UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K




(Mark
One)





T
            ANNUAL
      REPORT  PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
      EXCHANGE ACT OF 1934


For the
fiscal ended December 31, 2008.


or




*          
TRANSITION REPORT PURSUANT TO
SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934


For the
transition period from ______________ to ______________.





Commission
file number: 000-52748



















FIRST GUARANTY
BANCSHARES, INC.


(Exact
name of registrant as specified in its charter)





Louisiana
            26-0513559(State
      or other jurisdiction
            (I.R.S.
      Employerincorporation
      or organization)
            Identification
      Number)400
      East Thomas StreetHammond,
      Louisiana
            70401(Address
      of principal executive offices)
            (Zip
      Code)(985)
      345-7685(Registrant’s
      telephone number, including area code)Not
      Applicable(Former
      name or former address, if changed since last report)Securities
      registered pursuant to Section 12(b) of the
      Act:  NoneSecurities
      registered pursuant to Section 12(g) of the Act:Title of each
      class
            Name of each exchange
      on which registeredCommon
      Stock, $1 par value per share
            None








Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


YES *                                     NO
T





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


YES *                                    NO
T





Indicate
by check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.  YES T        NO
*





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K.T





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





Large
accelerated filer * Accelerated
filer  *                               Non-accelerated
filer  *                                Smaller
reporting company  T








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Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).   YES *     NO
T





The
aggregate market value of the voting stock held by non-affiliates of the
registrant as of June 30, 2008 was $72,174,350 based upon the price from the
last trade which occurred on June 30, 2008 in which 1,400 shares were traded at
a price of $25.00 per share.  The common stock is not quoted or traded
on an exchange and there is no established or liquid market for the common
stock.





As of
March 27, 2009, there were issued and outstanding 5,559,644 shares of the
Registrant’s Common Stock.





DOCUMENTS
INCORPORATED BY REFERENCE:
 (1)  Proxy
Statement for the 2009 Annual Meeting of Stockholders of the Registrant (Part
III).





- 2
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 Table of Contents


TABLE OF CONTENTS





PagePart
      I.Item
      1
              Business
              4Item
      1A
              Risk Factors
              12Item
      1B
              Unresolved Staff Comments
              16Item
      2
              Properties
              17Item
      3
              Legal Proceedings
              18Item
      4
              Submissions of Matters to a Vote of Security
      Holders
              18Part
      II.Item
      5
              Market for Registrant's Common Equity, Related Stockholder
      Matters and IssuerPurchases of Equity Securities
              18Item
      6
              Selected Financial Data
              19Item
      7
              Management's Discussion and Analysis of Financial Condition
      and Resultsof Operations
              20Item
      7A
              Quantitative and Qualitative Disclosures about Market
      Risk
              41Item
      8
              Financial Statements and Supplementary
    Data
              43Item
      9
              Changes in and Disagreements with Accountants on Accounting
      and FinancialDisclosures
              68Item
      9a(T)
              Controls and Procedures
              68Item
      9b
              Other Information
              68Part
      III.Item
      10
              Directors, Executive Officers and Corporate
      Governance
              69Item
      11
              Executive Compensation
              69Item
      12
              Security Ownership of Certain Beneficial Owners, Management
      and Related Stockholder
              69MattersItem
      13
              Certain Relationships and Related Transactions and Director
      Independence
              69Item
      14
              Principal Accountant Fees and Services
              69Part
      IV.Item
      15
              Exhibits and Financial Statement
    Schedules
              70



















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PART
1





Item 1 – Business


Background


First
Guaranty Bancshares, Inc. (the “Company”) is a bank holding company
headquartered in Hammond, Louisiana with one wholly owned subsidiary, First
Guaranty Bank (the “Bank”). At December 31, 2008, the Company had total
consolidated assets of $871.4 million with $66.6 million in total consolidated
stockholders’ equity. The Company’s executive office is located at 400 East
Thomas Street, Hammond, Louisiana 70401. The telephone number is (985) 345-7685.
The Company is subject to extensive regulation by the Federal Reserve Bank
(“FRB”).


First
Guaranty Bank is a state chartered commercial bank with 16 full-service banking
facilities and one drive-up only facility located in southeast, southwest and
north Louisiana. The Bank was organized under Louisiana law under the name
Guaranty Bank and Trust Company in 1934 and changed its name to First Guaranty
Bank in 1971. Deposits are insured up to the maximum legal limits by the FDIC.
The Bank is not a member of the Federal Reserve System. As of December 31, 2008,
the Bank was the eighth largest Louisiana-based bank and the fifth largest
Louisiana bank not headquartered in New Orleans, as measured by total
assets.





Business
Objective


The Company’s
business objective is to be a bank holding company of a customer-driven
financial institution focused on providing value to customers by delivering
products and services matched to customer needs. We emphasize personal
relationships and localized decision making. The Board of Directors and senior
Management have extensive experience and contacts in our marketplace and are an
important source of new business opportunities.


The Company’s
business plan emphasizes both growth and profitability. From December 31, 2003
to December 31, 2008, assets have grown from $484.7 million to $871.4 million.
During this period, the number of full-service banking center locations
increased from 15 locations to 17 locations.





Market
Areas


Our focus is
on the bedroom communities of metropolitan markets, small cities and rural areas
in southeast, southwest and north Louisiana. In southeast Louisiana, seven
branches are located in Tangipahoa Parish in the towns of Amite, Hammond (2),
Independence, Kentwood and Ponchatoula (2). Two branches are located in
Livingston Parish, one branch in Denham Springs and the other in Walker. In
southwest Louisiana, we have branches in Abbeville and Jennings which are
located in Vermillion Parish and Jefferson Davis Parish, respectively. The
remaining six branches are located in north Louisiana, in Haynesville and Homer,
which are both in Claiborne Parish; in Oil City and Vivian, both in Caddo
Parish; in Dubach in Lincoln Parish and Benton, in Bossier Parish. Our core
market remains in the home parish of Tangipahoa where approximately 46.6% of
deposits and 54.6% of net loans were based in 2008.


Our southeast
Louisiana market is strategically located near the intersection of Interstates
12 and 55, which places it at a crossroads of commercial activity for the
southeastern United States. In addition, this market area is largely populated
by the work force of several nearby petrochemical refineries and other
industrial plants and is a bedroom community for the urban centers of New
Orleans and Baton Rouge, which are approximately 45 miles and 60 miles,
respectively, from Hammond, where the main office is located. Hammond is home to
one of the largest medical centers in the state of Louisiana and the third
largest state university in Louisiana.


Our southwest
Louisiana market benefits from a profitable casino gaming industry and
substantial tourism revenue derived from the Louisiana Acadian culture. It also
has a concentration of oilfield and oilfield services activity and is a thriving
agricultural center for rice, sugarcane and crawfish.


Timber
cultivation and its related industries, including milling and logging, are key
commercial activities in the north Louisiana market. It is also an agrarian
center in which corn, cotton and soybeans are the primary crops. The poultry
industry, including independent poultry grower farms that contract with national
poultry processing companies, are also very important to the local
economy.





Banking
Products and Services


The Company
offers personalized commercial banking services to businesses, professionals and
individuals. We offer a variety of deposit products including personal and
business checking and savings accounts, time deposits, money market accounts and
NOW accounts. Other services provided include personal and commercial credit
cards, remote deposit capture, safe deposit boxes, official checks, travelers’
checks, internet banking, online bill pay, mobile banking and lockbox services.
Also offered is 24-hour banking through internet banking, voice response and 25
automated teller machines. Although full trust powers have been granted, we do
not actively operate or have any present intentions to activate a trust
department.





Loans


The Bank is
engaged in a diversity of lending activities to serve the credit needs of its
customer base including commercial loans, commercial real estate loans, real
estate construction loans, mortgage loans, agricultural loans, home equity lines
of credit, equipment loans, inventory financing and student loans. In addition,
the Bank provides consumer loans for a variety of reasons such as the purchase
of automobiles, recreational vehicles or boats, investments or other consumer
needs. The Bank issues MasterCard and Visa credit cards and provides merchant
processing services to commercial customers. The loan portfolio is divided, for
regulatory purposes, into four broad classifications: (i) real estate loans,
which include all loans secured in whole or part by real estate; (ii)
agricultural loans, comprised of all farm loans; (iii) commercial and industrial
loans, which include all commercial and industrial loans that are not secured by
real estate; and (iv) consumer loans.





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Competition


The banking
business in Louisiana is extremely competitive. We compete for deposits and
loans with existing Louisiana and out-of-state financial institutions that have
longer operating histories, larger capital reserves and more established
customer bases. The competition includes large financial services companies and
other entities in addition to traditional banking institutions such as savings
and loan associations, savings banks, commercial banks and credit
unions.


Many of our
larger competitors have a greater ability to finance wide-ranging advertising
campaigns through their greater capital resources. Marketing efforts depend
heavily upon referrals from officers, directors and shareholders, selective
advertising in local media and direct mail solicitations. We compete for
business principally on the basis of personal service to customers, customer
access to officers and directors and competitive interest rates and
fees.


In the
financial services industry, intense market demands, technological and
regulatory changes and economic pressures have eroded industry classifications
in recent years that were once clearly defined. Financial institutions have been
forced to diversify their services, increase rates paid on deposits and become
more cost effective, as a result of competition with one another and with new
types of financial services companies, including non-banking competitors. Some
of the results of these market dynamics in the financial services industry have
been a number of new bank and non-bank competitors, increased merger activity,
and increased customer awareness of product and service differences among
competitors. These factors could affect business prospects.





Employees







Data
Processing


Since
November 2001, customer information has been housed on equipment owned by
Financial Information Service Corporation (FISC). FISC is a cooperative jointly
owned by a number of Louisiana and Mississippi state banks that are
currently serviced by FISC. The 2008 annual cost of this service was $639,000.
The current arrangements are adequate and are expected to be able to accommodate
our needs for the foreseeable future.





Information
Technology Infrastructure


Our wide area
network links more than 25 remote sites using a fully meshed multiple protocol
layered switch network with managed virtual private networking throughout.
Authentication is based on a Novell-Citrix hybrid network ecosystem. We have
over 400 secure networked devices on the First Guaranty Bank
network.  The employees are not limited to their branch location, but
instead can access the network and authenticate securely from any branch. We
have a redundant back-up site located at the far northwestern corner of the
state in Homer, Louisiana.





Subsidiaries


The Company
is a one-bank holding company with First Guaranty Bank as its subsidiary. The
Company also acquired a non-bank subsidiary during the Homestead Bank merger in
2007. Homestead Bancorp Trust I was a trust established for the sole purpose of
issuing trust preferred securities and using the proceeds to purchase junior
subordinated debentures issued by Homestead Bancorp. These securities were
assumed by the Company in connection with the acquisition of Homestead Bancorp
in 2007, but were redeemed in August of 2008.  Homestead Bancorp Trust
I was dissolved on December 16, 2008.




Bank
Regulatory Compliance


First
Guaranty Bank is a Federal Deposit Insurance Corporation (“FDIC”) insured,
non-member Louisiana state bank. Regulation of financial institutions is
intended primarily to protect depositors, the deposit insurance funds of the
FDIC and the banking system as a whole, and generally is not intended to protect
stockholders or other investors.


The Bank is
subject to regulation and supervision by both the Louisiana Office of Financial
Institutions and the FDIC. In addition, the Bank is subject to various
requirements and restrictions under federal and state law, including
requirements to maintain reserves against deposits, restrictions on the types
and amounts of loans that are made and the interest that is charged on those
loans, and limitations on the types of investments that are made and the types
of services that are offered. Various consumer laws and regulations also affect
operations. See “Bank Regulation and Supervision.”





Bank
Regulation and Supervision


Banking is a
complex, highly regulated industry. Consequently, the growth and earnings
performance of First Guaranty Bancshares, Inc. and its subsidiary bank can be
affected not only by Management decisions and general and local economic
conditions, but also by the statutes administered by, and the regulations and
policies of, various governmental regulatory authorities. These authorities
include, but are not limited to, the FRB, the FDIC, the Louisiana Office of
Financial Institutions (“OFI”) the U.S. Internal Revenue Service and state
taxing authorities. The effect of these statutes, regulations and policies and
any changes to any of them can be significant and cannot be
predicted.





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The primary
goals of the regulatory scheme are to maintain a safe and sound banking system
and to facilitate the conduct of sound monetary policy. In furtherance of these
goals, Congress has created several largely autonomous regulatory agencies and
enacted numerous laws that govern banks, bank holding companies and the banking
industry. The system of supervision and regulation applicable to First Guaranty
Bancshares, Inc. establishes a comprehensive framework for their respective
operations and is intended primarily for the protection of the FDIC’s deposit
insurance funds, depositors and the public, rather than the shareholders and
creditors. The following is an attempt to summarize some of the relevant laws,
rules and regulations governing banks and bank holding companies, but does not
purport to be a complete summary of all such applicable laws, rules and
regulations. The descriptions are qualified in their entirety by reference to
the specific statutes and regulations discussed.





First
Guaranty Bancshares, Inc.


General. First
Guaranty Bancshares, Inc. is a bank holding company registered with, and subject
to regulation by, the FRB under the Bank Holding Company Act of 1956, as amended
(the “Bank Holding Company Act”). The Bank Holding Company Act and other federal
laws subject bank holding companies to particular restrictions on the types of
activities in which they may engage, and to a range of supervisory requirements
and activities, including regulatory enforcement actions for violations of laws
and regulations.


In accordance
with FRB policy, a bank holding company, such as First Guaranty Bancshares,
Inc., is expected to act as a source of financial strength to its subsidiary
banks and commit resources to support its banks. This support may be required
under circumstances when we might not be inclined to do so absent this FRB
policy.  The Company is required to obtain prior written approval
before engaging in any of the following:


·
            Incurring
      any indebtedness;


·
            Declaring
      or paying any corporate dividend;
and


·
            Redeeming
      any corporate stock.





Certain
Acquisitions. Federal law requires every bank holding company to obtain
the prior approval of the FRB before (i) acquiring more than five percent of the
voting stock of any bank or other bank holding company, (ii) acquiring all or
substantially all of the assets of any bank or bank holding company or (iii)
merging or consolidating with any other bank holding company.


Additionally,
federal law provides that the FRB may not approve any of these transactions if
it would result in or tend to create a monopoly or substantially lessen
competition or otherwise function as a restraint of trade, unless the
anti-competitive effects of the proposed transaction are clearly outweighed by
the public interest in meeting the convenience and needs of the community to be
served. The FRB is also required to consider the financial and managerial
resources and future prospects of the bank holding companies and banks concerned
and the convenience and needs of the community to be served. Further, the FRB is
required to consider the record of a bank holding company and its subsidiary
bank(s) in combating money laundering activities in its evaluation of bank
holding company merger or acquisition transactions.


Under the
Bank Holding Company Act, if adequately capitalized and adequately managed, any
bank holding company located in Louisiana may purchase a bank located outside of
Louisiana. However, as discussed below, restrictions currently exist on the
acquisition of a bank that has only been in existence for a limited amount of
time or will result in specified concentrations of deposits.





Change in Bank
Control. The Bank Holding Company Act and the Change in Bank Control Act
of 1978, as amended, generally require FRB approval prior to any person or
company acquiring control of a bank holding company. Control is conclusively
presumed to exist if an individual or company acquires 25% or more of any class
of voting securities of the bank holding company. Control is rebuttably presumed
to exist if a person or company acquires 10% or more, but less than 25%, of any
class of voting securities.





Permitted
Activities. Generally, bank holding companies are prohibited by federal
law from engaging in or acquiring direct or indirect control of more than 5% of
the voting shares of any company engaged in any activity other than (i) banking
or managing or controlling banks or (ii) an activity that the FRB determines to
be so closely related to banking as to be a proper incident to the business of
banking.


Activities
that the FRB has found to be so closely related to banking as to be a proper
incident to the business of banking include:


·  factoring
accounts receivable;


·  making,
acquiring, brokering or servicing loans and usual related
activities;


·  leasing
personal or real property;


·  operating
a non-bank depository institution, such as a savings association;


·  trust
company functions;


·  financial
and investment advisory activities;




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·  conducting
discount securities brokerage activities;


·  underwriting
and dealing in government obligations and money market instruments;


·  providing
specified Management consulting and counseling activities;


·  performing
selected data processing services and support services;


· acting as agent or
broker in selling credit life insurance and other types of insurance in
connection with credit transactions; and


· performing
selected insurance underwriting activities.




Despite prior
approval, the FRB has the authority to require a bank holding company to
terminate an activity or terminate control of or liquidate or divest certain
subsidiaries or affiliates when the FRB believes the activity or the control of
the subsidiary or affiliate constitutes a significant risk to the financial
safety, soundness or stability of any of its banking subsidiaries. A bank
holding company that qualifies and elects to become a financial holding company
is permitted to engage in additional activities that are financial in nature or
incidental or complementary to financial activity. The Bank Holding Company Act
expressly lists the following activities as financial in nature:




·  lending,
exchanging, transferring, investing for others, or safeguarding money or
securities;


· insuring,
guaranteeing or indemnifying against loss or harm, or providing and issuing
annuities, and acting as principal, agent or broker for these purposes, in any
state;


·  providing
financial, investment or advisory services;


·  issuing
or selling instruments representing interests in pools of assets permissible for
a bank to hold directly;


·  underwriting,
dealing in or making a market in securities;


· other
activities that the FRB may determine to be so closely related to banking or
managing or controlling banks as to be a proper incident to managing or
controlling banks;


· foreign
activities permitted outside of the United States if the FRB has determined them
to be usual in connection with banking operations abroad;


·  merchant
banking through securities or insurance affiliates; and


·  insurance
company portfolio investments.





To qualify to
become a financial holding company, First Guaranty Bancshares, Inc. and its
subsidiary bank must be well-capitalized and well managed and must have a
Community Reinvestment Act rating of at least satisfactory. Additionally, First
Guaranty Bancshares, Inc. would be required to file an election with the FRB to
become a financial holding company and to provide the FRB with 30 days’ written
notice prior to engaging in a permitted financial activity. A bank holding
company that falls out of compliance with these requirements may be required to
cease engaging in some of its activities. First Guaranty Bancshares, Inc.
currently has no plans to make a financial holding company
election.





Anti-tying
Restrictions. Bank holding companies and affiliates are prohibited from
tying the provision of services, such as extensions of credit, to other services
offered by a holding company or its affiliates.





Deposit Insurance
Assessments. On December 22, 2008, the FDIC published a final rule that
raises the current deposit insurance assessment rates uniformly for all
institutions by 7 basis points (to a range from 12 to 50 basis points) effective
for the first quarter of 2009.  On February 27, 2009, the FDIC also
issued a final rule that revises the way the FDIC calculates federal deposit
insurance assessment rates beginning in the second quarter of
2009.  Under the new rule, the FDIC will first establish an
institution’s initial base assessment rate.  This initial base
assessment rate will range, depending on the risk category of the institution,
from 12 to 45 basis points.  The FDIC will then adjust the initial
base assessment (higher or lower) to obtain the total base assessment
rate.  The adjustments to the initial base assessment rate will be
based upon an institution’s levels of unsecured debt, secured liabilities, and
brokered deposits.  The total base assessment rate will range from 7
to 77.5 basis points of the institution’s deposits. Additionally, the FDIC
issued an interim rule that would impose a special 20 basis points assessment on
June 30, 2009, which would be collected on September 30, 2009. However, the FDIC
has indicated a willingness to decrease the special assessment under certain
circumstances concerning the overall financial health of the insurance fund.
Special assessments of 10 and 20 basis points would result in additional expense
of approximately $300,000 to $600,000, respectively. The interim rule also
allows for additional special assessments.





Other
Regulations. Interest and other charges collected or contracted is
subject to state usury laws and federal laws concerning interest rates. Loan
operations are also subject to federal laws applicable to credit transactions,
such as:





·
            the
      federal “Truth-In-Lending Act,” governing disclosures of credit terms to
      consumer borrowers;


·
            the
      “Home Mortgage Disclosure Act of 1975,” requiring financial institutions
      to provide information to enable the public and public officials to
      determine whether a financial institution is fulfilling its obligation to
      help meet the housing needs of the community it
  serves;


·
            the
      “Equal Credit Opportunity Act,” prohibiting discrimination on the basis of
      race, creed or other prohibited factors in extending
    credit;


·
            the
      “Fair Credit Reporting Act of 1978,” governing the use and provision of
      information to credit reporting
agencies;


·
            the
      “Real Estate Settlement Procedures
Act”;


·
            the
      “Fair Debt Collection Act,” governing the manner in which consumer debts
      may be collected by collection agencies;
and


·
            the
      rules and regulations of the various federal agencies charged with the
      responsibility of implementing these federal
  laws.





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The deposit
operations are subject to:


·
            the
      “Right to Financial Privacy Act,” which imposes a duty to maintain
      confidentiality of consumer financial records and prescribes procedures
      for complying with administrative subpoenas of financial
      records;


·
            the
      “Electronic Funds Transfer Act” and Regulation E issued by the FRB to
      implement that act, which govern automatic deposits to and withdrawals
      from deposit accounts and customers’ rights and liabilities arising from
      the use of automated teller machines and other electronic banking
      services;


·
            the
      “Truth-In Savings Act”; and


·
            the
      “Expedited Funds Availability Act”.





Dividends. The
Company is a legal entity separate and distinct from its subsidiary, First
Guaranty Bank. The majority of the Company’s revenue is from dividends paid to
the Company by the Bank. First Guaranty Bank may not pay dividends or distribute
capital assets if it is in default on any assessment due to the FDIC. The FRB
has indicated generally that it may be an unsafe or unsound practice for a bank
holding company to pay dividends unless the bank holding company’s net income
over the preceding year is sufficient to fund the dividends and the expected
rate of earnings retention is consistent with the organization’s capital needs,
asset quality and overall financial condition.


First
Guaranty Bank is also subject to regulations that impose minimum regulatory
capital and minimum state law earnings requirements that affect the amount of
cash available for distribution. In addition, under the Louisiana Banking Law,
dividends may not be paid if it would reduce the unimpaired surplus below 50% of
outstanding capital stock in any year. If the Company does not comply with these
laws, regulations or policies it may materially affect the ability of the Bank
to pay dividends.




Capital
Adequacy. The FRB monitors the capital adequacy of bank holding
companies, such as First Guaranty Bancshares, Inc., and the OFI and FDIC monitor
the capital adequacy of First Guaranty Bank. The federal bank regulators use a
combination of risk-based guidelines and leverage ratios to evaluate capital
adequacy and consider these capital levels when taking action on various types
of applications and when conducting supervisory activities related to safety and
soundness. The risk-based guidelines apply on a consolidated basis to bank
holding companies with consolidated assets of $500 million or more and,
generally, on a bank-only basis for bank holding companies with less than $500
million in consolidated assets. Each insured depository subsidiary of a bank
holding company with less than $500 million in consolidated assets is expected
to be “well-capitalized.”


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


The minimum
guideline for the ratio of total capital to risk-weighted assets is 8%. Total
capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1
Capital generally consists of common stock, minority interests in the equity
accounts of consolidated subsidiaries, noncumulative perpetual preferred stock
and a limited amount of qualifying cumulative perpetual preferred stock, less
goodwill and other specified intangible assets. Tier 1 Capital must equal at
least 4% of risk-weighted assets. Tier 2 Capital generally consists of
subordinated debt, preferred stock (other than that which is included in Tier I
Capital), and a limited amount of loan loss reserves. The total amount of Tier 2
Capital is limited to 100% of Tier 1 Capital.


In addition,
the FRB has established minimum leverage ratio guidelines for bank holding
companies with assets of $500 million or more. These guidelines provide for a
minimum ratio of Tier 1 Capital to average assets, less goodwill and other
specified intangible assets, of 3% for bank holding companies that meet
specified criteria, including having the highest regulatory rating and
implementing the FRB’s risk-based capital measure for market risk. All other
bank holding companies with assets of $500 million or more generally are
required to maintain a leverage ratio of at least 4%. The guidelines also
provide that bank holding companies of such size experiencing internal growth or
making acquisitions will be expected to maintain strong capital positions
substantially above the minimum supervisory levels without reliance on
intangible assets. The FRB considers the leverage ratio and other indicators of
capital strength in evaluating proposals for expansion or new activities. The
FRB and the FDIC recently adopted amendments to their risk-based capital
regulations to provide for the consideration of interest rate risk in the
agencies’ determination of a banking institution’s capital
adequacy.


Failure to
meet capital guidelines could subject a bank or bank holding company to a
variety of enforcement remedies, including issuance of a capital directive, the
termination of federal deposit insurance, a prohibition on accepting brokered
deposits and other restrictions on its business.




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Concentrated
Commercial Real Estate Lending Regulations. The FRB and FDIC have
recently promulgated guidance governing financial institutions with
concentrations in commercial real estate lending. The guidance provides that a
company has a concentration in commercial real estate lending if (i) total
reported loans for construction, land development, and other land represent 100%
or more of total capital or (ii) total reported loans secured by multifamily and
non-farm residential properties and loans for construction, land development,
and other land represent 300% or more of total capital and the outstanding
balance of such loans has increased 50% or more during the prior 36 months. If a
concentration is present, Management must employ heightened risk Management
practices including board and Management oversight and strategic planning,
development of underwriting standards, risk assessment and monitoring through
market analysis and stress testing, and increasing capital requirements. The
Company is subject to these regulations.




Prompt Corrective
Action Regulations. Under the prompt corrective action regulations, bank
regulators are required and authorized to take supervisory actions against
undercapitalized banks. For this purpose, a bank is placed in one of the
following five categories based on its capital:


·
            well-capitalized
      (at least 5% leverage capital, 6% Tier 1 risk-based capital and 10% total
      risk-based capital); ·
              adequately
      capitalized (at least 4% leverage capital, 4% Tier 1 risk-based capital
      and 8% total risk-based capital);
 ·
              undercapitalized
      (less than 8% total risk-based capital, 4% Tier 1 risk-based capital or 3%
      leverage capital);
 ·
              significantly
      undercapitalized (less than 6% total risk-based capital, 3% Tier 1
      risk-based capital or 3% leverage capital);
and
 ·
              critically
      undercapitalized (less than 2% tangible
  capital).




Federal
banking regulators are required to take various mandatory supervisory actions
and are authorized to take other discretionary actions with respect to
institutions in the three undercapitalized categories. The severity of the
action depends upon the capital category in which the institution is placed.
Generally, subject to a narrow exception, banking regulators must appoint a
receiver or conservator for an institution that is “critically
undercapitalized.” The federal banking agencies have specified by regulation the
relevant capital level for each category. An institution that is categorized as
“undercapitalized”, “significantly undercapitalized” or “critically
undercapitalized” is required to submit an acceptable capital restoration plan
to its appropriate federal banking agency. A bank holding company must guarantee
that a subsidiary depository institution meets its capital restoration plan,
subject to various limitations. The controlling holding company’s obligation to
fund a capital restoration plan is limited to the lesser of 5% of an
“undercapitalized” subsidiary’s assets at the time it became “undercapitalized”
or the amount required to meet regulatory capital requirements. An
“undercapitalized” institution is also generally prohibited from increasing its
average total assets, making acquisitions, establishing any branches or engaging
in any new line of business, except under an accepted capital restoration plan
or with regulatory approval. The regulations also establish procedures for
downgrading an institution to a lower capital category based on supervisory
factors other than capital.




Restrictions on
Transactions with Affiliates and Loans to Insiders.  First
Guaranty Bank is subject to the provisions of Section 23A of the FRB Act and its
implementing regulations. These provisions place limits on the amount
of:


·
            First
      Guaranty Bank’s loans or extensions of credit to
    affiliates;


·
            First
      Guaranty Bank’s  investment in
  affiliates;


·
            assets
      that First Guaranty Bank may purchase from affiliates, except for real and
      personal property exempted by the
FRB;


·
            the
      amount of loans or extensions of credit to third parties collateralized by
      the securities or obligations of affiliates; and·
            First
      Guaranty Bank’s guarantee, acceptance or letter of credit issued on behalf
      of an affiliate.




The total
amount of the above transactions is limited in amount, as to any one affiliate,
to 10% of First Guaranty Bank’s capital and surplus and, as to all affiliates
combined, to 20% of its capital and surplus. In addition to the limitation on
the amount of these transactions, each of the above transactions must also meet
specified collateral requirements.


First
Guaranty Bank is also subject to the provisions of Section 23B of the FRB Act
and its implementing regulations, which, among other things, prohibit First
Guaranty Bank from engaging in any transaction with an affiliate, such as First
Guaranty Bancshares, Inc., unless the transaction is on terms substantially the
same, or at least as favorable to First Guaranty Bank as those prevailing at the
time for comparable transactions with nonaffiliated companies.


First
Guaranty Bank is also subject to restrictions on extensions of credit to its
executive officers, directors, principal shareholders and their related
interests. These types of extensions of credit must be made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with third parties and must not involve more
than the normal risk of repayment or present other unfavorable
features.




Anti-terrorism
Legislation.
Financial institutions are required to establish anti-money laundering programs.
In 2001, the USA PATRIOT Act was enacted.  The USA PATRIOT Act
significantly enhanced the powers of the federal government and law enforcement
organizations to combat terrorism, organized crime and money laundering. While
the USA PATRIOT Act imposed additional anti-money laundering requirements, these
additional requirements are not material to our operations.


Aside from
the above, the USA PATRIOT Act also requires the federal banking regulators to
assess the effectiveness of an institution’s anti-money laundering program in
connection with merger and acquisition transactions.  Failure to
maintain an effective anti-money laundering program is grounds for the denial of
merger or acquisition transactions.





Federal
Securities Laws


First
Guaranty Bancshares, Inc. common stock is registered with the Securities and
Exchange Commission under the Securities Exchange Act of 1934. First Guaranty
Bancshares, Inc. will continue to be subject to the information, proxy
solicitation, insider trading restrictions and other requirements under the
Securities Exchange Act of 1934.





Non-Banking
Activities


The
Gramm-Leach-Bliley Act of 1999 eliminated most of the barriers to affiliations
among banks and securities firms, insurance companies and other financial
companies previously imposed under federal banking laws if certain criteria are
satisfied. The financial subsidiaries of “well capitalized” banks are generally
permitted to engage in activities that are financial in nature including
securities underwriting, dealing and market making; sponsoring mutual funds and
investment companies; insurance brokerage and underwriting activities; merchant
banking activities; and other activities that the Federal Reserve Board has
determined to be closely related to banking.





Brokered
Deposits and Pass-Through Insurance


An
FDIC-insured depository institution cannot accept, rollover or renew brokered
deposits unless it is well capitalized or adequately capitalized and receives a
waiver from the FDIC. A depository institution that cannot receive brokered
deposits also cannot offer “pass-through” insurance on certain employee benefit
accounts. Whether or not it has obtained such a waiver, an adequately
capitalized depository institution may not pay an interest rate on any deposits
in excess of 75 basis points over certain prevailing market rates specified by
regulation. As of December 31, 2008, the Bank had $9.7 million in brokered
deposits.





Interstate
Branching


Effective
June 1, 1997, the Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994 permits state and national banks with different home states to
operate branches across state lines with approval of the appropriate federal
banking agency, unless the home state of a participating bank passed legislation
“opting out” of interstate banking. This federal law allows branching through
acquisition only, which means a bank must acquire another bank and merge the two
institutions in order to operate across state lines. If a state opted out of
interstate branching within a specified time period, no bank in any other state
may establish a branch in the state which has opted out, whether through an
acquisition or de novo.
Louisiana did not opt out of this law. The Company currently has no branches
located outside of Louisiana.





Community
Reinvestment Act


Under the
Community Reinvestment Act, or CRA, a financial institution has a continuing and
affirmative obligation, consistent with its safe and sound operation, to help
meet the credit needs of its entire community, including low and moderate income
neighborhoods. The FDIC assigns banks a CRA rating of “outstanding,”
“satisfactory,” “needs to improve” or “substantial noncompliance,” and the bank
must publicly disclose its rating. The FDIC rated the Bank as “satisfactory” in
meeting community credit needs under the CRA at its most recent CRA performance
examination.





Privacy
Provisions


Under the
Gramm-Leach-Bliley Act, federal banking regulators have adopted new rules
requiring disclosure of privacy policies and information sharing practices to
consumers. These rules prohibit depository institutions from sharing customer
information with nonaffiliated parties without the customer’s consent, except in
limited situations, and require disclosure of privacy policies to consumers and,
in some circumstances, enable consumers to prevent disclosure of personal
information to nonaffiliated third parties. In addition, the Fair and Accurate
Credit Transactions Act of 2003 requires banks to notify their customers if they
report negative information about them to a credit bureau or if they grant
credit to them on terms less favorable than those generally
available.


The Company
has instituted risk Management systems to comply with all required privacy
provisions and believes that the new disclosure requirements and implementation
of the privacy laws will not materially increase operating
expenses.




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Check
21


The Check 21
Act facilitates check truncation and electronic check exchange by authorizing a
new negotiable instrument called a “substitute check”. The Act provides that a
properly prepared substitute check is the legal equivalent of the original check
for all purposes. This law supercedes contradictory state laws (i.e., state laws
that allow customers to demand the return of original checks).


Although the
Check 21 Act does not require any bank to create substitute checks or to accept
checks electronically, it does require banks to accept a legally equivalent
substitute check in place of an original check after the Check 21 Act’s
effective date of October 28, 2004.





Sarbanes-Oxley
Act


The Company
is also subject to the Sarbanes-Oxley Act of 2002, which has imposed corporate
governance and accounting oversight restrictions and responsibilities on the
board of directors, executive officers and independent auditors. The law has
increased the time spent discharging responsibilities and costs for audit
services. Beginning in 2007, Management was required to report on the
effectiveness of internal controls and procedures. Beginning with the year
ending December 31, 2009, the Company will be required to obtain an
attestation report from our external auditor on the effectiveness of our
internal controls over financial reporting.





Effect
of Governmental Policies


The
difference between the interest rate paid on deposits and other borrowings and
the interest rate received on loans and securities comprise most of a bank’s
earnings.  In order to mitigate the interest rate risk inherent in the
industry, the banking business is becoming increasingly dependent on the
generation of fee and service charge revenue.


The earnings
and growth of a bank will be affected by both general economic conditions and
the monetary and fiscal policy of the United States Government and its agencies,
particularly the Federal Reserve. The Federal Reserve sets national monetary
policy such as seeking to curb inflation and combat recession.  This
is accomplished by its open-market operations in Unites States government
securities, adjustments to the discount rates on borrowings and target rates for
federal funds transactions.  The actions of the Federal Reserve in
these areas influence the growth of bank loans, investments and deposits and
also affect interest rates on loans and deposits.  The nature and
timing of any future changes in monetary policies and their potential impact on
the Company cannot be predicted.


Our
noninterest income and expenses can be affected by increasing rates of
inflation; however, unlike most industrial companies, the assets and liabilities
of financial institutions such as the Banks are primarily monetary in
nature.  Interest rates, therefore, have a more significant impact on
the Bank’s performance than the effect of general levels of inflation on the
price of goods and services.





