision for possible loan losses         |       | 7,601                                         |       | 6,692 |   | 5,206 |   |
| Provision for possible loan losses                                    |       | 305                                           |       | 440 |   | 361 |   |
| Net interest income after provision for possible loan losses          |       | 7,296                                         |       | 6,252 |   | 4,845 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Non-interest income                                                   |       | 1,935                                         |       | 1,582 |   | 998 |   |
| Non-interest expense                                                  |       | 6,135                                         |       | 5,532 |   | 4,605 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Earnings before income taxes                                          |       | 3,096                                         |       | 2,302 |   | 1,238 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Income tax expense                                                    |       | 1,011                                         |       | 696 |   | 409 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Net earnings                                                          |       | $                                             | 2,085      |   | 1,606 |   | 829 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Basic earnings per common share                                       |       | $                                             | 1.47       |   | 1.15 |   | .60 |   |
|                                                                  |       |                                          |       |   |   |   |   |
| Diluted earnings per common share                                     |       | $                                             | 1.42       |   | 1.12 |   | .59 |   |

 

See accompanying notes to consolidated financial statements.

 

50

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Consolidated Statements of Comprehensive Earnings***

***For the Years Ended December 31, 2005, 2004 and2003***

 
| ** **                                                                                                                                    | ** ** | **In Thousands** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                                    | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                          |       |             |       |   |   |   |   |
| Net earnings                                                                                                                                  |       | $                | 2,085      |   | 1,606 |   | 829 |   |
|                                                                                                                                          |       |             |       |   |   |   |   |
| Other comprehensive earnings (loss):                                                                                                          |       |             |       |   |   |   |   |
| Unrealized gains (losses) on available-for-sale securities arising  during year, net of taxes of $160,000, $32,000 and $225,000, respectively |       | (259             | )          | 53 |   | (366 | ) |
| Reclassification adjustment for (gains) losses included in net  earnings, net of taxes of $1,000, $26,000 and $8,000, respectively            |       | 3                |       | (41 | ) | 13 |   |
| Other comprehensive earnings (loss)                                                                                                           |       | (256             | )          | 12 |   | (353 | ) |
|                                                                                                                                          |       |             |       |   |   |   |   |
| Comprehensive earnings                                                                                                                        |       | $                | 1,829      |   | 1,618 |   | 476 |   |

 

See accompanying notes to consolidated financial statements.

 

51

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Statements of Changes in Stockholders’ Equity***

***For the Years Ended December 31, 2005, 2004 and2003***

 
| ** **                                                                                                       | ** ** | **In  Thousands** | ** ** |
|------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                       | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings** | ** ** | **Net  Unrealized  Gain  (Loss)  On Available-  For-Sale  Securities** | ** ** | **Total** | ** ** |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2002                                                                                        |       | $                 | 1,379      |   | 12,267 |   | 43 |   | 158 |   | 13,847 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Issuance of 2,666 shares of $1 par value common stock                                                            |       | 3                 |       | 20 |   | — |   | — |   | 23 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.15 per share)                                                                         |       | —            |       | — |   | (206 | ) | — |   | (206 | ) |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net change in unrealized gain (loss) on available-for-sale securities  during the year, net of taxes of $217,000 |       | —            |       | — |   | — |   | (353 | ) | (353 | ) |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                        |       | —            |       | — |   | 829 |   | — |   | 829 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2003                                                                                        |       | 1,382             |       | 12,287 |   | 666 |   | (195 | ) | 14,140 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Issuance of 26,748 shares of $1 par value common stock                                                           |       | 26                |       | 208 |   | — |   | — |   | 234 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.20 per share)                                                                         |       | —            |       | — |   | (279 | ) | — |   | (279 | ) |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net change in unrealized loss on available-for-sale securities during  the year, net of taxes of $6,000          |       | —            |       | — |   | — |   | 12 |   | 12 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                        |       | —            |       | — |   | 1,606 |   | — |   | 1,606 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2004                                                                                        |       | 1,408             |       | 12,495 |   | 1,993 |   | (183 | ) | 15,713 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Issuance of 18,602 shares of $1 par value common stock                                                           |       | 19                |       | 216 |   | — |   | — |   | 235 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.30 per share)                                                                         |       | —            |       | — |   | (427 | ) | — |   | (427 | ) |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net change in unrealized loss on available-for-sale securities during  the year, net of taxes of $159,000        |       | —            |       | — |   | — |   | (256 | ) | (256 | ) |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                        |       | —            |       | — |   | 2,085 |   | — |   | 2,085 |   |
|                                                                                                             |       |              |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2005                                                                                        |       | $                 | 1,427      |   | 12,711 |   | 3,651 |   | (439 | ) | 17,350 |   |

 

See accompanying notes to consolidated financial statements.

 

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Consolidated Statements of Cash Flows***

***For the Years Ended December 31, 2005, 2004 and2003***

***Increase (Decrease) in Cash and Cash Equivalents***

 
| ** **                                                                               | ** ** | **In  Thousands** | ** ** |
|------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                               | ** ** | **2005**          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                     |       |              |       |   |   |   |   |
| Cash flows from operating  activities:                                                   |       |              |       |   |   |   |   |
| Interest received                                                                        |       | $                 | 11,497     |   | 8,910 |   | 6,803 |   |
| Fees and commissions received                                                            |       | 1,935             |       | 1,515 |   | 977 |   |
| Proceeds from sales of loans                                                             |       | —            |       | 1,207 |   | 13,014 |   |
| Origination of loans held for sale                                                       |       | —            |       | (933 | ) | (11,601 | ) |
| Interest paid                                                                            |       | (3,516            | )          | (2,196 | ) | (1,481 | ) |
| Cash paid to suppliers and employees                                                     |       | (5,960            | )          | (4,920 | ) | (4,251 | ) |
| Income taxes paid                                                                        |       | (1,442            | )          | (212 | ) | (539 | ) |
| Net cash provided by operating activities                                                |       | 2,514             |       | 3,371 |   | 2,922 |   |
|                                                                                     |       |              |       |   |   |   |   |
| Cash flows from investing  activities:                                                   |       |              |       |   |   |   |   |
| Purchase of available-for-sale securities                                                |       | (19,339           | )          | (15,228 | ) | (32,846 | ) |
| Purchase of restricted equity securities                                                 |       | (98               | )          | (159 | ) | (75 | ) |
| Proceeds from maturities, calls and principal payments of  available-for-sale securities |       | 7,692             |       | 5,247 |   | 14,521 |   |
| Proceeds from sale of available-for-sale securities                                      |       | 1,962             |       | 4,225 |   | 9,685 |   |
| Loans made to customers, net of repayments                                               |       | (23,766           | )          | (25,464 | ) | (26,109 | ) |
| Purchase of bank premises and equipment, net                                             |       | (1,066            | )          | (664 | ) | (1,784 | ) |
| Proceeds from sale of fixed assets                                                       |       | 51                |       | 2 |   | 32 |   |
| Proceeds from sale of other real estate                                                  |       | 195               |       | 295 |   | — |   |
| Proceeds from sale of repossessed property                                               |       | 15                |       | — |   | — |   |
| Proceeds from acquisition of NBC, net                                                    |       | —            |       | — |   | 1,334 |   |
| Net cash used in investing activities                                                    |       | (34,354           | )          | (31,746 | ) | (35,242 | ) |
|                                                                                     |       |              |       |   |   |   |   |
| Cash flows from financing  activities:                                                   |       |              |       |   |   |   |   |
| Net increase in non-interest bearing, savings and NOW deposit  accounts                  |       | 30,635            |       | 16,815 |   | 36,599 |   |
| Net increase (decrease) in time deposits                                                 |       | 14,068            |       | 8,344 |   | (4,472 | ) |
| Proceeds from sale of common stock                                                       |       | 235               |       | 234 |   | 23 |   |
| Proceeds from (repayment of) Federal fund purchased                                      |       | (3,804            | )          | 3,804 |   | — |   |
| Advances from advances from Federal Home Loan Bank                                       |       | 876               |       | 3,928 |   | 3,491 |   |
| Advances from (repayment of) repurchase agreements                                       |       | 1,343             |       | (15 | ) | (3,031 | ) |
| Dividends paid                                                                           |       | (427              | )          | (279 | ) | (206 | ) |
| Net cash provided by financing activities                                                |       | 42,926            |       | 32,831 |   | 32,404 |   |
|                                                                                     |       |              |       |   |   |   |   |
| Net increase in cash and  cash equivalents                                               |       | 11,086            |       | 4,456 |   | 84 |   |
|                                                                                     |       |              |       |   |   |   |   |
| Cash and cash equivalents  at beginning of year                                          |       | 11,052            |       | 6,596 |   | 6,512 |   |
|                                                                                     |       |              |       |   |   |   |   |
| Cash and cash equivalents  at end of year                                                |       | $                 | 22,138     |   | 11,052 |   | 6,596 |   |

 

See accompanying notes to consolidated financial statements.

 

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| ** **                                                                                                                   | ** ** | **In  Thousands** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**          | ** ** | **2004** | ** ** | **2002** | ** ** |
|                                                                                                                         |       |              |       |   |   |   |   |
| Reconciliation of net earnings to net cash provided by operating  activities:                                                |       |              |       |   |   |   |   |
| Net earnings                                                                                                                 |       | $                 | 2,085      |   | 1,606 |   | 829 |   |
| Adjustments to reconcile net earnings to net cash provided by  operating activities:                                         |       |              |       |   |   |   |   |
| Depreciation                                                                                                                 |       | 422               |       | 413 |   | 343 |   |
| Amortization and accretion                                                                                                   |       | 223               |       | 205 |   | 303 |   |
| Loss (gain) on sale of securities, net                                                                                       |       | 4                 |       | (67 | ) | 21 |   |
| Loss on sale of fixed assets                                                                                                 |       | 8                 |       | 20 |   | — |   |
| Loss on sale of other real estate                                                                                            |       | 53                |       | — |   | — |   |
| FHLB dividend reinvestment                                                                                                   |       | (28               | )          | (16 | ) | (10 | ) |
| Provision for possible loan losses                                                                                           |       | 305               |       | 440 |   | 361 |   |
| Decrease in loans held for sale                                                                                              |       | —            |       | 274 |   | 1,413 |   |
| Increase in accrued interest receivable                                                                                      |       | (241              | )          | (133 | ) | (121 | ) |
| Increase in other assets                                                                                                     |       | (156              | )          | (107 | ) | (37 | ) |
| Decrease (increase) in income tax receivable                                                                                 |       | —            |       | 121 |   | (121 | ) |
| Increase (decrease) in accrued interest payable                                                                              |       | 426               |       | (34 | ) | (56 | ) |
| Increase (decrease) in other liabilities                                                                                     |       | (156              | )          | 286 |   | 7 |   |
| Increase (decrease) in income taxes payable                                                                                  |       | (388              | )          | 388 |   | (54 | ) |
| Decrease (increase) in deferred taxes                                                                                        |       | (43               | )          | (25 | ) | 44 |   |
| Total adjustments                                                                                                            |       | 429               |       | 1,765 |   | 2,093 |   |
|                                                                                                                         |       |              |       |   |   |   |   |
| Net cash provided by operating activities                                                                                    |       | $                 | 2,514      |   | 3,371 |   | 2,922 |   |
|                                                                                                                         |       |              |       |   |   |   |   |
| Supplemental Schedule of Non-Cash Activities:                                                                                |       |              |       |   |   |   |   |
|                                                                                                                         |       |              |       |   |   |   |   |
| Non-cash transfers from loans to other real estate, net                                                                      |       | $                 | 570        |   | 484 |   | 92 |   |
|                                                                                                                         |       |              |       |   |   |   |   |
| Unrealized gain (loss) on available-for-sale securities, net of  income taxes of $159,000, $6,000 and $217,000, respectively |       | $                 | (256       | ) | 12 |   | (353 | ) |

 

See accompanying notes to consolidated financial statements.

 

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***LEGENDS FINANCIAL HOLDINGS, INC.***

***Notes to Consolidated Financial Statements***

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

 

***(1)******          ******Summary of Significant AccountingPolicies***

 

The consolidated financial statements include theaccounts of Legends Financial Holdings, Inc. (the “Company”), Legends Bank (the“Bank”), its wholly-owned subsidiary, and Legends Financial Services, Inc., awholly-owned subsidiary of Legends Bank.

 

The accounting and reporting policies of LegendsFinancial Holdings, Inc. are in accordance with accounting principles generallyaccepted in the United States of America and conform to general practiceswithin the banking industry. The following is a brief summary of the moresignificant policies.

 

***(a)******          ******Principles ofConsolidation***

 

The consolidated financial statements include theaccounts of the Company, its wholly-owned subsidiary, Legends Bank and the Bank’swholly-owned subsidiary, Legends Financial Services, Inc. All significantintercompany accounts and transactions have been eliminated in consolidation.

 

***(b)******          ******Nature of Operations***

 

The Company is registered as a one bank holdingcompany under the Bank Holding Company Act of 1956. Legends Bank operates undera state bank charter and provides full banking services. As a state bank, theBank is subject to regulations of the Tennessee Department of FinancialInstitutions and the Federal Deposit Insurance Corporation. The area served byLegends Bank is Montgomery County, Tennessee and surrounding counties of MiddleTennessee. Services are provided at the main office, four branches inClarksville, Tennessee and a branch in Dover, Tennessee. Legends FinancialServices, Inc. offers a wide array of financial products such as annuities,stocks, bonds, mutual funds and other investment products.

 

***(c)******          ******Estimates***

 

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates. Materialestimates that are particularly susceptible to significant change in the nearterm relate to determination of the allowance for possible loan losses and thevaluation of debt and equity securities and the related deferred taxes.

