Tableof Contents

 

 

 

**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 June 30,2010**

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

 

**For the transition period from               to              **

** **

**Commission File Number 000-51112**

** **

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

(Exact Name of SmallBusiness Issuer as Specified in Its Charter)

 

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

 

**1701 BassRoad**

**Macon,Georgia 31210**

(Address of PrincipalExecutive Offices)

 

**(478) 476-2170**

(Issuer’s Telephone Number, IncludingArea Code)

 

**NotApplicable**

(Former Name, Former Addressand Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submittedelectronically and posted on its corporate Web site, if any, every InteractiveData File required to be submitted and posted pursuant to Rule 405 ofRegulation S-T during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  Yes o  No o

 

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

 

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

 

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

 

**APPLICABLE ONLY TO CORPORATEISSUERS**

 

State the number of shares outstanding of each of the issuer’s classesof common equity, as of the latest practicable date: Common Stock, no parvalue, 4,280,745 shares outstanding at July 23,2010

 

 

 

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**ATLANTIC SOUTHERN FINANCIALGROUP, INC.**

 

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INDEX

 
| ** **                                                                                                      | ** **                                                                                                                                         | **PAGE** |
|-----------------------------------------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------------------------------|----------|
|                                                                                                            |                                                                                                                                               |     |
| PART I:                                                                                                    | FINANCIAL INFORMATION                                                                                                                              |     |
| ITEM 1.                                                                                                         | FINANCIAL STATEMENTS                                                                                                                               |     |
|                                                                                                            |                                                                                                                                               |     |
| The following consolidated  financial statements are provided for Atlantic Southern Financial  Group, Inc. |                                                                                                                                               |
|                                                                                                            |                                                                                                                                               |     |
|                                                                                                            | Consolidated  Balance Sheets — June 30, 2010  (unaudited) and December 31,  2009 (audited).                                         | 2        |
|                                                                                                            |                                                                                                                                               |     |
|                                                                                                            | Consolidated Statements of Operations (unaudited) —  For the Three Months And Six Months Ended June 30, 2010 and 2009.                   | 3        |
|                                                                                                            |                                                                                                                                               |     |
|                                                                                                            | Consolidated Statements of Comprehensive Income (Loss)  (unaudited) — For the Three Months and Six Months Ended June 30, 2010  and 2009. | 4        |
|                                                                                                            |                                                                                                                                               |     |
|                                                                                                            | Consolidated Statements of Cash Flows (unaudited) —  For the Six Months Ended June 30, 2010 and 2009.                                    | 5        |
|                                                                                                            |                                                                                                                                               |     |
|                                                                                                            | Notes to Consolidated Financial Statements (unaudited)                                                                                             | 7        |
|                                                                                                            |                                                                                                                                               |     |
| ITEM  2.                                                                                                        | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                                                        | 22       |
|                                                                                                            |                                                                                                                                               |     |
| ITEM  3.                                                                                                        | Quantitative  and Qualitative Disclosures About Market Risk                                                                                        | 42       |
|                                                                                                            |                                                                                                                                               |     |
| ITEM  4T.                                                                                                       | Controls  and Procedures                                                                                                                           | 43       |
|                                                                                                            |                                                                                                                                               |     |
| PART II:                                                                                                   | OTHER  INFORMATION                                                                                                                                 | 44       |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedBalance Sheets**

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

 
| ** **                                                                                                                                                                                  | ** ** | **As of**         | ** **  |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|-------------|
| ** **                                                                                                                                                                                  | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
| ** **                                                                                                                                                                                  | ** ** | **2010**          | ** **  | **2009** | ** ** |
| **Assets**                                                                                                                                                                                  | ** ** | ** **        | ** **  | ** ** | ** ** |
|                                                                                                                                                                                        |       |              |        |   |   |
| Cash and due from banks                                                                                                                                                                     |       | $                 | 8,519,395   |   | $ | 4,990,374 |   |
| Interest-bearing deposits in other banks                                                                                                                                                    |       | 75,142,356        |        | 28,401,303 |   |
| Total cash and cash equivalents                                                                                                                                                             |       | 83,661,751        |        | 33,391,677 |   |
| Securities available for sale, at fair value                                                                                                                                                |       | 72,334,563        |        | 126,939,601 |   |
| Federal Home Loan Bank stock, restricted, at cost                                                                                                                                           |       | 4,316,800         |        | 4,316,800 |   |
| Loans held for sale                                                                                                                                                                         |       | 1,453,490         |        | 1,089,108 |   |
| Loans, net of unearned income                                                                                                                                                               |       | 663,781,730       |        | 718,306,915 |   |
| Less - allowance for loan losses                                                                                                                                                            |       | (19,323,225       | )           | (21,478,748 | ) |
| Loans, net                                                                                                                                                                                  |       | 644,458,505       |        | 696,828,167 |   |
| Bank premises and equipment, net                                                                                                                                                            |       | 30,360,216        |        | 31,016,982 |   |
| Accrued interest receivable                                                                                                                                                                 |       | 4,066,884         |        | 4,549,769 |   |
| Cash surrender value of life insurance                                                                                                                                                      |       | 13,275,536        |        | 13,011,018 |   |
| Intangible assets, net of amortization                                                                                                                                                      |       | 2,367,692         |        | 2,548,850 |   |
| Other real estate owned                                                                                                                                                                     |       | 41,720,587        |        | 21,066,480 |   |
| Income tax receivable                                                                                                                                                                       |       | 11,063,312        |        | 11,174,666 |   |
| Other assets                                                                                                                                                                                |       | 2,507,325         |        | 2,446,748 |   |
| **Total Assets**                                                                                                                                                                            |       | $                 | 911,586,661 |   | $ | 948,379,866 |   |
|                                                                                                                                                                                        |       |              |        |   |   |
| **Liabilities and Shareholders’  Equity**                                                                                                                                              |       |              |        |   |   |
| Deposits:                                                                                                                                                                                   |       |              |        |   |   |
| Non-interest bearing                                                                                                                                                                        |       | $                 | 53,182,187  |   | $ | 53,747,355 |   |
| Money market and NOW accounts                                                                                                                                                               |       | 113,621,646       |        | 132,469,652 |   |
| Savings                                                                                                                                                                                     |       | 9,143,293         |        | 8,890,713 |   |
| Time deposits                                                                                                                                                                               |       | 659,160,509       |        | 666,049,168 |   |
| Total deposits                                                                                                                                                                              |       | 835,107,635       |        | 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                                                                                                                                                                    |       | 4,041,544         |        | 4,977,554 |   |
| Accrued expenses and other liabilities                                                                                                                                                      |       | 2,560,337         |        | 1,896,265 |   |
| Total liabilities                                                                                                                                                                           |       | 887,419,516       |        | 918,740,707 |   |
| Commitments and contingencies                                                                                                                                                               |       |              |        |   |   |
| Shareholders’ Equity:                                                                                                                                                                  |       |              |        |   |   |
| Preferred stock, authorized 2,000,000 shares, no  shares outstanding                                                                                                                        |       | —            |        | — |   |
| Common stock, no par value, authorized 110,000,000  shares, 4,280,745 issued and outstanding in 2010, no par value, authorized  10,000,000 shares, 4,211,780 issued and outstanding in 2009 |       | 74,742,733        |        | 74,630,831 |   |
| Deferred compensation, 68,965 shares in 2010                                                                                                                                                |       | (93,750           | )           | — |   |
| Accumulated deficit                                                                                                                                                                         |       | (51,263,120       | )           | (45,592,212 | ) |
| Accumulated other comprehensive income                                                                                                                                                      |       | 781,282           |        | 600,540 |   |
| Total shareholders’ equity                                                                                                                                                             |       | 24,167,145        |        | 29,639,159 |   |
| **Total Liabilities and  Shareholders’ Equity**                                                                                                                                        |       | $                 | 911,586,661 |   | $ | 948,379,866 |   |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Operations**

**For the Three Months andSix Months Ended June 30, 2010 and 2009**

**(Unaudited)**

 
| ** **                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                     | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| **Interest and Dividend Income:**                              |       |                                  |       |                                |       |   |   |   |   |
| Interest and fees on loans                                     |       | $                                     | 8,333,148  |                                | $          | 10,729,675 |   | $ | 17,485,138 |   | $ | 22,131,412 |   |
| Interest on securities:                                        |       |                                  |       |                                |       |   |   |   |   |
| Taxable income                                                 |       | 417,007                               |       | 811,478                             |       | 882,127 |   | 1,785,725 |   |
| Non-taxable income                                             |       | 144,596                               |       | 156,520                             |       | 289,956 |   | 323,252 |   |
| Other interest and dividend income                             |       | 54,658                                |       | 4,323                               |       | 72,698 |   | 8,481 |   |
| Total interest and dividend income                             |       | 8,949,409                             |       | 11,701,996                          |       | 18,729,919 |   | 24,248,870 |   |
| **Interest Expense:**                                          |       |                                  |       |                                |       |   |   |   |   |
| Deposits                                                       |       | 4,838,988                             |       | 6,692,934                           |       | 9,875,521 |   | 13,347,697 |   |
| Subordinated debentures                                        |       | 42,466                                |       | 42,467                              |       | 84,466 |   | 84,467 |   |
| Junior subordinated debentures                                 |       | 61,328                                |       | 84,860                              |       | 120,720 |   | 186,247 |   |
| FHLB borrowings and other interest expense                     |       | 224,301                               |       | 387,480                             |       | 456,804 |   | 738,962 |   |
| Total interest expense                                         |       | 5,167,083                             |       | 7,207,741                           |       | 10,537,511 |   | 14,357,373 |   |
|                                                           |       |                                  |       |                                |       |   |   |   |   |
| Net interest income                                            |       | 3,782,326                             |       | 4,494,255                           |       | 8,192,408 |   | 9,891,497 |   |
| **Provision for loan losses**                                  |       | 2,034,000                             |       | 5,718,000                           |       | 3,336,000 |   | 6,068,000 |   |
| Net interest income (expense) after provision for  loan losses |       | 1,748,326                             |       | (1,223,745                          | )          | 4,856,408 |   | 3,823,497 |   |
| **Noninterest Income:**                                        |       |                                  |       |                                |       |   |   |   |   |
| Service charges on deposit accounts                            |       | 407,915                               |       | 418,094                             |       | 792,227 |   | 839,675 |   |
| Other service charges, commissions and fees                    |       | 159,358                               |       | 125,536                             |       | 291,512 |   | 238,127 |   |
| Gain on sales / calls of investment securities                 |       | 42,906                                |       | 1,095,390                           |       | 42,906 |   | 1,315,818 |   |
| Mortgage origination income                                    |       | 57,977                                |       | 186,631                             |       | 150,013 |   | 393,587 |   |
| Other income                                                   |       | 228,580                               |       | 254,933                             |       | 489,193 |   | 556,076 |   |
| Total noninterest income                                       |       | 896,736                               |       | 2,080,584                           |       | 1,765,851 |   | 3,343,283 |   |
| **Noninterest Expense:**                                       |       |                                  |       |                                |       |   |   |   |   |
| Salaries and employee benefits                                 |       | 2,223,163                             |       | 2,638,685                           |       | 4,550,465 |   | 5,415,452 |   |
| Occupancy expense                                              |       | 444,531                               |       | 436,857                             |       | 883,343 |   | 891,754 |   |
| Equipment rental and depreciation of equipment                 |       | 298,411                               |       | 326,202                             |       | 594,774 |   | 631,503 |   |
| Loss on sale of other assets                                   |       | 500                                   |       | 5,550                               |       | 775 |   | 43,797 |   |
| Loss on sale and impairment of other real estate               |       | 295,414                               |       | 1,466,000                           |       | 396,927 |   | 1,490,688 |   |
| Other real estate expense                                      |       | 827,714                               |       | 210,603                             |       | 1,301,170 |   | 336,296 |   |
| FDIC and state banking assessments                             |       | 1,417,262                             |       | 958,385                             |       | 2,328,219 |   | 1,154,611 |   |
| Goodwill impairment                                            |       | —                                |       | 19,533,501                          |       | — |   | 19,533,501 |   |
| Other expenses                                                 |       | 1,175,934                             |       | 1,658,438                           |       | 2,237,494 |   | 3,051,620 |   |
| Total noninterest expense                                      |       | 6,682,929                             |       | 27,234,221                          |       | 12,293,167 |   | 32,549,222 |   |
|                                                           |       |                                  |       |                                |       |   |   |   |   |
| **Loss before income taxes**                                   |       | (4,037,867                            | )          | (26,377,382                         | )          | (5,670,908 | ) | (25,382,442 | ) |
| Income tax benefit                                             |       | —                                |       | 2,595,673                           |       | — |   | 2,342,486 |   |
| **Net Loss**                                                   |       | $                                     | (4,037,867 | )                                   | $          | (23,781,709 | ) | $ | (5,670,908 | ) | $ | (23,039,956 | ) |
| **Net Loss per Share:**                                        |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                          |       | $                                     | (0.96      | )                                   | $          | (5.65 | ) | $ | (1.35 | ) | $ | (5.47 | ) |
| Diluted                                                        |       | $                                     | (0.96      | )                                   | $          | (5.65 | ) | $ | (1.35 | ) | $ | (5.47 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Comprehensive Income (Loss)**

**For the Three Months andSix Months Ended June 30, 2010 and 2009**

**(Unaudited)**

 
| ** **                                                                                    | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| ** **                                                                                    | ** ** | **2010**                        | ** ** | **2009**                      | ** ** | **2010** | ** ** | **2009** | ** ** |
| Net loss                                                                                      |       | $                               | (4,037,867 | )                             | $          | (23,781,709 | ) | $ | (5,670,908 | ) | $ | (23,039,956 | ) |
| Other comprehensive income (loss):                                                            |       |                            |       |                          |       |   |   |   |   |
| Unrealized holding gains (losses) on investment  securities available for sale                |       | 206,622                         |       | (1,187,425                    | )          | 316,758 |   | (206,520 | ) |
| Reclassification adjustment for gains on  investments available for sale realized in net loss |       | (42,906                         | )          | (1,095,390                    | )          | (42,906 | ) | (1,315,818 | ) |
| Total other comprehensive income (loss), before  tax                                          |       | 163,716                         |       | (2,282,815                    | )          | 273,852 |   | (1,522,338 | ) |
| Income taxes related to other comprehensive income  (loss):                                   |       |                            |       |                          |       |   |   |   |   |
| Unrealized holding (gains) losses on investment  securities available for sale                |       | (70,251                         | )          | 403,725                       |       | (107,698 | ) | 70,217 |   |
| Reclassification adjustment for gains on  investments available for sale realized in net loss |       | 14,588                          |       | 372,433                       |       | 14,588 |   | 447,378 |   |
| Total income taxes related to other comprehensive  income (loss)                              |       | (55,663                         | )          | 776,158                       |       | (93,110 | ) | 517,595 |   |
| Total other comprehensive income (loss), net of  tax                                          |       | 108,053                         |       | (1,506,657                    | )          | 180,742 |   | (1,004,743 | ) |
| Total comprehensive income (loss)                                                             |       | $                               | (3,929,814 | )                             | $          | (25,288,366 | ) | $ | (5,490,166 | ) | $ | (24,044,699 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**ConsolidatedStatements of Cash Flows**

