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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-K





(Mark One)

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



| | For the fiscal year ended December 31, 2008
| | -------------------------------------------



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



| | For the transition period from  to
| | ----------------------------------

Commission File No. 001-15571





APPALACHIAN BANCSHARES, INC.

(Exact
name of registrant as specified in its charter)







|                                          |  |                                        
|----------------------------------------- |  | ---------------------------------------
|Georgia                                   |  | 58-2242407                             
|(State of Incorporation)                  |  | (I.R.S. Employer Identification Number)
|                                          | 
|822 Industrial Boulevard Ellijay, Georgia |  | 30540                                  
|(Address of Principal Executive Offices)  |  | (Zip Code)                             

(706) 276-8000

(Registrants telephone number, including area code)

Securities registered under
Section 12(b) of the Act:



|                              |  |                                          
|----------------------------- |  | -----------------------------------------
|Title of Each Class           |  | Name of each exchange on which registered
|Common Stock, $0.01 par value |  | The NASDAQ Stock Market LLC              

Securities registered under Section 12(g) of the Exchange Act:

None

(Title of class)





Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes   ̈    No  x

Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes   ̈    No  x

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  x    No   ̈

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K 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.    Yes   ̈    No  x

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 the definitions of large accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes   ̈    No  x

The aggregate market value of the voting common stock held by non-affiliates of the registrant (computed by reference to the closing sales price as reported on the NASDAQ Global Market System) was $68.2 million as of the last business day
of the registrants most recently completed second fiscal quarter. For the purpose of this response, officers, directors and holders of 5% or more of the registrants common stock are considered to be affiliates of the registrant at that
date.

There were 5,475,701 shares of the registrants common stock outstanding as of March 19, 2009.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the
registrants definitive proxy statement to be delivered to shareholders in connection with the registrants 2008 Annual Meeting of Shareholders are incorporated by reference in response to Part III of this report.









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APPALACHIAN BANCSHARES, INC.

2008 Form 10-K Annual Report

TABLE OF CONTENTS



|                         |  |                                                                                                                  |  |                
|------------------------ |  | ---------------------------------------------------------------------------------------------------------------- |  | ---------------
|Item Number In Form 10-K |  | Description                                                                                                      |  | Page orLocation
|                         |  |                                                                                                                 
|Part I                   |  |                                                                                                                  |  |                
|                         |  |                                                                                                                 
|Item 1.                  |  | Business                                                                                                         |  | 1              
|                         |  |                                                                                                                 
|Item 1A.                 |  | Risk Factors                                                                                                     |  | 16             
|                         |  |                                                                                                                 
|Item 1B.                 |  | Unresolved Staff Comments                                                                                        |  | 25             
|                         |  |                                                                                                                 
|Item 2.                  |  | Properties                                                                                                       |  | 26             
|                         |  |                                                                                                                 
|Item 3.                  |  | Legal Proceedings                                                                                                |  | 26             
|                         |  |                                                                                                                 
|Item 4.                  |  | Submission of Matters to a Vote of Security Holders                                                              |  | 26             
|                         |  |                                                                                                                 
|PART II                  |  |                                                                                                                  |  |                
|                         |  |                                                                                                                 
|Item 5.                  |  | Market for the Registrants Common Equity, Related Stockholder Matters and issuer purchases of equity securities |  | 27             
|                         |  |                                                                                                                 
|Item 6.                  |  | Selected Financial Data                                                                                          |  | 29             
|                         |  |                                                                                                                 
|Item 7.                  |  | Managements Discussion and Analysis of Financial Condition and Results of Operation                             |  | 31             
|                         |  |                                                                                                                 
|Item 7A.                 |  | Quantitative and Qualitative Disclosures About Market Risk                                                       |  | 53             
|                         |  |                                                                                                                 
|Item 8.                  |  | Financial Statements and Supplementary Data                                                                      |  | 53             
|                         |  |                                                                                                                 
|Item 9.                  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             |  | 54             
|                         |  |                                                                                                                 
|Item 9A(T).              |  | Controls and Procedures                                                                                          |  | 54             
|                         |  |                                                                                                                 
|Item 9B.                 |  | Other Information                                                                                                |  | 54             
|                         |  |                                                                                                                 
|PART III                 |  |                                                                                                                  |  |                
|                         |  |                                                                                                                 
|Item 10.                 |  | Directors, Executive Officers and Corporate Governance                                                           |  | 55             
|                         |  |                                                                                                                 
|Item 11.                 |  | Executive Compensation                                                                                           |  | 55             
|                         |  |                                                                                                                 
|Item 12.                 |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                   |  | 55             
|                         |  |                                                                                                                 
|Item 13.                 |  | Certain Relationships and Related Transactions, and Director Independence                                        |  | 55             
|                         |  |                                                                                                                 
|Item 14.                 |  | Principal Accountant Fees and Services                                                                           |  | 55             
|                         |  |                                                                                                                 
|PART IV                  |  |                                                                                                                  |  |                
|                         |  |                                                                                                                 
|Item 15.                 |  | Exhibits and Financial Statement Schedules                                                                       |  | 56             
|                         | 
|Signatures               |  | 60                                                                                                              



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PART I



|ITEM 1. | BUSINESS
|------- | --------

This Report contains
forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, such as statements relating to future plans and expectations, and are thus prospective. These statements are based on many assumptions
and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which
are beyond our control. The words may, would, could, will, expect, anticipate, believe, intend, plan, and estimate, as well as
similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties include, but are not limited to, those described below under Item 1A, entitled Risk Factors.

General Overview

We are a Georgia corporation
organized in 1996 to serve as the bank holding company for Appalachian Community Bank (formerly Gilmer County Bank), a state-chartered bank located in the foothills of the Blue Ridge Mountains in North Georgia. We are headquartered in Ellijay,
Georgia. As of April 2007, we also serve as the bank holding company for Appalachian Community Bank, F.S.B., a federally-chartered thrift headquartered in McCaysville, Georgia with offices in Murphy, North Carolina and Ducktown, Tennessee. We also
serve as the bank holding company for Appalachian Real Estate Holdings, Inc., which was formed in June 2008 to hold certain real estate that may be acquired by the Bank and the Thrift through foreclosure.

In 1995, Gilmer County Bank opened its first branch office in Ellijay, Georgia. In November 1998, we acquired a bank with one location in Blairsville,
Georgia, and changed its name to Appalachian Community Bank to reflect our strategy to build a community bank franchise in our geographic market area. In May 2000, we opened a branch office in East Ellijay, Georgia, and in August 2001, we opened a
loan production office in Blue Ridge, Georgia, which we converted to a full-service branch in February 2002. In August 2001, we merged Appalachian Community Bank into Gilmer County Bank, although we continue to operate our branches in Ellijay and
East Ellijay under the trade name Gilmer County Bank. During 2006, we opened full-service branches in Chatsworth, McCaysville, Dawsonville, Georgia, a second branch in East Ellijay, Georgia, as well as loan production offices in Murphy,
North Carolina and Ducktown, Tennessee. We received our final regulatory approval to form and open a federally-chartered thrift subsidiary on February 16, 2007, which opened and began operating, under the name Appalachian Community Bank,
F.S.B., on April 23, 2007. The thrift acquired, as its headquarters, our branch in McCaysville, Georgia and we converted our loan production offices in Murphy, North Carolina, and Ducktown, Tennessee, into full-service branches of the thrift.
In 2007, we opened a second bank branch in Dawsonville, Georgia, as well as bank branches in Dahlonega and Dalton, Georgia.

We provide a
full range of retail and commercial banking products and services to individuals and small- to medium- sized businesses through our community banking relationship model. Such products and services include the receipt of demand and time deposit
accounts, the extension of personal and commercial loans and the furnishing of personal and commercial checking accounts. As of December 31, 2008, we had total assets of approximately $1.2 billion, total loans of approximately $885.4 million,
total deposits of approximately $1.0 billion and total shareholders equity of approximately $72.4 million. Our website is located at www.apab.com.

Recent Development

As a result of the recently completed examination by the Federal Deposit Insurance Corporation
(FDIC), the Board of Directors and management anticipate that the FDIC and the Georgia Department of Banking and Finance (collectively with the FDIC, the Agencies) will place the Bank under an administrative action which will contain
certain operational and financial restrictions. We are currently in the process of reviewing and negotiating the proposed order of the FDIC and expect that this administrative action will require us, among other things, to assess and potentially
modify our management structure, reduce and improve our level of classified assets over designated periods of time, perform internal loan reviews on a more frequent basis, maintain an appropriate allowance for loan and lease losses, implement a
commercial real estate lending policy, restrict the use of brokered deposits, maintain a Tier 1 capital ratio equal to or greater than 8% of total assets and a total risk-based capital ratio equal to or greater than 10% of total assets, and to
review and, where appropriate, revise various Bank policies on



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matters such as liquidity and funds management, earnings improvement, lending and collection, loan review and underwriting. As with other similarly situated
banks, we anticipate that the Bank will be restricted from paying any dividends without the prior written consent of the Agencies. The issuance of such action will also result in the Bank not being considered well-capitalized and
therefore result in higher FDIC insurance assessments in 2009 and for at least the term of the action.

We further anticipate that the Bank
will be required to send periodic written progress reports to the Agencies to show its progress in complying with the restrictions so imposed. These restrictions will remain in place until terminated by the Agencies.

In conjunction with any administrative action placed on the Bank, we anticipate that the Federal Reserve System would impose an administrative action on
the Holding Company. We expect that the restrictions imposed by the Federal Reserve would (among other matters): limit the activities of the Holding Company by restricting dividend payments to shareholders without the prior approval of the Federal
Reserve Bank and the prior approval of the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve; prohibit any redemption of shares without prior approval of the Reserve Bank; prohibit the
appointment of new officers or directors of the Holding Company without prior Reserve Bank approval; and will require the Holding Company to provide quarterly progress reports to the Reserve Bank. These restrictions and requirements would remain in
place until terminated by the Federal Reserve.

In anticipation of such actions discussed above, the Company has hired a consulting firm to
assist them with raising additional capital in order to meet requirements for additional capital.

Our Market Area

Our market area is located approximately 80 miles north of Atlanta and is primarily comprised of Gilmer, Fannin, Union, Murray, Dawson, Lumpkin and
Whitfield Counties in Georgia, as well as Cherokee County North Carolina and Polk County Tennessee. Our market area includes both North Georgia and the Tri-State Area, the latter consisting of the contiguous three-county area
(Fannin, Polk and Cherokee Counties) where Georgia, Tennessee and North Carolina come together. Our market area provides a number of outdoor recreational activities, including hiking, canoeing, fishing, swimming, rafting, hunting and mountain
biking. We believe that the natural resources of our market area and its proximity to metropolitan Atlanta are two of the main reasons that our market area has experienced significant population growth in the past. In particular, our market
areas abundant outdoor and recreational activities have historically made it a popular area for second-home buyers and retirees. The current economic downturn, however, has greatly affected the growth in our area as well as this second-home
market. However, due to our location and natural resources, we believe that when the economy strengthens, our growth and this market will improve.

Operating and Growth Strategy

Our strategy is to build a community bank franchise servicing real estate developers, small
business owners and primary and second home buyers in our market area and surrounding communities. We believe we can execute this strategy and grow our business by building personal relationships with our customers, emphasizing superior customer
service and communicating a consistent set of operating principles to our employees.

Lending Activities

General. We offer a variety of loans, including real estate, construction, commercial and consumer loans to individuals and small to mid-size
businesses that are located or conduct a substantial portion of their business in our market area. Although we offer a variety of types of loans, we emphasize the use of real estate as collateral and our underwriting standards vary for each type of
loan, as described below. As of December 31, 2008, 87.6% of the loans in our loan portfolio were secured by real estate. At December 31, 2008, we had total loans of $885.4 million, representing 74.7% of our total assets. Historically, we
have focused our lending activities primarily to small business owners and residential real estate developers. However, due to the current downturn in real estate development and values, our current focus is to develop our commercial and industrial
loans as well as consumer type loans. At December 31, 2008, loans to the construction and development industry amounted to $389.3 million,



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or approximately 44.0% of our total loan portfolio, loans to the poultry industry amounted to $19.7 million, or approximately 2.2% of our total loan
portfolio and loans to the hospitality (hotel/motel) industry amounted to $8.0 million, or approximately 0.9% of our total loan portfolio.

Our underwriting standards vary for each type of loan. In underwriting all of our real estate related loans, we seek to minimize our risks by giving careful consideration to the propertys operating history, future operating
projections, current and projected occupancy, location and physical condition. Our underwriting analysis also includes credit checks, reviews of appraisals and environmental hazards and a review of the financial condition of the borrower. We attempt
to limit our risk by analyzing our borrowers cash flow and collateral value on a regular basis. After a loan is approved, our credit administration group focuses on the loan portfolio, including regularly monitoring the quality of the loan
portfolio. Further, we also engage outside firms to evaluate our loan portfolio on a quarterly basis for credit quality and compliance issues.

In addition, we engage in secondary-market mortgage activities by obtaining commitments from secondary mortgage purchasers for loans originated by our bank and thrift. Based on these commitments, we originate mortgage loans on comparable
terms and generate fee income and commissions to supplement our non-interest income.

Real Estate Loans. Loans secured by real
estate are the primary component of our loan portfolio. To increase the likelihood of the ultimate repayment of the loan, we obtain a security interest in the real estate whenever possible, in addition to the other available collateral. At
December 31, 2008, loans primarily secured by real estate amounted to $775.6 million, or 87.6%, of our total loan portfolio.

These
loans consist primarily of construction and development loans, commercial real estate loans and residential real estate loans. Interest rates for all categories may be fixed or adjustable. We generally charge an origination fee for each loan and may
collect renewal and late charge fees. Real estate loans are subject to the same general risks as other loans and are particularly sensitive to fluctuations in the value of real estate. Fluctuations in the value of real estate, as well as other
factors arising after a loan has been made, could negatively affect a borrowers cash flow, creditworthiness and ability to repay the loan.



| |  |  | Construction and Development Real Estate Loans.We offer adjustable and fixed rate real estate residential and commercial loans to builders and developers
for both construction and development and to consumers wishing to build their own homes. The duration of our construction and development loans is typically 12 months, although payments may be structured to amortize longer. Construction and
development loans generally carry a higher degree of risk than long-term financing of existing properties because repayment depends on the ultimate completion of the project and usually on the sale of the property. Specific risks include:
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | cost overruns;
| | - |  | --------------



| |  |  | mismanaged construction;
| | - |  | ------------------------



| |  |  | inferior or improper construction techniques;
| | - |  | ---------------------------------------------



| |  |  | economic changes or downturns during construction;
| | - |  | --------------------------------------------------



| |  |  | a downturn in the real estate market;
| | - |  | -------------------------------------



| |  |  | rising interest rates which may prevent sale of the property; and
| | - |  | -----------------------------------------------------------------



| |  |  | failure to sell completed projects in a timely manner.
| | - |  | ------------------------------------------------------

We attempt to reduce the risk associated with construction and development loans by obtaining personal guarantees where possible and by keeping the loan-to-value ratio of the completed project at or below 80%. At
December 31, 2008, total construction and development loans amounted to $389.3 million, or 44.0% of our loan portfolio. Residential construction and development loans totaled $328.5 million, or 37.1% of our loan portfolio, and commercial
construction loans represented $60.9 million,



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or 6.9% of our loan portfolio.



| |  |  | Commercial Real Estate Loans. Our commercial real estate loans generally have terms of five years or less, although payments can be structured to amortize
longer. We evaluate each borrower on an individual basis and attempt to determine the business risks and credit profile of each borrower. We attempt to reduce credit risk in the commercial real estate portfolio by emphasizing loans on owner-occupied
properties where the loan-to-value ratio, established by independent appraisals, does not exceed 80%. We also generally require that a borrowers cash flow exceeds 110% of monthly debt service obligations. In order to ensure secondary sources
of payment and liquidity, we typically review all of the personal financial statements of the principal owners and require their personal guarantees. These commercial real estate loans include various types of business purpose loans secured by
farmland and nonresidential commercial real estate. At December 31, 2008, commercial real estate loans (other than commercial construction loans) amounted to $173.6 million, or approximately 19.6% of our loan portfolio.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Residential Real Estate Loans. At December 31, 2008, our residential real estate loans consisted primarily of loans secured by one- to- four family
residences and multi-family (five or more) residences. These loans are generally secured by residential real estate. We also offer, through our mortgage banking department, fixed and adjustable-rate residential real estate loans which we sell under
fixed price commitments to third party lenders rather than originating and retaining these loans ourselves. We will not close these residential real estate loans without a fixed price commitment to sell from a correspondent lender, and we do not
service these loans. At December 31, 2008, total residential real estate loans amounted to $212.7 million, or 24.0% of our loan portfolio. Loans secured by one-to-four family residences totaled $199.8 million, or 22.6% of our loan portfolio,
and loans secured by multi-family residences totaled $12.9 million, or 1.5% of our loan portfolio.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Commercial
Business Loans. We make loans for commercial purposes to various lines of businesses. Commercial loans are generally considered to have greater risk than first or second mortgages on real estate because commercial loans may be unsecured or, if
they are secured, the value of the collateral may be difficult to assess and more likely to decrease than real estate. At December 31, 2008, commercial business loans amounted to $72.5 million, or 8.2% of our total loan portfolio, excluding for
these purposes commercial loans secured by real estate which are included in the real estate category above.

Consumer Loans. We
make a variety of loans to individuals for personal and household purposes, including secured and unsecured installment and term loans, home equity loans and lines of credit and revolving lines of credit such as credit cards. Consumer loans are
underwritten based on the individual borrowers income, current debt level, past credit history and value of any available collateral. Consumer loan rates are both fixed and variable, with negotiable terms. Our installment loans typically
amortize over periods up to 60 months. We will offer consumer loans with a single maturity date when a specific source of repayment is available. We typically require monthly payments of interest and a portion of the principal on our revolving loan
products. Consumer loans are generally considered to have greater risk than first or second mortgages on real estate because they may be unsecured or, if they are secured, the value of the collateral may be difficult to assess and more likely to
decrease in value than real estate. At December 31, 2008, consumer loans amounted to $28.6 million, or 3.2% of our loan portfolio.

Loan Approval. Certain credit risks are inherent in making loans. These include prepayment risks, risks resulting from uncertainties in the future value of collateral, risks resulting from changes in economic and industry conditions
and risks inherent in dealing with individual borrowers. We attempt to mitigate these risks by adhering to internal credit policies and procedures. Our policies and procedures include officer and client lending limits, a multi-layered approval
process for larger loans, documentation examination and follow-up procedures for any exceptions to credit policies. Our loan approval policies provide for various levels of officer lending authority. We have an officers loan committee and a
board of directors loan committee for each of the bank and the thrift. When the amount of aggregate loans to a single borrower exceeds an individual officers lending authority, and is below $500,000, the loan request will be considered
by senior lending officers of the bank or thrift. The members of our officers loan committee can approve loans up to $1.0 million. If total aggregate loans to a single borrower exceed $1.0 million, then the board of directors loan
committee may approve the loan. On a monthly basis, any actions of



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the respective board of directors loan committee are further ratified by the bank or thrifts entire board of directors. We do not make any loans
to directors or executive officers of the bank or the thrift unless the loan is approved by the board of directors of the bank or the thrift and is on terms not more favorable to such person than would be available to a person not affiliated with
the bank or thrift.

Credit Administration and Loan Review. We maintain a continuous loan review system and use an independent
consultant to review the loan files on a quarterly basis. Each loan officer is responsible for rating each loan he or she makes and for reviewing those loans on a periodic basis. Our credit underwriting and credit administration groups assist us in
strengthening our credit review processes and establishing performance benchmarks in the areas of nonperforming assets, charge-offs, past dues and loan documentation. Our credit administration meets weekly with all loan officers to review the status
of all past due loans, nonperforming loans and any relationships placed on our internal watch list. We have recently set up a special assets committee to address issues with classified credits when all account officer collection efforts have been
exhausted.

Lending Limits. Our lending activities are subject to a variety of lending limits imposed by state and
federal law. In general, the bank and the thrift are subject to a legal limit on loans to a single borrower equal to 15% of the banks or thrifts capital and unimpaired surplus for unsecured loans and 25% of the banks or
thrifts capital and unimpaired surplus for fully secured loans. This limit will increase or decrease as the banks or thrifts capital increases or decreases. Based on the capitalization of the bank at December 31, 2008, the
banks legal lending limits were approximately $18.0 million for secured loans and $10.8 million for unsecured loans. Based on the capitalization of the thrift at December 31, 2008, the thrifts legal lending limits were approximately
$2.1 million for fully secured loans and $1.2 million for unsecured loans. We sell participations in our larger loans to other financial institutions, which allows us to manage the risk involved in these loans and to meet the lending needs of our
customers requiring extensions of credit in excess of this limit. At December 31, 2008, we had participations sold totaling $68.4 million.

Deposit Services

Our principal source of funding is core deposits, supplemented by brokered deposits, Federal Home Loan
Bank (FHLB) advances, federal funds purchased, other borrowings and securities sold under agreements to repurchase. We offer a full range of deposit services, including checking accounts, commercial accounts, savings accounts and other
time deposits of various types, ranging from daily money market accounts to long-term certificates of deposit. All deposit accounts are insured by the FDIC up to the maximum amount allowed by law.

Other Products and Services

We provide a full range
of additional retail and commercial banking products and services, including checking, savings and money market accounts; certificates of deposit; internet banking and bill payment; credit cards; safe-deposit boxes; money orders; cashiers
checks; electronic funds transfer services; travelers checks and automatic teller machine access. We are also a member of the STAR ATM network, which permits our customers to perform certain banking transactions, both within and outside of our
market area. We currently do not offer trust or fiduciary services.

We are committed to modifying existing, or developing new, products
and services that are responsive to the banking demands of our customers. For example, in 2006 we began offering an internet-based cash management system for small businesses, as well as an enhancement to personal checking accounts that improves the
overdraft process. In 2007, we added remote deposit capture as an added convenience to our large commercial deposit customers. In the future we intend to upgrade and expand our services to ensure that we remain competitive in our product offerings.

Competition

The banking business is
highly competitive, and we experience competition in our market from many other financial institutions. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit
and service charges relating to loans, the quality and scope of the services offered, the convenience of banking facilities and, in the case of loans to commercial borrowers, relative



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lending limits. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies,
securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices within our market area and beyond.

Following is a summary of banks and thrifts in our market areas as of June 30, 2008, the most recent date for deposit data compiled by the Federal
Deposit Insurance Corporation (FDIC):



|                                |  |                                                    |  |                                                      
|------------------------------- |  | -------------------------------------------------- |  | -----------------------------------------------------
|County                          |  | Number of Locally Owned Banks/Thrifts with Offices |  | Number of Non-locally Owned Banks/Thrifts withOffices
|Gilmer County, Georgia          |  | Three                                              |  | Three                                                
|Union County, Georgia           |  | One                                                |  | Three                                                
|Fannin County, Georgia          |  | One                                                |  | Six                                                  
|Murray County, Georgia          |  | One                                                |  | Four                                                 
|Dawson County, Georgia          |  | Three                                              |  | Four                                                 
|Lumpkin County, Georgia         |  | None                                               |  | Six                                                  
|Whitfield County, Georgia       |  | Two                                                |  | Thirteen                                             
|Cherokee County, North Carolina |  | One                                                |  | Six                                                  
|Polk County, Tennessee          |  | Two                                                |  | Three                                                

Many of our competitors, such as Regions Bank, BB&T and United Community Bank, are
well-established, larger financial institutions which have substantially greater resources and lending limits. These institutions offer some services, such as extensive and established branch networks and trust services that we do not provide. We
also compete with small banks and thrifts in our markets. In addition, many of our non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally insured banks and thrifts.

