Tableof Contents

 

 

 

**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

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

** **

**For the quarterly period ended    September 30, 2008**

** **

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

** **

**For the transition period from                    to**

** **

**Commission File Number  000-51112**

** **

**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

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

 

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

 

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

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

(Address of Principal Executive Offices)

 

**(478) 476-2170**

(Issuer’s Telephone Number, IncludingArea Code)

 

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

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

 

Indicate by check mark whether the registrant: (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.

 

Yes    x         No o

 

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

 

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

 

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 CORPORATEISSUERS**

 

State the number of shares outstanding of eachof the issuer’s classes of common equity, as of the latest practicable date:**Common Stock $5 par value, 4,151,780 shares outstanding at November 7, 2008**

 

 

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

INDEX

 
| PART I:                                                                                                    | FINANCIAL  INFORMATION                                                                                                                           |     |
|-----------------------------------------------------------------------------------------------------------------|--------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                            |                                                                                                                                             |     |
| ITEM  1.                                                                                                        | FINANCIAL  STATEMENTS                                                                                                                            |     |
|                                                                                                            |                                                                                                                                             |     |
| ** **                                                                                                      | ** **                                                                                                                                       | **PAGE** |
|                                                                                                            |                                                                                                                                             |     |
| The  following consolidated financial statements are provided for Atlantic  Southern Financial Group, Inc. |                                                                                                                                             |
|                                                                                                            |                                                                                                                                             |     |
|                                                                                                            | Consolidated  Balance Sheets – September 30, 2008  (unaudited) and December 31,  2007 (audited)                                   | 2        |
|                                                                                                            |                                                                                                                                             |     |
|                                                                                                            | Consolidated  Statements of Operations (unaudited) – For the Three Months And Nine Months  Ended September 30, 2008 and 2007           | 3        |
|                                                                                                            |                                                                                                                                             |     |
|                                                                                                            | Consolidated  Statements of Comprehensive Income (unaudited) – For the Three Months and  Nine Months Ended September 30, 2008 and 2007 | 4        |
|                                                                                                            |                                                                                                                                             |     |
|                                                                                                            | Consolidated  Statements of Cash Flows (unaudited) – For the Nine Months Ended September 30, 2008 and 2007                             | 5        |
|                                                                                                            |                                                                                                                                             |     |
|                                                                                                            | Notes to Consolidated Financial Statements (unaudited)                                                                                           | 6        |
|                                                                                                            |                                                                                                                                             |     |
| ITEM 2.                                                                                                         | Management’s  Discussion and Analysis of Financial Condition and~Results of Operations                                                      | 13       |
|                                                                                                            |                                                                                                                                             |     |
| ITEM 3.                                                                                                         | Quantitative  and Qualitative Disclosures About Market Risk                                                                                      | 29       |
|                                                                                                            |                                                                                                                                             |     |
| ITEM 4T.                                                                                                   | Controls and  Procedures                                                                                                                         | 30       |
|                                                                                                            |                                                                                                                                             |     |
| PART II:                                                                                                   | OTHER INFORMATION                                                                                                                                | 31       |

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Balance Sheets**

**September 30, 2008****(Unaudited) and****December 31, 2007****(Audited)**

** **
| ** **                                                                                                    | ** ** | **As of**         | ** **  |
|---------------------------------------------------------------------------------------------------------------|------------|------------------------|-------------|
| ** **                                                                                                    | ** ** | **September 30,** | ** **  | **December 31,** | ** ** |
| ** **                                                                                                    | ** ** | **2008**               | ** **  | **2007** | ** ** |
| **Assets**                                                                                                    |       |                   |        |   |   |
|                                                                                                          |       |                   |        |   |   |
| Cash and due  from banks                                                                                      |       | $                      | 15,281,314  |   | $ | 8,059,524 |   |
| Interest-bearing  deposits in other banks                                                                     |       | 753,215                |        | 514,654 |   |
| Federal funds  sold                                                                                           |       | 1,649,000              |        | 11,350,000 |   |
| Total cash and  cash equivalents                                                                              |       | 17,683,529             |        | 19,924,178 |   |
| Securities  available for sale, at fair value                                                                 |       | 101,369,092            |        | 74,387,100 |   |
| Other  investments, restricted, at cost                                                                       |       | 3,212,818              |        | 3,210,618 |   |
| Loans held for  sale                                                                                          |       | 692,915                |        | 679,427 |   |
| Loans, net of  unearned income                                                                                |       | 794,377,447            |        | 697,145,715 |   |
| Less - allowance  for loan losses                                                                             |       | (10,311,525            | )           | (8,878,795 | ) |
| Loans, net                                                                                                    |       | 784,065,922            |        | 688,266,920 |   |
| Bank premises  and equipment, net                                                                             |       | 29,405,669             |        | 27,899,376 |   |
| Accrued interest  receivable                                                                                  |       | 6,654,471              |        | 7,239,571 |   |
| Cash surrender  value of life insurance                                                                       |       | 12,330,493             |        | 4,442,044 |   |
| Goodwill and  other intangible assets, net of amortization                                                    |       | 22,535,246             |        | 22,806,983 |   |
| Other assets                                                                                                  |       | 8,567,155              |        | 3,622,847 |   |
| **Total  Assets**                                                                                             |       | $                      | 986,517,310 |   | $ | 852,479,064 |   |
|                                                                                                          |       |                   |        |   |   |
| **Liabilities  and Shareholders’ Equity**                                                                | ** ** | ** **             | ** **  | ** ** | ** ** |
| Deposits:                                                                                                     |       |                   |        |   |   |
| Non-interest  bearing                                                                                         |       | $                      | 46,904,930  |   | $ | 46,075,374 |   |
| Money market and  NOW accounts                                                                                |       | 144,415,478            |        | 111,029,210 |   |
| Savings                                                                                                       |       | 8,467,776              |        | 7,808,443 |   |
| Time deposits                                                                                                 |       | 646,663,007            |        | 540,318,896 |   |
| Total deposits                                                                                                |       | 846,451,191            |        | 705,231,923 |   |
| Federal funds  purchased                                                                                      |       | 191,000                |        | — |   |
| Federal Home  Loan Bank advances                                                                              |       | 30,500,000             |        | 40,500,000 |   |
| Junior  subordinated debentures                                                                               |       | 10,310,000             |        | 10,310,000 |   |
| Subordinated  debentures                                                                                      |       | 950,000                |        | — |   |
| Accrued interest  payable                                                                                     |       | 6,229,901              |        | 5,446,473 |   |
| Accrued expenses  and other liabilities                                                                       |       | 1,809,825              |        | 1,908,156 |   |
| Total  liabilities                                                                                            |       | 896,441,917            |        | 763,396,552 |   |
| Shareholders’  Equity:                                                                                   |       |                   |        |   |   |
| Preferred stock,  authorized 2,000,000 shares, outstanding -0- shares                                         |       | —                 |        | — |   |
| Common stock, $5  par value, authorized 10,000,000 shares, 4,151,780 issued and outstanding in  2008 and 2007 |       | 20,758,900             |        | 20,758,900 |   |
| Paid-in capital  surplus                                                                                      |       | 53,454,404             |        | 53,413,202 |   |
| Retained  earnings                                                                                            |       | 15,783,577             |        | 14,606,121 |   |
| Accumulated  other comprehensive income                                                                       |       | 78,512                 |        | 304,289 |   |
| Total  shareholders’ equity                                                                              |       | 90,075,393             |        | 89,082,512 |   |
| **Total  Liabilities and Shareholders’ Equity**                                                          |       | $                      | 986,517,310 |   | $ | 852,479,064 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Statements of Operations**

**Forthe Three Months and Nine Months Ended September 30, 2008 and 2007**

**(Unaudited)**

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                      | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
| **Interest  and Dividend Income:**                                              |       |                             |       |                            |       |   |   |   |   |
| Interest and  fees on loans                                                     |       | $                                | 12,591,813 |                            | $          | 14,303,957 |   | $ | 38,457,367 |   | $ | 40,948,229 |   |
| Interest on  securities:                                                        |       |                             |       |                            |       |   |   |   |   |
| Taxable income                                                                  |       | 824,416                          |       | 677,118                         |       | 2,167,990 |   | 1,852,529 |   |
| Non-taxable  income                                                             |       | 227,177                          |       | 177,072                         |       | 652,614 |   | 514,508 |   |
| Income on  federal funds sold                                                   |       | 35,594                           |       | 79,698                          |       | 148,977 |   | 445,494 |   |
| Other interest  and dividend income                                             |       | 48,652                           |       | 62,363                          |       | 204,398 |   | 211,579 |   |
| Total interest  and dividend income                                             |       | 13,727,652                       |       | 15,300,208                      |       | 41,631,346 |   | 43,972,339 |   |
| **Interest  Expense:**                                                          |       |                             |       |                            |       |   |   |   |   |
| Deposits                                                                        |       | 7,310,723                        |       | 7,524,581                       |       | 21,889,215 |   | 21,256,737 |   |
| Junior  subordinated debentures                                                 |       | 125,961                          |       | 196,482                         |       | 428,351 |   | 580,456 |   |
| Federal funds  purchased                                                        |       | 8,037                            |       | 23,369                          |       | 52,797 |   | 66,362 |   |
| FHLB borrowings  and other interest expense                                     |       | 261,671                          |       | 414,983                         |       | 996,515 |   | 1,209,052 |   |
| Total interest  expense                                                         |       | 7,706,392                        |       | 8,159,415                       |       | 23,366,878 |   | 23,112,607 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| Net interest income                                                             |       | 6,021,260                        |       | 7,140,793                       |       | 18,264,468 |   | 20,859,732 |   |
| **Provision  for loan losses**                                                  |       | 907,000                          |       | 48,000                          |       | 2,255,000 |   | 640,000 |   |
| Net interest  income after provision for loan losses                            |       | 5,114,260                        |       | 7,092,793                       |       | 16,009,468 |   | 20,219,732 |   |
| **Noninterest  Income:**                                                        |       |                             |       |                            |       |   |   |   |   |
| Service charges  on deposit accounts                                            |       | 455,318                          |       | 403,522                         |       | 1,312,536 |   | 990,910 |   |
| Other service  charges, commissions and fees                                    |       | 128,818                          |       | 101,147                         |       | 357,549 |   | 260,425 |   |
| Gain (loss) on  sales, calls and impairment write-down of investment securities |       | (1,160,895                       | )          | 3,408                           |       | (1,120,650 | ) | 3,101 |   |
| Gain (loss) on  sale of other assets                                            |       | (23,951                          | )          | 1,946                           |       | (37,436 | ) | 96,505 |   |
| Mortgage  origination income                                                    |       | 210,794                          |       | 276,288                         |       | 640,826 |   | 725,534 |   |
| Other income                                                                    |       | 245,851                          |       | 162,163                         |       | 923,082 |   | 471,150 |   |
| Total  noninterest income                                                       |       | (144,065                         | )          | 948,474                         |       | 2,075,907 |   | 2,547,625 |   |
| **Noninterest  Expense:**                                                       |       |                             |       |                            |       |   |   |   |   |
| Salaries                                                                        |       | 2,411,074                        |       | 1,950,593                       |       | 6,881,027 |   | 5,485,480 |   |
| Employee  benefits                                                              |       | 616,925                          |       | 669,720                         |       | 1,834,587 |   | 1,879,072 |   |
| Occupancy  expense                                                              |       | 482,284                          |       | 367,025                         |       | 1,393,955 |   | 1,047,063 |   |
| Equipment rental  and depreciation of equipment                                 |       | 318,108                          |       | 237,285                         |       | 862,418 |   | 628,939 |   |
| Other expenses                                                                  |       | 1,889,478                        |       | 1,658,511                       |       | 5,252,736 |   | 4,514,368 |   |
| Total  noninterest expense                                                      |       | 5,717,869                        |       | 4,883,134                       |       | 16,224,723 |   | 13,554,922 |   |
|                                                                            |       |                             |       |                            |       |   |   |   |   |
| **Earnings  (Loss) Before Income Taxes**                                        |       | (747,674                         | )          | 3,158,133                       |       | 1,860,652 |   | 9,212,435 |   |
| Income tax  benefit/(expense)                                                   |       | 400,799                          |       | (1,097,260                      | )          | (309,535 | ) | (3,210,082 | ) |
| **Net  Earnings (Loss)**                                                        |       | $                                | (346,875   | )                               | $          | 2,060,873 |   | $ | 1,551,117 |   | $ | 6,002,353 |   |
| **Earnings  (Loss) per share:**                                                 |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                           |       | $                                | (0.08      | )                               | $          | 0.50 |   | $ | 0.37 |   | $ | 1.47 |   |
| Diluted                                                                         |       | $                                | (0.08      | )                               | $          | 0.46 |   | $ | 0.35 |   | $ | 1.35 |   |
| **Dividends  declared per share:**                                              |       | $                                | 0.03       |                            | $          | — |   | $ | 0.09 |   | $ | — |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Statements of Comprehensive Income**

