Table of Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

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

 

**For the quarterly period ended September 30, 2010**

 

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

 

**For the transition period from            to            **

 

**Commission File Number  000-51112**

 

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

(Exact Name of Small Business Issuer as Specified in Its Charter)

 

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

 

**1701 BassRoad**

**Macon,Georgia 31210**

(Address of Principal Executive Offices)

 

**(478) 476-2170**

(Issuer’s Telephone Number, Including Area Code)

 

**NotApplicable**

(Former Name, Former Address and Former Fiscal Year, if Changed SinceLast Report)

 

Indicateby check mark whether the registrant: (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days.  Yes x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during thepreceding 12 months (or for such shorter period that the registrant wasrequired to submit and post such files).  Yes o  No o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large acceleratedfiler,” “accelerated filer,” and “smaller reporting company” (in Rule 12b-2of the Exchange Act).

 

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

 

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

 

**APPLICABLE ONLY TO CORPORATE ISSUERS**

 

Statethe number of shares outstanding of each of the issuer’s classes of commonequity, as of the latest practicable date: Common Stock, no par value,4,280,745 shares outstanding at November 12,2010

 

 

 

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**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 — September 30,  2010 (unaudited) and December 31,  2009 (audited).                                          | 2        |
|                                                                                                            |                                                                                                                                                     |     |
|                                                                                                            | Consolidated Statements of  Operations (unaudited) — For the Three Months And Nine Months Ended  September 30, 2010 and 2009.                  | 3        |
|                                                                                                            |                                                                                                                                                     |     |
|                                                                                                            | Consolidated Statements of Comprehensive Income (Loss)  (unaudited) — For the Three Months and Nine Months Ended September 30,  2010 and 2009. | 4        |
|                                                                                                            |                                                                                                                                                     |     |
|                                                                                                            | Consolidated Statements of Cash Flows (unaudited) —  For the Nine Months Ended September 30, 2010 and 2009.                                    | 5        |
|                                                                                                            |                                                                                                                                                     |     |
|                                                                                                            | Notes to Consolidated Financial Statements (unaudited)                                                                                                   | 7        |
|                                                                                                            |                                                                                                                                                     |     |
| ITEM 2.                                                                                                         | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                                              | 22       |
|                                                                                                            |                                                                                                                                                     |     |
| ITEM 3.                                                                                                         | Quantitative  and Qualitative Disclosures About Market Risk                                                                                              | 42       |
|                                                                                                            |                                                                                                                                                     |     |
| ITEM 4T.                                                                                                        | Controls and Procedures                                                                                                                                  | 43       |
|                                                                                                            |                                                                                                                                                     |     |
| PART II:                                                                                                   | OTHER INFORMATION                                                                                                                                        | 44       |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedBalance Sheets**

**September 30,2010****(Unaudited) and****December 31,2009****(Audited)**

** **
| ** **                                                                                                                                                                                  | ** ** | **As of**         | ** **  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|
| ** **                                                                                                                                                                                  | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
| ** **                                                                                                                                                                                  | ** ** | **2010**               | ** **  | **2009** | ** ** |
| **Assets**                                                                                                                                                                                  |       |                   |        |   |   |
|                                                                                                                                                                                        |       |                   |        |   |   |
| Cash and due from banks                                                                                                                                                                     |       | $                      | 7,522,162   |   | $ | 4,990,374 |   |
| Interest-bearing deposits in other banks                                                                                                                                                    |       | 97,289,101             |        | 28,401,303 |   |
| Total cash and cash equivalents                                                                                                                                                             |       | 104,811,263            |        | 33,391,677 |   |
| Securities available for sale, at fair value                                                                                                                                                |       | 40,722,089             |        | 126,939,601 |   |
| Federal Home Loan Bank stock, restricted, at cost                                                                                                                                           |       | 4,007,400              |        | 4,316,800 |   |
| Loans held for sale                                                                                                                                                                         |       | 285,026                |        | 1,089,108 |   |
| Loans, net of unearned income                                                                                                                                                               |       | 607,722,880            |        | 718,306,915 |   |
| Less - allowance for loan losses                                                                                                                                                            |       | (18,652,884            | )           | (21,478,748 | ) |
| Loans, net                                                                                                                                                                                  |       | 589,069,996            |        | 696,828,167 |   |
| Bank premises and equipment, net                                                                                                                                                            |       | 30,043,245             |        | 31,016,982 |   |
| Accrued interest receivable                                                                                                                                                                 |       | 3,525,117              |        | 4,549,769 |   |
| Cash surrender value of life insurance                                                                                                                                                      |       | 13,409,122             |        | 13,011,018 |   |
| Intangible assets, net of amortization                                                                                                                                                      |       | 2,277,113              |        | 2,548,850 |   |
| Other real estate owned                                                                                                                                                                     |       | 61,612,054             |        | 21,066,480 |   |
| Income tax receivable                                                                                                                                                                       |       | 204,983                |        | 11,174,666 |   |
| Other assets                                                                                                                                                                                |       | 2,613,627              |        | 2,446,748 |   |
| **Total Assets**                                                                                                                                                                            |       | $                      | 852,581,035 |   | $ | 948,379,866 |   |
|                                                                                                                                                                                        |       |                   |        |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                                                                              |       |                   |        |   |   |
| Deposits:                                                                                                                                                                                   |       |                   |        |   |   |
| Non-interest bearing                                                                                                                                                                        |       | $                      | 54,045,637  |   | $ | 53,747,355 |   |
| Money market and NOW accounts                                                                                                                                                               |       | 107,131,121            |        | 132,469,652 |   |
| Savings                                                                                                                                                                                     |       | 12,820,004             |        | 8,890,713 |   |
| Time deposits                                                                                                                                                                               |       | 612,306,024            |        | 666,049,168 |   |
| Total deposits                                                                                                                                                                              |       | 786,302,786            |        | 861,156,888 |   |
| Federal Home Loan Bank advances                                                                                                                                                             |       | 29,000,000             |        | 39,000,000 |   |
| Subordinated debentures                                                                                                                                                                     |       | 1,400,000              |        | 1,400,000 |   |
| Junior subordinated debentures                                                                                                                                                              |       | 10,310,000             |        | 10,310,000 |   |
| Accrued interest payable                                                                                                                                                                    |       | 3,467,329              |        | 4,977,554 |   |
| Accrued expenses and other liabilities                                                                                                                                                      |       | 1,941,277              |        | 1,896,265 |   |
| Total liabilities                                                                                                                                                                           |       | 832,421,392            |        | 918,740,707 |   |
| Commitments and contingencies                                                                                                                                                               |       |                   |        |   |   |
| Shareholders’ Equity:                                                                                                                                                                  |       |                   |        |   |   |
| Preferred stock, authorized 2,000,000 shares,  outstanding -0- shares                                                                                                                       |       | —                 |        | — |   |
| Common stock, no par value, authorized 110,000,000  shares, 4,280,745 issued and outstanding in 2010, no par value, authorized  10,000,000 shares, 4,211,780 issued and outstanding in 2009 |       | 74,748,685             |        | 74,630,831 |   |
| Deferred compensation, 68,965 shares                                                                                                                                                        |       | (87,500                | )           | — |   |
| Accumulated deficit                                                                                                                                                                         |       | (54,921,667            | )           | (45,592,212 | ) |
| Accumulated other comprehensive income                                                                                                                                                      |       | 420,125                |        | 600,540 |   |
| Total shareholders’ equity                                                                                                                                                             |       | 20,159,643             |        | 29,639,159 |   |
| **Total Liabilities and  Shareholders’ Equity**                                                                                                                                        |       | $                      | 852,581,035 |   | $ | 948,379,866 |   |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Operations**

**For the Three Months andNine Months Ended September 30, 2010 and 2009**

**(Unaudited)**

** **
| ** **                                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Interest and Dividend Income:**                                        |       |                             |       |                            |       |   |   |   |   |
| Interest and fees on loans                                               |       | $                                | 8,111,829  |                            | $          | 10,424,193 |   | $ | 25,596,967 |   | $ | 32,555,605 |   |
| Interest on securities:                                                  |       |                             |       |                            |       |   |   |   |   |
| Taxable income                                                           |       | 288,544                          |       | 614,751                         |       | 1,170,671 |   | 2,400,476 |   |
| Non-taxable income                                                       |       | 140,299                          |       | 146,952                         |       | 430,255 |   | 470,204 |   |
| Other interest and dividend income                                       |       | 52,125                           |       | 68,928                          |       | 124,823 |   | 77,409 |   |
| Total interest and dividend income                                       |       | 8,592,797                        |       | 11,254,824                      |       | 27,322,716 |   | 35,503,694 |   |
| **Interest Expense:**                                                    |       |                             |       |                            |       |   |   |   |   |
| Deposits                                                                 |       | 4,291,024                        |       | 6,704,732                       |       | 14,166,545 |   | 20,052,429 |   |
| Subordinated debentures                                                  |       | 42,934                           |       | 42,933                          |       | 127,400 |   | 127,400 |   |
| Junior subordinated debentures                                           |       | 67,041                           |       | 69,176                          |       | 187,761 |   | 255,423 |   |
| FHLB borrowings and other interest expense                               |       | 252,942                          |       | 406,166                         |       | 709,746 |   | 1,145,128 |   |
| Total interest expense                                                   |       | 4,653,941                        |       | 7,223,007                       |       | 15,191,452 |   | 21,580,380 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| Net interest income                                                      |       | 3,938,856                        |       | 4,031,817                       |       | 12,131,264 |   | 13,923,314 |   |
| **Provision for loan losses**                                            |       | 2,178,000                        |       | 11,352,000                      |       | 5,514,000 |   | 17,420,000 |   |
| Net interest income (expense) after provision for  loan losses           |       | 1,760,856                        |       | (7,320,183                      | )          | 6,617,264 |   | (3,496,686 | ) |
| **Noninterest Income:**                                                  |       |                             |       |                            |       |   |   |   |   |
| Service charges on deposit accounts                                      |       | 386,702                          |       | 464,250                         |       | 1,178,929 |   | 1,303,925 |   |
| Other service charges, commissions and fees                              |       | 151,385                          |       | 135,817                         |       | 442,897 |   | 373,944 |   |
| Gain on sales, calls and impairment write-down of  investment securities |       | 556,613                          |       | 15,342                          |       | 599,519 |   | 1,331,160 |   |
| Mortgage origination income                                              |       | 68,330                           |       | 249,162                         |       | 218,343 |   | 642,749 |   |
| Other income                                                             |       | 238,177                          |       | 267,493                         |       | 727,370 |   | 823,569 |   |
| Total noninterest income                                                 |       | 1,401,207                        |       | 1,132,064                       |       | 3,167,058 |   | 4,475,347 |   |
| **Noninterest Expense:**                                                 |       |                             |       |                            |       |   |   |   |   |
| Salaries and employee benefits                                           |       | 2,045,953                        |       | 2,423,366                       |       | 6,596,418 |   | 7,838,818 |   |
| Occupancy expense                                                        |       | 442,535                          |       | 463,275                         |       | 1,325,878 |   | 1,355,029 |   |
| Equipment rental and depreciation of equipment                           |       | 300,476                          |       | 333,301                         |       | 895,250 |   | 964,804 |   |
| (Gain) loss on sale of other assets                                      |       | 5,338                            |       | (105,760                        | )          | 6,113 |   | (61,963 | ) |
| Loss on sale and impairment of other real estate                         |       | 1,322,408                        |       | 941,572                         |       | 1,719,335 |   | 2,432,260 |   |
| Other real estate expense                                                |       | 477,216                          |       | 316,962                         |       | 1,778,386 |   | 653,258 |   |
| FDIC and state banking assessments                                       |       | 1,103,010                        |       | 729,328                         |       | 3,431,229 |   | 1,883,939 |   |
| Goodwill impairment                                                      |       | —                           |       | —                          |       | — |   | 19,533,501 |   |
| Other expenses                                                           |       | 1,123,674                        |       | 1,392,846                       |       | 3,361,168 |   | 4,444,466 |   |
| Total noninterest expense                                                |       | 6,820,610                        |       | 6,494,890                       |       | 19,113,777 |   | 39,044,112 |   |
|                                                                     |       |                             |       |                            |       |   |   |   |   |
| **Loss before income taxes**                                             |       | (3,658,547                       | )          | (12,683,009                     | )          | (9,329,455 | ) | (38,065,451 | ) |
| Income tax benefit                                                       |       | —                           |       | 4,395,044                       |       | — |   | 6,737,530 |   |
| **Net Loss**                                                             |       | $                                | (3,658,547 | )                               | $          | (8,287,965 | ) | $ | (9,329,455 | ) | $ | (31,327,921 | ) |
| **Net Loss per share:**                                                  |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                    |       | $                                | (0.87      | )                               | $          | (1.97 | ) | $ | (2.22 | ) | $ | (7.44 | ) |
| Diluted                                                                  |       | $                                | (0.87      | )                               | $          | (1.97 | ) | $ | (2.22 | ) | $ | (7.44 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Comprehensive Income (Loss)**

**For the Three Months andNine Months Ended September 30, 2010 and 2009**

**(Unaudited)**

** **
| ** **                                                                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net loss                                                                                      |       | $                                                        | (3,658,547 | )                                                       | $          | (8,287,965 | ) | $ | (9,329,455 | ) | $ | (31,327,921 | ) |
| Other comprehensive income (loss):                                                            |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrealized holding gains on investment securities  available for sale                         |       | 9,406                                                    |       | 1,349,409                                               |       | 326,164 |   | 1,200,506 |   |
| Reclassification adjustment for gains on  investments available for sale realized in net loss |       | (556,613                                                 | )          | (15,342                                                 | )          | (599,519 | ) | (1,388,778 | ) |
| Total other comprehensive income (loss), before  tax                                          |       | (547,207                                                 | )          | 1,334,067                                               |       | (273,355 | ) | (188,272 | ) |
| Income taxes related to other comprehensive  (income) loss:                                   |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrealized holding gains on investment securities  available for sale                         |       | (3,198                                                   | )          | (458,799                                                | )          | (110,896 | ) | (408,172 | ) |
| Reclassification adjustment for gains on  investments available for sale realized in net loss |       | 189,248                                                  |       | 5,216                                                   |       | 203,836 |   | 472,185 |   |
| Total income taxes related to other comprehensive  (income) loss                              |       | 186,050                                                  |       | (453,583                                                | )          | 92,940 |   | 64,013 |   |
| Total other comprehensive income (loss), net of  tax                                          |       | (361,157                                                 | )          | 880,484                                                 |       | (180,415 | ) | (124,259 | ) |
| Total comprehensive income (loss)                                                             |       | $                                                        | (4,019,704 | )                                                       | $          | (7,407,481 | ) | $ | (9,509,870 | ) | $ | (31,452,180 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Cash Flows**

**For the Nine Months Ended September 30,2010 and 2009**

**(Unaudited)**

** **
| ** **                                                                            | ** ** | **Nine Months Ended September 30,** | ** **  |
|---------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                                            | ** ** | **2010**                                                | ** **  | **2009** | ** ** |
| **Cash Flows from Operating  Activities:**                                            |       |                                                    |        |   |   |
| Net loss                                                                              |       | $                                                       | (9,329,455  | ) | $ | (31,327,921 | ) |
| Adjustments to reconcile net loss to net cash  provided by operating activities:      |       |                                                    |        |   |   |
| Provision for loan losses                                                             |       | 5,514,000                                               |        | 17,420,000 |   |
| Depreciation                                                                          |       | 1,176,891                                               |        | 1,219,143 |   |
| Stock based compensation                                                              |       | 30,353                                                  |        | 19,026 |   |
| Goodwill impairment charge                                                            |       | —                                                  |        | 19,533,501 |   |
| Amortization and (accretion), net                                                     |       | 621,282                                                 |        | 536,481 |   |
| Loss on sale and impairment of other real estate                                      |       | 1,719,335                                               |        | 2,432,260 |   |
| (Gain) loss on sale of other assets                                                   |       | 6,113                                                   |        | (61,963 | ) |
| Gain on sales, calls and impairment write-down of  investment securities              |       | (599,519                                                | )           | (1,331,160 | ) |
| Earnings on cash surrender value of life insurance                                    |       | (398,104                                                | )           | (401,540 | ) |
| Change in:                                                                            |       |                                                    |        |   |   |
| Loans held for sale                                                                   |       | 939,082                                                 |        | (280,588 | ) |
| Accrued income and other assets                                                       |       | 12,617,274                                              |        | (5,012,219 | ) |
| Accrued expenses and other liabilities                                                |       | (1,465,213                                              | )           | (76,297 | ) |
| Net cash provided by operating activities                                             |       | 10,832,039                                              |        | 2,668,723 |   |
| **Cash Flows from Investing  Activities:**                                            |       |                                                    |        |   |   |
| Net change in loans to customers                                                      |       | 56,155,354                                              |        | 5,215,629 |   |
| Purchase of available for sale securities                                             |       | (7,467,125                                              | )           | (201,094,582 | ) |
| Proceeds from sales, calls, maturities and paydowns  of available for sale securities |       | 93,716,246                                              |        | 122,479,947 |   |
| Purchase of other investments                                                         |       | —                                                  |        | (880,600 | ) |
| Proceeds from sale of other investments                                               |       | 309,400                                                 |        | 484,000 |   |
| Property and equipment expenditures                                                   |       | (203,154                                                | )           | (1,492,611 | ) |
| Improvement of other real estate                                                      |       | (838,736                                                | )           | (25,048 | ) |
| Proceeds from sales of other real estate and other  assets                            |       | 3,769,664                                               |        | 4,693,445 |   |
| Net cash provided by (used in) investing  activities                                  |       | 145,441,649                                             |        | (70,619,820 | ) |
| **Cash Flows from Financing  Activities:**                                            |       |                                                    |        |   |   |
| Net change in deposits                                                                |       | (74,854,102                                             | )           | 120,708,633 |   |
| Advances on FHLB borrowings                                                           |       | —                                                  |        | 31,000,000 |   |
| Payments on FHLB borrowings                                                           |       | (10,000,000                                             | )           | (28,200,000 | ) |
| Net cash (used in) provided by financing  activities                                  |       | (84,854,102                                             | )           | 123,508,633 |   |
| **Net Increase in Cash and Cash  Equivalents**                                        |       | 71,419,586                                              |        | 55,557,536 |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                     |       | 33,391,677                                              |        | 15,130,136 |   |
| **Cash and Cash Equivalents, End of  Quarter**                                        |       | $                                                       | 104,811,263 |   | $ | 70,687,672 |   |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Consolidated Statements ofCash Flows, continued**

**For the Nine Months Ended September 30,2010 and 2009**

**(Unaudited)**

 

**Supplemental Disclosure of Cash Flow Information**

 

**Noncash transactions:**

 
| ** **                                                         | ** ** | **Nine Months Ended September 30,** | ** **  |
|--------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                         | ** ** | **2010**                                                | ** **  | **2009** | ** ** |
| Changes in unrealized gain/loss on investments,  net of tax effect |       | $                                                       | (180,415    | ) | $ | (124,259 | ) |
| Transfer of loans to other real estate and other  assets           |       | $                                                       | 47,520,667  |   | $ | 16,758,579 |   |
| Transfer of other real estate to loans and loans  held for sale    |       | $                                                       | 1,567,026   |   | $ | 4,078,873 |   |
| Interest on deposits and borrowings                                |       | $                                                       | 16,701,677  |   | $ | 21,918,066 |   |
| Income tax refunds                                                 |       | $                                                       | (10,969,783 | ) | $ | (848,760 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated FinancialStatements**

**(Unaudited)**

 

***(1) Basisof Presentation***

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with the instructions to Form 10-Q and therefore donot include all information and footnotes necessary for a fair presentation offinancial position, 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, 2009.

