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**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 
| **x**                                                   | **Quarterly  report under Section 13 or 15 (d) of the Securities Exchange Act of  1934** |
|---------------------------------------------------------|----------------------------------------------------------------------------------------------------|
|                                                    |                                                                                               |
| **For the quarterly period ended March 31,  2010** |
|                                                    |                                                                                               |
| **o**                                                   | **Transition  report under Section 13 or 15 (d) of the Exchange Act**                    |

 

**For the transition period from                 to                 **

** **

**Commission File Number  000-51112**

** **

**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

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

 

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

 

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

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

(Address of Principal Executive Offices)

 

**(478) 476-2170**

(Issuer’s Telephone Number, IncludingArea Code)

 

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

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

 

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

 

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

 

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

 

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

 

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

 

 

 

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**APPLICABLE ONLY TO CORPORATEISSUERS**

 

State the number ofshares outstanding of each of the issuer’s classes of common equity, as of thelatest practicable date: Common Stock, no par value, 4,211,780 sharesoutstanding at May 6, 2010

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

INDEX

 
| ** **                                                                                                      | ** ** | **PAGE**                                                                                                                             |
|-----------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------|
| PART I: FINANCIAL  INFORMATION

ITEM  1. FINANCIAL STATEMENTS                                    |       |                                                                                                                                 |
|                                                                                                            |       |                                                                                                                                 |
| The  following consolidated financial statements are provided for Atlantic  Southern Financial Group, Inc. |       |                                                                                                                                 |
|                                                                                                            |       |                                                                                                                                 |   |   |
|                                                                                                            |       | Consolidated Balance  Sheets — March 31, 2010  (unaudited) and December 31,  2009 (audited).                          |   | 2 |
|                                                                                                            |       |                                                                                                                                 |   |   |
|                                                                                                            |       | Consolidated Statements of Operations (unaudited) —  For the Three Months Ended March 31, 2010 and 2009.                   |   | 3 |
|                                                                                                            |       |                                                                                                                                 |   |   |
|                                                                                                            |       | Consolidated  Statements of Comprehensive Income (Loss) (unaudited) — For the Three Months  Ended March 31, 2010 and 2009. |   | 4 |
|                                                                                                            |       |                                                                                                                                 |   |   |
|                                                                                                            |       | Consolidated  Statements of Cash Flows (unaudited) — For the Three Months Ended  March 31, 2010 and 2009.                  |   | 5 |
|                                                                                                            |       |                                                                                                                                 |   |   |
|                                                                                                            |       | Notes to Consolidated Financial Statements (unaudited)                                                                               |   | 7 |
|                                                                                                            |       |                                                                                                                                 |   |   |
| ITEM 2.                                                                                                         |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                          |   | 20 |
|                                                                                                            |       |                                                                                                                                 |   |   |
| ITEM 3.                                                                                                         |       | Quantitative  and Qualitative Disclosures About Market Risk                                                                          |   | 38 |
|                                                                                                            |       |                                                                                                                                 |   |   |
| ITEM 4T.                                                                                                        |       | Controls and  Procedures                                                                                                             |   | 39 |
|                                                                                                            |       |                                                                                                                                 |   |   |
| PART II:                                                                                                   |       | OTHER INFORMATION                                                                                                                    |   | 40 |

 

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**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Balance Sheets**

**March 31, 2010****(Unaudited) and****December 31, 2009****(Audited)**

** **
| ** **                                                                                                   | ** ** | **As of**          | ** **  |
|--------------------------------------------------------------------------------------------------------------|------------|--------------------|-------------|
| ** **                                                                                                   | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
| ** **                                                                                                   | ** ** | **2010**           | ** **  | **2009** | ** ** |
| **Assets**                                                                                                   | ** ** | ** **         | ** **  | ** ** | ** ** |
| Cash and due from banks                                                                                      |       | $                  | 7,762,690   |   | $ | 4,990,374 |   |
| Interest-bearing deposits in other banks                                                                     |       | 52,690,371         |        | 28,401,303 |   |
| Total cash and cash equivalents                                                                              |       | 60,453,061         |        | 33,391,677 |   |
| Securities available for sale, at fair value                                                                 |       | 107,848,003        |        | 126,939,601 |   |
| Federal Home Loan Bank stock, restricted, at cost                                                            |       | 4,316,800          |        | 4,316,800 |   |
| Loans held for sale                                                                                          |       | —             |        | 1,089,108 |   |
| Loans, net of unearned income                                                                                |       | 698,077,903        |        | 718,306,915 |   |
| Less - allowance for loan losses                                                                             |       | (21,148,485        | )           | (21,478,748 | ) |
| Loans, net                                                                                                   |       | 676,929,418        |        | 696,828,167 |   |
| Bank premises and equipment, net                                                                             |       | 30,631,579         |        | 31,016,982 |   |
| Accrued interest receivable                                                                                  |       | 4,370,030          |        | 4,549,769 |   |
| Cash surrender value of life insurance                                                                       |       | 13,142,953         |        | 13,011,018 |   |
| Intangible assets, net of amortization                                                                       |       | 2,458,271          |        | 2,548,850 |   |
| Other real estate owned                                                                                      |       | 27,547,042         |        | 21,066,480 |   |
| Income tax receivable                                                                                        |       | 11,063,212         |        | 11,174,666 |   |
| Other assets                                                                                                 |       | 2,961,320          |        | 2,446,748 |   |
| **Total Assets**                                                                                             |       | $                  | 941,721,689 |   | $ | 948,379,866 |   |
|                                                                                                         |       |               |        |   |   |
| **Liabilities and Shareholders’  Equity**                                                               | ** ** | ** **         | ** **  | ** ** | ** ** |
| Deposits:                                                                                                    |       |               |        |   |   |
| Non-interest bearing                                                                                         |       | $                  | 52,755,933  |   | $ | 53,747,355 |   |
| Money market and NOW accounts                                                                                |       | 119,998,906        |        | 132,469,652 |   |
| Savings                                                                                                      |       | 9,250,769          |        | 8,890,713 |   |
| Time deposits                                                                                                |       | 679,289,543        |        | 666,049,168 |   |
| Total deposits                                                                                               |       | 861,295,151        |        | 861,156,888 |   |
| Federal Home Loan Bank advances                                                                              |       | 34,000,000         |        | 39,000,000 |   |
| Subordinated debentures                                                                                      |       | 1,400,000          |        | 1,400,000 |   |
| Junior subordinated debentures                                                                               |       | 10,310,000         |        | 10,310,000 |   |
| Accrued interest payable                                                                                     |       | 4,992,578          |        | 4,977,554 |   |
| Accrued expenses and other liabilities                                                                       |       | 1,639,202          |        | 1,896,265 |   |
| Total liabilities                                                                                            |       | 913,636,931        |        | 918,740,707 |   |
| Commitments and contingencies                                                                                |       |               |        |   |   |
| Shareholders’ Equity:                                                                                   |       |               |        |   |   |
| Preferred stock, authorized 2,000,000 shares, no  shares outstanding                                         |       | —             |        | — |   |
| Common stock, no par value, authorized 10,000,000  shares, 4,211,780 issued and outstanding in 2010 and 2009 |       | 74,636,782         |        | 74,630,831 |   |
| Accumulated deficit                                                                                          |       | (47,225,253        | )           | (45,592,212 | ) |
| Accumulated other comprehensive income                                                                       |       | 673,229            |        | 600,540 |   |
| Total shareholders’ equity                                                                              |       | 28,084,758         |        | 29,639,159 |   |
| **Total Liabilities and Shareholders’  Equity**                                                         |       | $                  | 941,721,689 |   | $ | 948,379,866 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

**Consolidated Statements of Operations**

**For the Three Months Ended March 31, 2010 and2009**

**(Unaudited)**

 
| ** **                                          | ** ** | **Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                          | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Interest and Dividend Income:**                   |       |                                  |       |   |   |
| Interest and fees on loans                          |       | $                                     | 9,151,990  |   | $ | 11,401,737 |   |
| Interest on securities:                             |       |                                  |       |   |   |
| Taxable income                                      |       | 465,120                               |       | 974,247 |   |
| Non-taxable income                                  |       | 145,360                               |       | 166,732 |   |
| Other interest and dividend income                  |       | 18,040                                |       | 4,158 |   |
| Total interest and dividend income                  |       | 9,780,510                             |       | 12,546,874 |   |
| **Interest Expense:**                               |       |                                  |       |   |   |
| Deposits                                            |       | 5,036,533                             |       | 6,654,763 |   |
| Subordinated debentures                             |       | 42,000                                |       | 42,000 |   |
| Junior subordinated debentures                      |       | 59,392                                |       | 101,387 |   |
| FHLB borrowings and other interest expense          |       | 232,503                               |       | 351,482 |   |
| Total interest expense                              |       | 5,370,428                             |       | 7,149,632 |   |
|                                                |       |                                  |       |   |   |
| Net interest income                                 |       | 4,410,082                             |       | 5,397,242 |   |
| **Provision for loan losses**                       |       | 1,302,000                             |       | 350,000 |   |
| Net interest income after provision for loan losses |       | 3,108,082                             |       | 5,047,242 |   |
| **Noninterest Income:**                             |       |                                  |       |   |   |
| Service charges on deposit accounts                 |       | 384,312                               |       | 421,581 |   |
| Other service charges, commissions and fees         |       | 132,154                               |       | 112,591 |   |
| Gain on sales / calls of investment securities      |       | —                                |       | 220,428 |   |
| Mortgage origination income                         |       | 92,036                                |       | 206,956 |   |
| Other income                                        |       | 260,613                               |       | 301,143 |   |
| Total noninterest income                            |       | 869,115                               |       | 1,262,699 |   |
| **Noninterest Expense:**                            |       |                                  |       |   |   |
| Salaries and employee benefits                      |       | 2,327,302                             |       | 2,776,767 |   |
| Occupancy expense                                   |       | 438,812                               |       | 454,897 |   |
| Equipment rental and depreciation of equipment      |       | 296,363                               |       | 305,301 |   |
| Loss on sale of other assets                        |       | 275                                   |       | 38,247 |   |
| Loss on sale and impairment of other real estate    |       | 101,513                               |       | 24,688 |   |
| Other real estate expense                           |       | 473,456                               |       | 125,693 |   |
| FDIC and state banking assessments                  |       | 910,957                               |       | 196,226 |   |
| Other expenses                                      |       | 1,061,560                             |       | 1,393,182 |   |
| Total noninterest expense                           |       | 5,610,238                             |       | 5,315,001 |   |
|                                                |       |                                  |       |   |   |
| **Earnings (loss) before income  taxes**            |       | (1,633,041                            | )          | 994,940 |   |
| Income tax expense                                  |       | —                                |       | 253,187 |   |
| **Net Earnings (loss)**                             |       | $                                     | (1,633,041 | ) | $ | 741,753 |   |
| **Net Earnings (loss) per share:**                  |       |                                  |       |   |   |
| Basic                                               |       | $                                     | (0.39      | ) | $ | 0.18 |   |
| Diluted                                             |       | $                                     | (0.39      | ) | $ | 0.18 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Statements of Comprehensive Income (Loss)**

**Forthe Three Months Ended March 31, 2010 and 2009**

**(Unaudited)**

 
| ** **                                                                                               | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                               | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Net earnings (loss)                                                                                      |       | $                                     | (1,633,041 | ) | $ | 741,753 |   |
| ** **                                                                                               | ** ** | ** **                            | ** ** | ** ** | ** ** |
| Other comprehensive income:                                                                              |       |                                  |       |   |   |
| Unrealized holding gains on investment securities  available for sale                                    |       | 110,136                               |       | 980,905 |   |
| Reclassification adjustment for gains on  investments available for sale realized in net earnings (loss) |       | —                                |       | (220,428 | ) |
| Total other comprehensive income, before tax                                                             |       | 110,136                               |       | 760,477 |   |
| Income taxes related to other comprehensive income:                                                      |       |                                  |       |   |   |
| Unrealized holding gains on investment securities  available for sale                                    |       | (37,447                               | )          | (333,508 | ) |
| Reclassification adjustment for gains on  investments available for sale realized in net earnings (loss) |       | —                                |       | 74,946 |   |
| Total income taxes related to other comprehensive  income                                                |       | (37,447                               | )          | (258,562 | ) |
| Total other comprehensive income, net of tax                                                             |       | 72,689                                |       | 501,915 |   |
| Total comprehensive income (loss)                                                                        |       | $                                     | (1,560,352 | ) | $ | 1,243,668 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Consolidated Statements of Cash Flows**