**Forthe Three Months and Nine Months Ended September 30, 2008 and 2007**

**(Unaudited)**

 
| ** **                                                                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                    | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| Net earnings  (loss)                                                                          |       | $                                                        | (346,875   | )                                                       | $          | 2,060,873 |   | $ | 1,551,117 |   | $ | 6,002,353 |   |
| Other comprehensive  income (loss):                                                           |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrealized  holding gain (losses) on investment securities available for sale                 |       | (463,367                                                 | )          | 1,125,727                                               |       | (1,462,738 | ) | 94,076 |   |
| Unrealized  holding gains on derivative financial instruments classified as cash flow  hedges |       | —                                                   |       | 30,230                                                  |       | — |   | 114,465 |   |
| Reclassification  adjustment for (gains) losses realized in net earnings                      |       | 1,160,895                                                |       | (3,408                                                  | )          | 1,120,650 |   | (3,101 | ) |
| Total other  comprehensive income (loss), before tax                                          |       | 697,528                                                  |       | 1,152,549                                               |       | (342,088 | ) | 205,440 |   |
| Income taxes  related to other comprehensive (income) loss:                                   |       |                                                     |       |                                                    |       |   |   |   |   |
| Unrealized  holding (gains) losses on investment securities available for sale                |       | 157,545                                                  |       | (382,748                                                | )          | 497,331 |   | (31,985 | ) |
| Unrealized  holding gains on derivative financial instruments classified as cash flow hedges  |       | —                                                   |       | (10,277                                                 | )          | — |   | (38,918 | ) |
| Reclassification  adjustment for gains (losses) realized in net earnings                      |       | (394,704                                                 | )          | 1,159                                                   |       | (381,020 | ) | 1,055 |   |
| Total income  taxes related to other comprehensive (income) loss                              |       | (237,159                                                 | )          | (391,866                                                | )          | 116,311 |   | (69,848 | ) |
| Total other  comprehensive income (loss), net of tax                                          |       | 460,369                                                  |       | 760,683                                                 |       | (225,777 | ) | 135,592 |   |
| Total  comprehensive income                                                                   |       | $                                                        | 113,494    |                                                    | $          | 2,821,556 |   | $ | 1,325,340 |   | $ | 6,137,945 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Statements of Cash Flows**

**Forthe Nine Months Ended September 30, 2008 and 2007**

**(Unaudited)**

** **
| ** **                                                                                  | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                  | ** ** | **2008**                                                | ** ** | **2007** | ** ** |
| **Cash  Flows from Operating Activities:**                                                  |       |                                                    |       |   |   |
| Net earnings                                                                                |       | $                                                       | 1,551,117  |   | $ | 6,002,353 |   |
| Adjustments to  reconcile net earnings to net cash provided by operating activities:        |       |                                                    |       |   |   |
| Provision for  loan losses                                                                  |       | 2,255,000                                               |       | 640,000 |   |
| Depreciation                                                                                |       | 1,072,085                                               |       | 781,144 |   |
| Stock based  compensation                                                                   |       | 41,202                                                  |       | 17,952 |   |
| Amortization and  (accretion), net                                                          |       | 233,401                                                 |       | 147,752 |   |
| (Gain) loss on  sales and impairment of other assets                                        |       | 119,505                                                 |       | (96,505 | ) |
| (Gain) loss on  sales, calls and impairment write-down of investment securities             |       | 1,120,650                                               |       | (3,101 | ) |
| Earnings on cash  surrender value of life insurance                                         |       | (388,449                                                | )          | (131,593 | ) |
| Changes in  assets and liabilities, net of effects of purchase acquisition in 2007:         |       |                                                    |       |   |   |
| Loans held for  sale                                                                        |       | (13,488                                                 | )          | (1,659,272 | ) |
| Changes in  accrued income and other assets                                                 |       | (1,306,061                                              | )          | 358,745 |   |
| Changes in  accrued expenses and other liabilities                                          |       | 801,407                                                 |       | 1,977,627 |   |
| Net cash  provided by operating activities                                                  |       | 5,486,369                                               |       | 8,035,102 |   |
| **Cash  Flows from Investing Activities, net of effects of purchase acquisition in  2007:** |       |                                                    |       |   |   |
| Net change in  loans to customers                                                           |       | (101,892,953                                            | )          | (81,045,120 | ) |
| Purchase of  available for sale securities                                                  |       | (51,214,050                                             | )          | (14,336,829 | ) |
| Proceeds from  sales, calls, maturities and paydowns of available for sale securities       |       | 22,778,346                                              |       | 7,789,165 |   |
| Cash received  from First Community, net of cash paid of $235,034                           |       | —                                                  |       | 5,556,520 |   |
| Cash paid to  Sapelo shareholders                                                           |       | —                                                  |       | (5,322,492 | ) |
| Purchase of  other investments                                                              |       | (686,200                                                | )          | (292,900 | ) |
| Proceeds from  sale of other investments                                                    |       | 684,000                                                 |       | — |   |
| Purchase of cash  surrender value of life insurance                                         |       | (7,500,000                                              | )          | — |   |
| Property and  equipment expenditures                                                        |       | (2,578,378                                              | )          | (8,434,964 | ) |
| Cash paid for  improvements of other assets                                                 |       | 117,259                                                 |       | — |   |
| Proceeds from  sales of assets                                                              |       | 578,351                                                 |       | 413,857 |   |
| Net cash used in  investing activities                                                      |       | (139,713,625                                            | )          | (95,672,763 | ) |
| **Cash  Flows from Financing Activities, net of effects of purchase acquisition in  2007:** |       |                                                    |       |   |   |
| Net change in  deposits                                                                     |       | 141,219,268                                             |       | 70,358,099 |   |
| Net increase in  federal funds purchased                                                    |       | 191,000                                                 |       | — |   |
| Advances on FHLB  borrowings                                                                |       | 20,200,000                                              |       | 28,400,000 |   |
| Payments on FHLB  borrowings                                                                |       | (30,200,000                                             | )          | (28,400,000 | ) |
| Proceeds from  subordinated debentures                                                      |       | 950,000                                                 |       | — |   |
| Payment for  fractional shares                                                              |       | —                                                  |       | (10,320 | ) |
| Payment for  issuance of common stock                                                       |       | —                                                  |       | (87,726 | ) |
| Dividends paid                                                                              |       | (373,661                                                | )          | — |   |
| Net cash  provided by financing activities                                                  |       | 131,986,607                                             |       | 70,260,053 |   |
| **Net  Decrease in Cash and Cash Equivalents**                                              |       | (2,240,649                                              | )          | (17,377,608 | ) |
| **Cash  and Cash Equivalents, Beginning of Year**                                           |       | 19,924,178                                              |       | 42,911,477 |   |
| **Cash  and Cash Equivalents, End of Quarter**                                              |       | $                                                       | 17,683,529 |   | $ | 25,533,869 |   |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

# ***(1)****        **Basis of Presentation*

# ** **

Theaccompanying unaudited consolidated financial statements have been prepared inaccordance with the instructions to Form 10-Q and therefore do not includeall information and footnotes necessary for a fair presentation of financialposition, results of operations, and changes in financial position inconformity with generally accepted accounting principles.  The interim financial statements furnishedreflect all adjustments, which are, in the opinion of management, necessary toa fair statement of the results for the interim periods presented.  The interim consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2007.  Certain reclassifications have been made to the 2007 financial statementpresentation to correspond to the current year’s format.

 

***(2)******        ******Stock-BasedCompensation***

 

The Company granted12,000 options during 2008 and 8,000 options during 2007.  The Company recognized $29,234 and$5,984 of stock-based employee compensation expense during the three monthsended September 30, 2008 and 2007, respectively, and $41,202 and $17,952of stock-based compensation expense during the nine months ended September 30,2008 and 2007, respectively, associated with its stock option grants.  The Company is recognizing the compensationexpense for stock option grants with graded vesting schedules on astraight-line basis over the requisite service period of the award as permittedby SFAS No. 123 (R).  As of September 30,2008, there was $136,582 of unrecognized compensation cost related to stockoption grants.  The cost is expected tobe recognized over the vesting period of approximately four years.

 

The weighted average grant-datefair value of each option granted during 2008 and 2007 was $6.87 and $14.96,respectively.  The fair value of eachoption is estimated on the date of grant using the Black-Scholes Model.  The following weighted average assumptionswere used for grants in 2008 and 2007:

 
| ** **               | ** ** | **2008**  | ** ** | **2007**  | ** ** |
|--------------------------|------------|-----------|------------|-----------|------------|
| Dividend yield           |       | 0.80      | %          | 0.00      | %          |
| Expected  volatility     |       | 35.59     | %          | 21.58     | %          |
| Risk-free  interest rate |       | 3.33      | %          | 4.75      | %          |
| Expected term            |       | 7.5 years |       | 7.5 years |       |

 

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

# ** **

Basic earnings per share are based on the weightedaverage number of common shares outstanding during the period while the effectsof potential shares outstanding during the period are included in dilutedearnings per share.

 

Thereconciliation of the amounts used in the computation of both “basic earningsper share” and “diluted earnings per share” for each period is presented asfollows:

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                  | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                                  | ** ** | **2008**                         | ** ** | **2007**                        | ** ** | **2008** | ** ** | **2007** | ** ** |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Net earnings  (loss)                                                        |       | $                                | (346,875   | )                               | $          | 2,060,873 |   | $ | 1,551,117 |   | $ | 6,002,353 |   |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Weighted average  common shares outstanding                                 |       | 4,151,780                        |       | 4,151,780                       |       | 4,151,780 |   | 4,092,215 |   |
| Shares issued  from assumed exercise of common stock equivalents            |       | 186,413                          |       | 331,887                         |       | 227,819 |   | 342,049 |   |
| Weighted average  number of common and common equivalent shares outstanding |       | 4,338,193                        |       | 4,483,667                       |       | 4,379,599 |   | 4,434,264 |   |
| Earnings (loss)  per share:                                                 |       |                             |       |                            |       |   |   |   |   |
| Basic                                                                       |       | $                                | (0.08      | )                               | $          | 0.50 |   | $ | 0.37 |   | $ | 1.47 |   |
|                                                                        |       |                             |       |                            |       |   |   |   |   |
| Diluted                                                                     |       | $                                | (0.08      | )                               | $          | 0.46 |   | $ | 0.35 |   | $ | 1.35 |   |

 

***(4)   Fair Value***

 

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

 

TheCompany utilizes fair value measurements to record fair value adjustments tocertain assets and liabilities and to determine fair value disclosures.  Securities available-for-sale, derivativeinstruments and certain brokered deposits are recorded at fair value on arecurring basis.  Additionally, from timeto time, the Company may be required to record at fair value other assets on anonrecurring basis, such as loans held for sale, loans held for investment andcertain other assets.  These nonrecurringfair value adjustments typically involve application of lower of cost or marketaccounting or write-downs of individual assets.

 

FairValue Hierarchy

 

UnderSFAS 157, the Company groups assets and liabilities at fair value in threelevels, based on the markets in which the assets and liabilities are traded andthe reliability of the assumptions used to determine fair value.  These levels are:

 

Level 1 – Valuation isbased upon quoted prices for identical instruments traded in active markets.

 

Level 2 – Valuation is based upon quoted prices forsimilar instruments in active markets, quoted prices for identical or similarinstruments in markets that are not active, and model-based valuationtechniques for which all significant assumptions are observable in the market.

 

Level 3 – Valuation is generated from model-basedtechniques that use at least one significant assumption not observable in themarket.  These unobservable assumptionsreflect estimates of assumptions that market participants would use in pricingthe asset or liability.  Valuationtechniques include use of option pricing models, discounted cash flow modelsand similar techniques.

 

Followingis a description of valuation methodologies used for assets and liabilitiesrecorded at fair value.

