**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**WASHINGTON, D.C. 20549

**FORM 10-K/A**

(Mark One)

**x**                               Annual reportpursuant to Section 13 or 15(d) of the Securities Exchange Act of1934

**For the fiscal year ended December 31, 2006**

**OR**

**o**                                  Transitionreport pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**For the transition period from                  to                  .**

**Commission File Number 000-50771**

**BGFinancial Group, Inc.**

(Exactname of registrant as specified in Charter)

| **Tennessee**                           | ** ** | **62-1852691**      |
|-----------------------------------------|------------|---------------------|
| (State or other jurisdiction            |       | (I.R.S. Employer    |
| of incorporation or organization)       |       | Identification No.) |
| **3095 East Andrew Johnson  Highway,**  | ** ** | ** **          |
| **Greeneville, Tennessee**              | ** ** | **37745**           |
| (Address of principal executive office) |       | (Zip Code)          |

 

Registrant’stelephone number, including area code  **(423) 636-1555**

Securities registeredpursuant to Section 12(b) of the Act:

**None**

Securities registeredpursuant to Section 12(g) of the Act:

**Common Stock, $0.333 par value per share**

Indicateby check mark if the registrant is a well-known, seasoned issuer, as defined inRule 405 of the Securities Act. Yes  o    No  x

Indicateby check mark if the registrant is not required to file reports pursuant to Section 13or Section 15(d) of the Act. Yes  o    No  x

Indicateby check mark whether registrant (1) has filed reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934during the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days:   Yes  x    No  o.

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K.  x

Indicate  by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):

| Large accelerated  filer  o |   | Accelerated filer  o |   | Non-accelerated filer  x |
|---------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

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

Theaggregate market value of the registrant’s voting stock held by non-affiliatesof the registrant at February 28, 2007 was $18,486,168, based upon theaverage sale price on that date.

Asof March 27, 2007, there were 2,310,771 shares of the registrant’s commonstock outstanding.

DOCUMENTSINCORPORATED BY REFERENCE

Part III—Definitive Proxy Statement involvingthe election of directors at the annual meeting of shareholders to be held June 6,2007.

 

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**TABLEOF CONTENTS**

| **PART I**   |   |                                                                                                           |   |
|--------------|--------|----------------------------------------------------------------------------------------------------------------|--------|
| ITEM 1.      |   | BUSINESS                                                                                                       |   | 1 |   |
| ITEM 1A.     |   | RISK  FACTORS                                                                                                  |   | 14 |   |
| ITEM 1B.     |   | UNRESOLVED STAFF COMMENTS                                                                                      |   | 18 |   |
| ITEM 2.      |   | PROPERTIES                                                                                                     |   | 18 |   |
| ITEM  3.     |   | LEGAL  PROCEEDINGS                                                                                             |   | 18 |   |
| ITEM 4.      |   | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                            |   | 18 |   |
| **PART II**  |   |                                                                                                           |   |
| ITEM 5.      |   | MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED  STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES |   | 19 |   |
| ITEM  6.     |   | SELECTED  FINANCIAL DATA                                                                                       |   | 23 |   |
| ITEM 7.      |   | MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL  CONDITION AND RESULTS OF OPERATION                          |   | 24 |   |
| ITEM 7A.     |   | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET  RISK                                                    |   | 41 |   |
| ITEM 8.      |   | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                                    |   | 41 |   |
| ITEM 9.      |   | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON  ACCOUNTING AND FINANCIAL DISCLOSURE                          |   | 41 |   |
| ITEM 9A.     |   | CONTROLS AND PROCEDURES                                                                                        |   | 41 |   |
| ITEM  9B.    |   | OTHER  INFORMATION                                                                                             |   | 41 |   |
| **PART III** |   |                                                                                                           |   |
| ITEM 10.     |   | DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE                                                         |   | 42 |   |
|         |   | EXECUTIVE  OFFICERS                                                                                            |   | 44 |   |
|         |   | INFORMATION ABOUT THE BOARD OF DIRECTORS                                                                       |   | 45 |   |
| ITEM 11.     |   | EXECUTIVE COMPENSATION                                                                                         |   | 48 |   |
|         |   | SUMMARY  COMPENSATION TABLE                                                                                    |   | 48 |   |
|         |   | OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END 2006                                                              |   | 49 |   |
|         |   | DIRECTOR  COMPENSATION TABLE                                                                                   |   | 49 |   |
|         |   | COMPENSATION DISCUSSION AND ANALYSIS                                                                           |   | 50 |   |
|         |   | COMPENSATION  COMMITTEE REPORT                                                                                 |   | 51 |   |
|         |   | COMPENSATION COMMITTEE INTERLOCKS AND INSIDER  PARTICIPATION                                                   |   | 51 |   |
| ITEM 12.     |   | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND  MANAGEMENT AND RELATED STOCKHOLDER MATTERS                |   | 52 |   |
| ITEM 13.     |   | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                 |   | 53 |   |
| ITEM 14.     |   | PRINCIPAL ACCOUNTING FEES AND SERVICES                                                                         |   | 53 |   |
| **PART IV**  |   |                                                                                                           |   |
| ITEM 15.     |   | EXHIBITS, FINANCIAL STATEMENT SCHEDULES                                                                        |   | 55 |   |

 

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**PART I**

**ITEM 1.**                BUSINESS

*General*

BG Financial Group, Inc. (the “Corporation” or “we”or “us”) is a one-bank holding company formed as a Tennessee corporation to ownthe shares of Bank of Greeneville (the “Bank”). The Corporation wasincorporated on October 10, 2003, for the purpose of acquiring 100% of theshares of the Bank by means of a share exchange, and becoming a registered bankholding company under the Federal Reserve Act. The share exchange was completedon January 23, 2004. The activities of the Corporation are subject to thesupervision of the Board of Governors of the Federal Reserve System (“FederalReserve Board”). The offices of the Corporation are the same as the principaloffice of the Bank. The Bank is the only subsidiary of the Corporation.

Bank of Greeneville commenced operations as a statechartered bank on July 9, 2001. The Bank has total assets of approximately$98 million at December 31, 2006. The Bank’s deposit accounts are insuredby the FDIC, up to the maximum applicable limits thereof. The Bank is not amember of the Federal Reserve System.

The Bank’s customer base consists primarily of smallto medium-sized business retailers, manufacturers, distributors, contractors,professionals, service businesses and local residents. The Bank offers a fullrange of competitive retail and commercial banking services. The depositservices offered include various types of checking accounts, savings accounts,money market investment accounts, certificates of deposits, and retirementaccounts. Lending services include consumer installment loans, various types ofmortgage loans, personal lines of credit, home equity loans, credit cards, realestate construction loans, commercial loans to small and medium size businessesand professionals, and letters of credit. The Bank also offers safe depositboxes of various sizes. The Bank issues VISA and MasterCard credit cards and isa merchant depository for cardholder drafts under both types of credit cards. TheBank offers its customers drive-through banking services at both offices andautomated teller machines (“ATMs”). The Bank has trust powers but does not havea trust department.

The Bank is subject to the regulatory authority of theDepartment of Financial Institutions of the State of Tennessee (“TDFI”) and theFederal Deposit Insurance Corporation (“FDIC”).

The Corporation’s and theBank’s principal executive offices are both located at 3095 East Andrew JohnsonHighway, Greeneville, Tennessee 37745, and its telephone number is (423) 636-1555.

*Market Area and Competition*

All phases of the Bank’s business are highlycompetitive. The Bank is subject to intense competition from various financialinstitutions and other companies or firms that offer financial services. TheBank competes for deposits with other commercial banks, savings and loanassociations, credit unions and issuers of commercial paper and othersecurities, such as money-market and mutual funds. In making loans, the Bank isexpected to compete with other commercial banks, savings and loan associations,consumer finance companies, credit unions, leasing companies, and otherlenders.

In Greene County as of June 30,2006, there were 7 banks and 1 savings and loan institution, with at least 26offices actively engaged in banking activities, including 3 major state-widefinancial institutions, with a total of $998 million in deposits. In addition,there are numerous credit unions, finance companies, and other financialservices providers.

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*Employees*

At December 31, 2006,the Bank employed 34 persons on a full-time basis, and 8 persons on a part-timebasis. The Bank’s employees are not represented by any union or othercollective bargaining agreement and the Bank believes its employee relationsare satisfactory.

*Supervision and Regulation*

*Bank Holding CompanyRegulation*

The Corporation is a bank holding company within themeaning of the Bank Holding Company Act of 1956, as amended (the “HoldingCompany Act”), and is registered with the Federal Reserve Board. Its bankingsubsidiaries are subject to restrictions under federal law which limit thetransfer of funds by the subsidiary banks to their respective holding companiesand nonbanking subsidiaries, whether in the form of loans, extensions ofcredit, investments, or asset purchases. Such transfers by any subsidiary bankto its holding company or any non-banking subsidiary are limited in amount to10% of the subsidiary bank’s capital and surplus and, with respect to theCorporation and all such nonbanking subsidiaries, to an aggregate of 20% ofsuch bank’s capital and surplus. Furthermore, such loans and extensions ofcredit are required to be secured in specified amounts. The Holding Company Actalso prohibits, subject to certain exceptions, a bank holding company fromengaging in or acquiring direct or indirect control of more than 5% of thevoting stock of any company engaged in non banking activities. An exception tothis prohibition is for activities expressly found by the Federal Reserve Boardto be so closely related to banking or managing or controlling banks as to be aproper incident thereto or financial in nature.

As a bank holding company, the Corporation is requiredto file with the Federal Reserve Board semi-annual reports and such additionalinformation as the Federal Reserve Board may require. The Federal Reserve Boardalso makes examinations of the Corporation.

According to Federal Reserve Board policy, bankholding companies are expected to act as a source of financial strength to eachsubsidiary bank and to commit resources to support each such subsidiary. Thissupport may be required at times when a bank holding company may not be able toprovide such support. Furthermore, in the event of a loss suffered oranticipated by the FDIC - either as a result of default of a banking or thriftsubsidiary of the Corporation or related to FDIC assistance provided to asubsidiary in danger of default - the other banking subsidiaries of theCorporation may be assessed for the FDIC’s loss, subject to certain exceptions.

Various federal and state statutory provisions limitthe amount of dividends the subsidiary banks can pay to their holding companieswithout regulatory approval. The payment of dividends by any bank also may beaffected by other factors, such as the maintenance of adequate capital for suchsubsidiary bank. In addition to the foregoing restrictions, the Federal ReserveBoard has the power to prohibit dividends by bank holding companies if theiractions constitute unsafe or unsound practices. The Federal Reserve Board hasissued a policy statement on the payment of cash dividends by bank holdingcompanies, which expresses the Federal Reserve Board’s view that a bank holdingcompany experiencing earnings weaknesses should not pay cash dividends thatexceed its net income or that could only be funded in ways that weaken the bankholding company’s financial health, such as by borrowing. Furthermore, the TDFIalso has authority to prohibit the payment of dividends by a Tennessee bankwhen it determines such payment to be an unsafe and unsound banking practice.

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A bank holding company and its subsidiaries are alsoprohibited from acquiring any voting shares of, or interest in, any bankslocated outside of the state in which the operations of the bank holdingcompany’s subsidiaries are located, unless the acquisition is specificallyauthorized by the statutes of the state in which the target is located. Further,a bank holding company and its subsidiaries are prohibited from engaging incertain tie-in arrangements in connection with the extension of credit orprovision of any property or service. Thus, an affiliate of a bank holdingcompany may not extend credit, lease or sell property, or furnish any servicesor fix or vary the consideration for these on the condition that (i) thecustomer must obtain or provide some additional credit, property or servicesfrom or to its bank holding company or subsidiaries thereof or (ii) thecustomer may not obtain some other credit, property, or services from acompetitor, except to the extent reasonable conditions are imposed to assurethe soundness of the credit extended.

In approving acquisitions by bank holding companies ofbanks and companies engaged in the banking-related activities described above,the Federal Reserve Board considers a number of factors, including the expectedbenefits to the public such as greater convenience, increased competition, orgains in efficiency, as weighed against the risks of possible adverse effectssuch as undue concentration of resources, decreased or unfair competition,conflicts of interest, or unsound banking practices. The Federal Reserve Boardis also empowered to differentiate between new activities and activitiescommenced through the acquisition of a going concern.

The Attorney General ofthe United States may, within 30 days after approval by the Federal ReserveBoard of an acquisition, bring an action challenging such acquisition under thefederal antitrust laws, in which case the effectiveness of such approval isstayed pending a final ruling by the courts. Failure of the Attorney General tochallenge an acquisition does not, however, exempt the holding company fromcomplying with both state and federal antitrust laws after the acquisition isconsummated or immunize the acquisition from future challenge under theanti-monopolization provisions of the Sherman Act.

*Capital Guidelines*

The Federal Reserve Board has risk based capitalguidelines for bank holding companies and member banks. Under the guidelines,the minimum ratio of capital to risk weighted assets (including certain offbalance sheet items, such as standby letters of credit) is 8%. To be considereda “well capitalized” bank or bank holding company under the guidelines, a bankor bank holding company must have a total risk based capital ratio in excess of10%. At December 31, 2006, on a pro forma basis, the Corporation wouldhave been sufficiently capitalized to be considered “well capitalized.”

At least half of the total capital is to be comprisedof common equity, retained earnings, and a limited amount of perpetual preferredstock, after subtracting goodwill and certain other adjustments (“Tier Icapital”). The remainder may consist of perpetual debt, mandatory convertibledebt securities, a limited amount of subordinated debt, other preferred stocknot qualifying for Tier I capital, and a limited amount of loan loss reserves (“TierII capital”). The Bank is subject to similar capital requirements adopted bythe FDIC. In addition, the Federal Reserve Board, and the FDIC have adopted aminimum leverage ratio (Tier I capital to total assets) of 3% (or 4% if thebank’s CAMEL rating is below “1”). Generally, banking organizations areexpected to operate well above the minimum required capital level of 3% unlessthey meet certain specified criteria, including that they have the highestregulatory ratings. Most banking organizations are required to maintain aleverage ratio of 3%, plus an additional cushion of at least 1% to 2%. Mostcommunity banks are encouraged to maintain a minimum leverage ratio of 6.5% to7.0%; the Bank’s leverage ratio at December 31, 2006, was 9.76%. Theguidelines also provide that banking organizations experiencing internal growthor making acquisitions will be expected to maintain strong capital positionssubstantially above the minimum supervisory levels without significant relianceupon intangible assets.

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Under the FinancialInstitutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), failureto meet the capital guidelines could subject a banking institution to a varietyof enforcement remedies available to federal regulatory authorities, includingthe termination of deposit insurance by the FDIC.

*Sarbanes-Oxley Act of 2002*

On July 30, 2002, President Bush signed into lawthe Sarbanes-Oxley Act of 2002. This legislation represents a comprehensiverevision of laws affecting corporate governance, accounting obligations andcorporate reporting. The Sarbanes-Oxley Act is applicable to all companies withequity securities registered, or that file reports under, the SecuritiesExchange Act of 1934. In particular, the act establishes (i) newrequirements for audit committees, including independence, expertise andresponsibilities; (ii) additional responsibilities regarding financialstatements for the chief executive officer and chief financial officer of thereporting company and new requirements for them to certify the accuracy ofperiodic reports; (iii) new standards for auditors and regulation ofaudits; (iv) increased disclosure and reporting obligations for thereporting company and its directors and executive officers, including anaccelerated time frame for reporting of insider transactions; and (v) newand increased civil and criminal penalties for violations of the federalsecurities laws. The legislation also established a new accounting oversightboard to enforce auditing standards and restrict the scope of services thataccounting firms may provide to their public company audit clients.

Because the Corporation’s common stock is registeredwith the SEC, it is subject to the requirements of this legislation. At thepresent time, and subject to the final rules and regulations to be adoptedand issued by the SEC, management anticipates that the Corporation will incuradditional expense as a result of the act but does not expect that theCorporation’s compliance will have a material impact on its business. To theextent that the Corporation has already implemented the requirements of thislegislation and the related regulations, compliance has been accomplished withexisting Corporation personnel.

The Corporation filesperiodic reports with the SEC. The public may read and copy any materials theCorporation files with the SEC at the SEC’s Public Reference Room at 450Fifth Street, N.W., Washington, D.C. 20549. Information regarding the PublicReference Room may be obtained by calling the SEC at 1-800-SEC-0330.The SEC also maintains an Internet site that contains reports, proxy andinformation statements, and other information regarding the Corporation thatthe Corporation files electronically with the SEC. This information may befound at www.sec.gov.

*Bank Regulation*

The Bank is a Tennessee state-chartered bank and issubject to the regulations of and supervision by the FDIC as well as the TDFI,Tennessee’s state banking authority. The Bank is also subject to variousrequirements and restrictions under federal and state law, includingrequirements to maintain reserves against deposits, restrictions on the typesand amounts of loans that may be granted and the interest that may be chargedthereon and limitations on the types of investments that may be made and thetypes of services that may be offered. Various consumer laws and regulationsalso affect the operations of the Bank. In addition to the impact ofregulation, commercial banks are affected significantly by the actions of theFederal Reserve Board as it attempts to control the money supply and creditavailability in order to influence the economy.

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From time to time, legislation is enacted which hasthe effect of increasing the cost of doing business, limiting or expandingpermissible activities or affecting the competitive balance between banks andother financial institutions. Proposals to change the laws and regulationsgoverning the operations and taxation of banks, bank holding companies and otherfinancial institutions are frequently made in Congress, in the Tennesseelegislature and before various bank regulatory and other professional agencies.The likelihood of any major legislative changes and the impact such changesmight have on the Bank are impossible to predict.

*General.**  *The Bank, as a Tennessee statechartered bank, is subject to primary supervision, periodic examination andregulation by the Commissioner of the TDFI (“Commissioner”) and the FDIC. If,as a result of an examination of a bank, the FDIC should determine that thefinancial condition, capital resources, asset quality, earnings prospects,management, liquidity or other aspects of the Bank’s operations areunsatisfactory or that the Bank or its management is violating or has violatedany law or regulation, various remedies are available to the FDIC. Suchremedies include the power to enjoin “unsafe or unsound” practices, to requireaffirmative action to correct any conditions resulting from any violation orpractice, to issue an administrative order that can be judicially enforced, todirect an increase in capital, to restrict the growth of the Bank, to assesscivil monetary penalties, to remove officers and directors and ultimately toterminate a Bank’s deposit insurance. The Commissioner has many of the sameremedial powers, including the power to take possession of a bank whose capitalbecomes impaired.

The deposits of the Bank are insured by the FDIC inthe manner and to the extent provided by law. For this protection, the Bankpays a semiannual statutory assessment. Although the Bank is not a member ofthe Federal Reserve System, it is nevertheless subject to certain regulationsof the Federal Reserve Board.

Various requirements and restrictions under the lawsof the State of Tennessee and the United States affect the operations of theBank. State and federal statutes and regulations relate to many aspects of theBank’s operations, including reserves against deposits, interest rates payableon deposits, loans, investments, mergers and acquisitions, borrowings,dividends, locations of branch offices and capital requirements. Further, theBank is required to maintain certain levels of capital.

Tennessee law contains limitations on the interestrates that may be charged on various types of loans and restrictions on thenature and amount of loans that may be granted and on the types of investmentswhich may be made. The operations of banks are also affected by variousconsumer laws and regulations, including those relating to equal creditopportunity and regulation of consumer lending practices. All Tennessee banksmust become and remain insured banks under the FDIA. (See 12 U.S.C. §1811, etseq.).

*Paymentof Dividends.*   The Bank is subject to theTennessee Banking Act, which limits a bank’s ability to pay dividends. Thepayment of dividends by any bank is dependent upon its earnings and financialcondition and subject to the statutory power of certain federal and stateregulatory agencies to act to prevent what they deem unsafe or unsound bankingpractices. The payment of dividends could, depending upon the financialcondition of the Bank, be deemed to constitute such an unsafe or unsoundbanking practice. Under Tennessee law, the board of directors of a state bankmay not declare dividends in any calendar year that exceeds the total of itsretained net income of the preceding two (2) years without the priorapproval of the TDFI. The FDIA prohibits a state bank, the deposits of whichare insured by the FDIC, from paying dividends if it is in default in thepayment of any assessments due the FDIC. The Bank is also subject to theminimum capital requirements of the FDIC which impact the Bank’s ability to paydividends. If the Bank fails to meet these standards, it may not be able to paydividends or to accept additional deposits because of regulatory requirements.

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If, in the opinion of the applicable federal bankregulatory authority, a depository institution is engaged in or is about toengage in an unsafe or unsound practice (which, depending on the financialcondition of the depository institution, could include the payment ofdividends), such authority may require that such institution cease and desistfrom such practice. The federal banking agencies have indicated that payingdividends that deplete a depository institution’s capital base to an inadequatelevel would be such an unsafe and unsound banking practice. Moreover, theFederal Reserve Board, the Comptroller of the Currency and the FDIC have issuedpolicy statements which provide that bank holding companies and insureddepository institutions generally should only pay dividends out of currentoperating earnings.

The payment of dividends by the Bank may also beaffected or limited by other factors, such as the requirement to maintainadequate capital above regulatory guidelines.

*FIRREA.*   Congressenacted the Financial Institutions Reform, Recovery and Enforcement Act of 1989(“FIRREA”) on August 9, 1989. FIRREA provides that a depositoryinstitution insured by the FDIC can be held liable for any loss incurred by, orreasonable expected to be incurred by, the FDIC after August 9, 1989 inconnection with (i) the default of a commonly controlled FDIC insureddepository institution or (ii) any assistance provided by the FDIC to acommonly controlled FDIC insured depository institution in danger of default. FIRREAprovides that certain types of persons affiliated with financial institutionscan be fined by the federal regulatory agency having jurisdiction over adepository institution with federal deposit insurance (such as the Bank) up to$1 million per day for each violation of certain regulations related(primarily) to lending to and transactions with executive officers, directors,principal shareholders and the interests of these individuals. Other violationsmay result in civil money penalties of $5,000 to $30,000 per day or in criminalfines and penalties. In addition, the FDIC has been granted enhanced authorityto withdraw or to suspend deposit insurance in certain cases.