 

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***(d)******          ******Loans***

 

Loans are stated at the principal amount outstanding. Unearneddiscount, deferred loan fees net of loan acquisition costs, and the allowancefor possible loan losses are shown as reductions of loans. Loan origination andcommitment fees and certain loan-related costs are being deferred and the netamount amortized as an adjustment of the related loan’s yield over thecontractual life of the loan. Unearned discount represents the unamortizedamount of finance charges, principally related to certain installment loans. Interestincome on most loans is accrued based on the principal amount outstanding.

 

The Company follows the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 114, “Accounting by Creditors forImpairment of a Loan” and SFAS No. 118, “Accounting by Creditors for Impairmentof a Loan - Income Recognition and Disclosures.”  These pronouncements apply to impaired loansexcept for large groups of smaller-balance homogeneous loans that arecollectively evaluated for impairment including residential mortgage andinstallment loans.

 

A loan is impaired when it is probable that theCompany will be unable to collect the scheduled payments of principal andinterest due under the contractual terms of the loan agreement. Impaired loansare measured at the present value of expected future cash flows discounted atthe loan’s effective interest rate, at the loan’s observable market price, orthe fair value of the collateral if the loan is collateral dependent. If themeasure of the impaired loan is less than the recorded investment in the loan,the Company shall recognize an impairment by creating a valuation allowancewith a corresponding charge to the provision for possible loan losses or byadjusting an existing valuation allowance for the impaired loan with acorresponding charge or credit to the provision for possible loan losses.

 

The Company’s residential mortgage and installmentloans are divided into various groups of smaller-balance, homogeneous loansthat are collectively evaluated for impairment and, thus, are not subject tothe provisions of SFAS Nos. 114 and 118. Substantially all other loans of theCompany are evaluated for impairment under the provisions of SFAS Nos. 114 and118.

 

The Company considers all loans subject to theprovisions of SFAS Nos. 114 and 118 that are on a nonaccrual status to beimpaired. Loans are placed on nonaccrual status when doubt as to timelycollection of principal or interest exists, or when principal or interest ispast due 90 days or more unless such loans are well-collateralized and in theprocess of collection. Delays or shortfalls in loan payments are evaluatedalong with various other factors to determine if a loan is impaired. Generally,delinquencies under 90 days are considered insignificant unless certain otherfactors are present which indicate impairment is probable. The decision toplace a loan on nonaccrual status is also based on an evaluation of theborrower’s financial condition, collateral, liquidation value, and otherfactors that affect the borrower’s ability to pay.

 

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Generally, at the time a loan is placed on nonaccrualstatus, all interest accrued and uncollected on the loan in the current fiscalyear is reversed from income, and all interest accrued and uncollected from theprior year is charged off against the allowance for possible loan losses. Thereafter,interest on nonaccrual loans is recognized as interest income only to theextent that cash is received and future collection of principal is not in doubt.If the collectibility of outstanding principal is doubtful, such cash receivedis applied as a reduction of principal. A nonaccrual loan may be restored to anaccruing status when principal and interest are no longer past due and unpaidand future collection of principal and interest on a timely basis is not indoubt.

 

Loans not on nonaccrual status are classified asimpaired in certain cases when there is inadequate protection by the currentnet worth and financial capacity of the borrower or of the collateral pledged,if any. In those cases, such loans have a well-defined weakness or weaknessesthat jeopardize the liquidation of the debt, and if such deficiencies are notcorrected, there is a probability that the Company will sustain some loss. Insuch cases, interest income continues to accrue as long as the loan does notmeet the Company’s criteria for nonaccrual status.

 

Generally, the Company also classifies as impaired anyloans the terms of which have been modified in a troubled debt restructuring. Interestis generally accrued on such loans that continue to meet the modified terms oftheir loan agreements.

 

The Company’s charge-off policy for impaired loans issimilar to its charge-off policy for all loans in that loans are charged off inthe month when they are considered uncollectible.

 

***(e)******          ******Allowance for PossibleLoan Losses***

 

The provision for possible loan losses represents acharge to earnings necessary, after loan charge-offs and recoveries, tomaintain the allowance for possible loan losses at an appropriate level whichis adequate to absorb estimated losses inherent in the loan portfolio. Suchestimated losses arise primarily from the loan portfolio but may also bederived from other sources, including commitments to extend credit and standbyletters of credit. The level of the allowance is determined on a quarterlybasis using procedures which include: (1) categorizing commercial and commercial real estate loans into riskcategories to estimate loss probabilities based primarily on the historicalloss experience of those risk categories and current economic conditions; (2)analyzing significant commercial and commercial real estate credits andcalculating specific reserves as necessary; (3) assessing various homogeneousconsumer loan categories to estimate loss probabilities based primarily onhistorical loss experience; (4) reviewing unfunded commitments (included inother liabilities if significant); and (5) considering various other factors,such as changes in credit concentrations, loan mix, and economic conditionswhich may not be specifically quantified in the loan analysis process.

 

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The allowance for possible loan losses consists of anallocated portion and an unallocated, or general portion. The allocated portionis maintained to cover estimated losses applicable to specific segments of theloan portfolio. The unallocated portion is maintained to absorb losses whichprobably exist as of the evaluation date but are not identified by the moreobjective processes used for the allocated portion of the allowance due to riskof errors or imprecision. While the total allowance consists of an allocatedportion and an unallocated portion, these terms are primarily used to describea process. Both portions of the allowance are available to provide for inherentloss in the entire portfolio.

 

The allowance for possible loan losses is increased byprovisions for possible loan losses charged to expense and is reduced by loanscharged off net of recoveries on loans previously charged off. The provision isbased on management’s determination of the amount of the allowance necessary toprovide for estimated loan losses based on its evaluation of the loan portfolio.Determining the appropriate level of the allowance and the amount of theprovision involves uncertainties and matters of judgment and therefore cannotbe determined with precision.

 

***(f)******           ******Securities***

 

The Company accounts for securities under theprovisions of Statement of Financial Accounting Standards (SFAS) No. 115, “Accountingfor Certain Investments in Debt and Equity Securities”. Under the provisions ofthe Statement, securities are to be classified in three categories andaccounted for as follows:

 

•      ***Securities Held-to-Maturity***

 

Debt securities that the enterprise has the positiveintent and ability to hold to maturity are classified as held-to-maturitysecurities and reported at amortized cost. No securities have been classifiedas securities held-to-maturity.

 

•      ***Trading Securities***

 

Debt and equity securities that are bought and heldprincipally for the purpose of selling them in the near term are classified astrading securities and reported at fair value, with unrealized gains and lossesincluded in earnings. No securities have been classified as trading securities.

 

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•      ***Securities Available-for-Sale***

 

Debt and equity securities not classified as eitherheld-to-maturity securities or trading securities are classified asavailable-for-sale securities and reported at fair value, with unrealized gainsand losses excluded from earnings and reported in a separate component ofstockholders’ equity.

 

The Company has classified all its securities assecurities available-for-sale.

 

Realized gains or losses from the sale of securitiesare recognized upon realization based upon the specific identification method.

 

***(g)******          ******Premises and Equipment***

 

Premises and equipment are stated at cost. Depreciationis computed by the straight-line method over the estimated useful lives of therelated assets. Gain or loss on items retired and otherwise disposed of iscredited or charged to operations and cost and related accumulated depreciationare removed from the asset and accumulated depreciation accounts.

 

Expenditures for major renewals and improvements ofpremises and equipment are capitalized and those for maintenance and repairsare charged to earnings as incurred.

 

***(h)******          ******IntangibleAssets***

 

Statement of Financial Accounting Standards No. 142, “Goodwilland Other Intangible Assets” (SFAS No. 142) requires that management determinethe allocation of intangible assets into identifiable groups at the date ofacquisition and appropriate amortization periods be established. Under theprovisions of SFAS No. 142 goodwill is not to be amortized rather it is to bemonitored for impairment and written down to the impairment value at the timeimpairment occurs. The Company has determined that no impairment loss needs tobe recognized related to the goodwill.

 

***(i)******           ******Long-TermAssets***

 

Premises and equipment and other long-term assets arereviewed for impairment when events indicate their carrying amount may not berecoverable from future undiscounted cash flows. If impaired, the assets arerecorded at fair value.

 

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***(j)******           ******Stock Options***

 

The Company uses the fair value method to calculatethe compensation reported in the proforma earnings in note 18 to theconsolidated financial statements.

 

***(k)******          ******OtherReal Estate***

 

Real estate acquired in settlement of loans isinitially recorded at the lower of cost (loan value of real estate acquired insettlement of loans plus incidental expense) or estimated fair value, lessestimated cost of disposal. Based on periodic evaluations by management, thecarrying values are reduced by a direct charge to earnings when they exceed netrealizable value. Costs relating to the development and improvement of theproperty are capitalized, while holding costs of the property are charged toexpense in the period incurred.

 

***(l)******           ******Cash and Cash Equivalents***

 

For purposes of reporting cash flows, cash and cashequivalents include cash on hand, amounts due from banks, and Federal fundssold. Generally, Federal funds sold are purchased and sold for one-day periods.The Company maintains deposits in excess of the Federal insurance amounts withother financial institutions. Management makes deposits only with financialinstitutions it considers to be financially sound.

 

***(m)******         ******SecuritiesSold Under Agreements to Repurchase***

 

All repurchase agreement liabilities represent amountsadvanced by various customers. Securities are pledged to cover theseliabilities, which are not covered by federal deposit insurance.

 

***(n)******          ******Income Taxes***

 

Provisions for income taxes are based on taxes payableor refundable for the current year (after exclusion of non-taxable income suchas interest on state and municipal securities) and deferred taxes on temporarydifferences between the amount of taxable and pretax financial income andbetween the tax bases of assets and liabilities and their reported amounts inthe financial statements. Deferred tax assets and liabilities are included inthe financial statements at currently enacted income tax rates applicable tothe period in 

 

 

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which the deferred tax asset and liabilities are expectedto be realized or settled as prescribed in Statement of Financial AccountingStandards (SFAS) No. 109, “Accounting for Income Taxes.”  As changes in tax laws or rates are enacted,deferred tax assets and liabilities are adjusted through the provision forincome taxes.

 

The Company and its subsidiaries file a consolidatedFederal income tax return. Each corporation provides for income taxes on aseparate return basis.

 

***(o)******          ******Advertising Costs***

 

Advertising costs areexpensed when incurred.

 

***(p)******          ******Off-Balance-SheetFinancial Instruments***

 

In the ordinary course of business the Company hasentered into off- balance- sheet financial instruments consisting ofcommitments to extend credit, commitments under credit card arrangements,commercial letters of credit and standby letters of credit. Such financialinstruments are recorded in the financial statements when they are funded orrelated fees are incurred or received.

 

***(q)******          ******Reclassifications***

 

Certain reclassifications have been made to the 2004and 2003 figures to conform to the presentation for 2005.

 

***(r)******           ******Impact of New AccountingStandards***

 

In June, 2002, the FASB issued SFAS 146, “Accountingfor Costs Associated with Exit or Disposal Activities”. SFAS 146 addressesfinancial accounting and reporting for costs associated with exit or disposalactivities and nullifies Emerging Issues Task Force (EITF) Issue No. 94-3, “LiabilityRecognition for Certain Employee Termination Benefits and Other  Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).”  Theprovisions of the Statement are effective for exit or disposal activities thatare initiated after December 31, 2002. The adoption of SFAS 146 did not have amaterial impact on the Company’s financial position or results of operations.

 

In October, 2002, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standard No. 147, “Acquisitionsof Certain Financial Institutions”. SFAS No. 147 amends SFAS No. 72 and FASBInterpretation No. 9 to eliminate all acquisitions of financial institutionsother than transactions between mutual enterprises from their scope. 

 

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Accordingly, the excess of the purchase price paid toacquire a financialinstitution over the fair value of the identifiable tangible and intangibleassets and liabilities acquired now must be recorded as goodwill following SFASNo. 141 and assessed for impairment following SFAS No. 142, “Goodwill and OtherIntangible Assets”. Furthermore, any previously recognized unidentifiableintangible assets resulting from prior business combinations that do not meetSFAS No. 141’s criteria for separate recognition must be reclassified togoodwill. The Company has adopted SFAS 147, and it has not had any impact onthe Company’s financial position or results of operations. 

 

In November, 2002, the FASB issued Interpretation(FIN) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees,Including Indirect Guarantee of Indebtedness of Others”, which elaborates on thedisclosure to be made by a guarantor in its interim and annual financialstatements about its obligations under certain guarantees that it has issued. Theinterpretation also clarifies that a guarantor is required to recognize, at theinception of the guarantee, a liability for the fair value of the obligationundertaken in issuing the guarantee. The adoption of FIN 45 did not have amaterial impact on the consolidated financial statements.

 

In May, 2003, the FASB issued SFAS 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity”. This Statement established standards for how an issuer classifies andmeasures certain financial instruments with characteristics of both liabilitiesand equity. It requires that an issuer classify a financial instrument that iswithin its scope as a liability (or an asset in some circumstances). Many ofthose instruments were previously classified as equity. This statement iseffective for financial instruments entered into or modified after May 31,2003, and otherwise is effective at the beginning of the first interim periodbeginning after June 15, 2003. The adoption of SFAS 150 did not have an impacton the Company’s financial position or results of operations.

