Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**x****                 ****Quarterly report under Section 13 or 15 (d) ofthe Securities Exchange Act of 1934**

 

**For the quarterly period ended June 30,2009**

 

**o****                    ****Transition report under Section 13 or 15(d) of the Exchange Act**

 

**For the transition period from               to               **

 

**Commission File Number  000-51112**

 

**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

(Exact Name of Small Business Issuer asSpecified in Its Charter)

 

| **GEORGIA**                      | ** ** | **20-2118147**      |
|----------------------------------|------------|---------------------|
| (State or Other  Jurisdiction of |       | (I.R.S. Employer    |
| Incorporation or  Organization)  |       | Identification No.) |

 

###### **1701 Bass Road**

###### **Macon, Georgia 31210**

(Address of Principal Executive Offices)

 

**(478) 476-2170**

(Issuer’s Telephone Number, IncludingArea Code)

 

###### **Not Applicable**

(Former Name, Former Address and FormerFiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.   Yes x   No o

 

Indicate by check mark whether the registranthas submitted electronically and posted on its corporate Web site, if any,every Interactive Data File required to be submitted and posted pursuant to Rule 405of Regulation S-T during the preceding 12 months (or for such shorter periodthat the registrant was required to submit and post such files).   Yes o   No o

 

Indicate by check mark whether the registrant isa large accelerated filer, an accelerated filer, a non-accelerated filer or asmaller reporting company.  See thedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” (in Rule 12b-2 of the Exchange Act).

 
| Large  accelerated filer o | Accelerated  filer o         |
|---------------------------------|-----------------------------------|
|                            |                              |
| Non-accelerated  filer o   | Smaller  reporting company x |

 

Indicate by checkmark whether the registrant isa shell company (as defined by Rule 12b-2 of the Exchange Act).   Yes o   No x

 

 

 

----

Table ofContents

 

**APPLICABLE ONLY TO CORPORATEISSUERS**

 

State the number of shares outstanding of eachof the issuer’s classes of common equity, as of the latest practicable date: CommonStock, no par value, 4,211,780 shares outstanding at August 13, 2009

 

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

 

INDEX

 
| ** **    | ** **                                                                                                                                  | **PAGE** |
|---------------|---------------------------------------------------------------------------------------------------------------------------------------------|----------|
|          |                                                                                                                                        |     |
| PART I:  | FINANCIAL INFORMATION                                                                                                                       |     |
| ITEM 1.       | FINANCIAL STATEMENTS                                                                                                                        |     |
|          |                                                                                                                                        |     |
|          | The following  consolidated financial statements are provided for Atlantic Southern  Financial Group, Inc.                             |     |
|          |                                                                                                                                        |     |
|          | Consolidated  Balance Sheets – June 30, 2009  (unaudited) and December 31,  2008 (audited).                                  | 2        |
|          |                                                                                                                                        |     |
|          | Consolidated  Statements of Operations (unaudited) – For the Three Months And Six Months  Ended June 30, 2009 and 2008.           | 3        |
|          |                                                                                                                                        |     |
|          | Consolidated  Statements of Comprehensive Income (unaudited) – For the Three Months and Six  Months Ended June 30, 2009 and 2008. | 4        |
|          |                                                                                                                                        |     |
|          | Consolidated  Statements of Cash Flows (unaudited) – For the Six Months Ended June 30, 2009 and 2008.                             | 5        |
|          |                                                                                                                                        |     |
|          | Notes to Consolidated Financial Statements (unaudited)                                                                                      | 6        |
|          |                                                                                                                                        |     |
| ITEM 2.       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                 | 15       |
|          |                                                                                                                                        |     |
| ITEM 3.       | Quantitative  and Qualitative Disclosures About Market Risk                                                                                 | 31       |
|          |                                                                                                                                        |     |
| ITEM 4T.      | Controls and  Procedures                                                                                                                    | 32       |
|          |                                                                                                                                        |     |
| PART II: | OTHER INFORMATION                                                                                                                           | 33       |

 

----

Table ofContents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Balance Sheets**

**June 30, 2009****(Unaudited) and****December 31, 2008****(Audited)**

 
| ** **                                                                                                                                                                                 | ** ** | **As of**         | ** **    |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|---------------|
| ** **                                                                                                                                                                                 | ** ** | **June 30,** | ** **    | **December 31,** | ** ** |
| ** **                                                                                                                                                                                 | ** ** | **2009**          | ** **    | **2008** | ** ** |
| **Assets**                                                                                                                                                                                 |       |              |          |   |   |
| Cash and due from banks                                                                                                                                                                    |       | $                 | 10,957,558    |   | $ | 14,010,580 |   |
| Interest-bearing deposits in other banks                                                                                                                                                   |       | 93,721,608        |          | 1,119,556 |   |
| Total cash and cash equivalents                                                                                                                                                            |       | 104,679,166       |          | 15,130,136 |   |
| Securities available for sale, at fair value                                                                                                                                               |       | 147,802,865       |          | 100,619,437 |   |
| Federal Home Loan Bank stock, restricted, at cost                                                                                                                                          |       | 4,316,800         |          | 3,670,200 |   |
| Loans held for sale                                                                                                                                                                        |       | 4,072,134         |          | 1,291,352 |   |
| Loans, net of unearned income                                                                                                                                                              |       | 790,129,903       |          | 792,883,664 |   |
| Less - allowance for loan losses                                                                                                                                                           |       | (14,910,792       | )             | (11,671,534 | ) |
| Loans, net                                                                                                                                                                                 |       | 775,219,111       |          | 781,212,130 |   |
| Bank premises and equipment, net                                                                                                                                                           |       | 31,671,914        |          | 31,049,394 |   |
| Accrued interest receivable                                                                                                                                                                |       | 5,194,880         |          | 6,342,138 |   |
| Cash surrender value of life insurance                                                                                                                                                     |       | 12,730,286        |          | 12,465,228 |   |
| Goodwill and other intangible assets, net of  amortization                                                                                                                                 |       | 2,730,008         |          | 22,444,667 |   |
| Other real estate owned                                                                                                                                                                    |       | 7,566,940         |          | 10,196,165 |   |
| Other assets                                                                                                                                                                               |       | 7,033,149         |          | 7,320,743 |   |
| **Total Assets**                                                                                                                                                                           |       | $                 | 1,103,017,253 |   | $ | 991,741,590 |   |
|                                                                                                                                                                                       |       |              |          |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                                                                             | ** ** | ** **        | ** **    | ** ** | ** ** |
| Deposits:                                                                                                                                                                                  |       |              |          |   |   |
| Non-interest bearing                                                                                                                                                                       |       | $                 | 56,800,423    |   | $ | 48,482,128 |   |
| Money market and NOW accounts                                                                                                                                                              |       | 162,683,416       |          | 141,224,574 |   |
| Savings                                                                                                                                                                                    |       | 8,933,960         |          | 7,972,230 |   |
| Time deposits                                                                                                                                                                              |       | 736,400,769       |          | 638,772,511 |   |
| Total deposits                                                                                                                                                                             |       | 964,818,568       |          | 836,451,443 |   |
| Federal Home Loan Bank advances                                                                                                                                                            |       | 56,300,000        |          | 47,500,000 |   |
| Subordinated debentures                                                                                                                                                                    |       | 1,400,000         |          | 1,400,000 |   |
| Junior subordinated debentures                                                                                                                                                             |       | 10,310,000        |          | 10,310,000 |   |
| Accrued interest payable                                                                                                                                                                   |       | 5,116,924         |          | 5,487,499 |   |
| Accrued expenses and other liabilities                                                                                                                                                     |       | 140,817           |          | 1,630,080 |   |
| Total liabilities                                                                                                                                                                          |       | 1,038,086,309     |          | 902,779,022 |   |
| Shareholders’ Equity:                                                                                                                                                                 |       |              |          |   |   |
| Preferred stock, authorized 2,000,000 shares, no  shares outstanding                                                                                                                       |       | —            |          | — |   |
| Common stock, no par value, authorized 10,000,000  shares, 4,211,780 issued and outstanding in 2009, $5 par value, authorized 10,000,000  shares, 4,211,780 issued and outstanding in 2008 |       | 74,618,930        |          | 21,058,900 |   |
| Paid-in capital surplus                                                                                                                                                                    |       | —            |          | 53,546,955 |   |
| Retained earnings (accumulated deficit)                                                                                                                                                    |       | (9,450,990        | )             | 13,588,966 |   |
| Accumulated other comprehensive income (loss)                                                                                                                                              |       | (236,996          | )             | 767,747 |   |
| Total shareholders’ equity                                                                                                                                                            |       | 64,930,944        |          | 88,962,568 |   |
| **Total Liabilities and  Shareholders’ Equity**                                                                                                                                       |       | $                 | 1,103,017,253 |   | $ | 991,741,590 |   |

 

*See Accompanying Notes toConsolidated Financial Statements (Unaudited).*

 

2

----

Table ofContents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Statements of Operations**

**For the Three Months and Six Months Ended June 30,2009 and 2008**

**(Unaudited)**

 
| ** **                                                     | ** ** | **Three Months Ended** | ** **  | **Six Months Ended** | ** ** |
|----------------------------------------------------------------|------------|------------------------|-------------|----------------------|------------|
| ** **                                                     | ** ** | **June 30,**      | ** **  | **June 30,**    | ** ** |
| ** **                                                     | ** ** | **2009**               | ** **  | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| **Interest and Dividend Income:**                              |       |                   |        |                 |       |   |   |   |   |
| Interest and fees on loans                                     |       | $                      | 10,729,675  |                 | $          | 12,436,315 |   | $ | 22,131,412 |   | $ | 25,865,554 |   |
| Interest on securities:                                        |       |                   |        |                 |       |   |   |   |   |
| Taxable income                                                 |       | 811,478                |        | 706,552              |       | 1,785,725 |   | 1,343,574 |   |
| Non-taxable income                                             |       | 156,520                |        | 225,165              |       | 323,252 |   | 425,437 |   |
| Income on federal funds sold                                   |       | —                 |        | 32,830               |       | — |   | 113,383 |   |
| Other interest and dividend income                             |       | 4,323                  |        | 76,863               |       | 8,481 |   | 155,746 |   |
| Total interest and dividend income                             |       | 11,701,996             |        | 13,477,725           |       | 24,248,870 |   | 27,903,694 |   |
| **Interest Expense:**                                          |       |                   |        |                 |       |   |   |   |   |
| Deposits                                                       |       | 6,692,934              |        | 7,031,657            |       | 13,347,697 |   | 14,578,492 |   |
| Junior subordinated debentures                                 |       | 84,860                 |        | 126,296              |       | 186,247 |   | 302,390 |   |
| Federal funds purchased                                        |       | —                 |        | 19,868               |       | 97 |   | 44,760 |   |
| FHLB borrowings and other interest expense                     |       | 429,947                |        | 334,107              |       | 823,332 |   | 734,844 |   |
| Total interest expense                                         |       | 7,207,741              |        | 7,511,928            |       | 14,357,373 |   | 15,660,486 |   |
|                                                           |       |                   |        |                 |       |   |   |   |   |
| Net interest income                                            |       | 4,494,255              |        | 5,965,797            |       | 9,891,497 |   | 12,243,208 |   |
| **Provision for loan losses**                                  |       | 5,718,000              |        | 946,000              |       | 6,068,000 |   | 1,348,000 |   |
| Net interest income (expense) after provision for  loan losses |       | (1,223,745             | )           | 5,019,797            |       | 3,823,497 |   | 10,895,208 |   |
| **Noninterest Income:**                                        |       |                   |        |                 |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 418,094                |        | 440,776              |       | 839,675 |   | 857,218 |   |
| Other service charges, commissions and fees                    |       | 125,536                |        | 118,848              |       | 238,127 |   | 228,731 |   |
| Gain on sales / calls of investment securities                 |       | 1,095,390              |        | 8,405                |       | 1,315,818 |   | 40,245 |   |
| Mortgage origination income                                    |       | 186,631                |        | 192,206              |       | 393,587 |   | 430,032 |   |
| Other income                                                   |       | 254,933                |        | 470,149              |       | 556,076 |   | 677,231 |   |
| Total noninterest income                                       |       | 2,080,584              |        | 1,230,384            |       | 3,343,283 |   | 2,233,457 |   |
| **Noninterest Expense:**                                       |       |                   |        |                 |       |   |   |   |   |
| Salaries and employee benefits                                 |       | 2,638,685              |        | 2,823,534            |       | 5,415,452 |   | 5,687,615 |   |
| Occupancy expense                                              |       | 436,857                |        | 462,873              |       | 891,754 |   | 911,671 |   |
| Equipment rental and depreciation of equipment                 |       | 326,202                |        | 280,296              |       | 631,503 |   | 544,310 |   |
| Loss (gain) on sale of other assets                            |       | 1,460,750              |        | (165                 | )          | 1,523,685 |   | 13,485 |   |
| Goodwill impairment                                            |       | 19,533,501             |        | —               |       | 19,533,501 |   | — |   |
| Other expenses                                                 |       | 2,838,226              |        | 1,766,184            |       | 4,553,327 |   | 3,363,258 |   |
| Total noninterest expense                                      |       | 27,234,221             |        | 5,332,722            |       | 32,549,222 |   | 10,520,339 |   |
|                                                           |       |                   |        |                 |       |   |   |   |   |
| **Earnings (Loss) Before Income  Taxes**                       |       | (26,377,382            | )           | 917,459              |       | (25,382,442 | ) | 2,608,326 |   |
| Income tax benefit (expense)                                   |       | 2,595,673              |        | (209,183             | )          | 2,342,486 |   | (710,334 | ) |
| **Net Earnings (Loss)**                                        |       | $                      | (23,781,709 | )                    | $          | 708,276 |   | $ | (23,039,956 | ) | $ | 1,897,992 |   |
| **Net Earnings (Loss) per share:**                             |       |                   |        |                 |       |   |   |   |   |
| Basic                                                          |       | $                      | (5.65       | )                    | $          | 0.17 |   | $ | (5.47 | ) | $ | 0.46 |   |
| Diluted                                                        |       | $                      | (5.65       | )                    | $          | 0.16 |   | $ | (5.47 | ) | $ | 0.43 |   |
| **Dividends declared per share:**                              |       | $                      | —      |                 | $          | 0.03 |   | $ | — |   | $ | 0.06 |   |