Recent
Developments


Troubled Assets Relief Program.Under
the TARP, the United States Department of the Treasury authorized a voluntary
capital purchase program (the “CPP”) to purchase up to $250 billion of senior
preferred shares of qualifying financial institutions that elected to
participate. Participating companies must adopt certain standards for executive
compensation, including (a) prohibiting “golden parachute” payments as
defined in the EESA to senior Executive Officers; (b) requiring recovery of
any compensation paid to senior Executive Officers based on criteria that is
later proven to be materially inaccurate; and (c) prohibiting incentive
compensation that encourages unnecessary and excessive risks that threaten the
value of the financial institution. The terms of the CPP also limit certain uses
of capital by the issuer, including repurchases of company stock and increases
in dividends. The Company has filed an application to receive up to $20.7
million in TARP funds. The application is currently under review.





FDIC Temporary Liquidity Guarantee
Program.First Guaranty
Bancshares, Inc. and First Guaranty Bank have chosen to participate in the
FDIC’s Temporary Liquidity Guarantee Program (the “TLGP”), which applies to,
among other, all U.S. depository institutions insured by the FDIC and all United
States bank holding companies, unless they have opted out. Under the TLPG, the
FDIC guarantees certain senior unsecured debt of the holding company and bank,
as well as non-interest bearing transaction account deposits at First Guaranty
Bank. Under the debt guarantee component of the TLGP, the FDIC will pay the
unpaid principal and interest on an FDIC-guaranteed debt instrument upon the
uncured failure of the participating entity to make a timely payment of
principal or interest. First Guaranty Bancshares, Inc. nor First Guaranty Bank
issued an debt under the TLGP.


Under the
transaction account guarantee component of the TLGP, all non-interest bearing
transaction accounts maintained at First Guaranty Bank are insured in full by
the FDIC until December 31, 2009, regardless of the standard maximum deposit
insurance amounts. An annualized 10 basis point assessment on balances in
noninterest-bearing transaction accounts that exceed the existing deposit
insurance limit of $250,000 will be assessed on a quarterly basis to insured
depository institutions participating in this component of the
TLGP.  The Company has chosen to participate in this component of the
TLGP.  The additional expense related to this coverage is not expected
to be significant for the Bank. See the Deposit Insurance Assessments
section above for more information.




Financial Stability Plan.On
February 10, 2009, the Financial Stability Plan (the “FSP”) was announced
by the U.S. Department of the Treasury. The FSP is a comprehensive set of
measures intended to shore up the financial system. The core elements of the FSP
include making bank capital injections, creating a public-private investment
fund to buy troubled assets, establishing guidelines for loan modification
programs and expanding the Federal Reserve lending program. The Treasury
Department has indicated more details regarding the FSP are to be announced. We
continue to monitor these developments and assess their potential impact on our
business.




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American Recovery and Reinvestment Act of 2009.On February 17, 2009, the American Recovery and Reinvestment
Act of 2009 (the “ARRA”) was enacted. The ARRA is intended to provide a stimulus
to the U.S. economy in the wake of the economic downturn brought about by the
subprime mortgage crisis and the resulting credit crunch. The bill includes
federal tax cuts, expansion of unemployment benefits and other social welfare
provisions, and domestic spending in education, healthcare, and infrastructure,
including the energy structure. The new law also includes numerous non-economic
recovery related items, including a limitation on executive compensation in
federally aided banks.





Under the
ARRA, an institution will be subject to the following restrictions and standards
through out the period in which any obligation arising from financial assistance
provided under the TARP remains outstanding:


·
            Limits
      on compensation incentives for risk taking by senior executive
      officers.


·
            Requirement
      of recovery of any compensation paid based on inaccurate financial
      information.


·
            Prohibition
      on “Golden Parachute Payments”.


·
            Prohibition
      on compensation plans that would encourage manipulation of reported
      earnings to enhance the compensation of
  employees.


·
            Publicly
      registered TARP recipients must establish a board compensation committee
      comprised entirely of independent directors, for the purpose of reviewing
      employee compensation plans.


·
            Prohibition
      on bonus, retention award, or incentive compensation, except for payments
      of long term restricted stock.


·
            Limitation
      on luxury expenditures.


·
            TARP
      recipients are required to permit a separate shareholder vote to approve
      the compensation of executives, as disclosed pursuant to the SEC’s
      compensation disclosure rules.




The foregoing
is a summary of requirements to be included in standards to be established by
the Secretary of the Treasury.
  The chief
executive officer and chief financial officer of each TARP recipient will be
required to provide a written certification of compliance with these standards
to the SEC. The foregoing is a summary of requirements to be included in
standards to be established by the Secretary of the Treasury.





Homeowner Affordability and Stability Plan.On February 18, 2009, the Homeowner Affordability and Stability Plan
(the “HASP”) was announced by the President of the United States. The plan will
help up to 7 to 9 million families restructure or refinance their mortgages to
avoid foreclosure.HASP is intended to
support a recovery in the housing market and ensure that workers can continue to
pay off their mortgages through the following elements:


·
            Provide
      access to low-cost refinancing for responsible homeowners suffering from
      falling home prices.


·
            A
      $75 billion homeowner stability initiative to prevent foreclosure and help
      responsible families stay in their
homes.


·
            Support
      low mortgage rates by strengthening confidence in Fannie Mae and Freddie
      Mac.





On March 4,
2009, the following programs were disclosed:





The Home Affordable
Refinanceprogram
will be available to 4 to 5 million homeowners who have a solid payment history
on an existing mortgage owned by Fannie Mae or Freddie Mac. Normally, these
borrowers would be unable to refinance because their homes have lost value,
pushing their current loan-to-value ratios above 80%. Under the Home Affordable
Refinance program, many of them will now be eligible to refinance their loan to
take advantage of today’s lower mortgage rates or to refinance an
adjustable-rate mortgage into a more stable mortgage, such as a 30-year fixed
rate loan.





GSE lenders
and servicers already have much of the borrower’s information on file, so
documentation requirements are not likely to be burdensome. In addition, in some
cases an appraisal will not be necessary. This flexibility will make the
refinance quicker and less costly for both borrowers and lenders. The Home
Affordable Refinance program ends in June 2010.





The Home Affordable
Modificationprogram
will help up to 3 to 4 million at-risk homeowners avoid foreclosure by reducing
monthly mortgage payments. Working with the banking and credit union regulators,
the FHA, the VA, the USDA and the Federal Housing Finance Agency, the Treasury
Department announced program guidelines that are expected to become standard
industry practice in pursuing affordable and sustainable mortgage modifications.
This program will work in tandem with an expanded and improved Hope for
Homeowners program.





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Item 1A – Risk Factors


(references
to “our,” “we” or similar terms under this subheading refer to First Guaranty
Bancshares, Inc.)


Various
factors, such as general economic conditions in the U.S. and Louisiana,
regulatory and legislative initiatives and increasing competition could impact
our business. The risks and uncertainties described below are not the only risks
that may have a material adverse effect on us.  Additional risks and
uncertainties also could adversely affect our business and results of
operations.  If any of the following risks actually occur, our
business, financial condition or results of operations could be negatively
affected, the market price for your securities could decline, and you could lose
all or part of your investment.  Further, to the extent that any of
the information contained in this Annual Report on Form 10-K constitutes
forward-looking statements, the risk factors set forth below also are cautionary
statements identifying important factors that could cause our actual results to
differ materially from those expressed in any forward-looking statements made by
or on behalf of us.





Risks
Associated with our Business





We
may be vulnerable to certain sectors of the economy.


A
portion of our loan portfolio is secured by real estate. If the economy
deteriorated and depressed real estate values beyond a certain point, that
collateral value of the portfolio and the revenue stream from those loans could
come under stress and possibly require additional provision to the allowance for
loan losses. Our ability to dispose of foreclosed real estate at prices above
the respective carrying values could also be impinged, causing additional
losses.





Difficult
market conditions have adversely affected the industry in which we
operate.


The
capital and credit markets have been experiencing volatility and disruption for
more than twelve months. In recent months, the volatility and disruption has
reached unprecedented levels. Dramatic declines in the housing market over the
past year, with falling home prices and increasing foreclosures, unemployment
and under-employment, have negatively impacted the credit performance of
mortgage loans and resulted in significant write-downs of asset values by
financial institutions, including government-sponsored entities as well as major
commercial and investment banks. These write-downs have caused many financial
institutions to seek additional capital, to merge with larger and stronger
institutions and, in some cases, to fail. Reflecting concern about the stability
of the financial markets generally and the strength of counterparties, many
lenders and institutional investors have reduced or ceased providing funding to
borrowers, including to other financial institutions. This market turmoil and
tightening of credit have led to an increased level of commercial and consumer
delinquencies, lack of consumer confidence, increased market volatility and
widespread reduction of business activity generally. We do not expect that the
difficult conditions in the financial markets are likely to improve in the near
future. A worsening of these conditions would likely exacerbate the adverse
effects of these difficult market conditions on us and others in the financial
institution industry. In particular, we may face the following risks in
connection with these events:


•
            We
      may expect to face increased regulation of our industry, including as a
      result of the Emergency Economic Stabilization Act of 2008 (EESA).
      Compliance with such regulation may increase our costs and limit our
      ability to pursue business opportunities.•
            Market
      developments and the resulting economic pressure on consumers may affect
      consumer confidence levels and may cause increases in delinquencies and
      default rates, which, among other effects, could affect our charge-offs
      and provision for loan losses.•
            Competition
      in the industry could intensify as a result of the increasing
      consolidation of financial services companies in connection with current
      market conditions.•
            The
      current market disruptions make valuation even more difficult and
      subjective, and our ability to measure the fair value of our assets could
      be adversely affected. If we determine that a significant portion of our
      assets have values that are significantly below their recorded carrying
      value, we could recognize a material charge to earnings in the quarter
      during which such determination was made, our capital ratios would be
      adversely affected and a rating agency might downgrade our credit rating
      or put us on credit watch.





There
can be no assurance that the Emergency Economic Stabilization Act of 2008 will
help stabilize the U.S. Financial System.


On
October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (EESA) in response to the current crisis in the
financial sector. The U.S. Department of the Treasury and banking regulators are
implementing a number of programs under this legislation to address capital and
liquidity issues in the banking system. There can be no assurance, however, as
to the actual impact that the EESA will have on the financial markets, including
the extreme levels of volatility and limited credit availability currently being
experienced. The failure of the EESA to help stabilize the financial markets and
a continuation or worsening of current financial market conditions could
materially and adversely affect our business, financial condition, results of
operations, access to credit or the trading price of our common
stock.





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Certain
changes in interest rates, inflation, deflation, or the financial markets could
affect demand for our products and our ability to deliver products
efficiently.


Loan
originations, and potentially loan revenues, could be adversely impacted by
sharply rising interest rates. Conversely, sharply falling rates could increase
prepayments within our securities portfolio lowering interest earnings from
those investments. An underperforming stock market could reduce brokerage
transactions, therefore reducing investment brokerage revenues; in addition,
wealth management fees associated with managed securities portfolios could also
be adversely affected. An unanticipated increase in inflation could cause our
operating costs related to salaries & benefits, technology, and supplies to
increase at a faster pace than revenues.


The
fair market value of our securities portfolio and the investment income from
these securities also fluctuate depending on general economic and market
conditions. In addition, actual net investment income and/or cash flows from
investments that carry prepayment risk, such as mortgage-backed and other
asset-backed securities, may differ from those anticipated at the time of
investment as a result of interest rate fluctuations.





Changes
in the policies of monetary authorities and other government action could
adversely affect our profitability.


The
results of operations are affected by credit policies of monetary authorities,
particularly the Federal Reserve Board. The instruments of monetary policy
employed by the Federal Reserve Board include open market operations in U.S.
government securities, changes in the discount rate or the federal funds rate on
bank borrowings and changes in reserve requirements against bank deposits. In
view of changing conditions in the national economy and in the money markets,
particularly in light of the continuing threat of terrorist attacks and the
current military operations in the Middle East, we cannot predict possible
future changes in interest rates, deposit levels, loan demand or our business
and earnings. Furthermore, the actions of the United States government and other
governments in responding to such terrorist attacks or the military operations
in the Middle East may result in currency fluctuations, exchange controls,
market disruption and other adverse effects.





We
engage in acquisitions of other businesses from time to time.


On
occasion, we will engage in acquisitions of other businesses. Inability to
successfully integrate acquired businesses can pose varied risks to us,
including customer and employee turnover, thus increasing the cost of operating
the new businesses. The acquired companies may also have legal contingencies,
beyond those that we are aware of, that could result in unexpected costs.
Moreover, there can be no assurance that acquired businesses will achieve prior
or planned results of operations.





We
may not be able to successfully maintain and manage our growth.


Since
December 31, 2003, assets have grown 79.8%, loan balances have grown 59.0% and
deposits have grown 107.5%.  Continued growth depends, in part, upon
the ability to expand market presence, to successfully attract core deposits,
and to identify attractive commercial lending opportunities.


Management
cannot be certain as to its ability to manage increased levels of assets and
liabilities. We may be required to make additional investments in equipment and
personnel to manage higher asset levels and loans balances, which may adversely
impact our efficiency ratio, earnings and shareholder returns.


In addition,
franchise growth may increase through acquisitions and de novo branching. The
ability to successfully integrate such acquisitions into our consolidated
operations will have a direct impact on our financial condition and results of
operations.





Our
loan portfolio consists of a high percentage of loans secured by non-farm
non-residential real estate. These loans are riskier than loans secured by one-
to four-family properties.


At December
31, 2008, $261.7 million, or 43.0% of the loan portfolio consisted of non-farm
non-residential real estate loans (primarily loans secured by commercial real
estate such as office buildings, hotels and gaming facilities). Management
intends to continue to emphasize the origination of these types of
loans.  These loans generally expose a lender to greater risk of
nonpayment and loss than one- to four-family residential mortgage loans because
repayment of the loans often depends on the successful operation and income
stream of the borrowers. Such loans typically involve larger loan balances to
single borrowers or groups of related borrowers compared to one- to four-family
residential loans. Consequently, an adverse development with respect to one loan
or one credit relationship can expose us to a significantly greater risk of loss
compared to an adverse development with respect to a one- to four-family
residential mortgage loan.





Emphasis
on the origination of short-term loans could expose us to increased lending
risks.


At December
31, 2008, $546.2 million, or 90.1% of our loan portfolio consisted of loans that
mature within five years. These loans typically provide for payments based on a
twenty-year amortization schedule. This results in our borrowers having
significantly higher final payments due at maturity, known as a “balloon
payment”. In the event our borrowers are unable to make their balloon payments
when they are due, we may incur significant losses in our loan portfolio.
Moreover, while the shorter maturities of our loan portfolio help us to manage
our interest rate risk, they also increase the reinvestment risk associated with
new loan originations. To mitigate this risk, we generally will originate loans
to existing customers. There can be no assurance that during an economic
slow-down we might not incur significant losses as our loan portfolio
matures.





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Hurricane
Activity in Louisiana can have an adverse impact on our market
area.


Our market
area in Southeast Louisiana is close to New Orleans and the Gulf of Mexico, an
area which is susceptible to hurricanes and tropical storms.


Hurricane
Katrina hit the greater New Orleans area in August 2005. The hurricane caused
widespread property damage, required the relocation of an unprecedented number
of residents and business operations, and severely disrupted normal economic
activity in the impacted areas. The hurricane affected our loan originations and
impacted our deposit base. While Hurricane Katrina did not affect our operations
as adversely as other areas of Southeast Louisiana, future hurricane activity
may have a severe and adverse affect on our operations. More generally, our
ability to compete effectively with financial institutions whose operations are
not concentrated in areas affected by hurricanes or whose resources are greater
than ours, will depend primarily on our ability to continue normal business
operations following a hurricane. The severity and duration of the effects of
hurricanes will depend on a variety of factors that are beyond our control,
including the amount and timing of government, private and philanthropic
investments including deposits in the region, the pace of rebuilding and
economic recovery in the region and the extent to which a hurricane’s property
damage is covered by insurance.


None of the
effects described above can be accurately predicted or quantified at this time.
As a result, significant uncertainty remains regarding the impact a hurricane
may have on our business, financial condition and results of
operations.





If
the allowance for loan losses is not sufficient to cover actual loan losses,
earnings could decrease.


Loan
customers may not repay their loans according to the terms of their loans, and
the collateral securing the payment of their loans may be insufficient to assure
repayment. We may experience significant credit losses, which could have a
material adverse effect on our operating results. Various assumptions and
judgments about the collectability of the loan portfolio are made, including the
creditworthiness of borrowers and the value of the real estate and other assets
serving as collateral for the repayment of many loans. In determining the amount
of the allowance for loan losses, Management reviews the loans and the loss and
delinquency experience and evaluates economic conditions. If assumptions prove
to be incorrect, the allowance for loan losses may not cover inherent losses in
the loan portfolio at the date of the financial statements. Material additions
to the allowance would materially decrease net income. At December 31, 2008, our
allowance for loan losses totaled $6.5 million, representing 1.07% of loans, net
of unearned income.


Management
believes it has underwriting standards to manage normal lending risks, and at
December 31, 2008, nonperforming loans consisted of $9.3 million, or 1.54% of
loans, net of unearned income. We can give no assurance that the nonperforming
loans will not increase or that nonperforming or delinquent loans will not
adversely affect future performance.


In addition,
federal and state regulators periodically review the allowance for loan losses
and may require an increase in the allowance for loan losses or recognize
further loan charge-offs. Any increase in our allowance for loan losses or loan
charge-offs as required by these regulatory agencies could have a material
adverse effect on the results of operations and financial
condition.





Adverse
events in Louisiana, where our business is concentrated, could adversely affect
our results and future growth.


Our business,
the location of our branches and the real estate used as collateral on our real
estate loans are primarily concentrated in Louisiana. As a result, we are
exposed to geographic risks. The occurrence of an economic downturn in
Louisiana, or adverse changes in laws or regulations in Louisiana could impact
the credit quality of our assets, the business of our customers and our ability
to expand our business.


Our
success significantly depends upon the growth in population, income levels,
deposits and housing in our market area.  If the communities in which
we operate do not grow or if prevailing economic conditions locally or
nationally are unfavorable, our business may be negatively
affected.  In addition, the economies of the communities in which we
operate are substantially dependent on the growth of the economy in the state of
Louisiana.  To the extent that economic conditions in Louisiana are
unfavorable or do not continue to grow as projected, the economy in our market
area would be adversely affected.  Moreover, we cannot give any
assurance that we will benefit from any market growth or favorable economic
conditions in our market area if they do occur.


In addition,
the market value of the real estate securing loans as collateral could be
adversely affected by unfavorable changes in market and economic conditions. As
of December 31, 2008, approximately 76.6% of our total loans were secured by
real estate.  Adverse developments affecting commerce or real estate
values in the local economies in our primary market areas could increase the
credit risk associated with our loan portfolio. In addition, substantially all
of our loans are to individuals and businesses in Louisiana.  Our
business customers may not have customer bases that are as diverse as businesses
serving regional or national markets. Consequently, any decline in the economy
of our market area could have an adverse impact on our revenues and financial
condition.  In particular, we may experience increased loan
delinquencies, which could result in a higher provision for loan losses and
increased charge-offs. Any sustained period of increased non-payment,
delinquencies, foreclosures or losses caused by adverse market or economic
conditions in our market area could adversely affect the value of our assets,
revenues, results of operations and financial condition.





- 14
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 Table of Contents


Our
continued pace of growth may require us to raise additional capital in the
future, but that capital may not be available when it is needed and could result
in dilution of shareholders’ ownership.


We are
required by federal and state regulatory authorities to maintain adequate levels
of capital to support our operations.  We anticipate that our existing
capital resources will satisfy our capital requirements for the foreseeable
future. We may, at some point, need to raise additional capital to support
continued growth, both internally and for potential acquisitions. Such issuance
of our securities will dilute the ownership interest of our
shareholders.


Our
ability to raise additional capital, if needed, will depend on conditions in the
capital markets at that time, which are outside of our control. Accordingly, we
cannot assure you of our ability to raise additional capital if needed or that
the terms acceptable to us will be available. If we cannot raise additional
capital when needed, our ability to further expand our operations through
internal growth and potential acquisitions could be materially
impaired.





We
rely on our Management team for the successful implementation of our business
strategy.


Our success
of First Guaranty Bancshares, Inc. and First Guaranty Bank has been largely due
to the efforts of our executive Management team consisting of Michael R. Sharp,
President and Chief Executive Officer, Larry A. Stark, Executive Vice President,
L. Thomas Bulla, North Louisiana Area President and Michele E. LoBianco, Chief
Financial Officer. In addition, we substantially rely upon Marshall T. Reynolds,
our Chairman of the Board of Directors.  The loss of services of one
or more of these individuals may have a material adverse effect on our ability
to implement our business plan.





There
is no assurance that we will be able to successfully compete with others for
business.


The area in
which we operate is considered attractive from an economic and demographic
viewpoint, and is a highly competitive banking market. We compete for loans and
deposits with numerous regional and national banks and other community banking
institutions, as well as other kinds of financial institutions and enterprises,
such as securities firms, insurance companies, savings associations, credit
unions, mortgage brokers and private lenders. Many competitors have
substantially greater resources than we do and operate under less stringent
regulatory environments. The differences in resources and regulations may make
it harder for us to compete profitably, reduce the rates that we can earn on
loans and investments, increase the rates we must offer on deposits and other
funds, and adversely affect our overall financial condition and
earnings.





We
depend primarily on net interest income for our earnings rather than noninterest
income.


Net interest
income is the most significant component of our operating income. We do not rely
on nontraditional sources of fee income utilized by some community banks, such
as fees from sales of insurance, securities or investment advisory products or
services. For the years ended December 31, 2008 and 2007, our net interest
income was $31.9 million and $34.1 million, respectively.  The amount
of our net interest income is influenced by the overall interest rate
environment, competition, and the amount of interest-earning assets relative to
the amount of interest-bearing liabilities. In the event that one or more of
these factors were to result in a decrease in our net interest income, we do not
have significant sources of fee income to make up for decreases in net interest
income.





Fluctuations
in interest rates could reduce our profitability.


We realize
income primarily from the difference between the interest we earn on loans and
investments and the interest we pay on deposits and borrowings. Unexpected
movement in interest rates markedly changing the slope of the current yield
curve could cause our net interest margins to decrease, subsequently decreasing
net interest income.  In addition, such changes could adversely affect
the valuation of our assets and liabilities.  The interest rates on
our assets and liabilities respond differently to changes in market interest
rates, which means our interest-bearing liabilities may be more sensitive to
changes in market interest rates than our interest-earning assets, or vice
versa. In either event, if market interest rates change, this “gap” between the
amount of interest-earning assets and interest-bearing liabilities that reprice
in response to these interest rate changes may work against us, and our earnings
may be negatively affected.


We are unable
to predict fluctuations in market interest rates, which are affected by, among
other factors, changes in the following:


·  inflation
rates;


·  business
activity levels;


·  money
supply; and


·  domestic
and foreign financial markets.




The value of
our investment portfolio and the composition of our deposit base are influenced
by prevailing market conditions and interest rates. Our asset-liability
Management strategy, which is designed to mitigate the risk to us from changes
in market interest rates, may not prevent changes in interest rates or
securities market downturns from reducing deposit outflow or from having a
material adverse effect on our results of operations, our financial condition or
the value of our investments.




- 15
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 Table of Contents


We
expect to incur additional expenses in connection with our compliance with
Sarbanes-Oxley.


Under
Section 404 of the Sarbanes-Oxley Act of 2002, we were required to conduct
a comprehensive review and assessment of the adequacy of our existing financial
systems and controls beginning with the year ended December 31, 2007. 
Future reviews of our financial systems and controls may uncover deficiencies in
existing systems and controls. If that is the case, we would have to take the
necessary steps to correct any deficiencies, which may be costly and may strain
our Management resources and negatively impact earnings.  We also would be
required to disclose any such deficiencies, which could adversely affect the
market price of our common stock. At December 31, 2009, we will be required to
obtain an attestation report from a registered public accounting firm on the
effectiveness of our internal controls over financial reporting.





The
Company’s expenses will increase as a result of increases in FDIC insurance
premiums.


On December
22, 2008, the FDIC published a final rule raising the current deposit insurance
assessment rates uniformly for all institutions by seven basis points (to a
range from 12 to 50 basis points) for the first quarter of 2009. On February 27,
2009, the FDIC issued a final rule changing the way that the FDIC calculates
federal deposit insurance assessment rates beginning in the second quarter of
2009. Additionally, the FDIC issued an interim rule that would impose a special
20 basis points assessment on June 30, 2009, which would be collected on
September 30, 2009. For more information on FDIC assessments, see “Regulation
and Supervision—FDIC Insurance on Deposits”.





Future
legislative or regulatory actions responding to perceived financial and market
problems could impair the Company’s rights against borrowers.


There have
been proposals made by members of Congress and others that would reduce the
amount distressed borrowers are otherwise contractually obligated to pay under
their mortgage loans and limit an institution’s ability to foreclose on mortgage
collateral. Were proposals such as these, or other proposals limiting the
Company’s rights as a creditor, to be implemented, the Company could experience
increased credit losses or increased expense in pursuing its remedies as a
creditor.





Continued
or further declines in the value of certain investment securities could require
write-downs, which would reduce the Company’s earnings.


During 2008,
the Company recorded losses from other-than-temporary impairment on investment
securities totaling $4.6 million, net of the related tax benefits of $3.0. At
December 31, 2008, gross unrealized losses in the Company’s investment portfolio
equaled approximately $5.7 million relating to securities with an aggregate fair
value of $139.3 million.  There can be no assurance that future
factors or combinations of factors will not cause the Company to conclude in one
or more future reporting periods that an unrealized loss that exists with
respect to any of its securities constitutes an impairment that is other than
temporary.





We
operate in a highly regulated environment and may be adversely affected by
changes in federal, state and local laws and regulations.


We are
subject to extensive regulation, supervision and examination by federal and
state banking authorities. Any change in applicable regulations or federal,
state or local legislation could have a substantial impact on us and our
operations. Additional legislation and regulations that could significantly
affect our powers, authority and operations may be enacted or adopted in the
future, which could have a material adverse effect on our financial condition
and results of operations. Further, regulators have significant discretion and
authority to prevent or remedy unsafe or unsound practices or violations of laws
by banks and bank holding companies in the performance of their supervisory and
enforcement duties. The exercise of regulatory authority may have a negative
impact on our results of operations and financial condition.


Like other
bank holding companies and financial institutions, we must comply with
significant anti-money laundering and anti-terrorism laws.  Under
these laws, we are required, among other things, to enforce a customer
identification program and file currency transaction and suspicious activity
reports with the federal government. Government agencies have substantial
discretion to impose significant monetary penalties on institutions which fail
to comply with these laws or make required reports.





Risks
Associated with an Investment in our Common Stock:


The
market price of our common stock is established between a buyer and
seller.


First
Guaranty Bank acts as the transfer agent for First Guaranty Bancshares, Inc. All
shares traded are agreed upon by mutual buyers and sellers. First Guaranty
Bancshares, Inc. is not traded on an exchange, therefore liquidation and/or
purchases of stock may not be readily available.





Our
Management controls a substantial percentage of our common stock and therefore
have the ability to exercise substantial control over our affairs.


As of
December 31, 2008, our directors and executive officers (and their affiliates)
beneficially owned 1,820,750 shares or approximately 32.7% of our common stock.
Because of the large percentage of common stock held by our directors and
executive officers, such persons could significantly influence the outcome of
any matter submitted to a vote of our shareholders even if other shareholders
were in favor of a different result.





Item 1B – Unresolved Staff Comments


None.


- 16
-
 Table of Contents


Item 2 - Properties


The Company
does not directly own any real estate, but it does own real estate indirectly
through its subsidiary. The Bank operates 17 retail-banking centers. The
following table sets forth certain information relating to each office. The Bank
also owns four additional properties which are currently not being used as
banking facilities. One of the properties is a banking center location
previously owned and operated by Homestead Bank in Amite, Louisiana but was
closed at the time of the merger. The Bank’s intentions are to sell this
property. In addition, the Bank owns three parcels of raw land on which it
intends to build de nevo banking center locations. The net book value of our
properties at December 31, 2008 was $9.2 million.




Location
            
            Use
      of Facilities
            
            Year
      Facility Opened or Acquired
            
            Owned/
              LeasedFirst
      Guaranty Square
              400
      East Thomas Street
              Hammond,
      LA 70401
            
            Bank’s
      Main Office
            
            1975
            
            Owned2111
      West Thomas Street
              Hammond,
      LA 70401
            
            Guaranty West Banking Center
            
            1974
            
            Owned100
      East Oak Street
              Amite,
      LA 70422
            
            Amite Banking Center
            
            1970
            
            Owned455
      Railroad Avenue
              Independence,
      LA 70443
            
            Independence Banking Center
            
            1979
            
            Owned301
      Avenue F
              Kentwood,
      LA 70444
            
            Kentwood Banking Center
            
            1975
            
            Owned170
      West Hickory
              Ponchatoula,
      LA 70454
            
            Ponchatoula
      Banking Center1
            
            1960
            
            Owned196
      Burt Blvd
              Benton,
      LA 71006
            
            Benton Banking Center
            
            1999
            
            Owned126
      South Hwy. 1
              Oil
      City, LA 71061
            
            Oil City Banking Center
            
            1999
            
            Owned401
      North 2nd
      Street
              Homer,
      LA  71040
            
            Homer Main Banking Center
            
            1999
            
            Owned10065
      Hwy 79
              Haynesville,
      LA 71038
            
            Haynesville Banking Center
            
            1999
            
            Owned117
      East Hico Street
              Dubach,
      LA 71235
            
            Dubach Banking Center
            
            1999
            
            Owned102
      East Louisiana Avenue
              Vivian,
      LA 71082
            
            Vivian Banking Center
            
            1999
            
            Owned500
      North Cary
              Jennings,
      LA 70546
            
            Jennings Banking Center
            
            1999
            
            Owned799
      West Summers Drive
              Abbeville,
      LA 70510
            
            Abbeville Banking Center
            
            1999
            
            Owned105
      Berryland
              Ponchatoula,
      LA 70454
            
            Berryland Banking Center
            
            2004
            
            Leased2231
      S. Range Avenue
              Denham
      Springs, LA 70726
            
            Denham Springs Banking Center
            
            2005
            
            OwnedNorth
      6th
      Street
              Ponchatoula,
      LA 70454
            
            Ponchatoula Banking Center
            
            2007
            
            Owned29815
      Walker Rd S
              Walker,
      LA 70785
            
            Walker Banking Center
            
            2007
            
            Owned 1This
banking facility was closed on March 14, 2008 and consolidated with the
Ponchatoula Banking Center.


- 17
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 Table of Contents


Item 3 - Legal Proceedings


The Company
is subject to various legal proceedings in the normal course of its business. It
is Management’s belief that the ultimate resolution of such claims will not have
a material adverse effect on the financial position or results of operations. At
December 31, 2008, we were not involved in any material legal
proceedings





Item 4 - Submission of Matters to a Vote of Security
Holders


There were no
matters submitted to a vote of security holders, through the solicitation of
proxies or otherwise, during the fourth quarter of fiscal 2008.





PART
II





Item 5 - Market for Registrant’s Common Equity, Related
Stockholder Matters and Issuer Purchases of Equity Securities


There is no
liquid or active market for our common stock. The Company’sshares of common stock
are not traded on a stock exchange or in any established over-the-counter
market. Trades occur primarily between individuals at a price mutually agreed
upon by the buyer and seller. Trading in the Company’s common stock has been
infrequent and such trades cannot be characterized as constituting an active
trading market. Based on information recorded in the Company’s Stock Transfer
Agent records, Management believes that approximately 368,454 shares of the
Company’s common stock were traded during 2008 of which 137,626 shares were
traded in the fourth quarter of 2008. The purchasers in these transactions were,
in most cases, either affiliates of the Company or their associates. No
assurance can be given that an active trading market for the common stock will
develop.


The following
table sets forth the high and low bid quotations for First Guaranty Bancshares,
Inc.’s (and First Guaranty Bank prior to July 27, 2007) common stock for the
periods indicated. These quotations represent trades of which we are aware and
do not include retail markups, markdowns, or commissions and do not necessarily
reflect actual transactions. As of December 31, 2008, there were
5,559,644 shares of First Guaranty Bancshares, Inc. common stock issued and
outstanding. At December 31, 2008, First Guaranty Bancshares, Inc. had
approximately 1,343 shareholders of record.




2008
            
            2007Quarter
      Ended:
            High
            Low
            Dividend
            
            High
            Low
            DividendMarch
            $    25.00
            $    24.30
            $      0.16
            
            $    24.30
            $    23.42
            $      0.15June
            25.00
            25.00
            0.16
            
            24.30
            24.30
            0.16September
            25.00
            25.00
            0.16
            
            24.30
            24.30
            0.16December
            25.00
            25.00
            0.16
            
            24.30
            24.30
            0.16


Our
stockholders are entitled to receive dividends when, and if declared by the
board of directors, out of funds legally available for dividends. We have paid
consecutive quarterly cash dividends on our common stock for each of the last
ten years and the board of directors intends to continue to pay regular
quarterly cash dividends. The ability to pay dividends in the future will depend
on earnings and financial condition, liquidity and capital requirements,
regulatory restrictions, the general economic and regulatory climate and ability
to service any equity or debt obligations senior to common stock.


There are
legal restrictions on the ability of First Guaranty Bank to pay cash dividends
to First Guaranty Bancshares, Inc.  Under federal and state law, we
are required to maintain certain surplus and capital levels and may not
distribute dividends in cash or in kind, if after such distribution we would
fall below such levels.  Specifically, an insured depository
institution is prohibited from making any capital distribution to its
shareholders, including by way of dividend, if after making such distribution,
the depository institution fails to meet the required minimum level for any
relevant capital measure including the risk-based capital adequacy and leverage
standards.


Additionally,
under the Louisiana Business Corporation Act, First Guaranty Bancshares, Inc. is
prohibited from paying any cash dividends to shareholders if, after the payment
of such dividend, if its total assets would be less than its total liabilities
or where net assets are less than the liquidation value of shares that have a
preferential right to participate in First Guaranty Bancshares, Inc.’s assets in
the event First Guaranty Bancshares, Inc. were to be liquidated.


First
Guaranty Bancshares, Inc. must seek prior approval from the Federal Reserve Bank
before paying dividends to its shareholders.


We have not
repurchased any shares of our outstanding common stock during the past
year.





- 18
-
 Table of Contents


Stock
Performance Graph


The line
graph below compares the cumulative total return for the Company’s common stock
with the cumulative total return of both the NASDAQ Stock Market Index for U.S.
companies and the NASDAQ Index for bank stocks for the period December 31, 2003
through December 31, 2008. The total return assumes the reinvestment of all
dividends and is based on a $100 investment on December 31, 1998. It also
reflects the stock price on December 31st of each year shown, although this
price reflects only a small number of transactions involving a small number of
directors of the Company or affiliates or associates and cannot be taken as an
accurate indicator of the market value of the Company’s common
stock.