 

***(2) Regulatory Orders***

 

OnSeptember 11, 2009, Atlantic Southern Bank (the “Bank”), the wholly-ownedsubsidiary bank of Atlantic Southern Financial Group, Inc., entered into aStipulation and Consent to the Issuance of an Order to Cease and Desist (the “ConsentAgreement”) with the Federal Deposit Insurance Corporation (the “FDIC”) and theGeorgia Department of Banking and Finance (the “GDBF”), whereby the Bankconsented to the issuance of an Order to Cease and Desist (the “Order”).  Under the terms of the Order, the Bank cannotdeclare dividends without the prior written approval of the FDIC and the GDBF.Other material provisions of the order require the Bank to: (i) strengthenits board of directors’ oversight of management and operations of the Bank,(ii) establish a committee consisting of at least four members, three ofwhich must be independent, to oversee the Bank’s compliance with the Order,(iii) maintain specified capital and liquidity ratios, (iv)  improvethe Bank’s lending and collection policies and procedures, particularly withrespect to the origination and monitoring of commercial real estate andacquisition, development and construction loans, (v) eliminate from itsbooks, by charge off or collection, all assets classified as “loss” and 50% ofall assets classified as doubtful, (vi) perform risk segmentation analysiswith respect to concentrations of credit, (vii) receive a brokered depositwaiver from the FDIC prior to accepting, rolling over or renewing any brokereddeposits and submit a written plan for eliminating its reliance on brokereddeposits, (viii) adopt and implement a policy limiting the use of loaninterest reserves, (ix) formulate and fully implement a written plan andcomprehensive budget for all categories of income and expense, and(x) prepare and submit progress reports to the FDIC and the GDBF. The FDICorder will remain in effect until modified or terminated by the FDIC and theGDBF.

 

TheBank has continued to serve its customers in all areas including making loans,establishing lines of credit, accepting deposits and processing bankingtransactions.  The Bank’s deposits remaininsured by the FDIC to the maximum limits allowed by law.  The FDIC and GDBF did not impose or recommendany monetary penalties.

 

Asof the date of this report, the Bank has made the following progress incomplying with the above stated provisions of the Order:

 

(i)            Since the Orderand throughout 2010, the board of directors’ participation in the affairs ofthe Bank has continued to increase through greater communication withmanagement, an analysis of management reports to the board, as well asincreased committee activities.

 

(ii)           The Bank hasformed an oversight committee for the purpose of monitoring the Bank’s overallcompliance with the Order and this committee meets monthly and reports to thefull board of the Bank at each regularly scheduled board meeting.  Although not specifically required by theOrder, the board engaged an independent management consulting firm to conductan assessment of Bank management.

 

(iii)          The Bankdeveloped a capital plan, which includes reducing expenses to improve earnings,restructuring the balance sheet to reduce non-performing assets, seeking newcapital and limiting loan growth and will continue to revise the planquarterly.  The Bank has also reviewedits written liquidity, contingency funding, and funds management policies.  Both the revised capital plan and the revisedliquidity policy have been submitted to the supervisory authorities forreview.  The 

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Bank’s Total Risk Based Capital ratio was 5.49% and the Tier 1 LeverageRatio was 3.14% at September 30, 2010. The Bank’s liquidity ratio at September 30, 2010 was 17.94%.

 

(iv)          The Bank hasreviewed and revised lending policies to provide additional guidance andcontrol over the lending functions.

 

(v)           The Bank haseliminated from its books all assets or portions of assets classified as “Loss”and 50% of all assets or portions of assets classified as “Doubtful”.

 

(vi)          The Bank hasand will continue to perform a risk segmentation analysis with respect toconcentrations of credit.  Management islimiting credit availability especially for commercial real estate andacquisition, development and construction loans and pursuing collection effortsaggressively in an effort to reduce the Bank’s exposure to commercial realestate and acquisition, development and construction, pursuant to the Order.

 

(vii)         The Bank hassubmitted to the supervisory authorities a written plan for eliminating itsreliance on brokered deposits and will not accept, roll over or renew anybrokered deposits unless a waiver has been received from the FDIC.  The Bank continues to significantly reduceits exposure to brokered deposits.  SinceJune 30, 2008, the Bank has been proactive in reducing brokered depositsby 59.1%, or $238.4 million, while increasing core deposits by $188.9 millionduring the same period.

 

(viii)        The Bank hasadopted a policy limiting the use of interest reserves.

 

(ix)           A three-yearprofit plan has been developed and is updated quarterly and reviewed by theoversight committee.

 

(x)            The Bank hassubmitted all required progress reports to the appropriate supervisoryauthorities.

 

OnMarch 26, 2010, the Company entered into a written agreement (the “Agreement”)with the Board of Governors of the Federal Reserve System (the “Federal ReserveBoard”) and the GDBF, pursuant to which the Company is prohibited fromdeclaring or paying dividends without prior written consent from theregulators.  In addition, pursuant to theAgreement, without the prior written consent of regulators, the Company isprohibited from taking dividends, or any other form of payment representing areduction of capital, from the Bank; paying interest, principal or other sumson subordinated debentures and trust preferred securities; incurring,increasing or guaranteeing any debt; redeeming any shares of the Company’scommon stock; and increasing salaries or bonuses paid to executiveofficers.  All salaries, bonuses andfees, excluding the reimbursement of expenses valued at less than $500 in theaggregate per month per executive officer, must be preapproved by the board ofdirectors on a regular basis.  Inappointing any new director or any executive officer, the Company is requiredto notify regulatory authorities and comply with restrictions onindemnification and severance.  TheCompany will also provide quarterly written progress reports to the FederalReserve Board.

 

Within60 days of the Agreement, the Company was required to submit to the FederalReserve Board a written plan designed to maintain sufficient capital at theCompany, on a consolidated basis, and at the Bank.  The Agreement does not contain specifictarget capital ratios or specific timelines, but requires that the plan addressthe Company’s current and future capital requirements, the Bank’s current andfuture capital requirements, the adequacy of the Bank’s capital taking intoaccount its risk profile, and the source and timing of additional fundsnecessary to fulfill the Company’s and the Bank’s future capital requirements.

 

***(3) Going Concern***

 

Asa result of the extraordinary effects of what may ultimately be the worsteconomic downturn since the Great Depression, the Company’s and the Bank’scapital have been significantly depleted.  The Company recorded a net loss of $59.2million in 2009 and continued in the first nine months of 2010 in recording anet loss of $9.3 million.  These netlosses are primarily the result of significant increases in the provision forloan losses in 2009,

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

therecognition of goodwill impairment in 2009, the establishment of a valuationallowance against the Company’s deferred tax asset in 2009, a decrease in theCompany’s net interest margin due to the loss of interest on non-accrual loansand from the purchase of low-yielding investment securities during 2009, asignificant increase in the FDIC quarterly assessment in 2009 and 2010 andincreases in other real estate expenses due to the increase in foreclosedproperties in 2009 and 2010.  The impactof the current financial crisis in the U.S. and abroad is having far-reachingconsequences and it is difficult to say at this point when the economy willbegin to recover.  As a result, it cannotbe assured that the Company will be able to resume profitable operations in thenear future, if at all.

 

TheCompany and the Bank are required by federal regulatory authorities to maintainadequate levels of capital to support their operations.  As part of the Order, the Bank is required toincrease its capital and maintain certain regulatory capital ratios.  To comply with the Order, the Bank isrequired to have Tier 1 capital in such an amount as to equal or exceed 8% ofthe Bank’s total assets and total risk-based capital in an amount as to equalor exceed 10% of the Bank’s risk-weighted assets.  At September 30, 2010, the Bank’s totalcapital to risk-weighted assets and ratio of Tier 1 capital to average assetswere 5.49% and 3.14%, respectively.  TheCompany’s existing capital resources may not satisfy the requirements for theforeseeable future and may not be sufficient to offset any additional problemassets.  Further, should erosion to theBank’s asset quality continue and require significant additional provision forcredit losses, resulting in consistent net operating losses at the Bank, theBank’s capital levels will decline and the Company will need to raiseadditional capital to satisfy the Order.

 

TheCompany’s ability to raise additional capital will depend on conditions in thecapital markets at that time, which are outside its control, and on itsfinancial performance.  Accordingly, theCompany cannot be certain of its ability to raise additional capital on termsacceptable to them.  The Company’sinability to raise capital or comply with the terms of the Order raisessubstantial doubt about its ability to continue as a going concern.

 

TheCompany’s Board of Directors is seeking all strategic alternatives to enhancethe stability of the Company, including a capital investment.  There can be no assurance, however, that theCompany will be able to comply with the regulatory requirements.  In addition, a transaction involving equityfinancing, would result in substantial dilution to current stockholders andcould adversely affect the price of the Company’s common stock.  As a result of the Bank’s financialcondition, the regulatory authorities are continually monitoring its liquidityand capital adequacy.  Based on theirassessment of the Bank’s ability to continue to operate in a safe and soundmanner, including its compliance with established capital requirements,regulatory authorities may take other and further actions, including placingthe Bank into conservatorship or receivership, to protect the interests ofdepositors.

 

Theaccompanying consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and the dischargeof liabilities in the normal course of business for the foreseeable future, anddo not include any adjustments to reflect the possible future effects on therecoverability or classification of assets, and the amounts or classificationof liabilities that may result from the outcome of any regulatory action, whichwould affect the Company’s ability to continue as a going concern.  The Company’s independent public accountantshave expressed, in their opinion on the Company’s consolidated financialstatements as of December 31, 2009, that a substantial doubt existsregarding the Company’s ability to continue as a going concern.

 

***(4) Net Earnings (Loss) per Share***

 

Basic earnings (loss) per share arebased on the weighted average number of common shares outstanding during theperiod while the effects of potential shares outstanding during the period areincluded in diluted earnings per share.  Approximately 381,000 shares of reserved forissuance pursuant to options and warrants and 68,965 shares of restricted stockwere not included in the diluted loss per share computation for the three andnine months ended September 30, 2010 and 2009 as they are anti-dilutive.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

The reconciliation of the amountsused in the computation of both “basic earnings (loss) per share” and “dilutedearnings (loss) per share” for each period is presented as follows:

 
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                  | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Net loss                                                                    |       | $                                | (3,658,547 | )                               | $          | (8,287,965 | ) | $ | (9,329,455 | ) | $ | (31,327,921 | ) |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Weighted average common shares outstanding                                  |       | 4,211,780                        |       | 4,211,780                       |       | 4,211,780 |   | 4,211,780 |   |
| Shares issued from assumed exercise of common  stock equivalents            |       | —                           |       | —                          |       | — |   | — |   |
| Weighted average number of common and common  equivalent shares outstanding |       | 4,211,780                        |       | 4,211,780                       |       | 4,211,780 |   | 4,211,780 |   |
| Loss per share:                                                             |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                       |       | $                                | (0.87      | )                               | $          | (1.97 | ) | $ | (2.22 | ) | $ | (7.44 | ) |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Diluted                                                                     |       | $                                | (0.87      | )                               | $          | (1.97 | ) | $ | (2.22 | ) | $ | (7.44 | ) |

 

***(5) ******InvestmentSecurities***

 

Debt and equity securities have been classified in the balance sheetaccording to management’s intent.  Allinvestments as of September 30, 2010 and December 31, 2009 areclassified as available for sale.  The followingtable reflects the amortized cost and estimated fair values of the investments:

 
| ** **                                | ** ** | ** **    | ** **  | **Gross**      | ** ** | **Gross**      | ** ** | ** **          | ** ** |
|-------------------------------------------|------------|---------------|-------------|----------------|------------|----------------|------------|---------------------|------------|
| ** **                                | ** ** | **Amortized** | ** **  | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated**       | ** ** |
| **September 30, 2010**          | ** ** | **Cost**      | ** **  | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| Non-mortgage backed debt securities of :  |       |          |        |           |       |           |       |                |       |
| U.S. Treasury obligations                 |       | $             | —      |           | $          | —         |       | $                   | —     |   | $ | — |   |
| U.S. Government sponsored enterprises     |       | 5,007,037     |        | 97,051         |       | —         |       | 5,104,088           |       |
| State and political subdivisions          |       | 15,206,929    |        | 440,816        |       | (316,670       | )          | 15,331,075          |       |
| Other investments                         |       | 250,000       |        | —         |       | (34,802        | )          | 215,198             |       |
| Total non-mortgage backed debt securities |       | 20,463,966    |        | 537,867        |       | (351,472       | )          | 20,650,361          |       |
| Mortgage backed securities                |       | 19,582,141    |        | 470,553        |       | —         |       | 20,052,694          |       |
| Equity securities                         |       | 39,428        |        | —         |       | (20,394        | )          | 19,034              |       |
| Total                                     |       | $             | 40,085,535  |           | $          | 1,008,420      |       | $                   | (371,866   | ) | $ | 40,722,089 |   |
| **December 31, 2009**                |       |          |        |           |       |           |       |                |       |
| Non-mortgage backed debt securities of :  |       |          |        |           |       |           |       |                |       |
| U.S. Treasury obligations                 |       | $             | 57,114,838  |           | $          | 42,027         |       | $                   | —     |   | $ | 57,156,865 |   |
| U.S. Government sponsored enterprises     |       | 27,191,611    |        | 425,213        |       | —         |       | 27,616,824          |       |
| State and political subdivisions          |       | 15,404,985    |        | 234,535        |       | (483,685       | )          | 15,155,835          |       |
| Other investments                         |       | 250,000       |        | 9,208          |       | —         |       | 259,208             |       |
| Total non-mortgage backed debt securities |       | 99,961,434    |        | 710,983        |       | (483,685       | )          | 100,188,732         |       |
| Mortgage backed securities                |       | 26,028,829    |        | 733,712        |       | (51,100        | )          | 26,711,441          |       |
| Equity securities                         |       | 39,428        |        | —         |       | —         |       | 39,428              |       |
| Total                                     |       | $             | 126,029,691 |           | $          | 1,444,695      |       | $                   | (534,785   | ) | $ | 126,939,601 |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Theamortized cost and fair values of pledged securities for public deposits andfor federal funds lines of credit with correspondent banks were as follows:

 
| ** **     | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------|------------|------------------------|------------|-----------------------|------------|
| ** **     | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| Amortized cost |       | $                      | 20,028,613 |                  | $          | 23,141,062 |   |
| Fair value     |       | $                      | 20,636,370 |                  | $          | 23,003,692 |   |

 

The amortized cost and estimated fair value ofdebt securities available for sale at September 30, 2010, by contractualmaturity, are shown below.  Expectedmaturities for mortgage-backed securities may differ from contractualmaturities because in certain cases borrowers can prepay obligations withoutprepayment penalties.  Therefore, thesesecurities are not included in the following maturity summary.

 
| ** **                                | ** ** | ** **              | ** ** | **Estimated**       | ** ** |
|-------------------------------------------|------------|-------------------------|------------|---------------------|------------|
| ** **                                | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
| Non-mortgage backed debt securities:      |       |                    |       |                |       |
| Due in one year or less                   |       | $                       | —     |                | $          | — |   |
| Due after one year through five years     |       | 3,622,236               |       | 3,663,800           |       |
| Due after five years through ten years    |       | 6,584,773               |       | 6,803,072           |       |
| Due after ten years                       |       | 10,256,957              |       | 10,183,489          |       |
| Total non-mortgage backed debt securities |       | $                       | 20,463,966 |                | $          | 20,650,361 |   |

 

The fair value is established by an independent pricing service as ofthe approximate dates indicated.  Thedifferences between the amortized cost and fair value reflect current interestrates and represent the potential loss (or gain) had the portfolio beenliquidated on that date.  Security losses(or gains) are realized only in 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:

 
| ** **                                       | ** ** | **September 30, 2010**           | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **Less Than Twelve Months** | ** ** | **More Than Twelve Months** | ** ** |
| ** **                                       | ** ** | **Unrealized**                             | ** ** | **Estimated** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| **Securities Available for Sale** | ** ** | **Losses**                                 | ** ** | **Fair Value** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Non-mortgage backed debt securities of:          |       |                                       |       |   |   |   |   |   |   |
| State and political subdivisions                 |       | $                                          | (245,125   | ) | $ | 2,736,344 |   | $ | (71,545 | ) | $ | 1,290,454 |   |
| Other investments                                |       | (34,802                                    | )          | 215,198 |   | — |   | — |   |
| Total non-mortgage backed debt securities        |       | (279,927                                   | )          | 2,951,542 |   | (71,545 | ) | 1,290,454 |   |
| Mortgage backed securities                       |       | —                                     |       | — |   | — |   | — |   |
| Equity securities                                |       | (20,394                                    | )          | 19,034 |   | — |   | — |   |
| Total                                            |       | $                                          | (300,321   | ) | $ | 2,970,576 |   | $ | (71,545 | ) | $ | 1,290,454 |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                                       | ** ** | **December 31, 2009**            | ** ** |
|--------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                       | ** ** | **Less Than Twelve Months** | ** ** | **More Than Twelve Months** | ** ** |
| ** **                                       | ** ** | **Unrealized**                             | ** ** | **Estimated** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| **Securities Available for Sale** | ** ** | **Losses**                                 | ** ** | **Fair Value** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Non-mortgage backed debt securities of:          |       |                                       |       |   |   |   |   |   |   |
| State and political subdivisions                 |       | $                                          | (6,966     | ) | $ | 2,466,046 |   | $ | (476,719 | ) | $ | 4,814,097 |   |
| Other investments                                |       | —                                     |       | — |   | — |   | — |   |
| Total non-mortgage backed debt securities        |       | (6,966                                     | )          | 2,466,046 |   | (476,719 | ) | 4,814,097 |   |
| Mortgage backed securities                       |       | (51,100                                    | )          | 7,799,758 |   | — |   | — |   |
| Equity securities                                |       | —                                     |       | — |   | — |   | — |   |
| Total                                            |       | $                                          | (58,066    | ) | $ | 10,265,804 |   | $ | (476,719 | ) | $ | 4,814,097 |   |

 

Management evaluates securitiesfor other-than-temporary impairment at least on a quarterly basis, and morefrequently 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 September 30, 2010,twelve debt securities had unrealized losses with aggregate depreciation of0.88% from the Company’s amortized cost basis. In analyzing an issuer’s financial condition, management considerswhether the securities are issued by the federal government or its agencies,whether downgrades 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.