 

*See Accompanying Notes toConsolidated Financial Statements (Unaudited).*

 

3

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Statements of Comprehensive Income**

**For the Three Months and Six Months Ended June 30,2009 and 2008**

**(Unaudited)**

 
| ** **                                                             | ** ** | **Three Months Ended June 30,** | ** **  | **Six Months Ended June 30,** | ** ** |
|------------------------------------------------------------------------|------------|--------------------------------------|-------------|------------------------------------|------------|
| ** **                                                             | ** ** | **2009**                             | ** **  | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Net earnings (loss)                                                    |       | $                                    | (23,781,709 | )                                  | $          | 708,276 |   | $ | (23,039,956 | ) | $ | 1,897,992 |   |
| Other comprehensive loss:                                              |       |                                 |        |                               |       |   |   |   |   |
| Unrealized holding losses on investment securities  available for sale |       | (1,187,425                           | )           | (1,700,583                         | )          | (206,520 | ) | (999,370 | ) |
| Reclassification adjustment for gains realized in  net earnings (loss) |       | (1,095,390                           | )           | (8,405                             | )          | (1,315,818 | ) | (40,245 | ) |
| Total other comprehensive loss, before tax                             |       | (2,282,815                           | )           | (1,708,988                         | )          | (1,522,338 | ) | (1,039,615 | ) |
| Income taxes related to other comprehensive loss:                      |       |                                 |        |                               |       |   |   |   |   |
| Unrealized holding losses on investment securities  available for sale |       | 403,725                              |        | 578,198                            |       | 70,217 |   | 339,786 |   |
| Reclassification adjustment for gains realized in net  earnings (loss) |       | 372,433                              |        | 2,858                              |       | 447,378 |   | 13,683 |   |
| Total income taxes related to other comprehensive  loss                |       | 776,158                              |        | 581,056                            |       | 517,595 |   | 353,469 |   |
| Total other comprehensive loss, net of tax                             |       | (1,506,657                           | )           | (1,127,932                         | )          | (1,004,743 | ) | (686,146 | ) |
| Total comprehensive income (loss)                                      |       | $                                    | (25,288,366 | )                                  | $          | (419,656 | ) | $ | (24,044,699 | ) | $ | 1,211,846 |   |

 

*See Accompanying Notes toConsolidated Financial Statements (Unaudited).*

 

4

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Statements of Cash Flows**

**For the Six Months Ended June 30, 2009 and2008**

**(Unaudited)**

 
| ** **                                                                                  | ** ** | **Six Months Ended June 30,** | ** **  |
|---------------------------------------------------------------------------------------------|------------|------------------------------------|-------------|
| ** **                                                                                  | ** ** | **2009**                           | ** **  | **2008** | ** ** |
| **Cash Flows from Operating Activities:**                                                   |       |                               |        |   |   |
| Net earnings (loss)                                                                         |       | $                                  | (23,039,956 | ) | $ | 1,897,992 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by operating activities: |       |                               |        |   |   |
| Provision for loan losses                                                                   |       | 6,068,000                          |        | 1,348,000 |   |
| Depreciation                                                                                |       | 808,320                            |        | 697,209 |   |
| Stock based compensation                                                                    |       | 13,075                             |        | 11,968 |   |
| Goodwill impairment charge                                                                  |       | 19,533,501                         |        | — |   |
| Amortization and (accretion), net                                                           |       | 350,527                            |        | 157,063 |   |
| Loss on sale of other assets                                                                |       | 1,523,685                          |        | 13,485 |   |
| Gain on sales / calls of investment securities                                              |       | (1,315,818                         | )           | (40,245 | ) |
| Earnings on cash surrender value of life insurance                                          |       | (265,058                           | )           | (253,856 | ) |
| Change in:                                                                                  |       |                               |        |   |   |
| Loans held for sale                                                                         |       | (2,780,782                         | )           | (1,446,629 | ) |
| Accrued income and other assets                                                             |       | 1,136,982                          |        | (1,253,308 | ) |
| Accrued expenses and other liabilities                                                      |       | (1,342,243                         | )           | 403,926 |   |
| Net cash provided by operating activities                                                   |       | 690,233                            |        | 1,535,605 |   |
| **Cash Flows from Investing  Activities:**                                                  |       |                               |        |   |   |
| Net change in loans to customers                                                            |       | (4,780,049                         | )           | (99,288,142 | ) |
| Purchase of available for sale securities                                                   |       | (136,272,035                       | )           | (22,589,987 | ) |
| Proceeds from sales, calls, maturities and paydowns  of available for sale securities       |       | 88,770,336                         |        | 10,734,605 |   |
| Purchase of other investments                                                               |       | (880,600                           | )           | (436,200 | ) |
| Proceeds from sales of other investments                                                    |       | 447,526                            |        | 414,000 |   |
| Purchase of cash surrender value of life insurance                                          |       | —                             |        | (7,500,000 | ) |
| Property and equipment expenditures                                                         |       | (1,430,840                         | )           | (1,475,707 | ) |
| Proceeds from sales of assets                                                               |       | 5,837,334                          |        | 317,309 |   |
| Net cash used in investing activities                                                       |       | (48,308,328                        | )           | (119,824,122 | ) |
| **Cash Flows from Financing  Activities:**                                                  |       |                               |        |   |   |
| Net change in deposits                                                                      |       | 128,367,125                        |        | 130,068,275 |   |
| Advances on FHLB borrowings                                                                 |       | 31,000,000                         |        | 20,200,000 |   |
| Payments on FHLB borrowings                                                                 |       | (22,200,000                        | )           | (24,200,000 | ) |
| Dividends paid                                                                              |       | —                             |        | (249,108 | ) |
| Net cash provided by financing activities                                                   |       | 137,167,125                        |        | 125,819,167 |   |
| **Net Increase in Cash and Cash  Equivalents**                                              |       | 89,549,030                         |        | 7,530,650 |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                           |       | 15,130,136                         |        | 19,924,178 |   |
| **Cash and Cash Equivalents, End of  Quarter**                                              |       | $                                  | 104,679,166 |   | $ | 27,454,828 |   |

 

*See Accompanying Notes toConsolidated Financial Statements (Unaudited).*

 

5

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

# ***(1)  Basis ofPresentation***

# ** **

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith the instructions to Form 10-Q and therefore do not include allinformation and footnotes necessary for a fair presentation of financialposition, results of operations, and changes in financial position inconformity with generally accepted accounting principles.  The interim financial statements furnishedreflect all adjustments, which are, in the opinion of management, necessary toa fair statement of the results for the interim periods presented.  The interim consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2008.

 

# ***(2)  Subsequent Events***

# ** **

The Companyperformed an evaluation of subsequent events through August 13, 2009, thedate upon which the Company’s quarterly report on Form 10-Q was filed withthe Securities and Exchange Commission. No subsequent events were identified that would have required a changeto the financial statements or disclosure in the notes to the financialstatements.

 

# ***(3)  Net Earnings(Loss) per Share***

# ** **

Basicearnings (loss) per share are based on the weighted average number of commonshares outstanding during the period while the effects of potential sharesoutstanding during the period are included in diluted earnings per share.  Options and warrants were not included in thediluted (loss) per share computations for the three and six months ended June 30,2009 as they were antidilutive.

 

The reconciliation of the amounts used in the computationof both “basic earnings (loss) per share” and “diluted earnings (loss) pershare” for each period is presented as follows:

 
| ** **                                                                 | ** ** | **Three  Months Ended** | ** **  | **Six  Months Ended** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------|-------------|-----------------------|------------|
| ** **                                                                 | ** ** | **June 30,**       | ** **  | **June 30,**     | ** ** |
| ** **                                                                 | ** ** | **2009**                | ** **  | **2008**              | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                       |       |                    |        |                  |       |   |   |   |   |
| Net earnings (loss)                                                        |       | $                       | (23,781,709 | )                     | $          | 708,276 |   | $ | (23,039,956 | ) | $ | 1,897,992 |   |
|                                                                       |       |                    |        |                  |       |   |   |   |   |
| Weighted average common shares outstanding                                 |       | 4,211,780               |        | 4,151,780             |       | 4,211,780 |   | 4,151,780 |   |
| Shares issued from assumed exercise of common stock  equivalents           |       | —                  |        | 255,008               |       | — |   | 257,984 |   |
| Weighted average number of commonand common  equivalent shares outstanding |       | 4,211,780               |        | 4,406,788             |       | 4,211,780 |   | 4,409,764 |   |
| Earnings (loss) per share:                                                 |       |                    |        |                  |       |   |   |   |   |
| Basic                                                                      |       | $                       | (5.65       | )                     | $          | 0.17 |   | $ | (5.47 | ) | $ | 0.46 |   |
|                                                                       |       |                    |        |                  |       |   |   |   |   |
| Diluted                                                                    |       | $                       | (5.65       | )                     | $          | 0.16 |   | $ | (5.47 | ) | $ | 0.43 |   |

 

6

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Notes to ConsolidatedFinancial Statements**

**(Unaudited)**

 

***(4)  ******InvestmentSecurities***

 

Debtand equity securities have been classified in the balance sheet according tomanagement’s intent.  All investments asof June 30, 2009 and December 31, 2008 are classified as availablefor sale.  The following table reflectsthe amortized cost and estimated fair values of the investments:

 
| ** **                                | ** ** | **Amortized  Cost** | ** **  | **Unrealized  Gains** | ** ** | **Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|---------------------|-------------|-----------------------|------------|------------------------|------------|---------------------------|------------|
| **June 30, 2009**                    |       |                |        |                  |       |                   |       |                      |       |
| Non-mortgage backed debt securities of :  |       |                |        |                  |       |                   |       |                      |       |
| U.S. Treasury obligations                 |       | $                   | 67,921,605  |                  | $          | 1,253                  |       | $                         | (3,799     | ) | $ | 67,919,059 |   |
| U.S. government sponsored enterprises     |       | 41,551,503          |        | 210,613               |       | (62,838                | )          | 41,699,278                |       |
| State and political subdivisions          |       | 16,079,500          |        | 66,971                |       | (959,894               | )          | 15,186,577                |       |
| Other investments                         |       | 250,000             |        | 11,040                |       | —                 |       | 261,040                   |       |
| Total non-mortgage backed debt securities |       | 125,802,608         |        | 289,877               |       | (1,026,531             | )          | 125,065,954               |       |
| Mortgage backed securities                |       | 22,274,617          |        | 466,429               |       | (35,232                | )          | 22,705,814                |       |
| Equity securities                         |       | 84,725              |        | —                |       | (53,628                | )          | 31,097                    |       |
| Total                                     |       | $                   | 148,161,950 |                  | $          | 756,306                |       | $                         | (1,115,391 | ) | $ | 147,802,865 |   |
| **December 31, 2008**                |       |                |        |                  |       |                   |       |                      |       |
| Non-mortgage backed debt securities of :  |       |                |        |                  |       |                   |       |                      |       |
| U.S. Treasury obligations                 |       | $                   | 249,892     |                  | $          | 1,701                  |       | $                         | —     |   | $ | 251,593 |   |
| U.S. government sponsored enterprises     |       | 17,051,518          |        | 709,477               |       | —                 |       | 17,760,995                |       |
| State and political subdivisions          |       | 21,241,661          |        | 119,635               |       | (1,063,228             | )          | 20,298,068                |       |
| Other investments                         |       | 250,000             |        | —                |       | —                 |       | 250,000                   |       |
| Total non-mortgage backed debt securities |       | 38,793,071          |        | 830,813               |       | (1,063,228             | )          | 38,560,656                |       |
| Mortgage backed securities                |       | 60,578,388          |        | 1,470,122             |       | (12,465                | )          | 62,036,045                |       |
| Equity securities                         |       | 84,725              |        | —                |       | (61,989                | )          | 22,736                    |       |
| Total                                     |       | $                   | 99,456,184  |                  | $          | 2,300,935              |       | $                         | (1,137,682 | ) | $ | 100,619,437 |   |

 

Theamortized cost and fair values of pledged securities for public deposits wereas follows:

 
| ** **     | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|----------------|------------|-------------------|------------|-----------------------|------------|
| ** **     | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Amortized cost |       | $                 | 7,132,334  |                  | $          | 12,098,353 |   |
| Fair value     |       | $                 | 6,611,847  |                  | $          | 12,106,428 |   |

 

The amortized cost and estimated fair value of debtsecurities available for sale at June 30, 2009, by contractual maturity,is shown below.  Expected maturities formortgage-backed securities may differ from contractual maturities because incertain cases borrowers can prepay obligations without prepaymentpenalties.  Therefore, these securitiesare not included in the following maturity summary.

 
| ** **                                | ** ** | ** **         | ** **  | **Estimated**  | ** ** |
|-------------------------------------------|------------|--------------------|-------------|----------------|------------|
| ** **                                | ** ** | **Amortized Cost** | ** **  | **Fair Value** | ** ** |
| Non-mortgage backed debt securities:      |       |               |        |           |       |
| Due in one year or less                   |       | $                  | 71,274,386  |           | $          | 71,300,373 |   |
| Due after one year through five years     |       | 30,162,758         |        | 30,176,749     |       |
| Due after five years through ten years    |       | 11,695,052         |        | 11,659,652     |       |
| Due after ten years                       |       | 12,670,412         |        | 11,929,180     |       |
| Total non-mortgage backed debt securities |       | $                  | 125,802,608 |           | $          | 125,065,954 |   |

 

Thefair value is established by an independent pricing service as of theapproximate dates indicated.  Thedifferences between the amortized cost and fair value reflect current interestrates and represent the potential

 

7

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Notes to ConsolidatedFinancial Statements**

**(Unaudited)**

 

loss(or gain) had the portfolio been liquidated on that date.  Security losses (or gains) are realized onlyin the event of dispositions prior to maturity.