Performance
Graph


Cummulative
Total Return of First Guaranty Bancshares, Inc. Compared to NASDAQ Bank
Index


and
NASDAQ Composite Index











Total
      Returns for the Year2004
            2005
            2006
            2007
            2008First
      Guaranty Bancshares, Inc.
            $114
            $139
            $168
            $179
            $189NASDAQ
      Index
            $175
            $168
            $186
            $145
            $110NASDAQ
      Composite
            $  99
            $101
            $110
            $121
            $  72





We have no
equity based benefit plans.





Item 6- Selected Financial Data


The following
selected financial data should be read in conjunction with the financial
statements, including the related notes, and “Management’s Discussion and
Analysis of Financial Condition and Results of Operations,” which are included
elsewhere in this Form 10-K. Except for the data under “Performance Ratios,”
“Capital Ratios” and “Asset Quality Ratios,” the income statement data and share
and per share data for the years ended December 31, 2008, 2007 and 2006 and the
balance sheet data as of December 31, 2008 and 2007 are derived from the audited
financial statements and related notes which are included elsewhere in this Form
10-K, and the income statement data and share and per share data for the years
ended December 31, 2005 and 2004 and the balance sheet data as of December 31,
2006, 2005 and 2004 are derived from the audited financial statements and
related notes that are not included in this Form 10-K.


At
      or For the Years Ended December 31,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(dollars
      in thousands)Year
      End Balance Sheet Data:(dollars
      in thousands)Securities
              
              $
              139,162
              
              
              $
              142,068
              
              
              $
              158,352
              
              
              $
              175,200
              
              
              $
              106,526Federal
      funds sold
              
              
              838
              
              
              
              35,869
              
              
              
              6,793
              
              
              
              1,786
              
              
              
              552Loans,
      net of unearned income
              
              
              606,369
              
              
              
              575,256
              
              
              
              507,195
              
              
              
              491,582
              
              
              
              456,104Allowance
      for loan losses
              
              
              6,482
              
              
              
              6,193
              
              
              
              6,675
              
              
              
              7,597
              
              
              
              5,910Total
      assets(1)
              
              
              871,432
              
              
              
              808,060
              
              
              
              715,216
              
              
              
              713,544
              
              
              
              607,154Total
      deposits
              
              
              780,372
              
              
              
              723,094
              
              
              
              626,293
              
              
              
              632,908
              
              
              
              481,358Borrowings
              
              
              18,122
              
              
              
              13,494
              
              
              
              24,568
              
              
              
              22,132
              
              
              
              71,771Stockholders'
      equity(1)
              
              
              66,630
              
              
              
              67,262
              
              
              
              59,932
              
              
              
              53,923
              
              
              
              51,706Average
      Balance Sheet Data:(dollars
      in thousands)Securities
              
              $
              127,586
              
              
              $
              152,990
              
              
              $
              178,419
              
              
              $
              109,236
              
              
              $
              87,232Federal
      funds sold
              
              
              17,247
              
              
              
              8,083
              
              
              
              3,115
              
              
              
              6,028
              
              
              
              618Loans,
      net of unearned income
              
              
              600,854
              
              
              
              543,946
              
              
              
              505,623
              
              
              
              476,144
              
              
              
              415,606Total
      earning assets
              
              
              752,093
              
              
              
              712,212
              
              
              
              690,057
              
              
              
              595,141
              
              
              
              509,261Total
      assets
              
              
              797,024
              
              
              
              751,237
              
              
              
              726,593
              
              
              
              631,554
              
              
              
              542,460Total
      deposits
              
              
              707,114
              
              
              
              658,456
              
              
              
              622,869
              
              
              
              526,995
              
              
              
              438,214Borrowings
              
              
              16,287
              
              
              
              23,450
              
              
              
              42,435
              
              
              
              45,732
              
              
              
              51,558Stockholders'
      equity
              
              
              67,769
              
              
              
              63,564
              
              
              
              56,640
              
              
              
              54,901
              
              
              
              49,257Performance
      Ratios:Return
      on average assets
              
              
              0.72
              %
              
              
              1.37
              %
              
              
              1.21
              %
              
              
              0.95
              %
              
              
              1.58
              %Return
      on average equity
              
              
              8.48
              %
              
              
              16.15
              %
              
              
              15.54
              %
              
              
              10.97
              %
              
              
              17.37
              %Return
      on average tangible assets(2)
              
              
              0.72
              %
              
              
              1.37
              %
              
              
              1.21
              %
              
              
              0.96
              %
              
              
              1.58
              %Return
      on average tangible equity(3)
              
              
              8.77
              %
              
              
              16.47
              %
              
              
              15.73
              %
              
              
              11.24
              %
              
              
              18.08
              %Net
      interest margin
              
              
              4.25
              %
              
              
              4.79
              %
              
              
              4.60
              %
              
              
              4.71
              %
              
              
              5.09
              %Average
      loans to average deposits
              
              
              84.97
              %
              
              
              82.61
              %
              
              
              81.18
              %
              
              
              90.35
              %
              
              
              94.84
              %Efficiency
      ratio
              
              
              69.78
              %
              
              
              54.50
              %
              
              
              50.90
              %
              
              
              55.44
              %
              
              
              52.47
              %Efficiency
      ratio (excluding amortization ofintangibles
      and securities transactions)
              
              
              69.17
              %
              
              
              53.32
              %
              
              
              49.12
              %
              
              
              53.55
              %
              
              
              50.33
              %Full
      time equivalent employees (year end)
              
              
              225
              
              
              
              222
              
              
              
              196
              
              
              
              189
              
              
              
              181




(1)  For the
years ended 2006 and 2007 amounts have been restated to reflect a prior period
adjustment of $729,000. See Note 3 to the Consolidated Financial Statements


for additional information.


(2)  Average
tangible assets represent average assets less average core deposit
intangibles.


(3)  Average
tangible equity represents average equity less average core deposit
intangibles.




- 19
-
 Table of Contents


At
      or For the Years Ended December 31,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(dollars
      in thousands)Capital
      Ratios:Average
      stockholders' equity to average assets
              
              
              8.50
              %
              
              
              8.46
              %
              
              
              7.80
              %
              
              
              8.69
              %
              
              
              9.08
              %Average
      tangible equity to average tangible assets(1),(2)
              
              
              8.25
              %
              
              
              8.31
              %
              
              
              7.71
              %
              
              
              8.51
              %
              
              
              8.76
              %Stockholders'
      equity to total assets
              
              
              7.65
              %
              
              
              8.24
              %
              
              
              8.29
              %
              
              
              7.56
              %
              
              
              8.52
              %Tier
      1 leverage capital
              
              
              8.01
              %
              
              
              7.38
              %
              
              
              8.16
              %
              
              
              7.67
              %
              
              
              8.53
              %Tier
      1 capital
              
              
              9.34
              %
              
              
              10.13
              %
              
              
              9.92
              %
              
              
              8.80
              %
              
              
              9.50
              %Total
      risk-based capital
              
              
              10.26
              %
              
              
              11.09
              %
              
              
              11.03
              %
              
              
              10.05
              %
              
              
              10.62
              %Income
      Data:(dollars
      in thousands)Interest
      income
              
              $
              47,661
              
              
              $
              55,480
              
              
              $
              50,937
              
              
              $
              40,329
              
              
              $
              33,835Interest
      expense
              
              
              15,733
              
              
              
              21,398
              
              
              
              19,206
              
              
              
              12,367
              
              
              
              8,057Net
      interest income
              
              
              31,928
              
              
              
              34,082
              
              
              
              31,731
              
              
              
              27,962
              
              
              
              25,778Provision
      for loan losses
              
              
              1,634
              
              
              
              1,918
              
              
              
              4,419
              
              
              
              5,621
              
              
              
              1,670Noninterest
      income (excluding securities transactions)
              
              
              5,689
              
              
              
              5,176
              
              
              
              4,601
              
              
              
              5,221
              
              
              
              5,082Securities
      (losses) gains
              
              
              (1
              )
              
              
              (478
              )
              
              
              (234
              )
              
              
              7
              
              
              
              (56
              )Loss
      on securities impairment
              
              
              (4,611
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Noninterest
      expense
              
              
              23,032
              
              
              
              21,133
              
              
              
              18,373
              
              
              
              18,399
              
              
              
              16,162Earnings
      before income taxes
              
              
              8,339
              
              
              
              15,729
              
              
              
              13,306
              
              
              
              9,170
              
              
              
              12,972Net
      income
              
              
              5,748
              
              
              
              10,263
              
              
              
              8,802
              
              
              
              6,024
              
              
              
              8,556Per
      Common Share Data:(3)Net
      earnings
              
              $
              1.03
              
              
              $
              1.85
              
              
              $
              1.58
              
              
              $
              1.08
              
              
              $
              1.54Cash
      dividends paid
              
              
              0.64
              
              
              
              0.63
              
              
              
              0.60
              
              
              
              0.57
              
              
              
              0.50Book
      value
              
              
              11.98
              
              
              
              11.97
              
              
              
              10.65
              
              
              
              9.70
              
              
              
              9.30Dividend
      payout ratio
              
              
              61.89
              %
              
              
              34.13
              %
              
              
              37.89
              %
              
              
              52.67
              %
              
              
              32.16
              %Weighted
      average number of shares outstanding
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644Number
      of share outstanding (year end)
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644Market
      data:High
              
              $
              25.00
              
              
              $
              24.30
              
              
              $
              23.42
              
              
              $
              20.00
              
              
              $
              15.27Low
              
              $
              24.30
              
              
              $
              23.42
              
              
              $
              18.57
              
              
              $
              15.27
              
              
              $
              15.12Trading
      Volume
              
              
              368,454
              
              
              
              924,692
              
              
              
              535,264
              
              
              
              279,503
              
              
              
              104,835Stockholders
      of record
              
              
              1,343
              
              
              
              1,293
              
              
              
              1,181
              
              
              
              1,141
              
              
              
              1,148Asset
      Quality Ratios:Nonperforming
      assets to total assets
              
              
              1.14
              %
              
              
              1.39
              %
              
              
              1.81
              %
              
              
              3.05
              %
              
              
              1.18
              %Nonperforming
      assets to loans
              
              
              1.63
              %
              
              
              1.95
              %
              
              
              2.55
              %
              
              
              4.43
              %
              
              
              1.57
              %Loan
      loss reserve to nonperforming assets
              
              
              65.46
              %
              
              
              55.26
              %
              
              
              51.53
              %
              
              
              34.92
              %
              
              
              82.59
              %Net
      charge-offs to average loans
              
              
              0.22
              %
              
              
              0.50
              %
              
              
              1.06
              %
              
              
              0.83
              %
              
              
              0.17
              %Provision
      for loan loss to average loans
              
              
              0.27
              %
              
              
              0.35
              %
              
              
              0.87
              %
              
              
              1.18
              %
              
              
              0.40
              %Allowance
      for loan loss to total loans
              
              
              1.07
              %
              
              
              1.08
              %
              
              
              1.32
              %
              
              
              1.55
              %
              
              
              1.30
              %


(1)  Average
tangible assets represents average assets less average core deposit
intangibles.


(2)  Average
tangible equity represents average equity less average core deposit
intangibles.


(3)  For the
years ended 2004 and 2005 amounts have been restated to reflect a stock dividend
of one-third of a share of $1 par value common stock for each share of $1


and $5 par value common stock outstanding, accounted for as a four-for-three
stock split, effective and payable to stockholders of record as of October 20,
2005.





Item 7 - Management’s Discussion and Analysis of Financial
Condition and Results of Operations


First
Guaranty Bancshares, Inc. became the holding company for First Guaranty Bank on
July 27, 2007 in a corporate reorganization. Information at or for the year
ended December 31, 2006, and any prior periods, reflects the operations of
First Guaranty Bank on a stand-alone basis. Prior to becoming the holding
company of First Guaranty Bank, First Guaranty Bancshares, Inc. had no assets,
liabilities or operations.


This
discussion and analysis reflects our financial statements and other relevant
statistical data, and is intended to enhance your understanding of our financial
condition and results of operations. Reference should be made to those financial
statements of this Form 10-K and the selected financial data (above) presented
in this report in order to obtain a better understanding of the commentary which
follows.


For the years
ended 2005 and 2004 all per share data in this discussion has been adjusted to
reflect the stock dividend of one-third of a share of the $1 par value common
stock for each share of the $1 and $5 par value common stock outstanding,
accounted for as a four-for-three stock split, effective and payable to
stockholders of record as of October 20, 2005. Fractional shares were settled
for cash.




- 20
-
 Table of Contents


Special
Note Regarding Forward-Looking Statements


Congress
passed the Private Securities Litigation Act of 1995 in an effort to encourage
corporations to provide information about a company’s anticipated future
financial performance. This act provides a safe harbor for such disclosure,
which protects us from unwarranted litigation, if actual results are different
from Management expectations. This discussion and analysis contains
forward-looking statements and reflects Management’s current views and estimates
of future economic circumstances, industry conditions, company performance and
financial results. The words “may,” “should,” “expect,” “anticipate,” “intend,”
“plan,” “continue,” “believe,” “seek,” “estimate” and similar expressions are
intended to identify forward-looking statements. These forward-looking
statements are subject to a number of factors and uncertainties, which could
cause our actual results and experience to differ from the anticipated results
and expectations, expressed in such forward-looking statements.





Application
of Critical Accounting Policies


The
accounting and reporting policies of the Company conform to generally accepted
accounting principles in the United States of America and to predominant
accounting practices within the banking industry. Certain critical accounting
policies require judgment and estimates which are used in the preparation of the
financial statements.


Other-Than-Temporary Impairment of Investment
Securities.Securities are
evaluated periodically to determine whether a decline in their value is
other-than-temporary. The term “other-than-temporary” is not intended to
indicate a permanent decline in value. Rather, it means that the prospects for
near term recovery of value are not necessarily favorable, or that there is a
lack of evidence to support fair values equal to, or greater than, the carrying
value of the investment. Management reviews criteria such as the magnitude and
duration of the decline, the reasons for the decline, and the performance and
valuation of the underlying collateral, when applicable, to predict whether the
loss in value is other-than-temporary. Once a decline in value is determined to
be other-than-temporary, the carrying value of the security is reduced to its
fair value and a corresponding charge to earnings is recognized.


Allowance for Loan Losses.The Company’s most critical accounting
policy relates to its allowance for loan losses. The allowance for loan losses
is established through a provision for loan losses charged to expense. Loans are
charged against the allowance for loan losses when Management believes that the
collectability of the principal is unlikely. The allowance, which is based on
the evaluation of the collectability of loans and prior loan loss experience, is
an amount Management believes will be adequate to reflect the risks inherent in
the existing loan portfolio and that exist at the reporting date. The
evaluations take into consideration a number of subjective factors including
changes in the nature and volume of the loan portfolio, overall portfolio
quality, review of specific problem loans, current economic conditions that may
affect a borrower’s ability to pay, adequacy of loan collateral and other
relevant factors.


Changes in
such estimates may have a significant impact on the financial statements. For
further discussion of the allowance for loan losses, see the “Allowance for Loan
Losses” section of this analysis and Note 1 to the Consolidated Financial
Statements.


Valuation of Goodwill, Intangible Assets and Other
Purchase Accounting Adjustments.The Company accounts for
acquisitions in accordance with Statement of Financial Accounting Standards
(“SFAS”) No. 141, “Business Combinations,” which requires the use of the
purchase method of accounting. For purchase acquisitions, the Company is
required to record the assets acquired, including identified intangible assets
and liabilities assumed, at their fair value, which in many instances involves
estimates based on third party valuations, such as appraisals, or internal
valuations based on discounted cash flow analyses or other valuation techniques.
The determination of the useful lives of intangible assets is subjective as is
the appropriate amortization period for such intangible assets. In addition,
purchase acquisitions typically result in recording goodwill. The Company
performs a goodwill valuation at least annually. Impairment testing of goodwill
is a two step process that first compares the fair value of goodwill with its
carrying amount, and second measures impairment loss by comparing the implied
fair value of goodwill with the carrying amount of that goodwill. Based on
Management’s goodwill impairment tests, there was no impairment of goodwill at
December 31, 2008. For additional information on goodwill and intangible
assets, see Note 8 to the Consolidated Financial Statements.





Financial
Condition


Assets.Total assets at December 31,
2008 were $871.4 million, an increase of $63.4 million, or 7.8%, from $808.1
million at December 31, 2007. Federal funds sold decreased $35.0 million
from December 31, 2007 to December 31, 2008 and loans for the same period
increased $31.1 million. Cash and due from banks increased $54.4 million and
interest-earning time deposits with banks increased $19.3 million from 2007 to
2008. Total deposits increased by $57.3 million or 7.9% from 2007 to 2008.
At December 31, 2008, long-term borrowings were $8.4 million, an increase of
$5.3 million or 170.1%, from $3.1 million at December 31, 2007.


Cash and Cash
Equivalents.Cash and cash equivalents at December 31, 2008 totaled
$78.0 million, an increase of $19.3 million when compared to $58.7 million at
December 31, 2007. Cash and due from banks increased $54.4 million, and federal
funds sold decreased $35.0 million.  At December 31, 2008, the Company
invested the majority of its excess cash in the Federal Reserve Bank rather than
in federal funds sold. The Federal Reserve paid interest of 25 basis points on
all reserve balances and excess reserves. This rate was slightly higher than
rates being paid at other institutions on overnight federal funds.


Investment
Securities. The securities portfolio consisted principally of U.S.
Government agency securities, mortgage-backed obligations, asset-backed
securities, corporate debt securities and mutual funds or other equity
securities. The securities portfolio provides us with a relatively stable source
of income and provides a balance to interest rate and credit risks as compared
to other categories of assets.




- 21
-
 Table of Contents


The
securities portfolio totaled $139.2 million at December 31, 2008, representing a
decrease of $2.9 million from December 31, 2007. The primary changes in the
portfolio consisted of $773.8 million in purchases, calls totaling $40.6
million and maturities of $727.0 million. An other than temporary impairment
charge totaling $4.6 million was taken on twelve securities during the third
quarter of 2008. See Note 5 to the Consolidated Financial Statements for
additional information.


At December
31, 2008 approximately 25.1% of the securities portfolio (excluding Federal Home
Loan Bank stock) matures in less than one year while securities with maturity
dates over 10 years totaled 34.1% of the portfolio. At December 31, 2008, the
average maturity of the securities portfolio was 3.7 years, compared to the
average maturity at December 31, 2007 of 3.3 years.


At December
31, 2008, securities totaling $114.4 million were classified as available for
sale and $24.8 million were classified as held to maturity as compared to $105.6
million and $36.5 million, respectively at December 31, 2007.


Securities
classified as available for sale are measured at fair market value. For these
securities, the Company obtains fair value measurements from an independent
pricing service. The fair value measurements consider observable data that may
include dealer quotes, market spreads, cash flows, market yield curves,
prepayment speeds, credit information and the instrument’s contractual terms and
conditions, among other things. Securities classified as held to maturity are
measured at book value. See Note 5 and Note 20 to the Consolidated Financial
Statements for additional information.


The book
yields on securities available for sale ranged from 0.0% to 13.3% at December
31, 2008, exclusive of the effect of changes in fair value reflected as a
component of stockholders’ equity. The book yields on held to maturity
securities ranged from 3.6% to 6.1%.


Securities
classified as available for sale had gross unrealized losses totaling $5.7
million at December 31, 2008, which includes $5.1 million in unrealized losses
on corporate debt securities. The majority of the corporate debt securities with
unrealized losses have been in a loss position for less than twelve months. The
Company believes that it will collect all amounts contractually due and has the
intent and the ability to hold these securities until the fair value is at least
equal to the carrying value. At December 31, 2007, securities classified as
available for sale had gross unrealized losses totaling $0.6 million. See Note 5
to the Consolidated Financial Statements for additional
information.


Average
securities as a percentage of average interest-earning assets were
17.0% and 21.5% at December 31, 2008 and 2007, respectively. At December
31, 2008, $54.1 million of the total securities portfolio did not qualify as
pledgeable securities to collateralize repurchase agreements and public funds.
Most securities held at December 31, 2007 qualified as pledgeable securities. At
December 31, 2008 and 2007, $85.4 million and $131.6 million in securities were
pledged, respectively.


Mortgage Loans Held
for Sale. The
Company did not hold any mortgage loans for sale at December 31, 2008 compared
to $4.0 million at December 31, 2007.


Loans.The origination of loans is
our primary use of our financial resources and represents the largest component
of earning assets. At December 31, 2008, the loan portfolio (loans, net of
unearned income) totaled $606.4 million, an increase of approximately $31.1
million, or 5.4%, from the December 31, 2007 level of $575.3 million. The
increase in net loans includes $40.6 million in assignments purchased on
non-real estate commercial and industrial loans. The loan assignments purchased
meet the same underwriting criteria used when making in-house
loans.


Loans to
related parties are included in total loans. Related parties include the
Company’s executive officers, directors and certain business organizations and
individuals with which such persons are associated. At December 31, 2008 and
2007, loans to related parties totaled $22.5 million and $19.1 million,
respectively. See Note 14 to the Consolidated Financial Statements for
additional information.


Loans
represented 77.7% of deposits at December 31, 2008, compared to 79.6% of
deposits at December 31, 2007. Loans secured by real estate increased $9.8
million to $465.2 million at December 31, 2008. Commercial and industrial loans
increased $24.5 million to $105.6 million at December 31, 2008. Real estate and
related loans comprised 76.6% of the portfolio in 2008 as compared to 79.1% in
2007. Commercial and industrial loans comprised 17.4% of the portfolio in 2008
as compared to 14.1% in 2007.


Loan
charge-offs taken during 2008 totaled $1.6 million, compared to charge-offs of
$3.9 million in 2007. Of the loan charge-offs in 2008, approximately $0.7
million were loans secured by real estate, $0.6 million were commercial and
industrial loans $0.4 million were consumer and other loans. In 2008, recoveries
of $0.3 million were recognized on loans previously charged off as compared to
$1.2 million in 2007.


In 2008, loan
growth was geographically dispersed between north and south Louisiana
(throughout our market area). Increased loan volume from larger commercial real
estate customers outpaced loan demand from consumer clients in this
period.


Nonperforming
Assets. Nonperforming assets were $9.9 million, or 1.1% of total assets
at December 31, 2008, compared to $11.2 million, or 1.4% of total assets at
December 31, 2007. The decrease resulted from a $1.2 million, or 11.3%,
reduction in nonaccrual loans offset with a $0.2 million increase in other real
estate. The decrease in nonaccrual loans was primarily a reduction in non-farm
non-residential loans. The increase in other real estate was primarily the
result of an increase in non-farm nonresidential properties.


Deposits.
Total deposits increased by $57.3 million or 7.9%, to $780.4 million at December
31, 2008 from $723.1 million at December 31, 2007. In 2008, noninterest-bearing
demand deposits decreased $2.5 million, interest-bearing demand deposits
decreased $42.9 million and savings deposits decreased $3.7 million. Time
deposits increased $106.4 million, or 31.8% which includes brokered deposits
totaling $13.0 million in reciprocal time deposits acquired from the Certificate
of Deposit Account Registry Service (CDARS). The increase in deposits was due to
a $39.4 million increase in individual and business deposits and a $17.9 million
increase in public fund deposits. The increase in deposits resulted from a
series of marketing campaigns launched in 2008, time deposit promotions and a
continued effort to obtain deposit relationships with new and existing loan
customers.





- 22
-
 Table of Contents


Public fund
deposits totaled $225.8 million or 28.9% of total deposits at December 31, 2008.
At December 31, 2007, public fund deposits represented 28.8% of total deposits
with a balance of $207.9 million.


Borrowings.Short-term borrowings
decreased $0.6 million in 2008 to $9.8 million at December 31, 2008 from $10.4
million at December 31, 2007. Short-term borrowings are used to manage liquidity
on a daily or otherwise short-term basis. The short-term borrowings at December
31, 2008 and 2007 respectively was solely comprised of repurchase agreements.
Overnight repurchase agreement balances are monitored daily for sufficient
collateralization.


Long-term
borrowings increased $5.3 million, or 170.1%, to $8.4 million at December 31,
2008, compared to $3.1 million at December 31, 2007. At December 31, 2008, one
long-term advance was outstanding at FHLB totaling $8.4 million with a rate of
3.14% and a maturity date of October 1, 2009. At December 31, 2007, long-term
borrowings consisted solely of subordinated debt (see Note 10 to the
Consolidated Financial Statements).


Stockholders’
Equity.Total stockholders’ equity decreased $0.6 million or 0.9% to $66.6
million at December 31, 2008 from $67.3 million at December 31, 2007. The
decrease in stockholders’ equity reflected consolidated net income of $5.7
million during 2008, offset by dividends paid of $3.6 million and changes in
unrealized losses on available for sale securities totaling $2.8
million.


- 23
-
 Table of Contents


Loan Portfolio
Composition.The following table sets forth the composition of our loan
portfolio, excluding loans held for sale, by type of loan at the dates
indicated.





December
      31,2008
              
              
              2007
              
              
              2006As
      % of
              
              
              
              
              
              As
      % of
              
              
              
              
              
              As
      % ofBalance
              
              
              Category
              
              
              Balance
              
              
              Category
              
              
              Balance
              
              
              Category(dollars
      in thousands)Real
      estateConstruction
      & land development
              
              $
              92,029
              
              
              
              15.2
              %
              
              $
              98,127
              
              
              
              17.0
              %
              
              $
              49,837
              
              
              
              9.9
              %Farmland
              
              
              16,403
              
              
              
              2.7
              %
              
              
              23,065
              
              
              
              4.0
              %
              
              
              25,582
              
              
              
              5.0
              %1-4
      Family
              
              
              79,285
              
              
              
              13.1
              %
              
              
              84,640
              
              
              
              14.7
              %
              
              
              67,022
              
              
              
              13.2
              %Multifamily
              
              
              15,707
              
              
              
              2.6
              %
              
              
              13,061
              
              
              
              2.3
              %
              
              
              14,702
              
              
              
              2.9
              %Non-farm
      non-residential
              
              
              261,744
              
              
              
              43.0
              %
              
              
              236,474
              
              
              
              41.1
              %
              
              
              256,176
              
              
              
              50.5
              %Total
      real estate
              
              
              465,168
              
              
              
              76.6
              %
              
              
              455,367
              
              
              
              79.1
              %
              
              
              413,319
              
              
              
              81.5
              %Agricultural
              
              
              18,536
              
              
              
              3.0
              %
              
              
              16,816
              
              
              
              2.9
              %
              
              
              16,359
              
              
              
              3.2
              %Commercial
      and industrial
              
              
              105,555
              
              
              
              17.4
              %
              
              
              81,073
              
              
              
              14.1
              %
              
              
              59,072
              
              
              
              11.6
              %Consumer
      and other
              
              
              17,926
              
              
              
              3.0
              %
              
              
              22,517
              
              
              
              3.9
              %
              
              
              18,880
              
              
              
              3.7
              %Total
      loans before unearned income
              
              
              607,185
              
              
              
              100.0
              %
              
              
              575,773
              
              
              
              100.0
              %
              
              
              507,630
              
              
              
              100.0
              %Less:
      unearned income
              
              
              (816
              )
              
              
              
              
              
              
              (517
              )
              
              
              
              
              
              
              (435
              )Total
      loans after unearned income
              
              $
              606,369
              
              
              
              
              
              
              $
              575,256
              
              
              
              
              
              
              $
              507,1952005
              
              
              2004As
      % of
              
              
              
              
              
              
              As
      % ofBalance
              
              
              Category
              
              
              Balance
              
              
              Category(dollars
      in thousands)Real
      estateConstruction
      & land development
              
              $
              67,099
              
              
              
              13.6
              %
              
              $
              72,063
              
              
              
              15.8
              %Farmland
              
              
              24,903
              
              
              
              5.1
              %
              
              
              18,303
              
              
              
              4.0
              %1-4
      Family
              
              
              78,789
              
              
              
              16.0
              %
              
              
              86,162
              
              
              
              18.9
              %Multifamily
              
              
              11,125
              
              
              
              2.3
              %
              
              
              7,601
              
              
              
              1.7
              %Non-farm
      non-residential
              
              
              223,622
              
              
              
              45.5
              %
              
              
              178,090
              
              
              
              39.0
              %Total
      real estate
              
              
              405,538
              
              
              
              82.5
              %
              
              
              362,219
              
              
              
              79.4
              %Agricultural
              
              
              11,490
              
              
              
              2.3
              %
              
              
              9,546
              
              
              
              2.1
              %Commercial
      and industrial
              
              
              54,740
              
              
              
              11.1
              %
              
              
              59,135
              
              
              
              12.9
              %Consumer
      and other
              
              
              20,078
              
              
              
              4.1
              %
              
              
              25,495
              
              
              
              5.6
              %Total
      loans before unearned income
              
              
              491,846
              
              
              
              100.0
              %
              
              
              456,395
              
              
              
              100.0
              %Less:
      unearned income
              
              
              (264
              )
              
              
              
              
              
              
              (291
              )Total
      loans after unearned income
              
              $
              491,582
              
              
              
              
              
              
              $
              456,104


The three
most significant categories of our loan portfolio are non-farm non-residential
real estate loans, 1-4 family residential loans and land development real estate
loans.


The Company’s
credit policy dictates specific loan-to-value and debt service coverage
requirements.  The Company generally requires a maximum loan-to-value
of 85% and a debt service coverage ratio of 1.25x to 1.0x for non-farm
non-residential real estate loans. In addition, personal guarantees of borrowers
are required as well as applicable hazard, title and flood insurance. Loans may
have a maximum maturity of five years and a maximum amortization of 25 years.
The Company may require additional real estate or non-real estate collateral
when deemed
appropriate to secure the loan.


The Company
generally requires all 1-4 family residential loans to be underwritten based on
the Fannie Mae guidelines provided through Desktop Underwriter. These guidelines
include the evaluation of risk and eligibility, verification and approval of
conditions, credit and liabilities, employment and income, assets, property and
appraisal information. It is required that all borrowers have proper hazard,
flood and title insurance prior to a loan closing. Appraisals and Desktop
Underwriter approvals are good for six months. The Company has an in-house
underwriter review the final package for compliance to these
guidelines.




- 24
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The Company
generally requires a maximum loan-to value of 75% and a debt service coverage
ratio of 1.25x to 1.0x for land development loans. In addition, detailed
construction cost breakdowns, personal guarantees of borrowers and applicable
hazard, title and flood insurance are required. Loans may have a maximum
maturity of 12 months for the construction phase and a maximum maturity of 24
months for the sell-out phase. The Company may require additional real estate or
non-real estate collateral when deemed appropriate to secure the
loan.


The Company
will allow exceptions to this policy with appropriate mitigating circumstances
and approvals. The Company has a defined credit underwriting process for all
loan requests. The Company actively monitors loan concentrations by industry
type and will make adjustments to underwriting standards as deemed necessary.
The Company has a loan review department that monitors the performance and
credit quality of loans. The Company has a special assets department that
manages loans that have become delinquent or have serious credit issues
associated with them.


For new loan
originations, appraisals and evaluations on all properties shall be valid for a
period not to exceed two (2) calendar years from the effective appraisal date
for non-residential properties and one (1) calendar year from the effective
appraisal date for residential properties.  However, an appraisal may
be valid longer if there has been no material decline in the property condition
or market condition that would negatively affect the bank’s collateral
position.  This must be supported with a “Validity Check
Memorandum”.


For renewals
with or without new money, any commercial appraisal greater than two years or
greater than one year for residential appraisals must be updated with a Validity
Check Memorandum.  Any renewal loan request, in which new money will
be disbursed, whether commercial or residential, and the appraisal is older than
five years a new appraisal must be obtained.


The Company
does not require new appraisals between renewals unless the loan becomes
impaired and is considered collateral dependent. At this time, an appraisal may
be ordered in accordance with the Company’s Allowance for Loan Losses
policy.


The Company
does not mitigate risk using products such as credit default agreements and/or
credit derivatives.  These, accordingly, have no impact on our
financial statements.


The Company
does not offer loan products with established loan-funded interest
reserves.




Loan Maturities by
Type.The following table summarizes the scheduled repayments of our loan
portfolio at December 31, 2008. Loans having no stated repayment schedule or
maturity and overdraft loans are reported as being due in one year or less.
Maturities are based on the final contractual payment date and do not reflect
the effect of prepayments and scheduled principal amortization.





One
      Year
            
            
            One
      Through
            
            
            Afteror
      Less
            
            
            Five
      Years
            
            
            Five
      Years
            
            
            Total(in
      thousands)Real
      estate:Construction
      & land development
            
            $
            68,242
            
            
            $
            20,096
            
            
            $
            3,691
            
            
            $
            92,029Farmland
            
            
            13,228
            
            
            
            2,005
            
            
            
            1,170
            
            
            
            16,4031-4
      Family
            
            
            29,331
            
            
            
            22,655
            
            
            
            27,299
            
            
            
            79,285Multifamily
            
            
            13,776
            
            
            
            1,855
            
            
            
            76
            
            
            
            15,707Non-farm
      non-residential
            
            
            187,584
            
            
            
            58,753
            
            
            
            15,407
            
            
            
            261,744Total
      real estate
            
            
            312,161
            
            
            
            105,364
            
            
            
            47,643
            
            
            
            465,168Agricultural
            
            
            12,612
            
            
            
            3,005
            
            
            
            2,919
            
            
            
            18,536Commercial
      and industrial
            
            
            55,869
            
            
            
            49,567
            
            
            
            119
            
            
            
            105,555Consumer
      and other
            
            
            8,842
            
            
            
            8,998
            
            
            
            86
            
            
            
            17,926Total
      loans before unearned income
            
            $
            389,484
            
            
            $
            166,934
            
            
            $
            50,767
            
            
            $
            607,185Less:
      unearned income
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (816
            )Total
      loans after unearned income
            
            
            
            
            
            
            
            
            
            
            
            
            
            $
            606,369






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 Table of Contents


The following
table sets forth the scheduled contractual maturities at December 31, 2008 of
fixed- and floating-rate loans excluding non-accrual loans.


December
      31, 2008Fixed
              
              
              Floating
              
              
              Total(in
      thousands)One
      year or less
              
              $
              134,750
              
              
              $
              244,498
              
              
              $
              379,248One
      to five years
              
              
              123,903
              
              
              
              43,027
              
              
              
              166,930Five
      to 15 years
              
              
              34,478
              
              
              
              164
              
              
              
              34,642Over
      15 years
              
              
              16,420
              
              
              
              -
              
              
              
              16,420Subtotal
              
              
              309,551
              
              
              
              287,689
              
              
              
              597,240Nonaccrual
      loans
              
              
              
              
              
              
              
              
              
              
              9,129Total
      loans after unearned income
              
              $
              309,551
              
              
              $
              287,689
              
              
              $
              606,369





At December 31, 2008, fixed rate loans
totaled $309.6 million or 51.0% of total loans, an increase from 40.5% of total
loans for the same period in 2007. At December 31, 2008, total loans include
$218.0 million in loans maturing after December 31, 2009.