Market Share

As of June 30, 2008, according
to the most recent data compiled by the FDIC, our North Georgia market area (Gilmer, Fannin, Union, Murray, Dawson, Lumpkin and Whitfield Counties) had total deposits of approximately $5.7 billion, which represented a 4.2% deposit
increase from 2007. As of June 30, 2008, we had over 56% market share in Gilmer County, a 21% share in Murray County, a 17% share in Fannin County, a 7% share in Union County, an 8% share in Dawson County, a 4% share in Lumpkin County and a 1%
share in Whitfield County. In Polk County, Tennessee, as of June 30, 2008, total deposits amounted to approximately $183.5 million, of which we had $5.1 million, or 3%. In Cherokee County, North Carolina, as of June 30, 2008, total
deposits were $489.4 million of which we had $11.9 million or a 2% share of these deposits.

Employees

As of December 31, 2008, we had 288 full-time equivalent employees.

Monetary Policies

The operations of the bank are significantly affected by the credit policies of
monetary authorities, particularly the Board of Governors of the Federal Reserve System (the Federal Reserve). The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government
securities, changes in discount rates on member bank borrowings, and changes in reserve requirements against bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of action by monetary
and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and earnings of our banking subsidiaries.



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SUPERVISION AND REGULATION

Our business is subject to extensive state and federal banking laws and regulations that impose restrictions on and provide general regulatory oversight
of our operations. These laws and regulations are generally intended to protect depositors and not shareholders. Legislation and regulations authorized by legislation influence, among other things:



| |  |  | how, when, and where we may expand geographically;
| | - |  | --------------------------------------------------



| |  |  | into what product or service market we may enter;
| | - |  | -------------------------------------------------



| |  |  | how we must manage our assets; and
| | - |  | ----------------------------------



| |  |  | under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.
| | - |  | ----------------------------------------------------------------------------------------------------------------

Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. The
following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative changes and the policies of various
regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.

Appalachian Bancshares, Inc.

Because the Company
owns all of the capital stock of each of Appalachian Community Bank, our bank subsidiary, Appalachian Community Bank, F.S.B., our thrift subsidiary, and Appalachian Real Estate Holdings, Inc, our other real estate subsidiary, it is a bank holding
company under the federal Bank Holding Company Act of 1956. As a result, we are primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Board of Governors of the
Federal Reserve System (the Federal Reserve Board). As a bank holding company located in Georgia, the Georgia Department of Banking and Finance (the Department) also regulates and monitors all significant aspects of our
operations.

Acquisitions of Banks.The Bank Holding Company Act requires every bank holding company to obtain the
Federal Reserve Boards prior approval before:



| |  |  | acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly
own or control more than 5% of the banks voting shares;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | acquiring all or substantially all of the assets of any bank; or
| | - |  | ----------------------------------------------------------------



| |  |  | merging or consolidating with any other bank holding company.
| | - |  | -------------------------------------------------------------

Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition, or
otherwise function as a restraint of trade, unless the anticompetitive 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 Federal Reserve Board 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. The Federal Reserve Boards consideration of
financial resources generally focuses on capital adequacy, which is discussed below.

Under the Bank Holding Company Act, if adequately
capitalized and adequately managed, the Company or any other bank holding company located in Georgia may purchase a bank located outside of Georgia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of
Georgia may purchase a bank located inside Georgia. In each case, however, restrictions may be placed 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.
Currently, Georgia law prohibits the acquisition of a bank that has been chartered for less than three years.



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Change in Bank Control.Subject to various exceptions, the Bank Holding Company Act and the
Change in Bank Control Act, together with related regulations, require Federal Reserve Board 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 also presumed to exist, although rebuttable, if a person or company acquires 10% or more, but less than 25%, of any class of voting securities
and either:



| |  |  | the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | no other person owns a greater percentage of that class of voting securities immediately after the transaction.
| | - |  | ---------------------------------------------------------------------------------------------------------------

The regulations provide a procedure for challenging the rebuttable presumption of control.

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

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary
of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least satisfactory. Additionally, the Company must file an election with the Federal Reserve Board to become a financial
holding company and must provide the Federal Reserve Board with 30 days written notice prior to engaging in a permitted financial activity. While the Company meets the qualification standards applicable to financial holding companies, we have
not elected to become a financial holding company at this time.

Support of Subsidiary Institutions.Under
Federal Reserve Board policy, we are expected to act as a source of financial strength for both the Bank and the Thrift and to commit resources to support both wholly-owned subsidiaries. This support may be required at times when, without this
Federal Reserve Board policy, we might not be inclined to provide it. In addition, any capital loans made by us to the Bank or the Thrift will be repaid only after deposits and various other obligations are repaid in full. In the event of our
bankruptcy, any commitment that we give to the respective federal banking regulator to maintain the capital of the Bank or the Thrift will be assumed by the bankruptcy trustee and entitled to a priority of payment.

Appalachian Community Bank and Appalachian Community Bank, F.S.B.

Because the Bank is a commercial bank chartered under the laws of the State of Georgia, it is primarily subject to the supervision, examination, and reporting requirements of the FDIC and the Department. The FDIC and
the Department regularly examine the Banks operations and have the authority to approve or disapprove mergers, the establishment of branches, and similar corporate actions. Both regulatory agencies also have the power to prevent the
continuance or development of unsafe or unsound banking practices or other violations of law. The Bank is also subject to numerous state and federal statutes and regulations that affect the Banks business, activities, and operations.

The Thrift, pursuant to the provisions of the Home Owners Loan Act of 1933, is subject to the supervision, examination, and
reporting requirements of the Office of Thrift Supervision (OTS). Pursuant to the provisions of the Home Owners Loan Act and the regulations of the OTS promulgated thereunder, the Thrift is required to maintain its status as a
qualified thrift lender and, additionally, to conduct its lending and investment activities within certain prescribed categories.



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To meet the OTS requirements as a qualified thrift lender, a thrift institution is required
to either qualify as a domestic building and loan association under the Internal Revenue Code or maintain at least 65% of its portfolio assets (total assets less: (i) specified liquid assets up to 20% of total assets;
(ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain qualified thrift investments (primarily residential mortgages and related investments, including certain mortgage-backed
securities) in at least 9 months out of each 12 month period. An institution that fails the qualified thrift lender test is subject to certain operating restrictions and may be required to convert to a bank charter. Appalachian Community Bank,
F.S.B. met the OTS requirements as a qualified thrift lender throughout 2008. The Thrift will continue to calculate the ratio at least quarterly.

Further, unlike commercial banks, thrifts may generally make the following categories of loans, only to the extent specified:



| |  |  | Commercial loans up to 20% of assets (50% of which must be in small business loans).
| | - |  | ------------------------------------------------------------------------------------



| |  |  | Nonresidential real property loans up to 400% of capital (the OTS may grant increased authority if it is determined that the increased authority poses no
significant threat to the safe and sound operation of the institution and is consistent with prudent operating practices).
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Consumer loans up to 35% of assets (all loans in excess of 30% of assets must be direct loans).
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | Education loans up to 5% of assets.
| | - |  | -----------------------------------



| |  |  | Non-conforming loans up to 5% of assets.
| | - |  | ----------------------------------------



| |  |  | Construction loans (residential) without security up to 5% of assets.
| | - |  | ---------------------------------------------------------------------

We received approval from the OTS of our application for permission to organize Appalachian Community Bank, F.S.B. on February 16, 2007, and began
operations on April 23, 2007. This approval includes, but is not limited to, the following conditions that must be complied with in a manner satisfactory to the Regional Director of the OTS:



| |  |  | independent audit reports must be submitted to the Regional Director for the first three years of operations;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | the Thrift must operate within the parameters of the business plan submitted with the application and submit any proposed major deviations or material changes from
the plan for the prior, written non-objection of the Regional Director. The request for change must be submitted no later than 60 calendar days prior to the desired implementation date with a copy sent to the FDIC Regional Officer;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Thrift must receive prior written non-objection of the Regional Director of the OTS for any proposed new directors or senior executive officers or any
significant change in responsibilities of any senior executive officer during the first two years of operation; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the Thrift must submit quarterly business plan variance reports, detailing the thrifts compliance with its business plan and explaining any deviations
therein, to the Regional Director of the OTS, within 45 days of the end of each quarter, for the first three years of operations.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Branching.Under Georgia law, the Bank may open branch offices throughout Georgia with the prior approval of its primary bank regulator. In addition, with prior regulatory approval, the Bank may acquire branches of
existing banks located in Georgia. Our subsidiaries (subject to the provisions of the Home Owners Loan Act, applicable to our Thrift subsidiary), and any other national or state-chartered bank generally may branch across state lines by
merging with financial institutions in other states if allowed by the target states laws. Georgias law, subject to limited exceptions, currently permits branching across state lines through interstate mergers.

Under the Federal Deposit Insurance Act, states may opt-in and allow out-of-state banks to branch into their state by establishing a new
start-up branch in the state. Currently, Georgia has not opted-in to this provision. Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia. This provides a limited barrier of entry
into the Georgia banking market, which protects us from an



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important segment of potential competition. However, because Georgia has elected not to opt-in, our ability to establish a new start-up branch in another
state may be limited. Consequently, until Georgia changes its election, the only way the Bank will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger. However, notwithstanding
contradictory state law, the Home Owners Loan Act permits nationwide interstate branching for federal thrifts, subject to certain approvals and restrictions under federal law and regulations. As a result, branches of the Companys thrift
subsidiary are located in Georgia, Tennessee and North Carolina.

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

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, the
banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The other capital categories are well capitalized, adequately capitalized, and undercapitalized. As of December 31, 2008, the Bank
and the Thrift qualified for the well-capitalized category.

A well-capitalized bank or thrift is one that significantly
exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6%, and a tier 1 leverage ratio of at least 5%. Generally, a classification as well
capitalized will place a bank or thrift outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank or thrift may be reclassified as adequately capitalized based on criteria other than
capital, if the federal regulator determines that a bank or thrift is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices and has not corrected the deficiency.

FDIC Insurance Assessments.The FDIC is an independent agency of the United States government that uses the Deposit Insurance Fund to
protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. The FDIC must maintain the Deposit Insurance Fund within a range between 1.15 percent and 1.50 percent of all insured deposits.

The FDIC has adopted a risk-based assessment system for insured depository institutions that accounts for the risks attributable
to different categories and concentrations of assets and liabilities. The system is designed to assess higher rates on those institutions that pose greater risks to the Deposit Insurance Fund. The FDIC places each institution in one of four risk
categories using a two-step process based first on capital ratios (the capital group assignment) and then on other relevant information (the supervisory group assignment). Within the lower risk category, Risk Category I, rates will vary based on
each institutions CAMELS component ratings, certain financial ratios, and long-term debt issuer ratings, if any.

Capital group
assignments are made quarterly and an institution is assigned to one of three capital categories: (1) well capitalized, (2) adequately capitalized, or (3) undercapitalized. These three categories are substantially similar to the
prompt corrective action categories described above, with the undercapitalized category including institutions that are undercapitalized, significantly undercapitalized, and critically undercapitalized for prompt corrective action
purposes. The FDIC also assigns an institution to one of three supervisory subgroups based on a supervisory evaluation that the institutions primary federal banking regulator provides to the FDIC and information that the FDIC determines to be
relevant to the institutions financial condition and the risk posed to the deposit insurance funds.

The FDIC is an independent
agency of the United States government that uses the Deposit Insurance Fund to protect against the loss of insured deposits if an FDIC-insured bank or savings association fails. The FDIC must maintain the Deposit Insurance Fund within a range
between 1.15 percent and 1.50 percent of all insured deposits.



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Because the Deposit Insurance Fund reserve fell below 1.15 percent as of June 30, 2008, and was
expected to remain below 1.15 percent, the Federal Deposit Insurance Reform Act of 2005 required the FDIC to establish and implement a restoration plan to restore the reserve ratio to no less than 1.15 percent within five years, absent extraordinary
circumstances.

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

FDIC Temporary Liquidity Guarantee Program.On October 14, 2008, the FDIC announced that its Board of Directors, under the authority to prevent systemic risk in the U.S. banking system,
approved the Temporary Liquidity Guarantee Program (TLGP). The purpose of the TLGP is to strengthen confidence and encourage liquidity in the banking system. The TLGP is composed of two components, the Debt Guarantee Program and the
Transaction Account Guarantee Program, and institutions had the opportunity, prior to December 5, 2008, to opt-out of either or both components of the TLGP.

The Debt Guarantee Program. Under the TLGP, the FDIC is permitted to guarantee certain newly issued senior unsecured debt issued by participating financial institutions. The annualized fee that the FDIC will
assess to guarantee the senior unsecured debt varies by the length of maturity of the debt. For debt with a maturity of 180 days or less (excluding overnight debt), the fee is 50 basis points; for debt with a maturity between 181 days and 364 days,
the fee is 75 basis points, and for debt with a maturity of 365 days or longer, the fee is 100 basis points. The Bank did not opt-out of the Debt Guarantee component of the TLGP.

The Transaction Account Guarantee Program. Under the TLGP, the FDIC is permitted to fully insure non-interest bearing deposit accounts held at
participating FDIC-insured institutions, regardless of dollar amount. The temporary guarantee will expire at the end of 2009. For the eligible noninterest-bearing transaction deposit accounts (including accounts swept from a noninterest bearing
transaction account into an noninterest bearing savings deposit account), a 10 basis point annual rate surcharge will be applied to noninterest-bearing transaction deposit amounts over $250,000. Institutions will not be assessed a surcharge on
amounts that are otherwise insured. The Bank did not opt-out of the Transaction Account Guarantee component of the TLGP.

Allowance for
Loan and Lease Losses. The Allowance for Loan and Lease Losses (the ALLL) represents one of the most significant estimates in the financial statements and regulatory reports of the Companys subsidiaries. Because of its
significance, our subsidiaries have developed a system by which they develop, maintain, and document a comprehensive, systematic, and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses.
The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006 encourages all institutions to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the
institutions stated policies and procedures, managements best judgment, and relevant supervisory guidance. Consistent with supervisory guidance, our subsidiaries maintain a prudent and conservative, but not excessive, ALLL, that is at a
level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. The estimate of the credit losses of
our subsidiaries reflects consideration of all significant factors that affect the collectability of the portfolio as of the evaluation date. See Managements Discussion and Analysis  Control Accounting Policies.

Commercial Real Estate Lending.The lending operations of our subsidiaries may be subject to enhanced scrutiny by federal banking regulators
based on their concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (CRE) lending
concentrations. CRE loans generally include land development, construction loans, and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated
with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:



| |  |  | total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or
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| |  |  | total commercial real estate loans represent 300% or more of the institutions total capital, and the outstanding balance of the institutions commercial
real estate loan portfolio has increased by 50% or more.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

As of December 31, 2008, the banks and thrifts
concentration in construction, land development and other land loans were $709.1 million and $66.5 million, respectively, both of which were in excess of the above stated guidelines. Concentrations in commercial real estate loans for the bank and
the thrift were $143.3 million and $30.3 million, respectively, which were also in excess of the above stated guidelines. We are currently making an effort to reduce our exposure to these type loans and our focus has shifted to developing our
commercial and industrial loans as well as our consumer loans.

Community Reinvestment Act.The Community Reinvestment Act requires
that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking agencies shall evaluate the record of each financial institution in meeting the credit needs of its local community, including
low- and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and
limitations on the Companys subsidiaries. Additionally, our subsidiaries must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Other Regulations.Interest and other charges collected or contracted for by the Bank and the Thrift are subject to state usury laws and federal laws concerning interest rates. The Companys
loan operations as conducted by our subsidiaries are also subject to federal laws applicable to credit transactions, such as the:



| |  |  | Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting
agencies, certain identity theft protections, and certain credit and other disclosures;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | Soldiers and Sailors Civil Relief Act of 1940, as amended, governing the repayment terms of, and property rights underlying, secured obligations of
persons currently on active duty with the United States military;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees,
for certain types of consumer loans to military service members and their dependents; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
| | - |  | -------------------------------------------------------------------------------------------------------------------------

In addition, the deposit operations of the Bank and the Thrift are subject to federal laws applicable to depository accounts, such as the following:



| |  |  | 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;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board 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; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.
| | - |  | -------------------------------------------------------------------------------------------------------------------------

Capital Adequacy

The Company and its subsidiaries
are required to comply with the capital adequacy standards established by the Federal Reserve Board, in the case of the Company, the FDIC, in the case of the Bank, and the OTS, in the case of the Thrift. The Federal Reserve Board has established a
risk-based and a leverage measure of capital adequacy for bank holding companies. The Companys subsidiaries are also subject to risk-based and leverage capital requirements adopted by its primary regulator, which are substantially similar to
those adopted by the Federal Reserve Board for bank holding companies.

The risk-based capital standards are designed to make regulatory
capital requirements more sensitive to differences in risk profiles among banks and bank 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 stockholders equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying 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, other preferred stock
and hybrid capital, and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2008 our ratio of total capital to risk-weighted assets was 9.89% and our ratio of Tier 1
Capital to risk-weighted assets was 7.96%.

In addition, the Federal Reserve Board has established minimum leverage ratio guidelines for
bank holding companies. 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 Federal Reserve Boards risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2008,
our leverage ratio was 6.64%. The guidelines also provide that bank holding companies 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 Federal Reserve Board considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

Failure to meet capital guidelines could subject a bank holding company or its subsidiaries to a variety of enforcement remedies, including issuance of a
capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured
depository institutions that fail to meet applicable capital requirements. See Prompt Corrective Action above.

The FDIC
approved Appalachian Community Bank, F.S.B.s application for federal deposit insurance on January 19, 2007, subject to the condition that the Tier 1 capital to assets leverage ratio be maintained at not less than 8%, throughout the first
three years of operation, and that an adequate allowance for loan and lease losses be provided.

Payment of Dividends

The Company is a legal entity separate and distinct from its subsidiaries. The principal source of the Companys cash flow, including cash flow to
pay dividends to its shareholders, is dividends that the Bank and the Thrift pay to the Company as the respective subsidiaries sole shareholder. Statutory and regulatory limitations apply to the payment of dividends to the Company by its
subsidiaries, as well as to the Companys payment of dividends to its shareholders. If, in the opinion of the federal banking regulator, the Bank or the Thrift were engaged in or about to engage in an unsafe or unsound practice, the respective
federal banking regulator could require, after notice and a hearing, that the subsidiary stop or refrain from engaging in the practice. The federal banking agencies



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have indicated that paying dividends that deplete a depository institutions capital base to an inadequate level would be an unsafe and unsound banking
practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal
agencies have issued policy statements that provide that bank holding companies and insured banks and thrifts should generally only pay dividends out of current operating earnings.

The Bank is required to obtain prior approval of the Department if the total of all dividends declared by the Bank in any year will exceed 50% of the
Banks net income for the prior year. This limitation also applies to a bank holding companys payment of dividends to its shareholders. The payment of dividends by the Company and its subsidiaries may also be affected by other factors,
such as the requirement to maintain adequate capital above regulatory guidelines. At December 31, 2008, due to the Banks net loss for the year, cash dividends could not be paid without prior regulatory approval.

Restrictions on Transactions with Affiliates

The
Company and its subsidiaries are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:



| |  |  | an institutions loans or extensions of credit to affiliates;
| | - |  | -------------------------------------------------------------



| |  |  | an institutions investment in affiliates;
| | - |  | ------------------------------------------



| |  |  | assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve Board;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and
| | - |  | -----------------------------------------------------------------------------------------------------------------



| |  |  | an institution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 an institutions capital and surplus and, as to
all affiliates combined, to 20% of an institutions 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. The Bank and the Thrift
must also comply with other provisions designed to avoid taking low-quality assets.

The Company and its subsidiaries are also subject to
the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as
favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

Our subsidiaries are also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders, and their related interests. These extensions of credit (1) 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 (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Liability of Commonly Controlled Depository Institutions

Pursuant to Section 5(e) of the Federal Deposit Insurance Act, commonly controlled institutions, such as the Bank and the Thrift, which are controlled by the same company, may be liable for losses incurred or reasonably anticipated by
the FDIC in the event of an affiliate financial institutions default or a rendering of assistance by the FDIC if such institution is in danger of default. The FDIC, however, in its sole discretion, may exempt the Bank, or any insured
depository institution, from this liability if it determines that such exemption is in the best interest of the Bank Insurance Fund or the Savings Association Insurance Fund. If the FDIC determined that the Bank, or another commonly
controlled institution, was not exempt from such liability, the liability would attach at the time of default. Such liability would be superior to any obligation to shareholders and any liability owed to an affiliate of the Bank. On the other hand,
such liability would be junior in right and payment to any deposit liability, any



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secured obligation, and any other senior liability or obligation subordinate to depositors or other general creditors, similar to the indebtedness to be
represented by the Notes.

Proposed Legislation and Regulatory Action

New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of financial institutions operating and doing business in
the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Effect of Governmental Monetary Policies

The
Companys earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Boards monetary policies have had, and are likely to continue to
have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve Board
affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks, and its influence over reserve requirements to
which member banks are subject. Neither the Company nor its subsidiaries can predict the nature or impact of future changes in monetary and fiscal policies.



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|ITEM 1A. | RISK FACTORS
|-------- | ------------

The following are certain risks that
management believes are specific to our business. This should not be viewed as an all inclusive list or in any particular order.

We could suffer
additional loan losses from a continued decline in credit quality.

We could sustain losses if borrowers, guarantors, and related
parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for credit losses that we believe are
appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially
adversely affect our results of operations.

Declines in real estate values have adversely affected our credit quality and profitability.

During 2008, confidence in the credit market for residential housing finance significantly eroded, which resulted in a reduction in
financing available to buyers of new homes and borrowers wishing to refinance existing financing terms. The tightening of credit for residential housing led to lower demand for residential housing and more foreclosures, and has reduced the
absorption rate for new and existing properties. In turn, this tightening of credit has caused market prices to fall as some property owners, including lenders who acquired property by foreclosure, have accepted lower prices to reduce their exposure
to these real estate assets, which has reduced the market values for comparable real estate.

The declines in values and the increased
level of marketing required to sell properties has reduced or eliminated the potential profits to many of the builders and developers of properties to whom we have extended loans. As a result, some of these borrowers have been unable to repay their
loans in accordance with their terms, which has led to an increase in our past due, impaired and non-performing loans. If these housing trends continue or exacerbate, the Company expects that it will continue to experience increased delinquencies
and credit losses. In addition, declining real estate and other asset values may reduce the available equity associated with these assets, which, in turn, would limit the ability of borrowers to use such equity to support borrowings.