 

Informationpertaining to securities with gross unrealized losses, aggregated by investmentcategory and length of time that individual securities have been in acontinuous unrealized loss position, follows:

 
| ** **                                | ** ** | **June 30, 2009**      | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **Less Than Twelve Months** | ** ** | **More Than Twelve Months** | ** ** |
| ** **                                | ** ** | **Unrealized**              | ** ** | **Estimated** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                                | ** ** | **Losses**                  | ** ** | **Fair Value** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| ***Securities  Available for Sale***      |       |                        |       |   |   |   |   |   |   |
| Non-mortgage backed debt securities of:   |       |                        |       |   |   |   |   |   |   |
| U.S. Treasury obligations                 |       | $                           | (3,799     | ) | $ | 44,930,819 |   | $ | — |   | $ | — |   |
| U.S. government sponsored enterprises     |       | (62,838                     | )          | 14,403,201 |   | — |   | — |   |
| State and political subdivisions          |       | (324,179                    | )          | 6,487,840 |   | (635,715 | ) | 3,929,733 |   |
| Total non-mortgage backed debt securities |       | (390,816                    | )          | 65,821,860 |   | (635,715 | ) | 3,929,733 |   |
| Mortgage backed securities                |       | (35,232                     | )          | 2,453,008 |   | — |   | — |   |
| Equity securities                         |       | (53,628                     | )          | 84,725 |   | — |   | — |   |
| Total                                     |       | $                           | (479,676   | ) | $ | 68,359,593 |   | $ | (635,715 | ) | $ | 3,929,733 |   |
|                                      |       |                        |       |
| ** **                                | ** ** | **December 31, 2008**  | ** ** |
| ** **                                | ** ** | **Less Than Twelve Months** | ** ** | **More Than Twelve Months** | ** ** |
| ** **                                | ** ** | **Unrealized**              | ** ** | **Estimated** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| ** **                                | ** ** | **Losses**                  | ** ** | **Fair Value** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| ***Securities  Available for Sale***      |       |                        |       |   |   |   |   |   |   |
| Non-mortgage backed debt securities of:   |       |                        |       |   |   |   |   |   |   |
| U.S. government sponsored enterprises     |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   |
| State and political subdivisions          |       | (1,038,539                  | )          | 12,911,929 |   | (24,689 | ) | 390,310 |   |
| Total non-mortgage backed debt securities |       | (1,038,539                  | )          | 12,911,929 |   | (24,689 | ) | 390,310 |   |
| Mortgage backed securities                |       | (12,465                     | )          | 2,644,664 |   | — |   | — |   |
| Equity securities                         |       | (61,989                     | )          | 22,736 |   | — |   | — |   |
| Total                                     |       | $                           | (1,112,993 | ) | $ | 15,579,329 |   | $ | (24,689 | ) | $ | 390,310 |   |

 

Management evaluatessecurities for other-than-temporary impairment at least on a quarterly basis,and more frequently when economic or market concerns warrant such evaluation.Consideration is given to (1) the length of time and the extent to whichthe fair value has been less than cost, (2) the financial condition andnear-term prospects of the issuer, and (3) the intent and ability of theCompany to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.

 

At June 30, 2009, fortydebt securities had unrealized losses with aggregate depreciation of 0.72% fromthe Company’s amortized cost basis.  Inanalyzing an issuer’s financial condition, management considers whether thesecurities are issued by the federal government or its agencies, whetherdowngrades by bond rating agencies have occurred, and industry analysts’reports. As management has the ability and intent to hold debt securities untilmaturity, or for the foreseeable future if classified as available for sale andit is more likely than not that the Company will not be required to sell theseinvestments before recovery of their amortized cost basis, no declines aredeemed to be other than temporary.

 

8

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Notes to ConsolidatedFinancial Statements**

**(Unaudited)**

 

The following tablesummarizes securities sales activity for the three month and six month periodsended June 30, 2009 and 2008:

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                         | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Proceeds from sales                                |       | $                      | 64,863,931 |                 | $          | 890,000 |   | $ | 80,531,819 |   | $ | 8,815,000 |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Gross gains on sales                               |       | $                      | 1,153,008  |                 | $          | 8,405 |   | $ | 1,384,133 |   | $ | 40,245 |   |
| Gross losses on sales                              |       | —                 |       | —               |       | (10,697 | ) | — |   |
| Impairment losses                                  |       | (57,618                | )          | —               |       | (57,618 | ) | — |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Net gains (losses) on sales of securities          |       | $                      | 1,095,390  |                 | $          | 8,405 |   | $ | 1,315,818 |   | $ | 40,245 |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Income tax expense (benefit) attributable to sales |       | $                      | 372,433    |                 | $          | 2,858 |   | $ | 447,378 |   | $ | 13,683 |   |

 

During the second quarter of2009, the Company recognized an impairment loss of $57,618 on an equityinvestment in Silverton Bank, a financial institution that failed during thequarter.  The impairment loss representsthe full amount of the Company’s investment in Silverton.

 

During the second quarter of2009, the Bank restructured approximately $36 million in U.S. agency andmortgage backed securities to capture gains on securities prepaying at highspeeds, to offset FDIC special assessment and to shorten the average maturityof the portfolio.

 

***(5)  Allowance for Loan Losses***

 

Activityin the allowance for loan losses for the six months ended June 30, 2009and for the year ended December 31, 2008 is as follows:

 
| ** **                                 | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Beginning Balance                          |       | $                 | 11,671,534 |                  | $          | 8,878,795 |   |
| Add:                                       |       |              |       |                  |       |
| Provision for possible loan losses         |       | 6,068,000         |       | 7,443,000             |       |
| Subtotal                                   |       | 17,739,534        |       | 16,321,795            |       |
| Less:                                      |       |              |       |                  |       |
| Loans charged off                          |       | 2,911,003         |       | 4,843,627             |       |
| Recoveries on loans previously charged off |       | (82,261           | )          | (193,366              | )          |
| Net loans charged off                      |       | 2,828,742         |       | 4,650,261             |       |
| Balance, end of period                     |       | $                 | 14,910,792 |                  | $          | 11,671,534 |   |

 

9

----

Table of Contents

 

**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Notes to ConsolidatedFinancial Statements**

**(Unaudited)**

 

***(6)  Nonperforming Assets***

 

### **Nonperformingassets consist of non-accrual loans, accruing loans 90 days past due,repossessed assets and other real estate owned. The following summarizesnon-performing assets:**

### ** **

| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Accruing loans 90 days past due |       | $                 | —     |                  | $          | — |   |
| Non-accrual loans               |       | 64,246,642        |       | 21,103,468            |       |
| Repossessed assets              |       | 49,400            |       | 34,783                |       |
| Other real estate               |       | 7,566,940         |       | 10,196,165            |       |
| Total non-performing assets     |       | $                 | 71,862,982 |                  | $          | 31,334,416 |   |

 

Nonperforming assetsincreased $40.5 million, or 129%, from December 31, 2008 to June 30,2009.  This increase is largely due toseveral large relationships that are secured by commercial and residential realestate construction and land development real estate being placed onnon-accrual during the first and second quarters of 2009.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other Real Estatedecreased $2.6 million during the second quarter of 2009 which is largely dueto the $3.5 million sale of a $4.8 million condominium complex in SouthGeorgia, resulting in a $1.3 million loss on the property.  The Company also added approximately $2.0million in 13 other real estate properties during the second quarter of 2009.

 

As of June 30, 2009and December 31, 2008, the Company’s Other Real Estate consisted of thefollowing:

 
| ** **                                          | ** ** | **As of June 30, 2009** | ** ** | **As of December 31, 2008** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| 1-4 Family residential properties                   |       | 11                           |       | $                                | 3,524,290  |   | 8 |   | $ | 3,574,090 |   |
| Nonfarm nonresidential properties                   |       | 5                            |       | 655,265                          |       | 5 |   | 520,101 |   |
| Multifamily residential properties                  |       | 1                            |       | 31,675                           |       | — |   | — |   |
| Construction & land development properties |       | 20                           |       | 3,355,710                        |       | 15 |   | 6,101,974 |   |
| Total                                               |       | 37                           |       | $                                | 7,566,940  |   | 28 |   | $ | 10,196,165 |   |

 

All properties are beingactively marketed for sale and management is continuously monitoring these propertiesin order to minimize any losses.

 

The Company’s policy isto place loans on non-accrual status when it appears that the collection ofinterest in accordance with the terms of the loan is doubtful.  Any loan which becomes 90 days past due as toprincipal or interest is automatically placed on non-accrual.  Exceptions are allowed for 90-day past dueloans when such loans are well secured and in process of collection.  Other Real Estate is defined as real estateacquired through or in lieu of foreclosure. At the time of foreclosure, an appraisal is obtained on the realestate.  The amount charged to Other RealEstate will be the estimated fair value less costs to sell.  The recorded investment is the unpaid balanceof the loan, increased by accrued and uncollected interest, unamortizedpremium, finance charges, and loan acquisition costs, if any, and decreased byprevious direct write down and unamortized discount.  Any excess of the recorded investment in theloan satisfied over the appraised value of the property must be charged toallowance for loan losses.

 

10

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

***(7)  ******Goodwill***

 

Asummary of the changes in goodwill as of June 30, 2009 and December 31,2008 is presented below.

 
| ** **        | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|-------------------|------------|-------------------|------------|-----------------------|------------|
| ** **        | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Beginning Balance |       | $                 | 19,533,501 |                  | $          | 19,533,501 |   |
| Impairment        |       | (19,533,501       | )          | —                |       |
| Ending Balance    |       | $                 | —     |                  | $          | 19,533,501 |   |

 

Duringthe second quarter of 2009, the Company updated its goodwill impairmentassessment based upon the current economic environment.  The current economic environment factors haveresulted in lower earnings with higher credit costs being reflected in thestatement of operations as well as valuation adjustments to the loan balancesthrough increases in the level of the allowance for loan losses.  As a result of the updated assessment,goodwill was found to be impaired and was written down to its estimated fairvalue.  The impairment charge of $19.5million was recognized as an expense in the second quarter consolidatedstatement of operations.

 

***(8)  ******Shareholders’Equity***

 

OnMay 27, 2009, the Company amended its Articles of Incorporation toeliminate par value per share with respect to its common stock from theprevious $5.00 par value per share of its common stock.  Therefore, the paid-in capital surplus forthe Company as of that date was included with the Company’s common stock.

 

***(9)  ******FairValue Measurements and Disclosures***

 

EffectiveJanuary 1, 2008, the Company adopted Financial Accounting Standards Board(“FASB”) Statement No. 157, *Fair Value Measurements*(“SFAS No. 157”), which provides a framework for measuring fair valueunder generally accepted accounting principles. SFAS No. 157 applies to all financial elements that are beingmeasured and reported on a fair value basis.

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

Thetable below presents the recorded amount of assets and liabilities measured atfair value on a recurring basis.

 
| ** **                    | ** ** | **As of June 30,** | ** **  |
|-------------------------------|------------|-------------------------|-------------|
| ** **                    | ** ** | **2009**                | ** **  |
| ** **                    | ** ** | **Total**               | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                    |       |                    |        |   |   |   |   |   |   |
| Securities available-for-sale |       | $                       | 147,802,865 |   | $ | — |   | $ | 147,802,865 |   | $ | — |   |
|                               |            |                         |             |  |  |  |  |  |  |  |  |  |  |

 

Duringthe first quarter of 2009, the Company changed its investment bondaccountants.  Therefore, the level ofmeasurement techniques to evaluate some of the securities available-for-salechanged to include all in the Level 2 category since they are using differentpricing sources and different matrixes for the securities available-for-sale.

 

Assets Recorded at Fair Value on a Nonrecurring Basis

 

TheCompany may be required, from time to time, to measure certain assets at fairvalue on a nonrecurring basis in accordance with U.S. generally acceptedaccounting principles.  These includeassets that are measured at the lower of cost or market that were recognized atfair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included inthe table below.

 

11

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                     | ** ** | **As of June 30,** | ** ** |
|--------------------------------|------------|-------------------------|------------|
| ** **                     | ** ** | **2009**                | ** ** |
| ** **                     | ** ** | **Total**               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                           |       |                    |       |   |   |   |   |   |   |
| Loans                          |       | $                       | 72,589,621 |   | $ | — |   | $ | 72,589,621 |   | $ | — |   |
| Loans held for sale            |       | 4,072,134               |       |   |   | 4,072,134 |   |   |   |
| Other real estate owned        |       | 7,566,940               |       | — |   | 7,566,940 |   | — |   |
|                           |       |                    |       |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                       | 84,228,695 |   | $ | — |   | $ | 84,228,695 |   | $ | — |   |

 

The carrying amount and estimated fair values of theCompany’s assets and liabilities which are required to be either disclosed orrecorded at fair value at June 30, 2009 and December 31, 2008 are asfollows:

 
| ** **                             | ** ** | **June 30, 2009** | ** **  | **December 31, 2008** | ** ** |
|----------------------------------------|------------|------------------------|-------------|----------------------------|------------|
| ** **                             | ** ** | **Carrying**           | ** **  | **Estimated**              | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amount**             | ** **  | **Fair Value**             | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Assets:**                            |       |                   |        |                       |       |   |   |   |   |
| Cash and cash equivalents              |       | $                      | 104,679,166 |                       | $          | 104,679,166 |   | $ | 15,130,136 |   | $ | 15,130,136 |   |
| Securities available for sale          |       | 147,802,865            |        | 147,802,865                |       | 100,619,437 |   | 100,619,437 |   |
| Federal Home Loan Bank Stock           |       | 4,316,800              |        | 4,316,800                  |       | 3,670,200 |   | 3,670,200 |   |
| Loans held for sale                    |       | 4,072,134              |        | 4,072,134                  |       | 1,291,352 |   | 1,291,352 |   |
| Loans, net                             |       | 775,219,111            |        | 777,377,491                |       | 781,212,130 |   | 783,884,588 |   |
| Other real estate owned                |       | 7,566,940              |        | 7,566,940                  |       | 10,196,165 |   | 10,196,165 |   |
| Cash surrender value of life insurance |       | 12,730,286             |        | 12,730,286                 |       | 12,465,228 |   | 12,465,228 |   |
| **Liabilities:**                       |       |                   |        |                       |       |   |   |   |   |
| Deposits                               |       | 964,818,568            |        | 969,525,824                |       | 836,451,443 |   | 838,965,232 |   |
| FHLB borrowings                        |       | 56,300,000             |        | 57,018,817                 |       | 47,500,000 |   | 48,403,420 |   |
| Subordinated debentures                |       | 1,400,000              |        | 1,400,000                  |       | 1,400,000 |   | 1,400,000 |   |
| Junior subordinated debentures         |       | 10,310,000             |        | 10,310,000                 |       | 10,310,000 |   | 10,310,000 |   |
|                                        |            |                        |             |                            |            |  |  |  |  |  |  |  |  |

 

***Limitations*** - Fair value estimates aremade at a specific point in time, based on relevant market information andinformation about the financial statement elements.  These estimates are subjective in nature andinvolve uncertainties and matters of significant judgment and therefore cannotbe determined with precision.  Changes inassumptions could significantly affect the estimates.