 

The following tablesummarizes securities disposal activities for the three month and nine monthperiods ended September 30, 2010 and 2009:

 
| ** **               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **               | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **               | ** ** | **2010**                         | ** ** | **2009**                        | ** ** | **2010** | ** ** | **2009** | ** ** |
| Proceeds from sales      |       | $                                | 11,347,462 |                            | $          | — |   | $ | 11,347,462 |   | $ | 51,611,819 |   |
| Proceeds from calls      |       | 2,545,000                        |       | 5,040,000                       |       | 18,635,000 |   | 5,220,000 |   |
| Proceeds from maturities |       | 20,500,000                       |       | 27,347,247                      |       | 57,000,000 |   | 56,080,247 |   |
| Paydowns                 |       | 2,208,266                        |       | 1,329,364                       |       | 6,733,784 |   | 9,567,881 |   |
| Total                    |       | $                                | 36,600,728 |                            | $          | 33,716,611 |   | $ | 93,716,246 |   | $ | 122,479,947 |   |
|                     |       |                             |       |                            |       |   |   |   |   |
| Gross gains              |       | $                                | 557,149    |                            | $          | 16,119 |   | $ | 600,055 |   | $ | 1,400,252 |   |
| Gross losses             |       | (536                             | )          | (777                            | )          | (536 | ) | (11,474 | ) |
| Impairment losses        |       | —                           |       | —                          |       | — |   | (57,618 | ) |
|                     |       |                             |       |                            |       |   |   |   |   |
| Net gains of securities  |       | $                                | 556,613    |                            | $          | 15,342 |   | $ | 599,519 |   | $ | 1,331,160 |   |
|                     |       |                             |       |                            |       |   |   |   |   |
| Income tax expense       |       | $                                | —     |                            | $          | 5,216 |   | $ | — |   | $ | 472,185 |   |

 

During the third quarter of2010, the Bank sold approximately $11.3 million in U.S. agency and mortgagebacked securities to capture gains on securities prepaying at a high pace.  During the second quarter of 2009, the Bankrestructured approximately $36 million in U.S. agency and mortgage backedsecurities to capture gains on securities prepaying at a high pace, to offsetFDIC special assessment and to shorten the average maturity of the portfolio.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

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.

 

***(6) Loans***

 

The following is a summary of the loan portfolioby purpose code categories:

 
| ** **                                        | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                                        | ** ** | **2010**               | ** **  | **2009**              | ** ** |
|                                              |       |                   |        |                  |       |
| Commercial                                        |       | $                      | 44,788,031  |                  | $          | 51,673,928 |   |
| Real estate - commercial                          |       | 273,745,608            |        | 304,468,535           |       |
| Real estate - construction                        |       | 190,463,314            |        | 263,270,892           |       |
| Real estate - mortgage                            |       | 93,154,714             |        | 92,012,553            |       |
| Obligations of political subdivisions in the U.S. |       | 204,792                |        | 294,779               |       |
| Consumer                                          |       | 5,488,624              |        | 6,838,169             |       |
| Total loans                                       |       | 607,845,083            |        | 718,558,856           |       |
| Less:                                             |       |                   |        |                  |       |
| Unearned loan fees                                |       | (122,203               | )           | (251,941              | )          |
| Allowance for loan losses                         |       | (18,652,884            | )           | (21,478,748           | )          |
| Loans, net                                        |       | $                      | 589,069,996 |                  | $          | 696,828,167 |   |

 

The Company considers aloan to be impaired when it is probable that it will be unable to collect allamounts due according to the original terms of the loan agreement.  Impaired loans include loans which are notaccruing interest and restructured loans which are accruing interest.  The Company measures impairment of a loan ona loan-by-loan basis by either the present value of expected future cash flowsdiscounted at the loan’s effective interest rate, the loan’s obtainable marketprice, or the fair value of the collateral if the loan is collateraldependent.  Non-accrual loans are loanswhich collection of interest is not probable and all cash flows received arerecorded as reduction in principal. Restructured loans have modified terms from the original contract thatgive the debtor a more manageable arrangement for meeting financial obligationsunder their current situation.  Amountsof impaired loans that are not probable of collection are charged offimmediately.

 

At September 30, 2010and December 31, 2009, all impaired loans with a related allowance havebeen evaluated based upon the fair value of the underlying collateral.  Impaired loans without a related allowancewere previously written down to the net realizable value of the collateral orthe collateral was sufficient to ensure no principal loss.  At September 30, 2010, the Company hadapproximately $61.9 million in impaired loans without a related allowance withthe Company having previously partially charged off approximately $6.4 millionto date to write down the loans to their net realizable value.  Impaired loans and related amounts includedin the allowance for loan losses at September 30, 2010 and December 31,2009 are as follows:

 
| ** **                               | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2010**               | ** ** | **2009**              | ** ** |
| ** **                               | ** ** | ** **             | ** ** | **Allowance**         | ** ** | ** ** | ** ** | **Allowance** | ** ** |
| ** **                               | ** ** | **Balance**            | ** ** | **Amount**            | ** ** | **Balance** | ** ** | **Amount** | ** ** |
| Impaired loans with related allowance    |       | $                      | 26,694,726 |                  | $          | 5,267,864 |   | $ | 3,261,723 |   | $ | 1,024,001 |   |
| Impaired loans without related allowance |       | 61,866,212             |       | —                |       | 112,031,829 |   | — |   |
|                                          |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

The Company had $16.0 million and $12.8 million in loans that would bedefined as a troubled debt restructuring (“TDR”) at September 30, 2010 andat December 31, 2009, respectively. Of those amounts, $13.5 million and $1.6 million were accruing as of September 30,2010 and December 31, 2009, respectively, as they were performing inaccordance with their restructured terms. At September 30, 2010, there were approximately

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

$2.0 million in TDR loans that had a related allowance of approximately$501 thousand.  At December 31,2009, there were no TDR loans that had a related allowance.

 

***(7) Allowancefor Loan Losses***

 

Activity in the allowance for loan losses for the three and nine monthsended September 30, 2010 and 2009 is as follows:

 
| ** **                                 | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|--------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                 | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| Beginning balance                          |       | $                                                        | 19,323,225 |                                                    | $          | 14,910,792 |   | $ | 21,478,748 |   | $ | 11,671,534 |   |
| Add:                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| Provision for possible loan losses         |       | 2,178,000                                                |       | 11,352,000                                              |       | 5,514,000 |   | 17,420,000 |   |
| Subtotal                                   |       | 21,501,225                                               |       | 26,262,792                                              |       | 26,992,748 |   | 29,091,534 |   |
| Less:                                      |       |                                                     |       |                                                    |       |   |   |   |   |
| Loans charged off                          |       | 3,089,252                                                |       | 11,797,795                                              |       | 8,810,288 |   | 14,708,798 |   |
| Recoveries on loans previously charged off |       | (240,911                                                 | )          | (137,757                                                | )          | (470,424 | ) | (220,018 | ) |
| Net loans charged off                      |       | 2,848,341                                                |       | 11,660,038                                              |       | 8,339,864 |   | 14,488,780 |   |
| Balance, end of period                     |       | $                                                        | 18,652,884 |                                                    | $          | 14,602,754 |   | $ | 18,652,884 |   | $ | 14,602,754 |   |

 

***(8) NonperformingAssets***

 

Nonperforming assetsconsist of non-accrual loans, accruing loans 90 days past due, repossessedassets and other real estate owned. The following summarizes non-performingassets:

 
| ** **                      | ** ** | **September 30.** | ** **  | **December 31,** | ** ** |
|---------------------------------|------------|------------------------|-------------|-----------------------|------------|
| ** **                      | ** ** | **2010**               | ** **  | **2009**              | ** ** |
| Accruing loans 90 days past due |       | $                      | —      |                  | $          | 644,920 |   |
| Non-accrual loans               |       | 88,560,938             |        | 115,293,553           |       |
| Repossessed assets              |       | 5,375                  |        | 1,000                 |       |
| Other real estate               |       | 61,612,054             |        | 21,066,480            |       |
| Total non-performing assets     |       | $                      | 150,178,367 |                  | $          | 137,005,953 |   |

 

Nonperformingassets increased $13.2 million, or 9.61%, from December 31, 2009 to September 30,2010.  Non-accrual loans decreasedapproximately $26.7 million from December 31, 2009 to September 30,2010, largely due to approximately $47.5 million moving to other real estateowned and other assets, $8.6 million in partial charge-offs on non-accrualloans and approximately $8.6 million in pay downs.  During the first nine months of 2010,approximately $38.0 million in loans were moved to non-accrual.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other real estateowned increased $40.5 million from December 31, 2009 to September 30,2010.  This increase is largely due tothe addition of $46.7 million in foreclosed properties and $839 thousand incapitalized improvements on several foreclosed properties being offset by thesale of $5.3 million in foreclosed properties resulting in a loss of $225thousand on these properties.  TheCompany has written down $1.5 million for several foreclosed properties basedupon updated appraisals.

 

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.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Asof September 30, 2010 and December 31, 2009, the Company’s other realestate owned consisted of the following:

 
| ** **                                           | ** ** | **As of September 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                           | ** ** | **Number of  Properties**                   | ** ** | **Carrying  Amount**                            | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| 1-4 Family residential properties                    |       | 25                                               |       | $                                               | 2,732,127  |   | 23 |   | $ | 2,958,213 |   |
| Multifamily residential properties                   |       | 4                                                |       | 13,719,694                                      |       | 2 |   | 238,225 |   |
| Nonfarm nonresidential properties                    |       | 18                                               |       | 13,513,773                                      |       | 13 |   | 8,994,372 |   |
| Farmland properties                                  |       | 3                                                |       | 1,252,104                                       |       | — |   | — |   |
| Construction & land development  properties |       | 52                                               |       | 30,394,356                                      |       | 35 |   | 8,875,670 |   |
| Total                                                |       | 102                                              |       | $                                               | 61,612,054 |   | 73 |   | $ | 21,066,480 |   |

 

Allproperties are being actively marketed for sale and management is continuouslymonitoring these properties in order to minimize any losses.

 

Otherreal estate owned is defined as real estate acquired through or in lieu offoreclosure.  At the time of foreclosure,an appraisal is obtained on the real estate. All other real estate owned properties are initially recorded at fairvalue, less estimated cost to sell.  Ifthe fair value less estimated costs to sell at the time of foreclosure is lessthan the loan balance, the deficiency is charged against the allowance for loanlosses.  An updated appraisal is orderedon each anniversary if the property is owned for more than one year.  If the fair value of the other real estateowned, less estimated costs to sell at the time of foreclosure, decreasesduring the holding period, the other real estate owned is written down with acharge to noninterest expense.  When theother real estate owned is sold, a gain or loss is recognized on the sale forthe difference between the sales proceeds and the carrying amount of the otherreal estate owned.

 

***(9)  Shareholders’Equity***

 

OnJune 11, 2010, the Company amended its Articles of Incorporation toincrease the total number of authorized shares of common stock from 10 millionshares to 110 million shares.  Theamendment to the Company’s Articles of Incorporation was approved by the boardof directors on March 18, 2010 and by shareholders of the Company at theAnnual Meeting of Shareholders on June 8, 2010, in accordance withO.C.G.A. 14-2-1003.

 

TheCompany granted 68,965 shares of restricted stock to Edward P. Loomis, Jr.,President of the Bank.  The stock will bevested in installments over a period of four years.  All shares of restricted stock will be heldby the Company until the conditions are satisfied.  All shares are nonvested as of September 30,2010.  Compensation expense totaling$12,500 was recognized as of September 30, 2010 in connection withrestricted stock.

 

***(10) ******FairValue Measurements and Disclosures***

 

Fairvalue measurements are determined based on the assumptions that marketparticipants would use in pricing the asset or liability.  As a basis for considering market participantassumptions in fair value measurements, generally accepted accountingprinciples establish a fair value hierarchy that distinguishes between marketparticipant assumptions based on market data obtained from sources independentof the reporting entity (observable inputs that are classified within Levels 1and 2 of the hierarchy) and the reporting entity’s own assumptions about marketparticipant assumptions (unobservable inputs classified within Level 3 of thehierarchy).

 

Fair Value Hierarchy

 

Level1 —Valuation is based upon quoted prices (unadjusted) in active markets foridentical assets or liabilities that the Company has the ability to access.

 

Level 2 — Valuation is based upon quoted prices for similar assets andliabilities in active markets, as well as inputs that are observable for theasset or liability (other than quoted prices), such as interest rates, foreignexchange rates, and yield curves that are observable at commonly quotedintervals.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Level 3 — Valuation is generated from model-based techniques that useat least one significant assumption based on unobservable inputs for the assetor liability, which are typically based on an entity’s own assumptions, asthere is little, if any, related market activity.  In instances where the determination of thefair value measurement is based on inputs from different levels of the fairvalue hierarchy, the level in the fair value hierarchy within which the entirefair value measurement falls is based on the lowest level input that issignificant to the fair value measurement in its entirety.  The Company’s assessment of the significanceof a particular input to the fair value measurement in its entirety requiresjudgment, and considers factors specific to the asset or liability.

 

Followingis a description of valuation methodologies used for assets and liabilitiesrecorded or disclosed at fair value:

 

***Cash and Cash Equivalents*****—**For disclosurepurposes for cash, due from banks, federal funds sold and interest-bearingdeposits with other banks, the carrying amount is a reasonable estimate of fairvalue.

 

***Securities Available for Sale*** - Securitiesavailable-for-sale consist of U.S. Treasury obligations, U.S. governmentsponsored enterprises, state and political subdivisions, corporate bonds,mortgage backed securities and equity securities.  They are recorded at fair value on a recurringbasis.  Where quoted market prices areavailable in an active market, securities are classified within Level 1 of thevaluation hierarchy.  If quoted pricesare not available, fair values are measured using independent pricing models orother model-based valuation techniques such as the present value of future cashflows, adjusted for the security’s credit rating, prepayment assumptions andother factors such as credit loss assumptions.

 

·                  U.S. Treasury obligations, U.S. governmentsponsored enterprises, corporate bonds, mortgage backed securities and equitysecurities are valued primarily using data from an independent third-partypricing service for similar securities in an active market as applicable.  Pricing from the independent third partyservice is generally based on quoted prices of similar instruments (includingmatrix pricing); these valuations are Level 2 measurements.

 

·                  State and political subdivisions aregenerally based on data from an independent third-party pricing service forsimilar securities.  Where suchcomparable data is not available, the Company develops valuations based onassumptions that are not readily observable in the market place; thesevaluations are Level 3 measurements.

 

***Federal Home Loan Bank Stock*** — Fordisclosure purposes, for Federal Home Loan Bank Stock, the carrying value is areasonable estimate of fair value.

 

***Loans Held for Sale*** -   For loans held for sale, the carrying valueis a reasonable estimate of fair value given the short-term nature of the loansand similarity to what secondary markets are currently offering for portfoliosof loans with similar characteristics. Therefore, the Company records the loans held for sale as nonrecurringLevel 2.

 

***Loans*** - The Company does notrecord loans at fair value on a recurring basis.  However, from time to time, a loan isconsidered impaired and an allowance for loan losses is established.  Loans for which it is probable that paymentof interest and principal will not be made in accordance with the contractualterms of the loan agreement are considered impaired.  Once a loan is identified as individuallyimpaired, management measures impairment based on the present value of expectedfuture cash flows discounted at the loan’s effective interest rate, except thatas a practical expedient, a creditor may measure impairment based on a loan’sobservable market price, or the fair value of the collateral if repayment ofthe loan is dependent upon the sale of the underlying collateral.  Those impaired loans not requiring anallowance represent loans for which the fair value of the expected repaymentsor collateral exceed the recorded investments in such loans.  At September 30, 2010 and December 31,2009, substantially all of the total impaired loans were evaluated based on thefair value of the collateral.  Impairedloans where an allowance is established based on the fair value of collateralrequire classification in the fair value hierarchy.  When the fair value of the collateral isbased on an observable market price or a current appraised value, the Companyrecords the impaired loan as nonrecurring Level 2.  When an appraised value is not available ormanagement determines the fair value of the collateral is further impairedbelow the appraised value and there is no observable market price, the Companyrecords the impaired loan as nonrecurring Level 3.

 

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** **

**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Fordisclosure purposes, the fair value of fixed rate loans which are notconsidered impaired is estimated by discounting the future cash flows using thecurrent rates at which similar loans would be made to borrowers with similarcredit ratings.  For unimpaired variablerate loans, the carrying amount is a reasonable estimate of fair value fordisclosure purposes.

 

***Cash Surrender Value of Life Insurance*** — Fordisclosure purposes, for cash surrender value of life insurance, the carryingvalue is a reasonable estimate of fair value.

 

***Other Real Estate Owned*** — Other realestate is adjusted to fair value upon transfer of the loans to other realestate.  Subsequently, other real estateis carried at the lower of carrying value or fair value.  Fair value is based upon independent marketprices, appraised values of the collateral or management’s estimation of thevalue of the collateral.  When the fairvalue of the collateral is based on an observable market price or a currentappraised value, the Company records the other real estate as nonrecurringLevel 2.  When an appraised value is notavailable or management determines the fair value of the collateral is furtherimpaired below the appraised value and there is no observable market prices,the Company records the other real estate as nonrecurring Level 3.

 

***Deposits*** — For disclosure purposes,the fair value of demand deposits, savings accounts and certain money marketdeposits is the amount payable on demand at the reporting date.  The fair value of fixed maturity timedeposits is estimated by discounting the future cash flows using the ratescurrently offered for deposits of similar remaining maturities.

 

***FHLB Advances*** — Fordisclosure purposes, the fair value of the Company’s fixed rate borrowings isestimated using discounted cash flows, based on the Company’s current incrementalborrowing rates for similar types of borrowing arrangements.  For variable rate borrowings, the carryingamount is a reasonable estimate of fair value.

 

***Subordinated Debentures*** — Fordisclosure purposes, for subordinated debentures, the carrying value is areasonable estimate of fair value.

 

***Junior Subordinated Debentures*** — Fordisclosure purposes, the fair value of the Company’s junior subordinateddebentures is estimated using quoted market prices.  If quoted market prices are not available,fair values are estimated using discounted future cash flow analyses based oncurrent interest rates, liquidity and credit spreads.

 

***Commitments to Extend Credit and Standby Letters ofCredit*** — Because commitments to extend credit and standbyletters of credit are generally short-term and at variable rates, the contractvalue and estimated fair value associated with these instruments areimmaterial.