**For the Six Months EndedJune 30, 2010 and 2009**

**(Unaudited)**

 
| ** **                                                                                 | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                                                 | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| **Cash Flows from Operating  Activities:**                                                 |       |                          |       |   |   |
| Net loss                                                                                   |       | $                             | (5,670,908 | ) | $ | (23,039,956 | ) |
| Adjustments to reconcile net loss to net cash  (used in) provided by operating activities: |       |                          |       |   |   |
| Provision for loan losses                                                                  |       | 3,336,000                     |       | 6,068,000 |   |
| Depreciation                                                                               |       | 784,883                       |       | 808,320 |   |
| Stock based compensation                                                                   |       | 18,152                        |       | 13,075 |   |
| Goodwill impairment charge                                                                 |       | —                        |       | 19,533,501 |   |
| Amortization and (accretion), net                                                          |       | 473,288                       |       | 350,527 |   |
| Loss on sale and impairment of other real estate                                           |       | 396,927                       |       | 1,490,688 |   |
| Loss on sale of other assets                                                               |       | 775                           |       | 43,797 |   |
| Gain on sales / calls of investment securities                                             |       | (42,906                       | )          | (1,315,818 | ) |
| Earnings on cash surrender value of life insurance                                         |       | (264,518                      | )          | (265,058 | ) |
| Change in:                                                                                 |       |                          |       |   |   |
| Loans held for sale                                                                        |       | (229,382                      | )          | (2,780,782 | ) |
| Accrued income and other assets                                                            |       | 1,151,030                     |       | 1,141,850 |   |
| Accrued expenses and other liabilities                                                     |       | (271,938                      | )          | (1,342,243 | ) |
| Net cash (used in) provided by operating  activities                                       |       | (318,597                      | )          | 705,901 |   |
| **Cash Flows from Investing  Activities:**                                                 |       |                          |       |   |   |
| Net change in loans to customers                                                           |       | 24,267,006                    |       | (4,780,049 | ) |
| Purchase of available for sale securities                                                  |       | (2,439,000                    | )          | (136,272,035 | ) |
| Proceeds from sales, calls, maturities and  paydowns of available for sale securities      |       | 57,115,518                    |       | 88,770,336 |   |
| Purchase of other investments                                                              |       | —                        |       | (880,600 | ) |
| Proceeds from sales of other investments                                                   |       | —                        |       | 447,526 |   |
| Property and equipment expenditures                                                        |       | (128,117                      | )          | (1,430,840 | ) |
| Improvement of other real estate                                                           |       | (419,317                      | )          | (15,668 | ) |
| Proceeds from sales of other real estate and other  assets                                 |       | 3,241,834                     |       | 5,837,334 |   |
| Net cash provided by (used in) investing  activities                                       |       | 81,637,924                    |       | (48,323,996 | ) |
| **Cash Flows from Financing  Activities:**                                                 |       |                          |       |   |   |
| Net change in deposits                                                                     |       | (26,049,253                   | )          | 128,367,125 |   |
| Advances on FHLB borrowings                                                                |       | —                        |       | 31,000,000 |   |
| Payments on FHLB borrowings                                                                |       | (5,000,000                    | )          | (22,200,000 | ) |
| Net cash (used in) provided by financing  activities                                       |       | (31,049,253                   | )          | 137,167,125 |   |
| **Net Increase in Cash and Cash  Equivalents**                                             |       | 50,270,074                    |       | 89,549,030 |   |
| **Cash and Cash Equivalents,  Beginning of Year**                                          |       | 33,391,677                    |       | 15,130,136 |   |
| **Cash and Cash Equivalents, End of  Quarter**                                             |       | $                             | 83,661,751 |   | $ | 104,679,166 |   |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Consolidated Statements ofCash Flows, continued**

**For the Six Months EndedJune 30, 2010 and 2009**

**(Unaudited)**

 

**Supplemental Disclosures of Cash Flow Information**

 

**Noncash transactions:**

 
| ** **                                                         | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------------------------------|------------|-------------------------------|------------|
| ** **                                                         | ** ** | **2010**                      | ** ** | **2009** | ** ** |
| Changes in unrealized gain/loss on investments,  net of tax effect |       | $                             | 180,742    |   | $ | (1,004,743 | ) |
| Transfer of loans to other real estate and other  assets           |       | $                             | 25,071,376 |   | $ | 4,705,068 |   |
| Transfer of other real estate to loans and loans  held for sale    |       | $                             | 435,153    |   | $ | — |   |
| Interest on deposits and borrowings                                |       | $                             | 11,473,521 |   | $ | 14,727,948 |   |
| Income tax refunds                                                 |       | $                             | (111,454   | ) | $ | (848,760 | ) |

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

*** ***

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

 

The accompanying unaudited consolidated financial statements have beenprepared in accordance with the instructions to Form 10-Q and therefore do notinclude all information and footnotes necessary for a fair presentation offinancial position, results of operations, and changes in financial position inconformity with generally accepted accounting principles.  The interim financial statements furnishedreflect all adjustments, which are, in the opinion of management, necessary toa fair statement of the results for the interim periods presented.  The interim consolidated financial statementsshould be read in conjunction with the Company’s Annual Report on Form 10-K forthe year ended December 31, 2009.

 

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

 

OnSeptember 11, 2009, Atlantic Southern Bank (the “Bank”), the wholly-ownedsubsidiary bank of Atlantic Southern Financial Group, Inc., entered into aStipulation and Consent to the Issuance of an Order to Cease and Desist (the “ConsentAgreement”) with the Federal Deposit Insurance Corporation (the “FDIC”) and theGeorgia Department of Banking and Finance (the “GDBF”), whereby the Bankconsented to the issuance of an Order to Cease and Desist (the “Order”).  Under the terms of the Order, the Bank cannotdeclare dividends without the prior written approval of the FDIC and the GDBF.Other material provisions of the order require the Bank to: (i) strengthenits board of directors’ oversight of management and operations of the Bank,(ii) establish a committee consisting of at least four members, three ofwhich must be independent, to oversee the Bank’s compliance with the Order,(iii) maintain specified capital and liquidity ratios, (iv)  improvethe Bank’s lending and collection policies and procedures, particularly withrespect to the origination and monitoring of commercial real estate andacquisition, development and construction loans, (v) eliminate from its books,by charge off or collection, all assets classified as “loss” and 50% of allassets classified as doubtful, (vi) perform risk segmentation analysis withrespect to concentrations of credit, (vii) receive a brokered deposit waiverfrom 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 loan interestreserves, (ix) formulate and fully implement a written plan and comprehensivebudget for all categories of income and expense, and (x) prepare and submit progressreports to the FDIC and the GDBF. The FDIC order will remain in effect untilmodified or terminated by the FDIC and the GDBF.

 

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

 

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

 

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

 

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

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Bank’s Total Risk Based Capital ratio was 5.83% and the Tier 1 LeverageRatio was 3.27% at June 30, 2010.  TheBank’s liquidity ratio at June 30, 2010 was 18.61%.

 

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

 

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

 

(vi)          The Bank hasand will continue to perform a risk segmentation analysis with respect toconcentrations of credit. Management is limiting credit availability especiallyfor commercial real estate and acquisition, development and construction loansand pursuing collection efforts aggressively in an effort to reduce the Bank’sexposure to commercial real estate and acquisition, development andconstruction, pursuant to the Order.

 

(vii)         The Bank hassubmitted to the supervisory authorities a written plan for eliminating itsreliance on brokered deposits and will not accept, roll over or renew anybrokered deposits unless a waiver has been received from the FDIC.  The Bank continues to significantly reducedits exposure to brokered deposits.  SinceJune 30, 2008, the Bank has been proactive in reducing brokered deposits by48.9%, or $197.5 million, while increasing core deposits by $197.6 millionduring the same period.

 

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

 

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

 

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

 

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

 

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

 

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

 

Asa result of the extraordinary effects of what may ultimately be the worsteconomic downturn since the Great Depression, the Company’s and the Bank’scapital have been significantly depleted. The Company recorded a net loss of $59.2 million in 2009 and continuedin the first half of 2010 in recording a net loss of $5.7 million.  These net losses are primarily the result ofsignificant increases in the provision for loan losses in 2009, the recognitionof goodwill impairment in 2009, the establishment of a valuation allowanceagainst the Company’s deferred tax asset in 2009, a decrease in the Company’snet interest margin due to the loss of interest on non-accrual loans and fromthe purchase of low-yielding investment securities during 2009, a significantincrease in

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated FinancialStatements**

**(Unaudited)**

 

theFDIC quarterly assessment in 2009 and 2010 and increases in other real estateexpenses due to the increase in foreclosed properties in 2009 and 2010.  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 result, it cannot be assured that theCompany will be able to resume profitable operations in the near future, if atall.

 

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 June 30, 2010, the Bank’s totalcapital to risk-weighted assets and ratio of Tier 1 capital to average assetswere 5.83% and 3.27%, respectively.  TheCompany’s existing capital resources may not satisfy the requirements for theforeseeable future and may not be sufficient to offset any additional problemassets.  Further, should erosion to theBank’s asset quality continue and require significant additional provision forcredit losses, resulting in consistent net operating losses at the Bank, theBank’s capital levels will decline and the Company will need to raiseadditional capital to satisfy the Order.

 

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

 

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

 

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

 

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

 

Basic earnings (loss) per share arebased on the weighted average number of common shares outstanding during theperiod while the effects of potential shares outstanding during the period areincluded in diluted earnings per share.  Approximately 381,000 shares of options andwarrants were not included in the diluted loss per share computation for thethree and six months ended June 30, 2010 and 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 SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                                                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                  | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Net loss                                                                    |       | $                                     | (4,037,867 | )                                   | $          | (23,781,709 | ) | $ | (5,670,908 | ) | $ | (23,039,956 | ) |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Weighted average common shares outstanding                                  |       | 4,211,780                             |       | 4,211,780                           |       | 4,211,780 |   | 4,211,780 |   |
| Shares issued from assumed exercise of common  stock equivalents            |       | —                                |       | —                              |       | — |   | — |   |
| Weighted average number of common and common  equivalent shares outstanding |       | 4,211,780                             |       | 4,211,780                           |       | 4,211,780 |   | 4,211,780 |   |
| Loss per share:                                                             |       |                                  |       |                                |       |   |   |   |   |
| Basic                                                                       |       | $                                     | (0.96      | )                                   | $          | (5.65 | ) | $ | (1.35 | ) | $ | (5.47 | ) |
|                                                                        |       |                                  |       |                                |       |   |   |   |   |
| Diluted                                                                     |       | $                                     | (0.96      | )                                   | $          | (5.65 | ) | $ | (1.35 | ) | $ | (5.47 | ) |

 

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

 

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

 
| ** **                                | ** ** | **Amortized  Cost** | ** **  | **Gross  Unrealized  Gains** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|---------------------|-------------|------------------------------|------------|-------------------------------|------------|---------------------------|------------|
| **June 30, 2010**                    | ** ** | ** **          | ** **  | ** **                   | ** ** | ** **                    | ** ** | ** **                | ** ** |
| Non-mortgage backed debt securities of :  |       |                |        |                         |       |                          |       |                      |       |
| U.S. Treasury obligations                 |       | $                   | 20,511,283  |                         | $          | 11,032                        |       | $                         | —     |   | $ | 20,522,315 |   |
| U.S. Government sponsored enterprises     |       | 11,065,732          |        | 412,432                      |       | —                        |       | 11,478,164                |       |
| State and political subdivisions          |       | 15,259,851          |        | 321,893                      |       | (244,884                      | )          | 15,336,860                |       |
| Other investments                         |       | 250,000             |        | 2,630                        |       | —                        |       | 252,630                   |       |
| Total non-mortgage backed debt securities |       | 47,086,866          |        | 747,987                      |       | (244,884                      | )          | 47,589,969                |       |
| Mortgage backed securities                |       | 24,024,508          |        | 707,477                      |       | (6,883                        | )          | 24,725,102                |       |
| Equity securities                         |       | 39,428              |        | —                       |       | (19,936                       | )          | 19,492                    |       |
| Total                                     |       | $                   | 71,150,802  |                         | $          | 1,455,464                     |       | $                         | (271,703   | ) | $ | 72,334,563 |   |
| **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:

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **     | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|----------------|------------|-------------------------|------------|-----------------------------|------------|
| Amortized cost |       | $                       | 22,231,325 |                        | $          | 23,141,062 |   |
| Fair value     |       | $                       | 22,487,456 |                        | $          | 23,003,692 |   |

 

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

 
| ** **                                | ** ** | **Amortized Cost** | ** ** | **Estimated  Fair Value** | ** ** |
|-------------------------------------------|------------|--------------------|------------|---------------------------|------------|
| Non-mortgage backed debt securities:      |       |               |       |                      |       |
| Due in one year or less                   |       | $                  | 20,511,283 |                      | $          | 20,522,315 |   |
| Due after one year through five years     |       | 7,616,815          |       | 7,784,982                 |       |
| Due after five years through ten years    |       | 6,886,157          |       | 7,130,702                 |       |
| Due after ten years                       |       | 12,072,611         |       | 12,151,970                |       |
| Total non-mortgage backed debt securities |       | $                  | 47,086,866 |                      | $          | 47,589,969 |   |

 

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:

 
| ** **                                | ** ** | **June 30, 2010**        | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **Less Than Twelve Months**   | ** ** | **More Than Twelve Months** | ** ** |
| **Securities Available for Sale**         | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** |
| Non-mortgage backed debt securities of:   |       |                          |       |   |   |   |   |   |   |
| U.S. Treasury obligations                 |       | $                             | —     |   | $ | — |   | $ | — |   | $ | — |   |
| U.S. Government sponsored enterprises     |       | —                        |       | — |   | — |   | — |   |
| State and political subdivisions          |       | (691                          | )          | 346,031 |   | (244,193 | ) | 3,754,373 |   |
| Total non-mortgage backed debt securities |       | (691                          | )          | 346,031 |   | (244,193 | ) | 3,754,373 |   |
| Mortgage backed securities                |       | (6,883                        | )          | 2,431,981 |   | — |   | — |   |
| Equity securities                         |       | (19,936                       | )          | 19,492 |   | — |   | — |   |
| Total                                     |       | $                             | (27,510    | ) | $ | 2,797,504 |   | $ | (244,193 | ) | $ | 3,754,373 |   |

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                                | ** ** | **December 31, 2009**    | ** ** |
|-------------------------------------------|------------|-------------------------------|------------|
| ** **                                | ** ** | **Less Than Twelve Months**   | ** ** | **More Than Twelve Months** | ** ** |
| **Securities Available for Sale**         | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  Fair Value** | ** ** | **Gross  Unrealized  Losses** | ** ** | **Estimated  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 |   | — |   | — |   |
| Equity securities                         |       | —                        |       | — |   | — |   | — |   |
| 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 prospects of the issuer, and (3) the intent and ability of theCompany to retain its investment in the issuer for a period of time sufficientto allow for any anticipated recovery in fair value.