 

Fairvalue estimates are based on existing on- and off-balance sheet financialinstruments without attempting to estimate the value of anticipated futurebusiness and the fair value of assets and liabilities that are not required tobe recorded or disclosed at fair value like the mortgage banking operation,brokerage network and premises and equipment.

 

***(10) RecentAccounting Pronouncements***

 

In April 2009, theFASB issued FSP FAS 141 (R)-1, *Accounting for AssetsAcquired and Liabilities Assumed in a Business Combination That Arise fromContingencies*.  This FASBStaff Position amends and clarifies SFAS No. 141 (R), *BusinessCombinations*, to address application issues on the initialrecognition and measurement, subsequent measurement and accounting, anddisclosure of assets and liabilities arising from contingencies in a businesscombination.  This statement is effectivefor financial statements issued for fiscal years beginning after December 15,2008.  The Company cannot determine whatimpact this will have until the transactions occur.

 

In April 2009, the FASB issued FSP FAS 157-4, *DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly*.  This FASB Staff Position provides additionalguidance for estimating fair value in accordance with SFAS No. 157, *Fair Value Measurements*, when the volume and level ofactivity for the asset or liability have 

 

12

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

significantly decreased.  It also includes guidance on identifyingcircumstances that indicate a transaction is not orderly.  It emphasizes that even if there has been asignificant decrease in the volume and level of activity for the asset orliability and regardless of the valuation technique used, the objective of afair value measurement remains the same. Fair value is the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction between market participants atthe measurement date under current market conditions.  This accounting standard become effective forthe Company in the second quarter of 2009. Theadoption did not have a significant impact on results of operations orfinancial position.

 

In April 2009, the FASB issued FSP FAS 115-2and FAS 124-2, *Recognition and Presentation ofOther-Than-Temporary Impairments*. This FASB Staff Position amends the other-than-temporary impairmentguidance in U.S. GAAP for debt securities to make the guidance more operationaland to improve the presentation and disclosure of other-than-temporaryimpairments on debt and equity securities in the financial statements and doesnot amend existing recognition and measurement guidance related toother-than-temporary impairments of equity securities.  This accounting standard become effective forthe Company in the second quarter of 2009. Theadoption did not have a significant impact on results of operations orfinancial position.

 

In April 2009, the FASB issued FSP FAS 107-1and APB 28-1, *Interim Disclosures about Fair Value ofFinancial Instruments*.  ThisFASB Staff Position amends SFAS No. 107, *Disclosuresabout Fair Value of Financial Instruments*, to require disclosuresabout fair value of financial instruments for interim reporting periods ofpublicly traded companies as well as in annual financial statements.  It also amends APB No. 28, *Interim Financial Reporting*, to require those disclosures insummarized financial information at interim reporting periods.  This accounting standard become effective forthe Company in the second quarter of 2009. Theadoption did not have a significant impact on results of operations orfinancial position.

 

In May 2009,the FASB issued SFAS No. 165, *Subsequent Events*.  This statement establishes general standardsof accounting for and disclosure of events that occur after the balance sheetdate but before financial statements are issued or are available to beissued.  In particular, this statementsets (1) the period after the balance sheet date during which managementof a reporting entity should evaluate events or transactions that may occur forpotential recognition or disclosure in the financial statements (2) thecircumstances under which an entity should recognize events or transactions occurring after the balancesheet date in its financial statements and (3) the disclosures that anentity should make about events or transactions that occurred after the balancesheet date.  This statement is effectivefor interim and annual reporting periods ending after June 15, 2009.    The Company adopted the provisions of SFAS 165 for thequarter ended June 30, 2009, as required, and adoption did not have amaterial impact on the consolidated financial statements taken as a whole.

 

On June 29, 2009,the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 168,*The*FASB Accounting StandardsCodificationTM *and the Hierarchy of Generally Accepted AccountingPrinciples — a replacement of FASB Statement No. 162 (“SFAS 168”)*.  SFAS168 establishes the *FASB AccountingStandards Codification*TM as the source of authoritative accountingprinciples recognized by the FASB to be applied by nongovernmental entities inthe preparation of financial statements in conformity with USGAAP.  SFAS 168 will be effective for financial statements issued forinterim and annual periods ending after September 15, 2009, for mostentities.  On the effective date, all non-SEC accounting andreporting standards will be superceded.  The Company will adopt SFAS168 for the quarterly period ended September 30, 2009, as required, andadoption is not expected to have a material impact on the consolidatedfinancial statements.

 

On June 12, 2009,the FASB issued SFAS No. 166, *Accountingfor Transfers of Financial Assets* (“SFAS 166”), and SFAS No.167,*Amendments to FASB Interpretation No. 46(R) *(“SFAS167”), which changed the way entities account for securitizations andspecial-purpose entities.

 

SFAS 166 is a revision toFASB SFAS No. 140, *Accounting forTransfers and Servicing of Financial Assets and Extinguishments of Liabilities*,and will require more information about transfers of financial assets,including securitization transactions, and where companies have continuingexposure to the risks related to transferred financial assets.  SFAS166 also eliminates the concept of a “qualifying special-purpose entity”,changes the requirements for derecognizing financial assets and requiresadditional disclosures.

 

13

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

SFAS 167 is a revision toFASB Interpretation No. 46(R), *Consolidationof Variable Interest Entities*, and changes how a company determineswhen an entity that is insufficiently capitalized or is not controlled throughvoting (or similar rights) should be consolidated.  The determinationof whether a company is required to consolidate an entity is based on, among otherthings, an entity’s purpose and design and a company’s ability to direct theactivities of the entity that most significantly impact the entity’s economicperformance.

 

Both SFAS 166 and SFAS167 will be effective as of the beginning of each reporting entity’s firstannual reporting period that begins after November 15, 2009, for interimperiods within that first annual reporting period and for interim and annualreporting periods thereafter.  Earlier application isprohibited.  The recognition and measurement provisions of SFAS 166shall be applied to transfers that occur on or after the effectivedate.  The Company will adopt both SFAS 166 and SFAS 167 on January 1,2010, as required.  Management has not determined the impact adoptionmay have on our consolidated financial statements.

 

14

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Item 2. Management’s Discussionand Analysis of Financial Condition and Results of Operations**

**For Each of the Three Months and Six Months in thePeriod Ended**

**June 30, 2009 and 2008**

 

Thefollowing discussion of financial condition as of June 30, 2009 compared to December 31, 2008, and the results of operations for thethree months and six months ended June 30,2009 compared to the three months and six months ended June 30,2008 should be read in conjunction with the condensed financial statements andaccompanying footnotes appearing in this report.

 

##### ***Advisory Note Regarding Forward-Looking Statements***

##### *** ***

The statements contained in this report on Form 10-Q thatare not historical facts are forward-looking statements subject to the safeharbor created by the Private Securities Litigation Reform Act of 1995.  We caution readers of this report that suchforward-looking statements involve known and unknown risks, uncertainties andother factors which may cause the actual results, performance or achievementsto be materially different from those expressed or implied by suchforward-looking statements.  Although webelieve that our expectations of future performance is based on reasonableassumptions within the bounds of our knowledge of our business and operations,there can be no assurance that actual results will not differ materially fromour expectations.

 

Factors which could cause actual results to differ fromexpectations include, among other things:

 

·                 the challenges,costs and complications associated with the continued development of ourbranches;

·                 the potentialthat loan charge-offs may exceed the allowance for loan losses or that suchallowance will be increased as a result of factors beyond our control;

·                 our dependenceon senior management;

·                 competition fromexisting financial institutions operating in our market areas as well as theentry into such areas of new competitors with greater resources, broader branchnetworks and more comprehensive services;

·                 adverseconditions in the stock market, the public debt market, and other capitalmarkets (including changes in interest rate conditions);

·                 the effect ofany mergers, acquisitions or other transactions to which we or our subsidiarymay from time to time be a party, including, without limitation, our ability tosuccessfully integrate any businesses that we acquire;

·                 changes indeposit rates, the net interest margin, and funding sources;

·                 inflation,interest rate, market, and monetary fluctuations;

·                 risks inherentin making loans including repayment risks and value of collateral;

·                 the strength ofthe United States economy in general and the strength of the local economies inwhich we conduct operations may be different than expected resulting in, amongother things, a deterioration in credit quality or a reduced demand for credit,including the resultant effect on our loan portfolio and allowance for loanlosses;

·                 fluctuations inconsumer spending and saving habits;

·                 the demand forour products and services;

·                 technologicalchanges;

·                 the challengesand uncertainties in the implementation of our expansion and developmentstrategies;

·                 the ability toincrease market share;

·                 the adequacy ofexpense projections and estimates of impairment loss;

·                 the impact ofchanges in accounting policies by the Securities and Exchange Commission;

·                 unanticipatedregulatory or judicial proceedings;

·                 the potentialnegative effects of future legislation affecting financial institutions(including, without limitation, laws concerning taxes, banking, securities, andinsurance);

·                 the effects of,and changes in, trade, monetary and fiscal policies and laws, includinginterest rate policies of the Board of Governors of the Federal Reserve System;

·                 the timelydevelopment and acceptance of products and services, including products andservices offered through alternative delivery channels such as the Internet;

·                 the impact onour business, as well as on the risks set forth above, of various domestic orinternational military or terrorist activities or conflicts;

 

15

----

Table of Contents

 

·                 other factorsdescribed in this report and in other reports we have filed with the Securitiesand Exchange Commission; and

·                 Our success atmanaging the risks involved in the foregoing.

 

#### **Forward-lookingstatements speak only as of the date on which they are made.  We undertake no obligation to update anyforward-looking statement to reflect events or circumstances after the date onwhich the statement is made to reflect the occurrence of unanticipated events.**

#### ** **

**Executive Summary and RecentDevelopments**

 

### **The Company’s total assets at June 30, 2009,were approximately $1.1 billion, which represented an increase of approximately$111.3 million, or 11%, from December 31, 2008.  Net earnings (loss) decreased $24.9 million,or 1313.91%, for the six months ended June 30, 2009 to a loss of $23.0million, or $5.47 per diluted share, compared to earnings of $1.9 million, or$0.43 per diluted share, for the six months ended June 30, 2008.**

### ** **

During the second quarterof 2009, the Company recognized a $19.5 million goodwill impairment charge toearnings.  The Company completed itsannual goodwill impairment assessment during the fourth quarter of 2008.  At the time of the annual assessment, therewas no impairment of goodwill.  Sinceyear-end, the Company has continuously updated its goodwill impairmentassessment and found an impairment of goodwill during the second quarter of2009.  Because goodwill is an intangibleasset that cannot be sold separately or otherwise disposed of, it is notrecognized in determining capital adequacy for regulatory purposes.  Therefore, the goodwill impairment charge hadno effect on the Company’s regulatory capital ratios.

 

On May 27, 2009, theCompany amended its Articles of Incorporation to eliminate par value per sharewith respect to its common stock from the previous $5.00 par value per share ofits common stock.  Therefore, the paid-incapital surplus for the Company as of that date was included with the Company’scommon stock.

 

During the second quarterof 2009, the Company created a Special Assets Division to address problemcredits and to assist in the collection efforts from problem loans andcharged-off loans.  Senior Vice PresidentRandy Griffin will manage this department of three people and will reportdirectly to Edward P. Loomis, President and Chief Executive Officer of theBank.

 

On July 31, 2009,the Board of Directors promoted Edward P. Loomis, Jr. to the role ofPresident and Chief Executive Officer of Atlantic Southern Bank.  Mark Stevens will continue as President andChief Executive Officer of the holding company, Atlantic Southern FinancialGroup, Inc.

 

16

----

Table of Contents

 

**Financial Condition**

 

The composition of assetsand liabilities for the Company is as follows:

 
| ** **                             | ** ** | **June 30,** | ** **  | **December 31,** | ** ** | ** **        | ** ** | ** **   | ** ** |
|----------------------------------------|------------|-------------------|-------------|-----------------------|------------|-------------------|------------|--------------|------------|
| ** **                             | ** ** | **2009**          | ** **  | **2008**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Assets:**                            |       |              |        |                  |       |              |       |         |       |
| Total cash and cash equivalents        |       | $                 | 104,679,166 |                  | $          | 15,130,136        |       | $            | 89,549,030 |   | 591.86 | % |
| Securities available for sale          |       | 147,802,865       |        | 100,619,437           |       | 47,183,428        |       | 46.89        | %          |
| Loans, net of unearned income          |       | 790,129,903       |        | 792,883,664           |       | (2,753,761        | )          | -0.35        | %          |
| Cash surrender value of life insurance |       | 12,730,286        |        | 12,465,228            |       | 265,058           |       | 2.13         | %          |
| Goodwill and other intangible assets   |       | 2,730,008         |        | 22,444,667            |       | (19,714,659       | )          | -87.84       | %          |
| Total assets                           |       | 1,103,017,253     |        | 991,741,590           |       | 111,275,663       |       | 11.22        | %          |
| **Liabilities:**                       |       |              |        |                  |       |              |       |         |       |
| Deposits                               |       | 964,818,568       |        | 836,451,443           |       | 128,367,125       |       | 15.35        | %          |
| FHLB advances                          |       | 56,300,000        |        | 47,500,000            |       | 8,800,000         |       | 18.53        | %          |
| Subordinated debentures                |       | 1,400,000         |        | 1,400,000             |       | —            |       | —       |       |
| Junior subordinated debentures         |       | 10,310,000        |        | 10,310,000            |       | —            |       | —       |       |
| Accrued expenses and other liabilities |       | 140,817           |        | 1,630,080             |       | (1,489,263        | )          | -91.36       | %          |
|                                   |       |              |        |                  |       |              |       |         |       |
| Loan to Deposit Ratio                  |       | 81.89             | %           | 94.79                 | %          |              |       |         |       |
|                                        |            |                   |             |                       |            |                   |            |              |            |  |  |  |

 

The most significantchange in the composition of assets was the increase in cash and due from banksdue to the growth of deposits of the Company. The most significant change in the composition of liabilities was theincrease in deposits, especially time deposits. Time deposits, including brokered and core deposits, are our principalsource of funds for loans and investing in securities.  Local retail time deposits at June 30,2009, increased approximately $134.6 million since December 31, 2008 dueto managements’ aggressive efforts to increase core deposits and reduce theBank’s reliance on brokered deposits. The Company was able to decrease brokered deposits since December 31,2008 by approximately $36.9 million at June 30, 2009 primarily due to itsability to replace them with retail deposits. Other core deposits (non-interest bearing, interest bearing and savingaccounts) increased approximately $30.7 million at June 30, 2009 comparedto December 31, 2008.