*FDICIA.*   TheFederal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) whichwas enacted on December 19, 1991, substantially revised the depositoryinstitution regulatory and funding provisions of the FDIA and made revisions toseveral other federal banking statutes. Among other things, FDICIA requires thefederal banking regulators to take “prompt corrective action” in respect ofFDIC-insured depository institutions that do not meet minimum capitalrequirements. FDICIA establishes five capital tiers: “well capitalized,” “adequatelycapitalized,” “undercapitalized,” “significantly undercapitalized” and “criticallyundercapitalized.”  Under applicableregulations, a FDIC-insured depository institution is defined to be wellcapitalized if it maintains a Leverage Ratio of at least 5%, a risk adjustedTier 1 Capital Ratio of at least 6% and a Total Risk-Based Capital Ratio of atleast 10% and is not subject to a directive, order or written agreement to meetand maintain specific capital levels. An insured depository institution isdefined to be adequately capitalized if it meets all of its minimum capitalrequirements as described above. In addition, an insured depository institutionwill be considered undercapitalized if it fails to meet any minimum requiredmeasure, significantly undercapitalized if it is significantly below suchmeasure and critically undercapitalized if it fails to maintain a level oftangible equity equal to not less than 2% of total assets. An insureddepository institution may be deemed to be in a capitalization category that islower than is indicated by its actual capital position if it receives anunsatisfactory examination rating.

The capital-based prompt corrective action provisionof FDICIA and their implementing regulations apply to FDIC-insured depositoryinstitutions and are not directly applicable to holding companies which controlsuch institutions. However, the Federal Reserve Board has indicated that, inregulating bank holding companies, it will take appropriate action at theholding company level based on an assessment of the effectiveness ofsupervisory actions imposed upon subsidiary depository institutions pursuant tosuch provisions and regulations.

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FDICIA generally prohibits an FDIC-insured depositoryinstitution from making any capital distribution (including payment ofdividends) or paying any management fee to its holding company if thedepository institution would thereafter be undercapitalized. Undercapitalizeddepository institutions are subject to restrictions on borrowing from theFederal Reserve System. In addition, undercapitalized depository institutionsare subject to growth limitations and are required to submit capitalrestoration plans. A depository institution’s holding company must guaranteethe capital plan, up to an amount equal to the lesser of 5% of the depositoryinstitution’s assets at the time it becomes undercapitalized or the amount ofthe capital deficiency when the institution fails to comply with the plan. Thefederal banking agencies may not accept a capital plan without determining,among other things, that the plan is based on realistic assumptions and islikely to succeed in restoring the depository institution’s capital. If adepository institution fails to submit an acceptable plan, it is treated as ifit is significantly undercapitalized.

Significantly undercapitalized depository institutionsmay be subject to a number of requirements and restrictions, including ordersto sell sufficient voting stock to become adequately capitalized, requirementsto reduce total assets and cessation of receipt of deposits from correspondentbanks. Critically undercapitalized depository institutions are subject toappointment of a receiver or conservator generally within 90 days of the dateon which they became critically undercapitalized.

The Bank believes that at December 31, 2006, theBank was well capitalized under the criteria discussed above.

FDICIA contains numerous other provisions, includingaccounting, audit and reporting requirements, termination of the “too big tofail” doctrine except in special cases, limitations on the FDIC’s payment ofdeposits at foreign branches, new regulatory standards in such areas as assetquality, earnings and compensation and revised regulatory standards for, amongother things, powers of state banks, real estate lending and capital adequacy. FDICIAalso requires that a depository institution provide 90 days prior notice of theclosing of any branches.

Various other legislation, including proposals torevise the bank regulatory system and to limit the investments that adepository institution may make with insured funds, is from time to timeintroduced in Congress. The TDFI and FDIC will examine the Bank periodicallyfor compliance with various regulatory requirements. Such examinations,however, are for the protection of the Deposit Insurance Fund (“DIF”) and fordepositors, and not for the protection of investors and shareholders.

*InterstateAct.*   The Riegle-Neal Interstate Banking andBranching Efficiency Act of 1994 (“Interstate Act”), which was enacted on September 29,1994, among other things and subject to certain conditions and exceptions,permits on an interstate basis (i) bank holding company acquisitionscommencing one year after enactment of banks of a minimum age of up to fiveyears as established by state law in any state, (ii) mergers of nationaland state banks after May 31, 1997 unless the home state of either bankhas opted out of the interstate bank merger provision, (iii) branching denovo by national and state banks if the host state has opted-in to thisprovision of the Interstate Act, and (iv) certain bank agency activitiesafter one year after enactment. The Interstate Act contains a 30% intrastatedeposit cap, except for the initial acquisition in the state, restriction thatapplies to certain interstate acquisitions unless a different intrastate caphas been adopted by the applicable state pursuant to the provisions of theInterstate Act and a 10% national deposit cap restriction. Tennessee has opted-into the Interstate Act. Management cannot predict the extent to which thebusiness of the Bank may be affected. Tennessee has also adopted legislationallowing banks to acquire branches across state lines subject to certainconditions, including the availability of similar legislation in the otherstate.

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*BrokeredDeposits and Pass-Through Insurance.*   The FDIChas adopted regulations under FDICIA governing the receipt of brokered depositsand pass-through insurance. Under the regulations, a bank cannot accept orrollover or renew brokered deposits unless (i) it is well capitalized or (ii) itis adequately capitalized and receives a waiver from the FDIC. A bank thatcannot receive brokered deposits also cannot offer “pass-through” insurance oncertain employee benefit accounts. Whether or not it has obtained such awaiver, an adequately capitalized bank may not pay an interest rate on anydeposits in excess of 75 basis points over certain index prevailing marketrates specified by regulation. There are no such restrictions on a bank that iswell capitalized. Because it believes that the Bank was well capitalized as of December 31,2005, the Bank believes the brokered deposits regulation will have no materialeffect on the funding or liquidity of the Bank.

*FDICInsurance Premiums.*   The Bank is required to paysemiannual FDIC deposit insurance assessments to the Deposit Insurance Fund (“DIF”).The FDIC merged the Bank Insurance Fund (“BIF”) and the Savings AssociationInsurance Fund (“SAIF”) to form the DIF on March 31, 2006 in accordancewith the Federal Deposit Insurance Reform Act of 2005. The FDIC maintains theDIF by assessing depository institutions an insurance premium. The amount eachinstitution is assessed is based upon statutory factors that include thebalance of insured deposits as well as the degree of risk the institution posesto the insurance fund. The FDIC uses a risk-based premium system that assesseshigher rates on those institutions that pose greater risks to the DIF. Underthe rule adopted by the FDIC in November 2006, beginning in 2007, theFDIC will place each institution in one of four risk categories using atwo-step process based first on capital ratios (the capital group assignment)and then on other relevant information (the supervisory group assignment). Beginningin 2007, rates will range between $.05 and $.43 per $100 in assessable deposits.Any change in these rates and the category of risk into which the Bank willfall could have an adverse effect on the Bank’s earnings.

Under the FDIA, insurance of deposits may beterminated by the FDIC upon a finding that the institution has engaged inunsafe and unsound practices, is in an unsafe or unsound condition to continueoperations or has violated any applicable law, regulation, rule, order orcondition imposed by a federal bank regulatory agency.

G*ramm-Leach-BlileyAct.* The Gramm-Leach-BlileyAct adopted in November 1999 has been referred to as the most importantbanking bill in over 60 years. The most significant provisions ratify newpowers for banks and bank holding companies, especially in the areas ofsecurities and insurance. The Act also includes requirements regarding theprivacy and protection of customer information held by financial institutions,as well as many other providers of financial services. There are provisionsproviding for functional regulation of the various services provided byinstitutions among different regulators. There are other provisions which limitthe future expansion of unitary thrift holding companies which now preventcompanies like Wal-Mart from owning a thrift institution. Finally, among manyother sections of the Act, there is some relief for small banks from theregulatory burden of the Community Reinvestment Act. The regulatory agencieshave been adopting many new regulations to implement the Act.

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*USAPatriot Act.*   On October 26, 2001, thePresident signed the USA PATRIOT Act of 2001 into law. This act contains theInternational Money Laundering Abatement and Financial Anti-Terrorism Act of2001 (the “IMLAFA”). The IMLAFA substantially broadens existing anti-money launderinglegislation and the extraterritorial jurisdiction of the United States, imposesnew compliance and due diligence obligations, creates new crimes and penalties,compels the production of documents located both inside and outside the UnitedStates, including those of foreign institutions that have a correspondentrelationship in the United States, and clarifies the safe harbor from civilliability to customers. The U.S. Treasury Department has issued a number ofregulations implementing the USA PATRIOT Act that apply certain of itsrequirements to financial institutions such as our banking and broker-dealersubsidiaries. The regulations impose new obligations on financial institutionsto maintain appropriate policies, procedures and controls to detect, preventand report money laundering and terrorist financing. The Treasury Department isexpected to issue a number of additional regulations which will further clarifythe USA PATRIOT Act’s requirements.

The IMLAFA requires all “financial institutions,” asdefined, to establish anti-money laundering compliance and due diligenceprograms no later than April 2003. Such programs must include, among otherthings, adequate policies, the designation of a compliance officer, employeetraining programs, and an independent audit function to review and test theprogram. The Bank has established anti-money laundering compliance and duediligence programs to comply with IMLAFA.

*CapitalRequirements.*   The federal regulatory agenciesuse capital adequacy guidelines in their examination and regulation of banks. Ifthe capital falls below the minimum levels established by these guidelines, theBank may (1) be denied approval to acquire or establish additional banksor non-bank businesses or to open facilities, or (2) be subject toother regulatory restrictions or actions.

Banking organizationshistorically were required to maintain a minimum ratio of primary capital tototal assets of 5.5%, and a minimum ratio of total capital to total assets of6.0%. The primary and total capital ratio requirements have been replaced bythe adoption of risk-based and leverage capital requirements.

*Risk-Based CapitalRequirements*

The FDIC adopted risk-based capital guidelinesfor banks effective after December 31, 1990. The risk-based capitalguidelines are designed to make regulatory capital requirements more sensitiveto differences in risk profile among banks to account for off-balancesheet exposure and to minimize disincentives for holding liquid assets. Assetsand off-balance sheet items are assigned to broad risk categories eachwith appropriate weights. The resulting capital ratios represent capital as apercentage of total risk-weighted assets and off-balance sheet items.The ratios are minimums. The guidelines require all federally regulated banksto maintain a minimum risk-based total capital ratio of 8%, of which atleast 4% must be Tier I capital (see the description of Tier I capital and TierII capital below).

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A banking organization’s qualifying total capitalconsists of two components:  Tier Icapital (core capital) and Tier II capital (supplementary capital). Tier Icapital is an amount equal to the sum of: (i) common shareholders’ equity (including adjustments for anysurplus or deficit); (ii) non-cumulative perpetual preferred stock;and (iii) the company’s minority interests in the equity accounts ofconsolidated subsidiaries. Intangible assets generally must be deducted fromTier I capital, subject to limited exceptions for goodwill arising from certainsupervisory acquisitions. Other intangible assets may be included in an amountup to 25% of Tier I capital, provided that the asset meets each of thefollowing criteria:  (i) the assetmust be able to be separated and sold apart from the banking organization orthe bulk of its assets; (ii) the market value of the asset must beestablished on an annual basis through an identifiable stream of cash flows andthere must be a high degree of certainty that the asset will hold this marketvalue notwithstanding the future prospects of the banking organization; and (iii) thebanking organization must demonstrate that a liquid market exists for the asset.Intangible assets in excess of 25% of Tier I capital generally are deductedfrom a banking organization’s regulatory capital. At least 50% of the bankingorganization’s total regulatory capital must consist of Tier I capital.

Tier II capital is an amount equal to the sum of (i) theallowance for possible credit losses in an amount up to 1.25% of risk-weightedassets; (ii) cumulative perpetual preferred stock with an originalmaturity of 20 years or more and related surplus; (iii) hybrid capitalinstruments (instruments with characteristics of both debt and equity), perpetualdebt and mandatory convertible debt securities; and (iv) in an amount upto 50% of Tier I capital, eligible term subordinated debt and intermediate-termpreferred stock with an original maturity of five years or more, includingrelated surplus. The inclusion of the foregoing elements of Tier II capital aresubject to certain requirements and limitations of the FDIC.

Investments in unconsolidated banking and financesubsidiaries, investments in securities subsidiaries and reciprocal holdings ofcapital instruments must be deducted from capital. The federal bankingregulators may require other deductions on a case-by-case basis.

Under the risk-weightedcapital guidelines, balance sheets assets and certain off-balance sheetitems, such as standby letters of credit, are assigned to one of four riskweight categories (0%, 20%, 50%, or 100%) according to the nature of the assetand its collateral or the identity of any obligor or guarantor. For example,cash is assigned to the 0% risk category, while loans secured by one-to-fourfamily residences are assigned to the 50% risk category. The aggregate amountof such asset and off-balance sheet items in each risk category isadjusted by the risk weight assigned to that category to determine weightedvalues, which are added together to determine the total risk-weightedassets for the banking organization. Accordingly, an asset, such as acommercial loan, which is assigned to a 100% risk category is included in risk-weightedassets at its nominal face value, whereas a loan secured by a single-familyhome mortgage is included at only 50% of its nominal face value. Theapplication ratios are equal to capital, as determined, divided by risk-weightedassets, as determined.

*Leverage Capital Requirements*

The FDIC has a regulation requiring certain bankingorganizations to maintain additional capital of 1% to 2% above a 3% minimumTier I Leverage Capital Ratio (Tier I capital, less intangible assets, to totalassets). In order for an institution to operate at or near the minimum Tier Ileverage capital requirement of 3%, the FDIC expects that such institutionwould have well-diversified risk, no undue rate risk exposure, excellentasset quality, high liquidity and good earnings. In general, the bank wouldhave to be considered a strong banking organization, rated in the highestcategory under the bank rating system and have no significant plans forexpansion. Higher Tier I leverage capital ratios of up to 5% will generally berequired if all of the above characteristics are not exhibited, or if theinstitution is undertaking expansion, seeking to engage in new activities, orotherwise faces unusual or abnormal risks.

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The FDIC rule provides that institutions not incompliance with the regulation are expected to be operating in compliance witha capital plan or agreement with the regulator. If they do not do so, they aredeemed to be engaging in an unsafe and unsound practice and may be subject toenforcement action. In addition, failure by an institution to maintain capitalof at least 2% of assets constitutes an unsafe and unsound practice and maysubject the institution to enforcement action. An institution’s failure tomaintain capital of at least 2% of assets constitutes an unsafe and unsoundcondition justifying termination of FDIC insurance.

*DepositorPreference.*   The Omnibus Budget ReconciliationAct of 1993 provides that deposits and certain claims for administrativeexpenses and employee compensation against an insured depositary institutionwould be afforded a priority over other general unsecured claims against suchan institution, including federal funds and letters of credit, in the “liquidationor other resolution” of such an institution by any receiver.

*Effectof Governmental Policies.*   The Bank is affectedby the policies of regulatory authorities, including the Federal Reserve System.An important function of the Federal Reserve System is to regulate the nationalmoney supply. Among the instruments of monetary policy used by the FederalReserve are: purchases and sales of U.S. Government securities in themarketplace; changes in the discount rate, which is the rate any depositoryinstitution must pay to borrow from the Federal Reserve; and changes in thereserve requirements of depository institutions. These instruments areeffective in influencing economic and monetary growth, interest rate levels andinflation.

The monetary policies of the Federal Reserve Systemand other governmental policies have had a significant effect on the operatingresults of commercial banks in the past and are expected to continue to do soin the future. Because of changing conditions in the national economy and inthe money market, as well as the result of actions by monetary and fiscalauthorities, it is not possible to predict with certainty future changes ininterest rates, deposit levels, loan demand or the business and earnings of theBank or whether the changing economic conditions will have a positive ornegative effect on operations and earnings.

Bills are pending beforethe United States Congress and the Tennessee General Assembly which couldaffect the business of the Bank, and there are indications that other similarbills may be introduced in the future. It cannot be predicted whether or inwhat form any of these proposals will be adopted or the extent to which thebusiness of the Bank may be affected thereby.

*Investment Policy*

The objective of the Bank’sinvestment policy is to invest funds not otherwise needed to meet the loandemand of its market area to earn the maximum return for the Bank, yet stillmaintain sufficient liquidity to meet fluctuations in the Bank’s loan demandand deposit structure. In doing so, the Bank balances the market and creditrisks against the potential investment return, makes investments compatiblewith the pledge requirements of the Bank’s deposits of public funds, maintainscompliance with regulatory investment requirements, and assists the variouspublic entities with their financing needs. The asset liability and investmentcommittee has full authority over the investment portfolio and makes decisionson purchases and sales of securities. The entire portfolio, along with allinvestment transactions occurring since the previous Board of Director’smeeting, is reviewed by the Board at its next monthly meeting. The investmentpolicy allows portfolio holdings to include short-term securitiespurchased to provide the Bank’s needed liquidity and longer term securitiespurchased to generate level income for the Bank over periods of interest ratefluctuations. At this time the Bank does not have a security portfolio.

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*Loan Policy*

All lending activities of the Bank are under thedirect supervision and control of the full Board of Directors and Douglas P.Archbold, Chief Credit Officer. The Board of Directors enforces loanauthorizations, decides on loans exceeding such limits, services all requestsfor officer credits to the extent allowable under current laws and regulations,administers all problem credits, and determines the allocation of funds foreach lending division. The Bank’s established maximum loan volume to depositsis 100%. The loan portfolio consists primarily of real estate, commercial,farming and installment loans. Commercial loans consist of either real estateloans or term loans. Maturity of term loans is normally limited to five toseven years. Conventional real estate loans may be made up to 85% of theappraised value or purchase cost of the real estate for no more than a thirtyyear term. Installment loans are based on the earning capacity and vocationalstability of the borrower.

The full Board makes a monthly review of loans whichare 30 days or more past due and the full Board of Directors makes a monthlyreview of loans which are 45 days or more past due.

Management of the Bank periodically reviews the loanportfolio, particularly nonaccrual and renegotiated loans. The review mayresult in a determination that a loan should be placed on a nonaccrual statusfor income recognition. In addition, to the extent that management identifiespotential losses in the loan portfolio, it reduces the book value of suchloans, through charge-offs, to their estimated collectible value. The Bank’spolicy is that accrual of interest is discontinued on a loan when management ofthe Bank determines upon consideration of economic and business factorsaffecting collection efforts that collection of interest is doubtful. The Bankmaintains a specific reserve for impaired loans.

When a loan is classified as nonaccrual, any unpaidinterest is reversed against current income. Interest is included in incomethereafter only to the extent received in cash. The loan remains in anonaccrual classification until such time as the loan is brought current, whenit may be returned to accrual classification. When principal or interest on anonaccrual loan is brought current, if in management’s opinion future paymentsare questionable, the loan would remain classified as nonaccrual. After anonaccrual or renegotiated loan is charged off, any subsequent payments ofeither interest or principal are applied first to any remaining balanceoutstanding, then to recoveries and lastly to income.

The Bank had no tax-exemptloans during the period ended December 31, 2006. The Bank had no loansoutstanding to foreign borrowers at December 31, 2006. The Bank’sunderwriting guidelines are applied to four major categories of loans,commercial and industrial, consumer, agricultural and real estate whichincludes residential, construction and development and certain other realestate loans. The Bank requires its loan officers and Board to consider theborrower’s character, the borrower’s financial condition as reflected incurrent financial statements, the borrower’s management capability, theborrower’s industry and the economic environment in which the loan will berepaid. Before approving a loan, the loan officer or Board must determine thatthe borrower is basically honest and creditworthy, determine that the borroweris a capable manager, understand the specific purpose of the loan, understandthe source and plan of repayment, determine that the purpose, plan and sourceof repayment as well as collateral are acceptable, reasonable and practicalgiven the normal framework within which the borrower operates.

*Credit Risk Management and Reservefor Loan Losses*

Credit risk and exposure to loss are inherent parts ofthe banking business. Management seeks to manage and minimize these risksthrough its loan and investment policies and loan review procedures. Managementestablishes and continually reviews lending and investment criteria andapproval procedures that it believes reflect the risk sensitive nature of theBank. The loan review procedures are set to monitor adherence to theestablished criteria and to ensure that on a continuing basis such standardsare enforced and maintained. Management’s objective in establishing lending andinvestment standards is to manage the risk of loss and provide for incomegeneration through pricing policies.

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The loan portfolio isregularly reviewed and management determines the amount of loans to becharged-off. In addition, such factors as the Bank’s previous loan lossexperience, prevailing and anticipated economic conditions, any industryconcentrations and the overall quality of the loan portfolio are considered. Whilemanagement uses available information to recognize losses on loans and realestate owned, future additions to the allowance may be necessary based onchanges in economic conditions. In addition, various regulatory agencies, as anintegral part of their examination process, periodically review the allowancesfor losses on loans and real estate owned. Such agencies may require the Bankto recognize additions to the allowances based on their judgments aboutinformation available at the time of their examinations. In addition, any loanor portion thereof which is classified as a “loss” by regulatory examiners ischarged-off.

*Capital Resources/Liquidity*

*Liquidity.*   Ofprimary importance to depositors, creditors and regulators is the ability tohave readily available funds sufficient to repay fully maturing liabilities. TheBank’s liquidity, represented by cash and cash due from banks, is a result ofits operating, investing and financing activities. In order to insure funds areavailable at all times, the Bank devotes resources to projecting on a monthlybasis the amount of funds which will be required and maintains relationshipswith a diversified customer base so funds are accessible. Liquidityrequirements can also be met through short-term borrowings or thedisposition of short-term assets which are generally matched to correspond tothe maturity of liabilities.