**Forthe Three Months Ended March 31, 2010 and 2009**

**(Unaudited)**

 
| ** **                                                                                  | ** ** | **Three Months Ended March 31,** | ** ** |
|---------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                  | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| **Cash Flows from Operating  Activities:**                                                  |       |                                  |       |   |   |
| Net earnings (loss)                                                                         |       | $                                     | (1,633,041 | ) | $ | 741,753 |   |
| Adjustments to reconcile net earnings (loss) to net  cash provided by operating activities: |       |                                  |       |   |   |
| Provision for loan losses                                                                   |       | 1,302,000                             |       | 350,000 |   |
| Depreciation                                                                                |       | 394,895                               |       | 397,597 |   |
| Stock based compensation                                                                    |       | 5,951                                 |       | 6,626 |   |
| Amortization and (accretion), net                                                           |       | 275,394                               |       | 208,979 |   |
| Loss on sale and impairment of other real estate                                            |       | 101,513                               |       | 24,688 |   |
| Loss on sale of other assets                                                                |       | 275                                   |       | 38,247 |   |
| Gain on sales / calls of investment securities                                              |       | —                                |       | (220,428 | ) |
| Earnings on cash surrender value of life insurance                                          |       | (131,935                              | )          | (133,582 | ) |
| Change in:                                                                                  |       |                                  |       |   |   |
| Loans held for sale                                                                         |       | 1,089,108                             |       | 692,176 |   |
| Accrued income and other assets                                                             |       | 466,990                               |       | 1,158,223 |   |
| Accrued expenses and other liabilities                                                      |       | (242,039                              | )          | 217,299 |   |
| Net cash provided by operating activities                                                   |       | 1,629,111                             |       | 3,481,578 |   |
| **Cash Flows from Investing  Activities:**                                                  |       |                                  |       |   |   |
| Net change in loans to customers                                                            |       | 8,725,222                             |       | (4,473,846 | ) |
| Purchase of available for sale securities                                                   |       | —                                |       | (7,465,725 | ) |
| Proceeds from sales, calls, maturities and paydowns  of available for sale securities       |       | 19,043,934                            |       | 19,284,260 |   |
| Purchase of other investments                                                               |       | —                                |       | (475,600 | ) |
| Proceeds from sales of other investments                                                    |       | —                                |       | 447,526 |   |
| Property and equipment expenditures                                                         |       | (9,492                                | )          | (1,317,848 | ) |
| Improvement of other real estate                                                            |       | (3,742                                | )          | (15,118 | ) |
| Proceeds from sales of assets                                                               |       | 2,538,088                             |       | 706,990 |   |
| Net cash provided by investing activities                                                   |       | 30,294,010                            |       | 6,690,639 |   |
| **Cash Flows from Financing Activities:**                                                   |       |                                  |       |   |   |
| Net change in deposits                                                                      |       | 138,263                               |       | 57,399,229 |   |
| Advances on FHLB borrowings                                                                 |       | —                                |       | 22,000,000 |   |
| Payments on FHLB borrowings                                                                 |       | (5,000,000                            | )          | (22,200,000 | ) |
| Net cash (used in) provided by financing activities                                         |       | (4,861,737                            | )          | 57,199,229 |   |
| **Net Increase in Cash and Cash  Equivalents**                                              |       | 27,061,384                            |       | 67,371,446 |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                           |       | 33,391,677                            |       | 15,130,136 |   |
| **Cash and Cash Equivalents, End of  Quarter**                                              |       | $                                     | 60,453,061 |   | $ | 82,501,582 |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**ConsolidatedStatements of Cash Flows, continued**

**Forthe Three Months Ended March 31, 2010 and 2009**

**(Unaudited)**

 

**Supplemental Disclosure of Cash Flow Information**

 

**Noncash transactions:**

 
| ** **                                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| Changes in unrealized gain/loss on investments, net  of tax effect |       | $                                     | 72,689     |   | $ | 501,915 |   |
| Transfer of loans to other real estate and other  assets           |       | $                                     | 10,061,264 |   | $ | 2,650,179 |   |
| Transfer of other real estate to loans                             |       | $                                     | 185,170    |   | $ | — |   |

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes toConsolidated Financial Statements**

**(Unaudited)**

 

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

 

The accompanyingunaudited consolidated financial statements have been prepared in accordancewith the instructions to Form 10-Q and therefore do not include allinformation and footnotes necessary for a fair presentation of financialposition, results of operations, and changes in financial position inconformity with generally accepted accounting principles.  The interim financial statements furnishedreflect all adjustments, which are, in the opinion of management, necessary toa fair statement of the results for the interim periods presented.  The interim consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-Kfor the year ended December 31, 2009.

 

# ***(2) Regulatory Orders***

# ** **

On September 11,2009, Atlantic Southern Bank (the “Bank”), the wholly-owned subsidiary bank ofAtlantic Southern Financial Group, Inc., entered into a Stipulation andConsent to the Issuance of an Order to Cease and Desist (the “Consent Agreement”)with the Federal Deposit Insurance Corporation (the “FDIC”) and the GeorgiaDepartment of Banking and Finance (the “GDBF”), whereby the Bank consented tothe issuance of an Order to Cease and Desist (the “Order”).  Under the terms of the Order, the Bank cannotdeclare dividends without the prior written approval of the FDIC and the GDBF.Other material provisions of the order require the Bank to: (i) strengthenits board of directors’ oversight of management and operations of the Bank, (ii) establisha committee consisting of at least four members, three of which must beindependent, to oversee the Bank’s compliance with the Order, (iii) maintainspecified capital and liquidity ratios, (iv)  improve the Bank’s lendingand collection policies and procedures, particularly with respect to theorigination and monitoring of commercial real estate and acquisition,development and construction loans, (v) eliminate from its books, bycharge off or collection, all assets classified as “loss” and 50% of all assetsclassified as doubtful, (vi) perform risk segmentation analysis withrespect to concentrations of credit, (vii) receive a brokered depositwaiver from the FDIC prior to accepting, rolling over or renewing any brokereddeposits and submit a written plan for eliminating its reliance on brokereddeposits, (viii) adopt and implement a policy limiting the use of loaninterest reserves, (ix) formulate and fully implement a written plan andcomprehensive budget for all categories of income and expense, and (x) prepareand submit progress reports to the FDIC and the GDBF. The FDIC order will remainin effect until modified or terminated by the FDIC and the GDBF.

 

The Bank has continued toserve its customers in all areas including making loans, establishing lines ofcredit, accepting deposits and processing banking transactions.  The Bank’s deposits remain insured by theFDIC to the maximum limits allowed by law. The FDIC and GDBF did not impose or recommend any monetary penalties.

 

Following is an update asto the actions taken by the Bank in response to the Order.  As of the date of this report, the Bank hasmade the following progress in complying with the above stated provisions:

 

(i)            Since the Order and throughout 2010, theboard of directors’ participation in the affairs of the Bank has increasedthrough greater communication with management, an analysis of managementreports to the board, as well as increased committee activities.

 

(ii)           The Bank has formed an oversightcommittee for the purpose of monitoring the Bank’s overall compliance with theOrder and this committee meets bi-monthly and reports to the full board of theBank at each regularly scheduled board meeting. Although not specifically required by the Order, the board engaged anindependent management consulting firm to conduct an assessment of Bankmanagement.

 

(iii)          The Bank developed a capital plan, whichincludes reducing expenses to improve earnings, restructuring the balance sheetto reduce non-performing assets, seeking new capital and limiting loangrowth.  The Bank is currently updatingthe plan and will continue to revise the plan quarterly.  The Bank has also reviewed its writtenliquidity, contingency funding, and funds management policies and has madeappropriate revisions.  Both the revisedcapital plan and the revised liquidity policy have been submitted to the supervisoryauthorities for review.  The Bank’s

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Total Risk BasedCapital ratio was 6.16% and the Tier 1 Leverage Ratio was 3.65% at March 31,2010.  The Bank’s liquidity ratio at March 31,2010 was 18.92%.

 

(iv)          The Bank has reviewed and revised lendingpolicies to provide additional guidance and control over the lending functions.

 

(v)           The Bank has eliminated from its booksall assets or portions of assets classified as “Loss” and 50% of all assets orportions of assets classified as “Doubtful”.

 

(vi)          The Bank has performed a risksegmentation analysis with respect to concentrations of credit and isdeveloping a plan to reduce the concentrations of credit.  Upon completion, the plan will be submittedto the supervisory authorities.

 

(vii)         TheBank has submitted to the supervisory authorities a written plan foreliminating its reliance on brokered deposits and will not accept, roll over orrenew any brokered deposits unless a waiver has been received from theFDIC.  The Bank has significantly reducedit exposure to brokered deposits.  Since June 30,2008, the Bank reduced brokered deposits by 44.3%, or $178.6 million, whileincreasing core deposits by $204.2 million during the same period.

 

(viii)        TheBank has adopted a policy limiting the use of interest reserves.

 

(ix)           A three-year profit plan has beendeveloped and is currently under review by the oversight committee.

 

(x)            The Bank has submitted all requiredprogress reports to the appropriate supervisory authorities.

 

On March 26, 2010,the Company entered into a written agreement (the “Agreement”) with the Boardof Governors of the Federal Reserve System (the “Federal Reserve Board”) andthe GDBF, pursuant to which the Company will be prohibited from declaring orpaying dividends without prior written consent from the regulators.  In addition, pursuant to the Agreement,without the prior written consent of regulators, the Company is prohibited fromtaking dividends, or any other form of payment representing a reduction ofcapital, from the Bank; paying interest, principal or other sums onsubordinated debentures and trust preferred securities; incurring, increasingor guaranteeing any debt; redeeming any shares of the Company’s common stock;and increasing salaries or bonuses paid to executive officers.  All salaries, bonuses and fees, excluding thereimbursement of expenses valued at less than $500 in the aggregate per monthper executive officer, must be preapproved by the board of directors on aregular basis.  In appointing any newdirector or any executive officer, the Company is required to notify regulatoryauthorities and comply with restrictions on indemnification and severance.  The Company will also provide quarterlywritten progress reports to the Federal Reserve Board.

 

Within 60 days of theAgreement, the Company will submit to the Federal Reserve Board a written plandesigned to maintain sufficient capital at the Company, on a consolidatedbasis, and at the Bank.  The Agreementdoes not contain specific target capital ratios or specific timelines, butrequires that the plan address the Company’s current and future capitalrequirements, the Bank’s current and future capital requirements, the adequacyof the Bank’s capital taking into account its risk profile, and the source andtiming of additional funds necessary to fulfill the Company’s and the Bank’sfuture capital requirements.

 

# ***(3) Going Concern***

 

Asa result of the extraordinary effects of what may ultimately be the worsteconomic downturn since the Great Depression, the Company’s and the Bank’scapital have been significantly depleted. The Company recorded a net loss of $59.2 million in 2009 and continuedin the first quarter of 2010 in recording a net loss of $1.6 million.  These net losses are primarily the result ofsignificant increases in the provision for loan losses in 2009 and 2010, therecognition of goodwill impairment in 2009 and the establishment of a valuationallowance against the Company’s deferred tax asset in 2009.  The impact of the current financial crisis inthe U.S. and abroad is having far-reaching consequences and it is difficult tosay at this point when the economy will begin to recover.  As a 

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

result,there can be no assurance that the Company will be able to resume profitableoperations in the near future, if at all.

 

TheCompany and the Bank are required by federal regulatory authorities to maintainadequate levels of capital to support their operations.  As part of the Order, the Bank is required toincrease its capital and maintain certain regulatory capital ratios.  To comply with the Order, the Bank isrequired to have Tier 1 capital in such an amount as to equal or exceed 8% ofthe Bank’s total assets and total risk-based capital in an amount as to equalor exceed 10% of the Bank’s risk-weighted assets.  At March 31, 2010, the Bank’s totalcapital to risk-weighted assets and ratio of Tier 1 capital to risk-weightedassets were 6.16% and 4.70%, respectively. The Company’s existing capital resources may not satisfy therequirements for the foreseeable future and may not be sufficient to offset anyadditional problem assets.  Further,should erosion to the Bank’s asset quality continue and require significantadditional provision for credit losses, resulting in consistent net operatinglosses at the Bank, the Bank’s capital levels will decline and the Company willneed to raise additional capital to satisfy the Order.

 

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

 

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

 

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

 

# ***(4) Net Earnings (Loss) perShare***

 

Basicearnings (loss) per share are based on the weighted average number of commonshares outstanding during the period while the effects of potential sharesoutstanding during the period are included in diluted earnings per share.  Approximately 381,000 shares of options andwarrants were not included in the diluted loss per share computation for thethree months ended March 31, 2010 and approximately 387,000 shares ofoptions and warrants were not included in the diluted earnings per sharecomputation for the three months ended March 31, 2009 as they areanti-dilutive.