 

At June 30, 2010,fourteen debt securities had unrealized losses with aggregate depreciation of0.35% from the Company’s amortized cost basis. In analyzing an issuer’s financial condition, management considerswhether the securities are issued by the federal government or its agencies,whether downgrades by bond rating agencies have occurred, and industry analysts’reports. As management has the ability and intent to hold debt securities untilmaturity, or for the foreseeable future if classified as available for sale andit is more likely than not that the Company will not be required to sell theseinvestments before recovery of their amortized cost basis, no declines aredeemed to be other than temporary.

 

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

 
| ** **               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|
| ** **               | ** ** | **2010**                              | ** ** | **2009**                            | ** ** | **2010** | ** ** | **2009** | ** ** |
| Proceeds from sales      |       | $                                     | —     |                                | $          | 37,033,981 |   | $ | — |   | $ | 50,771,869 |   |
| Proceeds from calls      |       | 13,545,000                            |       | 2,339,950                           |       | 16,090,000 |   | 2,519,950 |   |
| Proceeds from maturities |       | 22,500,000                            |       | 25,490,000                          |       | 36,500,000 |   | 27,240,000 |   |
| Paydowns                 |       | 2,026,584                             |       | 4,622,145                           |       | 4,525,518 |   | 8,238,517 |   |
| Total                    |       | $                                     | 38,071,584 |                                | $          | 69,486,076 |   | $ | 57,115,518 |   | $ | 88,770,336 |   |
|                     |       |                                  |       |                                |       |   |   |   |   |
| Gross gains              |       | $                                     | 42,906     |                                | $          | 1,153,008 |   | $ | 42,906 |   | $ | 1,384,133 |   |
| Gross losses             |       | —                                |       | —                              |       | — |   | (10,697 | ) |
| Impairment losses        |       | —                                |       | (57,618                             | )          | — |   | (57,618 | ) |
|                     |       |                                  |       |                                |       |   |   |   |   |
| Net gains of securities  |       | $                                     | 42,906     |                                | $          | 1,095,390 |   | $ | 42,906 |   | $ | 1,315,818 |   |
|                     |       |                                  |       |                                |       |   |   |   |   |
| Income tax expense       |       | $                                     | —     |                                | $          | 372,433 |   | $ | — |   | $ | 447,378 |   |

 

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

 

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

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

***(6)******        ******Loans***

 

The following is a summaryof the loan portfolio by purpose code categories:

 
| ** **                                        | ** ** | **June 30,  2010** | ** **  | **December 31,  2009** | ** ** |
|---------------------------------------------------|------------|-------------------------|-------------|-----------------------------|------------|
|                                              |       |                    |        |                        |       |
| Commercial                                        |       | $                       | 43,643,750  |                        | $          | 51,673,928 |   |
| Real estate - commercial                          |       | 311,001,349             |        | 304,468,535                 |       |
| Real estate - construction                        |       | 204,327,888             |        | 263,270,892                 |       |
| Real estate - mortgage                            |       | 98,808,541              |        | 92,012,553                  |       |
| Obligations of political subdivisions in the U.S. |       | 254,396                 |        | 294,779                     |       |
| Consumer                                          |       | 5,911,741               |        | 6,838,169                   |       |
| Total loans                                       |       | 663,947,665             |        | 718,558,856                 |       |
| Less:                                             |       |                    |        |                        |       |
| Unearned loan fees                                |       | (165,935                | )           | (251,941                    | )          |
| Allowance for loan losses                         |       | (19,323,225             | )           | (21,478,748                 | )          |
| Loans, net                                        |       | $                       | 644,458,505 |                        | $          | 696,828,167 |   |

 

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

 

At June 30, 2010 and December 31,2009, all impaired loans with a related allowance have been evaluated basedupon the fair value of the underlying collateral.  Impaired loans without a related allowancewere previously written down to the net realizable value of the collateral orthe collateral was sufficient to ensure no principal loss.  At June 30, 2010, the Company hadapproximately $57.4 million in impaired loans without a related allowance withthe Company having previously partially charged off approximately $11.1 millionto date to write down the loans to their net realizable value.  Impaired loans and related amounts includedin the allowance for loan losses at June 30, 2010 and December 31,2009 are as follows:

 
| ** **                               | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                               | ** ** | **Balance**             | ** ** | **Allowance  Amount**       | ** ** | **Balance** | ** ** | **Allowance  Amount** | ** ** |
| Impaired loans with related allowance    |       | $                       | 50,897,156 |                        | $          | 4,012,221 |   | $ | 3,261,723 |   | $ | 1,024,001 |   |
| Impaired loans without related allowance |       | 57,427,645              |       | —                      |       | 112,031,829 |   | — |   |
|                                          |            |                         |            |                             |            |  |  |  |  |  |  |  |  |

 

The Company had $12.3 million and $12.8 million in loans that would bedefined as a troubled debt restructuring (“TDR”) at June 30, 2010 and at December 31,2009, respectively.  Of those amounts,$10.5 million and $1.6 million were accruing as of June 30, 2010 and December 31,2009, respectively, as they were performing in accordance with their restructuredterms.  At June 30, 2010, there wereapproximately $989 thousand in TDR loans that had a related allowance ofapproximately $357 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***

 

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

 
| ** **                                 | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|--------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                 | ** ** | **2010**                             | ** ** | **2009**                           | ** ** | **2010** | ** ** | **2009** | ** ** |
| Beginning balance                          |       | $                                    | 21,148,485 |                               | $          | 11,492,656 |   | $ | 21,478,748 |   | $ | 11,671,534 |   |
| Add:                                       |       |                                 |       |                               |       |   |   |   |   |
| Provision for possible loan losses         |       | 2,034,000                            |       | 5,718,000                          |       | 3,336,000 |   | 6,068,000 |   |
| Subtotal                                   |       | 23,182,485                           |       | 17,210,656                         |       | 24,814,748 |   | 17,739,534 |   |
| Less:                                      |       |                                 |       |                               |       |   |   |   |   |
| Loans charged off                          |       | 4,029,703                            |       | 2,317,177                          |       | 5,721,036 |   | 2,911,003 |   |
| Recoveries on loans previously charged off |       | (170,443                             | )          | (17,313                            | )          | (229,513 | ) | (82,261 | ) |
| Net loans charged off                      |       | 3,859,260                            |       | 2,299,864                          |       | 5,491,523 |   | 2,828,742 |   |
| Balance, end of period                     |       | $                                    | 19,323,225 |                               | $          | 14,910,792 |   | $ | 19,323,225 |   | $ | 14,910,792 |   |

 

***(8) Nonperforming Assets***

 

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

 
| ** **                      | ** ** | **June 30,** | ** **  | **December 31,** | ** ** |
|---------------------------------|------------|-------------------|-------------|-----------------------|------------|
| ** **                      | ** ** | **2010**          | ** **  | **2009**              | ** ** |
| Accruing loans 90 days past due |       | $                 | —      |                  | $          | 644,920 |   |
| Non-accrual loans               |       | 108,324,802       |        | 115,293,553           |       |
| Repossessed assets              |       | 10,838            |        | 1,000                 |       |
| Other real estate owned         |       | 41,720,587        |        | 21,066,480            |       |
| Total non-performing assets     |       | $                 | 150,056,227 |                  | $          | 137,005,953 |   |

 

Nonperformingassets increased $13.1 million, or 9.53%, from December 31, 2009 to June 30,2010.  Non-accrual loans decreasedapproximately $7.0 million from December 31, 2009 to June 30, 2010,largely due to approximately $25.1 million moving to other real estate ownedand other assets, $5.7 million in partial charge-offs on non-accrual loans andapproximately $4.6 million in pay downs. During the first six months of 2010, there was approximately $28.4million in loans moved to non-accrual. All non-accrual loans are adequately collateralized based on management’sjudgment and supported by recent collateral appraisals.  Other real estate owned increased $20.7million from December 31, 2009 to June 30, 2010.  This increase is largely due to the additionof $24.3 million in foreclosed properties and $419 thousand in capitalized improvementson several foreclosed properties being offset by the sale of $3.6 million inforeclosed properties resulting in a loss of $51 thousand on theseproperties.  The Company has written down$350 thousand for several foreclosed properties based upon updated appraisals.

 

TheCompany’s policy is to place loans on non-accrual status when it appears thatthe collection of interest in accordance with the terms of the loan isdoubtful.  Any loan which becomes 90 dayspast due as to principal or interest is automatically placed onnon-accrual.  Exceptions are allowed for90-day past due loans when such loans are well secured and in process ofcollection.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

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

 
| ** **                                           | ** ** | **As of June 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **Number of  Properties**    | ** ** | **Carrying  Amount**             | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| 1-4 Family residential properties                    |       | 23                           |       | $                                | 2,313,906  |   | 23 |   | 2,958,213 |   |
| Multifamily residential properties                   |       | 2                            |       | 1,675,096                        |       | 2 |   | 238,225 |   |
| Nonfarm nonresidential properties                    |       | 14                           |       | 9,738,879                        |       | 13 |   | 8,994,372 |   |
| Farmland properties                                  |       | 2                            |       | 950,604                          |       | — |   | — |   |
| Construction & land development  properties |       | 51                           |       | 27,042,102                       |       | 35 |   | 8,875,670 |   |
| Total                                                |       | 92                           |       | $                                | 41,720,587 |   | 73 |   | 21,066,480 |   |

 

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

 

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

 

***(9) Shareholders’Equity***

 

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

 

TheCompany granted restricted stock for 68,965 shares to Edward P. Loomis, Jr.,President of the Bank.  The stock will bevested in installments over a period of four years.  All shares of restricted stock will be heldby the Company until the conditions are satisfied.  All shares are nonvested as of June 30,2010.  Compensation expense totaling$6,250 was recognized during the second quarter of 2010 in connection withrestricted stock.

 

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

 

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

 

Fair Value Hierarchy

 

Level 1 – Valuation is basedupon quoted prices (unadjusted) in active markets for identical assets orliabilities that the Company has the ability to access.

 

Level 2 – Valuation is basedupon quoted prices for similar assets and liabilities in active markets, aswell as inputs that are observable for the asset or liability (other thanquoted prices), such as interest rates, foreign exchange rates, and yieldcurves that are observable at commonly quoted intervals.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

Level 3 – Valuation isgenerated from model-based techniques that use at least one significantassumption based on unobservable inputs for the asset or liability, which aretypically based on an entity’s own assumptions, as there is little, if any,related market activity.  In instanceswhere the determination of the fair value measurement is based on inputs fromdifferent levels of the fair value hierarchy, the level in the fair valuehierarchy within which the entire fair value measurement falls is based on thelowest level input that is significant to the fair value measurement in itsentirety.  The Company’s assessment ofthe significance of a particular input to the fair value measurement in itsentirety requires judgment, and considers factors specific to the asset orliability.

 

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

 

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

 

***Securities Available for Sale*** - Securitiesavailable-for-sale consist of U.S. Treasury obligations, U.S. governmentsponsored enterprises, state and political subdivisions, corporate bonds,mortgage backed securities and equity securities.  They are recorded at fair value on arecurring basis.  Where quoted marketprices are available in an active market, securities are classified withinLevel 1 of the valuation hierarchy.  Ifquoted prices are not available, fair values are measured using independentpricing models or other model-based valuation techniques such as the present valueof future cash flows, adjusted for the security’s credit rating, prepaymentassumptions and other factors such as credit loss assumptions.

 

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

 

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

 

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

 

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

 

***Loans*** - The Company does notrecord loans at fair value on a recurring basis.  However, from time to time, a loan isconsidered impaired and an allowance for loan losses is established.  Loans for which it is probable that paymentof interest and principal will not be made in accordance with the contractualterms of the loan agreement are considered impaired.  Once a loan is identified as individuallyimpaired, management measures impairment based on the present value of expectedfuture cash flows discounted at the loan’s effective interest rate, except thatas a practical expedient, a creditor may measure impairment based on a loan’sobservable market price, or the fair value of the collateral if repayment ofthe loan is dependent upon the sale of the underlying collateral.  Those impaired loans not requiring anallowance represent loans for which the fair value of the expected repaymentsor collateral exceed the recorded investments in such loans.  At December 31, 2009 and 2008,substantially all of the total impaired loans were evaluated based on the fairvalue of the collateral.  Impaired loanswhere an allowance is established based on the fair value of collateral requireclassification in the fair value hierarchy. When the fair value of the collateral is based on an observable marketprice or a current appraised value, the Company records the impaired loan asnonrecurring Level 2.  When an appraisedvalue is not available or management determines the fair value of thecollateral is further impaired below the appraised value and there is noobservable market price, the Company records the impaired loan as nonrecurringLevel 3.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

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

 

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

 

***Goodwill and Other Intangible Assets*** - Goodwill andidentified intangible assets are subject to impairment testing.  A current market valuation method is used toanalyze the carrying value of goodwill for impairment.  This valuation method estimates the fairvalue of the Bank based on the price that would be received to sell the Bank asa whole in an orderly transaction between market participants at themeasurement date.  This valuation methodrequires a significant degree of management judgment.  In the event the valuation value for the Bankis less than the carrying value of goodwill, the asset amount is recorded at fairvalue as determined by the valuation model. As such, the Company classifies goodwill and other intangible assetssubjected to nonrecurring fair value adjustments as Level 3.

 

***Other Real Estate Owned*** — Other realestate is adjusted to fair value upon transfer of the loans to other realestate.  Subsequently, other real estateis carried at the lower of carrying value or fair value.  Fair value is based upon independent market prices,appraised values of the collateral or management’s estimation of the value ofthe collateral.  When the fair value ofthe collateral is based on an observable market price or a current appraisedvalue, the Company records the other real estate as nonrecurring Level 2.  When an appraised value is not available ormanagement determines the fair value of the collateral is further impairedbelow the appraised value and there is no observable market prices, the Companyrecords the other real estate as nonrecurring Level 3.

 

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

 

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

 

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

 

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

 

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

 

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

Thetable below presents the recorded amount of assets and liabilities measured atfair value on a recurring basis at June 30, 2010 and December 31,2009.