 

Due to our strong loandemand in the past, we chose to obtain a portion of our deposits from outsideof our market.  The deposits obtained outside of our market area generallyhave lower rates than rates being offered for certificates of deposits in ourlocal market.  We have also utilizedout-of-market deposits in certain instances to obtain longer term deposits thanare readily available in our local market. Our brokered time deposits represented 38.5% of our deposits as of June 30,2009 when compared to 46.2% of our deposits as of December 31, 2008.

 

We generally obtainout-of-market time deposits of $100,000 or more through brokers with whom wemaintain ongoing relationships.  We haveadopted guidelines regarding our use of brokered CDs that limit our brokeredCDs as a percentage of total deposits and dictate that we leverage our branchnetwork in order to further reduce our reliance on brokered deposits.  In the past, the Bank has relied heavily onbrokered deposits.  Management expectsthat this source of funding may not be available in the future and hasinstituted an aggressive retail deposit marketing campaign to replace a portionof the brokered CDs as they mature.

 

**Investment Securities**

 

Securitiesin our portfolio totaled $147.8 million at June 30, 2009, compared to$100.6 million at December 31, 2008. The most significant increase in the securities portfolio has resultedfrom the purchase of $92.9 million in U.S. Treasury securities and $35.9million of U.S Government Sponsored Enterprises securities, which were offsetby the sale of $5.1 million in state, county and municipal bonds, the maturityof $25.0 million in U.S. Treasury securities and the sales and/or paydowns of $46.5million in mortgage-backed securities. At June 30, 2009, the securities portfolio had unrealized netlosses of approximately $359 thousand.

 

17

----

Table of Contents

 

Thefollowing table shows the carrying value of the investment securities at June 30,2009 and December 31, 2008.

 
| ** **                             | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
| Securities available for sale:         |       |                       |       |                  |       |
| U. S. Government Sponsored Enterprises |       | $                          | 41,699     |                  | $          | 17,761 |   |
| U. S. Treasury Securities              |       | 67,919                     |       | 251                   |       |
| State, County and Municipal            |       | 15,187                     |       | 20,298                |       |
| Mortgage-backed Securities             |       | 22,706                     |       | 62,036                |       |
| Other Investments                      |       | 292                        |       | 273                   |       |
| Total                                  |       | $                          | 147,803    |                  | $          | 100,619 |   |

### ** **

The following tablesummarizes securities sales activity for the three month and six month periodsended June 30, 2009 and 2008:

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                         | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                         | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| Proceeds from sales                                |       | $                      | 64,863,931 |                 | $          | 890,000 |   | $ | 80,531,819 |   | $ | 8,815,000 |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Gross gains on sales                               |       | $                      | 1,153,008  |                 | $          | 8,405 |   | $ | 1,384,133 |   | $ | 40,245 |   |
| Gross losses on sales                              |       | —                 |       | —               |       | (10,697 | ) | — |   |
| Impairment losses                                  |       | (57,618                | )          | —               |       | (57,618 | ) | — |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Net gains (losses) on sales of securities          |       | $                      | 1,095,390  |                 | $          | 8,405 |   | $ | 1,315,818 |   | $ | 40,245 |   |
|                                               |       |                   |       |                 |       |   |   |   |   |
| Income tax expense (benefit) attributable to sales |       | $                      | 372,433    |                 | $          | 2,858 |   | $ | 447,378 |   | $ | 13,683 |   |

 

During the second quarter of2009, the Company recognized an impairment loss of $57,618 on an equityinvestment in Silverton Bank, a financial institution that failed during thequarter.  The impairment loss representsthe full amount of the Company’s investment in Silverton.

 

During the second quarter of2009, the Bank restructured approximately $36 million in U.S. agency andmortgage backed securities to capture gains on securities prepaying at highspeeds, to offset FDIC special assessment and to shorten the average maturityof the portfolio.

 

### **Loans**

### ** **

Totalloans, net of unearned income decreased approximately $2.8 million, or 0.35%,at June 30, 2009, from December 31, 2008 as management has made aneffort to limit loan growth in order to preserve capital for the Company.  Management is limiting credit availabilityespecially for acquisitions, development and construction loans and pursuingcollection efforts aggressively.  Thefollowing table presents a summary of the loan portfolio by category.

 

18

----

Tableof Contents

 
| ** **                                        | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2009**                   | ** ** | **2008**              | ** ** |
| ** **                                        | ** ** | **(Amounts in Thousands)** | ** ** |
|                                              |       |                       |       |                  |       |
| Commercial                                        |       | $                          | 62,772     |                  | $          | 70,187 |   |
| Real estate - commercial                          |       | 312,176                    |       | 310,459               |       |
| Real estate - construction                        |       | 315,220                    |       | 314,405               |       |
| Real estate - mortgage                            |       | 91,542                     |       | 89,102                |       |
| Obligations of political subdivisions in the U.S. |       | 346                        |       | 347                   |       |
| Consumer                                          |       | 8,454                      |       | 8,905                 |       |
| Total Loans                                       |       | 790,510                    |       | 793,405               |       |
| Less:                                             |       |                       |       |                  |       |
| Unearned loan fees                                |       | (380                       | )          | (521                  | )          |
| Allowance for loan losses                         |       | (14,911                    | )          | (11,672               | )          |
| Loans, net                                        |       | $                          | 775,219    |                  | $          | 781,212 |   |

### ** **

### **AssetQuality**

### ** **

### **Management considers asset quality to be of primaryimportance.  Management has a creditadministration and loan review process, which monitors, controls and measuresour credit risk, standardized credit analyses and our comprehensive creditpolicy.  Management has an establishedwarning and early detection system regarding the loans and a comprehensiveanalysis of the allowance for loan losses.**

### ** **

Thefollowing table presents a summary of changes in the allowance for loan lossesfor the three and six-month periods ended June 30, 2009 and 2008.

 

**Analysisof Changes in Allowance for Loan Losses**

 
| ** **                                         | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                         | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                         | ** ** | **(Amounts in Thousands)**           | ** ** |
|                                               |       |                                 |       |                               |       |   |   |   |   |
| Balance  beginning of period                       |       | $                                    | 11,493     |                               | $          | 9,158 |   | $ | 11,672 |   | $ | 8,879 |   |
| Loans  charged-off                                 |       | (2,317                               | )          | (453                               | )          | (2,911 | ) | (585 | ) |
| Recoveries                                         |       | 17                                   |       | 83                                 |       | 82 |   | 92 |   |
| Net  charge-offs                                   |       | (2,300                               | )          | (370                               | )          | (2,829 | ) | (493 | ) |
| Provision  for loan losses                         |       | 5,718                                |       | 946                                |       | 6,068 |   | 1,348 |   |
| Balance  end of period                             |       | $                                    | 14,911     |                               | $          | 9,734 |   | $ | 14,911 |   | $ | 9,734 |   |
|                                               |       |                                 |       |                               |       |   |   |   |   |
| Total  Loans:                                      |       |                                 |       |                               |       |   |   |   |   |
| At  period end                                     |       | $                                    | 790,130    |                               | $          | 792,618 |   | $ | 790,130 |   | $ | 792,618 |   |
| Average                                            |       | 791,354                              |       | 758,009                            |       | 793,493 |   | 731,324 |   |
|                                               |       |                                 |       |                               |       |   |   |   |   |
| As a  percentage of average loans (annualized):    |       |                                 |       |                               |       |   |   |   |   |
| Net  charge-offs                                   |       | 1.16                                 | %          | 0.20                               | %          | 0.71 | % | 0.13 | % |
| Provision  for loan losses                         |       | 2.89                                 | %          | 0.50                               | %          | 1.53 | % | 0.37 | % |
| Allowance  as a percentage of period end loans     |       | 1.89                                 | %          | 1.23                               | %          | 1.89 | % | 1.23 | % |
| Allowance  as a percentage of non-performing loans |       | 23.21                                | %          | 244.71                             | %          | 23.21 | % | 244.71 | % |

 

19

----

Tableof Contents

 

### **Management believes that the allowance for loanlosses at June 30, 2009 is adequate to absorb losses inherent in the loanportfolio.  This assessment involvesuncertainty and judgment; therefore, the adequacy of the allowance for loanlosses cannot be determined with precision and may be subject to change in futureperiods.  Significant increases to theprovision for loan losses may be necessary if material adverse changes ingeneral economic conditions occur or the performance of our loan portfoliodeteriorates.  In addition, bankregulatory authorities, as part of their periodic examination of the Bank, mayrequire adjustments to the provision for loan losses in future periods if, intheir opinion, the results of their review warrant such additions.  Because of these factors, it is reasonablypossible that the estimated losses on loans may change materially in the nearterm.  However, the amount of the changecannot be estimated.**

### ** **

### **Nonperforming assets consist of non-accrual loans,accruing loans 90 days past due, repossessed assets and other real estateowned. The following summarizes non-performing assets:**

### ** **

| ** **                      | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2009**          | ** ** | **2008**              | ** ** |
| Accruing loans 90 days past due |       | $                 | —     |                  | $          | — |   |
| Non-accrual loans               |       | 64,246,642        |       | 21,103,468            |       |
| Repossessed assets              |       | 49,400            |       | 34,783                |       |
| Other real estate               |       | 7,566,940         |       | 10,196,165            |       |
| Total non-performing assets     |       | $                 | 71,862,982 |                  | $          | 31,334,416 |   |

 

Nonperforming assetsincreased $40.5 million, or 129%, from December 31, 2008 to June 30,2009.  This increase is largely due toseveral large relationships that are secured by commercial and residential realestate construction and land development real estate being placed onnon-accrual during the first and second quarters of 2009.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other Real Estatedecreased $2.6 million during the second quarter of 2009 which is largely dueto the $3.5 million sale of a $4.8 million condominium complex in SouthGeorgia, resulting in a $1.3 million loss on the property.  The Company also added approximately $2.0million in 13 other real estate properties during the second quarter of 2009.

 

As of June 30, 2009and December 31, 2008, the Company’s Other Real Estate consisted of thefollowing:

 
| ** **                                          | ** ** | **As of June 30, 2009** | ** ** | **As of December 31, 2008** | ** ** |
|-----------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| 1-4 Family residential properties                   |       | 11                           |       | $                                | 3,524,290  |   | 8 |   | $ | 3,574,090 |   |
| Nonfarm nonresidential properties                   |       | 5                            |       | 655,265                          |       | 5 |   | 520,101 |   |
| Multifamily residential properties                  |       | 1                            |       | 31,675                           |       | — |   | — |   |
| Construction & land development properties |       | 20                           |       | 3,355,710                        |       | 15 |   | 6,101,974 |   |
| Total                                               |       | 37                           |       | $                                | 7,566,940  |   | 28 |   | $ | 10,196,165 |   |

 

All properties are beingactively marketed for sale and management is continuously monitoring theseproperties in order to minimize any losses.

 

TheCompany’s policy is to place loans on non-accrual status when it appears thatthe collection of interest in accordance with the terms of the loan isdoubtful.  Any loan which becomes 90 dayspast due as to principal or interest is automatically placed onnon-accrual.  Exceptions are allowed for90-day past due loans when such loans are well secured and in process ofcollection.  Other Real Estate is definedas real estate acquired as salvage on uncollectible loans.  At the time of foreclosure, an appraisal isobtained on the real estate.  The amountcharged to Other Real Estate will be the lower of appraised value or recordedinvestment in the loan satisfied.  Therecorded investment is the unpaid balance of the loan, increased by accrued anduncollected interest, unamortized premium, finance charges, and loanacquisition costs, if any, and decreased by previous direct write down andunamortized 

 

20

----

Table of Contents

 

discount.  Any excess of the recorded investment in theloan satisfied over the appraised value of the property must be charged toallowance for loan losses.

 

**Goodwill**

 

TheCompany reviews its goodwill for impairment annually, or more frequently ifcircumstances indicate that goodwill has been impaired.  The Company completed its annual goodwillimpairment assessment as of December 31, 2008.  In completing the annual assessment, theCompany engaged an independent business valuation firm to assist with thevaluation.  The Company’s year-endgoodwill impairment assessment indicated that there was no goodwill impairment.

 

Sinceyear-end, however, the Company’s stock price continues to trade below itsper-share book value which management believes reflects uncertainty about theeconomic cycle.  The current economicenvironment has also resulted in lower earnings with higher credit costs.  Higher credit costs are reflected in theincome statement as well as valuation adjustments to the loan balances, throughincreases to the level of the allowance for loan losses.  With these factors in place, managementbelieved that goodwill should be re-assessed for impairment.  The Company engaged the same businessvaluation firm to update their year-end valuation analysis, which included adiscounted cash flow analysis.  Theconclusion from the updated impairment analysis was that impairment was presentand a $19.5 million charge to earnings was taken.

 

Becausegoodwill is an intangible asset that cannot be sold separately or otherwisedisposed of, it is not recognized in determining capital adequacy forregulatory purposes.  Therefore, thenon-cash goodwill impairment charge had no effect on the Company’s regulatorycapital ratios or cash flows of the Company.

 

**Deposits**

 

Totaldeposits at June 30, 2009 were $964.8 million, an increase of $128.4million, or 15%, from December 31, 2008. Total interest bearing demand and savings accounts of $171.6 millionincreased $22.4 million, or 15%, resulting mainly from our branching effortsand our emphasis on increasing core deposits.