 

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

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Three  Months Ended** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                                  | ** ** | **March 31,**      | ** ** |
| ** **                                                                  | ** ** | **2010**                | ** ** | **2009** | ** ** |
|                                                                        |       |                    |       |   |   |
| Net earnings (loss)                                                         |       | $                       | (1,633,041 | ) | $ | 741,753 |   |
|                                                                        |       |                    |       |   |   |
| Weighted average common shares outstanding                                  |       | 4,211,780               |       | 4,211,780 |   |
| Shares issued from assumed exercise of common stock  equivalents            |       | —                  |       | — |   |
| Weighted average number of common and common equivalent  shares outstanding |       | 4,211,780               |       | 4,211,780 |   |
| Earnings (loss) per share:                                                  |       |                    |       |   |   |
| Basic                                                                       |       | $                       | (0.39      | ) | $ | 0.18 |   |
| Diluted                                                                     |       | $                       | (0.39      | ) | $ | 0.18 |   |

 

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

 

Debt and equity securities have been classified in the balance sheetaccording to management’s intent.  All investmentsas of March 31, 2010 and December 31, 2009 are classified asavailable for sale.  The following tablereflects the amortized cost and estimated fair values of the investments:

 
| ** **                                | ** ** | **Amortized** | ** **  | **Unrealized** | ** ** | **Unrealized** | ** ** | **Estimated**  | ** ** |
|-------------------------------------------|------------|---------------|-------------|----------------|------------|----------------|------------|----------------|------------|
| ** **                                | ** ** | **Cost**      | ** **  | **Gains**      | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** |
| **March 31, 2010**                        |       |          |        |           |       |           |       |           |       |
| Non-mortgage backed debt securities of :  |       |          |        |           |       |           |       |           |       |
| U.S. Treasury obligations                 |       | $             | 43,040,330  |           | $          | 24,581         |       | $              | —     |   | $ | 43,064,911 |   |
| U.S. government sponsored enterprises     |       | 24,680,377    |        | 437,942        |       | —         |       | 25,118,319     |       |
| State and political subdivisions          |       | 15,356,075    |        | 345,604        |       | (357,570       | )          | 15,344,109     |       |
| Other investments                         |       | 250,000       |        | 6,787          |       | —         |       | 256,787        |       |
| Total non-mortgage backed debt securities |       | 83,326,782    |        | 814,914        |       | (357,570       | )          | 83,784,126     |       |
| Mortgage backed securities                |       | 23,461,748    |        | 582,078        |       | (32,889        | )          | 24,010,937     |       |
| Equity securities                         |       | 39,428        |        | 13,512         |       | —         |       | 52,940         |       |
| Total                                     |       | $             | 106,827,958 |           | $          | 1,410,504      |       | $              | (390,459   | ) | $ | 107,848,003 |   |
| **December 31, 2009**                |       |          |        |           |       |           |       |           |       |
| Non-mortgage backed debt securities of :  |       |          |        |           |       |           |       |           |       |
| U.S. Treasury obligations                 |       | $             | 57,114,838  |           | $          | 42,027         |       | $              | —     |   | $ | 57,156,865 |   |
| U.S. government sponsored enterprises     |       | 27,191,611    |        | 425,213        |       | —         |       | 27,616,824     |       |
| State and political subdivisions          |       | 15,404,985    |        | 234,535        |       | (483,685       | )          | 15,155,835     |       |
| Other investments                         |       | 250,000       |        | 9,208          |       | —         |       | 259,208        |       |
| Total non-mortgage backed debt securities |       | 99,961,434    |        | 710,983        |       | (483,685       | )          | 100,188,732    |       |
| Mortgage backed securities                |       | 26,028,829    |        | 733,712        |       | (51,100        | )          | 26,711,441     |       |
| Equity securities                         |       | 39,428        |        | —         |       | —         |       | 39,428         |       |
| Total                                     |       | $             | 126,029,691 |           | $          | 1,444,695      |       | $              | (534,785   | ) | $ | 126,939,601 |   |

 

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

 
| ** **     | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|----------------|------------|--------------------|------------|-----------------------|------------|
| ** **     | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| Amortized cost |       | $                  | 26,074,327 |                  | $          | 23,141,062 |   |
| Fair value     |       | $                  | 26,177,625 |                  | $          | 23,003,692 |   |

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

The amortized cost and estimated fair value of debtsecurities available for sale at March 31, 2010, by contractual maturity,are shown below.  Expected maturities formortgage-backed securities may differ from contractual maturities because incertain cases borrowers can prepay obligations without prepaymentpenalties.  Therefore, these securitiesare not included in the following maturity summary.

 
| ** **                                | ** ** | ** **         | ** ** | **Estimated**  | ** ** |
|-------------------------------------------|------------|--------------------|------------|----------------|------------|
| ** **                                | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
| Non-mortgage backed debt securities:      |       |               |       |           |       |
| Due in one year or less                   |       | $                  | 43,040,330 |           | $          | 43,064,911 |   |
| Due after one year through five years     |       | 18,832,368         |       | 19,038,071     |       |
| Due after five years through ten years    |       | 8,955,064          |       | 9,197,609      |       |
| Due after ten years                       |       | 12,499,020         |       | 12,483,535     |       |
| Total non-mortgage backed debt securities |       | $                  | 83,326,782 |           | $          | 83,784,126 |   |

 

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

 

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

 
| ** **                                | ** ** | **March 31, 2010**     | ** ** |
|-------------------------------------------|------------|-----------------------------|------------|
| ** **                                | ** ** | **Less Than Twelve Months** | ** ** | **More Than Twelve Months** | ** ** |
| ** **                                | ** ** | **Unrealized**              | ** ** | **Estimated** | ** ** | **Unrealized** | ** ** | **Estimated** | ** ** |
| **Securities Available for Sale**         | ** ** | **Losses**                  | ** ** | **Fair  Value** | ** ** | **Losses** | ** ** | **Fair  Value** | ** ** |
| Non-mortgage backed debt securities of:   |       |                        |       |   |   |   |   |   |   |
| U.S. Treasury obligations                 |       | $                           | —     |   | $ | — |   | $ | — |   | $ | — |   |
| U.S. government sponsored enterprises     |       | —                      |       | — |   | — |   | — |   |
| State and political subdivisions          |       | (168                        | )          | 347,293 |   | (357,402 | ) | 4,433,314 |   |
| Total non-mortgage backed debt securities |       | (168                        | )          | 347,293 |   | (357,402 | ) | 4,433,314 |   |
| Mortgage backed securities                |       | (32,889                     | )          | 5,141,028 |   | — |   | — |   |
| Total                                     |       | $                           | (33,057    | ) | $ | 5,488,321 |   | $ | (357,402 | ) | $ | 4,433,314 |   |

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

 

Management evaluatessecurities for other-than-temporary impairment at least on a quarterly basis,and more frequently when economic or market concerns warrant such evaluation.Consideration is given to (1) the length of time and the extent to whichthe fair value has been less than cost, (2) the financial condition andnear-term

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

prospects of the issuer, and (3) theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value.

 

At March 31, 2010,sixteen debt securities had unrealized losses with aggregate depreciation of0.37% from the Company’s amortized cost basis. In analyzing an issuer’s financial condition, management considerswhether the securities are issued by the federal government or its agencies,whether downgrades by bond rating agencies have occurred, and industry analysts’reports. As management has the ability and intent to hold debt securities untilmaturity, or for the foreseeable future if classified as available for sale andit is more likely than not that the Company will not be required to sell theseinvestments before recovery of their amortized cost basis, no declines aredeemed to be other than temporary.

 

The following tablesummarizes securities disposal activities for the three month period ended March 31,2010 and 2009:

 
| ** **                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------|------------|----------------------------------------|------------|
| ** **                       | ** ** | **2010**                               | ** ** | **2009** | ** ** |
| Proceeds from sales              |       | $                                      | —     |   | $ | 13,737,888 |   |
| Proceeds from calls              |       | 2,545,000                              |       | 180,000 |   |
| Proceeds from maturities         |       | 14,000,000                             |       | 1,750,000 |   |
| Paydowns                         |       | 2,498,934                              |       | 3,616,372 |   |
| Total                            |       | $                                      | 19,043,934 |   | $ | 19,284,260 |   |
|                             |       |                                   |       |   |   |
| Gross gains                      |       | $                                      | —     |   | $ | 231,125 |   |
| Gross losses                     |       | —                                 |       | (10,697 | ) |
|                             |       |                                   |       |   |   |
| Net gains (losses) of securities |       | $                                      | —     |   | $ | 220,428 |   |
|                             |       |                                   |       |   |   |
| Income tax expense (benefit)     |       | $                                      | —     |   | $ | 74,946 |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

***(6)  Loans***

 

Thefollowing is a summary of the loan portfolio by purpose code categories:

 
| ** **                                        | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|---------------------------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                                        | ** ** | **2010**           | ** **  | **2009**              | ** ** |
|                                              |       |               |        |                  |       |
| Commercial                                        |       | $                  | 48,696,551  |                  | $          | 51,673,928 |   |
| Real estate - commercial                          |       | 319,634,394        |        | 304,468,535           |       |
| Real estate - construction                        |       | 226,249,546        |        | 263,270,892           |       |
| Real estate - mortgage                            |       | 97,144,402         |        | 92,012,553            |       |
| Obligations of political subdivisions in the U.S. |       | 328,507            |        | 294,779               |       |
| Consumer                                          |       | 6,236,593          |        | 6,838,169             |       |
| Total Loans                                       |       | 698,289,993        |        | 718,558,856           |       |
| Less:                                             |       |               |        |                  |       |
| Unearned loan fees                                |       | (212,090           | )           | (251,941              | )          |
| Allowance for loan losses                         |       | (21,148,485        | )           | (21,478,748           | )          |
| Loans, net                                        |       | $                  | 676,929,418 |                  | $          | 696,828,167 |   |

### ** **

### **The Company considers a loan to be impaired when it is probable that itwill be unable to collect all amounts due according to the original terms ofthe loan agreement.  Impaired loansinclude loans which are not accruing interest and restructured loans which areaccruing interest.  The Company measuresimpairment of a loan on a loan-by-loan basis by either the present value ofexpected future cash flows discounted at the loan’s effective interest rate,the loan’s obtainable market price, or the fair value of the collateral if theloan is collateral dependent. Non-accrual loans are loans which collection of interest is not probableand all cash flows received are recorded as reduction in principal.  Restructured loans have modified terms fromthe original contract that give the debtor a more manageable arrangement formeeting financial obligations under their current situation.  Amounts of impaired loans that are notprobable of collection are charged off immediately.**

### ** **

### **At March 31, 2010 and December 31, 2009, all impaired loanswith a related allowance have been evaluated based upon the fair value of theunderlying collateral.  Impaired loanswithout a related allowance were previously written down to the net realizablevalue of the collateral or the collateral was sufficient to ensure no principalloss.  Impaired loans and related amountsincluded in the allowance for loan losses at March 31, 2010 and December 31,2009 are as follows:**

 
| ** **                               | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                               | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| ** **                               | ** ** | ** **         | ** ** | **Allowance**         | ** ** | ** ** | ** ** | **Allowance** | ** ** |
| ** **                               | ** ** | **Balance**        | ** ** | **Amount**            | ** ** | **Balance** | ** ** | **Amount** | ** ** |
| Impaired loans with related allowance    |       | $                  | 13,968,551 |                  | $          | 1,062,224 |   | $ | 3,261,723 |   | $ | 1,024,001 |   |
| Impaired loans without related allowance |       | 94,248,963         |       | —                |       | 112,031,829 |   | — |   |
|                                          |            |                    |            |                       |            |  |  |  |  |  |  |  |  |

 

The Company had $7.4million and $12.8 million in loans that would be defined as a troubled debtrestructuring (“TDR”) at March 31, 2010 and at December 31, 2009,respectively.  Of those amounts, $1.8million and $1.6 million were accruing as of March 31, 2010 and December 31,2009, respectively, and performing in accordance with their restructuredterms.  At March 31, 2010, therewere approximately $1.6 million in TDR loans that had a related allowance ofover $289 thousand.  At December 31,2009, there were no TDR loans that had a related allowance.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

***(7)  Allowance for Loan Losses***

 

Activityin the allowance for loan losses for the three months ended March 31, 2010and 2009 is as follows:

 
| ** **                                 | ** ** | **March 31,** | ** ** | **March 31,** | ** ** |
|--------------------------------------------|------------|--------------------|------------|--------------------|------------|
| ** **                                 | ** ** | **2010**           | ** ** | **2009**           | ** ** |
| Beginning Balance                          |       | $                  | 21,478,748 |               | $          | 11,671,534 |   |
| Add:                                       |       |               |       |               |       |
| Provision for possible loan losses         |       | 1,302,000          |       | 350,000            |       |
| Subtotal                                   |       | 22,780,748         |       | 12,021,534         |       |
| Less:                                      |       |               |       |               |       |
| Loans charged off                          |       | 1,691,333          |       | 593,826            |       |
| Recoveries on loans previously charged off |       | (59,070            | )          | (64,948            | )          |
| Net loans charged off                      |       | 1,632,263          |       | 528,878            |       |
| Balance, end of period                     |       | $                  | 21,148,485 |               | $          | 11,492,656 |   |

 

***(8)  Nonperforming Assets***

 

### **Nonperforming assets consist ofnon-accrual loans, accruing loans 90 days past due, repossessed assets andother real estate owned. The following summarizes non-performing assets:**

 
| ** **                      | ** ** | **March 31,** | ** **  | **December 31,** | ** ** |
|---------------------------------|------------|--------------------|-------------|-----------------------|------------|
| ** **                      | ** ** | **2010**           | ** **  | **2009**              | ** ** |
| Accruing loans 90 days past due |       | $                  | —      |                  | $          | 644,920 |   |
| Non-accrual loans               |       | 108,217,514        |        | 115,293,553           |       |
| Repossessed assets              |       | 8,338              |        | 1,000                 |       |
| Other real estate owned         |       | 27,547,042         |        | 21,066,480            |       |
| Total non-performing assets     |       | $                  | 135,772,894 |                  | $          | 137,005,953 |   |

 

Nonperforming assetsdecreased $1.2 million, or 0.90%, from December 31, 2009 to March 31,2010.  This decrease is primarily due to$1.2 million in pay downs and $1.7 million in partial charge-offs onnon-accrual loans since December 31, 2009. Non-accrual loans decreased $7.1 million from December 31, 2009 to March 31,2010, largely due to approximately $9.3 million moving to other real estateowned.  During the first quarter of 2010,there were approximately $5.1 million in loans moved to non-accrual.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other real estateowned increased $6.5 million from December 31, 2009 to March 31,2010.  This increase is largely due tothe addition of $9.3 million in foreclosed properties being offset by the saleof $2.7 million in foreclosed properties resulting in a small gain of $6thousand on these properties.