 

SecuritiesAvailable-for-Sale

 

Securitiesavailable-for-sale are recorded at fair value on a recurring basis.  Fair value measurement is based upon quotedprices, if available.  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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

assumptions.  Level 1 securities include those traded on anactive exchange, such as the New York Stock Exchange and U.S. Treasurysecurities that are traded by dealers or brokers in active over-the-countermarket funds.  Level 2 securities includemortgage-backed securities issued by government sponsored enterprises andmunicipal bonds.  Securities classifiedas Level 3 include asset-backed securities in less liquid markets.

 

LoansHeld for Sale

 

Loansheld for sale are recorded at the lower of cost or market value.  The fair value of loans held for sale isbased on what secondary markets are currently offering for portfolios withsimilar characteristics.  As such, theCompany classifies loans held for sale subject to nonrecurring fair valueadjustments as Level 2.

 

Loans

 

TheCompany does not record 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 in accordance with SFAS 114, *Accounting by Creditors for Impairment of a Loan*, (“SFAS 114”).  The fair value of impaired loans is estimatedusing one of several methods, including collateral value, market value ofsimilar debt, enterprise value, liquidation value and discounted cashflows.  Those impaired loans not requiringan allowance represent loans for which the fair value of the expectedrepayments or collateral exceed the recorded investments in such loans.  At September 30, 2008, only a smallportion of the impaired loans were evaluated based on the fair value of thecollateral.  In accordance with SFAS 157,impaired loans where an allowance is established based on the fair value ofcollateral require 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.

 

ForeclosedAssets

 

Foreclosedassets are adjusted to fair value upon transfer of the loans to foreclosedassets.  Subsequently, foreclosed assetsare 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 foreclosed asset as nonrecurring Level2.  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, theCompany records the foreclosed asset as nonrecurring Level 3.

 

Goodwilland Other Intangible Assets

 

Goodwilland identified intangible assets are subject to impairment testing.  A current market valuation method is used toanalyze the carrying value of goodwill for impairment.  This valuation method estimates the fairvalue of the Bank based on the price that would be received to sell the Bank asa whole in an orderly transaction between market participants at the measurementdate.  This valuation method requires asignificant degree of management judgment. In the event the valuation value for the Bank is less than the carryingvalue of goodwill, the asset amount is recorded at fair value as determined bythe valuation model.  As such, theCompany classifies goodwill and other intangible assets subjected tononrecurring fair value adjustments as Level 3.

 

Assetsand 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.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 
| ** **                      | ** ** | **As of September 30,** | ** **  |
|---------------------------------|------------|----------------------------------------|-------------|
| ** **                      | ** ** | **2008**                               | ** **  |
| ** **                      | ** ** | **Total**                              | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                      |       |                                   |        |   |   |   |   |   |   |
| Securities  available-for-sale  |       | $                                      | 101,369,092 |   | $ | 18,820,999 |   | $ | 82,298,093 |   | $ | 250,000 |   |
| **Total  assets at fair value** |       | $                                      | 101,369,092 |   | $ | 18,820,999 |   | $ | 82,298,093 |   | $ | 250,000 |   |

 

Therewas no change in the unrealized gain/loss for the Level 3 assets during theperiod.

 

AssetsRecorded at Fair Value on a Nonrecurring Basis

 

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

 
| ** **                        | ** ** | **As of September 30,** | ** ** |
|-----------------------------------|------------|----------------------------------------|------------|
| ** **                        | ** ** | **2008**                               | ** ** |
| ** **                        | ** ** | **Total**                              | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Loans                             |       | $                                      | 6,054,775  |   | $ | — |   | $ | 6,054,775 |   | $ | — |   |
| Other assets -  foreclosed assets |       | 3,342,024                              |       | — |   | 3,342,024 |   | — |   |
| **Total  assets at fair value**   |       | $                                      | 9,396,799  |   | $ | — |   | $ | 9,396,799 |   | $ | — |   |

 

***(5)   Impairment of Investment in Preferred Stock***

 

On October 1, 2008,the Company determined that at September 30, 2008 the value of itsinvestment in the preferred stock of the Federal Home Loan Mortgage Corporation(“Freddie Mac”) and the Federal National Mortgage Association (“Fannie Mae”)was impaired.  On September 7, 2008,the United States Department of Treasury and the Federal Housing Finance Agency(the “FHFA”) announced, among other things, that Freddie Mac and Fannie Maewere being placed under conservatorship, that control of their management wasbeing given to their regulator, the FHFA, and that Fannie Mae and Freddie Macwere prohibited from paying dividends on their common and preferred stock.  Following this announcement, the estimatedfair market value of the Company’s investment in Freddie Mac and Fannie Maepreferred stock has declined significantly and it remains unclear when and ifthe value of this investment will improve. The Company has 5,365 shares of Freddie Mac series F preferred stock and40,000 shares of Fannie Mae series R preferred stock.  As of the market close on September 30,2008, the total market value of these securities declined to $84,725, resultingin an unrealized loss, on a pre-tax basis, to the Company on these securitiesof $1,165,284.  As a result of theseevents, the Company recorded a non-cash other than temporary impairment onthese securities for the quarter ended September 30, 2008 in the amount of$722,477, net of tax benefit.  Managementutilized tax planning strategies that anticipated future capital gains andenabled the Company to record the deferred tax benefit associated with theimpairment.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

***(6)******        ******NonperformingAssets***

 

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

 
| ** **                       | ** ** | **September 30.** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Accruing loans  90 days past due |       | $                      | —     |                  | $          | 504,783 |   |
| Non-accrual  loans               |       | 8,718,913              |       | 4,276,950             |       |
| Repossessed  assets              |       | 23,783                 |       | —                |       |
| Other real  estate               |       | 3,862,925              |       | 758,787               |       |
| Total  non-performing assets     |       | $                      | 12,605,621 |                  | $          | 5,540,520 |   |

 

Nonperformingassets increased $7.1 million or 128% from December 31, 2007 to September 30,2008.  In July 2008, managementplaced one loan with a balance of approximately $5.5 million on non-accrual that is secured bya condominium complex and other commercial real estate property appraised atapproximately $7.3 million.  Managementis continuously monitoring the non-accrual loans to minimize any losses.

 

At September 30,2008, the Company’s other real estate consisted of the following:

 
| 1-4 Family  residential properties                   |   | 3  |   | $       | 2,898,768 |   |
|------------------------------------------------------|--------|----|--------|---------|-----------|--------|
| Construction &  land development properties |   | 8  |   | 964,157 |      |
| Total                                                |   | 11 |   | $       | 3,862,925 |   |

 

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

 

TheCompany’s policy is to place loans on non-accrual status when it appears thatthe collection of interest in accordance with the terms of the loan isdoubtful.  Any loan which becomes 90 dayspast due as to principal or interest is automatically placed on non-accrual.  Exceptions are allowed for 90-day past dueloans when such loans are well secured and in process of collection.  Other Real Estate is defined as real estateacquired as salvage on uncollectible loans. At the time of foreclosure, an appraisal is obtained on the realestate.  The amount charged to Other RealEstate will be the lower of appraised value or recorded investment in the loansatisfied.  The recorded investment isthe unpaid balance of the loan, increased by accrued and uncollected interest,unamortized premium, finance charges, and loan acquisition costs, if any, anddecreased by previous direct write down and unamortized discount.  Any excess of the recorded investment in theloan satisfied over the appraised value of the property must be charged toallowance for loan losses.

 

***(7)******        ******SubordinatedDebentures***

 

OnSeptember 30, 2008, the Bank issued an aggregate of $950,000 in fixed ratesubordinated debentures, which will mature on September 30, 2018 (the “Notes”),to several bank directors.  Interest onthe Notes is fixed at 12% per annum, subject to an adjustment by the Bank on orbefore December 31, 2008 that may increase the annual rate, but suchincrease will not exceed 12.5%.  Theinterest will be payable semiannually in arrears on June 30 and December 31of each year.  The Bank may redeem all orsome of the Notes at any time beginning on September 30, 2013 at a priceequal to 100% of the principal amount of such Notes redeemed plus accrued, butunpaid, interest to the redemption date. Payment of the principal on the Notes may be accelerated by holders ofthe Notes only in the case of the Bank’s insolvency or liquidation.  There is no right of acceleration in the caseof default in payment of principal or interest on the Notes.  The proceeds will be used to help the Bankremain well capitalized under the federal prompt corrective actionguidelines.  The subordinated debenturesqualify as Tier II capital under risk-based capital guidelines.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

***(8)******        ******RecentAccounting Pronouncement and Industry Events***

 

*Disclosures about DerivativeInstruments and Hedging Activities*

 

In March 2008, theFASB issued SFAS No. 161, *Disclosures aboutDerivative Instruments and Hedging Activities*.  SFAS No. 161 is an amendment to SFAS No. 133,*Accounting for Derivative Instruments and HedgingActivities*.  The objective ofSFAS No. 161 is to expand the disclosure requirements of SFAS No. 133with the intent to improve the financial reporting of how and why an entityuses derivative instruments; how derivative instruments and related hedgeditems are accounted for under SFAS No. 133 and its related interpretations;and how derivative instruments and related hedged items affect an entity’sfinancial position, financial performance and cash flows.  The statement is effective for financialstatements issued for fiscal years beginning after November 15, 2008.  The Companydoes not anticipate the new accounting principle to have a material effect onits financial position or results of operation.

 

In May 2008, theFASB issued SFAS No. 162, *The Hierarchy of GenerallyAccepted Accounting Principles*. SFAS No. 162 identifies the sources of accounting principles andthe framework for selecting the principles to be used in the preparation offinancial statements of nongovernmental entities that are presented inconformity with generally accepted accounting principles (GAAP) in the UnitedStates (the GAAP hierarchy).  The currentGAAP hierarchy, as set forth in the American Institute of Certified PublicAccountants (AICPA) Statement on Auditing Standards No. 69, *The Meaning of Present Fairly in Conformity With Generally AcceptedAccounting Principles*, has been criticized because (1) it isdirected to the auditor rather than the entity, (2) it is complex, and (3) itranks FASB Statements of Financial Accounting Concepts, which are subject tothe same level of due process as FASB Statements of Financial AccountingStandards, below industry practices that are widely recognized as generallyaccepted but that are not subject to due process.  The FASB believes that the GAAP hierarchyshould be directed to entities because it is the entity (not its auditor) thatis responsible for selecting accounting principles for financial statementsthat are presented in conformity with GAAP. Accordingly, the FASB concluded that the GAAP hierarchy should reside inthe accounting literature established by the FASB and is issuing this Statementto achieve that result.  TheCompany does not anticipate the new accounting principle to have a materialeffect on its financial position or results of operation.

 

In October 2008, the FASB issuedFSP FAS 157-3, *Determining the Fair Value of a FinancialAsset When the Market for That Asset is Not Active*.  This FASB Staff Position clarifies theapplication of SFAS No. 157, *Fair Value Measurements*,in a market that is not active and provides an example to illustrate keyconsiderations in determining the fair value of a financial asset when themarket for that financial asset is not active. FSP FAS 157-3 provides guidance on (1) how an entity’s ownassumption should be considered when measuring fair value when relevantobservable inputs do not exist, (2) how available observable inputs in amarket that is not active should be considered when measuring fair value and (3) howthe use of market quotes should be considered when assessing the relevance ofobservable and unobservable inputs available to measure fair value.  This FASB Staff Position is effectiveimmediately.  The Company does not anticipate the newaccounting principle to have a material effect on its financial position orresults of operation.

 

On October 3, 2008,Congress passed the Emergency Economic Stabilization Act of 2008 (“EESA”),which creates the Troubled Asset Relief Program (“TARP”) and provides the U.S. Secretary of the Treasury with broadauthority to implement certain actions to help restore stability and liquidityto U.S. markets. The Capital Purchase Program (the “CPP”) was announced by theU.S. Treasury on October 14, 2008 as part of TARP.  Pursuant to the CPP,the U.S. Treasury will purchase up to $250 billion of senior preferred shareson standardized terms from qualifying financial institutions. The purpose ofthe CPP is to encourage U.S. financial institutions to build capital toincrease the flow of financing to U.S. businesses and consumers and to supportthe U.S. economy.  The CPP is voluntaryand requires a participating institution to comply with a number ofrestrictions and provisions, including standards for executive compensation andcorporate governance and limitations on share repurchases and the declarationand payment of dividends on common shares. The CPP allows qualifying financial institutions to issue seniorpreferred shares to the U.S. Treasury in aggregate amounts between 1 percentand 3 percent of the institution’s risk weighted assets (“Senior PreferredShares”).   The Senior Preferred Shares will qualify as Tier 1 capital andrank senior to our common stock.  TheSenior Preferred Shares will pay a cumulative dividend rate of 5 percent perannum for the first five years and will reset

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

to a rate of 9 percentper annum after year five.  The Senior Preferred Shares will benon-voting, other than class voting rights on matters that could adverselyaffect the shares.  The Senior Preferred Shares will be callable at parafter three years.  Prior to the end of three years, the Senior PreferredShares may be redeemed with the proceeds from a qualifying equity offering ofany Tier 1 perpetual preferred or common stock.  U.S. Treasury may alsotransfer the Senior Preferred Shares to a third party at any time.  Inconjunction with the purchase of Senior Preferred Shares, Treasury will receivewarrants to purchase common stock with an aggregate market price equal to 15percent of the Senior Preferred Shares.  The exercise price on thewarrants will be the market price of the participating institution’s commonstock at the time of issuance, calculated on a 20-trading day trailing average. Companies participating in the CPP must adopt the U.S. Treasury’sstandards for executive compensation and corporate governance.  TheCompany is currently evaluating its participation in the CPP.