 

In June, 2003, the American Institute of CertifiedPublic Accountants issued an exposure draft on a Proposed Statement of Position(SOP) on Allowance for Credit Losses. If approved, the Proposed SOP wouldsignificantly change the way the allowance for possible loan losses iscalculated. Under the Proposed SOP, any loans determined to be impaired, asdefined in FASB Statement No. 114, would be assigned a specific reserve basedon facts and circumstances surrounding the particular loan and no losspercentage would be assigned. If a loan is determined not to be impaired, itwould be assigned to a pool of similar homogeneous loans. A loss percentagewould then be assigned to the pool based on historical charge-offs adjusted forinternal or external factors such as the economy, changes in underwritingstandards, etc. Management has not yet determined the impact this Proposed SOPwould have on their consolidated financial statements, but anticipates that itcould result in a reduction in the allowance for possible loan losses. Underthe Proposal, any changes resulting from the initial application of thisProposed SOP would be treated as a change in accounting estimate.

 

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In addition, there is currently outstanding a bankregulatory interagency proposal dated March 28, 2005 related to the methodologyfor assigning risk factors to loans and other extensions of credit. The policy,if adopted, could effect the calculation of the allowance for possible loanlosses. Management has not determined the impact of this policy statement;however, it is not expected to have a material impact on the consolidatedfinancial statements.

 

In June, 2003, the Financial Accounting StandardsBoard issued Statement of Financial Accounting Standard No. 149, “Amendment ofStatement 133 on Derivative Instruments and Hedging Activities”. SFAS 149amends and clarifies financial accounting and reporting for derivativeinstruments, including certain derivative instruments embedded in othercontracts (collectively referred to as derivatives) and for hedging activitiesunder FASB Statement No. 133, “Accounting for Derivative Instruments andHedging Activities”. Under SFAS 149 loan commitments that relate to theorigination of mortgage loans that will be held for sale, commonly referred toas interest rate lock commitments, must be accounted for as derivatives by theissuer of the commitment. Commitments to originate mortgage loans that will beheld for investment purposes and commitments to originate other types of loansare not considered derivatives. The Company has adopted SFAS 149, but it hasnot had any material impact on the Company’s financial position or results ofoperations.

 

In November 2003, the Emerging Issues Task Force (“EITF”)issued Position 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments”. The EITF provides guidance on the meaningof the phrase other-than-temporary impairment and its application to severaltypes of investments, including debt securities classified as held-to-maturityand available-for-sale under FASB Statement No. 115, “Accounting for CertainInvestments in Debt and Equities Securities”. For purposes of EITF No. 03-1 aninvestment is impaired if the fair market value of the investment is less thanits cost. Controversy has developed over the criteria to be used to determinewhether an impairment is other than temporary. The EITF requires that aninvestor should make an evidenced-based judgment about a recovery of fair valueup to (or beyond) the cost of the investment by considering the severity andduration of the impairment in relation to the forecasted recovery of fair value.Because of the controversy related to the determination of whether theimpairment is other than temporary, certain aspects of the position of the EITFhave been temporarily delayed. The Company cannot access the effect on thefinancial position or results of operations until the controversy has beenresolved. The EITF requires disclosures related to securities with fair valuesless than cost. The disclosures have been included in note 3 to theconsolidated financial statements.

 

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On December 31, 2003, Legends Financial Holdings, Inc.adopted certain disclosure requirements of Emerging Issues Task Force (EITF)Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments”. These disclosures concerned unrealizedlosses related to investments in debt and marketable equity securities that areaccounted for under SFAS No. 115. Disclosures include the length of timeinvestments have been in a loss position and discussion pertaining to thenature of the impairment. In September, 2004, the FASB approved issuance ofStaff Position (FSP) EITF 03-1-1, “Effective Date of Paragraphs 10 through 20of EITF Issue No. 03-1, the Meaning of Other-Than-Temporary Impairment and ItsApplication to Certain Investments” (EITF 03-1). FSP EITF 03-1-1 delays theeffective date of paragraphs 10 through 20 of EITF 03-1 as they relate torecognition of other-than-temporary impairment for cost method and marketableinvestments. This deferral will extend until the FASB provides clarification ofthe guidance presented in paragraphs 10 through 20. Effective July 1, 2004Legends Financial Holdings, Inc. adopted all remaining provisions of EITFIssue 03-1, including measurement guidance for evaluating whetherimpairment has occurred for marketable securities and cost method investments. Theeffect of implementing the final provisions of paragraphs 10 through 20 cannotcurrently be estimated due to the pending implementation issues. The adoptionof all other provisions of EITF Issue No. 03-1 did not have an impact on theresults of operations.

 

In December, 2004, the Financial Accounting StandardsBoard (“FASB”) reissued Statement of Financial Accounting Standards No. 123(revised 2004) (“SFAS”) related to share based payments. For Legends FinancialHoldings, Inc. the SFAS applies to the accounting for stock options. Thesubstance of the revised statement is to require companies to record as anexpense amortization of the fair market value of stock options determined as ofthe grant date. The offsetting credit is to additional paid-in capital unlessthere is an obligation to buy back the stock or exchange other assets for thestock. If such an obligation exists the offsetting credit would be to aliability account. The statement is effective for the first interim reportingperiod after December 15, 2005. Effective January 18, 2005, the Board ofDirectors of Legends Financial Holdings, Inc. approved 100% vesting on alloutstanding options; and accordingly, there will be no further impact onearnings related to options outstanding at December 31, 2005.

 

On June 30, 2005, the FASB issued an exposure draft “BusinessCombinations - a replacement of SFAS No. 141 (141 Revised). The proposedStatement would require the acquirer to measure the fair value of the acquiree,as a whole, as of the acquisition date as opposed to the definitive agreementdate. The proposal also requires that contingent consideration be estimated andrecorded at the acquisition which is in conflict with SFAS No. 5. SFAS No. 5would be amended for this exception. Acquisition related costs incurred in connectionwith the business combination would generally be expensed.

 

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This proposed Statement would require the acquirer ina business combination in which the acquisition-date fair value of the acquirer’sinterest in the acquiree exceeds the fair value of the considerationtransferred for that interest (referred to as a bargain purchase) to accountfor that excess by first reducing the goodwill related to that businesscombination to zero, and then by recognizing any excess in income. Statement141 requires that excess to be allocated as a pro rata reduction of the amountsthat would have been assigned to particular assets acquired. The proposedStatement is expected to be effective for acquisitions after January 1, 2007.

 

On June 1, 2005, the FASB issued Statement No. 154, “AccountingChanges and Error Corrections”, a replacement of APB 20 and Statement 3. TheStatement applies to all voluntary changes in accounting principle, and changesthe requirements for accounting for and reporting of a change in accountingprinciple. In the absence of specific transition requirements to the contraryin the adoption of an accounting principle, Statement 154 requiresretrospective application to prior periods’ financial statements of a voluntarychange in accounting principle unless it is impracticable for comparability andconsistency of financial information between periods. Statement 154 iseffective for accounting changes and corrections of errors made in fiscal yearsbeginning after December 15, 2005. Earlier application is permitted foraccounting changes and corrections of errors occurring in fiscal yearsbeginning after June 1, 2005.

 

On July 14, 2005, the FASB issued an Exposure Draft onAccounting for Uncertain Tax Positions, a proposed interpretation of FASBStatement No. 109. The proposed interpretation requires that only benefits fromtax positions that are probable of being sustained under audit should berecognized in the financial statements. These benefits would be recorded atamounts considered to be the best estimates of management. At the time thesepositions become “more likely than not” to be disallowed under audit, theirrecognition would be reversed. Legends Financial Holdings, Inc. is currentlyreviewing the potential impact of this proposed Interpretation; any cumulative effect associated with the application ofthe provisions of the proposed Interpretation will be reported as a change inaccounting principle in the period in which the Interpretation is adopted.

 

65

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***(2)******          ******Loans and Allowance for PossibleLoan Losses***

 

Thedetail of loans at December 31, 2005 and 2004 are as follows:

 
| ** **                              | ** ** | **In Thousands** | ** ** |
|-----------------------------------------|------------|------------------|------------|
| ** **                              | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                                    |       |             |       |   |   |
| Commercial,  financial and agricultural |       | $                | 30,059     |   | 24,481 |   |
| Installment                             |       | 5,204            |       | 5,307 |   |
| Real estate  - mortgage                 |       | 85,999           |       | 77,646 |   |
| Real estate  - construction             |       | 31,721           |       | 22,417 |   |
|                                    |       | 152,983          |       | 129,851 |   |
| Allowance  for possible loan losses     |       | (1,758           | )          | (1,517 | ) |
|                                    |       | $                | 151,225    |   | 128,334 |   |

 

At December 31, 2005, variable rate and fixed rateloans totaled $61,297,000 and $91,686,000, respectively. At December 31, 2004,variable rate and fixed rate loans totaled $52,423,000 and $77,428,000,respectively.

 

The principal maturities on loans at December 31, 2005are as follows:

 
| ** **        | ** ** | **In Thousands**                              | ** ** |
|-------------------|------------|-----------------------------------------------|------------|
| ** **        | ** ** | **Commercial,  Financial  and  Agricultural** | ** ** | **Installment** | ** ** | **Real estate -  Mortgage** | ** ** | **Real estate -  Construction** | ** ** | **Total** | ** ** |
|              |       |                                          |       |   |   |   |   |   |   |   |   |
| 3 months or  less |       | $                                             | 12,317     |   | 743 |   | 23,944 |   | 23,309 |   | 60,313 |   |
| 3 to 12  months   |       | 782                                           |       | 388 |   | 5,334 |   | 3,190 |   | 9,694 |   |
| 1 to 5 years      |       | 15,791                                        |       | 3,988 |   | 53,818 |   | 1,767 |   | 75,364 |   |
| over 5 years      |       | 1,169                                         |       | 85 |   | 2,903 |   | 3,455 |   | 7,612 |   |
|              |       | $                                             | 30,059     |   | 5,204 |   | 85,999 |   | 31,721 |   | 152,983 |   |

 

In the normal course of business, the Company has madeloans at prevailing interest rates and terms to its executive officers,directors and their affiliates aggregating $1,760,000 and $2,092,000 atDecember 31, 2005 and 2004, respectively. As of December 31, 2005 and 2004,none of these loans were restructured, nor were any related party loans chargedoff in 2005 or 2004.

 

An analysis of the activity with respect to such loansto related parties is as follows:

 
| ** **                  | ** ** | **In Thousands** | ** ** |
|-----------------------------|------------|------------------|------------|
| ** **                  | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                        |       |             |       |   |   |
| Balance,  January 1         |       | $                | 2,092      |   | 2,097 |   |
| New loans  during the year  |       | 383              |       | 806 |   |
| Repayments  during the year |       | (715             | )          | (811 | ) |
| Balance,  December 31       |       | $                | 1,760      |   | 2,092 |   |

 

66

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Transactions in the allowance for possible loan lossesof the Company for the years ended December 31, 2005, 2004 and 2003 aresummarized as follows:

 
| ** **                              | ** ** | **In Thousands** | ** ** |
|-----------------------------------------|------------|------------------|------------|
| ** **                              | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                    |       |             |       |   |   |   |   |
| Balance -  beginning of year            |       | $                | 1,517      |   | 1,225 |   | 879 |   |
| Provision  charged to operating expense |       | 305              |       | 440 |   | 361 |   |
| Loans  charged off                      |       | (72              | )          | (157 | ) | (49 | ) |
| Recoveries                              |       | 8                |       | 9 |   | 34 |   |
| Net  charge-offs                        |       | (64              | )          | (148 | ) | (15 | ) |
|                                    |       |             |       |   |   |   |   |
| Balance -  end of year                  |       | $                | 1,758      |   | 1,517 |   | 1,225 |   |

 

The Company’s principal customers are basically in theMiddle Tennessee area with a concentration in Montgomery County. Credit isextended to businesses and individuals and is evidenced by promissory notes. Theterms and conditions of the loans including collateral varies depending uponthe purpose of the credit and the borrower’s financial condition.

 

There were no restructured loans outstanding atDecember 31, 2005 and 2004. The Company had $1,037,000 and $420,000,respectively, of nonaccrual loans outstanding as of December 31, 2005 and2004, respectively. Had interest income been recognized on non-accrual loans in2005 and 2004, net earnings would have increased by approximately $53,000and $33,000, respectively. There were no loans greater than 90 dayspast due at December 31, 2005 or 2004 that were not included in non-accrualloans.

 

Impaired loans and related loan loss reserve amountsat December 2005 and 2004 were as follows:

 
| ** **            | ** ** | **In Thousands** | ** ** |
|-----------------------|------------|------------------|------------|
| ** **            | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                  |       |             |       |   |   |
| Recorded  investment  |       | $                | 2,010      |   | 3,052 |   |
| Loan loss  allocation |       | $                | 225        |   | 196 |   |

 

The average recorded investment in impaired loans forthe years ended December 31, 2005, 2004 and 2003 was $2,531,000, $2,443,000 and$1,529,000, respectively.

 

The related total amount of interest income recognizedon the accrual basis for the period that such loans were impaired was $167,000for 2005, $195,000 in 2004 and $105,000 in 2003.

 

67

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During 2005, the Company did not originate loans forsale loans in the secondary market. In 2004 and 2003, the Company originatedloans for sale in the secondary market of $933,000 and $11,601,000. The feesand gain on sale of these loans totaled $544,000 and $246,000 in 2004 and 2003,respectively. During 2004, the Company began receiving fees related toorigination of mortgage loans as opposed to originating, funding and sellingmortgage loans. During 2005, the Company earned fees related to origination ofmortgage loans of $415,000.

 

Of the loans sold in the secondary market, therecourse to the wholly-owned subsidiary Bank is limited. Nearly all other loanssold in the secondary market provide the purchaser recourse to the Bank for aperiod of 60 to 90 days from the date of purchase and only in the event of adefault by the borrower pursuant to the terms of the individual loan agreement.At December 31, 2005, the Bank did not have loans sold with recourse.