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 Table of Contents


Non-Performing
Assets.The
table below sets forth the amounts and categories of our non-performing assets
at the dates indicated.





At
      December 31,2008
            
            
            2007
            
            
            2006
            
            
            2005
            
            
            2004(dollars
      in thousands)Non-accrual
      loans:Real estate loans:Construction and land development
            
            $
            1,644
            
            
            $
            1,841
            
            
            $
            2,676
            
            
            $
            16,376
            
            
            $
            206Farmland
            
            
            182
            
            
            
            419
            
            
            
            33
            
            
            
            -
            
            
            
            -One- to four- family residential
            
            
            1,445
            
            
            
            1,819
            
            
            
            3,202
            
            
            
            3,548
            
            
            
            1,059Multifamily
            
            
            -
            
            
            
            2
            
            
            
            -
            
            
            
            -
            
            
            
            -Non-farm non-residential
            
            
            5,263
            
            
            
            4,950
            
            
            
            3,882
            
            
            
            153
            
            
            
            1,232Non-real estate loans:Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial and industrial
            
            
            275
            
            
            
            978
            
            
            
            267
            
            
            
            358
            
            
            
            514Consumer and other
            
            
            320
            
            
            
            279
            
            
            
            302
            
            
            
            655
            
            
            
            450Total non-accrual loans
            
            
            9,129
            
            
            
            10,288
            
            
            
            10,362
            
            
            
            21,090
            
            
            
            3,461Loans
      90 days and greater delinquentand
      still accruing:Real estate loans:Construction and land development
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Farmland
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -One- to four- family residential
            
            
            185
            
            
            
            544
            
            
            
            334
            
            
            
            248
            
            
            
            370Multifamily
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Non-farm non-residential
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Non-real estate loans:Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial and industrial
            
            
            17
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            28Consumer and other
            
            
            3
            
            
            
            3
            
            
            
            -
            
            
            
            -
            
            
            
            11Total loans 90 days greaterdelinquent and still accruing
            
            
            205
            
            
            
            547
            
            
            
            334
            
            
            
            248
            
            
            
            409Restructured loans
            
            
            -
            
            
            
            -
            
            
            
            51
            
            
            
            121
            
            
            
            134Total
      non-performing loans
            
            
            9,334
            
            
            
            10,835
            
            
            
            10,747
            
            
            
            21,459
            
            
            
            4,004Real estate owned:Construction and land development
            
            
            89
            
            
            
            84
            
            
            
            2,217
            
            
            
            -
            
            
            
            -Farmland
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            144
            
            
            
            133One- to four- family residential
            
            
            223
            
            
            
            170
            
            
            
            78
            
            
            
            81
            
            
            
            554Multifamily
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Non-farm non-residential
            
            
            256
            
            
            
            119
            
            
            
            245
            
            
            
            321
            
            
            
            3,018Non-real
      estate loans:Agricultural
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Commercial and industrial
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Consumer and other
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -
            
            
            
            -Total real estate owned
            
            
            568
            
            
            
            373
            
            
            
            2,540
            
            
            
            546
            
            
            
            3,705Total
      non-performing assets
            
            $
            9,902
            
            
            $
            11,208
            
            
            $
            13,287
            
            
            $
            22,005
            
            
            $
            7,709Ratios:Non-performing assets to total loans
            
            
            1.63
            %
            
            
            1.95
            %
            
            
            2.62
            %
            
            
            4.48
            %
            
            
            1.69
            %Non-performing assets to total assets
            
            
            1.14
            %
            
            
            1.39
            %
            
            
            1.86
            %
            
            
            3.08
            %
            
            
            1.27
            %


For the years
ended December 31, 2008 and 2007, gross interest income that would have been
recorded had our non-accruing loans been current in accordance with their
original terms was $0.5 million and $0.6 million, respectively.




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Total
non-performing assets at December 31, 2008 decreased $1.3 million to $9.9
million from $11.2 million at December 31, 2007. One- to four- family nonaccrual
loans decreased $0.4 million in 2008 primarily due to one loan which was
partially written off and the remaining balance was transferred to other real
estate. Commercial and industrial nonaccrual loans decreased $0.7 million in
2008 primarily due to three large loans taken out of nonaccrual status. Non-farm
non-residential nonaccrual loans increased $0.3 million to $5.3 at December 31,
2008 from $5.0 million at December 31, 2007. The increase resulted from the
addition of four loans totaling $1.0 million. These additions were offset by
principal write downs, balances being paid down and one loan which was paid in
full.
 Allowance for Loan
Losses.The allowance for loan losses is maintained at a level considered
sufficient to absorb potential losses embedded in the loan portfolio. The
allowance is increased by the provision for anticipated loan losses as well as
recoveries of previously charged-off loans and is decreased by loan charge-offs.
The provision is the necessary charge to current expense to provide for current
loan losses and to maintain the allowance at an adequate level commensurate with
Management’s evaluation of the risks inherent in the loan portfolio. Various
factors are taken into consideration when determining the amount of the
provision and the adequacy of the allowance. These factors include but are not
limited to:


·
            past
      due and nonperforming assets; ·
              specific
      internal analysis of loans requiring special
  attention;
 ·
              the
      current level of regulatory classified and criticized assets and the
      associated risk factors with each;·
              changes
      in underwriting standards or lending procedures and policies;·
              charge-off
      and recovery practices;·
              national
      and local economic and business conditions;·
              nature
      and volume of loans;·
              overall
      portfolio quality;·
              adequacy
      of loan collateral;·
              quality
      of loan review system and degree of oversight by its Board of
      Directors;·
              competition
      and legal and regulatory requirements on borrowers;·
              examinations
      and review by our internal loan review department, independent accountants
      and third-party independent loan review personnel; and·
              examinations
      of the loan portfolio by federal and state regulatory
  agencies.




The data
collected from all sources in determining the adequacy of the allowance is
evaluated on a regular basis by Management with regard to current national and
local economic trends, prior loss history, underlying collateral values, credit
concentrations and industry risks. An estimate of potential loss on specific
loans is developed in conjunction with an overall risk evaluation of the total
loan portfolio. This evaluation is inherently subjective as it requires
estimates that are susceptible to significant revision as new information
becomes available.


The allowance
consists of specific, general and unallocated components. The specific component
relates to loans that are classified as doubtful, substandard or special
mention. For such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that
loan. The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. An unallocated
component is maintained to cover uncertainties that could affect the estimate of
probable losses. The unallocated component of the allowance reflects the margin
of imprecision inherent in the underlying assumptions used in the methodologies
for estimating specific and general losses in the portfolio.


Allocation of
Allowance for Loan Losses.In prior years, the Company used an internal
method to calculate the allowance for loan losses which categorized loans by
risk rather than by type. We do not have the ability to accurately and
efficiently provide the allocation of the allowance for loan losses by loan type
for a five-year historical period. Beginning in 2008, the Company modified the
allowance calculation to segregate loans by category and allocate the allowance
for loan losses accordingly.


The allowance
for loan losses calculation considers both qualitative and quantitative risk
factors. The quantitative risk factors include, but are not limited to, past due
and nonperforming assets, adequacy of collateral, changes in underwriting
standings or lending procedures and policies, specific internal analysis of
loans requiring special attention and the nature and volume of loans.
Qualitative risk factors include, but are not limited to, local and regional
business conditions and other economic factors.





- 28
-
 Table of Contents


The following
table shows the allocation of the allowance for loan losses by loan type as of
December 31, 2008.





At
      December 31, 2008Percent
      ofAllowance
              
              
              loans
      in eachfor
      Loan
              
              
              category
      toLosses
              
              
              total
      loans(dollars
      in thousands)Real
      estate loans:Construction and land development
              
              $
              315
              
              
              
              15.2
              %Farmland
              
              
              39
              
              
              
              2.7
              %One- to four- family residential
              
              
              1,712
              
              
              
              13.1
              %Multifamily
              
              
              227
              
              
              
              2.6
              %Non-farm non-residential
              
              
              2,572
              
              
              
              43.0
              %Non-real
      estate loans:Agricultural
              
              
              92
              
              
              
              3.0
              %Commercial and industrial
              
              
              1,119
              
              
              
              17.4
              %Consumer and other
              
              
              355
              
              
              
              3.0
              %Unallocated
              
              
              51
              
              
              
              N/ATotal
              
              $
              6,482
              
              
              
              100.0
              %
  - 29
-
 Table of Contents


The following table
sets forth activity in our allowance for loan losses for the periods
indicated.





At
      or For the Years Ended December 31,2008
              
              
              2007
              
              
              2006
              
              
              2005
              
              
              2004(dollars
      in thousands)Balance
      at beginning of period
              
              $
              6,193
              
              
              $
              6,675
              
              
              $
              7,597
              
              
              $
              5,910
              
              
              $
              4,942Charge-offs:Real estate loans:Construction and land development
              
              
              (166
              )
              
              
              (386
              )
              
              
              (5,008
              )
              
              
              -
              
              
              
              -Farmland
              
              
              (10
              )
              
              
              (123
              )
              
              
              -
              
              
              
              -
              
              
              
              -One- to four- family residential
              
              
              (260
              )
              
              
              (639
              )
              
              
              (59
              )
              
              
              (2,001
              )
              
              
              (208
              )Multifamily
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Non-farm non-residential
              
              
              (256
              )
              
              
              (1,901
              )
              
              
              (208
              )
              
              
              -
              
              
              
              -Commercial
      and industrial loans
              
              
              (561
              )
              
              
              (273
              )
              
              
              (301
              )
              
              
              (1,649
              )
              
              
              (313
              )Consumer
      and other
              
              
              (360
              )
              
              
              (563
              )
              
              
              (312
              )
              
              
              (512
              )
              
              
              (405
              )Total charge-offs
              
              
              (1,613
              )
              
              
              (3,885
              )
              
              
              (5,888
              )
              
              
              (4,162
              )
              
              
              (926
              )Recoveries:Real estate loans:Construction and land development
              
              
              2
              
              
              
              779
              
              
              
              39
              
              
              
              -
              
              
              
              -Farmland
              
              
              -
              
              
              
              14
              
              
              
              -
              
              
              
              -
              
              
              
              -One- to four- family residential
              
              
              10
              
              
              
              14
              
              
              
              25
              
              
              
              5
              
              
              
              20Multifamily
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -Non-farm non-residential
              
              
              57
              
              
              
              4
              
              
              
              40
              
              
              
              -
              
              
              
              -Commercial and industrial loans
              
              
              10
              
              
              
              148
              
              
              
              304
              
              
              
              86
              
              
              
              152Consumer and other
              
              
              189
              
              
              
              201
              
              
              
              139
              
              
              
              137
              
              
              
              52Total recoveries
              
              
              268
              
              
              
              1,160
              
              
              
              547
              
              
              
              228
              
              
              
              224Net
      charge-offs
              
              
              (1,345
              )
              
              
              (2,725
              )
              
              
              (5,341
              )
              
              
              (3,934
              )
              
              
              (702
              )Provision
      for loan losses
              
              
              1,634
              
              
              
              1,918
              
              
              
              4,419
              
              
              
              5,621
              
              
              
              1,670Additional
      provision from acquisition
              
              
              -
              
              
              
              325
              
              
              
              -
              
              
              
              -
              
              
              
              -Balance
      at end of period
              
              $
              6,482
              
              
              $
              6,193
              
              
              $
              6,675
              
              
              $
              7,597
              
              
              $
              5,910Ratios:Net
      loan charge-offs to average loans
              
              
              0.22
              %
              
              
              0.50
              %
              
              
              1.06
              %
              
              
              0.83
              %
              
              
              0.17
              %Net
      loan charge-offs to loans at end of period
              
              
              0.22
              %
              
              
              0.47
              %
              
              
              1.05
              %
              
              
              0.80
              %
              
              
              0.15
              %Allowance
      for loan losses to loans at end of period
              
              
              1.07
              %
              
              
              1.08
              %
              
              
              1.32
              %
              
              
              1.55
              %
              
              
              1.30
              %Net
      loan charge-offs to allowance for loan losses
              
              
              20.75
              %
              
              
              44.00
              %
              
              
              80.01
              %
              
              
              51.78
              %
              
              
              11.88
              %Net
      loan charge-offs to provision charged to expense
              
              
              82.32
              %
              
              
              142.04
              %
              
              
              120.86
              %
              
              
              69.99
              %
              
              
              42.04
              %




Investment Securities
Portfolio. The securities portfolio totaled $139.2 million at December
31, 2008 and consisted principally of U.S. Government agency securities,
mortgage-backed obligations, asset-backed securities, corporate debt securities
and mutual funds or other equity securities. The portfolio provides us with a
relatively stable source of income and provides a balance to interest rate and
credit risks as compared to other categories of the balance sheet.


U.S.
Government Agency, also known as Government Sponsored Enterprises (GSEs) are
privately owned but federally chartered companies. While they enjoy certain
competitive advantages as a result of their government charters, their debt
obligations are unsecured and are not direct obligations of the U.S. Government.
However, debt securities issued by GSEs are considered to be of high credit
quality and the senior debt of GSEs is AAA rated. GSEs raise funds through
a variety of debt issuance programs, including:


·  Federal
Home Loan Mortgage Corporation (Freddie Mac)


·  Federal
National Mortgage Association (Fannie Mae)


·  Federal
Home Loan Bank (FHLB)


·  Federal
Farm Credit Bank System (FFCB)




- 30
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 Table of Contents


With the
variety of GSE-issued debt securities and programs available, investors may
benefit from a unique combination of high credit quality, liquidity, pricing
transparency and cash flows that can be customized to closely match their
objectives.


Mortgage-backed
securities (MBS) represent an investment in mortgage loans. AN MBS investor owns
an interest in a pool of mortgages, which serves as the underlying assets and
source of cash flow for the security. The loans backing the MBS are issued by a
nation network of lenders consisting or mortgage bankers, savings and loan
associations, commercial banks and other lending institutions. MBS are issued by
Government National Mortgage Association (GNMA or Ginnie Mae), Federal Home Loan
Mortgage Corporation (FHLMC or Freddie MAC), and Federal National Mortgage
Association (FNMA or Fannie Mae). Mortgage-backed securities typically carry
some of the highest yields of any government or agency security. The secondary
market is generally large and liquid, with active trading by dealers and
investors.


The risks
associated with MBS including interest rate risk (refinancing risk), prepayment
risk and extension risk.


Asset-backed
are securities whose value and income payments are derived from and
collateralized (or "backed") by a specified pool of underlying assets. The pool
of assets is typically a group of small and illiquid assets that are unable to
be sold individually. Pooling the assets allows them to be sold to general
investors, a process called securitization, and allows the risk of investing in
the underlying assets to be diversified because each security will represent a
fraction of the total value of the diverse pool of underlying assets. The pools
of underlying assets can include common payments from credit cards, auto loans,
and mortgage loans, to esoteric cash flows from aircraft leases, royalty
payments and movie revenues.


As with all
fixed-income securities, the prices of ABS fluctuate in response to changing
interest rates in the general economy. When interest rates fall, prices rise,
and vice versa. Prices of ABS with floating rates are, of course, much less
affected, because the index against which the ABS rate adjusts reflects external
interest-rate changes. Some ABS are subject to another type of interest rate
risk—the risk that a change in rates may influence the pace of prepayments of
the underlying loans, which, in turn, affects yields. Most revolving ABS are
also subject to early-amortization events—also known as payout events or early
calls. Another risk, is the risk of default. This is most often thought of as a
borrower’s failure to make timely interest and principal payments when due, but
default may result from a borrower’s failure to meet other obligations as
well.


Corporate
bonds are fully taxable debt obligations issued by corporations. These bonds
fund capital improvements, expansions, debt refinancing or acquisitions that
require more capital than would ordinarily be available from a single lender.
Corporate bond rates are set according to prevailing interest rates at the time
of the issue, the credit rating of the issuer, the length of the maturity and
the other terms of the bond, such as a call feature. Corporate bonds have
historically been one of the highest yielding of all taxable debt securities.
Interest can be paid monthly, quarterly or semi-annually. There are five main
sectors of corporate bonds: industrials, banks/finance, public utilities,
transportation, and Yankee and Canadian bonds.


The secondary
market for corporate securities is fairly liquid. Therefore, an investor who
wishes to sell a corporate bond will often be able to find a buyer for the
security at market prices. However, the market price of a bond might be
significantly higher or lower than its face value due to fluctuations in
interest rates and other price determining factors. Other factors include credit
risk, market risk, even risk, call risk, make-whole call risk and inflation
risk.


Mutual funds
are a professionally managed type of collective investment scheme that
pools money from many investors and invests it in stocks, bonds, short-term
money market instruments, and/or other securities. The mutual fund will have a
fund manager that trades the pooled money on a regular basis. Mutual funds allow
investors spread their investment around widely. That makes it much less risky
than investing in one or two stocks.


An equity
security is a share in the capital stock of a company (typically common stock,
although preferred equity is also a form of capital stock). The holder of an
equity is a shareholder, owning a share, or fractional part of the issuer.
Unlike debt securities, which typically require regular payments (interest) to
the holder, equity securities are not entitled to any payment. In bankruptcy,
they share only in the residual interest of the issuer after all obligations
have been paid out to creditors. However, equity generally entitles the holder
to a pro rata portion of control of the company, meaning that a holder of a
majority of the equity is usually entitled to control the issuer. Equity also
enjoys the right to profits and capital gain, whereas holders of debt securities
receive only interest and repayment of principal regardless of how well the
issuer performs financially. Furthermore, debt securities do not have voting
rights outside of bankruptcy. In other words, equity holders are entitled to the
"upside" of the business and to control the business.


Equity
securities may include, but not be limited to: bank stock, bank holding company
stock, listed stock, savings and loan association stock, savings and loan
association holding company stock, subsidiary structured as liminted liability
company, subsidiary structued as limited partnership, limited liability company,
and unlisted stock.


Equity
securities are generally traded on either one of the listed stock exchanges or
on the NASDAQ Over-the-Counter market. The market value of equity shares is
influence by prevailing economic conditions such as the company’s performance
(ie. earnings) supply and demand and interest rates.


At December
31, 2008, $35.0 million or 25.1% of our securities (excluding Federal Home Loan
Bank of Dallas stock) were scheduled to mature in less than one year. This
includes $29.9 million in discount notes that are being used solely for pledging
purposes. When excluding these securities, only 4.7% of our securities mature in
less than one year. Securities with maturity dates 10 years and over totaled
34.1% of the total portfolio or 43.4% of the portfolio after deducting the
discount notes for pledging. The average maturity of the securities portfolio
was 3.7 years.





- 31
-
 Table of Contents


At December
31, 2008, securities totaling $114.4 million were classified as available for
sale and $24.8 million were classified as held to maturity, compared to $105.6
million classified as available for sale and $36.5 million classified as held to
maturity at December 31, 2007.


Securities
classified as available for sale are measured at fair market value and
securities classified as held to maturity are measured at book value. The
Company obtains fair value measurements from an independent pricing service to
value securities classified as available for sale. The fair value measurements
consider observable data that may include dealer quotes, market spreads, cash
flows, market yield curves, prepayment speeds, credit information and the
instrument’s contractual terms and conditions, among other things. For more
information on securities and fair market value see Notes 5 and 19 to the
Consolidated Financial Statements.


Securities
classified as available for sale had gross unrealized losses totaling $5.7
million at December 31, 2008, which includes $5.1 million in unrealized losses
on corporate debt securities. The majority of the corporate debt securities with
unrealized losses have been in a loss position for less than twelve months. The
Company believes that it will collect all amounts contractually due and has the
intent and the ability to hold these securities until the fair value is at least
equal to the carrying value. At December 31, 2007, securities classified as
available for sale had gross unrealized losses totaling $0.6 million. Management
periodically assesses the quality of our investment holdings using procedures
similar to those used in assessing the credit risks inherent in the loan
portfolio. For the third quarter 2008, Management identified twelve securities
that were other than temporarily impaired. An other than temporary impairment
charge was taken on these twelve securities totaling $4.6 million. At December
31, 2008, it is Management’s opinion that we held no investment securities which
bear a greater than the normal amount of credit risk as compared to similar
investments and that no securities had an amortized cost greater than their
recoverable value. See Notes 5 and 19 to the Consolidated Financial Statements
for additional information.


Average
securities as a percentage of average interest-earning assets were 17.0% for the
year December 31, 2008 and 21.5% for the year ended December 31, 2007. All
securities held at December 31, 2008 qualified as pledgeable securities, except
$54.4 million of debt securities and $0.6 million of equity securities.
Securities pledged at December 31, 2008 totaled $85.4 million.


The following
tables set forth the composition of our investment securities portfolio
(excluding Federal Home Loan Bank of Dallas stock) at the dates
indicated.




December
      31, 2008
              
              
              December
      31, 2007
              
              
              December
      31, 2006Gross
              
              
              Gross
              
              
              
              
              
              
              
              
              Gross
              
              
              Gross
              
              
              
              
              
              
              
              
              Gross
              
              
              GrossAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              Fair
              
              
              Amortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              Fair
              
              
              Amortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              FairCost
              
              
              Gains
              
              
              Losses
              
              
              Value
              
              
              Cost
              
              
              Gains
              
              
              Losses
              
              
              Value
              
              
              Cost
              
              
              Gains
              
              
              Losses
              
              
              Value(in
      thousands)Available-for-sale:U.S. Government Agencies
              
              $
              58,389
              
              
              $
              132
              
              
              $
              -
              
              
              $
              58,521
              
              
              $
              92,962
              
              
              $
              26
              
              
              $
              (25
              )
              
              $
              92,963
              
              
              $
              98,369
              
              
              $
              -
              
              
              $
              (1,226
              )
              
              $
              97,143Mortgage-backed
                obligations
              
              
              1,701
              
              
              
              82
              
              
              
              (5
              )
              
              
              1,778
              
              
              
              2,016
              
              
              
              43
              
              
              
              (23
              )
              
              
              2,036
              
              
              
              4,077
              
              
              
              39
              
              
              
              (103
              )
              
              
              4,013Asset-backed securities
              
              
              532
              
              
              
              -
              
              
              
              (439
              )
              
              
              93
              
              
              
              1,340
              
              
              
              -
              
              
              
              (95
              )
              
              
              1,245
              
              
              
              1,385
              
              
              
              1
              
              
              
              (1
              )
              
              
              1,385Corporate debt securities
              
              
              57,773
              
              
              
              644
              
              
              
              (5,077
              )
              
              
              53,340
              
              
              
              5,954
              
              
              
              50
              
              
              
              (214
              )
              
              
              5,790
              
              
              
              7,394
              
              
              
              31
              
              
              
              (61
              )
              
              
              7,364Mutual funds or other
                equity securities
              
              
              795
              
              
              
              26
              
              
              
              (147
              )
              
              
              674
              
              
              
              3,805
              
              
              
              22
              
              
              
              (291
              )
              
              
              3,536
              
              
              
              1,500
              
              
              
              -
              
              
              
              (52
              )
              
              
              1,448Total securities
              
              $
              119,190
              
              
              $
              884
              
              
              $
              (5,668
              )
              
              $
              114,406
              
              
              $
              106,077
              
              
              $
              141
              
              
              $
              (648
              )
              
              $
              105,570
              
              
              $
              112,725
              
              
              $
              71
              
              
              $
              (1,443
              )
              
              $
              111,353Held-to-maturity:U 
      .S. Government Agencies
              
              $
              22,680
              
              
              $
              160
              
              
              $
              -
              
              
              $
              22,840
              
              
              $
              33,984
              
              
              $
              24
              
              
              $
              (281
              )
              
              $
              33,727
              
              
              $
              43,976
              
              
              $
              -
              
              
              $
              (1,280
              )
              
              $
              42,696Mortgage-backed
                obligations
              
              
              2,076
              
              
              
              21
              
              
              
              (1
              )
              
              
              2,096
              
              
              
              2,514
              
              
              
              -
              
              
              
              (35
              )
              
              
              2,479
              
              
              
              3,023
              
              
              
              -
              
              
              
              (105
              )
              
              $
              2,918Total securities
              
              $
              24,756
              
              
              $
              181
              
              
              $
              (1
              )
              
              $
              24,936
              
              
              $
              36,498
              
              
              $
              24
              
              
              $
              (316
              )
              
              $
              36,206
              
              
              $
              46,999
              
              
              $
              -
              
              
              $
              (1,385
              )
              
              $
              45,614
  On
September 7, 2008 the U.S. Treasury and the Federal Housing Finance Agency
(FHFA) announced that Fannie Mae and Freddie Mac were being placed under
conservatorship and giving management control to their regulator, the FHFA. Key
provisions of the U.S. Government’s Plan announced to date are as
follows:


·
            Dividends
      on Fannie Mae and Freddie Mac common and preferred stock were
      eliminated.


·
            Fannie
      Mae and Freddie Mac will be required to reduce their mortgage portfolios
      over time.


·
            The
      U.S. Government agreed to provide equity capital to cover mortgage
      defaults in return for $1 billion of senior preferred stock in Fannie Mae
      and Freddie Mac and warrants for the purchase of 79.9% of the common stock
      of Fannie Mae and Freddie Mac.


·
            The
      U.S. Government also announced that the U.S. Treasury would provide
      secured loans to Fannie Mae and Freddie Mac as needed until the end of
      2009 and that the U.S. Treasury plans to purchase mo9rtgage backed
      securities from Fannie Mae and Freddie Mac in the open
    market.


During 2008
the Company recorded an impairment writedown totaling $4,611,000. The impairment
writedown consisted of three preferred stocks of Fannie Mae and Freddie Mac
totaling $3,046,000, on a cost basis, which had unrealized losses of $1,991,000
and $1,010,000, respectively, debt securities totaling $727,000 and $240,000
issued by Lehman Brothers and Washington Mutual which had unrealized losses of
$634,000 and $239,000, respectively.  The Company also recorded an
impairment writedown on $510,000 and $739,000 in asset backed securities issued
by TRAPEZA and ALESCO (CDOs) which had unrealized losses of $344,000 and
$409,000, respectively. The impact of the above actions and concerns in the
market place about the future value of the preferred stock of Fannie Mae and
Freddie Mac, as well as the bankruptcy of Lehman Brothers, the acquisition of
Washington Mutual by J.P. Morgan and the material decrease in values in
asset-backed securities due to the lack of trading has made it unclear when and
if the value of these investments will improve in the future. Given the above
developments, the Bank’s management and Chairman of the Board of Directors met
on October 14, 2008 to review the most recent developments and concluded that
the Bank’s investment in the preferred stock, debt securities and asset-backed
securities were other than temporarily impaired. Following a full board review
of the foregoing, on October 16, 2008, the Bank recorded a non-cash
other-than-temporary impairment (“OTTI”) on these investments for the quarter
ending September 30, 2008.


- 32
-
 Table of Contents


The OTTI
charges recorded for the quarter ending September 30, 2008 totaled $4.6 million
before tax, $3.0 million after tax.


The Company
did not recognize any other impairment charges in 2008 other than those stated
above.





Investment Portfolio
Maturities and Yields.The composition and maturities of the investment
securities portfolio at December 31, 2008 are summarized in the following table.
Maturities are based on the final contractual payment dates, and do not reflect
the impact of prepayments or early redemptions that may occur.





More
      than One Year
              
              
              More
      than Five YearsOne
      Year or Less
              
              
              through
      Five Years
              
              
              through
      Ten Years
              
              
              More
      than Ten YearsWeighted
              
              
              
              
              
              Weighted
              
              
              
              
              
              Weighted
              
              
              
              
              
              WeightedAmortized
              
              
              Average
              
              
              Amortized
              
              
              Average
              
              
              Amortized
              
              
              Average
              
              
              Amortized
              
              
              AverageCost
              
              
              Yield
              
              
              Cost
              
              
              Yield
              
              
              Cost
              
              
              Yield
              
              
              Cost
              
              
              Yield(dollars
      in thousands)Investment
      securities held to maturity:U.S. Government agencies
              
              $
              -
              
              
              
              -
              
              
              $
              999
              
              
              
              4.15
              %
              
              $
              6,437
              
              
              
              5.19
              %
              
              $
              15,244
              
              
              
              5.53
              %Mortgage-backed obligations
              
              
              -
              
              
              
              -
              
              
              
              262
              
              
              
              3.65
              %
              
              
              687
              
              
              
              4.33
              %
              
              
              1,127
              
              
              
              4.96
              %Total securities held to maturity
              
              $
              -
              
              
              
              -
              
              
              $
              1,261
              
              
              
              4.04
              %
              
              $
              7,124
              
              
              
              5.11
              %
              
              $
              16,371
              
              
              
              5.49
              %Investment
      securities available for sale:U.S. Government agencies
              
              $
              29,899
              
              
              
              0.02
              %
              
              $
              -
              
              
              
              -
              
              
              $
              5,000
              
              
              
              5.98
              %
              
              $
              23,490
              
              
              
              5.97
              %Mortgage-backed obligations
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,701
              
              
              
              5.69
              %Asset-backed securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              532
              
              
              
              14.87
              %Corporate debt securities
              
              
              5,114
              
              
              
              7.54
              %
              
              
              32,307
              
              
              
              7.38
              %
              
              
              14,441
              
              
              
              7.38
              %
              
              
              5,911
              
              
              
              7.24
              %Mutual funds or other equity
                securities
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              795
              
              
              
              3.66
              %Total securities available for sale
              
              $
              35,013
              
              
              
              1.12
              %
              
              $
              32,307
              
              
              
              7.38
              %
              
              $
              19,441
              
              
              
              7.02
              %
              
              $
              32,429
              
              
              
              6.28
              %Total
      SecuritiesWeightedAmortized
              
              
              
              
              
              
              AverageCost
              
              
              Fair
      Value
              
              
              Yield(dollars
      in thousands)Investment
      securities held to maturity:U.S. Government agencies
              
              $
              22,680
              
              
              $
              22,840
              
              
              
              5.37
              %Mortgage-backed obligations
              
              
              2,076
              
              
              
              2,096
              
              
              
              4.58
              %Total securities held to maturity
              
              $
              24,756
              
              
              $
              24,936
              
              
              
              5.31
              %Investment
      securities available for sale:U.S. Government agencies
              
              $
              58,389
              
              
              $
              58,521
              
              
              
              2.92
              %Mortgage-backed obligations
              
              
              1,701
              
              
              
              1,778
              
              
              
              5.69
              %Asset-backed securities
              
              
              532
              
              
              
              93
              
              
              
              14.87
              %Corporate debt securities
              
              
              57,773
              
              
              
              53,340
              
              
              
              7.38
              %Mutual funds or other equity
                securities
              
              
              795
              
              
              
              674
              
              
              
              3.66
              %Total securities available for sale
              
              $
              119,190
              
              
              $
              114,406
              
              
              
              5.18
              %
 - 33
-
 Table of Contents


Deposits. The
following table sets forth the distribution of our total deposit accounts, by
account type, for the periods indicated.


December
      31,2008
              
              2007
              
              2006(dollars
      in thousands)Balance
              
              
              As
      % of Total
              
              
              Wtd
      Avg Rate
              
              Balance
              
              
              As
      % of Total
              
              
              Wtd
      Avg Rate
              
              Balance
              
              
              As
      % of Total
              
              
              Wtd
      Avg RateNoninterest-bearing
      demand
              
              $
              118,255
              
              
              
              15.2
              %
              
              
              0.0
              %
              
              $
              120,740
              
              
              
              16.7
              %
              
              
              0.0
              %
              
              $
              122,540
              
              
              
              19.5
              %
              
              
              0.0
              %Interest-bearing
      demand
              
              
              180,230
              
              
              
              23.1
              %
              
              
              1.3
              %
              
              
              223,142
              
              
              
              30.9
              %
              
              
              3.1
              %
              
              
              185,308
              
              
              
              29.6
              %
              
              
              3.1
              %Savings
              
              
              41,357
              
              
              
              5.3
              %
              
              
              0.4
              %
              
              
              45,044
              
              
              
              6.2
              %
              
              
              0.5
              %
              
              
              41,161
              
              
              
              6.6
              %
              
              
              0.4
              %Time
              
              
              440,530
              
              
              
              56.4
              %
              
              
              3.6
              %
              
              
              334,168
              
              
              
              46.2
              %
              
              
              4.6
              %
              
              
              277,284
              
              
              
              44.3
              %
              
              
              4.2
              %Total
      deposits
              
              $
              780,372
              
              
              
              100.0
              %
              
              
              
              
              
              $
              723,094
              
              
              
              100.0
              %
              
              
              
              
              
              $
              626,293
              
              
              
              100.0
              %





As of
December 31, 2008, the aggregate amount of outstanding certificates of deposit
in amounts greater than or equal to $100,000 was approximately $247.8 million.
The following table sets forth the maturity of those certificates as of December
31, 2008, 2007 and 2006.




December
      31,2008
              
              
              2007
              
              
              2006Weighted
              
              
              
              
              
              Weighted
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              Average
              
              
              
              
              
              AverageBalance
              
              
              Rate
              
              
              Balance
              
              
              Rate
              
              
              Balance
              
              
              Rate(dollars
      in thousands)Due
      in one year or less
              
              $
              163,375
              
              
              
              2.10
              %
              
              $
              140,052
              
              
              
              4.43
              %
              
              $
              114,793
              
              
              
              4.88
              %Due
      after one year through three years
              
              
              57,431
              
              
              
              4.04
              %
              
              
              20,207
              
              
              
              4.39
              %
              
              
              15,228
              
              
              
              4.27
              %Due
      after three years
              
              
              26,944
              
              
              
              4.19
              %
              
              
              7,083
              
              
              
              5.14
              %
              
              
              12,526
              
              
              
              5.07
              %Total
              
              $
              247,750
              
              
              
              2.78
              %
              
              $
              167,342
              
              
              
              4.46
              %
              
              $
              142,547
              
              
              
              4.83
              %


Borrowings.
The following table sets forth information concerning balances and interest
rates on all of our short-term borrowings at the dates and for the periods
indicated.


December
      31,2008
              
              2007
              
              2006(dollars
      in thousands)Outstanding
      at year end
              $9,767
              
              $10,401
              
              $6,584Maximum
      month-end outstanding
              41,321
              
              45,766
              
              37,353Average
      daily outstanding
              11,379
              
              16,655
              
              23,731Weighted
      average rate during the year
              2.16%
              
              5.18%
              
              5.19%Average
      rate at year end
              0.19%
              
              3.50%
              
              4.41%




At December 31,
2008, long-term debt consisted of an advance from the Federal Home Loan Bank. In
October 2008, the Company made an original $10.0 million, amortizing, one year
advance, at a rate of 3.14%. The Company makes monthly principal and interest
payments. The outstanding balance on the long-term debt was $8.4 million at
December 31, 2008.


