----

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549________________________
FORM10-K

(Mark One)

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 or 15(D) OF THE SECURITIESEXCHANGE              ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31,2007

[  ]       Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission file number 0-11709________________________
First CitizensBancshares, Inc.(Exact name of registrant as specified in its charter)
**Tennessee**62-1180360
(State or other jurisdiction of
(IRS Employer Identification No.)
incorporation or organization) **One FirstCitizens PlaceDyersburg, Tennessee 38024(Address of principal executive offices including zip code) **(731) 285-4410(Registrant's telephone number, including area code)**________________________
Securities registered pursuant to Section 12(b) of the Act:Title of each class    NoneName of Each Exchange on Which Registered****N/A
**Securities registered pursuant to Section 12(g) of the Act:Common Stock(Title of class)**________________________**
Indicate by check mark if theregistrant is a well-known seasoned issuer, as defined in Rule 405 of theSecurities Act. Yes [ ]   No [ x ]

Indicate by check mark if theregistrant is not required to file reports pursuant to Section 13 or Section15(d) of the Act.  Yes [ ]  No [x]

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

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 RegulationS-K (Section 229.40) is not contained herein, and will not be contained, to the best of registrant's knowledge, indefinitive proxy or information statements incorporated by reference in Part IIIof this Form 10-K or any amendment to this Form 10-K.  [x]

Indicateby check mark whether the registrant is a large accelerated filer, an acceleratedfiler or a non-accelerated filer.  See definition of "accelerated filer and large acceleratedfiler" in Rule 12b-2 of the Exchange Act (Check One):                                        Large accelerated filer [ ]     Accelerated filer[x]    Non-accelerated filer [ ]

Indicateby check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Act).  Yes [ ]  No [x]

**________________________**
The aggregate market value ofvoting and non-voting common stock held by non-affiliates of the registrant on June 30, 2008 wasapproximately$82,824,918.

As ofFebruary 13, 2009, the registrant had 3,624,500 outstanding shares of commonstock.

**________________________**

**DOCUMENTSINCORPORATED BYREFERENCE:**

Certain information called for by Part III of Form10-K is incorporated by reference to the Proxy Statement for our 2009 AnnualMeeting of Shareholders to be filed with the Commission within 120 days afterDecember 31, 2008.
ITEM 1.  BUSINESS.
**General**

First Citizens Bancshares, Inc. (the "Company") is a financial holdingcompany incorporated in Tennessee in 1982. Through its principal banksubsidiary, First Citizens National Bank (the "Bank"), the Company conductscommercial banking and financial services operations primarily in West Tennessee. At December 31, 2008, the Company and its subsidiaries had total assets ofapproximately $927 million and total deposits of approximately $735 million.The Company's principal executive offices are located at One First CitizensPlace, Dyersburg, Tennessee 38024 and its telephone number is (731) 285-4410.

The Company,headquartered in Dyersburg, Tennessee, is the holding company for the Bank andFirst Citizens (TN) Statutory Trusts III and IV.  These trusts hold theCompany's trust preferred debt and are not consolidated but are accounted forunder the equity method in accordance with generally accepted accountingprinciples.

The Bank is adiversified financial service institution that provides banking and otherfinancial services to its customers. The Bank provides customary bankingservices, such as checking and savings accounts, fund transfers, various typesof time deposits, safe deposit facilities, financing of commercial transactionsand making and servicing both secured and unsecured loans to individuals, firmsand corporations. The Bank is the only community bank in Tennessee recognizedas a Preferred Lender for Farm Service Agency.  The Bank's agriculturalservices include operating loans as well as financing for the purchase ofequipment and farmland. The Bank's consumer lending department makes directloans to individuals for personal, automobile, real estate, home improvement,business and collateral needs. The Bank typically sells long-term residentialmortgages that it originates to the secondary market without retainingservicing rights. The Bank's commercial lending operations include varioustypes of credit services for customers.

The Bank has thefollowing subsidiaries:
-  First Citizens Financial Plus, Inc., a bank service corporationwholly owned by the Bank, provides licensed brokerage services that allow theBank to compete on a limited basis with numerous non-bank entities that providesuch services to the Company's customer base.  The brokerage firm operatesthree locations in West Tennessee. 
-  White and Associates/First Citizens Insurance, LLC was charteredby the State of Tennessee and is a general insurance agency offering a fullline of insurance products including casualty, life and health, and cropinsurance.  The Bank holds a 50% ownership in the company, which is accountedfor using the equity method.  The insurance agency operates nine offices in Northwest Tennessee.    
-  First Citizens/White and Associates Insurance Company, isorganized and existing under the laws of the state of Arizona.  Its principalactivity is credit insurance.  The Bank holds a 50% ownership in the company,which is accounted for using the equity method.
-  First Citizens Investments, Inc. was organized and exists underlaws of the state of Nevada.  The principal activity of this entity is toacquire and sell investment securities as well as collect income from theportfolio.  First Citizens Investments, Inc. owns the following subsidiary: 
-  First Citizens Holdings, Inc., a wholly owned subsidiary of FirstCitizens Investments, Inc., acquires and sells certain investment securities,collects income from its portfolio, and owns the following subsidiary:
-  First Citizens Properties, Inc. is a real estate investment trustwhose principal activity is to invest in participation interests of real estateloans made by the Bank and provide the Bank with an alternative vehicle forraising capital.  First Citizens Holdings**,** Inc. owns 100% of theoutstanding common stock and 98% of the outstanding preferred stock of FirstCitizens Properties, Inc., while directors, executive officers and certainemployees own the remaining 2% of such preferred stock.  The minority interestis not material to the consolidated financial statements of the Company. 

The followingtable sets forth a comparative analysis of key metrics of the Company as ofDecember 31, for the years indicated (in thousands):

2008

2007

2006

Total Assets

 $

927,502 

 $

876,156 

 $

831,420 

Total Deposits

734,915 

690,595 

666,063 

Total Net Loans

589,458 

578,311 

542,623 

Total Equity Capital

77,008 

75,031 

69,498 

The table belowprovides a comparison of the Company's performance to industry standardsthrough utilization of information provided by the Federal Reserve.   TheCompany is grouped with peers with assets totaling $500 million to $1 billionin this analysis. The Company's peer group consisted of 421 bank holdingcompanies in connection with the September 30, 2008 Bank Holding CompanyPerformance Report, which is the most recent report available as of the date ofthis Annual Report on Form 10-K. The following table presents comparisons ofthe Company with its peers as indicated in Bank Holding Company PerformanceReports for the periods indicated:

Year Ended  December 31, 2008

Year Ended  December 31, 2007

Year Ended  December 31, 2006

COMPANY

PEER*

COMPANY

PEER 

COMPANY

PEER

Net Interest Income/Average Assets

3.42%

3.42%

3.36%

3.61%

3.60%

3.74%

Net Operating Income/Average Assets

0.83%

0.54%

1.08%

0.96%

1.10%

1.01%

Net Loan Losses/ Average Total Loans

0.31%

0.35%

0.13%

0.13%

0.23%

0.11%

Primary Capital/Average Assets 

8.10%

8.82%

8.55%

9.32%

8.11%

9.27%

Cash Dividends/Net Income

55.85%

36.84%

45.93%

30.82%

46.04%

29.09%

________________

* Peer information is provided for the nine months endedSeptember 30, 2008, which is the most recent information available.

The Company andthe Bank employed a total of 263 full-time equivalent employees as of December31, 2008.  The Company and the Bank are committed to hiring and retaining highquality employees to execute strategic plans of the Company.

The Company's Internet website address is www.firstcitizens-bank.com. TheCompany makes its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q,Current Reports on Form 8-K and all amendments to those reports available freeof charge by link on its website on the "About Us - Investor Relations" webpageunder the caption "SEC Filings" as soon as reasonably practicable after suchmaterial is electronically filed with, or furnished to, the Securities andExchange Commission (the "SEC"). Shareholders may request a copy of the annual,quarterly or current reports without charge by contacting Judy Long, Secretary,First Citizens Bancshares, Inc., P. O. Box 370, Dyersburg, Tennessee 38025-0370.

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**Expansion**

The Company,through its strategic planning process, intends to seek profitableopportunities that utilize excess capital and maximize income in Tennessee.  If the Company decides to acquire other banking institutions, its objectivewould be for asset growth and diversification into other market areas.Acquisitions and de novo branches might afford the Company increased economiesof scale within the operation functions and better utilization of humanresources. The Company would only pursue an acquisition or de novo branch ifthe board of directors determine it to be in the best interest of the Companyand its shareholders.  The Company does not currently have any plans to acquireother banking institutions.

In 2007, theCompany expanded by opening loan production offices in Jackson and Franklin, Tennessee.  In July 2008, the Franklin office was relocated and opened as a fullservice branch.

**Competition**

The business ofproviding financial services is highly competitive. In addition to competingwith other commercial banks in the Bank's service area, the Bank competes withsavings and loan associations, insurance companies, savings banks, small loancompanies, finance companies, mortgage companies, real estate investmenttrusts, certain governmental agencies, credit card organizations, credit unionsand other enterprises.  In 1998, federal legislation allowed credit unions toexpand their membership criterion.  Expanded membership criterion coupled withan existing tax-exempt status give credit unions a competitive advantagecompared to banks.    

The Bank buildsand implements strategic plans and commitments to address competitive factorsin the various markets it serves.  The Bank's primary strategic focus is onobtaining and maintaining profitable customer relationships in all markets. The markets demand competitive pricing, but the Bank competes on high qualitycustomer service that will attract and enhance loyal, profitable customers tothe Bank.  Industry surveys have consistently revealed that 65-70% of customersleave banks due to customer service issues.  Accordingly, the Bank is committedto excellent customer service in all markets that it serves as a means ofbranding and distinguishing itself from other financial institutions.  The Bankutilizes advertising, including both newspaper and radio, and promotional activitiesto support its defined strategic plans.  

In the marketsit serves, the Bank offers a typical mix of interest-bearing transaction,savings and time deposit products as well as traditional non-interest bearingdeposit accounts.  The Bank is a leader in deposit market share compared tocompetitors in the Dyer, Fayette, Lauderdale, Obion, Tipton and Weakley County, Tennessee markets.

The Bank hasconsistently been a leader in market share of deposits in its markets forseveral years.  The Bank's market share has been 19% to 20% in Dyer, Fayette,Lauderdale, Obion, Tipton and Weakley Counties in Tennessee combined and inexcess of 62% in Dyer County for the last three years.  The following marketshare information for these counties in Tennessee (banks only, deposits insideof market) is from the Deposit Market Share Report, as of June 30, 2008,prepared annually by the FDIC:

Bank  Name

# of Offices

Total Deposits (in thousands)

% of Market Share

First Citizens National  Bank

15

 $

569,939 

18.69%

First State Bank

14

679,570 

22.29

Regions Bank

9

255,574 

8.38

Bank of Fayette County

6

181,277 

5.95

Somerville Bank & Trust  Co.

5

170,340 

5.59

BancorpSouth Bank

6

145,640 

4.78

Bank of Ripley

4

141,152 

4.63

Commercial Bank & Trust

2

114,762 

3.76

INSOUTH Bank

2

94,374 

3.10

Reelfoot Bank

6

94,259 

3.09

Oakland Deposit Bank

3

86,968 

2.85

Security Bank

6

82,875 

2.72

First South Bank

2

66,080 

2.17

Bank of Gleason

1

55,695 

1.83

Bank of Halls

2

45,826 

1.50

All others

17

264,669 

8.69

      Total

100

 $

3,049,000 

100.00%

The Bank beganoffering full service branch operations in Williamson County in July 2008. Therefore, market share data discussed above excludes the Franklin and Williamson County markets. The Bank also competes in the Shelby County market.  Because thesize and composition of the Shelby County market is much larger and morediverse than the other markets in which the Bank operates, Shelby County is excluded from the above table. The Bank's market share in Shelby County was 0.72% and 0.46% in 2008 and 2007, respectively.

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**Regulation and Supervision**

The Company is aone-bank financial holding company under the Bank Holding Company Act of 1956,as amended, and is subject to supervision and examination by the Board ofGovernors of the Federal Reserve. As a financial holding company, the Companyis required to file with the Federal Reserve annual reports and otherinformation regarding its business obligations and those of its subsidiaries. Federal Reserve approval must be obtained before the Company may:
-  Acquire ownership or control of any voting securities of a bankor bank holding company where the acquisition results in the bank holdingcompany owning or controlling more than 5% of a class of voting securities ofthat bank or bank holding company; or 
-  Acquire substantially all assets of a bank or bank holdingcompany or merge with another bank holding company.

Federal Reserveapproval is not required for a bank subsidiary of a bank holding company tomerge with or acquire substantially all assets of another bank if priorapproval of a federal supervisory agency, such as the Comptroller of theCurrency is required under the Bank Merger Act.  Relocation of a subsidiarybank of a bank holding company from one state to another requires priorapproval of the Federal Reserve and is subject to the prohibitions of theDouglas Amendment.

The Bank HoldingCompany Act provides that the Federal Reserve shall not approve anyacquisition, merger or consolidation that would result in a monopoly or wouldbe in furtherance of any combination or conspiracy to monopolize or attempt tomonopolize the business of banking in any part of the United States.  Further, the Federal Reserve may not approve any other proposedacquisition, merger, or consolidation, the effect of which might be tosubstantially lessen competition or tend to create a monopoly in any section ofthe country, or which in any manner would be in restraint of trade, unless theanti-competitive effect of the proposed transaction is clearly outweighed in favorof public interest by the probable effect of the transaction in meetingconvenience and needs of the community to be served. Further, an applicationmay be denied if the applicant has failed to provide the Federal Reserve withadequate assurances that it will make available such information on itsoperations and activities, and the operations and activities of any affiliate,deemed appropriate to determine and enforce compliance with the Bank HoldingCompany Act and any other applicable federal banking statutes and regulations. In addition, consideration is given to the competence, experience and integrityof the officers, directors and principal shareholders of the applicant and anysubsidiaries as well as the banks and bank holding companies concerned.  TheFederal Reserve also considers the record of the applicant and its affiliatesin fulfilling commitments to conditions imposed by the Federal Reserve inconnection with prior applications.

A bank holdingcompany is prohibited with limited exceptions from engaging directly orindirectly through its subsidiaries in activities unrelated to banking ormanaging or controlling banks. One exception to this limitation permitsownership of a company engaged solely in furnishing services to banks; anotherpermits ownership of shares of the company, all of the activities of which theFederal Reserve has determined after due notice and opportunity for hearing, tobe so closely related to banking or managing or controlling banks, as to be aproper incident thereto. Moreover, a financial holding company and itssubsidiaries are prohibited from engaging in certain "tie-in" arrangements inconnection with any extension of credit or provision of any property orservice. Subsidiary banks of a financial holding company are subject to certainrestrictions imposed by the Federal Reserve Act on any extension of credit tothe financial holding company or to any of its other subsidiaries, orinvestments in the stock or other securities thereof, and on the taking of suchstock for securities as collateral for loans to any borrower.

Financialholding companies are required to file an annual report of their operationswith the Federal Reserve, and they and their subsidiaries are subject toexamination by the Federal Reserve. 

*Usury, State Legislation andEconomic Environment*

Tennessee usury laws limit the rate of interest that may be charged by banks. Certainfederal laws provide for preemption of state usury laws. 

Tennessee usury laws permit interest at an annual rate of four percentage points above theaverage prime loan rate for the most recent week for which such an average ratehas been published by the Board of Governors of the Federal Reserve, or 24%,whichever is less. The "Most Favored Lender Doctrine" permits national banks tocharge the highest rate permitted by any state lender.

Specific usurylaws may apply to certain categories of loans, such as the limitation placed oninterest rates on single pay loans of $1,000.00 or less with a term of one yearor less.  Rates charged on installment loans, including credit cards as well asother types of loans, may be governed by the Industrial Loan and ThriftCompanies Act.

*Gramm-Leach-Bliley Act*

TheGramm-Leach-Bliley Financial Modernization Act of 1999 ("GLBA") permits bankholding companies meeting certain management, capital and communityreinvestment act standards to engage in a substantially broader range ofnon-banking activities than permitted previously, including insuranceunderwriting and merchant banking activities.  GLBA repeals sections 20 and 32of the Glass Steagall Act, permitting affiliations of banks with securitiesfirms and registered investment companies. GLBA authorizes financial holdingcompanies, permitting banks to be owned by security firms, insurance companiesand merchant banking companies and vice-versa. Some of these affiliations arealso permissible for bank subsidiaries. GLBA gives the Federal Reserve Boardauthority to regulate financial holding companies, but provides for functionalregulation of subsidiary activities.

GLBA alsomodifies financial privacy and community reinvestment laws. The new financialprivacy provisions generally prohibit financial institutions such as the Bankfrom disclosing non-public personal financial information to third partiesunless customers have the opportunity to opt out of the disclosure.  GLBA alsomagnifies the consequences of a bank receiving less than a satisfactoryCommunity Reinvestment Act ("CRA") rating, by freezing new activities until theinstitution achieves a better CRA rating.

*Bank Secrecy Act*

Over the past 30plus years, Congress has passed several laws impacting a financialinstitution's responsibilities relating to the Bank Secrecy Act.  In 2005, theFederal Financial Institutions Examination Council ("FFIEC") and the federalbanking agencies released the interagency "Bank Secrecy Act Anti-MoneyLaundering Examination Manual." The manual emphasizes a banking organization'sresponsibility to establish and implement risk-based policies, procedures andprocesses to comply with the Bank Secrecy Act and safeguard its operations frommoney laundering and terrorist financing. It is a compilation of existingregulatory requirements, supervisory expectations and sound practices for BankSecrecy Act/Anti-Money Laundering ("BSA/AML") compliance. An effective BSA/AMLcompliance program requires sound risk management; therefore, the manual alsoprovides guidance on identifying and controlling risk associated with moneylaundering and terrorist financing.  The development of this manual was acollaborative effort of the federal banking agencies and the Financial CrimesEnforcement Network, a bureau of the Department of the Treasury, to ensureconsistency in the application of the BSA/AML requirements and consistentexaminations of banking organizations.  

The specificexamination procedures performed will depend on the BSA/AML risk profile of thebanking organization, the quality and quantity of independent testing, thefinancial institution's history of BSA/AML compliance and other relevantfactors.   The Bank has implemented effective risk-based policies andprocedures that reinforce existing practices and encourage a vigilantdetermination to prevent the institution from becoming associated withcriminals or being used as a channel for money laundering or terroristfinancing activities.

*USA Patriot Act*

The USA PatriotAct (the "Patriot Act") enhances the powers of the federal government and lawenforcement organizations to combat terrorism, organized crime and moneylaundering.  The Patriot Act significantly amended and expanded the applicationof the Bank Secrecy Act, including enhanced customer identity measures, newsuspicious activity reporting rules and enhanced anti-money launderingprograms. Under the Patriot Act, each financial institution is required toestablish and maintain anti-money laundering programs, which include, at aminimum, the development of internal policies, procedures, and controls; thedesignation of a compliance officer; an ongoing employee training program; andan independent audit function to test programs.  In addition, the Patriot Actrequires the federal banking agencies to consider the record of a bank orbanking holding company in combating money laundering activities in their evaluationof bank and bank holding company merger or acquisition transactions. The Bankhas implemented policies and procedures in compliance with stated regulationsof the Patriot Act.

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*FederalDeposit Insurance Reform Act of 2005*

The FederalDeposit Insurance Reform Act of 2005 ("FDIRA") was passed in 2006, as part ofthe Deficit Reduction Act of 2005.  The primary components of FDIRA are asfollows:  merges the Bank Insurance Savings Fund and the Saving AssociationInsurance Fund into a new Deposit Insurance Fund; raises coverage on retirementaccounts to $250,000; establishes indexing insurance levels for inflation; capsthe fund; sets up a system of dividends; gives banks credit for past paymentsto the fund; and provides for flexibility if the fund should ever facefinancial difficulty.  The FDIC was required to implement most of theprovisions of FDIRA by November 5, 2006.  

*FDIC Insurance CoverageAmended in 2008*

Beginning withthe Emergency Economic Stabilization Act of 2008, several changes have beenmade to federal deposit insurance coverage with regard to the types of accountscovered and coverage limits.  Included in these changes, basic FDIC coverageper depositor temporarily increased to $250,000 effective through December 31,2009 and rules on revocable trusts were amended to remove qualificationrequirements and allow $250,000 coverage per beneficiary. Two separateinsurance components were created under the FDIC Temporary Liquidity GuaranteeProgram: (i) the Debt Guarantee Program; and (ii) the Transaction AccountGuarantee Program ("TAGP").  The Bank opted to participate only in the TAGPcomponent, under which certain non-interest-bearing transaction accountbalances are temporarily fully guaranteed through December 31, 2009.  TheBank's FDIC insurance premium assessments will be affected based onparticipation in TAGP and also as a result of assessment increases required toreplenish the FDIC insurance fund following the failure of numerous financialinstitutions in 2008 and 2009. 

In October 2008,the FDIC proposed a rule to alter the way in which it differentiates for riskin the risk-based assessment system and to revise deposit insurance assessmentrates, including base assessment rates.  The FDIC also proposed to introducethree adjustments that could be made to an institution's initial baseassessment rate, including (i) a potential decrease of up to two basis pointsfor long-term unsecured debt, including senior and subordinated debt, (ii) apotential increase for secured liabilities in excess of 15% of domesticdeposits and (iii) for certain institutions, a potential increase for brokereddeposits in excess of 10% of domestic deposits. In addition, the FDIC proposedraising the current rates uniformly by 7 basis points for the assessment forthe first quarter of 2009. The proposal for first quarter 2009 assessment rateswas adopted as a final rule in December 2008. On February 27, 2009, the FDICproposed an interim rule that would impose a one-time special assessment of 20basis points on all institutions on June 30, payable on September 30. Theinterim rule would also allow the FDIC to impose additional special assessmentsof 10 basis points on a quarterly basis. The proposal also increases quarterlyassessments by another two basis points beginning in second quarter 2009.

*Customer Information Securityand Customer Financial Privacy*

The Board ofGovernors of the Federal Reserve System published guidelines for CustomerInformation Security and Customer Financial Privacy with a mandatory effectivedate of July 1, 2001.  The Bank has established policies in adherence to thepublished guidelines.  

The threeprincipal requirements relating to the Privacy of Consumer FinancialInformation in GLBA are as follows:
-  Financial institutions must provide customers with noticesdescribing their privacy policies and practices, including policies withrespect to disclosure of nonpublic personal information to affiliates and tononaffiliated third parties. Notices must be provided at the time the customerrelationship is established and annually thereafter; 
-  Subject to specified exceptions, financial institutions may notdisclose nonpublic personal information about consumers to any nonaffiliatedthird party unless consumers are given a reasonable opportunity to direct thatsuch information not be shared (to "opt out"); and 
-  Financial  institutions generally may not disclose customer account numbers to any  nonaffiliated third party for marketing purposes.

The Customer Information Security guidelines implement section 501(b) of GLBA,which requires the agencies to establish standards for financial institutionsrelating to administrative, technical and physical safeguards for customerrecords and information. The guidelines require financial institutions toestablish an information security program to: identify and assess the risks thatmay threaten customer information; develop a written plan containing policiesand procedures to manage and control these risks; implement and test the plan;and adjust the plan on a continuing basis to account for changes in technology,the sensitivity of customer information, and internal or external threats toinformation security.

Each institution may implement a security program appropriate to its size,complexity, nature and scope of its operations. The Bank has structured andimplemented a financial security program that complies with all principalrequirements of the act.

The regulatory agencies also published the "Interagency Guidance on ResponsePrograms for Unauthorized Access to Customer Information and Customer Notice." Each financial institution is required to implement a response program toaddress unauthorized access to sensitive customer information maintained by theinstitution or its service providers.  The Bank has implemented anappropriate response program, which includes: formation of an "Incident ResponseTeam"; properly assessing and investigating any incident; notifying the Officeof the Comptroller of the Currency (the "OCC") of any security breach, ifnecessary; taking appropriate steps to contain and control any incident; andnotifying affected customers when required.

*Identity TheftPrevention Program*

The Fair and Accurate Credit Transactions Act ("FACT") requires bankinginstitutions to implement an Identity Theft Prevention Program to detect,prevent and mitigate identity theft in connection with the opening of certainaccounts or certain existing accounts. Program requirements includeincorporating federal guidelines on investigating customer address discrepanciesand identifying other "red flags" that may indicate potential identity theft. The Bank has implemented a comprehensive Identity Theft Prevention Program,which covers all customer accounts and accomplishes the following standards asset forth in FACT: (1) identify relevant red flags for covered accounts; (2)detect red flags; (3) respond appropriately to any red flags detected; and (4)ensure the program is updated periodically.

*FederalLegislation on Banking Products and Services*

During 2008, Congress issued federal legislation creating or amending numerousrequirements on disclosures, documentation, and procedures in relation toseveral products and services offered by financial institutions.  Much ofthe legislation is being issued in response to current adverse economicconditions and provides customers with additional disclosure information andprotections.  The regulatory changes include, but are not limited to, theReal Estate Settlement Procedures Act, the Truth in Lending Act and the Truth inSavings Act.  The Bank's policies and procedures are being revised toincorporate all of the recent regulatory requirements and ensure fullcompliance.

*Federal MonetaryPolices*

The monetary policies of regulatory authorities, including the Federal Reservehave a significant effect on operating results of bank holding companies andtheir subsidiary banks.  The Federal Reserve regulates the national supplyof bank credit by open market operations in U.S. government securities, changesin the discount rate on bank borrowings and changes in reserve requirementsagainst bank deposits.

Federal Reserve monetary policies have materially affected the operating resultsof commercial banks in the past and are expected to do so in the future. The nature of future monetary policies and the effect of such policies on thebusiness and earnings of the company and its subsidiaries cannot be accuratelypredicted.

*EmergencyEconomic Stabilization Act of 2008*

Asreferenced above, in response to recent unprecedented market turmoil, Congressenacted the Emergency Economic Stabilization Act ("EESA") on October 3, 2008.EESA authorizes the Secretary of the Treasury (the "Secretary") to purchase upto $700 billion in troubled assets from financial institutions under theTroubled Asset Relief Program ("TARP"). Troubled assets include residential orcommercial mortgages and related instruments originated prior to March 14, 2008and any other financial instrument the purchase of which the Secretarydetermines, after consultation with the Chairman of the Board of Governors ofthe Federal Reserve System, is necessary to promote financial stability. The Secretary was authorized to purchase up to $250 billion in troubled assetsimmediately and up to $350 billion upon certification by the President that suchauthority is needed.  EESA also increased the maximum deposit insuranceamount up to $250,000 until December 31, 2009.  Pursuant to his authorityunder EESA, the Secretary of the Treasury created the TARP Capital PurchaseProgram under which the Treasury Department is investing up to $250 billion insenior preferred stock of U.S. banks and savings associations or their holdingcompanies. The Company elected not to participate in the TARP Capital PurchaseProgram.

*InsuranceActivities*

Subsidiaries of the Company sell various types of insurance as agents in theState of Tennessee.  Insurance activities are subject to regulation by thestates in which such business is transacted.  Although most of suchregulation focuses on insurance companies and their insurance products,insurance agents and their activities are also subject to regulation by thestates, including, among other things, licensing and marketing and salespractices.

-4-
ITEM 1A. RISK FACTORS.
Informationcontained herein includes forward-looking statements with respect to thebeliefs, plans, risks, goals and estimates of First Citizens Bancshares, Inc. Forward-looking statements are necessarily based upon estimates and assumptionsthat are inherently subject to significant banking, economic, and competitiveuncertainties, many of which are beyond management's control.  When used inthis discussion, the words "anticipate," "project," "expect," "believe,""should," "will," "intend," "is likely," "going forward" and other expressionsare intended to identify forward-looking statements.  These forward-lookingstatements are within the meaning of section 27A of the Securities Act of 1933,as amended, and section 21E of the Securities Exchange Act of 1934, asamended.  Such statements may include, but are not limited to, capitalresources, strategic planning, acquisitions or de novo branching, ability tomeet capital guidelines, governmental regulations, construction of new branchlocations, dividends, the impact of current economic, competitive and marketrate factors, critical accounting policies, allowance for loan losses, fairvalue of financial instruments, goodwill, occupancy and depreciation expense,held-to-maturity securities, available-for-sale securities, trading securities,cash flows, diversification in the real estate loan portfolio, net interestincome, maturity of loans, loan impairment, loan ratings, re-pricing ofdeposits, borrowings with call features, dividend payout ratio, off-balancesheet arrangements, the impact of recently issued accounting standards, changesin funding sources, liquidity, interest rate sensitivity, net interest marginsand the effectiveness of internal control over financial reporting. 

Forward-lookingstatements are based upon information currently available and representmanagement's expectations or predictions of the future. As a result of risksand uncertainties involved, actual results could differ materially from suchforward-looking statements. The potential factors that could affect theCompany's results include but are not limited to:

•        Changes in general economic and business conditions;

•        Changes in market rates and prices of securities, loans, depositsand other financial instruments;

•        Changes in legislative or regulatory developments affectingfinancial institutions in general, including changes in tax, banking,insurance, securities or other financial service related laws;

•        Changes in government fiscal and monetary policies;

•        The ability of the Company to provide and market competitiveproducts and services;

•        Concentrations within our loan portfolio;

•        The Company's ability to maintain credit quality;

•        The effectiveness of the Company's risk monitoring systems;

•        The ability of the Company's borrowers to repay loans;

•        The availability of and costs associated with maintaining and/orobtaining adequate and timely sources of liquidity;

•        Geographic concentration of the Company's assets;

•        The ability of the Company to attract, train and retain qualifiedpersonnel;

•        Changes in consumer preferences; and

•        Other factors generally understood to affect the financialresults of financial services companies,

The Company undertakes no obligationto update its forward-looking statements to reflect events or circumstancesthat occur after the date of this Annual Report on Form 10-K. 

In addition tothe factors listed above, management believes that the risk factors set forthbelow should be considered in evaluating the Company's business. The relevantrisk factors outlined below may be supplemented from time to time in theCompany's press releases and filings with the Securities and ExchangeCommission.