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 
| ** **                               | ** ** | **As of June 30,** | ** ** |
|------------------------------------------|------------|-------------------------|------------|
| ** **                               | ** ** | **2010**                | ** ** |
| **Assets**                               | ** ** | **Total**               | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Debt securities available-for-sale       |       |                    |       |   |   |   |   |   |   |
| U.S. Treasury obligations                |       | $                       | 20,522,315 |   | $ | — |   | $ | 20,522,315 |   | $ | — |   |
| U.S. government sponsored enterprises    |       | 11,478,164              |       | — |   | 11,478,164 |   | — |   |
| State and political subdivisions         |       | 15,336,860              |       | — |   | 14,544,906 |   | 791,954 |   |
| Other investments                        |       | 252,630                 |       | — |   | 252,630 |   | — |   |
| Mortgage backed securities               |       | 24,725,102              |       | — |   | 24,725,102 |   | — |   |
| Total debt securities available-for-sale |       | 72,315,071              |       | — |   | 71,523,117 |   | 791,954 |   |
| Equity securities available-for-sale     |       | 19,492                  |       | — |   | 19,492 |   | — |   |
| Total available-for-sale securities      |       | $                       | 72,334,563 |   | $ | — |   | $ | 71,542,609 |   | $ | 791,954 |   |

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

 

Duringthe second quarter of 2010, the Company’s independent third-party pricingservice changed its methodology for one of its state and political subdivisionsecurities.  Therefore, the level ofmeasurement techniques to evaluate this security available-for-sale changedfrom a Level 2 category to a Level 3 category since there was no readilyobservable assumptions in the market place and valuation was determined fromother model-based techniques.

 

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 June 30, 2010 and December 31, 2009.

 
| ** **                     | ** ** | **As of June 30,** | ** **  |
|--------------------------------|------------|-------------------------|-------------|
| ** **                     | ** ** | **2010**                | ** **  |
| ** **                     | ** ** | **Total**               | ** **  | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|                           |       |                    |        |   |   |   |   |   |   |
| Loans                          |       | $                       | 104,944,654 |   | $ | — |   | $ | 104,944,654 |   | $ | — |   |
| Loans held for sale            |       | 1,453,490               |        | — |   | 1,453,490 |   | — |   |
| Other real estate owned        |       | 41,720,587              |        | — |   | 41,720,587 |   | — |   |
|                           |       |                    |        |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                       | 148,118,731 |   | $ | — |   | $ | 148,118,731 |   | $ | — |   |

 

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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** | ** ** |
|                           |       |                   |              |   |   |   |   |   |   |
| Loans                          |       | $                      |  125,166,754 |   | $ | — |   | $ |  125,166,754 |   | $ | — |   |
| Loans held for sale            |       | 1,089,108              |              | — |   | 1,089,108 |   | — |   |
| Other real estate owned        |       | 21,066,480             |              | — |   | 21,066,480 |   | — |   |
|                           |       |                   |              |   |   |   |   |   |   |
| **Total assets at fair value** |       | $                      |  147,322,342 |   | $ | — |   | $ |  147,322,342 |   | $ | — |   |

 

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

 
| ** **                             | ** ** | **June 30, 2010** | ** **              | **December 31, 2009** | ** ** |
|----------------------------------------|------------|-------------------|-------------------------|-----------------------|------------|
| ** **                             | ** ** | **Carrying**      | ** **              | **Estimated**         | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                             | ** ** | **Amount**        | ** **              | **Fair Value**        | ** ** | **Amount** | ** ** | **Fair Value** | ** ** |
| **Assets:**                            |       |              |                    |                  |       |   |   |   |   |
| Cash and cash equivalents              |       | $                 |    83,661,751 |                  | $          |    83,661,751 |   | $ | 33,391,677.00 |   | $ |  33,391,677 |   |
| Securities available for sale          |       | 72,334,563        |                    | 72,334,563            |       | 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                    |       | 1,453,490         |                    | 1,453,490             |       | 1,089,108 |   | 1,089,108 |   |
| Loans, net                        |       | 644,458,505       |                    | 644,789,196           |       | 696,828,167 |   | 698,284,092 |   |
| Cash surrender value of life insurance |       | 13,275,536        |                    | 13,275,536            |       | 13,011,018 |   | 13,011,018 |   |
| Other real estate owned                |       | 41,720,587        |                    | 41,720,587            |       | 21,066,480 |   | 21,066,480 |   |
| **Liabilities:**                       |       |              |                    |                  |       |   |   |   |   |
| Deposits                               |       | 835,107,635       |                    | 838,854,327           |       | 861,156,888 |   | 866,219,696 |   |
| FHLB borrowings                        |       | 34,000,000        |                    | 34,990,692            |       | 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        |                    | 1,811,364             |       | 10,310,000 |   | 10,310,000 |   |
|                                        |            |                   |                         |                       |            |  |  |  |  |  |  |  |  |

 

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

 

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

 

***(11)RegulatoryMatters***

 

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

 

Inaddition, quantitative measures established by regulations to ensure capitaladequacy require the Bank to maintain minimum amounts and ratios (set forthbelow in the table) of total and Tier I capital (as defined in the regulations)to risk-weighted assets (as defined in the regulations), and of Tier I capital(as defined in the regulations) to average assets (as defined in theregulations).  To comply with the Order, the Bank is required to

 

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**ATLANTIC SOUTHERNFINANCIAL GROUP, INC.**

**Notes to Consolidated Financial Statements**

**(Unaudited)**

 

haveTier 1 capital in such an amount as to equal or exceed 8% of the Bank’s totalassets and total risk-based capital as to equal or exceed 10% of the Bank’srisk-weighted assets.  As of June 30,2010, the Bank’s ratio of total capital to risk-weighted assets and ratio ofTier 1 Capital to risk-weighted assets were 5.83% and 4.36%, respectively.  The Company and the Bank were considered “significantlyundercapitalized” by bank regulatory authorities as of June 30, 2010 and “undercapitalized”as of December 31, 2009.  As aresult, on March 26, 2010, the Bank received a Notification of PromptCorrective Action from the FDIC and, in accordance with Section 325.104 of theFDIC Rules and Regulations, the Bank was required, among other things, to filea written capital restoration plan with the FDIC.

 

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

 
| ** **                                         | ** ** | ** ** | ** ** | ** **            | ** ** | ** **            | ** ** | ** **                  | ** ** | ** **       | ** ** | **To Be Well Capitalized** | ** ** |
|----------------------------------------------------|------------|------------|------------|-----------------------|------------|-----------------------|------------|-----------------------------|------------|------------------|------------|----------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **            | ** ** | **For Capital**       | ** ** | **Under Prompt Corrective** | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                         | ** ** | **Amount** | ** ** | **Ratio**             | ** ** | **Amount**            | ** ** | ** **                  | ** ** | **Ratio**        | ** ** | **Amount**                 | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ***June 30, 2010***                                |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
|                                               |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Total Risk-Based Capital  To Risk Weighted Assets: |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Consolidated                                       |       | $          | 41,275,000 |                  | 5.90       | %                     | $          | 55,966,102                  |       |  >  |       | 8.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                               |       | 40,795,000 |       | 5.83                  | %          | 55,979,417            |       |  >             |       | 8.0              | %          | 69,974,271                 |       |  >  |   | 10.0 | % |
|                                               |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Tier I Capital To Risk  Weighted Assets:           |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Consolidated                                       |       | $          | 28,788,000 |                  | 4.11       | %                     | $          | 28,017,518                  |       |  >  |       | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                               |       | 30,522,000 |       | 4.36                  | %          | 28,001,835            |       |  >             |       | 4.0              | %          | 42,002,752                 |       |  >  |   | 6.0 | % |
|                                               |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Tier I Capital To Average  Assets                  |       |       |       |                  |       |                  |       |                        |       |             |       |                       |       |   |   |   |   |
| Consolidated                                       |       | $          | 28,788,000 |                  | 3.08       | %                     | $          | 37,387,013                  |       |  >  |       | 4.0                        | %          | N/A |   |   |   | N/A |   |
| Bank                                               |       | 30,522,000 |       | 3.27                  | %          | 37,335,780            |       |  >             |       | 4.0              | %          | 46,669,725                 |       |  >  |   | 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 | % |

 

***(12)Accounting Standards Updates***

 

 InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-01, *Accounting for Distributions to Shareholders with Components of Stockand Cash* (“ASU No. 2010-01”). ASU No. 2010-01 provides guidance on the accounting for distributionsoffering shareholders the choice of receiving cash or stock.  Under such guidance, the stock portion of thedistribution is not considered to be a stock dividend, and for purposes ofcalculating earnings per share it is deemed a new share issuance not requiringretroactive restatement.  This guidanceis effective for the

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Notes to ConsolidatedFinancial Statements**

**(Unaudited)**

 

firstreporting period, including interim periods, ending after December 15,2009.  It is not expected to have amaterial impact on the Company’s results of operations, financial position ordisclosures.

 

InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-04, *Technical Corrections to SEC Paragraphs* (“ASU No. 2010-04”).  It is not expected to have an impact on theCompany.

 

InJanuary 2010, the FASB issued Accounting Standards Update No. 2010-06, *Improving Disclosures about Fair Value Measurements* (“ASUNo. 2010-06”).  ASU No. 2010-06 amendsFASB ASC Topic 820-10-50, *Fair Value Measurementsand Disclosures*, to require additional information to be disclosedprincipally regarding Level 3 measurements and 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 disclose separatelypurchases, sales, issuances, and settlements in the Level 3 reconciliation areeffective for fiscal years beginning after December 15, 2010 (and for interimperiods within such years).  ASU No.2010-06 is not expected to have a material impact on the Company’s results ofoperations or financial position, and will have a minimal impact on itsdisclosures.

 

InFebruary 2010, the FASB issued Accounting Standards Update No. 2010-09, *Amendments to Certain Recognition and Disclosure Requirements*(“ASU No. 2010-09).  ASU No. 2010-09amends FASB ASC Subtopic 855-10, *Subsequent Events*,to remove the requirement for an SEC filer to disclose the date through whichsubsequent events 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 is notexpected to have a material impact on the Company.

 

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

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item 2.Management’s Discussion and Analysis of Financial Condition and Results ofOperations**

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

**June 30, 2010 and 2009**

 

Thefollowing discussion of financial condition as of June 30, 2010 compared to December31, 2009, and the results of operations for the three months and sixmonths ended June 30, 2010 comparedto the three months and six months ended June 30, 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 reporton Form 10-Q that are not historical facts are forward-looking statementssubject to the safe harbor created by the Private Securities Litigation ReformAct of 1995.  We caution readers of thisreport that such forward-looking statements involve known and unknown risks,uncertainties and other factors which may cause the actual results, performanceor achievements to be materially different from those expressed or implied bysuch forward-looking statements. Although we believe that our expectations of future performance is basedon reasonable assumptions within the bounds of our knowledge of our businessand operations, there can be no assurance that actual results will not differmaterially from our expectations.

 

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

 

·                  Deterioration in the condition of borrowers resulting insignificant increase in loan losses and provisions for those losses;

·                  the potential that loan charge-offs may exceed the allowance forloan losses or that such allowance will be increased as a result of factorsbeyond our control or the failure of assumptions underlying the establishmentof reserves for possible loan losses;

·                  changes in loan underwriting, credit review or loss reservepolicies associated with economic conditions, examination conclusions, orregulatory developments;

·                  our dependence on senior management;

·                  competition from existing financial institutions, includingcommercial banks, thrifts, mortgage banking firms, consumer finance companies,credit unions, securities brokerage firms, insurance companies, money marketand other mutual funds, operating in our market areas and elsewhere, includinginstitutions operating regionally, nationally and internationally, togetherwith such competitors offering banking products and services by mail, telephoneand the Internet;

·                  changes in political and economic conditions, including thepolitical and economic effects of the current economic downturn and other majordevelopments, including the ongoing war on terrorism and potential adverseconditions in the stock market, the public debt market, and other capitalmarkets (including changes in interest rate conditions);

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

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

·                  risks inherent in making loans including repayment risks andvalue of collateral;

·                  the strength of the United States economy in general and thestrength of the local economies in which we conduct operations may be differentthan expected resulting in, among other things, a deterioration in creditquality or a reduced demand for credit, including the resultant effect on ourloan portfolio and allowance for loan losses;

·                  changes in financial market conditions, either internationally,nationally or locally in areas in which the Company conducts its operations,including, without limitation, reduced rates of business formation and growth,commercial and residential real estate development, and fluctuations inconsumer spending and saving habits;

·                  the demand for our products and services;

·                  technological changes;

·                  the challenges and uncertainties in the implementation of ourexpansion and development strategies;

·                  the ability to increase market share;

·                  the adequacy of expense projections and estimates of impairmentloss;

·                  the impact of changes in accounting policies by the Securitiesand Exchange Commission;

·                  unanticipated regulatory or judicial proceedings;

 

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·                  future legislation affecting financial institutions and changesto governmental monetary and fiscal policies (including without limitation lawsconcerning taxes, banking, securities, and insurance);

·                  the effects of, and changes in, trade, monetary and fiscalpolicies and laws, including interest rate policies of the Board of Governorsof the Federal Reserve System;

·                  the timely development and acceptance of products and services,including products and services offered through alternative delivery channelssuch as the Internet;

·                  other factors described in this report and in other reports wehave filed with the Securities and Exchange Commission; and

·                  Our success at managing the risks involved in the foregoing.

 

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

 

**Executive Summary and Recent Developments**

 

The Company’s total assetsat June 30, 2010, were approximately $911.6 million, which represented a decreaseof approximately $36.8 million, or 3.88%, from December 31, 2009.  Net loss of $5.7 million, $1.35 per dilutedshare, was recorded for the six months ended June 30, 2010 compared to a netloss of $23.0 million, or $5.47 per diluted share, for the six months endedJune 30, 2009.

 

OnSeptember 11, 2009, the Bank consented to the issuance of an Order to Cease andDesist by the FDIC and the GDBF.  Underthe terms of the Order, the Bank cannot declare dividends without the priorwritten approval of the FDIC and the GDBF. Other material provisions of the Order require the Bank to: (i)strengthen its board of directors’ oversight of management and operations ofthe Bank, (ii) establish a committee consisting of at least four members, threeof which must be independent, to oversee the Bank’s compliance with the Order,(iii) maintain specified liquidity ratios, (iv) improve the Bank’s lending andcollection 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, by charge offor collection, all assets classified as “loss” and 50% of all assets classifiedas doubtful, (vi) perform risk segmentation analysis with respect to concentrationsof credit, (vii) receive a brokered deposit waiver from the FDIC prior toaccepting, rolling over or renewing any brokered deposits and submit a writtenplan for eliminating its reliance on brokered deposits, (viii) adopt andimplement 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 the FDICand the GDBF.  In addition, pursuant to theOrder, the Bank is required to maintain Tier 1 capital equal to at least 8% ofthe Bank’s total assets and total risk-based capital equal to at least 10% ofthe Bank’s risk-weighted assets.  TheFDIC order will remain in effect until modified or terminated by the FDIC andthe GDBF.