At December
31, 2007, long-term borrowings consisted of junior subordinated debentures
totaling $3.1 million. These debentures were issued in August 2003 for a 30 year
period, callable after 5 years. The rate was LIBOR plus 300 basis points with
quarterly interest payments. In August 2008, the Company redeemed these
debentures (see Note 10 to the Consolidated Financial Statements).




Stockholders’ Equity
and Return on Equity and Assets.Stockholders’ equity provides a source
of permanent funding, allows for future growth and the ability to absorb
unforeseen adverse developments. At December 31, 2008, stockholders’ equity
totaled $66.6 million compared to $67.3 million at December 31,
2007.





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Information
regarding performance and equity ratios is as follows:


December
      31,2008
              2007
              2006Return
      on average assets
              0.72%
              1.37%
              1.21%Return
      on average equity
              8.48%
              16.15%
              15.54%Dividend
      payout ratio
              61.89%
              34.13%
              37.89%





During the first quarter of 2009, total
deposits increased to the extent that it resulted in a reduction of regulatory
capital ratios. As a result, in March 2009 the Company borrowed $6.0 million on
its available line of credit and injected the $6.0 into the Bank to enhance
capital. See Note 24 to the Consolidated Financial Statements for additional
information. The
Company anticipates First Guaranty Bank maintaining a well capitalized status as
defined by regulatory standards.


Results
of Operations for the Years Ended December 31, 2008 and 2007


Net
Income. Net income for the year ended December 31, 2008 was $5.7 million,
a decrease of $4.5 million or 44.0%, from $10.3 million for the year ended
December 31, 2007. The largest decrease in net income resulted from a $4.6
million other than temporary impairment charge recorded on the securities
portfolio in the third quarter of 2008, resulting in a $3.0 million net of tax
decrease in net income (see Notes 5 and 19 to the Consolidated Financial
Statements). Net interest income decreased by $2.2 million due to market
pressure placed on our net interest margin with the decline in market interest
rates. In addition, noninterest expense increased due to additional costs
related to enhancement of the internal audit and control process, costs
associated with education and training of existing and new personnel, and the
addition of staff.


Earnings per share for the year ended
December 31, 2008 was $1.03 per share, a decrease of 44.0% or $0.82 per share
from $1.85 per share for the year ended December 31, 2007.


Net Interest
Income. Net interest income is the largest component of our
earnings. It is calculated by subtracting the cost of interest-bearing
liabilities from the income earned on interest-earning assets and represents the
earnings from our primary business of gathering deposits and making loans and
investments. Our long-term objective is to manage this income to provide the
largest possible amount of income while balancing interest rate, credit and
liquidity risks.


A financial institution’s asset and
liability structure is substantially different from that of an industrial
company, in that virtually all assets and liabilities are monetary in nature.
Accordingly, changes in interest rates, which are generally impacted by
inflation rates, may have a significant impact on a financial institution’s
performance. The impact of interest rate changes depends on the sensitivity to
change of our interest-earning assets and interest-bearing liabilities. The
effects of the changing interest rate environment in recent years and our
interest sensitivity position are discussed below.


Net interest income in 2008 was $31.9
million, a decrease of $2.2 million or 6.3%, when compared to $34.1 million in
2007.  The decrease in net interest income reflected a decrease in net
interest spread and net interest margin as the yield on our interest-earning
assets decreased more than the cost of our interest-bearing liabilities. Loans
are our largest interest-earning asset, and 47.4% of our total loans are
floating rate loans which are primarily tied to the prime lending rate. During
2008, the prime lending rate decreased 400 basis points which adversely impacted
the yield on our interest-earning assets. The cost of our interest-bearing
liabilities was adversely impacted by the $106.4 million increase in time
deposits, which is currently our most costly interest-bearing liability. As of
December 31, 2008, time deposits represented 56.5% of our total deposits, which
is an increase from 46.2% of total deposits at December 31, 2007.


Comparing 2008 to 2007, the average
yield on interest-earning assets decreased by 150 basis points and the average
rate paid on interest-bearing liabilities decreased by 120 basis points.
The net yield on interest-earning assets was 4.2% for the year ended December
31, 2008, compared to 4.8% for 2007.


During the first quarter of 2009, the
Company borrowed $6.0 million on its available line of credit at a variable
interest rate of prime less 100 basis points. As a result of this additional
debt, the Company’s interest expense will likely increase in future
periods.


The net interest income yield shown
below in the average balance sheet is calculated by dividing net interest income
by average interest-earning assets and is a measure of the efficiency of the
earnings from balance sheet activities. It is affected by changes in the
difference between interest on interest-earning assets and interest-bearing
liabilities and the percentage of interest-earning assets funded by
interest-bearing liabilities (leverage). The leverage for the year ending
December 31, 2008 and 2007 was 80.3% and 78.6%,
respectively.


The following tables set forth average
balance sheets, average yields and costs, and certain other information for the
periods indicated. No tax-equivalent yield adjustments were made, as the effect
thereof was not material. All average balances are daily average
balances.  Non-accrual loans were included in the computation of
average balances, but have been reflected in the table as loans carrying a zero
yield. The yields set forth below include the effect of deferred fees, discounts
and premiums that are amortized or accreted to interest income or
expense.





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Years
      Ended December 31,2008
              2007
              2006Average
              Yield/
              Average
              Yield/
              Average
              Yield/Balance
              Interest
              Rate
              Balance
              Interest
              Rate
              Balance
              Interest
              Rate(dollars
      in thousands)AssetsInterest-earning
      assets:Interest-bearing
      deposits with banks
              $     5,725
              $       224
              3.9%
              
              $     1,977
              $       87
              4.4%
              
              $     2,323
              $       95
              4.1%Securities
      (including FHLB stock)
              127,586
              6,594
              5.2%
              
              152,990
              8,381
              5.5%
              
              178,419
              9,654
              5.4%Federal
      funds sold
              17,247
              392
              2.3%
              
              8,083
              400
              4.9%
              
              3,115
              159
              5.1%Loans
      held for sale
              681
              45
              6.6%
              
              5,216
              142
              2.7%
              
              577
              27
              4.7%Loans,
      net of unearned income
              600,854
              40,406
              6.7%
              
              543,946
              46,470
              8.5%
              
              505,623
              41,002
              8.1%Total
      interest-earning assets
              752,093
              47,661
              6.3%
              
              712,212
              55,480
              7.8%
              
              690,057
              50,937
              7.4%Noninterest-earning
      assets:Cash
      and due from banks
              22,468
              
              
              
              19,569
              
              
              
              20,415Premises
      and equipment, net
              15,960
              
              
              
              14,812
              
              
              
              12,442Other
      assets
              6,503
              
              
              
              4,644
              
              
              
              3,679Total
              $797,024
              $47,661
              
              
              $751,237
              $55,480
              
              
              $726,593
              $50,937Liabilities
      and Stockholders' EquityInterest-bearing
      liabilities:Demand
      deposits
              $  197,822
              $  2,650
              1.3%
              
              $  196,805
              $  6,152
              3.1%
              
              $  180,384
              $  5,657
              3.1%Savings
      deposits
              43,631
              193
              0.4%
              
              42,564
              228
              0.5%
              
              42,727
              174
              0.4%Time
      deposits
              346,282
              12,432
              3.6%
              
              297,193
              13,673
              4.6%
              
              269,016
              11,224
              4.2%Borrowings
              16,287
              458
              2.8%
              
              23,450
              1,345
              5.7%
              
              42,435
              2,151
              5.1%Total
      interest-bearing liabilities
              604,022
              15,733
              2.6%
              
              560,012
              21,398
              3.8%
              
              534,562
              19,206
              3.6%Noninterest-bearing
      liabilities:Demand
      deposits
              119,379
              
              
              
              121,894
              
              
              
              130,742Other
              5,854
              
              
              
              5,767
              
              
              
              4,649Total
      liabilities
              729,255
              15,733
              
              
              687,673
              21,398
              
              
              669,953
              19,206Stockholders'
      equity
              67,769
              
              
              
              63,564
              
              
              
              56,640Total
              $
      797,024
              15,733
              
              
              $
      751,237
              21,398
              
              
              $
      726,593
              19,206Net
      interest income
              $31,928
              
              
              
              $34,082
              
              
              
              $31,731Net
      interest rate spread(1)
              3.7%
              
              
              
              4.0%
              
              
              
              3.8%Net
      interest-earning assets(2)
              $  148,071
              
              
              
              $  152,200
              
              
              
              $  155,495Net
      interest margin (3)
              4.2%
              
              
              
              4.8%
              
              
              
              4.6%


(1)  Net
interest rate spread represents the difference between the yield on average
interest-earning assets and the cost of average interest-bearing
liabilities.


(2)  Net
interest-earning assets represents total interest-earning assets less total
interest-bearing liabilities.


(3)  Net
interest margin represents net interest income divided by average total
interest-earning assets.





Rate/Volume
Analysis.The
following table presents the dollar amount of changes in interest income and
interest expense for major components of interest-earning assets and
interest-bearing liabilities for the periods indicated. The table distinguishes
between (i) changes attributable to rate (change in rate multiplied by the prior
period’s volume), (ii) changes attributable to volume (changes in volume
multiplied by the prior period’s rate), (iii) mixed changes (changes that are
not attributable to either rate of volume) and (iv) total increase (decrease)
(the sum of the previous columns).


Years
      Ended December 31,2008
      Compared to 2007
              
              2007
      Compared to 2006Increase
      (Decrease) Due To
              
              Increase
      (Decrease) Due ToRate/
              Increase/
              
              
              Rate/
              Increase/Volume
              Rate
              Volume
              Decrease
              Volume
              Rate
              Volume
              Decrease(in
      thousands)Interest
      earned on:Interest-bearing
      deposits with banks
              $       165
              $       (10)
              $        (18)
              $        137
              
              $       (14)
              $           7
              $         (1)
              $         (8)Securities
      (including FHLB stock)
              (1,392)
              (474)
              79
              (1,787)
              
              (1,376)
              120
              (17)
              (1,273)Federal
      funds sold
              453
              (216)
              (245)
              (8)
              
              254
              (5)
              (8)
              241Loans
      held for sale
              (123)
              204
              (178)
              (97)
              
              217
              (11)
              (91)
              115Loans,
      net of unearned income
              4,862
              (9,892)
              (1,034)
              (6,064)
              
              3,108
              2,194
              166
              5,468Total
      interest income
              3,965
              (10,388)
              (1,396)
              (7,819)
              
              2,189
              2,305
              49
              4,543Interest
      paid on:Demand
      deposits
              32
              (3,516)
              (18)
              (3,502)
              
              515
              (18)
              (2)
              495Savings
      deposits
              6
              (40)
              (1)
              (35)
              
              (1)
              55
              -
              54Time
      deposits
              2,258
              (3,003)
              (496)
              (1,241)
              
              1,176
              1,153
              120
              2,449Borrowings
              (411)
              (685)
              209
              (887)
              
              (962)
              283
              (127)
              (806)Total
      interest expense
              1,885
              (7,244)
              (306)
              (5,665)
              
              728
              1,473
              (9)
              2,192Change
      in net interest income
              $    2,080
              $  (3,144)
              $   (1,090)
              $    (2,154)
              
              $    1,461
              $       832
              $         58
              $    2,351


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Provisionfor
Loan Losses.The provision for loan losses was $1.6 million and $1.9
million in 2008 and 2007, respectively. The decreased 2008 provisions were
attributable to $1.3 million in net loan charge-offs during 2008 compared to
$2.7 million in net loan charge-offs during 2007. Of the loan charge-offs in
2008, approximately $0.7 million were loans secured by real estate of which
$0.3 million were commercial real estate and approximately $0.4 million
were residential properties. In 2008, recoveries of $0.3 million were recognized
on loans previously charged-off as compared to $1.2 million in 2007. Of the
loan charge-offs during 2007, approximately $3.0 million were loans secured by
real estate of which $2.2 million were commercial real estate and approximately
$0.8 million were residential properties. The allowance for loan losses at
December 31, 2008 was $6.5 million, compared to $6.2 million at December 31,
2007, and was 1.07% and 1.08% of total loans, respectively. Management
believes that the current level of the allowance is adequate to cover losses in
the loan portfolio given the current economic conditions, expected net
charge-offs and nonperforming asset levels.


Noninterest
Income.Noninterest income totaled $1.1 million in 2008, a decrease of $3.6
million when compared to $4.7 million in 2007. Service charges, commissions and
fees totaled $4.0 million and $3.8 million for the years ended December 31, 2008
and 2007, respectively. Net securities losses were $1,000 in 2008, compared to
$478,000 in 2007. Other than temporary impairment charges totaling $4.6 million
were taken on securities in 2008 (see Notes 5 and 19 to the Consolidated
Financial Statements). Net gains on sale of loans were $210,000 in 2008 and
$272,000 in 2007. Other noninterest income increased $407,000 to $1.5 million in
2008 from $1.1 million in 2007.


Noninterest
Expense. Noninterest expense totaled $23.0 million in 2008 and
$21.1 million in 2007. Salaries and benefits increased $1.0 million in
2008 to $10.7 million from $9.7 million in 2007. The increase in salaries
resulted from the additional key management personnel including an Internal
Audit manager and a chief credit officer. At December 31, 2008, 241 employees
represented 224.5 full-time equivalent staff members as compared to 222
full-time equivalent staff members in 2007. Occupancy and equipment expense
totaled $2.9 million in 2008 and $2.6 million in 2007. The net cost of other
real estate and repossessions decreased $147,000 in 2008 to $249,000, when
compared to $396,000 in 2007. Other noninterest expense totaled $9.2 million in
2008, an increase of $726,000 or 8.5% when compared to $8.5 million in
2007.


The following is a summary of the
significant components of other noninterest expense:


Years
      Ended December 31,2008
              
              
              2007
              
              
              2006(in
      thousands)Other
      noninterest expense:Legal
      and professional fees
              
              $
              1,496
              
              
              $
              1,610
              
              
              $
              1,390Operating
      supplies
              
              
              572
              
              
              
              615
              
              
              
              545Marketing
      and public relations
              
              
              1,131
              
              
              
              842
              
              
              
              823Data
      processing
              
              
              1,063
              
              
              
              955
              
              
              
              904Travel
      and lodging
              
              
              416
              
              
              
              439
              
              
              
              280Taxes
      - sales and capital
              
              
              571
              
              
              
              628
              
              
              
              582Telephone
              
              
              185
              
              
              
              211
              
              
              
              244Amortization
      of core deposit intangibles
              
              
              311
              
              
              
              203
              
              
              
              525Other
              
              
              3,482
              
              
              
              2,999
              
              
              
              2,535Total
      other expense
              
              $
              9,227
              
              
              $
              8,502
              
              
              $
              7,828
 Total
noninterest expense includes expenses paid to related parties. Related parties
include the Company’s executive officers, directors and certain business
organizations and individuals with which such persons are associated. During the
years ended 2006, 2007 and 2008, the Company paid approximately $2.0 million,
$2.2 million and $2.1 million, respectively, for goods and services from related
parties. See Note 14 to the Consolidated Financial Statements for additional
information.


Income
Taxes.  The provision for income taxes for the years ended
December 31, 2008 and 2007 was $2.6 million and $5.5 million respectively. The
decreased provision for income taxes in 2008 resulted from lower income
recognized during 2008 when compared to 2007, which resulted from decreases in
net interest income, decreases in noninterest income and increases in
noninterest expense. The Company’s effective tax rate amounted to 31.1% and
34.8% during 2008 and 2007, respectively. The difference between the effective
tax rate and the statutory tax rate primarily relates to variances in items that
are non-taxable or non-deductible and various tax credits.




Results
of Operations for the Years Ended December 31, 2007 and 2006
 Net Income.
Net income for the year ended December 31, 2007 was $10.3 million, an increase
of $1.5 million or 16.6%, from $8.8 million for the year ended December 31,
2006. The increase in income was due primarily to an increase in net interest
income, and a decrease in the provision for loan losses partially offset by
increases in salaries and employee benefits. Net interest income increased $2.4
million in 2007 due to an increase in average balances and the net yield on
interest-earning assets. $1.9 million was charged against the provision for loan
losses during the year ended December 31, 2007, a decrease of $2.5 million as
compared to $4.4 million for the year ended December 31, 2006. Salaries and
employee benefits increased by $1.7 million in connection with the additional
staff acquired from the Homestead Bank merger in 2007 and from increased support
staff.


Earnings per
share for the year ended December 31, 2007 was $1.85 per share, an increase of
16.6% or $0.26 per share from $1.58 per share for the year ended December 31,
2006.
 Net Interest Income.Net interest income is the largest component of our earnings. It is
calculated by subtracting the cost of interest-bearing liabilities from the
income earned on interest-earning assets and represents the earnings from our
primary business of gathering deposits and making loans and investments. Our
long-term objective is to manage this income to provide the largest possible
amount of income while balancing interest rate, credit and liquidity
risks.
 A financial
institution’s asset and liability structure is substantially different from that
of an industrial company, in that virtually all assets and liabilities are
monetary in nature. Accordingly, changes in interest rates, which are generally
impacted by inflation rates, may have a significant impact on a financial
institution’s performance. The impact of interest rate changes depends on the
sensitivity to change of our interest-earning assets and interest-bearing
liabilities. The effects of the changing interest rate environment in recent
years and our interest sensitivity position are discussed below.
 Net interest
income in 2007 was $34.1 million, an increase of $2.4 million or 7.4%, as
compared to $31.8 million in 2006. The increase in interest income was due
principally to increases in the average balances of loans. Also during those
same periods, yields on investment securities and loans enhanced interest
income. An increase in interest income was partially offset by the increase in
interest expense from 2006 to 2007, which was attributable to the increased
volume of interest-bearing liabilities and increased cost of funds.
 Comparing
2007 to 2006, the average yield on interest-earning assets increased by 40 basis
points and the average rate paid on interest-bearing liabilities increased by 20
basis points. The net yield on interest-earning assets was 4.8% for the year
ended December 31, 2007, compared to 4.6% for 2006.
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The net
interest income yield is calculated by dividing net interest income by average
interest-earning assets and is a measure of the efficiency of the earnings from
balance sheet activities. It is affected by changes in the difference between
interest on interest-earning assets and interest-bearing liabilities and the
percentage of interest-earning assets funded by interest-bearing liabilities
(leverage). Leverage for the year ending December 31, 2007 and 2006 was
78.6% and 77.5%, respectively.


Provisionfor
Loan Losses.The provision for loan losses was $1.9 million and $4.4
million in 2007 and 2006, respectively. The decreased 2007 provisions were
attributable to $2.7 million in net loan charge-offs during 2007 compared to
$5.3 million in net loan charge-offs during 2006. Of the loan charge-offs in
2007, approximately $3.0 million were loan secured by real estate of which $2.2
million were commercial real estate and approximately $0.8 million were
residential properties. In 2007, recoveries of $1.2 million were recognized on
loans previously charged off as compared to $547,000 in 2006. Of the loan
charge-offs during 2006, and the consequent increase in the provision, $4.8
million related specifically to home mortgages. The allowance for loan losses at
December 31, 2007 was $6.2 million, compared to $6.7 million at December 31,
2006, and comprised 1.08% and 1.32% of total loans, respectively. Management
believes that the current level of the allowance is adequate to cover losses in
the loan portfolio given the current economic conditions, expected net
charge-offs and nonperforming asset levels.


In July 2007,
the Company signed a Final Release and Settlement Agreement with BankInsurance,
Inc., the Company’s insurance company, for a claim made by the Company under the
Financial Institution Bond for suspected fraudulent mortgage loans. Under this
Release and Agreement, the Company received $1.1 million. After attorney fees
and expenses, the Company recorded a loan recovery totaling $723,000 in
2007.


Noninterest
Income.Noninterest income totaled $4.7 million in 2007, an increase of $331,000,
compared to $4.4 million in 2006. Service charges, commissions and fees totaled
$3.8 million and $3.6 million for the years ended December 31, 2007 and 2006,
respectively. Net securities losses were $478,000 in 2007, compared to $234,000
in 2006. As a result of increases in staff and mortgage loan volume, gains on
sale of loans were $272,000 in 2007, up $201,000 when compared to $71,000 gains
in 2006. Other noninterest income increased $156,000 to $1.1 million in 2007
from $926,000 in 2006 primarily from increases in bankcard fees and credit card
fee income.


Noninterest
Expense. Noninterest expense totaled $21.1 million in 2007 and $18.4
million in 2006. Salaries and benefits increased $1.7 million in 2007 to
$9.7 million from $7.9 million in 2006. The increase in salaries was primarily
related the Homestead Bank merger and to staffing several operational
departments, including, credit and audit, to accommodate increased activities.
At December 31, 2007, 240 employees represented 222 full-time equivalent staff
members as compared to 196 full-time equivalent staff members in 2006. Occupancy
and equipment expense totaled $2.6 million in 2007 and $2.3 million in 2006. The
net cost of other real estate and repossessions increased $119,000 million in
2007 to $396,000 from $277,000 in 2006 due to increases in costs incurred
in connection with owning, maintaining and the sale and disposition of other
real estate owned. Other noninterest expense totaled $8.5 million in 2007,
compared to $7.8 million in 2006, an increase of $673,000 or 8.6%. The increase
in other noninterest expense was primarily attributable to increased legal and
professional fees, operating supplies, data processing expenses, travel and
lodging, sales tax and tax on capital expenses offset by the reduction in
amortization of core deposits.


Income
Taxes.  The provision for income taxes for the years ended
December 31, 2007 and 2006 was $5.5 million and $4.5 million respectively. The
higher provision for income taxes in 2007 reflected higher income during 2007 as
compared to 2006 resulting from increases in net interest income, reductions in
the provision for loan losses offset by increases in noninterest expense. The
Company’s effective tax rate amounted to 34.8% and 33.8% during 2007 and 2006,
respectively. The difference between the effective tax rate and the statutory
tax rate primarily relates to variances in items that are non-taxable or
non-deductible and various tax credits.


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Asset/Liability
Management and Market Risk


Asset/LiabilityManagement.Our asset/liability Management (ALM) process consists of quantifying,
analyzing and controlling interest rate risk (IRR) to maintain reasonably stable
net interest income levels under various interest rate environments. The
principal objective of ALM is to maximize net interest income while operating
within acceptable limits established for interest rate risk and maintain
adequate levels of liquidity.


The majority
of our assets and liabilities are monetary in nature. Consequently, one of our
most significant forms of market risk is interest rate risk. Our assets,
consisting primarily of loans secured by real estate, have longer maturities
than our liabilities, consisting primarily of deposits. As a result, a principal
part of our business strategy is to manage interest rate risk and reduce the
exposure of our net interest income to changes in market interest rates.
Accordingly, our Board of Directors has established an Asset/Liability Committee
which is responsible for evaluating the interest rate risk inherent in our
assets and liabilities, for determining the level of risk that is appropriate
given our business strategy, operating environment, capital, liquidity and
performance objectives, and for managing this risk consistent with the
guidelines approved by the Board of Directors. Senior Management monitors the
level of interest rate risk on a regular basis and the Asset/Liability
Committee, which consists of executive Management and other bank personnel
operating under a policy adopted by the Board of Directors, meets as needed to
review our asset/liability policies and interest rate risk
position.


The interest
spread and liability funding discussed below are directly related to changes in
asset and liability mixes, volumes, maturities and repricing opportunities for
interest-earning assets and interest-bearing liabilities. Interest-sensitive
assets and liabilities are those which are subject to being repriced in the near
term, including both floating or adjustable rate instruments and instruments
approaching maturity. The interest sensitivity gap is the difference between
total interest-sensitive assets and total interest-sensitive liabilities.
Interest rates on our various asset and liability categories do not respond
uniformly to changing market conditions. Interest rate risk is the degree to
which interest rate fluctuations in the marketplace can affect net interest
income.


To maximize
our margin, we attempt to be somewhat more asset sensitive during periods of
rising rates and more liability sensitive during periods of falling rates. The
need for interest sensitivity gap Management is most critical in times of rapid
changes in overall interest rates. We generally seek to limit our exposure to
interest rate fluctuations by maintaining a relatively balanced mix of rate
sensitive assets and liabilities on a one-year time horizon. The mix is
relatively difficult to manage. Because of the significant impact on net
interest margin from mismatches in repricing opportunities, the asset-liability
mix is monitored periodically depending upon Management’s assessment of current
business conditions and the interest rate outlook. Exposure to interest rate
fluctuations is maintained within prudent levels by the use of varying
investment strategies.


We monitor
interest rate risk using an interest sensitivity analysis set forth on the
following table. This analysis, which we prepare monthly, reflects the maturity
and repricing characteristics of assets and liabilities over various time
periods. The gap indicates whether more assets or liabilities are subject to
repricing over a given time period. The interest sensitivity analysis at
December 31, 2008 shown below reflects an asset-sensitive position with a
positive cumulative gap on a one-year basis.


Interest
      Sensitivity Within3
      Months
              Over
      3 Months
              Total
              OverOr
      Less
              thru
      12 Months
              One
      Year
              One
      Year
              Total(dollars
      in thousands)Earning
      Assets:Loans
      (including loans held for sale)
              $314,433
              $107,028
              $421,461
              $184,908
              $606,369Securities
      (including FHLB stock)
              32,206
              3,722
              35,928
              104,178
              140,106Federal
      Funds Sold
              838
              -
              838
              -
              838Other
      earning assets
              21,501
              -
              21,501
              -
              21,501Total
      earning assets
              368,978
              110,750
              479,728
              289,086
              $768,814Source
      of Funds:Interest-bearing
      accounts:Demand
      deposits
              119,905
              -
              119,905
              60,325
              180,230Savings
      deposits
              10,339
              -
              10,339
              31,018
              41,357Time
      deposits
              129,780
              136,231
              266,011
              174,519
              440,530Short-term
      borrowings
              9,767
              -
              9,767
              -
              9,767Long-term
      borrowings
              -
              8,355
              8,355
              -
              8,355Noninterest-bearing,
      net
              -
              
              -
              88,575
              88,575Total
      source of funds
              269,791
              144,586
              414,377
              354,437
              $768,814Period
      gap
              99,187
              (33,836)
              65,351
              (65,351)Cumulative
      gap
              $  99,187
              $
      65,351
              $
      65,351
              $          -Cumulative
      gap as apercent
      of earning assets
              12.90%
              8.50%
              8.50%




- 39
-
 Table of Contents


Net Interest Income
at Risk.Net
interest income (NII) at risk measures the risk of a decline in earnings due to
changes in interest rates. The table below presents an analysis of our interest
rate risk as measured by the estimated changes in net interest income resulting
from an instantaneous and sustained parallel shift in the yield curve at
December 31, 2008. Shifts are measured in 100 basis point increments (+ 200
through - 200 basis points,) from base case. Base case encompasses key
assumptions for asset/liability mix, loan and deposit growth, pricing,
prepayment speeds, deposit decay rates, securities portfolio cash flows and
reinvestment strategy and the market value of certain assets under the various
interest rate scenarios. The base case scenario assumes that the current
interest rate environment is held constant throughout the forecast period; the
instantaneous shocks are performed against that yield curve.


Estimated
      IncreaseChange
      in
              
              (Decrease)
      in NIIInterest
      Rates
              
              December
      31, 2008(basis
      points)-200
              
              -21.25%-100
              
              -11.18%Stable
              
              0.00%+100
              
              14.86%+200
              
              25.96%


The
increasing rate scenarios shows higher levels of net interest income while the
decreasing scenarios show higher levels of volatility and subsequently lower
levels of NII. These scenarios are instantaneous shocks that assume balance
sheet Management will mirror base case. Should the yield curve begin to rise or
fall, Management has several strategies available to maximize earnings
opportunities or offset the negative impact to earnings. For example, in a
falling rate environment, deposit pricing strategies could be adjusted to
further sway customer behavior to non-contractual or short-term (less than 12
months) contractual deposit products which would reset downward with the changes
in the yield curve and prevailing market rates. Another opportunity at the start
of such a cycle would be reinvesting the securities portfolio cash flows into
longer term, non-callable bonds that would lock in higher yields.


Even if
interest rates change in the designated amounts, there can be no assurance that
our assets and liabilities would perform as anticipated. Additionally, a change
in the U.S. Treasury rates in the designated amounts accompanied by a change in
the shape of the U.S. Treasury yield curve would cause significantly different
changes to NII than indicated above. Strategic management of our balance sheet
and earnings would be adjusted to accommodate these movements. As with any
method of measuring IRR, certain shortcomings are inherent in the methods of
analysis presented above. For example, although certain assets and liabilities
may have similar maturities or periods to repricing, they may react in different
degrees to changes in market interest rates. Also, the interest rates on certain
types of assets and liabilities may fluctuate in advance of changes in market
interest rates, while interest rates on other types may lag behind changes in
market rates. Also, the ability of many borrowers to service their debt may
decrease in the event of an interest rate increase. We consider all of these
factors in monitoring its exposure to interest rate risk.





Liquidity
and Capital Resources


Liquidityand Capital
Resources.Liquidity refers to the
ability or flexibility to manage future cash flows to meet the needs of
depositors and borrowers and fund operations. Maintaining appropriate levels of
liquidity allows us to have sufficient funds available to meet customer demand
for loans, withdrawal of deposit balances and maturities of deposits and other
liabilities. Liquid assets include cash and due from banks, interest-earning
demand deposits with banks, federal funds sold and available for sale investment
securities. Including securities pledged to collateralize public fund deposits,
these assets represent 22.1%, 20.3% and 19.1% of the total liquidity base at
December 31, 2008, 2007 and 2006, respectively. In addition, we maintained
borrowing availability with the Federal Home Loan Bank, or FHLB, approximating
$63.1 million and $54.7 million at December 31, 2008 and December 31, 2007,
respectively.  We also maintain federal funds lines of credit totaling
$63.2 million at three other correspondent banks, of which $63.2 was available
at December 31, 2008, and $59.7 million was available at December 31, 2007.
Management believes there is sufficient liquidity to satisfy current operating
needs.


During the
first quarter of 2009, total deposits increased to the extent that it resulted
in a reduction of regulatory capital ratios. As a result, in March 2009 the
Company borrowed $6.0 million on its available line of credit and injected the
$6.0 into the Bank to enhance capital. The interest rate on the line of credit
is a floating rate and it set at prime less 100 basis points. The Company
intends to repay the debt in full by December 31, 2009. As a result of this
additional debt, the Company’s interest expense will likely increase in future
periods. See Note 24 to the Consolidated Financial Statements for additional
information.


Regulatory
CapitalRisk-based
capital regulations adopted by the FDIC require banks to achieve and maintain
specified ratios of capital to risk-weighted assets. Similar capital regulations
apply to bank holding companies. The risk-based capital rules are designed to
measure “Tier 1” capital (consisting of common equity, retained earnings and a
limited amount of qualifying perpetual preferred stock and trust preferred
securities, net of goodwill and other intangible assets and accumulated other
comprehensive income) and total capital in relation to the credit risk of both
on and off balance sheet items. Under the guidelines, one of its risk weights is
applied to the different on balance sheet items. Off-balance sheet items, such
as loan commitments, are also subject to risk weighting. All bank holding
companies and banks must maintain a minimum total capital to total risk weighted
assets ratio of 8.00%, at least half of which must be in the form of core or
Tier 1 capital. These guidelines also specify that bank holding companies that
are experiencing internal growth or making acquisitions will be expected to
maintain capital positions substantially above the minimum supervisory
levels.


At December
31, 2008, we satisfied the minimum regulatory capital requirements and were
“well capitalized” within the meaning of federal regulatory
requirements.





- 40
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 Table of Contents


Off-Balance
Sheet Arrangements


We had $155.0
million, $105.0 million and $45.0 million in letters of credit issued by the
Federal Home Loan Bank at December 31, 2008, 2007, and 2006, respectively, which
was used as collateral for public fund deposits.





Contractual
Obligations


The following
table summarizes our significant fixed and determinable contractual obligations
and other funding needs by payment date at December 31, 2008. The payment
amounts represent those amounts due to the recipient and do not include any
unamortized premiums or discounts or other similar carrying amount
adjustments.





At of
December 31, 2008, our contractual obligations were as follows:




Payments
      Due by PeriodOne
      Year
              
              
              One
      Through
              
              
              Over
      Threeor
      Less
              
              
              Three
      Years
              
              
              Years
              
              
              Total(in
      thousands)Operating
      leases
              
              $
              10
              
              
              $
              21
              
              
              $
              85
              
              
              $
              116Time
      deposits
              
              
              260,298
              
              
              
              128,203
              
              
              
              52,029
              
              
              
              440,530Short-term
      borrowings
              
              
              9,767
              
              
              
              -
              
              
              
              -
              
              
              
              9,767Long-term
      borrowings
              
              
              8,355
              
              
              
              -
              
              
              
              -
              
              
              
              8,355Total
              
              $
              278,430
              
              
              $
              128,224
              
              
              $
              52,114
              
              
              $
              458,768





Impact
of Inflation and Changing Prices


The
consolidated financial statements and related financial data presented herein
have been prepared in accordance with generally accepted accounting principles,
which generally require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in relative
purchasing power over time due to inflation. Unlike most industrial companies,
the majority of the Company’s assets and liabilities are monetary in nature. As
a result, interest rates generally have a more significant impact on the
Company’s performance than does the effect of inflation. Although fluctuations
in interest rates are neither completely predictable or controllable, the
Company regularly monitors its interest rate position and oversees its financial
risk Management by establishing policies and operating limits (see
“Asset/Liability Management and Market Risk” section). Interest rates do not
necessarily move in the same direction or in the same magnitude as the prices of
goods and services, since such prices are affected by inflation to a larger
extent than interest rates. Although not as critical to the banking industry as
to other industries, inflationary factors may have some impact on the Company’s
growth, earnings, total assets and capital levels. Management does not expect
inflation to be a significant factor in 2009.





Item 7A – Quantitative and Qualitative Disclosures about Market
Risk


For discussion on
this matter, see the “Asset/Liability Management and Market Risk” section of
this analysis.





- 41
-
 Table of Contents


Report
of Castaing, Hussey & Lolan, LLC


Independent
Registered Accounting Firm








To the
Stockholders and Board of Directors


First
Guaranty Bancshares, Inc.







We have
audited the accompanying consolidated balance sheets of First Guaranty
Bancshares, Inc. as of December 31, 2008 and 2007, and the related consolidated
statements of income, changes in stockholders’ equity and cash flows for each of
the years in the three-year period ended December 31, 2008. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.




We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. The Company is not required to
have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audit included consideration of internal control over
financial reporting as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.




In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of First Guaranty
Bancshares, Inc. as of December 31, 2008 and 2007, and the consolidated results
of its operations and its cash flows for each of the years in the three-year
period ended December 31, 2008 in conformity with accounting principles
generally accepted in the United States of America.