 

The Company’s policy isto place loans on non-accrual status when it appears that the collection ofinterest in accordance with the terms of the loan is doubtful.  Any loan which becomes 90 days past due as toprincipal or interest is automatically placed on non-accrual.  Exceptions are allowed for 90-day past dueloans when such loans are well secured and in process of collection.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

As of March 31, 2010and December 31, 2009, the Company’s other real estate consisted of thefollowing:

 
| ** **                                          | ** ** | **As of March 31, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **Number of  Properties**     | ** ** | **Carrying  Amount**             | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| 1-4 Family residential properties                   |       | 28                            |       | $                                | 2,865,502  |   | 23 |   | 2,958,213 |   |
| Multifamily residential properties                  |       | 2                             |       | 1,364,992                        |       | 2 |   | 238,225 |   |
| Nonfarm nonresidential properties                   |       | 13                            |       | 8,875,669                        |       | 13 |   | 8,994,372 |   |
| Farmland properties                                 |       | 1                             |       | 758,700                          |       | — |   | — |   |
| Construction & land development properties |       | 40                            |       | 13,682,179                       |       | 35 |   | 8,875,670 |   |
| Total                                               |       | 84                            |       | $                                | 27,547,042 |   | 73 |   | 21,066,480 |   |

 

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

 

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

 

***(9)  ******Fair Value Measurementsand Disclosures***

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

Thetable below presents the recorded amount of assets and liabilities measured atfair value on a recurring basis at March 31, 2010 and December 31,2009.

 
| ** **                               | ** ** | **As of March 31,** | ** **  |
|------------------------------------------|------------|--------------------------|-------------|
| ** **                               | ** ** | **2010**                 | ** **  |
| ** **                               | ** ** | **Total**                | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| **Assets**                               |       |                     |        |   |   |   |   |   |   |
| Debt securities available-for-sale       |       |                     |        |   |   |   |   |   |   |
| U.S. Treasury obligations                |       | $                        | 43,064,911  |   | $ | — |   | $ | 43,064,911 |   | $ | — |   |
| U.S. government sponsored enterprises    |       | 25,118,319               |        | — |   | 25,118,319 |   | — |   |
| State and political subdivisions         |       | 15,344,109               |        | — |   | 15,344,109 |   | — |   |
| Other investments                        |       | 256,787                  |        | — |   | 256,787 |   | — |   |
| Mortgage backed securities               |       | 24,010,937               |        | — |   | 24,010,937 |   | — |   |
| Total debt securities available-for-sale |       | 107,795,063              |        | — |   | 107,795,063 |   | — |   |
| Equity securities available-for-sale     |       | 52,940                   |        | — |   | 52,940 |   | — |   |
| Total available-for-sale securities      |       | $                        | 107,848,003 |   | $ | — |   | $ | 107,848,003 |   | $ | — |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

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

 

Assets Recorded at Fair Value on a Nonrecurring Basis

 

TheCompany may be required, from time to time, to measure certain assets at fairvalue on a nonrecurring basis in accordance with U.S. generally acceptedaccounting principles.  These includeassets that are measured at the lower of cost or market that were recognized atfair value below cost at the end of the period. Assets measured at fair value on a nonrecurring basis are included inthe table below at March 31, 2010 and December 31, 2009.

 
| ** **                     | ** ** | **As of March 31,** | ** **  |
|--------------------------------|------------|--------------------------|-------------|
| ** **                     | ** ** | **2010**                 | ** **  |
| ** **                     | ** ** | **Total**                | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                           |       |                     |        |   |   |   |   |   |   |
| Loans                          |       | $                        | 119,531,926 |   | $ | — |   | $ | 119,531,926 |   | $ | — |   |
| Loans held for sale            |       | —                   |        | — |   | — |   | — |   |
| Other real estate owned        |       | 27,547,042               |        | — |   | 27,547,042 |   | — |   |
|                           |       |                     |        |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                        | 147,078,968 |   | $ | — |   | $ | 147,078,968 |   | $ | — |   |

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

The carrying amount and estimated fair values of theCompany’s assets and liabilities which are required to be either disclosed orrecorded at fair value at March 31, 2010 and December 31, 2009 are asfollows:

 
| ** **                             | ** ** | **March 31, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                             | ** ** | **Carrying**            | ** ** | **Estimated**              | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amount**              | ** ** | **Fair Value**             | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Assets:**                            |       |                    |       |                       |       |   |   |   |   |
| Cash and cash equivalents              |       | $                       | 60,453,061 |                       | $          | 60,453,061 |   | $ | 33,391,677 |   | $ | 33,391,677 |   |
| Securities available for sale          |       | 107,848,003             |       | 107,848,003                |       | 126,939,601 |   | 126,939,601 |   |
| Federal Home Loan Bank Stock           |       | 4,316,800               |       | 4,316,800                  |       | 4,316,800 |   | 4,316,800 |   |
| Loans held for sale                    |       | —                  |       | —                     |       | 1,089,108 |   | 1,089,108 |   |
| Loans, net                             |       | 676,929,418             |       | 677,403,519                |       | 696,828,167 |   | 698,284,092 |   |
| Cash surrender value of life insurance |       | 13,142,953              |       | 13,142,953                 |       | 13,011,018 |   | 13,011,018 |   |
| Other real estate owned                |       | 27,547,042              |       | 27,547,042                 |       | 21,066,480 |   | 21,066,480 |   |
| **Liabilities:**                       |       |                    |       |                       |       |   |   |   |   |
| Deposits                               |       | 861,295,151             |       | 864,227,946                |       | 861,156,888 |   | 866,219,696 |   |
| FHLB borrowings                        |       | 34,000,000              |       | 34,965,521                 |       | 39,000,000 |   | 39,984,264 |   |
| Subordinated debentures                |       | 1,400,000               |       | 1,400,000                  |       | 1,400,000 |   | 1,400,000 |   |
| Junior subordinated debentures         |       | 10,310,000              |       | 10,310,000                 |       | 10,310,000 |   | 10,310,000 |   |
|                                        |            |                         |            |                            |            |  |  |  |  |  |  |  |  |

 

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

 

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

 

***(10) Regulatory Matters***

 

TheCompany and the Bank are subject to various regulatory capital requirementsadministered by the federal banking agencies.  Failure to meet minimalcapital requirements can initiate certain mandatory and possibly additionaldiscretionary actions by regulators that, if undertaken, could have a directmaterial effect on the consolidated financial statements.  Under capitaladequacy guidelines and the regulatory framework for prompt corrective action,we must meet specific capital guidelines that involve quantitative measures ofassets, liabilities and certain off-balance sheet items as calculated underregulatory accounting practices.  The Company’s and the Bank’s capitalamounts and classification are also subject to qualitative judgments by the regulatorsabout components, risk weightings and other factors.

 

Inaddition, quantitative measures established by regulations to ensure capitaladequacy require us to maintain minimum amounts and ratios (set forth below inthe table) of total and Tier I capital (as defined in the regulations) torisk-weighted assets (as defined in the regulations), and of Tier I capital (asdefined in the regulations) to average assets (as defined in theregulations).  To comply with the Order, the Bank is required to have Tier1 capital in such an amount as to equal or exceed 8% of the Bank’s total assetsand total risk-based capital as to equal or exceed 10% of the Bank’srisk-weighted assets.  As of March 31,2010, the Bank’s ratio of total capital to risk-weighted assets and ratio ofTier 1 Capital to risk-weighted assets were 6.16% and 4.70%, respectively.  The Company and the Bank were considered “undercapitalized”by bank regulatory authorities as of March 31, 2010 and December 31,2009.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

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

 
| ** **                                        | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | **To Be Well Capitalized**  | ** ** |
|---------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------------|------------|
| ** **                                        | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                                        | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                        | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | ** **                  | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ***March 31,  2010***                        |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| * *                                          |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 45,651,000 |                  | 6.25       | %                     | $          | 58,433,280                  |       | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 45,022,000 |       | 6.16                  | %          | 58,470,130            |       | >                   |       | 8.0 | % | $ | 73,087,662 |   | >  |   | 10.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 34,954,000 |                  | 4.78       | %                     | $          | 29,250,209                  |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 34,328,000 |       | 4.70                  | %          | 29,215,319            |       | >                   |       | 4.0 | % | $ | 43,822,979 |   | >  |   | 6.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 34,954,000 |                  | 3.72       | %                     | $          | 37,584,946                  |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 34,328,000 |       | 3.65                  | %          | 37,619,726            |       | >                   |       | 4.0 | % | $ | 47,024,658 |   | >  |   | 5.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| ***December 31,  2009***                     |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| * *                                          |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 47,485,000 |                  | 6.28       | %                     | $          | 60,490,446                  |       | >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 46,763,000 |       | 6.19                  | %          | 60,436,834            |       | >                   |       | 8.0 | % | $ | 75,546,042 |   | >  |   | 10.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 36,490,000 |                  | 4.83       | %                     | $          | 30,219,462                  |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 35,771,000 |       | 4.73                  | %          | 30,250,317            |       | >                   |       | 4.0 | % | $ | 45,375,476 |   | >  |   | 6.0 | % |
|                                              |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Tier I Capital To Average Assets                  |       |       |       |                  |       |                  |       |                        |       |   |   |   |   |   |   |   |   |
| Consolidated                                      |       | $          | 36,490,000 |                  | 3.44       | %                     | $          | 42,430,233                  |       | >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                              |       | 35,771,000 |       | 3.37                  | %          | 42,458,160            |       | >                   |       | 4.0 | % | $ | 53,072,700 |   | >  |   | 5.0 | % |

 

***(11) AccountingStandards Updates***

 

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

 

In January 2010, theFASB issued Accounting Standards Update No. 2010-04, *TechnicalCorrections to SEC Paragraphs* (“ASU No. 2010-04”).  It is not expected to have an impact on theCompany.

 

In January 2010, theFASB issued Accounting Standards Update No. 2010-06, *ImprovingDisclosures about Fair Value Measurements* (“ASU No. 2010-06”).  ASU No. 2010-06 amends FASB ASC Topic820-10-50, *Fair Value Measurements and Disclosures*,to require additional information to be disclosed principally regarding Level 3measurements and

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

transfers to and from Level 1and 2.  In addition, enhanced disclosureis required concerning inputs and valuation techniques used to determine Level2 and Level 3 measurements.  Thisguidance is generally effective for interim and annual reporting periodsbeginning after December 15, 2009; however, requirements to discloseseparately purchases, sales, issuances, and settlements in the Level 3reconciliation are effective for fiscal years beginning after December 15,2010 (and for interim periods within such years).  ASU No. 2010-06 is not expected to havea material impact on the Company’s results of operations or financial position,and will have a minimal impact on its disclosures.

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

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

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

**March 31, 2010 and 2009**

 

Thefollowing discussion of financial condition as of March 31, 2010 compared to December 31, 2009, and the results of operations for thethree months ended March 31, 2010compared to the three months ended March 31, 2009 should be read inconjunction with the condensed financial statements and accompanying footnotesappearing in this report.

 

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

##### *** ***

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

 

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

 

·                  Deteriorationin the condition of borrowers resulting in significant increase in loan lossesand provisions for those losses;

·                  thepotential that loan charge-offs may exceed the allowance for loan losses orthat such allowance will be increased as a result of factors beyond our controlor the failure of assumptions underlying the establishment of reserves forpossible loan losses;

·                  changesin loan underwriting, credit review or loss reserve policies associated witheconomic conditions, examination conclusions, or regulatory developments;

·                  ourdependence on senior management;

·                  competitionfrom existing financial institutions, including commercial banks, thrifts,mortgage banking firms, consumer finance companies, credit unions, securitiesbrokerage firms, insurance companies, money market and other mutual funds,operating in our market areas and elsewhere, including institutions operatingregionally, nationally and internationally, together with such competitorsoffering banking products and services by mail, telephone and the Internet;

·                  changesin political and economic conditions, including the political and economiceffects of the current economic downturn and other major developments,including the ongoing war on terrorism and potential adverse conditions in thestock market, the public debt market, and other capital markets (includingchanges in interest rate conditions);

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

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

·                  risksinherent in making loans including repayment risks and value of collateral;

·                  thestrength of the United States economy in general and the strength of the localeconomies in which we conduct operations may be different than expectedresulting in, among other things, a deterioration in credit quality or areduced demand for credit, including the resultant effect on our loan portfolioand allowance for loan losses;

·                  changesin financial market conditions, either internationally, nationally or locallyin areas in which the Company conducts its operations, including, withoutlimitation, reduced rates of business formation and growth, commercial andresidential real estate development, and fluctuations in consumer spending andsaving habits;

·                  thedemand for our products and services;

·                  technologicalchanges;

·                  thechallenges and uncertainties in the implementation of our expansion anddevelopment strategies;

·                  theability to increase market share;

·                  theadequacy of expense projections and estimates of impairment loss;

·                  theimpact of changes in accounting policies by the Securities and ExchangeCommission;

·                  unanticipatedregulatory or judicial proceedings;

 

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·                  futurelegislation affecting financial institutions and changes to governmentalmonetary and fiscal policies (including without limitation laws concerningtaxes, banking, securities, and insurance);

·                  theeffects of, and changes in, trade, monetary and fiscal policies and laws,including interest rate policies of the Board of Governors of the FederalReserve System;

·                  thetimely development and acceptance of products and services, including productsand services offered through alternative delivery channels such as theInternet;

·                  otherfactors described in this report and in other reports we have filed with theSecurities and Exchange Commission; and

·                  Oursuccess at managing the risks involved in the foregoing.