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Item 2. Management’s Discussion and Analysis of Financial Condition andResults of Operations**

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

**September 30, 2008 and 2007**

 

The following discussion of financial condition as of September 30, 2008 compared to December 31, 2007, and theresults of operations for the three months and nine months ended September 30, 2008 compared tothe three months and nine months ended September 30,2007 should be read in conjunction with the condensed financialstatements and accompanying footnotes appearing in this report.

 

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

##### *** ***

The statements contained in this reporton Form 10-Q that are not historical facts are forward-looking statementssubject to the safe harbor created by the Private Securities Litigation ReformAct of 1995.  We caution readers of thisreport that such forward-looking statements involve known and unknown risks,uncertainties and other factors which may cause the actual results, performanceor achievements to be materially different from those expressed or implied bysuch forward-looking statements. Although we believe that our expectations of future performance is basedon reasonable assumptions within the bounds of our knowledge of our businessand operations, there can be no assurance that actual results will not differmaterially from our expectations.

 

Factors which could cause actual resultsto differ from expectations include, among other things:

 

·                  the challenges, costs andcomplications associated with the continued development of our branches;

·                  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;

·                  our dependence on seniormanagement;

·                  competition from existingfinancial institutions operating in our market areas as well as the entry intosuch areas of new competitors with greater resources, broader branch networksand more comprehensive services;

·                  adverse conditions in the stockmarket, the public debt market, and other capital markets (including changes ininterest rate conditions);

·                  the effect of any mergers,acquisitions or other transactions to which we or our subsidiary may from timeto time be a party, including, without limitation, our ability to successfullyintegrate any businesses that we acquire;

·                  changes in deposit rates, the netinterest 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 United Stateseconomy in general and the strength of the local economies in which we conductoperations may be different than expected resulting in, among other things, adeterioration in credit quality or a reduced demand for credit, including theresultant effect on our loan portfolio and allowance for loan losses;

·                  fluctuations in consumer spendingand saving habits;

·                  the demand for our products andservices;

·                  technological changes;

·                  the challenges and uncertaintiesin the implementation of our expansion and development strategies;

·                  the ability to increase marketshare;

·                  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;

·                  the potential negative effects offuture legislation affecting financial institutions (including, withoutlimitation, laws concerning taxes, banking, securities, and insurance);

·                  the effects of, and changes in,trade, monetary and fiscal policies and laws, including interest rate policiesof 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;

·                  the impact on our business, aswell as on the risks set forth above, of various domestic or internationalmilitary or terrorist activities or conflicts;

 

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

·                  Our success at managing the risksinvolved in the foregoing.

 

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

#### ** **

**ExecutiveSummary and Recent Developments**

 

### **The Company’s total assets at September 30,2008, were approximately $986,517,000, which represented an increase ofapproximately $134,038,000 or 16% from December 31, 2007.  Net earnings decreased 74% for the ninemonths ended September 30, 2008 to $1,551,000 or $0.35 per diluted sharecompared to $6,002,000 or $1.35 per diluted share for the nine months ended September 30,2007.**

### ** **

OnJanuary 10, 2008, the Company declared a first quarter dividend of $0.03per share to all shareholders of record as of February 1, 2008.  On April 11, 2008, the Company announceda second quarter dividend of $0.03 per share to all shareholders of record asof May 1, 2008.  On July 18,2080, the Company announced a third quarter dividend of $0.03 per share to allshareholders of record as of August 1, 2008.  On October 24, 2008, however, theCompany announced that it was suspending the fourth quarter dividend.  While the dividends were small in comparisonto overall earnings, the Company wants to retain appropriate amounts of capitalto facilitate the growth of the Bank. Any future determination relating to the Company declaring dividendswill be made at the discretion of our Board of Directors and will depend on anystatutory and regulatory limitations.  Inaddition, if the Company participates in the TARP Capital Purchase Program asit is currently structured, it will be unable to pay cash dividends on itscommon stock without prior governmental permission for a period of three yearsfrom the date of its participation, unless the issued securities are no longerheld by the U.S. Treasury Department.

 

Duringthe first quarter of 2008, the Company added a wealth management division inanticipation of increasing non-interest income. The Company has hired a seasoned financial advisor to provide financialservices including retirement planning, estate planning and asset allocationstrategies.

 

OnOctober 1, 2008, the Company determined that at September 30, 2008the value of its investment in the preferred stock of the Federal Home Loan MortgageCorporation (“Freddie Mac”) and the Federal National Mortgage Association (“FannieMae”) was impaired.  On September 7,2008, the United States Department of Treasury and the Federal Housing FinanceAgency (the “FHFA”) announced, among other things, that Freddie Mac and FannieMae were being placed under conservatorship, that control of their managementwas being given to their regulator, the FHFA, and that Fannie Mae and FreddieMac were prohibited from paying dividends on their common and preferredstock.  Following this announcement, theestimated fair market value of the Company’s investment in Freddie Mac andFannie Mae preferred stock has declined significantly and it remains unclearwhen and if the value of this investment will improve.  The Company has 5,365 shares of Freddie Macseries F preferred stock and 40,000 shares of Fannie Mae series R preferredstock.  As of the market close on September 30,2008, the total market value of these securities declined to $84,725, resultingin an unrealized loss, on a pre-tax basis, to the Company on these securitiesof $1,165,284.  As a result of theseevents, the Company recorded a non-cash other than temporary impairment onthese securities for the quarter ended September 30, 2008 in the amount of$722,477, net of tax benefit.  Managementutilized tax planning strategies that anticipated future capital gains andenabled the Company to record the deferred tax benefit associated with theimpairment.

 

OnSeptember 30, 2008, the Bank issued an aggregate of $950,000 in fixed ratesubordinated debentures, which will mature on September 30, 2018, toseveral bank directors.  Interest on theNotes is fixed at 12% per annum, subject to an adjustment by the Bank on orbefore December 31, 2008 that may increase the annual rate, but suchincrease will not exceed 12.5%.  Theinterest will be payable semiannually in arrears on June 30 and December 31of each year.  The Bank may redeem all orsome of the Notes at any time beginning on September 30, 2013 at a priceequal to 100% of the principal amount of such Notes redeemed plus accrued, butunpaid, interest to the redemption date. Payment of the principal on the Notes may be accelerated by holders ofthe Notes only in the case of the Bank’s insolvency or liquidation.  There is no right of acceleration in the caseof default in payment of principal or interest on the Notes.

 

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Theproceeds will be used to help the Bank remain well capitalized under thefederal prompt corrective action guidelines. The subordinated debentures qualify as Tier II capital under risk-basedcapital guidelines.

 

OnOctober 3, 2008, Congress passed the Emergency Economic Stabilization Actof 2008 (“EESA”), which creates the Troubled Asset Relief Program (“TARP”) and provides the U.S. Secretaryof the Treasury with broad authority to implement certain actions to helprestore stability and liquidity to U.S. markets. The Capital Purchase Program(the “CPP”) was announced by the U.S. Treasury on October 14, 2008 as partof TARP.  Pursuant to the CPP, the U.S. Treasury willpurchase up to $250 billion of senior preferred shares on standardized termsfrom qualifying financial institutions. The purpose of the CPP is to encourageU.S. financial institutions to build capital to increase the flow of financingto U.S. businesses and consumers and to support the U.S. economy.  The CPP is voluntary and requires a participatinginstitution to comply with a number of restrictions and provisions, includingstandards for executive compensation and corporate governance and limitationson share repurchases and the declaration and payment of dividends on commonshares.  The CPP allows qualifyingfinancial institutions to issue senior preferred shares to the U.S. Treasury inaggregate amounts between 1 percent and 3 percent of the institution’s riskweighted assets (“Senior Preferred Shares”).   The Senior Preferred Shareswill qualify as Tier 1 capital and rank senior to our common stock.  The Senior Preferred Shares will pay acumulative dividend rate of 5 percent per annum for the first five years andwill reset to a rate of 9 percent per annum after year five.  The SeniorPreferred Shares will be non-voting, other than class voting rights on mattersthat could adversely affect the shares.  The Senior Preferred Shares willbe callable at par after three years.  Prior to the end of three years,the Senior Preferred Shares may be redeemed with the proceeds from a qualifyingequity offering of any Tier 1 perpetual preferred or common stock.  U.S.Treasury may also transfer the Senior Preferred Shares to a third party at anytime.  In conjunction with the purchase of Senior Preferred Shares,Treasury will receive warrants to purchase common stock with an aggregatemarket price equal to 15 percent of the Senior Preferred Shares.  Theexercise price on the warrants will be the market price of the participatinginstitution’s common stock at the time of issuance, calculated on a 20-tradingday trailing average.  Companies participating in the CPP must adopt theU.S. Treasury’s standards for executive compensation and corporate governance. The Company is currently evaluating its participation in the CPP.

 

**FinancialCondition**

 

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

 
| ** **                              | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | ** **        | ** ** | ** **        | ** ** |
|-----------------------------------------|------------|------------------------|------------|-----------------------|------------|-------------------|------------|-------------------|------------|
| ** **                              | ** ** | **2008**               | ** ** | **2007**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| **Assets:**                             |       |                   |       |                  |       |              |       |              |       |
| Cash and due  from banks                |       | $                      | 15,281,314 |                  | $          | 8,059,524         |       | $                 | 7,221,790  |   | 89.61 | % |
| Federal funds  sold                     |       | 1,649,000              |       | 11,350,000            |       | (9,701,000        | )          | -85.47            | %          |
| Securities  available for sale          |       | 101,369,092            |       | 74,387,100            |       | 26,981,992        |       | 36.27             | %          |
| Loans, net of  unearned income          |       | 794,377,447            |       | 697,145,715           |       | 97,231,732        |       | 13.95             | %          |
| Cash surrender  value of life insurance |       | 12,330,493             |       | 4,442,044             |       | 7,888,449         |       | 177.59            | %          |
| Goodwill and  other intangible assets   |       | 22,535,246             |       | 22,806,983            |       | (271,737          | )          | -1.19             | %          |
| Total assets                            |       | 986,517,310            |       | 852,479,064           |       | 134,038,246       |       | 15.72             | %          |
| **Liabilities:**                        |       |                   |       |                  |       |              |       |              |       |
| Deposits                                |       | 846,451,191            |       | 705,231,923           |       | 141,219,268       |       | 20.02             | %          |
| Federal funds  purchased                |       | 191,000                |       | —                |       | 191,000           |       | 100.00            | %          |
| Federal Home  Loan Bank advances        |       | 30,500,000             |       | 40,500,000            |       | (10,000,000       | )          | -24.69            | %          |
| Subordinated  debentures                |       | 950,000                |       | —                |       | 950,000           |       | 100.00            | %          |
| Accrued expenses  and other liabilities |       | 1,809,825              |       | 1,908,156             |       | (98,331           | )          | -5.15             | %          |
| Total  liabilities                      |       | 896,441,917            |       | 763,396,552           |       | 133,045,365       |       | 17.43             | %          |
|                                    |       |                   |       |                  |       |              |       |              |       |
| Loan to Deposit  Ratio                  |       | 93.85                  | %          | 98.85                 | %          |              |       |              |       |
|                                         |            |                        |            |                       |            |                   |            |                   |            |  |  |  |

 

Onesignificant change in the composition of assets was the increase in loans of$97.2 million due to continued growth of the Company.  We were able to generate loan growth byincreasing loan growth in all regions with the

 

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majorityof the increase in the middle Georgia region. Another significant change in the composition of assets was the $7.9million increase in the cash surrender value of life insurance.  The majority of the increase is due to theCompany’s purchase of $7.5 million additional life insurance policies onseveral senior bank officers.  The mostsignificant change in the composition of liabilities was the increase indeposits, especially time deposits, to fund loan growth.  Time deposits, including wholesale and coredeposits, are our principal source of funds for loans and investing insecurities.