**We aresubject to credit quality risks and our credit policies may not be sufficientto avoid losses.**

We are subjectto the risk of losses resulting from the failure of borrowers, guarantors andrelated parties to pay interest and principal amounts on loans.  Although wemaintain credit policies and credit underwriting, monitoring and collectionprocedures that management believes are sufficient to manage this risk, thesepolicies and procedures may not prevent losses, particularly during periods inwhich the local, regional or national economy suffers a general decline.  If alarge number of borrowers fail to repay their loans, our financial conditionand results of operations would be adversely affected.

**If our allowance for loanlosses becomes inadequate, our financial condition and results of operationscould be adversely affected.**

We maintain anallowance for loan losses that we believe is a reasonable estimate of known andinherent losses in our loan portfolio. Management uses various assumptions andjudgments to evaluate on a quarterly basis the adequacy of the allowance forloan losses in accordance with generally accepted accounting principles as wellas regulatory guidelines. The amount of future losses is susceptible to changesin economic, operating and other conditions, including changes in interestrates, which may be beyond our control, and these losses may exceed our currentestimates. Although we believe the allowance for loan losses is a reasonableestimate of known and inherent losses in our loan portfolio, we cannot fullypredict such losses or that our loan loss allowance will be adequate in thefuture. Excessive loan losses could have an adverse effect on our financialperformance. 

Federal andstate regulators periodically review our allowance for loan losses and mayrequire us to increase our provision for loan losses or recognize further loancharge-offs, based on judgments different than those of our management. Anyincrease in the amount of our provision or loans charged-off as required bythese regulatory agencies could have an adverse effect on our results ofoperations.

**Changes in interest ratescould have an adverse effect on our earnings.**

Ourprofitability is in part a function of the spread between interest rates earnedon investments, loans and other interest-earning assets and the interest ratespaid on deposits and other interest-bearing liabilities. Interest rates arelargely driven by monetary policies set by the Federal Open Market Committeeand the shape of the yield curve.  The FOMC sets interest rates to influencethe cost and availability of money and credit to help promote national economicgoals.  The shape of the yield curve is the relationship of shorter-term ratesto longer-term rates.  The FOMC cut rates to a historical low of a range of0.00% to 0.25% in December 2008.  Although the Bank maintains a fairly neutralposition for interest rate risk, steep rate cuts in a short period of timecoupled with competitive factors pressuring pricing of loans and deposits inthe current economic environment will continue to exert pressure on netinterest margins.  Deposits are already priced historically low and have littleroom to re-price downward.  Federal Home Loan Bank borrowings comprise themajority of wholesale borrowings with the majority of those advances havingfixed rates for at least the next 12 months.  

Prepayment ofprincipal cash flows from the investment portfolio is expected to increase in2009 as rates continue to be very low and credit availability has improvedrecently due to the actions of the Federal Reserve and U. S. TreasuryDepartment. Reinvestment rates on the investment portfolio have droppedsignificantly (at least 100 basis points) from December 2008 to February 2009.

If the rate ofinterest paid on deposits and other borrowings increases more than the rate ofinterest earned on loans and other investments, our net interest income and,therefore, earnings could be adversely affected. Earnings could also beadversely affected if the rates on loans and other investments fall more quicklythan those on deposits and other borrowings. While management takes measures toguard against interest rate risk, there can be no assurance that such measureswill be effective in minimizing the exposure to interest rate risk.

-5-

**We are geographically concentratedin West Tennessee, and changes in local economic conditions impact ourprofitability.**

We operateprimarily in western Tennessee and substantially all of our loan customers andmost of our deposit and other customers live or have operations in this area.Accordingly, our success significantly depends upon the growth in population,income levels, deposits and housing starts, along with the continued attractionof business ventures to this area. Our profitability is impacted by the changesin general economic conditions in this market. One area of particular concernfor 2009 is the residential real estate market in the Shelby County and surrounding markets as inventories escalated and values declined in 2008. Additionally,unfavorable local or national economic conditions could reduce our growth rate,affect the ability of our customers to repay their loans and generally affectour financial condition and results of operations. 

We are less ablethan a larger institution to spread the risks of unfavorable local economicconditions across a large number of diversified economies. Moreover, we cannotgive any assurance that we will benefit from any market growth or favorableeconomic conditions in our primary market areas if they do occur.

**If financial market conditionsworsen or our loan demand increases significantly, our liquidity position couldbe adversely affected.**

We rely ondividends from the Bank as our primary source of funds. The primary sources offunds of the Bank are client deposits and loan repayments. While scheduled loanrepayments are a relatively stable source of funds, they are subject to theability of borrowers to repay the loans. The ability of borrowers to repayloans can be adversely affected by a number of factors, including changes ineconomic conditions, adverse trends or events affecting business industrygroups, reductions in real estate values or markets, business closings orlay-offs, natural disasters and international instability. Additionally,deposit levels may be affected by a number of factors, including rates paid bycompetitors, general interest rate levels, regulatory capital requirements,returns available to clients on alternative investments and general economicconditions. Accordingly, we may be required from time to time to rely onsecondary sources of liquidity to meet withdrawal demands or otherwise fundoperations. Such sources include Federal Home Loan Bank advances, sales ofsecurities and loans, and federal funds lines of credit from correspondent banks,as well as out-of-market time deposits. While we believe that these sources arecurrently adequate, there can be no assurance they will be sufficient to meetfuture liquidity demands, particularly if we continue to grow and experienceincreasing loan demand. We may be required to slow or discontinue loan growth,capital expenditures or other investments or liquidate assets should suchsources not be adequate.

**Market conditions couldadversely affect our ability to obtain additional capitalon favorable terms, should we need it.**

Our businessstrategy calls for continued growth. We anticipate that we will be able tosupport this growth through the generation of additional deposits at new branchlocations, as well as investment opportunities. However, we may need to raiseadditional capital in the future to support our continued growth and tomaintain our capital levels. We may not be able to obtain additional capital inthe amounts or on terms satisfactory to us. Our growth may be constrained if weare unable to raise additional capital as needed.

**Failure to compete effectivelymay adversely affect our results of operations and financial condition.**

We encounterstrong competition from other financial institutions in our market areas. Inaddition, established financial institutions not already operating in ourmarket areas may open branches there at future dates or can compete in themarket via the internet. In the conduct of certain aspects of banking business,we also compete with savings institutions, credit unions, mortgage bankingcompanies, consumer finance companies, insurance companies and otherinstitutions, some of which are not subject to the same degree of regulation orrestrictions as are imposed upon us. Many of these competitors have substantiallygreater resources and lending limits and can offer services that we do notprovide. While we believe that we compete effectively with these otherfinancial institutions in our market areas, we may face a competitivedisadvantage as a result of our smaller size, smaller asset base, lack ofgeographic diversification and inability to spread our marketing costs across abroader market. If we have to raise interest rates paid on deposits or lowerinterest rates charged on loans to compete effectively, our net interest marginand income could be negatively affected. Failure to compete effectively toattract new, or to retain existing, clients may reduce or limit our margins andour market share and may adversely affect our results of operations andfinancial condition.

**We expect the failure of otherbanks to increase our expenses.**

The failure ofnumerous banks in 2008 and 2009 may have a negative impact to our earnings, aspremiums required for FDIC insurance will increase in 2009.  We expect the newproposed fee structure to help replenish the FDIC's reserve funds will resultin an additional expense of approximately $1 million in 2009 compared to 2008. An interim rule adopted February 27, 2009, proposes to impose a one-time 20basis point emergency assessment payable September 30, 2009 and allows the FDICto impose up to an additional 10 basis points in any quarter thereafter. Weexpect the new proposed fee structure and emergency assessment to help replenishthe FDIC's reserve funds will result in an additional expense of at least $2.5million in 2009 compared to 2008.

**Adverseperceptions about our business could adversely affect our results of operationsand financial condition.**

We believe thatour reputational risk increased significantly in 2008 as a result of the numberof bank failures and volume of negative media headlines related to the bankingindustry. As a result, the FDIC implemented various programs includingincreasing deposit insurance limits to $250,000 to help mitigate such risks. Aspart of its strategic initiatives, management implemented various action plansincluding communications and training sessions for our staff and communicationsto local customers and civic groups regarding management's view on thestability in the Company as well as most community banking institutions. 

The publicperception of our ability to conduct business and expand our customer base mayalso be affected by practices of the Company's board, management and employees.Significant relationships with vendors, customers and other external partiesmay also affect our reputation. Adverse perceptions about our businesspractices or practices of those with whom we have significant relationshipscould adversely impact our results of operations and financial condition. 

**We are subject to extensivegovernment regulation and supervision.**

We are subjectto extensive federal and state regulation and supervision.  Banking regulationsare primarily intended to protect depositors' funds, federal deposit insurancefunds and the banking system as a whole, not our shareholders.  Theseregulations affect our lending practices, capital structure, investmentpractices and dividend policy and growth, among other things.  Future changesto statutes, regulations or regulatory policies, including changes ininterpretation or implementation of statutes, regulations or policies, couldaffect us in substantial and unpredictable ways.  Such changes could subject usto additional costs, limit the types of financial services and products we mayoffer and/or increase the ability of non-banks to offer competing financialservices and products, among other things.  Failure to comply with laws,regulations or policies could result in sanctions by regulatory agencies, civilmoney penalties and/or reputation damage, which could have a material adverseeffect on our financial condition and results of operations. While our policiesand procedures are designed to deter and detect any such violations, there canbe no assurance that such violations will not occur.

**Our common stock is not listedor traded on any established securities market and is normally less liquid thansecurities traded in those markets.**

Our common stockis not listed or traded on any established securities market and there are noplans to seek to list our common stock on any recognized exchange. Accordingly,our common stock has substantially less daily trading volume than the averagesecurities listed on any national securities exchange. Most transactions in ourcommon stock are privately negotiated trades and the shares are very thinlytraded. There is no dealer for our stock and no "market maker." Our shares donot have a trading symbol. These factors can reduce the marketability of ourshares and the lack of a liquid market can produce downward pressure on thestock price. 

**Our ability to pay dividendsmay be limited.**

As a holdingcompany, the Company is a separate legal entity from the Bank and does not havesignificant operations of its own. It currently depends upon the Bank's cashand liquidity to pay dividends to its shareholders. We cannot provide assurancethat in the future the Bank will have the capacity to pay dividends to theCompany. Various statutes and regulations limit the availability of dividendsfrom the Bank. It is possible, depending upon the Bank's financial conditionand other factors, that the Bank's regulators could assert that payment ofdividends by the Bank to the Company is an unsafe or unsound practice. In theevent that the Bank is unable to pay dividends to the Company, we may not beable to pay dividends to our shareholders.

-6-
ITEM 1B UNRESOLVED STAFF COMMENTS
** **None. 
ITEM 2. PROPERTIES
The Bank has 17full service bank branches, three drive-thru only branches, one loan productionoffice and 31 ATMs spread over nine****Tennessee counties. A list ofavailable banking locations and hours is maintained on the Bank's website(www.firstcitizens-bank.com) under the "Locate Us" section. The Bank owns andoccupies the following properties:

•      The Bank's main branch and executive offices are located in asix-story building at One First Citizens Place (formerly 200 West Court),Dyersburg, Tennessee.  This property also includes the Banking Annex, which hasan address of 215-219 Masonic Street.  The Banking Annex houses the Bank'soperations, information technology, call center, bank security and maildepartments;

•      The Bank's downtown drive-through branch is located at 113 South Church Street, Dyersburg, Tennessee and is a remote motor bank with six drive-thrulanes and a drive-up ATM lane;

•     The Green Village Office, located at 620 U.S. 51 Bypass adjacent to the Green Village Shopping Center in Dyersburg, Tennessee, is a full servicebanking facility;

•     The Newbern Branch, a full service facility, is located on North Monroe Street, Newbern, Tennessee;

•     The Industrial Park Branch located at 2211 St. John Avenue, Dyersburg,   Tennessee is a full service banking facility;

•     The Ripley, Lauderdale County full service facility is located at  316 Cleveland Street in Ripley, Tennessee;

•      The Troy Branch is a full service banking facility located on Harper Street just west of Highway 51 in Troy, Tennessee;

•      As of December 31, 2008, the Union City branch operates one fullservice facility, two motor branches and three ATMs in Obion County.  The main office is located at 100 Washington Avenue in Union City, Tennessee.  Motorbranches are located at First and Harrison Streets across from the main officeand at 1509 East Reelfoot Avenue in Union City.  The 1509 East Reelfoot Avenueoffice closed on January 15, 2009 and was consolidated into the 100 Washington Avenue office;

•      The Martin office is located at 200 University Avenue, Martin, Tennessee and is a full service banking facility;

•      The Munford, Tennessee branch is located at 1426 Munford Avenue. A remote building located at 1483 Munford Avenue serves as a drive-throughfacility;

•      The Atoka full-service branch is located at 123 Atoka-Munford  Avenue, Atoka, Tennessee;

•      The Millington Branch is a full service branch facility locatedat 8170 Highway 51 N. Millington, Tennessee;

•      The full-service Bartlett branch is located at 7580 Highway 70, Bartlett, Tennessee;

•      The Arlington branch located at 5845 Airline Road, Arlington,   Tennessee serves as a full service branch facility;

•      The Oakland branch is located at 7285 Highway 64, Oakland, Fayette County, Tennessee;

•      The Collierville branch facility is located at 3668 South HoustonLevee in Collierville;

•      A building and lot at 1304 Murfreesboro Road in Franklin, Williamson County, Tennessee was purchased in 2007.  The building was renovated and openedJuly 23, 2008 as a full service location;

•      A lot located on Christmasville Cove in Jackson was purchased in2007 and will be used to construct a full service branch location in two tofive years; and

•      In February 2008, a lot located on Union University Drive in Jackson, Tennessee was purchased.  Construction of a full service branch at this locationis expected in the next one to three years.

The Bank ownsall properties and there are no liens or encumbrances against any propertiesowned by the Bank.  All of the properties described above are adequate andappropriate facilities to provide banking services as noted and are adequate tohandle growth expected in the foreseeable future.  As growth continues or needschange, individual property enhancements or additional properties will beevaluated if considered necessary.
ITEM 3. LEGAL PROCEEDINGS.
Various legal claimsarise from time to time through the normal course of business of the Companyand its subsidiaries.  There was no material pending or threatened litigationagainst the Company or its subsidiaries as of December 31, 2008.
ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.
During thefourth quarter of the year ending December 31, 2008, there were no annual orspecial meetings of the Company's shareholders. No matters were submitted to avote of the shareholders nor were proxies solicited by management or any otherperson.

-7-
PART IIITEM 5.  MARKET FOR REGISTRANT'S COMMON EQUITYAND RELATED STOCKHOLDER MATTERS 
The following graph reflects theCompany's cumulative return (including dividends) as compared to the S&P500 and Southeast Bank Group Index over a five-year period:

**Holders and Market Information**

As of February13, 2009, there were 1,070 shareholders of the Company's common stock. TheCompany's common stock is not listed or traded on any established publictrading market. The table below shows the quarterly range of high and low saleprices for the Company's common stock during the fiscal years 2008 and 2007.These sale prices represent known transactions reported to the Company and donot necessarily represent all trading transactions for the periods.

Year

 
   
High

 

Low

2008:

First Quarter
   
 $

34.00 

 $

34.00 

Second Quarter
   
34.00 

34.00 

Third Quarter
   
34.00 

31.00 

Fourth Quarter
   
31.00 

31.00 
   
2007:

First Quarter
   
 $

35.00 

 $

35.00 

Second Quarter
   
36.45 

35.00 

Third Quarter
   
36.45 

36.45 

Fourth Quarter
   
36.45 

34.00 

**Dividends**

The Company paidaggregate dividends per share of the Company's common stock of $1.16 in each of2008 and 2007.  The following quarterly dividends per share of common stockwere paid for 2008 and 2007:

Quarter

2008

2007

First Quarter

 $

0.29 

 $

0.29 

Second Quarter

0.29 

0.29 

Third Quarter

0.29 

0.29 

Fourth Quarter

0.29 

0.29 

      Total

 $

1.16 

 $

1.16 

Future dividendswill depend on the Company's earnings, financial condition, regulatory capitallevels and other factors, which the board of directors considers relevant.  SeeNote 16 to the Company's Consolidated Financial Statements included elsewherein this Annual Report on 10-K for more information on restrictions andlimitations on the Company's ability to pay dividends.

**Issuer Purchases of EquitySecurities**

The Company hadno publicly announced plans or programs for purchase of stock during 2008. TheCompany purchased 407 shares of its common stock at a weighted average cost of$35.07 per share for the year ended December 31, 2008.  The number of shares ofCompany common stock repurchased in open-market transactions not pursuant topublicly announced plans or programs and the average price paid by month forthe most recent fiscal quarter is as follows:

Period

Total Number of Shares  Purchased

Average Price Paid  Per Share

Total Number of Shares Purchased as Part of  Publicly Announced Plans or Programs

Maximum Number of Shares that May Yet Be  Purchased Under the Plans or Programs

October 1 - October 31,  2008

-

 $

        -  

-

-

November 1 - November 30,  2008

37

31.00 

-

-

December  1 - December 31, 2008

-

-  

-

-

   Total

37

 $

31.00 

-

-

**Unregistered Sale ofSecurities**

The Company sold150 shares of its common stock in 2008 at a weighted average price of $34.74per share for an aggregate price of $5,211. The Company also sold 413 shares ofits common stock in 2007 at a weighted average price of $36.10 per share for anaggregate price of $14,909 and sold 1,664 shares of its common stock in 2006 ata weighted average price of $34.00 per share for an aggregate price of$56,570.  The Company used proceeds from such sales to reacquire additionalshares of Company common stock. All of these shares of common stock were issuedin reliance upon the exemption from the registration requirements of theSecurities Act of 1933, as amended (the "Securities Act"), as set forth inSection 4(2) under the Securities Act and, in some cases, Rule 506 of RegulationD promulgated thereunder relating to sales by an issuer not involving anypublic offering, to the extent an exemption from such registration wasrequired.
ITEM 6. SELECTED FINANCIAL DATA.
The followingtable presents selected financial data of the Company for the 12 months endedDecember 31, for the years indicated:

2008

2007

2006

2005

2004

      (Dollars in  thousands, except per share data)

Net interest and fee income 

 $

29,833 

 $

27,429 

 $

26,785 

 $

25,740 

 $

24,628 

Gross interest income 

52,467 

54,279 

50,927 

43,432 

37,977 

Income from continuing operations

7,529 

9,160 

9,157 

8,665 

8,049 

Income from continuing operations per common share

2.08 

2.53 

2.52 

2.38 

2.20 

Net income per common share

2.08 

2.53 

2.52 

2.38 

2.20 

Cash dividends declared per common share

1.16 

1.16 

1.16 

1.12 

1.12 

Total assets at year end

927,502 

876,156 

831,420 

815,749 

773,204 

Long-term obligations (1)

73,843 

63,165 

59,538 

78,128 

84,481 

Allowances for loan losses as a % loans

1.22 %

1.08 %

1.13 %

1.25 %

1.16 %

Allowances for loan losses as a % of non-performing loans

168.11 %

336.24 %

471.96 %

349.36 %

262.25 %

Loans 90 days past due as a  % of loans

0.73 %

0.32 %

0.24 %

0.36 %

0.44 %

________________

(1) Long-term obligations consistof Federal Home Loan Bank ("FHLB") advances and acquisition debts funded by aline of credit with First Tennessee Bank and trust-preferred securities.

 

-8-
**ITEM 7. MANAGEMENT'SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**Executive Overview
For the year ended December 31,2008, the Company's core earnings streams were stable and resulted in a returnon equity in excess of 10%. Dividends in 2008 were held at a level consistentwith the prior year despite the numerous challenges faced by the Company'sindustry over the past 12 months.  Such challenges include, but are not limitedto, increasing provision for loan losses, impairment of shares of Fannie Maeand Freddie Mac preferred stock, stressed real estate conditions in localmarkets, job losses and volatility in bond markets.  

The year ended December 31, 2008resulted in decreased earnings of $7.53 million compared to $9.16 million in2007 and****$9.16 in 2006.  The two major causes of decreased earnings wereincreased provision for loan losses and other-than-temporary impairment lossesincurred on shares of Fannie Mae and Freddie Mac preferred stock.  Provisionfor loan losses was $2.86 million in 2008 compared to approximately $834,000 in2007 and approximately $683,000 in 2006.  The gross impairment loss on sharesof Fannie Mae and Freddie Mac preferred stock was $1.8 million and theimpairment loss, net of applicable tax adjustments, was $1.2 million.  Earningsper share were $2.08 for the year ended December 31, 2008 compared to $2.53 and$2.52 per share for the years ended December 31, 2007 and 2006, respectively. 

During 2008, asset growth of5.9% outpaced capital growth of approximately 2.6%.  Capital growth was lessthan asset growth primarily because of a $1.9 million reduction in retainedearnings as a result of lower net income and the cumulative effect of change inaccounting principle for adoption of Emerging Issues Task Force ("EITF") IssueNo. 06-4, "Accounting for Deferred Compensation and Postretirement BenefitAspects of Endorsement Split-Dollar Life Insurance Arrangements" ("EITF06-4").  Decreased earnings combined with modest capital growthlowered returnon average equity to 10.07% for 2008 compared to 12.79% and 13.88% for 2007 and2006, respectively.  Return on assets ("ROA") was 0.86%, 1.08% and 1.10%, for2008, 2007 and 2006, respectively.  The return on equity ("ROE") of 10.07% andROA of 0.86% for 2008 exceeded the same measures for the Southeast Bank GroupIndex, as produced by Mercer Capital, which reported an average ROE of 1.75%and average ROA of 0.21% for 2008.  

In 2008, the Company's dividendpayout ratio was 56%, compared to historical range of 45% - 55% over the pastfive years, and the dividend yield was 3.4%, which was comparable to historicaldividend yields in excess of 3%.  The Southeast Bank Group reported peerdividend payout ratio in excess of 68% and dividend yield of 2.66% for 2008. 

Maintaining and improving netinterest margins continue to be a top priority for many financial institutions,including the Bank.  Net interest margin has been stable over the last fiveyears in the range of 3.7% to 3.9% despite the volatility in federal fundsrates during that timeframe.  Net interest margin for 2008 improved slightly to3.84% from 3.78% for 2007.  Current economic, competitive and market ratefactors are expected to continue to exert pressure on margins going forward. Interest rate risk position for the Company is maintained at a fairly neutrallevel, which also contributes to the stability of net interest margins.  Formore information, see Item 7A of this Annual Report on Form 10-K.  

As evidenced in the cash flowstatements, the Company continues to deploy capital for purchases of premisesand equipment totaling $3.3 million, $4.2 million and $2.7 million in 2008,2007 and 2006, respectively.  Premises and equipment purchases in 2008 wereprimarily related to renovation of property for the full service branch in Franklin, Tennessee that opened in July 2008.  Opportunity cost on the 2008 purchases wasapproximately $220,000 based on the average yield on earning assets of 6.65%,as the funds likely would have been invested in loans or investments if fixedassets were not purchased.  
Critical Accounting Policies
The accountingand reporting of the Company and its subsidiaries conform to accountingprinciples generally accepted in the United States ("GAAP") and follow generalpractices within the industry.  Preparation of financial statements requiresmanagement to make estimates and assumptions that affect amounts reported inthe financial statements and accompanying notes. Management believes that theCompany's estimates are reasonable under the facts and circumstances based onpast experience and information supplied from professionals, regulators andothers.  Accounting estimates are considered critical if (i) management isrequired to make assumptions or judgments about items that are highly uncertainat the time estimates are made and (ii) different estimates reasonably couldhave been used during the current period, or changes in such estimates arereasonably likely to occur from period to period, that could have a materialimpact on presentation of the Company's Consolidated Financial Statements. 

The development,selection and disclosure of critical accounting policies are discussed by theAudit Committee of the Board of Directors.  Because of the potential impact onthe financial condition or results of operations and the required subjective orcomplex judgments involved, management believes its critical accountingpolicies consist of the allowance for loan losses, fair value of financialinstruments and goodwill and assessment of impairment.
*Allowance For Loan Losses*
The allowancefor loan losses represents management's best estimate of inherent losses in theexisting loan portfolio.  Management's policy is to maintain the allowance forloan losses at a level sufficient to absorb reasonably estimated and probablelosses within the portfolio.  Management believes the loan loss reserveestimate is a critical accounting estimate because  changes can materiallyaffect provision for loan losses on the income statement, changes in the borrower'scash flows can impact the allowance and estimates must be made at the balancesheet date and also into the future in reference to the allowance.  Whilemanagement uses the best information available to establish the allowance forloan losses, future adjustments may be necessary if economic or otherconditions change materially.  The section below entitled "Loan PortfolioAnalysis" provides further detail regarding how loans are monitored andevaluated in relation to the determination of the allowance for loan losses. In addition, see Note 1 of the Company's Consolidated Financial Statementsincluded elsewhere in this Annual Report on Form 10-K for more information.
*Fair Value of Financial Instruments*
GAAP requiresthat certain assets and liabilities be carried on the balance sheet at fairvalue.  Furthermore, fair value of financial instruments is required to bedisclosed as a part of the notes to the Consolidated Financial Statements forother assets and liabilities.  Beginning with the year ended December 31, 2008,fair value estimates are determined in accordance with Statement of FinancialAccounting Standards ("SFAS") No. 157, "Fair Value Measurements" ("SFAS 157")(see section below entitled "Recently Issued Accounting Standards").  Fair valuesare volatile and may be influenced by a number of factors, including marketinterest rates, prepayment speeds, discount rates, the shape of yield curvesand the credit worthiness of counter parties.  

Fair values forthe majority of the Bank's available-for-sale investment securities are basedon observable market prices obtained from independent asset pricing servicesthat are based on observable transactions but not quoted market prices.  

Fair value ofthe only derivative held by the Company is determined using a combination ofquoted market rates for similar instruments and quantitative models based onmarket inputs including rate, price and index scenarios to generate continuousyield or pricing curves and volatility factors.  Third party vendors are usedto obtain fair value of available-for-sale securities and the cash flow hedge.For more information, see Notes 1 and 20 in the Company's Consolidated FinancialStatements included elsewhere in this Annual Report on Form 10-K.  

*Goodwill*

The Company's policyis to review goodwill for impairment at the reporting unit level on an annualbasis unless an event occurs that could potentially impair the goodwillamount.  Goodwill represents the excess of the cost of an acquired entity overfair value assigned to assets and liabilities.  Management believes accountingestimates associated with determining fair value as part of the goodwill testis a critical accounting estimate because estimates and assumptions are madebased on prevailing market factors, historical earnings and multiples and othercontingencies. For more information, see Notes 1 and 8 in the Consolidated FinancialStatements included elsewhere in this Annual Report on Form 10-K.

-9-
RESULTS OF OPERATIONS
The Companyreported consolidated net income of $7.53 million for the year ended December31, 2008 compared to $9.16 million in 2007 and $9.16 million in 2006.  Earningsper share decreased to $2.08 for 2008 compared to $2.53 in 2007 and $2.52 for2006. Return on average assets was 0.86%, 1.08% and 1.10%, for the years endingDecember 31, 2008, 2007 and 2006, respectively.  Return on average equity was10.07%, 12.79% and 13.88% for 2008, 2007 and 2006, respectively.  Increases innet interest income and other non-interest income were offset by increases in provisionfor loan losses, impairment losses on shares of Fannie Mae and Freddie Macpreferred stock and other non-interest expenses.

Balance sheetgrowth was steady at 5.9% in 2008 compared to 5.4% in 2007.  Asset growth of$51.3 million consisted of growth in federal funds sold of $21 million, growthin available-for-sale investments of $20 million and loan growth of $11million.  Asset growth in 2008 was primarily funded through growth in depositsof $44 million. 

Current economicfactors including, but not limited to, stressed real estate markets, volatilefuel and energy costs and the market interest rate environment have putpressure on asset quality across the industry.  The Bank experienced somestress to certain assets in 2008, but overall asset quality was consideredsatisfactory despite unfavorable trends in non-performing assets in 2007 and2008.  While trends have been unfavorable, such trends are not as significantto the Company as those at peer and larger financial institutions that have incurredsignificant losses in 2008.  Non-performing loans and other real estate as apercent of total loans plus other real estate at December 31, 2008 were 1.63%,compared to 0.71% at December 31, 2007 and****0.57% at December 31, 2006,****while the Bank's peer group's average was 2.59% as reported in the December31, 2008 Uniform Bank PerformanceReport for the Bank.  Net charge-offs in 2008 were $1.9 million compared toapproximately $717,000 in 2007 and $1.3 million in 2006.  The allowance forloan losses as a percent of non-performing assets was 74.8%, 151.2% and 198.4%for 2008, 2007 and 2006, respectively.  The negative trend in this ratio overthe last three years is primarily driven by increases in other real estateowned ("OREO").  Other real estate totaled $5.4 million, $2.3 million and $1.8million as of December 31, 2008, 2007 and 2006, respectively.   

Provision forloan losses increased in 2008 as trends in non-performing assets continued inan unfavorable direction.  Additions made to the reserve account, as a percentof gross charge-offs, for 2008 were 125.7% compared to 76.1% for 2007.  Theallowance for loan losses as a percent of total loans was 1.22% at year-end2008 compared to 1.08% at year-end 2007 and 1.13% at year-end 2006.  Theallowance for loan losses is evaluated in accordance with GAAP and isweighted toward actual historical losses and includes factor adjustments forchanges in environmental conditions.  Allowance for loan losses as a percent ofloans for the Bank's peers was 1.38% as reported in the most recent UniformBank Performance Report.  For  more information regarding allowance for loanlosses, see the section below entitled "Loan Portfolio Analysis" and Note 1 tothe Consolidated Financial Statements included in Item 8 of this Annual Reporton Form 10-K.

There was amodest improvement in net yield on average earning assets at 3.84% for 2008compared to 3.78% and 3.75% for 2007 and 2006, respectively.  Net interestmargin stability is attributed primarily to the fairly neutral position of thebalance sheet in terms of interest rate risk. Therefore, fluctuations in yieldson interest-earning assets were primarily offset by fluctuations in costs ofinterest-bearing liabilities over the past three years.  The Bank, along withother financial institutions, continues to battle net interest marginscompressed by turbulent market conditions and competitive factors.  For moreinformation, see Item 7A of this Annual Report on Form 10-K.