 

Totaltime deposits as of June 30, 2009 were $736.4 million, an increase of$97.6 million, or 15%, from December 31, 2008.  Total retail time deposits at June 30,2009 increased approximately $134.6 million, or 21% of total time deposits,from December 31, 2008 due to managements’ aggressive efforts to increasecore deposits and reduce reliance on brokered deposits. The weighted average rates paid for retail time deposits for the threeand six months ended June 30, 2009 were 3.29% and 3.45%, respectively,compared to 4.52% and 4.79% for the three and six months ended June 30,2008, respectively.  Total brokereddeposits at June 30, 2009 decreased approximately $36.9 million, or 6% oftotal time deposits, from December 31, 2008, resulting mainly from ourability to replace brokered deposits with retail deposits during the first andsecond quarters of 2009.  The weightedaverage rates paid for brokered deposits for the three and six months ended June 30,2009 were 3.55% and 3.67%, respectively, compared to 4.21% and 4.56% for thethree and six months ended June 30, 2008.

 

### **Resultsof Operations**

### ** **

# **General**

# ** **

The Company’sresults of operations are determined by its ability to effectively manageinterest income and expense, to minimize loan and investment losses, togenerate noninterest income and to control noninterest expense.  Since interest rates are determined by marketforces and economic conditions beyond the control of the Company, the abilityto generate interest income is dependent upon the Bank’s ability to obtain an adequatespread between the rate earned on earning assets and the rate paid oninterest-bearing liabilities.

 

21

----

Tableof Contents

 

# **The following table shows thesignificant components of net earnings:**

# ** **

| ** **                            | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------------|------------|----------------------|------------|------------|------------|-------------------|------------|
| ** **                            | ** ** | **June 30,**    | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                            | ** ** | **2009**             | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Interest and Dividend Income          |       | $                    | 24,248,870 |       | $          | 27,903,694        |       | $ | (3,654,824 | ) | -13.10 | % |
| Interest Expense                      |       | 14,357,373           |       | 15,660,486 |       | (1,303,113        | )          | -8.32 | % |
| Net Interest Income                   |       | 9,891,497            |       | 12,243,208 |       | (2,351,711        | )          | -19.21 | % |
| Provision for Loan Losses             |       | 6,068,000            |       | 1,348,000  |       | 4,720,000         |       | 350.15 | % |
| Net Earnings (Loss)                   |       | (23,039,956          | )          | 1,897,992  |       | (24,937,948       | )          | -1313.91 | % |
| Net Earnings (Loss) Per Diluted Share |       | $                    | (5.47      | )          | $          | 0.43              |       | (5.90 | ) | -1372.09 | % |
|                                       |            |                      |            |            |            |                   |            |  |  |  |  |  |

 
| ** **                             | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|----------------------------------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                             | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                             | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Interest and Dividend Income           |       | $                      | 11,701,996 |       | $          | 13,477,725        |       | $ | (1,775,729 | ) | -13.18 | % |
| Interest Expense                       |       | 7,207,741              |       | 7,511,928  |       | (304,187          | )          | -4.05 | % |
| Net Interest Income                    |       | 4,494,255              |       | 5,965,797  |       | (1,471,542        | )          | -24.67 | % |
| Provision for Loan Losses              |       | 5,718,000              |       | 946,000    |       | 4,772,000         |       | 504.44 | % |
| Net Earnings (Loss)                    |       | (23,781,709            | )          | 708,276    |       | (24,489,985       | )          | -3457.69 | % |
| Net Earnings (Loss) Per Diluted Shares |       | $                      | (5.65      | )          | $          | 0.16              |       | (5.81 | ) | -3631.25 | % |
|                                        |            |                        |            |            |            |                   |            |  |  |  |  |  |

 

# **NetInterest Income**

# ** **

Our primary source ofincome is interest income from loans and investment securities.  Our profitability depends largely on netinterest income, which is the difference between the interest received oninterest-earning assets and the interest paid on deposits, borrowings, andother interest-bearing liabilities.  Netinterest income decreased $2.4 million, or 19%, for the six months ended June 30,2009 compared to the six months ended June 30, 2008.  Net interest income decreased $1.5 million,or 25%, for the second quarter of 2009 compared to the same period in 2008.

 

Total interest anddividend income for the three and six months ended June 30, 2009 decreased$1.8 million, or 13%, and $3.7 million, or 13%, respectively, when compared tothe three and six months ended June 30, 2008.  This decrease is primarily due to the effectof the Federal Reserve decreasing the federal funds rate, which affects amajority of the interest rates for our loans. Also, the number and balances of loans in non-accrual status reducedinterest income.  The average loan andloan held for sale portfolios for the three and six months ended June 30,2009 increased approximately $33.3 million, or 4%, and $62.2 million, or 9%,respectively, when compared to average loan and loan held for sale portfoliosfor the three and six months ended June 30, 2008.  The average yield on loans, however,decreased during the three and six months ended June 30, 2009 to 5.43% and5.58%, respectively, compared to an average yield of 6.56% and 7.08% for thethree and six months ended June 30, 2008, respectively.

 

Total interest expensefor the three and six months ended June 30, 2009 decreased $304 thousand,or 4%, and $1.3 million, or 8%, respectively, when compared to the three andsix months ended June 30, 2008.  Twofactors impact interest expense: average balances of deposit and borrowingportfolios and average rates paid on each. Average deposit balances increased approximately $156.3 million and$150.3 million when comparing the three and six months ended June 30, 2009to the three and six months ended June 30, 2008.  The average rate paid on the depositportfolios for the three and six months ended June 30, 2009 decreased to3.07% and 3.18%, respectively, from 3.89% and 4.20% when compared to the threeand six months ended June 30, 2008, respectively.  Average borrowing balances increasedapproximately $11.2 million and $9.2 million when comparing the three and sixmonths ended June 30, 2009 to the three and six months ended June 30,2008, respectively.  Average interestrates

 

22

----

Table of Contents

 

paid on borrowings were3.15% and 3.19% for the three and six months ended June 30, 2009,respectively, compared to 3.54% and 4.00% for the three and six months ended June 30,2008, respectively.

 

The banking industry usestwo key ratios to measure relative profitability of net interest income, whichare net interest spread and net interest margin.  The interest rate spread measures thedifference between the average yield on earning assets and the average ratepaid on interest-bearing liabilities. The interest rate spread eliminates the impact of non-interest-bearingfunding sources and gives a direct perspective on the effect of market interestrate movements.  The net interest marginis an indication of the profitability of our investments, and is defined as netinterest revenue as a percentage of total average earning assets which includesthe positive impact of funding a portion of earning assets with customers’non-interest-bearing deposits and with stockholders’ equity.

 

For the three monthsended June 30, 2009 and 2008, our tax equivalent net interest spread was1.93% and 2.55%, respectively, while the tax equivalent net interest margin was1.94% and 2.87%, respectively.  For thesix months ended June 30, 2009 and 2008, our tax equivalent net interestspread was 2.12% and 2.69%, respectively, while the tax equivalent net interestmargin was 2.19% and 3.04%, respectively. The decreases in net interest spread and net interest margin from thethree and six months ended June 30, 2008 to the three and six months endedJune 30, 2009, were due to our promotion of higher short-term yields onretail time deposits, which reduced our dependence on  brokered time deposits, purchase ofinvestment securities and the reduction of the short-term rates by the FederalReserve, starting in the second quarter of 2007 and continuing through thefourth quarter of 2008, and its effect on the Company’s slightlyasset-sensitive balance sheet.

 

23

----

Table of Contents

 

The following table showsthe relationship between interest revenue and interest expense and the averagebalances of interest-earning assets and interest-earning liabilities for thethree months ended June 30, 2009 and 2008.

 

**AverageConsolidated Balance Sheet and Net Interest Margin Analysis**

 
| ** **                                       | ** ** | **For  the Three Months Ended June 30,** | ** ** |
|--------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                       | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
| ** **                                       | ** ** | **(Amounts  in thousands)**                   | ** ** |
| ** **                                       | ** ** | **Average**                                   | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                       | ** ** | **Balance**                                   | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning  Assets                                  |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Loans,  net of unearned income (4) (5) (6)       |       | $                                             | 791,354    |   | $ | 10,730 |   | 5.43 | % | $ | 758,009 |   | $ | 12,436 |   | 6.56 | % |
| Federal  funds sold                              |       | —                                        |       | — |   | 0.00 | % | 6,258 |   | 33 |   | 2.11 | % |
| Investment  securities - taxable (7)             |       | 113,981                                       |       | 811 |   | 2.85 | % | 55,260 |   | 707 |   | 5.12 | % |
| Investment  securities - tax-exempt (6) (7) |       | 15,247                                        |       | 157 |   | 6.24 | % | 22,639 |   | 225 |   | 6.02 | % |
| Other  interest and dividend income              |       | 22,924                                        |       | 4 |   | 0.07 | % | 4,990 |   | 77 |   | 6.17 | % |
| Total  Earning Assets                            |       | 943,506                                       |       | 11,702 |   | 5.00 | % | 847,156 |   | 13,478 |   | 6.42 | % |
|                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                     |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Allowance  for loan losses                       |       | -12,071                                       |       |   |   |   |   | -9,356 |   |   |   |   |   |
| Cash  and due from banks                         |       | 65,226                                        |       |   |   |   |   | 9,095 |   |   |   |   |   |
| Premises  and equipment                          |       | 31,822                                        |       |   |   |   |   | 28,476 |   |   |   |   |   |
| Accrued  interest receivable                     |       | 6,023                                         |       |   |   |   |   | 6,750 |   |   |   |   |   |
| Other  assets                                    |       | 55,454                                        |       |   |   |   |   | 41,258 |   |   |   |   |   |
| Total  Assets                                    |       | $                                             | 1,089,960  |   |   |   |   |   | $ | 923,379 |   |   |   |   |   |
|                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities                    |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing demand                         |       | $                                             | 150,983    |   | $ | 605 |   | 1.60 | % | $ | 116,242 |   | $ | 557 |   | 1.92 | % |
| Savings                                          |       | 8,651                                         |       | 8 |   | 0.37 | % | 8,082 |   | 12 |   | 0.59 | % |
| Time  deposits                                   |       | 712,828                                       |       | 6,080 |   | 3.41 | % | 598,053 |   | 6,463 |   | 4.32 | % |
| Total  interest bearing deposits                 |       | 872,462                                       |       | 6,693 |   | 3.07 | % | 722,377 |   | 7,032 |   | 3.89 | % |
| Federal  Home Loan Bank advances                 |       | 53,701                                        |       | 388 |   | 2.89 | % | 40,456 |   | 334 |   | 3.30 | % |
| Other  borrowings                                |       | 1,400                                         |       | 42 |   | 12.00 | % | 3,425 |   | 20 |   | 2.34 | % |
| Trust  Preferred Securities                      |       | 10,310                                        |       | 85 |   | 3.30 | % | 10,310 |   | 126 |   | 4.89 | % |
| Total  borrowed funds                            |       | 65,411                                        |       | 515 |   | 3.15 | % | 54,191 |   | 480 |   | 3.54 | % |
| Total  interest-bearing liabilities              |       | 937,873                                       |       | 7,208 |   | 3.07 | % | 776,568 |   | 7,512 |   | 3.87 | % |
|                                             |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                   |       | 54,683                                        |       |   |   |   |   | 48,468 |   |   |   |   |   |
| Other  liabilities                               |       | 7,926                                         |       |   |   |   |   | 7,439 |   |   |   |   |   |
| Shareholder’s  equity                       |       | 89,478                                        |       |   |   |   |   | 90,904 |   |   |   |   |   |
| Total  Liabilities and Shareholder’s Equity |       | $                                             | 1,089,960  |   |   |   |   |   | $ | 923,379 |   |   |   |   |   |
| Net  interest revenue (1)                        |       |                                          |       | $ | 4,494 |   |   |   |   |   | $ | 5,966 |   |   |   |
| Net  interest spread (2)                         |       |                                          |       |   |   | 1.93 | % |   |   |   |   | 2.55 | % |
| Net  interest margin (3) (6)                |       |                                          |       |   |   | 1.94 | % |   |   |   |   | 2.87 | % |

 

----

(1) Netinterest revenue is computed by subtracting the expense from the averageinterest-bearing liabilities from the income from the average earning assets.

(2) Netinterest spread is computed by subtracting the yield from the expense of theaverage interest-bearing liabilities from the yield from the average earningassets.

(3) Netinterest margin is computed by dividing net interest revenue by average totalearning assets.

(4) Averageloans are shown net of unearned income. Included in the average balance of loans outstanding are loans where theaccrual of interest has been discounted.

(5) Interestincome includes loan fees as follows (in thousands): 2009 - $355; 2008 - $484

(6) Averagerate reflects taxable equivalent adjustments using a tax rate of 34 percent.

(7) Investmentsecurities are stated at amortized or accreted cost.

 

24

----

Table of Contents

 

The following table showsthe relationship between interest revenue and interest expense and the averagebalances of interest-earning assets and interest-earning liabilities for thesix months ended June 30, 2009 and 2008.