 

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 at September 30, 2010 and December 31,2009.

 
| ** **                               | ** ** | **As of September 30,** | ** ** |
|------------------------------------------|------------|----------------------------------------|------------|
| ** **                               | ** ** | **2010**                               | ** ** |
| ** **                               | ** ** | **Total**                              | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                               | ** ** | ** **                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Debt securities available-for-sale       |       |                                   |       |   |   |   |   |   |   |
| U.S. Treasury obligations                |       | $                                      | —     |   | $ | — |   | $ | — |   | $ | — |   |
| U.S. government sponsored enterprises    |       | 5,104,088                              |       | — |   | 5,104,088 |   | — |   |
| State and political subdivisions         |       | 15,331,075                             |       | — |   | 15,331,075 |   | — |   |
| Other investments                        |       | 215,198                                |       | — |   | 215,198 |   | — |   |
| Mortgage backed securities               |       | 20,052,694                             |       | 2,520,312 |   | 17,532,382 |   | — |   |
| Total debt securities available-for-sale |       | 40,703,055                             |       | 2,520,312 |   | 38,182,743 |   | — |   |
| Equity securities available-for-sale     |       | 19,034                                 |       | — |   | 19,034 |   | — |   |
| Total available-for-sale securities      |       | $                                      | 40,722,089 |   | $ | 2,520,312 |   | $ | 38,201,777 |   | $ | — |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                               | ** ** | **As of December 31,** | ** **  |
|------------------------------------------|------------|---------------------------------------|-------------|
| ** **                               | ** ** | **2009**                              | ** **  |
| ** **                               | ** ** | **Total**                             | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                               |       |                                  |        |   |   |   |   |   |   |
| Debt securities available-for-sale       |       |                                  |        |   |   |   |   |   |   |
| U.S. Treasury obligations                |       | $                                     | 57,156,865  |   | $ | — |   | $ | 57,156,865 |   | $ | — |   |
| U.S. government sponsored enterprises    |       | 27,616,824                            |        | — |   | 27,616,824 |   | — |   |
| State and political subdivisions         |       | 15,155,835                            |        | — |   | 15,155,835 |   | — |   |
| Other investments                        |       | 259,208                               |        | — |   | 259,208 |   | — |   |
| Mortgage backed securities               |       | 26,711,441                            |        | — |   | 26,711,441 |   | — |   |
| Total debt securities available-for-sale |       | 126,900,173                           |        | — |   | 126,900,173 |   | — |   |
| Equity securities available-for-sale     |       | 39,428                                |        | — |   | 39,428 |   | — |   |
| Total available-for-sale securities      |       | $                                     | 126,939,601 |   | $ | — |   | $ | 126,939,601 |   | $ | — |   |

 

Duringthe third quarter of 2010, the Company changed its investment bondaccountants.  Therefore, the level ofmeasurement techniques to evaluate some of the securities available-for-salechanged to include at least one security in the Level 1 category while theother securities remain 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 at September 30, 2010 and December 31, 2009.

 
| ** **                     | ** ** | **As of September 30,** | ** **  |
|--------------------------------|------------|----------------------------------------|-------------|
| ** **                     | ** ** | **2010**                               | ** **  |
| ** **                     | ** ** | **Total**                              | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                           |       |                                   |        |   |   |   |   |   |   |
| Loans                          |       | $                                      | 84,819,793  |   | $ | — |   | $ | 84,819,793 |   | $ | — |   |
| Loans held for sale            |       | 285,026                                |        | — |   | 285,026 |   | — |   |
| Other real estate owned        |       | 61,612,054                             |        | — |   | 61,612,054 |   | — |   |
|                           |       |                                   |        |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                                      | 146,716,873 |   | $ | — |   | $ | 146,716,873 |   | $ | — |   |

 
| ** **                     | ** ** | **As of December 31,** | ** **  |
|--------------------------------|------------|---------------------------------------|-------------|
| ** **                     | ** ** | **2009**                              | ** **  |
| ** **                     | ** ** | **Total**                             | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                           |       |                                  |        |   |   |   |   |   |   |
| Loans                          |       | $                                     | 125,166,754 |   | $ | — |   | $ | 125,166,754 |   | $ | — |   |
| Loans held for sale            |       | 1,089,108                             |        | — |   | 1,089,108 |   | — |   |
| Other real estate owned        |       | 21,066,480                            |        | — |   | 21,066,480 |   | — |   |
|                           |       |                                  |        |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                                     | 147,322,342 |   | $ | — |   | $ | 147,322,342 |   | $ | — |   |

 

The carrying amount and estimated fair values ofthe Company’s assets and liabilities which are required to be either disclosedor recorded at fair value at September 30, 2010 and December 31, 2009are as follows:

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                             | ** ** | **September 30, 2010** | ** **  | **December 31, 2009** | ** ** |
|----------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| ** **                             | ** ** | **Carrying**                     | ** **  | **Estimated**                   | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amount**                       | ** **  | **Fair Value**             | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Assets:**                            |       |                             |        |                            |       |   |   |   |   |
| Cash and cash equivalents              |       | $                                | 104,811,263 |                            | $          | 104,811,263 |   | $ | 33,391,677 |   | $ | 33,391,677 |   |
| Securities available for sale          |       | 40,722,089                       |        | 40,722,089                      |       | 126,939,601 |   | 126,939,601 |   |
| Federal Home Loan Bank Stock           |       | 4,007,400                        |        | 4,007,400                       |       | 4,316,800 |   | 4,316,800 |   |
| Loans held for sale                    |       | 285,026                          |        | 285,026                         |       | 1,089,108 |   | 1,089,108 |   |
| Loans, net                             |       | 589,069,996                      |        | 589,111,059                     |       | 696,828,167 |   | 698,284,092 |   |
| Cash surrender value of life insurance |       | 13,409,122                       |        | 13,409,122                      |       | 13,011,018 |   | 13,011,018 |   |
| Other real estate owned                |       | 61,612,054                       |        | 61,612,054                      |       | 21,066,480 |   | 21,066,480 |   |
| **Liabilities:**                       |       |                             |        |                            |       |   |   |   |   |
| Deposits                               |       | 786,302,786                      |        | 791,303,628                     |       | 861,156,888 |   | 866,219,696 |   |
| FHLB borrowings                        |       | 29,000,000                       |        | 29,924,932                      |       | 39,000,000 |   | 39,984,264 |   |
| Subordinated debentures                |       | 1,400,000                        |        | 1,400,000                       |       | 1,400,000 |   | 1,400,000 |   |
| Junior subordinated debentures         |       | 10,310,000                       |        | 2,243,402                       |       | 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.

 

Fair value estimates are based on existing on- and off-balance sheetfinancial instruments without attempting to estimate the value of anticipatedfuture business and the fair value of assets and liabilities that are notrequired to be recorded or disclosed at fair value like the mortgage bankingoperation, brokerage network and premises and equipment.

 

***(11)RegulatoryMatters***

 

TheCompany and the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies.  Failure to meet minimalcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the consolidated financial statements.  Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,the Bank must meet specific capital guidelines that involve quantitativemeasures of assets, liabilities and certain off-balance sheet items ascalculated under regulatory accounting practices.  The Company’s and theBank’s capital amounts and classification are also subject to qualitativejudgments by the regulators about components, risk weightings and otherfactors.

 

Inaddition, quantitative measures established by regulations to ensure capitaladequacy require the Bank to maintain minimum amounts and ratios (set forthbelow in the table) of total and Tier I capital (as defined in the regulations)to risk-weighted assets (as defined in the regulations), and of Tier I capital(as defined in the regulations) to average assets (as defined in theregulations).  To comply with the Order, the Bank is required to have Tier1 capital in such an amount as to equal or exceed 8% of the Bank’s total assetsand total risk-based capital as to equal or exceed 10% of the Bank’srisk-weighted assets.  As of September 30,2010, the Bank’s ratio of total capital to risk-weighted assets and ratio ofTier 1 Capital to risk-weighted assets were 5.49% and 4.02%, respectively.  The Company and the Bank were considered “significantlyundercapitalized” by bank regulatory authorities as of September 30, 2010and “undercapitalized” as of December 31, 2009.  As a result, on March 26, 2010, the Bankreceived a Notification of Prompt Corrective Action from the FDIC and, inaccordance with Section 325.104 of the FDIC Rules and Regulations,the Bank was required, among other things, to file a written capitalrestoration plan with the FDIC.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

TheCompany’s and the Bank’s actual capital amounts and ratios as of September 30,2010 and December 31, 2009 follow:

 
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | **To Be Well Capitalized** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective**     | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions**                | ** ** |
| ** **                                         | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                                | ** ** | ** ** | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ***September 30, 2010***                      |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total  Risk-Based Capital To Risk Weighted Assets: |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 37,396,000 |                       | 5.55       | %                                         | $          | 53,904,144 |   | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 37,018,000 |       | 5.49                       | %          | 53,942,441                                |       | >  |   | 8.0 | % | $ | 67,428,051 |   | >  |   | 10.0 | % |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Tier  I Capital To Risk Weighted Assets:           |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 24,018,000 |                       | 3.56       | %                                         | $          | 26,986,517 |   | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 27,069,000 |       | 4.02                       | %          | 26,934,328                                |       | >  |   | 4.0 | % | $ | 40,401,493 |   | >  |   | 6.0 | % |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Tier  I Capital To Average Assets                  |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 24,018,000 |                       | 2.79       | %                                         | $          | 34,434,409 |   | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 27,069,000 |       | 3.14                       | %          | 34,482,803                                |       | >  |   | 4.0 | % | $ | 43,103,503 |   | >  |   | 5.0 | % |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| ***December 31, 2009***                       |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total  Risk-Based Capital To Risk Weighted Assets: |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 47,485,000 |                       | 6.28       | %                                         | $          | 60,490,446 |   | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 46,763,000 |       | 6.19                       | %          | 60,436,834                                |       | >  |   | 8.0 | % | $ | 75,546,042 |   | >  |   | 10.0 | % |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Tier  I Capital To Risk Weighted Assets:           |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 36,490,000 |                       | 4.83       | %                                         | $          | 30,219,462 |   | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 35,771,000 |       | 4.73                       | %          | 30,250,317                                |       | >  |   | 4.0 | % | $ | 45,375,476 |   | >  |   | 6.0 | % |
|                                               |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Tier  I Capital To Average Assets                  |       |       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 36,490,000 |                       | 3.44       | %                                         | $          | 42,430,233 |   | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 35,771,000 |       | 3.37                       | %          | 42,458,160                                |       | >  |   | 4.0 | % | $ | 53,072,700 |   | >  |   | 5.0 | % |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

***(12)AccountingStandards Updates***

 

InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-01,*Accounting for Distributions to Shareholders withComponents of Stock and Cash* (“ASU No. 2010-01”).  ASU No. 2010-01 provides guidance on theaccounting for distributions offering shareholders the choice of receiving cashor stock.  Under such guidance, the stockportion of the distribution is not considered to be a stock dividend, and forpurposes of calculating earnings per share it is deemed a new share issuancenot requiring retroactive restatement. This guidance is effective for the first reporting period, includinginterim periods, ending after December 15, 2009.  It is not expected to have a material impacton the Company’s results of operations, financial position or disclosures.

 

InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-04,*Technical Corrections to SEC Paragraphs*(“ASU No. 2010-04”).  It is notexpected to have an impact on the Company.

 

InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-06, *Improving Disclosures about Fair Value Measurements* (“ASU No. 2010-06”).  ASU No. 2010-06 amends FASB ASC Topic820-10-50, *Fair Value Measurements and Disclosures*,to require additional information to be disclosed principally regarding Level 3measurements and transfers to and from Level 1 and 2.  In addition, enhanced disclosure is requiredconcerning inputs and valuation techniques used to determine Level 2 and Level3 measurements.  This guidance isgenerally effective for interim and annual reporting periods beginning after December 15,2009; however, requirements to disclose separately purchases, sales, issuances,and settlements in the Level 3 reconciliation are effective for fiscal yearsbeginning after December 15, 2010 (and for interim periods within suchyears).  ASU No. 2010-06 is notexpected to have a material impact on the Company’s results of operations orfinancial position, and will have a minimal impact on its disclosures.

 

InFebruary 2010, the FASB issued Accounting Standards Update No. 2010-09,*Amendments to Certain Recognition and DisclosureRequirements* (“ASU No. 2010-09”).  ASU No. 2010-09 amends FASB ASC Subtopic855-10, *Subsequent Events*, to remove therequirement for an SEC filer to disclose the date through which subsequentevents have been evaluated in both issued and revised financialstatements.  This change alleviatespotential conflicts between ASC Subtopic 855-10 and the SEC’srequirements.  ASU No. 2010-09 isnot expected to have a material impact on the Company.

 

InApril 2010, the FASB issued Accounting Standards Update No. 2010-18, *Effect of a Loan Modification When the Loan Is Part of a Pool ThatIs Accounted for as a Single Asset* (“ASU No. 2010-18”).  ASU No. 2010-18 provides guidance on theaccounting for loan modifications when the loan is part of a pool of loansaccounted for as a single asset such as acquired loans that have evidence ofcredit deterioration upon acquisition that are accounted for under the guidancein ASC 310-30.  ASU No. 2010-18 addressesdiversity in practice on whether a loan that is part of a pool of loansaccounted for as a single asset should be removed from that pool upon amodification that would constitute a troubled debt restructuring or remain inthe pool after modification.  ASU No. 2010-18clarifies that modifications of loans that are accounted for within a poolunder ASC 310-30 do not result in the removal of those loans from the pool evenif the modification of those loans would otherwise be considered a troubleddebt restructuring.  An entity willcontinue to be required to consider whether the pool of assets in which theloan is included is impaired if the expected cash flows for the poolchange.  The amendments in this update donot require any additional disclosures and are effective for modifications ofloans accounted for within pools under ASC 310-30 occurring in the firstinterim or annual period ending on or after July 15, 2010.  ASU 2010-18 is not expected to have amaterial impact on the Company’s results of operations, financial position ordisclosures.

 

InJuly 2010, the FASB issued Accounting Standards Update No. 2010-20, *Disclosures about the Credit Quality of Financing Receivables and theAllowance for Credit Losses*(“ASU No. 2010-20”).  ASU No. 2010-20 requires disclosuresregarding loans and the allowance for loan losses that are disaggregated byportfolio segment and class of financing receivable.  Existing disclosures were amended to requirea rollforward of the allowance for loan losses by portfolio segment, with theending balance broken out by basis of impairment method, as well as therecorded investment in the respective loans. Nonaccrual and impaired loans by class must also be shown.  ASU No. 2010-20 also requiresdisclosures regarding: 1) credit quality indicators by class, 2) aging of pastdue loans by class, 3) troubled debt restructuring (“TDRs”) by class and theireffect on the allowance for loan losses, 4) defaults on TDRs by class and theireffect on the allowance for loan losses, and 5) significant purchases and salesof loans disaggregated by portfolio segment. This guidance is effective for interim and annual reporting periodsending on or after December 15, 2010, for end of period typedisclosures.  Activity relateddisclosures are effective for interim and annual reporting periods beginning onor after December 15, 2010.  ASU No. 2010-20will have an impact on the Company’s disclosures, but not its financialposition or results of operations.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item 2.Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

**For Each of the ThreeMonths and Nine Months in the Period Ended**

**September 30, 2010and 2009**

 

The following discussion of financial condition asof September 30, 2010compared to December 31, 2009,and the results of operations for the three months and nine months ended September 30, 2010 compared to the three monthsand nine months ended September 30, 2009 should be read in conjunctionwith the condensed financial statements and accompanying footnotes appearing inthis report.

 

**Advisory Note RegardingForward-Looking Statements**

 

Thestatements contained in this report on Form 10-Q that are not historicalfacts are forward-looking statements subject to the safe harbor created by thePrivate 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.

 

Factorswhich could cause actual results to differ from expectations include, amongother things:

 

·                  Deterioration in thecondition of borrowers resulting in significant increase in loan losses andprovisions for those losses;

·                  the potential that loancharge-offs may exceed the allowance for loan losses or that such allowancewill be increased as a result of factors beyond our control or the failure ofassumptions underlying the establishment of reserves for possible loan losses;

·                  changes in loanunderwriting, credit review or loss reserve policies associated with economicconditions, examination conclusions, or regulatory developments;

·                  our dependence on seniormanagement;

·                  competition from existingfinancial institutions, including commercial banks, thrifts, mortgage bankingfirms, consumer finance companies, credit unions, securities brokerage firms,insurance companies, money market and other mutual funds, operating in ourmarket areas and elsewhere, including institutions operating regionally,nationally and internationally, together with such competitors offering bankingproducts and services by mail, telephone and the Internet;

·                  changes in political andeconomic conditions, including the political and economic effects of thecurrent economic downturn and other major developments, including the ongoingwar on terrorism and potential adverse conditions in the stock market, the publicdebt market, and other capital markets (including changes in interest rateconditions);

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

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

·                  risks inherent in making loansincluding repayment risks and value of collateral;

·                  the strength of the UnitedStates economy in general and the strength of the local economies in which weconduct operations may be different than expected resulting in, among otherthings, a deterioration in credit quality or a reduced demand for credit,including the resultant effect on our loan portfolio and allowance for loanlosses;

·                  changes in financial marketconditions, either internationally, nationally or locally in areas in which theCompany conducts its operations, including, without limitation, reduced ratesof business formation and growth, commercial and residential real estatedevelopment, and fluctuations in consumer spending and saving habits;

·                  the demand for our productsand services;

·                  technological changes;

·                  the challenges anduncertainties in the implementation of our expansion and developmentstrategies;

·                  the ability to increasemarket share;

·                  the adequacy of expenseprojections and estimates of impairment loss;

·                  the impact of changes inaccounting policies by the Securities and Exchange Commission;

·                  unanticipated regulatory orjudicial proceedings;

 

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·                  future legislation affectingfinancial institutions and changes to governmental monetary and fiscal policies(including without limitation laws concerning taxes, banking, securities, andinsurance);

·                  the effects of, and changesin, trade, monetary and fiscal policies and laws, including interest ratepolicies of the Board of Governors of the Federal Reserve System;

·                  the timely development andacceptance of products and services, including products and services offeredthrough alternative delivery channels such as the Internet;

·                  other factors described inthis report and in other reports we have filed with the Securities and ExchangeCommission; and

·                  Our success at managing therisks involved in the foregoing.

 

Forward-looking statements speak only as of the dateon which they are made.  We undertake noobligation to update any forward-looking statement to reflect events orcircumstances after the date on which the statement is made to reflect theoccurrence of unanticipated events.

 

**Executive Summary and Recent Developments**

 

The Company’s total assetsat September 30, 2010, were approximately $852.6 million, whichrepresented a decrease of approximately $95.8 million, or 10.10%, from December 31,2009.  A net loss of $9.3 million, $2.22per diluted share, was recorded for the nine months ended September 30,2010 compared to a net loss of $31.3 million, or $7.44 per diluted share, forthe nine months ended September 30, 2009.

 

OnSeptember 11, 2009, the Bank consented to the issuance of an Order toCease and Desist by the FDIC and the GDBF. Under the terms of the Order, the Bank cannot declare dividends withoutthe prior written approval of the FDIC and the GDBF.  Other material provisions of the Orderrequire the Bank to: (i) strengthen its board of directors’ oversight ofmanagement and operations of the Bank, (ii) establish a committeeconsisting of at least four members, three of which must be independent, tooversee the Bank’s compliance with the Order, (iii) maintain specified liquidityratios, (iv) improve the Bank’s lending and collection policies andprocedures, particularly with respect to the origination and monitoring ofcommercial real estate and acquisition, development and construction loans, (v) eliminatefrom its books, by charge off or collection, all assets classified as “loss”and 50% of all assets classified as doubtful, (vi) perform risksegmentation analysis with respect to concentrations of credit, (vii) receivea brokered deposit waiver from the FDIC prior to accepting, rolling over orrenewing any brokered deposits and submit a written plan for eliminating itsreliance on brokered deposits, (viii) adopt and implement a policylimiting the use of loan interest reserves, (ix) formulate and fullyimplement a written plan and comprehensive budget for all categories of incomeand expense, and (x) prepare and submit progress reports to the FDIC andthe GDBF.  In addition, pursuant to theOrder, the Bank is required to maintain Tier 1 capital equal to at least 8% ofthe Bank’s total assets and total risk-based capital equal to at least 10% ofthe Bank’s risk-weighted assets.  TheFDIC order will remain in effect until modified or terminated by the FDIC andthe GDBF.