 

The fees and gains on sale of small businessadministration loans totaled $340,000 for 2005. There were no commissions onthe sale of small business administration loans for the years 2004 and 2003.

 

***(3)******          ******Debt and Equity Securities***

 

Debt and equity securities have been classified in thebalance sheet according to management’s intent. The Company’s classification ofsecurities at December 31, 2005 was as follows:

 
| ** **                                                         | ** ** | **In Thousands**                  | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                         | ** ** | **Securities Available-For-Sale** | ** ** |
| ** **                                                         | ** ** | **2005**                          | ** ** |
| ** **                                                         | ** ** | **Amortized  Cost**               | ** ** | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Market  Value** | ** ** |
|                                                               |       |                              |       |   |   |   |   |   |   |
| U.S. Treasury and other U.S. government  agencies and corporations |       | $                                 | 4,904      |   | — |   | 122 |   | 4,782 |   |
| Obligations of states and political  subdivisions                  |       | 16,589                            |       | 109 |   | 144 |   | 16,554 |   |
| Domestic corporate bonds                                           |       | 2,520                             |       | — |   | 30 |   | 2,490 |   |
| Mortgage-backed securities                                         |       | 23,322                            |       | 2 |   | 527 |   | 22,797 |   |
|                                                               |       | $                                 | 47,335     |   | 111 |   | 823 |   | 46,623 |   |

 

68

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The Company’s classification of securities at December31, 2004 was as follows:

 
| ** **                                                         | ** ** | **In Thousands**                  | ** **   |
|--------------------------------------------------------------------|------------|-----------------------------------|--------------|
| ** **                                                         | ** ** | **Securities Available-For-Sale** | ** **   |
| ** **                                                         | ** ** | **2004**                          | ** **   |
| ** **                                                         | ** ** | **Amortized  Cost**               | ** **   | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Market  Value** | ** ** |
| U.S. Treasury and other U.S. government  agencies and corporations |       | $                                 | 4,070        |   | 2 |   | 71 |   | 4,001 |   |
| Obligations of states and political  subdivisions                  |       | 12,123                            |         | 102 |   | 121 |   | 12,104 |   |
| Domestic corporate bonds                                           |       | 2,750                             |         | — |   | 19 |   | 2,731 |   |
| Mortgage-backed securities                                         |       | 18,934                            |         | 34 |   | 224 |   | 18,744 |   |
|                                                               |       | $                                 |  37,877 |   | 138 |   | 435 |   | 37,580 |   |

 

Included in mortgage backed securities as of December31, 2005 and 2004, are collateralized mortgage obligations with a market valueof $959,000 (amortized cost of $992,000) and $497,000 (amortized cost of$509,000), respectively. The effective yield at December 31, 2005 and 2004, oncollateralized mortgage obligations was 4.28% and 3.50%, respectively.

 

The amortized cost and estimated market value of debtand equity securities at December 31, 2005, by contractual maturity, are shownbelow. Expected maturities will differ from contractual maturities becauseborrowers may have the right to call or prepay obligations with or without callor prepayment penalties.

 
| ** **                              | ** ** | **In Thousands** | ** ** |
|-----------------------------------------|------------|------------------|------------|
| **Securities Available-For-Sale**       | ** ** | **Cost**         | ** ** | **Estimated  Market  Value** | ** ** |
|                                    |       |             |       |   |   |
| Due in one  year or less                |       | $                | 1,201      |   | 1,179 |   |
| Due after  one year through five years  |       | 7,746            |       | 7,616 |   |
| Due after  five years through ten years |       | 7,524            |       | 7,480 |   |
| Due after  ten years                    |       | 7,542            |       | 7,551 |   |
|                                    |       | 24,013           |       | 23,826 |   |
| Mortgage-backed  securities             |       | 23,322           |       | 22,797 |   |
|                                    |       | $                | 47,335     |   | 46,623 |   |

 

69

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Results from sales of debt and equity securities areas follows:

 
| ** **                  | ** ** | **In Thousands** | ** ** |
|-----------------------------|------------|------------------|------------|
| ** **                  | ** ** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
|                        |       |             |       |   |   |   |   |
| Gross  proceeds             |       | $                | 1,962      |   | 4,225 |   | 9,685 |   |
|                        |       |             |       |   |   |   |   |
| Gross  realized gains       |       | $                | 13         |   | 67 |   | — |   |
| Gross  realized losses      |       | (17              | )          | — |   | (21 | ) |
| Net realized gains (losses) |       | $                | (4         | ) | 67 |   | (21 | ) |

 

Investment securities carried in the balance sheet of$28,057,000 (amortized cost of $28,567,000) and $27,501,000 (amortized cost of$27,724,000) as of December 31, 2005 and 2004, respectively, were pledged tosecure public and trust deposits and for other purposes as required orpermitted by law.

 

Securities that have rates that adjust prior tomaturity totaled $12,748,000 (approximate amortized cost of $12,985,000) and$12,866,000 (approximate amortized cost of $12,991,000) at December 31, 2005and 2004, respectively.

 

The following table shows the Company’s investments’gross unrealized losses and fair value, aggregated by investment category andlength of time that individual securities have been in a continuous unrealizedloss position, at December 31, 2005:

 
| ** **                                                       | ** ** | **In Thousands, Except Number of Securities** | ** ** |
|------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                       | ** ** | **Less than 12 Months**                       | ** ** | **12 Months or More** | ** ** | **Total** | ** ** |
| ** **                                                       | ** ** | **Fair  Value**                               | ** ** | **Unrealized  Losses** | ** ** | **Number of  Securities  Included** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** | **Number of  Securities  Included** | ** ** | **Fair  Value** | ** ** | **Unrealized  Losses** | ** ** |
| U.S. Treasury obligations and direct obligations  of US agencies |       | $                                             | 2,352      |   | $ | 56 |   | 5 |   | $ | 1,935 |   | $ | 66 |   | 4 |   | $ | 4,287 |   | $ | 122 |   |
|                                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Obligations of states and political  sub- divisions         |       | 7,775                                         |       | 78 |   | 31 |   | 2,884 |   | 66 |   | 15 |   | 10,659 |   | 144 |   |
|                                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mortgage-backed securities                                       |       | 11,576                                        |       | 195 |   | 28 |   | 9,265 |   | 332 |   | 31 |   | 20,841 |   | 527 |   |
|                                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate bonds                                                  |       | 268                                           |       | 2 |   | 1 |   | 486 |   | 28 |   | 1 |   | 754 |   | 30 |   |
|                                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Total temporarily impaired securities                            |       | $                                             | 21,971     |   | $ | 331 |   | 65 |   | $ | 14,570 |   | $ | 492 |   | 51 |   | $ | 36,541 |   | $ | 823 |   |

 

70

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The impaired securities are considered high qualityinvestments in line with normal industry investing practices. The unrealizedlosses are primarily the result of changes in the interest rate and sectorenvironments. Consistent with the original classification, asavailable-for-sale, the Company intends and has the ability to hold the abovesecurities until the value is realized.

 

The Company may sell the above or other securities inthe ordinary course of business in response to significant changes in liquidityneeds, unexpected and significant increases in interest rates and/or securityspreads that significantly extend a security’s holding period, or whenconducting a small volume of security transactions.

 

***(4)******          ******RestrictedEquity Securities***

 

Restricted equity securities consisted of stock of TheBankers Bank and the Federal Home Loan Bank amounting to $183,000 and $598,000,respectively, at December 31, 2005. The stocks totaled to $162,000 and$493,000, respectively, at December 31, 2004. The stock can be sold back to TheBankers Bank and Federal Home Loan Bank only at par. The securities arerecorded at cost.

 

***(5)******          ******Bank Premises and Equipment***

 

The detail of premises and equipment at December 31,2005 and 2004 is as follows:

 
| ** **                     | ** ** | **In Thousands** | ** ** |
|--------------------------------|------------|------------------|------------|
| ** **                     | ** ** | **2005**         | ** ** | **2004** | ** ** |
|                           |       |             |       |   |   |
| Land                           |       | $                | 1,539      |   | 1,539 |   |
| Buildings                      |       | 3,929            |       | 3,403 |   |
| Leasehold  improvements        |       | 316              |       | 316 |   |
| Furniture  and fixtures        |       | 281              |       | 253 |   |
| Equipment  and software        |       | 1,985            |       | 1,804 |   |
| Construction  in process       |       | 250              |       | 9 |   |
|                           |       | 8,300            |       | 7,324 |   |
| Less  accumulated depreciation |       | 1,998            |       | 1,607 |   |
|                           |       | $                | 6,302      |   | 5,717 |   |

 

Depreciation expense was $422,000, $413,000 and$343,000 for the years ended December 31, 2005, 2004 and 2003,respectively.

 

71

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***(6)******                                 Goodwill***

 

Effective March 24,2003, the Company acquired certain assets and assumed certain liabilities ofNBC Bank in the Clarksville, Tennessee area. The acquisition was accounted for as a purchase summarized as follows:

 
| *** ***                          | *** *** | **In Thousands** | *** *** |
|---------------------------------------|--------------|------------------|--------------|
|                                  |         |             |         |
| Loans  including overdrafts purchased |         | $                | 1,243        |   |
| Deposits  assumed                     |         | (2,718           | )            |
| Accrued  interest payable             |         | (6               | )            |
| Cash  received from NBC               |         | 1,328            |         |
| Goodwill                              |         | 153              |         |
|                                       |              |                  |              |  |

 

The change in the carrying value of goodwill during the years ended December 31,2005 and 2004 follows:

 
| *** ***                        | *** *** | **In Thousands** | *** *** |
|-------------------------------------|--------------|------------------|--------------|
| ** **                          | ** **   | **2005**         | ** **   | **2004** | ** ** |
|                                |         |             |         |   |   |
| Carrying  value - beginning of year |         | $                | 153          |   | 153 |   |
| Goodwill  acquired                  |         | —           |         | — |   |
| Goodwill  impairment losses         |         | —           |         | — |   |
| Carrying  value - end of year       |         | $                | 153          |   | 153 |   |

 

***(7)******                                 Deposits***

 

Deposits at December 31, 2005 and 2004 are summarized as follows:

 
| *** ***                                        | *** *** | **In Thousands** | *** *** |
|-----------------------------------------------------|--------------|------------------|--------------|
| ** **                                          | ** **   | **2005**         | ** **   | **2004** | ** ** |
|                                                |         |             |         |   |   |
| Demand  deposits                                    |         | $                | 42,384       |   | 26,965 |   |
| Savings  deposits                                   |         | 4,155            |         | 3,262 |   |
| Negotiable  order of withdrawal                     |         | 39,581           |         | 34,597 |   |
| Money market  demand accounts                       |         | 38,490           |         | 29,151 |   |
| Certificates  of deposit $100,000 or greater        |         | 47,694           |         | 39,580 |   |
| Other  certificates of deposit                      |         | 23,036           |         | 18,925 |   |
| Individual  retirement accounts $100,000 or greater |         | 1,845            |         | 787 |   |
| Other  individual retirement accounts               |         | 2,493            |         | 1,708 |   |
|                                                |         | $                | 199,678      |   | 154,975 |   |

 

72

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Principal maturities of certificates of deposit and individualretirement accounts at December 31, 2005 are as follows:

 
| *** ***      | *** *** | **In Thousands**    | *** *** |
|-------------------|--------------|---------------------|--------------|
| ** **        | ** **   | **Single Deposits** | ** **   | **Single Deposits** | ** ** | ** ** | ** ** |
| **Maturity**      | ** **   | **Under $100,000**  | ** **   | **Over $100,000** | ** ** | **Total** | ** ** |
|              |         |                |         |   |   |   |   |
| 3 months or  less |         | $                   | 6,470        |   | 12,755 |   | 19,225 |   |
| 3 to 12  months   |         | 13,609              |         | 23,757 |   | 37,366 |   |
| 1 to 5 years      |         | 5,450               |         | 13,027 |   | 18,477 |   |
|              |         | $                   | 25,529       |   | 49,539 |   | 75,068 |   |

 

At December 31,2005 and 2004 certificates of deposit and other deposits in denominations of$100,000 or more amounted to $142,860,000 and $103,749,000, respectively.

 

The aggregateamount of overdrafts reclassified as loans receivable was $452,000 and $390,000at December 31, 2005 and 2004, respectively.

 

The Companymaintains significant cash deposit accounts for various local municipalitiesand related departments. As of December 31, 2005, these deposits totaledapproximately $37,232,000.

 

The Companymaintains a significant cash deposit account with a customer.  As of December 31, 2005, this deposittotaled $16,339,000.  Subsequent to December 31,2005 this deposit relationship has increased significantly by approximately $45million. (see note 23 to the consolidated financial statements).

 

The Company isrequired to maintain cash balances or balances with the Federal Reserve Bank orother correspondent banks based on certain percentages of deposit types.  The average required amounts for the yearsended December 31, 2005 and 2004 were approximately $1,191,000 and$2,101,000, respectively.

 

***(8)******                                 SecuritiesSold Under Repurchase Agreements***

 

The maximumamounts of outstanding repurchase agreements during 2005, 2004 and 2003 were$2,823,000, $1,403,000 and $7,379,000, respectively.  The average daily balance outstanding during2005, 2004 and 2003 was $1,452,000, $565,000 and $$1,444,000,respectively.  The weighted averageinterest rate at December 31, 2005, 2004 and 2003 was 3.15%, 1.50% and..14%, respectively.  The underlyingsecurities are typically held by other financial institutions and aredesignated as pledged.  As of December 31,2005, the Company had pledged $3,703,000 (amortized cost of $3,752,000) insecurities to collaterize their arrangement.