Moreover, if the current recession continues, the Company may be required to further increase our loan loss provision, and may experience significantly
higher delinquencies and credit losses. An increase in our loan loss provision or increased credit losses would reduce earnings and adversely affect the Companys financial condition. Furthermore, to the extent that real estate collateral is
obtained through foreclosure, the costs of holding and marketing the real estate collateral, as well as the ultimate values obtained from disposition, could reduce the Companys earnings and adversely affect the Companys financial
condition.

The Companys business volume and growth is affected by the rate of growth and demand for housing in specific geographic
markets. Based on the activity discussed above, the Companys future rate of growth, if any, could be significantly less than its historical levels and its assets may in fact shrink, depending on the duration and extent of the current
disruption in the housing and mortgage markets.

We make and hold in our portfolio a significant number of land acquisition and development and
construction loans, which pose more credit risk than other types of loans typically made by financial institutions.

We offer land
acquisition and development and construction loans for builders and developers. As of December 31, 2008, approximately $389.3 million, or 44.0%, of our total loan portfolio represented loans for which the related property is neither presold nor
preleased. These land acquisition and development and construction loans are considered more risky than other types of loans. The primary credit risks associated with land acquisition and development and construction lending are underwriting,
project risks, and market risks. Project risks include cost overruns, borrower credit risk, project completion risk, general contractor credit risk, and environmental and other hazard risks. Market risks are risks associated with the sale of the
completed residential units. They include affordability risk, which means the risk that borrowers cannot obtain affordable financing, product design risk, and risks posed by competing projects. There can be no assurance that losses in our land
acquisition and development and construction loan portfolio will not exceed our reserves, which could adversely impact our earnings. Given the



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current environment, the non-performing loans in our land acquisition and development and construction portfolio may increase substantially in 2009, and
these non-performing loans could result in a material level of charge-offs, which will negatively impact our capital and earnings.

Ongoing
deterioration in the housing market and the homebuilding industry may lead to increased losses and further worsening of delinquencies and non-performing assets in our loan portfolios. Consequently, our results of operations may be adversely
impacted.

There has been substantial industry concern and publicity over asset quality among financial institutions due in large
part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. As of December 31, 2008, our non-performing assets increased significantly to $41.5 million, or 4.62%, of our loan portfolio plus
other real estate owned. Furthermore, the housing and the residential mortgage markets recently have experienced a variety of difficulties and changed economic conditions. If market conditions continue to deteriorate, they may lead to additional
valuation adjustments on our loan portfolios and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default, and the net realizable value of real estate owned.

The homebuilding industry has experienced a significant and sustained decline in demand for new homes and an oversupply of new and existing homes
available for sale in various markets, including some of the markets in which we lend. Our customers who are builders and developers face greater difficulty in selling their homes in markets where these trends are more pronounced. Consequently, we
are facing increased delinquencies and non-performing assets as these builders and developers are forced to default on their loans with us. We do not know when the housing market will improve, and accordingly, additional downgrades, provisions for
loan losses, and charge-offs related to our loan portfolio may occur.

Weakness in residential property values and mortgage loan markets could
adversely affect us.

Recent weakness in the secondary market for residential lending could have an adverse impact upon our
profitability. Pricing may change rapidly impacting the value of loans in our portfolio. This has been most pronounced in residential construction and development loans, and in subprime and Alt-A lending. The turmoil in the mortgage markets,
combined with the ongoing correction in real estate markets, could result in further price reductions in single family home prices and lack of liquidity in refinancing markets. These factors could adversely impact the quality of our residential
construction and residential mortgage portfolio in various ways, including creating discrepancies in value between the original appraisal and the value at time of sale, and by decreasing the value of the collateral for our mortgage loans. We also
have a significant amount of loans on one-to-four family residential properties, which are secured principally by single-family residences. Loans of this type are generally smaller in size and geographically dispersed throughout our market area.
Losses on the residential loan portfolio depend to large degree on the level of interest rates, the unemployment rate, economic conditions, and collateral values, and are therefore difficult to predict.

Additionally, we may be required to repurchase mortgage loans or indemnify mortgage loan purchasers as a result of certain borrower defaults, which could
harm our liquidity, results of operations, and financial condition. When we sell mortgage loans, whether as whole loans or pursuant to a securitization, we are required to make customary representations and warranties to the purchaser about the
mortgage loans and the manner in which the loans were originated. Our whole loan sale agreements sometimes require us to repurchase or substitute mortgage loans in the event we breach any of these representations or warranties. In addition, we may
be required to repurchase mortgage loans in the event of early payment default of the borrower on a mortgage loan. While we have taken steps to enhance our underwriting policies and procedures, these steps might not be effective and might not lessen
the risks associated with loans sold in the past. If repurchase demands increase, our liquidity, results of operations, and financial condition could be adversely affected.

The amount of other real estate owned (OREO) may increase significantly, resulting in additional losses, and costs and expenses that will negatively affect our operations

At December 31, 2007, we had a total of $1.5 million of OREO, and at December 31, 2008, we had a total of $13.2 million
of OREO, reflecting a $11.7 increase, or 775.7%, from 2007 to 2008. This increase in OREO is due, among other things, to the continued deterioration of the residential real estate market and the tightening of the



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credit market. As the amount of OREO increases, our losses, and the costs and expenses to maintain the real estate likewise increase. Due to the on-going
economic crisis, the amount of OREO may continue to increase throughout 2009. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of
operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and may reduce our
ultimate realization from any OREO sales.

Recent negative developments in the financial industry, and the domestic and international credit markets
may adversely affect our operations and results.

Negative developments during 2008 in the global credit and derivative markets
have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing in 2009. As a result of this credit crunch, commercial as well as consumer loan portfolio performances have
deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to
decline. Global securities markets, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. If these negative trends
continue, our business operations and financial results may be negatively affected.

The deterioration in the residential mortgage market may
continue to spread to commercial credits, which may result in greater losses and non-performing assets, adversely affecting our business operations.

The losses that were initially associated with subprime residential mortgages rapidly spread into the residential mortgage market generally. If the losses in the residential mortgage market continue to spread to
commercial credits, then we may be forced to take greater losses or to hold more non-performing assets. Our business operations and financial results could be adversely affected if we continue to experience losses from our commercial loan portfolio.

The FDIC Deposit Insurance assessments that we are required to pay may materially increase in the future, which would have an adverse effect on our
earnings.

As an insured depository institution, we are required to pay quarterly deposit insurance premium assessments to the
FDIC. These assessments are required to ensure that FDIC deposit insurance reserve ratio is at least 1.15% of insured deposits. Under the Federal Deposit Insurance Act, the FDIC, absent extraordinary circumstances, must establish and implement a
plan to restore the deposit insurance reserve ratio to 1.15% of insured deposits, over a five-year period, when the reserve ratio falls below 1.15%. The recent failures of several financial institutions have significantly increased the Deposit
Insurance Funds loss provisions, resulting in a decline in the reserve ratio. The FDIC expects a higher rate of insured institution failures in the next few years, which may result in a continued decline in the reserve ratio.

Beginning on January 1, 2009, there is a uniform 7 basis points (annualized) increase to the assessments that banks pay for deposit insurance. The
increased assessment rates range from 12 to 50 basis points (annualized) for the first quarter of 2009 assessment. In addition, the FDIC is currently considering a proposal that would increase the assessments that riskier institutions pay, beginning
in the second quarter of 2009. As of January 31, 2009, the FDIC had not adopted the proposed increased assessments for riskier institutions, but we cannot predict whether the FDIC will adopt this rule.

During the year ended December 31, 2008, we paid $809,545 in deposit insurance assessments. Due to the recent failure of several unaffiliated FDIC
insurance depository institutions and the corresponding increase in assessments, we will be required to pay additional amounts to the Deposit Insurance Fund throughout 2009, which could have an adverse effect on our earnings. If the deposit
insurance premium assessment rate applicable to us increases again, either because of our risk classification or because of another uniform increase, our earnings could be further adversely impacted.



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Future impairment losses could be required on various investment securities, which may materially reduce the
Companys and the Banks regulatory capital levels.

The Company establishes fair value estimates of securities
available-for-sale in accordance with generally accepted accounting principles. The Companys estimates can change from reporting period to reporting period, and we cannot provide any assurance that the fair value estimates of our investment
securities would be the realizable value in the event of a sale of the securities.

A number of factors could cause the Company to conclude
in one or more future reporting periods that any difference between the fair value and the amortized cost of one or more of the securities that we own constitutes an other-than-temporary impairment. These factors include, but are not limited to, an
increase in the severity of the unrealized loss on a particular security, an increase in the length of time unrealized losses continue without an improvement in value, a change in our intent or ability to hold the security for a period of time
sufficient to allow for the forecasted recovery, or changes in market conditions or industry or issuer specific factors that would render us unable to forecast a full recovery in value, including adverse developments concerning the financial
condition of the companies in which we have invested.

The Company may be required to take other-than-temporary impairment charges on
various securities in its investment portfolio. In addition, depending on various factors, including the fair values of other securities that we hold, we may be required to take additional other-than-temporary impairment charges on other investment
securities. Any other-than-temporary impairment charges would negatively affect our regulatory capital levels, and may result in a change to our capitalization category, which could limit certain corporate practices and could compel us to take
specific actions.

During the third quarter of 2008, the Company recognized an other than temporary impairment charge of $816,000 on its
investment in Freddie Mac preferred stock. The value of these securities declined significantly after the U.S. Government placed the company into conservatorship in September 2008. The remaining carrying value of the preferred stock at
December 31, 2008 is $6,000.

A reduction in the fair value attributable to recently acquired units of our business may result in the Company
having to recognize a non-cash goodwill impairment charge, which would negatively impact our earnings and, consequently, our ability to pay dividends.

In 1998 the Company acquired a bank located in Blairsville, Georgia. We booked $1,991,891 in goodwill as an intangible asset on its balance sheet in connection with this acquisition. Statement of Financial
Accounting Standards No. 142, Goodwill and Other Intangible Assets, requires us to make a periodic assessment of any goodwill we carry on our balance sheet by comparing the current fair value of each unit for which
goodwill has been recognized to that units book value. In the event that the assessment shows that the book value of any unit exceeds its fair value, a non-cash, after-tax, we must take a goodwill impairment charge equal to the
difference between relevant book and fair values. While such a goodwill impairment charge would have no impact on our regulatory capital ratios or liquidity position, it would result in a reduction of our earnings.

The goodwill impairment assessment must occur on at least an annual basis, or more frequently as changing circumstances would
dictate. The Company normally performs its annual assessment on December 31 of each year. After its December 31, 2008 assessment, we determined that no goodwill impairment change was necessary. However, the weakening of real
estate markets, both nationally and locally in our primary market area, the tightening of credit, and other events of the past months have generally resulted in the lowered market valuation of financial institutions operating in the
southeastern United States and may require that we realize a goodwill impairment charge in 2009.



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

Our success depends to a significant extent upon the quality of our assets, particularly loans. In originating loans, there is a
substantial likelihood that we will experience credit losses. The risk of loss will vary with, among other things, general economic conditions, the type of loan, the creditworthiness of the borrower over the term of the loan and, in the case of a
collateralized loan, the quality of the collateral for the loan.

Our loan customers may not repay their loans according to the terms of
these loans, and the collateral securing the payment of these loans may be insufficient to assure repayment. As a result, we may experience significant loan losses, which could have a material adverse effect on our operating results. Management
makes various assumptions and judgments about the collectibility of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans.
We maintain an allowance for loan losses in an attempt to cover any loan losses that may occur. In determining the size of the allowance, we rely on an analysis of our loan portfolio based on historical loss experience, volume and types of loans,
trends in classification, volume and trends in delinquencies and non-accruals, national and local economic conditions, and other pertinent information.

If our assumptions are wrong, our current allowance may not be sufficient to cover future loan losses, and we may need to make adjustments to allow for different economic conditions or adverse developments in our loan
portfolio. Material additions to our allowance would materially decrease our net income. As a result of a difficult real estate market, we have increased our allowance from $9.8 million as of December 31, 2007 to $14.5 million as of
December 31, 2008. We expect to continue to increase our allowance in 2009; however, given current and future market conditions, we can make no assurance that our allowance will be adequate to cover future loan losses.

In addition, federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses
or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in our allowance for loan losses or loan charge-offs as required by these regulators could have a negative effect on our operating
results.

Weakness in the economy and in the real estate market, including specific weakness within our geographic footprint, has adversely affected
us and may continue to adversely affect us.

Declines in the U.S. economy and our local real estate markets contributed to our
increasing provisions for loan losses during 2008, and may result in additional loan losses and loss provisions for 2009. These factors could result in further increases in loan loss provisions, and additional delinquencies, charge-offs, or both in
future periods, any of which may adversely affect our financial condition and results of operations. If the strength of the U.S. economy in general and the strength of the local economies in which we conduct operations continue to decline, this
could result in, among other things, further deterioration in credit quality or a reduced demand for credit, including a resultant adverse effect on our loan portfolio and additional increases to our allowance for loan and lease losses.

In addition, deterioration of the U.S. economy may adversely impact our banking business more generally. Economic declines may be accompanied by a
decrease in demand for consumer or commercial credit and declining real estate and other asset values. Declining real estate and other asset values may reduce the ability of borrowers to use such equity to support borrowings. Delinquencies,
foreclosures and losses generally increase during economic slowdowns or recessions. Additionally, our servicing costs, collection costs, and credit losses may also increase in periods of economic slowdown or recessions. Effects of the current real
estate slowdown have not been limited to those directly involved in the real estate construction industry (such as builders and developers). Rather, it has impacted a number of related businesses such as building materials suppliers, equipment
leasing firms, and real estate attorneys, among others, and the current recession has negatively impacted businesses of all types. All of these affected businesses have banking relationships, and when their businesses suffer from an economic
slowdown or recession, the banking relationship suffers as well.



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Our net interest income could be negatively affected by the Federal Reserves recent interest rate
adjustments, as well as by competition in our market area.

As a financial institution, our earnings significantly depend on our
net interest income, which is the difference between the interest income that we earn on interest-earning assets, such as investment securities and loans, and the interest expense that we pay on interest-bearing liabilities, such as deposits and
borrowings. Therefore, any change in general market interest rates, including changes resulting from changes in the Federal Reserves fiscal and monetary policies, affects us more than non-financial institutions and can have a significant
effect on our net interest income and total income. Our assets and liabilities may react differently to changes in overall market rates or conditions because there may be mismatches between the repricing or maturity characteristics of the assets and
liabilities. As a result, an increase or decrease in market interest rates could have material adverse effects on our net interest margin and results of operations.

Since January 2008, in response to the dramatic deterioration of the subprime, mortgage, credit, and liquidity markets, the Federal Reserve has taken action on seven occasions to reduce interest rates by a total of
400 to 425 basis points, which has reduced our net interest income and will likely continue to reduce this income for the foreseeable future. Any reduction in our net interest income will negatively affect our business, financial condition,
liquidity, operating results, cash flows and, potentially, the price of our securities. Additionally, in 2009, we expect to have continued margin pressure given these historically low interest rates, along with elevated levels of non-performing
assets.

Our access to additional short term funding to meet our liquidity needs is limited.

We must maintain, on a daily basis, sufficient funds to cover withdrawals from depositors accounts and to supply new borrowers with funds. We
routinely monitor asset and liability maturities in an attempt to match maturities to meet liquidity needs. To meet our cash obligations, we rely on repayments as assets mature, keep cash on hand, maintain account balances with correspondent banks,
purchase and sell federal funds, purchase brokered deposits, and maintain a line of credit with the Federal Home Loan Bank. If we are unable to meet our liquidity needs through our cash on hand, and loan and other asset repayments, we may need to
borrow additional funds. Currently, our access to additional borrowed funds is limited, and we may be required to pay above market rates for additional borrowed funds, which may adversely affect our results of operations.

As of December 31, 2008, we had approximately $262.7 million in out of market deposits, including brokered deposits, which represented approximately
25.9% of our total deposits. At times, the cost of out of market and brokered deposits exceeds the cost of deposits in our local market. In addition, the cost of out of market and brokered deposits can be volatile, and if we are unable to access
these markets or if our costs related to out of market and brokered deposits increases, our liquidity and ability to support demand for loans could be adversely affected.

Our business strategy includes stabilizing growth, preserving market presence and raising capital, and as a result, our financial condition and results of operations could be negatively affected if we fail to
effectively stabilize our growth, preserve our market presence or raise capital.

In light of the current adverse economic
conditions, expenses, and difficulties currently being experienced in our industry, we intend to stabilize the growth of our business while preserving our market presence. In addition, as a result of the current economic environment, we plan to
raise additional capital. We cannot assure you we will be able to stabilize growth and preserve our market presence in our existing markets or successfully raise capital. Failure to manage our growth effectively could have a material adverse effect
on our business, financial condition, results of operations, or future prospects, and could adversely affect our ability to successfully implement our business strategy.

Our ability to successfully stabilize our growth and preserve our market presence will depend on a variety of factors including the current economic environment, the availability of desirable business opportunities,
and the competitive responses from other financial institutions in our market areas. While we believe we have the management resources and internal systems in place to preserve our market presence, stabilize our growth and raise capital, there can
be no assurance that capital will be available or growth, in light of current economic conditions, will be managed successfully.



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Adverse market conditions and future losses may require us to raise additional capital to support our operations,
but that capital may not be available when it is needed, which could adversely affect our financial condition and results of operations.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. We anticipate that our current capital resources will satisfy our capital requirements for the foreseeable future.
We may at some point, however, need to raise additional capital to support our operations.

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

Our ability to raise capital could
be limited and could be dilutive to existing shareholders.

Current capital markets are such that traditional sources of capital
may not be available to us on reasonable terms. If we need to raise capital, there is no guarantee that we will be able to borrow funds or successfully raise additional capital at all or on terms that are favorable or otherwise not dilutive to
existing shareholders.

Our directors and executive officers own a significant portion of our common stock and can influence stockholder decisions.

Our directors and executive officers, as a group, beneficially owned approximately 19% of our fully diluted outstanding common
stock as of December 31, 2008. As a result of their ownership, the directors and executive officers will have the ability, if they voted their shares in concert, to influence the outcome of all matters submitted to our stockholders for
approval, including the election of directors.

We face intense competition in all of our markets.

The financial services industry, including commercial banking, mortgage banking, consumer lending, and home equity lending, is highly competitive, and we
encounter strong competition for deposits, loans, and other financial services in all of our market areas in each of our lines of business. Our principal competitors include other commercial banks, savings banks, savings and loan associations,
mutual funds, money market funds, finance companies, trust companies, insurers, credit unions, and mortgage companies. Many of our non-bank competitors are not subject to the same degree of regulation as us and have advantages over us in providing
certain services. Many of our competitors are significantly larger than us and have greater access to capital and other resources. Also, our ability to compete effectively in our business depends on our ability to adapt successfully to regulatory
and technological changes within the banking and financial services industry generally. If we are unable to compete effectively, we will lose market share and our income from loans and other products may diminish.

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



| |  |  | the ability to develop, maintain, and build upon long-term customer relationships based on top quality service and high ethical standards;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the scope, relevance, and pricing of products and services offered to meet customer needs and demands;
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | the rate at which we introduce new products and services relative to our competitors;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | customer satisfaction with our level of service; and
| | - |  | ----------------------------------------------------



| |  |  | industry and general economic trends.
| | - |  | -------------------------------------

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and
results of operations.



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Negative publicity about financial institutions, generally, or about the Company or Bank, specifically, could
damage the Companys reputation and adversely impact its business operations and financial results.

Reputation risk, or the
risk to our business from negative publicity, is inherent in our business. Negative publicity can result from the actual or alleged conduct of financial institutions, generally, or the Company or Bank, specifically, in any number of activities,
including leasing practices, corporate governance, and actions taken by government regulators in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and
regulatory action, any of which could negatively affect our business operations or financial results.

We are subject to extensive regulation that
could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.

As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Our
subsidiary bank is primarily regulated by the Federal Deposit Insurance Corporation (the FDIC), the State Department of Banking and Finance, and the Office of Thrift Supervision. Our compliance with Federal Reserve Board, FDIC, and
Department of Banking and Finance regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on
deposits and locations of offices. We are also subject to capital requirements of our regulators.

The laws and regulations applicable to
the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank
holding companies, our cost of compliance could adversely affect our ability to operate profitably.

The Sarbanes-Oxley Act of 2002, the
related rules and regulations promulgated by the SEC that currently apply to us and the related exchange rules and regulations, have increased the scope, complexity and cost of corporate governance, reporting, and disclosure practices. Additional
legislation or regulations, or amendments to current legislation or regulations, related to corporate governance, reporting, and disclosure may cause us to experience greater compliance costs.

The Emergency Economic Stabilization Act of 2008 (EESA) or other governmental actions may not stabilize the financial services industry.

The EESA, which was signed into law on October 3, 2008, is intended to alleviate the financial crisis affecting the U.S.
banking system. A number of programs are being developed and implemented under EESA. The EESA may not have the intended effect, however, and as a result, the condition of the financial services industry could decline instead of improve. The failure
of the EESA to improve the condition of the U.S. banking system could significantly adversely affect our access to funding or capital, the trading price of our stock, and other elements of our business, financial condition, and results of
operations.

In addition to EESA, a variety of legislative, regulatory, and other proposals have been discussed or may be introduced in an
effort to address the financial crisis. Depending on the scope of such proposals, if they are adopted and applied to the Company, our financial condition, results of operations or liquidity could, directly or indirectly, benefit or be adversely
affected in a manner that could be material to our business.

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

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



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Confidential customer information transmitted through the Banks online banking service is vulnerable to
security breaches and computer viruses, which could expose the Bank to litigation and adversely affect its reputation and ability to generate deposits.

The Bank provides its customers with the ability to bank online. The secure transmission of confidential information over the Internet is a critical element of online banking. The Banks network could be
vulnerable to unauthorized access, computer viruses, phishing schemes, and other security problems. The Bank may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or
to alleviate problems caused by security breaches or viruses. To the extent that the Banks activities or the activities of its clients involve the storage and transmission of confidential information, security breaches and viruses could expose
the Bank to claims, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in the Banks systems and could adversely affect its reputation
and its ability to generate deposits.



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|ITEM 1B. | UNRESOLVED STAFF COMMENTS
|-------- | -------------------------

Not applicable.



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|ITEM 2. | PROPERTIES
|------- | ----------

Our executive offices and the
operations center for the company, the bank and the thrift are located at 822 Industrial Boulevard, Ellijay, Georgia. We own this property. In addition to this facility, we operate thirteen branch offices, of which nine are owned and four are
subject to either building or ground leases. In February 2008, we completed construction on our new Chatsworth location, which replaced a temporary leased facility. Also during 2008, we began construction on new branch offices to replace three other
leased facilities. These new facilities are located at Georgia Highway 400 in Dawson County, Georgia, in Dahlonega, Georgia and in Murphy, North Carolina. We began banking operations in the Dawson and Dahlonega facilities in 2008 and we were able to
occupy the Murphy location in January 2009.

We also own a building in Ellijay, Georgia, which previously housed our operations center.
This building is approximately 14,200 square feet, including approximately 8,000 square feet of commercial space that we have leased to various third parties in the past. We have two tenants occupying sections of this building and at this time we
are using the remaining space as a storage facility for all of our branches and operations.