Totalnon-interest income for 2008 decreased $1.2 million as a result of net realizedlosses of $1.37 million on available-for-sale securities in 2008 compared tonet loss of approximately $29,000 in 2007.  The 2008 net loss was primarily aresult of a $1.81 million other-than-temporary impairment charge on shares ofFannie Mae and Freddie Mac preferred stock, partially offset by net gains onsale and calls of available-for-sale securities totaling approximately$436,000.  The impairment was a result of the Federal Housing Finance Agencyplacing both Fannie Mae and Freddie Mac under conservatorship in the thirdquarter of 2008.

Although totalnon-interest income decreased as a result of net realized losses onavailable-for-sale securities, trends of strong core non-interest incomestreams continued in 2008.  Despite the challenges of the national real estatemarket, the markets served by the Bank continued to deliver strong mortgageactivity and stable income.  Gross income and fees recorded from this activitytotaled $1.1 million in 2008 compared to $1.2 million in each of 2007 and2006.  Fee income from deposit accounts, which includes interchange fees ondebit and ATM transactions, increased to $7.2 million in 2008 from $6.9 millionin 2007.  Increased service charges on deposits served to offset declines intrust and brokerage fees.  Volatility in stock and bond markets resulted inlower values of managed assets in the trust and brokerage divisions. Therefore, fees in these divisions also decreased.  

The Company'seffective tax rate was 27% in 2008 compared to 25% in 2007 and 24% in 2006. The effective tax rate and changes therein are impacted by fluctuations incertain factors including, but not limited to, the level of tax-free investmentswithin the Bank's investment portfolio, tax-exempt earnings and expenses onBank-owned life insurance policies, certain tax benefits that result fromdividends and payouts under the Company's Employee Stock Ownership Plan("ESOP"), temporary differences resulting from use of accelerated deprecationfor tax purposes and other factors incidental to the financial servicesbusiness.  Fluctuations in the deduction related to the ESOP dividends andpayouts, tax-exempt interest earned in the investment portfolio and increasedearnings and expenses on Bank-owned life insurance were the largest contributorsto the various effective rates for the past three years.

-10-

Interest-earningassets in 2008 averaged $808 million at an average rate of 6.65% compared to$753 million at an average rate of 7.34% in 2007 and $740 million at an averagerate of 7.01% in 2006.  Interest bearing liabilities at year-end 2008 averaged$737 million at a cost of 3.07% compared to $679 million at a cost of 3.96% atyear-end 2007 and $670 million at a cost of 3.60% at year-end 2006.  Thefollowing table presents the year-to-date daily average balance sheet and netinterest income analysis for the years ended December 31, 2008, 2007 and 2006(dollars in thousands):

YEAR-TO-DATE AVERAGES AND RATES

2008

2007

2006

 Average  

Average

 Average  

Average

 Average  

Average

 Balance  

 Interest  

Rate

 Balance  

 Interest  

Rate

 Balance  

 Interest  

Rate

ASSETS

INTEREST EARNING

   ASSETS:

Loans (1)(2)(3)

 $

606,015  

$    42,356  

6.99%

 $

560,229  

 $

44,700  

7.98%

 $

554,219  

 $

42,372  

7.65%

Investment Securities:

   Taxable

141,724  

7,643  

5.39%

137,571  

7,087  

5.15%

128,205  

6,078  

4.74%

   Tax-Exempt (4)

54,204  

3,529  

6.51%

46,481  

3,020  

6.50%

43,135  

2,738  

6.35%

Interest Earning

   Deposits

867  

42  

4.84%

773  

47  

6.08%

703  

37  

5.26%

Federal Funds Sold

4,721  

97  

2.05%

7,968  

452  

5.67%

13,586  

633  

4.66%

Total Interest Earning  Assets

807,531  

53,667  

6.65%

753,022  

55,306  

7.34%

739,848  

51,858  

7.01%

NON-INTEREST

   EARNING ASSETS:

Cash and Due from Banks

16,357  

- 

-

 

16,586  

- 

-

 

16,043  

- 

-

Bank Premises and Equipment

34,771  

- 

-

28,743  

- 

-

28,554  

- 

-

Other Assets

51,325  

- 

-

49,705  

- 

-

46,988  

- 

-

Total Assets

 $

909,984  

- 

-

 $

848,056   

- 

-

 $

831,433   

- 

-

LIABILITIES AND

   SHAREHOLDERS' EQUITY

 

INTEREST BEARING 

   LIABILITIES:

Savings Deposits

$     217,754  

$     2,846  

1.31%

 $

201,506  

 $

3,794  

1.88%

 $

197,115  

 $

3,264  

1.66%

Time Deposits

390,233  

14,671  

3.76%

372,109  

17,822  

4.79%

365,839  

15,568  

4.26%

Federal Funds Purchased and

   Other Interest Bearing

   Liabilities

129,194  

5,117  

3.96%

105,218  

5,234  

4.97%

107,238  

5,310  

4.95%

Total Interest Bearing  Liabilities

737,181  

22,634  

3.07%

678,833  

26,850  

3.96%

670,192  

24,142  

3.60%

(Table continued on next page.)

-11-

**YEAR-TO-DATE AVERAGES AND RATES****(cont'd)**

YEAR-TO-DATE AVERAGES AND RATES

2008

2007

2006

 Average 

Average

 Average 

Average

 Average 

Average

 Balance 

 Interest 

Rate

 Balance 

 Interest 

Rate

 Balance 

 Interest 

Rate

NON-INTEREST BEARING

   LIABILITIES:

Demand deposits

 $

90,999  

- 

- 

 $

93,413  

- 

-

 $

90,360  

- 

-

Other liabilities

7,061  

- 

- 

           4,189  

- 

-

            4,911  

- 

-

Total liabilities

835,241  

- 

- 

776,435  

- 

-

765,463   

- 

-

SHAREHOLDERS' EQUITY

74,743  

- 

- 

71,621  

- 

-

65,970  

- 

-

TOTAL LIABILITIES AND

   SHAREHOLDERS' EQUITY

 $

909,984  

- 

- 

 $

848,056  

- 

-

 $

831,433  

- 

-

NET INTEREST INCOME
   
 $

31,033  
      
 $

28,456  
      
 $

27,716  
   
NET YIELD ON AVERAGE

   EARNING ASSETS
      
3.84 %
      
3.78%
      
3.75%

(1)    Loan totals areloans held for investments and net of unearned income and loan loss reserves.

(2)    Fee income on loans held for investment isincluded in interest income and the computations of the yield. Loans held forsale and related mortgage banking income, however, are reported in other        assets and other income and,therefore, are excluded. 

(3)    Includes loans onnon-accrual status.

(4)    Interest and rateson securities, which are non-taxable for federal income tax purposes, arepresented on a taxable equivalent basis.

-12-

*Volume Rate Analysis*

The following table is an analysis of theimpact of the changes in balances and rates on interest income and interestexpense changes from 2008 to 2007 and 2007 to 2006 (in thousands):
   **2008 Compared to 2007Due to Changes in:****2007 Compared to 2006Due to Changes in:**
** **

** **

** **

** **

**Total**

** **

** **

** **

** **

** **

**Total**

**Average**

** **

**Average**

** **

**Increase**

** **

**Average**

** **

**Average**

** **

**Increase**

**Volume**

** **

**Rate**

** **

**(Decrease)**

** **

**Volume**

** **

**Rate**

** **

**(Decrease)**

Interest Earned On:

** **

** **

** **

** **

** **

** **

** **

** **

** **

Loans

 $

3,200  

 $

(5,544)

 $

(2,344)

 $

480  

 $

1,848  

 $

2,328  

Taxable Investments

224  

332 

556 

482  

527  

1,009  

Tax Exempt Investment

 Securities

503  

6  

509 

217  

65  

282  

Interest Bearing Deposits  with

 Other Banks

5  

(10)

(5)

4  

6  

10  

Federal Funds Sold and  Securities

 Purchased Under  Agreements

 to Resell

(67)

(288)

(355)

(319)

138   

(181)

TOTAL INTEREST EARNING

 ASSETS

 $

3,865  

 $

(5,504)

 $

(1,639)

 $

864  

 $

2,584  

 $

3,448  

Interest Expense On:

 Savings Deposits

213  

(1,161)

(948)

83  

447  

530  

 Time Deposits

681  

(3,832)

(3,151)

300  

1,954  

2,254  

 Federal Funds Purchased  and

     Securities Sold Under

     Agreements to  Repurchase

949  

(1,066)

(117)

(100)

24  

(76)

TOTAL INTEREST EARNING

 LIABILITIES

1,843  

(6,059)

(4,216)

283  

2,425  

2,708  

NET INTEREST EARNINGS

 $

2,022   

 $

555   

 $

2,577   

 $

581   

 $

159   

 $

740   

*Non-Interest Income*

The followingtable compares non-interest income for the years ended December 31, 2008, 2007and 2006 (dollars in thousands):

** **

** **

**Increase**

** **

** **

** **

**Increase**

** **

** **

**    Total**

** **

**(Decrease)**

** **

**  Total**

** **

**(Decrease)**

** **

**Total**

**     2008**

** **

**   Amount**

** **

**     %**

** **

**  2007**

** **
   Amount
** **

**      %**

** **

**2006**

Mortgage Banking Income

 $

1,139   

 $

(39)

(3.31)%

 $

1,178   

 $

(7)

(0.59)%

 $

1,185   

Income from Fiduciary  Activities

816  

(191)

(18.97)%

1,007   

67  

7.13%

940  

Service Charges on Deposit  Accounts

7,272   

310  

4.45%

6,962   

903  

14.90%

6,059   

Brokerage Fees

1,473   

(92)

(5.88)%

1,565   

208  

15.33%

1,357   

Earnings on Bank Owned Life  Insurance

833  

138  

19.86%

695  

14  

2.06%

681  

Realized Gains (Losses) on  Available-

   For-Sale Securities

(1,374)

(1,345)

4637.93%

(29)

(29)

                - 

-  

Other Income

1,511   

(25)

(1.63)%

1,536   

(75)

(4.66)%

1,611   

Total Non-Interest Income

 $

11,670   

 $

(1,244)

(9.63)%

 $

12,914   

 $

1,081   

9.14%

 $

11,833   

Service chargeson deposits increased approximately 4% primarily due to increased income fromdebit and ATM interchange fees.  Trust and brokerage fees decreasedapproximately $300,000 in the aggregate as a result of decreased market valuesof managed assets.  Earnings on Bank-owned life insurance ("BOLI") assetsincreased approximately 19% in 2008 from 2007 primarily because of increasedyields as a result of transferring approximately $12 million from generalaccount BOLI products into separate account BOLI products.  In 2008, totalnon-interest income (fee income) contributed 18.2% of total revenue compared to19.2% and 18.9% for 2007 and 2006, respectively.  

Income from First Citizens/White and Associates Insurance Company, LLC wasincluded in other non-interest income.  Income from this subsidiaryincreased approximately $139,000 in 2008 compared to 2007.  This incomeincreased primarily because income on crop insurance increased by approximately$102,000 or 26% in 2008 compared to 2007.  The Company's portion of othernon-interest income generated by First Citizens/White and Associates InsuranceCompany, LLC for the years ending 2008, 2007, and 2006 totaled approximately$773,000, $634,000 and $653,000, respectively.

-13-

*Non-InterestExpense*

The followingtable compares non-interest expense for the years ended December 31, 2008, 2007and 2006 (dollars in thousands):

** **

**Increase**

** **

** **

**Increase**

** **

** **

**Total**

**(Decrease)**

** **

**Total**

**(Decrease)**

** **

**Total**

**2008**

**Amount**

**Percentage**

**2007**

**Amount**

**Percentage**

**2006**

Salaries and Employees

    Benefits

 $

16,390 

 $

703  

4.48%

 $

15,687  

 $

613  

4.07%

 $

15,074  

Occupancy Expense

4,596  

(27)

(0.58)%

4,623  

120  

2.66%

4,503  

Other Non-interest Expense

7,362  

327  

4.65%

7,034  

683  

10.75%

6,351  

Total Non-Interest Expense

 $

28,348   

 $

1,003   

3.67%

 $

27,344   

 $

1,416   

5.46%

 $

25,928   

The non-interestexpense category is dominated by salaries and benefits expense, which comprised58% of the total in 2008, 57% in 2007 and 58% in 2006.  Employees receiveperformance-based incentives based on factors including achievement of acertain ROE level (calculated excluding incentives at the holding companylevel), accomplishing annual budget goals and attaining or exceeding businessdevelopment and other individual performance goals.  Incentive pay totaled 9.3%of salaries and benefits compared to 10.4% in 2007 and 11.0% in 2006.  Of theapproximately $703,000 increase in salaries and employee benefits expenses,approximately $268,000 was as a result of adoption of EITF 06-04 effectiveJanuary 1, 2008 for accounting for post-retirement death benefits pursuant toendorsement split dollar life insurance plans.  Also, approximately $371,000 ofthe $703,000 increase was attributable to accrual of the imputed income taxreimbursement plan, a non-qualified defined benefit plan associated withcertain executives.  For more information regarding these plans, see Note 10 inthe Company's Consolidated Financial Statements included elsewhere in thisAnnual Report on Form 10-K.  Significant expense associated with salaries andbenefits is consistent with the Company's strategic plan to hire and retainhigh quality employees to provide outstanding customer service and strive forexceptional shareholder returns.

The efficiencyratio is a measurement of non-interest expense as a percentage of totalrevenue.  The efficiency ratio for the years 2008, 2007 and 2006 was 66.23%,65.98% and 65.44%, respectively.  

The followingtable compares assets per employee for the Company compared to its peers, basedon information obtained from Uniform Bank Performance Reports at the datesspecified (in thousands):

** **

**Assets Per Employee**

**Assets Per Employee**

**December 31,**

**Company**
 Peer Group
2008

 $

3,400  

 $

4,400  

2007

 $

3,210  

 $

4,060  

2006

 $

3,121  

 $

3,940  

2005

 $

2,967  

 $

3,860  

2004

 $

2,903   

 $

3,700   

Comparison ofassets per employee for the Company and its peers reveals that the Companyimproved in 2008 but continues to be more heavily staffed than its counterparts. The ratio of assets per employee is less than the Company's peers primarilybecause of growth through the addition of new branches over the past fiveyears.  New branches typically have an inefficient assets-per-employee ratioand dilute the total assets per employee ratio as compared to peers.  TheCompany's ratio improved during 2008 as assets grew but average full-timeequivalent employees decreased slightly. As the Company continues its expansioninto Jackson and Franklin, Tennessee, assets per employee for the Company willlikely continue to lag behind the Company's peers.  Also, in an effort toprovide a high level of customer service, the Company has decided to staff itslocations with more employees than is typical with its peers. This strategic managementdecision has contributed to a lower asset to employee ratio.

Occupancyexpense decreased in 2008 primarily because of decreased depreciation ofapproximately $227,000.  Decreased depreciation was a result of controllingpurchases and expenses related primarily to computer equipment and software. Certain shorter lived assets, primarily computer equipment and software, werefully depreciated by early 2008 and were not immediately replaced with newpurchases.  While the Company strives for efficiencies in these areas,expansion, data integrity/security and customer service strategies adopted bythe Board will continue to exert pressure on occupancy and depreciation expensegoing forward.  

Total othernon-interest expense increased 5% and 11% in 2008 and 2007, respectively.  Theintegration of newer branches, expenses related to other real estate andincreasing regulatory burdens continue to put pressure on non-interestexpenses.  However, strategic efforts to reduce and control other operating expenseshave served to offset increases in certain categories such as expense relatedto other real estate.  For example, advertising costs decreased approximately$54,000 in 2008 as a result of strategic efforts to control expenses in thecurrent economic environment.  Successful implementation of strategies toincrease non-interest income streams also yielded higher non-interestexpenses.  Expenses incurred to implement strategic action plans to increaseservice charges on deposits increased approximately $150,000 in 2008 ascompared to 2007.  Expenses incurred related to OREO increased approximately$386,000 in 2008 as compared to 2007. For more information regarding OREO, seethe section below entitled "- Financial Condition - Other Real Estate Owned" andNote 9  in the Company's Consolidated Financial Statements included elsewherethis Annual Report on Form 10-K.

No impairment ofgoodwill has been recognized since the adoption of SFAS No. 142 in 2002. Goodwill was 1.27% of total assets and 15.36% of total capital as of December31, 2008. 

**Financial Condition**

*Investment Securities Analysis*

The followingtable presents the composition of securities at December 31 for the last threeyears (in thousands):

**December 31,**

 
**2008**

**2007**

 

**2006**

** **

 
U. S. Treasury and  Government Agencies     and Corporations

 $

148,271  

 $

134,460  

 $

127,602  

State and Political  Subdivisions

59,588  

51,037  

44,338  

 
All Others

2,641  

4,910  

5,436  

 
     Total Investment Securities

 $

210,500   

 $

190,407  

 $

177,376   

 
-14-

*Maturityand Yield on Securities*

The followingtable presents contractual maturities and yields by category for debtsecurities as of December 31, 2008 (dollars in thousands):

Maturing 

Maturing 

Maturing 

After One 

After Five 

Maturing 

Within One

Year Within 

Years Within

After Ten

Year

Five Years

Ten Years

Years

Amount

 

Yield*

 

Amount

 

Yield*

 

Amount

 

Yield*

 

Amount

 

Yield*

 

Total

U. S. Treasury and

   Government Agencies

 $

2,545  

6.86%

 $

3,442  

4.62%

 $

14,807  

5.12%

 $

127,476  

4.94%

 $

148,270  

State and Political

   Subdivisions

3,241  

3.78%

10,771  

6.71%

18,557  

6.97%

27,019  

6.40%

59,588  

All Others

- 

-

- 

-

- 

-

2,605  

6.73%

2,605  

   Total Debt Securities

 $

5,786  

 $

14,213  

 $

33,364  

 $

157,100  

 $

210,463  

Equity Securities

 $

37  

0.00%

 $

37  

   Total 

 $

210,500   

________________

*              Yields arepresented on a tax-equivalent basis using a federal statutory rate of 34%.

*Held-To-Maturity andAvailable-For-Sale Securities*

                The followingtable presents amortized cost and fair value of held-to-maturity andavailable-for-sale securities as of December 31, 2008 (in thousands):

Held to Maturity

 

Available for Sale

(In Thousands)

Amortized  

Fair  

Amortized  

Fair  

Cost

 

Value

 

Cost  

 

Value

U. S. Treasury securities

 $

-   

 $

-   

 $

-   

 $

-   

U. S. Government agencies and corporation obligations

-   

-   

144,596   

148,270   

Securities issued by states and political subdivisions in

   the United States:

     Taxable securities

-   

-   

-   

-   

     Tax-exempt securities

115   

115   

59,196   

59,473   

U. S. securities:

 Other debt securities

-   

-   

3,909   

2,605   

 Equity securities

-   

30   

37   

           Total

 $

115   

 $

115   

 $

207,731   

 $

210,385   

In addition to amounts presentedabove, the Bank also had $5.7 million in FHLB and Federal Reserve Bank ("FRB")stock recorded at cost.

Equitysecurities listed above consisted primarily of shares of Fannie Mae and FreddieMac preferred stock, which were written down through earnings by $1.8 millionin September 2008.

Investmentsincreased $20 million or 10.7% in 2008 and consisted primarily of interest cashflows which were reinvested into new securities.  Objectives of the Bank'sinvestment portfolio management are to provide safety of principal, adequateliquidity, insulate GAAP capital against excessive changes in market value,insulate earnings from excessive change and optimize investment performance. Investments also serve as collateral for government, public funds and largedeposit accounts that exceed FDIC-insured limits.  Pledged investments at year-end2008 had a fair market value of $125 million.  Total held-to-maturity andavailable-for-sale investments at December 31, 2008, 2007 and 2006 were $210million, $190 million and $177 million, respectively.  The average expectedlife of the investment securities portfolio was 3.7 years, 4.2 years and 4.4years for 2008, 2007 and 2006, respectively.  Portfolio yields (on a taxequivalent basis) held steady at approximately 5.5% in 2008 and 2007 comparedto 5.21% in 2006.

The Companyclassifies investments, based on intent, into trading, available-for-sale andheld-to-maturity categories in accordance with GAAP.  The Company held nosecurities in the trading category for any of the last five years and does notexpect to hold any such securities in 2009.  The Company's investment strategyis to classify most of the securities portfolio as available-for-sale, whichare carried on the balance sheet at fair market value.  Classification ofavailable-for-sale investments allows flexibility to actively manage theportfolio under various market conditions.  Cash flows increased in 2008 as aresult of the current rate environment and portfolio strategies.  Cash flowsfor 2009 are projected to be in excess of $40 million.    

-15-

U.S. Treasurysecurities and government agencies and corporations obligations consistedprimarily of mortgage-backed securities ("MBS") and collateralized mortgageobligations ("CMO") and accounted for approximately 70% of the investmentportfolio in each of the last two years.  Credit quality of the Company's MBSand CMO portfolio was considered strong and reflected a net unrealized gain of$3.6 million as of December 31, 2008.  Credit quality factors on the bonds andrelated underlying mortgages that are evaluated at the time of purchase and ona periodic basis thereafter include, but are not limited to, averageloan-to-value ratios, average FICO credit score, payment seasoning (how manymonths of payment history), geographic dispersion, average maturity and averageduration.

Approximately 28%of the portfolio was primarily invested in municipal securities at December 31,2008.  Municipal securities totaled $59 million and were geographicallydiversified.  Approximately 85%, or $50 million, were general obligationmunicipal bonds and the remaining 15% were revenue bonds.  Overall creditquality of the municipal portfolio was considered strong and reflected a netunrealized gain of approximately $277,000 as of year-end 2008.

The remaining 2%of the portfolio consisted primarily of pooled trust-preferred securities thatreflected a net unrealized loss of $1.3 million as of year-end 2008.  Themarket for these securities has become inactive and as a result, the quotedmarket values have trended significantly below amortized cost over the last 12 months. These securities are evaluated for other-than-temporary impairment on aquarterly basis.  As of December 31, 2008, no impairment charge had beenrecognized on such securities and unrealized loss was reflected in accumulatedother comprehensive income.  For more information, see Note 3 in the Company'sConsolidated Financial Statements included elsewhere in this Annual Report onForm 10-K.  

The Company hasone interest rate swap classified as a cash flow hedge. For more information,see Note 3 in the Company's Consolidated Financial Statements includedelsewhere in this Annual Report on Form 10-K.

The followingtable indicates by category unrealized gains and losses within theavailable-for-sale portfolio as of December 31, 2008 (in thousands):

Unrealized 

 
Gain

 

Loss

 

Net

 
U. S. Treasury Securities  and Obligations of U. S.

 
 Government Agencies and  Corporations

 $

3,688  

 $

(14)

 $

3,674  

Obligations of States and  Political Subdivisions

1,065  

(788)

277  

 
All Others

7  

(1,304)

(1,297)

 
     Total

 $

4,760   

 $

(2,106)

 $

2,654   

 
*Loan Portfolio Analysis*

The followingtable compares the portfolio mix of loans held for investment as of year-endfor the last five years (in thousands):

December 31

2008

2007

 

2006

 

2005

 

2004

 

Real Estate Loans:

   Construction

 $

97,340  

 $

106,695  

 $

86,206  

 $

74,817  

 $

99,028  

   Mortgage

375,714  

353,655  

340,839  

352,749  

320,630  

Commercial, Financial and  

 Agricultural Loans

80,317  

80,509  

80,033  

78,086  

72,330  

Installment Loans to  

 Individuals

36,220  

37,106  

36,735  

37,761  

38,550  

Other Loans

7,167  

6,674  

5,021  

3,804  

4,147  

 TOTAL LOANS

 $

596,758   

 $

584,639   

 $

548,834   

 $

550,260   

 $

536,012   

*Changes In Loan Categories*

For purposes ofthis discussion, loans do not include loans that are sold in the secondarymortgage market.  The Company classifies loans to be sold in the secondarymortgage market separately in its consolidated financial statements. Secondarymarket mortgages totaled $2.6 million, $2.2 million and $3.4 million for 2008,2007 and 2006, respectively.  For more information, see Notes 4, 5 and 6 in theCompany's Consolidated Financial Statements included elsewhere in this AnnualReport on Form 10-K.  Interest and fees earned on secondary mortgage loans wereincluded in mortgage banking income as reported in other non-interest income inthe Company's Consolidated Financial Statements.

Total loans atDecember 31, 2008 were $597 million compared to $585 million at December 31,2007 and $549 million at December 31, 2006.  Loan growth was 2.1% in 2008compared to 6.5% in 2007.  The following table details the breakdown of thatgrowth by category for 2008 (dollars in thousands):

Increase

Percent

 
 

(Decrease)

 

Change

 

 
Real Estate Loans:

 
 Construction

 $

(9,355)

(10.85)%

 Mortgage

 $

22,059  

6.47%

 
Commercial, Financial

 
 and Agricultural

 $

(192)

(0.24)%

 
Installment Loans to  Individuals

 $

(886)

(2.41)%

 
Other Loans

 $

493  

9.82%

 
     TOTAL LOANS

 $

12,119   

2.21%

 
The loanportfolio was heavily weighted in real estate loans, which accounted for $473million or 79% of total portfolio.  Commercial and residential constructionloans accounted for $97 million of the $460 million invested in real estateloans.  Although the portfolio was heavily weighted in real estate, the Bankdoes not invest in sub-prime or non-traditional mortgages.  The Bank monitorsits concentrations in commercial real estate in accordance with regulatoryguidelines. Within real estate loans, residential mortgage loans (includingresidential construction) were the largest category comprising 35% of totalloans.  Diversification of the real estate portfolio is a necessary anddesirable goal of the real estate loan policy.  In order to achieve andmaintain a prudent degree of diversity, given the composition of the marketarea and the general economic state of the market area, the Company will striveto maintain real estate loan portfolio diversification.  Risk monitoring ofcommercial real estate concentrations is performed in accordance withregulatory guidelines and includes assessment of risk levels of various typesof commercial real estate and review of ratios of various concentrations ofcommercial real estate as a percentage of capital.  

-16-

Loan growth in2008 occurred primarily in real estate loans other than construction.  In 2008,focus for real estate lending shifted to owner occupied commercial real estateand growth occurred primarily in Dyer, Obion, Madison and Williamson Counties.  Growth in Shelby County and surrounding markets was flat in 2008.  Flat growth inthose markets was attributable to a combination of slower customer demand andresistance to allocate additional capital to residential real estateconstruction because of declining residential real estate market conditions inthose areas.   Residential real estate construction as a percent of capital hastrended downward over the last 12 months and was 58.53% of capital as ofDecember 31, 2008 as compared to 79.9% at December 31, 2007 and 73.7% atDecember 31, 2006.

Portfolioquality remained satisfactory with the ratio of net charge offs to average netloans outstanding for 2008, 2007 and 2006 at 0.31%, 0.13% and 0.23%,respectively.  Non-performing assets as a percent of total loans plusforeclosed property at 2008 year-end increased to 1.63% compared to 0.71% and0.57% at year-end 2007 and 2006, respectively.  A negative trend in problemcredits and charge offs was expected given negative economic trends across theindustry during the last 12 months.  However, strong credit risk managementprovided a means for timely identification and assessment of problem credits inorder to minimize losses.  

The following data details theinternally classified loans by category as of December 31, 2008 (dollars inthousands):

Total

Internally

Problem Loans %

Category

Outstanding

Classified

of Category

Residential Real Estate

 $

200,018 

 $

8,325 

4.16%

Home Equity Lines

26,869 

206 

0.77%

Commercial Real Estate

195,869 

2,903 

1.48%

Commercial Other

52,556 

942 

1.79%

Commercial - SBA Guaranteed

695 

7 

1.01%

Agriculture - Real Estate

31,941 

34 

0.11%

Agriculture - Other

19,848 

7 

0.04%

Agriculture - FSA  Guaranteed

10,499 

58 

0.55%

USDA Guaranteed

3,776 

519 

13.74%

Internallyclassified loans are those loans that have certain characteristics orcircumstances that warrant additional credit quality monitoring and may requirespecific reserve allocations as determined in accordance with SFAS No. 114.

*Policy Guidelines*

The Bank's LoanAdministration sets policy guidelines approved by the Board of Directorsregarding portfolio diversification and underwriting standards. Loan policyalso includes Board-approved guidelines for collateralization, loans in excessof loan to value ("LTV") limits, maximum loan amount and maximum maturity andamortization period for each loan type.  Policy guidelines for loan to valueratios and maturities related to various collateral are as follows:

Collateral

Max.  Amortization

Max LTV

Real Estate

Various (see discussion)

Various (see discussion)

Equipment*

5 Years

75%

Inventory

5 Years

50%

Accounts Receivable

5 Years

75%

Livestock

5 Years

80%

Crops

1 Year

50%

Securities**

10 Years

75%

(Listed)

50%

(Unlisted)

*        New farm equipment can beamortized over seven years.

**    When proceeds are used to purchase or carry margin stocks (stocks not listed ona national exchange), maximum LTV shall be 50%

-17-

The Company'spolicy manages risk in the real estate portfolio by adherence to supervisorylimits in regards to LTV percentages, as designated by the followingcategories:

Loan Category

 

LTV Limit

Raw Land

65%

Land Development or Farmland

75%

Construction:

 Commercial, Multi-Family*, and Other Non-Residential

80%

 1-4 Family Residential

80%

Improved Property

80%

Owner-Occupied 1-4 Family and Home Equity

80%

Home Equity Lines

90%

Non-Owner Occupied 1-4 Family Residential

75%

* Multi-family construction loansinclude loans secured by cooperatives and condominiums.  

On an approved exception basis,loans may be approved in excess of the LTV limits, provided that:
-  The request is fully documented     to support the fact that other credit factors justify the approval of that     particular loan as an exception to the LTV limit;  
-  The loan, if approved, is     designated in the Bank's records and reported as an aggregate number with     all other such loans approved by the full Board of Directors on at least a     quarterly basis;  
-  The aggregate total of all     loans so approved, including the extension of credit then under     consideration, shall not exceed 65% of the Bank's total capital; and  
-  The     aggregate portion of these loans in excess of the LTV limits that are     classified as commercial, agricultural, multi-family or non-1-to-4 family     residential property shall not exceed 30% of the Bank's total capital.