 

73

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***(9)******                                 Advancesfrom Federal Home Loan Bank***

 

The advances from the Federal Home Loan Bank at December 31, 2005and 2004 consist of the following:

 
| *** ***                      | *** *** | **In Thousands**      | *** *** |
|-----------------------------------|--------------|-----------------------|--------------|
| ** **                        | ** **   | **December 31,** | ** **   |
| ** **                        | ** **   | **2005**              | ** **   | **2004** | ** ** |
| ** **                        | ** **   | ** **            | ** **   | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                        | ** **   | **Amount**            | ** **   | **Average Rate** | ** ** | **Amount** | ** ** | **Average Rate** | ** ** |
| ** **                        | ** **   | ** **            | ** **   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fixed and  variable rate advances |         | $                     |  9,795  |   | 3.83 | % | $ |  8,919 |   | 2.41 | % |
|                                   |              |                       |              |  |  |  |  |  |  |  |  |

 

Advances from the Federal Home Loan Bank are to mature as follows at December 31,2005:

 
| *** *** | *** *** | **In Thousands** | *** *** |
|--------------|--------------|------------------|--------------|
| ** **   | ** **   | **Amount**       | ** **   |
|         |         |             |         |
| 2006         |         | $                | 1,000        |   |
| 2007         |         | 4,500            |         |
| 2008         |         | 2,960            |         |
| 2009         |         | —           |         |
| 2010         |         | 980              |         |
| Thereafter   |         | 355              |         |
|         |         | $                | 9,795        |   |

 

Loans totaling $13,223,000 were pledged to FHLB as collateral at December 31,2005.

 

***(10)******                          Non-InterestIncome and Non-Interest Expense***

 

The significant components of non-interest income and non-interestexpense for the years ended December 31 are presented below:

 
| ** **                          | ** **   | **In Thousands** | ** ** |
|-------------------------------------|--------------|------------------|------------|
| *** ***                        | *** *** | **2005**         | ** ** | **2004** | ** ** | **2003** | ** ** |
| * *                            | * *     | * *         | * *   | * * | * * | * * | * * |
| Non-interest  income:               |         |             |       |   |   |   |   |
| Service charges on deposit accounts |         | $                | 780        |   | 657 |   | 489 |   |
| Other fees and commissions          |         | 400              |       | 314 |   | 263 |   |
| Gains and fees on sales of loans    |         | 755              |       | 544 |   | 246 |   |
| Gain on sale of securities          |         | —           |       | 67 |   | — |   |
|                                |         | $                | 1,935      |   | 1,582 |   | 998 |   |

 

74

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| *** ***                      | *** *** | **In Thousands** | *** *** |
|-----------------------------------|--------------|------------------|--------------|
| ** **                        | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
|                              |         |             |         |   |   |   |   |
| Non-interest  expense:            |         |             |         |   |   |   |   |
| Employee salaries and benefits    |         | $                | 3,215        |   | 2,811 |   | 2,220 |   |
| Occupancy expenses                |         | 444              |         | 399 |   | 282 |   |
| Furniture and equipment expenses  |         | 481              |         | 475 |   | 450 |   |
| Data processing expenses          |         | 462              |         | 413 |   | 357 |   |
| Professional fees                 |         | 230              |         | 271 |   | 243 |   |
| Advertising                       |         | 143              |         | 185 |   | 134 |   |
| Directors fees                    |         | 157              |         | 153 |   | 136 |   |
| Printing and supplies             |         | 186              |         | 129 |   | 120 |   |
| Community relations               |         | 130              |         | 135 |   | 128 |   |
| Loss on sale of securities        |         | 4                |         | — |   | 21 |   |
| Loss on sale of fixed assets      |         | 8                |         | 20 |   | — |   |
| Loss on sale of other real estate |         | 53               |         | — |   | — |   |
| Other operating expenses          |         | 622              |         | 541 |   | 514 |   |
|                              |         | $                | 6,135        |   | 5,532 |   | 4,605 |   |

 

***(11)******                          IncomeTaxes***

 

The components of the net deferred income tax asset at December 31,2005 and 2004 are as follows:

 
| *** ***             | *** *** | **In Thousands** | *** *** |
|--------------------------|--------------|------------------|--------------|
| ** **               | ** **   | **2005**         | ** **   | **2004** | ** ** |
|                     |         |             |         |   |   |
| Deferred tax  asset:     |         |             |         |   |   |
| Federal                  |         | $                | 712          |   | 511 |   |
| State                    |         | 146              |         | 104 |   |
|                     |         | 858              |         | 615 |   |
|                     |         |             |         |   |   |
| Deferred tax  liability: |         |             |         |   |   |
| Federal                  |         | (275             | )            | (241 | ) |
| State                    |         | (56              | )            | (49 | ) |
|                     |         | (331             | )            | (290 | ) |
|                     |         |             |         |   |   |
| Net deferred assets      |         | $                | 527          |   | 325 |   |

 

75

----

 

The tax effects of each type of significant item that gave rise todeferred taxes at December 31, 2005 and 2004 are:

 
| ** **                                                                                                                | ** ** | **In Thousands** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                                | ** ** | **2005**         | ** ** | **2004** | ** ** |
| Financial statement allowance for loan  losses in excess of the tax allowance                                             |       | $                | 583        |   | 498 |   |
|                                                                                                                      |       |             |       |   |   |
| Excess of depreciation deducted for tax  purposes over the amounts deducted in the financial statements                   |       | (286             | )          | (260 | ) |
|                                                                                                                      |       |             |       |   |   |
| Pre-opening costs amortized over a  five-year period for tax purposes, expensed for financial statements in initial  year |       | 2                |       | 3 |   |
|                                                                                                                      |       |             |       |   |   |
| Excess of amortized cost over estimated  market value related to available-for-sale securities                            |       | 273              |       | 114 |   |
|                                                                                                                      |       |             |       |   |   |
| Financial statement income on FHLB stock  dividends not recognized for tax purposes                                       |       | (34              | )          | (23 | ) |
|                                                                                                                      |       |             |       |   |   |
| Goodwill amortized for tax purposes and  monitored for impairment for financial reporting purposes                        |       | (11              | )          | (7 | ) |
|                                                                                                                      |       |             |       |   |   |
|                                                                                                                      |       | $                | 527        |   | 325 |   |

 

The components of income tax expense are summarized as follows:

 
| *** ***       | *** *** | **In Thousands** | *** *** |
|--------------------|--------------|------------------|--------------|
| ** **         | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
| Current:           |         |             |         |   |   |   |   |
| Federal            |         | $                | 838          |   | 562 |   | 285 |   |
| State              |         | 216              |         | 160 |   | 87 |   |
|               |         | 1,054            |         | 722 |   | 372 |   |
| Deferred:          |         |             |         |   |   |   |   |
| Federal            |         | (36              | )            | (22 | ) | 31 |   |
| State              |         | (7               | )            | (4 | ) | 6 |   |
|               |         | (43              | )            | (26 | ) | 37 |   |
|               |         |             |         |   |   |   |   |
| Actual tax expense |         | $                | 1,011        |   | 696 |   | 409 |   |

 

76

----

 

Areconciliation of actual income tax expense in the consolidated financialstatements to the “expected” tax expense (computed by applying the statutoryFederal income tax rate of 34% to earnings before income taxes) is as follows:

 
| *** ***                                               | *** *** | **In Thousands** | *** *** |
|------------------------------------------------------------|--------------|------------------|--------------|
| ** **                                                 | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
|                                                       |         |             |         |   |   |   |   |
| Computed “expected” tax expense                  |         | $                | 1,052        |   | 783 |   | 421 |   |
| State income taxes, net of effect of  Federal income taxes |         | 133              |         | 101 |   | 53 |   |
| Disallowed expenses                                        |         | 4                |         | 5 |   | 5 |   |
| Benefit related to nonqualified stock  options             |         | (3               | )            | (47 | ) | (5 | ) |
| Tax exempt interest, net of interest  expense exclusion    |         | (176             | )            | (137 | ) | (75 | ) |
| Other                                                      |         | 1                |         | (9 | ) | 10 |   |
|                                                       |         |             |         |   |   |   |   |
| Actual tax expense                                         |         | $                | 1,011        |   | 696 |   | 409 |   |

 

***(12)******                          Commitmentand Contingencies***

 

The Companyhas entered into three separate federal funds guideline facilities with certaintime restrictions on outstanding borrowings. The lines are generally renewable annually and bear interest at avariable rate equivalent to the correspondent bank’s daily internal lendingrate.  The combined lines provide for upto $7,450,000 in borrowings at December 31, 2005.

 

The Companycurrently has two leases related to the operation of two branches.  One lease, entered into in 1998, is for aperiod of five years and can be renewed for two consecutive five-year terms.  The Company renewed this lease December 1,2003.  The other lease was entered intoduring 2001 and is for a period of two years and can be renewed for twoconsecutive three-year terms.  TheCompany renewed this lease in 2004.

 

The Companyalso has three leases related to space for automated teller machines inClarksville, Tennessee.  The leasescommenced in June, 2003 for two years and can be renewed for two consecutivetwo year terms.   The Company renewedthis lease in 2005.

 

The Companyhas a lease related to its mortgage operations. The lease is for one year and can be renewed for two consecutiveone-year terms.  The Company exercisedits first year renewal option in February, 2005.

 

The Companyalso has a lease related to office equipment. The lease commenced during February, 2004 for a four-year term.

 

The Companyalso has three leases related to office equipment which commenced during April,2005 and September, 2005 for a four and five year term, respectively.

 

77

----

 

Minimum future rental payments required under the terms of the leasesare as follows:

 
| **Year Ending**       | ** **   | ** **       | ** **   |
|-----------------------|--------------|------------------|--------------|
| **December 31,** | *** *** | **In Thousands** | *** *** |
|                  |         |             |         |
| 2006                  |         | $                | 117          |   |
| 2007                  |         | 54               |         |
| 2008                  |         | 46               |         |
| 2009                  |         | 8                |         |
| 2010                  |         | 1                |         |
|                  |         | $                | 226          |   |

 

Total rentexpense under the leases amounted to $118,000, $114,000 and $69,000 during theyears ended December 31, 2005, 2004 and 2003, respectively.

 

The Companyhas committed to the construction of a facility in Clarksville, MontgomeryCounty, Tennessee during 2006 at an estimated cost of $2,000,000.  The facility will accommodate the Company’smortgage department, administrative offices as well as consolidating anexisting branch.

 

***(13)******                          FinancialInstruments with Off-Balance-Sheet Risk***

 

The Company isparty to financial instruments with off-balance-sheet risk in the normal courseof business to meet the financing needs of its customers.  These financial instruments consist primarilyof commitments to extend credit.  Theseinstruments involve, to varying degrees, elements of credit risk in excess ofthe amount recognized in the consolidated balance sheets.  The contract or notional amounts of thoseinstruments reflect the extent of involvement the Company has in particularclasses of financial instruments.

 

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

 
| *** ***                                                         | *** *** | **In Thousands** | *** *** |
|----------------------------------------------------------------------|--------------|------------------|--------------|
| ** **                                                           | ** **   | **2005**         | ** **   | **2004** | ** ** |
| ** **                                                           | ** **   | ** **       | ** **   | ** ** | ** ** |
| Financial instruments whose contract amounts  represent credit risk: |         |             |         |   |   |
| Unused commitments to extend credit                                  |         | $                | 32,660       |   | 28,974 |   |
| Standby letters of credit                                            |         | 3,780            |         | 1,161 |   |
|                                                                 |         |             |         |   |   |
| Total                                                                |         | $                | 36,440       |   | 30,135 |   |

 

78

----

 

Unusedcommitments to extend credit are agreements to lend to a customer as long asthere is no violation 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 tobe drawn upon, the total commitment amounts generally represent future cashrequirements.  The Company evaluates eachcustomer’s credit-worthiness on a case-by-case basis.  The amount of collateral, if deemed necessaryby the Company upon extension of credit, is based on management’s creditevaluation of the counterparty.  Collateralnormally consists of real property.

 

Standbyletters of credit are conditional commitments issued by the Company toguarantee the performance of a customer to a third party.  Those guarantees are primarily issued tosupport public and private borrowing arrangements, including commercial paper,bond financing, and similar transactions. Most guarantees extend from one to two years.  The credit risk involved in issuing lettersof credit is essentially the same as that involved in extending loan facilitiesto customers.  The fair value of standbyletters of credit is estimated using the fees currently charged to enter intosimilar agreements, taking into account the remaining terms of the agreements,the likelihood of the counter parties drawing on such financial instruments andthe present creditworthiness of such counter parties.  Such commitments have been made on termswhich are competitive in the markets in which the Company operates, thus, thefair value of standby letters of credit equals the carrying value for thepurposes of this disclosure.  The maximumpotential amount of future payments that the Company could be required to makeunder the guarantees totaled $3,780,000 at December 31, 2005.