 

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

 

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

 

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

 

OnMarch 26, 2010, the Bank received Notification of Prompt Corrective Action(the “Notice”), which, pursuant to Section 325.102 of the FDIC Rules andRegulations, requires the Bank to submit a capital restoration plan within 45days of receipt of the Notice.  Inaddition, because the Bank is currently classified as “significantlyundercapitalized”, in addition to the requirements in the Order, the Bank isrequired to adhere to the following restrictions, pursuant to which regulatorsmay

 

·                  Require sale of securities, or, if groundsfor conservatorship or receivership exist, direct the Bank to merge or beacquired;

·                  Restrict affiliate transactions;

·                  Restrict or prohibit all activities that aredetermined to pose an excessive risk to the Bank;

·                  Require the institution to elect newdirectors, dismiss directors or senior executive officers, or employ seniorexecutive officers to improve management;

·                  Prohibit the acceptance of deposits fromcorrespondent banks;

·                  Require holding company divestiture of thefinancial institution, bank divestiture of subsidiaries and/or holding companydivestiture of other affiliates; or

·                  Require the bank to take any other action thefederal regulator determines will “better achieve” prompt correction action.

 

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

 

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

 

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

 

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

 

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

 

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**FinancialCondition**

 

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

 
| ** **                              | ** ** | **June 30,**                    | ** ** | **December 31,** | ** ** | ** **        | ** ** | ** **   | ** ** |
|-----------------------------------------|------------|--------------------------------------|------------|-----------------------|------------|-------------------|------------|--------------|------------|
| ** **                              | ** ** | **2010**                             | ** ** | **2009**              | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** | ** **            | ** ** |
| **Assets:**                             |       |                                 |       |                  |       |              |       |         |       |
| Total cash and cash  equivalents        |       | $                                    | 83,662     |                  | $          | 33,392            |       | $            | 50,270     |   | 150.55 | % |
| Securities available  for sale          |       | 72,335                               |       | 126,940               |       | (54,605           | )          | -43.02       | %          |
| Loans, net of unearned  income          |       | 663,782                              |       | 718,307               |       | (54,525           | )          | -7.59        | %          |
| Cash surrender value of  life insurance |       | 13,276                               |       | 13,011                |       | 265               |       | 2.04         | %          |
| Intangible assets, net  of amortization |       | 2,368                                |       | 2,549                 |       | (181              | )          | -7.10        | %          |
| Other real estate owned                 |       | 41,721                               |       | 21,066                |       | 20,655            |       | 98.05        | %          |
| Total assets                            |       | 911,587                              |       | 948,380               |       | (36,793           | )          | -3.88        | %          |
| **Liabilities:**                        |       |                                 |       |                  |       |              |       |         |       |
| Deposits                                |       | 835,108                              |       | 861,157               |       | (26,049           | )          | -3.02        | %          |
| 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 |       | 2,560                                |       | 1,896                 |       | 664               |       | 35.02        | %          |
| Total liabilities                       |       | 887,420                              |       | 918,741               |       | (31,321           | )          | -3.41        | %          |
|                                    |       |                                 |       |                  |       |              |       |         |       |
| Loan to Deposit Ratio                   |       | 79.48                                | %          | 83.41                 | %          |              |       |         |       |
|                                         |            |                                      |            |                       |            |                   |            |              |            |  |  |  |

 

Significantchanges in the composition of assets include the increase in total cash andcash equivalents of $50.3 million which was primarily due to the maturities,calls and paydowns of securities of $57.1 million and to the payoffs of loansfrom customers of approximately $24.3 million. This increase in total cash and cash equivalents was reduced by thepayout of $26.0 million of deposits, mostly maturing wholesale time deposits,and by the $5.0 million pay off of a maturing Federal Home Loan Bankadvance.  The Company investedapproximately $2.5 million in securities during the second quarter of 2010.

 

Othersignificant changes in the composition of assets were the decrease in loansfollowed by the increase in other real estate owned during the first six monthsof 2010.  The Company had approximately$5.7 million in loans charged off during the first six months of 2010 alongwith approximately $25.1 million moving to other real estate owned and to otherassets.

 

Themost significant change in the composition of liabilities was the decrease indeposits, which decreased approximately $26.0 million.  Savings accounts had a small increase ofapproximately $253 thousand while non-interest bearing deposits, money marketand NOW accounts and time deposits decreased $26.3 million.  Time deposits, including wholesale and coredeposits, are our principal source of funds for loans and investing in securities.  Local retail time deposits at June 30,2010, increased approximately $23.2 million since December 31, 2009 due tomanagement’s efforts to increase core deposits and to continue reducing theBank’s reliance on brokered deposits. The Company was able to decrease brokered deposits at June 30, 2010by approximately $30.1 million compared to December 31, 2009 primarily dueto its ability to replace them with retail deposits obtained both locally andthrough a national rate-listing service.

 

Dueto our strong loan demand in the past, we chose to obtain a portion of ourdeposits from outside of our market.  The deposits obtained outside of ourmarket area generally have lower rates than rates being offered forcertificates of deposits in our local market. We have also utilized out-of-market deposits in certain instances toobtain longer term deposits than are readily available in our localmarket.  Our brokered time deposits represented24.68% of our deposits as of June 30, 2010 when compared to 27.43% of ourdeposits as of December 31, 2009.

 

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

 

**InvestmentSecurities**

 

Securitiesin our portfolio totaled $72.3 million at June 30, 2010, compared to$126.9 million at December 31, 2009. The decrease in the securities portfolio has resulted from the calls ofapproximately $16.1 million in U.S. government sponsored enterprises and state,county and municipal bonds, the maturity of $36.5 million in U.S. Treasurysecurities and the paydowns of approximately $4.5 million in mortgage-backedsecurities.  The Company purchasedapproximately $2.5 million in mortgage-backed securities during the secondquarter of 2010.  At June 30, 2010,the securities portfolio had unrealized net gains of approximately $1.2million.

 

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

 
| ** **                              | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                              | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                              | ** ** | **(Dollars in Thousands)** | ** ** |
| Securities available  for sale:         |       |                       |       |                  |       |
| U. S. Treasury  securities              |       | $                          | 20,523     |                  | $          | 57,157 |   |
| U. S. Government  sponsored enterprises |       | 11,478                     |       | 27,617                |       |
| State and political  subdivisions       |       | 15,337                     |       | 15,156                |       |
| Mortgage-backed  securities             |       | 24,725                     |       | 26,711                |       |
| Other Investments                       |       | 272                        |       | 299                   |       |
| Total                                   |       | $                          | 72,335     |                  | $          | 126,940 |   |

 

Thefollowing table summarizes securities disposal activities for the three and sixmonth periods ended June 30, 2010 and 2009:

 
| ** **                | ** ** | **Three Months Ended**     | ** ** | **Six Months Ended**       | ** ** |
|---------------------------|------------|--------------------------------------|------------|--------------------------------------|------------|
| ** **                | ** ** | **June 30,**                    | ** ** | **June 30,**                    | ** ** |
| ** **                | ** ** | **2010**                             | ** ** | **2009**                             | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                | ** ** | **(Dollars in Thousands)** | ** ** | **(Dollars in Thousands)** | ** ** |
| Proceeds from sales       |       | $                                    | —     |                                 | $          | 37,034 |   | $ | — |   | $ | 50,772 |   |
| Proceeds from calls       |       | 13,545                               |       | 2,340                                |       | 16,090 |   | 2,520 |   |
| Proceeds from  maturities |       | 22,500                               |       | 25,490                               |       | 36,500 |   | 27,240 |   |
| Paydowns                  |       | 2,027                                |       | 4,622                                |       | 4,526 |   | 8,238 |   |
| Total                     |       | $                                    | 38,072     |                                 | $          | 69,486 |   | $ | 57,116 |   | $ | 88,770 |   |
|                      |       |                                 |       |                                 |       |   |   |   |   |
| Gross gains               |       | $                                    | 43         |                                 | $          | 1,153 |   | $ | 43 |   | $ | 1,384 |   |
| Gross losses              |       | —                               |       | —                               |       | — |   | (11 | ) |
| Impairment losses         |       | —                               |       | (58                                  | )          | — |   | (58 | ) |
| Net gains of securities   |       | $                                    | 43         |                                 | $          | 1,095 |   | $ | 43 |   | $ | 1,315 |   |
|                      |       |                                 |       |                                 |       |   |   |   |   |
| Income tax expense        |       | $                                    | —     |                                 | $          | 372 |   | $ | — |   | $ | 447 |   |

 

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**Loans**

 

Total loans, net of unearned income decreasedapproximately $54.5 million, or 7.59%, at June 30, 2010, from December 31,2009 as management has made an effort to limit loan growth in order to preservecapital for the Company.  Also, totalloans have decreased due to approximately $5.7 million in loans being chargedoff and approximately $25.1 million in loans being transferred to other realestate owned and other assets during the first six months of 2010.  Management is limiting credit availabilityespecially for commercial real estate and acquisition, development and constructionloans and pursuing collection efforts aggressively in an effort to reduce theBank’s exposure to commercial real estate and acquisition, development andconstruction, pursuant to the Order.  Thefollowing table presents a summary of the loan portfolio by category.

 
| ** **                                         | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                                         | ** ** | **(Amounts in Thousands)** | ** ** |
|                                               |       |                       |       |                  |       |
| Commercial                                         |       | $                          | 43,644     |                  | $          | 51,674 |   |
| Real estate -  commercial                          |       | 311,001                    |       | 304,468               |       |
| Real estate -  construction                        |       | 204,328                    |       | 263,271               |       |
| Real estate - mortgage                             |       | 98,809                     |       | 92,013                |       |
| Obligations of  political subdivisions in the U.S. |       | 254                        |       | 295                   |       |
| Consumer                                           |       | 5,912                      |       | 6,838                 |       |
| Total loans                                        |       | 663,948                    |       | 718,559               |       |
| Less:                                              |       |                       |       |                  |       |
| Unearned loan fees                                 |       | (166                       | )          | (252                  | )          |
| Allowance for loan  losses                         |       | (19,323                    | )          | (21,479               | )          |
| Loans, net                                         |       | $                          | 644,459    |                  | $          | 696,828 |   |

 

AtJune 30, 2010, the Company had twenty-two loans with outstanding balancestotaling $65.3 million with loan-funded interest reserves.  The amount of capitalized interest frominterest reserves for 2010 was $937 thousand.

 

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

 

Withrespect to accounting for interest reserves on loans, interest that has beenadded to the balance of a loan through the use of an interest reserve shouldnot be recognized as income if its collectability is not 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 thefeasibility of the project, the creditworthiness of the borrower andguarantors, and the protection 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.

 

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**Asset Quality**

 

At June 30, 2010, gross loans were 72.8% oftotal assets.  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 non-performing assets have continued toincrease since the beginning of the economic downturn in 2007, when managementbegan to aggressively recognize impaired loans based on an ongoing process ofidentifying early signs of stress in our loan portfolio.  Any significant events that may occursubsequent to any financial statement date are reviewed by management todetermine if any impact is material to the financial statements.  If the event is deemed to be material, thefinancial statements are adjusted to reflect the impact of the event.

 

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

 

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

 
| ** **                                        | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|---------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                        | ** ** | **2010**                                            | ** ** | **2009**                                          | ** ** | **2010** | ** ** | **2009** | ** ** |
| ** **                                        | ** ** | **(Dollars in Thousands)**                | ** ** |
|                                              |       |                                                |       |                                              |       |   |   |   |   |
| Balance beginning of period                       |       | $                                                   | 21,148     |                                              | $          | 11,493 |   | $ | 21,479 |   | $ | 11,672 |   |
| Loans charged-off                                 |       | (4,030                                              | )          | (2,317                                            | )          | (5,721 | ) | (2,911 | ) |
| Recoveries                                        |       | 171                                                 |       | 17                                                |       | 229 |   | 82 |   |
| Net charge-offs                                   |       | (3,859                                              | )          | (2,300                                            | )          | (5,492 | ) | (2,829 | ) |
| Provision for loan losses                         |       | 2,034                                               |       | 5,718                                             |       | 3,336 |   | 6,068 |   |
| Balance end of period                             |       | $                                                   | 19,323     |                                              | $          | 14,911 |   | $ | 19,323 |   | $ | 14,911 |   |
|                                              |       |                                                |       |                                              |       |   |   |   |   |
| Loans, net of unearned income:                    |       |                                                |       |                                              |       |   |   |   |   |
| At period end                                     |       | $                                                   | 663,782    |                                              | $          | 790,130 |   | $ | 663,782 |   | $ | 790,130 |   |
| Average                                           |       | 684,930                                             |       | 791,354                                           |       | 697,908 |   | 793,493 |   |
|                                              |       |                                                |       |                                              |       |   |   |   |   |
| As a percentage of average loans (annualized):    |       |                                                |       |                                              |       |   |   |   |   |
| Net charge-offs                                   |       | 2.26                                                | %          | 1.16                                              | %          | 1.59 | % | 0.71 | % |
| Provision for loan losses                         |       | 1.19                                                | %          | 2.89                                              | %          | 0.96 | % | 1.53 | % |
| Allowance as a percentage of period end loans     |       | 2.91                                                | %          | 1.89                                              | %          | 2.91 | % | 1.89 | % |
| Allowance as a percentage of non-performing loans |       | 17.84                                               | %          | 23.21                                             | %          | 17.84 | % | 23.21 | % |

 

The loan portfolio isreviewed periodically to evaluate outstanding loans and to measure the performanceof the portfolio and the adequacy of the allowance for loan losses.  Management believes that the allowance forloan losses at June 30, 2010 is adequate to absorb losses inherent in theloan portfolio.  This analysis includes areview of delinquency 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.  The allowance 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 information availableto them at the time of their examination. Because of these factors, it is reasonably possible that the estimatedlosses on loans may change materially in the near term.  However, the amount of the change cannot beestimated.

 

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Theallowance is composed of general allocations and specific allocations.  General allocations are determined byapplying loss percentages to the portfolio that are based on historical lossexperience and management’s evaluation and “risk grading” of the commercialloan portfolio.  Additionally, thegeneral economic and business conditions affecting key lending areas, creditquality trends, collateral values, loan volumes and concentrations, seasoningof the loan portfolio, the findings of internal credit reviews and results fromexternal bank regulatory examinations are included in this evaluation.  The need for specific allocations 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 underlyingcollateral.  Loans for which specificallocations are provided are excluded from the calculation of generalallocations.

 

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

 

A loan is consideredimpaired when, based on current information and events, it is probable that acreditor will be unable to collect the scheduled payments of principal orinterest when due according to the contractual terms of the loanagreement.  Factors considered bymanagement in determining impairment include payment status, collateral valueand the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experienceinsignificant payment delays and payment shortfalls generally are notclassified as impaired.  Managementdetermines the significance of payment delays and payment shortfalls on acase-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment history and the amount ofthe shortfall in relation to the principal and interest owed.  Impairment is measured on a loan-by-loanbasis by either the present value of expected future cash flows discounted atthe loan’s effective interest rate, the loan’s obtainable market price, or thefair value of the collateral if the loan is collateral dependent.