*AmortizationSchedules*

Loan policy requires every loanto have a documented repayment arrangement.  While reasonable flexibility isnecessary to meet credit needs of customers, in general all loans are to berepaid within the following time frames:

Loan Category

Amortized Period

Raw Land

10 years

Construction

1 year

Commercial, Multi-family, and Other Non-residential

20 years

1-4 Family Residential

20 years

Improved Property Farmland

20 years

Owner-occupied 1-4 Family and Home Equity

20 years

*Average LoanYields*

The average yield on loans of theBank for the years indicated were as follows:
2008 - 6.99%
2007 - 7.98%

2006 - 7.65%

2005 - 6.86%

2004 - 6.30%

The aggregateamount of unused guarantees, commitments to extend credit and standby lettersof credit was $128 million at year-end 2008.  For more information regardingcommitments and standby letters of credit, see Note 18 in the Company'sConsolidated Financial Statements included elsewhere in this Annual Report onForm 10-K.

-18-

*LoanMaturities*

Contractual maturities of loansas of December 31, 2008, are as follows:

** **

** **

** **

**Due After**

** **

** **

** **

**Due in One**

** **

**One Year but**

** **

**Due After**

** **

**Year or Less**

** **

**Within Five  Years**

** **

**Five Years**

** **

** **

** **

**(in thousands)**

** **

** **

Real Estate

 $

133,523   

 $

247,694   

 $

91,837

Commercial, Financial

 and Agricultural

 $

49,019   

 $

35,950   

 $

2,515   

All Other Loans

 $

10,189

 $

24,191   

 $

1,840   

TOTALS

 $

192,731   

 $

307,835  

 $

96,192   

Loans with Maturities After One Year for which:

(In Thousands)

Interest Rates are Fixed or Predetermined

 $

316,101   

Interest Rates are Floating or Adjustable

 $

87,926   

The degree of interest rate riskto which a bank is subjected can be controlled through a well-defined fundsmanagement program.  The Company controls interest rate risk by matchinginterest sensitive assets and liabilities.  Overall, the Company remains in afairly neutral position in terms of interest rate risk as evidenced by flat netinterest margins during a three-year period in which federal funds rates haveranged from 0.25% to 5.25%.  At year-end 2008, the Company was asset-sensitivewhich means that assets re-price at a faster rate than liabilities.  Therefore,in a rising rate environment (with a normal yield curve) net interest incomewould improve, while a declining rate environment would result in decreasedinterest rate margins and net interest income.  Approximately $193 million or32% of total loans will either mature over the next 12 months, while $193million or 52% of total loans will mature after one year, but less than fiveyears.  Approximately $96 million or 16% of total loans will mature after fiveyears. 

*Non-Performing Loans*

Non-performingloans and related ratios as of December 31 for each of the years presented wereas follows (dollars in thousands): 

**December 31,**

**2008**

**2007**

** **

**2006**

** **

**2005**

** **

**2004**

Non-Accrual Loans

 $

3,673  

 $

1,678  

 $

371  

 $

1,524  

 $

1,581  

Restructured Loans

- 
-  

-  

-  

-  

Foreclosed Property Other Real Estate 

5,424  

2,302  

1,815  

129  

337  

Other Repossessed Assets

22  

-  

-  

-  

2  

Loans and Leases 90 Days  Past Due and Still

 Accruing Interest

670  

204  

945  

431  

798  

Total Non-Performing Loans  and Other Assets

 $

9,789  

 $

4,184  

 $

3,131  

 $

2,084  

 $

2,718  

Non-Performing Assets as a  Percent of Loans and

 Leases Plus Foreclosed  Property at End of Year

1.63%

0.71%

0.57%

0.38%

0.51%

Allowance for Loan Loss as  a Percent of:

 Non-Performing Loans

167.26%

336.24%

471.96%

349.36%

262.03%

 Gross Loans

1.22%

1.08%

1.13%

1.25%

1.16%

 Addition to Reserve as a  Percent of Charge-Offs

125.74%

76.09%

44.41%

167.56%

90.44%

 Loans and Leases 90 days  Past Due as a Percent of

     Loans and Leases at  Year-End

0.73%

0.32%

0.24%

0.36%

0.44%

 Recoveries as a Percent of Gross Charge-Offs

17.07%

34.58%

15.34%

25.95%

20.66%

Non-performingassets consist of non-accrual loans, restructured loans, foreclosed propertiesand loans and leases 90 days past due and still accruing interest.  Theincrease in non-performing assets was primarily attributable to residentialreal estate lots and properties located in Shelby and surrounding counties. Other real estate has trended higher over the last two years.  For moreinformation about OREO, see the section below entitled "- Other Real EstateOwned."

Categorizationof a loan as non-performing is not in itself a reliable indicator of probableloan losses.  The Bank's policy is to not accrue interest or discount on (i)any asset which is maintained on a cash basis because of deterioration in thefinancial position of the borrower, (ii) any asset for which payment in full ofinterest or principal is not expected or (iii) any asset upon which principalor interest has been in default for a period of 90 days or more unless it isboth well secured and in the process of collection. For purposes of applyingthe 90 days past due test for the non-accrual of interest discussed above, thedate on which an asset reaches non-accrual status is determined by itscontractual term.  A debt is well secured if it is secured by collateral in theform of liens or pledges of real or personal property, including securitiesthat have a realizable value sufficient to discharge the debt (includingaccrued interest) in full, considered to be proceeding in due course eitherthrough legal action, including judgment enforcement procedures or, inappropriate circumstances, through collection efforts not involving legalaction which are reasonably expected to result in repayment of the debt or inits restoration to a current status.  Loans that represent probable losses areadequately reserved for in the allowance for loan losses.

Interest incomeon loans is recorded on an accrual basis.  The accrual of interest isdiscontinued on all loans, except consumer loans, which become 90 days pastdue, unless the loan is well secured and in the process of collection. Consumerloans which become past due 90 to 120 days are charged to the allowance forloan losses.  The gross interest income that would have been recorded for the12 months ending December 31, 2008 if all loans reported as non-accrual hadbeen current in accordance with their original terms and had been outstandingthroughout the period was approximately $178,000 compared to approximately$103,000, $25,000, $33,000 and $82,000 for the same periods in 2007, 2006, 2005and 2004, respectively.  Loans on which terms have been modified to provide fora reduction of either principal or interest as a result of deterioration in thefinancial position of the borrower are considered to be restructured loans. The Company had restructured loans totaling $1.15 million, of whichapproximately $635,000 was on non-accrual status as of December 31, 2008. 

Certain loanscontained on the Bank's Internally Classified Problem Loan List were notincluded in the above listing of non-accrual, past due or restructured loans.Management is confident that, although certain of these loans may pose creditproblems, any probable loss has been provided for by specific allocations tothe loan loss reserve account.  Loan officers are required to develop a "planof action" for each problem loan within their portfolio. Adherence to eachestablished plan is monitored by Loan Administration and re-evaluated at regularintervals for effectiveness.

-19-

*Loan Loss Experience andReserve for Loan Losses*

The followingtable summarizes activity posted to the loan loss reserve account for the pastfive years (in thousands):

**2008**

**2007**

** **

**2006**

** **

**2005**

** **

**2004**

 

Average Net Loans Outstanding

 $

606,014  

 $

560,229  

 $

554,219  

 $

536,315  

 $

511,946  

Balance of Reserve for Loan  Losses

 at Beginning of Period

6,328  

6,211  

6,830  

6,239  

6,124  

Loan Charge-Offs

(2,274)

(1,096)

(1,538)

(632)

(1,036)

Recovery of Loans  Previously Charged-Off

388  

379  

236  

164  

214  

Net Loans Charged-Off

(1,886)

(717)

(1,302)

(468)

(822)

Additions to Reserve  Charged to Expense

2,858  

834  

683  

1,059  

937  

Changes Incident to Mergers

- 
-  

-  

-  

-  

Balance at End of Period

 $

7,300  

 $

6,328  

 $

6,211  

 $

6,830  

 $

6,239  

Ratio of Net Charge-Offs to  Average Net

 Loans Outstanding

0.31%

0.13%

0.23%

0.09%

0.16%

Changes to thereserve account for 2008 consisted of (i) loans charged off of $2.3 million,(ii) recovery of loans previously charged off of approximately $388,000, and(iii) additions to reserves totaling $2.9 million.  Charge-offs for 2008 werespread among various markets served by the Bank with approximately half relatedto loans made in the Shelby County and surrounding markets.  Increasedprovision for loan losses in 2008 was attributable to the need to provideadditional reserves given the negative trends in charge-offs and non-performingloans in 2008.

The followingtable identifies charge-offs and recoveries by category for the years presented(in thousands):

**2008**

**2007**

** **

**2006**

** **

**2005**

** **

**2004**

 
Charge-offs:

 
    Commercial, Financial  and Agricultural

 $

(638)

 $

(227)

 $

(447)

 $

(139)

 $

(459)

    Real  Estate-Construction

(569)

(107)

-  

(242)

(115)

 
    Real Estate-Mortgage

(655)

(406)

(685)

(62)

(138)

 
    Installment Loans to Individuals and Credit Cards

(412)

(356)

(406)

(189)

(324)

 
        Total Charge-offs

 $

(2,274)

 $

(1,096)

 $

(1,538)

 $

(632)

 $

(1,036)

 
 
Recoveries:

 
    Commercial, Financial  and Agricultural

$             141 

 $

124  

 $

76  

 $

62  

 $

66  

 
    Real  Estate-Construction

23 

22  

-  

10  

3  

 
    Real Estate-Mortgage

82 

148  

51  

4  

37  

 
    Installment Loans to Individuals and Credit Cards

142 

85  

109  

88  

108  

 
        Total Recoveries

 $

388  

 $

379  

 $

236  

 $

164  

 $

214  

 
Net Charge-offs

 $

(1,886)

 $

(717)

 $

(1,302)

 $

(468)

 $

(822)

 
An analysis ofthe allocation of the allowance for loan losses is made on a fiscal quarter atthe end of the second month (i.e., February, May, August, and November) andreported to the Board at its meeting immediately preceding quarter-end.  Theallowance for loan losses is estimated using methods consistent with GAAP aswell as regulatory guidance on the allowance.  Such guidance consideredspecifically includes but is not limited to SFAS No. 114 and SFAS No. 118 andthe Interagency Policy Statement on the Allowance for Loan and Lease Lossesissued by the federal financial regulatory agencies in December 2006. 

The evaluationof the adequacy of the allowance includes the identification of impaired loansand allocation of specific reserves if considered necessary on a case-by-casebasis for significant loans.  A loan is impaired when it is probable that acreditor will be unable to collect all amounts of principal and interest dueaccording to the original contractual terms of the loan. Impairment occurs when(i) the present value of expected future cash flows discounted at the loanseffective interest rate impede full collection of the contract and (ii) fairvalue of the collateral, if the loan is collateral dependent, indicatesunexpected collection of full contract value.  Specific reserve allocations aremade for loans found to be collateral or interest cash flow deficient.  Inaddition, an allowance is determined for pools of loans including all othercriticized assets as well as small homogeneous loans managed by delinquency.Impairment decisions are reported to the Board of Directors and in externalreports as required by regulations.  Income recognition from impaired loans isdetermined in accordance with GAAP, as well as financial institution regulatoryguidance.

Credit riskmanagement procedures include assessment of loan quality through use of aninternal loan rating system.  Each loan is assigned a rating upon originationand the rating may be revised over the life of the loan as circumstanceswarrant.  The rating system utilizes eight major classification types based onrisk of loss.  

Credit riskmanagement process also includes an annual review of a minimum of 70% of thegross portfolio less installment loans.  The loan review function isindependent of the lending process itself and results of loan review arereported to the Board of Directors.  In addition, any single note or series ofnotes directly or indirectly related to one borrower that equals 25% of theBank's legal lending limit are included in the review.  The results of loanreview as well as current portfolio mix by rating are incorporated into thequarterly evaluation of the allowance for loan losses.

Examples offactors taken into consideration during assessment of loan quality for ratingpurposes, for independent loan review and for evaluation of the adequacy of theallowance for loan losses include, but are not limited to, the following: 

•        Economic conditions; 

•        Management experience and depth; 

•        Credit history; 

•        Business conditions; 

•        Sources of repayment; 

•        Debt service coverage ratios; 

•        Financial condition of borrower(s) and/or guarantor(s); 

•        Deposit relationship; 

•        Payment history; 

•        Collateral values; and

•        Adherence to loan policy and adherence to loan documentation requirements.

-20-

*Other Real Estate Owned*

The book value of OREO was $5.4million as of December 31, 2008 compared to $2.3 million at December 31, 2007and $1.8 million at December 31, 2006. As of December 31, 2008, there wereapproximately 30 properties in OREO consisting primarily of newly constructedsingle-family homes and residential lots.  Approximately 95% of the $5.4million in OREO was located in Shelby and surrounding counties.  Whilemanagement continues efforts to liquidate OREO, Shelby and surrounding countieshave been under stress with increasing home inventories and declining marketvalues.  According to MarketGraphics Research Group, Inc., new home closingsare projected to be less than 4,000 for the 12 months ended March 31, 2009compared to a high in excess of 7,600 in 2006.

OREO is recordedat the time of foreclosure at the lesser of its appraised value or the loanbalance.  Any reduction in value at the time of foreclosure is charged to theallowance for loan losses.  All other real estate parcels are appraised atleast annually and carrying values are adjusted to reflect the decline, if any,in its realizable value.  Such adjustments made subsequent to foreclosure arecharged directly to OREO expense included in other non-interest expense.

*Composition of Deposits*

The averageamount of deposits and rates paid on such deposits are summarized in thefollowing table for the three years ended December 31, 2008, 2007 and 2006(dollars in thousands):

** **

**2008**

** **

**2007**

** **

**2006**

** **

**Average**

** **

**Average**

** **

**Average**

** **

**Average**

** **

**Average**

** **

**Average**

** **

**Balance**

** **

**Rate**

** **

**Balance**

** **

**Rate**

** **

**Balance**

** **

**Rate**

Non-Interest Bearing Demand  Deposits

 $

90,999  

0.00%

 $

93,413  

0.00%

 $

90,360  

0.00%

Savings Deposits

217,754  

1.31%

201,506  

1.88%

197,115  

1.66%

Time Deposits

390,233  

3.76%

372,109  

4.79%

365,839  

4.26%

    Total Deposits

 $

698,986   

2.51%

 $

667,028   

3.24%

 $

653,314   

2.88%

The decrease inaverage cost of deposits was a result of a declining rate environment offset bycompetitive factors on time and savings deposits.  The current market andcompetitive environment continues to yield fierce competition in pricing ofinterest-bearing deposit products.  The Bank does not compete solely on price,as strategies are focused more on customer relationships that attract andretain core deposit customers rather than time deposits.

Total depositsgrew $44 million or 6.4% during the year ended December 31, 2008.  Growth wasspread among various types of deposits including 12% growth in demand, 10%growth in savings and 3% growth in time deposits.  During 2008, demand depositbalances fluctuated in the range of $85 million to $110 million.  Savingsdeposit growth was primarily attributable to growth in the Bank's competitivelypriced interest bearing transaction accounts, including the Wall Street,e-Solutions and First Rate accounts.  

Time depositsincreased in excess of $12 million in 2008.  In June 2008, the Bank beganparticipating in Certificate of Deposit Account Registry Service ("CDARS"). CDARS is a deposit placement service that allows the Bank to accept verylarge-denomination certificates of deposit ("CDs") (up to $50,000,000) fromcustomers and ensures that 100% of those CDs are FDIC-insured.  Participatingin this network enhances the Bank's ability to attract and retainlarge-denomination depositors without having to place them in a Sweep orRepurchase Agreement.  The CDARS network provides a means to place reciprocaldeposits for the Bank's customers, purchase time deposits (referred to as"One-Way Buy" deposits) or to sell excess deposits (referred to as "One-WaySell" deposits).  One-Way Buy deposits are structured similar to traditionalbrokered deposits.  As of year end 2008, the Bank held reciprocal deposits and"One-Way Buy" deposits in the CDARS program totaling $45 million.  CDARSaccounts are classified as brokered time deposits for regulatory reportingpurposes.  Brokered deposits including CDARS accounted for $76 million or 10%of total deposits as of December 31, 2008 compared to $34 million or 4% oftotal deposits as of December 31, 2007.  

Time depositsover $100,000 plus brokered time deposits comprised 40.5% of total timedeposits as of year-end 2008 compared to 52.2% as of year-end 2007 and 51.8% asof year-end 2006.  Over 90% of time deposits greater than $100,000 and brokeredtime deposits will re-price over the next 12 months as a result of establishedstrategies to deal with the current competitive market and rate environment. 

*Maturity Distribution of TimeDeposits in Amounts of $100,000 and Over*

Deposits over$100,000 decreased $11.0 million or 6.5% from 2007 to 2008.  This was primarilya result of movement of certain retail time deposits over $100,000 to the CDARSproduct.  Time deposits placed into the CDARS program are primarily reported asbrokered time deposits in denominations of $100,000 or less.  Because of recentincrease in FDIC insurance limits from $100,000 to $250,000 in October 2008,newer CDARS deposits may be provided in increments up to $250,000.  TheBank has matched certain competitors that have priced local retail time depositswell above brokered and other markets, allowing some price-sensitive volatiledeposits to roll off.  These volatile price-sensitive deposits includevolatile public fund time deposits.  Overall public fund time depositsdecreased $14 million from $82 million at year-end 2007 to $68 million atyear-end 2008.

-21-

The followingtable sets forth the maturity distribution of CDs and other time deposits of$100,000 or more outstanding on December 31, 2008 and 2007 (dollars inthousands): 

**December 31, 2008**

** **

**December 31, 2007**

**Amount**

** **

**Percent**

** **

**Amount**

** **

**Percent**

Maturing in:

   Three Months or Less

 $

51,394  

32.30%

 $

46,427  

27.29%

   Over Three Months  Through Six Months

56,899  

35.76%

67,203  

39.50%

   Over Six Months Through 12 Months

38,378  

24.12%

45,540  

26.76%

   Over 12 Months

12,443  

7.82%

10,972  

6.90%

      Total

 $

159,114   

100.00%

 $

170,142   

105.05%

*Other Borrowings*

In addition todeposits, the Company uses a combination of short-term and long-term borrowingsto supplement its funding needs.  Short-term borrowings consist of a treasury,tax and loan demand note, federal funds purchased and short-term advances fromthe FHLB.  The short-term borrowings table below reflects the maximum amount ofborrowings at any month end during the years presented.  Short-term borrowingsare used to manage fluctuations in liquidity based on seasonality ofagricultural production loans and other factors.  The maximum amount ofborrowings in any given month increased in 2008 compared to 2007 and 2006because of increased loan growth.  Loan growth accelerated in the first half of2008 at an annualized rate in excess of 10% and then slowed to a modest 2.1% byyear-end as a result of strategic efforts to improve our liquidity position.  For more information about short-term borrowings, see Note 12 in theCompany's Consolidated Financial Statements included elsewhere in this AnnualReport on Form 10-K. 

The followingtable presents short-term borrowing balances at year end, maximum borrowings atmonth end during the year and average cost for the years presented (dollars inthousands):

**2008**

**2007**

**2006**

Amount Outstanding at End  of Year

 $

1,000  

 $

11,100  

 $

1,000  

Weighted Average Interest  Rate at End of Year

0.00%

4.35%

5.04%

Maximum Outstanding at Any  Month End

 $

48,500  

 $

22,400  

 $

13,155  

Average Outstanding During  Year

 $

20,679  

 $

8,804  

 $

4,501  

Weighted Average Interest Rate During Year

2.70%

5.30%

4.98%

Long-term debtat the holding company level carries a variable rate and consists of arevolving line of credit with First Tennessee Bank and trust-preferred debt. The line of credit with First Tennessee Bank was paid in full in December2008.  

The Bank'slong-term debt consists of advances from the FHLB.  Average volume of FHLBadvances for 2008 was $61.1 million at an average rate of 5.03% compared to$48.8 million at an average rate of 5.58% in 2007 and $58 million at an averagerate of 5.67% in 2006.  The average remaining maturity for FHLB long-termborrowings is two years.  FHLB borrowings are comprised of fixed rate positionsranging from 2.16% to 6.55%.  Most of the FHLB borrowings have quarterly callfeatures and maturities ranging from 2009 to 2017.  Approximately 54% or $34.5million will mature on or before December 31, 2010 with $2 million maturing in2009.  Advances totaling $40.5 million have call features offer the option topay off the advance without penalty or to have the advance reprice at avariable rate tied to the 90-day LIBOR, when called.  As of December 31, 2008,advances totaling $14 million require repayment if the call feature wereexercised.  Under the current and forecasted rate environments, borrowings withcall features in place are not likely to be called in the next 12 months and,therefore, are not included in current liabilities. For more information aboutliquidity, see the section below entitled "-  Liquidity."  

The followingtable presents average volumes, rates, maturities and re-pricing frequenciesfor long-term debt for the year ended December 31, 2008 (dollars in thousands):

**Average**

**Average**

**Average**

**Repricing**

**Volume**

**Rate**

**Maturity**

**Frequency**

FHLB Borrowings

 $

61,078  

5.03%

2

Fixed

Revolving Line of Credit

424  

3.77%

0

Variable

Trust Preferred Debt

10,310   

5.05%

24

Variable

*Aggregate ContractualObligations and Off-Balance Sheet Arrangements*

At December 31, 2008,contractual obligations were due as follows:

Contractual Obligations

Total

Less Than 1 Year

1-3 Years

3-5 Years

More Than 5 Years

Unfunded Loan Commitments

 $

114,982  

 $

114,982  

 $

-  

 $

-  

 $

-  

Standby Letters of Credit

6,442  

6,442  

-  

-  

-  

Long-Term Debt*

73,843  

2,603  

42,950  

3,480  

24,810  

Capital Lease Obligations

-  

-  

-  

-  

-  

Operating Leases

479  

206  

268  

5  

-  

Purchase Obligations

-  

-  

-  

-  

-  

Other Long-Term  Liabilities

-  

-  

-  

-  

-  

   Total

 $

195,746   

 $

124,233   

 $

43,218   

 $

3,485   

 $

24,810   

________________________

*              Long-term debt ispresented as principal only, excluding interest.

Except for unfunded loancommitments and standby letters of credit, the Bank does not materially engagein off-balance sheet activities and does not anticipate material changes involume going forward.

For moreinformation about long-term obligations and off-balance sheet risk, see Notes 13and 18 in the Company's Consolidated Financial Statements included elsewhere inthis Annual Report on Form 10-K.

-22-

**Capital Resources**

The followingtable presents return on equity and assets for the years presented:

2008

2007

2006

Return on Assets

0.83%

1.08%

1.10%

Return on Equity

10.07%

12.79%

13.88%

Percentage of Dividends  Declared to Net Income

55.85%

45.93%

46.04%

Equity to Asset Ratio

8.21%

8.45%

7.93%

Total capital(excluding reserve for loan losses) as a percentage of total assets ispresented in the following table for years indicated: 

2008
2007

2006

2005

2004

8.30%
8.56%

8.36%

7.80%

7.92%

Total capitalincreased 2.6% to $77.0 million at year-end 2008 from $75.0 million at year-end2007.  Growth in capital during 2008 was from undistributed net income from theBank, which was offset by a $1.9 million reduction in capital from thecumulative effect from change in accounting principle for adoption of EITF06-04 for accounting for post-retirement benefits of endorsement split dollarlife insurance plans.  Increases in other comprehensive income from improvedfair market values of available-for-sale investments securities alsocontributed to the increase in capital in 2008.  Adjustments to capitalresulting from changes in market value of available-for-sale securities andcash flow hedge are made quarterly and contributed approximately $582,000 tothe growth in 2008.  

The Company hashistorically maintained capital in excess of minimum levels established byregulation and reflects continuous improvement when comparing previous years. The risk-based capital ratio of 12.75% at December 31, 2008 was significantlyin excess of the 8% mandated by regulation.  This ratio has been maintained inthe 10-12% range over the past three years.  Total capital as a percentage oftotal assets was 8.30%, 8.56% and 8.36%, at December 31, 2008, 2007, and 2006,respectively.  

Risk-basedcapital focuses primarily on broad categories of credit risk and incorporateselements of transfer, interest rate and market risks. The calculation ofrisk-based capital ratio is accomplished by dividing qualifying capital byweighted risk assets in accordance with financial institution regulatoryguidelines.  The minimum risk-based capital ratio is 8.00%.  At least one-halfor 4.00% must consist of core capital (Tier 1), and the remaining 4.00% may bein the form of core (Tier 1) or supplemental capital (Tier 2).  Tier 1 capitalor core capital consists of common shareholders' equity, qualified perpetualpreferred stock and minority interests in consolidated subsidiaries.  Tier 2capital or supplementary capital may consist of the allowance for loan andlease losses, perpetual preferred stock, term-subordinated debt and other debtand stock instruments.

Dividendspayments have been steady at $1.16 per share per year in each of the last threeyears.  The Company's strategy continues to be to pay dividends at a level thatprovides dividend payout ratio and dividend yield in excess of average forpeers as reported for the Southeast Bank Group and tracked by Mercer Capital. The dividend payout ratio was 55.85% in 2008, 45.93% in 2007 and 46.04% in2006.  The projected payout ratio for 2009 is in the range of 50-60 percent. Dividend payout for Southeast Bank Group for 2008 was in excess of 65%.  TheCompany's dividend yield in 2008 was 3.41% compared to 3.31% in 2007.  Thedividend yield for the Southeast Bank Group was 2.66% for 2008.  The higherdividend payout ratios but lower dividend yields for peer was reflective oflower earnings (or even net losses) and lower dividend payments experienced bypeers in 2008.

As of year-end2008, there were approximately $10 million of retained earnings available forthe payment of future dividends from the Bank to the Company.  Bankingregulations require certain capital levels to be maintained and may limitdividends paid by the Bank to the Company or by the Company to itsshareholders.  Historically, these restrictions have posed no practical limiton the ability of the Bank or the Company to pay dividends. 

Over the past 15years, the Company has repurchased approximately 93,094 shares of its commonstock and the treasury stock has weighted average cost basis of $26.39 pershare.  Approximately 400 treasury shares were repurchased during 2008 at aweighted average cost of $33.73 per share.  Also, the Company soldapproximately 150 shares of treasury stock in 2008 at a weighted average priceof $34.74 per share.  There are currently no publicly announced plans orprograms to repurchase shares in place.

**Liquidity**

The Company manages liquidity ina manner to ensure the availability of ample funding to satisfy loan demand,fund investment opportunities and large deposit withdrawals.  Primary fundingsources for the Company include customer core deposits, FHLB borrowings, aswell as correspondent bank and other borrowings.  The Company's liquidityposition is further strengthened by ready access to a diversified base ofwholesale borrowings which include lines of credit with the FHLB andFTNFinancial, federal funds purchased, securities sold under agreements torepurchase, brokered CDs and others.  The Company has a line of credit withFirst Tennessee Bank for $5 million earmarked for acquisitions and otherfinancial needs of the holding company with the entire line available atyear-end 2008.  

The turmoil and events infinancial markets on Wall Street and across the banking industry serve as areminder that adequate liquidity is critical to the Company's success andsurvival especially during times of turbulent market conditions.  Therefore,management has reviewed, tested and updated strategic action plans related toliquidity including the crisis and contingency liquidity plans to defendagainst any material downturn in the liquidity position.  

Deposits account for 86% offunding for each of the last two years.  Borrowed funds from the FHLB amountedto 7.5% ($63 million) of total funding at year-end 2008 compared to 6.5% ($52million) of total funding at year-end 2007.  The Bank had additional borrowingcapacity of approximately $33 million with FHLB at year-end 2008.  In 2008, theBank expanded its correspondent banking relationship base which resulted infederal fund lines of credit being expanded from four banks with lines totaling$52.5 million as of year-end 2007 to eight banks with lines totaling $112.5million as of year-end 2008.  As of December 31, 2008, the Bank held $23million in short-term CDs with the State of Tennessee.  Brokered time depositswere approximately $76 million and $34 million as of year-end 2008 and 2007,respectively.  The increase in brokered deposits was primarily due to additionof CDARS as an additional liquidity tool in 2008.  For more information aboutCDARS, see the section above entitled "- Financial Condition - Composition ofDeposits." 

When evaluatingliquidity, comparison is made between funding needs and the current level ofliquidity, plus liquidity that would likely be available from other sources.This comparison provides a means for determining whether funds managementpractices are adequate. Management should be able to manage unplanned changesin funding sources, as well as react to changes in market conditions that couldhinder the Bank's ability to quickly liquidate assets with minimal loss.  Fundsmanagement practices are designed and implemented to ensure that the Companydoes not maintain liquidity by paying up for funds or by relying unduly onwholesale or credit-sensitive funding sources.  The OCC has establishedbenchmarks to be used for guidelines in managing liquidity. The following areasare considered liquidity red flags:
-  Significant increases in     reliance on wholesale funding;
-  Significant increases in large     CDs, brokered deposits, or deposits with interest     rates higher than the market;
-  Mismatched funding - funding     long-term assets with short-term liabilities or short-term assets with     long-term liabilities;
-  Significant increases in     borrowings;
-  Significant increases in     dependence on funding sources other than core deposits;
-  Reduction in borrowing lines by     correspondent banks;
-  Increases in cost of funds;
-  Declines in levels of core     deposits; and
-  Significant decreases in     short-term investments.

Liquidity ishigh priority for the Company's Funds Management Committee, which continues toseek alternative funding sources conducive to net interest margin strategies. The following table reflects the liquidity position of the Bank as of December31, 2008, 2007 and 2006 in comparison to the OCC Liquidity Benchmarks:

OCC Liquidity  Benchmark

December 31,  2008

 

December 31,  2007

 

December 31,  2006

Short Term Liabilities/ Total Assets > 20%

16.63%

21.93%

20.12%

On Hand Liquidity to Total Liabilities < 8%

10.77%

6.72%

8.56%

Loan to Deposits < 80%

80.21%

84.05%

82.91%

Wholesale Funds/Total Sources > 15%

15.28%

16.39%

14.71%

Non Core Funding Dependence > 20%

65.25%

67.09%

50.73%

The abovecomparison is one quantitative means of monitoring liquidity levels.  However,other quantitative and qualitative factors are considered in the overall riskmanagement process for liquidity.  Such other factors evaluated by managementinclude, but are not limited to, forecasting and stress testing capital levels,diversification of funding sources, degree of reliance on short-term volatilefunding sources, deposit volume trends and stability of deposits.  There are noknown trends or uncertainties that are likely to have a material effect on theCompany's liquidity or capital resources.  There currently exist norecommendations by regulatory authorities, which, if implemented, would havesuch an effect.  There are no matters of which management is aware that havenot been disclosed.