We believe that all of our properties are
adequately covered by insurance. Further disclosures pertaining to our properties may be found in the notes to our consolidated financial statements.



|ITEM 3. | LEGAL PROCEEDINGS
|------- | -----------------

In the ordinary course of
operations, we are a party to various legal proceedings from time to time. We do not believe that there is any pending or threatened proceeding against us, which, if determined adversely, would have a material effect on our business, results of
operations or financial condition.



|ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
|------- | ---------------------------------------------------

No matters were submitted to a vote of shareholders during the fourth quarter of the fiscal year covered by this report.



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PART II



|ITEM 5. | MARKET FOR THE REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
|------- | ----------------------------------------------------------------------------------------------------------------

Our common stock trades on the Nasdaq Global Market under the symbol APAB. As of March 19, 2009, we had approximately 1,257 shareholders
of record.

The following table shows the reported high and low sales prices reported by the Nasdaq Global Market for each of the four
quarters in 2008 and 2007.



|               |  |                                |       |     |   |      
|-------------- |  | ------------------------------ | ----- | --- | - | -----
|               |  | Estimated PriceRange Per Share
|               |  | High                           |       | Low
|Year End 2008: |  |                                |       |     |   |      
|First Quarter  |  | $                              | 12.50 |     | $ | 8.10 
|Second Quarter |  |                                | 7.50  |     |   | 7.50 
|Third Quarter  |  |                                | 7.71  |     |   | 4.99 
|Fourth Quarter |  |                                | 5.84  |     |   | 2.50 
|               |  |                               
|Year End 2007: |  |                                |       |     |   |      
|First Quarter  |  | $                              | 21.92 |     | $ | 18.35
|Second Quarter |  |                                | 19.75 |     |   | 17.10
|Third Quarter  |  |                                | 17.84 |     |   | 13.97
|Fourth Quarter |  |                                | 15.24 |     |   | 9.43 

To date, we have not paid cash dividends on our common stock. For the foreseeable future we do not
intend to declare cash dividends. We intend to retain earnings to grow our business and strengthen our capital base. Our ability to pay cash dividends is dependent upon receiving cash dividends from our subsidiaries. In addition, Georgia and federal
banking regulations restrict the amount of cash dividends that can be paid to the company from its subsidiaries. See Subsidiary Dividends in the section entitled Supervision and Regulation.



27



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Unregistered Sales of Equity Securities and Use of Proceeds.

Issuer Repurchases of Equity Securities



|                  |  |                                         |  |                                     |       |                                                                                     |        |                                                                                                                   |   |          
|----------------- |  | --------------------------------------- |  | ----------------------------------- | ----- | ----------------------------------------------------------------------------------- | ------ | ----------------------------------------------------------------------------------------------------------------- | - | ---------
|Period            |  | TotalNumber ofShares(or Units)Purchased |  | Average PricePaid perShare(or Unit) |       | Total Numberof Shares(or Units)Purchased asPart ofPubliclyAnnouncedPlans
orPrograms |        | MaximumNumber(or ApproximateDollar Value)of Shares(or Units) thatMay Yet
BePurchasedUnder the Plansor Programs(1)
|1/1/08 to 1/31/08 |  | 0                                       |  | $                                   | 0.00  |                                                                                     | 0      |                                                                                                                   | $ | 1,987,600
|2/1/08 to 2/29/08 |  | 16,000                                  |  |                                     | 11.44 |                                                                                     | 16,000 |                                                                                                                   |   | 1,804,560
|3/1/08 to 3/31/08 |  | 0                                       |  |                                     | 0.00  |                                                                                     | 0      |                                                                                                                   |   |         
|                  |  |                                         |  |                                     |       |                                                                                     |        |                                                                                                                   |   |          
|Total             |  | 16,000                                  |  | $                                   | 11.44 |                                                                                     | 16,000 |                                                                                                                   | $ |         
|                  |  |                                         |  |                                     |       |                                                                                     |        |                                                                                                                   |   |          



|(1) | On March 2, 2007, we announced a program to repurchase up to an aggregate of $2.5 million of our common stock over the twelve month period ending February 27, 2008. This
program expired on February 27, 2008.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

|ITEM 6. | SELECTED FINANCIAL DATA
|------- | -----------------------

Our selected consolidated
financial data presented below as of and for the years ended December 31, 2004 through 2008 is derived from our audited consolidated financial statements. Our audited consolidated financial statements as of December 31, 2008 and 2007 and
for each of the years in the three year period ended December 31, 2008 are included elsewhere in this report.



|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|--------------------------------------------------- |  | ------------------------------------------------ | --------- | - | ---- | - | --------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                                    |  | At and for the Years Ended December 31,         
|                                                    |  | 2008                                             |           |   | 2007 |   | 2006      |  | 2005 |           | 2004
|                                                    |  | (In thousands, except shares and per share data)
|Selected Balance Sheet Data                         |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Assets                                              |  | $                                                | 1,185,678 |   |      | $ | 971,200   |  | $    | 758,214   |      | $ | 592,606   |  | $ | 472,811  
|Investment securities                               |  |                                                  | 79,308    |   |      |   | 76,565    |  |      | 72,413    |      |   | 68,872    |  |   | 61,985   
|Restricted equity securities                        |  |                                                  | 4,932     |   |      |   | 3,945     |  |      | 2,312     |      |   | 2,698     |  |   | 2,670    
|Foreclosed assets                                   |  |                                                  | 13,323    |   |      |   | 1,573     |  |      | 1,218     |      |   | 147       |  |   | 516      
|Loans, held for sale                                |  |                                                  | 2,783     |   |      |   | 6,503     |  |      | 733       |      |   |          |  |   |         
|Loans                                               |  |                                                  | 885,374   |   |      |   | 807,522   |  |      | 631,053   |      |   | 457,418   |  |   | 377,352  
|Allowance for loan losses                           |  |                                                  | 14,510    |   |      |   | 9,808     |  |      | 7,670     |      |   | 6,059     |  |   | 4,349    
|Deposits                                            |  |                                                  | 1,013,276 |   |      |   | 807,597   |  |      | 651,134   |      |   | 473,310   |  |   | 381,498  
|Short-term borrowings                               |  |                                                  | 10,604    |   |      |   | 21,048    |  |      | 4,738     |      |   | 24,892    |  |   | 15,470   
|Accrued interest payable                            |  |                                                  | 1,936     |   |      |   | 2,059     |  |      | 1,454     |      |   | 728       |  |   | 540      
|FHLB advances                                       |  |                                                  | 72,000    |   |      |   | 57,350    |  |      | 25,050    |      |   | 24,950    |  |   | 31,950   
|Subordinated long-term capital notes                |  |                                                  | 12,511    |   |      |   | 6,186     |  |      | 6,186     |      |   | 6,186     |  |   | 6,186    
|Other liabilities                                   |  |                                                  | 2,913     |   |      |   | 3,297     |  |      | 2,889     |      |   | 2,715     |  |   | 1,084    
|Shareholders equity                                |  |                                                  | 72,438    |   |      |   | 73,663    |  |      | 66,763    |      |   | 59,825    |  |   | 36,083   
|                                                    |  |                                                  |           |   |     
|Summary Results of Operations Data                  |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Interest income                                     |  | $                                                | 69,005    |   |      | $ | 72,127    |  | $    | 53,193    |      | $ | 34,750    |  | $ | 25,736   
|Interest expense                                    |  |                                                  | 34,034    |   |      |   | 34,800    |  |      | 22,494    |      |   | 11,880    |  |   | 7,558    
|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Net interest income                                 |  |                                                  | 34,971    |   |      |   | 37,327    |  |      | 30,699    |      |   | 22,870    |  |   | 18,178   
|Provision for loan losses                           |  |                                                  | 12,915    |   |      |   | 4,726     |  |      | 3,253     |      |   | 2,211     |  |   | 1,235    
|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Net interest income after provision for loan losses |  |                                                  | 22,056    |   |      |   | 32,601    |  |      | 27,446    |      |   | 20,659    |  |   | 16,943   
|Non-interest income                                 |  |                                                  | 4,247     |   |      |   | 5,518     |  |      | 3,971     |      |   | 3,303     |  |   | 2,829    
|Non-interest expense                                |  |                                                  | 31,614    |   |      |   | 29,786    |  |      | 22,561    |      |   | 16,338    |  |   | 13,840   
|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Income (loss) before taxes                          |  |                                                  | (5,311    | ) |      |   | 8,333     |  |      | 8,856     |      |   | 7,624     |  |   | 5,932    
|Income tax expense (benefit)                        |  |                                                  | (2,452    | ) |      |   | 2,763     |  |      | 2,852     |      |   | 2,502     |  |   | 1,885    
|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Net income (loss)                                   |  | $                                                | (2,859    | ) |      | $ | 5,570     |  | $    | 6,004     |      | $ | 5,122     |  | $ | 4,047    
|                                                    |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|                                                    |  |                                                  |           |   |     
|Per Share Data                                      |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Net income (loss)basic                             |  | $                                                | (0.53     | ) |      | $ | 1.06      |  | $    | 1.16      |      | $ | 1.24      |  | $ | 1.09     
|Net income (loss)diluted                           |  |                                                  | (0.53     | ) |      |   | 1.06      |  |      | 1.14      |      |   | 1.21      |  |   | 1.04     
|Book value                                          |  |                                                  | 13.48     |   |      |   | 13.94     |  |      | 12.83     |      |   | 11.62     |  |   | 9.58     
|Cash dividends declared per common share            |  |                                                  | 0.00      |   |      |   | 0.00      |  |      | 0.00      |      |   | 0.00      |  |   | 0.00     
|Weighted average number shares outstanding:         |  |                                                  |           |   |      |   |           |  |      |           |      |   |           |  |   |          
|Basic                                               |  |                                                  | 5,366,658 |   |      |   | 5,265,555 |  |      | 5,170,687 |      |   | 4,123,403 |  |   | 3,724,095
|Diluted                                             |  |                                                  | 5,366,658 |   |      |   | 5,276,200 |  |      | 5,278,711 |      |   | 4,247,334 |  |   | 3,885,490



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|                                                         |  |                                         |    |  |        |    |  |        |   |  |        |   |  |        |  
|-------------------------------------------------------- |  | --------------------------------------- | -- |  | ------ | -- |  | ------ | - |  | ------ | - |  | ------ | -
|                                                         |  | At and for the Years Ended December 31, |   
|                                                         |  | 2008                                    |    |  | 2007   |    |  | 2006   |   |  | 2005   |   |  | 2004   |  
|Performance Ratios                                       |  |                                         |    |  |        |    |  |        |   |  |        |   |  |        |  
|Return on average assets                                 |  | (0.27                                   | )% |  | 0.65   | %  |  | 0.91   | % |  | 0.99   | % |  | 0.91   | %
|Return on average equity                                 |  | (3.80                                   | )  |  | 7.93   |    |  | 9.57   |   |  | 12.18  |   |  | 12.23  |  
|Net interest margin (1)                                  |  | 3.61                                    |    |  | 4.68   |    |  | 5.04   |   |  | 4.77   |   |  | 4.43   |  
|Efficiency ratio (2)                                     |  | 79.05                                   |    |  | 69.53  |    |  | 65.07  |   |  | 62.42  |   |  | 65.81  |  
|Loan to deposit ratio                                    |  | 87.38                                   |    |  | 99.99  |    |  | 97.03  |   |  | 96.64  |   |  | 98.91  |  
|                                                         |  |                                         |    |  |       
|Asset Quality Ratios                                     |  |                                         |    |  |        |    |  |        |   |  |        |   |  |        |  
|Nonperforming loans to total loans                       |  | 3.18                                    | %  |  | 0.57   | %  |  | 0.55   | % |  | 0.24   | % |  | 0.41   | %
|Nonperforming assets to total assets                     |  | 3.50                                    |    |  | 0.64   |    |  | 0.62   |   |  | 0.21   |   |  | 0.44   |  
|Net charge-offs to average total loans                   |  | 0.95                                    |    |  | 0.36   |    |  | 0.30   |   |  | 0.12   |   |  | 0.14   |  
|Allowance for loan losses to nonperforming loans         |  | 51.51                                   |    |  | 212.57 |    |  | 220.21 |   |  | 555.36 |   |  | 279.14 |  
|Allowance for loan losses to total loans                 |  | 1.64                                    |    |  | 1.21   |    |  | 1.21   |   |  | 1.32   |   |  | 1.15   |  
|                                                         |  |                                         |    |  |       
|Capital Ratios                                           |  |                                         |    |  |        |    |  |        |   |  |        |   |  |        |  
|Average equity to average assets                         |  | 7.14                                    | %  |  | 8.14   | %  |  | 9.49   | % |  | 8.11   | % |  | 7.42   | %
|Leverage ratio                                           |  | 6.64                                    |    |  | 8.30   |    |  | 9.55   |   |  | 11.35  |   |  | 8.53   |  
|Tier 1 risk-based capital ratio                          |  | 7.96                                    |    |  | 9.36   |    |  | 10.69  |   |  | 13.27  |   |  | 10.32  |  
|Total risk-based capital ratio                           |  | 9.89                                    |    |  | 10.55  |    |  | 11.85  |   |  | 14.52  |   |  | 11.45  |  
|                                                         |  |                                         |    |  |       
|Growth Ratios and Other Data                             |  |                                         |    |  |        |    |  |        |   |  |        |   |  |        |  
|Percentage change in net income (loss)                   |  | (151.33                                 | )% |  | (7.23  | )% |  | 17.22  | % |  | 26.56  | % |  | 31.14  | %
|Percentage change in diluted net income (loss) per share |  | (150.00                                 | )  |  | (7.02  | )  |  | (5.79  | ) |  | 16.35  |   |  | 28.40  |  
|Percentage change in assets                              |  | 22.08                                   |    |  | 28.09  |    |  | 27.95  |   |  | 25.34  |   |  | 15.43  |  
|Percentage change in loans                               |  | 9.64                                    |    |  | 27.96  |    |  | 38.12  |   |  | 21.22  |   |  | 13.56  |  
|Percentage change in deposits                            |  | 25.47                                   |    |  | 24.03  |    |  | 37.57  |   |  | 24.07  |   |  | 14.59  |  
|Percentage change in equity                              |  | (1.66                                   | )  |  | 10.34  |    |  | 11.60  |   |  | 65.80  |   |  | 16.09  |  



|(1) | Taxable Equivalent.
|--- | -------------------

|(2) | Computed by dividing noninterest expense by the sum of net interest and noninterest income, excluding any realized gains/losses on sales of securities.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------



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|ITEM 7. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion reviews our results of operations and assesses our financial condition. You should read the following discussion and analysis
in conjunction with our Selected Consolidated Financial Data and our consolidated financial statements and the related notes included elsewhere in this Report.

Overview

We were incorporated in 1996 to serve as the holding company for Gilmer County Bank (now
Appalachian Community Bank). As of April 2007, we also serve as the holding company for Appalachian Community Bank, F.S.B.

The following
table sets forth selected measures of our financial performance for the periods indicated.



|                     |  |                          |           |   |      |   |         |  |   |        
|-------------------- |  | ------------------------ | --------- | - | ---- | - | ------- |  | - | -------
|                     |  | Years Ended December 31,
|                     |  | 2008                     |           |   | 2007 |   | 2006   
|                     |  | (In thousands)          
|Net income (loss)    |  | $                        | (2,859    | ) |      | $ | 5,570   |  | $ | 6,004  
|Total assets         |  |                          | 1,185,678 |   |      |   | 971,200 |  |   | 758,214
|Total loans(1)       |  |                          | 885,374   |   |      |   | 807,522 |  |   | 631,053
|Total deposits       |  |                          | 1,013,276 |   |      |   | 807,597 |  |   | 651,134
|Shareholders equity |  |                          | 72,438    |   |      |   | 73,663  |  |   | 66,763 



|(1) | Loans are net of unearned income
|--- | --------------------------------

Like most community
banks and thrifts, we derive the majority of our income from interest and fees received on our loans. Our primary sources of funds for making these loans and investments are our deposits and advances from the Federal Home Loan Bank of Atlanta
(FHLB). Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income earned on our interest-earning assets, such as loans and investments, and the interest paid on our
interest-bearing liabilities, such as deposits and advances from the FHLB. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net
interest spread.

We have included a number of tables to assist in our description of these measures. For example, the Average
Balances, Income and Expense and Rates tables show for the periods indicated the average balance for each category of our assets and liabilities, as well as the yield we earned or the rate we paid with respect to each category. A review of
these tables show that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we intend to channel a substantial percentage of our earning assets into our loan portfolio. Similarly, the
Analysis of Changes in Net Interest Income table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the periods shown. We also track the sensitivity of our various categories of
assets and liabilities to changes in interest rates, and we have included an Interest Sensitivity Analysis table to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our
loans, our deposits and other borrowings.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb
probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. We have included a detailed discussion of this process, as well as
several tables describing our allowance for loan losses.

In addition to earning interest on our loans and investments, we earn income
through fees and other charges to our customers. We have also included a discussion of the various components of this noninterest income, as well as of our noninterest expense, included in the Noninterest Income and Expense section.



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The following discussion and analysis also identifies significant factors that have affected our
financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information
included in this Report.

Critical Accounting Policies

In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States as well as the
general practices within the banking and thrift industry. Our significant accounting policies are described in the notes to our audited consolidated financial statements included in this Report.

Certain accounting policies involve significant judgments and assumptions by management that may have a material impact on the carrying value of certain
assets and liabilities. We consider such accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which are believed to be reasonable under the circumstances.
Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates. These differences could have a material impact on our carrying values of assets and liabilities and our results of
operations.

We believe the determination of the allowance for loan losses is the critical accounting policy that requires the most
significant judgments and estimates when preparing our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the
estimated value of the underlying collateral, cash flow assumptions, determination of loss factors for estimating credit losses, the impact of current events and other factors impacting the level of probable inherent losses. Under different
conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from managements estimates provided in our consolidated financial statements. Refer to the section entitled Allowance for Loan
Losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Results of Operations

Income Statement Review

Overview

For the year ended December 31, 2008, we had a net loss of $2.9 million, or $(0.53) basic net loss per common share, as compared
to a net income of $5.6 million, or $1.06 basic net income per common share, for the year ended December 31, 2007, and compared to a net income of $6.0 million, or $1.16 basic net income per common share, for the year ended December 31,
2006.

Our net loss for 2008 is primarily due to the large increase in our provision for loan losses, our decrease to net interest margin,
losses on our sales of other real estate (ORE), the write-down of our 20,000 shares of Federal Home Loan Mortgage Corporation (Freddie Mac) Preferred Stock, our increase in nonaccrual loans, and the increases to other
operating expenses necessary to support the Companys growth.

Net Interest Income

Years Ended December 31, 2008, 2007, and 2006

Our primary source of revenue is net interest income, which represents the difference between the income on interest-earning assets and expense on interest-bearing liabilities. Net interest income decreased $2.4
million, or 6.3%, to $35.0 million for 2008, compared to $37.3 million for 2007. Net interest income increased $6.6 million, or 21.6%, to $37.3 million for 2007, compared to $30.7 million for 2006. During the year ended December 31, 2008, the
Prime rate (Prime) dropped a total of 4.00%. These decreases lowered the yield on earning assets more rapidly than it lowered the cost of funds. The average maturity of our time deposits at December 31, 2008 was 7.5 months. These
time deposits made up 67% of our total deposits at December 31, 2008. Additionally, loans placed on nonaccrual status during 2008 required us to reverse interest income associated with these loans. This interest



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reversal had an effect on our net interest margin for the year ended December 31, 2008 of 22 basis points. Core deposit growth in our newest markets has
allowed us to replace alternative funding sources with core deposits. Our core deposits, which exclude national and brokered deposits, have grown $182.8 million since December 31, 2007, of which $50.5 million of this growth is directly related
to the opening of our Chatsworth facility in February 2008, and our Dawsonville facility in November 2007. During 2008, we began construction to replace three of our current temporary locations in Dawson County, Georgia, Dahlonega, Georgia and in
Murphy, North Carolina. We opened our Dawson County and Dahlonega, Georgia facilities in December 2008 and we moved into our Murphy, North Carolina facility in January 2009. The net interest income increase from 2006 to 2007 was primarily the result
of the growth in our loan portfolio during 2007.

The trend in net interest income is also evaluated in terms of average rates using the
net interest margin and the interest rate spread. The net interest margin, or the net yield on earning assets, is computed by dividing fully taxable equivalent net interest income by average earning assets. This ratio represents the difference
between the average yield returned on average earning assets and the average rate paid for funds used to support those earning assets, including both interest-bearing and noninterest-bearing sources. The net interest margin for 2008 was 3.61%
compared to a net interest margin of 4.68% in 2007 and 5.04% in 2006. Net interest spread, the difference between the average yield on earning assets and the average rate paid on interest-bearing sources of funds, was 3.39% in 2008, compared to
4.25% in 2007, and 4.53% in 2006. During 2008, the prime rate decreased a total of 400 basis points, which decreased the yield on our earning assets more rapidly than our cost of funds. Our certificate of deposit rates for similar maturities did not
follow these decreases, yet our prime-based loan portfolio rates decreased immediately. The average maturity of our certificate of deposit portfolio at the end of 2008 was 7.5 months and our loan portfolio is comprised of 62% fixed rate loans. We
believe that these factors will be beneficial as we adjust to a lower interest rate environment and continue to manage our margin. Although we continue to confront this margin compression with lower cost alternative funding sources, we must pay
competitive rates in order to continue our core deposit growth strategy for liquidity purposes. We believe that, as our current temporary branch locations are converted to permanent banking facilities in our expansion markets, we will continue to
grow core deposits and this will allow us to replace alternative funding sources with these core deposits. Until then, we will continue to use alternative funding sources as secondary sources to fund loan growth when necessary. We also believe that
the Federal Reserves rate drops will dictate much lower competitive deposit rates because this interest margin squeeze is a banking industry concern and not unique to our company.



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Average Balances, Income and Expenses, and Rates. The following table shows, for years ended
December 31, 2008, 2007 and 2006, the average daily balances outstanding for the major categories of interest-earning assets and interest-bearing liabilities, and the average interest rate earned or paid. Such yields are calculated by dividing
income or expense by the average daily balance of the corresponding assets or liabilities.