 

79

----

 

***(14)******                          LegendsFinancial Holdings, Inc. -***

***Parent Company FinancialInformation***

 

**LEGENDSFINANCIAL HOLDINGS, INC.**

**(ParentCompany Only)**

**BalanceSheets**

**December 31,2005 and 2004**

 
| *** ***                                                                                                                             | *** *** | **In Thousands** | *** *** |
|------------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------|--------------|
| ** **                                                                                                                               | ** **   | **2005**         | ** **   | **2004** | ** ** |
| ASSETS                                                                                                                                   |         |             |         |   |   |
|                                                                                                                                     |         |             |         |   |   |
| Cash                                                                                                                                     |         | $                | 86           | *  | 145 | * |
| Deferred tax  asset                                                                                                                      |         | 2                |         | 4 |   |
| Investment  in commercial bank subsidiary                                                                                                |         | 17,221           | *       | 15,489 | * |
| Due from  commercial bank subsidiary                                                                                                     |         | 41               | *       | 75 | * |
|                                                                                                                                     |         |             |         |   |   |
| Total assets                                                                                                                             |         | $                | 17,350       |   | 15,713 |   |
|                                                                                                                                     |         |             |         |   |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                |         |             |         |   |   |
|                                                                                                                                     |         |             |         |   |   |
| Stockholders’ equity:                                                                                                               |         |             |         |   |   |
| Preferred stock, no par value, authorized  1,000,000 shares, no shares issued                                                            |         | $                | —       |   | — |   |
| Common stock, par value $1 per share,  authorized 2,000,000 shares, 1,427,099 and 1,408,497 shares issued and  outstanding, respectively |         | 1,427            |         | 1,408 |   |
| Additional paid-in capital                                                                                                               |         | 12,711           |         | 12,495 |   |
| Retained earnings                                                                                                                        |         | 3,651            |         | 1,993 |   |
| Net unrealized losses on available-for-sale  securities, net of income taxes of $273,000 and $114,000, respectively                      |         | (439             | )            | (183 | ) |
| Total stockholders’ equity                                                                                                          |         | 17,350           |         | 15,713 |   |
|                                                                                                                                     |         |             |         |   |   |
| Total liabilities and stockholders’ equity                                                                                          |         | $                | 17,350       |   | 15,713 |   |

 

----

*Eliminated in consolidation.

 

80

----

 

**LEGENDSFINANCIAL HOLDINGS, INC.**

**(ParentCompany Only)**

**Statementsof Earnings and Comprehensive Earnings**

**For theYears Ended December 31, 2005, 2004 and 2003**

 
| *** ***                                                                                                                                       | *** *** | **In Thousands** | *** *** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------|--------------|
| ** **                                                                                                                                         | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Income:                                                                                                                                            |         |             |         |   |   |   |   |
| Dividends from commercial bank subsidiary                                                                                                          |         | $                | 150          | *  | 100 | *  | 349 | *  |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Operating  expenses                                                                                                                                |         | 92               |         | 56 |   | 107 |   |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Earnings before Federal income tax benefits  and equity in undistributed earnings of commercial bank subsidiary                                    |         | 58               |         | 44 |   | 242 |   |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Federal  income tax benefit                                                                                                                        |         | 39               |         | 74 |   | 47 |   |
|                                                                                                                                               |         | 97               |         | 118 |   | 289 |   |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Equity in  undistributed earnings of commercial bank subsidiary                                                                                    |         | 1,988            | *       | 1,488 | *  | 540 | *  |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Net earnings                                                                                                                                       |         | 2,085            |         | 1,606 |   | 829 |   |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Other  comprehensive earnings (loss) , net of tax:                                                                                                 |         |             |         |   |   |   |   |
| Unrealized gains (losses) on  available-for-sale securities arising during the year, net of taxes of $160,000,  $32,000 and $225,000, respectively |         | (259             | )            | 53 |   | (366 | ) |
| Reclassification adjustment for (gains)  losses included in net earnings, net of taxes of $1,000, $26,000 and $8,000,  respectively                |         | 3                |         | (41 | ) | 13 |   |
| Other comprehensive earnings (loss)                                                                                                                |         | (256             | )            | 12 |   | (353 | ) |
|                                                                                                                                               |         |             |         |   |   |   |   |
| Comprehensive earnings                                                                                                                             |         | $                | 1,829        |   | 1,618 |   | 476 |   |

 

----

*Eliminated in consolidation.

 

81

----

 

**LEGENDSFINANCIAL HOLDINGS, INC.**

**(ParentCompany Only)**

**Statementsof Stockholders’ Equity**

**For theYears Ended December 31, 2005, 2004 and 2003**

 
| ** **                                                                                                        | ** ** | **In Thousands** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **Net Unrealized** | ** ** | ** ** | ** ** |
| ** **                                                                                                        | ** ** | ** **       | ** ** | ** ** | ** ** | ** ** | ** ** | **Gains (Losses)** | ** ** | ** ** | ** ** |
| ** **                                                                                                        | ** ** | ** **       | ** ** | **Additional** | ** ** | ** ** | ** ** | **On Available-** | ** ** | ** ** | ** ** |
| ** **                                                                                                        | ** ** | **Common**       | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **For-Sale** | ** ** | ** ** | ** ** |
| ** **                                                                                                        | ** ** | **Stock**        | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Securities** | ** ** | **Total** | ** ** |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2002                                                                                    |       | $                | 1,379      |   | 12,267 |   | 43 |   | 158 |   | 13,847 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Issuance of 2,666 shares of $1 par value common  stock                                                            |       | 3                |       | 20 |   | — |   | — |   | 23 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.15 per share)                                                                          |       | —           |       | — |   | (206 | ) | — |   | (206 | ) |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net change in unrealized gains (loss) on available-for-sale  securities during the year, net of taxes of $217,000 |       | —           |       | — |   | — |   | (353 | ) | (353 | ) |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                         |       | —           |       | — |   | 829 |   | — |   | 829 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2003                                                                                    |       | 1,382            |       | 12,287 |   | 666 |   | (195 | ) | 14,140 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Issuance of 26,748 shares of $1 par value common  stock                                                           |       | 26               |       | 208 |   | — |   | — |   | 234 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.20 per share)                                                                          |       | —           |       | — |   | (279 | ) | — |   | (279 | ) |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net change in unrealized loss on  available-for- sale securities during the year, net of taxes of $6,000          |       | —           |       | — |   | — |   | 12 |   | 12 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                         |       | —           |       | — |   | 1,606 |   | — |   | 1,606 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2004                                                                                    |       | 1,408            |       | 12,495 |   | 1,993 |   | (183 | ) | 15,713 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Issuance of 18,602 shares of $1 par value common  stock                                                           |       | 19               |       | 216 |   | — |   | — |   | 235 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Cash dividends declared ($.30 per share)                                                                          |       | —           |       | — |   | (427 | ) | — |   | (427 | ) |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net change in unrealized loss on  available-for- sale securities during the year, net of taxes of $159,000        |       | —           |       | — |   | — |   | (256 | ) | (256 | ) |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Net earnings for the year                                                                                         |       | —           |       | — |   | 2,085 |   | — |   | 2,085 |   |
|                                                                                                              |       |             |       |   |   |   |   |   |   |   |   |
| Balance December 31, 2005                                                                                    |       | $                | 1,427      |   | 12,711 |   | 3,651 |   | (439 | ) | 17,350 |   |

 

82

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**LEGENDSFINANCIAL HOLDINGS, INC.**

**(ParentCompany Only)**

**Statementsof Cash Flows**

**For theYears Ended December 31, 2005, 2004 and 2003**

**Increase (Decrease)in Cash and Cash Equivalents**

 
| *** ***                                         | *** *** | **In Thousands** | *** *** |
|------------------------------------------------------|--------------|------------------|--------------|
| ** **                                           | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
|                                                 |         |             |         |   |   |   |   |
| Cash flows  from operating activities:               |         |             |         |   |   |   |   |
| Cash paid to suppliers                               |         | $                | (92          | ) | (56 | ) | (107 | ) |
| Net cash used in operating activities                |         | (92              | )            | (56 | ) | (107 | ) |
|                                                 |         |             |         |   |   |   |   |
| Cash flows  from investing activities:               |         |             |         |   |   |   |   |
| Repayment of subsidiary advance, net                 |         | 75               |         | 49 |   | 6 |   |
| Dividends received from subsidiary                   |         | 150              |         | 100 |   | 349 |   |
| Net cash provided by investing activities            |         | 225              |         | 149 |   | 355 |   |
|                                                 |         |             |         |   |   |   |   |
| Cash flows  from financing activities:               |         |             |         |   |   |   |   |
| Dividends paid                                       |         | (427             | )            | (279 | ) | (206 | ) |
| Proceeds from sale of common stock                   |         | 235              |         | 234 |   | 23 |   |
| Net cash used in financing activities                |         | (192             | )            | (45 | ) | (183 | ) |
|                                                 |         |             |         |   |   |   |   |
| Net increase (decrease) in cash and cash equivalents |         | (59              | )            | 48 |   | 65 |   |
|                                                 |         |             |         |   |   |   |   |
| Cash and  cash equivalents at beginning of period    |         | 145              |         | 97 |   | 32 |   |
|                                                 |         |             |         |   |   |   |   |
| Cash and  cash equivalents at end of year            |         | $                | 86           |   | 145 |   | 97 |   |

 

83

----

 
| *** ***                                                                                                                                        | *** *** | **In Thousands** | *** *** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------|--------------|------------------|--------------|
| ** **                                                                                                                                          | ** **   | **2005**         | ** **   | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                                |         |             |         |   |   |   |   |
| Reconciliation of net earnings to net cash  used in operating operating activities:                                                                 |         |             |         |   |   |   |   |
| Net earnings                                                                                                                                        |         | $                | 2,085        |   | 1,606 |   | 829 |   |
|                                                                                                                                                |         |             |         |   |   |   |   |
| Adjustments to reconcile net earnings to  net cash used in operating activities:                                                                    |         |             |         |   |   |   |   |
| Equity in earnings of commercial bank  subsidiary                                                                                                   |         | (2,138           | )            | (1,588 | ) | (889 | ) |
| Increase in assets                                                                                                                                  |         | (39              | )            | (74 | ) | (47 | ) |
| Total adjustments                                                                                                                                   |         | (2,177           | )            | (1,662 | ) | (936 | ) |
|                                                                                                                                                |         |             |         |   |   |   |   |
| Net cash used in operating activities                                                                                                               |         | $                | (92          | ) | (56 | ) | (107 | ) |
|                                                                                                                                                |         |             |         |   |   |   |   |
| Supplemental Schedule of Non-Cash  Activities:                                                                                                 |         |             |         |   |   |   |   |
|                                                                                                                                                |         |             |         |   |   |   |   |
| Increase (decrease) in unrealized gain  (loss on available-for-sale securities, net of income taxes of $159,000,  $6,000 and $217,000, respectively |         | $                | (256         | ) | 12 |   | (353 | ) |

 

84

----

 

***(15)******                          Concentrationof Credit Risk***

 

Practicallyall of the Company’s loans, commitments, and commercial and standby letters ofcredit have been granted to customers in the Company’s market area.  Practically all such customers are depositorsof the Company.  The concentrations ofcredit by type of loan are set forth in note 2 to the consolidated financialstatements.

 

***(16)******                          EmployeeBenefit Plan***

 

The Company maintains a 401(K) plan whichcovers eligible employees.  All full timeemployees are eligible to participate. The plan provides for both employee and employer contributions.  For the years ended December 31, 2005,2004, and 2003 the Company contributed $107,000, $86,000 and $64,000,respectively.

 

***(17)******                          RegulatoryMatters and Restrictions on Dividends***

 

The Companyand its subsidiary is subject to regulatory capital requirements administeredby theFederal Deposit Insurance Corporation and the Tennessee Department of FinancialInstitutions.  Failure to meet capitalrequirements can initiate certain mandatory — and possibly additionaldiscretionary-actions by regulators that could, in that event, have a directmaterial effect on the institution’s financial statements.  The relevant regulations require the Companyand its subsidiary to meet specific capital adequacy guidelines that involvequantitative measures of the Company’s assets, liabilities and certainoff-balance- sheet items as calculated under regulatory accountingprinciples.  The Company’s capitalclassifications are also subject to qualitative judgments by the Regulatorsabout components, risk weightings and other factors.  Those qualitative judgments could also affectthe Company’s capital status and the amount of dividends the Company maydistribute.

 

The Companyand its subsidiary is required to maintain minimum amounts of capital to total “riskweighted” assets, as defined by the banking regulators.  The Company and its subsidiary is required tohave a minimum Tier I and Total Capital ratios of 4.0% and 8.0%,respectively.  The actual ratioswere 10.1% and 11.2% at December 31, 2005 and 11.0% and 12.1% at December 31,2004.  The leverage ratios at December 31,2005 and 2004 were 8.3% and 8.7%, respectively, and the minimum requirement was4.0%.

 

As of December 31,2005, the Company and its subsidiary is categorized as “well capitalized” underthe regulatory framework for prompt corrective action.  There are no conditions or events since thenotification that management believes have changed the Company’s category.

 

85

----

 

***(18)******                          StockOption Arrangement***

 

In December,1998, the Board of Directors of the Bank approved the Legends Bank 1998 StockOption Arrangement (the “1998 Arrangement”). The Arrangement provides for the granting of stock options, andauthorizes the issuance of common stock upon the exercise of such options, forup to 74,400 shares of common stock, to officers of the Bank and up to 33,600shares of common stock to the Directors of the Bank.

 

Under theStock Option Arrangement, stock option awards may be granted in the form ofincentive stock options or nonstatutory stock options.  Exercise prices of incentive stock optionsmust be equal to or greater than 100% of the fair market value of the commonstock on the grant date.

 

In April of2001 the Board of Directors of the Bank approved the 2001 Stock Option Plan(the “2001 Plan”).  The 2001 Planprovides for the granting of 215,998 shares of stock available foroptions.  Under the 2001 Plan, stockoption awards may be granted in the form of incentive stock options ornonstatutory stock options.

 

The Company’sstockholders approved Legends Bank 1998 Stock Option Arrangement and 2001 StockOption Plan.  The Company exchanged itsoptions with the holders of Legends Bank stock options under the 1998Arrangement and the 2001 Plan on an option-for-option basis.  Thus options that were outstanding under the1998 Arrangement and the 2001 Plan have been exchanged for options under theCompany’s Stock Option Plan.