-23-
Recently Issued Accounting Standards
*Fair Value Measurements*In September2006, the Financial Accounting Standards Board ("FASB") issued SFAS 157, whichdefines fair value, establishes a framework for measuring fair value in GAAPand expands disclosures about fair value measurements.  SFAS 157 was issued toaddress the need for increased consistency and comparability in fair valuemeasurements and for expanded disclosures about fair value measurements.  SFAS157 emphasizes that fair value measurement should be determined based onassumptions that market participants would use in pricing the asset orliability.  Also, SFAS 157 establishes a fair value hierarchy that prioritizesinformation used to develop those assumptions. FASB issued a Staff Positionwhich delays the effective date of SFAS 157 until fiscal years beginning afterNovember 15, 2008 for nonfinancial assets and nonfinancial liabilities, exceptfor items that are recognized or disclosed at fair value in the financialstatements on a recurring basis (at least annually).  Adoption of SFAS 157 didnot have a material impact on the Company's consolidated financial statements.

*Accounting for Deferred Compensation andPostretirement Benefit Aspects of Endorsement Split-Dollar Life InsuranceArrangements*In September2006, FASB ratified EITF 06-4, which addresses accounting for split-dollar lifeinsurance arrangements after the employer purchases a life insurance policy onthe covered employee.  EITF 06-4 states that an obligation arises as a resultof a substantive agreement with an employee to provide future postretirementbenefits.  Under this issue, the obligation is not settled upon entering intoan insurance arrangement. Because the obligation is not settled, a liabilityshould be recognized in accordance with applicable authoritative guidance. EITF 06-4 is effective for fiscal years beginning after December 15, 2007.  Theadoption of EITF 06-4 did have a material impact on the Company's consolidatedfinancial statements. For more information about the adoption of EITF 06-4, seeNote 10 in the Company's Consolidated Financial Statements included elsewherein this Annual Report on Form 10-K.

*Fair Value Option for Financial Assetsand Financial Liabilities*In February2007, FASB issued SFAS No. 159 "The Fair Value Option for Financial Assets andFinancial Liabilities" (SFAS 159") to permit entities to choose to measurecertain financial instruments at fair value.  This statement is expected toexpand the use of fair value measurement with the intent to improve financialreporting by providing entities with the opportunity to mitigate volatility inreported earnings caused by measuring related assets and liabilitiesdifferently without having to apply complex hedge accounting provisions. SFAS159 is effective as of the beginning of an entity's first fiscal year thatbegins after November 15, 2007.  Adoption of SFAS 159 did not have a materialimpact on the Company's consolidated financial statements.

*Noncontrolling Interests in ConsolidatedFinancial Statements - an amendment of ARB No. 51*In December2007, FASB issued SFAS No. 160, "Noncontrolling Interests in ConsolidatedFinancial Statements - an amendment of ARB No. 51" ("SFAS 160") to improve therelevance, comparability and transparency of financial information that areporting entity provides in its consolidated financial statements.  Thestandard establishes reporting requirements for ownership interests insubsidiaries held by parties other than the parent, net income attributable tothe parent and to the noncontrolling interest, changes in parent's ownershipinterest, initially recording any retained noncontrolling equity investment atfair value rather than carrying amount of retained investment and sufficientdisclosures that clearly identify and distinguish between the interests of theparent and the interests of noncontrolling owners.  SFAS 160 is effective forfiscal years, and interim periods within those fiscal years, beginning on orafter December 15, 2008 (that is, January 1, 2009, for entities with calendaryear-ends). Adoption of SFAS 160 did not have a material impact on theCompany's consolidated financial statements.

*Business Combinations - Revised*In December2007, FASB revised SFAS No. 141, "Business Combinations." This revisionestablishes principles and requirements for how the acquirer: (i) recognizesand measures in its financial statements the identifiable assets acquired, theliabilities assumed, and any noncontrolling interest in the acquiree; (ii)recognizes and measures the goodwill acquired in the business combination or again from a bargain purchase; and (iii) determines what information to discloseto enable users of the financial statements to evaluate the nature andfinancial effects of the business combination.  The effective dates of thisrevision are the same as SFAS 160.  Adoption of this revision did not have amaterial impact on the Company's consolidated financial statements.

*Disclosures about DerivativeInstruments and Hedging Activities - an amendment of FASB Statement No. 133*SFAS No. 161amends SFAS No. 133, "Accounting for Derivative Instruments and HedgingActivities," to amend and expand the disclosure requirements of SFAS No. 133 toprovide greater transparency about (i) how and why an entity uses derivativeinstruments, (ii) how derivative instruments and related hedge items areaccounted for under SFAS No. 133 and its related interpretations, and (iii) howderivative instruments and related hedged items affect an entity's financialposition, results of operations and cash flows. To meet those objectives, SFASNo. 161 requires qualitative disclosures about objectives and strategies forusing derivatives, quantitative disclosures about fair value amounts of gainsand losses on derivative instruments and disclosures about credit-risk-relatedcontingent features in derivative agreements. SFAS No. 161 was effective forthe Company on January 1, 2009 and did not have a significant impact on theconsolidated financial statements of the Company.

*Hierarchy of GAAP*In May 2008,FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted AccountingPrinciples" ("SFAS 162"). This statement identifies the sources of accountingprinciples and the framework for selecting the principles to be used in thepreparation of financial statements of nongovernmental entities that arepresented in conformity with GAAP (the GAAP hierarchy). SFAS 162 divides thebody of GAAP into four categories by level of authority. This statement iseffective 60 days following the SEC's approval of the Public Company AccountingOversight Board amendments to AU Section 411, "The Meaning of Present Fairly inConformity With Generally Accepted Accounting Principles."  Adoption of SFAS162 is not expected to have a material impact on the Company's consolidatedfinancial statements as they are already presented in conformity with GAAP.

*Accounting for Financial GuaranteeInsurance Contracts*In May 2008,FASB issued SFAS No. 163 "Accounting for Financial Guarantee InsuranceContracts-an interpretation of FASB Statement No. 60" ("SFAS 163").  Thisstatement requires an insurance enterprise to recognize a claim liability priorto an event of default when there is evidence that credit deterioration hasoccurred in an insured financial obligation and clarifies how SFAS No. 60applies to financial guarantee insurance contracts.  SFAS 163 is effective forfinancial statements issued for fiscal years beginning after December 15,2008.  Adoption of this statement did not have a material impact on theCompany's consolidated financial statements.

*Written Loan Commitments Recorded atFair Value through Earnings*SAB No. 109,"Written Loan Commitments Recorded at Fair Value Through Earnings" ("SAB 109"),supersedes SAB No. 105, "Application of Accounting Principles to LoanCommitments," and indicates that the expected net future cash flows related tothe associated servicing of the loan should be included in the measurement ofall written loan commitments that are accounted for at fair value throughearnings. The guidance in SAB 109 became effective on January 1, 2008 and didnot have a material impact on the consolidated financial statements of theCompany.

*Amendments to the Impairment Guidanceof EITF Issue No. 99-20*FASB Staff Position ("FSP") No.EITF 99-20-1 was issued January 12, 2009 to amend EITF Issue No. 99-20,"Recognition of Interest Income and Impairment on Purchased BeneficialInterests and Beneficial Interests That Continue to Be Held by a Transferor inSecuritized Financial Assets."  The amendment is designed to achieve moreconsistent determination of whether an other-than-temporary impairment hasoccurred.  The FSP retains and emphasizes the objective of another-than-temporary impairment assessment and the related disclosure requirementsin SFAS No. 115, "Accounting for Certain Instruments in Debt and EquitySecurities."  The guidance is effective for interim and annual reportingperiods ending after December 15, 2008.  This guidance is applied in evaluatinginvestment securities for other-than-temporary impairment.  For moreinformation, see Note 3 in the Company's Consolidated Financial Statementsincluded elsewhere in this Annual Report on Form 10-K.

*Determining the Fair Value of a Financial Asset Whenthe Market for That Asset is Not Active*FSP No. FAS 157-3 was issuedOctober 10, 2008 to clarify the application of SFAS 157 in a market that is notactive.  The FSP also provides an example to illustrate key considerations indetermining fair value of a financial instrument when the market for thatfinancial asset is not active.  This FSP was effective upon issuance.  Thisguidance was considered when determining fair value of trust-preferredsecurities held in the investment portfolio. For more information, see Notes 1,3 and 20 in the Company's Consolidated Financial Statements included elsewherein this Annual Report on Form 10-K. 

-24-
ITEM 7A.  QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK
Interest ratesensitivity varies with different types of interest earning assets andinterest-bearing liabilities.  Overnight federal funds, on which rates changedaily, and loans which are tied to the prime rate are much more sensitive thanlong-term investment securities and fixed rate loans. The shorter-term interestsensitive assets and liabilities are key to measurement of the interestsensitivity gap.  Minimizing this gap is a continual challenge and a primaryobjective of the asset/liability management program.

The Companymonitors and employs multiple strategies to continuously manage interest raterisk and liquidity at acceptable levels.  Such strategies include but are notlimited to use of FHLB borrowings, floors on variable rate loans, use ofinterest rate swaps and investments in mortgage-backed investments that enablethe Company to have steady cash inflows.  

Overall, theCompany maintained a fairly neutral position in terms of interest rate riskfrom December 2005 to December 2008 as evidenced by the following comparison ofthe federal funds rate compared to net yield on average earning assets:

Interest raterisk is separated and analyzed according to the following categories of risk:(1) re-pricing;, (2) yield curve;, (3) option risk; (4) price risk; and (5)basis risk. Trading assets are utilized infrequently and are addressed in theinvestment policy.  Any unfavorable trends reflected in interest rate marginswill cause an immediate adjustment to the Bank's gap position orasset/liability management strategies.  The data schedule below reflects asummary of the Company's interest rate risk using simulations.  The projected12-month exposure is based on different rate movements (flat, rising ordeclining).  

-25-

The followingcondensed gap report provides an analysis of interest rate sensitivity ofearning assets and costing liabilities in a flat rate environment:

**CONDENSEDGAP REPORT****CURRENT BALANCESDECEMBER 31, 2008**

One

Three

Six

12

Two

Three

Five

More than Five

Non

Month

Months

Months

Months

Years

Years

Years

Years

Sensitive

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Total

Assets:

Total Cash and Due

   From

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

17,888   

 $

17,888   

Total Investments

4,549  

16,307  

35,849  

41,196  

28,408  

15,564  

17,217  

50,555  

855  

210,500

Total Fed Funds Sold

22,816  

- 

- 

- 

- 

- 

- 

- 

- 

22,816  

Total Net Loans

182,842  

36,848  

47,802  

76,698  

86,676  

73,644  

92,144  

-    

(7,196)

589,458  

Total Other Assets

- 

- 

- 

- 

- 

- 

- 

- 

86,840  

86,840  

Total Assets

 $

210,207  

 $

53,155  

 $

83,651  

 $

117,894  

 $

115,084  

 $

89,208  

 $

109,361  

 $

50,555  

 $

98,387  

 $

927,502  

Liabilities:

Total Demand

 $

-    

 $

-    

 $

-    

 $

10,841   

 $

5,440   

 $

5,440   

 $

-    

 $

87,041   

 $

-    

 $

108,762   

Total Savings

48,603  

-  

-  

-  

19,785  

19,785  

50,814  

94,326  

-  

233,313  

Total Time

46,111  

88,003  

114,611  

113,033  

17,698  

5,039  

7,905  

433  

7  

392,840  

Total Deposits

94,714  

88,003  

114,611  

123,874  

42,923  

30,264  

58,719  

181,800  

7  

734,915  

Total Borrowings

26,088  

12,167  

800  

7,213  

30,653  

10,978  

5,571  

14,138  

-  

107,608  

Other Liabilities

- 

- 

- 

- 

- 

- 

- 

- 

7,971  

7,971  

Total Other Liabilities

26,088  

12,167  

800  

7,213  

30,653  

10,978  

5,571  

14,138  

7,971  

115,579  

Total Liabilities

120,802  

100,170  

115,411  

131,087  

73,576  

41,242  

64,290  

195,721  

7,978  

850,494  

Total Equity

- 

- 

- 

- 

- 

- 

- 

- 

77,008  

77,008  

Total Liabilities/Equity

 $

120,802  

 $

100,170  

 $

115,411  

 $

131,087  

 $

73,576   

 $

41,242  

 $

64,290  

 $

195,721  

 $

84,984  

 $

927,502  

Period Gap

(15,174)

(47,015)

(31,760)

(13,193)

41,508  

47,966  

45,071  

(145,383)

13,401  

-  

Cumulative Gap

89,405  

42,390  

10,630  

(2,563)

38,945  

86,911  

131,982  

(13,401)

-  

-  

RSA/RSL*

87.44%

53.06%

72.48%

89.94%

156.42%

216.30%

170.11%

25.80%

115.77%

0.00%

_______________

*              RSA/RSL means the ratio of rate-sensitiveassets to rate-sensitive liabilities.

-26-

**CONDENSEDGAP REPORTCURRENTBALANCES****DECEMBER 31, 2007**

One

Three

Six

12

Two

Three

Five

More Than Five

Non

Month

Months

Months

Months

Years

Years

Years

Years

Sensitive

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Balance

Total

Assets:

Total Cash and Due

   From

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

-    

 $

23,740  

 $

23,740  

Total Investments

7,180  

10,293  

10,983  

17,445  

29,852  

22,121  

35,885  

54,957  

1,691  

190,407  

Total Fed Funds Sold

1,502  

- 

- 

- 

- 

- 

- 

- 

- 

1,502  

Total Net Loans

190,124  

39,395  

51,640  

92,763  

94,580  

68,241  

47,896  

-    

(6,328)

578,311  

Total Other Assets

- 

- 

- 

- 

- 

- 

- 

- 

82,196  

82,196  

Total Assets

 $

198,806  

 $

49,688  

 $

62,623  

 $

110,208  

 $

124,432  

 $

90,362  

 $

83,781  

 $

54,957  

 $

101,299  

 $

876,156  

Liabilities:

Total Demand

 $

-    

 $

-    

 $

-    

 $

9,715  

 $

4,857  

 $

4,857  

 $

-    

 $

77,661  

 $

-    

 $

97,090  

Total Savings

129,623  

-  

-  

-  

13,626  

13,626  

29,301  

26,667  

-  

212,843  

Total Time

42,152  

69,149  

114,807  

127,037  

11,138  

7,237  

8,964  

178  

-  

380,662  

Total Deposits

171,775  

69,149  

114,807  

136,752  

29,621  

25,720  

38,265  

104,506  

-  

690,595  

Total Borrowings

45,949  

3,977  

1,972  

9,397  

113  

31,000  

9,500  

5,000  

-  

106,908  

Other Liabilities

- 

- 

- 

- 

- 

- 

- 

- 

3,622  

3,622  

Total Other Liabilities

45,949  

3,977  

1,972  

9,397  

113  

31,000  

9,500  

5,000  

3,622  

110,530  

Total Liabilities

217,724  

73,126  

116,779  

146,149  

29,734  

56,720  

47,765  

109,506  

3,622  

801,125  

Total Equity

- 

- 

- 

- 

- 

- 

- 

- 

75,031  

75,031  

Total Liabilities/Equity

 $

217,724  

 $

73,126  

 $

116,779  

 $

146,149  

 $

29,734  

 $

56,720  

 $

47,765  

 $

109,506  

 $

78,653  

 $

876,156  

Period Gap

(18,975)

(23,438)

(54,156)

(35,941)

94,698  

33,642  

36,016  

(54,549)

22,646  

-  

Cumulative Gap

(18,918)

(42,356)

(96,512)

(132,453)

(37,755)

(4,113)

31,903  

(22,646)

-  

-  

RSA/RSL*

91.28%

67.95%

53.63%

75.41%

418.48%

159.31%

175.40%

50.19%

128.79%

0.00%

_______________

*              RSA/RSL means the ratio of rate-sensitiveassets to rate-sensitive liabilities.

*Notes to the Gap Reports*

1.             The gap report reflects the interest sensitivity positions during a flatrate environment.  Time frames could change depending on whether rates rise orfall. 

2.             Re-pricing overrides maturities in various time frames. 

3.             Demand depositsare considered to be core and are spread among the one-year, two-year,three-year and greater than five-year categories for gap analysis.

4.             Savings accounts, also considered core, are split into various timeframes based on characteristics of the various accounts and pricing strategiesrelated to those accounts.  In a flat rate environment, regular savingsaccounts tend not to re-price or liquidate and become price sensitive onlyafter a major increase in the six-month CD rate.  First Rate and WallStreet deposit products are more rate sensitive and, therefore, are placed in thevariable category of less than one month.  

5.             Simulations are utilized to reflect the impact of multiple ratescenarios on net interest income at risk, net income at risk and economic valueof equity at risk.  Strategies are implemented to increase net interest income, while always considering the impact on interest rate risk.  Overall, theBankmanages the gap between rate sensitive liabilities to expand and contract withthe rate cycle phase.  The Bank's Funds Management Committee isresponsible for implementing and monitoring procedures to improve net interestincome through volume increases and better pricing techniques. Long term fixedrate positions will be held to less than 25% of assets, unless they are fundedwith matched deposits or borrowings.  

-27-

The Company'sinterest rate risk position is asset sensitive at year-end 2008.  Therefore,net interest margins could benefit from a slight increase in rates and would bediluted by decreases in rates over the next 12 months under a normal interestrate environment.  However, the current rate environment is unusual and allfour rate-shock scenarios indicate that net interest income would increase overa 12-month period.  These unusual results are driven primarily by historicallylow prime and federal funds rates coupled with the use of rate floors onloans.  As of December 2008, federal funds rates have been set at thehistorical low of a range of 0.00% - 0.25%.  Federal funds rates at this leveldo not have the capacity to decrease even 100 basis points.  Therefore, in theinterest rate risk models, the rates on federal funds and prime hit a floor ofzero and 3.0%, respectively.  The prime rate floor of 3% assumes that the normalspread between federal funds rates and prime is maintained and remains fixed at300 basis points.   While prime rate in the model reaches a floor of 3%, theBank's variable rate loan pricing carries an average floor of 5.5%.  As ratesin the model are shocked, loans will decrease only until the floor position isreached while some liabilities continue to re-price downward.  Therefore, thevariance between the flat rate scenario and the down rate shocks are positive. With federal funds rates currently at 0.25%, the down 100 basis points and down200 basis point scenarios are the most unlikely scenarios.  Exposure in the up100 basis points and up 200 basis points are more realistic scenarios. 

The Company'sexposure to interest rate risk is well within established policy limits aspresented in the following table (dollars in thousands):  

InterestRate RiskDecember31, 2008

Tier 1 Capital                             $73,678

Projected 12 Month Exposure

Rate

**POLICY**

Moves In

Current

Possible

% of Net Interest

% of Net Interest

Net Interest Income Levels*

Basis Pts

 

Position

 

Scenarios

 

Variance

 

Income

 

Income

Declining 2

(200)

 $

27,492  

 $

30,167  

 $

2,675  

9.7%

-20.0%

Declining 1

(100)

27,492  

28,476  

984  

3.6%

-10.0%

**Most Likely-Base**

**0**

** **

**27,492 **

** **

**27,492 **

** **

**-   **

** **

**0.0%**

** **

**0.0%**

Rising 1

100  

27,492  

28,030  

538  

2.0%

-10.0%

Rising 2

200  

27,492  

28,221  

729  

2.7%

-25.0%

____________________________

*              Netinterest income assumes that interest rates would change immediately within thetotal portfolio, a scenario which would reflect a worst case position and isunlikely to happen.  

-28-
ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.Management's Annual Report on Internal Control Over Financial Reporting
The management of First CitizensBancshares, Inc. (the "Company") is responsible for establishing andmaintaining adequate internal control over financial reporting.  The Company'sinternal control system is designed to provide reasonable assurance tomanagement and the Board of Directors regarding the preparation and fairpresentation of the Company's annual financial statements in accordance withgenerally accepted accounting principles of the United States.  

Inherentlimitations exist in the effectiveness of any internal control structure,including the possibility of human error and circumvention of controls. Accordingly, even effective internal control can only provide reasonableassurance with respect to financial statement preparation.  

Managementassessed the effectiveness of the Company's internal controls over financialreporting as of December 31, 2008, based on criteria for effective internalcontrol over financial reporting described in Internal Control-IntegratedFramework issued by the Committee of Sponsoring Organizations of the TreadwayCommission.  Based on this assessment, management believes that, as of December31, 2008, the Company's internal control over financial reporting waseffective.  

AlexanderThompson Arnold, PLLC, the Company's independent registered public accountingfirm, has audited the Company's consolidated financial statements and issued anattestation report on the Company's internal control over financial reporting.This report appears on page 48 of this Annual Report on Form 10-K.

 -29-
** 

                                                                           
185 N. Church      Street                                                      Telephone: (731) 285-7900      Dyersburg, TN       38024                                                      (800) 608-5612                                                                                               Fax: (731) 285-6221
                                                                                                                                                                                                                 Members      of:                                                                                                                                                                                                                                                                              American Institute of Certified Public Accountants                                                                                                                                                                                                                   Governmental Audit Quality Center - AICPA                                                                                                                                                                                                                              Tennessee Society of Certified Public Accountants                                                                                                                                                                                                                 Center for Public Company Audit      Firms                                                                                                                                                                                                                                     Employee Benefit Plan Audit Quality Center - AICPA                                                                                                                                                                                                                 www.atacpa.net                                                       **REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors andStockholders of First Citizens Bancshares, Inc. and SubsidiariesDyersburg, Tennessee 38024

Wehave audited the accompanying consolidated balance sheets of First CitizensBancshares, Inc., and subsidiaries as of December 31, 2008 and 2007, and therelated consolidated statements of income, comprehensive income, stockholders'equity, and cash flows for each of the years in the three year period ended December31, 2008.  We also have audited First Citizens Bancshares, Inc. andsubsidiaries' internal control over financial reporting as of December 31, 2008,based on criteria established in *Internal Control-Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  First Citizens Bancshares, Inc. and subsidiaries' management isresponsible for these financial statements, for maintaining effective internalcontrol over financial reporting, and for its assessment of the effectivenessof internal control over financial reporting.  Our responsibility is to expressan opinion on these financial statements and an opinion on the company'sinternal control over financial reporting based on our audits.

Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States).  Those standards require that weplan and perform the audits to obtain reasonable assurance about whether thefinancial statements are free of material misstatement and whether effectiveinternal control over financial reporting was maintained in all materialrespects.  Our audits of the financial statements included examining, on a testbasis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, and evaluating the overall financial statementpresentation.  Our audit of internal control over financial reporting includedobtaining an understanding of internal control over financial reporting, assessingthe risk that a material weakness exists, and testing and evaluating the designand operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considerednecessary in the circumstances.  We believe that our audits provide areasonable basis for our opinions.

Acompany's internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles.  A company's internal controlover financial reporting includes those policies and procedures that (1)pertain to the maintenance of records that, in reasonable detail, accuratelyand fairly reflect the transactions and dispositions of the assets of thecompany; (2) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that receipts and expenditures ofthe company are being made only in accordance with authorizations of managementand directors of the company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company's assets that could have a material effect on the financialstatements.

-30 -

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements.  Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls maybecome inadequate because of changes in conditions, or that the degree ofcompliance with the policies or procedures may deteriorate.

Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of First Citizens Bancshares, Inc.,and subsidiaries as of December 31, 2008 and 2007, and the results of itsoperations and its cash flows for each of the years in the three-year periodended December 31, 2008, in conformity with accounting principles generallyaccepted in the United States of America.  Also, in our opinion, First CitizensBancshares, Inc. and subsidiaries maintained, in all material respects,effective internal control over financial reporting as of December 31, 2008, basedon criteria established in *Internal Control-Integrated Framework* issuedby the Committee of Sponsoring Organizations of the Treadway Commission(COSO).  
** 

/s/ ALEXANDER THOMPSON ARNOLD PLLC

Dyersburg, Tennessee

March 3, 2009
**Dyersburg, TNFulton, KYHenderson, TNJackson, TNMartin, TN Milan, TNMcKenzie, TNParis, TNTrenton, TNUnion City, TN
 

 

 

 

 

-31-
FIRST CITIZENS BANCSHARES, INC. AND SUBSIDIARIES**CONSOLIDATEDBALANCE SHEETS**DECEMBER 31, 2008 AND 2007***(dollars in thousands)***
**December 31,  2008**

** **

**December 31,  2007**

Assets

Cash and Due From Banks

 $

17,888   

 $

23,740   

Federal Funds Sold

22,816   

1,502   

Cash and Cash Equivalents

40,704   

25,242   

Investment Securities:

Trading Investments-Stated at Market

-   

-   

Held-To-Maturity, at Amortized Cost, Fair

Value of $115 at December 31, 2008

and $291 at December 31, 2007

115   

290   

Available-For-Sale, Stated at Market

210,385   

190,117   

Loans (Excluding Unearned Income of $506 at December 31,  2008

and $425 at December 31, 2007)

596,758   

584,639   

Less:  Allowance for Loan Losses

7,300   

6,328   

Net Loans

589,458   

578,311   

Loans Held-For-Sale

2,632   

2,187   

Federal Home Loan Bank and Federal Reserve Bank Stocks, at  Cost

5,684   

5,505   

Premises and Equipment

31,746   

30,308   

Accrued Interest Receivable

5,581   

6,564   

Goodwill

11,825   

11,825   

Other Intangible Assets

289   

373   

Other Real Estate

5,424   

2,302   

Bank Owned Life Insurance Policies

20,627   

19,933   

Other Assets

3,032   

3,199   

TOTAL ASSETS

 $

927,502   

 $

876,156   

LIABILITIES AND SHAREHOLDERS' EQUITY

Deposits

Demand

 $

108,762   

 $

97,090   

Time

392,840   

380,662   

Savings

233,313   

212,843   

Total Deposits

734,915   

690,595   

Securities Sold Under Agreements to  

Repurchase

32,765   

32,643   

Federal Funds Purchased and Other Short

Term Borrowings

1,000   

11,100   

Long-Term Debt

73,843   

63,165   

Other Liabilities

7,971   

3,622   

Total Liabilities

850,494   

801,125   

Shareholders' Equity:

Common Stock, No Par Value - 10,000,000

Authorized; 3,717,593 Issued and  

Outstanding at December 31, 2008 and 3,717,593

Issued and Outstanding at December 31, 2007

 $

3,718   

 $

3,718   

Surplus

15,331   

15,331   

Retained Earnings

58,890   

57,485   

Accumulated Other Comprehensive Income

1,526   

944   

Total Common Stock and Retained Earnings

79,465   

77,478   

Less-93,094 Treasury Shares, at Cost as of December 31,  2008

 and 92,837 Treasury Shares, at Cost as of December 31,  2007

2,457   

2,447   

Total Shareholders' Equity

77,008   

75,031   

TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 $

927,502   

 $

876,156   

*Note:  Seeaccompanying notes to consolidated financial statements.*

-32-

**FIRST CITIZENSBANCSHARES, INC. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF INCOME****YEARS ENDED DECEMBER 31, 2008, 2007 AND 200****6  **

2008

 

2007

 

2006

**Interest Income**

   Interest and Fees on Loans

 $

42,357   

 $

44,700   

 $

42,372   

   Interest and Dividends on Investment Securities:

     Taxable

7,334   

6,679   

5,719   

     Tax-exempt

2,329   

1,993   

1,807   

     Dividends

309   

408   

359   

   Other Interest Income

138   

499   

670   

     Total Interest Income

52,467   

54,279   

50,927   

**Interest Expense**

   Interest on Deposits

17,517   

21,616   

18,832   

   Interest on Borrowings

4,166   

4,057   

4,370   

   Other Interest Expense

951   

1,177   

940   

     Total Interest Expense

22,634   

26,850   

24,142   

         Net Interest Income

29,833   

27,429   

26,785   

**Provision for Loan Losses**

2,858   

834   

683   

 Net Interest Income After Provision for Loan Losses

26,975   

26,595   

26,102   

**Other Income**

   Mortgage Banking Income

1,139   

1,178   

1,185   

   Income from Fiduciary Activities

816   

1,007   

940   

   Service Charges on Deposit Accounts

7,272   

6,962   

6,059   

   Brokerage Fees

1,473   

1,565   

1,357   

   Earnings on Bank Owned Life Insurance

833   

695   

681   

   Securities Gains (Losses) - Net

(1,374)

(29)

-     

   Other Income

1,511   

1,536   

1,611   

     Total Other Income

11,670   

12,914   

11,833   

**Other Expenses**

   Salaries and Employee Benefits

16,833   

15,687   

15,074   

   Net Occupancy Expense

1,745   

1,685   

1,591   

   Depreciation

1,868   

2,095   

2,059   

   Data Processing Expense

984   

843   

853   

   Legal and Professional Fees

353   

327   

284   

   Stationary and Office Supplies

259   

286   

284   

   Amortization of Intangibles

85   

85   

85   

   Advertising and Promotions

711   

765   

654   

   Expenses Related to Other Real Estate

719   

332   

50   

   Other Expenses

5,234  

5,239   

4,994   

     Total Other Expenses

28,348   

27,344   

25,928   

Net Income Before Income Taxes

10,297   

12,165   

12,007   

Provision for Income Tax Expense

2,768   

3,005   

2,850   

Net Income

 $

7,529   

 $

9,160   

 $

9,157   

Earnings Per Common Share:

 Net Income

 $

2.08   

 $

2.53   

 $

2.52   

Weighted Average Shares Outstanding

3,625   

3,626   

3,633   

*Note:  Seeaccompanying notes to consolidated financial statements.*

** **-33-

**FIRST CITIZENSBANCSHARES, INC. AND SUBSIDIARIESCONSOLIDATEDSTATEMENTS OF COMPREHENSIVE INCOMEYEARS ENDEDDECEMBER 31, 2008, 2007 AND 2006**

**2008**

** **

**2007**

** **

**2006**

Net Income For Year

 $

7,529   

 $

9,160   

 $

9,157   

Other Comprehensive Income, Net of Tax:

    Net Change in Unrealized (Losses) Gains on Cash Flow  Hedge

(14)

(37)

40   

    Net Change in Unrealized Gains on Available-

       for-Sale Securities

596   

873   

968   

         Total Other Comprehensive Income, Net of Tax

582   

836   

1,008   

**  Total Comprehensive Income**

** **

 $

8,111   

 $

9,996   

 $

10,165   

** **Related tax effects allocated to each component of othercomprehensive income are as follows:

Before-tax

Tax (Expense)

Net-of-tax

 
Amount

or Benefit

Amount

 
 
**Year Ended December 31, 2008:**

 
 Unrealized (Losses) Gains on Cash Flow Hedge

 $

(23)

 $

9   

 $

(14)

 Unrealized Gains (Losses) on Available-for-Sale  Securities:

 
           Unrealized (Losses) Gains Arising During the  Period

(408)

156   

(252)

 
           Reclassification Adjustments For Net Losses  Included in Net Income

1,374   

(526)

848   

 
 Unrealized Gains (Losses) on Available-for-Sale  Securities, net

966   

(370)

596   

 
                  Net Unrealized Gains (Losses)

 $

943   

 $

(361)

 $

582   

 
 
**Year Ended December 31, 2007;**

 
 Unrealized (Losses) Gains on Cash Flow Hedge

 $

(60)

 $

23   

 $

(37)

 
 Unrealized Gains (Losses) on Available-for-Sale  Securities:

 
           Unrealized Gains (Losses) Arising During the  Period

1,385   

(530)

855   

 
           Reclassification Adjustments For Gains (Losses)  Included

 
               in Net Income

29   

(11)

18   

 
 Unrealized Gains (Losses) on Available-for-Sale  Securities, net

1,414   

(541)

873   

 
                  Net Unrealized Gains (Losses)

 $

1,354   

 $

(518)

 $

836   

 
 
**Year Ended December 31, 2006;**

 
 Unrealized Gains (Losses) on Cash Flow Hedge

 $

61   

 $

(21)

 $

40   

 
 Unrealized Gains (Losses) on Available-for-Sale  Securities:

 
           Unrealized Gains (Losses) Arising During the  Period

1,465   

(497)

968   

 
           Reclassification Adjustments For Losses  Included in Net Income

-     

-     

-     

 
 Unrealized Gains (Losses) on Available-for-Sale  Securities, net

1,465   

(497)

968   

 
                  Net Unrealized Gains (Losses)

 $

1,526   

 $

(518)

 $

1,008   

 
*Note:  See accompanying notes to consolidated financial statements.*

** **-34-

**FIRST CITIZENSBANCSHARES, INC.CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS' EQUITYYEARS ENDEDDECEMBER 31, 2007, 2006 AND 2005*(in thousands,except per share data)***

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Accum.**

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Other**

** **

** **

** **

** **

**Common Stock**

** **

** **

** **

**Retained**

** **

**Compre.**

** **

**Treasury**

** **

** **

**Shares**

** **

**Amount**

** **

**Surplus**

** **

**Earnings**

** **

**Income**

** **

**Stock**

** **

**Total**

** **

**(#)**

** **

**($)**

** **

**($)**

** **

**($)**

** **

**($)**

** **

**($)**

** **

**($)**

**Balance January 1, 2006**

3,718 

 $

3,718  

 $

15,331  

 $

47,591  

 $

(900)

 $

(2,094)

 $

63,646  

Net Income, Year Ended  December 31, 2006

9,157  

9,157  

Adjustment of Unrealized  Gain on

 Securities  Available-for-Sale, net of tax

968  

968  

Adjustment of Unrealized  Gain on

 Cash Flow Hedge, net of  tax

40  

40  

Cash Dividends Paid - $1.16  per Share

(4,216)

(4,216)

Treasury Stock Transitions -  Net

(97)

(97)

**Balance December 31, 2006**

3,718 

 $

3,718  

 $

15,331  

 $

52,532  

 $

108  

 $

(2,191)

 $

69,498  

Net Income, Year Ended  December 31, 2007

9,160  

9,160  

Adjustment of Unrealized  Gain on

 Securities  Available-for-Sale, net of tax

873  

873  

Adjustment of Unrealized  Gain (Loss) on

 Cash Flow Hedge, net of  tax

(37)

(37)

Cash Dividends Paid - $1.16  per Share

(4,207)

(4,207)

Treasury Stock Transitions -  Net

(256)

(256)

**Balance December 31, 2007**

3,718 

 $

3,718  

 $

15,331  

 $

57,485  

 $

944  

 $

(2,447)

 $

75,031  

Net Income, Year Ended  December 31, 2008

7,529  

7,529  

Cumulative effect for change in accounting

   principle (adoption of EITF 06-04)

(1,919)

(1,919)

Adjustment of Unrealized  Gain on

 Securities  Available-for-Sale, net of tax

596  

596  

Adjustment of Unrealized  Gain (Loss) on

 Cash Flow Hedge, net of  tax

(14)

(14)

Cash Dividends Paid - $1.16  per Share

(4,205)

(4,205)

Treasury Stock Transitions -  Net

(10)

(10)

**Balance December 31, 2008**

3,718 

 $

3,718  

 $

15,331  

 $

58,890  

 $

1,526  

 $

(2,457)

 $

77,008  

** **

*Note:  Seeaccompanying notes to consolidated financial statements.*

-35-

** FIRST CITIZENSBANCSHARES, INC. AND SUBSIDIARIESCONSOLIDATEDSTATEMENT OF CASH FLOWSYEARS ENDEDDECEMBER 31, 2008, 2007 AND 2006*(in thousands)***

*** ***

**2008**

** **

**2007**

** **

**2006**

**Operating Activities**

Net Income

 $

7,529   

 $

9,160   

 $

9,157   

Adjustments to Reconcile Net Income to Net

 Cash Provided by Operating Activities:

     Provision for Loan Losses

2,858   

834   

683   

     Provision for Depreciation

1,868   

2,095   

2,059   

     Provision for Amortization - Intangibles

85   

85   

85   

     Deferred Income Taxes

(870)

669   

336   

     Realized Investment Security Losses

1,374   

29   

-   

     Net (Increase) Decrease in Loans Held-for-Sale

(445)

1,262   

(406)

     Decrease (Increase) in Accrued Interest Receivable

983   

196   

(1,282)

     Increase in Accrued Interest Payable

148   

245   

632   

     (Increase) in Cash Surrender Value of Bank Owned Life  Insurance

(694)

(564)

(676)

     Net (Increase) in Other Assets

(12)

(403)

(441)

     Net Increase (Decrease) in Other Liabilities

2,821   

(362)

(630)

NET CASH PROVIDED BY OPERATING ACTIVITIES

 $

15,645   

 $

13,246   

 $

9,517   

**Investing Activities**

 Proceeds of Maturities of Held-to-Maturity Investment Securities

 $

175   

 $

-   

 $

-   

 Proceeds of Sales of Available-for-Sale Investment  Securities

30,497   

23,413   

-   

 Proceeds of Paydowns and Maturities of  Available-for-Sale

     Investment Securities

50,402   

18,572   

22,669   

 Purchases of Available-for-Sale Investment Securities

(101,226)

(53,361)

(36,637)

 Increase in Loans - Net

(18,807)

(38,286)

(6,037)

 Proceeds from Sale of Other Real Estate

1,396   

969   

654   

 Premiums on Bank Owned Life Insurance-Net

-   

(2,145)

(535)

 Purchase of Premises and Equipment

(3,306)

(4,169)

(2,651)

NET CASH USED BY INVESTING ACTIVITIES

 $

(40,869)

 $

(55,007)

 $

(22,537)

**Financing Activities**

 Net Increase in Demand Deposits, NOW Accounts,

     and Savings Accounts

 $

32,142   

 $

14,016   

 $

8,928   

 Increase in Time Deposits - Net

12,178   

10,516   

21,626   

 Increase in Long-Term Borrowings

12,000   

10,155   

-   

 Payment of Principal on Long-Term Debt

(1,319)

(6,528)

(18,590)

 Cash Dividends Paid

(4,205)

(4,207)

(4,216)

 Net (Decrease) Increase in Short-Term Borrowings

(10,100)

10,762   

(2,772)

 Treasury Stock Transactions - Net

(10)

(256)

(97)

NET CASH PROVIDED BY FINANCING ACTIVITIES

$       40,686   

$       34,458   

 $           4,879 

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

15,462   

(7,303)

(8,141)

Cash and Cash Equivalents at Beginning of Year

25,242   

32,545   

40,686   

**CASH AND CASH EQUIVALENTS AT END OF YEAR**

 $

40,704   

 $

25,242   

 $

32,545   

Supplemental Cash Flow Information:

 Interest Paid

 $

22,782   

 $

27,095   

 $

24,142   

 Income Taxes Paid

 $

2,425   

 $

2,950   

 $

2,870   

Supplemental Noncash Disclosures:

 Transfers from Loans to Foreclosed Assets

 $

5,510   

 $

488   

 $

2,613   

 Transfers from Foreclosed Assets to Loans

 $

423   

 $

416   

 $

220   

*Note:  Seeaccompanying notes to consolidated financial statements.*

** **-36-

**FIRST CITIZENSBANCSHARES, INC. AND SUBSIDIARIESNOTES TOCONSOLIDATED FINANCIAL STATEMENTSDECEMBER 31, 2008AND 2007**

**NOTE 1 - SUMMARY OFSIGNIFICANT ACCOUNTING AND REPORTING POLICIES**

The accounting and reportingpolicies of First Citizens Bancshares, Inc., and subsidiaries (the "Company")conform to generally accepted accounting principles.  The significant policiesare described as follows:

**Basis of Presentation**

All dollar amounts set forthbelow, other than per-share amounts, are in thousands unless otherwise noted. The Consolidated Financial Statements include all accounts of the Company andits subsidiary, First Citizens National Bank (the "Bank").  First CitizensCapital Assets, Inc., a subsidiary of the Company, was liquidated in December2006 with no material impact to Consolidated Financial Statements.  FirstCitizens (TN) Statutory Trusts II, III and IV are reported under the equitymethod in accordance with generally accepted accounting principles for VariableInterest Entities for all periods presented.  These investments are included inOther Assets and the proportionate share of income (loss) is included in othernon-interest income.  The Bank also has two wholly owned subsidiaries, FirstCitizens Financial Plus, Inc. and First Citizens Investments, Inc., which areconsolidated into its financial statements.  The Company's investment in thesesubsidiaries is reflected on the Company's condensed balance sheet (See Note22).  

The Bank has a 50% ownership intwo insurance subsidiaries both of which are accounted for using the equitymethod.  White and Associates/First Citizens Insurance, LLC is a generalinsurance agency offering a full line of insurance products and FirstCitizens/White and Associates Insurance Company's principal activity is creditinsurance.  The investment in these subsidiaries is included in Other Assets onthe Balance Sheets presented in this report and earnings from these subsidiariesare recorded in Other Income on the Income Statements presented in thisreport.  

The principal activity of FirstCitizens Investments, Inc. is to acquire and sell investment securities as wellas collect the income from the portfolio.  First Citizens Holdings, Inc., awholly owned subsidiary of First Citizens Investments, Inc., acquires and sellscertain investment securities, collects income from its portfolio, and ownsFirst Citizens Properties, Inc., a real estate investment trust.  First CitizensProperties, Inc. invests in participation interests of real estate loans madeby the Bank and provides the Company with an alternative vehicle for raisingcapital.  First Citizens Holdings, Inc. owns 98% of the outstanding preferredstock of First Citizens Properties, Inc. and directors, executive officers andcertain employees own the remaining 2%.  

The Company also has two whollyowned subsidiaries, First Citizens (TN) Statutory Trust III and First Citizens(TN) Statutory Trust IV.  First Citizens (TN) Statutory Trust II was terminatedin March 2007.  The purpose and activities of these trusts are furtherdiscussed in Note 13 of Notes to the Consolidated Financial Statements. 

All significant inter-companybalances and transactions are eliminated in consolidation.  Certain balanceshave been reclassified to conform to current year presentation.  

**Nature of Operations**

The Company and its subsidiariesprovide commercial banking services of a wide variety to individuals andcorporate customers in the mid-southern United States with a concentration in West Tennessee.  The Company's primary products are checking and savings deposits andresidential, commercial, and consumer lending.

**Basis of Accounting**

The Consolidated FinancialStatements are presented using the accrual basis of accounting.

**Use of Estimates**

The preparation of financialstatements in conformity with generally accepted accounting principles requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent assets and liabilitiesat the date of the financial statements and the reported amounts of revenuesand expenses during the reporting periods.  Actual results could differ fromthose estimates.

Material estimates that areparticularly susceptible to significant change relate to the fair value ofinvestment securities, determination of the allowance for losses on loans andthe valuation of real estate acquired in connection with foreclosures or insatisfaction of loans.  In connection with the determination of the allowancesfor losses on loans and foreclosed real estate, management obtains independentappraisals for significant properties.

**Cash Equivalents**

Cash equivalents include amountsdue from banks, which do not bear interest and federal funds sold. Generally,federal funds are purchased or sold for one-day periods.  

-37-

**Securities**

Investment securities areclassified as follows:

•        Held-to-maturity, which includes those investment securitieswhich the Company has the intent and the ability to hold until maturity; 

•        Trading securities, which include those investments that are heldfor short-term resale; and

•        Available-for-sale, which includes all other investmentsecurities.

Held-to-maturity securities arereflected at cost, adjusted for amortization of premiums and accretion ofdiscounts using methods, which approximate the interest method. Available-for-sale securities are carried at fair value, and unrealized gainsand losses are recognized as direct increases or decreases to accumulated othercomprehensive income unless unrealized losses are considered to beother-than-temporarily impaired.  Other-than-temporary impairment losses arerecorded against earnings in Realized Gains (Losses) on Available-for-Sale Securities,which is separately stated in Other Income section on the Consolidated IncomeStatements.  Trading securities, where applicable, are carried at fair value,and unrealized gains and losses on these securities are included in net income.

Realized gains and losses oninvestment securities transactions are determined based on the specificidentification method and are included in net income.

**Loans Held for Sale**

Mortgage loans originated andintended for sale in the secondary market are carried at the lower of aggregatecost or market, as determined by outstanding commitments from investors.  Netunrealized losses, if any, are recorded as a valuation allowance and charged toearnings.  Servicing rights are not retained when mortgage loans are sold. Income from loans held for sale is reported in Mortgage Banking Income, whichis included in Other Non-Interest Income in the Consolidated FinancialStatements.

**Loans**

Loans that management has theintent and ability to hold for the foreseeable future or until maturity orpayoff are reflected on the balance sheets at the unpaid principal amount lessthe allowance for loan losses and unearned interest and fees.

Loans are generally placed onnon-accrual status when, in the judgment of management, the loans have becomeimpaired.  Unpaid interest on loans placed on non-accrual status is reversedfrom income and further accruals of income are not usually recognized. Subsequent collections related to impaired loans are usually credited first toprincipal and then to previously uncollected interest.

**Allowancefor Loan Losses**

The allowance for loan losses isestablished as losses are estimated to have occurred through a provision forloan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses isevaluated on a regular basis by management and is based upon management's periodicreview of the collectability of the loans in light of historical experience,the nature and volume of the loan portfolio, adverse situations that may affectthe borrower's ability to repay, estimated value of any underlying collateraland prevailing economic conditions.  This evaluation is inherently subjective,as it requires estimates that are susceptible to significant revision as moreinformation becomes available.

The allowance consists ofspecific and general components.  The specific component relates to specificloans that are considered impaired in accordance with Statement of FinancialAccounting Standards ("SFAS") No. 114.  For each impaired loan, a specificallowance is established when the discounted cash flows (or collateral value orobservable market price) of the impaired loan is lower than the carrying valueof that loan.  The general component covers non-impaired loans and pools ofhomogeneous loans not evaluated individually for impairment.  The generalcomponent is based on historical loss experience adjusted for qualitativefactors.  

A loan is considered impairedwhen, based on current information and events, it is probable that the Companywill be unable to collect scheduled payments of principal or interest when dueaccording to contractual terms of the loan agreement.  Factors considered bymanagement in determining impairment include payment status, collateral value,and the probability of collecting scheduled principal and interest paymentswhen due.  Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines thesignificance of payment delays and payment shortfalls on a case-by-case basis,taking into consideration all circumstances surrounding the loan and theborrower, including the length of delay, reasons for the delay, borrower'sprior payment record, and amount of the shortfall in relation to principal andinterest owed.  Impairment is measured on a loan by loan basis for commercialand construction loans by either the present value of expected future cashflows discounted at the loan's effective interest rate, the loan's obtainablemarket price, or fair value of the collateral if the loan is collateraldependent.

Large groups of smaller balancehomogeneous loans are collectively evaluated for impairment.  Accordingly, theCompany does not separately identify individual consumer and smaller balanceresidential loans for impairment disclosures, unless such loans are the subjectof a restructuring agreement.

**Premises and Equipment**

Bank premises and equipment arestated at cost less accumulated depreciation. The provision for depreciation iscomputed using straight-line and accelerated methods for both financialreporting and income tax purposes.  Expenditures for maintenance and repairsare charged against income as incurred. Cost of major additions andimprovements are capitalized and depreciated over estimated useful lives.

**Other Real Estate**

Real estate acquired throughforeclosure is separately stated on the Consolidated Balance Sheets as "OtherReal Estate" and recorded at the lower of fair value.  Adjustments made at thedate of foreclosure are charged to the allowance for loan losses.  Expensesincurred in connection with ownership, subsequent adjustments to book value,and gains and losses upon disposition are included in other non-interestexpenses.  

Adjustments to net realizablevalue subsequent to acquisition are made at least annually if necessary basedon appraisal.

-38-

**Income Taxes**

The Company uses the accrualmethod of accounting for federal and state income tax reporting.   Deferred taxassets or liabilities are computed for significant differences in financialstatement and tax bases of assets and liabilities, which result from temporarydifferences in financial statement and tax accounting. A valuation allowance,if needed, reduces deferred tax assets to the amount expected to be realized. Provision for income taxes is made on a separate income tax return basis foreach entity included in the Consolidated Financial Statements.  

**InterestIncome on Loans**

Interest income on commercial andreal estate loans is computed on the basis of daily principal balanceoutstanding using the accrual method.  Interest on installment loans is creditedto operations by the level-yield method.  Interest income on loans isdiscontinued at the time the loan is 90 days delinquent unless the loan is wellsecured and in process of collection.  Loans may be placed on non-accrualstatus at an earlier date if collection of principal or interest is considereddoubtful.  All interest accrued but not received for loans placed onnon-accrual status is reversed against interest income.  Interest received onsuch loans is accounted for on the cash-basis or cost-recovery method untilqualifying to return to accrual status.  Loans are returned to accrual statuswhen all principal and interest amounts contractually due are brought currentand future payments are reasonably assured.  

**Net Income Per Share of CommonStock**

Net income per share of commonstock is computed by dividing net income by the weighted average number ofshares of common stock outstanding during the period, after giving retroactiveeffect to stock dividends and stock splits.

**Income from Fiduciary Activities**

Income from fiduciary activitiesis recorded on the accrual basis.

**Advertising and Promotions**

The Company's policy is to chargeadvertising and promotions to expense as incurred.

**Fair Value**

Fair value measurements are usedto record fair value adjustments to certain assets and liabilities and todetermine fair value disclosures.  The Company adopted SFAS No. 157, "FairValue Measurements" ("SFAS 157") effective January 1, 2008 for all applicablefinancial and non-financial assets and liabilities.  SFAS 157 defines fairvalue, establishes a framework for measuring fair value and expands disclosurerequirements regarding fair value measurements.   This standard does not expandthe use of fair value in any new circumstances but clarifies the principle thatfair value should be based on assumptions that market participants would usewhen pricing the asset or liability.  The standard outlines the following threeacceptable valuation techniques that may be used to measure fair value: 
-  Market approach-The market     approach uses prices and other relevant information generated by market     transactions involving identical or similar assets or liabilities.  This     technique includes matrix pricing that is a mathematical technique used     principally to value debt securities without relying solely on quoted     prices for specific securities but rather by relying on securities'     relationship to other benchmark quoted securities.   
-  Income approach-The income     approach uses valuation techniques to convert future amounts such as     earnings or cash flows to a single present discounted amount.  The     measurement is based on the value indicated by current market expectations     about those future amounts.  Such valuation techniques include present     value techniques, option-pricing models (such as Black-Scholes-Merton     formula and a binomial model), and multi-period excess earnings method     (used to measure fair value of certain intangible assets).
-  Cost approach-The cost approach     is based on current replacement cost which is the amount that would     currently be required to replace the service capacity of an asset.   

Valuation techniques are selectedas appropriate for the circumstances and for which sufficient data isavailable.  Valuation techniques are to be consistently applied but a change invaluation techniques or its application may be made if the change results in ameasurement that is equally or more representative of fair value in thecircumstances.  Revisions resulting from a change in valuation technique or itsapplication are accounting for as a change in accounting estimate (inaccordance with SFAS No. 154, "Accounting Changes and Error Corrections") whichdoes not require the change in accounting estimate to be accounted for byrestating or retrospectively adjusting amounts reported in financial statementsof prior periods or by reporting pro forma amounts for prior periods. 

SFAS 157 also establishes ahierarchy that prioritizes information used to develop those assumptions.  Thelevel in the hierarchy within which the fair value measurement in its entiretyfalls is determined based on the lowest level input that is significant to thefair value measurement in its entirety.  The Company considers an input to besignificant if it drives more than 10% of the total fair value of a particularasset or liability.  The hierarchy is as follows:

**Level 1Inputs**(Highest ranking):    Unadjusted quoted prices in active markets foridentical assets or liabilities that the entity has the ability to access atthe measurement date.

**Level 2 Inputs**:    Inputsother than quoted prices included in Level 1 that are observable for the assetor liability, either directly or indirectly.  Such inputs may include quotedprices for similar assets or liabilities in active markets, and inputs otherthan quoted market prices that are observable for the assets and liabilitiessuch as interest rates and yield curves that are observable at commonly quotedintervals.

**Level 3Inputs**(Lowest ranking):     Unobservable inputs for determining fairvalues of assets and liabilities that reflect an entity's own assumptions aboutthe assumptions that market participants would use in pricing the assets andliabilities.

Assets and liabilities may bemeasured for fair value on a recurring basis (daily, weekly, monthly or quarterly)or on a non-recurring basis in periods subsequent to initial recognition. Recurring valuations are measured regularly for investment securities and thecash flow hedge.  Loans held for sale, other real estate and impaired loans aremeasured at fair value on a non-recurring basis and do not necessarily resultin a change in the amount recorded on the balance sheet.  Generally, theseassets have non-recurring valuations that are the result of application ofother accounting pronouncements that require the assets be assessed forimpairment or at the lower of cost or fair value.  Fair values of loans heldfor sale are considered Level 2.  Fair values for other real estate andimpaired loans are considered Level 3.  See also Note 20.

The Company obtains fair value measurements forsecurities and the cash flow hedge from a third party vendor.  The cash flowhedge and the majority of the available-for-sale securities are valued usingLevel 2 inputs.  Collateralized debt obligation securities that are backed bytrust preferred securities and account for less than 2% of theavailable-for-sale securities portfolio are valued using Level 3 inputs.  Thefair value measurements reported in Level 2 are primarily matrix pricing thatconsiders observable data (such as dealer quotes, market spreads, cash flows,the U.S. Treasury yield curve, live trading levels, trade execution data,market consensus prepayment speeds, credit information and terms and conditionsof bonds, and other factors).  Fair value measurements for trust-preferredsecurities are obtained through the use of valuation models that includeunobservable inputs which are considered Level 3.  See additional discussion ofvaluation techniques and inputs at Note 20.

Certain non-financial assets and non-financialliabilities measured at fair value on a recurring basis include reporting unitsmeasured at fair value in the first step of a goodwill impairment test. Certainnon-financial assets measured at fair value on a non-recurring basis includenon-financial assets and non-financial liabilities measured at fair value inthe second step of a goodwill impairment test, as well as intangible assets andother non-financial long-lived assets measured at fair value for impairmentassessment.  SFAS 157 will be applicable to these fair value measurementsbeginning January 1, 2009.

Effective January 1, 2008, the Company adopted provisionsof SFAS No. 159, "The Fair Value Option for Financial Assets and FinancialLiabilities - Including an amendment of FASB Statement No. 115" ("SFAS 159").SFAS 159 permits the Company to choose to measure eligible items at fair valueat specified election dates. Unrealized gains and losses on items for which thefair value measurement option has been elected are reported in earnings at eachsubsequent reporting date. The fair value option (i) may be applied instrumentby instrument, with certain exceptions enabling the Company to record identicalfinancial assets and liabilities at fair value or by another measurement basispermitted under generally accepted accounting principles, (ii) is irrevocable(unless a new election date occurs) and (iii) is applied only to entireinstruments and not to portions of instruments. Adoption of SFAS 159 on January1, 2008 did not have a material impact on the financial statements of theCompany.

-39-

**NOTE 2 - CASH RESERVEREQUIREMENTS**

The Bank maintains cash reservebalances as required by the Federal Reserve Bank.  Average required balancesduring both 2008 and 2007 were, approximately $500,000.

**NOTE 3 - INVESTMENT SECURITIES**

The following tables reflectamortized cost, unrealized gains, unrealized losses and fair value ofinvestment securities for the dates presented, segregated into held-to-maturityand available-for-sale categories:

Gross

Gross

Amortized

Unrealized

Unrealized

Fair

Cost

 

Gains

 

Losses

 

Value

**As of December 31, 2008  (in thousands):**

Securities  Held-to-Maturity:

Obligations of States  and  Political Subdivisions

 $

115  

 $

-  

 $

-  

 $

115  

Securities  Available-for-Sale:

U.S. Treasury Securities  and Obligations of U.S.

 Government Agencies and  Corporations

 $

144,596   

 $

3,688   

 $

(14)

 $

148,269   

Obligations of States  and  Political Subdivisions

59,196   

1,065   

(788)

59,474   

All Others

3,939   

7  

(1,304)

2,642   

 $

207,731   

 $

4,760   

 $

(2,106)

 $

210,385   

**As of December 31, 2007  (in thousands):**

Securities  Held-to-Maturity:

Obligations of States  and  Political Subdivisions

 $

290  

 $

1  

 $

-  

 $

291  

Securities  Available-for-Sale:

U.S. Treasury Securities  and Obligations of U.S.

 Government Agencies and  Corporations

 $

134,139   

 $

1,004   

 $

(971)

 $

134,171   

Obligations of States  and  Political Subdivisions

49,374   

1,772   

(110)

51,037   

All Others

4,913   

131  

(135)

4,909   

 $

188,426   

 $

2,907   

 $

(1,216)

 $

190,117   

The table below summarizes contractual maturities of debtsecurities held-to-maturity and available-for-sale as of December 31, 2008 (inthousands):

Securities

Securities

Held to Maturity

Available for Sale

Amortized Cost

Fair Value

Amortized Cost

Fair Value

Amounts Maturing In:

 One Year or Less

 $

-   

 $

-   

 $

5,733   

 $

5,786   

 After One Year Through Five Years

115   

115   

13,870  

14,098  

 After Five Years Through Ten Years

-   

-   

32,532  

33,364  

 After Ten Years

-   

-   

155,566  

157,100  

 $

115   

 $

115   

 $

207,701   

 $

210,348   

Equity securities

30   

37   

       Total securities

 $

115   

 $

115   

 $

207,731   

 $

210,385 

Sales and gains (losses) on saleof available-for-sale securities are presented as follows (in thousands):

**Gross Sales**

**Gains**

**Losses**

**Net**

**Year Ended December 31,**

2008 - Securities Available-for-Sale

 $

30,497   

 $

396   

 $

(40)

 $

356   

2007 - Securities Available-for-Sale

23,341   

77   

(106)

(29)

2006 - Securities Available-for-Sale

-   

-   

-   

-   

Realized losses on available-for-salesecurities for the year ended December 31, 2008 include the net gain on sale ofapproximately $356,000 as presented in the above table as well as $1.8 millionimpairment loss on shares of Fannie Mae and Freddie Mac preferred stock and an approximately$80,000 gain on calls of securities available-for-sale totaling $6.1 million.  

At December 31, 2008 and 2007,investment securities were pledged to secure government, public and trustdeposits as follows (in thousands):

** **

**Amortized  Cost**

** **

**Fair Value**

2008

 $

121,820   

 $

124,868   

2007

 $

129,328   

 $

130,107   

-40-

The following table presentsinformation on securities with gross unrealized losses at December 31, 2008,aggregated by investment category and the length of time that the individualsecurities have been in a continuous loss position:

** **

**Less Than  Twelve Months**

** **

**Over Twelve  Months**

** **

**Total**

 
** **

**Gross**

** **

** **

** **

**Gross**

** **

** **

** **

**Gross**

** **

** **

 
**Unrealized**

** **

**Fair**

** **

**Unrealized**

** **

**Fair**

** **

**Unrealized**

** **

**Fair**

 
**Losses**

** **

**Value**

** **

**Losses**

** **

**Value**

** **

**Losses**

** **

**Value**

 
*(In Thousands)*

 
Securities Available-for-Sale:

 
 U.S. Treasury Securities and

 
     Obligations of U.S. Government

 
     Corporations and Agencies

 $

(11)

 $

1,988   

 $

(3)

 $

95   

 $

(14)

 $

2,083   

 
Obligations of States and Political

 
 Subdivisions

(788)

22,682   

- 

 * 

840   

(788)

23,522   

 
 
Other Debt Securities

(317)

1,592   

(987)

1,013   

(1,304)

2,605   

 
 
       Total

 $

(1,116)

 $

26,262   

 $

(990)

 $

1,948   

 $

(2,106)

 $

28,210   

 
*Rounds to lessthan $1,000.

In reviewing the investmentportfolio for other-than-temporary impairment of individual securities,consideration is given but not limited to (1) the length of time in which fairvalue has been less than cost and the extent of the unrealized loss, (2) thefinancial condition of the issuer, and (3) the positive intent and ability ofthe Company to maintain its investment in the issuer for a time that wouldprovide for any anticipated recovery in the fair value.