Average Balances, Income and Expenses, and
Rates



|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|--------------------------------------- |  | ------------------------ | ------- | -------------- | ---- | ------------ |  | ---- | -------------- |  | -------------- | ------- | ------------ | - | ------ | -------------- | ---- | -------------- |  | ------------ | ------- |  | - | ------ |  | ---- | -
|                                        |  | Years Ended December 31, |        
|                                        |  | 2008                     |         |                | 2007 |              |  | 2006 |               
|                                        |  | AverageBalance           |         | Income/Expense |      | Yields/Rates |  |      | AverageBalance |  | Income/Expense |         | Yields/Rates |   |        | AverageBalance |      | Income/Expense |  | Yields/Rates |        
|                                        |  | (Dollars in thousands)   |        
|Earning assets:                         |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Loans, held for sale                    |  | $                        | 3,075   |                | $    | 178          |  | 5.79 | %              |  | $              | 3,356   |              | $ | 205    |                | 6.11 | %              |  | $            | 60      |  | $ | 2      |  | 3.33 | %
|Loans, net of unearned income(1)        |  |                          | 856,912 |                |      | 64,481       |  | 7.52 |                |  |                | 716,737 |              |   | 68,035 |                | 9.49 |                |  |              | 537,914 |  |   | 49,869 |  | 9.27 |  
|Investment securities(2)                |  |                          | 80,824  |                |      | 4,178        |  | 5.17 |                |  |                | 77,099  |              |   | 3,839  |                | 4.98 |                |  |              | 72,450  |  |   | 3,338  |  | 4.61 |  
|Interest-bearing deposits               |  |                          | 1,375   |                |      | 16           |  | 1.16 |                |  |                | 1,497   |              |   | 78     |                | 5.21 |                |  |              | 632     |  |   | 30     |  | 4.75 |  
|Federal funds sold                      |  |                          | 35,953  |                |      | 513          |  | 1.43 |                |  |                | 6,176   |              |   | 338    |                | 5.47 |                |  |              | 6,539   |  |   | 351    |  | 5.37 |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Total interest-earning assets(3)        |  | $                        | 978,139 |                |      | 69,366       |  | 7.09 |                |  | $              | 804,865 |              |   | 72,495 |                | 9.01 |                |  | $            | 617,595 |  |   | 53,590 |  | 8.68 |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Interest-bearing liabilities:           |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Demand deposits                         |  | $                        | 79,322  |                |      | 1,800        |  | 2.27 |                |  | $              | 62,943  |              |   | 1,389  |                | 2.21 |                |  | $            | 74,125  |  |   | 1,610  |  | 2.17 |  
|Savings deposits                        |  |                          | 183,234 |                |      | 4,774        |  | 2.61 |                |  |                | 185,799 |              |   | 7,992  |                | 4.30 |                |  |              | 105,022 |  |   | 3,544  |  | 3.38 |  
|Time deposits                           |  |                          | 579,366 |                |      | 24,419       |  | 4.22 |                |  |                | 431,565 |              |   | 22,986 |                | 5.33 |                |  |              | 315,429 |  |   | 15,197 |  | 4.82 |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Total deposits                          |  |                          | 841,922 |                |      | 30,993       |  | 3.68 |                |  |                | 680,307 |              |   | 32,367 |                | 4.76 |                |  |              | 494,576 |  |   | 20,351 |  | 4.12 |  
|Other short-term borrowings             |  |                          | 13,858  |                |      | 417          |  | 3.01 |                |  |                | 8,271   |              |   | 283    |                | 3.42 |                |  |              | 12,178  |  |   | 472    |  | 3.88 |  
|Long-term debt                          |  |                          | 65,245  |                |      | 2,624        |  | 4.02 |                |  |                | 43,226  |              |   | 2,150  |                | 4.97 |                |  |              | 34,976  |  |   | 1,671  |  | 4.78 |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Total interest-bearing liabilities      |  | $                        | 921,025 |                |      | 34,034       |  | 3.70 |                |  | $              | 731,804 |              |   | 34,800 |                | 4.76 |                |  | $            | 541,730 |  |   | 22,494 |  | 4.15 |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Net interest income/net interest spread |  |                          |         |                |      | 35,332       |  | 3.39 | %              |  |                |         |              |   | 37,695 |                | 4.25 | %              |  |              |         |  |   | 31,096 |  | 4.53 | %
|Net yield on earning assets             |  |                          |         |                |      |              |  | 3.61 | %              |  |                |         |              |   |        |                | 4.68 | %              |  |              |         |  |   |        |  | 5.04 | %
|Taxable equivalent adjustment:          |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Loans                                   |  |                          |         |                |      | 22           |  |      |                |  |                |         |              |   | 27     |                |      |                |  |              |         |  |   | 28     |  |      |  
|Investment securities                   |  |                          |         |                |      | 339          |  |      |                |  |                |         |              |   | 341    |                |      |                |  |              |         |  |   | 369    |  |      |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Total taxable equivalent adjustment     |  |                          |         |                |      | 361          |  |      |                |  |                |         |              |   | 368    |                |      |                |  |              |         |  |   | 397    |  |      |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  
|Net interest income                     |  |                          |         |                | $    | 34,971       |  |      |                |  |                |         |              | $ | 37,327 |                |      |                |  |              |         |  | $ | 30,699 |  |      |  
|                                        |  |                          |         |                |      |              |  |      |                |  |                |         |              |   |        |                |      |                |  |              |         |  |   |        |  |      |  



|(1) | Average loans exclude nonaccrual loans of $8.3, $3.2, and $1.6 million for years ended December 31, 2008, 2007 and 2006, respectively. All loans and deposits are domestic.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) | Average securities exclude average unrealized gains/(losses) of $379,000, $(257,000), and $(839,000) for years ended December 31, 2008, 2007, and 2006, respectively.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Tax equivalent adjustments have been based on an assumed tax rate of 39%.
|--- | -------------------------------------------------------------------------



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Analysis of Changes in Net Interest Income. The following table sets forth a summary of the
changes in interest income and interest expense resulting from changes in interest rates and in changes in the volume of earning assets and interest-bearing liabilities, segregated by category. The change due to volume is calculated by multiplying
the change in volume by the prior years rate. The change due to rate is calculated by multiplying the change in the applicable rate by the prior years volume. Figures are presented on a taxable equivalent basis. The change in interest
due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Analysis of Changes in Net Interest Income



|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|--------------------------------------- |  | --------------------------------------------- | ------ | - | --------------------------------------------- | - | ------- | ---------- |  | - | ------ | - |  | ---- | ------ | - | ---------- | - | ------ | - |  | - | ------ | -
|                                        |  | For the Years EndedDecember 31, 2008 vs. 2007 |        |   | For the Years EndedDecember 31, 2007 vs. 2006 |  
|                                        |  | Volume                                        |        |   | Rate                                          |   |         | Net Change |  |   | Volume |   |  | Rate |        |   | Net Change |  
|                                        |  | (In thousands)                                |       
|Earning assets:                         |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Loans, held for sale                    |  | $                                             | (17    | ) |                                               | $ | (10     | )          |  | $ | (27    | ) |  | $    | 200    |   |            | $ | 3      |   |  | $ | 203    |  
|Loans, net of unearned income           |  |                                               | 11,975 |   |                                               |   | (15,529 | )          |  |   | (3,554 | ) |  |      | 16,955 |   |            |   | 1,211  |   |  |   | 18,166 |  
|Investment securities                   |  |                                               | 189    |   |                                               |   | 150     |            |  |   | 339    |   |  |      | 222    |   |            |   | 279    |   |  |   | 501    |  
|Interest bearing deposits               |  |                                               | (6     | ) |                                               |   | (56     | )          |  |   | (62    | ) |  |      | 45     |   |            |   | 3      |   |  |   | 48     |  
|Federal funds sold                      |  |                                               | 585    |   |                                               |   | (410    | )          |  |   | 175    |   |  |      | (20    | ) |            |   | 7      |   |  |   | (13    | )
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Total earning assets                    |  |                                               | 12,726 |   |                                               |   | (15,855 | )          |  |   | (3,129 | ) |  |      | 17,402 |   |            |   | 1,503  |   |  |   | 18,905 |  
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Interest-bearing liabilities:           |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Demand deposits                         |  |                                               | 371    |   |                                               |   | 40      |            |  |   | 411    |   |  |      | (246   | ) |            |   | 25     |   |  |   | (221   | )
|Savings deposits                        |  |                                               | (109   | ) |                                               |   | (3,109  | )          |  |   | (3,218 | ) |  |      | 3,278  |   |            |   | 1,170  |   |  |   | 4,448  |  
|Time deposits                           |  |                                               | 6,851  |   |                                               |   | (5,418  | )          |  |   | 1,433  |   |  |      | 6,054  |   |            |   | 1,735  |   |  |   | 7,789  |  
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Total deposits                          |  |                                               | 7,113  |   |                                               |   | (8,487  | )          |  |   | (1,374 | ) |  |      | 9,086  |   |            |   | 2,930  |   |  |   | 12,016 |  
|Other short-term borrowings             |  |                                               | 172    |   |                                               |   | (38     | )          |  |   | 134    |   |  |      | (138   | ) |            |   | (51    | ) |  |   | (189   | )
|Long-term debt                          |  |                                               | 943    |   |                                               |   | (469    | )          |  |   | 474    |   |  |      | 408    |   |            |   | 71     |   |  |   | 479    |  
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Total interest-bearing liabilities      |  |                                               | 8,228  |   |                                               |   | (8,994  | )          |  |   | (766   | ) |  |      | 9,356  |   |            |   | 2,950  |   |  |   | 12,306 |  
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  
|Net interest income/net interest spread |  | $                                             | 4,498  |   |                                               | $ | (6,861  | )          |  | $ | (2,363 | ) |  | $    | 8,046  |   |            | $ | (1,447 | ) |  | $ | 6,599  |  
|                                        |  |                                               |        |   |                                               |   |         |            |  |   |        |   |  |      |        |   |            |   |        |   |  |   |        |  

Provision for Loan Losses

Years Ended December 31, 2008, 2007 and 2006

The provision for loan losses is based on the
growth of the loan portfolio, the amount of net loan losses incurred and managements estimation of potential future losses based on an evaluation of the risk in the loan portfolio. The provision for loan losses was $12.9 million for 2008, $4.7
million for 2007, and $3.3 million for 2006. Please see the discussion below under Allowance for Loan Losses for a description of the factors we consider in determining the amount of the provision we expense each period to maintain this
allowance.

Noninterest Income

Years Ended December 31, 2008, 2007 and 2006

Noninterest income for 2008, 2007 and 2006 totaled $4.2 million, $5.5
million, and $4.0 million, respectively. These amounts are primarily from customer service fees, mortgage origination commissions, insurance commissions, as well as other fees charged to customers such as safe deposit box rental and ATM fees.
Customer



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service fees increased from from $1.7 million in 2006, to $2.2 in 2007, and grew to $2.5 million in 2008. The increase in customer service fees for all years
is primarily related to deposits growth through our continuing efforts to gain market share in our newly established facilities. We also are continuing our efforts to increase the amount of deposit account charges based on our surveys of
competitors. As a result, non-sufficient funds (NSF) and returned check charges increased during 2008. Mortgage origination commissions increased from $1.3 million in 2006 to $2.0 million in 2007 and decreased to $1.4 million in 2008. The increase
in mortgage origination commissions from 2006 to 2007 relates primarily to the additional mortgage activity generated from our expansion initiative, however, the economic decline that our area experienced in 2008 greatly reduced mortgage activity.
Noninterest income for the year ended December 31, 2008 was offset by net losses on sales of securities in the amount of $776,000, compared to a net gain of $7,000 for the same period in 2007 and $-0- net gains/losses for the year ended
December 31, 2006. The 2008 net securities losses include the recognition of the loss on our Freddie Mac Preferred Stock in the amount of $816,000.

Noninterest Expenses

Years Ended December 31, 2008, 2007 and 2006

Noninterest expenses totaled $31.6 million in 2008, up from $29.8 million in 2007, and $22.6 million in 2006. As a percentage of total assets, our total
noninterest expenses increased from 3.0% in 2006 to 3.1% in 2007, and decreased to 2.7% in 2008. Salaries and employee benefits increased $233,000, or 1.3%, to $17.7 million in 2008, and increased $4.2 million, or 31.3%, to $17.5 million in 2007. As
part of managements efforts to keep costs at a minimum in 2008, we have reduced our workforce in areas where feasible, however this was the first full year of operations for two of our newly built facilities. Since December 31, 2007, we
added only five full time equivalent staff. The increase from 2006 to 2007 in salaries and employee benefits was primarily due to the additional staff necessary to support our existing market growth and our expansion initiative, as well as the
addition of several management-level employees necessary to provide the infrastructure to support our continued growth. During 2006, 97 full-time equivalent employees were hired, of which 2007 was the first full year that experienced this staffing
increase. In addition, certain of the agreements under our salary continuation plan were amended in May and August of 2006, which caused an increase in noninterest expenses of approximately $153,000 from 2006 to 2007.

Occupancy, furniture and equipment expenses totaled $4.3 million in 2008, $3.7 million in 2007, and $2.7 million in 2006. The 16.5% and 37.0% increases
from 2007 to 2008 and from 2006 to 2007, respectively are primarily due to our expansion initiative which increased the number of branches and loan production offices from four locations to 13. As noted earlier, two of our newly built facilities had
their first full year of depreciation in 2008. Additionally, we just completed three new branch facilities, two in December 2008 and another in January 2009.

Other operating expenses increased to $9.6 million from $8.6 million in 2007 and from $6.5 million in 2006. The increases for all years is primarily the result of increased losses on sales of ORE and related ORE
expenses, increases in state regulatory examination fees and FDIC deposit-assessments, amortization costs, and data processing costs. Net losses on sales of ORE were approximately $764,000 in 2008, an increase of $500,000, compared to $264,000 in
2007 and $32,000 in 2006. ORE related expenses were $347,000 in 2008, compared to $206,000 in 2007 and $32,000 in 2006. Our FDIC deposit insurance and state regulatory examination costs were $927,000 in 2008, an increase of $734,000 compared to
$193,000 in 2007 and $109,000 in 2006. These increases were due primarily to the increase in our FDIC deposit-insurance assessments, which occurred in the third quarter of 2007, as well as the increase in premiums relating to our growth in deposits
as compared to the prior periods. Data processing fees increased by $104,000, to just over $1.0 million in 2008, compared to $932,000 in 2007 and 776,000 in 2006. Data processing increases were due to our market share growth, as well as the addition
of the thrift in 2007. Our director and committee fees and other director compensation expenses increased by $100,000 to $887,000 in 2008, compared to $787,000 in 2007 and $608,000 in 2006. This increase was due in part to an increase in committee
fees paid to directors, addition of community directors for our new markets, as well as increased retirement benefit expenses. Also, we had increases in postage, correspondent bank charges, as well as ATM costs and other various expenses which were
all necessary to support our new thrift charter, expanded market growth and new branches. In 2008 these costs were offset in part by a decrease in our marketing expenses of $435,000 to $1.3 million in 2008, from $1.7 million in 2007, as well as
various other expense decreases resulting from managements



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efforts keep expenses at a minimum. The $239,000 increase in marketing expenses from 2006 to 2007 was due to the increased advertising and promotional
activities necessitated by our expansion initiative.

Balance Sheet Review

General

At December 31, 2008, we had total assets of $1.2 billion, consisting principally of
$870.9 million in net loans (net of allowance of $14.5 million), $79.3 million in securities available-for-sale, $146.9 million in cash and cash equivalents, and $39.6 million in net premises and equipment (net of accumulated depreciation of $7.1
million). Our liabilities at December 31, 2008 totaled $1.1 billion, consisting principally of $1.0 billion in deposits, $72.0 million in FHLB advances, $10.6 million of short-term borrowings and $12.5 million of subordinated long-term capital
notes. At December 31, 2008, our shareholders equity was $72.4 million.

At December 31, 2007, we had total assets of
$971.2 million, consisting principally of $797.7 million in net loans (net of allowance of $9.8 million), $76.6 million in securities available-for-sale, $26.5 million in cash and cash equivalents, and $33.0 million in net premises and equipment
(net of accumulated depreciation of $5.9 million). Our liabilities at December 31, 2007 totaled $897.5 million, consisting principally of $807.6 million in deposits, $57.4 million in FHLB advances, $21.0 million of short-term borrowings and
$6.2 million of subordinated long-term capital notes. At December 31, 2007, our shareholders equity was $73.7 million.

Federal Funds Sold

Management maintains federal funds sold as a tool in managing daily cash needs. Federal funds sold at December 31, 2008 and
December 31, 2007 were $133.4 million and $12.8 million, respectively. The increase in federal funds sold is the primary result of efforts to improve our liquidity using core deposits and not renew various alternative funding as they mature.
Average federal funds sold for the twelve months ended December 31, 2008 and 2007 were approximately $36.0 million or 3.7% of average earning assets, and approximately $6.2 million, or 0.8% of average earning assets, respectively. Although we
use federal funds as a source of liquidity, we prefer core deposits to alternative funding.

Securities Portfolio

The primary objectives of our investment strategy are to maintain an appropriate level of liquidity, and to provide a tool with which to control our
interest rate position while, at the same time, producing adequate levels of interest income.

The following table presents the carrying
amounts of the securities portfolio at December 31 in each of the last three years.



|                               |  |                |        |      |   |        |  |   |       
|------------------------------ |  | -------------- | ------ | ---- | - | ------ |  | - | ------
|                               |  | December 31,  
|                               |  | 2008           |        | 2007 |   | 2006  
|                               |  | (In thousands)
|Securities Available-for-Sale: |  |                |        |      |   |        |  |   |       
|Government sponsored agencies  |  | $              | 30,982 |      | $ | 33,159 |  | $ | 43,396
|State and municipal securities |  |                | 10,913 |      |   | 14,031 |  |   | 13,148
|Mortgage-backed securities     |  |                | 37,215 |      |   | 28,513 |  |   | 14,833
|Equity securities              |  |                | 198    |      |   | 862    |  |   | 1,036 
|                               |  |                |        |      |   |        |  |   |       
|Total                          |  | $              | 79,308 |      | $ | 76,565 |  | $ | 72,413
|                               |  |                |        |      |   |        |  |   |       

Equity securities includes Federal Home Loan Bank preferred stock with a carrying value of $6,000,
$671,000 and $850,000 at December 31, 2008, 2007 and 2006, respectively; an investment in Appalachian Capital Trust I in the amount of $186,000 at December 31, 2008, 2007 and 2006; and an investment of $5,500 in a mortgage cooperative at
December 31, 2008 and 2007.



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Gross unrealized gains in the portfolio amounted to $1.7 million at year-end 2008 and gross unrealized
losses amounted to $274,000. Gross unrealized gains in the portfolio amounted to $847,000 at year-end 2007 and gross unrealized losses amounted to $421,000. Gross unrealized gains in the portfolio amounted to $502,000 at year-end 2006 and gross
unrealized losses amounted to $837,000. During the third quarter of 2008, the Company recognized an other than temporary impairment charge of $816,000 on its investment in Freddie Mac preferred stock. The value of these securities declined
significantly after the U.S. Government placed the company into conservatorship in September 2008. The remaining carrying value of the preferred stock at December 31, 2008 is $6,000.

At December 31, 2008, 2007 and 2006 the percentage of the total carrying value of the securities portfolio to total assets was 6.7%, 7.9%, and 9.9%,
respectively.

The maturities and weighted average yields of our investments in securities (all available for sale) at December 31,
2008 are presented below. Taxable equivalent adjustments (using a 39% tax rate) have been made in calculating yields on tax-exempt obligations.



|                               |  |                        |       |         |                                |   |        |                                |         |  |                |        |  |         |        |  |        |   |         |   |        |  |       |  
|------------------------------ |  | ---------------------- | ----- | ------- | ------------------------------ | - | ------ | ------------------------------ | ------- |  | -------------- | ------ |  | ------- | ------ |  | ------ | - | ------- | - | ------ |  | ----- | -
|                               |  | Maturing               |      
|                               |  | Within One Year        |       |         | After One ButWithin Five Years |   |        | After Five ButWithin Ten Years |         |  | AfterTen Years |       
|                               |  | Amount                 |       | % Yield |                                |   | Amount |                                | % Yield |  |                | Amount |  | % Yield |        |  | Amount |   | % Yield |  
|                               |  | (Dollars in thousands) |      
|Securities Available-for-Sale: |  |                        |       |         |                                |   |        |                                |         |  |                |        |  |         |        |  |        |   |         |   |        |  |       |  
|Government sponsored agencies  |  | $                      | 5,108 |         | 4.09                           | % |        | $                              | 11,059  |  | 4.86           | %      |  | $       | 11,256 |  | 5.05   | % |         | $ | 3,559  |  | 5.24  | %
|State and municipal            |  |                        |      |         | 0.00                           |   |        |                                | 965     |  | 7.82           |        |  |         | 3,703  |  | 8.09   |   |         |   | 6,245  |  | 7.78  |  
|Mortgage-backed                |  |                        |      |         | 0.00                           |   |        |                                | 468     |  | 3.66           |        |  |         | 2,871  |  | 4.13   |   |         |   | 33,876 |  | 5.25  |  
|Equity securities              |  |                        |      |         | 0.00                           |   |        |                                |        |  | 0.00           |        |  |         |       |  | 0.00   |   |         |   | 198    |  | 15.14 |  
|                               |  |                        |       |         |                                |   |        |                                |         |  |                |        |  |         |        |  |        |   |         |   |        |  |       |  
|Total Securities               |  | $                      | 5,108 |         | 4.09                           |   |        | $                              | 12,492  |  | 5.05           |        |  | $       | 17,830 |  | 5.54   |   |         | $ | 43,878 |  | 5.63  |  
|                               |  |                        |       |         |                                |   |        |                                |         |  |                |        |  |         |        |  |        |   |         |   |        |  |       |  

There were no securities held by us of which the aggregate value by issuer on December 31,
2008 exceeded 10% of shareholders equity at that date. Securities which are payable from and secured by the same source of revenue or taxing authority are considered to be securities of a single issuer. Securities of Government agencies and
corporations are not included.

Loan Portfolio

Loans make up the largest component of our earning assets. In 2008, average loans (excluding average nonaccrual loans of $8.3 million) represented 88.0%, while in 2007 average loans (excluding average nonaccrual loans of $3.2 million)
represented 89.1%. Average loans increased to $856.9 million (excluding average nonaccrual loans of $8.3 million) with a yield of 7.52% in 2008, from $716.7 million (excluding average nonaccrual loans of $3.2 million) with a yield of 9.5% in 2007.
The ratio of total loans to total deposits was 87.4% in 2008 and 100.0% in 2007.

Our business model, which includes having strong
connected local bankers in each of our geographic markets, gives us a unique ability to monitor loan activity. We continue to see a slowing in the requests for acquisition, development and construction loans. Consistent with much of the country, the
residential real estate market in North Georgia has slowed considerably, and it is estimated that there is approximately a 20 to 27 month supply of housing on the market at December 31, 2008. This is an improvement over this same time last
year, as it was estimated that we had a 36 to 40 months supply at December 31, 2007. In December 2008, we experienced a slight increase in residential real estate loan activity due to the lower mortgage rates, which has continued into
2009. A special assets group was formed in May of 2008 to deal exclusively with real estate related credit issues.