/s/ Castaing, Hussey & Lolan,
LLC


Castaing,
Hussey & Lolan, LLC


New
Iberia, Louisiana


March 30,
2009





























- 42
-
 Table of Contents




Item 8 - Financial Statements and Supplementary Data





FIRST
      GUARANTY BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED
      BALANCE SHEETS(dollars
      in thousands, except share data)December
      31,
              
              
              December
      31,2008
              
              
              2007AssetsCash
      and cash equivalents:Cash
      and due from banks
              
              $
              77,159
              
              
              $
              22,778Interest-earning
      demand deposits with banks
              
              
              20
              
              
              
              30Federal
      funds sold
              
              
              838
              
              
              
              35,869Cash
      and cash equivalents
              
              
              78,017
              
              
              
              58,677Interest-earning
      time deposits with banks
              
              
              21,481
              
              
              
              2,188Investment
      securities:Available
      for sale, at fair value
              
              
              114,406
              
              
              
              105,570Held
      to maturity, at cost (estimated fair value of$24,936
      and $36,206, respectively)
              
              
              24,756
              
              
              
              36,498Investment
      securities
              
              
              139,162
              
              
              
              142,068Federal
      Home Loan Bank stock, at cost
              
              
              944
              
              
              
              955Loans
      held for sale
              
              
              -
              
              
              
              3,959Loans,
      net of unearned income
              
              
              606,369
              
              
              
              575,256Less:
      allowance for loan losses
              
              
              6,482
              
              
              
              6,193Net
      loans
              
              
              599,887
              
              
              
              569,063Premises
      and equipment, net
              
              
              16,141
              
              
              
              16,240Goodwill
              
              
              1,980
              
              
              
              1,911Intangible
      assets, net
              
              
              2,078
              
              
              
              2,383Other
      real estate, net
              
              
              568
              
              
              
              373Accrued
      interest receivable
              
              
              4,611
              
              
              
              5,126Other
      assets
              
              
              6,563
              
              
              
              5,117Total
      Assets
              
              $
              871,432
              
              
              $
              808,060Liabilities
      and Stockholders' EquityDeposits:Noninterest-bearing
      demand
              
              $
              118,255
              
              
              $
              120,740Interest-bearing
      demand
              
              
              180,230
              
              
              
              223,142Savings
              
              
              41,357
              
              
              
              45,044Time
              
              
              440,530
              
              
              
              334,168Total
      deposits
              
              
              780,372
              
              
              
              723,094Short-term
      borrowings
              
              
              9,767
              
              
              
              10,401Accrued
      interest payable
              
              
              3,033
              
              
              
              2,956Long-term
      borrowings
              
              
              8,355
              
              
              
              3,093Other
      liabilities
              
              
              3,275
              
              
              
              1,254Total
      Liabilities
              
              
              804,802
              
              
              
              740,798Stockholders'
      EquityCommon
      stock:$1
      par value - authorized 100,000,000 shares; issued andoutstanding
      5,559,644 shares
              
              
              5,560
              
              
              
              5,560Surplus
              
              
              26,459
              
              
              
              26,459Retained
      earnings
              
              
              37,769
              
              
              
              35,578Accumulated
      other comprehensive loss
              
              
              (3,158
              )
              
              
              (335
              )Total
      Stockholders' Equity
              
              
              66,630
              
              
              
              67,262Total
      Liabilities and Stockholders' Equity
              
              $
              871,432
              
              
              $
              808,060





See Notes to Consolidated Financial
Statements.


- 43
-
 Table of Contents
  FIRST
      GUARANTY BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF INCOME(dollars
      in thousands, except share data)Years
      Ended December 31,2008
              
              
              2007
              
              
              2006Interest
      Income:Loans
      (including fees)
              
              $
              40,406
              
              
              $
              46,470
              
              
              $
              41,002Loans
      held for sale
              
              
              45
              
              
              
              142
              
              
              
              27Deposits
      with other banks
              
              
              224
              
              
              
              87
              
              
              
              95Securities
      (including FHLB stock)
              
              
              6,594
              
              
              
              8,381
              
              
              
              9,654Federal
      funds sold
              
              
              392
              
              
              
              400
              
              
              
              159Total
      Interest Income
              
              
              47,661
              
              
              
              55,480
              
              
              
              50,937Interest
      Expense:Demand
      deposits
              
              
              2,650
              
              
              
              6,152
              
              
              
              5,657Savings
      deposits
              
              
              193
              
              
              
              228
              
              
              
              174Time
      deposits
              
              
              12,432
              
              
              
              13,673
              
              
              
              11,224Borrowings
              
              
              458
              
              
              
              1,345
              
              
              
              2,151Total
      Interest Expense
              
              
              15,733
              
              
              
              21,398
              
              
              
              19,206Net
      Interest Income
              
              
              31,928
              
              
              
              34,082
              
              
              
              31,731Provision
      for loan losses
              
              
              1,634
              
              
              
              1,918
              
              
              
              4,419Net
      Interest Income after Provision for Loan Losses
              
              
              30,294
              
              
              
              32,164
              
              
              
              27,312Noninterest
      Income:Service
      charges, commissions and fees
              
              
              3,990
              
              
              
              3,822
              
              
              
              3,604Net
      losses on sale of securities
              
              
              (1
              )
              
              
              (478
              )
              
              
              (234
              )Loss
      on securities impairment
              
              
              (4,611
              )
              
              
              -
              
              
              
              -Net
      gains on sale of loans
              
              
              210
              
              
              
              272
              
              
              
              71Other
              
              
              1,489
              
              
              
              1,082
              
              
              
              926Total
      Noninterest Income
              
              
              1,077
              
              
              
              4,698
              
              
              
              4,367Noninterest
      Expense:Salaries
      and employee benefits
              
              
              10,653
              
              
              
              9,662
              
              
              
              7,926Occupancy
      and equipment expense
              
              
              2,903
              
              
              
              2,573
              
              
              
              2,342Net
      cost of other real estate and repossessions
              
              
              249
              
              
              
              396
              
              
              
              277Other
              
              
              9,227
              
              
              
              8,502
              
              
              
              7,828Total
      Noninterest Expense
              
              
              23,032
              
              
              
              21,133
              
              
              
              18,373Income
      Before Income Taxes
              
              
              8,339
              
              
              
              15,729
              
              
              
              13,306Provision
      for income taxes
              
              
              2,591
              
              
              
              5,466
              
              
              
              4,504Net
      Income
              
              $
              5,748
              
              
              $
              10,263
              
              
              $
              8,802Per
      Common Share:Earnings
              
              $
              1.03
              
              
              $
              1.85
              
              
              $
              1.58Cash
      dividends paid
              
              $
              0.64
              
              
              $
              0.63
              
              
              $
              0.60Average
      Common Shares Outstanding
              
              
              5,559,644
              
              
              
              5,559,644
              
              
              
              5,559,644








See Notes to Consolidated Financial
Statements.


- 44
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 Table of Contents




FIRST
      GUARANTY BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY(in
      thousands)AccumulatedCommon
              
              
              Common
              
              
              
              
              
              
              
              
              OtherStock
              
              
              Stock
              
              
              
              
              
              Retained
              
              
              Comprehensive$1
      Par
              
              
              $5
      Par
              
              
              Surplus
              
              
              Earnings
              
              
              Loss
              
              
              TotalBalance
      December 31, 2005 as previously reported
              
              $
              5,076
              
              
              $
              2,416
              
              
              $
              24,527
              
              
              $
              22,622
              
              
              $
              (718
              )
              
              $
              53,923Correction
      of an error
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              729
              
              
              
              -
              
              
              
              729Balance
      December 31, 2005 as restated
              
              
              5,076
              
              
              
              2,416
              
              
              
              24,527
              
              
              
              23,351
              
              
              
              (718
              )
              
              
              54,652Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              8,802
              
              
              
              -
              
              
              
              8,802Reclassification
      of $5 par value into $1 par value
              
              
              484
              
              
              
              (2,416
              )
              
              
              1,932
              
              
              
              
              
              
              
              
              
              
              
              0Change
      in unrealized loss onavailable
      for sale securities,net
      of reclassification adjustments, and taxes
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (187
              )
              
              
              (187
              )Comprehensive
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              8,615Cash
      dividends on common stock ($0.60 per share)
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (3,335
              )
              
              
              -
              
              
              
              (3,335
              )Balance
      December 31, 2006
              
              
              5,560
              
              
              
              -
              
              
              
              26,459
              
              
              
              28,818
              
              
              
              (905
              )
              
              
              59,932Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              10,263
              
              
              
              -
              
              
              
              10,263Change
      in unrealized loss onavailable
      for sale securities,net
      of reclassification adjustments, and taxes
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              570
              
              
              
              570Comprehensive
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              10,833Cash
      dividends on common stock ($0.63 per share)
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (3,503
              )
              
              
              -
              
              
              
              (3,503
              )Balance
      December 31, 2007
              
              
              5,560
              
              
              
              -
              
              
              
              26,459
              
              
              
              35,578
              
              
              
              (335
              )
              
              
              67,262Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              5,748
              
              
              
              -
              
              
              
              5,748Change
      in unrealized loss onavailable
      for sale securities,net
      of reclassification adjustments, and taxes
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (2,823
              )
              
              
              (2,823
              )Comprehensive
      income
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              2,925Cash
      dividends on common stock ($0.64 per share)
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (3,557
              )
              
              
              -
              
              
              
              (3,557
              )Balance
      December 31, 2008
              
              $
              5,560
              
              
              $
              -
              
              
              $
              26,459
              
              
              $
              37,769
              
              
              $
              (3,158
              )
              
              $
              66,630





See
Notes to Consolidated Financial Statements.


- 45
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 Table of Contents


FIRST
      GUARANTY BANCSHARES, INC. AND SUBSIDIARYCONSOLIDATED
      STATEMENTS OF CASH FLOWS(in
      thousands)Years
      Ended December 31,2008
              
              
              2007
              
              
              2006Cash
      Flows From Operating ActivitiesNet
      income
              
              $
              5,748
              
              
              $
              10,263
              
              
              $
              8,802Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Provision
      for loan losses
              
              
              1,634
              
              
              
              1,918
              
              
              
              4,419Depreciation
      and amortization
              
              
              1,451
              
              
              
              1,238
              
              
              
              1,438Amortization
      of premium/discount on investments
              
              
              (807
              )
              
              
              (1,011
              )
              
              
              66Loss
      on call / sale of securities
              
              
              1
              
              
              
              478
              
              
              
              234Gain
      on sale of assets
              
              
              (211
              )
              
              
              (272
              )
              
              
              (81
              )Other
      than temporary impairment charge on securities
              
              
              4,611
              
              
              
              -
              
              
              
              -ORE
      writedowns and loss/(gain) on disposition
              
              
              113
              
              
              
              180
              
              
              
              (365
              )FHLB
      stock dividends
              
              
              (32
              )
              
              
              (134
              )
              
              
              (134
              )Net
      decrease (increase) in loans held for sale
              
              
              3,959
              
              
              
              31,090
              
              
              
              (1,049
              )Change
      in other assets and liabilities, net
              
              
              3,090
              
              
              
              (1,270
              )
              
              
              (106
              )Net
      Cash Provided By Operating Activities
              
              
              19,557
              
              
              
              42,480
              
              
              
              13,224Cash
      Flows From Investing ActivitiesProceeds
      from maturities and calls of HTM securities
              
              
              11,740
              
              
              
              10,493
              
              
              
              20,604Proceeds
      from maturities, calls and sales of AFS securities
              
              
              756,642
              
              
              
              627,001
              
              
              
              26,770Funds
      invested in AFS securities
              
              
              (773,772
              )
              
              
              (575,534
              )
              
              
              (31,108
              )Proceeds
      from sale of Federal Home Loan Bank stock
              
              
              1,900
              
              
              
              4,175
              
              
              
              1,797Funds
      invested in Federal Home Loan Bank stock
              
              
              (1,857
              )
              
              
              (639
              )
              
              
              (2,346
              )Proceeds
      from maturities of time deposits with banks
              
              
              2,923
              
              
              
              -
              
              
              
              -Funds
      invested in time deposits with banks
              
              
              (22,216
              )
              
              
              -
              
              
              
              -Net
      increase in loans
              
              
              (33,196
              )
              
              
              (31,222
              )
              
              
              (29,492
              )Proceeds
      from sale of Mortgage Servicing Rights
              
              
              -
              
              
              
              583
              
              
              
              -Purchase
      of premises and equipment
              
              
              (1,017
              )
              
              
              (801
              )
              
              
              (2,478
              )Proceeds
      from sales of other real estate owned
              
              
              443
              
              
              
              3,103
              
              
              
              6,909Cash
      paid in excess of cash received in acquisition
              
              
              (72
              )
              
              
              (10,646
              )
              
              
              -Net
      Cash Provided By (Used In) Investing Activities
              
              
              (58,482
              )
              
              
              26,513
              
              
              
              (9,344
              )Cash
      Flows From Financing ActivitiesNet
      increase (decrease) in deposits
              
              
              57,194
              
              
              
              29,355
              
              
              
              (6,615
              )Net
      (decrease) increase in federal funds purchased and short-term
                borrowings
              
              
              (634
              )
              
              
              3,817
              
              
              
              (2,397
              )Proceeds
      from long-term borrowings
              
              
              10,000
              
              
              
              -
              
              
              
              30,000Repayment
      of long-term borrowings
              
              
              (4,738
              )
              
              
              (64,802
              )
              
              
              (25,167
              )Dividends
      paid
              
              
              (3,557
              )
              
              
              (3,503
              )
              
              
              (3,335
              )Net
      Cash Provided By (Used In) Financing Activities
              
              
              58,265
              
              
              
              (35,133
              )
              
              
              (7,514
              )Net
      Increase (Decrease) In Cash and Cash Equivalents
              
              
              19,340
              
              
              
              33,860
              
              
              
              (3,634
              )Cash
      and Cash Equivalents at the Beginning of the Period
              
              
              58,677
              
              
              
              24,817
              
              
              
              28,451Cash
      and Cash Equivalents at the End of the Period
              
              $
              78,017
              
              
              $
              58,677
              
              
              $
              24,817Noncash
      Activities:Loans
      transferred to foreclosed assets
              
              $
              751
              
              
              $
              1,118
              
              
              $
              8,538Cash
      paid during the year:Interest
      on deposits and borrowed funds
              
              $
              15,656
              
              
              $
              21,512
              
              
              $
              18,241Income
      taxes
              
              $
              1,200
              
              
              $
              6,015
              
              
              $
              5,590
  See Notes to
Consolidated Financial Statements.


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NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





Note
1.  Business and Summary of Significant Accounting
Policies





Business


First
Guaranty Bancshares, Inc. (the “Company”) is a Louisiana corporation. On July
27, 2007 the Company became the parent of First Guaranty Bank. The Company owns
all of the outstanding shares of common stock of First Guaranty Bank. First
Guaranty Bank (the “Bank”) is a Louisiana state-chartered commercial bank that
provides a diversified range of financial services to consumers and businesses
in the communities in which it operates. These services include consumer and
commercial lending, mortgage loan origination, the issuance of credit cards and
retail banking services. The Bank has 17 banking offices and 25 automated teller
machines (ATMs) in northern and southern of Louisiana.





Summary
of significant accounting policies


Information
for the year ended December 31, 2006 and any prior period reflects the
operations of First Guaranty Bank on a stand-alone basis. Prior to becoming the
holding company of First Guaranty Bank, First Guaranty Bancshares, Inc. had no
assets, liabilities or operations.


The
accounting and reporting policies of the Company conform to generally accepted
accounting principles and to predominant accounting practices within the banking
industry. The more significant accounting and reporting policies are as
follows:





Consolidation


The
consolidated financial statements include the accounts of First Guaranty
Bancshares, Inc. (the “Company”), and its wholly owned subsidiary, First
Guaranty Bank (the “Bank”). All significant intercompany balances and
transactions have been eliminated in consolidation.





Use
of estimates


The
preparation of financial statements in conformity with generally accepted
accounting principles requires Management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the dates of the financial statements and
the reported amounts of revenue and expense during the reporting periods. Actual
results could differ from those estimates.


Material
estimates that are particularly susceptible to significant change in the
near-term economic environment and market conditions relate to the determination
of the allowance for loan losses and the valuation of real estate acquired in
connection with foreclosures or in satisfaction of loans. In connection with the
determination of the allowance for loan losses and real estate owned, the
Company obtains independent appraisals for significant properties.


Available for
sale investment securities are stated at estimated fair value, with the
unrealized gains and losses determined on a specific identification basis. Such
unrealized gains and losses, net of tax, are reported as a separate component of
stockholders’ equity and included in other comprehensive income (loss). The
Company utilizes an independent third party as its principal pricing source for
determining fair value. For investment securities traded in an active market,
fair values are measured on a recurring basis obtained from an independent
pricing service and based on quoted market prices if available. If quoted market
prices are not available, fair values are based on quoted market prices of
comparable securities, broker quotes or comprehensive interest rate tables and
pricing matrices. For investment securities traded in a market that is not
active, fair value is determined using unobservable inputs or value drivers and
is generally determined using expected cash flows and appropriate risk-adjusted
discount rates. Expected cash flows are based primarily on the contractual cash
flows of the instrument.


Any security
that has experienced a decline in value, which management believes is deemed
other than temporary, is reduced to its estimated fair value by a charge to
operations.  In estimating other-than-temporary impairment losses,
management considers (1) the length of time and the extent to which the fair
value has been less than cost, (2) the financial condition and near-term
prospects of the issuer, and (3) the intent and ability of the Company to retain
its investment in the issuer for a period of time sufficient to allow for any
anticipated recovery in fair value.  Realized gains and losses on
security transactions are computed using the specific identification
method.  Amortization of premiums and discounts is included in
interest and dividend income.  Discounts and premiums related to debt
securities are amortized using the effective interest rate
method.  The Company did not have any derivative financial instruments
as of December 31, 2008 or 2007.





Cash
and cash equivalents


For purposes
of reporting cash flows, cash and cash equivalents are defined as cash, due from
banks, interest-bearing demand deposits with banks and federal funds sold with
maturities of three months or less.





Securities


The Company
reviews its financial position, liquidity and future plans in evaluating the
criteria for classifying investment securities. At December 31, 2008, the
securities portfolio contained two classifications of securities - held to
maturity and available for sale. At December 31, 2008, $114.4 million were
classified as available for sale and $24.8 million were classified as held to
maturity.




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Debt
securities that Management has the ability and intent to hold to maturity are
classified as held to maturity and carried at cost, adjusted for amortization of
premiums and accretion of discounts using methods approximating the interest
method. Securities available for sale are stated at fair value. The unrealized
difference, if any, between amortized cost and fair value of these securities is
excluded from income and is reported, net of deferred taxes, as a component of
stockholders' equity. Realized gains and losses on securities are computed based
on the specific identification method and are reported as a separate component
of other income.


Management
evaluates securities for other-than-temporary impairment at least quarterly and
more frequently when economic or market conditions warrant such evaluation.
Consideration is given to (1) the length of time and the extent to which the
fair value has been less than cost, (2) the financial condition and near-term
prospects of the issuer (3) the recovery of contractual principal and interest
and (4) the intent and ability of the Company to retain its investment in the
issuer for a period of time sufficient to allow for any anticipated recovery in
fair value.


The Company
has a required investment in Federal Home Loan Bank stock that is carried at
cost that approximates fair value. This stock must be maintained by the
Company.





Loans
held for sale


Mortgage
loans originated and intended for sale in the secondary market are carried at
the lower of cost or estimated fair value in the aggregate. Net unrealized
losses, if any, are recognized through a valuation allowance by charges to
income. Loans held for sale have primarily been fixed rate single-family
residential mortgage loans under contract to be sold in the secondary market. In
most cases, loans in this category are sold within thirty days. Buyers generally
have recourse to return a purchased loan under limited circumstances. Recourse
conditions may include early payment default, breach of representations or
warranties and documentation deficiencies.


Mortgage
loans held for sale are generally sold with the mortgage servicing rights
released. Gains or losses on sales of mortgage loans are recognized based on the
differences between the selling price and the carrying value of the related
mortgage loans sold.





Loans


Loans are
stated at the principal amounts outstanding, net of unearned income and deferred
loan fees. In addition to loans issued in the normal course of business,
overdrafts on customer deposit accounts are considered to be loans and
reclassified as such. At December 31, 2008 and 2007, $161,000 and $461,000,
respectively, in overdrafts have been reclassified to loans. Interest income on
all classifications of loans is calculated using the simple interest method on
daily balances of the principal amount outstanding.


Accrual of
interest is discontinued on a loan when Management believes, after considering
economic and business conditions and collection efforts, the borrower’s
financial condition is such that reasonable doubt exists as to the full and
timely collection of principal and interest. This evaluation is made for all
loans that are 90 days or more contractually past due. When a loan is placed in
non-accrual status, all interest previously accrued but not collected is
reversed against current period interest income. Income on such loans is then
recognized only to the extent that cash is received and where the future
collection of interest and principal is probable. Loans are returned to accrual
status when, in the judgment of Management, all principal and interest amounts
contractually due are reasonably assured of repayment within a reasonable time
frame and when the borrower has demonstrated payment performance of cash or cash
equivalents for a minimum of six months.





Loan
fees and costs


Nonrefundable
loan origination and commitment fees and direct costs associated with
originating loans are deferred and recognized over the lives of the related
loans as an adjustment to the loans' yield using the level yield
method.





Allowance
for loan losses


The allowance
for loan losses is established through a provision for loan losses charged to
expense. Loans are charged against the allowance for loan losses when Management
believes that the collectability of the principal is unlikely. The allowance,
which is based on evaluation of the collectability of loans and prior loan loss
experience, is an amount that Management believes will be adequate to reflect
the risks inherent in the existing loan portfolio and exist at the reporting
date. The evaluations take into consideration a number of subjective factors
including changes in the nature and volume of the loan portfolio, overall
portfolio quality, review of specific problem loans, current economic conditions
that may affect a borrower’s ability to pay, adequacy of loan collateral and
other relevant factors. In addition, regulatory agencies, as an integral part of
their examination process, periodically review the estimated losses on loans.
Such agencies may require additional recognition of losses based on their
judgments about information available to them at the time of their
examination.


Although
Management uses available information to recognize losses on loans, because of
uncertainties associated with local economic conditions, collateral values and
future cash flows on impaired loans, it is reasonably possible that a material
change could occur in the allowance for loan losses in the near term. However,
the amount of the change that is reasonably possible cannot be
estimated.


The
evaluation of the adequacy of loan collateral is often based upon estimates and
appraisals. Because of changing economic conditions, the valuations determined
from such estimates and appraisals may also change. Accordingly, the Company may
ultimately incur losses that vary from Management's current estimates.
Adjustments to the allowance for loan losses will be reported in the period such
adjustments become known or can be reasonably estimated. All loan losses are
charged to the allowance for loan losses when the loss actually occurs or when
Management believes that the collectability of the principal is unlikely.
Recoveries are credited to the allowance at the time of recovery.





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The allowance
consists of specific, general and unallocated components. The specific component
relates to loans that are classified as doubtful, substandard or special
mention. For such loans that are also classified as impaired, an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan is lower than the carrying value of that
loan. The general component covers non-classified loans and is based on
historical loss experience adjusted for qualitative factors. An unallocated
component is maintained to cover uncertainties that could affect Management’s
estimate of probable losses. The unallocated component of the allowance reflects
the margin of imprecision inherent in the underlying assumptions used in the
methodologies for estimating specific and general losses in the
portfolio.


A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement. Factors considered by Management in determining impairment include
payment status, collateral value and the probability of collecting scheduled
principal and interest payments when due. Loans that experience insignificant
payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls
on a case-by-case basis, taking into consideration all of the circumstances
surrounding the loan and the borrower, including the length of the delay, the
reasons for the delay, the borrower’s prior payment record and the amount of the
shortfall in relation to the principal and interest owed. Impairment is measured
on a loan-by-loan basis for commercial and construction loans by either the
present value of expected future cash flows discounted at the loan’s effective
interest rate, the loan’s obtainable market price or the fair value of the
collateral if the loan is collateral dependent.


Large groups
of smaller balance homogeneous loans are collectively evaluated for impairment.
Accordingly, individual consumer and residential loans are not separately
identified for impairment disclosures, unless such loans are the subject of a
restructuring agreement.





Goodwill
and Intangible assets


Intangible
assets are comprised of goodwill and core deposit intangibles. Goodwill is
accounted for in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets. The Company’s goodwill is tested for impairment on an annual
basis, or more often if events or circumstances indicate that there may be
impairment. Adverse changes in the economic environment, declining operations,
or other factors could result in a decline in the implied fair value of
goodwill. If the implied fair value is less than the carrying amount, a loss
would be recognized in other non-interest expense to reduce the carrying amount
to implied fair value of goodwill. A goodwill impairment test includes two
steps. Step one, used to identify potential impairment, compares the estimated
fair value of a reporting unit with its carrying amount, including goodwill. If
the estimated fair value of a reporting unit exceeds its carrying amount,
goodwill of the reporting unit is considered not impaired. If the carrying
amount of a reporting unit exceeds its estimated fair value, the second step of
the goodwill impairment test is performed to measure the amount of impairment
loss, if any. Step two of the goodwill impairment test compares the implied
estimated fair value of reporting unit goodwill with the carrying amount of that
goodwill. If the carrying amount of goodwill for that reporting unit exceeds the
implied fair value of that unit’s goodwill, an impairment loss is recognized in
an amount equal to that excess. The Company did not record goodwill impairment
charges in 2008.


Identifiable
intangible assets are acquired assets that lack physical substance but can be
distinguished from goodwill because of contractual or legal rights or because
the assets are capable of being sold or exchanged either on their own on in
combination with related contract, asset or liability. The Company’s intangible
assets primarily relate to core deposits.  These core deposit
intangibles are amortized on a straight-line basis over terms ranging from seven
to 15 years. Management periodically evaluates whether events or circumstances
have occurred that would result in impairment of value.





Premises
and equipment


Premises and
equipment are stated at cost, less accumulated depreciation. Depreciation is
computed for financial reporting purposes using the straight-line method over
the estimated useful lives of the respective assets as follows:





Buildings and
improvements                     10-40
years


Equipment, fixtures and
automobiles          3-10
years




Expenditures
for renewals and betterments are capitalized and depreciated over their
estimated useful lives. Repairs, maintenance and minor improvements are charged
to operating expense as incurred. Gains or losses on disposition, if any, are
recorded in the Statements of Income.





Other
real estate


Other real
estate includes properties acquired through foreclosure or acceptance of deeds
in lieu of foreclosure. These properties are recorded at the lower of the
recorded investment in the property or its fair value less the estimated cost of
disposition. Any valuation adjustments required prior to foreclosure are charged
to the allowance for loan losses. Subsequent to foreclosure, losses on the
periodic revaluation of the property are charged to current period earnings as
other real estate expense. Costs of operating and maintaining the properties are
charged to other real estate expense as incurred. Any subsequent gains or losses
on dispositions are credited or charged to income in the period of
disposition.





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Off-balance
sheet financial instruments


The Company
accounts for its guarantees in accordance with the provisions of Financial
Accounting Standards Board (“FASB”) Interpretation No. 45, Guarantor’s Accounting and
Disclosure Requirements for Guarantees, (“FIN 45”). In the ordinary
course of business, the Company has entered into commitments to extend credit,
including commitments under credit card arrangements, commitments to fund
commercial real estate, construction and land development loans secured by real
estate, and performance standby letters of credit. Such financial instruments
are recorded when they are funded.





Income
taxes


The Company
and all subsidiaries file a consolidated federal income tax return on a calendar
year basis. In lieu of Louisiana state income tax, the Bank is subject to the
Louisiana bank shares tax, which is included in noninterest expense in the
Company’s consolidated financial statements. With few exceptions, the Company is
no longer subject to U.S. federal, state or local income tax examinations for
years before 2005.


Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax basis. Deferred tax
assets and liabilities are measured using enacted tax rates expected to apply to
taxable income in the years in which the deferred tax assets or liabilities are
expected to be settled or realized. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be
utilized.





Comprehensive
income


Accounting
principles generally require that recognized revenue, expenses, gains and losses
be included in net income. Although certain changes in assets and liabilities,
such as unrealized gains and losses on available for sale securities, are
reported as a separate component of the equity section of the balance sheet,
such items along with net income, are components of comprehensive income. The
components of other comprehensive income and related tax effects are presented
in the Statements of Changes in Stockholders’ Equity and Note 17 of the
Consolidated Notes to the Financial Statements.





Earnings
per common share


Earnings per
share is computed and presented in accordance with SFAS No. 128 “Earnings Per
Share”. No convertible shares or other agreements to issue common stock are
outstanding.





Transfers
of Financial Assets


Transfers of
financial assets are accounted for as sales, when control over the assets has
been surrendered. Control over transferred assets is deemed to be surrendered
when (i) the assets have been isolated from the Company, (ii) the transferee
obtains the right (free of conditions that constrain it from taking advantage of
that right) to pledge or exchange the transferred assets, and (iii) the Company
does not maintain effective control over the transferred assets through an
agreement to repurchase them before their maturity.





Recent
Accounting Pronouncements


In January
2009, the FASB Staff Position (FSP) EITF Issue 99-20-1 amends the impairment
guidance in EITF Issue No.99-20, “Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That
Continue to Be Held by a Transferor in Securitized Financial Assets,” to
achieve more consistent determination of whether an other-than-temporary
impairment has occurred. The FSP also retains and emphasizes the objective of an
other than-temporary impairment assessment and the related disclosure
requirements in FASB Statement No. 115, Accounting for Certain Investments
in Debt and Equity Securities,and other related guidance. The FSP shall
be effective for interim and annual reporting periods ending after December 15,
2008, and shall be applied prospectively. Retrospective application to a prior
interim or annual reporting period is not permitted. EITF Issue 99-20-1 resulted
in a material impact on the Company’s financial condition or results of
operations for 2008 (see Notes 5 and 19 to the Consolidated Financial
Statem


In November
2008, the SEC issued a proposed roadmap regarding the potential use by U.S.
issuers of financial statements prepared in accordance with International
Financial Reporting Standards (“IFRS”). IFRS is a comprehensive series of
accounting standards published by the International Accounting Standards Board
(“IASB”). Under the proposed roadmap, the Company may be required to prepare
financial statements in accordance with IFRS as early as 2014. The SEC will make
a determination in 2011 regarding the mandatory adoption of IFRS. The Company is
currently assessing the impact that this potential change would have on its
operating results and financial condition, and will continue to monitor the
development of the potential implementation of IFRS.




In October
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (FSP) 157-3, Determining the Fair Value of a
Financial Asset in a Market That is Not Active, which clarifies the
application of Statement of Financial Accounting Standard (SFAS) No. 157, Fair Value Measurements, in
an inactive market. Application issues clarified include: how management’s
internal assumptions should be considered when measuring fair value when
relevant observable data do not exist; how observable market information in a
market that is not active should be considered when measuring fair value; and
how the use of market quotes should be considered when assessing the relevance
of observable and unobservable data available to measure fair value. FSP 157-3
is effective immediately and resulted in a material impact on the Company’s
financial condition or results of operations for 2008 (see Notes 5 and 19 to the
Consolidated Financial Statements).




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In September
2008, the FASB issued EITF No 08-6, Equity Method Investment Accounting
Considerations, which clarifies how the initial carrying value of an
equity method investment should be determined; how the difference between the
investor’s carrying value and the investor’s share of the underlying equity of
the investee should be allocated to the underlying assets and liabilities of the
investee; how an impairment assessment of an underlying indefinite-lived
intangible asset of an equity method investment should be performed; how an
equity method investee’s issuance of shares should be accounted for; and how to
account for a change in an investment from the equity method to the cost method.
The Company will adopt the provisions of EITF No. 08-6 in the first quarter of
2009, as required, and the impact on the Company’s financial condition or
results of operations is dependent on the extent of future business
combinations.


In June 2008,
the FASB ratified EITF Issue No. 08-3, Accounting for Lessees for
Maintenance Deposits Under Lease Arrangements, (EITF 08-3). EITF 08-3
provides guidance for accounting of nonrefundable maintenance deposits. EITF
08-3 is effective for fiscal years beginning after December 15, 2008. We
anticipate the adoption of EITF 08-3 will not have a significant impact to the
Company’s financial condition or results of operations.


In May 2008,
the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted
Accounting Principles (SFAS 162). SFAS 162 identifies the sources of
accounting principles and the framework for selecting the principles to be used
in the preparation of financial statements that are presented in conformity with
generally accepted accounting principles in the United States. This
Statement is effective 60 days following the Securities and Exchange
Commission’s approval of the Public Company Accounting Oversight Board
amendments to AU Section 411, The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles. We anticipate
the adoption of SFAS 162 will not have a significant impact to the Company’s
financial condition or results of operations.


In
May 2008, the FASB issued FASB Staff Position (“FSP”) APB 14-a, Accounting for Convertible
Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash
Settlement). The FSP requires that proceeds from the issuance of
convertible debt instruments be allocated between debt (at a discount) and an
equity component. The debt discount will be amortized over the period the
convertible debt is expected to be outstanding as additional non-cash interest
expense. This FSP is effective for fiscal years beginning after
December 15, 2008, and will be applied retrospectively to prior periods. We
anticipate the adoption of  APB 14-a will not have a significant
impact to the Company’s financial condition or results of
operations.


In April
2008, the FASB issued FASB Staff Position (FSP) 142-3, Determination of the Useful Life
of Intangible Assets, (FSP 142-3). FSP 142-3 amends the factors that
should be considered in developing renewal or extension assumptions used to
determine the useful life of a recognized intangible asset under SFAS
No. 142, Goodwill and
Other Intangible Assets. FSP 142-3 is effective for fiscal years
beginning after December 15, 2008. We anticipate the adoption of FSP 142-3
will not have a significant impact to the Company’s financial condition or
results of operations.


In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments andHedgingActivities—an amendment of FASB Statement No. 133. This Statement changes
the disclosure requirements for derivative instruments and hedging activities.
Entities are required to provide enhanced disclosures about (a) how and why an
entity uses derivative instruments, (b) how derivative instruments and related
hedged items are accounted for under Statement 133 and its related
interpretations, and (c) how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash flows.
This Statement is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application
encouraged. This Statement encourages, but does not require, comparative
disclosures for earlier periods at initial adoption. We anticipate the adoption
of SFAS No. 161 will not have a significant impact to the Company’s financial
condition or results of operations.


In December
2007, the Financial Accounting Standards Board (“FASB”) issued SFAS 160,
Non-controlling Interests in
Consolidated Financial Statements, an Amendment of ARB 51. SFAS 160
establishes new accounting and reporting standards for non-controlling interests
in a subsidiary. SFAS 160 will require entities to classify non-controlling
interests as a component of stockholders’ equity and will require subsequent
changes in ownership interests in a subsidiary to be accounted for as an equity
transaction. SFAS 160 will also require entities to recognize a gain or
loss upon the loss of control of a subsidiary and to re-measure any ownership
interest retained at fair value on that date. This statement also requires
expanded disclosures that clearly identify and distinguish between the interests
of the parent and the interests of the non-controlling owners. SFAS 160 is
effective on a prospective basis for fiscal years, and interim periods within
those fiscal years, beginning on or after December 15, 2008, except for the
presentation and disclosure requirements, which are required to be applied
retrospectively. We anticipate the adoption of SFAS No. 160 will not have a
significant impact to the Company’s financial condition or results of
operations.