 

Becauseof our strong loan demand, we have chosen to obtain a portion of our depositsfrom outside our market.  Our wholesale time deposits represented 47.0% ofour deposits as of September 30, 2008 when compared to 40.2% of ourdeposits as of December 31, 2007. The Company’s Fund Management Policy allows for the ratio of wholesaledeposits to total deposits to be 60.0%. The Company has been successful in replacing maturing brokered depositsand does not expect to experience significant disintermediation as the brokereddeposits mature.

 

OnSeptember 30, 2008, the Bank issued an aggregate of $950,000 in fixed ratesubordinated debentures, which will mature on September 30, to severalbank directors.  Interest on the Notes isfixed at 12% per annum, subject to an adjustment by the Bank on or before December 31,2008 that may increase the annual rate, but such increase will not exceed12.5%.  The interest will be payablesemiannually in arrears on June 30 and December 31 of each year.  The proceeds will be used to help the Bankremain well capitalized under the federal prompt corrective actionguidelines.  The subordinated debenturesqualify as Tier II capital under risk-based capital guidelines.

 

**Investment Securities**

 

Securities in our portfolio totaled $101.4 million atSeptember 30, 2008, compared to $74.4 million at December 31, 2007.  The most significant growth in the securitiesportfolio has resulted from the purchase of $44.8 million in mortgage backedsecurities that have been offset by $12.4 million in U.S. Government SponsoredEnterprises securities being called and/or matured.  The majority of the mortgage backed securitiespurchased consist of U.S. Government National Mortgage Association (“Ginnie Mae”)securities.  At September 30, 2008,the securities portfolio had unrealized net gains of approximately $119thousand.

 

The following table shows the carrying value of theinvestment securities at September 30, 2008 and December 31, 2007.

 
| ** **                              | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                              | ** ** | **(Amounts in Thousands)** | ** ** |
| Securities  available for sale:         |       |                                 |       |                  |       |
| U. S. Government  Sponsored Enterprises |       | $                                    | 18,112     |                  | $          | 27,493 |   |
| U. S. Treasury  Securities              |       | 253                                  |       | 254                   |       |
| State, County  and Municipal            |       | 20,826                               |       | 21,346                |       |
| Mortgage-backed  Securities             |       | 61,838                               |       | 23,844                |       |
| Other  Investments                      |       | 340                                  |       | 1,450                 |       |
| Total                                   |       | $                                    | 101,369    |                  | $          | 74,387 |   |

### ** **

### **Loans**

### ** **

Our loan demand continues to be strong.  Total loans increased $97.5 million or 14%from December 31, 2007 to September 30, 2008.  The increase in loans in 2008 is attributableto our branching efforts along with the lending efforts of our seniormanagement lending team.  The followingtable presents a summary of the loan portfolio by category.

 

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| ** **                                         | ** ** | **September 30,**               | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2008**                             | ** ** | **2007**              | ** ** |
| ** **                                         | ** ** | **(Dollars in Thousands)** | ** ** |
| Commercial                                         |       | $                                    | 72,296     |                  | $          | 69,079 |   |
| Real estate -  commercial                          |       | 310,460                              |       | 259,070               |       |
| Real estate -  construction                        |       | 313,783                              |       | 292,152               |       |
| Real estate -  mortgage                            |       | 89,103                               |       | 67,898                |       |
| Obligations of  political subdivisions in the U.S. |       | 345                                  |       | 290                   |       |
| Consumer                                           |       | 8,981                                |       | 8,934                 |       |
| Total Loans                                        |       | 794,968                              |       | 697,423               |       |
| Less:                                              |       |                                 |       |                  |       |
| Unearned loan  fees                                |       | (591                                 | )          | (277                  | )          |
| Allowance for  loan losses                         |       | (10,312                              | )          | (8,879                | )          |
| Loans, net                                         |       | $                                    | 784,065    |                  | $          | 688,267 |   |

 

### **Asset Quality**

### ** **

### **Management considers asset quality to be of primaryimportance.  Management has a creditadministration and loan review process, which monitor, control and measure ourcredit risk, standardized credit analyses and our comprehensive credit policy.  As a result, management believes they have agood understanding of the asset quality, an established warning and earlydetection system regarding the loans and a comprehensive analysis of theallowance for loan losses.**

### ** **

The following table presents a summary of changes inthe allowance for loan losses for the three and nine-month periods ended September 30,2008 and 2007.

 

**Analysis of Changes in Allowancefor Loan Losses**

 
| ** **                                         | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                         | ** ** | **2008**                                                 | ** ** | **2007**                                                | ** ** | **2008** | ** ** | **2007** | ** ** |
| ** **                                         | ** ** | **(Amounts in Thousands)**                     | ** ** |
| Balance  beginning of period                       |       | $                                                        | 9,734      |                                                    | $          | 9,163 |   | $ | 8,879 |   | $ | 7,258 |   |
| Loans  charged-off                                 |       | (349                                                     | )          | (75                                                     | )          | (934 | ) | (621 | ) |
| Recoveries                                         |       | 20                                                       |       | 39                                                      |       | 112 |   | 258 |   |
| Net charge-offs                                    |       | (329                                                     | )          | (36                                                     | )          | (822 | ) | (363 | ) |
| Provision for  loan losses                         |       | 907                                                      |       | 48                                                      |       | 2,255 |   | 640 |   |
| Allowance from  purchase acquisition               |       | —                                                   |       | —                                                  |       | — |   | 1,640 |   |
| Balance end of  period                             |       | $                                                        | 10,312     |                                                    | $          | 9,175 |   | $ | 10,312 |   | $ | 9,175 |   |
|                                               |       |                                                     |       |                                                    |       |   |   |   |   |
| Total Loans:                                       |       |                                                     |       |                                                    |       |   |   |   |   |
| At period end                                      |       | $                                                        | 794,377    |                                                    | $          | 662,605 |   | $ | 794,377 |   | $ | 662,605 |   |
| Average                                            |       | 804,406                                                  |       | 654,236                                                 |       | 755,685 |   | 631,404 |   |
|                                               |       |                                                     |       |                                                    |       |   |   |   |   |
| As a percentage  of average loans (annualized):    |       |                                                     |       |                                                    |       |   |   |   |   |
| Net charge-offs                                    |       | 0.16                                                     | %          | 0.02                                                    | %          | 0.15 | % | 0.08 | % |
| Provision for  loan losses                         |       | 0.45                                                     | %          | 0.03                                                    | %          | 0.40 | % | 0.14 | % |
| Allowance as a  percentage of period end loans     |       | 1.30                                                     | %          | 1.38                                                    | %          | 1.30 | % | 1.38 | % |
| Allowance as a  percentage of non-performing loans |       | 118.27                                                   | %          | 261.57                                                  | %          | 118.27 | % | 261.57 | % |

 

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### **Management believes that the allowance for loanlosses at September 30, 2008 is adequate to absorb losses inherent in theloan portfolio.  This assessment involvesuncertainty and judgment; therefore, the adequacy of the allowance for loanlosses cannot be determined with precision and may be subject to change infuture periods.  In addition, bankregulatory authorities, as part of their periodic examination of the Bank, mayrequire adjustments to the provision for loan losses in future periods if, intheir opinion, the results of their review warrant such additions.**

### ** **

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

 
| ** **                       | ** ** | **September 30.** | ** ** | **December 31,** | ** ** |
|----------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                       | ** ** | **2008**               | ** ** | **2007**              | ** ** |
| Accruing loans  90 days past due |       | $                      | —     |                  | $          | 504,783 |   |
| Non-accrual  loans               |       | 8,718,913              |       | 4,276,950             |       |
| Repossessed  assets              |       | 23,783                 |       | —                |       |
| Other real  estate               |       | 3,862,925              |       | 758,787               |       |
| Total  non-performing assets     |       | $                      | 12,605,621 |                  | $          | 5,540,520 |   |

 

Nonperformingassets increased $7.1 million or 128% from December 31, 2007 to September 30,2008.  In July 2008, managementplaced one loan with a balance of approximately $5.5 million on non-accrual that is secured bya condominium complex and other commercial real estate property appraised atapproximately $7.3 million.  Managementis continuously monitoring the non-accrual loans to minimize any losses.

 

At September 30,2008, the Company’s other real estate consisted of the following:

 
| 1-4 Family  residential properties                   |   | 3  |   | $       | 2,898,768 |   |
|------------------------------------------------------|--------|----|--------|---------|-----------|--------|
| Construction &  land development properties |   | 8  |   | 964,157 |      |
| Total                                                |   | 11 |   | $       | 3,862,925 |   |

 

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

 

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

 

**Goodwill**

 

TheCompany reviews its goodwill for impairment annually, or more frequently ifcircumstances indicate that goodwill has been impaired.  During the last four quarters, the Company’sstock price has traded below its per-share book value and it has also fallenbelow tangible book value for a short period of time.  Management believes that the low stock priceis more indicative of uncertainty about the economic environment rather thanthe value of the Company’s underlying business. Although the Company has not performed a complete goodwill impairmentassessment, management does not believe that goodwill is impaired.  The current economic environment has resultedin lower earnings due mainly to the effect of the Federal Reserve’s action inlowering short-term rates starting in the

 

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secondquarter of 2007.  Management believesthat the value of the Company’s business remains intact and that earningsshould return to past levels when the economic environment recovers.  The Company will complete a full goodwillimpairment assessment during the fourth quarter of 2008.

 

**Deposits**

 

Totaldeposits at September 30, 2008 were $846.5 million, an increase of $141.2million, or 20%, from December 31, 2007. Total interest bearing demand and savings accounts of $152.9 millionincreased $34.0 million, or 29%, resulting mainly from our branching effortsand our emphasis on increasing core deposits.

 

Totaltime deposits as of September 30, 2008 were $646.7 million, an increase of$106.3 million, or 20%, from December 31, 2007.  Total retail time deposits at September 30,2008 decreased approximately $10.0 million, or 2% of total time deposits, from December 31,2007 due to competitive rates drawing customers to other financial institutions. The weighted average rates paid for retail time deposits for the threeand nine months ended September 30, 2008 were 4.07% and 4.55%,respectively, compared to 5.27% and 5.15% for the three and nine months ended September 30,2007, respectively.  Total wholesaledeposits at September 30, 2008 increased approximately $116.4 million, or22% of total time deposits, from December 31, 2007, resulting mainly fromour need to fund our loan growth during the second quarter of 2008.  The weighted average rates paid for wholesaledeposits for the three and nine months ended September 30, 2008 were 3.96%and 4.33%, respectively, compared to 5.27% and 5.25% for the three and ninemonths ended September 30, 2007, respectively.

 

### **Results of Operations**

### ** **

# **General**

# ** **

The Company’s results ofoperations are determined by its ability to effectively manage interest incomeand expense, to minimize loan and investment losses, to generate noninterestincome and to control noninterest expense. Since interest rates are determined by market forces and economicconditions beyond the control of the Company, the ability to generate interestincome is dependent upon the Bank’s ability to obtain an adequate spreadbetween the rate earned on earning assets and the rate paid on interest-bearingliabilities.