The Bank has a formal liquidity policy whereby managementconsiders several liquidity ratios on a monthly basis to determine the adequacyof liquidity. In the opinion of management, its liquidity levels are consideredadequate.  The Bank is subject to generalFDIC guidelines which do not require a minimum level of liquidity. Managementbelieves its liquidity ratios meet or exceed these guidelines. Management doesnot know of any trends or demands which are reasonably likely to result inliquidity increasing or decreasing in any material manner.

*Impact of Inflation andChanging Prices.*   The financial statements andrelated financial data presented herein have been prepared in accordance withU.S. generally accepted accounting principles which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time anddue to inflation. The impact of inflation on operations of the Bank isreflected in increased operating costs. Unlike most industrial companies,virtually all of the assets and liabilities of the Bank are monetary in nature.As a result, interest rates have a more significant impact on the Bank’sperformance than the effects of general levels of inflation. Interest rates donot necessarily move in the same direction or in the same magnitude as theprice of goods and services.

*Capital Adequacy*

Capital adequacy refers to the level of capitalrequired to sustain asset growth over time and to absorb losses. The objectiveof the Bank’s management is to maintain a level of capitalization that issufficient to take advantage of profitable growth opportunities while meetingregulatory requirements. This is achieved by improving profitability througheffectively allocating resources to more profitable businesses, improving assetquality, strengthening service quality, and streamlining costs. The primarymeasures used by management to monitor the results of these efforts are theratios of average equity to average assets, average tangible equity to averagetangible assets, and average equity to net loans.

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The Federal Reserve Board has adopted capitalguidelines governing the activities of bank holding companies. These guidelinesrequire the maintenance of an amount of capital based on risk-adjusted assetsso that categories of assets with potentially higher credit risk will requiremore capital backing than assets with lower risk. In addition, banks and bankholding companies are required to maintain capital to support, on arisk-adjusted basis, certain off-balance sheet activities such as loancommitments.

The capital guidelines classify capital into twotiers, referred to as Tier I and Tier II. Under risk-based capitalrequirements, total capital consists of Tier I capital which is generallycommon stockholders’ equity less goodwill and Tier II capital which isprimarily a portion of the allowance for loan losses and certain qualifyingdebt instruments. In determining risk-based capital requirements, assets areassigned risk-weights of 0% to 100%, depending primarily on the regulatoryassigned levels of credit risk associated with such assets. Off-balance sheetitems are considered in the calculation of risk-adjusted assets throughconversion factors established by the regulators. The framework for calculatingrisk-based capital requires banks and bank holding companies to meet theregulatory minimums of 4% Tier I and 8% total risk-based capital. In 1990regulators added a leveraged computation to the capital requirements, comparingTier I capital to total average assets less goodwill.

The Federal DepositInsurance Corporation Improvement Act of 1991 (“FDICIA”) established fivecapital categories for banks and bank holding companies. The bank regulatorsadopted regulations defining these five capital categories in September 1992.Under these new regulations each bank is classified into one of the fivecategories based on its level of risk-based capital as measured by Tier Icapital, total risk-based capital, and Tier I leverage ratios and itssupervisory ratings.

Thefollowing table lists the five categories of capital and each of the minimumrequirements for the three risk-based capital ratios.

| ** **                      | ** ** | **Total Risk-Based  Capital Ratio** | ** **   | **Tier I Risk-Based  Capital Ratio** | ** ** | **Leverage Ratio** | ** **   |
|---------------------------------|------------|-----------------------------------------------|--------------|-----------------------------------------------------|------------|-------------------------|--------------|
| Well-capitalized                |       |                                          | 10% or above |                                                |       |                    | 6% or above  |   |   | 5% or above |   |
| Adequately capitalized          |       |                                          | 8% or above  |                                                |       |                    | 4% or above  |   |   | 4% or above |   |
| Undercapitalized                |       |                                          | Less than 8% |                                                |       |                    | Less than 4% |   |   | Less than 4% |   |
| Significantly  undercapitalized |       |                                          | Less than 6% |                                                |       |                    | Less than 3% |   |   | Less than 3% |   |
| Critically undercapitalized     |       |                                          | —       |                                                |       |                    | —       |   |   | 2% or less |   |

 

**ITEM1A.**        RISK FACTORS

Investing in our commonstock involves various risks which are particular to us, our bank, our industryand our market area. Several risk factors regarding investing in our commonstock are discussed below. This listing should not be considered asall-inclusive. If any of the following risks were to occur, we may not be ableto conduct our business as currently planned and our financial condition oroperating results could be negatively impacted. These matters could cause thetrading price of our common stock to decline in future periods.

**We are geographicallyconcentrated in the Greeneville, Tennessee, and changes in local economicconditions impact our profitability.**

We operate primarily in Greeneville, Tennessee, andsubstantially all of our loan customers and most of our deposit and othercustomers live or have operations in Greeneville. Accordingly, our successsignificantly depends upon the growth in population, income levels, deposits andhousing starts in Greeneville, along with the continued attraction of businessventures to the area. Our profitability is impacted by the changes in generaleconomic conditions in this market. Additionally, unfavorable local or nationaleconomic conditions could reduce our growth rate, affect the ability of ourcustomers to repay their loans to us and generally affect our financialcondition and results of operations.

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We are less able than alarger institution to spread the risks of unfavorable local economic conditionsacross a large number of diversified economies. Moreover, we cannot give anyassurance that we will benefit from any market growth or favorable economicconditions in our primary market areas if they do occur.

**Our continued growth mayrequire the need for additional capital and further regulatory approvals which,if not obtained, could adversely impact our profitability and implementation ofour current business plan.**

To continue to grow, wewill need to provide sufficient capital to the Corporation through earningsgeneration, additional equity offerings or borrowed funds or any combination ofthese sources of funds. Should we incur indebtedness, we are required to obtaincertain regulatory approvals beforehand. Should our growth exceed ourexpectations, we may need to raise additional capital over our projectedcapital needs. However, our ability to raise additional capital, if needed,will depend on conditions in the capital markets at that time, which areoutside our control, and on our financial performance. Accordingly, we cannotassure our ability to raise additional capital if needed on terms acceptable tous. If we cannot raise additional capital when needed, our ability to furtherexpand and grow our operations could be materially impaired. Additionally, ourcurrent plan involves increasing our branch network, which will require capitalexpenditures. Our expansion efforts may also require certain regulatoryapprovals. Should we not be able to obtain such approvals or otherwise not be ableto grow our asset base, our ability to attain our long-term profitability goalswill be more difficult.

**If our allowancefor loan losses is not sufficient to cover actual loan losses, our earningswill decrease.**

If loan customers with significant loan balances failto repay their loans according to the terms of these loans, our earnings wouldsuffer. We make various assumptions and judgments about the collectibility ofour loan portfolio, including the creditworthiness of our borrowers and thevalue of any collateral securing the repayment of our loans. We maintain anallowance for loan losses in an attempt to cover the inherent risks associatedwith lending. In determining the size of this allowance, we rely on an analysisof our loan portfolio based on volume and types of loans, internal loanclassifications, trends in classifications, volume and trends in delinquencies,nonaccruals and charge-offs, national and local economic conditions, otherfactors and other pertinent information. Because we are a relatively youngorganization, our allowance estimation may be less reflective of our historicalloss experience than a more mature organization. If our assumptions areinaccurate, our current allowance may not be sufficient to cover potential loanlosses, and additional provisions may be necessary which would decrease ourearnings.

In addition, federal andstate regulators periodically review our loan portfolio and may require us toincrease our allowance for loan losses or recognize loan charge-offs. Theirconclusions about the quality of our loan portfolio may be different than ours.Any increase in our allowance for loan losses or loan charge-offs as requiredby these regulatory agencies could have a negative effect on our operatingresults.

**Fluctuations ininterest rates could reduce our profitability.**

Changes in interest rates may affect our level ofinterest income, the primary component of our gross revenue, as well as thelevel of our interest expense. Interest rate fluctuations are caused by many factorswhich, for the most part, are not under our direct control. For example,national monetary policy plays a significant role in the determination ofinterest rates. Additionally, competitor pricing and the resulting negotiationsthat occur with our customers also impact the rates we collect on loans and therates we pay on deposits.

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As interest rates change, we expect that we willperiodically experience “gaps” in the interest rate sensitivities of our assetsand liabilities, meaning that either our interest-bearing liabilities will bemore sensitive to changes in market interest rates than our interest-earningassets, or vice versa. In either event, if market interest rates should movecontrary to our position, this “gap” may work against us, and our earnings maybe negatively affected.

Changes in the level ofinterest rates also may negatively affect our ability to originate real estateloans, the value of our assets and our ability to realize gains from the saleof our assets, all of which ultimately affect our earnings. A decline in themarket value of our assets may limit our ability to borrow additional funds. Asa result, we could be required to sell some of our loans and investments underadverse market conditions, upon terms that are not favorable to us, in order tomaintain our liquidity. If those sales are made at prices lower than theamortized costs of the investments, we will incur losses.

**The Corporationcould sustain losses if its asset quality declines.**

The Corporation’s earningsare affected by the Bank’s ability to properly originate, underwrite andservice loans. The Corporation could sustain losses if it incorrectly assessesthe creditworthiness of its borrowers or fails to detect or respond todeterioration in asset quality in a timely manner. Problems with asset qualitycould cause the Bank’s interest income and net interest margin to decrease andits provisions for loan losses to increase, which could adversely affect theCorporation’s results of operations and financial condition.

**Loss of our seniorexecutive officers or other key employees could impair our relationship withour customers and adversely affect our business.**

We have assembled a seniormanagement team which has a substantial background and experience in bankingand financial services in the Greeneville market. Loss of these key personnelcould negatively impact our earnings because of their skills, customerrelationships and/or the potential difficulty of promptly replacing them.

**Competition withother banking institutions could adversely affect our profitability.**

A number of bankinginstitutions in the Greeneville market have higher lending limits, more bankingoffices, and a larger market share. In addition, our asset management divisioncompetes with numerous brokerage firms and mutual fund companies which are alsomuch larger. In some respects, this may place these competitors in acompetitive advantage, although many of our customers have selected us becauseof service quality concerns at the larger enterprises. This competition maylimit or reduce our profitability, reduce our growth and adversely affect ourresults of operations and financial condition.

**The Corporation’s commonstock is currently traded on a local basis, the trading volume in its commonstock has been thin and the sale of substantial amounts of the Corporation’scommon stock could depress the price of its common stock.**

The Corporation cannot say with any certainty when amore active and liquid trading market for its common stock will develop or besustained. Because of this, the Corporation’s shareholders may not be ableto sell their shares at the volumes, prices, or times that they desire.

The Corporation cannot predict the effect, if any,that future sales of its common stock, or availability of shares of its commonstock for sale, will have on the price of the Corporation’s common stock. TheCorporation, therefore, can give no assurance that sales of substantial amountsof its common stock, or the potential for large amounts of sales, would notcause the price of its common stock to decline or impair its ability to raisecapital through sales of its common stock.

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The price of theCorporation’s common stock may fluctuate in the future, and thesefluctuations may be unrelated to its performance.

**The Corporation may issueadditional common stock or other equity securities in the future which coulddilute the ownership interest of existing shareholders.**

In order to maintain itscapital at desired levels or required regulatory levels, or to fund futuregrowth, the Corporation’s board of directors may decide from time to time toissue additional shares of common stock, or securities convertible into,exchangeable for or representing rights to acquire shares of its common stock.The sale of these shares may significantly dilute the Corporation’sshareholders ownership interest as a shareholder and the per share book valueof its common stock. New investors in the future may also have rights,preferences and privileges senior to its current shareholders which mayadversely impact its current shareholders.

**The Corporation’s abilityto declare and pay dividends is limited by law and it may be unable to payfuture dividends.**

The Corporation’s abilityto pay dividends is derived from the income of the Bank. The Bank’s ability todeclare and pay dividends is limited by its obligations to maintain sufficientcapital and by other general restrictions on its dividends that are applicableto banks that are regulated by the FDIC and the Department of FinancialInstitutions. In addition, the FRB may impose restrictions on theCorporation’s ability to pay dividends on its common stock. As a result, theCorporation cannot assure its shareholders that it will declare or paydividends on shares of its common stock in the future.

**Liquidity needs couldadversely affect the Corporation’s results of operations and financialcondition.**

The Corporation relies ondividends from the Bank as its primary source of funds. The primary source offunds of the Bank are customer deposits and loan repayments. While scheduledloan repayments are a relatively stable source of funds, they are subject tothe ability 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, inclement weather, natural disasters and international instability.Additionally, deposit levels may be affected by a number of factors,including rates paid by competitors, general interest rate levels, returnsavailable to customers on alternative investments and general economicconditions. Accordingly, the Bank may be required from time to time torely on secondary sources of liquidity to meet withdrawal demands or otherwisefund operations. Such sources include Federal Home Loan Bank advances andfederal funds lines of credit from correspondent banks. While the Bank believesthat these sources are currently adequate, there can be no assurance they willbe sufficient to meet future liquidity demands. The Bank may be requiredto slow or discontinue loan growth, capital expenditures or other investmentsor liquidate assets should such sources not be adequate.

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**Our business is dependenton technology, and an inability to invest in technological improvements mayadversely affect our results of operations and financial condition.**

The financial servicesindustry is undergoing rapid technological changes with frequent introductionsof new technology-driven products and services. In addition to better servingcustomers, the effective use of technology increases efficiency and enablesfinancial institutions to reduce costs. We have made significant investments indata processing, management information systems and internet bankingaccessibility. Our future success will depend in part upon our ability tocreate additional efficiencies in our operations through the use of technology,particularly in light of our past and projected growth strategy. Many of ourcompetitors have substantially greater resources to invest in technologicalimprovements. We cannot make assurances that our technological improvementswill increase our operational efficiency or that we will be able to effectivelyimplement new technology-driven products and services or be successful inmarketing these products and services to our customers.

**ITEM 1B.**       UNRESOLVEDSTAFF COMMENTS

Not applicable.

**ITEM 2.**                PROPERTIES

The main office of theCorporation is located at 3095 East Andrew Johnson Highway, Greeneville, GreeneCounty, Tennessee, which is also the main office of the Bank. This location isa 2.66 acre lot, on which there is a fully operational modular bank unit. Afull service branch banking office of the Bank is located at 506 AshevilleHighway, Greeneville, Greene County, Tennessee. Recently the Bank purchasedproperty in Maryville, Tennessee at 710 South Foothills Plaza Drive. Thislocation is a 1.17 acre lot, on which there is a 3,272 square foot fullyoperational brick bank building with drive through facilities. These locationsare centrally located and in high traffic/exposure areas. Automatic tellermachines and overnight “deposit drops” are positioned to serve the Bank’sclients. Additional branches may be established as market opportunitiessurface.

**ITEM 3.**                LEGALPROCEEDINGS

To the best of theCorporation’s knowledge, there are no pending legal proceedings, other thanroutine litigation incidental to the business, to which the Corporation or theBank is a party or of which any of the Corporation’s or the Bank’s property isthe subject.

**ITEM 4.**                SUBMISSIONOF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holdersduring the fourth quarter of 2006 through the solicitation of proxies orotherwise.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUERPURCHASES OF EQUITY SECURITIES

Thecommon stock of the Corporation is not traded through an organized exchange noris there a known active trading market. The number of shareholders of record atDecember 31, 2006 was 1,725. Holders of the Corporation’s common stock areentitled to receive dividends when declared by the Board of Directors out offunds legally available. Dividends will be affected by other factors includingapplicable government regulations and policies. The following table shows thequarterly range of high and low sale prices for the Corporation’s stock duringthe fiscal years 2006 and 2005. These sale prices represent known transactionsand do not necessarily represent all trading transactions for the periods.

| **Year** | ** ** | ** **     | ** ** | **High** | ** ** | **Low** | ** ** |
|----------|------------|----------------|------------|----------|------------|---------|------------|
| 2005:    |       | First Quarter  |       | $        | 19.00      |    | $          | 14.00 |   |
|     |       | Second Quarter |       | $        | 19.00      |    | $          | 16.00 |   |
|     |       | Third Quarter  |       | $        | 17.00      |    | $          | 14.00 |   |
|     |       | Fourth Quarter |       | $        | 16.00      |    | $          | 15.00 |   |
| 2006:    |       | First Quarter  |       | $        | 15.00      |    | $          | 12.00 |   |
|     |       | Second Quarter |       | $        | 13.00      |    | $          | 12.00 |   |
|     |       | Third Quarter  |       | $        | 11.00      |    | $          | 9.50 |   |
|     |       | Fourth Quarter |       | $        | 10.00      |    | $          | 9.00 |   |

 

**Dividends**

The payment of cashdividends is subject to the discretion of the Corporation’s Board of Directorsand the Bank’s ability to pay dividends. The Bank’s ability to pay dividends isrestricted by applicable regulatory requirements. For more information on theserestrictions, please see PART I, ITEM 1 “DESCRIPTION OF BUSINESS—Paymentof Dividends”. No assurances can be given that any dividend will be declaredor, if declared, what the amount of such dividend would be or whether suchdividends would continue in future periods.

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**SecuritiesAuthorized for Issuance Under Equity Compensation Plans**

The Bank issuedstock option agreements to certain officers and employees (“Options”), atvarious times beginning on July 16, 2001. These Options were not approvedby the shareholders, as such approval is not necessary for these non-qualifiedoption agreements. Upon consummation of the Share Exchange, the Corporationbecame party to these options issued by the Bank.

Thefollowing table reflects the number of shares to be issued upon the exercise ofoptions granted under the Option agreements, the weighted-average exerciseprice of all such options, and the total number of shares of common stockreserved for issuance upon the exercise of authorized, not-yet-granted optionsas of December 31, 2006:

| **Plan Category**                                      | ** ** | ** ** | ** ** | **# of Securities to be   Issued Upon Exercise of  Outstanding Options,  Warrants and Rights  (a)** | ** ** | **Weighted-average  Exercise Price of  Outstanding Options,  Warrants, and Rights  (b)** | ** ** | **# of Equity Securities  Remaining Available for  Future Issuance Under  Equity Compensation  Plans (excluding  securities reflected in  column (a))  (c)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  Compensation Plans Approved by Security Holders     |       |       | —     |                                                                                                                                                       |       |                                                                                                              | —     |                                                                                                                                                                                                                     |       |   | — |   |   |
| Equity  Compensation Plans Not Approved by Security Holders |       |       | 242,629    |                                                                                                                                                       |       |                                                                                                              | $          | 5.12                                                                                                                                                                                                                     |       |   |   | 73,700 |   |   |
| Total                                                       |       |       | 242,629    |                                                                                                                                                       |       |                                                                                                              | $          | 5.12                                                                                                                                                                                                                     |       |   |   | 73,700 |   |   |

 

The maximum number ofshares of the Corporation’s common stock available for issuance pursuant tostock options is 375,000 shares. As of December 31, 2006 the maximumnumber of shares available for future stock option grants is 73,700 shares. Theoption exercise price is equal to the fair market value of the Corporation’scommon stock at the date of the grant. The options expire on the tenthanniversary of the date of the option. In anticipation of adopting Statement ofFinancial Accounting Standards (SFAS) No. 123 (revised 2004), *Share-Based Payment*, the Corporation elected to immediatelyvest all remaining stock options during 2005 to avoid the recognition ofcompensation costs in the consolidated statements of income in future periods. Proceedsreceived by the Corporation from exercises of the stock options are credited tocommon stock and additional paid-in capital.

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**Comparison ofFive-Year Cumulative Total Return**

Thefollowing graph compares the cumulative total return on BG Financial Group, Inc.’scommon stock with the NASDAQ Bank Index and the Russell 3000 Index over thefive-year period extending through December 31, 2006. The graph assumesthat $100.00 was invested on December 31, 2001 in BG Financial Group, Inc.’scommon stock, the NASDAQ Bank Index and the Russell 3000 Index and that alldividends were reinvested.

**Cumulative TotalReturns (1)**

**Comparison of**

**BG FINANCIAL GROUP,INC.NASDAQ BANK INDEXRUSSELL 3000 INDEX**

**At December 31,2001 through December 31, 2006**

****

| **Index**                      | ** ** | ** ** | ** ** | **12/31/01** | ** ** | **12/31/02** | ** ** | **12/31/03** | ** ** | **12/31/04** | ** ** | **12/31/05** | ** ** | **12/31/06** | ** ** |   |
|--------------------------------|------------|------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------------|------------|--------|
| BG Financial  Group, Inc. |       |       | 100.00     |         |       |         | 160.00     |         |       |         | 266.67     |         |       |         | 360.00     |   |   |   | 300.00 |   |   |   | 200.00 |   |   |
| Russell 3000  Index            |       |       | 100.00     |         |       |         | 81.94      |         |       |         | 64.29      |         |       |         | 84.25      |   |   |   | 94.32 |   |   |   | 108.16 |   |   |
| Nasdaq Bank Index              |       |       | 100.00     |         |       |         | 123.68     |         |       |         | 126.65     |         |       |         | 162.92     |   |   |   | 186.45 |   |   |   | 159.40 |   |   |

 

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**Recent Sales ofUnregistered Securities**

In July 2001,the Bank issued 750,000 shares of its common stock in an initial offering. Thissale was exempt from registration under the Securities Act of 1933, as amended,pursuant to Section 3. Since its initial offering, neither the Bank northe Corporation has sold any additional shares of its common stock, except asfollows:

·       On December 31, 2002,J. Robert Grubbs, exercised the option to purchase 30,000 shares of commonstock at an exercise price of $3.33 per share. On December 31, 2003, J.Robert Grubbs, Don Waddell and Julia Hawk exercised the option to purchase3,175, 4,500 and 3,000 shares of common stock at an exercise price of $3.33 pershare, respectively. On December 31, 2004, Don Waddell, Julia Hawk andEric Scott exercised the option to purchase 2,000, 3,000 and 6,000 shares ofcommon stock at an exercise price of $3.33 per share, respectively. On July 6,2005, Julia Hawk exercised the option to purchase 1,000 shares of common stockat an exercise price of $3.33 per share. On July 8, 2005, Julia Hawkexercised the option to purchase 900 shares of common stock at an exerciseprice of $3.33 per share. On July 12, 2005, Julia Hawk exercised theoption to purchase 1,334 shares of common stock at an exercise price of $3.33per share. On July 22, 2005, Julia Hawk exercised the option to purchase162 shares of common stock at an exercise price of $3.33 per share. On August 23,2005, Julia Hawk exercised the option to purchase 600 shares of common stock atan exercise price of $3.33 per share. The Corporation relied on the exemptionprovided by Section 4(2) of the Securities Act of 1933 for each ofthese transactions.