 

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

#### ** **

**ExecutiveSummary and Recent Developments**

 

### **The Company’s total assets at March 31, 2010,were approximately $941.7 million, which represented a decrease ofapproximately $6.7 million, or 0.70%, from December 31, 2009.  Net earnings (loss) decreased $2.4 million,or 320.16%, for the three months ended March 31, 2010 to a loss of $1.6million, or $0.39 per diluted share, compared to earnings of $742 thousand, or$0.18 per diluted share, for the three months ended March 31, 2009.**

### ** **

On September 11,2009, the Bank consented to the issuance of an Order to Cease and Desist by theFDIC and the GDBF.  Under the terms ofthe Order, the Bank cannot declare dividends without the prior written approvalof the FDIC and the GDBF.  Other materialprovisions of the Order require the Bank to: (i) strengthen its board ofdirectors’ oversight of management and operations of the Bank, (ii) establisha committee consisting of at least four members, three of which must beindependent, to oversee the Bank’s compliance with the Order, (iii) maintainspecified liquidity ratios, (iv) improve the Bank’s lending and collectionpolicies and procedures, particularly with respect to the origination andmonitoring of commercial real estate and acquisition, development andconstruction loans, (v) eliminate from its books, by charge off orcollection, all assets classified as “loss” and 50% of all assets classified asdoubtful, (vi) perform risk segmentation analysis with respect toconcentrations of credit, (vii) receive a brokered deposit waiver from theFDIC prior to accepting, rolling over or renewing any brokered deposits andsubmit a written plan for eliminating its reliance on brokered deposits, (viii) adoptand implement a policy limiting the use of loan interest reserves, (ix) formulateand fully implement a written plan and comprehensive budget for all categoriesof income and expense, and (x) prepare and submit progress reports to theFDIC and the GDBF.  In addition, pursuantto the Order, the Bank is required to maintain Tier 1 capital equal to at least8% of the Bank’s total assets and total risk-based capital equal to at least10% of the Bank’s risk-weighted assets. The FDIC order will remain in effect until modified or terminated by theFDIC and the GDBF.

 

On March 26, 2010,the Company entered into a written agreement with the Federal Reserve Board andthe GDBF, pursuant to which the Company will be prohibited from declaring orpaying dividends without prior written consent from the regulators.  In addition, pursuant to the Agreement,without the prior written consent of regulators, the Company is prohibited fromtaking dividends, or any other form of payment representing a reduction ofcapital, from the Bank; paying interest, principal or other sums onsubordinated debentures and trust preferred securities; incurring, increasingor guaranteeing any debt; redeeming any shares of the Company’s common stock;and increasing salaries or bonuses paid to executive officers.  All salaries, bonuses and fees, excluding thereimbursement of expenses valued at less than $500 in the aggregate per monthper executive officer, must be preapproved by the Board of Directors on aregular basis.  In appointing any newdirector or any executive officer, the Company is required to notify regulatorauthorities and comply with restrictions on indemnification and severance.  The Company will also provide quarterlywritten progress reports to the Federal Reserve Board.

 

Within 60 days of theAgreement, the Company will submit to the Federal Reserve Board a written plandesigned to maintain sufficient capital at the Company, on a consolidatedbasis, and at the Bank.  The Agreementdoes not contain specific target capital ratios or specific timelines, butrequires that the plan address the Company’s current 

 

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

 

On February 17,2010, Michael C. Griffin submitted his resignation as a director of the Companyand of the Bank, effective immediately. On April 14, 2010, Raymond O. Ballard, Jr. and J. RussellLipford, Jr. submitted their resignations as a director of the Company andof the Bank effectively immediately.  Messrs. Griffin,Ballard and Lipford have advised the Company that their resignation were notdue to any disagreement with the Company.

 

On April 30, 2010,Gary P. Hall retired as Executive Vice President and Chief Credit Officer ofthe Company and of the Bank.  He hasagreed to continue to serve the Company and the Bank in a consultingcapacity.  Mr. Hall has advised theCompany that his retirement was not due to any disagreement with the Company.

 

**Financial Condition**

 

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

 
| ** **                             | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** | ** **        | ** ** | ** **   | ** ** |
|----------------------------------------|------------|----------------------------|------------|-----------------------|------------|-------------------|------------|--------------|------------|
| ** **                             | ** ** | **2010**                   | ** ** | **2009**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** | ** **            | ** ** |
| **Assets:**                            |       |                       |       |                  |       |              |       |         |       |
| Total cash and cash equivalents        |       | $                          | 60,453     |                  | $          | 33,392            |       | $            | 27,061     |   | 81.04 | % |
| Securities available for sale          |       | 107,848                    |       | 126,940               |       | (19,092           | )          | -15.04       | %          |
| Loans, net of unearned income          |       | 698,078                    |       | 718,307               |       | (20,229           | )          | -2.82        | %          |
| Cash surrender value of life insurance |       | 13,143                     |       | 13,011                |       | 132               |       | 1.01         | %          |
| Intangible assets, net of amortization |       | 2,458                      |       | 2,549                 |       | (91               | )          | -3.55        | %          |
| Other real estate owned                |       | 27,547                     |       | 21,066                |       | 6,481             |       | 30.76        | %          |
| Total assets                           |       | 941,722                    |       | 948,380               |       | (6,658            | )          | -0.70        | %          |
| **Liabilities:**                       |       |                       |       |                  |       |              |       |         |       |
| Deposits                               |       | $                          | 861,295    |                  | $          | 861,157           |       | $            | 138        |   | 0.02 | % |
| FHLB advances                          |       | 34,000                     |       | 39,000                |       | (5,000            | )          | -12.82       | %          |
| Subordinated debentures                |       | 1,400                      |       | 1,400                 |       | —            |       | —       |       |
| Junior subordinated debentures         |       | 10,310                     |       | 10,310                |       | —            |       | —       |       |
| Accrued expenses and other liabilities |       | 1,639                      |       | 1,896                 |       | (257              | )          | -13.56       | %          |
| Total liabilities                      |       | 913,637                    |       | 918,741               |       | (5,104            | )          | -0.56        | %          |
|                                   |       |                       |       |                  |       |              |       |         |       |
| Loan to Deposit Ratio                  |       | 81.05                      | %          | 83.41                 | %          |              |       |         |       |

 

Significant changes inthe composition of assets include the increase in total cash and cashequivalents of $27.1 million which was primarily due to the maturities, callsand paydowns of securities of $19.1 million and to the payoffs of loans fromcustomers of approximately $8.7 million. The Company did not invest any additional funds in securities during thefirst quarter of 2010.

 

Other significant changesin the composition of assets were the decrease in loans followed by theincrease in other real estate owned during the first quarter of 2010.  The Company had approximately $1.7 million inloans charged off during the first quarter of 2010 along with approximately$10.1 million moving to other real estate owned and to other assets.

 

The most significantchange in the composition of liabilities was the decrease in Federal Home LoanBank advances which was due to the $5.0 million pay off of a maturing FederalHome Loan Bank advance.

 

Total deposits remainedrelatively flat during the first quarter of 2010.  However, non-interest bearing deposits and moneymarket and NOW accounts decreased $13.5 million which was offset by an increaseof $13.6 million in time

 

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deposits and savingsaccounts.  Time deposits, includingwholesale and core deposits, are our principal source of funds for loans andinvesting in securities.  Local retailtime deposits at March 31, 2010, increased approximately $24.5 millionsince December 31, 2009 due to management’s efforts to increase coredeposits and to continue reducing the Bank’s reliance on brokereddeposits.  The Company was able todecrease brokered deposits at March 31, 2010 by approximately $11.3million compared to December 31, 2009 primarily due to its ability toreplace them with retail deposits obtained both locally and through a nationalrate-listing service.

 

Due to our strong loandemand in the past, we chose to obtain a portion of our deposits from outsideof our market.  The deposits obtained outside of our market area generallyhad lower rates than rates being offered for certificates of deposits in ourlocal market.  We also utilizedout-of-market deposits in certain instances to obtain longer term deposits thanare readily available in our local market. Our brokered time deposits represented 26.12% of our deposits as of March 31,2010 when compared to 27.43% of our deposits as of December 31, 2009.

 

In the past, the Bankrelied heavily on brokered deposits. Pursuant to the Order and FDIC regulations as a result of ourundercapitalized status, we are unable to accept, renew or roll over brokereddeposits absent a waiver from the FDIC. Accordingly, management has instituted an aggressive retail depositmarketing campaign both locally and through a national rate-listing service toreplace a portion of the brokered deposits as they mature.

 

**Investment Securities**

 

Securitiesin our portfolio totaled $107.8 million at March 31, 2010, compared to$126.9 million at December 31, 2009. The decrease in the securities portfolio has resulted from the calls ofover $2.5 million in U.S. government sponsored enterprises and state, countyand municipal bonds, the maturity of $14.0 million in U.S. Treasury securitiesand the paydowns of approximately $2.5 million in mortgage-backedsecurities.  The Company did not have anypurchases of securities during the first quarter of 2010.  At March 31, 2010, the securitiesportfolio had unrealized net gains of over $1.0 million.

 

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

 
| ** **                             | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                             | ** ** | **(Dollars in Thousands)** | ** ** |
| Securities available for sale:         |       |                       |       |                  |       |
| U. S. treasury securities              |       | $                          | 43,065     |                  | $          | 57,157 |   |
| U. S. government sponsored enterprises |       | 25,118                     |       | 27,617                |       |
| State, county and municipal            |       | 15,344                     |       | 15,156                |       |
| Mortgage-backed securities             |       | 24,011                     |       | 26,711                |       |
| Other Investments                      |       | 310                        |       | 299                   |       |
| Total                                  |       | $                          | 107,848    |                  | $          | 126,940 |   |

### ** **

The following tablesummarizes securities disposal activities for the three month period ended March 31,2010 and 2009:

 

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| ** **                       | ** ** | **Three Months Ended**     | ** ** |
|----------------------------------|------------|----------------------------|------------|
| ** **                       | ** ** | **March 31,**         | ** ** |
| ** **                       | ** ** | **2010**                   | ** ** | **2009** | ** ** |
| ** **                       | ** ** | **(Dollars in Thousands)** | ** ** |
| Proceeds from sales              |       | $                          | —     |   | $ | 13,738 |   |
| Proceeds from calls              |       | 2,545                      |       | 180 |   |
| Proceeds from maturities         |       | 14,000                     |       | 1,750 |   |
| Paydowns                         |       | 2,499                      |       | 3,616 |   |
| Total                            |       | $                          | 19,044     |   | $ | 19,284 |   |
|                             |       |                       |       |   |   |
| Gross gains                      |       | $                          | —     |   | $ | 231 |   |
| Gross losses                     |       | —                     |       | (11 | ) |
| Net gains (losses) of securities |       | $                          | —     |   | $ | 220 |   |
|                             |       |                       |       |   |   |
| Income tax expense (benefit)     |       | $                          | —     |   | $ | 75 |   |

 

### **Loans**

### ** **

Totalloans, net of unearned income decreased approximately $20.2 million, or 2.82%,at March 31, 2010, from December 31, 2009 as management has made aneffort to limit loan growth in order to preserve capital for the Company.  Also, total loans have decreased due toapproximately $1.7 million in loans being charged off and approximately $10.1million in loans being transferred to other real estate owned and in otherassets during the first quarter of 2010. Management is limiting credit availability especially for commercialreal estate and acquisition, development and construction loans and pursuingcollection efforts aggressively in an effort to reduce the Bank’s exposure tocommercial real estate and acquisition, development and construction, pursuantto the Order.  The following tablepresents a summary of the loan portfolio by category.

 
| ** **                                        | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)** | ** ** |
|                                              |       |                       |       |                  |       |
| Commercial                                        |       | $                          | 48,697     |                  | $          | 51,674 |   |
| Real estate - commercial                          |       | 319,634                    |       | 304,468               |       |
| Real estate - construction                        |       | 226,250                    |       | 263,271               |       |
| Real estate - mortgage                            |       | 97,144                     |       | 92,013                |       |
| Obligations of political subdivisions in the U.S. |       | 328                        |       | 295                   |       |
| Consumer                                          |       | 6,237                      |       | 6,838                 |       |
| Total Loans                                       |       | 698,290                    |       | 718,559               |       |
| Less:                                             |       |                       |       |                  |       |
| Unearned loan fees                                |       | (212                       | )          | (252                  | )          |
| Allowance for loan losses                         |       | (21,149                    | )          | (21,479               | )          |
| Loans, net                                        |       | $                          | 676,929    |                  | $          | 696,828 |   |

### ** **

At March 31, 2010,the Company had twenty-two loans with outstanding balances totaling $69.1million with loan-funded interest reserves. The amount of capitalized interest from interest reserves for 2010 was$688 thousand.

 

Pursuantto the Order, the Bank adopted, and is currently implementing, a policy limitingthe use of loan interest reserves.  Thispolicy confines the use of interest reserves to properly underwrittenconstruction and development

 

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loanswhere development or building plans have specific timetables that commencewithin a reasonable time of the loan’s approval and that include realistictimetables.

 

Withrespect to accounting for interest reserves on loans, interest that has beenadded to the balance of a loan through the use of an interest reserve shouldnot be recognized as income if its collectability is not reasonablyassured.  The accrual of uncollectedinterest and its capitalization into the loan balance will not be appropriatewhen the loan becomes troubled and the full collection of contractual principaland interest is no longer expected.