 

# **Thefollowing table shows the significant components of net earnings:**

 
| ** **                      | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------|------------|---------------------------------|------------|------------|------------|-------------------|------------|
| ** **                      | ** ** | **September 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                      | ** ** | **2008**                        | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Interest Income                 |       | $                               | 41,631,346 |       | $          | 43,972,339        |       | $ | (2,340,993 | ) | -5.32 | % |
| Interest Expense                |       | 23,366,878                      |       | 23,112,607 |       | 254,271           |       | 1.10 | % |
| Net Interest  Income            |       | 18,264,468                      |       | 20,859,732 |       | (2,595,264        | )          | -12.44 | % |
| Provision for  Loan Losses      |       | 2,255,000                       |       | 640,000    |       | 1,615,000         |       | 252.34 | % |
| Net Earnings                    |       | 1,551,117                       |       | 6,002,353  |       | (4,451,236        | )          | -74.16 | % |
| Net Earnings Per  Diluted Share |       | $                               | 0.35       |       | $          | 1.35              |       | (1.00 | ) | -74.07 | % |
|                                 |            |                                 |            |            |            |                   |            |  |  |  |  |  |

 
| ** **                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|------------|------------|-------------------|------------|
| ** **                              | ** ** | **September 30,**           | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                              | ** ** | **2008**                         | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Interest Income                         |       | $                                | 13,727,652 |       | $          | 15,300,208        |       | $ | (1,572,556 | ) | -10.28 | % |
| Interest Expense                        |       | 7,706,392                        |       | 8,159,415  |       | (453,023          | )          | -5.55 | % |
| Net Interest  Income                    |       | 6,021,260                        |       | 7,140,793  |       | (1,119,533        | )          | -15.68 | % |
| Provision for  Loan Losses              |       | 907,000                          |       | 48,000     |       | 859,000           |       | 1789.58 | % |
| Net Earnings  (Loss)                    |       | (346,875                         | )          | 2,060,873  |       | (2,407,748        | )          | -116.83 | % |
| Net Earnings  (Loss) Per Diluted Shares |       | $                                | (0.08      | )          | $          | 0.46              |       | (0.54 | ) | -117.39 | % |
|                                         |            |                                  |            |            |            |                   |            |  |  |  |  |  |

 

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# **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 $2.6 million,or 12%, for the nine months ended September 30, 2008 compared to the ninemonths ended September 30, 2007. Net interest income decreased $1.1 million, or 16%, for the thirdquarter of 2008 compared to the same period in 2007.

 

Totalinterest and dividend income for the three and nine months ended September 30,2008 decreased $1.6 million, or 10%, and $2.3 million, or 5%, respectively,when compared to the three and nine months ended September 30, 2007,primarily due to the effect of the Federal Reserve decreasing the federal fundsrate, which affects a majority of the interest rates for our loans.  The average loan and loan held for saleportfolios for the three and nine months ended September 30, 2008increased approximately $150.2 million, or 23%, and $124.3 million, or 20%,respectively, when compared to average loan and loan held for sale portfoliosfor the three and nine months ended September 30, 2007.  Additionally, the average yield on loansdecreased during the three and nine months ended September 30, 2008 to6.21% and 6.81%, respectively, compared to an average yield of 8.68% and 8.67%for the three and nine months ended September 30, 2007, respectively.

 

Totalinterest expense for the three months ended September 30, 2008 decreased$453 thousand, or 6%, when compared to the three months ended September 30,2007.  Total interest expense for thenine months ended September 30, 2008 increased $254 thousand, or 1%, whencompared to the nine months ended September 30, 2007.  Two factors impact interest expense: averagebalances of deposit and borrowing portfolios and average rates paid oneach.  Average deposit balances increasedapproximately $175.4 million and $130.7 million when comparing the three andnine months ended September 30, 2008 to the three and nine months ended September 30,2007.  The average rate paid on thedeposit portfolios for the three months ended September 30, 2008 decreasedto 3.67% from 4.83% when compared to the three months ended September 30,2007.   The average rate paid on thedeposits for the nine months ended September 30, 2008 decreased to 4.03%from 4.75% when compared to the nine months ended September 30, 2007.  Average borrowing balances decreasedapproximately $4.1 million when comparing the three months ended September 30,2008 to the three months ended September 30, 2007.  Average borrowing balances increasedapproximately $4.1 million when comparing the nine months ended September 30,2008 to the nine months ended September 30, 2007.  Average interest rates paid on borrowingswere 3.68% and 3.93% for the three and nine months ended September 30,2008, respectively, compared to 5.38% and 5.37% for the three and nine monthsended September 30, 2007, 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, 2008 and 2007, our tax equivalent netinterest spread was 2.41% and 3.40%, respectively, while the tax equivalent netinterest margin was 2.70% and 3.89%, respectively.  For the nine months ended September 30,2008 and 2007, our tax equivalent net interest spread was 2.60% and 3.44%,respectively, while the tax equivalent net interest margin was 2.94% and 3.93%,respectively.  The decreases in netinterest spread and net interest margin from the three and nine months ended September 30,2007 to the three and nine months ended September 30, 2008, were due toour promotion of higher short-term yields on retail time deposits in order tofund loan growth and to invest in investment securities and the effect of theFederal Reserve’s action in lowering short-term rates, starting in the secondquarter of 2007 and continuing through the second quarter of 2008, on theCompany’s slightly asset-sensitive balance sheet.

 

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Thefollowing table shows the relationship between interest revenue and interestexpense and the average balances of interest-earning assets andinterest-earning liabilities for the three months ended September 30, 2008and 2007.

 

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

 
| ** **                                       | ** ** | **For the Three Months Ended September 30,** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                                                   | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(Dollar amounts in thousands)**                           | ** ** |
| ** **                                       | ** ** | **Average**                                                                | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                       | ** ** | **Balance**                                                                | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning Assets                                   |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned  income (4) (5) (6)       |       | $                                                                          | 804,406    |   | $ | 12,592 |   | 6.21 | % | $ | 654,236 |   | $ | 14,304 |   | 8.68 | % |
| Federal funds sold                               |       | 6,774                                                                      |       | 36 |   | 2.08 | % | 6,303 |   | 80 |   | 5.04 | % |
| Investment securities  - taxable (7)        |       | 63,684                                                                     |       | 824 |   | 5.13 | % | 55,101 |   | 677 |   | 4.87 | % |
| Investment securities  - tax-exempt (6) (7)      |       | 22,998                                                                     |       | 227 |   | 5.93 | % | 18,601 |   | 177 |   | 5.72 | % |
| Other interest and  dividend income              |       | 5,351                                                                      |       | 49 |   | 3.63 | % | 4,208 |   | 62 |   | 5.85 | % |
| Total Earning Assets                             |       | 903,213                                                                    |       | 13,728 |   | 6.08 | % | 738,449 |   | 15,300 |   | 8.27 | % |
|                                             |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                     |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan  losses                       |       | -9,985                                                                     |       |   |   |   |   | -9,160 |   |   |   |   |   |
| Cash and due from  banks                         |       | 10,149                                                                     |       |   |   |   |   | 13,908 |   |   |   |   |   |
| Premises and equipment                           |       | 29,086                                                                     |       |   |   |   |   | 25,968 |   |   |   |   |   |
| Accrued interest  receivable                     |       | 6,805                                                                      |       |   |   |   |   | 6,540 |   |   |   |   |   |
| Other assets                                     |       | 41,842                                                                     |       |   |   |   |   | 28,447 |   |   |   |   |   |
| Total Assets                                     |       | $                                                                          | 981,110    |   |   |   |   |   | $ | 804,152 |   |   |   |   |   |
|                                             |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities                    |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  demand                         |       | $                                                                          | 122,957    |   | $ | 646 |   | 2.08 | % | $ | 113,692 |   | $ | 925 |   | 3.23 | % |
| Savings                                          |       | 8,294                                                                      |       | 12 |   | 0.57 | % | 8,352 |   | 12 |   | 0.57 | % |
| Time deposits                                    |       | 659,375                                                                    |       | 6,653 |   | 4.00 | % | 496,097 |   | 6,588 |   | 5.27 | % |
| Total interest bearing  deposits                 |       | 790,626                                                                    |       | 7,311 |   | 3.67 | % | 618,141 |   | 7,525 |   | 4.83 | % |
| Federal Home Loan  Bank advances                 |       | 30,952                                                                     |       | 262 |   | 3.36 | % | 34,700 |   | 415 |   | 4.75 | % |
| Other borrowings                                 |       | 1,408                                                                      |       | 8 |   | 2.25 | % | 1,737 |   | 23 |   | 5.25 | % |
| Junior subordinated  debentures                  |       | 10,310                                                                     |       | 126 |   | 4.85 | % | 10,310 |   | 196 |   | 7.54 | % |
| Total borrowed funds                             |       | 42,670                                                                     |       | 396 |   | 3.68 | % | 46,747 |   | 634 |   | 5.38 | % |
| Total interest-bearing  liabilities              |       | 833,296                                                                    |       | 7,707 |   | 3.67 | % | 664,888 |   | 8,159 |   | 4.87 | % |
|                                             |       |                                                                       |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  deposits                   |       | 49,770                                                                     |       |   |   |   |   | 46,816 |   |   |   |   |   |
| Other liabilities                                |       | 7,871                                                                      |       |   |   |   |   | 7,101 |   |   |   |   |   |
| Shareholders’ equity                        |       | 90,173                                                                     |       |   |   |   |   | 85,347 |   |   |   |   |   |
| Total Liabilities  and Shareholders’ Equity |       | $                                                                          | 981,110    |   |   |   |   |   | $ | 804,152 |   |   |   |   |   |
| Net interest revenue  (1)                        |       |                                                                       |       | $ | 6,021 |   |   |   |   |   | $ | 7,141 |   |   |   |
| Net interest spread  (2)                         |       |                                                                       |       |   |   | 2.41 | % |   |   |   |   | 3.40 | % |
| Net interest margin  (3)                         |       |                                                                       |       |   |   | 2.70 | % |   |   |   |   | 3.89 | % |

 

----

(1) Net interest revenue is computed bysubtracting the expense from the average interest-bearing liabilities from theincome from the average earning assets.

(2) Net interest spread is computed bysubtracting the yield from the expense of the average interest-bearingliabilities from the yield from the average earning assets.

(3) Net interest margin is computed by dividingnet interest revenue by average total earning assets.

(4) Average loans are shown net of unearnedincome.  Included in the average balanceof loans outstanding are loans where the accrual of interest has beendiscounted.

(5) Interest income includes loan fees asfollows (in thousands): 2008 - $432; 2007 - $464

(6) Average rate reflects taxable equivalentadjustments using a tax rate of 34 percent.

(7) Investment securities are stated atamortized 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-earning liabilities for the nine months ended September 30, 2008and 2007.

 

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

 
| ** **                                       | ** ** | **For the Nine Months Ended September 30,**      | ** ** |
|--------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                       | ** ** | **2008**                                         | ** ** | **2007** | ** ** |
| ** **                                       | ** ** | **(Dollar amounts in thousands)** | ** ** |
| ** **                                       | ** ** | **Average**                                      | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                       | ** ** | **Balance**                                      | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning Assets                                   |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned  income (4) (5) (6)       |       | $                                                | 755,685    |   | $ | 38,457 |   | 6.81 | % | $ | 631,404 |   | $ | 40,948 |   | 8.67 | % |
| Federal funds sold                               |       | 7,986                                            |       | 149 |   | 2.49 | % | 11,604 |   | 445 |   | 5.13 | % |
| Investment securities  - taxable (7)             |       | 56,663                                           |       | 2,168 |   | 5.12 | % | 53,149 |   | 1,853 |   | 4.66 | % |
| Investment securities  - tax-exempt (6) (7)      |       | 21,969                                           |       | 653 |   | 6.02 | % | 18,393 |   | 514 |   | 5.66 | % |
| Other interest and  dividend income              |       | 5,254                                            |       | 204 |   | 5.19 | % | 4,280 |   | 212 |   | 6.63 | % |
| Total Earning Assets                             |       | 847,557                                          |       | 41,631 |   | 6.62 | % | 718,830 |   | 43,972 |   | 8.23 | % |
|                                             |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                     |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan  losses                       |       | -9,465                                           |       |   |   |   |   | -9,036 |   |   |   |   |   |
| Cash and due from  banks                         |       | 9,506                                            |       |   |   |   |   | 13,544 |   |   |   |   |   |
| Premises and equipment                           |       | 28,537                                           |       |   |   |   |   | 23,537 |   |   |   |   |   |
| Accrued interest  receivable                     |       | 6,992                                            |       |   |   |   |   | 6,205 |   |   |   |   |   |
| Other assets                                     |       | 40,414                                           |       |   |   |   |   | 25,861 |   |   |   |   |   |
| Total Assets                                     |       | $                                                | 923,541    |   |   |   |   |   | $ | 778,941 |   |   |   |   |   |
|                                             |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  liabilities                    |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing  demand                         |       | $                                                | 115,746    |   | $ | 1,852 |   | 2.14 | % | $ | 112,934 |   | $ | 2,662 |   | 3.15 | % |
| Savings                                          |       | 8,080                                            |       | 34 |   | 0.56 | % | 8,374 |   | 35 |   | 0.56 | % |
| Time deposits                                    |       | 602,788                                          |       | 20,003 |   | 4.44 | % | 477,083 |   | 18,560 |   | 5.20 | % |
| Total interest bearing  deposits                 |       | 726,614                                          |       | 21,889 |   | 4.03 | % | 598,391 |   | 21,257 |   | 4.75 | % |
| Federal Home Loan  Bank advances                 |       | 37,282                                           |       | 997 |   | 3.58 | % | 34,192 |   | 1,209 |   | 4.73 | % |
| Other borrowings                                 |       | 2,661                                            |       | 53 |   | 2.66 | % | 1,680 |   | 66 |   | 5.25 | % |
| Junior subordinated  debentures                  |       | 10,310                                           |       | 428 |   | 5.46 | % | 10,310 |   | 580 |   | 7.52 | % |
| Total borrowed funds                             |       | 50,253                                           |       | 1,478 |   | 3.93 | % | 46,182 |   | 1,855 |   | 5.37 | % |
| Total interest-bearing  liabilities              |       | 776,867                                          |       | 23,367 |   | 4.02 | % | 644,573 |   | 23,112 |   | 4.79 | % |
|                                             |       |                                             |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing  deposits                   |       | 48,471                                           |       |   |   |   |   | 46,016 |   |   |   |   |   |
| Other liabilities                                |       | 7,908                                            |       |   |   |   |   | 6,895 |   |   |   |   |   |
| Shareholders’ equity                        |       | 90,295                                           |       |   |   |   |   | 81,457 |   |   |   |   |   |
| Total Liabilities  and Shareholders’ Equity |       | $                                                | 923,541    |   |   |   |   |   | $ | 778,941 |   |   |   |   |   |
| Net interest revenue  (1)                        |       |                                             |       | $ | 18,264 |   |   |   |   |   | $ | 20,860 |   |   |   |
| Net interest spread  (2)                         |       |                                             |       |   |   | 2.60 | % |   |   |   |   | 3.44 | % |
| Net interest margin  (3)                         |       |                                             |       |   |   | 2.94 | % |   |   |   |   | 3.93 | % |