**Purchases of EquitySecurities by the Registrant and Affiliated Purchasers**

The Corporation made no repurchases of its equitysecurities, and no Affiliated Purchasers (as defined in Rule 10b - 18(a)(3) underthe Securities Exchange Act of 1934) purchased any shares of the Corporation’sequity securities during the fourth quarter of the fiscal year ended December 31,2006.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Thefollowing selected financial data for the years ended December 31, 2006,2005, 2004, 2003, and 2002 should be read in conjunction with the financialstatements included in Item 8:

| ** **                                                                 | ** ** | **2006**   | ** ** | **2005**   | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| Income  Statement Data:                                                    |       |       |       |       |       |       |       |       |       |       |       |
| Total interest and dividend  income                                        |       | $          | 6,686,333  |       | $          | 5,499,510  |       | $          | 5,498,717  |       | $          | 4,308,390 |   | $ | 2,598,782 |   |
| Total interest expense                                                     |       | 2,842,427  |       | 2,118,949  |       | 1,576,080  |       | 1,216,359  |       | 790,959    |       |
| Net interest income before  provision for loan losses                      |       | 3,843,906  |       | 3,380,561  |       | 3,922,637  |       | 3,092,031  |       | 1,807,823  |       |
| (Provision for)/benefit  from loan losses                                  |       | 23,758     |       | 555,222    |       | (615,251   | )          | (956,609   | )          | (315,620   | )          |
| Net interest income after provision  for loan losses                       |       | 3,867,664  |       | 3,935,783  |       | 3,307,386  |       | 2,135,422  |       | 1,492,203  |       |
| Noninterest income                                                         |       | 547,783    |       | 565,259    |       | 531,677    |       | 612,465    |       | 461,892    |       |
| Noninterest expenses                                                       |       | (3,601,111 | )          | (3,573,651 | )          | (3,107,363 | )          | (2,404,681 | )          | (1,823,986 | )          |
| Income before income taxes                                                 |       | 814,336    |       | 927,391    |       | 731,700    |       | 343,206    |       | 130,109    |       |
| Income tax expense                                                         |       | (318,631   | )          | (342,981   | )          | (227,555   | )          | (89,704    | )          | 510,006    |       |
| Net income                                                                 |       | $          | 495,705    |       | $          | 584,410    |       | $          | 504,145    |       | $          | 253,502 |   | $ | 640,115 |   |
| **Per Share Data:(1)**                                                     |       |       |       |       |       |       |       |       |       |       |       |
| Net income, basic                                                          |       | $          | 0.21       |       | $          | 0.25       |       | $          | 0.22       |       | $          | 0.11 |   | $ | 0.28 |   |
| Net  income, assuming                                                      |       |       |       |       |       |       |       |       |       |       |       |
| dilution                                                                   |       | $          | 0.20       |       | $          | 0.24       |       | $          | 0.21       |       | $          | 0.11 |   | $ | 0.28 |   |
| Dividends declared                                                         |       | N/A        |       | N/A        |       | N/A        |       | N/A        |       | N/A        |       |
| Book value                                                                 |       | $          | 3.82       |       | $          | 3.61       |       | $          | 3.36       |       | $          | 3.14 |   | $ | 3.03 |   |
| **Financial Condition Data:**                                              |       |       |       |       |       |       |       |       |       |       |       |
| Total assets                                                               |       | $          | 97,752,681 |       | $          | 87,784,710 |       | $          | 91,174,368 |       | $          | 85,075,150 |   | $ | 53,045,438 |   |
| Loans, net                                                                 |       | $          | 77,059,828 |       | $          | 64,054,625 |       | $          | 72,355,286 |       | $          | 68,539,235 |   | $ | 42,293,917 |   |
| Federal Home Loan Bank  stock                                              |       | $          | 258,800    |       | $          | 244,500    |       | $          | 226,500    |       | $          | 171,700 |   | $ | 134,300 |   |
| Federal funds sold                                                         |       | $          | 12,224,443 |       | $          | 13,557,689 |       | $          | 7,619,619  |       | $          | 7,244,455 |   | $ | 5,579,365 |   |
| Deposits                                                                   |       | $          | 82,503,052 |       | $          | 74,702,688 |       | $          | 78,387,227 |       | $          | 73,461,766 |   | $ | 43,269,854 |   |
| Federal Home Loan Bank -  advances                                         |       | $          | 2,368,159  |       | $          | 4,179,052  |       | $          | 4,359,346  |       | $          | 4,254,106 |   | $ | 2,672,000 |   |
| Stockholder’s equity                                                  |       | $          | 8,836,528  |       | $          | 8,340,823  |       | $          | 7,743,097  |       | $          | 7,207,287 |   | $ | 6,901,202 |   |
| **Selected Ratios:**                                                       |       |       |       |       |       |       |       |       |       |       |       |
| Interest rate spread                                                       |       | 4.29       | %          | 3.95       | %          | 4.40       | %          | 4.55       | %          | 4.59       | %          |
| Net yield on  interest-earning assets                                      |       | 4.78       | %          | 4.24       | %          | 4.61       | %          | 4.85       | %          | 4.99       | %          |
| Return on average assets                                                   |       | 0.56       | %          | 0.67       | %          | 0.55       | %          | 0.37       | %          | 1.62       | %          |
| Return on average equity                                                   |       | 5.79       | %          | 7.32       | %          | 6.60       | %          | 3.51       | %          | 10.33      | %          |
| Average equity to average  assets                                          |       | 9.70       | %          | 9.12       | %          | 8.37       | %          | 10.64      | %          | 15.64      | %          |
| Dividend payout ratio                                                      |       | N/A        |       | N/A        |       | N/A        |       | N/A        |       | N/A        |       |
| Ratio of nonperforming assets  to total assets                             |       | 1.56       | %          | 2.39       | %          | 0.59       | %          | 0.10       | %          | 0.00       | %          |
| Ratio of allowance for loan  losses to nonperforming assets                |       | 40.47      | %          | 33.28      | %          | 300.79     | %          | 1,626.14   | %          | N/A        |       |
| Ratio of allowance for loan losses to total loans, net of unearned  income |       | 0.80       | %          | 1.08       | %          | 2.17       | %          | 1.93       | %          | 1.25       | %          |

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(1)           Amounts havebeen restated to reflect the effect of the Company’s three-for-one stock spliteffected April 25, 2003.

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

The following is adiscussion of our financial condition and results of operations for the yearsended December 31, 2006, 2005 and 2004. The discussion and analysis shouldbe read in conjunction with our consolidated financial statements and relatednotes in order to obtain a better understanding of the information contained inthe financial statements. The discussions contained herein are for theconsolidated entity BG Financial Group, Inc. (the “Corporation”) and itswholly-owned subsidiary Bank of Greeneville (the “Bank”) collectively referredto herein as the “Company”.

**Overview**

Net income for the Companydecreased 15.2% from $584,410 in 2005 to $495,705 in 2006. The primary reasonfor the decrease in net income can be attributed to the Company not having asmuch benefit from recapture of income from the estimated allowance for loanlosses. In 2005, the Company was able to recapture $555,222 in income fromloans that had previously been charged off or placed on nonaccrual. Therecapture of income or benefit was only $23,758 in 2006, which is a (95.7percent) $531,464 decrease. As of December 31, 2006 approximately 63% ofthe Company’s loans are adjustable rate loans that reprice with the Wall StreetJournal prime rate increases on a daily basis. The Company will continue toplace our emphasis on making adjustable rate loans to better matchcorresponding rising costs of funds. Please refer to the Benefit from / Provisionfor loan losses section under the Results for Operations caption that followsfor a more in depth discussion.

**Impact of inflation**

The consolidated financialstatements and related financial data presented herein have been prepared inaccordance with accounting principles generally accepted in the United Statesand practices within the banking industry which require the measurement offinancial position and operating results in terms of historical dollars withoutconsidering the changes in the relative purchasing power of money over time dueto inflation. Unlike most industrial companies, virtually all the assets andliabilities of a financial institution are monetary in nature. As a result,interest rates have a more significant impact on a financial institution’sperformance than the effects of general levels of inflation.

**Critical AccountingEstimates**

The Company followsgenerally accepted accounting principles that are recognized in the UnitedStates, along with general practices within the banking industry. In connectionwith the application of those principles and practices, we have made judgmentsand estimates which, in the case of our allowance for loan and lease losses(ALLL), are material to the determination of our financial position and resultsof operation. Other estimates relate to the valuation of assets acquired inconnection with foreclosures or in satisfaction of loans, and realization ofdeferred tax assets.

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**Recent AccountingPronouncements**

In March 2006, the Financial Account Standards Board(“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 156,*Accounting for Servicing of Financial Assets*,an Amendment of FASB Statement No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments of Liabilities*,(“SFAS 140”) which requires that all separately recognized servicing assets andliabilities be initially measured at fair value, if practicable, and requiresentities to elect either fair value measurement with changes in fair valuereflected in earnings or the amortization and impairment requirements ofStatement 140 for subsequent measurement. SFAS 156 is effective as of thebeginning of an entity’s first fiscal year that begins after September 15,2006. The Company plans to adopt SFAS 156 on January 1, 2007. The adoptionof SFAS 156 is not expected to have any material impact on the Company’sconsolidated financial condition or results of operations.

In July 2006, FASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes*,(“FIN 48”). FIN 48 is effective for fiscal years beginning after December 15,2006. FIN 48 applies to all income tax positions subject to FASB Statement No. 109,*Accounting for Income Tax* (“SFAS 109”),including tax positions considered to be routine and those with a high degreeof uncertainty. FIN 48 is not expected to have a material impact on the Company’sconsolidated financial statements.

In September 2006, the FASB issued SFAS No. 157,*Fair Value Measurements* (“SFAS 157”). SFAS157 defines fair value, establishes a framework for measuring fair value andexpands disclosures about fair value measurements. SFAS 157 will be appliedprospectively and is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. SFAS 157 is not expected tohave a material impact on the Company’s consolidated financial statements.

FASB Staff Position on FAS No. 115-1 andFAS No. 124-1 (“the FSP”), *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments,*was issued in November 2005 and addresses the determination of when aninvestment is considered impaired; whether the impairment isother-than-temporary; and how to measure an impairment loss. The FSP alsoaddresses accounting considerations subsequent to the recognition of another-than-temporary impairment on a debt security, and requires certaindisclosures about unrealized losses that have not been recognized asother-than-temporary impairments. The FSP replaces the impairment guidance onEmerging Issues Task Force (EITF) Issue No. 03-1 with references toexisting authoritative literature concerning other-than-temporarydeterminations. Under the FSP, losses arising from impairment deemed to beother-than-temporary, must be recognized in earnings at an amount equal to theentire difference between the security’s cost and its fair value at thefinancial statement date, without considering partial recoveries subsequent tothat date. The FSP also required that an investor recognize another-than-temporary impairment loss when a decision to sell a security hasbeen made and the investor does not expect the fair value of the security tofully recover prior to the expected time of sale. The FSP was effective forreporting periods beginning after December 15, 2005. The adoption of thisstatement did not have a material impact on the Company’s consolidatedfinancial statements.

In December 2004, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”), which revisedSFAS No. 123, *Accounting for Stock-BasedCompensation*. This statement supercedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Therevised statement addresses the accounting for share-based payment transactionswith employees and other third parties, eliminates the ability to account forshare-based compensation transactions using APB 25 and requires that thecompensation costs relating to such transactions be recognized in theconsolidated statement of income. The revised statement was effective as of thefirst interim or annual period beginning after September 15, 2005. Inanticipation of adopting SFAS No. 123R, the Company elected to immediatelyvest all remaining stock options during 2005 to avoid the recognition ofcompensation costs in the consolidated statement of income in future periods.

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The FASB issued a FASBStaff Position (FSP) on December 15, 2005, SOP 94-6-1—Terms ofLoan Products That May Give Rise to a Concentration of Credit Risk whichaddresses the disclosure requirements for certain nontraditional mortgage andother loan products the aggregation of which may constitute a concentration ofcredit risk under existing accounting literature. Pursuant to this FSP, theFASB’s intentions were to reemphasize the adequacy of such disclosures andnoted that the recent popularity of certain loan products such as negativeamortization loans, high loan-to-value loans, interest only loans, teaser rateloans, option adjusted rate mortgage loans and other loan product types mayaggregate to the point of being a concentration of credit risk to an issuer andthus may require enhanced disclosures under existing guidance. This FSP waseffective immediately. The adoption of this FSP did not have a material impacton the consolidated financial statements.

**Forward-LookingStatements**

Management’s discussion ofthe Company and management’s analysis of the Company’s operations andprospects, and other matters, may include forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995 and otherprovisions of federal and state securities laws. Although the Company believesthat the assumptions underlying such forward-looking statements contained inthis Report are reasonable, any of the assumptions could be inaccurate and,accordingly, there can be no assurance that the forward-looking statementsincluded herein will prove to be accurate. The use of such words as “expect,” “anticipate,”“forecast,” and comparable terms should be understood by the reader to indicatethat the statement is “forward-looking” and thus subject to change in a mannerthat can be unpredictable. Factors that could cause actual results to differfrom the results anticipated, but not guaranteed, in this Report, include(without limitation) economic and social conditions, competition for loans,mortgages, and other financial services and products, changes in interestrates, unforeseen changes in liquidity, results of operations, and financialconditions affecting the Company’s customers, and other risks that cannot beaccurately quantified or completely identified. Many factors affecting theCompany’s financial condition and profitability, including changes in economicconditions, the volatility of interest rates, political events and competitionfrom other providers of financial services simply cannot be predicted. Becausethese factors are unpredictable and beyond the Company’s control, earnings mayfluctuate from period to period. The purpose of this type of information is toprovide readers with information relevant to understanding and assessing thefinancial condition and results of operations of the Company, and not topredict the future or to guarantee results. The Company is unable to predictthe types of circumstances, conditions and factors that can cause anticipatedresults to change. The Company undertakes no obligation to publish revisedforward-looking statements to reflect the occurrence of changes orunanticipated events, circumstances, or results.

**Results ofOperations**

The Company had net incomeof $495,705 for the year ended December 31, 2006 (or $.21 per share)compared to $584,410 (or $.25 per share) and $504,145 (or $.22 per share) forthe years ended December 31, 2005 and 2004 respectively.

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*Net InterestIncome/Margin*

Net interest incomerepresents the amount by which interest earned on various assets exceedsinterest paid on deposits and other interest-bearing liabilities and is themost significant component of the Company’s earnings. Interest income for 2006was $6,686,333 compared to $5,499,510 and $5,498,717 in 2005 and 2004respectively. Total interest expense was $2,842,427 in 2006 compared to$2,118,949 and $1,576,080 in 2005 and 2004 respectively. Average earning assetsdecreased from approximately $85 million in 2004 to approximately $80 millionin 2005 (6%) and remained relatively unchanged at approximately $80 million in2006. Average interest-bearing deposits decreased from approximately $77million in 2004 to approximately $72 million in 2005 (6%) and decreased toapproximately $71 million (1%) in 2006. Net interest margin was 4.78% in 2006compared to 4.24% in 2005, or 54 basis points. The net change in the netinterest margin was significant because the net increases in the yield oninterest-earning assets was approximately 142 basis points compared to theincrease in the rate paid on interest-bearing liabilities of 108 basis points.

*Benefit from /Provision for Loan Losses*

The provision for (benefit from) loan lossesrepresents a charge (or recovery) to operations necessary to establish anestimated allowance for loan losses, which in management’s evaluation, isadequate to provide coverage for estimated losses on outstanding loans.  The estimated allowance for loan losses isevaluated on a regular basis by management and is based upon the Bank’shistorical loss experience adjusted for certain other factors based onmanagement’s judgment.

The year ended December 31, 2006 represents theBank’s fifth full year of operations. In determining the component forhistorical loss experience, the Bank has considered the average of the lastfive years’ experience. Management has considered whether the historical lossexperience needs to be adjusted for other factors including:  past due trends, classified asset trends,recovery trends, loan volume increases or decreases, loan underwriting/riskmanagement, lending staff experience, local employment conditions, and creditconcentrations.

For the year ended December 31,2006, there was a net benefit to earnings of $23,758. Prior to 2006, the Bankhad adjusted historical loss experience by adding 25 basis points for a lack ofhistorical experience. In 2006, the Bank removed this factor from its estimateof the allowance for loan losses. The removal of this factor accounts for themajority of the benefit from the reduction of the estimated allowance for loanlosses. For the year ended December 31, 2005, there was a net benefit toearnings of 555,222 from the reduction of the estimated allowance for loanlosses. One factor was that several loans, which were classified as specialmention, substandard or doubtful as of December 31, 2004, were paid outduring 2005 with minimal losses. In addition, the Bank’s loan portfolio as awhole, as of December 31, 2005, had decreased by approximately $9,200,000(includes classified loans from 2004 that paid out in 2005) since December 31,2004. Another factor is that the Bank modified its methodology to evaluate morespecific loans for impairment. This change in methodology provided a benefit ofapproximately $163,000 in 2005.

*Provisions forIncome Taxes*

Income taxes are providedfor the tax effects of the transactions reported in the financial statementsand consist of taxes currently due plus deferred taxes related primarily to differencesbetween the basis of the estimated allowance for loan losses and accumulateddepreciation. Deferred income tax assets and liabilities are determined usingthe liability (or balance sheet) method. Under this method, the net deferredtax asset or liability is determined based on the tax effects of the temporarydifferences between the book and tax bases of the various balance sheet assetsand liabilities and gives current recognition to changes in tax rates and laws.

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*Noninterest Income*

The Company’s noninterestincome consists of service charges on deposit accounts and other fees andcommissions. Total noninterest income for 2006 was $547,783 compared to$565,259 and $531,677 in 2005 and 2004 respectively. The main reasons for thedecrease in 2006 when compared to 2005 was due to a $10,782 or  3.5% decrease in service charges on depositaccounts and a $20,643 or 17.4% decrease in fees from origination of mortgageloans sold. These decreases were offset by an investment sales commissionincrease of $13,040 or 13.0%. The decrease in 2005 when compared to 2004 wasdue to a 14% increase in service charges on deposit accounts. Managementprojects that other fees, commissions and service charges will increase in 2007due to the growth of the Company and the implementation of a more aggressivecollection policy for other fees and service charges. The Company’s subsidiaryBank began a new service product in late 2006 called “Bounce Protection.”  This product has already shown increases inservice charges on deposit accounts.

*Noninterest Expense*

Noninterestexpense consists of salaries and employee benefits, equipment and occupancyexpenses, and other operating expenses. The following shows the comparison ofour noninterest expense for the years ended December 31, 2006, 2005 and2004:

| ** **                     | ** ** | ** **            | ** ** | ** **  | ** ** | **2006-2005**         | ** ** | ** **  | ** ** | **2005-2004**  | ** ** |
|--------------------------------|------------|-----------------------|------------|-------------|------------|-----------------------|------------|-------------|------------|----------------|------------|
| ** **                     | ** ** | **Years ended**  | ** ** | ** **  | ** ** | **Year ended**   | ** ** | ** **  | ** ** |
| ** **                     | ** ** | **December 31,** | ** ** | **Percent** | ** ** | **December 31,** | ** ** | **Percent** | ** ** |
| ** **                     | ** ** | ** **            | ** ** | ** **  | ** ** | **Increase**          | ** ** | ** **  | ** ** | **Increase**   | ** ** |
| ** **                     | ** ** | **2006**              | ** ** | **2005**    | ** ** | **(Decrease)**        | ** ** | **2004**    | ** ** | **(Decrease)** | ** ** |
| **Noninterest  expense:**      |       |                  |       |        |       |                  |       |        |       |           |       |   |   |   |   |   |   |
| Salaries and employee benefits |       | 1,834,310             |       | 1,880,425   |       |                  | -2.5       | %           |       |           | 1,577,832  |   |   |   | 19.2 | % |   |
| Occupancy                      |       | 488,040               |       | 481,813     |       |                  | 1.3        | %           |       |           | 400,454    |   |   |   | 20.3 | % |   |
| Advertising                    |       | 88,523                |       | 121,858     |       |                  | -27.4      | %           |       |           | 143,266    |   |   |   | -14.9 | % |   |
| Data processing                |       | 217,919               |       | 191,202     |       |                  | 14.0       | %           |       |           | 191,748    |   |   |   | -0.3 | % |   |
| Legal and professional         |       | 347,595               |       | 366,128     |       |                  | -5.1       | %           |       |           | 289,990    |   |   |   | 26.3 | % |   |
| Other operating                |       | 624,724               |       | 532,225     |       |                  | 17.4       | %           |       |           | 504,073    |   |   |   | 5.6 | % |   |
| Total noninterest  expense     |       | 3,601,111             |       | 3,573,651   |       |                  | 0.8        | %           |       |           | 3,107,363  |   |   |   | 15.0 | % |   |

 

**Financial Condition**

Total assets at December 31, 2006, were$97,752,681, an increase of $9,967,971 or 11.4% over 2005 year end assets of$87,784,710. Total assets for the 2004 year end were $91,174,368. Depositsincreased to $82,503,052 at December 31, 2006, an increase of $7,800,364or 10.4% from $74,702,688 at December 31, 2005. Total deposits for theyear end 2004 were $78,387,227. Gross loans increased by $12,926,146, or 20.0%,to $77,677,784 at year end 2006, from $64,751,638 at year-end 2005. Total grossloans for the year end 2004 were $73,962,845.  Federal Home Loan Bank (FHLB) Stock was$258,800 at December 31, 2006 compared to $244,500 at December 31,2005. FHLB Stock was $226,500 at year end 2004.  Most of the increase in total assets from 2005to 2006 is accounted for by the growth in the loan portfolio.