 

**AverageConsolidated Balance Sheet and Net Interest Margin Analysis**

 
| ** **                                           | ** ** | **For  the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
| ** **                                           | ** ** | **(Amounts  in thousands)**                 | ** ** |
| ** **                                           | ** ** | **Average**                                 | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                           | ** ** | **Balance**                                 | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning  Assets                                      |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Loans,  net of unearned income (4) (5) (6) |       | $                                           | 793,493    |   | $ | 22,131 |   | 5.58 | % | $ | 731,324 |   | $ | 25,866 |   | 7.08 | % |
| Federal  funds sold                                  |       | —                                      |       | — |   | 0.00 | % | 8,592 |   | 113 |   | 2.63 | % |
| Investment  securities - taxable (7)                 |       | 96,956                                      |       | 1,786 |   | 3.68 | % | 53,152 |   | 1,344 |   | 5.06 | % |
| Investment  securities - tax-exempt (6) (7)     |       | 15,938                                      |       | 323 |   | 6.14 | % | 21,455 |   | 425 |   | 6.00 | % |
| Other  interest and dividend income                  |       | 14,748                                      |       | 9 |   | 0.12 | % | 4,896 |   | 156 |   | 6.37 | % |
| Total  Earning Assets                                |       | 921,135                                     |       | 24,249 |   | 5.30 | % | 819,419 |   | 27,904 |   | 6.87 | % |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Allowance  for loan losses                           |       | -11,903                                     |       |   |   |   |   | -9,205 |   |   |   |   |   |
| Cash  and due from banks                             |       | 51,503                                      |       |   |   |   |   | 9,184 |   |   |   |   |   |
| Premises  and equipment                              |       | 31,678                                      |       |   |   |   |   | 28,263 |   |   |   |   |   |
| Accrued  interest receivable                         |       | 6,137                                       |       |   |   |   |   | 7,085 |   |   |   |   |   |
| Other  assets                                        |       | 54,821                                      |       |   |   |   |   | 40,011 |   |   |   |   |   |
| Total  Assets                                        |       | $                                           | 1,053,371  |   |   |   |   |   | $ | 894,757 |   |   |   |   |   |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities                        |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing demand                             |       | $                                           | 147,249    |   | $ | 1,204 |   | 1.64 | % | $ | 112,140 |   | $ | 1,205 |   | 2.15 | % |
| Savings                                              |       | 8,384                                       |       | 15 |   | 0.36 | % | 7,973 |   | 23 |   | 0.58 | % |
| Time  deposits                                       |       | 684,710                                     |       | 12,129 |   | 3.54 | % | 574,495 |   | 13,351 |   | 4.65 | % |
| Total  interest bearing deposits                     |       | 840,343                                     |       | 13,348 |   | 3.18 | % | 694,608 |   | 14,579 |   | 4.20 | % |
| Federal  Home Loan Bank advances                     |       | 51,518                                      |       | 739 |   | 2.87 | % | 40,448 |   | 735 |   | 3.63 | % |
| Other  borrowings                                    |       | 1,422                                       |       | 85 |   | 11.95 | % | 3,287 |   | 45 |   | 2.74 | % |
| Trust  Preferred Securities                          |       | 10,310                                      |       | 186 |   | 3.61 | % | 10,310 |   | 302 |   | 5.86 | % |
| Total  borrowed funds                                |       | 63,250                                      |       | 1,010 |   | 3.19 | % | 54,045 |   | 1,082 |   | 4.00 | % |
| Total  interest-bearing liabilities                  |       | 903,593                                     |       | 14,358 |   | 3.18 | % | 748,653 |   | 15,661 |   | 4.18 | % |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 52,401                                      |       |   |   |   |   | 47,822 |   |   |   |   |   |
| Other  liabilities                                   |       | 7,730                                       |       |   |   |   |   | 7,926 |   |   |   |   |   |
| Shareholder’s  equity                           |       | 89,647                                      |       |   |   |   |   | 90,356 |   |   |   |   |   |
| Total  Liabilities and Shareholder’s Equity     |       | $                                           | 1,053,371  |   |   |   |   |   | $ | 894,757 |   |   |   |   |   |
| Net  interest revenue (1)                            |       |                                        |       | $ | 9,891 |   |   |   |   |   | $ | 12,243 |   |   |   |
| Net  interest spread (2)                             |       |                                        |       |   |   | 2.12 | % |   |   |   |   | 2.69 | % |
| Net  interest margin (3) (6)                    |       |                                        |       |   |   | 2.19 | % |   |   |   |   | 3.04 | % |

 

----

(1) Netinterest revenue is computed by subtracting the expense from the averageinterest-bearing liabilities from the income from the average earning assets.

(2) Netinterest spread is computed by subtracting the yield from the expense of the averageinterest-bearing liabilities from the yield from the average earning assets.

(3) Netinterest margin is computed by dividing net interest revenue by average totalearning assets.

(4) Averageloans are shown net of unearned income. Included in the average balance of loans outstanding are loans where theaccrual of interest has been discounted.

(5) Interestincome includes loan fees as follows (in thousands): 2009 - $693; 2008 - $932

(6) Averagerate reflects taxable equivalent adjustments using a tax rate of 34 percent.

(7) Investmentsecurities are stated at amortized or accreted cost.

 

25

----

Table of Contents

 

The following table providesa detailed analysis of the changes in interest income and interest expense dueto changes in rate and volume for the three months and six months ended June 30,2009 compared to June 30, 2008.

 

**Changein Interest Revenue and Expense on a Taxable Equivalent Basis**

 
|                                         |   | **Three  Months Ended June 30, 2009** | ** ** | **Six  Months Ended June 30, 2009** | ** ** |
|----------------------------------------------|--------|--------------------------------------------|------------|------------------------------------------|------------|
|                                         |   | **Compared  to 2008**                      | ** ** | **Compared  to 2008**                    | ** ** |
|                                         |   | **Changes  due to (a)**                    | ** ** | **Changes  due to (a)**                  | ** ** |
|                                         |   | ** **                                 | ** ** | **Yield/**                               | ** ** | **Net** | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Net** | ** ** |
|                                         |   | **Volume**                                 | ** ** | **Rate**                                 | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
|                                         |   | **(Amounts  in thousands)**                |       |
| Interest earned on:                          |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Loans                                        |   | $                                          | 311        |                                     | $          | (2,017 | ) | $ | (1,706 | ) | $ | 1,558 |   | $ | (5,293 | ) | $ | (3,735 | ) |
| Investment securities:                       |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Taxable investment securities                |   | 167                                        |       | (63                                      | )          | 104 |   | 496 |   | (54 | ) | 442 |   |
| Tax-exempt investment securities             |   | (83                                        | )          | 15                                       |       | (68 | ) | (121 | ) | 19 |   | (102 | ) |
| Interest earning deposits and fed funds sold |   | 28                                         |       | (134                                     | )          | (106 | ) | (8 | ) | (252 | ) | (260 | ) |
| Total interest income                        |   | 423                                        |       | (2,199                                   | )          | (1,776 | ) | 1,925 |   | (5,580 | ) | (3,655 | ) |
|                                         |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
|                                         |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest paid on:                            |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Deposits:                                    |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Interest bearing demand deposits             |   | 151                                        |       | (103                                     | )          | 48 |   | 331 |   | (332 | ) | (1 | ) |
| Savings                                      |   | —                                     |       | (4                                       | )          | (4 | ) | 1 |   | (9 | ) | (8 | ) |
| Time deposits                                |   | 1,230                                      |       | (1,613                                   | )          | (383 | ) | 2,417 |   | (3,639 | ) | (1,222 | ) |
| Other borrowings and FHLB advances           |   | 122                                        |       | (46                                      | )          | 76 |   | 235 |   | (191 | ) | 44 |   |
| Trust Preferred Securities                   |   | —                                     |       | (41                                      | )          | (41 | ) | — |   | (116 | ) | (116 | ) |
| Total interest expense                       |   | 1,503                                      |       | (1,807                                   | )          | (304 | ) | 2,984 |   | (4,287 | ) | (1,303 | ) |
|                                         |   |                                       |       |                                     |       |   |   |   |   |   |   |   |   |
| Decrease in net interest revenue             |   | $                                          | (1,080     | )                                        | $          | (392 | ) | $ | (1,472 | ) | $ | (1,059 | ) | $ | (1,293 | ) | $ | (2,352 | ) |

 

----

(a) Volume and ratecomponents are in proportion to the relationship of the absolute dollar amountof the change in each.

 

# **Provisionfor Loan Losses**

# ** **

The provision for loanlosses for the six months ended June 30, 2009 was $6.1 million compared to$1.3 million for the same period of 2008. The provision for loan losses for the second quarter of 2009 was $5.7million compared to $946 thousand for the same period of 2008.  The increase in the provision for loan lossesis directly related to the increase in nonperforming assets during the secondquarter of 2009.  Net charge-offs as anannualized percentage of average outstanding loans for the six months ended June 30,2009 were 0.71%, as compared with 0.13% for the same period of 2008.  Net charge-offs as an annualized percentageof average outstanding loans for the second quarter of 2009 were 1.16%, ascompared to 0.20% for the same period of 2008. Net loan charge-offs increased significantly during the three months andsix months ended June 30, 2009, as compared to the three months and sixmonths ended June 30, 2008, due mainly to the Company charging off $2.9million for several impaired loans in the first and second quarters of 2009.

 

The provision for loanlosses is based on management’s evaluation of inherent risks in the loanportfolio and the corresponding analysis of the allowance for loan losses.  Additional discussion on loan quality and theallowance for loan losses are included in the Asset Quality section of this report.

 

26

----

Table of Contents

 

# **Non-interestIncome**

# ** **

Composition of othernoninterest income is as follows:

 
| ** **                                     | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|----------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**    | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2009**             | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Service charges on deposit accounts            |       | $                    | 839,675    |       | $          | 857,218           |       | $ | (17,543 | ) | -2.05 | % |
| Other service charges, commissions and fees    |       | 238,127              |       | 228,731    |       | 9,396             |       | 4.11 | % |
| Gain on sales / calls of investment securities |       | 1,315,818            |       | 40,245     |       | 1,275,573         |       | 3169.52 | % |
| Mortgage origination income                    |       | 393,587              |       | 430,032    |       | (36,445           | )          | -8.47 | % |
| Other income                                   |       | 556,076              |       | 677,231    |       | (121,155          | )          | -17.89 | % |
| Total noninterest income                       |       | $                    | 3,343,283  |       | $          | 2,233,457         |       | $ | 1,109,826 |   | 49.69 | % |

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Service charges on deposit accounts            |       | $                      | 418,094    |       | $          | 440,776           |       | $ | (22,682 | ) | -5.15 | % |
| Other service charges, commissions and fees    |       | 125,536                |       | 118,848    |       | 6,688             |       | 5.63 | % |
| Gain on sales / calls of investment securities |       | 1,095,390              |       | 8,405      |       | 1,086,985         |       | 12932.60 | % |
| Mortgage origination income                    |       | 186,631                |       | 192,206    |       | (5,575            | )          | -2.90 | % |
| Other income                                   |       | 254,933                |       | 470,149    |       | (215,216          | )          | -45.78 | % |
| Total noninterest income                       |       | $                      | 2,080,584  |       | $          | 1,230,384         |       | $ | 850,200 |   | 69.10 | % |

 

Non-interest income forthe three and six months ended June 30, 2009 increased $850 thousand, or69%, and $1.1 million, or 50%, respectively, when compared to the three and sixmonths ended June 30, 2008.  Theincrease is primarily due to the gains on the sales of several mortgage-backedsecurities during the second quarter of 2009. The decrease in other income for the three and six months ended June 30,2009, compared to the same periods in 2008 is due to the Bank recognizing $171thousand from the fair value adjustments to an interest rate swap during thesecond quarter of 2008 and to the decrease in commission fees from our wealthmanagement department.

 

# **Non-interestExpense**

# ** **

Composition of othernoninterest expense is as follows:

 
| ** **                                     | ** ** | **Six Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|----------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**    | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2009**             | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Salaries                                       |       | $                    | 5,415,452  |       | $          | 5,687,615         |       | $ | (272,163 | ) | -4.79 | % |
| Occupancy expense                              |       | 891,754              |       | 911,671    |       | (19,917           | )          | -2.18 | % |
| Equipment rental and depreciation of equipment |       | 631,503              |       | 544,310    |       | 87,193            |       | 16.02 | % |
| Loss (gain) on sale of other assets            |       | 1,523,685            |       | 13,485     |       | 1,510,200         |       | 11199.11 | % |
| Goodwill impairment                            |       | 19,533,501           |       | —     |       | 19,533,501        |       | 100.00 | % |
| Other expenses                                 |       | 4,553,327            |       | 3,363,258  |       | 1,190,069         |       | 35.38 | % |
| Total noninterest expense                      |       | $                    | 32,549,222 |       | $          | 10,520,339        |       | $ | 22,028,883 |   | 209.39 | % |

 

27

----

Table of Contents

 
| ** **                                     | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**      | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2009**               | ** ** | **2008**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Salaries                                       |       | $                      | 2,638,685  |       | $          | 2,823,534         |       | $ | (184,849 | ) | -6.55 | % |
| Occupancy expense                              |       | 436,857                |       | 462,873    |       | (26,016           | )          | -5.62 | % |
| Equipment rental and depreciation of equipment |       | 326,202                |       | 280,296    |       | 45,906            |       | 16.38 | % |
| Loss (gain) on sale of other assets            |       | 1,460,750              |       | (165       | )          | 1,460,915         |       | -885403.03 | % |
| Goodwill impairment                            |       | 19,533,501             |       | —     |       | 19,533,501        |       | 100.00 | % |
| Other expenses                                 |       | 2,838,226              |       | 1,766,184  |       | 1,072,042         |       | 60.70 | % |
| Total noninterest expense                      |       | $                      | 27,234,221 |       | $          | 5,332,722         |       | $ | 21,901,499 |   | 410.70 | % |

 

For the three and sixmonths ended June 30, 2009, total non-interest expense was $27.2 millionand $32.5 million, respectively.  Thisincludes a $19.5 million charge for goodwill impairment.  Excluding this non-recurring charge, totalnon-interest expense for the three and six months ended June 30, 2009 was$7.7 million and $13.0 million, respectively. When compared to the same periods of 2008, excluding the goodwillimpairment charge, total non-interest expense for the three and six monthsincreased $2.4 million, or 44%, and $2.5 million, or 24%, respectively.  This increase is attributable to the loss onthe sales of Other Real Estate properties with one particular property losstotaling to $1.3 million during the second quarter of 2009, the recognition ofOther Real Estate expenses from several foreclosed properties acquired sincethe fourth quarter of 2008, the increase of $386 thousand in quarterly FDICassessments, and the accrual of $527 thousand for the special one-time FDICassessment payable on September 30, 2009. The decrease in salaries and employee benefits pertains to a reductionin the accrual of bonuses, the utilization of a bank officer one day perquarter furlough day, and a small reduction in staff.  The increases in equipment rental anddepreciation of equipment and other expenses are not attributable to any oneparticular item, but represent increases related to physical facilityexpansion.  The decreases in occupancyexpense are attributable to the Company closing of the St. Simons Island branchon December 31, 2008.  Since thefourth quarter of 2008, the Company continues to take measures to decreasecontrollable noninterest expense.