 

Large groups of smallerbalance homogenous loans are collectively evaluated for impairment.  Accordingly, we do not separately identifyindividual consumer loans for impairment disclosures.

 

The Company’s allowance as apercentage of nonperforming loans has decreased when comparing the three monthsand six months ended June 30, 2010 to the three months and six monthsended June 30, 2009.  This is duemostly to the increase in nonperforming loans which the Company has recorded atthe lower of the stated value of the loan or the fair value of the underlyingcollateral.  The Company recorded most ofthe nonperforming 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 December 31,2009 to June 30, 2010, the percentage decreased from 18.53% at December 31,2009 to 17.84% at June 30, 2010 due to partially charging off loans to thefair value of the underlying collateral during the first six months of 2010.

 

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

 

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| ** **                      | ** ** | **June 30,**          | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|----------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2010**                   | ** ** | **2009**              | ** ** |
| ** **                      | ** ** | **(Dollars in Thousands)** | ** ** |
| Accruing loans 90 days past due |       | $                          | —     |                  | $          | 645 |   |
| Non-accrual loans               |       | 108,325                    |       | 115,294               |       |
| Repossessed assets              |       | 11                         |       | 1                     |       |
| Other real estate owned         |       | 41,720                     |       | 21,066                |       |
| Total non-performing assets     |       | $                          | 150,056    |                  | $          | 137,006 |   |

 

Nonperformingassets increased $13.1 million, or 9.53%, from December 31, 2009 to June 30,2010.  Non-accrual loans decreasedapproximately $7.0 million from December 31, 2009 to June 30, 2010,largely due to approximately $25.1 million moving to other real estate ownedand other assets, $5.7 million in partial charge-offs on non-accrual loans andapproximately $4.6 million in pay downs.  During the first six months of 2010, there was approximately $28.4 millionin loans moved to non-accrual.  Allnon-accrual loans are adequately collateralized based on management’s judgmentand supported by recent collateral appraisals. Other real estate owned increased $20.7 million from December 31,2009 to June 30, 2010.  Thisincrease is largely due to the addition of $24.3 million in foreclosedproperties and $419 thousand in capitalized improvements on several foreclosedproperties being offset by the sale of $3.6 million in foreclosed propertiesresulting in a loss of $51 thousand on these properties.  The Company has written down $350 thousandfor several foreclosed properties based upon updated appraisals.

 

TheCompany had $12.3 million and $12.8 million in loans that would be defined astrouble debt restructurings (“TDR”) at June 30, 2010 and at December 31,2009, respectively.  Of those amounts,$10.5 million and $1.6 million were accruing as of June 30, 2010 and December 31,2009, respectively, as they were performing in accordance with theirrestructured terms.  At June 30,2010, there were approximately $989 thousand in TDR loans that had a relatedallowance of approximately $357 thousand. At December 31, 2009, there were no TDR loans that had a relatedallowance.

 

Our policy is to place loanson non-accrual status when it appears that the collection of principal andinterest 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.

 

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

 

For loans secured by realestate being placed on non-accrual, an impairment analysis is performed.  If a current appraisal is not on file, a newappraisal for the collateral is obtained by an independent, third-partyappraiser within thirty days of engagement. Once the new appraisal has been reviewed and accepted by the senior vicepresident of credit administration, the impairment calculation is completed todetermine the net realizable value of the loan with the appraised value beingadjusted for certain costs including, but not limited to, sales commissions,closing costs, costs to complete or make ready for sale, property taxes, and,if necessary, an additional adjustment for market conditions.  If the loan balance has been determined to bein excess of the net realizable value from the impairment calculation, the loanis considered to be impaired.  If theloan is determined to be collateral dependent, the loan balance in excess ofthe net realizable value is charged off immediately.  Generally, the underlying collateral securingcollateral-dependent nonperforming loans consists of residential lots,residential dwellings, undeveloped land tracts, timber tracts and developed landtracts.  If the loan is not determined tobe collateral dependent, a specific allocation within the allowance for loanloss is provided for the loan once the impairment calculation is complete.  Once management determines that the loan isimpaired and placed on non-accrual, the loan is transferred to our SpecialAssets Division for close monitoring and collection.

 

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

 

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

 
| ** **                                           | ** ** | **As of June 30, 2010** | ** ** | **As of December 31, 2009** | ** ** |
|------------------------------------------------------|------------|------------------------------|------------|----------------------------------|------------|
| ** **                                           | ** ** | **Number of  Properties**    | ** ** | **Carrying  Amount**             | ** ** | **Number of  Properties** | ** ** | **Carrying  Amount** | ** ** |
| ** **                                           | ** ** | **(Dollars in Thousands)**   | ** ** |
| 1-4 Family residential properties                    |       | 23                           |       | $                                | 2,314      |   | 23 |   | 2,958 |   |
| Multifamily residential properties                   |       | 2                            |       | 1,675                            |       | 2 |   | 238 |   |
| Nonfarm nonresidential properties                    |       | 14                           |       | 9,739                            |       | 13 |   | 8,994 |   |
| Farmland properties                                  |       | 2                            |       | 950                              |       | — |   | — |   |
| Construction & land development  properties |       | 51                           |       | 27,042                           |       | 35 |   | 8,876 |   |
| Total                                                |       | 92                           |       | $                                | 41,720     |   | 73 |   | 21,066 |   |

 

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

 

DuringJuly 2010, the Bank has foreclosed on approximately $3.8 million invarious construction and land development, commercial and 1-4 familyresidential real estate properties. These properties were being held as collateral against severalnon-accrual loans at June 30, 2010. Management is currently evaluating these properties for any additionallosses based on recently ordered appraisals.

 

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

 

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

 

**Deposits**

 

Total deposits at June 30,2010 were $835.1 million, a decrease of $26.0 million, or 3.02%, from December 31,2009.  Total interest bearing demand(money market and NOW accounts), non-interest bearing demand accounts andsavings accounts of $175.9 million decreased $19.2 million, or 9.82% from December 31,2009 resulting mainly from several customers moving their deposits to ourcompetitors, who have had more competitive rates during the first six months of2010.

 

Total time deposits as of June 30,2010 were $659.2 million, a decrease of $6.9 million, or 1.03%, from December 31,2009.  Total retail time deposits at June 30,2010 increased approximately $23.2 million, or 3.49% of total time deposits,from December 31, 2009 due to managements’ efforts to increase coredeposits with internet CDs and to continue reducing the Bank’s reliance onbrokered deposits.  Pursuant to the Orderand FDIC regulations, as a result of our significantly-undercapitalized status,the Bank is prohibited from accepting, renewing or rolling over brokereddeposits absent a waiver from the FDIC. The weighted average rates paid for retail time deposits for the threeand six months ended June 30, 2010 was 2.33% and 2.43%, respectively,compared to 3.29% and 3.45% for the

 

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three and six months ended June 30,2009, respectively.  Total brokereddeposits at June 30, 2010 decreased approximately $30.1 million, or 4.57%of total time deposits, from December 31, 2009, resulting mainly from ourability to replace brokered deposits with retail deposits during the first sixmonths of 2010.  The weighted averagerates paid for brokered deposits for the three and six months ended June 30,2010 were 3.59% and 3.58%, respectively, compared to 3.55% and 3.67% for thethree and six months ended June 30, 2009, respectively.  Because we are currently classified as lessthan well capitalized, we are prohibited from paying rates in excess of 75basis points above the local market average on deposits of comparable maturityin our Georgia markets.  In ourJacksonville market, however, we are prohibited from paying in excess of 75basis points above the national average on deposits, as calculated by the FDIC.

 

**Results of Operations**

 

**General**

 

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

 

The following table shows the significant componentsof net loss:

 
| ** **                   | ** ** | **Six Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                   | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                   | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                   | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Interest and Dividend Income |       | $                          | 18,730     |       | $          | 24,249            |       | $ | (5,519 | ) | -22.76 | % |
| Interest Expense             |       | 10,538                     |       | 14,358     |       | (3,820            | )          | -26.61 | % |
| Net Interest Income          |       | 8,192                      |       | 9,891      |       | (1,699            | )          | -17.18 | % |
| Provision for Loan Losses    |       | 3,336                      |       | 6,068      |       | (2,732            | )          | -45.02 | % |
| Noninterest Income           |       | 1,766                      |       | 3,343      |       | (1,577            | )          | -47.17 | % |
| Noninterest Expense          |       | 12,293                     |       | 32,549     |       | (20,256           | )          | -62.23 | % |
| Net Loss                     |       | (5,671                     | )          | (23,040    | )          | 17,369            |       | 75.39 | % |
| Net Loss Per Diluted Share   |       | (1.35                      | )          | (5.47      | )          | 4.12              |       | 75.32 | % |
|                              |            |                            |            |            |            |                   |            |  |  |  |  |  |

 
| ** **                   | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                   | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                   | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                   | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Interest and Dividend Income |       | $                          | 8,949      |       | $          | 11,702            |       | $ | (2,753 | ) | -23.53 | % |
| Interest Expense             |       | 5,167                      |       | 7,208      |       | (2,041            | )          | -28.32 | % |
| Net Interest Income          |       | 3,782                      |       | 4,494      |       | (712              | )          | -15.84 | % |
| Provision for Loan Losses    |       | 2,034                      |       | 5,718      |       | (3,684            | )          | -64.43 | % |
| Noninterest Income           |       | 897                        |       | 2,081      |       | (1,184            | )          | -56.90 | % |
| Noninterest Expense          |       | 6,683                      |       | 27,234     |       | (20,551           | )          | -75.46 | % |
| Net Loss                     |       | (4,038                     | )          | (23,782    | )          | 19,744            |       | 83.02 | % |
| Net Loss Per Diluted Share   |       | (0.96                      | )          | (5.65      | )          | 4.69              |       | 83.02 | % |
|                              |            |                            |            |            |            |                   |            |  |  |  |  |  |

 

**Net Interest Income**

 

Ourprimary source of income is interest income from loans and investmentsecurities.  Our profitability dependslargely on net interest income, which is the difference between the interestreceived on interest-earning assets and the interest paid on deposits,borrowings, and other interest-bearing liabilities.  Net interest income decreased $1.7

 

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million,or 17.18%, for the six months ended June 30, 2010 compared to the sixmonths ended June 30, 2009.  Netinterest income decreased $712 thousand, or 15.84%, for the three months ended June 30,2010 compared to the three months ended June 30, 2009.

 

Totalinterest and dividend income for the three and six months ended June 30,2010 decreased $2.8 million, or 23.53%, and $5.5 million, or 22.76%,respectively, when compared to the three and six months ended June 30,2009.  This decrease is primarily due todecrease in the volume of loans due to payoffs from customers, an increase inthe volume of nonperforming loans on non-accrual status and/or moving to otherreal estate owned and a decrease in interest on securities from the purchase oflow-yielding U.S. government sponsored enterprises securities purchased duringthe second quarter of 2009 when the Bank restructured its investment portfoliocombined with the purchase of short-term U.S. treasury bills during 2009 whichare being used to meet liquidity needs.

 

Averageloans and loans held for sale portfolios for the three and six months ended June 30,2010 decreased $106.4 million, or 13.45%, and $95.6 million, or 12.05%,respectively, when compared to average loans and loans held for sale portfoliosfor the three and six months ended June 30, 2009.  The average yield on loans decreased for thethree and six months ended June 30, 2010 to 4.87% and 5.01%, respectively,compared to an average yield of 5.43% and 5.58% for the three and six monthsended June 30, 2009.

 

Totalinterest expense for the three and six months ended June 30, 2010decreased $2.0 million, or 28.31%, and $3.8 million, or 26.61%, respectively,when compared to the three and six months ended June 30, 2009.  Two factors impact interest expense: averagebalances of deposit and borrowing portfolios and average rates paid oneach.  Average deposit balances decreasedapproximately $70.8 million and $36.8 million when comparing the three and sixmonths ended June 30, 2010 to the three and six months ended June 30,2009, respectively.  The average ratepaid on the deposit portfolios for the three and six months ended June 30,2010 decreased to 2.41% and 2.46%, respectively, from 3.07% and 3.18% whencompared to the three and six months ended June 30, 2009.  Average borrowing balances decreasedapproximately $19.7 million and $15.3 million when comparing the three and sixmonths ended June 30, 2010 to the three and six months ended June 30,2009, respectively.  Average interestrates paid on borrowings were 2.87% and 2.76% for the three and six monthsended June 30, 2010, respectively, compared to 3.15% and 3.19% for thethree and six months ended June 30, 2009, respectively.

 

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

 

Forthe three months ended June 30, 2010 and 2009, our tax equivalent netinterest spread was 1.84% and 1.93%, respectively, while the tax equivalent netinterest margin was 1.82% and 1.94%, respectively.  For the six months ended June 30, 2010and 2009, our tax equivalent net interest spread was 1.94% and 2.12%,respectively, while the tax equivalent net interest margin was 1.95% and 2.19%,respectively.  The decreases in netinterest spread and net interest margin from the three and six months ended June 30,2009 to the three and six months ended June 30, 2010, were due to the lossof interest on non-accrual loans and from the purchase of low-yieldinginvestment securities during 2009.

 

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Thefollowing table shows the relationship between interest revenue and interestexpense and the average balances of interest-earning assets andinterest-earning liabilities for the three months ended June 30, 2010 and2009.