 

Statement ofFinancial Accounting Standards (SFAS) No. 123, “Accounting for Stock BasedCompensation” as amended by SFAS No. 148, “Accounting for Stock-BasedCompensation - Transition and Disclosure” sets forth the methods forrecognition of cost of arrangements similar to those of the Company.  As is permitted, management has elected tocontinue accounting for the arrangement under APB Opinion 25 and relatedInterpretations in accounting for its arrangement.  However, under SFAS No. 123, the Companyis required to make proforma disclosures as if cost had been recognized inaccordance with the pronouncement.  Hadcompensation cost for the Company’s stock option arrangement been determinedbased on the fair value at the grant dates

 

for awards under the arrangement consistentwith the method of SFAS No. 123, the Company’s net earnings and basicearnings per common share and diluted earnings per common share would have beenreduced to the proforma amounts indicated below.

 

86

----

 
| ** **        | ** ** | ** **  | ** ** | **In Thousands, Except Per Share Amounts** | ** ** |
|-------------------|------------|-------------|------------|--------------------------------------------|------------|
| ** **        | ** ** | ** **  | ** ** | **2005**                                   | ** ** | **2004** | ** ** | **2003** | ** ** |
|              |       |        |       |                                       |       |   |   |   |   |
| Net earnings      |       | As Reported |       | $                                          | 2,085      |   | $ | 1,606 |   | $ | 829 |   |
|              |       | Proforma    |       | $                                          | 1,983      |   | $ | 1,576 |   | $ | 780 |   |
|              |       |        |       |                                       |       |   |   |   |   |
| Basic  earnings   |       | As Reported |       | $                                          | 1.47       |   | $ | 1.15 |   | $ | .60 |   |
| per common share  |       | Proforma    |       | $                                          | 1.39       |   | $ | 1.13 |   | $ | .57 |   |
|              |       |        |       |                                       |       |   |   |   |   |
| Diluted  earnings |       | As Reported |       | $                                          | 1.42       |   | $ | 1.12 |   | $ | .59 |   |
| per common share  |       | Proforma    |       | $                                          | 1.35       |   | $ | 1.10 |   | $ | .55 |   |

 

A summary of the stock option activity is as follows:

 
| ** **                       | ** ** | **2005**   | ** ** | **2004**     | ** ** | **2003**   | ** ** |
|----------------------------------|------------|------------|------------|--------------|------------|------------|------------|
| ** **                       | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Average**  | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                       | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                       | ** ** | **Shares** | ** ** | **Price**    | ** ** | **Shares** | ** ** | **Price** | ** ** | **Shares** | ** ** | **Price** | ** ** |
|                             |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Outstanding at beginning of year |       | 232,006    |       | $            | 16.19      |       | 258,754    |   | $ | 15.42 |   | 259,860 |   | $ | 15.38 |   |
| Granted                          |       | 38,000     |       | 17.00        |       | —     |       | — |   | 6,720 |   | 16.98 |   |
| Exercised                        |       | (18,602    | )          | 12.62        |       | (26,748    | )          | 8.80 |   | (2,666 | ) | 8.33 |   |
| Forfeited                        |       | (3,500     | )          | 18.75        |       | —     |       | — |   | (5,160 | ) | 18.75 |   |
| Outstanding at end of year       |       | 247,904    |       | $            | 16.54      |       | 232,006    |   | $ | 16.19 |   | 258,754 |   | $ | 15.42 |   |
|                             |       |       |       |         |       |       |       |   |   |   |   |   |   |
| Options exercisable at year end  |       | 247,904    |       |         |       | 193,317    |       |   |   | 198,952 |   |   |   |

 

The following table summarizes information about fixed stock optionsoutstanding at December 31, 2005:

 
| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **               | ** ** | ** **              | ** ** | ** **              | ** ** | **Weighted** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **               | ** ** | ** **              | ** ** | **Weighted**            | ** ** | **Average** | ** ** | ** ** | ** ** | **Weighted** | ** ** |
| **Range of**             | ** ** | **Number**              | ** ** | **Average**             | ** ** | **Remaining** | ** ** | **Number** | ** ** | **Average** | ** ** |
| **Exercise**             | ** ** | **Outstanding**         | ** ** | **Exercise**            | ** ** | **Contractual** | ** ** | **Exercisable** | ** ** | **Exercise** | ** ** |
| **Prices**               | ** ** | **at 12/31/05**         | ** ** | **Price**               | ** ** | **Life** | ** ** | **at 12/31/05** | ** ** | **Price** | ** ** |
|                     |       |                    |       |                    |       |   |   |   |   |   |   |
| $ 8.33              |       | 46,084                  |       | $                       | 8.33       |   | 3.0 years |   | 46,084 |   | $ | 8.33 |   |
| $ 17 - $ 18.75 |       | 201,820                 |       | $                       | 18.42      |   | 6.1 years |   | 201,820 |   | $ | 18.42 |   |
|                     |       |                    |       |                    |       |   |   |   |   |   |   |
|                     |       | 247,904                 |       |                    |       |   |   | 247,904 |   |   |   |

 

87

----

 

Certainforfeited options were reallocated to remaining plan participants during 2005.

 

The fair valueof options granted in 2005, 2004 and 2003 was $1.41, $1.55 and $1.41,respectively, for each option.  The fairvalue was estimated using the Black-Scholes option-pricing model using the followingassumptions:  risk free rate of 4.19%,4.05% and 4.70%; expected life of ten years; volatility of 0.01%; and dividendyield of 3.00% for 2005 and 2.88% for 2004 and 2003.

 

***(19)******                          EarningsPer Share***

 

Statement ofFinancial Accounting Standards (SFAS) No. 128 “Earnings Per Share”establishes uniform standards for computing and presenting earnings pershare.  The computation of basic earningsper share is based on the weighted average number of common shares outstandingduring the period.  For the Company, thecomputation of diluted earnings per share begins with the basic earnings pershare plus the effect of common shares contingently issuable from stock optionsand warrants.

 

The followingis a summary of the components comprising basic and diluted earnings per commonshare (EPS):

 
| ** **                                                               | ** ** | **In Thousands,**                      | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                               | ** ** | **Except Share and Per Share Amounts** | ** ** |
| ** **                                                               | ** ** | **2005**                               | ** ** | **2004** | ** ** | **2003** | ** ** |
| Basic EPS Computation:                                                   |       |                                   |       |   |   |   |   |
| Numerator – Net earnings for the year                               |       | $                                      | 2,085      |   | 1,606 |   | 829 |   |
|                                                                     |       |                                   |       |   |   |   |   |
| Denominator – Weighted average number of  common shares outstanding |       | 1,421,824                              |       | 1,399,524 |   | 1,379,764 |   |
| Basic earnings per common share                                          |       | $                                      |  1.47 |   | 1.15 |   | .60 |   |
|                                                                     |       |                                   |       |   |   |   |   |
| Diluted EPS Computation:                                                 |       |                                   |       |   |   |   |   |
| Numerator – Net earnings for the year                               |       | $                                      | 2,085      |   | 1,606 |   | 829 |   |
|                                                                     |       |                                   |       |   |   |   |   |
| Denominator:                                                             |       |                                   |       |   |   |   |   |
| Weighted average number of common shares  outstanding                    |       | 1,421,824                              |       | 1,399,524 |   | 1,379,764 |   |
|                                                                     |       |                                   |       |   |   |   |   |
| Dilutive effect of stock options                                         |       | 49,346                                 |       | 33,148 |   | 31,967 |   |
|                                                                     |       | 1,471,170                              |       | 1,432,672 |   | 1,411,731 |   |
|                                                                     |       |                                   |       |   |   |   |   |
| Diluted earnings per common share                                        |       | $                                      | 1.42       |   | 1.12 |   | .59 |   |
|                                                                          |            |                                        |            |  |  |  |  |  |  |

 

88

----

 

***(20)         DisclosuresAbout Fair Value of Financial Instruments***

 

Statement ofFinancial Accounting Standards (SFAS) No. 107, “Disclosures about FairValue of Financial Instruments” requires that the Company disclose estimatedfair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below forthe Company’s financial instruments.

 

*Cash and short-term investments*

 

For those short-term instruments, the carrying amount is a reasonableestimate of fair value.

 

*Federal Funds Sold*

 

Federal funds sold clear on a daily basis.  For this reason, the carrying amount is areasonable estimate of fair value.

 

*Investments and Mortgage-Backed Securities*

 

The carryingamounts for short-term securities approximate fair value because they mature in90 days or less and do not present unanticipated credit concerns.  The fair value of longer-term securities andmortgage-backed securities, except certain state and municipal securities, isestimated based on bid prices published in financial newspapers or bidquotations received from securities dealers. The fair value of certain state and municipal securities is not readily available through market sourcesother than dealer quotations, so fair value estimates are based on quotedmarket prices of similar instruments, adjusted for differences between thequoted instruments and the instruments being valued.

 

SFAS No. 107specifies that fair values should be calculated based on the value of one unitwithout regard to any premium or discount that may result from concentrationsof ownership of a financial instrument, possible tax ramifications, orestimated transaction costs. Accordingly, these considerations have not been incorporated into thefair value estimates.

 

*Loans*

 

Fair valuesare estimated for portfolios of loans with similar financialcharacteristics.  Loans are segregated bytype such as commercial, mortgage, credit card and other consumer.  Each loan category is further segmented intofixed and adjustable rate interest terms.

 

The fair valueof the various categories of loans is estimated by discounting the future cashflows using the current rates at which similar loans would be made to borrowerswith similar credit ratings and for the same remaining average estimatedmaturities.

 

89

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*Loans,Continued*

 

The estimatedmaturity for mortgages is modified from the contractual terms to giveconsideration to management’s experience with prepayments.  Management has made estimates of fair valuediscount rates that it believes to be reasonable.  However, because there is no market for manyof these financial instruments, management has no basis to determine whetherthe fair value presented below would be indicative of the value negotiated inan actual sale.

 

The value ofthe loan portfolio is also discounted in consideration of the credit quality ofthe loan portfolio as would be the case between willing buyers and sellers.  Particular emphasis has been given to loanson the subsidiary bank’s internal watch list. Valuation of these loans is based upon borrower performance, collateralvalues (including external appraisals), etc.

 

*Deposit Liabilities*

 

The fair valueof demand deposits, savings accounts and certain money market deposits is theamount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposit is estimatedusing the rates currently offered for deposits of similar remainingmaturities.  Under the provision of SFAS No. 107the fair value estimates for deposits does not include the benefit that resultsfrom the low cost funding provided by the deposit liabilities compared to thecost of borrowing funds in the market.

 

*Advances from Federal Home Loan Bank*

 

The fair valueof these advances is estimated by discounting the future payments using thecurrent rates at which similar advances could be obtained for the sameremaining average maturities.

 

*Securities Sold Under Repurchase Agreements*

 

The securitiessold under repurchase agreements are payable upon demand.  For this reason the carrying amount is areasonable estimate of fair value.

 

90

----

 

*Commitmentsto Extend Credit, Standby Letters of Credit and Financial Guarantees Written*

 

Loancommitments are made to customers generally for a period not to exceed one yearand at the prevailing interest rates in effect at the time the loan isclosed.  Commitments to extend creditrelated to construction loans are made for a period not to exceed six monthswith interest rates at the current market rate at the date of closing.  In addition, standby letters of credit areissued for periods up to three years with rates to be determined at the datethe letter of credit is funded.  Fees areonly charged for the construction loans and the standby letters of credit andthe amounts unearned at December 31, 2005 and 2004 are insignificant.  Accordingly, these commitments have nocarrying value and management estimates the commitments to have no significantfair value.

 

The carryingvalue and estimated fair values of the Company’ financial instruments at December 31,2005 and 2004 are as follows:

 
| *** ***                                | *** *** | **In Thousands** | *** *** |
|---------------------------------------------|--------------|------------------|--------------|
| ** **                                  | ** **   | **2005**         | ** **   | **2004** | ** ** |
| ** **                                  | ** **   | **Carrying**     | ** **   | ** ** | ** ** | **Carrying** | ** ** | ** ** | ** ** |
| ** **                                  | ** **   | **Amount**       | ** **   | **Fair Value** | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| Financial assets:                           |         |             |         |   |   |   |   |   |   |
| Cash and short-term investments             |         | $                | 10,522       |   | 10,522 |   | 11,052 |   | 11,052 |   |
| Securities                                  |         | 46,623           |         | 46,623 |   | 37,580 |   | 37,580 |   |
| Restricted equity securities                |         | 781              |         | 1,118 |   | 655 |   | 912 |   |
| Federal funds sold                          |         | 11,616           |         | 11,616 |   | — |   | — |   |
| Loans                                       |         | 152,983          |         |   |   | 129,851 |   |   |   |
| Less: allowance for loan losses             |         | (1,758           | )            |   |   | (1,517 | ) |   |   |
| Loans, net of allowance                     |         | 151,225          |         | 148,987 |   | 128,334 |   | 127,895 |   |
|                                        |         |             |         |   |   |   |   |   |   |
| Financial liabilities:                      |         |             |         |   |   |   |   |   |   |
| Deposits                                    |         | 199,678          |         | 199,453 |   | 154,975 |   | 155,136 |   |
| Securities sold under repurchase agreements |         | 1,979            |         | 1,979 |   | 636 |   | 636 |   |
| Advances from FHLB                          |         | 9,795            |         | 9,573 |   | 8,919 |   | 8,761 |   |
| Federal funds purchased                     |         | —           |         | — |   | 3,804 |   | 3,804 |   |
|                                        |         |             |         |   |   |   |   |   |   |
| Unrecognized financial instruments:         |         |             |         |   |   |   |   |   |   |
| Commitments to extend credit                |         | —           |         | — |   | — |   | — |   |
| Standby letters of credit                   |         | —           |         | — |   | — |   | — |   |
|                                             |              |                  |              |  |  |  |  |  |  |  |

 

91

----

 

*Limitations*

 

Fair valueestimates are made at a specific point in time, based on relevant marketinformation and information about the financial instruments.  These estimates do not reflect any premium ordiscount that could result from offering for sale at one time the Company’sentire holdings of a particular financial instrument.  Because no market exists for a significantportion of the Company’s financial instruments, fair value estimates are basedon judgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors.  These estimates are subjectivein nature and involve uncertainties and matters of significant judgment andtherefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

Fair valueestimates are based on estimating on-and-off-balance sheet financialinstruments without attempting to estimate the value of anticipated futurebusiness and the value of assets and liabilities that are not consideredfinancial instruments.  For example, theCompany has a mortgage department that contributes net fee incomeannually.  The mortgage department is notconsidered a financial instrument, and its value has not been incorporated intothe fair value estimates.  Othersignificant assets and liabilities that are not considered financial assets orliabilities include deferred tax assets and liabilities and property, plant andequipment.  In addition, the taxramifications related to the realization of the unrealized gains and losses canhave a significant effect on fair value estimates and have not been consideredin the estimates.