 

# **IncomeTax Expense**

# ** **

Income tax benefit forthe three and six months ended June 30, 2009 was $2.6 million and $2.3million, respectively, compared to the income tax expense of $209 thousand and$710 thousand for the three and six months ended June 30, 2008,respectively.  The effective tax rate forthe three and six months ended June 30, 2009 were 9.84% and 9.23%,respectively, compared to 22.80% and 27.23% for the three and six months ended June 30,2008, respectively.  The effective taxrates were lower than the statutory tax rates primarily due to the tax-freeincome from certain investment securities and loans that are exempt from incometaxes, tax credits received from affordable housing investments and thegoodwill impairment charge.  The majorityof the goodwill from the two acquisitions was treated as tax-free exchanges,which was not recognized for tax reporting purposes and therefore no taxdeduction was allowed for the impairment charge.  Likewise, no tax benefit for the goodwill wasrecognized in the financial statements relating to the $19.5 million charge.

 

### **Liquidity**

### ** **

Liquidity managementinvolves the matching of the cash flow requirements of customers, eitherdepositors withdrawing funds or borrowers needing loans, and the ability of theCompany to meet those requirements.

 

The Company’s liquidityprogram is designed and intended to provide guidance in funding the credit andinvestment activities of the Company, while at the same time ensuring that thedeposit obligations of the Company are met on a timely basis. In order topermit active and timely management of assets and liabilities, these accountsare monitored regularly in regard to volume, mix and maturity.

 

The Company’s liquidityposition depends primarily upon the liquidity of its assets relative to itsneed to respond to short-term demand for funds caused by withdrawals fromdeposit accounts and loan funding commitments. Primary sources of liquidity arescheduled repayments on the Company’s loans and interest on, and maturities of,its 

 

28

----

Table of Contents

 

investment securities.Sales of investment securities available for sale represent another source ofliquidity to the Company. The Company may also utilize its cash and due frombanks and federal funds sold to meet liquidity requirements as needed.

 

The Company also has theability, on a short-term basis, to purchase up to $18 million in federal fundsfrom other financial institutions. At June 30, 2009, the Company had nofederal funds purchased. The Company had a total available line of $56.6million, subject to available collateral, from the Federal Home Loan Bank. TheCompany has $56.3 million in FHLB advances on this line at June 30,2009.  The Company has a total availableline of $56.3 million, subject to available collateral, from the FederalReserve Bank (FRB).  The Company had noadvances on the FRB line at June 30, 2009.

 

The Bank’s liquiditypolicy requires that the ratio of cash and certain short-term investments tonet withdrawable deposit accounts be at least 10%. The Bank’s liquidity ratiosat June 30, 2009 and 2008 were 26.06% and 12.83%, respectively.

 

The Bank has relied heavilyon brokered deposits in the past. Management expects that this source of funding may not be available inthe future and has instituted an aggressive retail deposit marketing campaignto replace a portion of the brokered CDs as they mature.  The increase in liquid assets is designed toprovide cash to payoff a portion of the brokered deposits as they mature.

 

### **CapitalResources**

### ** **

In February andMarch, 2009, the Bank underwent a customary periodic regulatory examinationperformed by its state and federal bank regulators.  The final examination report was issued bythe regulatory bodies during the third quarter of 2009.  Based on preliminary communications betweenBank management and the regulators, the Bank will be expected to enter into aprogram of corrective action.  When aprogram of corrective action is determined by the regulators, managementintends to fully and timely comply with all provisions.

 

We are subject to variousregulatory capital requirements administered by the federal bankingagencies.  Failure to meet minimalcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on our financial statements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, we must meet specific capital guidelines that involvequantitative measures of our assets, liabilities and certain off-balance sheetitems as calculated under regulatory accounting practices.  Our capital amounts and classification arealso subject to qualitative judgments by the regulators about components, riskweightings and other factors.

 

Quantitative measuresestablished by regulations to ensure capital adequacy require us to maintainminimum amounts and ratios (set forth below in the table) of total and Tier Icapital (as defined in the regulations) to risk-weighted assets (as defined inthe regulations), and of Tier I capital (as defined in the regulations) toaverage assets (as defined in the regulations). Management believes, as of June 30, 2009 and as of December 31,2008, that the Company and the Bank met all capital adequacy requirements towhich they are subject.

 

As of June 30, 2009,the Bank was categorized as well capitalized under the regulatory framework forprompt corrective action.  To becategorized as well capitalized, the Bank must maintain minimum totalrisk-based, Tier I risk-based and Tier I leverage ratios as set forth in thefollowing table.  Although the Bankcurrently satisfies the well-capitalized requirements, when the Bank and itsregulators enter into a program of corrective action or a formal enforcementaction, the Bank will be categorized as “adequately capitalized” until suchprogram of corrective action is no longer in effect.

 

29

----

Table of Contents

 

The Company’s and theBank’s actual capital amounts and ratios as of June 30, 2009 and December 31,2008 follow:

 
| ** **                                        | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **                  | ** ** | **To Be Well Capitalized** | ** ** |
|---------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------------|------------|----------------------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                                        | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                        | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | **Ratio**                   | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| ***June 30,  2009***                         |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 84,124,000 |                  | 10.24      | %                     | $          | 65,721,875                  | >  | 8.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 82,971,000 |       | 10.12                 | %          | 65,589,723            | >  | 8.0                         | %          | 81,987,154                 | >  | 10.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 72,402,000 |                  | 8.82       | %                     | $          | 32,835,374                  | >  | 4.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 71,260,000 |       | 8.69                  | %          | 32,800,921            | >  | 4.0                         | %          | 49,201,381                 | >  | 6.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 72,402,000 |                  | 6.66       | %                     | $          | 43,484,685                  | >  | 4.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 71,260,000 |       | 6.56                  | %          | 43,451,220            | >  | 4.0                         | %          | 54,314,024                 | >  | 5.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| ***December 31,  2008***                     |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 87,583,000 |                  | 10.47      | %                     | $          | 66,921,108                  | >  | 8.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 86,181,000 |       | 10.33                 | %          | 66,742,304            | >  | 8.0                         | %          | 83,427,880                 | >  | 10.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 75,709,000 |                  | 9.05       | %                     | $          | 33,462,541                  | >  | 4.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 74,332,000 |       | 8.91                  | %          | 33,370,146            | >  | 4.0                         | %          | 50,055,219                 | >  | 6.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                  |       |                  |       |                        |       |                       |       |   |   |
| Consolidated                                      |       | $          | 75,709,000 |                  | 7.84       | %                     | $          | 38,627,041                  | >  | 4.0                        | %          | N/A |   | N/A |   |
| Bank                                              |       | 74,332,000 |       | 7.71                  | %          | 38,563,943            | >  | 4.0                         | %          | 48,204,929                 | >  | 5.0 | % |

 

We had outstandingjunior subordinated debentures commonly referred to as Trust PreferredSecurities totaling $10.3 million at June 30, 2009 and December 31,2008.  The Trust Preferred Securitiesqualify as a Tier I capital under risk-based capital guidelines provided thattotal Trust Preferred Securities do not exceed certain quantitativelimits.  At June 30, 2009 and December 31,2008, all of the Trust Preferred Securities qualify as a Tier I capital.  We had outstanding subordinated debenturestotaling $1.4 million at June 30, 2009 and December 31, 2008.  The subordinated debentures qualify as a TierII capital under risk-based capital guidelines. At June 30, 2009 and December 31, 2008, all of thesubordinated debentures qualify as a Tier II capital.

 

30

----

Table of Contents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Item 3. Quantitative andQualitative Disclosures about Market Risk**

**For the Six Months Ended June 30, 2009**

 

Pursuant to Item 305(e) ofRegulation S-K, no disclosure under this item is required.

 

31

----

Table ofContents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Item 4T. Controls and Procedures**

**For the Six Months Ended June 30, 2009**

 

The Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, supervised and participated in an evaluation of theeffectiveness of its disclosure controls and procedures (as defined in federalsecurities rules) as of the end of the period covered by this report.  Based on, and as of the date of, thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures wereeffective in accumulating and communicating information to management, includingthe Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosures of that information underthe Securities and Exchange Commission’s rules and forms.  The Company’s disclosure controls andprocedures are designed to ensure that the information required to be disclosedin reports that are filed or submitted by the Company pursuant to theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

#### **During the second quarter of 2009, there were nosignificant changes in the Company’s internal control over financial reportingor, to the Company’s knowledge, in other factors that could significantlyaffect those internal controls subsequent to the date the Company carried outits evaluation that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.  However, the design of any system of controlsand procedures is based in part upon certain assumptions about the likelihoodof future events.  There can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.**

 

32

----

Table ofContents

 

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Part II.Other Information**

**For the Six Months Ended June 30, 2009**

#### ** **

#### **PART II:OTHER INFORMATION:**

#### ** **

Item1. Legal Proceedings

 

Pleaserefer to the material pending legal proceedings discussed in Part I, “Item3. Legal Proceedings” in our Annual Report on form 10-K for the year ended December 31,2008.  There have been no materialdevelopments in the matters discussed in our Annual Report and there are nofurther material legal proceedings to which the Company or the Bank is a partyor of which their property is the subject.

 

Item1A. Risk Factors

 

There have been no material changes from the riskfactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Reporton Form 10-K for the year ended December 31, 2008. You shouldcarefully consider the risk factor discussed below and those discussed in ourAnnual Report on Form 10-K, which could materially affect our business,financial condition or future results. The risks described below and in our Annual Report on Form 10-K arenot the only risks facing us. Additional risks and uncertainties not currentlyknown to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

 

**We expect to enter into a formal enforcement action withregulatory authorities, and we expect such action to place significantrestrictions on our operations.**

 

Underapplicable laws, the FDIC and the Georgia Department of Banking and Finance,our primary banking regulators, have the ability to impose substantialsanctions, restrictions and requirements on us if they determine, uponexamination or otherwise, violations of laws with which we must comply, orweaknesses or failures with respect to general standards of safety andsoundness. Applicable law prohibits disclosure of specific examination findingsby the institution although formal enforcement actions are routinely disclosedby the regulatory authorities. We expect the issuance of a formal enforcementaction primarily due to the high level of nonperforming assets of the Bank, thehigh level of brokered deposits and the resulting impact on the Company’sfinancial condition.  These actionsgenerally require certain corrective steps, impose limits on activities (suchas lending, acquisitions or branching), prescribe lending parameters (such asloan types, volumes and terms) and require heightened capital ratios to bemaintained.  In many cases, policies mustbe revised by the institution and submitted to the regulatory authority forapproval within time frames prescribed by the regulatory authorities. Failureto adhere to the requirements of the actions, once issued, can result in moresevere penalties. Generally, these enforcement actions can be lifted only aftersubsequent examinations substantiate complete correction of the underlyingissues.

 

**Future restrictions on the conductof our business could adversely impact our ability to attract deposits.**

 

Ifwe enter into a formal enforcement action, we will no longer be considered “wellcapitalized” by our banking regulators, we are, among other restrictions,prohibited from paying rates in excess of 75 basis points above the localmarket average on deposits of comparable maturity.  Effective January 1,2010, financial institutions that are not well capitalized will beprohibited from paying yields for deposits in excess of 75 basis points above anew national average rate for deposits of comparable maturity, as calculated bythe FDIC, except in very limited circumstances where the FDIC permits useof a higher local market rate.  This national rate may be lower than theprevailing rates in our local market, and we may be unable to secure thepermission of the FDIC to use a local market rate. If restrictions on therates we are able to pay on deposit accounts negatively impacts our ability tocompete for deposits in our market area, we may be unable to attract ormaintain core deposits, and our liquidity and ability to support demand forloans could be adversely affected.

 

Item2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item3. Defaults Upon Senior Securities

NotApplicable

 

33

----

Table of Contents

 

Item4. Submission of Matters to a Vote of Security-Holders

 

Theregular annual meeting of the shareholders of the Company was held on June 9,2009 (“Annual Meeting”).

 

Atthe Annual Meeting, the shareholders elected the following Class Idirectors to serve for three-year terms or until their successors are dulyqualified and elected.  The followingtable sets forth the number of votes cast and withheld with respect to eachnominated director.

 
| **Name**                      | ** ** | **Votes for** | ** ** | **Votes Withheld** | ** ** | **Votes Against** | ** ** |
|-------------------------------|------------|---------------|------------|--------------------|------------|-------------------|------------|
| Peter  R. Cates               |       | 2,745,358     |       | 124,212            |       | 0                 |       |
| Laudis  H. (Rick) Lanford     |       | 2,754,482     |       | 115,088            |       | 0                 |       |
| J.  Russell Lipford, Jr. |       | 2,726,227     |       | 143,343            |       | 0                 |       |
| Hugh  F. Smisson, III    |       | 2,714,124     |       | 155,446            |       | 0                 |       |
| Donald  L. Moore, Jr.    |       | 2,454,287     |       | 415,283            |       | 0                 |       |

 

Thefollowing directors did not stand for reelection as their term of officecontinued:  Carolyn Crayton, Michael C.Griffin, Thomas J. McMichael, Tyler J. Rauls, Jr., Mark A. Stevens,Raymond O. Ballard, Jr., J. Douglas Dunwody, William A. Fickling, III,Carl E. Hofstadter and George Waters, Jr.

 

Item5. Other Information

None

 

Item6. Exhibits

(a)                                  Exhibits:

31.1                           Certification of Chief Executive OfficerPursuant to Rule 13a-14 under the Securities Exchange Act of 1934, asamended

 

31.2                           Certification of Chief Financial OfficerPursuant to Rule 13a-14 under the Securities Exchange Act of 1934, asamended

 

32                                    Certificationof Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adoptedpursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

34

----

Table of Contents

 

**SIGNATURES**

 

Inaccordance with the requirements of the Securities Exchange Act, the registrantcaused this report to be signed on its behalf by the undersigned, thereuntoduly authorized.

 

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

 
| /s/ Mark A. Stevens                    |   |
|----------------------------------------|--------|
|                                   |   |
| Mark A. Stevens                        |   |
| President and Chief  Executive Officer |   |
|                                   |   |
|                                   |   |
| Date: August 13,  2009            |   |

 

35

----