38



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##### Table of Contents

The following table shows the classification of loans by major category at December 31, 2008, and
for each of the preceding four years.



|                                       |  |                        |         |   |                |       |   |        |   |         |                |  |       |        |  |   |                |   |  |        |   |  |                |         |   |        |       |   |                |   |         |   |  |       |  
|-------------------------------------- |  | ---------------------- | ------- | - | -------------- | ----- | - | ------ | - | ------- | -------------- |  | ----- | ------ |  | - | -------------- | - |  | ------ | - |  | -------------- | ------- | - | ------ | ----- | - | -------------- | - | ------- | - |  | ----- | -
|                                       |  | December 31,           |        
|                                       |  | 2008                   |         |   | 2007           |       |   | 2006   |   |         | 2005           |  |       | 2004   | 
|                                       |  | Amount                 |         |   | PercentofTotal |       |   | Amount |   |         | PercentofTotal |  |       | Amount |  |   | PercentofTotal |   |  | Amount |   |  | PercentofTotal |         |   | Amount |       |   | PercentofTotal |  
|                                       |  | (Dollars in thousands) |        
|Commercial, financial and agricultural |  | $                      | 72,543  |   |                | 8.2   | % |        | $ | 48,749  |                |  | 6.0   | %      |  | $ | 40,491         |   |  | 6.4    | % |  | $              | 33,778  |   |        | 7.4   | % |                | $ | 31,920  |   |  | 8.5   | %
|Real estate - construction(1)          |  |                        | 389,339 |   |                | 44.0  |   |        |   | 389,695 |                |  | 48.3  |        |  |   | 320,406        |   |  | 50.7   |   |  |                | 203,538 |   |        | 44.5  |   |                |   | 145,588 |   |  | 38.6  |  
|Real estate - other(2)                 |  |                        | 386,227 |   |                | 43.6  |   |        |   | 332,856 |                |  | 41.2  |        |  |   | 241,569        |   |  | 38.2   |   |  |                | 193,704 |   |        | 42.3  |   |                |   | 173,955 |   |  | 46.1  |  
|Consumer                               |  |                        | 28,574  |   |                | 3.2   |   |        |   | 30,598  |                |  | 3.8   |        |  |   | 25,386         |   |  | 4.0    |   |  |                | 21,051  |   |        | 4.6   |   |                |   | 20,957  |   |  | 5.6   |  
|Other loans                            |  |                        | 8,691   |   |                | 1.0   |   |        |   | 5,624   |                |  | 0.7   |        |  |   | 3,934          |   |  | 0.7    |   |  |                | 5,347   |   |        | 1.2   |   |                |   | 4,932   |   |  | 1.2   |  
|                                       |  |                        |         |   |                |       |   |        |   |         |                |  |       |        |  |   |                |   |  |        |   |  |                |         |   |        |       |   |                |   |         |   |  |       |  
|                                       |  |                        | 885,374 |   |                | 100.0 | % |        |   | 807,522 |                |  | 100.0 | %      |  |   | 631,786        |   |  | 100.0  | % |  |                | 457,418 |   |        | 100.0 | % |                |   | 377,352 |   |  | 100.0 | %
|                                       |  |                        |         |   |                |       |   |        |   |         |                |  |       |        |  |   |                |   |  |        |   |  |                |         |   |        |       |   |                |   |         |   |  |       |  
|Allowance for loan losses              |  |                        | (14,510 | ) |                |       |   |        |   | (9,808  | )              |  |       |        |  |   | (7,670         | ) |  |        |   |  |                | (6,059  | ) |        |       |   |                |   | (4,349  | ) |  |       |  
|                                       |  |                        |         |   |                |       |   |        |   |         |                |  |       |        |  |   |                |   |  |        |   |  |                |         |   |        |       |   |                |   |         |   |  |       |  
|Net loans                              |  | $                      | 870,864 |   |                |       |   |        | $ | 797,714 |                |  |       |        |  | $ | 624,116        |   |  |        |   |  | $              | 451,359 |   |        |       |   |                | $ | 373,003 |   |  |       |  
|                                       |  |                        |         |   |                |       |   |        |   |         |                |  |       |        |  |   |                |   |  |        |   |  |                |         |   |        |       |   |                |   |         |   |  |       |  



|(1) | The real estate - construction category includes residential construction and development loans and commercial construction loans.
|--- | ------------------------------------------------------------------------------------------------------------------------------------

|(2) | The real estate - other category includes one-to-four family residential, home equity, multi-family (five or more) residential, commercial real estate and undeveloped
agricultural real estate loans.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The following table shows the maturity distribution of selected loan classifications at
December 31, 2008, and an analysis of these loan maturities.



|                                       |  |                 |         |                               |   |                                                |  |       |        |                           |   |                           |  |   |         |  |   |       
|-------------------------------------- |  | --------------- | ------- | ----------------------------- | - | ---------------------------------------------- |  | ----- | ------ | ------------------------- | - | ------------------------- |  | - | ------- |  | - | ------
|                                       |  | Maturity        |         |                               |   | Rate Structure for LoansMaturing Over One Year
|                                       |  | One Yearor Less |         | Over OneYearThroughFive Years |   | OverFiveYears                                  |  | Total |        | PredeterminedInterestRate |   | Floating orAdjustableRate
|                                       |  | (In thousands) 
|Commercial, financial and agricultural |  | $               | 46,529  |                               | $ | 13,395                                         |  | $     | 12,619 |                           | $ | 72,543                    |  | $ | 23,441  |  | $ | 2,573 
|Real estate - construction             |  |                 | 347,106 |                               |   | 41,596                                         |  |       | 637    |                           |   | 389,339                   |  |   | 24,032  |  |   | 18,201
|Real estate - other                    |  |                 | 219,670 |                               |   | 151,105                                        |  |       | 15,452 |                           |   | 386,227                   |  |   | 134,176 |  |   | 32,381
|                                       |  |                 |         |                               |   |                                                |  |       |        |                           |   |                           |  |   |         |  |   |       
|Total                                  |  | $               | 613,305 |                               | $ | 206,096                                        |  | $     | 28,708 |                           | $ | 848,109                   |  | $ | 181,649 |  | $ | 53,155
|                                       |  |                 |         |                               |   |                                                |  |       |        |                           |   |                           |  |   |         |  |   |       



39



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##### Table of Contents

Allowance for Loan Losses

We have established an allowance for loan losses through a provision for loan losses charged as an expense on our statement of operations. The allowance
for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on estimated probable losses,
which we believe to be reasonable, but which may or may not prove to be accurate. In assessing adequacy, management relies predominantly on its ongoing review of the loan portfolio, which is undertaken both to determine whether there are probable
losses that must be charged off and to assess the risk characteristics of the aggregate portfolio. This review takes into consideration the judgments of the responsible lending officers and senior management, and also those of bank regulatory
agencies that review the loan portfolio as part of the regular bank examination process. In evaluating the allowance, management also considers our loan loss experience, the amount of past due and nonperforming loans, current economic conditions,
lender requirements and other appropriate information. Impaired loans are individually assessed for impairment under Statement of Accounting Financial Accounting Standards (SFAS) No. 114 and assigned specific allocations.

Periodically, we adjust the amount of the allowance based on changing circumstances, including changes in general economic conditions,
changes in the interest-rate environment, changes in loan concentrations in various areas of our banking activities, changes in identified troubled credits, and economic changes in our market area. We charge recognized losses to the allowance and
add subsequent recoveries back to the allowance for loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses
will not be significant to a particular accounting period.

The allocation of the allowance to the respective loan segments is an
approximation and not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses occurring in the overall loan portfolio. In addition, the allowance is subject to examination and adequacy
testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions, and other adequacy tests. Such regulatory agencies could require us to
adjust the allowance based on information available to them at the time of their examination.

At December 31, 2008, our allowance for
loan losses was $14.5 million, or 1.64% of total outstanding loans, compared to $9.8 million, or 1.21% of total outstanding loans at December 31, 2007, and $7.7 million, or 1.21% of total outstanding loans, at December 31, 2006.



40



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##### Table of Contents

The following table sets forth certain information with respect to our loans, net of unearned income, and
the allowance for loan losses for the years ended December 31, 2004 to 2008.



|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------------- |  | ----------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                    |  | Years ended December 31,      |        
|                                                                    |  | 2008                          |         |   | 2007 |   |         | 2006 |  |   | 2005    |   |  | 2004 |        
|                                                                    |  | (In thousands, except ratios) |        
|Allowance for loan losses, at beginning of period                   |  | $                             | 9,808   |   |      | $ | 7,670   |      |  | $ | 6,059   |   |  | $    | 4,349   |   |  | $ | 3,610   |  
|Loans charged off:                                                  |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Commercial, financial, and agricultural                             |  |                               | 643     |   |      |   | 149     |      |  |   | 859     |   |  |      | 359     |   |  |   | 30      |  
|Real estate - construction                                          |  |                               | 3,744   |   |      |   | 1,254   |      |  |   | 387     |   |  |      | 10      |   |  |   | 240     |  
|Real estate - other                                                 |  |                               | 3,125   |   |      |   | 833     |      |  |   | 317     |   |  |      | 41      |   |  |   | 158     |  
|Consumer                                                            |  |                               | 943     |   |      |   | 615     |      |  |   | 263     |   |  |      | 150     |   |  |   | 127     |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total loans charged off                                             |  |                               | 8,455   |   |      |   | 2,851   |      |  |   | 1,826   |   |  |      | 560     |   |  |   | 555     |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Recoveries on loans previously charged off:                         |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Commercial, financial, and agricultural                             |  |                               | 17      |   |      |   | 35      |      |  |   | 75      |   |  |      | 24      |   |  |   | 35      |  
|Real estate - construction                                          |  |                               |        |   |      |   | 25      |      |  |   | 1       |   |  |      |        |   |  |   |        |  
|Real estate - other                                                 |  |                               | 7       |   |      |   | 16      |      |  |   | 1       |   |  |      |        |   |  |   | 2       |  
|Consumer                                                            |  |                               | 218     |   |      |   | 187     |      |  |   | 107     |   |  |      | 35      |   |  |   | 22      |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                    |  |                               |         |   |     
|Total recoveries on loans previously charged off                    |  |                               | 242     |   |      |   | 263     |      |  |   | 184     |   |  |      | 59      |   |  |   | 59      |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                    |  |                               |         |   |     
|Net loans charged off                                               |  |                               | 8,213   |   |      |   | 2,588   |      |  |   | 1,642   |   |  |      | 501     |   |  |   | 496     |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                    |  |                               |         |   |     
|Provision for loan losses                                           |  |                               | 12,915  |   |      |   | 4,726   |      |  |   | 3,253   |   |  |      | 2,211   |   |  |   | 1,235   |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                    |  |                               |         |   |     
|Allowance for loan losses, at end of period                         |  | $                             | 14,510  |   |      | $ | 9,808   |      |  | $ | 7,670   |   |  | $    | 6,059   |   |  | $ | 4,349   |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                    |  |                               |         |   |     
|Loans, net of unearned income, at end of period                     |  | $                             | 885,374 |   |      | $ | 807,522 |      |  | $ | 631,786 |   |  | $    | 457,418 |   |  | $ | 377,352 |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Average loans, net of unearned income, outstanding for the period   |  | $                             | 865,225 |   |      | $ | 719,926 |      |  | $ | 539,577 |   |  | $    | 413,561 |   |  | $ | 360,261 |  
|                                                                    |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Ratios:                                                             |  |                               |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Allowance at end of period to loans, net of unearned income         |  |                               | 1.64    | % |      |   | 1.21    | %    |  |   | 1.21    | % |  |      | 1.32    | % |  |   | 1.15    | %
|Allowance at end of period to average loans, net of unearned income |  |                               | 1.68    |   |      |   | 1.36    |      |  |   | 1.42    |   |  |      | 1.47    |   |  |   | 1.21    |  
|Net charge-offs to average loans, net of unearned income            |  |                               | 0.95    |   |      |   | 0.36    |      |  |   | 0.30    |   |  |      | 0.12    |   |  |   | 0.14    |  
|Net charge-offs to allowance at end of period                       |  |                               | 56.60   |   |      |   | 26.39   |      |  |   | 21.41   |   |  |      | 8.27    |   |  |   | 11.40   |  
|Recoveries to prior year charge-offs                                |  |                               | 8.52    |   |      |   | 14.40   |      |  |   | 32.86   |   |  |      | 10.63   |   |  |   | 4.88    |  

Since 2005, economic conditions have worsened considerably and accordingly property values have
decreased. During 2008, these adverse conditions negatively impacted our borrowers ability to sell property and repay their debts timely. These events caused us to have to foreclose on the real estate collateral and lower market values led to
increased charge-offs as compared to prior periods.



41



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##### Table of Contents

The following table sets forth our estimate of the breakdown of the allowance for loan losses by loan
category and the percentage of loans in each category to total loans for the years ended December 31, 2004 to 2008.

Allocation of
Allowance for Loan Losses



|                                       |  |                        |        |  |      |   |  |      |       |  |      |   |  |      |       |  |     |   |  |   |       |  |     |   |  |   |       |  |     |  
|-------------------------------------- |  | ---------------------- | ------ |  | ---- | - |  | ---- | ----- |  | ---- | - |  | ---- | ----- |  | --- | - |  | - | ----- |  | --- | - |  | - | ----- |  | --- | -
|                                       |  | At December 31,        |       
|                                       |  | 2008                   |        |  | 2007 |   |  | 2006 |       |  | 2005 |   |  | 2004 |      
|                                       |  | (Dollars in thousands) |       
|Domestic Loans (1)                     |  |                        |        |  |      |   |  |      |       |  |      |   |  |      |       |  |     |   |  |   |       |  |     |   |  |   |       |  |     |  
|Commercial, financial and agricultural |  | $                      | 1,261  |  | 8    | % |  | $    | 2,392 |  | 6    | % |  | $    | 2,266 |  | 6   | % |  | $ | 3,209 |  | 7   | % |  | $ | 548   |  | 8   | %
|Real estate  construction             |  |                        | 6,202  |  | 44   |   |  |      | 3,836 |  | 48   |   |  |      | 1,399 |  | 51  |   |  |   | 271   |  | 45  |   |  |   | 421   |  | 39  |  
|Real estate  other                    |  |                        | 6,440  |  | 44   |   |  |      | 1,152 |  | 41   |   |  |      | 3,265 |  | 38  |   |  |   | 1,962 |  | 42  |   |  |   | 2,138 |  | 46  |  
|Consumer                               |  |                        | 465    |  | 3    |   |  |      | 1,981 |  | 4    |   |  |      | 199   |  | 4   |   |  |   | 202   |  | 5   |   |  |   | 425   |  | 6   |  
|Other                                  |  |                        | 142    |  | 1    |   |  |      | 447   |  | 1    |   |  |      | 541   |  | 1   |   |  |   | 415   |  | 1   |   |  |   | 817   |  | 1   |  
|                                       |  |                        |        |  |      |   |  |      |       |  |      |   |  |      |       |  |     |   |  |   |       |  |     |   |  |   |       |  |     |  
|Total                                  |  | $                      | 14,510 |  | 100  | % |  | $    | 9,808 |  | 100  | % |  | $    | 7,670 |  | 100 | % |  | $ | 6,059 |  | 100 | % |  | $ | 4,349 |  | 100 | %
|                                       |  |                        |        |  |      |   |  |      |       |  |      |   |  |      |       |  |     |   |  |   |       |  |     |   |  |   |       |  |     |  



|(1) | There are no foreign loans.
|--- | ---------------------------

Nonperforming Assets

Nonperforming assets include nonperforming loans and foreclosed assets. Nonperforming loans include loans classified as nonaccrual
and loans past due 90 days or more. Our general practice is to place a loan on nonaccrual status when it is contractually past due 90 days or more as to payment of principal or interest, unless the collateral value is significantly greater than both
the principal due and the accrued interest and collection of principal and interest is probable. At the time a loan is placed on nonaccrual status, interest previously accrued but not collected is reversed and charged against current earnings.
Recognition of any interest after a loan has been placed on nonaccrual status is accounted for on a cash basis. Nonperforming loans were 3.18% of total loans at December 31, 2008 and 0.57% of total loans at December 31, 2007, compared to
0.55% of total loans at December 31, 2006.

For the year ended December 31, 2008 the difference between gross interest income
that would have been recorded in such period, if the non-accruing loans had been current in accordance with their original terms, and the amount of interest income on those loans, that was included in such periods net income, was $519,000. For
each of the four years in the period ended December 31, 2007, that amount was immaterial.



42



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##### Table of Contents

The following table shows our nonperforming assets as well as the ratio of the allowance for loan losses
to total nonperforming assets, the total nonperforming loans to total loans, and the total nonperforming assets to total assets, for the years ended December 31, 2004 to 2008.



|                                                                    |  |                               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|------------------------------------------------------------------- |  | ----------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | ---- | ------ | - |  | - | ------ | -
|                                                                    |  | At December 31,               |       
|                                                                    |  | 2008                          |        |   | 2007 |   |        | 2006 |  |   | 2005   |   |  | 2004 |       
|                                                                    |  | (In thousands, except ratios) |       
|Non-accruing loans                                                  |  | $                             | 24,387 |   |      | $ | 4,250  |      |  | $ | 2,611  |   |  | $    | 1,020  |   |  | $ | 1,524  |  
|Loans past due 90 days or more                                      |  |                               | 3,783  |   |      |   | 364    |      |  |   | 871    |   |  |      | 71     |   |  |   | 34     |  
|                                                                    |  |                               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming loans                                           |  |                               | 28,170 |   |      |   | 4,614  |      |  |   | 3,482  |   |  |      | 1,091  |   |  |   | 1,558  |  
|Other real estate                                                   |  |                               | 13,171 |   |      |   | 1,504  |      |  |   | 1,218  |   |  |      | 147    |   |  |   | 516    |  
|Other repossessed property                                          |  |                               | 151    |   |      |   | 70     |      |  |   |       |   |  |      |       |   |  |   |       |  
|                                                                    |  |                               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Total nonperforming assets                                          |  | $                             | 41,492 |   |      | $ | 6,188  |      |  | $ | 4,700  |   |  | $    | 1,238  |   |  | $ | 2,074  |  
|                                                                    |  |                               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Ratios:                                                             |  |                               |        |   |      |   |        |      |  |   |        |   |  |      |        |   |  |   |        |  
|Allowance to total nonperforming assets                             |  |                               | 34.97  | % |      |   | 158.50 | %    |  |   | 163.19 | % |  |      | 489.42 | % |  |   | 209.69 | %
|                                                                    |  |                               |        |   |     
|Total nonperforming loans to total loans (net of unearned interest) |  |                               | 3.18   | % |      |   | 0.57   | %    |  |   | 0.55   | % |  |      | 0.24   | % |  |   | 0.41   | %
|                                                                    |  |                               |        |   |     
|Total nonperforming assets to total assets                          |  |                               | 3.50   | % |      |   | 0.64   | %    |  |   | 0.62   | % |  |      | 0.21   | % |  |   | 0.44   | %

The $24.4 million in non-accruing loans consist of 63 loans broken down as follows: 26 loans
totaling $15.1 million in real estate  construction loans, 25 loans totaling $8.4 million in real estate  other, 7 loans totaling $788,000 in the commercial/financial/agricultural industry and 5 loans totaling $66,000 in consumer loans.
Loans past due 90 days or more and still accruing consist of $1.8 million in real estate  construction loans, $1.8 million in real estate  other, $121,000 in commercial/financial/agricultural loans and $93,000 in consumer loans. We have
in reserve for the nonaccrual loans approximately $1.3 million at December 31, 2008.

Total impaired loans and amounts reserved at
December 31 2008 and 2007, respectively, are as follows:



|                                  |  |              |        |             |   |              |  |             |       |  |   |      
|--------------------------------- |  | ------------ | ------ | ----------- | - | ------------ |  | ----------- | ----- |  | - | -----
|                                  |  | 2008Impaired |        | 2008Reserve |   | 2007Impaired |  | 2007Reserve
|Nonaccrual loans                  |  | $            | 24,387 |             | $ | 1,342        |  | $           | 4,250 |  | $ | 500  
|Other specifically impaired loans |  |              | 12,914 |             |   | 1,950        |  |             | 2,733 |  |   | 1,483
|Restructured loans                |  |              | 20,306 |             |   |             |  |             | 1,248 |  |   |     
|                                  |  |              |        |             |   |              |  |             |       |  |   |      
|Total impaired loans              |  | $            | 57,606 |             |   | 3,292        |  | $           | 8,231 |  |   | 1,983
|                                  |  |              |        |             |   |              |  |             |       |  |   |      
|Reserve on all other loans        |  |              |        |             |   | 11,218       |  |             |       |  |   | 7,825
|                                  |  |              |        |             |   |              |  |             |       |  |   |      
|Total reserve                     |  |              |        |             | $ | 14,510       |  |             |       |  | $ | 9,808
|                                  |  |              |        |             |   |              |  |             |       |  |   |      

Deposits and Other Interest-Bearing Liabilities

Deposits are the primary source of funds to support our earning assets. Average deposits increased 21.5%, from $735.8 million in 2007 to $894.2 million in
2008. Average deposits increased 34.5%, from $546.9 million in 2006 to $735.8 million in 2007. At December 31, 2008, total deposits were $1.0 billion, of which $963.2 million or 95.1%, was interest bearing. At December 31, 2007, total
deposits were $807.6 million, of which $751.0 million or 93.0%, was interest bearing. Alternative funding sources such as FHLB Advances, national Certificates of DepositCertificates of Deposit and brokered deposits were used to supplement funding
sources. These alternative funding sources increased $26.0 million or 11.0% in 2008. National Certificates of Deposit and brokered deposits were $262.7 million at December 31, 2008. At December 31, 2007, national Certificates of Deposit
and brokered deposits were $236.7 million. The increase in our national Certificates of Deposit and brokered deposits was



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necessary to fund our growth in loans during the year ended December 31, 2008 at reasonable spreads. Alternative funding sources are a secondary source
of funds utilized to fund loan growth. The cost of these alternative funding sources can be less expensive than our local deposits as was the case in 2008.

The average amounts of, and the average rate paid on, each of the following categories of deposits, for the years ended December 31, 2008, 2007, and 2006, are as follows:



|                                    |  |                        |         |      |      |   |        |      |         |  |      |        |  |      |         |  |      |  
|----------------------------------- |  | ---------------------- | ------- | ---- | ---- | - | ------ | ---- | ------- |  | ---- | ------ |  | ---- | ------- |  | ---- | -
|                                    |  | At December 31,        |        
|                                    |  | 2008                   |         |      | 2007 |   |        | 2006 |        
|                                    |  | Amount                 |         | Rate |      |   | Amount |      | Rate    |  |      | Amount |  | Rate |        
|                                    |  | (Dollars in thousands) |        
|Noninterest-bearing demand deposits |  | $                      | 52,234  |      | 0.00 | % |        | $    | 55,462  |  | 0.00 | %      |  | $    | 52,298  |  | 0.00 | %
|                                    |  |                        |         |      |      |   |        |      |         |  |      |        |  |      |         |  |      |  
|                                    |  |                        |         |      |      |  
|Interest-bearing demand deposits    |  |                        | 79,322  |      | 2.27 |   |        |      | 62,943  |  | 2.21 |        |  |      | 74,125  |  | 2.17 |  
|Savings                             |  |                        | 183,234 |      | 2.61 |   |        |      | 185,799 |  | 4.30 |        |  |      | 105,022 |  | 3.37 |  
|Time deposits                       |  |                        | 579,366 |      | 4.21 |   |        |      | 431,565 |  | 5.33 |        |  |      | 315,429 |  | 4.82 |  
|                                    |  |                        |         |      |      |   |        |      |         |  |      |        |  |      |         |  |      |  
|Total interest-bearing deposits     |  | $                      | 841,922 |      | 3.68 |   |        | $    | 680,307 |  | 4.76 |        |  | $    | 494,576 |  | 4.11 |  
|                                    |  |                        |         |      |      |   |        |      |         |  |      |        |  |      |         |  |      |  
|Total average deposits              |  | $                      | 894,156 |      | 3.47 |   |        | $    | 735,769 |  | 4.40 |        |  | $    | 546,874 |  | 3.72 |  
|                                    |  |                        |         |      |      |   |        |      |         |  |      |        |  |      |         |  |      |  

Our core deposits, which exclude brokered and national certificates of deposits, were $750.6
million at December 31, 2008, an increase of 31.0% compared to $572.8 million at December 31, 2007. Core deposits as a percentage of total deposits were approximately 74.1% and 70.9% at December 31, 2008 and 2007, respectively.In 2005, we began using the Certificate of Deposit Account Registry Service (CDARS) in order to obtain FDIC insurance on some of our larger customers. Although CDARS are required to be categorized as brokered deposits, these deposits represent
deposits greater than $100,000 originated in our local markets that are placed with other institutions that are members in the CDARS network. By placing these deposits in these other institutions, the deposits of our customers are fully insured by
the FDIC. In return for the deposits that we place with network institutions, we receive from network institutions, deposits that are approximately equal in amount of what was originated from our customers. In addition, the CDARS are priced at local
rates, which generally have lower rates than rates being offered for brokered deposits. At December 31, 2008, CDARS represented $8.8 million of our deposits, or 0.9% and at December 31, 2007, CDARS represented $10.4 million of our
deposits, or 1.3%. We continue to focus on increasing our core deposit base. The categories of lowest cost deposits comprised the following percentages of average total deposits during 2008: average noninterest-bearing demand deposits, 5.8%; average
interest-bearing demand, 8.9%; and average savings deposits, 20.5%. Of average time deposits, approximately 52.0% were large denomination certificates of deposit.