 

OnMarch 26, 2010, the Company entered into a written agreement with theFederal Reserve Board and the GDBF, pursuant to which the Company will beprohibited from declaring or paying dividends without prior written consentfrom the regulators.  In addition,pursuant to the Agreement, without the prior written consent of regulators, theCompany is prohibited from taking dividends, or any other form of paymentrepresenting a reduction of capital, from the Bank; paying interest, principalor other sums on subordinated debentures and trust preferred securities; incurring,increasing or guaranteeing any debt; redeeming any shares of the Company’scommon stock; and increasing salaries or bonuses paid to executiveofficers.  All salaries, bonuses andfees, excluding the reimbursement of expenses valued at less than $500 in theaggregate per month per executive officer, must be preapproved by the Board ofDirectors on a regular basis.  Inappointing any new director or any executive officer, the Company is requiredto notify regulatory authorities and comply with restrictions onindemnification and severance.  TheCompany will also provide quarterly written progress reports to the FederalReserve Board.

 

Asrequired by the Agreement, the Company provided the Federal Reserve Board witha written plan designed to maintain sufficient capital at the Company, on aconsolidated basis, and at the Bank. Although the Agreement did not contain specific target capital ratios orspecific timelines the plan addressed the Company’s current and future 

 

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capitalrequirements, the Bank’s current and future capital requirements, the adequacyof the Bank’s capital taking into account its risk profile, and the source andtiming of additional funds necessary to fulfill the Company’s and the Bank’sfuture capital requirements, as required by the Agreement.

 

OnMarch 26, 2010, the Bank received Notification of Prompt Corrective Action(the “Notice”), which, pursuant to Section 325.102 of the FDIC Rules andRegulations, requires the Bank to submit a capital restoration plan within 45days of receipt of the Notice.  Becausethe Bank is currently classified as “significantly undercapitalized”, inaddition to the requirements in the Order, the Bank is required to adhere tothe following restrictions, pursuant to which regulators may

 

·                  Require sale ofsecurities, or, if grounds for conservatorship or receivership exist, directthe Bank to merge or be acquired;

·                  Restrictaffiliate transactions;

·                  Restrict orprohibit all activities that are determined to pose an excessive risk to the Bank;

·                  Require theinstitution to elect new directors, dismiss directors or senior executiveofficers, or employ senior executive officers to improve management;

·                  Prohibit theacceptance of deposits from correspondent banks;

·                  Require holdingcompany divestiture of the financial institution, bank divestiture ofsubsidiaries and/or holding company divestiture of other affiliates; or

·                  Require thebank to take any other action the federal regulator determines will “betterachieve” prompt correction action.

 

Inaddition, without prior regulatory approval, the Bank is required to restrictthe compensation paid to its senior executive officers.

 

OnFebruary 17, 2010, Michael C. Griffin submitted his resignation as adirector of the Company and of the Bank, effective immediately.  On April 14, 2010, Raymond O. Ballard, Jr.and J. Russell Lipford, Jr. submitted their resignations as a director ofthe Company and of the Bank effectively immediately.  Messrs. Griffin, Ballard and Lipfordhave advised the Company that their resignations were not due to anydisagreement with the Company.

 

OnApril 30, 2010, Gary P. Hall retired as Executive Vice President and ChiefCredit Officer of the Company and of the Bank. He has agreed to continue to serve the Company and the Bank in aconsulting capacity.  Mr. Hall hasadvised the Company that his retirement was not due to any disagreement withthe Company.

 

OnJune 11, 2010, the Company amended its Articles of Incorporation toincrease the total number of shares of authorized common stock from 10 millionshares to 110 million shares.  Theamendment to the Company’s Articles of Incorporation was approved by the boardof directors on March 18, 2010 and by shareholders of the Company at theAnnual Meeting of Shareholders on June 8, 2010.

 

OnJune 17, 2010, the Company appointed J. Randall Griffin as Senior VicePresident and Chief Credit Officer of the Bank. The FDIC approved Mr. Griffin’s appointment on May 21,2010.  In his role as Chief CreditOfficer, he will maintain and develop all lending operations, manage theSpecial Assets Division and credit function and develop loan policies andprocedures to ensure the overall quality of the Bank’s lending portfolio.

 

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**FinancialCondition**

 

Thecomposition of assets and liabilities for the Company is as follows:

 
| ** **                             | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** | ** **        | ** ** | ** **        | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|-------------------|------------|-------------------|------------|
| ** **                             | ** ** | **2010**                             | ** ** | **2009**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** | ** **            | ** ** |
| **Assets:**                            |       |                                 |       |                  |       |              |       |              |       |
| Total cash and cash equivalents        |       | $                                    | 104,811    |                  | $          | 33,392            |       | $                 | 71,420     |   | 213.88 | % |
| Securities available for sale          |       | 40,722                               |       | 126,940               |       | (86,218           | )          | -67.92            | %          |
| Loans, net of unearned income          |       | 607,723                              |       | 718,307               |       | (110,584          | )          | -15.40            | %          |
| Cash surrender value of life insurance |       | 13,409                               |       | 13,011                |       | 398               |       | 3.06              | %          |
| Intangible assets, net of amortization |       | 2,277                                |       | 2,549                 |       | (272              | )          | -10.67            | %          |
| Other real estate owned                |       | 61,612                               |       | 21,066                |       | 40,546            |       | 192.47            | %          |
| Total assets                           |       | 852,581                              |       | 948,380               |       | (95,799           | )          | -10.10            | %          |
| **Liabilities:**                       |       |                                 |       |                  |       |              |       |              |       |
| Deposits                               |       | 786,303                              |       | 861,157               |       | (74,854           | )          | -8.69             | %          |
| FHLB advances                          |       | 29,000                               |       | 39,000                |       | (10,000           | )          | -25.64            | %          |
| Subordinated debentures                |       | 1,400                                |       | 1,400                 |       | —            |       | —            |       |
| Junior subordinated debentures         |       | 10,310                               |       | 10,310                |       | —            |       | —            |       |
| Accrued expenses and other liabilities |       | 1,941                                |       | 1,896                 |       | 45                |       | 2.37              | %          |
| Total liabilities                      |       | 832,421                              |       | 918,741               |       | (86,320           | )          | -9.40             | %          |
|                                   |       |                                 |       |                  |       |              |       |              |       |
| Loan to Deposit Ratio                  |       | 77.29                                | %          | 83.41                 | %          |              |       |              |       |
|                                        |            |                                      |            |                       |            |                   |            |                   |            |  |  |  |

 

Significantchanges in the composition of assets include the increase in total cash andcash equivalents of $71.4 million which was primarily due to the sales,maturities, calls and paydowns of securities of $93.7 million and to thepayoffs of loans from customers of approximately $56.2 million.  The increase in total cash and cashequivalents was reduced by the payout of $74.9 million of deposits, mostlymaturing wholesale time deposits, and by the $10.0 million pay off of maturingFederal Home Loan Bank advances.  TheCompany invested approximately $7.5 million in securities as of September 30,2010.

 

Othersignificant changes in the composition of assets were the decrease in loansfollowed by the increase in other real estate owned during the first ninemonths of 2010.  The Company hadapproximately $8.8 million in loans charged off during the first nine months of2010 along with approximately $47.5 million moving to other real estate ownedand to other assets.

 

Themost significant change in the composition of liabilities was the decrease indeposits, which decreased approximately $74.8 million.  Savings accounts and non-interest bearingdeposits had an increase of approximately $4.2 million while money market andNOW accounts and time deposits decreased $79.0 million.  Time deposits, including wholesale and coredeposits, are our principal source of funds for loans and investing insecurities.  Local retail time depositsat September 30, 2010, increased approximately $17.4 million since December 31,2009 due to management’s efforts to increase core deposits and to continuereducing the Bank’s reliance on brokered deposits.  The Company was able to decrease brokereddeposits at September 30, 2010 by approximately $71.1 million compared to December 31,2009 primarily due to its ability to replace them with retail deposits obtainedboth locally and through a national rate-listing service.

 

Dueto our strong loan demand in the past, we chose to obtain a portion of ourdeposits from outside of our market.  The deposits obtained outside of ourmarket area generally have lower rates than rates being offered forcertificates of deposits in our local market. We have also utilized out-of-market deposits in certain instances toobtain longer term deposits than are readily available in our localmarket.  Our brokered time depositsrepresented 21.00% of our deposits as of September 30, 2010 when comparedto 27.43% of our deposits as of December 31, 2009.

 

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Inthe past, the Bank has relied heavily on brokered deposits.  Pursuant to the Order and FDIC regulations,as a result of our significantly-undercapitalized status, we are unable toaccept, renew or roll over brokered deposits absent a waiver from the FDIC.  Accordingly, management has instituted anaggressive retail deposit marketing campaign both locally and through anational rate-listing service to replace the brokered deposits as they mature.

 

**InvestmentSecurities**

 

Securitiesin our portfolio totaled $40.7 million at September 30, 2010, compared to$126.9 million at December 31, 2009. The decrease in the securities portfolio has resulted from the sales ofapproximately $11.3 million in U.S. government sponsored enterprises andmortgage-backed securities, the calls of approximately $18.6 million in U.S.government sponsored enterprises and state, county and municipal bonds, thematurity of $57.0 million in U.S. Treasury securities and the paydowns ofapproximately $6.7 million in mortgage-backed securities.  The Company purchased approximately $7.5 millionin mortgage-backed securities during the first nine months of 2010.  At September 30, 2010, the securitiesportfolio had unrealized net gains of approximately $637 thousand.

 

Thefollowing table shows the carrying value of the investment securities at September 30,2010 and December 31, 2009.

 
| ** **                             | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2010**                             | ** ** | **2009**              | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
| Securities available for sale:         |       |                                 |       |                  |       |
| U. S. Treasury Securities              |       | $                                    | —     |                  | $          | 57,157 |   |
| U. S. Government Sponsored Enterprises |       | 5,104                                |       | 27,617                |       |
| State and political subdivisions       |       | 15,331                               |       | 15,156                |       |
| Mortgage-backed Securities             |       | 20,053                               |       | 26,711                |       |
| Other Investments                      |       | 234                                  |       | 299                   |       |
| Total                                  |       | $                                    | 40,722     |                  | $          | 126,940 |   |

 

The following tablesummarizes securities disposal activities for the three and nine month periodsended September 30, 2010 and 2009:

 
| ** **               | ** ** | **Three Months Ended**     | ** ** | **Nine Months Ended**      | ** ** |
|--------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **               | ** ** | **September 30,**               | ** ** | **September 30,**               | ** ** |
| ** **               | ** ** | **2010**                             | ** ** | **2009**                             | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **               | ** ** | **(Dollars in Thousands)** | ** ** | **(Dollars in Thousands)** | ** ** |
| Proceeds from sales      |       | $                                    | 11,347     |                                 | $          | — |   | $ | 11,347 |   | $ | 51,612 |   |
| Proceeds from calls      |       | 2,545                                |       | 5,040                                |       | 18,635 |   | 5,220 |   |
| Proceeds from maturities |       | 20,500                               |       | 27,347                               |       | 57,000 |   | 56,080 |   |
| Paydowns                 |       | 2,208                                |       | 1,329                                |       | 6,734 |   | 9,568 |   |
| Total                    |       | $                                    | 36,600     |                                 | $          | 33,716 |   | $ | 93,716 |   | $ | 122,480 |   |
|                     |       |                                 |       |                                 |       |   |   |   |   |
| Gross gains              |       | $                                    | 557        |                                 | $          | 16 |   | $ | 600 |   | $ | 1,400 |   |
| Gross losses             |       | (1                                   | )          | (1                                   | )          | (1 | ) | (11 | ) |
| Impairment losses        |       | —                               |       | —                               |       | — |   | (58 | ) |
| Net gains of securities  |       | $                                    | 556        |                                 | $          | 15 |   | $ | 599 |   | $ | 1,331 |   |
|                     |       |                                 |       |                                 |       |   |   |   |   |
| Income tax expense       |       | $                                    | —     |                                 | $          | 5 |   | $ | — |   | $ | 472 |   |

 

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**Loans**

 

Totalloans, net of unearned income decreased approximately $110.6 million, or15.40%, at September 30, 2010, from December 31, 2009 as managementhas made an effort to limit loan growth in order to preserve capital for theCompany.  Also, total loans havedecreased due to approximately $8.8 million in loans being charged off andapproximately $47.5 million in loans being transferred to other real estateowned and other assets during the first nine months of 2010.  Management is limiting credit availabilityespecially for commercial real estate and acquisition, development andconstruction loans and pursuing collection efforts aggressively in an effort toreduce the Bank’s exposure to commercial real estate and acquisition,development and construction, pursuant to the Order.  The following table presents a summary of theloan portfolio by category.

 
| ** **                                        | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2010**                             | ** ** | **2009**              | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)** | ** ** |
|                                              |       |                                 |       |                  |       |
| Commercial                                        |       | $                                    | 44,788     |                  | $          | 51,674 |   |
| Real estate - commercial                          |       | 273,746                              |       | 304,468               |       |
| Real estate - construction                        |       | 190,463                              |       | 263,271               |       |
| Real estate - mortgage                            |       | 93,155                               |       | 92,013                |       |
| Obligations of political subdivisions in the U.S. |       | 205                                  |       | 295                   |       |
| Consumer                                          |       | 5,488                                |       | 6,838                 |       |
| Total Loans                                       |       | 607,845                              |       | 718,559               |       |
| Less:                                             |       |                                 |       |                  |       |
| Unearned loan fees                                |       | (122                                 | )          | (252                  | )          |
| Allowance for loan losses                         |       | (18,653                              | )          | (21,479               | )          |
| Loans, net                                        |       | $                                    | 589,070    |                  | $          | 696,828 |   |

 

AtSeptember 30, 2010, the Company had seventeen loans with outstandingbalances totaling $56.3 million with loan-funded interest reserves.  The amount of capitalized interest frominterest reserves for 2010 was $917 thousand.

 

Pursuantto the Order, the Bank adopted and implemented a policy limiting the use ofloan interest reserves.  This policyconfines the use of interest reserves to properly underwritten construction anddevelopment loans for which development or building plans have specifictimetables that commence within a reasonable time of the loan’s approval andthat include realistic timetables.

 

Withrespect to accounting for interest reserves on loans, interest that has beenadded to the balance of a loan through the use of an interest reserve shouldnot be recognized as income if its collectability is not reasonably assured.  The accrual of uncollected interest and itscapitalization into the loan balance will not be appropriate when the loanbecomes troubled and the full collection of contractual principal and interestis no longer expected.

 

Whenit is determined that the collectability of a loan with an interest reservecomponent is not reasonably assured, the loan is placed on non-accruing statusand any unpaid accrued interest is reversed.

 

Thedecision to establish a loan funded interest reserve upon origination of anacquisition, development or construction loan is determined based on thefeasibility of the project, the creditworthiness of the borrower andguarantors, and the protection provided by the real estate and othercollateral.  The total cost of theproject, including the interest reserve, is considered when determining theequity injection required from the borrower.

 

Interestreserves are required on all construction and development loans unless it isclearly established that the borrower has the capacity to pay the interestduring the initial stages of the development from alternative resources on theproposed contractual basis of payment. The reserve is included in the construction budget.  Interest is collected from the interestreserve on a monthly basis.  The interestis capitalized and added to the loan balance.

 

Norestructured loans include an interest reserve component.

 

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**Asset Quality**

 

At September 30, 2010, gross loans were 71.3%of total assets.  Management considersasset quality to be of primary importance. Management has a credit administration and loan review process, whichmonitors, controls and measures our credit risk, standardized credit analysesand our comprehensive credit policy.  Ourlevel of nonperforming assets has remained at a high level since 2009 as aresult of a slowing economy and the devaluation of real estate.  Our non-performing assets have continued toincrease since the beginning of the economic downturn in 2007, when managementbegan to aggressively recognize impaired loans based on an ongoing process ofidentifying early signs of stress in our loan portfolio.  Any significant events that may occursubsequent to any financial statement date are reviewed by management todetermine if any impact is material to the financial statements.  If the event is deemed to be material, thefinancial statements are adjusted to reflect the impact of the event.

 

Thefollowing table presents a summary of changes in the allowance for loan lossesfor the three and nine month periods ended September 30, 2010 and 2009.

 

**Analysis of Changes in Allowance for Loan Losses**

 
| ** **                                        | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                        | ** ** | **2010**                                                 | ** ** | **2009**                                                | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)**                     | ** ** |
|                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Balance beginning of period                       |       | $                                                        | 19,323     |                                                    | $          | 14,911 |   | $ | 21,479 |   | $ | 11,672 |   |
| Loans charged-off                                 |       | (3,089                                                   | )          | (11,798                                                 | )          | (8,810 | ) | (14,709 | ) |
| Recoveries                                        |       | 241                                                      |       | 138                                                     |       | 470 |   | 220 |   |
| Net charge-offs                                   |       | (2,848                                                   | )          | (11,660                                                 | )          | (8,340 | ) | (14,489 | ) |
| Provision for loan losses                         |       | 2,178                                                    |       | 11,352                                                  |       | 5,514 |   | 17,420 |   |
| Balance end of period                             |       | $                                                        | 18,653     |                                                    | $          | 14,603 |   | $ | 18,653 |   | $ | 14,603 |   |
|                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| Total Loans:                                      |       |                                                     |       |                                                    |       |   |   |   |   |
| At period end                                     |       | $                                                        | 607,723    |                                                    | $          | 760,500 |   | $ | 607,723 |   | $ | 760,500 |   |
| Average                                           |       | 640,979                                                  |       | 782,622                                                 |       | 678,932 |   | 789,869 |   |
|                                              |       |                                                     |       |                                                    |       |   |   |   |   |
| As a percentage of average loans (annualized):    |       |                                                     |       |                                                    |       |   |   |   |   |
| Net charge-offs                                   |       | 1.78                                                     | %          | 5.91                                                    | %          | 1.64 | % | 2.45 | % |
| Provision for loan losses                         |       | 1.36                                                     | %          | 5.80                                                    | %          | 1.08 | % | 2.95 | % |
| Allowance as a percentage of period end loans     |       | 3.07                                                     | %          | 1.92                                                    | %          | 3.07 | % | 1.92 | % |
| Allowance as a percentage of non-performing loans |       | 21.06                                                    | %          | 20.89                                                   | %          | 21.06 | % | 20.89 | % |

 

The loan portfolio is reviewed periodically toevaluate outstanding loans and to measure the performance of the portfolio andthe adequacy of the allowance for loan losses. Management believes that the allowance for loan losses at September 30,2010 is adequate to absorb losses inherent in the loan portfolio.  This analysis includes a review ofdelinquency trends, actual losses, and internal credit ratings.  Management’s judgment as to the adequacy ofthe allowance is based upon a number of assumptions about future events whichit believes to be reasonable.  Theallowance for loan losses is maintained at a level which, in management’sjudgment, is adequate to absorb credit losses inherent in the loanportfolio.  The amount of the allowanceis based on management’s evaluation of the collectability of the loanportfolio, including the nature of the portfolio, credit concentrations, trendsin historical loss experience, specific impaired loans, economic conditions andother risks inherent in the portfolio. Allowances for impaired loans are generally determined based oncollateral values or the present value of estimated cash flows.  While management uses available informationto recognize losses on loans, reductions in the carrying amounts of loans maybe necessary based on changes in local economic conditions.  In addition, regulatory agencies, as anintegral part of their examination process, periodically review the estimatedlosses on loans.  Such agencies mayrequire us to recognize losses based on their judgments about informationavailable to them at the time of their 

 

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examination. Because of these factors, it is reasonably possible that the estimatedlosses on loans may change materially in the near term.  However, the amount of the change cannot beestimated.