The Company places anemphasis on an integrated approach to its balance sheet management. Significantbalance sheet components of loans, sources of funds, and restricted equityinvestments are managed in an integrated manner with the management of interestrate risk, liquidity, and capital. These components are discussed below.

28

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*Loans*

Gross loans outstanding totaled $77,677,784 at December 31,2006 compared to $64,751,638 and $73,962,845 at December 31, 2005 and2004, respectively. The growth experienced in 2006 is primarily in thecommercial real estate segment of the portfolio which now encompassesapproximately fifty percent of the entire portfolio. Consumer and owneroccupied residential loans decreased slightly as a percentage of the entireportfolio. Aggregate commercial (non-real estate) loans declined as apercentage of the entire portfolio. The shift from commercial to commercialreal estate reflects the acceptable lending opportunities available in the Bank’sservice area and not any change in portfolio management strategy.

Management believes thatoverall portfolio quality remains sound and is indicative of reasonablyconservative policies and underwriting standards and effective risk managementpractices. In the event that a loan is 90 days or more past due the accrual ofincome is generally discontinued when the full collection of principal orinterest is in doubt unless the obligations are both well secured and in theprocess of collection. At December 31, 2006, there were no  loans 90 days or more past due and stillaccruing interest, while total loans 90 days or more past due and innon-accrual status equaled $1,526,880.

*Restricted EquityInvestments*

Federal Home Loan Bank(FHLB) stock at December 31, 2006 had an amortized cost of $258,800 ascompared to an amortized cost of $244,500 at December 31, 2005. Theamortized cost of the FHLB stock for the year end 2004 was $226,500. As amember of the FHLB, the Company is required to maintain stock in an amountequal to 0.15% of total assets and 4% of outstanding FHLB advances. FHLB stockis maintained by the Company at par value of $100 per share.

29

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*Deposits*

Totaldeposits, which are the principal source of funds for the Company, were$82,503,052 at December 31, 2006 compared to $74,702,688 and $78,387,227at December 31, 2005 and 2004, respectively. The increase of $7,800,364from year end 2005 to year end 2006 represents an increase of 10.4%. TheCompany has targeted local consumers, professional and commercial businesses asits central clientele, therefore, deposit instruments in the form of demanddeposits, savings accounts, money market demand accounts, NOW accounts,certificates of deposit and individual retirement accounts are offered tocustomers.  The Company has established aline of credit with the Federal Home Loan Bank secured by a blanket-pledge of 1-4family residential mortgage loans. At December 31, 2006, 2005 and 2004 theCompany had outstanding advances of $2,368,159, $4,179,052 and $4,359,346,respectively, at the Federal Home Loan Bank. Generally, banks classify theirfunding base as either core funding or non-core funding. Core funding consistsof all deposits, other than public funds and brokered deposits, issued indenominations of $100,000 or less while all other funding is deemed to benon-core. The following table represents the balances of our deposits and otherfundings and the percentage of each type to the total at December 31, 2006and December 31, 2005:

| ** **                                  | ** ** | **December 31** | ** ** | ** **  | ** ** | **December 31** | ** ** | ** **  | ** ** |
|---------------------------------------------|------------|----------------------|------------|-------------|------------|----------------------|------------|-------------|------------|
| ** **                                  | ** ** | **2006**             | ** ** | **Percent** | ** ** | **2005**             | ** ** | **Percent** | ** ** |
| **Core funding:**                           |       |                 |       |        |       |                 |       |        |       |   |   |   |   |
| Noninterest-bearing deposit accounts        |       | $                    | 9,326,547  |        |       | 11.0                 | %          |        | $          | 8,624,411 |   |   | 10.9 | % |   |
| Interest-bearing demand accounts            |       | 3,765,438            |       |        | 4.4        | %                    |       | 3,612,569   |       |   | 4.6 | % |   |
| Savings and money market accounts           |       | 24,731,496           |       |        | 29.1       | %                    |       | 18,457,814  |       |   | 23.4 | % |   |
| Time deposits accounts less than $100,000   |       | 29,315,300           |       |        | 34.5       | %                    |       | 35,881,060  |       |   | 45.5 | % |   |
| Total core funding                          |       | 67,138,781           |       |        | 79.0       | %                    |       | 66,575,854  |       |   | 84.4 | % |   |
| **Non-core  funding:**                      |       |                 |       |        |       |                 |       |        |       |   |   |   |   |
| Time deposit accounts greater than $100,000 |       | 11,538,508           |       |        | 13.6       | %                    |       | 7,099,697   |       |   | 9.0 | % |   |
| Public funds                                |       | 50,000               |       |        | 0.1        | %                    |       | 247,999     |       |   | 0.4 | % |   |
| Brokered deposits                           |       | 3,775,763            |       |        | 4.5        | %                    |       | 779,138     |       |   | 0.9 | % |   |
| Federal Home Loan Bank advances             |       | 2,368,159            |       |        | 2.8        | %                    |       | 4,179,052   |       |   | 5.3 | % |   |
| Total non-core funding                      |       | 17,732,430           |       |        | 21.0       | %                    |       | 12,305,886  |       |   | 15.6 | % |   |
| Totals                                      |       | $                    | 84,871,211 |        |       | 100.0                | %          |        | $          | 78,881,740 |   |   | 100.0 | % |   |

 

*Liquidity*

At December 31, 2006,the Company had liquid assets of approximately $15.7 million in the form ofcash, federal funds sold and Federal Home Loan Bank Stock available for salecompared to approximately $18.5 million and approximately $13.4 million on December 31,2005 and 2004 respectively. Management believes that the liquid assets areadequate at December 31, 2006. Additional liquidity will be provided bythe growth in deposit accounts and loan repayments. The Company also has theability to purchase federal funds and is a member of the Federal Home Loan Bankof Cincinnati that will provide an additional credit line if necessary. Managementis not aware of any trends, events or uncertainties that are reasonably likelyto have a material impact on the Company’s short term or long term liquidity.  

*Capital*

Total stockholders’ equity at December 31, 2006was $8,836,528, an increase of $495,705 from $8,340,823 at December 31,2005, due to the addition of $495,705 net income for the 2006 year. There wasno exercise of common stock options by key officers of the Company. The totalcapital for the year end 2004 was $7,743,097.

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At December 31, 2006, capital ratios were inexcess of the regulatory minimums with the Company’s Tier 1, total risk-basedand leverage ratio.

TheCompany’s actual capital amounts and ratios are as follows:  

| ** **                                   | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **To Be Well  Capitalized Under  Prompt Corrective** | ** ** |
|----------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|--------------------------------------------------------------------------|------------|
| ** **                                   | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                   | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                                                                | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
| As of December 31, 2006 (in Thousands)  |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Tier 1 Capital (To Average assets):*        |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 8,837                      |       |                       | 9.80       | %3                                                                  |       | $ | 3,607 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 8,803                      |       |                       | 9.76       | %3                                                                  |       | $ | 3,606 | 3 |   |   | 4 | %3 |   |   | $ | 4,508 | 3 |   |   | 5 | % |   |
| *Tier 1 Capital (To Risk Weighted Assets):*  |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 8,837                      |       |                       | 11.69      | %3                                                                  |       | $ | 3,024 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 8,803                      |       |                       | 11.65      | %3                                                                  |       | $ | 3,024 | 3 |   |   | 4 | %3 |   |   | $ | 4,535 | 3 |   |   | 6 | % |   |
| *Total Capital (To Risk Weighted Assets):*   |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 9,454                      |       |                       | 12.51      | %3                                                                  |       | $ | 6,048 | 3 |   |   | 8 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 9,420                      |       |                       | 12.46      | %3                                                                  |       | $ | 6,047 | 3 |   |   | 8 | %3 |   |   | $ | 7,559 | 3 |   |   | 10 | % |   |
| As of December 31, 2005  (in Thousands) |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Tier 1 Capital (To Average assets):*        |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 8,345                      |       |                       | 9.65       | %3                                                                  |       | $ | 3,459 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 8,317                      |       |                       | 9.62       | %3                                                                  |       | $ | 3,458 | 3 |   |   | 4 | %3 |   |   | $ | 4,322 | 3 |   |   | 5 | % |   |
| *Tier 1 Capital (To Risk Weighted Assets):*  |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 8,345                      |       |                       | 12.12      | %3                                                                  |       | $ | 2,756 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 8,317                      |       |                       | 12.08      | %3                                                                  |       | $ | 2,754 | 3 |   |   | 4 | %3 |   |   | $ | 4,132 | 3 |   |   | 6 | % |   |
| *Total Capital (To Risk Weighted Assets):*   |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 9,042                      |       |                       | 13.13      | %3                                                                  |       | $ | 5,511 | 3 |   |   | 8 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 9,014                      |       |                       | 13.09      | %3                                                                  |       | $ | 5,509 | 3 |   |   | 8 | %3 |   |   | $ | 6,886 | 3 |   |   | 10 | % |   |
| As of December 31, 2004  (in Thousands) |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| *Tier 1 Capital (To Average assets):*        |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 7,743                      |       |                       | 8.55       | %3                                                                  |       | $ | 3,621 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 7,690                      |       |                       | 8.50       | %3                                                                  |       | $ | 3,620 | 3 |   |   | 4 | %3 |   |   | $ | 4,525 | 3 |   |   | 5 | % |   |
| *Tier 1 Capital (To Risk Weighted Assets):*  |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 7,743                      |       |                       | 9.90       | %3                                                                  |       | $ | 3,129 | 3 |   |   | 4 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 7,690                      |       |                       | 10.00      | %3                                                                  |       | $ | 3,076 | 3 |   |   | 4 | %3 |   |   | $ | 4,614 | 3 |   |   | 6 | % |   |
| *Total Capital (To Risk Weighted Assets):*   |       |       |       |                       |       |                       |       |                                                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                 |       |       | $          | 8,713                      |       |                       | 11.14      | %3                                                                  |       | $ | 6,258 | 3 |   |   | 8 | %3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                          |       |       | $          | 8,659                      |       |                       | 11.26      | %3                                                                  |       | $ | 6,152 | 3 |   |   | 8 | %3 |   |   | $ | 7,691 | 3 |   |   | 10 | % |   |

 

*Liability and AssetManagement*

The Company’s Asset/Liability Committee (“ALCO”)actively measures and manages interest rate risk using a process developed bythe Company. The ALCO is also responsible for implementing the Company’sasset/liability management policies, overseeing the formulation andimplementation of strategies to improve balance sheet positioning and earnings,and reviewing the Company’s interest rate sensitivity position.

31

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The primary tool that management uses to measureshort-term interest rate risk is a net interest income simulation modelprepared by an independent correspondent institution. These simulationsestimate the impact that various changes in the overall level of interest ratesover one- and two-year time horizons would have on net interest income. Theresults help the Company develop strategies for managing exposures to interestrate risk.

Like any forecasting technique, interest ratesimulation modeling is based on a large number of assumptions. In this case,the assumptions relate primarily to loan and deposit growth, asset andliability prepayments, interest rates and balance sheet management strategies. Managementbelieves that both individually and in the aggregate the assumptions arereasonable. Nevertheless, the simulation modeling process produces only asophisticated estimate, not a precise calculation of exposure.

At December 31, 2006,approximately 63% of the Company’s gross loans had adjustable rates. Based onthe asset/liability modeling management believes that these loans reprice at afaster pace than liabilities held at the Company. Because the majority of theinstitution’s liabilities are 12 months and under and the gap in repricing isasset sensitive, with loans repricing daily, management believes that a risingrate environment would have a positive impact on the Company’s net interestmargin. Floors in the majority of the Company’s adjustable rate assets alsomitigate interest rate sensitivity in a decreasing rate environment.

**Off-Balance SheetArrangements**

The Company, at December 31, 2006, hadoutstanding unused lines of credit and standby letters of credit that totaled$12,568,294. These commitments have fixed maturity dates and many will maturewithout being drawn upon, meaning that the total commitment does notnecessarily represent the future cash requirements. The Company has the abilityto liquidate Federal funds sold or, on a short-term basis, to purchase Federalfunds from other banks and to borrow from the Federal Home Loan Bank. At December 31,2006, the Company had established with correspondent banks the ability topurchase Federal funds if needed.

32

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I.                   AVERAGE BALANCESHEETS, NET INTEREST REVENUE AND CHANGES IN INTEREST INCOME AND INTERESTEXPENSE

Thefollowing table shows the amount of our average balances, interest income orinterest expense for each category of interest-earning assets and interest-bearingliabilities and the average interest rate for total interest-earning assets andtotal interest-bearing liabilities, net interest spread and net yield onaverage interest-earning assets for each of the years in the two-year periodended December 31, 2006. The table is presented on taxable equivalentbasis, if applicable.

| ** **                                      | ** ** | **2006**    | ** ** | **2005**     | ** ** |
|-------------------------------------------------|------------|-------------|------------|--------------|------------|
| ** **                                      | ** ** | ** **  | ** ** | ** **   | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                      | ** ** | **Average** | ** ** | ** **   | ** ** | **Yields/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yields/** | ** ** |
| ** **                                      | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| Assets:                                         |       |        |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-earning  assets:                       |       |        |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Loans                                           |       | $           | 69,033,584 |         | $          | 6,124,535 |   |   | 8.87 | % |   | $ | 68,904,827 |   | $ | 5,149,519 |   |   | 7.47 | % |   |
| FHLB stock                                      |       | 249,782     |       | 14,520       |       |   | 5.81 | % |   | 234,889 |   | 11,780 |   |   | 5.02 | % |   |
| Deposits                                        |       | 757,580     |       | 32,960       |       |   | 4.35 | % |   | 1,590,170 |   | 45,806 |   |   | 2.88 | % |   |
| Federal funds sold                              |       | 10,401,186  |       | 514,318      |       |   | 4.94 | % |   | 9,053,400 |   | 292,405 |   |   | 3.23 | % |   |
| Total interest-earning assets                   |       | 80,442,132  |       | 6,686,333    |       |   | 8.31 | % |   | 79,783,286 |   | 5,499,510 |   |   | 6.89 | % |   |
| Cash and due from banks                         |       | 3,424,627   |       |         |       |   |   |   |   | 3,507,530 |   |   |   |   |   |   |   |
| Other assets                                    |       | 5,106,085   |       |         |       |   |   |   |   | 5,443,680 |   |   |   |   |   |   |   |
| Allowance for  loan losses                      |       | (690,544    | )          |         |       |   |   |   |   | (1,175,266 | ) |   |   |   |   |   |   |
| Total Assets                                    |       | $           | 88,282,300 |         |       |   |   |   |   |   | $ | 87,559,230 |   |   |   |   |   |   |   |
| Liabilities and  Stockholder’s Equity:     |       |        |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Interest-bearing  liabilities:                  |       |        |       |         |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Demand deposits                                 |       | $           | 23,018,915 |         | $          | 858,040 |   |   | 3.73 | % |   | $ | 11,125,760 |   | $ | 233,235 |   |   | 2.10 | % |   |
| Savings deposits                                |       | 4,978,901   |       | 97,872       |       |   | 1.97 | % |   | 7,267,492 |   | 132,254 |   |   | 1.82 | % |   |
| Other time  deposits                            |       | 39,417,361  |       | 1,775,042    |       |   | 4.50 | % |   | 49,375,553 |   | 1,613,861 |   |   | 3.27 | % |   |
| FHLB advances                                   |       | 3,328,626   |       | 111,473      |       |   | 3.35 | % |   | 4,276,160 |   | 139,599 |   |   | 3.26 | % |   |
| Total interest-bearing liabilities              |       | 70,743,803  |       | 2,842,427    |       |   | 4.02 | % |   | 72,044,965 |   | 2,118,949 |   |   | 2.94 | % |   |
| Non-interest bearing demand deposits            |       | 8,269,520   |       |         |       |   |   |   |   | 7,106,706 |   |   |   |   |   |   |   |
| Other liabilities                               |       | 703,285     |       |         |       |   |   |   |   | 421,067 |   |   |   |   |   |   |   |
| Stockholder’s  equity                      |       | 8,565,692   |       |         |       |   |   |   |   | 7,986,492 |   |   |   |   |   |   |   |
| Total liabilities and stockholder’s equity |       | $           | 88,282,300 |         |       |   |   |   |   |   | $ | 87,559,230 |   |   |   |   |   |   |   |
| Net interest earnings                           |       |        |       | $            | 3,843,906  |   |   |   |   |   |   |   | $ | 3,380,561 |   |   |   |   |   |
| Net interest spread                             |       |        |       |         |       |   | 4.29 | % |   |   |   |   |   |   | 3.95 | % |   |
| Net interest margin                             |       |        |       |         |       |   | 4.78 | % |   |   |   |   |   |   | 4.24 | % |   |

----

Note:                 Averageloan balances include nonaccrual loans. Interest income collected on nonaccrualloans has been included.

33

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The net interestmargin for 2006 was 4.78% compared to a net interest margin of 4.24% for thesame period in 2005, an increase of 54 basis points. The net change in the netinterest margin was significant because the net increases in the yield oninterest-earning assets was approximately 142 basis points compared to theincrease in the rate paid on interest-bearing liabilities of 108 basis points.The net interest margin for 2004 was 4.61%, compared to the 4.24% margin in2005 a decrease of 37 basis points. Other matters related to the changes in netinterest income, net yields and rate, and net interest margin are presentedbelow:

·       Ourloan yields increased from 2005 to 2006. For asset/liability managementpurposes, we have emphasized variable rate loans since our inception such thatapproximately 63.0% of our loans are variable rate loans at December 31,2006 compared to 57.0% at December 31, 2005 and 62.0% at December 31,2004. Variable rate loans generally have lower yields than do fixed rate loans,but better match the cost of funds in a rising rate environment.

·       During2006 the average balances of noninterest bearing deposits increased by$1,165,814 or 16.36%, while interest bearing deposits decreased by $1,301,162or 1.81%. Rates continued to increase in 2006 over 2005. Management anticipatesa continuation in funding rate increases on interest bearing deposits for mostof 2007.

Net interest income increased by $463,345 between theyears ended December 31, 2006 and 2005 and decreased by $542,076 betweenthe years ended December 31, 2005 and 2004.

The following is ananalysis of the changes in our net interest income comparing the changesattributable to rates and those attributable to volumes:

| ** **                         | ** ** | **2006 Compared to 2005**      | ** ** | **2005 Compared to 2004**      | ** ** |
|------------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                         | ** ** | **Increase (Decrease) due to** | ** ** | **Increase (Decrease) due to** | ** ** |
| ** **                         | ** ** | **Rate**                                      | ** ** | **Volume**                                    | ** ** | **Net** | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Net** | ** ** |
| Interest-earning assets:           |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Loans                              |       | $                                             | 965,398    |                                          | $          | 9,618 |   | $ | 975,016 |   | $ | 238,630 |   | $ | (465,620 | ) | $ | (226,990 | ) |
| FHLB stock                         |       | 1,966                                         |       | 774                                           |       | 2,740 |   | 1,990 |   | 1,212 |   | 3,202 |   |
| Deposits                           |       | 11,134                                        |       | (23,979                                       | )          | (12,845 | ) | 28,719 |   | (2,856 | ) | 25,863 |   |
| Federal funds  sold                |       | 178,379                                       |       | 43,533                                        |       | 221,912 |   | 180,695 |   | 18,023 |   | 198,718 |   |
| Total interest earning assets      |       | 1,156,877                                     |       | 29,946                                        |       | 1,186,823 |   | 450,034 |   | (449,241 | ) | 793 |   |
| Interest-bearing  liabilities:     |       |                                          |       |                                          |       |   |   |   |   |   |   |   |   |
| Demand deposits                    |       | 375,046                                       |       | 249,756                                       |       | 624,802 |   | 116,428 |   | 15,251 |   | 131,679 |   |
| Savings deposits                   |       | 7,209                                         |       | (41,652                                       | )          | (34,443 | ) | 58,870 |   | 27,788 |   | 86,658 |   |
| Other time  deposits               |       | 486,878                                       |       | (325,633                                      | )          | 161,245 |   | 521,360 |   | (190,914 | ) | 330,446 |   |
| FHLB advances                      |       | 2,764                                         |       | (30,890                                       | )          | (28,126 | ) | (1,521 | ) | (4,393 | ) | (5,914 | ) |
| Total interest-bearing liabilities |       | 871,897                                       |       | (148,419                                      | )          | 723,478 |   | 695,137 |   | (152,268 | ) | 542,869 |   |
| Net interest  income               |       | $                                             | 284,980    |                                          | $          | 178,365 |   | $ | 463,345 |   | $ | (245,103 | ) | $ | (296,973 | ) | $ | (542,076 | ) |

 

34

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Changesin net interest income are attributed to either changes in average balances(volume change) or changes in average rates (rate change) for earning assetsand sources of funds on which interest is received or paid. Volume changes havebeen determined by multiplying the prior years’ average rate by the change inaverage balances outstanding. The rate change is the difference between the netchange and the volume change.