 

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

 

Thedecision to establish a loan funded interest reserve upon origination of anacquisition, development or construction loan is determined based on the feasibilityof the project, the creditworthiness of the borrower and guarantors, and theprotection provided by the real estate and other collateral.  The total cost of the project, including theinterest reserve, is considered when determining the equity injection requiredfrom the borrower.

 

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

 

Norestructured loans include an interest reserve component.

 

**Asset Quality**

 

At March 31, 2010, the loan portfolio was 74.1% of totalassets.  Management considers assetquality to be of primary importance. Management has a credit administration and loan review process, whichmonitors, controls and measures our credit risk, standardized credit analysesand our comprehensive credit policy.  Ourlevel of nonperforming assets has remained at a high level since 2009 as aresult of a slowing economy and the devaluation of real estate.  Our nonperforming assets have continued toincrease since the beginning of the economic downturn in 2007, when managementbegan to recognize impaired loans based on an ongoing process of identifyingearly signs of stress in our loan portfolio. Any significant events that may occur subsequent to any financialstatement date are reviewed by management to determine if any impact ismaterial to the financial statements.  Ifthe event is deemed to be material, the financial statements are adjusted to reflectthe impact of the event.

 

Thefollowing table presents a summary of changes in the allowance for loan lossesfor the three month period ended March 31, 2010 and 2009.

 

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**Analysisof Changes in Allowance for Loan Losses**

 
| ** **                                         | ** ** | **Three Months Ended March 31,** | ** ** |
|----------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                         | ** ** | **2010**                              | ** ** | **2009** | ** ** |
| ** **                                         | ** ** | **(Dollars  in Thousands)**           | ** ** |
| Balance  beginning of period                       |       | $                                     | 21,479     |   | $ | 11,672 |   |
| Loans  charged-off                                 |       | (1,691                                | )          | (594 | ) |
| Recoveries                                         |       | 59                                    |       | 65 |   |
| Net  charge-offs                                   |       | (1,632                                | )          | (529 | ) |
| Provision  for loan losses                         |       | 1,302                                 |       | 350 |   |
| Balance  end of period                             |       | $                                     | 21,149     |   | $ | 11,493 |   |
|                                               |       |                                  |       |   |   |
| Total  Loans:                                      |       |                                  |       |   |   |
| At  period end                                     |       | $                                     | 698,078    |   | $ | 794,178 |   |
| Average                                            |       | 710,886                               |       | 795,633 |   |
|                                               |       |                                  |       |   |   |
| As a  percentage of average loans (annualized):    |       |                                  |       |   |   |
| Net  charge-offs                                   |       | 0.92                                  | %          | 0.27 | % |
| Provision  for loan losses                         |       | 0.73                                  | %          | 0.18 | % |
| Allowance  as a percentage of period end loans     |       | 3.03                                  | %          | 1.45 | % |
| Allowance  as a percentage of non-performing loans |       | 19.54                                 | %          | 46.69 | % |

 

The loan portfolio is reviewed periodically to evaluate outstandingloans and to measure the performance of the portfolio and the adequacy of theallowance for loan losses.  Managementbelieves that the allowance for loan losses at March 31, 2010 is adequateto absorb losses inherent in the loan portfolio.  This analysis includes a review ofdelinquency trends, actual losses, and internal credit ratings.  Management’s judgment as to the adequacy ofthe allowance is based upon a number of assumptions about future events whichit believes to be reasonable.  Theallowance for loan losses is maintained at a level which, in management’sjudgment, is adequate to absorb credit losses inherent in the loanportfolio.  The amount of the allowanceis based on management’s evaluation of the collectability of the loanportfolio, including the nature of the portfolio, credit concentrations, trendsin historical loss experience, specific impaired loans, economic conditions andother risks inherent in the portfolio. Allowances for impaired loans are generally determined based oncollateral values or the present value of estimated cash flows.  While management uses available informationto recognize losses on loans, reductions in the carrying amounts of loans maybe necessary based on changes in local economic conditions.  In addition, regulatory agencies, as anintegral part of their examination process, periodically review the estimatedlosses on loans.  Such agencies mayrequire us to recognize losses based on their judgments about informationavailable to them at the time of their examination.  Because of these factors, it is reasonablypossible that the estimated losses on loans may change materially in the nearterm.  However, the amount of the changecannot be estimated.

 

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

 

Management prepares amonthly analysis of the allowance for loan losses and material deficiencies areadjusted by increasing the provision for loan losses.  Management uses an outsourced independentloan review company on a

 

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quarterly basis to corroborateand challenge the internal loan grading system and provide additional analysisin determining the adequacy of the allowance for loan losses.  Management rotates the loan review company ona periodic basis to ensure objectivity in the loan review process.  In addition, an internal loan review processis conducted by a committee comprised of members of senior management.  All new loans are risk rated under loanpolicy guidelines.  The internal loanreview committee meets quarterly to evaluate the composite risk ratings.  Risk ratings may be changed if it appearsthat new loans were not assigned the proper initial grade, or, if on existingloans, credit conditions have improved or worsened.

 

Aloan is considered impaired when, based on current information and events, itis probable that a creditor will be unable to collect the scheduled payments ofprincipal or interest when due according to the contractual terms of the loanagreement.  Factors considered by managementin determining impairment include payment status, collateral value and theprobability of collecting scheduled principal and interest payments whendue.  Loans that experience insignificantpayment delays and payment shortfalls generally are not classified asimpaired.  Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all of the circumstances surrounding the loan and theborrower, including the length of the delay, the reasons for the delay, theborrower’s prior payment history and the amount of the shortfall in relation tothe principal and interest owed. Impairment is measured on a loan-by-loan basis by either the presentvalue of expected future cash flows discounted at the loan’s effective interestrate, the loan’s obtainable market price, or the fair value of the collateralif the loan is collateral dependent.

 

Largegroups of smaller balance homogenous loans are collectively evaluated forimpairment.  Accordingly, we do notseparately identify individual consumer loans for impairment disclosures.

 

TheCompany’s allowance as a percentage of nonperforming loans has decreasedsignificantly from 46.69% at the three months ended March 31, 2009 to19.54% at the three months ended March 31, 2010.  This is due mostly to the increase innonperforming loans which the Company has recorded at the lower of the statedvalue of the loan or the fair value of the underlying collateral.  The Company recorded most of thenonperforming loans at the fair value of the underlying collateral, whichsignificantly increased charge-offs during 2009 followed by an increase to theprovision for loan losses, based upon management’s analysis of the allowancefor loan losses.  When comparing theCompany’s allowance as a percentage of nonperforming loans from March 31,2010 to December 31, 2009, the percentage increased from 18.53% at December 31,2009 to 19.54% at March 31, 2010. This is due mostly to the decrease in nonperforming loans during thefirst quarter of 2010 as a result of pay downs and partial charge-offs.

 

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

 
| ** **                      | ** ** | **March 31,**         | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Accruing loans 90 days past due |       | $                          | —     |                  | $          | 645 |   |
| Non-accrual loans               |       | 108,218                    |       | 115,294               |       |
| Repossessed assets              |       | 8                          |       | 1                     |       |
| Other real estate owned         |       | 27,547                     |       | 21,066                |       |
| Total non-performing assets     |       | $                          | 135,773    |                  | $          | 137,006 |   |

 

Nonperforming assetsdecreased $1.2 million, or 0.90%, from December 31, 2009 to March 31,2010.  This decrease is primarily due to$1.2 million in pay downs and $1.7 million in partial charge-offs onnon-accrual loans since December 31, 2009. Non-accrual loans decreased $7.1 million from December 31, 2009 to March 31,2010, largely due to approximately $9.3 million moving to other real estateowned.  During the first quarter of 2010,there was approximately $5.1 million in loans moved to non-accrual.  All non-accrual loans are adequatelycollateralized based on management’s judgment and supported by recentcollateral appraisals.  Other real estateowned increased $6.5 million from December 31, 2009 to March 31,2010.  This increase is largely due tothe addition of $9.3 million in foreclosed properties being offset by the saleof $2.7 million in foreclosed properties resulting in a small gain of $6thousand on these properties.

 

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The Company had $7.4million and $12.8 million in loans that would be defined as trouble debtrestructuring (“TDR”) at March 31, 2010 and at December 31, 2009,respectively.  Of those amounts, $1.8million and $1.6 million were accruing as of March 31, 2010 and December 31,2009, respectively, as they were performing in accordance with theirrestructured terms.  At March 31,2010, there were approximately $1.6 million in TDR loans that had a relatedallowance of over $289 thousand.  At December 31,2009, there were no TDR loans that had a related allowance.

 

Ourpolicy is to place loans on non-accrual status when it appears that thecollection of principal and interest in accordance with the terms of the loanis doubtful.  Any loan which becomes 90days past 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.

 

Our loan officers usuallynotify management first when they determine that a loan relationship may beshowing signs of distress or issues with collectability of scheduledpayments.  Also, management is constantlyreviewing and discussing past due loans with loan officers in efforts toidentify further troubled loan relationships as soon as possible.  Quarterly rated loan reviews are held bymanagement to further monitor troubled loan relationships and potential lossexposure.  Also, all loan relationshipsgreater than $500 thousand are reviewed annually in the Officers’ Annual ReviewCommittee.  Loan officers are required toeither validate the appraised values of collateral or order new appraisals whenit is determined that a material change in the value of the property may have occurred.

 

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

 

There are nocommitments to lend additional funds to customers with loans on non-accrualstatus at March 31, 2010.  Moreover,pursuant to the Order, the Bank is prohibited from extending new credit toanyone who has caused a loss to the Bank.

 

As of March 31, 2010and December 31, 2009, the Company’s other real estate owned consisted ofthe following:

 

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| ** **                                          | ** ** | **As of March 31, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|-----------------------------------------------------|------------|-------------------------------|------------|----------------------------------|------------|
| ** **                                          | ** ** | **Number of  Properties**     | ** ** | **Carrying  Amount**             | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| ** **                                          | ** ** | **(Dollars in Thousands)**    | ** ** |
| 1-4 Family residential properties                   |       | 28                            |       | $                                | 2,866      |   | 23 |   | 2,958 |   |
| Multifamily residential properties                  |       | 2                             |       | 1,365                            |       | 2 |   | 238 |   |
| Nonfarm nonresidential properties                   |       | 13                            |       | 8,876                            |       | 13 |   | 8,994 |   |
| Farmland properties                                 |       | 1                             |       | 759                              |       | — |   | — |   |
| Construction & land development properties |       | 40                            |       | 13,682                           |       | 35 |   | 8,876 |   |
| Total                                               |       | 84                            |       | $                                | 27,547     |   | 73 |   | 21,066 |   |

 

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

 

On April 6, 2010,the Bank foreclosed on approximately $5.1 million in various construction andland development and 1-4 family residential real estate properties.  These properties were being held ascollateral against several non-accrual loans at December 31, 2009.  Management has evaluated these properties forany additional losses based upon current appraisals.

 

On May 4, 2010, the Bankforeclosed on approximately $7.6 million in various construction and landdevelopment and 1-4 family residential real estate properties. These propertieswere being held as collateral against several non-accrual loans at December 31,2009. Management is currently evaluating these properties for any additionallosses based on recently ordered appraisals.

 

The Company’s other realestate owned policy and procedures provide that a foreclosure appraisal beobtained.  The policy requires acertified appraiser conduct the appraisal for foreclosed property to obtain afair market value.  To qualify and beapproved as an appraiser for the Bank, appraisers must have met the AppraisalQualifications Board requirements and have not had any disciplinary actions.  Additionally, an appraiser must submit to theBank their resume, license, education and experience for review before beingapproved for appraisal work.  Upontransfer into other real estate owned, the property is listed with a realtor tobegin sales efforts.

 

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

 

**Deposits**

 

Totaldeposits at March 31, 2010 were $861.3 million, an increase of $138thousand, or 0.02%, from December 31, 2009.  Total interest bearing demand (money marketand NOW accounts), non-interest bearing demand accounts and savings accounts of$182.0 million decreased $13.1 million, or 6.72% from December 31, 2009resulting mainly from several customers moving their deposits to ourcompetitors, who have had more competitive rates during the first quarter of2010.

 

Totaltime deposits as of March 31, 2010 were $679.3 million, an increase of$13.2 million, or 1.99%, from December 31, 2009.  Total retail time deposits at March 31,2010 increased approximately $24.5 million, or 3.61% of total time deposits,from December 31, 2009 due to managements’ efforts to increase coredeposits with internet CDs and to continue reducing the Bank’s reliance onbrokered deposits.  Pursuant to the Order and FDIC regulations,as a result of our undercapitalized status, the Bank is prohibited fromaccepting, renewing or rolling over brokered deposits absent a waiver from theFDIC.  The weighted average rates paidfor retail time deposits for the three months ended March 31, 2010 was 2.54%compared to 3.65% for the three months ended March 31, 2009.  Total brokered deposits at March 31,2010 decreased approximately $11.3 million, or 1.66% of total time deposits,from December 31, 2009, resulting mainly from our ability to replacebrokered deposits with retail deposits during the first quarter of 2010.  The weighted average rates paid for brokereddeposits for the three months ended March 

 

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31, 2010 were 3.57% compared to 3.80% forthe three months ended March 31, 2009. Because we are currently classified as less than well capitalized, weare prohibited from paying rates in excess of 75 basis points above the localmarket average on deposits of comparable maturity in our Georgia markets.  In our Jacksonville market, however, we areprohibited from paying in excess of 75 basis points above the national averageon deposits, as calculated by the FDIC.