 

Theallowance is composed of general allocations and specific allocations.  General allocations are determined byapplying loss percentages to the portfolio that are based on historical lossexperience and management’s evaluation and “risk grading” of the commercialloan portfolio.  Additionally, thegeneral economic and business conditions affecting key lending areas, creditquality trends, collateral values, loan volumes and concentrations, seasoningof the loan portfolio, the findings of internal credit reviews and results fromexternal bank regulatory examinations are included in this evaluation.  The need for specific allocations is evaluatedon commercial loans that are classified in the Watch, Substandard or Doubtfulrisk grades, when necessary.  Thespecific allocations are determined on a loan-by-loan basis based on management’sevaluation of the Company’s exposure for each credit, given the current paymentstatus of the loan and the value of any underlying collateral.  Loans for which specific allocations areprovided are excluded from the calculation of general allocations.

 

Managementprepares a monthly analysis of the allowance for loan losses and materialdeficiencies are adjusted by increasing the provision for loan losses.  Management uses an outsourced independentloan review company on a quarterly basis to corroborate and challenge theinternal loan grading system and provide additional analysis in determining theadequacy of the allowance for loan losses. Management rotates the loan review company on a periodic basis to ensureobjectivity in the loan review process. In addition, an internal loan review process is conducted by a committeecomprised of members of senior management. All new loans are risk rated under loan policy guidelines.  The internal loan review committee meetsquarterly to evaluate the composite risk ratings.  Risk ratings may be changed if it appears thatnew loans were not assigned the proper initial grade, or, if on existing loans,credit conditions have improved or worsened.

 

A loan is considered impaired when, based oncurrent information and events, it is probable that a creditor will be unableto collect the scheduled payments of principal or interest when due accordingto the contractual terms of the loan agreement. Factors considered by management in determining impairment includepayment status, collateral value and the probability of collecting scheduledprincipal and interest payments when due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines the significance ofpayment delays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and the borrower,including the length of the delay, the reasons for the delay, the borrower’sprior payment history and the amount of the shortfall in relation to theprincipal and interest owed.  Impairmentis measured on a loan-by-loan basis by either the present value of expectedfuture cash flows discounted at the loan’s effective interest rate, the loan’sobtainable market price, or the fair value of the collateral if the loan iscollateral dependent.

 

Large groups of smaller balance homogenous loansare collectively evaluated for impairment. Accordingly, we do not separately identify individual consumer loans forimpairment disclosures.

 

The Company’s allowance as a percentage ofnonperforming loans has increased when comparing the three months and ninemonths ended September 30, 2010 to the three months and nine months ended September 30,2009.  While the nonperforming loans haveincreased when comparing the three months and nine months ended September 30,2010 to the same period in the prior year, the Company has been able tomaintain a higher allowance for loan loss and have been able to have fewerpartial charge-offs on the nonperforming loans. The Company recorded most of the nonperforming loans at the fair valueof the underlying collateral, which significantly increased charge-offs during2009 followed by an increase to the provision for loan losses, based uponmanagement’s analysis of the allowance for loan losses.  When comparing the Company’s allowance as apercentage of nonperforming loans from December 31, 2009 to September 30,2010, the percentage increased from 18.53% at December 31, 2009 to 21.06%at September 30, 2010 due to a decrease in nonperforming loans at September 30,2010.

 

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

 
| ** **                      | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**                             | ** ** | **2009**              | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Accruing loans 90 days past due |       | $                                    | —     |                  | $          | 645 |   |
| Non-accrual loans               |       | 88,561                               |       | 115,294               |       |
| Repossessed assets              |       | 5                                    |       | 1                     |       |
| Other real estate owned         |       | 61,612                               |       | 21,066                |       |
| Total non-performing assets     |       | $                                    | 150,178    |                  | $          | 137,006 |   |

 

Nonperformingassets increased $13.2 million, or 9.61%, from December 31, 2009 to September 30,2010.  Non-accrual loans decreasedapproximately $26.7 million from December 31, 2009 to September 30,2010, largely due to approximately $47.5 million moving to other real estateowned and other assets, $8.6 million in partial charge-offs on non-accrualloans and approximately $8.6 million in pay downs.   During the first nine months of 2010, therewas approximately $38.0 million in loans moved to non-accrual.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other real estateowned increased $40.5 million from December 31, 2009 to September 30,2010.  This increase is largely due tothe addition of $46.7 million in foreclosed properties and $839 thousand incapitalized improvements on several foreclosed properties being offset by thesale of $5.3 million in foreclosed properties resulting in a loss of $225thousand on these properties.  TheCompany has written down $1.5 million for several foreclosed properties basedupon updated appraisals.

 

TheCompany had $16.0 million and $12.8 million in loans that would be defined astrouble debt restructurings (“TDR”) at September 30, 2010 and at December 31,2009, respectively.  Of those amounts,$13.5 million and $1.6 million were accruing as of September 30, 2010 and December 31,2009, respectively, as they were performing in accordance with theirrestructured terms.  At September 30,2010, there were approximately $2.0 million in TDR loans that had a relatedallowance of approximately $501 thousand. At December 31, 2009, there were no TDR loans that had a relatedallowance.

 

Our policy is to place loans on non-accrual statuswhen it appears that the collection of principal and interest in accordancewith the terms of the loan is doubtful. Any loan which becomes 90 days past due as to principal or interest isautomatically placed on non-accrual. Exceptions are allowed for 90-day past due loans when such loans arewell secured and in process of collection.

 

Ourloan officers usually notify management first when they determine that a loanrelationship may be showing signs of distress or issues with collectability ofscheduled payments.  Also, management isconstantly reviewing and discussing past due loans with loan officers inefforts to identify further troubled loan relationships as soon aspossible.  Quarterly rated loan reviewsare conducted by management to further monitor troubled loan relationships andpotential loss exposure.  Also, all loanrelationships greater than $500 thousand are reviewed annually in the Officers’Annual Review Committee.  Loan officersare required to either validate the appraised values of collateral or order newappraisals when it is determined that a material change in the value of theproperty may have occurred.

 

At the time a loan is placed on non-accrual, animpairment analysis is performed.  If acurrent appraisal is not on file, a new appraisal for the collateral isobtained by an independent, third-party appraiser within thirty days of engagement.  Once the new appraisal has been reviewed andaccepted by the senior vice president of credit administration, the impairmentcalculation is completed to determine the net realizable value of the loan withthe appraised value being adjusted for certain costs including, but not limitedto, sales commissions, closing costs, costs to complete or make ready for sale,property taxes, and, if necessary, an additional adjustment for marketconditions.  If the loan is determined tobe collateral dependent, the loan balance in excess of the net realizable valueis charged off immediately.  Generally,the underlying collateral securing collateral-dependent nonperforming loansconsists of residential lots, residential dwellings, undeveloped land tracts,timber tracts and developed land tracts. If the loan is not determined to be collateral dependent, a specificallocation within the allowance for loan loss is provided for the loan once theimpairment calculation is complete.  Oncemanagement determines that the loan is impaired and placed on non-accrual, theloan is transferred to our Special Assets Division for close monitoring andcollection.

 

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There are no commitments to lend additional funds to customers withloans on non-accrual status at September 30, 2010.  Moreover, pursuant to the Order, the Bank isprohibited from extending new credit to anyone who has caused a loss to theBank.

 

Asof September 30, 2010 and December 31, 2009, the Company’s other realestate owned consisted of the following:

 
| ** **                                          | ** ** | **As of September 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                          | ** ** | **Number of  Properties**                   | ** ** | **Carrying  Amount**                            | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| ** **                                          | ** ** | **(Dollars in Thousands)**             | ** ** |
| 1-4 Family residential properties                   |       | 25                                               |       | $                                               | 2,732      |   | 23 |   | $ | 2,958 |   |
| Multifamily residential properties                  |       | 4                                                |       | 13,720                                          |       | 2 |   | 238 |   |
| Nonfarm nonresidential properties                   |       | 18                                               |       | 13,514                                          |       | 13 |   | 8,994 |   |
| Farmland properties                                 |       | 3                                                |       | 1,252                                           |       | — |   | — |   |
| Construction & land development properties |       | 52                                               |       | 30,394                                          |       | 35 |   | 8,876 |   |
| Total                                               |       | 102                                              |       | $                                               | 61,612     |   | 73 |   | $ | 21,066 |   |

 

Allproperties are being actively marketed for sale and management is continuouslymonitoring these properties in order to minimize any losses.

 

TheCompany’s other real estate owned policy and procedures provide that aforeclosure appraisal be obtained.  Thepolicy requires a certified appraiser conduct the appraisal for foreclosedproperty to obtain a fair market value. To qualify and be approved as an appraiser for the Bank, appraisers musthave met the Appraisal Qualifications Board requirements and have not had anydisciplinary actions.  Additionally, anappraiser must submit to the Bank their resume, license, education andexperience for review before being approved for appraisal work.  Upon transfer into other real estate owned,the property is listed with a realtor to begin sales efforts.

 

Allother real estate owned properties are initially recorded at fair value, lessestimated cost to sell.  If the fairvalue less estimated costs to sell at the time of foreclosure is less than theloan balance, the deficiency is charged against the allowance for loanlosses.  An updated appraisal is orderedon each anniversary if the property is owned for more than one year.  If the fair value of the other real estateowned, less estimated costs to sell at the time of foreclosure, decreasesduring the holding period, the other real estate owned is written down with acharge to noninterest expense.  When theother real estate owned is sold, a gain or loss is recognized on the sale forthe difference between the sales proceeds and the carrying amount of the otherreal estate owned.

 

**Deposits**

 

Total deposits at September 30, 2010 were$786.3 million, a decrease of $74.9 million, or 8.69%, from December 31,2009.  Total interest bearing demand(money market and NOW accounts), non-interest bearing demand accounts andsavings accounts of $174.0 million decreased $21.1 million, or 10.82% from December 31,2009 resulting mainly from several customers moving their deposits to ourcompetitors, who have had more competitive rates during the first nine monthsof 2010.

 

Total time deposits as of September 30, 2010were $612.3 million, a decrease of $53.7 million, or 8.07%, from December 31,2009.  Total retail time deposits at September 30,2010 increased approximately $17.4 million, or 2.84% of total time deposits,from December 31, 2009 due to managements’ efforts to increase coredeposits with internet CDs and to continue reducing the Bank’s reliance onbrokered deposits.  Pursuant to the Orderand FDIC regulations, as a result of our significantly-undercapitalized status,the Bank is prohibited from accepting, renewing or rolling over brokereddeposits absent a waiver from the FDIC. The weighted average rates paid for retail time deposits for the threeand nine months ended September 30, 2010 was 2.15% and 2.34%,respectively, compared to 3.00% and 3.27% for the three and nine months ended September 30,2009, respectively.  Total brokereddeposits at September 30, 2010 decreased approximately $71.1 million, or11.61% of total time deposits, from December 31, 2009, resulting mainlyfrom our ability to replace brokered deposits with retail deposits during thefirst nine months of 2010.  The weightedaverage rates paid for brokered deposits for the three and nine months ended September 30,

 

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2010 were 3.88% and 3.66%, respectively, comparedto 3.41% and 3.59% for the three and nine months ended September 30, 2009,respectively.  Because we are currentlyclassified as less than well capitalized, we are prohibited from paying ratesin excess of 75 basis points above the local market average on deposits ofcomparable maturity in our Georgia markets. In our Jacksonville market, however, we are prohibited from paying inexcess of 75 basis points above the national average on deposits, as calculatedby the FDIC.

 

**Results of Operations**

 

**General**

 

The Company’s results of operations are determined by its ability toeffectively manage interest income and expense, to minimize loan and investmentlosses, to generate 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 anadequate spread between the rate earned on earning assets and the rate paid oninterest-bearing liabilities.

 

The following table shows the significant componentsof net loss:

 
| ** **                   | ** ** | **Nine Months Ended**      | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                   | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                   | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                   | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Interest and Dividend Income |       | $                                    | 27,323     |       | $          | 35,504            |       | $ | (8,181 | ) | -23.04 | % |
| Interest Expense             |       | 15,191                               |       | 21,580     |       | (6,389            | )          | -29.61 | % |
| Net Interest Income          |       | 12,131                               |       | 13,923     |       | (1,792            | )          | -12.87 | % |
| Provision for Loan Losses    |       | 5,514                                |       | 17,420     |       | (11,906           | )          | -68.35 | % |
| Noninterest Income           |       | 3,167                                |       | 4,475      |       | (1,308            | )          | -29.23 | % |
| Noninterest Expense          |       | 19,114                               |       | 39,044     |       | (19,930           | )          | -51.05 | % |
| Net Loss                     |       | (9,329                               | )          | (31,328    | )          | 21,999            |       | 70.22 | % |
| Net Loss Per Diluted Share   |       | (2.22                                | )          | (7.44      | )          | 5.22              |       | 70.16 | % |
|                              |            |                                      |            |            |            |                   |            |  |  |  |  |  |

 
| ** **                   | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                   | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                   | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                   | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Interest and Dividend Income |       | $                                    | 8,593      |       | $          | 11,255            |       | $ | (2,662 | ) | -23.65 | % |
| Interest Expense             |       | 4,654                                |       | 7,223      |       | (2,569            | )          | -35.57 | % |
| Net Interest Income          |       | 3,939                                |       | 4,032      |       | (93               | )          | -2.31 | % |
| Provision for Loan Losses    |       | 2,178                                |       | 11,352     |       | (9,174            | )          | -80.81 | % |
| Noninterest Income           |       | 1,401                                |       | 1,132      |       | 269               |       | 23.77 | % |
| Noninterest Expense          |       | 6,821                                |       | 6,495      |       | 326               |       | 5.02 | % |
| Net Loss                     |       | (3,659                               | )          | (8,288     | )          | 4,629             |       | 55.86 | % |
| Net Loss Per Diluted Share   |       | (0.87                                | )          | (1.97      | )          | 1.10              |       | 55.84 | % |
|                              |            |                                      |            |            |            |                   |            |  |  |  |  |  |

 

**Net Interest Income**

 

Ourprimary source of income is interest income from loans and investmentsecurities.  Our profitability dependslargely on net interest income, which is the difference between the interestreceived on interest-earning assets and the interest paid on deposits,borrowings, and other interest-bearing liabilities.  Net interest income decreased $1.8 million,or 12.87%, for the nine months ended September 30, 2010 compared to thenine months ended September 30, 2009. Net interest income decreased $93 thousand, or 2.31%, for the threemonths ended September 30, 2010 compared to the three months ended September 30,2009.

 

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Totalinterest and dividend income for the three and nine months ended September 30,2010 decreased $2.7 million, or 23.65%, and $8.2 million, or 23.04%,respectively, when compared to the three and nine months ended September 30,2009.  This decrease is primarily due todecrease in the volume of loans due to payoffs from customers, an increase inthe volume of nonperforming loans on non-accrual status and/or moving to otherreal estate owned and a decrease in interest on securities from the purchase oflow-yielding U.S. government sponsored enterprises securities purchased duringthe second quarter of 2009 when the Bank restructured its investment portfoliocombined with the purchase of short-term U.S. treasury bills during 2009 whichare being used to meet liquidity needs.

 

Averageloans and loans held for sale portfolios for the three and nine months ended September 30,2010 decreased $141.6 million, or 18.10%, and $110.9 million, or 14.04%,respectively, when compared to average loans and loans held for sale portfoliosfor the three and nine months ended September 30, 2009.  The average yield on loans decreased for thethree and nine months ended September 30, 2010 to 5.02% and 5.04%,respectively, compared to an average yield of 5.29% and 5.51% for the three andnine months ended September 30, 2009. While we have experienced a decrease in the volume of loans, the Companyhas managed to increase the average rate paid on the remaining accruing loanswhen comparing the three and nine months ended September 30, 2010 to thesame periods in 2009.

 

Totalinterest expense for the three and nine months ended September 30, 2010decreased $2.6 million, or 35.57%, and $6.4 million, or 29.61%, respectively,when compared to the three and nine months ended September 30, 2009.  Two factors impact interest expense: averagebalances of deposit and borrowing portfolios and average rates paid oneach.  Average deposit balances decreasedapproximately $193.1 million and $88.9 million when comparing the three andnine months ended September 30, 2010 to the three and nine months ended September 30,2009, respectively.  The average ratepaid on the deposit portfolios for the three and nine months ended September 30,2010 decreased to 2.31% and 2.42%, respectively, from 2.87% and 3.09% whencompared to the three and nine months ended September 30, 2009.  Average borrowing balances decreasedapproximately $17.8 million and $16.1 million when comparing the three and ninemonths ended September 30, 2010 to the three and nine months ended September 30,2009, respectively.  Average interestrates paid on borrowings were 3.19% and 2.92% for the three and nine monthsended September 30, 2010, respectively, compared to 3.27% and 3.24% forthe three and nine months ended September 30, 2009, respectively.

 

Thebanking industry uses two key ratios to measure relative profitability of netinterest income, which are 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.

 

Forthe three months ended September 30, 2010 and 2009, our tax equivalent netinterest spread was 2.11% and 1.39%, respectively, while the tax equivalent netinterest margin was 2.07% and 1.56%, respectively.  For the nine months ended September 30,2010 and 2009, our tax equivalent net interest spread was 2.01% and 1.86%,respectively, while the tax equivalent net interest margin was 2.00% and 1.97%,respectively.  The increases in netinterest spread and net interest margin from the three and nine months ended September 30,2009 to the three and nine months ended September 30, 2010, were due tothe decrease in the average rates paid on interest-bearing deposits caused bythe rate restrictions from being less than well capitalized.  We are prohibited from paying rates in excessof 75 basis points above the local market average on deposits of comparablematurity in our Georgia markets.  In ourJacksonville market, however, we are prohibited from paying in excess of 75basis points above the national average on deposits, as calculated by the FDIC.

 

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Thefollowing table shows the relationship between interest revenue and interestexpense and the average balances of interest-earning assets andinterest-bearing liabilities for the three months ended September 30, 2010and 2009.