As of December 31, 2008, theCompany had 83 debt securities noted with unrealized losses with nine of thosesecurities having been in an unrealized loss position for greater than 12months.  Of the 83 securities, 62 municipal bonds and four corporate bondsaccounted for over 99% of the unrealized gross loss as of December 31, 2008. Of the 62 municipal bonds, 60 have been in an unrealized loss for less than 12months.  The securities in an unrealized loss position as of December 31, 2008have been evaluated for other-than-temporary impairment.  In analyzing reasonsfor the unrealized losses, management considers various factors including, butnot limited to, whether the securities are issued by the federal government orits agencies, whether downgrades of bond ratings have occurred, and alsoreviews any applicable industry analysts' reports.  With respect to unrealizedlosses on securities noted and the analysis performed relating to thesecurities, management currently believes that declines in market value are notother-than-temporary and asserts positive intent and ability to hold suchinvestments until anticipated recovery.  

Market values of certainmunicipal bonds have trended lower in 2008 primarily due to the impact of thefluctuation in market rates as well as due to down grades of insurers thatprovide credit support to municipal bonds rather than due to deterioratedcredit quality of the actual issuers.  Most of the municipal bonds in theportfolio carry credit support in the form of insurance.  When reviewing bondsfor purchase, this type of insurance serves as credit enhancement and not ascredit replacement.  Therefore, credit quality of the underlying credit isconsidered strong prior to purchase even if an underlying rating was notobtained by the issuer.  Bonds issued prior to 2007 often were rated by theprimary rating agencies solely on the basis of the insurance and did not obtaina rating for the underlying credit.  Therefore, as the issuers have beendowngraded, certain bonds have also been downgraded.  The factors related toturmoil of the insurers of municipal bonds have had a negative impact on theliquidity of the bonds, and thus their market values over the past year. However, management believes that the municipal portfolio is performing toterms and underlying credit quality is good.  Management monitors theperformance and financial condition of these bonds and the issuers on aperiodic basis as part of its risk management process and as part of theprocess of evaluating securities for other-than-temporary impairment. 

Four corporate bonds accountedfor $1.3 of the $2.1 million unrealized loss as of December 31, 2008.  Three ofthe four corporate debt securities are collateralized debt obligationsecurities that are backed by trust-preferred securities ("TRUP CDOs") issuedby banks, thrifts and insurance companies.  The fourth bond is an individualcorporate debt security.  The corporate debt security and one TRUP CDO have anunrealized loss of approximately $317,000 and have been in loss position forless than 12 months.  The two TRUP CDOs in an unrealized loss position for over12 months had an unrealized loss of approximately $987,000 as of December 31,2008 compared to an unrealized loss of approximately $135,000 as of December31, 2007.  The market for these bonds has been significantly impacted by thestress in the credit markets in general rather than credit problems of aparticular issuer and, therefore, market values trended downward in 2008.  Seediscussion of valuation techniques and hierarchy for determining fair value ofthese securities at Note 20.

Generally accepted accountingprinciples have established accounting and reporting standards for derivativefinancial instruments, including certain derivative instruments embedded inother contracts and for hedging activities. These standards require thatderivatives be reported either as assets or liabilities on the balance sheetsand be reflected at fair value. The accounting for changes in the fair value ofa derivative instrument depends on the intended use of the derivative and theresulting designation.   The Company has one derivative transaction, which isan interest rate swap that was purchased in June 2000.  Since a Federal HomeLoan Bank Variable LIBOR Borrowing has been designated as the hedged item andin doing so, the Company has effectively fixed the cost of this liability.  Asa floating rate liability was hedged, there are no significant fluctuations inits market value but there are fluctuations in the cash flows.  Thus, the swapis designated as a cash flow hedge, hedging the "benchmark interest rate."  The market value gain or loss of the swap is adjusted through othercomprehensive income.  The purpose of the transaction was to reduce exposure tointerest rate risk.  Volume of the transaction is $1.5 million and the term is10 years.  

The value of the derivative was aliability of approximately $183,000 as of December 31, 2008 and approximately$160,000 as of December 31, 2007.  Market interest rate fluctuations resultedin an increase of the liability by approximately $23,000, as well as anincrease in negative accumulated other comprehensive income of approximately$14,000, net of tax, during the year ended December 31, 2008.  There were noreclassification adjustments to other comprehensive income for gains or lossesrelated to the cash flow hedge for any of the periods presented in theConsolidated Financial Statements.

**NOTE 4 - LOANS**

Loans outstanding at December 31,2008 and 2007, were comprised of the following:

**2008**

**2007**

Commercial, Financial and Agricultural

 $

80,317   

 $

80,509   

Real Estate - Construction

97,340   

106,695   

Real Estate - Mortgage

375,714   

353,655   

Installment

36,220   

37,106   

Other Loans

7,167   

6,674   

596,758   

584,639   

Less: Allowance for Loan Losses

7,300   

6,328   

 Net Loans

 $

589,458   

 $

578,311   

In conformity with SFAS No. 114, the Company recognizedloans as impaired with carrying values of approximately $12.2 million as ofDecember 31, 2008 and $6.2 million at December 31, 2007.  The balancemaintained in the Allowance for Loan Losses related to these loans was $2.0million at December 31, 2008 and $1.1 million at December 31, 2007.  Averageinvestment in impaired loans in 2008 and 2007 was $10.0 million and $3.1million, respectively.  Interest income recognized under the accrual method onimpaired loans was approximately $609,000, $356,000 and $93,000 for the yearsended December 31, 2008, 2007 and 2006, respectively.  Loans on non-accrualstatus totaled $3.7 million and $1.7 million as of year-end 2008 and 2007,respectively.   Loans 90 days past due and still accruing interest totaledapproximately $747,000 as of year-end 2008, $204,000 as of year-end 2007 and $945,000as of year-end 2006.  

-41-

**NOTE 5 - ALLOWANCE FOR LOANLOSSES**

An analysis of the allowance forloan losses during the years ended December 31 is as follows:

**2008**

** **

**2007**

** **

**2006**

*(In Thousands)*

Balance  - Beginning of Period

 $

6,328   

 $

6,211   

 $

6,830   

Provision for Loan Losses

2,858   

834   

683   

Loans Charged to Allowance

(2,274)

(1,096)

(1,538)

Recovery of Loan Previously Charged Off

388   

379   

236   

 Net charge-offs

(1,886)

(717)

(1,302)

Balance - End of Period

 $

7,300   

 $

6,328   

 $

6,211   

**NOTE 6 - SECONDARY MORTGAGEMARKET ACTIVITIES**

Mortgage loans originated and intended for sale in thesecondary market are carried at the lower of aggregate cost or market, asdetermined by outstanding commitments from investors.  Net unrealized losses,if any, are recorded as a valuation allowance and charged to earnings.  Therewere no such losses for any of the years ended December 31, 2008, 2007 and2006.  There has been no material difference between cost and fair marketvalues of loans held for sale for any of the periods presented.  

Servicing rights are not retainedon any mortgage loans held for sale.  Mortgage banking income included in othernon-interest income was approximately $1,139,000, $1,178,000 and $1,185,000 forthe years ended December 31, 2008, 2007 and 2006, respectively.  

**NOTE 7 - PREMISES ANDEQUIPMENT**

The fixed assets used in theordinary course of business are summarized as follows:

Useful Lives

in Years

 

**2008**

 

**2007**

*(In Thousands)*

Land

 $

8,479   

 $

7,441   

Buildings

5 to 50

28,730   

27,344   

Furniture and Equipment

3 to 20

17,689   

16,892   

54,898   

51,677   

Less: Accumulated Depreciation

23,152   

21,369   

 Net Fixed Assets

 $

31,746   

 $

30,308   

**NOTE 8 - GOODWILL AND OTHERINTANGIBLE ASSETS**

Upon adoption of SFAS No. 142 in January 2002, theCompany ceased to amortize goodwill (approximately $25,000 per month). Impairment testing is performed during the first quarter of each year.  Basedon annual impairment testing since adoption of SFAS No. 142, there has been noimpairment of goodwill recorded.  Therefore, there are no impairment chargesrecorded for any periods presented in these Consolidated Financial Statementsand notes or subsequently.  There was no activity in goodwill during the yearsended December 31, 2008, 2007 and 2006.  Total goodwill as of December 31, 2008was $11.8 million or 1.27% of total assets or 15.36% of total capital. 

Other identifiable intangiblesconsisted of core deposit intangibles being amortized over a ten-year period asfollows:

**2008**

** **

**2007**

 Core Deposit Intangible

 $

373   

 $

458   

 Accumulated Amortization

(84)

(85)

      Net Core Deposit Intangible

 $

289   

 $

373   

Amortization expense wasapproximately $84,500 per year for 2008, 2007 and 2006.  Estimated amortizationexpense is estimated to be approximately $84,500 per year in years 2009 to 2011and approximately $35,000 in 2012.
NOTE 9 - OTHER REAL ESTATE 
The carrying value of repossessedreal property on the balance sheets of the Company is $5.4 million at December31, 2008 and $2.3 million at December 31, 2007.  The value of other real estateis based on the lower of cost or fair value.   Fair value is based onindependent appraisals for significant properties and may be adjusted bymanagement as discussed in Note 20.  
NOTE 10 - BANK OWNED LIFE INSURANCEAND IMPUTED INCOME TAX REIMBURSEMENT AGREEMENTS
The Bank has a significantinvestment in bank-owned life insurance policies ("BOLI") due to providing thisfringe benefits to certain employees in the position of Vice President andhigher after one year of service.  The cash surrender values of BOLI are $21million and $20 million as of December 31, 2008 and 2007, respectively.  BOLIare initially recorded at the amount of premiums paid and are adjusted tocurrent cash surrender values.  Changes in cash surrender values are recordedin other non-interest income and are based on premiums paid less expenses plusaccreted interest income.  Earnings on BOLI resulted in non-interest income ofapproximately $833,000, $695,000 and $681,000 for the years ended December 31,2008, 2007 and 2006, respectively.  

The Company adopted EmergingIssues Task Force ("EITF") Issue No. 06-4, "Accounting for DeferredCompensation and Postretirement Benefit Aspects of Endorsement Split-DollarLife Insurance Arrangements" ("EITF 06-4") effective January 1, 2008.  Thecumulative effect adjustment to retained earnings for change in accountingprinciple was recorded January 1, 2008 in the amount of $1.9 million to accruethe post-retirement death benefits for endorsement split dollar life insuranceplans.  Expense related to these accruals was approximately $265,000 for theyear ended December 31, 2008 and is reflected in Salaries and Employee Benefitson the Consolidated Income Statement.   The accrual for the post-retirementdeath benefits is included in Other Liabilities on the Consolidated BalanceSheet and totaled $2.16 million as of December 31, 2008.   

Executive Management LifeInsurance Death Benefit Only Salary Continuation Plans provided for in theemployment agreements for certain officers of the Bank were replaced inDecember 2007 with Endorsement Split Dollar Life Insurance Plans and Amendedand Restated Split Dollar Agreements.  The new agreements combine the deathbenefits from the Bank's larger group plan with the death benefits establishedin the Executive Management Life Insurance Death Benefit Only SalaryContinuation Plans.  The new agreements did not change the total after-taxdeath benefit provided to each participant.  Imputed Income Tax ReimbursementAgreements for each participant became effective January 1, 2008 and wereentered into in order to keep the participants at the same after-tax benefitunder the Amended and Restated Split Dollar Agreements.  These Imputed IncomeTax Reimbursement Agreements provide for annual cash payments to theparticipants until death beginning in March 2009 for the 2008 tax year inamounts equal to the portion of the amount of federal and state income taxesattributable to the income imputed to the participant on the benefit under theAmended and Restated Split Dollar Agreement.  

Because the new EndorsementSplit Dollar Life Insurance Plans created imputed income to each participantwithout generating cash to pay the tax expense associated with the imputedincome, and in order to provide participants the same after-tax benefitprovided under the previous plans, effective January 1, 2008 the Bank entered intoImputed Income Tax Reimbursement Agreements with the applicable officers underthe Amended and Restated Split Dollar Agreements. The Imputed Income TaxReimbursement Agreements provide for annual cash payments to the participantsuntil death beginning in March 2009 for the previous tax year in amounts equalto a portion of federal income taxes attributable to (i) the income imputed tothe participant on the benefit under the Amended and Restated Split DollarAgreement and (ii) the additional cash payments under the Imputed Income TaxReimbursement Agreement. 

Each participant was 100%vested in benefits provided under Imputed Income Tax Reimbursement Agreementsas of January 1, 2008. Therefore, 100% of the principal (or service) cost ofthe plan was accrued for as of January 1, 2008 and expensed through earnings inthe year ended December 31, 2008. Service costs are based on the net presentvalue of the sum of payments in accordance with each participant's agreement.  Interest accrues monthly at a discount rate of 7.0%.  The plan is accounted forunder guidance provided in Accounting Principles Board Opinion No. 12 asamended by SFAS No. 106 "Employers' Accounting for Postretirement BenefitsOther than Pensions."  

-42-

Net other post-retirementbenefits expense for Imputed Income Tax Reimbursement Agreements is included inSalaries and Employee Benefits on the Consolidated Statements of Income asfollows (in thousands):  

2008*

Service cost

 $

349   

Interest cost

22   

   Net other postretirement benefits expense

 $

371   

_______________

*              Because Imputed Income Tax Reimbursement Agreementsbecame effective in 2008, there was no reportable expense related to this planin 2007 or 2006.

The accumulated post-retirementdefined benefit obligation for Imputed Income Tax Reimbursement Agreements isincluded in Other Liabilities on the Consolidated Balance Sheet as follows: 

Accumulated Other

Postretirement  Defined

Benefit  Obligation

Balance as of December 31, 2007*

 $

-     

Service cost

349   

Interest cost

22   

Benefit payments

-   

Balance as of December 31, 2008

 $

371   

_______________

*              Because Imputed Income Tax Reimbursement Agreementsbecame effective in 2008, there was no reportable activity or balance prior toJanuary 1, 2008.  

The accumulated post-retirementbenefit obligation included in Other Liabilities as of December 31, 2008 isequal to the funded status of the plan as of year-end 2008 as there are norelated assets recognized on the Consolidated Balance Sheet for the ImputedIncome Tax Reimbursement Agreements.

**NOTE 11 - DEPOSITS**

Included in deposits shown on thebalance sheets are the following time and savings deposits in denominations of$100,000 or more (in thousands):

**2008**

** **

**2007**

Time Deposits

 $

159,114   

 $

204,194   

Savings Deposits

123,756   

145,619   

NOW accounts, included in savings deposits on the balancesheets, totaled $49.85 million at December 31, 2008 and $51.93 million atDecember 31, 2007.  Demand deposit balances reclassified as loans consisted ofoverdrafts totaling approximately $452,000 and $507,000 as of December 31, 2008and 2007, respectively.  

Time deposits maturing in yearssubsequent to December 31, 2008, are as follows (in thousands):

On or before December 31, 2009

 $

361,968  

On or during year ended December 31, 2010

17,911  

On or during year ended December 31, 2011

5,040  

On or during year ended December 31, 2012

5,678   

During or after year ended December 31, 2013

2,243

 $

392,840  

**NOTE 12 - SHORT-TERMBORROWINGS**

The Bank has three sources ofshort-term borrowings, which consist of cash management advances from theFederal Home Loan Bank ("FHLB"), Treasury, Tax and Loan ("TT&L") optionnote, and federal funds purchased from correspondent banks.  Short-termborrowings are used to manage seasonal fluctuations in liquidity.  

Cash management advances fromFHLB are secured 1-4 family first mortgages under the blanket collateral pledgeagreement that also collateralizes long-term advances from FHLB and havematurities of 90 days or less.  See the long-term debt footnote in regards tomaximum borrowing capacity with FHLB as of December 31, 2008.  There were noshort-term borrowings outstanding against this line as of December 31, 2008.

The Bank is an Option B bank inregards to TT&L and up to $1 million in collected TT&L paymentscollected can be retained as a short-term option note.  This option note iscallable upon demand by the TT&L.  The current balance of this line was$1.0 million as of December 31, 2008 and December 31, 2007.  

The Bank has federal fund linesof credit available with eight correspondent banks totaling $112.5 million. There were no federal funds purchased as of December 31, 2008.  Federal fundspurchased totaled $10.1 million as of December 31, 2007.  

The following tabular analysis presents short-termborrowing year-end balance, maximum month-end balance, yearly average andweighted average interest rates for 2008, 2007 and 2006:

**2008**

**2007**

**2006**

Amount Outstanding at End of Year

 $

1,000   

 $

11,100   

 $

1,000   

Weighted Average Interest Rate

0.00%

4.35%

5.04%

Maximum Outstanding at Any Month End

 $

48,500   

 $

22,400   

 $

13,155   

Average Outstanding During Year

 $

20,679   

 $

8,804   

 $

4,501   

Weighted Average Interest Rate During Year

2.70%

5.30%

4.98%

**NOTE 13 - LONG-TERM DEBT**

In March 2005, the Company formeda wholly owned subsidiary First Citizens (TN) Statutory Trust III.  The trustwas created as a Delaware statutory trust for the sole purpose of issuing andselling trust preferred securities and using proceeds from the sale to acquirelong-term subordinated debentures issued by the Company.  The debentures arethe sole assets of the trust.  The Company owns 100% of the common stock of theTrust.

On March 17, 2005, the Company,through its wholly owned subsidiary, First Citizens (TN) Statutory Trust III,sold 5,000 of its floating rate trust preferred securities at a liquidationamount of $1,000 per security for an aggregate amount of $5.0 million.  For theperiod beginning on (and including) the date of original issuance and ending on(but excluding) June 17, 2005, the rate per annum was 4.84%.  For eachsuccessive period beginning on (and including) June 17, 2005, and eachsucceeding interest payment date, interest accrues at a rate per annum equal tothe three-month LIBOR plus 1.80%.  Interest payment dates are March 17, June17, September 17, and December 17 during the 30-year term.  The entire $5.0million in proceeds was used to reduce the Company's revolving line of creditwith First Tennessee Bank N.A.  The Company's obligation under the debenturesand related documents constitute a full and unconditional guarantee by theCompany of the trust issuer's obligations under the trust preferredsecurities.  

In March 2007, the Company formeda wholly owned subsidiary First Citizens (TN) Statutory Trust IV.  The trustwas created as a Delaware statutory trust for the sole purpose of issuing andselling trust preferred securities and using proceeds from the sale to acquirelong-term subordinated debentures issued by the Company.  The debentures arethe sole assets of the trust.  The Company owns 100% of the common stock of thetrust.  

In March 2007, the Company,through its wholly owned subsidiary, First Citizens (TN) Statutory Trust IV, sold5,000 of its floating rate trust preferred securities at a liquidation amountof $1,000 per security for an aggregate amount of $5.0 million.  For the periodbeginning on (and including) the date of original issuance and ending on (butexcluding) June 15, 2007, the rate per annum was 7.10%.  For each successiveperiod beginning on (and including) June 15, 2007, and each succeeding interestpayment date, interest accrues at a rate per annum equal to the three-monthLIBOR plus 1.75%.  Interest payment dates are March 15, June 15, September 15,and December 15 during the 30-year term.  The purpose of proceeds was torefinance the debt issued through First Citizens (TN) Statutory Trust II at alower spread to LIBOR and results in savings of approximately $92,500annually.  First Citizens (TN) Statutory Trust II was terminated as a result ofthis transaction.  The Company's obligation under the debentures and relateddocuments constitute a full and unconditional guarantee by the Company of thetrust issuer's obligations under the trust preferred securities.  

-43-

Although for accountingpresentation, the trust preferred securities are presented as debt, theoutstanding balance qualifies as Tier I capital subject to the provision thatthe amount of the securities included in Tier I Capital cannot exceed 25% oftotal Tier I capital.

The Company also has a line ofcredit with First Tennessee Bank National Association in the amount of $5million, secured by common stock of the Bank with a book value totaling 143% ofthe total outstanding advances on the line.  The note was originally executedin 2002 with a two-year maturity with the purpose for use in various financialstrategies including the acquisition of Munford Union Bank.  Interest on theoutstanding balance is payable on a quarterly basis, calculated at 100 basispoints below the base rate of First Tennessee Bank.  Since its originalmaturity in 2004, the line has been renewed annually for a one-year term.  AtDecember 31, 2007, the outstanding balance on this line was $755,000.  Thisline was paid in full in 2008 and had no outstanding balance as of December 31,2008.  

The Company  will be dependent onthe profitability of its subsidiaries and their ability to pay dividends inorder to service its long-term debt.

The Bank had secured advancesfrom the FHLB in the amounts of $63.5 million at December 31, 2008 and $52.1million at December 31, 2007, which are considered long-term in nature. FHLBborrowings are comprised of fixed rate positions ranging from 2.16% to 6.55%. Most of the FHLB borrowings have quarterly call features and maturities rangefrom 2009 to 2017.  Most of the advances with call features when called offerthe option to pay off the advance without penalty or to have the advancereprice at a variable rate tied to the 90-day LIBOR.  Advances totaling $14million require repayment if the call feature is exercised.  Under the currentand forecasted rate environments, borrowings with call features in place arenot likely to be called in the next 12 months and, therefore, are not includedin current liabilities on the Consolidated Balance Sheet.  Obligations aresecured by loans totaling $320 million consisting of the Bank's entireportfolio of fully disbursed, one-to-four family residential mortgages,commercial mortgages, farm mortgages, second mortgages and multi-familyresidential mortgages.  The Bank had additional borrowing capacity of $33million as of December 31, 2008.

Annual average volume, rates andmaturities of long-term debt for the years 2008 and 2007 are as follows(dollars in thousands):

Average

Average

Average 

Volume

Interest Rate

Maturity

2008

 

 

 

First Citizens Bancshares,  Inc.

 $

10,734   

4.86%

28  years

First Citizens National  Bank

63,524   

5.06%

2.7  years

2007

First Citizens Bancshares,  Inc.

 $

11,559   

8.17%

24  years

First Citizens National Bank

52,088   

5.47%

3.5 years

Maturities of principal on theabove-referenced debt for the following five years are as shown (in thousands):

Year Ending  December 31,

2009

 $

2,603   

2010

33,020   

2011

9,930   

2012

3,316   

2013

165   

Thereafter

 

24,809   

 $

73,843   

**NOTE 14 - INCOME TAXES**

Provision for income taxes was comprised of the followingfor the years shown (in thousands):

**2008**

**2007**

**2006**

Income tax expense (benefit):

 Current

 $

3,638   

 $

2,336   

 $

2,970   

 Deferred

(870)

669   

(120)

 State income tax benefit of operating loss carryforwards

(260)  

(514)

(406)

 Change in valuation allowance

260 

514   

406   

 $

2,768   

 $

3,005   

 $

2,850   

Effective tax rates differed fromfederal statutory rate of 34% applied to income before income taxes due to thefollowing (in thousands):

**2008**

**2007**

**2006**

Tax expenses at statutory rate

 $

3,501   

 $

4,136   

 $

4,082   

Increase (decrease) resulting from:

 state income taxes, net federal income tax benefit

** **

** **

** **

       and change in valuation allowance

-   

-   

-   

 Tax exempt interest income

(858)

(728)

(685)

 Net earnings on bank owned life insurance

(162)

(236)

(232)

 ESOP dividend

(295)

(157)

(286)

 Impairment loss on Fannie Mae and Freddie

      Mac preferred stock

615   

-   

-   

 Other items

(33)

(10)

(29)

 $

2,768   

 $

3,005   

 $

2,850   

Inassessing the realizability of deferred tax assets, management considerswhether it is more likely than not that some portion or all of the deferred taxassets will not be realized.  The ultimate realization of the deferred taxassets is dependent upon the generation of future taxable income during theperiods in which those temporary differences become deductible.  Managementconsiders the scheduled reversal of deferred tax liabilities, projected futuretaxable income and tax planning strategies in making this assessment.  Basedupon the level of historical taxable income and projections for future taxableincome over the periods in which the deferred tax assets are deductible,management believes it is more likely than not that the Company will realizethe benefit of these deductible differences.  However, the amount of deferredtax assets considered realizable could be reduced in the near term if estimatesof future taxable income during the carryforward period are reduced.  Year-enddeferred tax assets and liabilities were due to the following (in thousands):

**2008**

**2007**

**2006**

Deferred tax assets:

   Allowance for loan losses

 $

2,482   

 $

2,423   

 $

2,168   

   Impairment loss on Fannie Mae and Freddie Mac

        preferred stock

615   

-   

-   

   Net unrealized loss on cash flow hedge

70   

61   

39   

   Deferred loan fees

108   

135   

119   

   State income tax benefit for net operating loss  carryforward

1,436   

1,176   

662   

   Other

43   

98   

73   

    Total deferred tax assets

4,754   

3,893   

3,061   

**2008**

**2007**

**2006**

Deferred tax liabilities:

** **

** **

** **

   Depreciation

(1,757)

(1,781)

(1,097)

   FHLB stock dividends

(748)

(773)

(773)

   Net unrealized gain on available-for-sale

     securities

(1,016)

(649)

(106)

   Prepaid expenses

(111)

(115)

(100)

   Other

(72)

(288)

-   

      Total deferred tax liabilities

(3,704)

(3,606)

(2,076)

Valuation allowance for state income tax benefit

(1,436)

(1,176)

(662)

          Net deferred tax assets (liabilities)

 $

(386)

 $

(889)

 $

323   

At year-end 2008, the Company hada net operating loss carryforward for state tax purposes of approximately $3.8million expiring in 2020, $6.2 million expiring in 2021, $7.9 million expiringin 2022 and an estimated $4.0 million in expiring in 2023.  The Company adoptedFinancial Accounting Standards Board ("FASB") Interpretation No. 48,"Accounting for Uncertainties in Income Taxes, an Interpretation of FASBStatement No. 109" ("FIN 48"), effective January 1, 2007.  FIN 48 providesguidance for how an entity should recognize, measure, present and discloseuncertain tax positions that it has taken or expects to take on a tax return. As of December 31, 2008 and 2007, the Company had no unrecognized taxbenefits.  The Company's policy is to recognize penalties and interest onunrecognized tax benefits in "Provision for Income Tax Expense" in theConsolidated Statements of Income.  There were no amounts related to interestand penalties recognized for the year ended December 31, 2008.  The tax yearssubject to examination by federal and state taxing authorities are the yearsending December 31, 2008, 2007, 2006 and 2005.

-44-

**NOTE 15 - REGULATORY MATTERS**

The Company is subject to variousregulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory,and possibly additional discretionary, actions by regulators that, ifundertaken, could have a direct material effect on the Company and theConsolidated Financial Statements.  The regulations require the Bank to meetspecific capital adequacy guidelines that involve quantitative measures of theBank's assets, liabilities and certain off-balance sheet items as calculatedunder regulatory accounting practices.  The Bank's capital classification isalso subject to qualitative judgments by the regulators about components, riskweightings and other factors.

Quantitative measures establishedby regulation to ensure capital adequacy require the Bank to maintain minimumamounts and ratios (set forth in the table below) of Tier I capital (as definedin the regulations) to total average assets (as defined), and minimum ratios ofTier I and total risk-based capital (as defined) to risk-weighted assets (asdefined).  To be considered adequately capitalized (as defined) under theregulatory framework for prompt corrective action, the Bank must maintainminimum Tier I leverage, Tier I risk-based and total risk-based ratios as setforth in the table.  The Bank's actual capital amounts and ratios are presentedin the table below.

As of December 31, 2008, the mostrecent notification from the Bank's primary regulatory authorities categorizedthe Bank and the Company as well capitalized under the regulatory framework forprompt corrective action. To be categorized as well capitalized, the Bank mustmaintain minimum total risk-based, Tier I risk-based and Tier I leverage ratiosas set forth in the table.  There are no conditions or events sincenotification that management believes have changed the institution's category.

The Bank's actual and minimumcapital amounts and ratios are presented in the following table:

To Be Well

Capitalized Under

For Capital

Prompt Corrective

Actual

Adequacy Purposes

Action Provisions

**Amount**

**Ratio**

**Amount**

**Ratio**

**Amount**

**Ratio**

*(Dollars In Thousands)*

**December 31, 2008:**

Total Capital to Risk

Weighted Assets:

 First Citizens  Bancshares, Inc.

 $

80,978   

12.8%

 $

50,810   

8.0%

N/A

10.0%

 First Citizens National  Bank

80,661   

12.7%

50,770   

8.0%

 $

63,463   

10.0%

Tier I Capital to Risk

Weighted Assets:

 First Citizens  Bancshares, Inc.

73,678   

11.6%

25,406   

4.0%

N/A

6.0%

 First Citizens National  Bank

73,361   

11.6%

25,384   

4.0%

38,077   

6.0%

Tier I Capital to 

Average Assets:

 First Citizens  Bancshares, Inc.

73,678   

8.1%

36,250   

4.0%

N/A

5.0%

 First Citizens National  Bank

73,361   

8.1%

36,228   

4.0%

45,285   

5.0%

**December 31, 2007:**

Total Capital to Risk

Weighted Assets:

 First Citizens  Bancshares, Inc.

 $

78,526   

12.5%

 $

50,418   

8.0%

N/A

N/A

 First Citizens National  Bank

78,839   

12.5%

50,457   

8.0%

 $

63,071   

10.0%

Tier I Capital to Risk

Weighted Assets:

 First Citizens  Bancshares, Inc.

72,198   

11.5%

25,200   

4.0%

N/A

N/A

 First Citizens National  Bank

72,511   

11.5%

25,221   

4.0%

37,832   

6.0%

Tier I Capital to 

Average Assets:

 First Citizens  Bancshares, Inc.

72,198   

8.5%

33,936   

4.0%

N/A

N/A

 First Citizens National Bank

72,511   

8.5%

34,083   

4.0%

42,603   

5.0%

**NOTE 16 -CAPITAL**

The Company is subject to capitaladequacy requirements imposed by the Federal Reserve Bank.  In addition, theBank is restricted by the Office of the Comptroller of the Currency from payingdividends in any years that exceeded the net earnings of the current year plusretained profits of the preceding two years.  As of December 31, 2008, $10million of retained earnings were available for future dividends from the Bankto the Company.