 

----

(1) Net interest revenue is computed bysubtracting the expense from the average interest-bearing liabilities from theincome from the average earning assets.

(2) Net interest spread is computed bysubtracting the yield from the expense of the average interest-bearingliabilities from the yield from the average earning assets.

(3) Net interest margin is computed by dividingnet interest revenue by average total earning assets.

(4) Average loans are shown net of unearnedincome.  Included in the average balanceof loans outstanding are loans where the accrual of interest has beendiscounted.

(5) Interest income includes loan fees asfollows (in thousands): 2008 - $1,363; 2007 - $1,521

(6) Average rate reflects taxable equivalentadjustments using a tax rate of 34 percent.

(7) Investment securities are stated atamortized 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, 2008 compared to September 30, 2007.

 

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

 
| ** **                                    | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|-----------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                    | ** ** | **2008 Compared to 2007**                 | ** ** | **2008 Compared to 2007**                | ** ** |
| ** **                                    | ** ** | **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                                         |       | $                                                        | 2,857      |                                                    | $          | (4,569 | ) | $ | (1,712 | ) | $ | 7,182 |   | $ | (9,673 | ) | $ | (2,491 | ) |
| Investment  securities:                       |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Taxable  investment securities                |       | 126                                                      |       | 21                                                      |       | 147 |   | 164 |   | 151 |   | 315 |   |
| Tax-exempt  investment securities             |       | 43                                                       |       | 7                                                       |       | 50 |   | 105 |   | 34 |   | 139 |   |
| Interest earning  deposits and fed funds sold |       | 9                                                        |       | (66                                                     | )          | (57 | ) | (79 | ) | (225 | ) | (304 | ) |
| Total interest  income                        |       | 3,035                                                    |       | (4,607                                                  | )          | (1,572 | ) | 7,372 |   | (9,713 | ) | (2,341 | ) |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Interest paid  on:                            |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Deposits:                                     |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Interest bearing  demand deposits             |       | 65                                                       |       | (344                                                    | )          | (279 | ) | 65 |   | (875 | ) | (810 | ) |
| Savings                                       |       | —                                                   |       | —                                                  |       | — |   | (2 | ) | 1 |   | (1 | ) |
| Time deposits                                 |       | 1,700                                                    |       | (1,635                                                  | )          | 65 |   | 3,945 |   | (2,502 | ) | 1,443 |   |
| Other borrowings  and FHLB advances           |       | (45                                                      | )          | (123                                                    | )          | (168 | ) | 130 |   | (355 | ) | (225 | ) |
| Junior  subordinated debentures               |       | —                                                   |       | (70                                                     | )          | (70 | ) | — |   | (152 | ) | (152 | ) |
| Total interest  expense                       |       | 1,720                                                    |       | (2,172                                                  | )          | (452 | ) | 4,138 |   | (3,883 | ) | 255 |   |
|                                          |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Increase in net  interest revenue             |       | $                                                        | 1,315      |                                                    | $          | (2,435 | ) | $ | (1,120 | ) | $ | 3,234 |   | $ | (5,830 | ) | $ | (2,596 | ) |

 

----

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

 

# **Provision for LoanLosses**

# ** **

Theprovision for loan losses for the nine months ended September 30, 2008,was $2,255,000 compared to $640,000 for the same period of 2007.  The provision for loan losses for the thirdquarter of 2008 was $907,000 compared to $48,000 for the same period of 2007.  The increase in the provision for loan lossesis due to the strong loan growth occurring in the second quarter of 2008 and toaccommodate for several charge-offs during the third quarter of 2008.  Net charge-offs as an annualized percentageof average outstanding loans for the nine months ended September 30, 2008were 0.15%, as compared with 0.08% for the same period of 2007.  Net charge-offs as an annualized percentageof average outstanding loans for the third quarter of 2008 were 0.16%, ascompared with 0.02% for the same period of 2007.  Net loan charge-offs increased during thethree months and nine months ended September 30, 2008 as compared to thethree months and nine months ended September 30, 2007 due mainly to theCompany charging off $375,000 for one single-family residential real estateloan when the foreclosed property was recorded to other real estate at netrealizable value.  Also, the Companycharged off approximately $344,000 for several impaired loans in the thirdquarter of 2008.

 

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,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                                      | ** ** | **2008**                        | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Service charges  on deposit accounts                                            |       | $                               | 1,312,536  |       | $          | 990,910           |       | $ | 321,626 |   | 32.46 | % |
| Other service  charges, commissions and fees                                    |       | 357,549                         |       | 260,425    |       | 97,124            |       | 37.29 | % |
| Gain (loss) on  sales, calls and impairment write-down of investment securities |       | (1,120,650                      | )          | 3,101      |       | (1,123,751        | )          | -36238.34 | % |
| Gain (loss) on  sale of other assets                                            |       | (37,436                         | )          | 96,505     |       | (133,941          | )          | -138.79 | % |
| Mortgage  origination income                                                    |       | 640,826                         |       | 725,534    |       | (84,708           | )          | -11.68 | % |
| Other income                                                                    |       | 923,082                         |       | 471,150    |       | 451,932           |       | 95.92 | % |
| Total  noninterest income                                                       |       | $                               | 2,075,907  |       | $          | 2,547,625         |       | $ | (471,718 | ) | -18.52 | % |

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                                                      | ** ** | **September 30,**           | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                                                      | ** ** | **2008**                         | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Service charges  on deposit accounts                                            |       | $                                | 455,318    |       | $          | 403,522           |       | $ | 51,796 |   | 12.84 | % |
| Other service  charges, commissions and fees                                    |       | 128,818                          |       | 101,147    |       | 27,671            |       | 27.36 | % |
| Gain (loss) on  sales, calls and impairment write-down of investment securities |       | (1,160,895                       | )          | 3,408      |       | (1,164,303        | )          | -34163.82 | % |
| Gain (loss) on  sale of other assets                                            |       | (23,951                          | )          | 1,946      |       | (25,897           | )          | -1330.78 | % |
| Mortgage  origination income                                                    |       | 210,794                          |       | 276,288    |       | (65,494           | )          | -23.70 | % |
| Other income                                                                    |       | 245,851                          |       | 162,163    |       | 83,688            |       | 51.61 | % |
| Total  noninterest income                                                       |       | $                                | (144,065   | )          | $          | 948,474           |       | $ | (1,092,539 | ) | -115.19 | % |

 

Service charges on deposit accounts are evaluatedagainst service charges from other banks in the local market and against theBank’s own cost structure in providing the deposit services.  This income should grow with the growth inthe Bank’s demand deposit account base. Total service charges, including non-sufficient funds fees, were $455thousand for the third quarter of 2008 compared with $404 thousand for thethird quarter of 2007.  Total servicecharges, including non-sufficient funds fees, were $1.3 million, or 63% oftotal noninterest income, for the nine months ended September 30, 2008compared with $991 thousand, or 39%, for the same period of 2007.  The year-over-year increase in servicecharges on deposit accounts is directly related to the increase in the numberof our core transaction deposit accounts. The number of deposit accounts for the nine months ended September 30,2008 was 13,334 accounts when compared to the same period of 2007 with 12,480accounts.  The decrease in the gain(loss) on sales, calls and impairment write-downs of investment securitiespertains to the impairment loss from the Company’s investment in the FreddieMac and the Fannie Mae preferred stocks. The most significant change in other income for the three months andnine months ended September 30, 2008, is the additional income from cashsurrender value of life insurance from the additional $7.5 million bank ownedlife insurance (“BOLI”) policies on several senior bank officers purchasedduring the first quarter of 2008.  TheBank also recognized $171 thousand in other income from the fair valueadjustments to an interest rate swap during the second quarter of 2008.  The interest rate swap was settled in thethird quarter of 2008 for an additional minimal gain.  The decrease of the gain (loss) on the saleof other assets for the three months and nine months ended September 30,2008, is primarily due to the loss on the sale of five foreclosed properties;in comparison, during the three months and nine months ended September 30,2007 there was a gain on the sale of two foreclosed properties and the sale ofone location that was acquired from our purchase of First Community Bank duringthe second quarter of 2007.

 

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# **Non-interest Expense**

# ** **

Compositionof other noninterest expense is as follows:

 
| ** **                                      | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------------|------------|---------------------------------|------------|------------|------------|-------------------|------------|
| ** **                                      | ** ** | **September 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                      | ** ** | **2008**                        | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Salaries                                        |       | $                               | 6,881,027  |       | $          | 5,485,480         |       | $ | 1,395,547 |   | 25.44 | % |
| Employee  benefits                              |       | 1,834,587                       |       | 1,879,072  |       | (44,485           | )          | -2.37 | % |
| Occupancy  expense                              |       | 1,393,955                       |       | 1,047,063  |       | 346,892           |       | 33.13 | % |
| Equipment rental  and depreciation of equipment |       | 862,418                         |       | 628,939    |       | 233,479           |       | 37.12 | % |
| Other expenses                                  |       | 5,252,736                       |       | 4,514,368  |       | 738,368           |       | 16.36 | % |
| Total  noninterest expense                      |       | $                               | 16,224,723 |       | $          | 13,554,922        |       | $ | 2,669,801 |   | 19.70 | % |

 
| ** **                                      | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | ** **        | ** ** |
|-------------------------------------------------|------------|------------------------|------------|------------|------------|-------------------|------------|
| ** **                                      | ** ** | **September 30,** | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                      | ** ** | **2008**               | ** ** | **2007**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| Salaries                                        |       | $                      | 2,411,074  |       | $          | 1,950,593         |       | $ | 460,481 |   | 23.61 | % |
| Employee  benefits                              |       | 616,925                |       | 669,720    |       | (52,795           | )          | -7.88 | % |
| Occupancy  expense                              |       | 482,284                |       | 367,025    |       | 115,259           |       | 31.40 | % |
| Equipment rental  and depreciation of equipment |       | 318,108                |       | 237,285    |       | 80,823            |       | 34.06 | % |
| Other expenses                                  |       | 1,889,478              |       | 1,658,511  |       | 230,967           |       | 13.93 | % |
| Total  noninterest expense                      |       | $                      | 5,717,869  |       | $          | 4,883,134         |       | $ | 834,735 |   | 17.09 | % |

 

Theincreases in noninterest expenses are primarily due to the growth of theBank.  The most significant increases inthe nine months ended September 30, 2008 are increases in salaries andemployee benefits.  The increase insalaries and employees benefits represents a normal increase in salaries and anincrease in the number of employees.  At September 30,2008, the number of full-time equivalent employees was 182 compared to 164 at September 30,2007.  The increase in the number offull-time equivalent employees is directly related to the growth of the Bankand the hiring for one new branch in Jacksonville, Florida.  The Bank operates from seventeen facilitiesas of September 30, 2008 compared to sixteen facilities as of September 30,2007.  The increases in other expensesare not attributable to any one particular item, but represent increasesrelated to physical facility expansion.