 

***(21)******                          QuarterlyFinancial Data (Unaudited)***

 

Selected quarterly results of operations for the four quarters ended December 31are as follows:

 
| *** ***                       | *** *** | **In Thousands, except per share data** | *** *** |
|------------------------------------|--------------|-----------------------------------------|--------------|
| ** **                         | ** **   | **2005**                                | ** **   | **2004** | ** ** |
| ** **                         | ** **   | **FourthQuarter**                       | ** **   | **Third****Quarter** | ** ** | **Second****Quarter** | ** ** | **First****Quarter** | ** ** | **Fourth****Quarter** | ** ** | **Third****Quarter** | ** ** | **Second****Quarter** | ** ** | **First****Quarter** | ** ** |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest income                    |         | $                                       | 3,227        |   | 2,917 |   | 2,843 |   | 2,556 |   | 2,469 |   | 2,250 |   | 2,102 |   | 2,033 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net interest income                |         | 1,968                                   |         | 1,840 |   | 1,935 |   | 1,858 |   | 1,849 |   | 1,692 |   | 1,595 |   | 1,556 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Provision for possible loan losses |         | 145                                     |         | 25 |   | 75 |   | 60 |   | 120 |   | 110 |   | 90 |   | 120 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Earnings before income taxes       |         | 858                                     |         | 789 |   | 700 |   | 749 |   | 735 |   | 551 |   | 528 |   | 488 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net earnings                       |         | 615                                     |         | 523 |   | 458 |   | 489 |   | 488 |   | 422 |   | 362 |   | 334 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic earnings per common share    |         | .43                                     |         | .37 |   | .32 |   | .35 |   | .35 |   | .30 |   | .26 |   | .24 |   |
|                               |         |                                    |         |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Diluted earnings per common share  |         | .41                                     |         | .36 |   | .31 |   | .34 |   | .34 |   | .29 |   | .26 |   | .23 |   |
|                                    |              |                                         |              |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

92

----

 

***(22)******                          ProposedCommon Stock Share Reclassification***

 

On December 20,2005, the Company’s Board of Directors voted to reclassify common stock toreduce the number of record holders of common stock below 300 for the purposeof going private.

 

To facilitatethis transaction a proposal to amend the Company charter and to reclassifycommon stock will be presented to Company shareholders for a vote.  Under the proposal, shares of existing commonstock held by shareholders who own between 500 and 1,500 shares will bereclassified into shares of Class A common stock.  Shares of existing common stock held byshareholders who own less than 500 shares will be reclassified into shares of Class Bcommon stock.  The reclassifications willbe made on the basis of one share of Class A or Class B common stockfor each share of common stock held.  Theproposal is subject to shareholder and regulatory approval.

 

***(23)******                          SubsequentEvent***

 

The Bank provides ACH services for a numberof its customers, one of which is an online payment processor (Legends’customer).  In late January andearly February, 2006, it was determined that one of the clients of the onlinepayment processor was operating a ponzi scheme. After the resulting payments were credited, a large level of ACH returnswere initiated, which Legends Bank is required to honor for a period of 60 daysfrom the initial transaction.  Through March 24,2006 the Bank has honored $15.5 million of returns, in accordance with the ACHagreement signed with Legends’ customer. The Bank continues to hold sufficient funds of its customer as of March 24,2006 to cover any remaining liability from ACH return activity.  By virtue of honoring its ACH returns andpreventing returns from other processors, Legends may have some potentialfuture liability to those parties. However, it is the opinion of both management and legal counsel that anyfurther liabilities arising from the aforementioned information are currentlyunknown and indeterminable from existing facts.

 

93

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## **ITEM 8.  CHANGES IN ANDDISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

## ** **

There havebeen no disagreements with Legends Financial’s independent auditors on anymatters of accounting principles or practices or financial statementdisclosure.

 

## **ITEM 8A.  CONTROLS ANDPROCEDURES.**

## ** **

### **Evaluation ofDisclosure Controls and Procedures**

### ** **

LegendsFinancial maintains disclosure controls and procedures, as defined in Rule 13a-15(a) promulgatedunder the Securities Exchange Act of 1934 (the “Exchange Act”), that aredesigned to ensure that information required to be disclosed by it in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time period specified in the SEC’s rules andforms and that such information is accumulated and communicated to LegendsFinancial’s management, including its Chief Executive Officer and ChiefFinancial Officer, as appropriate, to allow timely decisions regarding requireddisclosure. Legends Financial carried out an evaluation, under the supervisionand with the participation of its management, including its Chief ExecutiveOfficer and Chief Financial Officer, of the effectiveness of the design andoperation of its disclosure controls and procedures as of the end of the periodcovered by this report. Based on the evaluation of these disclosure controlsand procedures, the Chief Executive Officer and Chief Financial Officerconcluded that Legends Financial’s disclosure controls and procedures wereeffective.

 

### **Changes inInternal Controls**

### ** **

There were nochanges in Legends Financial’s internal control over financial reporting duringLegends Financial’s fiscal quarter ended December 31, 2005 that havematerially affected, or are reasonably likely to materially affect, itsinternal control over financial reporting.

 

## **ITEM 8B.  OTHER INFORMATION**

## ** **

None.

 

# **PART III**

# ** **

## **ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT**

## ** **

Informationwith respect to the directors and executive officers is incorporated herein byreference to the Proxy Statement relating to the Annual Meeting of Shareholdersto be filed with the SEC.

 

## **ITEM 10. EXECUTIVE COMPENSATION**

## ** **

Informationwith respect to executive compensation is incorporated herein by reference tothe Proxy Statement relating to the Annual Meeting of Shareholders to be filedwith the SEC.

 

## **ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ANDRELATED STOCKHOLDER MATTERS**

## ** **

Informationwith respect to the security ownership of certain beneficial owners andmanagement is incorporated herein by reference to the Proxy Statement relatingto the Annual Meeting of Shareholders to be filed with the SEC.

 

94

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## **ITEM 12.  CERTAIN RELATIONSHIPSAND RELATED TRANSACTIONS**

## ** **

Informationwith respect to certain relationships and related transactions is incorporatedherein by reference to the Proxy Statement relating to the Annual Meeting ofShareholders to be filed with the SEC.

 

## **ITEM 13.  EXHIBITS**

## ** **

List of Exhibits Filed. None.

 

## **ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES**

## ** **

Informationwith respect to certain relationships and related transactions is incorporatedherein by reference to the Proxy Statement relating to the Annual Meeting ofShareholders to be filed with the SEC.

 

# **INDEX OF EXHIBITSDESCRIPTION OF EXHIBITS**

 
| **EXHIBIT NO.** | ** ** |                                                                                                                                      |
|----------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                      |
| 3.1                  |       | Charter of  Legends Financial Holdings, Inc.*                                                                                        |
| 3.2                  |       | Bylaws for  Legends Financial Holdings, Inc.*                                                                                        |
| 4                    |       | Specimen  Stock Certificate for Legends Financial Holdings, Inc.*                                                                    |
| 10.1                 |       | 2001  Statutory and Non-Statutory Stock Option Plan for Legends Financial Holdings, Inc.,  as successor-in-interest to Legends Bank* |
| 21                   |       | Subsidiaries  of Registrant **                                                                                                            |
| 31.1                 |       | Certification  pursuant to Rule 13a-14a/15d-14(a)                                                                                    |
| 31.2                 |       | Certification  pursuant to Rule 13a-14a/15d-14(a)                                                                                    |
| 32.1                 |       | Certification  pursuant to Rule 18 USC Section 1350-Sarbanes-Oxley Act of 2002                                                  |
| 32.2                 |       | Certification  pursuant to Rule 18 USC Section 1350-Sarbanes-Oxley Act of 2002                                                  |

 

----

* Incorporated by reference to Form 10-SB filed by LegendsFinancial with the Commission on November 22, 2002.

 

** Incorporated by reference to Form 10-KSB for the year ended December 31,2004 filed by Legends Financial with the Commission on March 31, 2005.

 

95

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# **SIGNATURES**

# ** **

In accordance with Section 13 or 15(d) of the Exchange Act,the Registrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|   | LEGENDS FINANCIAL HOLDINGS, INC. |                                  |
|--------|----------------------------------|---------------------------------------|
|   | (Registrant)                     |
|   |                             |                                  |   |
|   | By:                              | /s/ Billy P. Atkins                   |   |
|   |                             | Billy P.  Atkins, President and Chief |   |
|   |                             | Executive  Officer                    |   |
|   |                             |                                  |   |
|   | Date:                            | March 31, 2006                        |   |
|        |                                  |                                       |  |  |  |  |

 

In accordance with the Exchange Act, this report has been signed belowby the following persons on behalf of the Registrant and in the capacities andon the dates indicated.

 

 
|   | By:    | /s/ Billy P. Atkins                   |   |
|--------|--------|---------------------------------------|--------|
|   |   | Billy P.  Atkins, President and Chief |   |
|   |   | Executive  Officer, Director          |   |
|   |   |                                  |   |
|   | Date:  |  March  31, 2006                 |   |
|        |        |                                       |        |  |

 

 
|   | By:    | /s/ Thomas E. Bates                                                                            |   |
|--------|--------|------------------------------------------------------------------------------------------------|--------|
|   |   | Thomas E.  Bates, Jr., Executive Vice   President and Chief Financial Officer,   Director |   |
|   |   |                                                                                           |   |
|   | Date:  | March 31, 2006                                                                                 |   |
|        |        |                                                                                                |        |  |

 

 
|   | By:    | /s/ James D. Amos        |   |
|--------|--------|--------------------------|--------|
|   |   | James D.  Amos, Director |   |
|   |   |                     |   |
|   | Date:  | March 31, 2006           |   |
|        |        |                          |        |  |

 

 
|   | By:    | /s/ Mark Ray Barnett        |   |
|--------|--------|-----------------------------|--------|
|   |   | Mark Ray  Barnett, Director |   |
|   |   |                        |   |
|   | Date:  | March 31, 2006              |   |
|        |        |                             |        |  |

 

96

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|   | By:    | /s/ William D. Dickson                  |   |
|--------|--------|-----------------------------------------|--------|
|   |   | William D.  Dickson, Sr., Director |   |
|   |   |                                    |   |
|   | Date:  | March 31, 2006                          |   |
|        |        |                                         |        |  |

 

 
|   | By:    | /s/ Ronald Alan Goad        |   |
|--------|--------|-----------------------------|--------|
|   |   | Ronald Alan  Goad, Director |   |
|   |   |                        |   |
|   | Date:  |  March  31, 2006       |   |
|        |        |                             |        |  |

 

 
|   | By:    | /s/ Dick Wright Littleton        |   |
|--------|--------|----------------------------------|--------|
|   |   | Dick Wright  Littleton, Director |   |
|   |   |                             |   |
|   | Date:  | March 31, 2006                   |   |
|        |        |                                  |        |  |

 

 
|   | By:    | /s/ David P. Nussbaumer        |   |
|--------|--------|--------------------------------|--------|
|   |   | David P.  Nussbaumer, Director |   |
|   |   |                           |   |
|   | Date:  | March 31, 2006                 |   |
|        |        |                                |        |  |

 

 
|   | By:    | /s/ Pravin Chhagan Patel        |   |
|--------|--------|---------------------------------|--------|
|   |   | Pravin  Chhagan Patel, Director |   |
|   |   |                            |   |
|   | Date:  | March 31, 2006                  |   |
|        |        |                                 |        |  |

 

 
|   | By:    | /s/ Jimmy Terry                  |   |
|--------|--------|----------------------------------|--------|
|   |   | Jimmy  Terry, Sr., Director |   |
|   |   |                             |   |
|   | Date:  |  March  31, 2006            |   |
|        |        |                                  |        |  |

 
|   | By:    | /s/ Francis Gene Washer        |   |
|--------|--------|--------------------------------|--------|
|   |   | Francis Gene  Washer, Director |   |
|   |   |                           |   |
|   | Date:  |  March  31, 2006          |   |
|        |        |                                |        |  |

 

97

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|   | By:    | /s/ Ralph D. Weiland        |   |
|--------|--------|-----------------------------|--------|
|   |   | Ralph D.  Weiland, Director |   |
|   |   |                        |   |
|   | Date:  |  March  31, 2006       |   |
|        |        |                             |        |  |

 

98

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