II.              DEBT SECURITIES

TheCompany had no debt securities as of December 31, 2006 and 2005.

III.         LOAN PORTFOLIO

A.             Loan Types.

The following schedule detailsthe loans of the Company at December 31, 2006 and 2005:

| ** **                           | ** ** | **December 31** | ** ** | **December 31** | ** ** |
|--------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                           | ** ** | **2006**             | ** ** | **2005**             | ** ** |
| Consumer  installment                |       | $                    | 4,579,391  |                 | $          | 4,642,731 |   |
| Commercial                           |       | 17,305,221           |       | 19,322,800           |       |
| Commercial real  estate              |       | 38,504,482           |       | 25,782,176           |       |
| Residential mortgage                 |       | 17,288,690           |       | 15,003,931           |       |
|                                 |       | 77,677,784           |       | 64,751,638           |       |
| Less:                                |       |                 |       |                 |       |
| Estimated  allowance for loan losses |       | 617,956              |       | 697,013              |       |
| Loans, net                           |       | $                    | 77,059,828 |                 | $          | 64,054,625 |   |

 

35

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B.              Maturitiesand Sensitivities of Loans to Changes in Interest Rates

Thefollowing schedule details maturities and sensitivities to interest ratechanges for loans and deposits as of December 31, 2006: 

| ** **                                                 | ** ** | **Within**      | ** **  | **1 to 5** | ** ** | **Over 5** | ** ** | ** ** | ** ** |
|------------------------------------------------------------|------------|-----------------|-------------|----------------------|------------|-----------------|------------|------------|------------|
| ** **                                                 | ** ** | **1 year** | ** **  | **years**            | ** ** | **years**       | ** ** | **Total**  | ** ** |
| Uses of Funds:                                             |       |            |        |                 |       |            |       |       |       |
| Loans                                                      |       |            |        |                 |       |            |       |       |       |
| Installment                                                |       | $               | 1,948,155   |                 | $          | 2,599,392       |       | $          | 31,844     |   | $ | 4,579,391 |   |
| Commercial                                                 |       | 6,535,027       |        | 10,730,666           |       | 39,528          |       | 17,305,221 |       |
| Commercial real estate                                     |       | 14,383,600      |        | 21,060,626           |       | 3,060,256       |       | 38,504,482 |       |
| Mortgage                                                   |       | 5,871,229       |        | 8,437,492            |       | 2,979,969       |       | 17,288,690 |       |
| Total Loans                                                |       | 28,738,011      |        | 42,828,176           |       | 6,111,597       |       | 77,677,784 |       |
| FHLB stock                                                 |       | 258,800         |        | —               |       | —          |       | 258,800    |       |
| Deposits                                                   |       | 10,950          |        | —     |       | —          |       | 10,950     |       |
| Federal funds  sold                                        |       | 12,224,443      |        | —               |       | —          |       | 12,224,443 |       |
| Total earning assets                                       |       | $               | 41,232,204  |                 | $          | 42,828,176      |       | $          | 6,111,597  |   | $ | 90,171,977 |   |
| Sources of funds:                                          |       |            |        |                 |       |            |       |       |       |
| Deposits:                                                  |       |            |        |                 |       |            |       |       |       |
| Interest-bearing                                           |       |            |        |                 |       |            |       |       |       |
| Money market, interest checking and savings                |       | $               | 28,496,934  |                 | $          | —          |       | $          | —     |   | $ | 28,496,934 |   |
| Time deposits                                              |       | 42,070,834      |        | 2,608,737            |       | —          |       | 44,679,571 |       |
| Total Deposits                                             |       | 70,567,768      |        | 2,608,737            |       | —          |       | 73,176,505 |       |
| Borrowings                                                 |       | 729,546         |        | 1,638,613            |       | —          |       | 2,368,159  |       |
| Total interest-bearing liabilities                         |       | $               | 71,297,314  |                 | $          | 4,247,350       |       | $          | —     |   | $ | 75,544,664 |   |
| Net repricing gap                                          |       | $               | (30,065,110 | )                    | $          | 38,580,826      |       | $          | 6,111,597  |   | $ | 14,627,313 |   |
| Rate sensitivity  gap:                                     |       |            |        |                 |       |            |       |       |       |
| Net repricing gap as a percentage of total earning  assets |       | (33.34          | )%          | 42.79                | %          | 6.78            | %          | 16.22      | %          |
| Cumulative Gap                                             |       | $               | (30,065,110 | )                    | $          | 8,515,716       |       | $          | 14,627,313 |   |   |   |
| Cumulative gap as a percentage of total earning  assets    |       | (33.34          | )%          | 9.44                 | %          | 16.22           | %          |       |       |
| Rate Risk:                                                 |       |            |        |                 |       |            |       |       |       |
| Loans with fixed rates                                     |       | $               | 9,110,955   |                 | $          | 19,496,586      |       | $          | 130,695    |   | $ | 28,738,236 |   |
| Loans with variable/adjusted rate                          |       | 19,627,056      |        | 23,331,590           |       | 5,980,902       |       | 48,939,548 |       |
|                                                       |       | $               | 28,738,011  |                 | $          | 42,828,176      |       | $          | 6,111,597  |   | $ | 77,677,784 |   |

 

36

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C.               RiskElements

Thefollowing table presents information regarding nonaccrual, past due andrestructured loans at December 31, 2006 and 2005:

| ** **                                                                                                                              | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Loans accounted  for on a non-accrual basis:                                                                                            |       |     |       |     |       |
| Number                                                                                                                                  |       | 19       |       | 28       |       |
| Amount                                                                                                                                  |       | $        | 1,526,880  |     | $          | 2,094,311 |   |
| Accruing loans  (including consumer loans) which are contractually past due 90 days or  more as to principal or interest payments: |       |     |       |     |       |
| Number                                                                                                                                  |       | 0        |       | 4        |       |
| Amount                                                                                                                                  |       | $        | —     |     | $          | 78,509 |   |
| Loans defined as  “troubled debt restructurings”                                                                              |       |     |       |     |       |
| Number                                                                                                                                  |       | —   |       | —   |       |
| Amount                                                                                                                                  |       | $        | —     |     | $          | — |   |

 

Accrual of interest is discontinued on a loan whenmanagement of the Company determines upon consideration of economic andbusiness factors affecting collection efforts that collection of interest isdoubtful.

The Bank collectively evaluates large groups ofsmaller balance homogeneous loans for impairment. Loans collectively evaluatedfor impairment, with a classification of substandard or doubtful, as of December 31,2006 and 2005, were $270,068 and $365,352, respectively.

There are no other loanswhich are not disclosed above, but where known information about possiblecredit problems of borrowers causes management to have serious doubts as to theability of such borrowers to comply with the present loan repayment terms.

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IV.         SUMMARYOF LOAN LOSS EXPERIENCE

Thefollowing schedule details selected information related to the estimatedallowance for loan loss account of the Company at December 31, 2006 and2005:

| ** **                                                                                 | ** ** | **December 31** | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------|------------|
| ** **                                                                                 | ** ** | **2006**             | ** ** | **2005** | ** ** |
| Balance at  beginning of year                                                              |       | $                    | 697,013    |   | $ | 1,607,559 |   |
| Provision charged to expense                                                               |       | (23,758              | )          | (555,222 | ) |
| Charge offs:                                                                               |       |                 |       |   |   |
| Installment loans                                                                          |       | (37,039              | )          | (47,838 | ) |
| Commercial                                                                                 |       | (18,660              | )          | (292,292 | ) |
| Mortgage                                                                                   |       | —               |       | (25,049 | ) |
| Overdrafts                                                                                 |       | —               |       | — |   |
| Total Charge Offs                                                                          |       | (55,699              | )          | (365,179 | ) |
| Recoveries:                                                                                |       |                 |       |   |   |
| Installment loans                                                                          |       | —               |       | 3,762 |   |
| Commercial                                                                                 |       | 400                  |       | 4,927 |   |
| Mortgage                                                                                   |       | —               |       | 1,166 |   |
| Total Loan Recoveries                                                                      |       | 400                  |       | 9,855 |   |
| Net Charge Offs                                                                            |       | (55,299              | )          | (355,324 | ) |
| Balance at end of year                                                                     |       | $                    | 617,956    |   | $ | 697,013 |   |
| Ratio of net charge offs during the period to  average loans outstanding during the period |       | 0.08                 | %          | 0.52 | % |
| Allowance for  loan losses as a percent of year end loans                                  |       | 0.80                 | %          | 1.08 | % |

 

At December 31,2006 and 2005, the allowance for loan losses was allocated as follows:

| ** **              | ** ** | **December 31, 2006** | ** ** | **December 31, 2005**  | ** ** |
|-------------------------|------------|---------------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | ** **                      | ** ** | **Percentage of loan** | ** ** | ** ** | ** ** | **Percentage of loan** | ** ** |
| ** **              | ** ** | ** **                      | ** ** | **in each category**   | ** ** | ** ** | ** ** | **in each category** | ** ** |
| ** **              | ** ** | **Amount**                      | ** ** | **to total loans**     | ** ** | **Amount** | ** ** | **to total loans** | ** ** |
| Installment             |       | $                               | 43,811     |                             |       | 7.09 | % |   | $ | 43,236 |   |   | 6.20 | % |   |
| Commercial              |       | 182,610                         |       |                             | 29.55      | % |   | 179,072 |   |   | 25.69 | % |   |
| Commercial real  estate |       | 304,864                         |       |                             | 49.33      | % |   | 303,691 |   |   | 43.57 | % |   |
| Mortgage                |       | 86,671                          |       |                             | 14.03      | % |   | 168,149 |   |   | 24.13 | % |   |
| Overdrafts              |       | —                          |       |                             | 0.00       | % |   | 2,865 |   |   | 0.41 | % |   |
|                    |       | $                               | 617,956    |                             |       | 100.00 | % |   | $ | 697,013 |   |   | 100.00 | % |   |

 

Nonaccrual and Past Due Loans:

| ** **                                        | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------------------|------------|----------|------------|----------|------------|
| Principal:                                        |       |     |       |     |       |
| Nonaccrual loans                                  |       | $        | 1,526,880  |     | $          | 2,094,311 |   |
| Loans past due 90 days or more and still accruing |       | —   |       | 78,509   |       |
|                                              |       | $        | 1,526,880  |     | $          | 2,172,820 |   |

 

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Theestimated allowance for loan losses is evaluated on a regular basis bymanagement and is based upon management’s periodic review of the collectibilityof the loans in light of historical experience, the nature and volume of theloan portfolio, adverse situations that may affect the borrower’s ability torepay, estimated value of any underlying collateral and prevailing economicconditions. This evaluation is inherently subjective as it requires estimatesthat are susceptible to significant revision as more information becomesavailable.

V.              DEPOSITS

Theaverage amounts and average interest rates for deposits for 2006 and 2005 aredetailed in the following schedule:

| ** **                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------|------------|---------------------------------------------|------------|
| ** **                  | ** ** | **2006**                                    | ** ** | **2005** | ** ** |
| **Deposit Category**   | ** ** | ** **                                  | ** ** | **Average  Amount** | ** ** | **Average Rate  Paid** | ** ** | **Average  Amount** | ** ** | **Average  Rate Paid** | ** ** |
| Noninterest-bearing  demand |       | $                                           | 8,269,520  |   |   | N/A |   |   | $ | 7,106,706 |   |   | N/A |   |   |
| NOW deposits                |       | 23,018,915                                  |       |   | 3.73 | % |   | 11,125,760 |   |   | 2.10 | % |   |
| Savings deposits            |       | 4,978,901                                   |       |   | 1.97 | % |   | 7,267,492 |   |   | 1.82 | % |   |
| Time deposits               |       | 39,417,361                                  |       |   | 4.50 | % |   | 49,375,553 |   |   | 3.27 | % |   |
|                             |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following scheduledetails the amount outstanding of time certificates of deposit of $100,000 ormore and respective maturities for the year ended December 31, 2006:

| ** **       | ** ** | **Certificates of Deposit** | ** ** |
|------------------|------------|---------------------------------------|------------|
| 3 months or less |       |                                  | $          | 5,488,953 | ** ** |   |
| 3-6 months       |       |                                  | 6,096,065  | ** ** |   |
| 6-12 months      |       |                                  | 2,628,886  | ** ** |   |
| Over 12 months   | * *   |                                  | 1,100,367  | ** ** |   |
| Total            |       |                                  | $          | 15,314,271 | ** ** |   |

 

VI.         RETURN ON EQUITY ANDASSETS

Returnson average consolidated assets and average consolidated equity for the periodsindicated are as follows:

| ** **                              | ** ** | **Year Ended December 31,**               | ** ** |
|-----------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                              | ** ** | **    2006    ** | ** ** | **    2005    ** | ** ** |
| Return on average  assets               |       |                                                     | .56        | % |   |   | .67 | % |   |
| Return on average  equity               |       |                                                     | 5.79       | % |   |   | 7.32 | % |   |
| Average equity to  average assets ratio |       |                                                     | 9.70       | % |   |   | 9.12 | % |   |
| Dividend payout ratio                   |       |                                                     | N/A        |   |   |   | N/A |   |   |

 

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VII.    SHORT-TERMBORROWINGS

*Federal Home Loan BankAdvances:*

Pursuantto collateral agreements with Federal Home Loan Bank (FHLB), the advances arecollateralized by specific first mortgage loans. The FHLB’s required unpaidprincipal balance of eligible mortgages was $3,192,605 and $7,719,341 at December 31,2006 and 2005, respectively. The advances at December 31, 2006 and 2005,have the maturity dates as follows:

| **Maturity Date** | ** ** | ** ** | ** ** | **Interest Rate** | ** ** | **December 31, 2006** | ** ** |
|------------------------|------------|------------|------------|------------------------|------------|---------------------------------|------------|
| 12/01/07               |       |       | 3.11       | %                      |       |                            | $          | 8,930 |   |   |
| 12/01/07               |       |       | 3.83       |                   |       |                            | 456,250    |   |   |
| 01/01/08               |       |       | 3.50       |                   |       |                            | 15,743     |   |   |
| 12/20/07               |       |       | 3.60       |                   |       |                            | 30,000     |   |   |
| 04/01/10               |       |       | 3.56       |                   |       |                            | 637,877    |   |   |
| 05/01/08               |       |       | 2.64       |                   |       |                            | 26,492     |   |   |
| 06/01/08               |       |       | 3.28       |                   |       |                            | 687,266    |   |   |
| 08/01/08               |       |       | 2.85       |                   |       |                            | 34,887     |   |   |
| 08/01/08               |       |       | 2.99       |                   |       |                            | 61,108     |   |   |
| 11/01/08               |       |       | 3.54       |                   |       |                            | 100,240    |   |   |
| 03/01/07               |       |       | 2.91       |                   |       |                            | 234,366    |   |   |
| 03/20/09               |       |       | 5.18       |                   |       |                            | 75,000     |   |   |
|                   |       |       |       |                   |       |                            | $          | 2,368,159 |   |   |

 

| **Maturity Date** | ** ** | ** ** | ** ** | **Interest Rate** | ** ** | **December 31, 2005** | ** ** |
|------------------------|------------|------------|------------|------------------------|------------|---------------------------------|------------|
| 12/01/07               |       |       | 3.11       | %                      |       |                            | $          | 17,586 |   |   |
| 12/01/07               |       |       | 3.83       |                   |       |                            | 488,984    |   |   |
| 01/01/08               |       |       | 3.50       |                   |       |                            | 16,886     |   |   |
| 12/20/07               |       |       | 3.60       |                   |       |                            | 30,000     |   |   |
| 07/07/06               |       |       | 3.07       |                   |       |                            | 1,600,000  |   |   |
| 08/04/06               |       |       | 2.99       |                   |       |                            | 100,000    |   |   |
| 04/01/10               |       |       | 3.56       |                   |       |                            | 682,779    |   |   |
| 05/01/08               |       |       | 2.64       |                   |       |                            | 45,192     |   |   |
| 06/01/08               |       |       | 3.28       |                   |       |                            | 735,680    |   |   |
| 08/01/08               |       |       | 2.85       |                   |       |                            | 39,573     |   |   |
| 08/01/08               |       |       | 2.99       |                   |       |                            | 65,422     |   |   |
| 11/01/08               |       |       | 3.54       |                   |       |                            | 106,886    |   |   |
| 03/01/07               |       |       | 2.91       |                   |       |                            | 250,064    |   |   |
|                   |       |       |       |                   |       |                            | $          | 4,179,052 |   |   |

 

40

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**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The information set forthon pages 24 through 40 of Item 7, “MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS is incorporated herein byreference.

**ITEM 8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

The report of IndependentAccountants, Consolidated Financial Statements and supplementary data requiredby Item 8 are set forth on pages F-1 through F-28 of this Report andare incorporated herein by reference.

**Index to FinancialStatements**

| **Financial Statements**                                    | ** ** | ** ** | ** ** | **Page** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|
| Consolidated Balance  Sheets                                     |       | F-2        |       |
| Consolidated  Statements of Income                               |       | F-3        |       |
| Consolidated  Statements of Changes in Stockholders’ Equity |       | F-4        |       |
| Consolidated  Statements of Cash Flows                           |       | F-5        |       |
| Notes to Consolidated  Financial Statements                      |       | F-6 - F-28 |       |

 

**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE 

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

a)     *Evaluation of Disclosure Controls and Procedures*. TheCorporation maintains disclosure controls and procedures, as defined in Rule 13a-15(a) promulgatedunder the Securities Exchange Act of 1934 (the “Exchange Act”), that aredesigned to ensure that information required to be disclosed by it in thereports that it files or submits under the Exchange Act is recorded, processed,summarized and reported within the time period specified in the SEC’s rules andforms and that such information is accumulated and communicated to theCorporation’s management, including its Chief Executive Officer and ChiefFinancial Officer. The Corporation carried out an evaluation, under thesupervision and with the participation of its management, including its ChiefExecutive Officer and Chief Financial Officer, of the effectiveness of thedesign and operation of its disclosure controls and procedures as of the end ofthe period covered by this report. Based on the evaluation of these disclosurecontrols and procedures, the Chief Executive Officer and Chief FinancialOfficer concluded that the Corporation’s disclosure control and procedures wereeffective.

b)     *Changes in Internal Controls and Procedures*.There were no changes in the Corporation’s internal control over financialreporting during the Corporation’s fiscal quarter ended December 31, 2006that have materially affected, or are reasonably likely to materially affect,its internal control over financial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

41

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**PART III**

**ITEM 10. DIRECTORS,EXECUTIVE OFFICERS  AND CORPORATEGOVERNANCE**

The board of directors is divided into three classes,designated Classes I, II, and III, as nearly equal in number as the thentotal number of directors permits. The board has nominated the following twopersons to serve as Class III directors: William J. Smead and Roger A.Woolsey, and if elected they will serve until the 2010 annual meeting ofshareholders. We do not anticipate that any of these nominees will beunavailable for election but, if such a situation arises, the proxy will bevoted in accordance with the best judgment of the named proxies unless you havedirected otherwise. The remaining members of the board listed below willcontinue as members of the board until their respective terms expire, asindicated below. All of the current directors and nominees have served asdirectors of the Bank since it began operations in July 2001, and havebeen members of the board of the Company since it was formed in 2003. Assuminga quorum is present, the election of directors requires a plurality of thevotes cast by the shares of common stock entitled to vote in the election ofdirectors.

Information about theindividuals nominated as directors and the remaining members of the board is providedbelow. Shares of common stock represented by proxy cards returned to us will be voted for the nominees listedbelow unless you specify otherwise.

**CLASS IIINOMINEES FOR ELECTION**

**(TermsExpiring 2010)**

| **Name**         | ** ** | ** ** | ** ** | **Age** | ** ** | **Business Experience During Past Five Years          and Position Held with the Bank and the Company       ** | ** ** | **Director Since** | ** ** |
|------------------|------------|------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| William J. Smead |       |       | 61         |    |       | Physician;  Director and Chairman of the Board                                                                                                                                                                                                             |       |                    | 2001       | * |   |
| Roger A. Woolsey |       |       | 52         |    |       | Attorney; Director                                                                                                                                                                                                                                         |       |                    | 2001       | * |   |

----

*                    Includestime served on Bank of Greeneville board of directors

*WilliamJ. Smead***is a director and Chairman of theBoard of the Company and the Bank. Dr. Smead is a physician and principalin The Greeneville Eye Clinic in Greeneville, Tennessee. He received hisundergraduate degrees from University of Arkansas in Fayetteville, Arkansas,and he also received his Medical Degree from University of Arkansas.

*Roger A. Woolsey*is a director of the Company and the Bank. Mr. Woolsey practices law inGreeneville, Tennessee, with Woolsey & Woolsey attorneys at law. Hereceived both his undergraduate degree and his law degree from the Universityof Tennessee in Knoxville.

42

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**CLASS IINCUMBENT DIRECTORS**

**(TermsExpiring 2008)**

| **Name**          | ** ** | ** ** | ** ** | **Age** | ** ** | **Business Experience During Past Five Years          and Position Held with the Bank and the Company       ** | ** ** | **Director Since** | ** ** |
|-------------------|------------|------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| J. Robert Grubbs  |       |       | 53         |    |       | Bank President;  President and   Chief Executive Officer; Director                                                                                                                                                                                         |       |                    | 2001       | * |   |
| Leonard B. Lawson |       |       | 50         |    |       | General Manager,  Chevrolet Dealership;   Director                                                                                                                                                                                                         |       |                    | 2001       | * |   |

----

*                    Includes timeserved on Bank of Greeneville board of directors

*J.Robert Grubbs* serves as the President and ChiefExecutive Officer of the Bank and the Company, and is a director of the Bankand the Company. Prior to joining the Bank, Mr. Grubbs was an ExecutiveVice President with Andrew Johnson Bank in Greeneville, Tennessee, and prior tothat was a Senior Vice President with Greene County Bank in Greeneville,Tennessee. Mr. Grubbs received his undergraduate degree from theUniversity of Tennessee in 1975 and has a law degree from the Nashville Schoolof Law.