 

### **Resultsof Operations**

### ** **

# **General**

# ** **

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

 

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

 
| ** **                            | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|---------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                            | ** ** | **March 31,**         | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                            | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                            | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** | ** **        | ** ** |
| Interest and Dividend Income          |       | $                          | 9,781      |       | $          | 12,547            |       | $ | (2,766 | ) | -22.05 | % |
| Interest Expense                      |       | 5,370                      |       | 7,150      |       | (1,779            | )          | -24.89 | % |
| Net Interest Income                   |       | 4,410                      |       | 5,397      |       | (987              | )          | -18.29 | % |
| Provision for Loan Losses             |       | 1,302                      |       | 350        |       | 952               |       | 272.00 | % |
| Noninterest Income                    |       | 869                        |       | 1,263      |       | (394              | )          | -31.17 | % |
| Noninterest Expense                   |       | 5,610                      |       | 5,315      |       | 295               |       | 5.55 | % |
| Net Earnings (Loss)                   |       | (1,633                     | )          | 742        |       | (2,375            | )          | -320.16 | % |
| Net Earnings (Loss) Per Diluted Share |       | (0.39                      | )          | 0.18       |       | (0.56             | )          | -320.16 | % |
|                                       |            |                            |            |            |            |                   |            |  |  |  |  |  |

 

**Net Interest Income**

 

Our primary source ofincome is interest income from loans and investment securities.  Our profitability depends largely on netinterest income, which is the difference between the interest received oninterest-earning assets and the interest paid on deposits, borrowings, andother interest-bearing liabilities.  Netinterest income decreased $987 thousand, or 18.29%, for the three months ended March 31,2010 compared to the three months ended March 31, 2009.

 

Total interest anddividend income for the three months ended March 31, 2010 decreased $2.8million, or 22.05%, when compared to the three months ended March 31,2009.  This decrease is primarily due todecrease in the volume of loans due to payoffs from customers, an increase inthe volume of nonperforming loans on non-accrual status and/or moving to otherreal estate owned and a decrease in interest on securities from the purchase oflow-yielding U.S. government sponsored enterprises securities purchased duringthe second quarter of 2009 when the Bank restructured its investment portfoliocombined with the purchase of short-term U.S. treasury bills during 2009 whichare being used to meet liquidity needs.

 

Average loans and loansheld for sale portfolio for the three months ended March 31, 2010decreased approximately $84.7 million, or 10.65%, when compared to averageloans and loans held for sale portfolios for the three months ended March 31,2009.  The average yield on loansdecreased for the three months ended March 31, 2010 to 5.15% compared toan average yield of 5.73% for the three months ended March 31, 2009.

 

Total interest expensefor the three months ended March 31, 2010 decreased $1.8 million, or24.89% when compared to the three months ended March 31, 2009.  Two factors impact interest expense: averagebalances of

 

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deposit and borrowingportfolios and average rates paid on each. Average deposit balances decreased approximately $2.7 million whencomparing the three months ended March 31, 2010 to the three months ended March 31,2009.  The average rate paid on thedeposit portfolios for the three months ended March 31, 2010 decreased to2.51% from 3.29% when compared to the three months ended March 31,2009.  Average borrowing balancesdecreased approximately $10.9 million when comparing the three months ended March 31,2010 to the three months ended March 31, 2009.  Average interest rates paid on borrowingswere 2.66% for the three months ended March 31, 2010 compared to 3.24% forthe three months ended March 31, 2009.

 

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

 

For the three monthsended March 31, 2010 and 2009, our tax equivalent net interest spread was2.05% and 2.33%, respectively, while the tax equivalent net interest margin was2.08% and 2.44%, respectively.  Thedecreases in net interest spread and net interest margin from the three monthsended March 31, 2009 to the three months ended March 31, 2010, weredue to the loss of interest on non-accrual loans and from the purchase oflow-yielding investment securities during 2009.

 

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The following table showsthe relationship between interest revenue and interest expense and the averagebalances of interest-earning assets and interest-earning liabilities for thethree months ended March 31, 2010 and 2009.

 

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

 
| ** **                                          | ** ** | **For  the Three Months Ended March 31,** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------|------------|
| ** **                                          | ** ** | **2010**                                       | ** ** | **2009** | ** ** |
| ** **                                          | ** ** | **(Dollars  in thousands)**                    | ** ** |
| ** **                                          | ** ** | **Average**                                    | ** ** | ** ** | ** ** | **Average** | ** ** | **Average** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                          | ** ** | **Balance**                                    | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Earning Assets                                      |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Loans, net of unearned income (4) (5) (6) |       | $                                              | 710,886    |   | $ | 9,152 |   | 5.15 | % | $ | 795,633 |   | $ | 11,402 |   | 5.73 | % |
| Investment securities - taxable (7)                 |       | 104,946                                        |       | 465 |   | 1.77 | % | 79,930 |   | 974 |   | 4.88 | % |
| Investment securities - tax-exempt (6) (7)     |       | 14,084                                         |       | 146 |   | 6.28 | % | 16,628 |   | 167 |   | 6.08 | % |
| Other interest and dividend income                  |       | 33,636                                         |       | 18 |   | 0.21 | % | 6,883 |   | 4 |   | 0.24 | % |
| Total Earning Assets                                |       | 863,552                                        |       | 9,781 |   | 4.57 | % | 899,074 |   | 12,547 |   | 5.62 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning assets                         |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Allowance for loan losses                           |       | -22,102                                        |       |   |   |   |   | -11,736 |   |   |   |   |   |
| Cash and due from banks                             |       | 9,041                                          |       |   |   |   |   | 37,780 |   |   |   |   |   |
| Premises and equipment                              |       | 30,821                                         |       |   |   |   |   | 31,534 |   |   |   |   |   |
| Accrued interest receivable                         |       | 4,702                                          |       |   |   |   |   | 6,252 |   |   |   |   |   |
| Other real estate owned                             |       | 26,185                                         |       |   |   |   |   | 10,499 |   |   |   |   |   |
| Other assets                                        |       | 30,090                                         |       |   |   |   |   | 43,380 |   |   |   |   |   |
| Total Assets                                        |       | $                                              | 942,289    |   |   |   |   |   | $ | 1,016,783 |   |   |   |   |   |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing liabilities                        |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Interest bearing demand                             |       | $                                              | 124,294    |   | $ | 248 |   | 0.80 | % | $ | 143,516 |   | $ | 599 |   | 1.66 | % |
| Savings                                             |       | 9,007                                          |       | 8 |   | 0.36 | % | 8,117 |   | 7 |   | 0.34 | % |
| Time deposits                                       |       | 670,068                                        |       | 4,781 |   | 2.85 | % | 656,592 |   | 6,049 |   | 3.69 | % |
| Total interest bearing deposits                     |       | 803,369                                        |       | 5,037 |   | 2.51 | % | 808,225 |   | 6,655 |   | 3.29 | % |
| Federal Home Loan Bank advances                     |       | 38,516                                         |       | 233 |   | 2.42 | % | 49,336 |   | 352 |   | 2.85 | % |
| Other borrowings                                    |       | 1,400                                          |       | 42 |   | 12.00 | % | 1,443 |   | 42 |   | 11.67 | % |
| Trust Preferred Securities                          |       | 10,310                                         |       | 59 |   | 2.29 | % | 10,310 |   | 101 |   | 3.93 | % |
| Total borrowed funds                                |       | 50,226                                         |       | 334 |   | 2.66 | % | 61,089 |   | 495 |   | 3.24 | % |
| Total interest-bearing liabilities                  |       | 853,595                                        |       | 5,371 |   | 2.52 | % | 869,314 |   | 7,150 |   | 3.29 | % |
|                                                |       |                                           |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest bearing deposits                       |       | 52,260                                         |       |   |   |   |   | 50,118 |   |   |   |   |   |
| Other liabilities                                   |       | 7,264                                          |       |   |   |   |   | 7,535 |   |   |   |   |   |
| Stockholder’s equity                           |       | 29,170                                         |       |   |   |   |   | 89,816 |   |   |   |   |   |
| Total Liabilities and Stockholder’s Equity     |       | $                                              | 942,289    |   |   |   |   |   | $ | 1,016,783 |   |   |   |   |   |
| Net interest revenue (1)                            |       |                                           |       | $ | 4,410 |   |   |   |   |   | $ | 5,397 |   |   |   |
| Net interest spread (2) (6)                    |       |                                           |       |   |   | 2.05 | % |   |   |   |   | 2.33 | % |
| Net interest margin (3) (6)                    |       |                                           |       |   |   | 2.08 | % |   |   |   |   | 2.44 | % |

 

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

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

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

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

(5) Interestincome includes loan fees as follows (in thousands): 2010 - $277; 2009 - $276

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

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

 

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The following tableprovides a detailed analysis of the changes in interest income and interestexpense due to changes in rate and volume for the three months ended March 31,2010 compared to March 31, 2009.

 

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

 
| ** **                         | ** ** | **Three  Months Ended March 31, 2010** | ** ** |
|------------------------------------|------------|---------------------------------------------|------------|
| ** **                         | ** ** | **Compared  to 2009**                       | ** ** |
| ** **                         | ** ** | **Changes  due to (a)**                     | ** ** |
| ** **                         | ** ** | ** **                                  | ** ** | **Yield/** | ** ** | **Net** | ** ** |
| ** **                         | ** ** | **Volume**                                  | ** ** | **Rate** | ** ** | **Change** | ** ** |
| ** **                         | ** ** | **(Dollars  in thousands)**                 | ** ** |
| Interest earned on:                |       |                                        |       |   |   |   |   |
| Loans                              |       | $                                           | (2,490     | ) | $ | 240 |   | $ | (2,250 | ) |
| Investment securities:             |       |                                        |       |   |   |   |   |
| Taxable investment securities      |       | (222                                        | )          | (287 | ) | (509 | ) |
| Tax-exempt investment securities   |       | (30                                         | )          | 9 |   | (21 | ) |
| Interest earning deposits          |       | 14                                          |       | — |   | 14 |   |
| Total interest income              |       | (2,728                                      | )          | (38 | ) | (2,766 | ) |
|                               |       |                                        |       |   |   |   |   |
| Interest paid on:                  |       |                                        |       |   |   |   |   |
| Deposits:                          |       |                                        |       |   |   |   |   |
| Interest bearing demand deposits   |       | (72                                         | )          | (279 | ) | (351 | ) |
| Savings                            |       | 1                                           |       | — |   | 1 |   |
| Time deposits                      |       | (232                                        | )          | (1,036 | ) | (1,268 | ) |
| Other borrowings and FHLB advances |       | (70                                         | )          | (49 | ) | (119 | ) |
| Trust Preferred Securities         |       | —                                      |       | (42 | ) | (42 | ) |
| Total interest expense             |       | (373                                        | )          | (1,406 | ) | (1,779 | ) |
|                               |       |                                        |       |   |   |   |   |
| Increase in net interest income    |       | $                                           | (2,355     | ) | $ | 1,368 |   | $ | (987 | ) |

 

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

 

# **Provisionfor Loan Losses**

# ** **

The provision for loanlosses for the three months ended March 31, 2010 was $1.3 million comparedto $350 thousand for the same period of 2009. Although there was a decrease in nonperforming assets and a decrease inloan activity for the first quarter of 2010 compared to the first quarter of2009, the Company increased its provision for loan losses to help offset $1.7million of charge-offs from nonperforming assets.  Net charge-offs as an annualized percentageof average outstanding loans for the three months ended March 31, 2010were 0.92%, as compared with 0.27% for the first quarter of 2009.  Net loan charge-offs increased significantlyduring the three months ended March 31, 2010, as compared to the threemonths ended March 31, 2009, due mainly to the Company continuing tocharge-off nonperforming loan balances to their net realizable value.

 

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

 

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**Non-interest Income**

 

Composition of othernoninterest income is as follows:

 
| ** **                                     | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **March 31,**         | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts            |       | $                          | 384        |       | $          | 422               |       | $ | (37 | ) | -8.84 | % |
| Other service charges, commissions and fees    |       | 132                        |       | 113        |       | 20                |       | 17.38 | % |
| Gain on sales / calls of investment securities |       | —                     |       | 220        |       | (220              | )          | -100.00 | % |
| Mortgage origination income                    |       | 92                         |       | 207        |       | (115              | )          | -55.53 | % |
| Other income                                   |       | 261                        |       | 301        |       | (41               | )          | -13.46 | % |
| Total noninterest income                       |       | $                          | 869        |       | $          | 1,263             |       | $ | (394 | ) | -31.17 | % |

 

Non-interest income forthe three months ended March 31, 2010 decreased $394 thousand, or 31.17%when compared to the three months ended March 31, 2009.  Service charges on deposit accounts areevaluated against service charges from other banks in our local markets andagainst the Bank’s own cost structure in providing the deposit services.  This income correlates with the Bank’s demanddeposit account base.  Total servicecharges, including non-sufficient funds fees, were approximately $384 thousand,or 44.22% of total noninterest income for the three months ended March 31,2010, compared with approximately $422 thousand, or 33.39% for the same periodin 2009.  During the first quarter of2010, the Bank experienced a decrease in the number of core transaction depositaccounts.

 

The decrease in the gainon sales/calls of investment securities is primarily due to the Company nothaving any gains on the sales/calls of investment securities during the firstquarter of 2010 compared to a $220 thousand gain on the sales of several state,county and municipal bonds and mortgage-backed securities during the firstquarter of 2009.