Accumulated Other ComprehensiveIncome, a component of capital, consists of unrealized gains (losses) onavailable-for-sale securities, net of tax and unrealized gain (loss) on cashflow hedge, net of tax.  Accumulated Other Comprehensive Income as of December31, 2008 and 2007 was as follows (in thousands)**:**

**2008**

** **

**2007**

 
 Unrealized Gain (Loss) on  Cash Flow Hedge, net of tax

 $

(113)

 $

(99)

 Unrealized Gains (Losses)  on Available-for-Sale Securities, net of tax

1,639   

1,043   

 
           Accumulated Other Comprehensive Income

 $

1,526   

 $

944   

 
 

-45-

**NOTE 17 - RELATED PARTYTRANSACTIONS**

The Company has loans anddeposits with certain executive officers, directors and their affiliates.  TheCompany also enters into contracts with certain related parties from time totime such as for construction of a branch.  All related party transactions areentered into under substantially the same terms as unrelated third-partytransactions.  All material contracts are awarded based on competitive bids. 

Activity in loans to executiveofficers, directors and their affiliates was as follows for the three yearsended December 31, 2008, 2007 and 2006:

**2008**

** **

**2007**

** **

**2006**

Balance at Beginning of Period

 $

17,247   

 $

13,450   

 $

14,396   

New Loans

10,665   

5,887   

6,231   

Repayments

(11,836)

(2,090)

(7,177)

Balance at End of Period

 $

16,076   

 $

17,247   

 $

13,450   

There were no charged-off,restructured or non-current loans to related parties for any of the periodspresented.  Loans to related parties are made on substantially the same termsas third-party transactions.  

Indebtedness shown representsamounts owed by directors and executive officers of the Company and the Bankand by entities in which such persons are general partners or have at least 10%or greater interest and trust and estates in which they have a substantialbeneficial interest.  All loans have been made on substantially the same terms,including interest rates and collateral, as those prevailing at the time forcomparable transactions with others and do not involve other than normal risksof collectibility.  

The Bank routinely enters into deposit relationships withits directors, officers and employees in the normal course of business.  Thesedeposits bear the same terms and conditions as those prevailing at the time forcomparable transactions with unrelated parties.  Balances of executive officersand directors on deposit as of December 31, 2008 and 2007 were $15.2 millionand $11.5 million, respectively.

The Bank has invested in theconstruction of new branches and the operations center over the past threeyears.  Contracts for construction and/or renovation of branch facilities,operations center and leasehold improvements for the loan production officeswere awarded on a competitive bid basis to a related party.  Contract paymentstotaling $1.2 million, approximately $117,000, and $1.1 million were paid tothe related party in years ended December 31, 2008, 2007 and 2006,respectively.  

**NOTE 18- FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK**

The Bank is a party to financialinstruments with off-balance sheet risk in the normal course of business tomeet the financing needs of its customers. These financial instruments includecommitments to extend credit and standby letters of credit. These instrumentsinvolve, to varying degrees, elements of credit risk not recognized in thestatement of financial position. 

The Bank's exposure to creditloss in the event of non-performance by the other party to the financialinstrument for commitments to extend credit and standby letters of credit isrepresented by the contractual amount of those instruments. The same policiesare utilized in making commitments and conditional obligations as are used forcreating on-balance sheet instruments. Ordinarily, collateral or other securityis not required to support financial instruments with off-balance sheet risk.

Commitments to extend credit areagreements to lend to a customer as long as there is no violation of anycondition established in the contract. Loan commitments generally have fixedexpiration dates or other termination clauses and may require payment of a fee.Since many commitments are expected to expire without being drawn upon, totalcommitment amounts do not necessarily represent future cash requirements. Eachcustomer's credit-worthiness is evaluated on a case-by-case basis, including thecollateral required, if deemed necessary by the Bank upon extension of credit,and is based on management's credit evaluation of the counter party. AtDecember 31, 2008 and 2007, the Bank had outstanding loan commitments of $115.0million and $122.6 million, respectively.  As of year-end 2008, variable ratecommitments were $91.6 million and fixed rate commitments were $23.4 million.As of year-end 2007, variable rate commitments were $90.3 million and fixedrate commitments were $32.2 million. Of these commitments, none had an originalmaturity in excess of one year.

Standby letters of credit andfinancial guarantees are conditional commitments issued by the Bank toguarantee performance of a customer to a third party. Those guarantees areissued primarily to support public and private borrowing arrangements, and thecredit risk involved is essentially the same as that involved in extendingloans to customers. The Bank requires collateral to secure these commitmentswhen deemed necessary. At December 31, 2008 and 2007, outstanding standbyletters of credit totaled $6.4 million and $5.9 million, respectively.

In the normal course of business,the Bank extends loans, which are subsequently sold to other lenders, includingagencies of the U.S. government.  Certain of these loans are conveyed withrecourse creating off-balance sheet risk with regard to the collectibility ofthe loan.  At December 31, 2008 and 2007, the Bank had no loans sold withrecourse. 

The Bank also had an off-balancesheet liability at December 31, 2008 in the form of a $25 million standbyletter of credit issued by FHLB on the Bank's behalf.  This letter of credit isused to collateralize public fund deposits.  

**NOTE 19 - SIGNIFICANTCONCENTRATIONS OF CREDIT RISK**

The Bank grants agribusiness,commercial, residential and personal loans to customers throughout a wide areaof the mid-southern United States.  A large majority of the Bank's loans,however, are concentrated in the immediate vicinity of the Bank or primarily West Tennessee.  Although the Bank has a diversified loan portfolio, a substantial portionof its debtors' ability to honor their obligations is dependent upon theagribusiness and industrial economic sectors of that geographic area.

**NOTE 20 -FAIR VALUEMEASUREMENTS**

**Recurring Basis**

Fair value measurements aredetermined in accordance with SFAS 157.  The following are descriptions ofvaluation methodologies used for assets and liabilities measured at fair valueon a recurring basis:

*Available for Sale Securities*

Fair values for available-for-salesecurities are obtained from a third party vendor and are valued using Level 2inputs, except for TRUP CDOs which are accounted for using Level 3 inputs. TRUP CDOs accounted for less than 2% of the portfolio at December 31, 2008. 

The markets for TRUP CDOs andother similar securities were not active at December 31, 2008.  The inactivitywas evidenced first by a significant widening of the bid-ask spread in thebrokered markets in which these securities trade and then by a significantdecrease in the volume of trades relative to historical levels.  The new issuemarket is also relatively inactive.  

The market values for thesesecurities (and other securities other than those issued or guaranteed by theU.S. Treasury) are very depressed relative to historical levels.  For example,the yield spreads for the broad market of investment grade and high yieldcorporate bonds reached all time wide levels versus Treasuries at the end ofNovember 2008 and remained near those levels at December 31, 2008.  Therefore,in the current market, a low market price for a particular bond may onlyprovide evidence of stress in credit markets in general rather than being anindicator of credit problems with a particular issuer.  

Given conditions in current debtmarkets and the relative inactivity in the secondary and new issue markets, theCompany determined:

•        Few observable transactions and market quotations that wereavailable are not reliable for purposes of determining fair value as ofDecember 31, 2008;

•        An income valuation approach technique (present value technique)that maximizes the use of relevant observable inputs and minimizes the use ofunobservable inputs will be equally or more representative of fair value thanthe market approach valuation technique used at prior measurement dates; and

•        The Company's TRUP CDOs will be classified within Level 3 of thefair value hierarchy because significant adjustments are required to determinefair value at the measurement date.

The Company's TRUP CDO valuationswere prepared by an independent third party. Their approach to determining fairvalue involved these steps:

•        The credit quality of the collateral was estimated using averagerisk-neutral probability of default values for each industry (i.e., banks andinsurance companies are evaluated separately);

•        Asset defaults were generated taking into account both theprobability of default of the asset and an assumed level of correlation amongthe assets;

•        A higher level of correlation was assumed among assets from thesame industry (e.g., banks with other banks) than among those from differentindustries;

•        The loss given a default was assumed to be 95% (i.e., a 5 %recovery);

•        The cash flows were forecast for the underlying collateral andapplied to each TRUP CDO tranche to determine the resulting distribution amongthe securities;

•        The calculations were modeled in several thousand scenarios usinga Monte Carlo engine;

•        The expected cash flows for each scenario were discounted at therisk-free rate plus 200 basis points (for illiquidity) to calculate the presentvalue of the security; and

•        The average price was used for valuation purposes.

The Company recalculated theoverall effective discount rates for these valuations.  The overall discountrates range from 7% to 22% and were highly dependent upon the credit quality ofthe collateral, the relative position of the tranche in the capital structureof the TRUP CDO and the prepayment assumptions.

-46-

*Cash Flow Hedge*

The Company's cash flow hedge isvalued by a third party vendor and based on matrix pricing using Level 2 inputsas noted in Note 1.

A summary of assets andliabilities as of December 31, 2008 measured at estimated fair value on arecurring basis is as follows (in thousands):

**Level 1**

** **

**Level 2**

** **

**Level 3**

** **

**Total Fair**

**Inputs**

** **

**Inputs**

** **

**Inputs**

** **

**Value**

Financial assets:

** **

** **

** **

** **

** **

** **

** **

     Securities  available-for-sale

 $

-  

 $

208,043   

 $

2,342   

 $

210,385   

Financial liabilities:

     Cash Flow Hedge

 $

-   

 $

183   

 $

-   

 $

183   

The following table presents areconciliation and income statement classification of gains and losses for allassets measured at fair value on a recurring basis using significantunobservable inputs (Level 3) for the year ended December 31, 2008 (inthousands):

**Available**

**for Sale**

Balance at December 31,  2007

 $

-     

   Total unrealized gains  (losses) included in:

         Net income

- 

         Other  comprehensive income

- 

   Purchases, sales,  issuances and settlements, net

   Transfers in and (out) of  Level 3

2,342   

Balance at December 31, 2008

 $

2,342   

**Non-Recurring Basis**

Certain assets are measured atfair value on a non-recurring basis as described below.

*Impaired Loans*

Impaired loans are evaluated andvalued at the time the loan is identified as impaired at the lower of cost orfair value.  Fair value is measured based on the value of the collateralsecuring these loans.  Collateral may be real estate and/or business assetsincluding equipment, inventory and/or accounts receivable.  Independentappraisals for collateral are obtained and may be discounted by managementbased on historical experience, changes in market conditions from time ofvaluation and/or management's knowledge of the borrower and the borrower'sbusiness.  As such discounts may be significant, these inputs are consideredLevel 3 in the hierarchy for determining fair value.  Values of impaired loansare reviewed on at least a quarterly basis to determine if specific allocationsin the reserve for loan losses are adequate.  

*Loans Held for Sale*

Loans held for sale are recordedat the lower of cost or fair value.  Fair value of loans held for sale arebased upon binding contracts and quotes from third party investors that qualifyas Level 2 inputs for determining fair value.  Loans held for sale did not havean impairment charge in 2008 or 2007.

*Other Real Estate*

Other real estate is recorded atthe lower of cost or fair value.  Fair value is measured based on independentappraisals and may be discounted by management based on historical experienceand knowledge and changes in market conditions from time of valuation.  As suchdiscounts may be significant, these inputs are considered Level 3 in thehierarchy for determining fair value.  Values of other real estate are reviewedat least annually or more often if circumstances require more frequentevaluations.  

A summary of assets andliabilities as of December 31, 2008 measured at estimated fair value on anon-recurring basis were as follows:

**Level 1**

** **

**Level 2**

** **

**Level 3**

** **

**Total Fair**

**Inputs**

** **

**Inputs**

** **

**Inputs**

** **

**Value**

Assets:

** **

** **

** **

** **

** **

** **

** **

     Impaired Loans

 $

-  

 $

-  

 $

12,200   

 $

12,200   

     Loans held for sale

-  

2,632   

-  

2,632   

     Other real estate

-
-
5,424   

5,424   

**FairValue Estimates**

SFAS No. 107, "Disclosures aboutFair Value of Financial Instruments," requires disclosure of the estimated fairvalue of financial instruments.  The following assumptions were made andmethods applied to estimate the fair value of each class of financialinstruments not measured at fair value on the Consolidated Balance Sheets ofthe Company:

*Cash and Cash Equivalents*

For instruments that qualify ascash equivalents, as described in Note 1, the carrying amount is assumed to befair value.

*Loans*

Fair value of variable-rate loanswith no significant change in credit risk subsequent to loan origination isbased on carrying amounts.  For other loans, such as fixed rate loans, fairvalues are estimated utilizing discounted cash flow analyses, applying interestrates currently offered for new loans with similar terms to borrowers ofsimilar credit quality.  Fair values of loans that have experienced significantchanges in credit risk have been adjusted to reflect such changes.

*Accrued Interest Receivable*

The fair values of accruedinterest receivable and other assets are assumed to be the carrying value.

*Federal Home Loan Bank andFederal Reserve Bank Stock*

Carrying amounts of capital stockof the Federal Home Loan Bank of Cincinnati and Federal Reserve Bank of St. Louis approximate fair value.

*Bank-Owned Life Insurance*

Carrying amount of bank-ownedlife insurance is the cash surrender value as of the end of the periodspresented and approximates fair value.

*Deposit Liabilities*

Demand Deposits

The fair values of deposits whichare payable on demand, such as interest-bearing and non-interest-bearingchecking accounts, passbook savings, and certain money market accounts areequal to the carrying amount of the deposits.

Variable-Rate Deposits

The fair value of variable-ratemoney market accounts and certificates of deposit approximate their carryingvalue at the balance sheet date.

Fixed-Rate Deposits

For fixed-rate certificates ofdeposit, fair values are estimated utilizing discounted cash flow analyses,which apply interest rates currently being offered on certificates to aschedule of aggregated monthly maturities on time deposits.

-47-

The carrying amount and fairvalue of assets and liabilities as of year-end 2008 and 2007 is as follows:

2008

2007

Carrying 

Fair 

Carrying 

Fair 

Amount

Value

Amount

Value

 

*(In Thousands)*

**Financial Assets**

Cash and Cash Equivalents

 $

40,704  

 $

40,704  

 $

25,242  

 $

25,242  

Investment Securities

210,500  

210,500  

190,407  

190,408  

Loans, Net of Allowance

589,458  

593,336  

578,311  

582,430  

Loans Held for Sale

2,632  

2,632  

2,187  

2,187  

Accrued Interest Receivable

5,581  

5,581  

6,564  

6,564  

Federal Reserve Bank and Federal

    Home Loan Bank Stock

5,684   

5,684   

5,505   

5,505   

Other Real Estate

5,424   

5,424   

2,302   

2,302   

Bank-Owned Life Insurance

20,627   

20,627   

19,933   

19,933   

**Financial Liabilities**

** **

Deposits

 $

734,915   

 $

738,466   

 $

690,595   

 $

691,677   

Short-term Borrowings

33,765   

33,811   

43,743   

43,658   

Long-term Debt

73,843   

75,913   

63,165   

71,717   

Other Liabilities

7,971   

7,971   

3,622   

3,622   

**Unrecognized Financial Instruments**

** **

Commitments to Extend Credit

 $

114,982   

 $

114,982   

 $

122,574   

 $

122,574   

Standby Letters of Credit

6,442   

6,442   

5,925   

5,925   

**NOTE 21 - EMPLOYEE STOCKOWNERSHIP AND 401(K) PLANS**

The Bank maintains the First Citizens National Bank ofDyersburg Employee Stock Ownership Plan (the "ESOP") and the First CitizensNational Bank 401(k) Plan (the "401(k) Plan") as employee benefits. The 401(k)Plan was adopted October 1, 2000.  The plans provide for a contributionannually not to exceed 25% of the total compensation of all participants andafford eligibility for participation to all full-time employees who havecompleted at least one year of service and are age 21 or older. 

The Company contributes annually amounts equal to 3% oftotal eligible compensation to the 401(k) Plan and 7% of total eligiblecompensation to the ESOP. Total eligible compensation for both plans consistsof total compensation subject to income tax.  Total eligible compensationincludes any salary deferrals made through the 401(k) Plan and Section 125Cafeteria Plan and is subject to maximum limits set annually by the IRS.  Eachparticipant may also elect to defer up to 75% of his or her pay into the 401(k)Plan, subject to dollar limitations imposed by law. 

Cash contributions to the 401(k) Plan totaledapproximately $339,000 in 2008, $346,000 in 2007 and $341,000 in 2006.  Cashcontributions to the ESOP totaled approximately $785,000 in 2008, $851,000 in2007 and $780,000 in 2006.  Cash contributions to the 401(k) Plan and ESOP arereported in Salaries and Employee Benefits in Other Expenses on theConsolidated Statements of Income. 

The ESOP is a non-leveraged plan and all shares owned bythe ESOP were allocated to participants as of December 31, 2008 and 2007.  Cashdividends paid by the Company on common stock held by the ESOP are charged toretained earnings.  All shares owned by the ESOP are considered outstanding forearnings per share computations.  In the event a terminated or retired ESOPparticipant desires to sell his or her shares of the Company's stock, or forcertain employees who elect to diversify their account balances, the Companymay be required to purchase the shares from the participant at their fairmarket value.  The ESOP owned 735,223 shares of common stock of the Companywith an estimated fair value of $22.8 million as of December 31, 2008 and746,572 shares of common stock of the Company with an estimated fair value of$25.4 million as of December 31, 2007.  

-48-

**NOTE 22 - CONDENSED FINANCIAL INFORMATION**

**FIRST CITIZENSBANCSHARES, INC.(Parent CompanyOnly)Balance Sheets****December 31, 2008 and 2007*******(In Thousands)*

December 31,

2008

2007

**ASSETS**

 Cash

 $

69   

 $

233   

 Investment in Subsidiaries

87,311   

85,964   

 Due from Subsidiaries

-   

- 

 Other Assets

-   

-   

TOTAL ASSETS

 $

87,380   

 $

86,197   

**LIABILITIES AND SHAREHOLDERS' EQUITY**

LIABILITIES

 Long Term Debt

 $

10,310   

 $

11,065   

 Accrued Expenses

62   

101   

TOTAL LIABILITIES

10,372   

11,166   

SHAREHOLDERS' EQUITY

77,008   

75,031   

 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY

 $

87,380   

 $

86,197   

**FIRST CITIZENSBANCSHARES, INC.(Parent CompanyOnly)Condensed IncomeStatementsYears endedDecember 31, 2008 and 2007***(In Thousands)*

2008

2007

INCOME

 Dividends from Bank Subsidiary

 $

5,268   

 $

6,023   

 Other Income

22   

31   

TOTAL INCOME

5,290   

6,054   

**EXPENSES**

2008 

2007 

 Interest Expense

538   

876   

 Other Expenses

165   

199   

TOTAL EXPENSES

703   

1,075   

Income Before Income Taxes and Equity in Undistributed

 Net Income of Bank Subsidiary

4,587   

4,979   

Income Tax Expense (Benefit)

(257)

(349)

4,844   

5,328   

Equity in Undistributed Net Income of Bank Subsidiary

2,685   

3,832   

**  NET INCOME**

 $

7,529   

 $

9,160   
 
**FIRST CITIZENSBANCSHARES, INC.(Parent CompanyOnly)CondensedStatements of Cash FlowsYears endedDecember 31, 2008 and 2007***(In Thousands)*

2008

2007

**Operating Activities**

Net Income

 $

7,529   

 $

9,160   

Adjustments to Reconcile Net Income to Net Cash

 Provided by Operating Activities:

 Undistributed Income of Subsidiary

(2,685)

(3,832)

 Decrease in Other Assets

-   

49   

 (Decrease) Increase in Other Liabilities

(38)

15   

NET CASH PROVIDED BY OPERATING ACTIVITIES

 $

4,806   

 $

5,392   

**Investing Activities**

Investment in Subsidiaries

-   

-   

**Financing Activities**

Payment of Dividends and Payments in Lieu of Fractional   Shares

(4,205)

(4,207)

Long-Term Borrowings Issued

-   

5,155   

Payment of Principal on Long-Term Debt

(755)

(5,983)

Treasury Stock Transactions - Net

(10)

(256)

NET CASH USED BY FINANCING ACTIVITIES

$       (4,970)

$       (5,291)

(DECREASE) INCREASE IN CASH

(164)

101   

Cash at Beginning of Year

233   

132   

**CASH AT END OF YEAR**

 $

69   

 $

233   

**NOTE 23 - QUARTERLY SELECTED FINANCIAL DATA (UNAUDITED)**

Interest  

Net Interest  

Net

EPS

EPS

Income

Income

Income

Basic

Diluted

**2008**

*(In Thousands,  Except Per Share Amounts)*

First Quarter

 $

13,384   

 $

7,092   

 $

2,131   

 $

0.59   

 $

0.59   

Second Quarter

13,091   

7,390   

2,265   

0.62   

0.62   

Third Quarter

13,255   

7,766   

1,072   

0.30   

0.30   

Fourth Quarter

12,737   

7,585   

2,061   

0.57   

0.57   

Total

 $

52,467   

 $

29,833   

 $

7,529   

 $

2.08   

 $

2.08   

**2007**

First Quarter

 $

13,150   

 $

6,678   

 $

2,011   

 $

0.55   

 $

0.55   

Second Quarter

13,451   

6,868   

2,245   

0.62   

0.62   

Third Quarter

13,880   

6,913   

2,504   

0.69   

0.69   

Fourth Quarter

13,789   

6,961   

2,390   

0.67  

0.67  

Total

 $

54,279   

 $

27,429   

 $

9,160   

 $

2.53   

 $

2.53   

 -49-

**ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE.**

There have been no changes in theCompany's independent registered public accounting firm for the two most recentfiscal years. 

**ITEM 9A.  CONTROLS AND PROCEDURES.**

The Company,under supervision of and with the participation of its management, includingthe Chief Executive Officer and Chief Financial Officer, evaluated theeffectiveness of the design and operation of the Company's disclosure controlsand procedures as of the end of the period covered by this Annual Report. Disclosure controls and procedures are defined in accordance with Rule13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934 asamended.  Based upon that evaluation as of the end of the period covered bythis Annual Report on Form 10-K, the Company's disclosure controls andprocedures were effective.  

There have beenno changes in internal control over financial reporting during the quarterending December 31, 2008 that have materially affected, or are reasonablylikely to materially affect, the Company's internal control over financialreporting. Management's report and the attestation report of the Company'sindependent registered public accounting firm regarding internal control overfinancial reporting are included in Item 8 of this Annual Report on Form 10-K.****

-50-

**PART III**

**ITEM 10.  DIRECTORS, EXECUTIVEOFFICERS AND CORPORATE GOVERNANCE.**

Informationappearing in the sections entitled "Proposal 1: Election of Directors," "GeneralInformation - Section 16(a) Beneficial Ownership Reporting Compliance,""Corporate Governance - Code of Ethics," "General Information - Proposals byShareholders/Director Selection," "Audit Committee Report" and "CorporateGovernance - Committees of the Board of Directors" of the Company's 2009 ProxyStatement is incorporated herein by reference.

**Executive Officers**

The followinginformation relates to the executive officers of the Company, as of December31, 2008:

Name

Age

Position and Office

Jeffrey D. Agee

48

Appointed CEO of the Company and First Citizens National  Bank in April 2007 and President of the Company and First Citizens National  Bank in April 2006.  Mr. Agee is a Certified Public Accountant and previously  served as Executive Vice President (August 1999 to April 2006) and Chief  Financial Officer of the Company (August 1999 to June 2004).  Employee of the  Company since 1982.  Elected to the Board in July 2005.

Sherrell Armstrong

46

Appointed Executive Vice President and Chief Credit  Officer of First Citizens National Bank in January 2007. Mr. Armstrong  previously served as Executive Vice President and Loan Administrator  (2003-2007), Senior Vice President (2002-2003) and Vice President and  Commercial Lender (1997-2002). Employee of the Company since June 1997.

Laura Beth Butler

33

Appointed Senior Vice President and Chief Financial  Officer of First Citizens National Bank and the Company in June 2004.  Ms.  Butler is a Certified Public Accountant and previously served as Senior Audit  Manager of the banking practice of a local accounting firm (2000 - 2004).

Christian Heckler

41

Appointed Regional President of the Southwest Region for  First Citizens National Bank in April 2006. ** **Previously served as  Community Bank President and Commercial Lender (2002- 2006).  Elected to the  Board in June 2006.

Judy Long

54

Vice President and Secretary to the Board of the Company.   Appointed Executive Vice President and Chief Operations Officer and Secretary  of the Board of both First Citizens National Bank and the Company in August  1999.  Previously served as Senior Vice President, Chief Operations Officer  and Secretary of the Company (1997 -1999),Senior Vice President and  Administrative Officer (1996 -1997) and Vice President and Loan Operations  Manager (1992-1996).  Employee of the Company since July 1974.

Bennett Ragan, Jr.

60

Appointed Regional President-Dyer County in March 2007 and  named as executive officer in April 2008.  Previously served as Senior Vice  President, Green Village Branch Manager and Commercial Lender (July 2003 to  March 2007). 

Katie S. Winchester

68

Chairman of the Board of the Company and First Citizens  National Bank since April 2005.  Previously served as Vice Chairman of Board  (2000 - 2005), Executive Vice President and Secretary of Board (1986 - 1992),  CEO of the Company and the Bank (1996 - 2007) and President (1992-2006).   Employee of the Company since 1961.  Elected to the Bank and the Company  Boards in 1990. 

-51-

**ITEM 11.  EXECUTIVECOMPENSATION**

Informationappearing in the sections entitled "Compensation Discussion and Analysis,""Corporate Governance - Compensation Committee Interlocks and InsiderParticipation" and "Compensation Committee Report" of the Company's 2009 ProxyStatement is incorporated herein by reference.  

**ITEM 12.  SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**

Information inthe section entitled "Security Ownership of Certain Beneficial Owners andManagement" of the Company's 2009 Proxy Statement is incorporated herein byreference. 

**ITEM 13.  CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR INDEPENDENCE**

Informationappearing in the sections entitled "Certain Relationships and RelatedTransactions" and "Corporate Governance - Director Independence" of theCompany's 2009 Proxy Statement is incorporated herein by reference.  

**ITEM 14. PRINCIPAL ACCOUNTANTFEES AND SERVICES **

Informationappearing in the section entitled "Proposal 2: Ratification of IndependentRegistered Public Accounting Firm" of the Company's 2009 Proxy Statement isincorporated herein by reference.  

-51-

**PARTIV**

**ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES, ANDREPORTS ON FORM 8-K**

1.  *Financial Statements*.  Thefollowing financial statements of the Company are set forth in Item 8 above:
- Reports of Independent Registered Public Accounting Firm;
- Consolidated Balance Sheets as of December 31, 2008 and     2007;
- Consolidated Statements of Income for the years ended     December 31, 2008, 2007 and 2006;
- Consolidated Statements of Changes in Shareholders' Equity     and Other Comprehensive Income for the years ended December 31, 2008, 2007     and 2006;
- Consolidated Statements of Cash Flows for the years ended     December 31, 2008, 2007 and 2006; and
- Notes to Consolidated Financial Statements.

2.  *Financial Statement Schedules.* All schedules are omitted because they are not applicable or are not required,or because the information is included in the consolidated financial statementsand notes thereto included herein.

3. *Exhibits.*  The followingExhibits are filed herewith or incorporated herein by reference:

ExhibitNumber                Description

3.1                          Charterof First Citizens Bancshares, Inc., as amended†

3.2                          Bylawsof First Citizens Bancshares, Inc.†

10.1                        Formof Amendment to Executive Employment Agreement for Jeffrey D. Agee and Judy D.Long*

10.2                        Formof First Citizens National Bank Amended and Restated Split Dollar Agreement*

10.3                        ExecutiveEmployment Agreement by and between First Citizens Bancshares, Inc. and JeffreyD. Agee, dated April 21, 1994*

10.4**                       **ExecutiveEmployment Agreement by and between First Citizens Bancshares, Inc. and KatieS. Winchester, dated December 28, 2007*

10.5**                       **ExecutiveEmployment Agreement by and between First Citizens Bancshares, Inc. and JudyD. Long, dated April 15, 1998*

10.6**                       **ExecutiveEmployment Agreement by and between First Citizens Bancshares, Inc. and RalphE. Henson, dated July 1, 2006*

10.7                        ExecutiveEmployment Agreement by and between First Citizens Bancshares, Inc. andStallings Lipford, dated December 28, 2007*

10.8                       Form of First Citizens National Bank Imputed Income Tax Reimbursement Agreement*

21                           Subsidiariesof the Registrant

31.1                        CertificationPursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2                        CertificationPursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1                        CertificationPursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2                        CertificationPursuant to Section 906 of the Sarbanes-Oxley Act of 2002

_____________________________

†      Thisexhibit is filed for restatement purposes only and supersedes in its entiretythe exhibit previously filed with the Company's Annual Report on Form 10-K onApril 1, 2002.*     Management contract or compensatory plan orarrangement.

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SIGNATURES

Pursuant to the requirements of Sections 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be  signed on its behalf by the undersigned,hereunto duly authorized.

First Citizens Bancshares, Inc.(Registrant)
** 

                                   Date: March 13, 2009                               /s/ JEFFREY D. AGEE                                                                                                      PRESIDENT AND CHIEF EXECUTIVE OFFICER                                                                                                    

                                   Date: March 13, 2009                              /s/    LAURA BETH BUTLER                                                                                                                 SENIORVICE PRESIDENT &PRINCIPAL                                                                                                            FINANCIAL OFFICER  
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following personson behalf of the Registrant and in the capacitiesindicated on March 13, 2009.**/s/        JEFFREY D. AGEE
/s/        RALPH E. HENSON**/s/        DWIGHT S. WILLIAMSDirectorDirectorDirector

/s/        EDDIE E. ANDERSON
/s/        BARRY T. LADD
/s/        KATIE S. WINCHESTERDirectorDirectorDirector

/s/        J. WALTER BRADSHAW
/s/        JOHN M. LANNOM
/s/        JOSEPH S. YATESDirectorDirectorDirector

/s/        J. DANIEL CARPENTER
/s/        STALLINGS LIPFORDDirectorDirector

/s/        WILLIAM C. CLOAR
/s/        MILTON E. MAGEEDirectorDirector

/s/        RICHARD W. DONNER
/s/        ALLEN SEARCYDirectorDirector

/s/        BENTLEY F. EDWARDS
/s/        GREEN SMITHEAL, IIIDirectorDirector

/s/        LARRY W. GIBSON
/s/        DAVID R. TAYLORDirectorDirector

/s/        CHRISTIAN E. HECKLER
/s/        LARRY S. WHITEDirectorDirector

/s/        P. H. WHITE, JR.Director
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