*Leonard B. Lawson*is a director of the Company and the Bank. He is the Vice President and GeneralManager of Lawson Chevrolet and Mazda, Inc. in Greeneville, Tennessee, theVice President Dealer-Operator of Lawson Mountain Mazda Mitsubishi, PresidentDealer Gateway Ford Lincoln and Mercury, and the Vice President of LawsonChevrolet. Mr. Lawson received his B.S. degree in marketing from theUniversity of Tennessee in 1978 and graduated from the General Motors School ofMerchandising and Management.

**CLASS II INCUMBENTDIRECTORS**

**(TermsExpiring 2009)**

| **Name**         | ** ** | ** ** | ** ** | **Age** | ** ** | **Business Experience During Past Five Years          and Position Held With the Bank and the Company       ** | ** ** | **Director Since** | ** ** |
|------------------|------------|------------|------------|---------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|
| Don E. Claiborne |       |       | 52         |    |       | Veterinarian;  Director and Senior Vice President of Bank                                                                                                                                                                                                  |       |                    | 2001       | * |   |
| Wendy C. Warner  |       |       | 46         |    |       | Real Estate; Director                                                                                                                                                                                                                                      |       |                    | 2001       | * |   |

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*                    Includestime served on Bank of Greeneville board of directors

*DonE. Claiborne* is a director of the Company and the Bank.Mr. Claiborne serves as Senior Vice President and Loan Officer of the Bank.A retired veterinarian, he is the former owner of Brookfield Animal Hospital inGreeneville, Tennessee. Mr. Claiborne received both his doctor ofveterinary medicine degree and his undergraduate degree from the University ofTennessee in Knoxville.

*Wendy C. Warner*is a director of the Company and the Bank. Ms. Warner is the President ofWarner Realty Company, West Main Cash, Inc. and SAWLEW Inc., all inGreeneville, Tennessee. She graduated from East Tennessee State University in1986 with a B.S. in business administration. She has received the CCIMdesignation.

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**EXECUTIVE OFFICERS**

Our board of directors hasthe power to appoint our officers. Each officer will hold office for such termas may be prescribed by the board of directors and until such person’ssuccessor is chosen and qualified or until such person’s death, resignation, orremoval. The Company has the following executive officers in addition to Mr. Grubbs,whose description is detailed above.

| **Name**       | ** ** | ** ** | ** ** | **Age** | ** ** | **Present Position**           | ** ** | ** ** | ** ** |
|----------------|------------|------------|------------|---------|------------|-------------------------------------|------------|------------|------------|
| T. Don Waddell |       |       | 59         |    |       | Chief Financial Officer,  Secretary |       |
|                |            |            |            |         |            |                                     |            |            |            |  |  |

 

T. Don Waddell serves asthe Chief Financial Officer and Secretary of the Bank and the Company. Prior tojoining the Bank, Mr. Waddell was a Certified Public Accountant in privatepractice and was the Chief Financial Officer of Greene County Bancshares, Inc.,Greeneville, Tennessee, for eight years. Mr. Waddell received hisundergraduate degree from East Tennessee State University in 1973.

| **Name**             | ** ** | ** ** | ** ** | **Age** | ** ** | **Present Position** | ** ** | ** ** | ** ** |
|----------------------|------------|------------|------------|---------|------------|---------------------------|------------|------------|------------|
| Douglas P.  Archbold |       |       | 62         |    |       | Chief  Credit Officer     | ** ** |
|                      |            |            |            |         |            |                           |            |            |            |  |  |

 

Douglas P. Archbold serves as the Chief Credit Officerof the Bank and the Company. Prior to joining the Bank, Mr. Archbold heldsimilar positions at other banks for a period spanning several decades.Mr. Archbold holds a baccalaureate degree in economics from Hobart Collegeand a MBA in accounting and finance from Rochester Institute of Technology.

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**INFORMATION ABOUTTHE BOARD OF DIRECTORS**

**Role of the Board**

Pursuant to Tennessee law,the Company’s business, property and affairs are managed under the direction ofour board of directors. The board has responsibility for establishing broadcorporate policies and for the overall performance and direction of theCompany, but is not involved in day-to-day operations. Members of the boardkeep informed of our business by participating in board and committee meetings,by reviewing analyses and reports sent to them regularly, and throughdiscussions with our executive officers.

**Board Structure**

The Company’s bylawsprovide that the board of directors shall consist of no fewer than five normore than 25 members. The board is currently composed of 6 members. The directorsare divided into three classes, each of which is as nearly equal in number aspossible. The directors in each class hold office for staggered terms of threeyears each. Staggered terms make it more difficult for shareholders, includingthose holding a majority of the Company’s common stock, to force an immediatechange in the composition of a majority of the board of directors. Since theterms of only one-third of the incumbent directors expire each year, two annualmeetings of shareholders would be required to change a majority of the Company’sdirectors, provided that no directors resigned, were removed, or died duringtheir terms of office and the vacancies created thereby were not filled by anaffirmative vote of a majority of the board of directors.

**2006 Board andCommittee Meetings**

During 2006 the Bank’sboard of directors held thirteen meetings, the Audit Committee held twomeetings, the ALCO Committee held twelve meetings, the Executive Committee heldone meeting, the IT Committee held one meeting, and the Compensation Committeeheld three meetings. All board members attended at least 75% of our boardmeetings and the meetings of the committees of which that director is a member.

**Attendance atAnnual Shareholders’ Meeting**

All directors are expectedto attend the annual shareholders’ meeting and their attendance is recorded inthe minutes. All board members attended the annual shareholders’ meeting lastyear.

**Board Committees**

The board has 2 standing committees: the AuditCommittee and the Compensation Committee.

*AuditCommittee.*   The Audit Committee consists of Messrs. Lawson,Woolsey and Smead and Ms. Warner. The Audit Committee has the authorityand responsibility to insure the accuracy and reliability of the Company’sfinancial statements; adequate internal controls and operating procedures; andcompliance with all laws, regulations, and policies. No member of the AuditCommittee is an “Audit Committee Financial Expert” as that term is defined inItem 401(h) of Regulation S-K. The board believes that the expense toretain an Audit Committee Financial Expert at this time is cost prohibitive.However, the board believes that each Audit Committee member has sufficientknowledge in financial and auditing matters to serve on the Audit Committee.The Committee has the authority to engage legal counsel or other experts orconsultants as it deems appropriate to carry out its responsibilities.

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*Compensation Committee.*   TheCompensation Committee consists of Messrs. Grubbs, Lawson, Woolsey andSmead. The Compensation Committee evaluates the performance of the Bank’sexecutive officers and determines their compensation. The CompensationCommittee does not have a charter. Mr. Grubbs, who is also a NamedExecutive Officer, does not participate in the discussion or approval of hiscompensation.

**Nominations forDirectorships**

The Company currently has no standing nominatingcommittee because of the long tenure of the current directors, because amajority of the members of the board are independent and because the Companyhas determined that the entire board of directors itself adequately serves thefunction of a nominating committee.

The board has determined that all of the directors,other than Messrs. Claiborne and Grubbs, are independent under the NewYork Stock Exchange requirements. Vacancies on the board may be filled by amajority of the remaining directors.

With respect to thenominating process, the board discusses and evaluates possible candidates indetail. The board selects new nominees for the position of an independentdirector based on the following criteria:

·       Personalqualities and characteristics, experience, accomplishments and reputation inthe business community.

·       Currentknowledge and contacts in market areas the Bank serves in the banking industryor other industries relevant to the Company’s business.

·       Diversityof viewpoints, background, experience and other demographics.

·       Abilityand willingness to commit adequate time to board and committee matters.

·       Thefit of the individual’s skills and personality with those of other directorsand potential directors in building a board that is effective and responsive toits duties and responsibilities.

The board does not set specific, minimumqualifications that nominees must meet in order for the board to select them asnominees, but rather believes that each nominee should be evaluated based onhis or her individual merits, taking into account the needs of the Company andthe composition of the board of directors.

Once a candidate isidentified whom the board wants seriously to consider and move towardnomination, the Chairman of the Board, the Chief Executive Officer and/or otherdirectors will enter into a discussion with that nominee.

**ShareholderNominations of Directors**

The board willconsider nominees recommended by shareholders, and any such nominee is givenappropriate consideration in the same manner as other nominees using the samecriteria described above and considering the additional information referred tobelow. Shareholders who wish to submit nominees for director for considerationby the board for election may do so by submitting in writing such nominees’names in compliance with the procedures as described below, to the Chairpersonof the Board, in care of the Corporate Secretary. A shareholder’s nominationmust contain:

·       Astatement that the writer is a shareholder and is proposing a candidate forconsideration by the board;

·       Thename of and contact information for the candidate;

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·       Astatement of the candidate’s business and educational experience;

·       Informationregarding each of the factors listed above, sufficient to enable the board toevaluate the candidate;

·       Astatement detailing any relationship or understanding between the proposingshareholder and the candidate;

·       Astatement that the candidate is willing to be considered and willing to serveas a director if nominated and elected; and

·       Astatement of the number of shares of the Company’s common stock that thenominating shareholder holds of record or in which shareholder has a beneficialinterest and the number of such shares that have been held for more than oneyear.

The Company does not pay afee to any third party to identify or evaluate or assist in the identificationor evaluation of potential nominees to its board. All directors are expected toattend the annual meeting and their attendance is recorded in the minutes.

**ShareholderCommunication with the Board of Directors**

Shareholders desiring tocommunicate with our board of directors on matters other than directornominations should submit their communication in writing to the Chairperson ofthe Board of Directors, c/o Corporate Secretary, BG Financial Group, Inc.,3095 Andrew Johnson Highway, Greeneville, Tennessee 37745, and identifythemselves as a shareholder. The Corporate Secretary will forward all suchcommunication to the Chairperson of the Board for a determination as to how toproceed.

**Other Directorshipsand Family Relationships**

No director of the Company currently serves as adirector of any other public company. We are not aware of any familyrelationships between any of our directors and executive officers.

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**ITEM 11.**         EXECUTIVECOMPENSATION

**SUMMARYCOMPENSATION TABLE**

Thefollowing table sets forth the aggregate remuneration paid by the Company forservices for the years ended December 31, 2006 to the Named ExecutiveOfficers of the Company. 

| **Name and Principal Position**                   | ** ** | ** ** | ** ** | **Year** | ** ** | **Salary** | ** ** | **(1)  Bonus** | ** ** | **Stock  awards** | ** ** | **Non-Equity  Incentive Plan  Compensation** | ** ** | **Change in  Pension Value  and  Nonqualified  Deferred  Compensation  Earnings** | ** ** | **Other  Annual  Compensation** | ** ** | **Total** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|----------|------------|------------|------------|----------------|------------|-------------------|------------|---------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|---------------------------------|------------|-----------|------------|
| J. Robert Grubbs  President and Chief Executive Officer          |       | 2006       |       | $        | 161,958    |       | $          | 4,961          |       |              | $          | 0                                                 |       |                                                                                        |       | $                               | 0          |      |       |   | $ | 0 |   |   |   | $ | 7,944 | (2) |   | $ | 187,363 |   |
| Douglas P. Archbold Sr.  Vice President and Chief Credit Officer |       | 2006       |       | $        | 141,450    |       | $          | 5,100          |       |              | $          | 0                                                 |       |                                                                                        |       | $                               | 0          |      |       |   | $ | 0 |   |   |   | $ | 0 |   |   | $ | 164,550 |   |
| T. Don Waddell  Chief Financial Officer                          |       | 2006       |       | $        | 75,597     |       | $          | 2,205          |       |              | $          | 0                                                 |       |                                                                                        |       | $                               | 0          |      |       |   | $ | 0 |   |   |   | $ | 0 |   |   | $ | 77,802 |   |

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(1)           Amount receivedthrough profit-sharing plan in which all full-time employees of the Bankparticipate based on a percentage of annual base salary.

(2)           This amountincludes an automobile allowance.

**GRANTS OFPLAN-BASED AWARDS**

The Company made no grantsof plan-based awards in fiscal 2006.

**EmploymentAgreements**

There are currently noemployment agreements in place with respect to the Bank’s executive officers orthe Company’s executive officers.

**Cash bonus**

The Named ExecutiveOfficers do not receive any cash bonus other than the profit sharing plan,available to all employees.

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**OUTSTANDING EQUITYAWARDS AT FISCAL YEAR-END 2006**

Thefollowing table sets forth information with respect to our outstanding optionawards as of December 31, 2006 for our Named Executive Officers.

| **OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END** | ** ** |
|--------------------------------------------------|------------|
| **OPTION AWARDS**                                | ** ** | **STOCK AWARDS** | ** ** |
| **Name   (a)**                              | ** ** | ** ** | ** ** | **Number of  Securities  Underlying  Unexercised  Options   (#)   Exercisable   (b)** | ** ** | **Number of  Securities  Underlying  Unexercised  Options   (#)   Unexercisable  (c)** | ** ** | **Equity  Incentive  Plan Awards:  Number of  Securities  Underlying  Unexercised  Unearned  Options  (#)  (d)** | ** ** | **Option  Exercise  Price  ($)  (e)** | ** ** | **Option  Expiration  Date  (f)** | ** ** | **Number  of Shares  or Units  of Stock  That Have  Not Vested  (#)  (g)** | ** ** | **Market Value  of Shares  or Units  of Stock  That Have  Not Vested  ($)   (h)** | ** ** | **Equity  Incentive  Plan Awards:  Number of  Unearned  Shares, Units  or Other  Rights That  Have Not  Vested  (#)  (i)** | ** ** | **Equity  Incentive  Plan Awards:  Market or  Payout Value  of Unearned  Shares, Units  or Other   Rights That  Have Not  Vested  (#)   (j)** | ** ** |
| J. Robert Grubbs                                 |       |   | 116,825 |   |   |   | — |   |   |   | — |   |   |   | $ | 3.33 |   |   | 7/16/2011 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| T. Don Waddell                                   |       |   | 16,000 |   |   |   | — |   |   |   | — |   |   |   | $ | 3.33 |   |   | 7/16/2011 |   |   | — |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Douglas P. Archbold                              |       |   | 15,000 |   |   |   |   |   |   |   |   |   |   |   | $ | 17.00 |   |   | 9/1/2014 |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |

 

**DIRECTORCOMPENSATION TABLE**

| **Name**          | ** ** | ** ** | ** ** | **Fees Earned  or Paid in  Cash(1)  ($)** | ** ** | **Stock  awards** | ** ** | **Option  Awards(2)  ($)** | ** ** | **Non-equity  incentive plan  compensation** | ** ** | **Non-qualified  deferred  compensation  earnings** | ** ** | **All other  compensation** | ** ** | **Total  ($)** | ** ** |
|-------------------|------------|------------|------------|----------------------------------------------------------|------------|-------------------|------------|----------------------------|------------|---------------------------------------------------|------------|-----------------------------------------------------|------------|----------------------------------|------------|----------------|------------|
| Don E. Claiborne  |       |       | 12,500     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 12,500 |   |   |
| Leonard B. Lawson |       |       | 12,950     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 12,950 |   |   |
| William J. Smead  |       |       | 13,550     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 13,550 |   |   |
| Wendy C. Warner   |       |       | 15,050     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 15,050 |   |   |
| Roger A. Woolsey  |       |       | 13,250     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 13,250 |   |   |
| J. Robert Grubbs  |       |       | 12,500     |                                                     |       |              | —     |                       |       |                                              | —     |                                                |       |                             | —     |           |       |   | — |   |   |   | — |   |   | 12,500 |   |   |

 

**DirectorCompensation**

Directors receive $500 foreach board meeting they attend. The directors, other than those individuals whoalso serve as officers, receive $150 for each committee meeting they attend.All directors receive an annual retainer of $6,000. During 2006, the Bank paid$79,800 in directors’ fees.

**OPTIONS EXERCISEDAND STOCK VESTED TABLE**

No options were exercisedby the Named Executive Officers during fiscal 2006.

**PENSION BENEFITS**

There are currently noPension Benefits in place with respect to the Bank’s executive officers or theCompany’s executive officers.

**NONQUALIFIEDDEFERRED COMPENSATION TABLE**

There are currently noNonqualified Deferred Compensation benefits in place with respect to the Bank’sexecutive officers or the Company’s executive officers

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**Compensation Discussion and Analysis**

**Introduction**

The Compensation Committeeof the Board is comprised of 4 directors on the Board of Directors and isresponsible for making decisions concerning cash and other compensation paid toour Chief Executive Officer and our other Named Executive Officers. Executiveofficers that are also Compensation Committee members do not participate indiscussions or vote on matters relating to their compensation. Except for theexecutive officers that are also members of the Compensation Committee, eachmember of the Compensation Committee is independent within the meaning of NASD’slisting standard and is appointed annually.

The Compensation Committeemeets periodically to evaluate the compensation and fringe benefits of ourNamed Executive Officers. The Compensation Committee met three times during2006.

**Executive Compensation Philosophy**

Bank of Greeneville seeksto provide an executive compensation package that is driven by overallfinancial performance, increase in shareholder value, success of the businessunit directly impacted by the executive’s performance and the performance ofthe individual executive. Executive compensation is intended to be set atlevels that the Compensation Committee, believes is consistent with a peergroup of banks selected by the Committee.

Compensation shouldreflect the value of the job in the marketplace. To attract and retain a highlyskilled workforce we must remain competitive with the pay of other employerswho compete with us for talent. Compensation programs must deliver top-tiercompensation for top-tier individual and company performance. The objectives ofpay for performance and retention must be balanced. Even in periods oftemporary downturns in company performance, the programs should continue toensure that successful, high-achieving employees remain motivated and committedto us.

**Objectives of Executive Compensation**

The objectives of ourexecutive compensation program are to attract and retain quality executiveleadership and to enhance the individual executive’s performance. Thecompensation committee bases its executive compensation program on the sameobjectives that guide us in establishing all of our compensation programs.Compensation is based upon the level of job responsibility, individualperformance and company performance.

The committee strives tomeet these objectives while maintaining market competitive pay levels andensuring that we make efficient use of our resources and have predictableexpense recognition.

**Competitive Positioning**

Base salaries for othernamed executive officers are determined initially by evaluating theresponsibilities of the positions held, and by reference to the competitivemarketplace for talent, including a comparison of base salaries for comparablepositions at comparable companies within the financial services industry. Annualsalary adjustments are determined by evaluating the competitive marketplace,the performance of Bank of Greeneville and the performance of the other namedexecutive officers.

**Base Salary**

Base salaries aredetermined initially by evaluating the responsibilities of the positions held,and by reference to the competitive marketplace for talent, including acomparison of base salaries for comparable positions at comparable companieswithin the financial services industry. Annual salary adjustments are determinedby evaluating the competitive marketplace, our performance and the performanceof the individual executive officer.

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**Equity Incentive**

Currently, we do not havean equity incentive plan but at various times our board of directors at theirdiscretion has granted stock option awards to the Chief Executive Officer andother executive officers as well as other employees.

**Composition ofTotal Compensation**

Bank of Greeneville provides a competitive mix of payelements that align executive incentives with shareholder value. The executivecompensation includes both short and long term compensation, with an emphasison long-term compensation that is tied to corporate and stock priceperformance. We choose to use stock options in the long-term component of totalcompensation for named executive officers as it makes stock price appreciationfundamental in realizing a compensation benefit. By emphasizing longerperformance measurement periods by using long-term incentives, we align ourexecutive’s interests with our shareholders and create a strong retention tool.

Base salaries are designedto provide competitive levels of compensation to executives based upon theirexperience, duties and scope of responsibility. Base salaries are provided toensure a basic level of compensation and necessary to recruit and retainexecutives. An important aspect of base salaries is the committee’s ability touse annual base salary adjustments to reflect an individual’s performance orchange in responsibilities.

**Summary**

In summary, we believe themix of salary, and the potential for equity ownership in Bank of Greenevillemotivates our management team to produce strong results for shareholders. Wefurther believe that this program strikes an appropriate balance in operatingour business and appropriate employee rewards based on shareholder valuecreation.

**CompensationCommittee Report**

*The above  Compensation Committee Report shall not bedeemed filed or incorporated by reference into any other document, includingthe Corporation’s filings under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, except to the extent the Corporation specificallyincorporates this Report into any such filing by reference.*

The Compensation Committeehas reviewed and discussed the Compensation Discussion and Analysis containedin this Proxy Statement with management. Based on this review and discussion,the Compensation Committee recommended to the Board of Directors that theCompensation Discussion and Analysis be included in our Proxy Statement for its2007 Annual Meeting of Shareholders.

Submitted by theCompensation Committee of our Board of Directors

**COMPENSATIONCOMMITTEE INTERLOCKS AND INSIDER PARTICIPATION**

None of the executive officers have served as adirector or member of the compensation committee of any other entity whoseexecutive officers served on our board of directors. All decisions relating toofficer compensation are reviewed by the full board. The Compensation Committeehas the authority to make all decisions relating to executive officercompensation. They may delegate that authority to other persons specifying whatauthority is so delegated and to whom.