In December
2007, FASB issued SFAS No. 141R, Business Combinations (“SFAS
No. 141R”) which applies to all business combinations. The statement requires
most identifiable assets, liabilities, non-controlling interests, and goodwill
acquired in a business combination to be recorded at “full fair value.” All
business combinations will be accounted for by applying the acquisition method
(previously referred to as the purchase method). Companies will have to identify
the acquirer; determine the acquisition date and purchase price; recognize at
their acquisition-date fair values the identifiable assets acquired, liabilities
assumed, and any non-controlling interests in the acquiree, and recognize
goodwill or, in the case of a bargain purchase, a gain. SFAS No. 141R is
effective for periods beginning on or after December 15, 2008, and early
adoption is prohibited. It will be applied to business combinations occurring
after the effective date. We anticipate the adoption of SFAS No. 141R will not
have a significant impact to the Company’s financial condition or results of
operations.




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In November
2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at
Fair Value Through Earnings (“SAB No. 109”). SAB No. 109 rescinds SAB No.
105’s prohibition on inclusion of expected net future cash flows related to loan
servicing activities in the fair value measurement of a written loan commitment.
SAB No. 109 applies to any loan commitments for which fair value accounting is
elected under SFAS No. 159. SAB No. 109 is effective prospectively for
derivative loan commitments issued or modified in fiscal quarters beginning
after December 15, 2007. We anticipate the adoption of SAB No. 109 will not
have a significant impact to the Company’s financial condition or results of
operations.





Reclassifications


Certain
reclassifications have been made to prior year financial statements in order to
conform to the classification adopted for reporting in 2008.





Note
2.  Merger and Acquisition Activity


On July 30,
2007, the Company acquired all of the outstanding stock of Homestead Bancorp,
Inc., the holding company for Homestead Bank located in Ponchatoula, Louisiana,
for approximately $12.1 million in cash. Homestead Bank and First Guaranty Bank
were also merged on July 30, 2007. This transaction was recorded using the
purchase accounting method. The Company received the following:





(in
      thousands)Cash
      and cash equivalents
              
              $
              1,422Securities
              
              
              45,000Loans,
      net (including loans held for sale)
              
              
              74,357Premises
      and equipment, net
              
              
              2,685Goodwill
              
              
              1,981Core
      deposit and other intangibles
              
              
              2,836Other
      assets
              
              
              1,382Deposits
              
              
              (67,503
              )Borrowings
              
              
              (49,911
              )Other
      liabilities
              
              
              (109
              )Total
      purchase price
              
              $
              12,140
  The
acquisition resulted in $4.8 million of intangible assets which includes $2.0
million of goodwill, $2.1 million of core deposit intangibles and $729,000 in
mortgage servicing rights. The goodwill acquired is not tax deductible. The core
deposit intangible is being amortized over the estimated useful life of 11.4
years using the straight line method.


The results
of operations of the acquired company subsequent to the acquisition date are
included in the Company’s consolidated statements of income.


The merger
increased the branch franchise and extended the Company’s presence to Walker,
Louisiana.


The Company
borrowed $12.1 million to acquire Homestead Bancorp, Inc. and Homestead Bank.
The Company repaid the debt with cash received from the sale of Homestead Bank
securities. The Company sold $46.4 million of securities owned by Homestead
Bank, which was comprised of $40.6 million in mortgage-backed securities and
$5.8 million in mutual funds. In addition, $46.9 million in Homestead Bank
short- and long-term FHLB advances matured or were prepaid by the Company in
2007.





Note
3.  Correction of an Error


During 2008,
the Company discovered an error related to the calculation of deferred tax
assets. As a result, a $91,000 adjustment was recorded in current year income.
The portion of the error attributable to years prior to December 31, 2005 was
recorded as an increase to retained earnings at December 31, 2005 of $729,000.
The adjustment is reflected in other assets and in retained earnings. There were
no adjustments to income as previously reported for the years ended December 31,
2007 and 2006.





Note
4. Cash and Due from Banks


Certain
reserves are required to be maintained at the Federal Reserve Bank. The
requirement as of December 31, 2008 and 2007 was $14.1 million and $750,000,
respectively. The Company has accounts at various correspondent banks, excluding
the Federal Reserve Bank, which exceed the FDIC insured limit of $250,000 by
$11.8 million at December 31, 2008.  This balance includes $9.7
million at JPMorgan Chase, the correspondent bank which is used to clear cash
letters.





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Note
5.  Securities


A summary
comparison of securities by type at December 31, 2008 and 2007 is shown
below.





December
      31, 2008
              
              
              December
      31, 2007Gross
              
              
              Gross
              
              
              
              
              
              
              
              
              Gross
              
              
              GrossAmortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              Fair
              
              
              Amortized
              
              
              Unrealized
              
              
              Unrealized
              
              
              FairCost
              
              
              Gains
              
              
              Losses
              
              
              Value
              
              
              Cost
              
              
              Gains
              
              
              Losses
              
              
              Value(in
      thousands)Available-for-sale:U.S. Government Agencies
              
              $
              58,389
              
              
              $
              132
              
              
              $
              -
              
              
              $
              58,521
              
              
              $
              92,962
              
              
              $
              26
              
              
              $
              (25
              )
              
              $
              92,963Mortgage-backed obligations
              
              
              1,701
              
              
              
              82
              
              
              
              (5
              )
              
              
              1,778
              
              
              
              2,016
              
              
              
              43
              
              
              
              (23
              )
              
              
              2,036Asset-backed securities
              
              
              532
              
              
              
              -
              
              
              
              (439
              )
              
              
              93
              
              
              
              1,340
              
              
              
              -
              
              
              
              (95
              )
              
              
              1,245Corporate debt securities
              
              
              57,773
              
              
              
              644
              
              
              
              (5,077
              )
              
              
              53,340
              
              
              
              5,954
              
              
              
              50
              
              
              
              (214
              )
              
              
              5,790Mutual funds or other equity
                securities
              
              
              795
              
              
              
              26
              
              
              
              (147
              )
              
              
              674
              
              
              
              3,805
              
              
              
              22
              
              
              
              (291
              )
              
              
              3,536Total securities
              
              $
              119,190
              
              
              $
              884
              
              
              $
              (5,668
              )
              
              $
              114,406
              
              
              $
              106,077
              
              
              $
              141
              
              
              $
              (648
              )
              
              $
              105,570Held-to-maturity:U.S. Government Agencies
              
              $
              22,680
              
              
              $
              160
              
              
              $
              -
              
              
              $
              22,840
              
              
              $
              33,984
              
              
              $
              24
              
              
              $
              (281
              )
              
              $
              33,727Mortgage-backed obligations
              
              
              2,076
              
              
              
              21
              
              
              
              (1
              )
              
              
              2,096
              
              
              
              2,514
              
              
              
              -
              
              
              
              (35
              )
              
              
              2,479Total securities
              
              $
              24,756
              
              
              $
              181
              
              
              $
              (1
              )
              
              $
              24,936
              
              
              $
              36,498
              
              
              $
              24
              
              
              $
              (316
              )
              
              $
              36,206


The scheduled
maturities of securities at December 31, 2008, by contractual maturity, are
shown below. Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties.





December
      31, 2008Amortized
              
              
              FairCost
              
              
              Value(in
      thousands)Available
      For Sale:Due
      in one year or less
              
              $
              35,013
              
              
              $
              34,984Due
      after one year through five years
              
              
              32,307
              
              
              
              31,141Due
      after five years through 10 years
              
              
              19,441
              
              
              
              17,202Over
      10 years
              
              
              32,429
              
              
              
              31,079Total
              
              $
              119,190
              
              
              $
              114,406Held
      to Maturity:Due
      in one year or less
              
              $
              -
              
              
              $
              -Due
      after one year through five years
              
              
              1,261
              
              
              
              1,278Due
      after five years through 10 years
              
              
              7,124
              
              
              
              7,265Over
      10 years
              
              
              16,371
              
              
              
              16,393Total
              
              $
              24,756
              
              
              $
              24,936




At December
31, 2008 and 2007, approximately $85.4 million and $131.6 million, respectively,
in securities were pledged to secure public fund deposits, and for other
purposes required or permitted by law. Gross realized gains were $4,000, $0 and
$0 for the years ended December 31, 2008, 2007 and 2006, respectively. Gross
realized losses were $5,000, $478,000 and $234,000 for the years ended December
31, 2008, 2007 and 2006. The tax (benefit) provision applicable to these
realized net (losses)/gains amounted to $0, $(163,000), and $(80,000),
respectively. Proceeds from sales of securities classified as available for sale
amounted to $0.2 million, $65.2 million and $6.8 million for the years ended
December 31, 2008, 2007 and 2006, respectively.




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The following
is a summary of the fair value of securities with gross unrealized losses and an
aging of those gross unrealized losses at December 31, 2008.







Less
      Than 12 Months
            
            
            12
      Months or More
            
            
            TotalGross
            
            
            
            
            
            Gross
            
            
            
            
            
            GrossUnrealized
            
            
            
            
            
            Unrealized
            
            
            
            
            
            UnrealizedFair
      Value
            
            
            Losses
            
            
            Fair
      Value
            
            
            Losses
            
            
            Fair
      Value
            
            
            Losses(in
      thousands)Available
      for sale:U.S. Government AgenciesMortgage-backed obligations
            
            $
            -
            
            
            $
            -
            
            
            $
            456
            
            
            $
            5
            
            
            $
            456
            
            
            $
            5Asset-backed securities
            
            
            -
            
            
            
            -
            
            
            
            93
            
            
            
            439
            
            
            
            93
            
            
            
            439Corporate debt securities
            
            
            29,330
            
            
            
            4,559
            
            
            
            1,415
            
            
            
            518
            
            
            
            30,745
            
            
            
            5,077Mutual funds or other equity securites
            
            
            15
            
            
            
            1
            
            
            
            604
            
            
            
            146
            
            
            
            619
            
            
            
            147Total securities
            
            $
            29,345
            
            
            $
            4,560
            
            
            $
            2,568
            
            
            $
            1,108
            
            
            $
            31,913
            
            
            $
            5,668Held
      to maturity:U.S. Treasury and U.S.Government Agencies
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -Mortgage-backed obligations
            
            
            -
            
            
            
            -
            
            
            
            719
            
            
            
            1
            
            
            
            719
            
            
            
            1Total securities
            
            $
            -
            
            
            $
            -
            
            
            $
            719
            
            
            $
            1
            
            
            $
            719
            
            
            $
            1


At December
31, 2008 156 debt securities and four equity securities have unrealized losses
of $5,669,000 or 15.1% of amortized cost. The gross unrealized losses in the
portfolio resulted from increases in market interest rates, illiquidity in the
market and declines in net income and other financial indicators caused by
the national economy and not from deterioration in the creditworthiness of the
issuer. The Company believes that it will collect all amounts contractually due
and has the intent and the ability to hold these securities until the fair value
is at least equal to the carrying value. The Company had 136 debt securities and
two equity securities that had gross unrealized losses for less than 12 months.
Two mortgage-backed securities, one fixed rate and one floating rate, one
classified as held to maturity and one classified as available for sale, have
also been in a continuous unrealized loss position for twelve months or longer.
Also, four corporate debt securities, nine floating rate preferred securities,
one floating rate preferred stock, five asset-backed securities, and one mutual
fund, all classified as available for sale, have been in a continuous unrealized
loss position for twelve months or longer. These securities with unrealized
losses resulted from increases in interest rates and illiquidity in the market
and not from deterioration in the creditworthiness of the issuer.


Irrespective
of the classification, accounting and reporting treatment as AFS or HTM
securities, if any decline in the market value of a security is deemed to be
other than temporary, then the security’s carrying value shall be written down
to fair value and the amount of the write down reflected in earnings. Management
evaluates securities for other-than-temporary impairment at least quarterly and
more frequently when economic or market conditions warrant such evaluation.
Consideration is given to (i) the length of time and the extent to which the
fair value has been less than cost, (ii) the financial condition and near-term
prospects of the issuer, (iii) the recovery of contractual principal and
interest and (iv) the intent and ability of the Company to retain its investment
in the issuer for a period of time sufficient to allow for any anticipated
recovery in fair value. In analyzing an issuer’s financial condition, Management
considers whether the securities are issued by the federal government or its
agencies, whether downgrades by bond rating agencies have occurred and industry
reports.


The amount of
investment securities issued by government agencies, mortgage-backed and
asset-backed securities with unrealized losses and the amount of unrealized
losses on those investment securities are primarily the result of market
interest rates and illiquidity in the market. The company has the ability and
intent to hold these securities until recovery, which may be until
maturity.


The corporate
debt securities consist primarily of corporate bonds issued by financial
institutions, insurance and real estate companies. Also included in corporate
debt securities are trust preferred capital securities, many issued by national
and global financial services firms. The market values of corporate bonds have
declined over the last several months due to larger credit spreads on financial
sector debt as well as the real estate markets. The Company believes that the
each of the issuers will be able to fulfill the obligations of these securities.
The Company has the ability and intent to hold these securities until they
recover, which could be at their maturity dates.


Other than
the corporate debt securities, the Company attributes the unrealized losses
mainly to increases in market interest rates over the yield available at the
time the underlying securities were purchased and does not expect to incur a
loss unless the securities are sold prior to maturity. Corporate debt securities
consists primarily of corporate bonds issued by financial institutions,
insurance and real estate companies. Also included in corporate debt securities
are trust preferred capital securities, many issued by national and global
financial services firms.





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Overall
market declines, particularly that of banking and financial institutions, as
well as the real estate market, are a result of significant stress throughout
the regional and national economy. Securities with unrealized losses, in which
the Company has not already taken an OTTI charge, are currently performing
according to their contractual terms. Management has the intent and ability to
hold these securities for the foreseeable future. The fair value is expected to
recover as the securities approach their maturity or repricing date or if market
yields for such investments decline. As a result of uncertainties in the market
place affecting companies in the financial services industry, it is at least
reasonably possible that a change in the estimate will occur in the near term.
The
Company believes that the securities with unrealized losses reflect impairment
that is temporary and that there are currently no securities with other than
temporary impairment.


During 2008
the Company recorded an impairment writedown totaling $4,611,000. The impairment
writedown consisted of three preferred stocks of Fannie Mae and Freddie Mac
totaling $3,046,000, on a cost basis, which had unrealized losses of $1,991,000
and $1,010,000, respectively, debt securities totaling $727,000 and $240,000
issued by Lehman Brothers and Washington Mutual which had unrealized losses of
$634,000 and $239,000, respectively.  The Company also recorded an
impairment writedown on $510,000 and $739,000 in asset backed securities issued
by TRAPEZA and ALESCO (CDOs) which had unrealized losses of $344,000 and
$409,000, respectively.


At December
31, 2008, the Company’s exposure to two investment security issuers exceeded 10%
of stockholders’ equity as follows:





Amortized
              
              
              FairCost
              
              
              Value(in
      thousands)Federal
      Home Loan Bank (FHLB)
              
              $
              23,339
              
              
              $
              23,456Federal
      National Mortgage Association (Fannie Mae)
              
              
              56,217
              
              
              
              56,412Total
              
              $
              79,556
              
              
              $
              79,868


Note
6.  Loans and Allowance for Loan Losses


The following
table summarizes the components of the Company's loan portfolio as of December
31, 2008 and 2007:





December
      31,2008
              
              
              2007As
      % of
              
              
              
              
              
              As
      % ofBalance
              
              
              Category
              
              
              Balance
              
              
              Category(dollars
      in thousands)Real
      estateConstruction
      & land development
              
              $
              92,029
              
              
              
              15.2
              %
              
              $
              98,127
              
              
              
              17.0
              %Farmland
              
              
              16,403
              
              
              
              2.7
              %
              
              
              23,065
              
              
              
              4.0
              %1-4
      Family
              
              
              79,285
              
              
              
              13.1
              %
              
              
              84,640
              
              
              
              14.7
              %Multifamily
              
              
              15,707
              
              
              
              2.6
              %
              
              
              13,061
              
              
              
              2.3
              %Non-farm
      non-residential
              
              
              261,744
              
              
              
              43.0
              %
              
              
              236,474
              
              
              
              41.1
              %Total
      real estate
              
              
              465,168
              
              
              
              76.6
              %
              
              
              455,367
              
              
              
              79.1
              %Agricultural
              
              
              18,536
              
              
              
              3.0
              %
              
              
              16,816
              
              
              
              2.9
              %Commercial
      and industrial
              
              
              105,555
              
              
              
              17.4
              %
              
              
              81,073
              
              
              
              14.1
              %Consumer
      and other
              
              
              17,926
              
              
              
              3.0
              %
              
              
              22,517
              
              
              
              3.9
              %Total
      loans before unearned income
              
              
              607,185
              
              
              
              100.0
              %
              
              
              575,773
              
              
              
              100.0
              %Less:
      unearned income
              
              
              (816
              )
              
              
              
              
              
              
              (517
              )Total
      loans after unearned income
              
              $
              606,369
              
              
              
              
              
              
              $
              575,256
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 Table of Contents


The following
table summarizes fixed and floating rate loans by maturity and repricing
frequencies as of December 31, 2008:





December
      31, 2008Fixed
            
            
            Floating
            
            
            Total(in
      thousands)One
      year or less
            
            $
            134,750
            
            
            $
            244,498
            
            
            $
            379,248One
      to five years
            
            
            123,903
            
            
            
            43,027
            
            
            
            166,930Five
      to 15 years
            
            
            34,478
            
            
            
            164
            
            
            
            34,642Over
      15 years
            
            
            16,420
            
            
            
            -
            
            
            
            16,420Subtotal
            
            
            309,551
            
            
            
            287,689
            
            
            
            597,240Nonaccrual
      loans
            
            
            
            
            
            
            
            
            
            
            9,129Total
      loans after unearned income
            
            $
            309,551
            
            
            $
            287,689
            
            
            $
            606,369





Changes in
the allowance for loan losses are as follows:





Years
      Ended December 31,2008
              
              
              2007
              
              
              2006(in
      thousands)Balance,
      beginning of year
              
              $
              6,193
              
              
              $
              6,675
              
              
              $
              7,597Additional
      provision from acquisition
              
              
              -
              
              
              
              325
              
              
              
              -Provision
      charged to expense
              
              
              1,634
              
              
              
              1,918
              
              
              
              4,419Loans
      charged off
              
              
              (1,613
              )
              
              
              (3,885
              )
              
              
              (5,888
              )Recoveries
              
              
              268
              
              
              
              1,160
              
              
              
              547Balance,
      end of year
              
              $
              6,482
              
              
              $
              6,193
              
              
              $
              6,675




The allowance
for loan losses is reviewed by Management on a monthly basis and additions
thereto are recorded in order to maintain the allowance at an adequate level. In
assessing the adequacy of the allowance, Management considers a variety of
internal and external factors that might impact the performance of individual
loans. These factors include, but are not limited to, economic conditions and
their impact upon borrowers' ability to repay loans, respective industry trends,
borrower estimates and independent appraisals. Periodic changes in these factors
impact Management's assessment of each loan and its overall impact on the
adequacy of the allowance for loan losses.


As of
December 31, 2008, 2007 and 2006, the Company had loans totaling $9.1 million,
$10.3 million and $10.4 million, respectively, on which the accrual of interest
had been discontinued. As of December 31, 2008, 2007 and 2006, the Company had
loans past due 90 days or more and still accruing interest totaling $205,000,
$547,000 and $334,000, respectively.


The average
amount of non-accrual loans in 2008 was $9.9 million compared to $10.3 million
in 2007. Had these loans performed in accordance with their original terms, the
Company's interest income would have been increased by approximately $0.5
million and $0.6 million for the years ended December 31, 2008 and 2007,
respectively. Impaired loans at December 31, 2008 and 2007, including
non-accrual loans, amounted to $11.4 million and $10.1 million, respectively.
The portion of the allowance for loan losses allocated to all impaired loans
amounted to $1.4 million and $0.9 million at December 31, 2008 and 2007,
respectively. As of December 31, 2008, the Company has no outstanding
commitments to advance additional funds in connection with impaired
loans.




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 Table of Contents


The following
is a summary of information pertaining to impaired loans as of December
31:




2008
              
              2007(in
      thousands)Impaired
      loans without a valuation allowance
              $
      6,084
              
              $
      2,559Impaired
      loans with a valuation allowance
              5,267
              
              7,523Total
      impaired loans
              $11,351
              
              $10,082Valuation
      allowance related to impaired loans
              $1,353
              
              $879Total
      nonaccrual loans
              $9,129
              
              $10,288Total
      loans past due ninety days and still accruing
              $205
              
              $5472008
              
              2007
              
              2006(in
      thousands)Average
      investment in impaired loans
              $9,027
              
              $7,571
              
              $17,128Interest
      income recognized on impaired loans
              $1,049
              
              $764
              
              $1,946Interest
      income recognized on a cash basis on impaired loans
              $283
              
              $182
              
              $1,636


Note
7.  Premises and Equipment


The major
categories comprising premises and equipment at December 31, 2008 and 2007 are
as follows:








December
      31,2008
            
            
            2007(in
      thousands)Land
            
            $
            4,693
            
            
            $
            4,301Bank
      premises
            
            
            15,333
            
            
            
            15,135Furniture
      and equipment
            
            
            13,763
            
            
            
            13,431Acquired
      value
            
            
            33,789
            
            
            
            32,867Less:
      accumulated depreciation
            
            
            17,648
            
            
            
            16,627Net
      book value
            
            $
            16,141
            
            
            $
            16,240





Depreciation
expense amounted to approximately $1.0 million, $0.9 million and $0.8 million
for 2008, 2007 and 2006, respectively.





Note
8.  Goodwill and Other Intangible Assets


The Company
accounts for goodwill and intangible assets in accordance with SFAS No. 142,
“Goodwill and Other Intangible Assets”. Under SFAS No. 142, goodwill and
intangible assets deemed to have indefinite lives are no longer amortized, but
are subject to annual impairment tests in accordance with the provision of SFAS
No. 142. Other intangible assets continue to be amortized over their useful
lives. Goodwill for the year ended December 31, 2008 was $2.0 million and was
acquired in the Homestead acquisition in 2007. No impairment charges were
recognized during 2008.


Mortgage
servicing rights totaled $29,000 at December 31, 2008 and $24,000 at December
31, 2007.


Other
intangible assets recorded include core deposit intangibles, which are subject
to amortization. The core deposits reflect the value of deposit relationships,
including the beneficial rates, which arose from the purchase of other financial
institutions and the purchase of various banking center locations from one
single financial institution. The following table summarizes the Company’s
purchased accounting intangible assets subject to amortization.





December
      31,2008
              
              
              2007Gross
      Carrying
              
              
              Accumulated
              
              
              Net
      Carrying
              
              
              Gross
      Carrying
              
              
              Accumulated
              
              
              Net
      CarryingAmount
              
              
              Amortization
              
              
              Amount
              
              
              Amount
              
              
              Amortization
              
              
              Amount(in
      thousands)Core
      deposit intangibles
              
              $
              7,997
              
              
              $
              5,948
              
              
              $
              2,049
              
              
              $
              7,997
              
              
              $
              5,638
              
              
              $
              2,359Mortgage
      servicing rights
              
              
              32
              
              
              
              3
              
              
              
              29
              
              
              
              24
              
              
              
              -
              
              
              
              24Total
              
              $
              8,029
              
              
              $
              5,951
              
              
              $
              2,078
              
              
              $
              8,021
              
              
              $
              5,638
              
              
              $
              2,383




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Amortization
expense relating to purchase accounting intangibles totaled $311,000, $203,000,
and $525,000 for the year ended December 31, 2008, 2007, and 2006, respectively.
The weighted average amortization period of these assets is 9.3 years. Estimated
future amortization expense is as follows:




For
      the Years Ended
                December
      31,
              
              Estimated
                Amortization
      Expense(in
      thousands)2009
              
              $2922010
              
              2182011
              
              2182012
              
              2162013
              
              185
  These
estimates do not assume the addition of any new intangible assets that may be
acquired in the future nor any write-downs resulting from
impairment.





Note
9.  Deposits


The aggregate
amount of jumbo time deposits, each with a minimum denomination of $100,000, was
approximately $247.8 million and $167.3 million at December 31, 2008 and 2007,
respectively.


At December
31, 2008, the scheduled maturities of time deposits are as follows:


December
      31, 2008(in
      thousands)Due
      in one year or less
              
              $
              260,299Due
      after one year through three years
              
              
              128,202Due
      after three years
              
              
              52,029Total
              
              $
              440,530
  The table
above includes brokered deposits totaling $13.0 million in reciprocal time
deposits acquired from the Certificate of Deposit Account Registry Service
(CDARS). At December 31, 2007, the Company did not have any brokered
deposits.





Note
10.  Borrowings


Short-term
borrowings are summarized as follows:




December
      31,2008
            
            
            2007(in
      thousands)Securities
      sold under agreements to repurchase
            
            $
            9,767
            
            
            $
            10,401Total
      short-term borrowings
            
            $
            9,767
            
            
            $
            10,401


Securities
sold under agreements to repurchase, which are classified as secured borrowings,
generally mature daily. Interest rates on repurchase agreements are set by
Management and are generally based on the 91-day Treasury bill rate. Repurchase
agreement deposits are fully collateralized and monitored daily.


The Company’s
available lines of credit with correspondent banks, including the Federal Home
Loan Bank, totaled $140.4 million at December 31, 2008 and $129.4 million at
December 31, 2007.


At December
31, 2008 the Company had $130.6 million in blanket lien availability (primarily
secured by commercial real estate loans) and $95.0 million in custody status
availability (primarily secured by commercial real estate loans and 1-4 family
mortgage loans). Total gross availability was $225.6 million at December 31,
2008 but was reduced by its outstanding long-term advance totaling $8.4 million
and letters of credit totaling $155.0 million. Net availability with the FHLB at
December 31, 2008 was $62.2 million.








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With the
exception of the FHLB, no other lines were outstanding with any other
correspondent bank at December 31, 2008 or December 31, 2007.


The following
schedule provides certain information about the Company’s short-term borrowings
during 2008 and 2007:





December
      31,2008
            
            2007
            
            2006(dollars
      in thousands)Outstanding
      at year end
            $9,767
            
            $10,401
            
            $6,584Maximum
      month-end outstanding
            41,321
            
            45,766
            
            37,353Average
      daily outstanding
            11,379
            
            16,655
            
            23,731Weighted
      average rate during the year
            2.16%
            
            5.18%
            
            5.19%Average
      rate at year end
            0.19%
            
            3.50%
            
            4.41%




At December
31, 2008, one long-term advance was outstanding at the FHLB totaling $8.4
million with a rate of 3.14% and a maturity date of October 1,
2009.


At December
31, 2008, letters of credit issued by the FHLB totaling $155.0 million were
outstanding and carried as off-balance sheet items, all of which expire in 2009.
At December 31, 2007, the Company had $105.0 million in letters of credit issued
by the FHLB which all expired in 2008 and were carried as off-balance sheet
items. The letters of credit are solely used for pledging towards public fund
deposits. See Note 18 to the Consolidated Financial Statements for additional
information.


In 2007, the
Company assumed $3.1 million in subordinated debentures in the Homestead Bank
acquisition. The debentures were issued in 2003 by the Homestead Bancorp Trust
I, a statutory trust. The interest rate on the debentures was LIBOR plus 300bp
and reset quarterly. The securities had a term of 30 years, callable after 5
years, with interest payments due on a quarterly basis.


In July 2008,
the Company requested regulatory approval for the redemption of the junior
subordinated debentures. As a condition of the approval of the redemption, the
Federal Reserve Bank of Atlanta requested, until further notice, that the
Company obtain prior written approval before incurring any indebtedness,
declaring or paying any corporate dividends or redeeming any corporate stock.
Also, the Louisiana Office of Financial Institutions requested that the Bank
obtain prior approval before paying any dividends until compliant with LSA-R.S.
6:263(C). On August 8, 2008, the $3.1 million in junior subordinated debentures
were redeemed.





Note
11.  Preferred Stock


The number of
authorized shares of preferred stock is 100,000 shares of $1,000 par value.
There is no preferred stock outstanding.





Note
12.  Minimum Capital Requirements


The Company
and the Bank are subject to various regulatory capital requirements administered
by the federal and state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Company’s financial statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities and certain off-balance sheet
items as calculated under regulatory accounting practices. The capital amounts
and classification are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors. Prompt corrective action
provisions are not applicable to bank holding companies.


Quantitative
measures established by regulation to ensure capital adequacy require the
Company and the Bank to maintain minimum amounts and ratios of total and Tier 1
capital to risk-weighted assets and of Tier 1 capital to average assets.
Management believes, as of December 31, 2008 and 2007, that the Company and
the Bank met all capital adequacy requirements to which they were
subject.


As of
December 31, 2008, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized, an institution must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios as set forth in the following table. There
are no conditions or events since the notification that Management believes have
changed the Bank’s category. The Company’s and the Bank’s actual capital amounts
and ratios as of December 31, 2008 and 2007 are presented in the following
table:





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MinimumTo
      Be WellCapitalized
      UnderMinimum
      Capital
              
              Prompt
      CorrectiveActual
              
              Requirements
              
              Action
      ProvisionsAmount
              Ratio
              
              Amount
              Ratio
              
              Amount
              Ratio(dollars
      in thousands)December
      31, 2008Total
      risk-based capital:First
      Guaranty Bancshares, Inc.
              $72,157
              10.26%
              
              $56,242
              8.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              71,584
              10.19%
              
              56,190
              8.00%
              
              70,237
              10.00%Tier
      1 capital:First
      Guaranty Bancshares, Inc.
              65,675
              9.34%
              
              28,121
              4.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              65,093
              9.27%
              
              28,095
              4.00%
              
              42,142
              6.00%Tier
      1 leverage capital:First
      Guaranty Bancshares, Inc.
              65,675
              8.01%
              
              32,783
              4.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              65,093
              7.95%
              
              32,754
              4.00%
              
              40,942
              5.00%December
      31, 2007Total
      risk-based capital:First
      Guaranty Bancshares, Inc.
              $71,556
              11.09%
              
              $51,600
              8.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              71,006
              11.02%
              
              51,558
              8.00%
              
              64,447
              10.00%Tier
      1 capital:First
      Guaranty Bancshares, Inc.
              65,364
              10.13%
              
              25,800
              4.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              64,813
              10.06%
              
              25,779
              4.00%
              
              38,668
              6.00%Tier
      1 leverage capital:First
      Guaranty Bancshares, Inc.
              65,364
              7.38%
              
              35,414
              4.00%
              
              N/A
              N/AFirst
      Guaranty Bank
              64,813
              8.22%
              
              31,556
              4.00%
              
              39,444
              5.00%


Note
13.  Dividend Restrictions


The Federal
Reserve Bank has stated that generally, a bank holding company, should not
maintain a rate of distributions to shareholders unless its available net income
has been sufficient to fully fund the distributions, and the prospective rate of
earnings retention appears consistent with the bank holding company’s capital
needs, asset quality and overall financial condition. As a Louisiana
corporation, the Company is restricted under the Louisiana corporate law from
paying dividends under certain conditions. The Company is currently required to
obtain prior written approval from the FRB before declaring or paying any
corporate dividend.


First
Guaranty Bank may not pay dividends or distribute capital assets if it is in
default on any assessment due to the FDIC.  First Guaranty Bank is
also subject to regulations that impose minimum regulatory capital and minimum
state law earnings requirements that affect the amount of cash available for
distribution. In addition, under the Louisiana Banking Law, dividends may not be
paid if it would reduce the unimpaired surplus below 50% of outstanding capital
stock in any year.


The Bank is
restricted under applicable laws in the payment of dividends to an amount equal
to current year earnings plus undistributed earnings for the immediately
preceding year, unless prior permission is received from the Commissioner of
Financial Institutions for the State of Louisiana. Dividends payable by the Bank
in 2009 without permission will be limited to 2009 earnings.
 Accordingly,
at January 1, 2009, $66,060,000 of the Company’s equity in the net assets
of the Bank was restricted. Funds available for loans or advances by the Bank to
the Company amounted to $7,158,000. In addition, dividends paid by the Bank to
the Company would be prohibited if the effect thereof would cause the Bank’s
capital to be reduced below applicable minimum capital
requirements.





Note
14.  Related Party Transactions


In the normal
course of business, the Company has loans, deposits and other transactions with
its executive officers, directors and certain business organizations and
individuals with which such persons are associated. An analysis of the activity
of loans made to such borrowers during the year ended December 31, 2008
follows:




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December
      31,2008
            
            
            2007(in
      thousands)Balance,
      beginning of year
            
            $
            19,120
            
            
            $
            19,989New
      loans
            
            
            18,947
            
            
            
            12,850Repayments
            
            
            (15,610
            )
            
            
            (13,719
            )Balance,
      end of year
            
            $
            22,457
            
            
            $
            19,120


Unfunded
commitments to the Company’s directors and executive officers totaled $12.4
million and $16.9 million at December 31, 2008 and 2007, respectively. During
2008, there were no participations in loans purchased from affiliated financial
institutions. At December 31, 2007 there were $0.8 million in participations in
loans purchased from affiliated financial institutions included in the Company’s
loan portfolio. Participations sold to affiliated financial institutions totaled
$10.4 million and $10.3 million at December 31, 2008 and 2007,
respectively.


During the
years ended 2008, 2007 and 2006, the Company paid approximately $504,000,
$715,000 and $633,000, respectively, for printing services and supplies and
office furniture and equipment to Champion Graphic Communications (or subsidiary
companies of Champion Industries, Inc.), of which Mr. Marshall T. Reynolds, the
Chairman of the Company’s Board of Directors, is President, Chief Executive
Officer, Chairman of the Board of Directors and holder of 41.8% of the capital
stock as of January 16, 2009; approximately $1.3 million, $1.1 million and $0.9
million, respectively, to participate in the Champion Industries, Inc. employee
medical benefit plan; and approximately $183,000, $245,000 and $134,000,
respectively, to Sabre Transportation, Inc. for travel expenses of the Chairman
and other directors. These expenses include, but are not limited to, the
utilization of an aircraft, fuel, air crew, ramp fees and other expenses
attendant to the Company’s use. The Harrah and Reynolds Corporation, of which
Mr. Reynolds is President and Chief Executive Officer and sole shareholder, has
controlling interest in Sabre Transportation, Inc.


During the
years ended 2008, 2007 and 2006, the Company engaged the services of Cashe,
Lewis, Coudrain and Sandage, attorneys-at-law, of which Mr. Alton Lewis, a
director of the Company, is a partner, to represent the Company with certain
legal matters. Mr. Lewis has a 25% ownership interest in the law firm. The fees
paid for these legal services totaled $162,000, $178,000 and $291,000 for the
years ended 2008, 2007 and 2006, respectively.