Noninterest-bearing deposits decreased $6.5 million, or 11.5%, from year-end 2007 to $50.0 million at December 31, 2008, and interest-bearing deposits increased $212.2 million, or 28.3%, during the same period to
$963.2 million. The increase in interest-bearing deposits has been the result of our focus on providing excellent customer service, as well as our branch staffs intensified efforts to obtain a greater deposit share in the newer markets. Our
recent transfers from temporary branch locations into permanent facilities, should make it easier for us to continue to grow deposits in those markets.



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The following table sets forth the maturities of our time deposits of $100,000 or more by category at
December 31, 2008.



|                               |  |                |        
|------------------------------ |  | -------------- | -------
|                               |  | (In thousands)
|Three months or less           |  | $              | 58,214 
|Over three through six months  |  |                | 94,333 
|Over six through twelve months |  |                | 162,167
|Over twelve months             |  |                | 23,331 
|                               |  |                |        
|Total                          |  | $              | 338,045
|                               |  |                |        

Borrowings

Short-Term Borrowings

Securities sold under agreements to repurchase amounted to $5.6 million at
December 31, 2008, compared to $6.5 million at December 31, 2007, and $4.7 million at December 31, 2006. The weighted average rates were 1.29%, 1.24%, and 1.62% for 2008, 2007 and 2006, respectively. The total amount of securities
sold under agreements to repurchase is associated with the cash flow needs of our corporate customers who participate in repurchase agreements. Included in our total FHLB line availability, as detailed under the FHLB Advances section below, is the
ability to obtain short-term daily rate credit advances. However there were no such short-term FHLB advances at December 31, 2008, 2007 and 2006. These advance rates float daily based on the overnight funds market. The line of credit has a one
year term and matures in May of each year. We have available $33.0 million in lines of credit to purchase federal funds, on an unsecured basis, from commercial banks, of which $33.0 was available at December 31, 2008. We had federal funds
purchased that amounted to $-0- at year-end 2008, and $10.0 at year-end 2007, compared to $-0- at year-end 2006. We also have a $10 million line of credit with a third party financial institution that can be utilized to provide additional capital
for the bank if deemed necessary. As of December 31, 2008, approximately $5.0 million of this line was available.

Short-term
borrowings at December 31, 2008, 2007 and 2006 consisted of the following:



|                                               |  |                    |        |      |   |        |  |   |      
|---------------------------------------------- |  | ------------------ | ------ | ---- | - | ------ |  | - | -----
|                                               |  | As of December 31,
|                                               |  | 2008               |        | 2007 |   | 2006  
|                                               |  | (In thousands)    
|Federal funds purchased                        |  | $                  |       |      | $ | 10,000 |  | $ |     
|Securities sold under agreements to repurchase |  |                    | 5,642  |      |   | 6,536  |  |   | 4,738
|Other short-term line of credit                |  |                    | 4,962  |      |   | 4,512  |  |   |     
|                                               |  |                    |        |      |   |        |  |   |      
|                                               |  | $                  | 10,604 |      | $ | 21,048 |  | $ | 4,738
|                                               |  |                    |        |      |   |        |  |   |      

In connection with the short-term line of credit with the third party financial institution, the
Company has agreed, among other things, not to: (1) permit the combined tangible capital of the subsidiary Banks to be less than $60,000,000; (2) permit the Tier 1 leverage ratio to be less than 7.0% and the total risk based ratio to be
less than 9.0% at any quarter end; (3) permit the return on average assets to be less than 0.50% for each fiscal quarter; (4) permit the ratio of consolidated loans classified as substandard, doubtful to Tier 1 capital plus its allowance
for loan losses to exceed 40%.

The Company was in violation of certain of the above covenants as of December 31, 2008; however, these
violations have been waived by the noteholder.



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FHLB Advances

Our total borrowed funds consist primarily of long-term debt with maturities from one to ten years. At December 31, 2008 we were approved to borrow up to approximately $108 million under various short-term and
long-term programs offered by the Federal Home Loan Bank of Atlanta. These borrowings are secured under a blanket lien agreement on certain qualifying mortgage instruments in the loan and securities portfolios. At December 31, 2008, the
outstanding balance of our credit line was $72.0 million, all of which was accounted for as long-term debt.

Subordinated Long-term
Capital Notes

On September 30, 2008 and October 30, 2008, Appalachian Community Bank issued an aggregate of $6,125,000 and
$200,000, respectively, in Fixed Rate Subordinated Notes, which will mature on September 30, 2015 (the Notes). Interest on the Notes is fixed at 10% per annum. The interest on the Notes is payable semi-annually in arrears on
June 30 and December 31 of each year. The bank may redeem all or some of the Notes at anytime beginning on September 30, 2013 at a price equal to 100% of the principal amount of such Notes redeemed plus accrued, but unpaid, interest
to the redemption date. Payment of the principal on the Notes may be accelerated by holders of the Notes only in the case of the banks insolvency or liquidation. There is no right of acceleration in the case of default in payment of principal
of or interest on the Notes. The proceeds will be used for general corporate purposes and to support loan growth. The Notes qualify as Tier II capital under risk-based capital guidelines and will strengthen the banks capital position under the
federal prompt corrective action guidelines.

On August 28, 2003, Appalachian Capital Trust I (the Trust), a Delaware
statutory trust established by us, received $6.0 million principal amount of the Trusts floating rate cumulative trust preferred securities in a trust preferred private placement. The proceeds of that transaction were used by the Trust to
purchase an equal amount of our floating rate-subordinated debentures. We have fully and unconditionally guaranteed all obligations of the Trust on a subordinated basis with respect to the trust preferred securities. We account for the trust
preferred securities as long-term debt liability in the amount of $6.2 million. Interest only is payable quarterly at a variable per annum rate of interest, reset quarterly, equal to LIBOR plus 3.00 % percent until the debt becomes due on
August 8, 2033. The interest rate on the Trust Preferred liability at December 31, 2008 and 2007 was 6.19% and 7.91% respectively. The debt is callable by Appalachian Bancshares, Inc. on August 28, 2008 and every quarter thereafter.
Subject to certain limitations, the trust preferred securities qualify as Tier 1 capital and are presented in the consolidated financial statements included elsewhere in this Form 10-K as subordinated long-term capital notes.

The sole assets of the Trust are the subordinated debentures issued by us. Both the trust preferred securities and the subordinated debentures have
approximately 30-year lives. However, both we and the Trust have options to call our respective securities after five years, subject to regulatory capital requirements.

Capital Resources

Total shareholders equity was $72.4 million at December 31, 2008,
compared to $73.7 million at December 31, 2007. Our net loss was $2.9 million. We issued 103,479 shares of stock to our 401(k) Plan during 2008 for proceeds of $885,000. We had a $652,000 increase in the accumulated other comprehensive gain on
our available-for-sale securities. We purchased 16,000 of our outstanding shares through our stock buy-back program in the amount of $183,000. In addition, the effects of the stock-based compensation expense during 2008 increased equity by $281,000,
including the tax benefit.

The Federal Deposit Insurance Corporation Improvement Act establishes risk-based capital guidelines that take
into consideration risk factors, as defined by regulators, associated with various categories of assets, both on and off the balance sheet. Under the guidelines, capital strength is measured in two tiers, which are used in conjunction with
risk-adjusted assets to determine the risk-based capital ratios. Our Tier 1 capital, which consists of common equity, paid-in capital, retained earnings and qualifying trust preferred securities (less intangible assets and treasury stock), amounted
to $73.8 million at December 31, 2008. Tier 2 capital components include supplemental capital components such as qualifying allowance for loan losses and trust preferred securities not qualified for Tier 1 capital. Tier 1 capital, plus the Tier
2 capital components, are referred to as Total Capital and was $91.8 million at year end 2008. The percentage ratios as calculated under regulatory guidelines were 7.96% and 9.89% for Tier 1 and Total Capital, respectively, at year-end 2008. Our
Tier 1 Capital and Total Capital exceeded the minimum ratios of 4.00% and 8.00%, respectively.



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Another important indicator of capital adequacy in the banking industry is the leverage ratio. The
leverage ratio is defined as the ratio which shareholders equity, minus intangibles, bears to total assets minus intangibles. At December 31, 2008, our leverage ratio was 6.64%, exceeding the regulatory minimum requirement of 4.00%.

The table following illustrates our regulatory capital ratios under federal guidelines at December 31, 2008, 2007 and 2006:



|                                                                   |         |                               |   |      |                          |         |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------ | ------- | ----------------------------- | - | ---- | ------------------------ | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                   |         | Statutory                     |   |      | Years ended December 31, |        
|                                                                   | Minimum |                               |   | 2008 |                          |         | 2007 |  |   | 2006    |  
|                                                                   |         | (In thousands, except ratios) |  
|Tier 1 Capital                                                     |         |                               |   |      | $                        | 73,827  |      |  | $ | 77,180  |   |  | $ | 70,730  |  
|                                                                   |         |                               |   |     
|Tier 2 Capital                                                     |         |                               |   |      |                          | 17,958  |      |  |   | 9,808   |   |  |   | 7,670   |  
|                                                                   |         |                               |   |      |                          |         |      |  |   |         |   |  |   |         |  
|                                                                   |         |                               |   |     
|Total Qualifying Capital                                           |         |                               |   |      | $                        | 91,785  |      |  | $ | 86,988  |   |  | $ | 78,400  |  
|                                                                   |         |                               |   |      |                          |         |      |  |   |         |   |  |   |         |  
|                                                                   |         |                               |   |     
|Risk Adjusted Total Assets (including off-balance sheet exposures) |         |                               |   |      | $                        | 927,732 |      |  | $ | 824,834 |   |  | $ | 661,431 |  
|                                                                   |         |                               |   |      |                          |         |      |  |   |         |   |  |   |         |  
|                                                                   |         |                               |   |     
|Tier 1 Risk-Based Capital Ratio                                    |         | 4.00                          | % |      |                          | 7.96    | %    |  |   | 9.36    | % |  |   | 10.69   | %
|                                                                   |         |                               |   |     
|Total Risk-Based Capital Ratio                                     |         | 8.00                          |   |      |                          | 9.89    |      |  |   | 10.55   |   |  |   | 11.85   |  
|                                                                   |         |                               |   |     
|Leverage Ratio                                                     |         | 4.00                          |   |      |                          | 6.64    |      |  |   | 8.30    |   |  |   | 9.55    |  

Return on Equity and Assets

The following table summarizes certain of our financial ratios for the years ended December 31, 2008, 2007 and 2006.



|                                       |  |       |    |  |      |   |  |      |  
|-------------------------------------- |  | ----- | -- |  | ---- | - |  | ---- | -
|                                       |  | 2008  |    |  | 2007 |   |  | 2006 |  
|Return on average assets               |  | (0.27 | )% |  | 0.65 | % |  | 0.91 | %
|Return on average equity               |  | (3.80 | )  |  | 7.93 |   |  | 9.57 |  
|Dividend payout ratio                  |  | 0.00  |    |  | 0.00 |   |  | 0.00 |  
|Average equity to average assets ratio |  | 7.14  |    |  | 8.14 |   |  | 9.49 |  

The decline in return on average equity and assets from 2007 to 2008 is primarily due to the large
increase in our provision for loan losses, increase in nonaccrual loans, our decrease to net interest margin, losses on our sales of other real estate (ORE), the write-down of our 20,000 shares of Federal Home Loan Mortgage Corporation
(Freddie Mac) Preferred Stock, and the increase to other operating expenses necessary to support the Companys growth. The decline in return on average equity from 2006 to 2007 is primarily due our expansion initiative during the
last half of 2006 and in 2007, lower interest margins experienced in 2007, as well as our loan charge-offs in 2007.

Interest Rate Sensitivity
Management

Interest rate sensitivity is a function of the repricing characteristics of our portfolios of assets and liabilities. These
repricing characteristics are the time frames within which the interest-bearing assets and liabilities are subject to changes in interest rates, either at replacement or maturity during the life of the instruments. Sensitivity is measured as the
difference between the volume of assets and liabilities in our current portfolio that is subject to repricing in future time periods. The differences are known as interest rate sensitivity gaps and are usually calculated



47



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separately for segments of time, ranging from zero to 30 days, 31 to 90 days, 91 days to one year, one to five years, over five years and on a cumulative
basis.

The following table indicates that, in a rising interest rate environment, our earnings may be adversely affected in the 0-365 day
periods where liabilities will reprice faster than assets, if rates move simultaneously. For purposes of this table, all demand and savings deposits are included in the 0  30 day period, but because these deposits are not as sensitive to rate
change, we do not anticipate these deposits to mature in this time period. We anticipate that these deposits will mature over all time periods. As seen in the following table, for the first 30 days of repricing opportunity, there is an excess of
interest-earning assets over interest-bearing liabilities of approximately $113.9 million. For the first 365 days, interest-bearing liabilities exceed earning assets by approximately $168.8 million. During this one-year time frame, 90.7% of all
interest-bearing liabilities will reprice compared to 73.5% of all interest-earning assets. Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate
sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remain the same, thus impacting net interest income. It should
be noted, therefore, that a matched interest-sensitive position by itself would not ensure maximum net interest income.

The following
table sets forth information regarding our rate sensitivity as of December 31, 2008 for each of the intervals indicated.



|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|---------------------------------------------------------------- |  | ----------------------------- | ------- | --------- | - | ------- | ---------- |  | - | -------- | - |  | ----------- | --------- | ----- |  | ------ |  | - | ---------
|                                                                 |  | 0-30Days                      |         | 31-90Days |   |         | 91-365Days |  |   | 1-5Years |   |  | Over 5Years |           | Total
|                                                                 |  | (In thousands, except ratios)
|Interest-earning assets(1)                                       |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|Loans                                                            |  | $                             | 371,382 |           | $ | 61,756  |            |  | $ | 217,596  |   |  | $           | 192,206 $ |       |  | 20,830 |  | $ | 863,770  
|Securities(2)                                                    |  |                               | 425     |           |   | 13      |            |  |   | 5,919    |   |  |             | 12,134    |       |  | 59,403 |  |   | 77,894   
|Interest-bearing deposits in other banks                         |  |                               | 731     |           |   |        |            |  |   |         |   |  |             |          |       |  |       |  |   | 731      
|Federal funds sold                                               |  |                               | 133,351 |           |   |        |            |  |   |         |   |  |             |          |       |  |       |  |   | 133,351  
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               | 505,889 |           |   | 61,769  |            |  |   | 223,515  |   |  |             | 204,340   |       |  | 80,233 |  |   | 1,075,746
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|Interest-bearing liabilities:(3)                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|Demand deposits(4)                                               |  |                               | 120,988 |           |   |        |            |  |   |         |   |  |             |          |       |  |       |  |   | 120,988  
|Savings deposits(4)                                              |  |                               | 164,156 |           |   |        |            |  |   |         |   |  |             |          |       |  |       |  |   | 164,156  
|Time deposits                                                    |  |                               | 66,208  |           |   | 81,008  |            |  |   | 475,824  |   |  |             | 55,057    |       |  |       |  |   | 678,097  
|Other short-term borrowings                                      |  |                               | 10,604  |           |   |        |            |  |   |         |   |  |             |          |       |  |       |  |   | 10,604   
|Long-term debt                                                   |  |                               | 30,000  |           |   |        |            |  |   | 5,000    |   |  |             | 35,000    |       |  | 2,000  |  |   | 72,000   
|Subordinated long-term capital notes                             |  |                               |        |           |   | 6,186   |            |  |   |         |   |  |             |          |       |  | 6,325  |  |   | 12,511   
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               | 391,956 |           |   | 87,194  |            |  |   | 480,824  |   |  |             | 90,057    |       |  | 8,325  |  |   | 1,058,356
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               |         |           |   |        
|Interest sensitivity gap                                         |  | $                             | 113,933 |           | $ | (25,425 | )          |  | $ | (257,309 | ) |  | $           | 114,283 $ |       |  | 71,908 |  | $ | 17,390   
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               |         |           |   |        
|Cumulative interest sensitivity gap                              |  | $                             | 113,933 |           | $ | 88,508  |            |  | $ | (168,801 | ) |  | $           | (54,518   | )$    |  | 17,390 |  |   |          
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               |         |           |   |        
|Ratio of interest-earning assets to interest-bearing liabilities |  |                               | 1.29    |           |   | 0.71    |            |  |   | 0.46     |   |  |             | 2.27      |       |  | 0.00   |  |   |          
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               |         |           |   |        
|Cumulative ratio                                                 |  |                               | 1.29    |           |   | 1.18    |            |  |   | 0.82     |   |  |             | 0.95      |       |  | 1.02   |  |   |          
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          
|                                                                 |  |                               |         |           |   |        
|Ratio of cumulative gap to total interest-earning assets         |  |                               | 0.11    |           |   | 0.08    |            |  |   | (0.16    | ) |  |             | (0.05     | )     |  | 0.02   |  |   |          
|                                                                 |  |                               |         |           |   |         |            |  |   |          |   |  |             |           |       |  |        |  |   |          



|(1) | Excludes nonaccrual loans. Excludes unrealized gains/losses on securities.
|--- | --------------------------------------------------------------------------

|(2) | Securities are at book value.
|--- | -----------------------------

|(3) | Excludes matured certificates which have not been redeemed by the customer and on which no interest is accruing.
|--- | ----------------------------------------------------------------------------------------------------------------

|(4) | Demand and savings deposits typically reprice simultaneously with market changes.
|--- | ---------------------------------------------------------------------------------



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Management continually evaluates the condition of the economy, the pattern of market interest rates and
other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest rate sensitivity gap positions to maximize net interest income based
upon anticipated movements in the general level of interest rates.

We also use simulation analysis to monitor and manage our interest rate
sensitivity. Simulation analysis is the primary method of estimating earnings at risk and capital at risk under varying interest rate conditions. Simulation analysis is used to test the sensitivity of our net interest income and shareholders
equity to both the level of interest rates and the slope of the yield curve. Simulation analysis accounts for the expected timing and magnitude of assets and liability cash flows, as well as the expected timing and magnitude of deposits that do not
reprice on a contractual basis. In addition, simulation analysis includes adjustments for the lag between movements in market interest rates on loans and interest-bearing deposits. These adjustments are made to reflect more accurately possible
future cash flows, repricing behavior and ultimately net interest income.

The estimated impact on our net interest income before provision
for loan loss sensitivity over a one-year time horizon is shown below. Such analysis assumes a sustained parallel shift in interest rates and our estimate of how interest-bearing transaction accounts will reprice in each scenario. Actual results
will differ from simulated results due to timing, magnitude and frequency of interest rate changes and changes in market conditions and managements strategies, among other factors.



|                                              |  |                                                                                   |    |  |                    |  
|--------------------------------------------- |  | --------------------------------------------------------------------------------- | -- |  | ------------------ | -
|                                              |  | Percentage Increase(Decrease) in InterestIncome/Expense GivenInterest Rate Shifts |   
|                                              |  | Down 200Basis Points                                                              |    |  | Up 200Basis Points |  
|For the Twelve Months After December 31, 2008 |  |                                                                                   |    |  |                    |  
|                                              |  |                                                                                  
|Projected change in:                          |  |                                                                                   |    |  |                    |  
|Interest income                               |  | (18.16                                                                            | )% |  | 22.23              | %
|Interest expense                              |  | (29.72                                                                            | )  |  | 29.02              |  
|Net interest income                           |  | (3.71                                                                             | )  |  | 13.73              |  

Market Risk

Market risk is the risk arising from adverse changes in the fair value of financial instruments due to a change in interest rates, exchange rates and equity prices. Our primary market risk is interest rate risk.

The primary objective of asset/liability management is to manage interest rate risk and achieve reasonable stability in net interest
income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate sensitive earning assets and rate sensitive liabilities. The relationship of rate sensitive earning assets to rate sensitive liabilities is the
principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate sensitive earning assets and interest-bearing liabilities are those that can be repriced to current market rates within a
relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the first year and through three years.

Management continues to monitor the proper matching of asset/liability repricing to keep our volatility at a low level. However, due to
adverse economic conditions that negatively impacted our customers ability to repay us, management reversed $2.1 million of previously accrued interest income during 2008. These interest reversals contributed to the unexpected contraction of
30 basis points in our net interest margin in the fourth quarter and 22 basis points for 2008. However, to continue our core deposit growth strategy and increase liquidity, we continued to pay market rates for deposit products.



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Off-Balance Sheet Arrangements

In the normal course of business, we offer a variety of financial products to our customers to aid them in meeting their requirements for liquidity, credit enhancement and interest rate protection. Generally accepted
accounting principles recognize these transactions as contingent liabilities and, accordingly, they are not reflected in the consolidated financial statements. Commitments to extend credit, credit card arrangements, commercial letters of credit and
standby letters of credit all include exposure to some credit loss in the event of nonperformance of the customer. We use the same credit policies and underwriting procedures for making off-balance sheet credit commitments and financial guarantees
as it does for on-balance sheet extensions of credit. Because these instruments have fixed maturity dates, and because many of them expire without being drawn upon, they do not generally present any significant liquidity risk to us. Management
conducts regular reviews of these instruments on an individual customer basis, and the results are considered in assessing the adequacy of our allowance for loan losses. Management does not anticipate any material losses as a result of these
commitments. The following is a discussion of these commitments:

Standby Letters of Credit.These agreements are used
by our customers as a means of improving their credit standings in their dealings with others. Under these agreements, we agree to honor certain financial commitments in the event that its customers are unable to do so. The amount of credit risk
involved in issuing letters of credit in the event of nonperformance by the other party is the contract amount. As of December 31, 2008 and 2007, we had issued standby letters of credit of approximately $5.9 million and $5.0 million,
respectively. When significant, we record a liability for the estimated fair value of standby letters of credit based on the fees charged.