 

# **Income Tax Expense**

 

Incometax expense expressed as a percentage of earnings before income taxes was16.64% and 34.85% for the nine months ended September 30, 2008 and 2007,respectively.  The income tax benefitexpressed as a percentage of the loss before taxes was 53.61% for the threemonths ended September 30, 2008 compared to the income tax expense as apercentage of earnings at 34.74% for the three months ended September 30,2007.  The fluctuation in the percentagecan be attributed to the tax-free income versus the pretax income and taxcredits received from affordable housing investments.  For the nine months ended September 30,2008, the tax-free income expressed as a percentage of earnings before incometaxes was 35.91% compared to 5.83% for the nine months ended September 30,2007.  For the three months ended September 30,2008, the tax-free income expressed as a percentage of earnings before incometaxes was 31.20% compared to 5.77% for the three months ended September 30,2007.  The increase in tax-free income isdue to an increase in the interest revenue on certain investment securities andloans that are exempt from income taxes. The average balance in tax-exempt investment securities and tax-exemptloans for the nine months ended September 30, 2008 was $22.3 millioncompared to $18.7 million for the nine months ended September 30, 2007.

 

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**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 onand 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 federal fundsfrom other financial institutions up to $31 million. At September 30,2008, the Company had $191,000 in federal funds purchased. The Company has atotal available line of $47.8 million, subject to available collateral, fromthe Federal Home Loan Bank. The Company has $30.5 million in advances on thisline at September 30, 2008.  TheCompany has a total available line of $148.0 million, subject to available collateral,from the Federal Reserve Bank.  TheCompany had no advances on this line at September 30, 2008.

 

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, 2008 and 2007 were 13.29% and 13.48%,respectively.

 

**Capital Resources**

 

We aresubject to various regulatory capital requirements administered by the federalbanking agencies.  Failure to meetminimal 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,liabilities and certain off-balance sheet items as calculated under regulatoryaccounting practices.  Our capitalamounts and classification are also subject to qualitative judgments by theregulators about 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), and of Tier I capital (as defined) to average assets (asdefined).  Management believes, as of September 30,2008 and as of December 31, 2007, that the Company and the Bank met allcapital adequacy requirements to which they are subject.

 

As of September 30,2008, the most recent notifications from both the Federal Deposit InsuranceCorporation and the Federal Reserve Bank of Atlanta categorized the Bank aswell capitalized under the regulatory framework for prompt correctiveaction.  To be categorized as wellcapitalized, the Bank must maintain minimum total risk-based, Tier I risk-basedand Tier I leverage ratios as set forth in the following table.  There are no conditions or events since thatnotification that management believes have changed the Bank’s categories.

 

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TheCompany’s and the Bank’s actual capital amounts and ratios as of September 30,2008 and December 31, 2007 follow:

 
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                            | ** ** | **To Be Well Capitalized** | ** ** |
|----------------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                         | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                             | ** ** | **Amount**                                | ** ** | **Ratio** | ** ** |
| ***September 30,  2008***                     |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total Risk-Based  Capital To Risk Weighted Assets: |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 88,729,000 |                       | 10.72      | %                          | $          | 66,215,672                            | >  | 8.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 87,237,000 |       | 10.56                      | %          | 66,088,636                 | >  | 8.0                                   | %          | 82,610,795                                | >  | 10.0 | % |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Tier I Capital  To Risk Weighted Assets:           |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 77,462,000 |                       | 9.36       | %                          | $          | 33,103,419                            | >  | 4.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 75,970,000 |       | 9.20                       | %          | 33,030,435                 | >  | 4.0                                   | %          | 49,545,652                                | >  | 6.0 | % |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Tier I Capital  To Average Assets                  |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 77,462,000 |                       | 8.08       | %                          | $          | 38,347,525                            | >  | 4.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 75,970,000 |       | 7.93                       | %          | 38,320,303                 | >  | 4.0                                   | %          | 47,900,378                                | >  | 5.0 | % |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| ***December 31,  2007***                      |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Total Risk-Based  Capital To Risk Weighted Assets: |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 84,800,000 |                       | 11.62      | %                          | $          | 58,382,100                            | >  | 8.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 82,541,000 |       | 11.32                      | %          | 58,332,862                 | >  | 8.0                                   | %          | 72,916,078                                | >  | 10.0 | % |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Tier I Capital  To Risk Weighted Assets:           |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 75,921,000 |                       | 10.40      | %                          | $          | 29,200,385                            | >  | 4.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 73,662,000 |       | 10.11                      | %          | 29,144,214                 | >  | 4.0                                   | %          | 43,716,320                                | >  | 6.0 | % |
|                                               |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Tier I Capital  To Average Assets                  |       |       |       |                       |       |                       |       |                                  |       |                                      |       |   |   |
| Consolidated                                       |       | $          | 75,921,000 |                       | 9.34       | %                          | $          | 32,514,347                            | >  | 4.0                                       | %          | N/A |   | N/A |   |
| Bank                                               |       | 73,662,000 |       | 9.08                       | %          | 32,450,220                 | >  | 4.0                                   | %          | 40,562,775                                | >  | 5.0 | % |

 

We haveoutstanding junior subordinated debentures commonly referred to as TrustPreferred Securities totaling $10.3 million at September 30, 2008.  The Trust Preferred Securities qualify as aTier I capital under risk-based capital guidelines provided that total TrustPreferred Securities do not exceed certain quantitative limits.  At September 30, 2008, all of the TrustPreferred Securities qualify as a Tier I capital.

 

We haveoutstanding subordinated debentures totaling $950,000 at September 30,2008.  The subordinated debenturesqualify as a Tier II capital under risk-based capital guidelines providedthat.  At September 30, 2008, all ofthe subordinated debentures qualify as a Tier 2 capital.

 

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**Regulatory Matters**

 

From time to time,various bills are introduced in the United States Congress with respect to theregulation of financial institutions. Certain of these proposals, if adopted, could significantly change theregulation of banks and the financial services industry.

 

On October 3,2008, in response to the financial crises affecting the banking system andfinancial markets and the going concern threats to investment banks and otherfinancial institutions, the U.S. Congress adopted the new EmergencyEconomic Stabilization Act of 2008 (“EESA”). The primary feature of the EESA isthe establishment of a troubled asset relief program (“TARP”), under which theU.S. Treasury is authorized to spend up to $700 billion to invest infinancial institutions (or potentially other entities), purchase troubledassets, including mortgage-backed and other securities, from financialinstitutions, and take other actions as it deems necessary to stabilize thefinancial markets. The Capital Purchase Program (the “CPP”) was announced bythe U.S. Treasury on October 14, 2008 as part of TARP.  Pursuant to the CPP,the U.S. Treasury will purchase up to $250 billion of Senior Preferred Shareson standardized terms from qualifying financial institutions. The purpose of the CPP is toencourage U.S. financial institutions to build capital to increase the flow offinancing to U.S. businesses and consumers and to support the U.S.economy.  The CPP is voluntary andrequires a participating institution to comply with a number of restrictionsand provisions, including standards for executive compensation and corporategovernance and limitations on share repurchases and the declaration and paymentof dividends on common shares.

 

On October 14,2008, the FDIC announced that its Board of Directors, under the authority toprevent “systemic risk” in the U.S. banking system, approved the TemporaryLiquidity Guarantee Program. The purpose of the program is to strengthenconfidence and encourage liquidity in the banking system by permitting the FDICto (i) guarantee certain newly issued senior unsecured debt issued byparticipating institutions, and (ii) fully insure non-interest bearingdeposit accounts held at participating FDIC-insured institutions, regardless ofdollar amount.

 

We cannot predictwhether any further proposals will be adopted or, if adopted, how theseproposals would affect us.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

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

**For the Nine Months Ended September 30, 2008**

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Item 4T. Controls and Procedures**

**For the Nine Months Ended September 30, 2008**

** **

The Company’s management, including the Chief Executive Officer and ChiefFinancial Officer, supervised and participated in an evaluation of theeffectiveness of its disclosure controls and procedures (as defined in federalsecurities rules) as of the end of the period covered by this report.  Based on, and as of the date of, thatevaluation, the Company’s Chief Executive Officer and Chief Financial Officerhave concluded that the Company’s disclosure controls and procedures wereeffective in accumulating and communicating information to management,including the Chief Executive Officer and Chief Financial Officer, asappropriate, to allow timely decisions regarding required disclosures of thatinformation 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, as amended, is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

#### **During the third quarter of 2008,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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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Part II.Other Information**

**For the Nine Months Ended September 30, 2008**

#### ** **

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

#### ** **

Item1. Legal Proceedings

 

Thereare no material legal proceedings to which the Company is a party or of whichtheir property is the subject.

 

Item1A. Risk Factors

 

There have been nomaterial changes from the factors discussed in Part I, “Item 1A. RiskFactors” in our Annual Report on Form 10-K for the year ended December 31,2007 and Part II, “Item 1A. Risk Factors” in our Quarterly Report on Form 10-Qfor the quarter ended June 30, 2008. You should carefully consider the factors discussed below and in ourAnnual Report on Form 10-K for the year ended December 31, 2007 andQuarterly Report on Form 10-Q for the quarter ended June 30, 2008,which could materially affect our business, financial condition or futureresults. The risks described below and in our Annual Report on Form 10-K andour Quarterly Report on Form 10-Q for the quarter ended June 30, 2008 are notthe only risks facing us. Additional risks and uncertainties not currentlyknown to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

 

***The U.S. government’s plan to purchase large amounts ofilliquid, mortgage-backed and other securities from financial institutions maynot be effective and/or it may not be available to us.***

 

There can be no assurance as to what impact the TARP will have on thefinancial markets, including the extreme levels of volatility currently beingexperienced. The failure of the U.S. government to execute this programexpeditiously could have a material adverse effect on the financial markets,which in turn could materially and adversely affect our business, financialcondition and results of operations. Because the rules and guidelines ofthe TARP are continuing to evolve and our potential participation is subject toregulatory and governmental approval, we are unable to assess whether any ofour assets will qualify for the program, whether our securities will bepurchased pursuant to the TARP Capital Purchase Program, or the extent to whichparticipation in the program would be beneficial to us.

 

***If we participate in the TARP CapitalPurchase Program as it is currently structured, our ability to pay cashdividends on the common stock will be restricted and your ownership of ourcommon stock will be diluted.***

 

If we participatein the TARP Capital Purchase Program as it is currently structured, we will beunable to pay cash dividends on our common stock without prior governmentalpermission for a period of three years from the date of our participation,unless the securities we issue under that program are no longer held by theU.S. Treasury Department.  Additionally,the warrants issuable under that program, as it is currently structured, willbe immediately exercisable for common stock and would thereby dilute yourownership of our common stock upon our entry into the program.

 

***The FDIC Deposit Insurance assessments thatwe are required to pay may materially increase in the future, which would havean adverse effect on our earnings.***

 

As amember institution of the FDIC, we are required to pay quarterly depositinsurance premium assessments to the FDIC. Due to the recent failure of several unaffiliated FDIC insurancedepository institutions and the recent increase of deposit insurance to$250,000 until December 31, 2009, we anticipate that the deposit insurancepremium assessments paid by all banks will increase.  In addition, on October 14, 2008, theFDIC announced its Temporary Liquidity Guarantee Program, which providesunlimited FDIC Insurance coverage to non-interest bearing accounts until December 31,2009 for an additional 10 basis point assessment.  If the deposit insurance premium assessmentrate applicable to us increases, or we do not opt out of the FDIC program, ourearnings could be adversely impacted.

 

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Item2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None

 

Item3. Defaults Upon Senior Securities

 

NotApplicable

 

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

 

None

 

Item5. Other Information

 

None

 

Item6. Exhibits

 

(a)           Exhibits:

 

4.1           Form ofAtlantic Southern Bank Fixed Rate Subordinated Debenture

 

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

 

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

 

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

 

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**SIGNATURES**

 

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

 

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

 
| /s/ Mark A. Stevens                    |   |
|----------------------------------------|--------|
|                                   |   |
| Mark A. Stevens                        |   |
| President and Chief  Executive Officer |   |
|                                   |   |
| Date:  November 7, 2008           |   |

 

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