 

The decrease in mortgageorigination income for the three months ended March 31, 2010 is primarilydue to the decrease in the number of mortgage loan closings.  Approximately 12 mortgage loan closingsoccurred during the first quarter of 2010 compared to 61 mortgage loan closingsfor the same period in 2009.

 

The decrease in otherincome for the three months ended March 31, 2010, compared to the sameperiod in 2009 is due to the decrease in commission fees from our wealthmanagement department.

 

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# **Non-interestExpense**

 

Composition of othernoninterest expense is as follows:

 
| ** **                                       | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **March 31,**         | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                       | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                   |       | $                          | 2,327      |       | $          | 2,777             |       | $ | (449 | ) | -16.19 | % |
| Occupancy expense                                |       | 439                        |       | 455        |       | (16               | )          | -3.54 | % |
| Equipment rental and depreciation of equipment   |       | 296                        |       | 305        |       | (9                | )          | -2.93 | % |
| Loss on sale of other assets                     |       | 0                          |       | 38         |       | (38               | )          | -99.28 | % |
| Loss on sale and impairment of other real estate |       | 102                        |       | 25         |       | 77                |       | 311.18 | % |
| Other real estate expense                        |       | 473                        |       | 126        |       | 348               |       | 276.68 | % |
| FDIC and state banking assessments               |       | 911                        |       | 196        |       | 715               |       | 364.24 | % |
| Other expenses                                   |       | 1,062                      |       | 1,393      |       | (332              | )          | -23.80 | % |
| Total noninterest expense                        |       | $                          | 5,610      |       | $          | 5,315             |       | $ | 295 |   | 5.55 | % |

 

Non-interest expense forthe three months ended March 31, 2010 increased $295 thousand, or 5.55%when compared to the three months ended March 31, 2009.  This increase is primarily due to an increasein other real estate expenses and to an increase in the FDIC and state bankingassessments.

 

The increase in the losson the sale and impairment of other real estate for the three months ended March 31,2010 is attributed to the impairment writedown of approximately $112 thousandof one other real estate property to its net realizable value compared to thesame period in 2009 with a loss on the sale of four foreclosed properties.  The increase in other real estate expenses isattributed to the number of other real estate properties that the Companyowns.  At March 31, 2010, theCompany had a total of 84 properties compared to 37 properties at March 31,2009.

 

The increase in the FDICand state banking assessments for the three months ended March 2010 isattributable to our risk classification with the FDIC.  Since entering into the Cease and DesistOrder with the FDIC, the Company has had higher quarterly assessments due toour risk classification.

 

The decrease in salariesand employee benefits for the three months ended March 31, 2010 comparedto the same period in 2009 is primarily due to no accrual of bonuses, noexpense relating to the salary continuation plan based upon changes with theplan, the utilization of a bank officer one day per quarter furlough, and asmall reduction in staff.  At March 31,2010, the number of full-time equivalent employees was 160 employees comparedto 172 employees at March 31, 2009.

 

The decreases in equipmentrental and depreciation of equipment, occupancy expense and other expenses arenot attributable to any one particular item, but represent the Company’sefforts to decrease controllable noninterest expense.

 

# **IncomeTax Expense**

 

Income tax benefit wasnot recognized for the three months ended March 31, 2010 because theCompany previously recorded a valuation allowance for the balance of therecorded deferred tax asset as of December 31, 2009 since it is morelikely than not that the deferred tax asset will not be realized.  With the Company’s cumulative losses as of March 31,2010, we have determined that it is more likely than not that any income taxbenefit that would have been recorded would not be realized.  For the three months ended March 31,2009, income tax expense of $253 thousand was recognized with an effective taxrate of 25.45%.  The effective tax ratefor the three months ended March 31, 2009 was lower than the statutory taxrates primarily due to the tax-free income from certain investment securitiesand loans that are exempt from income taxes and tax credits received fromaffordable housing investments.

 

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### **Liquidity**

 

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

 

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

 

The Company’s liquidityposition depends primarily upon the liquidity of its assets relative to itsneed to respond to short-term demand for funds caused by withdrawals fromdeposit accounts and loan funding commitments. Primary sources of liquidity arescheduled repayments on the Company’s loans and interest on, and maturities of,its investment securities. Sales of investment securities available for salerepresent another source of liquidity to the Company. The Company may alsoutilize its cash and due from banks and federal funds sold to meet liquidityrequirements as needed.

 

The Company also has theability, on a short-term basis, to purchase up to $16 million in federal fundsfrom other financial institutions. At March 31, 2010, the Company had nofederal funds purchased. At March 31, 2010, we do not have any furtherborrowing capacity at this time with the Federal Home Loan Bank with $34.0million in outstanding advances.  TheCompany has a total available line of $20.1 million, subject to availablecollateral, from the Federal Reserve Bank (FRB).  The Company had no advances on the FRB lineat March 31, 2010.

 

The Bank’s liquiditypolicy requires that the ratio of cash and certain short-term investments tonet withdrawable deposit accounts be at least 10%. The Bank’s liquidity ratiosat March 31, 2010 and 2009 were 18.92% and 18.76%, respectively.

 

In the past, the Bankrelied heavily on brokered deposits. Pursuant to the Order and FDIC regulations as a result of ourundercapitalized status, we are unable to accept, renew or roll over brokereddeposits absent a waiver from the FDIC. Accordingly, management has instituted an aggressive retail depositmarketing campaign both locally and through a national rate-listing service toreplace a portion of the brokered CDs as they mature.  The increase in liquid assets is designed toprovide cash to payoff a portion of the brokered deposits as they mature.

 

### **CapitalResources**

### ** **

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

 

Quantitative measuresestablished by regulations to ensure capital adequacy require us to maintainminimum amounts and ratios (set forth below in the table) of total and Tier Icapital (as defined in the regulations) to risk-weighted assets (as defined inthe regulations), and of Tier I capital (as defined in the regulations) toaverage assets (as defined in the regulations). Pursuant to the Order, Tier 1 Capital must equal or exceed 8.00% of theBank’s total assets and the Bank’s Total Risk-based Capital must equal orexceed 10.00% of the Bank’s total risk-weighted assets, within 90 days of theeffective date of the Order.  At March 31,2010, the Bank was not in compliance with the Order, with Tier 1 capital at4.70% and total risk-based capital at 6.16%. As a result of our regulatory capital ratios, we are considered “undercapitalized”by our bank regulatory authorities as of March 31, 2010.  As a result of our undercapitalized status,we are subject to greater regulatory monitoring and certain additionaldiscretionary safeguards may be imposed by regulatory authorities, which mayhave a direct material effect on our financial statements.

 

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Since the Bank consentedto the Order, it has taken steps to address the provisions of the Order.  Management has taken an active role inworking with the FDIC and the GDBF to improve its financial condition and isaddressing the terms of the Order on a continuing basis.  We are also in the process of developing ashort-term and a long-term capital plan to meet regulatory capital limits.  Failure to adequately address the Order mayresult in more severe actions by regulators, including the eventual appointmentof a receiver of the Bank’s assets.

 

The Company’s and theBank’s actual capital amounts and ratios as of March 31, 2010 and December 31,2009 follow:

 
| ** **                                        |   |       |       |                  |   |                  |       |                        |       |       |   | **To Be Well Capitalized** |       |
|---------------------------------------------------|--------|------------|------------|-----------------------|--------|-----------------------|------------|-----------------------------|------------|------------|--------|----------------------------|------------|
| ** **                                        |   |       |       |                  |   | **For Capital**       |       | **Under Prompt Corrective** |       |
| ** **                                        |   | **Actual** |       | **Adequacy Purposes** |   | **Action Provisions** |       |
| ** **                                        |   | **Amount** | ** ** | **Ratio**             |   | **Amount**            | ** ** | ** **                  | ** ** | **Ratio**  |   | **Amount**                 | ** ** | ** ** | ** ** | **Ratio** |   |
| ***March 31,  2010***                        |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| * *                                          |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 45,651,000 |                  | 6.25   | %                     | $          | 58,433,280                  |       | >  |   | 8.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 45,022,000 |       | 6.16                  | %      | 58,470,130            |       | >                   |       | 8.0        | %      | $                          | 73,087,662 |   | >  |   | 10.0 | % |
|                                              |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 34,954,000 |                  | 4.78   | %                     | $          | 29,250,209                  |       | >  |   | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 34,328,000 |       | 4.70                  | %      | 29,215,319            |       | >                   |       | 4.0        | %      | $                          | 43,822,979 |   | >  |   | 6.0 | % |
|                                              |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Tier I Capital To Average Assets                  |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 34,954,000 |                  | 3.72   | %                     | $          | 37,584,946                  |       | >  |   | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 34,328,000 |       | 3.65                  | %      | 37,619,726            |       | >                   |       | 4.0        | %      | $                          | 47,024,658 |   | >  |   | 5.0 | % |
|                                              |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| ***December 31,  2009***                     |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| * *                                          |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Total Risk-Based Capital To Risk Weighted Assets: |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 47,485,000 |                  | 6.28   | %                     | $          | 60,490,446                  |       | >  |   | 8.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 46,763,000 |       | 6.19                  | %      | 60,436,834            |       | >                   |       | 8.0        | %      | $                          | 75,546,042 |   | >  |   | 10.0 | % |
|                                              |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Tier I Capital To Risk Weighted Assets:           |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 36,490,000 |                  | 4.83   | %                     | $          | 30,219,462                  |       | >  |   | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 35,771,000 |       | 4.73                  | %      | 30,250,317            |       | >                   |       | 4.0        | %      | $                          | 45,375,476 |   | >  |   | 6.0 | % |
|                                              |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Tier I Capital To Average Assets                  |   |       |       |                  |   |                  |       |                        |       |       |   |                       |       |   |   |   |   |
| Consolidated                                      |   | $          | 36,490,000 |                  | 3.44   | %                     | $          | 42,430,233                  |       | >  |   | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                              |   | 35,771,000 |       | 3.37                  | %      | 42,458,160            |       | >                   |       | 4.0        | %      | $                          | 53,072,700 |   | >  |   | 5.0 | % |

 

We had outstandingjunior subordinated debentures commonly referred to as Trust PreferredSecurities totaling $10.3 million at March 31, 2010 and December 31,2009.  The Trust Preferred Securitiesqualify as a Tier I capital under risk-based capital guidelines provided thattotal Trust Preferred Securities do not exceed certain quantitativelimits.  At March 31, 2010 and December 31,2009, all of the Trust Preferred Securities qualify as a Tier I capital.  We had outstanding subordinated debentures totaling$1.4 million at March 31, 2010 and December 31, 2009.  The subordinated debentures qualify as a TierII capital under risk-based capital guidelines. At March 31, 2010 and December 31, 2009, all of thesubordinated debentures qualify as a Tier II capital.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

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

**For the Three Months Ended March 31, 2010**

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Item 4T. Controls and Procedures**

**For the Three Months Ended March 31, 2010**

 

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, as appropriate,to allow timely decisions regarding required disclosures of that informationunder the Securities and Exchange Commission’s rules and forms.  The Company’s disclosure controls andprocedures are designed to ensure that the information required to be disclosedin reports that are filed or submitted by the Company pursuant to theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

#### **During the first quarter of 2010, there were no significantchanges in the Company’s internal control over financial reporting or, to theCompany’s knowledge, in other factors that could significantly affect thoseinternal controls subsequent to the date the Company carried out its evaluationthat have materially affected, or are reasonably likely to materially affect,the Company’s internal control over financial reporting.  However, the design of any system of controlsand procedures is based in part upon certain assumptions about the likelihoodof future events.  There can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote.**

 

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**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

**Part II. Other Information**

**For the Three Months EndedMarch 31, 2010**

 

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

 

Item1. Legal Proceedings

 

Pleaserefer to the material pending legal proceedings discussed in Part I, “Item3. Legal Proceedings” in our Annual Report on form 10-K for the year ended December 31,2009.  There have been no materialdevelopments in the matters discussed in our Annual Report and there are nofurther material legal proceedings to which the Company or the Bank is a partyor of which their property is the subject.

 

Item1A. Risk Factors

 

In addition to theother information set forth in this report, you should carefully consider thefactors discussed in Part I, “Item 1A. Risk Factors” in our Annual Reporton Form 10-K for the year ended December 31, 2009, which couldmaterially affect our business, financial condition or future results. The risksdescribed in our Annual Report on Form 10-K are not the only risks facingus. Additional risks and uncertainties not currently known to us or that wecurrently deem to be immaterial also may materially adversely affect ourbusiness, financial condition and/or operating results.

 

Item2. Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item3. Defaults Upon Senior Securities

NotApplicable

 

Item4. Reserved

 

Item5. Other Information

None

 

Item6. Exhibits

 
|       | (a)    | Exhibits:                                                                                                                                                         |
|------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       | 31.1   | Certification  of Chief Executive Officer Pursuant to Rule 13a-14 under the Securities  Exchange Act of 1934, as amended                                     |
|       |   |                                                                                                                                                              |
|       | 31.2   | Certification  of Chief Financial Officer Pursuant to Rule 13a-14 under the Securities  Exchange Act of 1934, as amended                                     |
|       |   |                                                                                                                                                              |
| ** ** | **32** | **Certification of Chief Executive Officer pursuant to 18 U.S.C.  Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002** |

 

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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: May 6, 2010                 |   |

 

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