 

**Average Consolidated Balance Sheet and Net InterestMargin Analysis**

 
| ** **                                           | ** ** | **For the Three Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                                   | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(Dollar amounts in thousands)**                           | ** ** |
| ** **                                           | ** ** | **Average**                                                                | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                           | ** ** | **Balance**                                                                | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning assets                                       |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income  (4) (5) (6) |       | $                                                                          | 640,979    |   | $ | 8,112 |   | 5.02 | % | $ | 782,622 |   | $ | 10,424 |   | 5.29 | % |
| Investment securities - taxable (7)                  |       | 42,833                                                                     |       | 289 |   | 2.68 | % | 144,475 |   | 615 |   | 1.69 | % |
| Investment securities - tax-exempt (6) (7)      |       | 13,907                                                                     |       | 140 |   | 6.05 | % | 14,342 |   | 147 |   | 6.16 | % |
| Other interest and dividend income                   |       | 71,717                                                                     |       | 52 |   | 0.29 | % | 106,522 |   | 69 |   | 0.26 | % |
| Total earning assets                                 |       | 769,436                                                                    |       | 8,593 |   | 4.47 | % | 1,047,961 |   | 11,255 |   | 4.29 | % |
|                                                 |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning assets                          |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan losses                            |       | -19,190                                                                    |       |   |   |   |   | -15,049 |   |   |   |   |   |
| Cash and due from banks                              |       | 7,505                                                                      |       |   |   |   |   | 12,855 |   |   |   |   |   |
| Premises and equipment                               |       | 30,201                                                                     |       |   |   |   |   | 31,481 |   |   |   |   |   |
| Accrued interest receivable                          |       | 3,863                                                                      |       |   |   |   |   | 5,436 |   |   |   |   |   |
| Other real estate owned                              |       | 48,592                                                                     |       |   |   |   |   | 9,316 |   |   |   |   |   |
| Other assets                                         |       | 22,784                                                                     |       |   |   |   |   | 22,477 |   |   |   |   |   |
| Total assets                                         |       | $                                                                          | 863,191    |   |   |   |   |   | $ | 1,114,477 |   |   |   |   |   |
|                                                 |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities                         |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing demand                              |       | $                                                                          | 108,482    |   | $ | 188 |   | 0.69 | % | $ | 165,538 |   | $ | 655 |   | 1.57 | % |
| Savings                                              |       | 9,183                                                                      |       | 8 |   | 0.35 | % | 9,456 |   | 11 |   | 0.46 | % |
| Time deposits                                        |       | 618,971                                                                    |       | 4,095 |   | 2.62 | % | 751,271 |   | 6,039 |   | 3.19 | % |
| Total interest bearing deposits                      |       | 736,636                                                                    |       | 4,291 |   | 2.31 | % | 926,265 |   | 6,705 |   | 2.87 | % |
| Federal Home Loan Bank advances                      |       | 33,390                                                                     |       | 253 |   | 3.01 | % | 51,139 |   | 406 |   | 3.15 | % |
| Other borrowings                                     |       | 1,400                                                                      |       | 43 |   | 12.17 | % | 1,483 |   | 43 |   | 11.50 | % |
| Junior subordinated debentures                       |       | 10,310                                                                     |       | 67 |   | 2.58 | % | 10,310 |   | 69 |   | 2.66 | % |
| Total borrowed funds                                 |       | 45,100                                                                     |       | 363 |   | 3.19 | % | 62,932 |   | 518 |   | 3.27 | % |
| Total interest-bearing liabilities                   |       | 781,736                                                                    |       | 4,654 |   | 2.36 | % | 989,197 |   | 7,223 |   | 2.90 | % |
|                                                 |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                        |       | 52,503                                                                     |       |   |   |   |   | 56,016 |   |   |   |   |   |
| Other liabilities                                    |       | 6,253                                                                      |       |   |   |   |   | 5,382 |   |   |   |   |   |
| Shareholders’ equity                            |       | 22,699                                                                     |       |   |   |   |   | 63,882 |   |   |   |   |   |
| Total Liabilities and Shareholders’ Equity      |       | $                                                                          | 863,191    |   |   |   |   |   | $ | 1,114,477 |   |   |   |   |   |
| Net interest revenue (1)                             |       |                                                                       |       | $ | 3,939 |   |   |   |   |   | $ | 4,032 |   |   |   |
| Net interest spread (2)                              |       |                                                                       |       |   |   | 2.11 | % |   |   |   |   | 1.39 | % |
| Net interest margin (3) (6)                     |       |                                                                       |       |   |   | 2.07 | % |   |   |   |   | 1.56 | % |

 

----

(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): 2010 - $210; 2009 - $276

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

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

 

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Thefollowing table shows the relationship between interest revenue and interestexpense and the average balances of interest-earning assets andinterest-bearing liabilities for the nine months ended September 30, 2010and 2009.

 

**Average Consolidated Balance Sheet and Net InterestMargin Analysis**

 
| ** **                                           | ** ** | **For the Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                                           | ** ** | **2010**                                                                  | ** ** | **2009** | ** ** |
| ** **                                           | ** ** | **(Dollar amounts in thousands)**                          | ** ** |
| ** **                                           | ** ** | **Average**                                                               | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                           | ** ** | **Balance**                                                               | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning assets                                       |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income  (4) (5) (6) |       | $                                                                         | 678,932    |   | $ | 25,597 |   | 5.04 | % | $ | 789,869 |   | $ | 32,556 |   | 5.51 | % |
| Investment securities - taxable (7)                  |       | 74,601                                                                    |       | 1,171 |   | 2.10 | % | 112,795 |   | 2,400 |   | 2.84 | % |
| Investment securities - tax-exempt (6) (7)      |       | 13,994                                                                    |       | 430 |   | 6.22 | % | 15,406 |   | 470 |   | 6.18 | % |
| Other interest and dividend income                   |       | 58,964                                                                    |       | 125 |   | 0.28 | % | 45,340 |   | 77 |   | 0.23 | % |
| Total earning assets                                 |       | 826,491                                                                   |       | 27,323 |   | 4.46 | % | 963,410 |   | 35,503 |   | 4.96 | % |
|                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning assets                          |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan losses                            |       | -20,800                                                                   |       |   |   |   |   | -12,952 |   |   |   |   |   |
| Cash and due from banks                              |       | 8,939                                                                     |       |   |   |   |   | 38,620 |   |   |   |   |   |
| Premises and equipment                               |       | 30,503                                                                    |       |   |   |   |   | 31,613 |   |   |   |   |   |
| Accrued interest receivable                          |       | 4,361                                                                     |       |   |   |   |   | 5,903 |   |   |   |   |   |
| Other real estate owned                              |       | 36,568                                                                    |       |   |   |   |   | 10,841 |   |   |   |   |   |
| Other assets                                         |       | 27,674                                                                    |       |   |   |   |   | 36,305 |   |   |   |   |   |
| Total assets                                         |       | $                                                                         | 913,736    |   |   |   |   |   | $ | 1,073,740 |   |   |   |   |   |
|                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities                         |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing demand                              |       | $                                                                         | 116,481    |   | $ | 650 |   | 0.75 | % | $ | 153,345 |   | $ | 1,859 |   | 1.62 | % |
| Savings                                              |       | 9,146                                                                     |       | 23 |   | 0.34 | % | 8,741 |   | 26 |   | 0.40 | % |
| Time deposits                                        |       | 655,558                                                                   |       | 13,494 |   | 2.75 | % | 706,897 |   | 18,167 |   | 3.44 | % |
| Total interest bearing deposits                      |       | 781,185                                                                   |       | 14,167 |   | 2.42 | % | 868,983 |   | 20,052 |   | 3.09 | % |
| Federal Home Loan Bank advances                      |       | 35,302                                                                    |       | 710 |   | 2.69 | % | 51,392 |   | 1,145 |   | 2.98 | % |
| Other borrowings                                     |       | 1,400                                                                     |       | 127 |   | 12.13 | % | 1,442 |   | 128 |   | 11.87 | % |
| Junior subordinated debentures                       |       | 10,310                                                                    |       | 188 |   | 2.44 | % | 10,310 |   | 255 |   | 3.31 | % |
| Total borrowed funds                                 |       | 47,012                                                                    |       | 1,025 |   | 2.92 | % | 63,144 |   | 1,528 |   | 3.24 | % |
| Total interest-bearing liabilities                   |       | 828,197                                                                   |       | 15,192 |   | 2.45 | % | 932,127 |   | 21,580 |   | 3.10 | % |
|                                                 |       |                                                                      |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                        |       | 52,504                                                                    |       |   |   |   |   | 53,606 |   |   |   |   |   |
| Other liabilities                                    |       | 6,892                                                                     |       |   |   |   |   | 6,949 |   |   |   |   |   |
| Shareholders’ equity                            |       | 26,143                                                                    |       |   |   |   |   | 81,058 |   |   |   |   |   |
| Total Liabilities and Shareholders’ Equity      |       | $                                                                         | 913,736    |   |   |   |   |   | $ | 1,073,740 |   |   |   |   |   |
| Net interest revenue (1)                             |       |                                                                      |       | $ | 12,131 |   |   |   |   |   | $ | 13,923 |   |   |   |
| Net interest spread (2)                              |       |                                                                      |       |   |   | 2.01 | % |   |   |   |   | 1.86 | % |
| Net interest margin (3) (6)                     |       |                                                                      |       |   |   | 2.00 | % |   |   |   |   | 1.97 | % |

 

----

(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): 2010 - $708; 2009 - $969

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

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

 

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Thefollowing table provides a detailed analysis of the changes in interest incomeand interest expense due to changes in rate and volume for the three months andnine months ended September 30, 2010 compared to September 30, 2009.

 

**Change in Interest Revenue and Expense on a Taxable EquivalentBasis**

 
| ** **                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                         | ** ** | **2010 Compared to 2009**                 | ** ** | **2010 Compared to 2009**                | ** ** |
| ** **                         | ** ** | **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                              |       | $                                                        | (2,643     | )                                                       | $          | 331 |   | $ | (2,312 | ) | $ | (7,801 | ) | $ | 842 |   | $ | (6,959 | ) |
| Investment securities:             |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Taxable investment securities      |       | (370                                                     | )          | 44                                                      |       | (326 | ) | (832 | ) | (397 | ) | (1,229 | ) |
| Tax-exempt investment securities   |       | (5                                                       | )          | (2                                                      | )          | (7 | ) | (47 | ) | 7 |   | (40 | ) |
| Interest earning deposits          |       | (24                                                      | )          | 7                                                       |       | (17 | ) | 27 |   | 21 |   | 48 |   |
| Total interest income              |       | (3,042                                                   | )          | 380                                                     |       | (2,662 | ) | (8,653 | ) | 473 |   | (8,180 | ) |
|                               |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Interest paid on:                  |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Deposits:                          |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Interest bearing demand deposits   |       | (174                                                     | )          | (293                                                    | )          | (467 | ) | (370 | ) | (839 | ) | (1,209 | ) |
| Savings                            |       | —                                                   |       | (3                                                      | )          | (3 | ) | 1 |   | (4 | ) | (3 | ) |
| Time deposits                      |       | (1,462                                                   | )          | (482                                                    | )          | (1,944 | ) | (2,384 | ) | (2,289 | ) | (4,673 | ) |
| Other borrowings and FHLB advances |       | (136                                                     | )          | (17                                                     | )          | (153 | ) | (332 | ) | (104 | ) | (436 | ) |
| Junior subordinated debentures     |       | —                                                   |       | (2                                                      | )          | (2 | ) | — |   | (67 | ) | (67 | ) |
| Total interest expense             |       | (1,772                                                   | )          | (797                                                    | )          | (2,569 | ) | (3,085 | ) | (3,303 | ) | (6,388 | ) |
|                               |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Decrease in net interest revenue   |       | $                                                        | (1,270     | )                                                       | $          | 1,177 |   | $ | (93 | ) | $ | (5,568 | ) | $ | 3,776 |   | $ | (1,792 | ) |

 

----

(a) Volumeand rate components are in proportion to the relationship of the absolutedollar amount of the change in each.

 

**Provision for Loan Losses**

 

Theprovision for loan losses for the nine months ended September 30, 2010 was$5.5 million compared to $17.4 million for the same period of 2009.  The provision for loan losses for the thirdquarter of 2010 was $2.2 million compared to $11.4 million for the same periodof 2009.  While there is an increase innonperforming loans and a decrease in loan activity for the three and ninemonths ended September 30, 2010 compared to the three and nine monthsended September 30, 2009, the Company decreased its provision for loanlosses based on management’s analysis of the allowance for loan losses.  Net charge-offs as an annualized percentageof average outstanding loans for the three and nine months ended September 30,2010 were 1.78% and 1.64%, respectively, as compared with 5.91% and 2.45% forthe three and nine months ended September 30, 2009, respectively.  Net loan charge-offs decreased significantlyduring the three and nine months ended September 30, 2010, as compared tothe three and nine months ended September 30, 2009, due mainly to theCompany writing down $11.8 million for several impaired loans during the thirdquarter of 2009 to their net realizable value compared to $3.1 million in loansbeing written down during the third quarter of 2010.

 

Theprovision for loan losses is based on management’s evaluation of inherent risksin the loan portfolio and the corresponding analysis of the allowance for loanlosses.  Additional discussion on loanquality and the allowance for loan losses are included in the Asset Qualitysection of this report.

 

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**Non-interest Income**

 

Compositionof other noninterest income is as follows:

 
| ** **                                                               | ** ** | **Nine Months Ended**      | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                               | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                               | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                               | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                                      |       | $                                    | 1,179      |       | $          | 1,304             |       | $ | (125 | ) | -9.59 | % |
| Other service charges, commissions and fees                              |       | 443                                  |       | 374        |       | 69                |       | 18.45 | % |
| Gain on sales, calls and impairment write-down of  investment securities |       | 600                                  |       | 1,331      |       | (731              | )          | -54.92 | % |
| Mortgage origination income                                              |       | 218                                  |       | 643        |       | (425              | )          | -66.10 | % |
| Other income                                                             |       | 727                                  |       | 823        |       | (96               | )          | -11.66 | % |
| Total noninterest income                                                 |       | $                                    | 3,167      |       | $          | 4,475             |       | $ | (1,308 | ) | -29.23 | % |

 
| ** **                                                               | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                               | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                               | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                                               | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                                      |       | $                                    | 387        |       | $          | 464               |       | $ | (77 | ) | -16.59 | % |
| Other service charges, commissions and fees                              |       | 151                                  |       | 136        |       | 15                |       | 11.03 | % |
| Gain on sales, calls and impairment write-down of  investment securities |       | 557                                  |       | 15         |       | 542               |       | 3613.33 | % |
| Mortgage origination income                                              |       | 68                                   |       | 249        |       | (181              | )          | -72.69 | % |
| Other income                                                             |       | 238                                  |       | 268        |       | (30               | )          | -11.19 | % |
| Total noninterest income                                                 |       | $                                    | 1,401      |       | $          | 1,132             |       | $ | 269 |   | 23.76 | % |

 

Non-interestincome for the three months ended September 30, 2010 increased $269thousand, or 23.76%, when compared to the three months ended September 30,2009.  Non-interest income for the ninemonths ended September 30, 2010 decreased $1.3 million, or 29.23%, whencompared to the nine months ended September 30, 2009.  Service charges on deposit accounts areevaluated against service charges from other banks in our local markets andagainst the Bank’s own cost structure in providing the deposit services.  This income correlates with the Bank’s demanddeposit account base.  During the firstnine months of 2010, the Bank experienced a decrease in the number of coretransaction deposit accounts.  Totalservice charges, including non-sufficient funds fees, decreased approximately$77 thousand, or 16.59%, and $125 thousand, or 9.59%, for the three and ninemonths ended September 30, 2010, respectively, compared with the sameperiods in 2009.

 

Thedecrease in the gain on sales/calls of investment securities for the ninemonths ended September 30, 2010 compared to the nine months ended September 30,2009 is primarily due to the Company recording $1.3 million in gains from thesales of several mortgage-backed securities during the first nine months of2009 as compared to $600 thousand in gains from the calls of state, county andmunicipal bond and the sale of several U.S. government sponsored enterprisessecurities and mortgage—backed securities during the first nine months of2010.  The increase in the gain onsales/calls of investment securities for the three months ended September 30,2010 compared to the same period in 2009 is primarily due to the Companyrecording $557 thousand in gains from the sale of several U.S. governmentsponsored enterprises securities and mortgage-backed securities.

 

Thedecrease in mortgage origination income for the three and nine months ended September 30,2010 is primarily due to the decrease in the number of mortgage loanclosings.  Approximately 18 mortgage loanclosings occurred 

 

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duringthe third quarter of 2010 compared to 70 mortgage loan closings for the sameperiod in 2009.  For the nine monthsended September 30, 2010, there were approximately 53 mortgage loanclosings that occurred compared to 205 mortgage loan closings for the ninemonths ended September 30, 2009.

 

Thedecrease in other income for the three and nine months ended September 30,2010, compared to the same periods in 2009 is due to the decrease in commissionfees from our wealth management department.

 

**Non-interest Expense**

 

Compositionof other noninterest expense is as follows:

 
| ** **                                       | ** ** | **Nine Months Ended**      | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                       | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                   |       | $                                    | 6,597      |       | $          | 7,839             |       | $ | (1,242 | ) | -15.84 | % |
| Occupancy expense                                |       | 1,326                                |       | 1,355      |       | (29               | )          | -2.15 | % |
| Equipment rental and depreciation of equipment   |       | 895                                  |       | 965        |       | (70               | )          | -7.25 | % |
| (Gain) loss on sale of other assets              |       | 6                                    |       | (62        | )          | 68                |       | -109.68 | % |
| Loss on sale and impairment of other real estate |       | 1,719                                |       | 2,432      |       | (713              | )          | -29.32 | % |
| Other real estate expense                        |       | 1,779                                |       | 653        |       | 1,126             |       | 172.43 | % |
| FDIC and state banking assessments               |       | 3,431                                |       | 1,884      |       | 1,547             |       | 82.11 | % |
| Goodwill impairment                              |       | —                               |       | 19,534     |       | (19,534           | )          | -100.00 | % |
| Other expenses                                   |       | 3,361                                |       | 4,444      |       | (1,083            | )          | -24.37 | % |
| Total noninterest expense                        |       | $                                    | 19,114     |       | $          | 39,044            |       | $ | (19,930 | ) | -51.04 | % |

 
| ** **                                       | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|--------------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **September 30,**               | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                       | ** ** | **2010**                             | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                   |       | $                                    | 2,046      |       | $          | 2,424             |       | $ | (378 | ) | -15.59 | % |
| Occupancy expense                                |       | 443                                  |       | 463        |       | (20               | )          | -4.32 | % |
| Equipment rental and depreciation of equipment   |       | 300                                  |       | 333        |       | (33               | )          | -9.91 | % |
| (Gain) loss on sale of other assets              |       | 5                                    |       | (106       | )          | 111               |       | -104.72 | % |
| Loss on sale and impairment of other real estate |       | 1,323                                |       | 942        |       | 381               |       | 40.45 | % |
| Other real estate expense                        |       | 477                                  |       | 317        |       | 160               |       | 50.47 | % |
| FDIC and state banking assessments               |       | 1,103                                |       | 729        |       | 374               |       | 51.30 | % |
| Goodwill impairment                              |       | —                               |       | —     |       | —            |       | — |   |
| Other expenses                                   |       | 1,124                                |       | 1,393      |       | (269              | )          | -19.31 | % |
| Total noninterest expense                        |       | $                                    | 6,821      |       | $          | 6,495             |       | $ | 326 |   | 5.02 | % |

 

Non-interestexpense for the three months ended September 30, 2010 increased $326thousand, or 5.02%, when compared to the three months ended September 30,2009.  This increase is primarily due tothe loss on the sale and impairment of other real estate properties whichincreased by $381 thousand and from an increase of $374 thousand in quarterlyFDIC assessments with an offset of a decrease of $378 thousand in salary andemployee benefits with the Company eliminating its accrual on the 401k matchfor employees and from a reduction in staff. Non-interest expense for the nine months ended September 30, 2010decreased $19.9 million, or 51.04%, when compared to the nine months ended September 30,2009.  This decrease is primarily due tothe Company recording a $19.5 million charge for goodwill impairment during thesecond quarter of 2009.