 

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

 
| ** **                                           | ** ** | **For  the Three Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                           | ** ** | **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) |       | $                                             | 684,930    |   | $ | 8,333 |   | 4.87 | % | $ | 791,354 |   | $ | 10,730 |   | 5.43 | % |
| Investment  securities - taxable (7)                 |       | 76,025                                        |       | 417 |   | 2.19 | % | 113,981 |   | 811 |   | 2.85 | % |
| Investment  securities - tax-exempt (6) (7)     |       | 13,990                                        |       | 145 |   | 6.24 | % | 15,247 |   | 157 |   | 6.24 | % |
| Other  interest and dividend income                  |       | 71,538                                        |       | 54 |   | 0.31 | % | 22,924 |   | 4 |   | 0.07 | % |
| Total  earning assets                                |       | 846,483                                       |       | 8,949 |   | 4.27 | % | 943,506 |   | 11,702 |   | 5.00 | % |
|                                                 |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                         |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Allowance  for loan losses                           |       | -21,196                                       |       |   |   |   |   | -12,071 |   |   |   |   |   |
| Cash  and due from banks                             |       | 10,272                                        |       |   |   |   |   | 65,226 |   |   |   |   |   |
| Premises  and equipment                              |       | 30,487                                        |       |   |   |   |   | 31,822 |   |   |   |   |   |
| Accrued  interest receivable                         |       | 4,518                                         |       |   |   |   |   | 6,023 |   |   |   |   |   |
| Other  real estate owned                             |       | 35,017                                        |       |   |   |   |   | 12,707 |   |   |   |   |   |
| Other  assets                                        |       | 30,146                                        |       |   |   |   |   | 42,747 |   |   |   |   |   |
| Total  assets                                        |       | $                                             | 935,727    |   |   |   |   |   | $ | 1,089,960 |   |   |   |   |   |
|                                                 |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities                        |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing demand                             |       | $                                             | 116,666    |   | $ | 213 |   | 0.73 | % | $ | 150,983 |   | $ | 605 |   | 1.60 | % |
| Savings                                              |       | 9,248                                         |       | 8 |   | 0.35 | % | 8,651 |   | 8 |   | 0.37 | % |
| Time  deposits                                       |       | 677,634                                       |       | 4,618 |   | 2.73 | % | 712,828 |   | 6,080 |   | 3.41 | % |
| Total  interest bearing deposits                     |       | 803,548                                       |       | 4,839 |   | 2.41 | % | 872,462 |   | 6,693 |   | 3.07 | % |
| Federal  Home Loan Bank advances                     |       | 34,000                                        |       | 224 |   | 2.64 | % | 53,701 |   | 388 |   | 2.89 | % |
| Other  borrowings                                    |       | 1,400                                         |       | 42 |   | 12.00 | % | 1,400 |   | 42 |   | 12.00 | % |
| Trust  Preferred Securities                          |       | 10,310                                        |       | 62 |   | 2.41 | % | 10,310 |   | 85 |   | 3.30 | % |
| Total  borrowed funds                                |       | 45,710                                        |       | 328 |   | 2.87 | % | 65,411 |   | 515 |   | 3.15 | % |
| Total  interest-bearing liabilities                  |       | 849,258                                       |       | 5,167 |   | 2.43 | % | 937,873 |   | 7,208 |   | 3.07 | % |
|                                                 |       |                                          |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 52,748                                        |       |   |   |   |   | 54,683 |   |   |   |   |   |
| Other  liabilities                                   |       | 7,161                                         |       |   |   |   |   | 7,926 |   |   |   |   |   |
| Shareholder’s  equity                           |       | 26,560                                        |       |   |   |   |   | 89,478 |   |   |   |   |   |
| Total  liabilities and shareholder’s equity     |       | $                                             | 935,727    |   |   |   |   |   | $ | 1,089,960 |   |   |   |   |   |
| Net  interest revenue (1)                            |       |                                          |       | $ | 3,782 |   |   |   |   |   | $ | 4,494 |   |   |   |
| Net  interest spread (2)                             |       |                                          |       |   |   | 1.84 | % |   |   |   |   | 1.93 | % |
| Net  interest margin (3) (6)                    |       |                                          |       |   |   | 1.82 | % |   |   |   |   | 1.94 | % |

 

----

(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 - $220; 2009 - $355

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

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

 

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Thefollowing table shows the relationship between interest revenue and interestexpense and the average balances of interest-earning assets andinterest-earning liabilities for the six months ended June 30, 2010 and2009.

 

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

 
| ** **                                           | ** ** | **For  the Six Months Ended June 30,** | ** ** |
|------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                           | ** ** | **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) |       | $                                           | 697,908    |   | $ | 17,485 |   | 5.01 | % | $ | 793,493 |   | $ | 22,131 |   | 5.58 | % |
| Investment  securities - taxable (7)                 |       | 90,485                                      |       | 882 |   | 1.95 | % | 96,956 |   | 1,786 |   | 3.68 | % |
| Investment  securities - tax-exempt (6) (7)     |       | 14,037                                      |       | 290 |   | 6.26 | % | 15,938 |   | 323 |   | 6.14 | % |
| Other  interest and dividend income                  |       | 52,587                                      |       | 73 |   | 0.28 | % | 14,748 |   | 9 |   | 0.12 | % |
| Total  earning assets                                |       | 855,017                                     |       | 18,730 |   | 4.42 | % | 921,135 |   | 24,249 |   | 5.30 | % |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest-earning  assets                         |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Allowance  for loan losses                           |       | -21,649                                     |       |   |   |   |   | -11,903 |   |   |   |   |   |
| Cash  and due from banks                             |       | 9,657                                       |       |   |   |   |   | 51,503 |   |   |   |   |   |
| Premises  and equipment                              |       | 30,654                                      |       |   |   |   |   | 31,678 |   |   |   |   |   |
| Accrued  interest receivable                         |       | 4,610                                       |       |   |   |   |   | 6,137 |   |   |   |   |   |
| Other  real estate owned                             |       | 30,601                                      |       |   |   |   |   | 11,603 |   |   |   |   |   |
| Other  assets                                        |       | 30,118                                      |       |   |   |   |   | 43,218 |   |   |   |   |   |
| Total  assets                                        |       | $                                           | 939,008    |   |   |   |   |   | $ | 1,053,371 |   |   |   |   |   |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing liabilities                        |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Interest  bearing demand                             |       | $                                           | 120,480    |   | $ | 461 |   | 0.77 | % | $ | 147,249 |   | $ | 1,204 |   | 1.64 | % |
| Savings                                              |       | 9,127                                       |       | 16 |   | 0.35 | % | 8,384 |   | 15 |   | 0.36 | % |
| Time  deposits                                       |       | 673,851                                     |       | 9,399 |   | 2.79 | % | 684,710 |   | 12,129 |   | 3.54 | % |
| Total  interest bearing deposits                     |       | 803,458                                     |       | 9,876 |   | 2.46 | % | 840,343 |   | 13,348 |   | 3.18 | % |
| Federal  Home Loan Bank advances                     |       | 36,258                                      |       | 457 |   | 2.52 | % | 51,518 |   | 739 |   | 2.87 | % |
| Other  borrowings                                    |       | 1,400                                       |       | 84 |   | 12.00 | % | 1,422 |   | 85 |   | 11.95 | % |
| Trust  Preferred Securities                          |       | 10,310                                      |       | 121 |   | 2.35 | % | 10,310 |   | 186 |   | 3.61 | % |
| Total  borrowed funds                                |       | 47,968                                      |       | 662 |   | 2.76 | % | 63,250 |   | 1,010 |   | 3.19 | % |
| Total  interest-bearing liabilities                  |       | 851,426                                     |       | 10,538 |   | 2.48 | % | 903,593 |   | 14,358 |   | 3.18 | % |
|                                                 |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Non-interest  bearing deposits                       |       | 52,504                                      |       |   |   |   |   | 52,401 |   |   |   |   |   |
| Other  liabilities                                   |       | 7,213                                       |       |   |   |   |   | 7,730 |   |   |   |   |   |
| Shareholder’s  equity                           |       | 27,865                                      |       |   |   |   |   | 89,647 |   |   |   |   |   |
| Total  liabilities and shareholder’s equity     |       | $                                           | 939,008    |   |   |   |   |   | $ | 1,053,371 |   |   |   |   |   |
| Net  interest revenue (1)                            |       |                                        |       | $ | 8,192 |   |   |   |   |   | $ | 9,891 |   |   |   |
| Net  interest spread (2)                             |       |                                        |       |   |   | 1.94 | % |   |   |   |   | 2.12 | % |
| Net  interest margin (3) (6)                    |       |                                        |       |   |   | 1.95 | % |   |   |   |   | 2.19 | % |

 

----

(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 - $497; 2009 - $693

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

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

 

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

 

**Change inInterest Revenue and Expense on a Taxable Equivalent Basis**

 
| ** **                         | ** ** | **Three Months Ended June 30, 2010** | ** ** | **Six Months Ended June 30, 2010** | ** ** |
|------------------------------------|------------|-------------------------------------------|------------|-----------------------------------------|------------|
| ** **                         | ** ** | **Compared to 2009**                      | ** ** | **Compared to 2009**                    | ** ** |
| ** **                         | ** ** | **Changes due to (a)**                    | ** ** | **Changes due to (a)**                  | ** ** |
| ** **                         | ** ** | ** **                                | ** ** | **Yield/**                              | ** ** | **Net** | ** ** | ** ** | ** ** | **Yield/** | ** ** | **Net** | ** ** |
| ** **                         | ** ** | **Volume**                                | ** ** | **Rate**                                | ** ** | **Change** | ** ** | **Volume** | ** ** | **Rate** | ** ** | **Change** | ** ** |
| ** **                         | ** ** | **(Dollars in thousands)**                | ** ** |
| Interest earned on:                |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Loans                              |       | $                                         | (2,676     | )                                       | $          | 279 |   | $ | (2,397 | ) | $ | (5,184 | ) | $ | 538 |   | $ | (4,646 | ) |
| Investment securities:             |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Taxable investment securities      |       | (223                                      | )          | (171                                    | )          | (394 | ) | (441 | ) | (463 | ) | (904 | ) |
| Tax-exempt investment securities   |       | (13                                       | )          | 1                                       |       | (12 | ) | (45 | ) | 12 |   | (33 | ) |
| Interest earning deposits          |       | 37                                        |       | 13                                      |       | 50 |   | 53 |   | 11 |   | 64 |   |
| Total interest income              |       | (2,875                                    | )          | 122                                     |       | (2,753 | ) | (5,617 | ) | 98 |   | (5,519 | ) |
|                               |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest paid on:                  |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Deposits:                          |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Interest bearing demand deposits   |       | (116                                      | )          | (276                                    | )          | (392 | ) | (189 | ) | (554 | ) | (743 | ) |
| Savings                            |       | 1                                         |       | (1                                      | )          | — |   | 2 |   | (1 | ) | 1 |   |
| Time deposits                      |       | (651                                      | )          | (811                                    | )          | (1,462 | ) | (892 | ) | (1,838 | ) | (2,730 | ) |
| Other borrowings and FHLB advances |       | (134                                      | )          | (30                                     | )          | (164 | ) | (201 | ) | (82 | ) | (283 | ) |
| Trust Preferred Securities         |       | —                                    |       | (23                                     | )          | (23 | ) | — |   | (65 | ) | (65 | ) |
| Total interest expense             |       | (900                                      | )          | (1,141                                  | )          | (2,041 | ) | (1,280 | ) | (2,540 | ) | (3,820 | ) |
|                               |       |                                      |       |                                    |       |   |   |   |   |   |   |   |   |
| Decrease in net interest revenue   |       | $                                         | (1,975     | )                                       | $          | 1,263 |   | $ | (712 | ) | $ | (4,337 | ) | $ | 2,638 |   | $ | (1,699 | ) |

 

----

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

 

**Provision for Loan Losses**

 

Theprovision for loan losses for the six months ended June 30, 2010 was $3.3million compared to $6.1 million for the same period of 2009.  The provision for loan losses for the secondquarter of 2010 was $2.0 million compared to $5.7 million for the same periodof 2009.  While there is an increase innonperforming loans and a decrease in loan activity for the three and sixmonths ended June 30, 2010 compared to the three and six months ended June 30,2009, the Company decreased its provision for loan losses based on management’sanalysis of the allowance for loan losses. Net charge-offs as an annualized percentage of average outstanding loansfor the three and six months ended June 30, 2010 were 2.26% and 1.59%, respectively,as compared with 1.16% and 0.71% for the three and six months ended June 30,2009, respectively.  Net loan charge-offsincreased significantly during the three and six months ended June 30,2010, as compared to the three and six months ended June 30, 2009, duemainly to the Company continuing to charge-off nonperforming loan balances totheir net realizable value.

 

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

 

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**Non-interest Income**

 

Compositionof other noninterest income is as follows:

 
| ** **                                     | ** ** | **Six Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts            |       | $                          | 792        |       | $          | 840               |       | $ | (48 | ) | -5.71 | % |
| Other service charges, commissions and fees    |       | 292                        |       | 238        |       | 54                |       | 22.69 | % |
| Gain on sales / calls of investment securities |       | 43                         |       | 1,316      |       | (1,273            | )          | -96.73 | % |
| Mortgage origination income                    |       | 150                        |       | 393        |       | (243              | )          | -61.83 | % |
| Other income                                   |       | 489                        |       | 556        |       | (67               | )          | -12.05 | % |
| Total noninterest income                       |       | $                          | 1,766      |       | $          | 3,343             |       | $ | (1,577 | ) | -47.17 | % |

 
| ** **                                     | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                     | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                     | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                     | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts            |       | $                          | 408        |       | $          | 418               |       | $ | (10 | ) | -2.39 | % |
| Other service charges, commissions and fees    |       | 159                        |       | 126        |       | 33                |       | 26.19 | % |
| Gain on sales / calls of investment securities |       | 43                         |       | 1,095      |       | (1,052            | )          | -96.07 | % |
| Mortgage origination income                    |       | 58                         |       | 187        |       | (129              | )          | -68.98 | % |
| Other income                                   |       | 229                        |       | 255        |       | (26               | )          | -10.20 | % |
| Total noninterest income                       |       | $                          | 897        |       | $          | 2,081             |       | $ | (1,184 | ) | -56.90 | % |

 

Non-interestincome for the three months ended June 30, 2010 decreased $1.2 million, or56.90%, when compared to the three months ended June 30, 2009.  Non-interest income for the six months ended June 30,2010 decreased $1.6 million, or 47.17%, when compared to the six months ended June 30,2009.  Service charges on depositaccounts are evaluated against service charges from other banks in our localmarkets and against the Bank’s own cost structure in providing the depositservices.  This income correlates withthe Bank’s demand deposit account base. During the first six months of 2010, the Bank experienced a decrease inthe number of core transaction deposit accounts.  Total service charges, includingnon-sufficient funds fees, decreased approximately $10 thousand, or 2.43%, and$47 thousand, or 5.65%, for the three and six months ended June 30, 2010,respectively, compared with the same periods in 2009.

 

Thedecrease in the gain on sales/calls of investment securities is primarily dueto the Company recording $1.1 million in gains from the sales of severalmortgage-backed securities during the second quarter of 2009 as compared to $43thousand in gains from the calls of state, county and municipal bond andseveral U.S. government sponsored enterprises securities during the secondquarter of 2010.

 

Thedecrease in mortgage origination income for the three and six months ended June 30,2010 is primarily due to the decrease in the number of mortgage loanclosings.  Approximately 23 mortgage loanclosings occurred during the second quarter of 2010 compared to 74 mortgageloan closings for the same period in 2009. For the six months ended June 20, 2010, there were approximately 35mortgage loan closings that occurred compared to 135 mortgage loan closings forthe six months ended June 30, 2009.

 

Thedecrease in other income for the three and six months ended June 30, 2010,compared to the same periods in 2009 is due to the decrease in commission feesfrom our wealth management department.