Note
15.  Employee Benefit Plans


The Company
has an employee savings plan to which employees, who meet certain service
requirements, may defer one to 20 percent of their base salaries, six percent of
which may be matched up to 100%, at its sole discretion. Contributions to the
savings plan were $64,000, $115,000 and $101,000 in 2008, 2007 and 2006,
respectively.


An Employee
Stock Ownership Plan (“ESOP”) benefits all eligible employees. Full-time
employees who have been credited with at least 1,000 hours of service during a
12 consecutive month period and who have attained age 21 are eligible to
participate in the ESOP. The plan document has been approved by the Internal
Revenue Service. Contributions to the ESOP are at the sole discretion of the
Company.


Voluntary
contributions of $100,000 to the ESOP were made in 2008, 2007, and 2006 for the
purchase of shares from third parties at market value. At December 31, 2008, the
ESOP had acquired 3,703 shares of $1 par value common stock at a cost of $93,000
for the 2008 contribution and had distributions of 174 shares bringing the total
shares allocated to 21,882 shares.


In 2007, the
ESOP acquired 3,843 shares of $1 par value common stock for a cost of $90,000.
In 2006, the ESOP acquired 3,820 shares of $1 par value common stock for a cost
of $89,000. An analysis of ESOP shares allocated is presented
below:




2008
              
              
              2007
              
              
              2006Shares
      allocated, beginning of year
              
              
              18,353
              
              
              
              14,510
              
              
              
              10,690Shares
      allocated, during the year
              
              
              3,703
              
              
              
              3,843
              
              
              
              3,820Shares
      distributed, during the year
              
              
              (174
              )
              
              
              -
              
              
              
              -Allocated
      shares held by ESOP, end of year
              
              
              21,882
              
              
              
              18,353
              
              
              
              14,510





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Note 16.  Income
Taxes


The following
is a summary of the provision for income taxes included in the Statements of
Income:





Years
      Ended December 31,2008
            
            
            2007
            
            
            2006(in
      thousands)Current
            
            $
            5,423
            
            
            $
            4,632
            
            
            $
            4,046Deferred
            
            
            (2,727
            )
            
            
            213
            
            
            
            617Tax
      credits
            
            
            (105
            )
            
            
            (81
            )
            
            
            (135
            )Tax
      benefits attributable to items charged to goodwill
            
            
            -
            
            
            
            726
            
            
            
            -Benefit
      of operating loss carryforward
            
            
            -
            
            
            
            (24
            )
            
            
            (24
            )Total
            
            $
            2,591
            
            
            $
            5,466
            
            
            $
            4,504


The
difference between income taxes computed by applying the statutory federal
income tax rate and the provision for income taxes in the financial statements
is reconciled as follows:




Years
      Ended December 31,2008
            
            2007
            
            2006(dollars
      in thousands)Statutory
      tax rate
            34.3%
            
            34.2%
            
            34.2%Federal
      income taxes at statutory rate
            $2,860
            
            $5,379
            
            $4,551Tax
      credits
            (105)
            
            (81)
            
            (135)Other
            (164)
            
            168
            
            88Total
            $2,591
            
            $5,466
            
            $4,504




Deferred
taxes are recorded based upon differences between the financial statement and
tax basis of assets and liabilities, and available tax credit carryforwards.
Temporary differences between the financial statement and tax values of assets
and liabilities give rise to deferred tax assets (liabilities). The significant
components of deferred tax assets and liabilities at December 31, 2008 and 2007
are as follows:


Years
      Ended December 31,2008
              
              
              2007(in
      thousands)Deferred
      tax assets:Allowance
      for loan losses
              
              $
              2,204
              
              
              $
              2,023Other
      real estate owned
              
              
              45
              
              
              
              85Impairment
      writedown on securities
              
              
              1,568
              
              
              
              -Unrealized
      loss on available for sale securities
              
              
              1,627
              
              
              
              172Other
              
              
              96
              
              
              
              84Gross
      deferred tax assets
              
              $
              5,540
              
              
              $
              2,364Deferred
      tax liabilities:Depreciation
      and amortization
              
              
              (1,018
              )
              
              
              (1,095
              )Other
              
              
              (308
              )
              
              
              (695
              )Gross
      deferred tax liabilities
              
              
              (1,326
              )
              
              
              (1,790
              )Net
      deferred tax assets
              
              $
              4,214
              
              
              $
              574




As of
December 31, 2008 and 2007, there were no net operating loss carry forwards for
income tax purposes.





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On January 1,
2007, the Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in
income taxes recognized in financial statements in accordance with SFAS No. 109,
Accounting for Income
Taxes. The company does not believe it has any unrecognized tax benefits
included in its consolidated financial statements. The Company has not had any
settlements in the current period with taxing authorities, nor has it recognized
tax benefits as a result of a lapse of the applicable statue of
limitations.


The Company
recognizes interest and penalties accrued related to unrecognized tax benefits,
if applicable, in noninterest expense. During the years ended December 31,
2008, 2007, and 2006, the Company did not recognize any interest or penalties in
its consolidated financial statements, nor has it recorded an accrued liability
for interest or penalty payments.





Note
17.  Comprehensive Income


The following
is a summary of the components of other comprehensive income as presented in the
Statements of Changes in Stockholders’ Equity:





December
      31,2008
            
            
            2007
            
            
            2006(in
      thousands)Unrealized
      gain (loss) on available for sale securities, net
            
            $
            (8,889
            )
            
            $
            387
            
            
            $
            (517
            )Reclassification
      adjustments for net losses, realized net income
            
            
            4,612
            
            
            
            478
            
            
            
            234Other
      comprehensive income (loss)
            
            
            (4,277
            )
            
            
            865
            
            
            
            (283
            )Income
      tax (provision) benefit related to other comprehensive
    income
            
            
            1,454
            
            
            
            (295
            )
            
            
            96Other
      comprehensive income (loss), net of income taxes
            
            $
            (2,823
            )
            
            $
            570
            
            
            $
            (187
            )


Note
18.  Off-Balance Sheet Items


The Company
is a party to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers and to reduce
its own exposure to fluctuations in interest rates. These financial instruments
include commitments to extend credit and standby and commercial letters of
credit. Those instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the Consolidated
Balance Sheets. The contract or notional amounts of those instruments reflect
the extent of the involvement in particular classes of financial
instruments.


The exposure
to credit loss in the event of nonperformance by the other party to the
financial instrument for commitments to extend credit and standby and commercial
letters of credit is represented by the contractual notional amount of those
instruments. The same credit policies are used in making commitments and
conditional obligations as it does for on-balance sheet
instruments.


Unless
otherwise noted, collateral or other security is not required to support
financial instruments with credit risk.


Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require payment
of a fee. Since commitments may expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements. Each
customer's creditworthiness is evaluated on a case-by-case basis. The amount of
collateral obtained, if deemed necessary upon extension of credit, is based on
Management's credit evaluation of the counterpart. Collateral requirements vary
but may include accounts receivable, inventory, property, plant and equipment,
residential real estate and commercial properties.


Standby and
commercial letters of credit are conditional commitments to guarantee the
performance of a customer to a third party. These guarantees are primarily
issued to support public and private borrowing arrangements, including
commercial paper, bond financing and similar transactions. The majority of these
guarantees are short-term, one year or less; however, some guarantees extend for
up to three years. The credit risk involved in issuing letters of credit is
essentially the same as that involved in extending loan facilities to customers.
Collateral requirements are the same as on-balance sheet instruments and
commitments to extend credit.


There were no
losses incurred on any commitments in 2008 or 2007.


ummary of
the notional amounts of the financial instruments with off-balance sheet risk at
December 31, 2008 and 2007 follows:


December
      31,2008
              
              
              2007(in
      thousands)Financial
      instruments whose contractamounts
      represent credit risk:Commitments
      to extend credit
              
              $
              90,938
              
              
              $
              92,342Standby
      letters of credit
              
              
              7,647
              
              
              
              6,035





Note
19.  Fair Value Measurements


Effective
January 1, 2008, the Company adopted the provisions of Statement of Financial
Accounting Standards (SFAS) No. 157, “Fair Value Measurements,” for financial
assets and liabilities. SFAS 157 defines fair value as the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. A fair value measurement assumes that
the transaction to sell the asset or transfer the liability occurs in the
principal market for the asset or liability or, in the absence of a principal
market, the most advantageous market for the asset or liability. Valuation
techniques use certain inputs to arrive at fair value. Inputs to valuation
techniques are the assumptions that market participants would use in pricing the
asset or liability. They may be observable or unobservable. SFAS 157 establishes
a fair value hierarchy for valuation inputs that gives the highest priority to
quoted prices in active markets for identical assets or liabilities and the
lowest priority to unobservable inputs. The fair value hierarchy is as
follows:




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Level 1 Inputs





Level 2 Inputs





Level 3 Inputs








Fair
      Value Measurements atDecember
      31, 2008, UsingQuotedPrices
      InActiveMarkets
              SignificantAssets/Liabilities
              
              For
              Other
              SignificantMeasured
      at Fair
              
              Identical
              Observable
              UnobservableValue
              
              Assets
              Inputs
              Inputs(in
      thousands)
              December
      31, 2008
              
              (Level
      1)
              (Level
      2)
              (Level
      3)Securities
      available for sale
              $                  114,406
              
              $           32,898
              $           81,508
              $                  -


Securities Available for Sale. Securities classified as available
for sale are reported at fair value utilizing Level 1, Level 2 and Level 3
inputs. For these securities, the Company obtains fair value measurements from
an independent pricing service. The fair value measurements consider observable
data that may include dealer quotes, market spreads, cash flows, market yield
curves, prepayment speeds, credit information and the instrument’s contractual
terms and conditions, among other things. Cash flow valuations were done on
these securities to facilitate in the calculation of the other than temporary
impairment charge taken on those securities in 2008 (see Note 5 to the
Consolidated Financial Statements).


Impaired Loans. Certain financial assets such as
impaired loans are measured at fair value on a nonrecurring basis; that is, the
instruments are not measured at fair value on an ongoing basis but are subject
to fair value adjustments in certain circumstances, such as when there is
evidence of impairment. The fair value of impaired loans was $11.4 million at
December 31, 2008. The fair value of impaired loans is measured by either the
obtainable market price (Level 1), the fair value of the collateral as
determined by appraisals or independent valuation (Level 2), or the present
value of expected future cash flows discounted at the effective interest rate of
the loan (Level 3).


Certain
non-financial assets and non-financial liabilities are measured at fair value on
a non-recurring basis including assets and liabilities related to reporting
units measured at fair value in the testing of goodwill impairment, as well as
intangible assets and other non-financial long-lived assets measured at fair
value for impairment assessment. The Company will defer application of SFAS 157
for nonfinancial assets and nonfinancial liabilities until January 1,
2009.





Note
20.  Financial Instruments


Fair value
estimates are generally subjective in nature and are dependent upon a number of
significant assumptions associated with each instrument or group of similar
instruments, including estimates of discount rates, risks associated with
specific financial instruments, estimates of future cash flows and relevant
available market information. Fair value information is intended to represent an
estimate of an amount at which a financial instrument could be exchanged in a
current transaction between a willing buyer and seller engaging in an exchange
transaction. However, since there are no established trading markets for a
significant portion of the Company’s financial instruments, the Company may not
be able to immediately settle financial instruments; as such, the fair values
are not necessarily indicative of the amounts that could be realized through
immediate settlement. In addition, the majority of the financial instruments,
such as loans and deposits, are held to maturity and are realized or paid
according to the contractual agreement with the customer.





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Quoted market
prices are used to estimate fair values when available. However, due to the
nature of the financial instruments, in many instances quoted market prices are
not available. Accordingly, estimated fair values have been estimated based on
other valuation techniques, such as discounting estimated future cash flows
using a rate commensurate with the risks involved or other acceptable methods.
Fair values are estimated without regard to any premium or discount that may
result from concentrations of ownership of financial instruments, possible
income tax ramifications or estimated transaction costs. The fair value
estimates are subjective in nature and involve matters of significant judgment
and, therefore, cannot be determined with precision. Fair values are also
estimated at a specific point in time and are based on interest rates and other
assumptions at that date. As events change the assumptions underlying these
estimates, the fair values of financial instruments will change.


Disclosure of
fair values is not required for certain items such as lease financing,
investments accounted for under the equity method of accounting, obligations of
pension and other postretirement benefits, premises and equipment, other real
estate, prepaid expenses, the value of long-term relationships with depositors
(core deposit intangibles) and other customer relationships, other intangible
assets and income tax assets and liabilities. Fair value estimates are presented
for existing on- and off-balance sheet financial instruments without attempting
to estimate the value of anticipated future business and the value of assets and
liabilities that are not considered financial instruments. In addition, the tax
ramifications related to the realization of the unrealized gains and losses have
not been considered in the estimates. Accordingly, the aggregate fair value
amounts presented do not purport to represent and should not be considered
representative of the underlying market or franchise value of the
Company.


Because the
standard permits many alternative calculation techniques and because numerous
assumptions have been used to estimate the fair values, reasonable comparison of
the fair value information with other financial institutions' fair value
information cannot necessarily be made.


The methods
and assumptions used to estimate the fair values of each class of financial
instruments are as follows:


Cash and due from
banks, interest-bearing deposits with banks, federal funds sold and federal
funds purchased.These items are generally
short-term in nature and, accordingly, the carrying amounts reported in the
Statements of Condition are reasonable approximations of their fair
values.


Interest-bearing
time deposits with banks.Time deposits are purchased from other
financial institutions for investment purposes. Time deposits with banks do not
have a balance greater than $250,000. Interest earned is paid monthly and not
reinvested as principal. The carrying amount of interest-bearing time deposits
with banks approximates its fair value.


Investment
Securities. Fair values are principally based on quoted market prices. If
quoted market prices are not available, fair values are based on quoted market
prices of comparable instruments or the use of discounted cash flow
analyses.
 Loans Held for
Sale. Fair values of mortgage loans held for sale are based on
commitments on hand from investors or prevailing market prices.
 Loans,
net.Market
values are computed present values using net present value formulas. The present
value is the sum of the present value of all projected cash flows on a item at a
specified discount rate. The discount rate is set as an appropriate rate index,
plus or minus an appropriate spread.
 Accrued interest
receivable.


Deposits.
Market values are actually computed present values using net present value
formulas. The present value is the sum of the present value of all projected
cash flows on an item at a specified discount rate. The discount rate is set as
an appropriate rate index, plus or minus an appropriate spread.
 Accrued interest
payable. The carrying amount of accrued interest payable approximates its
fair value.
 Borrowings.The carrying amount of
federal funds purchased and other short-term borrowings approximate their fair
values. The fair value of the Company’s long-term borrowings is actually
computed present values using net present value formulas. The present value is
the sum of the present value of all projected cash flows on a item at a
specified discount rate. The discount rate is set as an appropriate rate index,
plus or minus an appropriate spread.
 Other
unrecognized financial instruments. The fair value of commitments to
extend credit is estimated using the fees charged to enter into similar legally
binding agreements, taking into account the remaining terms of the agreements
and customers' credit ratings. For fixed-rate loan commitments, fair value also
considers the difference between current levels of interest rates and the
committed rates. The fair values of letters of credit are based on fees charged
for similar agreements or on estimated cost to terminate them or otherwise
settle the obligations with the counterparties at the reporting date. At
December 31, 2008 and 2007 the fair value of guarantees under commercial and
standby letters of credit was immaterial.
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The estimated
fair values and carrying values of the financial instruments at December 31,
2008 and 2007 are presented in the following table:




December
      31,2008
              
              2007Estimated
              
              
              EstimatedCarrying
              Fair
              
              Carrying
              FairValue
              Value
              
              Value
              Value(in
      thousands)AssetsCash
      and cash equivalents
              $78,017
              $78,017
              
              $58,677
              $58,677Interest-bearing
      time deposits with banks
              21,481
              21,578
              
              2,188
              2,188Securities,
      available for sale
              114,406
              114,406
              
              105,570
              105,570Securities,
      held to maturity
              24,756
              24,936
              
              36,498
              36,206Federal
      Home Loan Bank stock
              944
              944
              
              955
              955Loans
      held for sale
              -
              -
              
              3,959
              3,959Loans,
      net
              599,887
              606,486
              
              569,063
              566,616Accrued
      interest receivable
              4,611
              4,611
              
              5,126
              5,126LiabilitiesDeposits
              $780,372
              $786,928
              
              $723,094
              $720,744Borrowings
              18,122
              18,224
              
              13,494
              13,491Accrued
      interest payable
              3,033
              3,033
              
              2,956
              2,956




There is no
material difference between the contract amount and the estimated fair value of
off-balance sheet items that are primarily comprised of short-term unfunded loan
commitments that are generally priced at market.





Note
21.  Concentrations of Credit and Other Risks


Personal,
commercial and residential loans are granted to customers, most of who reside in
northern and southern areas of Louisiana. Although we have a diversified loan
portfolio, significant portions of the loans are collateralized by real estate
located in Tangipahoa Parish and surrounding parishes in southeast Louisiana.
Declines in the Louisiana economy could result in lower real estate values which
could, under certain circumstances, result in losses to the
Company.


The
distribution of commitments to extend credit approximates the distribution of
loans outstanding. Commercial and standby letters of credit were granted
primarily to commercial borrowers. Generally, credit is not extended in excess
of $8.0 million to any single borrower or group of related
borrowers.


A significant
portion of the Company’s deposits (approximately 28.9%) is derived from local
governmental agencies. These governmental depositing authorities are generally
long-term customers. A number of the depositing authorities are under
contractual obligation to maintain their operating funds exclusively with us. In
most cases, the Company is required to pledge securities or letters of credit
issued by the Federal Home Loan Bank to the depositing authorities to
collateralize their deposits. Under certain circumstances, the withdrawal of all
of, or a significant portion of, the deposits of one or more of the depositing
authorities may result in a temporary reduction in liquidity, depending
primarily on the maturities and/or classifications of the securities pledged
against such deposits and the ability to replace such deposits with either new
deposits or other borrowings.





Note
22.  Litigation


The Company
is subject to various legal proceedings in the normal course of its business. It
is Management’s belief that the ultimate resolution of such claims will not have
a material adverse effect on the Company’s financial position or results of
operations.





Note
23.  Commitments and Contingencies


In the
ordinary course of business, various outstanding commitments and contingent
liabilities arise that are not reflected in the accompanying financial
statements. Included among these contingent liabilities are certain provisions
in agreements, entered into with outside third parties, to sell loans that may
require the Company to repurchase if it becomes delinquent within a specified
period of time.





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Note
24. Subsequent Event


During the
first quarter of 2009, total deposits have increased to the extent that it
resulted in a reduction of regulatory capital ratios. As a result, in March 2009
the Company borrowed $6.0 million on its available line of credit and injected
the $6.0 million into the Bank to enhance capital. The interest rate on the line
of credit is a floating rate and it set at prime less 100 basis points. The debt
is secured by 100% of the Bank’s common stock. The Company intends to repay the
debt in full by December 31, 2009. As a result of this additional debt, the
Company’s interest expense will likely increase in future periods.





Note
25.  Condensed Parent Company Information


The following
condensed financial information reflects the accounts and transactions of First
Guaranty Bancshares, Inc. (parent company only) for the dates
indicated:




First
      Guaranty Bancshares, Inc.Condensed
      Balance Sheet(in
      thousands)December
      31,
              
              December
      31,Assets
              2008
              
              2007Cash
              $93
              
              $49Investment
      in bank subsidiary
              66,060
              
              69,008Other
      assets
              662
              
              623Total
      Assets
              $66,815
              
              $69,680Liabilities
      and Stockholders' EquityJunior
      subordinated debentures
              -
              
              3,093Other
      liabilities
              185
              
              54Stockholders'
      Equity
              66,630
              
              66,533Total
      Liabilities and Stockholders' Equity
              $66,815
              
              $69,680


First
      Guaranty Bancshares, Inc.Condensed
      Statement of Income(in
      thousands)Years
      ended December 31,Operating
      Income
              
              2008
              
              
              2007Dividends
      received from bank subsidiary
              
              $
              7,200
              
              
              $
              19,630Other
      income
              
              
              143
              
              
              
              4Total
      operating income
              
              
              7,343
              
              
              
              19,634Operating
      ExpensesInterest
      expense
              
              
              152
              
              
              
              233Other
      expenses
              
              
              703
              
              
              
              448Total
      operating expenses
              
              
              855
              
              
              
              681Income
      before income tax expense and increase in equity in
      undistributedearnings
      of subsidiary
              
              
              6,488
              
              
              
              18,953Income
      tax benefit
              
              
              289
              
              
              
              220Income
      before increase in equity in undistributed earnings of
      subdisiary
              
              
              6,777
              
              
              
              19,173Decrease
      in equity in undistributed earnings of subsidiary
              
              
              (1,029
              )
              
              
              (15,222
              )Net
      Income
              
              $
              5,748
              
              
              $
              3,951


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First
      Guaranty Bancshares, Inc.Condensed
      Statement of Cash FlowYears
      ended December 31,2008
              
              
              2007(in
      thousands)Cash
      Flows From Operating ActivitiesNet
      income
              
              $
              5,748
              
              
              $
              3,951Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Provision
      for deferred income taxes
              
              
              (16
              )
              
              
              -Decrease
      in equity in undistributed earnings of subsidiary
              
              
              1,029
              
              
              
              15,222Net
      change in other liabilities
              
              
              65
              
              
              
              (17
              )Net
      change in other assets
              
              
              (132
              )
              
              
              (49
              )Net
      Cash Provided By Operating Activities
              
              
              6,694
              
              
              
              19,107Cash
      Flows From Investing ActivitiesPayments
      for investments in and advances to subsidiary
              
              
              -
              
              
              
              (5,489
              )Cash
      paid in excess of cash received in acquisition
              
              
              -
              
              
              
              (11,790
              )Net
      Cash Used in Investing Activities
              
              
              -
              
              
              
              (17,279
              )Cash
      Flows From Financing ActivitiesProceeds
      from purchased funds and other short-term borrowings
              
              
              -
              
              
              
              17,640Repayments
      of purchased funds and other short-term borrowings
              
              
              -
              
              
              
              (17,640
              )Repayment
      of long-term debt
              
              
              (3,093
              )
              
              
              -Dividends
      paid
              
              
              (3,557
              )
              
              
              (1,779
              )Net
      Cash Used In Financing Activities
              
              
              (6,650
              )
              
              
              (1,779
              )Net
      Increase In Cash and Cash Equivalents
              
              
              44
              
              
              
              49Cash
      and Cash Equivalents at the Beginning of the Period
              
              
              49
              
              
              
              -Cash
      and Cash Equivalents at the End of the Period
              
              $
              93
              
              
              $
              49


Item 9 -Changes in and
Disagreements with Accountants on Accounting and Financial
Disclosure


There were no
changes in or disagreements with accountants on accounting and financial
disclosures for the year ended December 31, 2008.




Item
9a(T) - Controls and Procedures


Evaluation
of Disclosure Controls and Procedures


As defined by
the Securities and Exchange Commission in Exchange Act Rules 13a-14(c) and
15d-14(c), a company’s “disclosure controls and procedures” means controls and
other procedures of an issuer that are designed to ensure that information
required to be disclosed by the issuer in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within
time periods specified in the Commission’s rules and forms. The Company
maintains such controls designed to ensure this material information is
communicated to Management, including the Chief Executive officer (“CEO”) and
Chief Financial Officer (“CFO”), as appropriate, to allow timely decision
regarding required disclosure.


Management,
with the participation of the CEO and CFO, have evaluated the effectiveness of
our disclosure controls and procedures as of the end of the period covered by
this annual report on Form 10-K. Based on that evaluation, the CEO and CFO have
concluded that the disclosure controls and procedures as of the end of the
period covered by this annual report are effective. There were no changes in the
Company’s internal control over financial reporting during the last fiscal
quarter in the period covered by this annual report that have materially
affected, or are reasonably likely to materially affect, the Company’s internal
control over financial reporting.


This annual
report does not include an attestation report of the Company’s registered public
accounting firm regarding internal controls over financial reporting.
Management’s report was not subject to attestation by the Company’s registered
public accounting firm pursuant to temporary rules of the Securities and
Exchange Commission that permit the Company to provide only Management’s report
in this annual report.





Management’s
Annual Report on Internal Control over Financial Reporting


The
Management of First Guaranty Bancshares, Inc. has prepared the consolidated
financial statements and other information in our Annual Report in accordance
with accounting principles generally accepted in the United States of America
and is responsible for its accuracy. The financial statements necessarily
include amounts that are based on Management’s best estimates and judgments. In
meeting its responsibility, Management relies on internal accounting and related
control systems. The internal control systems are designed to ensure that
transactions are properly authorized and recorded in our financial records and
to safeguard our assets from material loss or misuse. Such assurance cannot be
absolute because of inherent limitations in any internal control
system.


Management
is responsible for establishing and maintaining the adequate internal control
over financial reporting, as such term is defined in the Exchange Act Rules 13 –
15(f). Under the supervision and with the participation of Management, including
our principal executive officers and principal financial officer, we conducted
an evaluation of the effectiveness of internal control over financial reporting
based on the framework in Internal Control – Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. This section relates to Management’s evaluation of internal
control over financial reporting including controls over the preparation of the
schedules equivalent to the basic financial statements and compliance with laws
and regulations. Our evaluation included a review of the documentation of
controls, evaluations of the design of the internal control system and tests of
the effectiveness of internal controls.


Based
on our evaluation under the framework in Internal Control – Integrated
Framework, Management concluded that internal control over financial
reporting was effective as of December 31, 2008.





Item
9b - Other Information


None




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Part
III





Item 10-Directors, Executive Officers and Corporate
Governance


Pursuant to
General Instruction G (3), information on directors and executive officers of
the Registrant will be incorporated by reference from the Company’s 2009
Definitive Proxy Statement.





Item
11 -Executive
Compensation


Pursuant to
General Instruction G (3), information on directors and executive officers of
the Registrant will be incorporated by reference from the Company’s 2009
Definitive Proxy Statement.





Item
12 -Security
Ownership of Certain Beneficial Owners, Management and Related Stockholder
Matters


Pursuant to
General Instruction G (3), information on directors and executive officers of
the Registrant will be incorporated by reference from the Company’s 2009
Definitive Proxy Statement.





Item
13 - Certain Relationships and Related Transactions and Director
Independence


Pursuant to
General Instruction G (3), information on directors and executive officers of
the Registrant will be incorporated by reference from the Company’s 2009
Definitive Proxy Statement.





Item
14 -Principal
Accountant Fees and Services


Pursuant to
General Instruction G (3), information on directors and executive officers of
the Registrant will be incorporated by reference from the Company’s 2009
Definitive Proxy Statement.





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Part
IV




Item 15 - Exhibits and Financial
Statement Schedules   (a)
              1
              Consolidated Financial
      StatementsItem
              PageFirst
      Guaranty Bancshares, Inc. and SubsidiaryReport
      of Independent Registered Accounting Firm
              45Consolidated
      Balance Sheets - December 31, 2008 and 2007
              46Consolidated
      Statements of Income – Years Ended December 31, 2008, 2007 and
      2006
              47Consolidated
      Statements of Changes in Stockholders’ Equity -  December 31,
      2008, 2007 and 2006
              48Consolidated
      Statements of Cash Flows - Years Ended December 31, 2008, 2007 and
      2006
              49Notes
      to Consolidated Financial Statements
              502
              Consolidated Financial Statement
      SchedulesAll
      schedules to the consolidated financial statements of First Guaranty
      Bancshares, Inc. and its subsidiary have been omitted because they are not
      required under the related instructions or are inapplicable, or because
      the required information has been provided in the consolidated financial
      statements or the notes thereto.3
              ExhibitsThe
      exhibits required by Regulation S-K are set forth in the following
      list and are filed either by incorporation by reference from previous
      filings with the Securities and Exchange Commission or by attachment to
      this Annual Report on Form 10-K as indicated below.Exhibit Number
              
              Exhibit2
              
              Agreement
      and Plan of Reorganization between First Guaranty Bancshares, Inc. and
      First Community Holding Company dated November 2, 2007 (filed as Exhibit
      2.1 on the Company’s Form 8-K dated November 8, 2007 and incorporated
      herein by reference).2.1
              
              Agreement
      and Plan of Exchange dated July 27, 2007 between First Guaranty
      Bancshares, Inc. and First Guaranty Bank (filed as Exhibit 2 on Form
      8-K12G3 dated August 2, 2007 and incorporated herein by
      reference).2.2
              
              Amendment
      Number 1 to the Agreement and Plan of Reorganization between First
      Guaranty Bancshares, Inc. and First Community Holding Company dated
      November 2, 2007 (filed as Exhibit 2.1 on the Company’s Form 8-K dated
      April 7, 2008 and incorporated herein by reference).2.3
              
              Amendment
      Number 2 to the Agreement and Plan of Reorganization between First
      Guaranty Bancshares, Inc. and First Community Holding Company dated
      November 2, 2007 (filed as Exhibit 2.1 on the Company’s Form 8-K dated
      June 3, 2008 and incorporated herein by reference).2.4
              
              Amendment
      Number 3 to the Agreement and Plan of Reorganization between First
      Guaranty Bancshares, Inc. and First Community Holding Company dated
      November 2, 2007 (filed as Exhibit 2.1 on the Company’s Form 8-K dated
      June 13, 2008 and incorporated herein by reference).2.5
              
              Amendment
      Number 4 to the Agreement and Plan of Reorganization between First
      Guaranty Bancshares, Inc. and First Community Holding Company dated
      November 2, 2007 (filed as Exhibit 2.1 on the Company’s Form 8-K dated
      June 30, 2008 and incorporated herein by reference).2.6
              
              Termination
      of the Agreement and Plan of Reorganization between First
      Guaranty
                Bancshares,
      Inc. and First Community Holding Company dated November 2,
      2007
                (filed
      as Exhibit 1.02 on the Company’s Form 8-K dated July 22, 2008 and
      incorporated
                herein
      by reference).3.1
              
              Restatement
      of Articles of Incorporation of First Guaranty Bancshares, Inc. dated July
      27, 2007 (filed as Exhibit 3.1 on Form 8-K12G3 dated August 2, 2007 and
      incorporated herein by reference).


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3.2
              
              Bylaws
      of First Guaranty Bancshares, Inc. dated January 4, 2007 (filed as Exhibit
      3.2 on Form 8-K12G3 dated August 2, 2007 and incorporated herein by
      reference).3.3
              
              Amendment
      to Bylaws of First Guaranty Bancshares, Inc. dated May 17, 2007 (filed as
      Exhibit 3.3 on Form 8-K12G3 dated August 2, 2007 and incorporated herein
      by reference).4
              
              Specimen
      stock certificate for common stock of First Guaranty Bancshares, Inc.
      (filed as Exhibit 3.3 on Form 8-K12G3 dated August 2, 2007 and
      incorporated herein by reference).10.1
              
              First
      Guaranty Bank Employee Stock Ownership Plan (effective January 1, 2003)
      (filed as Exhibit 10.1 on Form 8-K12G3 dated August 2, 2007 and
      incorporated herein by reference).10.2
              
              Amendment
      Number One to the First Guaranty Bank Employee Stock Ownership Plan
      (effective January 1, 2003) (filed as Exhibit 10.2 on Form 8-K12G3 dated
      August 2, 2007 and incorporated herein by reference).10.3
              
              Amendment
      Number Two to the First Guaranty Bank Employee Stock Ownership Plan
      (effective January 1, 2003) (filed as Exhibit 10.3 on Form 8-K12G3 dated
      August 2, 2007 and incorporated herein by reference).10.4
              
              Amendment
      Number Three to the First Guaranty Bank Employee Stock Ownership Plan
      (effective January 1, 2003) (filed as Exhibit 10.3 on Form 8-K12G3 dated
      August 2, 2007 and incorporated herein by reference).10.5
              
              Employment
      Agreement and Ancillary Confidentiality and Non-Competition Agreement by
      and between Reggie H. Harper and First Guaranty Bank, and Employment
      Agreement and Ancillary Confidentiality and Non-Competition Agreement by
      and between Cordell H. White and First Guaranty Bank dated November 2,
      2007 (filed as Exhibit 10.1 on the Company’s Form 8-K dated November 8,
      2007 and incorporated herein by reference).11
              
              Statement
      Regarding Computation of Earnings Per Share
              7712
              
              Statement
      Regarding Computation of Ratios
              7814.1
              
              First
      Guaranty Bancshares, Inc. and Subsidiary Code of Conduct and Ethics for
      Employees, Officers and Directors dated January 25, 2008 (filed as Exhibit
      14.1 on the Company’s Form 8-K dated January 31, 2008 and incorporated
      herein by reference).14.2
              
              First
      Guaranty Bancshares, Inc. Code of Ethics for Senior Financial Officers
      dated January 25, 2008 (filed as Exhibit 14.2 on the Company’s Form 8-K
      dated January 31, 2008 and incorporated herein by
    reference).14.3
              
              First
      Guaranty Bancshares, Inc. and Subsidiary Code of Conduct and Ethics for
      Employees, Officers and Directors adopted March 20, 2009.14.4
              
              First
      Guaranty Bancshares, Inc. Code of Ethics for Senior Financial Officers
      adopted March 20, 2009.21
              
              Subsidiaries
      of the First Guaranty Bancshares, Inc. (filed as Exhibit 21 on the
      Company’s Form 8-K dated November 8, 2007 and incorporated herein by
      reference).24
              
              Power
      of attorney31.1
              
              Certification
      of principal executive officer pursuant to Exchange Act Rule 13a-14(a) or
      15d-14(a), pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.
              7931.2
              
              Certification
      of principal financial officer pursuant to Exchange Act Rule 13a-14(a) or
      15d-14(a), pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.
              8032.1
              
              Certification
      of principal executive officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
              8132.2
              
              Certification
      of principal financial officer pursuant to 18 U.S.C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002.
              8299
              
              Material
      impairments – Other-than-temporary impairment charge as of September 30,
      2008 (filed as Exhibit 2.06 on the Company’s Form 8-K dated October 20,
      2008 and incorporated herein by reference).
  - 71
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SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Bank has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.





FIRST
GUARANTY BANCSHARES, INC.





Dated:
March 31, 2009








Pursuant
to the requirements of the Securities and Exchange Act of 1934, this report has
been signed below by the following persons on behalf of the Company and in the
capacities and on the dates indicated.








/s/Michael R.
      Sharp
              Michael
      R. Sharp
            President
      and
              Chief
      Executive Officer
            March
      31, 2009/s/Michele E.
      LoBianco
              Michele
      E. LoBianco
            Chief
      Financial Officer,
              Secretary
      and Treasurer
              (Principal
      Financial and Accounting Officer)
            March
      31, 2009*____________________________
              Marshall
      T. Reynolds
            Chairman
      of the Board
            March
      31, 2009*____________________________
              William
      K. Hood
            Director
            March
      31, 2009*____________________________
              Alton
      B. Lewis
            Director
            March
      31, 2009






/s/ Michael R. Sharp







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