Loan Commitments.As of December 31, 2008 and 2007, the bank had commitments outstanding to extend credit totaling approximately $77.5 million and $97.0 million, respectively.

Contractual Obligations

We have various contractual
obligations that we must fund as part of our normal operations. The following table shows aggregate information about our contractual obligations, and the periods in which payments are due. The amounts and time periods are measured from
December 31, 2008.

Payments due by period (in thousands)



|                            |  |       |         |                 |   |           |  |           |        |                  |   |        |  |   |       
|--------------------------- |  | ----- | ------- | --------------- | - | --------- |  | --------- | ------ | ---------------- | - | ------ |  | - | ------
|                            |  | Total |         | Less than1 year |   | 1-3 years |  | 3-5 years |        | More than5 years
|Long-term debt              |  | $     | 84,511  |                 | $ | 5,000     |  | $         | 15,000 |                  | $ | 20,000 |  | $ | 44,511
|Operating lease obligations |  |       | 1,301   |                 |   | 125       |  |           | 135    |                  |   | 132    |  |   | 909   
|Time deposits               |  |       | 678,097 |                 |   | 623,040   |  |           | 44,188 |                  |   | 10,869 |  |   |      
|                            |  |       |         |                 |   |           |  |           |        |                  |   |        |  |   |       
|Total                       |  | $     | 763,909 |                 | $ | 628,165   |  | $         | 59,323 |                  | $ | 31,001 |  | $ | 45,420
|                            |  |       |         |                 |   |           |  |           |        |                  |   |        |  |   |       

Impact of Inflation

The effect of relative purchasing power over time due to inflation has not been taken into account in our consolidated financial statements. Rather, our financial statements have been prepared on an historical cost
basis in accordance with generally accepted accounting principles.

Unlike most industrial companies, our assets and liabilities are
primarily monetary in nature. Therefore, the effect of changes in interest rates will have a more significant impact on our performance than will the effect of changing prices and inflation in general. In addition, interest rates may generally
increase as the rate of inflation increases, although not necessarily in the same magnitude. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide rate
fluctuations, including those resulting from inflation.



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Recent Developments

In September 2006, the EITF reached a consensus on EITF Issue No. 06-4 (EITF 06-4), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements. EITF 06-4 requires an employer to recognize a liability for future benefits based on the substantive agreement with the employee. EITF 06-4 requires a company to use the guidance prescribed in FASB Statement No. 106,
Employers Accounting for Postretirement Benefits Other Than Pensions and Accounting Principles Board Opinion No. 12, Omnibus Opinion, when entering into an endorsement split-dollar life insurance agreement and
recognizing the liability. EITF 06-4 is effective for fiscal periods beginning after December 15, 2007. The Companys adoption of EITF 06-4 did not affect our financial position, results of operations or its cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities.
SFAS No. 159 permits entities to make an irrevocable election, at specified election dates, to measure eligible financial instruments and certain other items at fair value. This statement also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose different measurement attributes for similar types of assets and liabilities. The provisions of this statement are effective as of the beginning of the first fiscal year
that begins after November 15, 2007. The Company chose not to apply fair value measurements to any financial instruments in accordance with SFAS No. 159, and therefore, the adoption of this standard did not affect our financial position,
results of operations or disclosures.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and
Hedging Activities. SFAS No. 161 is an amendment to SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. The objective of SFAS No. 161 is to expand the disclosure requirements of SFAS No. 133 with the
intent to improve the financial reporting of how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and how derivative
instruments and related hedged items affect an entitys financial position, financial performance and cash flows. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The
Companys adoption of SFAS No. 161 did not affect our financial position or results of operation.

In May 2008, the FASB issued
SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). The current GAAP hierarchy, as set forth in the American Institute of Certified Public
Accountants (AICPA) Statement on Auditing Standards No. 69, The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles, has been criticized because (1) it is directed to the auditor rather than the entity,
(2) it is complex, and (3) it ranks FASB Statements of Financial Accounting Concepts, which are subject to the same level of due process as FASB Statements of Financial Accounting Standards, below industry practices that are widely
recognized as generally accepted but that are not subject to due process. The FASB believes that the GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for
financial statements that are presented in conformity with GAAP. Accordingly, the FASB concluded that the GAAP hierarchy should reside in the accounting literature established by the FASB and is issuing this Statement to achieve that result. The
Company does not anticipate the new accounting principle to have a material effect on its financial position or results of operation.

In
October 2008, the FASB issued FSP FAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active. This FASB Staff Position clarifies the application of SFAS No. 157, Fair Value Measurements, in a market
that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP FAS 157-3 provides guidance on (1) how an entitys
own assumption should be considered when measuring fair value when relevant observable inputs do not exist, (2) how available observable inputs in a market that is not active should be considered when measuring fair value and (3) how the
use of market quotes should be considered when assessing the relevance of observable and unobservable inputs available to measure fair value. This FASB Staff Position is effective immediately. The Company does not anticipate the new accounting
principle to have a material effect on its financial position or results of operation.



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On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008
(EESA), which creates the Troubled Asset Relief Program (TARP) and provides the U.S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. The
Capital Purchase Program (the CPP) was announced by the U.S. Treasury on October 14, 2008 as part of TARP. Pursuant to the CPP, the U.S. Treasury will purchase up to $250 billion of senior preferred shares on standardized terms from
qualifying financial institutions. The purpose of the CPP is to encourage U.S. financial institutions to build capital to increase the flow of financing to U.S. businesses and consumers and to support the U.S. economy. The Company will not
participate in the CPP.

In December 2008, the FASB issued FASB Staff Position No. 132(R)-1, Employers Disclosures about
Postretirement Benefit Plan Assets (FSP 132(R)-1). This FSP amends FASB Statement No. 132(R), Employers Disclosures about Pensions and Other Postretirement Benefits (FAS132(R)), to require
additional disclosures about assets held in an employers defined benefit pension or other postretirement plan. This FSP is applicable to an employer that is subject to the disclosure requirements of FAS 132(R) and is generally effective for
fiscal years ending after December 15, 2009. We are in the process of reviewing the potential impact of FSP 132(R)-1, however, the adoption of FSP 132(R)-1 is not expected to have a material effect on its financial position or results of
operation.

On February 27, 2009, The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) voted to amend the
restoration plan for the Deposit Insurance Fund (DIF). The Board also took action to ensure the continued strength of the insurance fund by imposing a special assessment on insured institutions of 20 basis points, implementing changes to the
risk-based assessment system, and setting rates beginning the second quarter of 2009. Under the restoration plan approved last October, the Board set a rate schedule to raise the DIF reserve ratio to 1.15 percent within five years. The
February 27, 2009 action extends the restoration plan horizon to seven years in recognition of the current significant strains on banks and the financial system and the likelihood of a severe recession. The amended restoration plan was
accompanied by a final rule that sets assessment rates and makes adjustments that improve how the assessment system differentiates for risk. Currently, most banks are in the best risk category and pay anywhere from 12 cents per $100 of deposits to
14 cents per $100 for insurance. Under the final rule, banks in this category will pay initial base rates ranging from 12 cents per $100 to 16 cents per $100 on an annual basis, beginning on April 1, 2009. The Board adopted an interim rule
imposing a 20 basis point emergency special assessment on the industry on June 30, 2009. The assessment is to be collected on September 30, 2009. The interim rule would also permit the Board to impose an emergency special assessment after
June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance. Comments on the interim rule on special assessments are due no later than 30 days after publication in the Federal Register.
Changes to the assessment system include higher rates for institutions that rely significantly on secured liabilities, which may increase the FDICs loss in the event of failure without providing additional assessment revenue. Under the final
rule, assessments will be higher for institutions that rely significantly on brokered deposits but, for well-managed and well-capitalized institutions, only when accompanied by rapid asset growth. Brokered deposits combined with rapid asset growth
have played a role in a number of costly failures, including some recent ones. The final rule also would provide incentives in the form of a reduction in assessment rates for institutions to hold long-term unsecured debt and, for smaller
institutions, high levels of Tier 1 capital. The Company is currently evaluating the effects of these insurance increases to its financial position and results of operation.



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|ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
|-------- | ----------------------------------------------------------

Information in response to this Item 7A is incorporated by reference from the following sections of Item 7 of this report: Interest Rate Sensitivity Management and Market Risk.



|ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
|------- | -------------------------------------------

The
following consolidated financial statements are included within Exhibit 13.1 of this Annual Report on Form 10-K:

Report of Independent Registered Public
Accounting Firm

Consolidated Statements of Financial Condition as of December 31, 2008 and 2007

Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007, and 2006

Consolidated Statements of Shareholders Equity for the Years Ended December 3, 2008, 2007 and 2006

Consolidated
Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006

Notes to Consolidated Financial Statements

Quarterly Results (Unaudited)



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|ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
|------- | ------------------------------------------------------------------------------------

None.



|ITEM 9A(T). | CONTROLS AND PROCEDURES
|----------- | -----------------------

Evaluation of Disclosure Controls and
Procedures

As of the end of the period covered by this Annual Report on Form 10-K, our principal executive officer and principal
financial officer have evaluated the effectiveness of our disclosure controls and procedures (Disclosure Controls). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act),
are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time
periods specified in the Securities and Exchange Commissions rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the chief
executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

Our management,
including the chief executive officer and chief financial officer, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future
events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based upon their controls evaluation, our chief executive officer and chief financial officer have concluded that our Disclosure Controls are effective at a reasonable assurance level.

Managements Annual Report on Internal Control over Financial Reporting

The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting. The Companys management, including its Principal Executive Officer and Principal
Financial Officer, conducted an evaluation of the effectiveness of its 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. Based on this evaluation, the Companys management concluded that the Companys internal control over financial reporting was effective as of December 31, 2008.

This Annual Report on Form 10-K does not include an attestation report of the Companys registered public accounting firm regarding internal control
over financial reporting. Managements report was not subject to attestation requirements 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.

Changes in Internal Control Over Financial Reporting

During the fourth quarter of 2008, there were no changes in our internal control over financial reporting that have materially affected, or that are
reasonably likely to materially affect, the our internal control over financial reporting.



|ITEM 9B. | OTHER INFORMATION
|-------- | -----------------



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PART III



|ITEM 10. | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
|-------- | ------------------------------------------------------

The information appearing under the headings Election of Directors, Executive Officers, Section 16(a) Beneficial Ownership Reporting Compliance and Corporate Governance and Board Matters in
the Proxy Statement (the 2009 Proxy Statement) relating to our 2009 Annual Meeting of Shareholders is incorporated herein by reference.



|ITEM 11. | EXECUTIVE COMPENSATION
|-------- | ----------------------

The information appearing
under the heading Compensation of Executive Officers and Directors in the 2009 Proxy Statement is incorporated herein by reference.



|ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
|-------- | ----------------------------------------------------------------------------------------------

The information appearing under the heading Ownership of Common Stock in the 2009 Proxy Statement is incorporated herein by reference.



|ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
|-------- | -------------------------------------------------------------------------

The information appearing under the caption Certain Relationships and Related Party Transactions in the 2009 Proxy Statement is incorporated herein by reference.



|ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES
|-------- | --------------------------------------

The
information appearing under the caption Independent Public Accountants in the 2009 Proxy Statement is incorporated herein by reference.



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PART IV



|ITEM 15. | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
|-------- | ------------------------------------------



|    |  |    |  |                                                                                                               
|--- |  | -- |  | --------------------------------------------------------------------------------------------------------------
|(a) |  | 1. |  | Financial Statements.                                                                                         
|    |  |   
|    |  |    |  | The following consolidated financial statements are located in Item 8 of this Report:                         
|    |  |   
|    |  |    |  | Report of Independent Registered Public Accounting Firm                                                       
|    |  |    |  | Consolidated Statements of Financial Condition as of December 31, 2008 and 2007                               
|    |  |    |  | Consolidated Statements of Operations for the Years Ended December 31, 2008, 2007 and 2006                    
|    |  |    |  | Consolidated Statements of Shareholders Equity for the Years Ended December 31, 2008, 2007 and 2006          
|    |  |    |  | Consolidated Statements of Cash Flows for the Years Ended December 31, 2008, 2007 and 2006                    
|    |  |    |  | Notes to Consolidated Financial Statements                                                                    
|    |  |    |  | Quarterly Results (Unaudited)                                                                                 
|    |  |   
|    |  | 2. |  | Financial Statement Schedules.                                                                                
|    |  |   
|    |  |    |  | Schedules to the consolidated financial statements are omitted, as the required information is not applicable.
|    |  |   
|    |  | 3. |  | Exhibits.                                                                                                     
|    |  |   
|    |  |    |  | The following exhibits are filed or incorporated by reference as part of this Report:                         



|              |  |                                                                                                                                                                                                             
|------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                      
|3.1           |  | Articles of Incorporation of the Company, as Restated (included as Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q, dated August 15, 2003 and incorporated herein by
reference).                 
|              | 
|3.2           |  | Bylaws of the Company, as Amended and Restated (included as Exhibit 3.2 to the Companys Current Report on Form 8-K, dated October 25, 2007 and incorporated herein by
reference).                          
|              | 
|4.1           |  | See Exhibits 3.1 and 3.2 for provisions in the Companys Articles of Incorporation and Bylaws defining the rights of holders of the common stock                                                            
|              | 
|4.2           |  | Form of Certificate of Common Stock (incorporated by reference to Exhibit 4.1 of the Companys Registration Statement on Form S-2, File No. 333-127898).                                                    
|              | 
|4.3           |  | Form of Appalachian Community Bank Fixed Rate Subordinated Debenture (included as Exhibit 4.1 to the Companys Quarterly Report on Form 10-Q, dated November 14, 2008 and incorporated
herein by reference).
|              | 
|10.1          |  | 1997 Directors Non-Qualified Stock Option Plan (included as Exhibit 10.1 to the Companys Annual Report on Form 10-KSB for the fiscal year ended December 31, 1996 and
incorporated herein by reference).* 
|              | 
|10.2          |  | 1997 Employee Incentive Stock Incentive Plan (included as Exhibit 10.2 to the Companys Annual Report onForm 10-KSB for the fiscal year ended December 31, 1996 and incorporated
herein by reference).*     



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|              |  |                                                                                                                                                                                                                                                                                                      
|------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                                                                                                               
|10.3          |  | Change in Control Agreement (as amended and restated), dated May 1, 2008, by and among Appalachian Community Bank, Appalachian Bancshares, Inc. and Tracy R. Newton (included as Exhibit 10.1
to the Companys March 31, 2008 10-Q, filed on May 14, 2008 and incorporated herein by reference).*    
|              | 
|10.4          |  | Change in Control Agreement (as amended and restated), dated May 1, 2008, by and among Appalachian Community Bank, Appalachian Bancshares, Inc. and J. Keith Hales (included as Exhibit 10.2
to the Companys March 31, 2008 10-Q, filed on May 14, 2008 and incorporated herein by reference).*     
|              | 
|10.5          |  | Form of Salary Continuation Agreement (as amended and restated) for the Directors of Appalachian Community Bank (and description of benefits for each of the Directors) (included as Exhibit 10.3
to the Companys March 31, 2008 10-Q, filed on May 14, 2008 and incorporated herein by reference).*
|              | 
|10.6          |  | Adoption Agreement for the Appalachian Bancshares, Inc. Employees Savings & Profit Sharing Plan Basic Plan Document and related documents (filed as Exhibit 10.2 to the Plans
Annual Report on Form 11-K for the fiscal year ended December 31, 2002 and incorporated herein by reference).        
|              | 
|10.7          |  | Pentegra Services, Inc. Employees Savings & Profit Sharing Plan Basic Plan Document and related documents (filed as Exhibit 10.3 to the Plans Annual Report on Form 11-K for the
fiscal year ended December 31, 2002 and incorporated herein by reference).                                        
|              | 
|10.8          |  | Form of Deferred Fee Agreement between Gilmer County Bank and certain directors and executive officers, with addendum (filed as Exhibit 10.6 to the Companys Quarterly Report on Form 10-QSB
for the period ended June 30, 1997 and incorporated herein by reference).                              
|              | 
|10.9          |  | Form of Data Processing Agreement by and between Appalachian Community Bank and Fiserv Solutions, Inc., effective as of July 26, 2002 (filed as Exhibit 10.3 to the Companys Quarterly
Report on Form 10-Q for the period ended September 30, 2003 and incorporated herein by reference).           
|              | 
|10.10         |  | 2003 Stock Option Plan (included as Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for the period ended June 30, 2003 and incorporated herein by
reference).*                                                                                                                           
|              | 
|10.11         |  | Form of Stock Option Agreement (included as Exhibit 10.2 to the Companys Quarterly Report on Form 10-Q for the quarter ended June 30, 2003 and incorporated herein by
reference).*                                                                                                                  



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|              |  |                                                                                                                                                                                                                                                                                                                             
|------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                                                                                                                                                                                                                                                      
|10.12         |  | Form of Change in Control Agreement for Named Executive Officers (and description of benefits for each Named Executive Officer) (included as Exhibit 10.1 to the Companys Quarterly Report
on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference).*                                        
|              | 
|10.13         |  | Form of Salary Continuation Agreement for Named Executive Officers (and description of benefits for each Named Executive Officer) (included as Exhibit 10.2 to the Companys Quarterly Report
on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference).*                                      
|              | 
|10.14         |  | Form of Salary Continuation Agreement for the Directors of Appalachian Community Bank (and description of benefits for each of the Directors) (included as Exhibit 10.3 to the Companys
Quarterly Report on Form 10-Q for the quarter ended June 30, 2004 and incorporated herein by reference).*                          
|              | 
|10.15         |  | Amended Salary Continuation Agreement dated August 11, 2006 by and among Appalachian Community Bank, Appalachian Bancshares, Inc. and Joseph T. Moss, Jr. (included as Exhibit 10.2 to the
Companys Quarterly Report on Form 10-Q, dated August 11, 2006 and incorporated herein by reference).*                           
|              | 
|10.16         |  | Appalachian Bancshares, Inc. 2007 Equity Incentive Plan (included as Exhibit 10.1 to the Companys Registration Statement on Form S-8, dated October 10, 2007, and incorporated herein
by reference) *                                                                                                                      
|              | 
|10.17         |  | Amended and Restated Salary Continuation Agreement dated March 27, 2008 by and among Appalachian Community Bank, Appalachian Bancshares, Inc. and Tracy R. Newton (included as Exhibit 10.14
to the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2007 and incorporated herein by reference).*
|              | 
|10.18         |  | Appalachian Bancshares, Inc. Amended and Restated Employee Stock Ownership Trust (included as Exhibit 10.4 to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2008 and incorporated herein by reference).*                                                                                  
|              | 
|10.19         |  | Appalachian Bancshares, Inc. Employee Stock Ownership Plan with 401(k) Provisions (included as Exhibit 10.4 to the Companys Quarterly Report on Form 10-Q for the quarter ended
September 30, 2008 and incorporated herein by reference).*                                                                                 
|              | 
|13.1          |  | Consolidated Financial Statements and Supplementary Data                                                                                                                                                                                                                                                                    
|              | 
|14            |  | Code of Ethics for CEO and Senior Financial Officers (included as Exhibit 14 to the Companys Annual Report on Form 10-K for the fiscal year ended December 31, 2003 and incorporated
herein by reference).                                                                                                                 



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|              |  |                                                                                                    
|------------- |  | ---------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                             
|21            |  | Subsidiaries of the Registrant                                                                     
|              | 
|23.1          |  | Consent of Mauldin & Jenkins, LLC                                                                  
|              | 
|24.1          |  | Power of Attorney (included a part of the signature page).                                         
|              | 
|31.1          |  | Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.    
|              | 
|31.2          |  | Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|              | 
|32            |  | Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                              



|* | The referenced exhibit is a compensatory contract, plan or arrangement.
|- | -----------------------------------------------------------------------



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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized, on the 3rd day of April 2009.



APPALACHIAN BANCSHARES, INC.By:

/s/ Tracy R. NewtonTracy R. NewtonPresident and Chief Executive Officer


KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes
and appoints Tracy R. Newton, his true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him and in his name, place and stead, in any and all capacities, to sign any and all amendments to this Annual
Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto attorney-in-fact and agent full power and authority to do and perform each
and every act and thing requisite or necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that attorney-in-fact and agent, or his substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.

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



|                                                                                                                  |  |  |  |                    
|----------------------------------------------------------------------------------------------------------------- |  |  |  | -------------------
|                                                                                                                  |  | 
|/s/ Tracy R. Newton                                                                                               |  |  |  | Date: April 3, 2009
|Tracy R. Newton, President, Chief Executive Officer and Director (principal executive officer)                    |  |  |  |                    
|                                                                                                                  |  | 
|/s/ Danny F. Dukes                                                                                                |  |  |  | Date: April 3, 2009
|Danny F. Dukes, Executive Vice President and Chief Financial Officer (principal accounting and financial officer) |  |  |  |                    
|                                                                                                                  |  | 
|                                                                                                                  |  |  |  | Date: April 3, 2009
|Alan S. Dover, Director                                                                                           |  |  |  |                    
|                                                                                                                  |  | 
|/s/ Charles A. Edmondson                                                                                          |  |  |  | Date: April 3, 2009
|Charles A. Edmondson, Director                                                                                    |  |  |  |                    
|                                                                                                                  |  | 
|/s/ Roger E. Futch                                                                                                |  |  |  | Date: April 3, 2009
|Roger E. Futch, Director                                                                                          |  |  |  |                    
|                                                                                                                  |  | 
|/s/ Joseph C. Hensley                                                                                             |  |  |  | Date: April 3, 2009
|Joseph C. Hensley, Director                                                                                       |  |  |  |                    
|                                                                                                                  |  | 
|/s/ Frank E. Jones                                                                                                |  |  |  | Date: April 3, 2009
|Frank E. Jones, Director                                                                                          |  |  |  |                    



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##### Table of Contents

|                                        |  |  |  |                    
|--------------------------------------- |  |  |  | -------------------
|                                        |  | 
|/s/ J. Ronald Knight                    |  |  |  | Date: April 3, 2009
|J. Ronald Knight, Chairman and Director |  |  |  |                    
|                                        |  | 
|/s/ Kenneth D. Warren                   |  |  |  | Date: April 3, 2009
|Kenneth D. Warren, Director             |  |  |  |                    



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##### Table of Contents

EXHIBIT INDEX

The following exhibits are filed as part of this report (in addition to those exhibits listed in Item 15 which are filed as a part of this report and incorporated by reference):



|              |  |                                                                                                    
|------------- |  | ---------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Description of Exhibit                                                                             
|13.1          |  | Consolidated Financial Statements and Supplementary Data                                           
|              | 
|21            |  | Subsidiaries of the Registrant                                                                     
|              | 
|23.1          |  | Consent of Mauldin & Jenkins, LLC                                                                  
|              | 
|31.1          |  | Certification of Principal Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|              | 
|31.2          |  | Certification of Principal Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|              | 
|32            |  | Certifications Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.                              



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