 

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**Non-interest Expense**

 

Compositionof other noninterest expense is as follows:

 
| ** **                                       | ** ** | **Six Months Ended**       | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                       | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                   |       | $                          | 4,550      |       | $          | 5,415             |       | $ | (865 | ) | -15.97 | % |
| Occupancy expense                                |       | 883                        |       | 892        |       | (9                | )          | -1.01 | % |
| Equipment rental and depreciation of equipment   |       | 595                        |       | 631        |       | (36               | )          | -5.71 | % |
| Loss on sale of other assets                     |       | 1                          |       | 44         |       | (43               | )          | -97.73 | % |
| Loss on sale and impairment of other real estate |       | 397                        |       | 1,491      |       | (1,094            | )          | -73.37 | % |
| Other real estate expense                        |       | 1,301                      |       | 336        |       | 965               |       | 287.20 | % |
| FDIC and state banking assessments               |       | 2,328                      |       | 1,155      |       | 1,173             |       | 101.56 | % |
| Goodwill impairment                              |       | —                     |       | 19,533     |       | (19,533           | )          | -100.00 | % |
| Other expenses                                   |       | 2,238                      |       | 3,052      |       | (814              | )          | -26.67 | % |
| Total noninterest expense                        |       | $                          | 12,293     |       | $          | 32,549            |       | $ | (20,256 | ) | -62.23 | % |

 
| ** **                                       | ** ** | **Three Months Ended**     | ** ** | ** ** | ** ** | ** **        | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------|------------|
| ** **                                       | ** ** | **June 30,**          | ** ** | ** ** | ** ** | ** **        | ** ** |
| ** **                                       | ** ** | **2010**                   | ** ** | **2009**   | ** ** | **$ Change** | ** ** | **% Change** | ** ** |
| ** **                                       | ** ** | **(Dollars in Thousands)** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                   |       | $                          | 2,223      |       | $          | 2,639             |       | $ | (416 | ) | -15.76 | % |
| Occupancy expense                                |       | 445                        |       | 437        |       | 8                 |       | 1.83 | % |
| Equipment rental and depreciation of equipment   |       | 298                        |       | 326        |       | (28               | )          | -8.59 | % |
| Loss on sale of other assets                     |       | 1                          |       | 6          |       | (5                | )          | -83.33 | % |
| Loss on sale and impairment of other real estate |       | 295                        |       | 1,466      |       | (1,171            | )          | -79.88 | % |
| Other real estate expense                        |       | 828                        |       | 211        |       | 617               |       | 292.42 | % |
| FDIC and state banking assessments               |       | 1,417                      |       | 958        |       | 459               |       | 47.91 | % |
| Goodwill impairment                              |       | —                     |       | 19,533     |       | (19,533           | )          | -100.00 | % |
| Other expenses                                   |       | 1,176                      |       | 1,658      |       | (482              | )          | -29.07 | % |
| Total noninterest expense                        |       | $                          | 6,683      |       | $          | 27,234            |       | $ | (20,551 | ) | -75.46 | % |

 

Non-interestexpense for the three and six months ended June 30, 2010 decreased $20.6million, or 75.46%, and $20.3 million, or 62.23%, respectively, when comparedto the three and six months ended June 30, 2009.  This decrease is primarily due to the Companyrecording a $19.5 million charge for goodwill impairment during the secondquarter of 2009.

 

Thedecrease in the loss on the sale and impairment of other real estate owned forthe three and six months ended June 30, 2010 is attributed to the Companyrecording a loss on one particular foreclosed property totaling to $1.3 millionduring the second quarter of 2009.  Theincrease in other real estate expenses is attributed to the number of otherreal estate properties that the Company owns. At June 30, 2010, the Company had a total of 92 properties comparedto 37 properties at June 30, 2009.

 

Theincrease in the FDIC and state banking assessments for the three and six monthsended June 30, 2010 is attributable to our risk classification with theFDIC.  Since entering into the Order withthe FDIC, the Company has had higher quarterly assessments due to our riskclassification.

 

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Thedecrease in salaries and employee benefits for the three and six months ended June 30,2010 compared to the same period in 2009 is primarily due to no accrual ofbonuses, a decrease in the expense relating to the salary continuation planbased upon changes with the plan, the utilization of a bank officer one day perquarter furlough, and a small reduction in staff.  At June 30, 2010, the number offull-time equivalent employees was 161 employees compared to 167 employees at June 30,2009.

 

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

 

**Income Tax Expense**

 

TheCompany recorded a valuation allowance for the balance of the recorded deferredtax asset as of December 31, 2009; however, an income tax benefit was notrecognized for the three and six months ended June 30, 2010 since it ismore likely than not that the deferred tax asset will not be realized.  With respect to the Company’s cumulativelosses as of June 30, 2010, we have determined that it is more likely thannot that any income tax benefit that would have been recorded would not berealized.  For the three and six monthsended June 30, 2009, income tax benefit of $2.6 million and $2.3 millionwas recognized with an effective tax rate of 9.84% and 9.23%,respectively.  The effective tax rate forthe three and six months ended June 30, 2009 was lower than the statutorytax rates primarily due to the tax-free income from certain investmentsecurities and loans that are exempt from income taxes and tax credits receivedfrom affordable housing investments and the goodwill impairment charge.  The majority of the goodwill from the twoacquisitions in 2006 and 2007 was treated as tax-free exchanges, which was notrecognized for tax reporting purposes and therefore no tax deduction wasallowed for the impairment charge. Likewise, no tax benefit for the goodwill was recognized in thefinancial statements relating to the $19.5 million charge.

 

**Liquidity**

 

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

 

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

 

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

 

TheCompany also has the ability, on a short-term basis, to purchase up to $11million in federal funds from other financial institutions. At June 30,2010, the Company had no federal funds purchased. At June 30, 2010, we donot have any further borrowing capacity with the Federal Home Loan Bank with$34.0 million in outstanding advances. The Company has a total available line of $18.7 million, subject toavailable collateral, from the Federal Reserve Bank (FRB).  The Company had no advances on the FRB lineat June 30, 2010.

 

TheBank’s liquidity policy requires that the ratio of cash and certain short-terminvestments to net withdrawable deposit accounts be at least 10%. The Bank’sliquidity ratios at June 30, 2010 and 2009 were 18.61% and 26.06%,respectively.

 

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

 

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**Capital Resources**

 

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

 

Quantitativemeasures established by regulations to ensure capital adequacy require us tomaintain minimum amounts and ratios (set forth below in the table) of total andTier I capital (as defined in the regulations) to risk-weighted assets (asdefined in the regulations), and of Tier I capital (as defined in theregulations) to average assets (as defined in the regulations).  Pursuant to the Order, Tier 1 Capital mustequal or exceed 8.00% of the Bank’s total assets and the Bank’s TotalRisk-based Capital must equal or exceed 10.00% of the Bank’s totalrisk-weighted assets, within 90 days of the effective date of the Order.  At June 30, 2010, the Bank was not incompliance with the Order, with Tier 1 capital to average assets at 3.27% andtotal risk-based capital to risk-weighted assets at 5.83%.  As a result of our regulatory capital ratios,we are considered “significantly undercapitalized” by our bank regulatoryauthorities as of June 30, 2010.  Asa result of our significantly-undercapitalized status, on March 26, 2010,the Bank received a Notification of Prompt Corrective Action, which notifiedthe Bank that it is subject to greater regulatory monitoring and certainadditional discretionary safeguards may be imposed by regulatory authorities,which may have a direct material effect on our financial statements.

 

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

 

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

 
| ** **                                         | ** ** | ** ** | ** ** | ** **             | ** ** | ** **             | ** ** | **To Be  Well Capitalized**  | ** ** |
|----------------------------------------------------|------------|------------|------------|------------------------|------------|------------------------|------------|------------------------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | ** **             | ** ** | **For  Capital**       | ** ** | **Under  Prompt Corrective** | ** ** |
| ** **                                         | ** ** | **Actual** | ** ** | **Adequacy  Purposes** | ** ** | **Action  Provisions** | ** ** |
| ** **                                         | ** ** | **Amount** | ** ** | **Ratio**              | ** ** | **Amount**             | ** ** | ** **                   | ** ** | **Ratio** | ** ** | **Amount** | ** ** | ** ** | ** ** | **Ratio** | ** ** |
| ***June 30, 2010***                           |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Total  Risk-Based Capital To Risk Weighted Assets: |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 41,275,000 |                   | 5.90       | %                      | $          | 55,966,102                   |       |  >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 40,795,000 |       | 5.83                   | %          | 55,979,417             |       |  >              |       | 8.0 | % | 69,974,271 |   |  >  |   | 10.0 | % |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Tier  I Capital To Risk Weighted Assets:           |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 28,788,000 |                   | 4.11       | %                      | $          | 28,017,518                   |       |  >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 30,522,000 |       | 4.36                   | %          | 28,001,835             |       |  >              |       | 4.0 | % | 42,002,752 |   |  >  |   | 6.0 | % |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Tier  I Capital To Average Assets                  |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 28,788,000 |                   | 3.08       | %                      | $          | 37,387,013                   |       |  >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 30,522,000 |       | 3.27                   | %          | 37,335,780             |       |  >              |       | 4.0 | % | 46,669,725 |   |  >  |   | 5.0 | % |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| ***December 31, 2009***                       |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Total  Risk-Based Capital To Risk Weighted Assets: |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 47,485,000 |                   | 6.28       | %                      | $          | 60,490,446                   |       |  >  |   | 8.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 46,763,000 |       | 6.19                   | %          | 60,436,834             |       |  >              |       | 8.0 | % | 75,546,042 |   |  >  |   | 10.0 | % |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Tier  I Capital To Risk Weighted Assets:           |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 36,490,000 |                   | 4.83       | %                      | $          | 30,219,462                   |       |  >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 35,771,000 |       | 4.73                   | %          | 30,250,317             |       |  >              |       | 4.0 | % | 45,375,476 |   |  >  |   | 6.0 | % |
|                                               |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Tier  I Capital To Average Assets                  |       |       |       |                   |       |                   |       |                         |       |   |   |   |   |   |   |   |   |
| Consolidated                                       |       | $          | 36,490,000 |                   | 3.44       | %                      | $          | 42,430,233                   |       |  >  |   | 4.0 | % | N/A |   |   |   | N/A |   |
| Bank                                               |       | 35,771,000 |       | 3.37                   | %          | 42,458,160             |       |  >              |       | 4.0 | % | 53,072,700 |   |  >  |   | 5.0 | % |

 

We had outstanding junior subordinated debentures commonly referred toas Trust Preferred Securities totaling $10.3 million at June 30, 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 June 30, 2010 and December 31,2009, all of the Trust Preferred Securities qualify as a Tier I capital.  We had outstanding subordinated debenturestotaling $1.4 million at June 30, 2010 and December 31, 2009.  The subordinated debentures qualify as a TierII capital under risk-based capital guidelines. At June 30, 2010 and December 31, 2009, all of thesubordinated debentures qualify as a Tier II capital.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item 3. Quantitative and Qualitative Disclosures about Market Risk**

**For theSix Months Ended June 30, 2010**

 

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

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Item4T. Controls and Procedures**

**For the Six Months EndedJune 30, 2010**

 

The Company’s management, including the ChiefExecutive Officer and Chief Financial Officer, supervised and participated inan evaluation of the effectiveness of its disclosure controls and procedures(as defined in federal securities rules) as of the end of the period covered bythis report.  Based on, and as of thedate of, that evaluation, the Company’s Chief Executive Officer and ChiefFinancial Officer have concluded that the Company’s disclosure controls andprocedures were effective in accumulating and communicating information tomanagement, including the Chief Executive Officer and Chief Financial Officer,as appropriate, to allow timely decisions regarding required disclosures ofthat information under the Securities and Exchange Commission’s rules andforms.  The Company’s disclosure controlsand procedures are designed to ensure that the information required to bedisclosed in reports that are filed or submitted by the Company pursuant to theSecurities Exchange Act of 1934, as amended, is recorded, processed, summarizedand reported within the time periods specified in the Securities and ExchangeCommission’s rules and forms.

 

During the second quarter of2010, there were no significant changes in the Company’s internal control overfinancial reporting or, to the Company’s knowledge, in other factors that couldsignificantly affect those internal controls subsequent to the date the Companycarried out its evaluation that have materially affected, or are reasonablylikely to materially affect, the Company’s internal control over financialreporting.  However, the design of anysystem of controls and procedures is based in part upon certain assumptionsabout the likelihood of future events. There can be no assurance that any design will succeed in achieving itsstated goals under all potential future conditions, regardless of how remote.

 

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**ATLANTICSOUTHERN FINANCIAL GROUP, INC.**

**Part II. Other Information**

**For the Six Months EndedJune 30, 2010**

 

 

PART II: OTHERINFORMATION:

 

Item 1. Legal Proceedings

 

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

 

Item 1A. Risk Factors

 

In addition to the other information set forth in this report, youshould carefully consider the factors discussed below and in Part I, “Item 1A.Risk Factors” in our Annual Report on Form 10-K for the year ended December 31,2009, which could materially affect our business, financial condition or futureresults. The risks described below and in our Annual Report on Form 10-K arenot the only risks facing us. Additional risks and uncertainties not currentlyknown to us or that we currently deem to be immaterial also may materiallyadversely affect our business, financial condition and/or operating results.

 

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

 

The Bank is currently categorizedas “significantly undercapitalized” and, pursuant to the prompt correctiveaction provisions of the Federal Deposit Insurance Act and the promptcorrective action regulations of the FDIC promulgated thereunder (collectively,the “PCA Provisions”), the Bank  receivedNotification of Prompt Corrective Action from the FDIC on March 26, 2010, whichrequired that the Bank file a capital restoration plan within 45 days ofreceiving the Notification.  In addition,because of the Bank’s “significantly-undercapitalized” status, the Bank isautomatically subject to, among other things, restrictions on dividends,management fees, and asset growth, and is prohibited from opening new branches,making acquisitions or engaging in new lines of business without the approvalof the FDIC.

 

Significantlyundercapitalized depository institutions may also be subject to any of thefollowing requirements and restrictions, including: (i) selling sufficientvoting stock to become adequately capitalized; (ii) directing the Bank to mergeor be acquired: (iii) limiting certain affiliate transactions; (iv) restrictinginterest rates paid on deposits; (v) restricting asset growth or reducing totalassets, (vi) altering or eliminating any activities that pose excessive risk tothe Bank; (vii) improving management through an election of a new board ofdirectors, dismissals, or the hiring of new executives, (viii) ceasing theacceptance of deposits from correspondent banks, (ix) divesting the holdingcompany; and (x) performing any other appropriate action.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

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

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

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

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

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

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

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

 

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

 

Item 2. Unregistered Sales of Equity Securitiesand Use of Proceeds

 

None

 

Item 3. Defaults Upon Senior Securities

 

Not Applicable

 

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Item 4. Reserved

 

Item 5. Other Information

 

None

 

Item 6. Exhibits

 

(a)                                  Exhibits:

 

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

 

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

 

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

 

**SIGNATURES**

 

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

 

**ATLANTIC SOUTHERN FINANCIAL GROUP, INC.**

 

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

 

 

Date: July 23, 2010

 

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