 

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Thedecrease in the loss on the sale and impairment of other real estate owned forthe nine months ended September 30, 2010 is primarily attributed to theCompany recording a loss on one particular foreclosed property totaling to $1.3million during the second quarter of 2009. The increase in the loss on the sale and impairment of other real estateowned for the three months ended September 30, 2010 is attributed to theimpairment of $1.1 million of several other real estate owned properties basedupon updated appraisals.  The increase inother real estate expenses is attributed to the number of other real estateproperties that the Company owns.  At September 30,2010, the Company had a total of 102 other real estate owned propertiescompared to 54 properties at September 30, 2009.

 

Theincrease in the FDIC and state banking assessments for the three and ninemonths ended September 30, 2010 is attributable to our risk classificationwith the FDIC.  Since entering into theOrder with the FDIC, the Company has had higher quarterly assessments due toour risk classification.

 

Thedecrease in salaries and employee benefits for the three and nine months ended September 30,2010 compared to the same period in 2009 is primarily due to no accrual ofbonuses, a decrease in the expense relating to the salary continuation planbased upon changes to the plan, the utilization of a bank officer one day perquarter furlough, the elimination of the accrual on the Company’s 401k matchfor their employees and a small reduction in staff.  At September 30, 2010, the number offull-time equivalent employees was 158 employees compared to 165 employees at September 30,2009.

 

Thedecreases in equipment rental and depreciation of equipment, occupancy expenseand other expenses are not attributable to any one particular item, butrepresent the Company’s efforts to decrease controllable noninterest expense.

 

**Income Tax Expense**

 

TheCompany recorded a valuation allowance for the balance of the recorded deferredtax asset as of December 31, 2009 and for the three and nine months ended September 30,2010 since it is presently more likely than not that the deferred tax assetwill not be realized.  With respect tothe Company’s cumulative losses as of September 30, 2010, we havedetermined that it is more likely than not that any income tax benefit thatwould have been recorded would not be realized. For the three and nine months ended September 30, 2009, income taxbenefit of $4.4 million and $6.7 million was recognized with an effective taxrate of 34.65% and 17.70%, respectively. The effective tax rate for the nine months ended September 30, 2009was lower than the statutory tax rates primarily due to the tax-free incomefrom certain investment securities and loans that are exempt from income taxesand tax credits received from affordable housing investments and the goodwillimpairment charge.  The majority of thegoodwill from the two acquisitions in 2006 and 2007 was treated as tax-freeexchanges, which was not recognized for tax reporting purposes and therefore notax deduction 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**

 

Liquiditymanagement involves the matching of the cash flow requirements of customers,either depositors withdrawing funds or borrowers needing loans, and the abilityof the Company to meet those requirements.

 

TheCompany’s liquidity program is designed and intended to provide guidance infunding the credit and investment activities of the Company, while at the sametime ensuring that the deposit obligations of the Company are met on a timelybasis. In order to permit active and timely management of assets andliabilities, these accounts are monitored regularly in regard to volume, mixand maturity.

 

TheCompany’s liquidity position depends primarily upon the liquidity of its assetsrelative to its need to respond to short-term demand for funds caused bywithdrawals from deposit accounts and loan funding commitments. Primary sourcesof liquidity are scheduled repayments on the Company’s loans and interest on,and maturities of, its investment securities. Sales of investment securitiesavailable for sale represent another source of liquidity to the Company. TheCompany may also utilize its cash and due from banks and federal funds sold tomeet liquidity requirements as needed.

 

TheCompany also has the ability, on a short-term basis, to purchase up to $11million in federal funds from other financial institutions. At September 30,2010, the Company had no federal funds purchased. At September 30, 2010, 

 

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wedo not have any further borrowing capacity with the Federal Home Loan Bank with$29.0 million in outstanding advances. The Company has a total available line of $21.9 million, subject toavailable collateral, from the Federal Reserve Bank (FRB).  The Company had no advances on the FRB lineat September 30, 2010.

 

TheBank’s liquidity policy requires that the ratio of cash and certain short-terminvestments to net withdrawable deposit accounts be at least 10%. The Bank’sliquidity ratios at September 30, 2010 and 2009 were 17.94% and 25.94%,respectively.

 

Inthe past, the Bank has relied heavily on brokered deposits.  Pursuant to the Order and FDIC regulations asa result of our significantly-undercapitalized status, we are unable to accept,renew or roll over brokered deposits absent a waiver from the FDIC.  Accordingly, management has instituted anaggressive retail deposit marketing campaign both locally and through anational rate-listing service to replace the brokered CDs as they mature.  The increase in liquid assets is designed toprovide cash to payoff the brokered deposits as they mature.

 

**Capital Resources**

 

Weare subject to various regulatory capital requirements administered by thefederal banking agencies.  Failure tomeet minimal capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on our financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, we must meet specificcapital guidelines that involve quantitative measures of our assets, liabilitiesand certain off-balance sheet items as calculated under regulatory accountingpractices.  Our capital amounts andclassification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors.

 

Quantitativemeasures established by regulations to ensure capital adequacy require us tomaintain minimum amounts and ratios (set forth below in the table) of total andTier I capital (as defined in the regulations) to risk-weighted assets (asdefined in the regulations), and of Tier I capital (as defined in theregulations) to average assets (as defined in the regulations).  Pursuant to the Order, Tier 1 Capital mustequal or exceed 8.00% of the Bank’s total assets and the Bank’s TotalRisk-based Capital must equal or exceed 10.00% of the Bank’s totalrisk-weighted assets, within 90 days of the effective date of the Order.  At September 30, 2010, the Bank was notin compliance with the Order, with Tier 1 capital to average assets at 3.14%and total risk-based capital to risk-weighted assets at 5.49%.  As a result of our regulatory capital ratios,we are considered “significantly undercapitalized” by our bank regulatoryauthorities as of September 30, 2010. As a result of our significantly-undercapitalized status, on March 26,2010, the Bank received a Notification of Prompt Corrective Action, whichnotified the Bank that it is subject to greater regulatory monitoring andcertain additional discretionary safeguards may be imposed by regulatoryauthorities, which may have a direct material effect on our financialstatements.

 

Sincethe Bank consented to the Order, it has taken steps to address the provisionsof the Order.  Management has taken anactive role in working with the FDIC and the GDBF to improve its financialcondition and is addressing the terms of the Order on a continuing basis.  We are also in the process of developing ashort-term and a long-term capital plan to meet regulatory capital limits.  Failure to adequately address the Order mayresult in more severe actions by regulators, including the eventual appointmentof a receiver of the Bank’s asset.

 

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TheCompany’s and the Bank’s actual capital amounts and ratios as of September 30,2010 and December 31, 2009 follow:

 
| ** **                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well Capitalized** | ** ** |
|---------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|-------------------------------------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective**     | ** ** |
| ** **                                        | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                        | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | ** **                                | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ***September 30,  2010***                    |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 37,396,000 |                       | 5.55       | %                          | $          | 53,904,144                                |       | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 37,018,000 |       | 5.49                       | %          | 53,942,441                 |       | >                                 |       | 8.0 | % | $ | 67,428,051 |   | >  |   | 10.0 | % |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 24,018,000 |                       | 3.56       | %                          | $          | 26,986,517                                |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 27,069,000 |       | 4.02                       | %          | 26,934,328                 |       | >                                 |       | 4.0 | % | $ | 40,401,493 |   | >  |   | 6.0 | % |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 24,018,000 |                       | 2.79       | %                          | $          | 34,434,409                                |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 27,069,000 |       | 3.14                       | %          | 34,482,803                 |       | >                                 |       | 4.0 | % | $ | 43,103,503 |   | >  |   | 5.0 | % |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| ***December 31,  2009***                     |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 47,485,000 |                       | 6.28       | %                          | $          | 60,490,446                                |       | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 46,763,000 |       | 6.19                       | %          | 60,436,834                 |       | >                                 |       | 8.0 | % | $ | 75,546,042 |   | >  |   | 10.0 | % |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 36,490,000 |                       | 4.83       | %                          | $          | 30,219,462                                |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 35,771,000 |       | 4.73                       | %          | 30,250,317                 |       | >                                 |       | 4.0 | % | $ | 45,375,476 |   | >  |   | 6.0 | % |
|                                              |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                       |       |                       |       |                                      |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 36,490,000 |                       | 3.44       | %                          | $          | 42,430,233                                |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 35,771,000 |       | 3.37                       | %          | 42,458,160                 |       | >                                 |       | 4.0 | % | $ | 53,072,700 |   | >  |   | 5.0 | % |

 

We had outstanding junior subordinated debentures commonly referred toas Trust Preferred Securities totaling $10.3 million at September 30, 2010and December 31, 2009.  The TrustPreferred Securities qualify as a Tier I capital under risk-based capitalguidelines provided that total Trust Preferred Securities do not exceed certainquantitative limits.  At September 30,2010, $6.6 million of the Trust Preferred Securities qualified as Tier 1capital and all of the Trust Preferred Securities qualified as a Tier I capitalat December 31, 2009.  We hadoutstanding subordinated debentures totaling $1.4 million at September 30,2010 and December 31, 2009.  Thesubordinated debentures qualify as a Tier II capital under risk-based capitalguidelines.  At September 30, 2010and December 31, 2009, all of the subordinated debentures qualify as aTier II capital.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item 3.Quantitative and Qualitative Disclosuresabout Market Risk**

**For the Nine Months Ended September 30,2010**

 

Pursuantto Item 305(e) of Regulation S-K, no disclosure under this item isrequired.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item4T. Controls and Procedures**

**For the Nine Months Ended September 30,2010**

 

The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, supervised and participated inan evaluation of the effectiveness of its disclosure controls and procedures(as defined in federal securities rules) as of the end of the period covered bythis report.  Based on, and as of thedate of, that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer have concluded that the Company’s disclosure controls andprocedures were effective in accumulating and communicating information tomanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosures ofthat information under the Securities and Exchange Commission’s rules andforms.  The Company’s disclosure controlsand procedures are designed to ensure that the information required to bedisclosed in 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 third quarter of2010, there were no significant changes in the Company’s internal control overfinancial reporting or, to the Company’s knowledge, in other factors that couldsignificantly affect those internal controls subsequent to the date the Companycarried out its evaluation that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.  However, the design of anysystem of controls and procedures is based in part upon certain assumptionsabout the likelihood of future events. There can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions, regardless of how remote.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Part II. Other Information**

**For the Nine Months EndedSeptember 30, 2010**

 

PART II: OTHERINFORMATION:

 

Item 1. Legal Proceedings

 

Please refer to the material pending legalproceedings discussed in Part I, “Item 3. Legal Proceedings” in our AnnualReport on form 10-K for the year ended December 31, 2009.  There have been no material developments inthe matters discussed in our Annual Report and there are no further materiallegal proceedings to which the Company or the Bank is a party or of which theirproperty is the subject.

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, youshould carefully consider the factors discussed below and in Part I, “Item1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31,2009, which could materially affect our business, financial condition or futureresults. The risks described below and in our Annual Report on Form 10-Kare not the only risks facing us. Additional risks and uncertainties notcurrently known to us or that we currently deem to be immaterial also maymaterially adversely affect our business, financial condition and/or operatingresults.

 

***Due to our currentnoncompliance with the Order and risk of future noncompliance we may be subjectto certain additional operational and financial restrictions that will requireus to take specific actions.***

 

The Bank is currentlycategorized as “significantly undercapitalized” and, pursuant to the promptcorrective action provisions of the Federal Deposit Insurance Act and theprompt corrective action regulations of the FDIC promulgated thereunder(collectively, the “PCA Provisions”), the Bank  received Notification of Prompt CorrectiveAction from the FDIC on March 26, 2010, which required that the Bank filea capital restoration plan within 45 days of receiving the Notification.  In addition, because of the Bank’s “significantly-undercapitalized”status, the Bank is automatically subject to, among other things, restrictionson dividends, management fees, and asset growth, and is prohibited from openingnew branches, making acquisitions or engaging in new lines of business withoutthe approval of the FDIC.

 

Significantlyundercapitalized depository institutions may also be subject to any of thefollowing requirements and restrictions, including: (i) selling sufficientvoting stock to become adequately capitalized; (ii) directing the Bank tomerge or be acquired: (iii) limiting certain affiliate transactions; (iv) restrictinginterest rates paid on deposits; (v) restricting asset growth or reducingtotal assets, (vi) altering or eliminating any activities that poseexcessive risk to the Bank; (vii) improving management through an electionof a new board of directors, dismissals, or the hiring of new executives, (viii) ceasingthe acceptance of deposits from correspondent banks, (ix) divesting theholding company; and (x) performing any other appropriate action.

 

If the capital at the Bankfurther deteriorates, and the Bank is categorized as criticallyundercapitalized, subject to limited exceptions, it will be subject to theappointment, by the appropriate federal banking agency, of a receiver or conservatorwithin 90 days of the date on which it becomes criticallyundercapitalized.  In addition,critically-undercapitalized banks are prohibited from paying principal orinterest on subordinated debt without FDIC approval.  FDIC approval is also required for acritically- undercapitalized institution to engage in certain activities,including, but not limited to, entering into any material transaction otherthan in the usual course of business, extending credit for any highly leveragedtransaction, making any material change in accounting methods, amending itsarticles or bylaws, engaging in any “covered transaction” with an affiliate (asdefined in section 23A of the Federal Reserve Act), paying excessivecompensation or bonuses, and paying interest on deposits in excess of theprevailing rate in the institution’s market area.

 

In addition, because theBank is not in compliance with the Order, it could also be subject toenforcement actions by the FDIC and Georgia Department. The various enforcementmeasures available to the FDIC and Georgia Department, include the impositionof a conservator or receiver (which would likely result in a substantialdiminution or a total loss of the Company’s investment in the Bank), thejudicial enforcement of the Order, the termination of insurance of deposits,the imposition of civil money penalties, and the issuance of removal and 

 

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prohibition orders againstinstitution-affiliated parties and the imposition of restrictions and sanctionsunder the prompt corrective action provisions discussed above.

 

Further noncompliance withthe Order, the failure to comply with our capital restoration plan, or furtherdeterioration of our capital, could impact our ability to continue operationsand, in such a scenario, it is unlikely that our shareholders would realize anyvalue for their common stock.

 

***We need to raiseadditional capital that may not be available to us.***

 

Regulatory authoritiesrequire us to maintain adequate levels of capital to support our operations. Asdescribed above, we are significantly-undercapitalized and have an immediateneed to raise capital. In addition, even if we succeed in raising this capital,we may need to raise additional capital in the future due to additional lossesor regulatory mandates. The ability to raise additional capital, if needed,will depend in part on conditions in the capital markets at that time, whichare outside our control, and on our financial performance. Accordingly,additional capital may not be raised, if and when needed, on terms acceptableto us, or at all. If we cannot raise additional capital when needed, ourability to increase our capital ratios could be materially impaired and wecould face additional regulatory challenges. In addition, if we issueadditional equity capital, it may be at a lower price and in all cases ourexisting shareholders’ interest would be diluted.

 

**Compliancewith the recently enacted Dodd-Frank Reform Act may adversely impact ourearnings.**

 

OnJuly 21, 2010, President Obama signed the Dodd-Frank Wall Street Reformand Consumer Protection Act (the “Dodd-Frank Reform Act”) into law.  The Dodd-Frank Reform Act represents asignificant overhaul of many aspects of the regulation of thefinancial-services industry.  Majorelements in the Dodd-Frank Reform Act include the following:

 

·                  The establishment of the Financial StabilityOversight Counsel, which will be responsible for identifying and monitoringsystemic risks posed by financial firms, activities, and practices.

·                  Enhanced supervision of large bank holdingcompanies (i.e., those with over $50 billion in total consolidated assets),with more stringent supervisory standards to be applied to them.

·                  The creation of a special regime to allow forthe orderly liquidation of systemically important financial companies,including the establishment of an orderly liquidation fund.

·                  The development of regulations to addressderivatives markets, including clearing and exchange trading requirements and aframework for regulating derivatives-market participants.

·                  Enhanced supervision of credit-ratingagencies through the Office of Credit Ratings within the SEC.

·                  Increased regulation of asset-backedsecurities, including a requirement that issuers of asset-backed securitiesretain at least 5% of the risk of the asset-backed securities.

·                  The establishment of a Bureau of ConsumerFinancial Protection, within the Federal Reserve, to serve as a dedicatedconsumer-protection regulatory body.

·                  Amendments to the Truth in Lending Act aimedat improving consumer protections with respect to mortgage originations,including originator compensation, minimum repayment standards, and prepaymentconsiderations.

 

Themajority of the provisions in the Dodd-Frank Reform Act are aimed at financialinstitutions that are significantly larger than the Company or the Bank.  Nonetheless, there are provisions with whichwe will have to comply now that the Dodd-Frank Reform Bill is signed intolaw.  As rules and regulations arepromulgated by the federal agencies responsible for implementing and enforcingthe provisions in the Dodd-Frank Reform Act, we will have to work to applyresources to ensure that we are in compliance with all applicable provisions,which may adversely impact our earnings.

 

Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds

 

None

 

Item 3. Defaults Upon Senior Securities

 

Not Applicable

 

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Item 4. Reserved

 

Item 5. Other Information

 

None

 

Item 6. Exhibits

 

(a)                                  Exhibits:

 

31.1                           Certificationof Chief Executive Officer Pursuant to Rule 13a-14 under the SecuritiesExchange Act of 1934, as amended

 

31.2                           Certificationof Chief Financial Officer Pursuant to Rule 13a-14 under the Securities ExchangeAct of 1934, as amended

 

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

 

**SIGNATURES**

 

In accordance with the requirements of theSecurities Exchange Act, the registrant caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

 
| /s/ Mark A. Stevens                   |   |
|---------------------------------------|--------|
|                                  |   |
| Mark A. Stevens                       |   |
| President and Chief Executive Officer |   |

 

 

Date: November 12, 2010

 

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