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**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

**SECURITY OWNERSHIPOF CERTAIN BENEFICIAL OWNERSAND MANAGEMENT**

As of April 20,2007, the Company’s records indicate the following number of shares of commonstock were beneficially owned by (i) each person who is a director or anamed executive officer of the Company and (ii) all directors andexecutive officers as a group. Management is not aware of any change in controlof the Company which has occurred since the Bank commenced operations on July 9,2001, other than the share exchange with the Company on January 23, 2004,or any arrangement which may, at a subsequent date, result in a change incontrol of the Company. Management of the Company does not know of any person,other than J. Robert Grubbs, who owns, beneficially or of record, more than 5%of the Company’s outstanding common stock. Except as otherwise indicated, eachshareholder listed below has sole voting and investment power as to the shares ownedby that person.

| ** **                                                       | ** ** | **Beneficial Ownership  of Common Stock** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Douglas P. Archbold  380 Golf Trace Drive  Greeneville, TN 37743 |       | 15,000                                                   | (8)        | .65 |   |
| Don E. Claiborne  3888 Buckingham Road  Greeneville, TN 37745    |       | 93,876                                                   | (2)        | 4.06 |   |
| J. Robert Grubbs  1706 Brentwood Drive  Greeneville, TN 37743    |       | 120,039                                                  | (3)        | 5.19 |   |
| Leonard B. Lawson  290 Meadowwood  Greeneville, TN 37745         |       | 39,014                                                   | (4)        | 1.68 |   |
| William J. Smead  330 Patricia Lane  Greeneville, TN 37743       |       | 110,166                                                  | (5)        | 4.75 |   |
| T. Don Waddell  231 Fairfield Drive  Greeneville, TN 37745       |       | 22,000                                                   | (6)        | 1.00 |   |
| Wendy C. Warner  401 Oak Grove Avenue  Greeneville, TN 37745     |       | 30,439                                                   |       | 1.32 |   |
| Roger A. Woolsey  3104 Charlie Doty Road  Greeneville, TN 37743  |       | 34,486                                                   | (7)        | 1.49 |   |
| Directors and  Executive Officers (seven total)                  |       | 465,020                                                  |       | 20.12 |   |

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(1)          Based on 2,310,771shares of issued and outstanding common stock as of April 20, 2007, plus,for each person, any shares of common stock that person has the right toacquire within 60 days pursuant to stock options.

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(2)          Includes 30,000 sharesbeneficially owned by Dr. Claiborne’s wife, 3,940 shares beneficiallyowned by Dr. Claiborne’s daughter and 4,000 shares beneficially owned by Dr. Claiborne’sson, and 15,000 exercisable stock options.

(3)          Includes 116,825exercisable stock options.

(4)          Includes 30,750 sharesheld in Lawson Chevrolet Retirement Fund and 125 shares owned by Mr. Lawson’sson.

(5)          Includes 54,500 sharesbeneficially owned by Dr. Smead’s wife, 150 shares owned by Dr. Smead’smother-in-law, 80 shares owned by grandchildren,  and 300 shares beneficially owned by each of Dr. Smead’sthree daughters to which Dr. Smead disclaims beneficial ownership of 600shares.

(6)          Includes 16,000exercisable stock options.

(7)          Includes 1,800 sharesbeneficially owned by each of Mr. Woolsey’s two children and 850 shares beneficially owned by Mr. Woolsey’swife.

(8)          15,000exercisable stock options.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

Some directors andofficers of the Bank and the Company are customers of the Bank and have had andexpect to have loan transactions with the Bank in the ordinary course ofbusiness. In addition, some of the directors and officers of the Company andthe Bank are, at present, as in the past, affiliated with businesses which arecustomers of the Bank and which have had and expect to have loan transactionswith the Bank in the ordinary course of business. As of December 31, 2006,the largest aggregate amount of loan transactions with directors and officersof the Bank and their affiliates during the year totaled approximately$2,323,168, which amount is equal to 26.3% of the equity capital accounts ofthe Bank. These loans were made in the ordinary course of business and weremade on substantially the same terms, including interest rates and collateral,as those prevailing at the time for comparable transactions with other parties.In the opinion of the board of directors, these loans do not involve more thana normal risk of collectibility or present other unfavorable features.

**Other Directorshipsand Family Relationships**

No director of the Companycurrently serves as a director of any other public company. We are not aware ofany family relationships between any of our directors and executive officers

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

Forservices rendered in 2006 and 2005 by Pershing, Yoakley and Associates, P.C.(PYA) we incurred the following fees:

**Audit Fees**

The aggregate fees billedby PYA for audit of our annual financial statements and the reviews of thefinancial statements included in our Forms 10-Q for fiscal years 2006 and2005 were $66,175 and $79,180, respectively.

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**Audit Related Fees**

**None**

**Tax Fees**

The aggregate fees billedby PYA for in fiscal years 2006 and 2005 for professional services for taxcompliance, tax advice and tax planning were $8,400 and $7,535, respectively.

**All Other Fees**

There were no fees billed by PYA for other servicesrendered in 2006 and 2005.

The Audit Committee approved the above services to beperformed by PYA for the current year ended.

The Audit Committee has adopted pre-approval policiesand procedures for audit and non-audit services to be performed by PYA, as theregistered public accounting firm that performs the audit of our consolidatedfinancial statements that are filed with the Securities and Exchange Commission.All services by PYA must be pre-approved by the Audit Committee. The AuditCommittee considered whether the provision of audit-related and other non-auditservices conflicts with PYA’s independence, and found that this provision ofservices is compatible with maintaining the principal accountant’sindependence.

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**PART IV**

**ITEM 15. EXHIBITS,FINANCIAL STATEMENT SCHEDULES**

(a)(1)   Financial Statements:

(2)       Schedulesrequired by Article 12 of Regulation S-X are either omitted because theyare not applicable or because the required information is shown in thefinancial statements or the notes thereto.

(3)       Exhibits:

| Exhibit No. | ** ** | **Description** | ** ** |
|------------------|------------|-----------------|------------|
|             | 3.1        | *               |       | Charter of BG  Financial Group, Inc. |   |
|             | 3.2        | *               |       | Bylaws of BG  Financial Group, Inc. |   |
|             | 10.1       | *               |       | Share Exchange  Agreement between BG Financial Group, Inc. and Bank of Greeneville,  effective January 23, 2004 |   |
|             | 10.2       | **              |       | Stock Option  Agreement between Bank of Greeneville and J. Robert Grubbs |   |
|             | 10.3       | **              |       | Stock Option  Agreement between Bank of Greeneville and T. Don Waddell |   |
|             | 10.4       | **              |       | Purchase and  Assumption Agreement between Bank of Greeneville and First Community Bank of  East Tennessee, dated July 6, 2001; |   |
|             | 21.1       |            |       | Subsidiaries of  BG Financial Group, Inc. |   |
|             | 31.1       |            |       | Certification  pursuant to Rule 13a-14a/15d-14(a) |   |
|             | 31.2       |            |       | Certification  pursuant to Rule 13a-14a/15d-14(a) |   |
|             | 32.1       |            |       | Certification  pursuant to Rule 18 USC Section 1350-Sarbanes-Oxley Act of  2002 |   |
|             | 32.2       |            |       | Certification pursuant  to Rule 18 USC Section 1350-Sarbanes-Oxley Act of 2002 |   |

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*                    Previouslyfiled as an exhibit to a Form 8-K filed by BG Financial Group, Inc.with the Commission on May 21, 2004.

**             Previouslyfiled as an exhibit to Bank of Greeneville’s Registration Statement on Form 10-SB,as filed with the Federal Deposit Insurance Corporation on April 27, 2002.

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**Signatures**

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

|        |   | BG FINANCIAL  GROUP, INC.  |
|--------|--------|----------------------------|
|   |   | By:                        | /s/ J. ROBERT GRUBBS |
|   |   |                       | J. Robert Grubbs, |
|   |   |                       | *President and Chief Executive Officer* |
|   |   | Date: April 30,  2007 |

 

Pursuant to therequirements of the Securities Exchange Act of 1934, this report has beensigned below by the following persons on behalf of the registrant in theircapacities as directors.

| By:                        | /s/ DON E.  CLAIBORNE |                       | By:    | /s/ WILLIAM J.  SMEAD |
|----------------------------|-----------------------|----------------------------|--------|-----------------------|
|                       | Don E. Claiborne      |                       |   | William J. Smead      |
| Date: April 30,  2007 |                  | Date: April 30,  2007 |
| By:                        | /s/ J. ROBERT GRUBBS  |                       | By:    | /s/ WENDY C. WARNER   |
|                       | J. Robert Grubbs      |                       |   | Wendy C. Warner       |
| Date: April 30,  2007 |                  | Date: April 30,  2007 |
| By:                        | /s/ LEONARD B. LAWSON |                       | By:    | /s/ ROGER A. WOOLSEY  |
|                       | Leonard B. Lawson     |                       |   | Roger A. Woolsey      |
| Date: April 30,  2007 |                  | Date: April 30,  2007 |

 

56

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**BG FINANCIAL GROUP,INC. AND SUBSIDIARY**

**Greeneville,Tennessee**

**AUDITEDCONSOLIDATED FINANCIAL STATEMENTS**

**Years Ended December 31,2006, 2005 and 2004**

----

**CONTENTS**

|                                                                  | ** ** | **Page** | ** ** |
|------------------------------------------------------------------|------------|----------|------------|
| Independent  Auditor’s Report                               |       | F-1      |       |
| CONSOLIDATED  FINANCIAL STATEMENTS                               |       |     |       |
| Consolidated Balance Sheets                                      |       | F-2      |       |
| Consolidated Statements of Income                                |       | F-3      |       |
| Consolidated Statements of Changes in Stockholders’  Equity |       | F-4      |       |
| Consolidated Statements of Cash Flows                            |       | F-5      |       |
| Notes to  Consolidated Financial Statements                      |       | F-6-F-28 |       |

 

----

****

**INDEPENDENT AUDITOR’SREPORT**

To the Boards ofDirectors ofBG Financial Group, Inc.:

We have audited the accompanying consolidated balancesheets of BG Financial Group, Inc. and Subsidiary (the Company) as of December 31,2006 and 2005 and the related consolidated statements of income, changes instockholders’ equity, and cash flows for each of the three years in the periodended December 31, 2006. These consolidated financial statements are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audit to obtain reasonableassurance about whether the consolidated financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidencesupporting the amounts and disclosures in the consolidated financial statements.Our audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallconsolidated financial statement presentation. We believe that our auditsprovide a reasonable basis for our opinion.

In ouropinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of BG Financial Group, Inc.and Subsidiary as of December 31, 2006 and 2005 and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2006 in conformity with U.S. generally accepted accountingprinciples.
|                      | PERSHING YOAKLEY & ASSOCIATES, P.C. |
|----------------------|----------------------------------------------|
|                 |                                              |
| Knoxville, Tennessee |                                         |
| April 10, 2007  |                                         |

 

F-1

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**BG FINANCIAL GROUP,INC. AND SUBSIDIARYGreeneville, Tennessee**

**CONSOLIDATEDBALANCE SHEETS**

| ** **                                                                                                                                | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **2006**              | ** ** | **2005** | ** ** |
| ASSETS                                                                                                                                    |       |                  |       |   |   |
| Cash and due from banks                                                                                                                   |       | $                     | 3,263,969  |   | $ | 4,716,153 |   |
| Federal funds  sold                                                                                                                       |       | 12,224,443            |       | 13,557,689 |   |
| Cash and cash equivalents                                                                                                                 |       | 15,488,412            |       | 18,273,842 |   |
| Federal Home Loan  Bank stock, at cost                                                                                                    |       | 258,800               |       | 244,500 |   |
| Loans, net of  estimated allowance for loan losses of $617,956 in 2006 and $697,013 in 2005                                               |       | 77,059,828            |       | 64,054,625 |   |
| Premises and  equipment, net                                                                                                              |       | 3,799,519             |       | 3,777,981 |   |
| Accrued interest  receivable                                                                                                              |       | 506,906               |       | 418,329 |   |
| Deferred tax  assets, net                                                                                                                 |       | 166,545               |       | 236,743 |   |
| Foreclosed assets                                                                                                                         |       | 393,900               |       | 616,279 |   |
| Other assets                                                                                                                              |       | 78,771                |       | 162,411 |   |
| Total Assets                                                                                                                              |       | $                     | 97,752,681 |   | $ | 87,784,710 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                |       |                  |       |   |   |
| LIABILITIES                                                                                                                               |       |                  |       |   |   |
| Deposits:                                                                                                                                 |       |                  |       |   |   |
| Noninterest-bearing                                                                                                                       |       |                  |       |   |   |
| Demand                                                                                                                                    |       | $                     | 9,326,547  |   | $ | 8,624,411 |   |
| Interest-bearing                                                                                                                          |       |                  |       |   |   |
| Money market, interest checking and savings                                                                                               |       | 28,496,934            |       | 22,070,383 |   |
| Time deposits                                                                                                                             |       | 44,679,571            |       | 44,007,894 |   |
| Total Deposits                                                                                                                            |       | 82,503,052            |       | 74,702,688 |   |
| Accrued interest payable                                                                                                                  |       | 698,825               |       | 353,534 |   |
| Other liabilities                                                                                                                         |       | 247,026               |       | 208,613 |   |
| Securitized borrowings                                                                                                                    |       | 3,099,091             |       | — |   |
| Federal Home Loan Bank advances                                                                                                           |       | 2,368,159             |       | 4,179,052 |   |
| Total Liabilities                                                                                                                         |       | 88,916,153            |       | 79,443,887 |   |
| Commitments and  Contingencies (Note 12)                                                                                                  |       |                  |       |   |   |
| STOCKHOLDERS’  EQUITY                                                                                                                |       |                  |       |   |   |
| Stock:                                                                                                                                    |       |                  |       |   |   |
| Preferred stock, no par value; authorized 1,000,000  shares; none issued and outstanding                                                  |       | —                |       | — |   |
| Common stock, $0.333 par value; authorized 6,000,000  shares; issued and outstanding 2,310,771 shares at December 31, 2006 and  2005 |       | 770,256               |       | 770,256 |   |
| Additional paid-in capital                                                                                                                |       | 6,932,307             |       | 6,932,307 |   |
| Retained earnings                                                                                                                         |       | 1,133,965             |       | 638,260 |   |
| Total Stockholders’ Equity                                                                                                           |       | 8,836,528             |       | 8,340,823 |   |
| Total Liabilities  and Stockholders’ Equity                                                                                          |       | $                     | 97,752,681 |   | $ | 87,784,710 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-2

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**BG FINANCIAL GROUP,INC. AND SUBSIDIARYGreeneville, Tennessee**

**CONSOLIDATEDSTATEMENTS OF INCOME**

| ** **                                                          | ** ** | **Year Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest and dividend income:**                                   | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans, including fees                                               |       | $                                          | 6,124,535  |   | $ | 5,149,519 |   | $ | 5,376,509 |   |
| Dividends on Federal Home Loan Bank stock                           |       | 14,520                                     |       | 11,780 |   | 8,578 |   |
| Federal funds sold and other                                        |       | 547,278                                    |       | 338,211 |   | 113,630 |   |
| Total interest and dividend income                                  |       | 6,686,333                                  |       | 5,499,510 |   | 5,498,717 |   |
| **Interest  expense:**                                              |       |                                       |       |   |   |   |   |
| Deposits                                                            |       | 2,730,954                                  |       | 1,979,350 |   | 1,430,567 |   |
| Borrowed funds                                                      |       | 111,473                                    |       | 139,599 |   | 145,513 |   |
| Total interest expense                                              |       | 2,842,427                                  |       | 2,118,949 |   | 1,576,080 |   |
| Net interest income before provision for loan losses                |       | 3,843,906                                  |       | 3,380,561 |   | 3,922,637 |   |
| **Provision for (benefit from) loan losses**                        |       | (23,758                                    | )          | (555,222 | ) | 615,251 |   |
| Net interest income after provision for (benefit  from) loan losses |       | 3,867,664                                  |       | 3,935,783 |   | 3,307,386 |   |
| **Noninterest  income:**                                            | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                                 |       | 300,153                                    |       | 310,935 |   | 272,611 |   |
| Fees from origination of mortgage loans sold                        |       | 97,710                                     |       | 118,353 |   | 127,417 |   |
| Investment sales commissions                                        |       | 113,106                                    |       | 100,066 |   | 97,313 |   |
| Other                                                               |       | 36,814                                     |       | 35,905 |   | 34,336 |   |
| Total noninterest income                                            |       | 547,783                                    |       | 565,259 |   | 531,677 |   |
| **Noninterest  expenses:**                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and employee benefits                                      |       | 1,834,310                                  |       | 1,880,425 |   | 1,577,832 |   |
| Occupancy                                                           |       | 488,040                                    |       | 481,813 |   | 400,454 |   |
| Advertising                                                         |       | 88,523                                     |       | 121,858 |   | 143,266 |   |
| Data processing                                                     |       | 217,919                                    |       | 191,202 |   | 191,748 |   |
| Legal and professional                                              |       | 347,595                                    |       | 366,128 |   | 289,990 |   |
| Other operating                                                     |       | 624,724                                    |       | 532,225 |   | 504,073 |   |
| Total noninterest expense                                           |       | 3,601,111                                  |       | 3,573,651 |   | 3,107,363 |   |
| **Net income before income taxes**                                  |       | 814,336                                    |       | 927,391 |   | 731,700 |   |
| Income tax expense                                                  |       | 318,631                                    |       | 342,981 |   | 227,555 |   |
| **Net income**                                                      |       | $                                          | 495,705    |   | $ | 584,410 |   | $ | 504,145 |   |
| **Per  share information:**                                         |       |                                       |       |   |   |   |   |
| Basic net income per common share                                   |       | $                                          | 0.21       |   | $ | 0.25 |   | $ | 0.22 |   |
| Diluted net income per common share                                 |       | $                                          | 0.20       |   | $ | 0.24 |   | $ | 0.21 |   |
| Weighted average basic shares outstanding                           |       | 2,310,771                                  |       | 2,308,609 |   | 2,299,656 |   |
| Weighted average  diluted shares outstanding                        |       | 2,459,005                                  |       | 2,480,337 |   | 2,382,873 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-3

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**BG FINANCIAL GROUP,INC. AND SUBSIDIARYGreeneville, Tennessee**

**CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’EQUITY**

| ** **                                                                                                        | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                        | ** ** | **Number  of  Shares**                      | ** ** | **Common  Stock** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Retained  Earnings  (Accumulated  Deficit)** | ** ** | **Total** | ** ** |
| Balance,  December 31, 2003                                                                                  |       | 2,295,775                                   |       | $ | 765,258 |   | $ | 6,887,325 |   |   | $ | (445,296 | ) |   | $ | 7,207,287 |   |
| Effect of the Plan of Share Exchange and consolidation  of Bank of Greeneville into BG Financial Group, Inc. |       |                                        |       | — |   | — |   |   | (4,999 | ) |   | (4,999 | ) |
| Comprehensive  income:                                                                                            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                        |       |                                        |       | — |   | — |   |   | 504,145 |   |   | 504,145 |   |
| Total comprehensive income                                                                                        |       |                                        |       |   |   |   |   |   |   |   |   | 504,145 |   |
| Issuance of 11,000 shares of common stock under  stock option plan                                                |       | 11,000                                      |       | 3,667 |   | 32,997 |   |   | — |   |   | 36,664 |   |
| Balance, December 31, 2004                                                                                   |       | 2,306,775                                   |       | 768,925 |   | 6,920,322 |   |   | 53,850 |   |   | 7,743,097 |   |
| Comprehensive  income:                                                                                            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                        |       |                                        |       | — |   | — |   |   | 584,410 |   |   | 584,410 |   |
| Total comprehensive income                                                                                        |       |                                        |       |   |   |   |   |   |   |   |   | 584,410 |   |
| Issuance of 3,996 shares of common stock under stock  option plan                                                 |       | 3,996                                       |       | 1,331 |   | 11,985 |   |   | — |   |   | 13,316 |   |
| Balance, December 31, 2005                                                                                   |       | 2,310,771                                   |       | 770,256 |   | 6,932,307 |   |   | 638,260 |   |   | 8,340,823 |   |
| Comprehensive  income:                                                                                            |       |                                        |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                                                        |       |                                        |       | — |   | — |   |   | 495,705 |   |   | 495,705 |   |
| Total comprehensive income                                                                                        |       | —                                      |       | — |   | — |   |   | — |   |   | 495,705 |   |
| Balance,  December 31, 2006                                                                                  |       | 2,310,771                                   |       | $ | 770,256 |   | $ | 6,932,307 |   |   | $ | 1,133,965 |   |   | $ | 8,836,528 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-4

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**BG FINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville,Tennessee**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

| ** **                                                                         | ** ** | **Year Ended December 31,** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                          | 495,705    |   | $ | 584,410 |   | $ | 504,145 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                       |       |   |   |   |   |
| Provision for (benefit  from) loan losses                                          |       | (23,758                                    | )          | (555,222 | ) | 615,251 |   |
| Write-down of foreclosed  assets                                                   |       | 37,600                                     |       | 19,149 |   | — |   |
| Depreciation                                                                       |       | 255,904                                    |       | 304,513 |   | 259,067 |   |
| Realized loss on sales  of premises and equipment                                  |       | —                                     |       | 4,913 |   | — |   |
| Realized loss (gain) on  sales of foreclosed assets                                |       | 33,997                                     |       | 8,543 |   | (8,919 | ) |
| Deferred income tax  expense                                                       |       | 70,198                                     |       | 364,564 |   | 4,831 |   |
| Federal Home Loan Bank  stock dividends                                            |       | (14,300                                    | )          | (18,000 | ) | (54,800 | ) |
| Net change in:                                                                     |       |                                       |       |   |   |   |   |
| Accrued income  receivable                                                         |       | (88,577                                    | )          | (29,021 | ) | (2,051 | ) |
| Other assets                                                                       |       | 83,640                                     |       | (8,343 | ) | (32,218 | ) |
| Other liabilities                                                                  |       | 38,413                                     |       | (369,287 | ) | 478,351 |   |
| Accrued interest payable                                                           |       | 345,291                                    |       | 150,970 |   | 147,842 |   |
| Net cash provided by operating  activities                                         |       | 1,234,113                                  |       | 457,189 |   | 1,911,499 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from sales of  foreclosed assets                                          |       | 175,039                                    |       | 731,061 |   | — |   |
| Loan originations and  principal collections, net                                  |       | (13,005,702                                | )          | 7,970,500 |   | (4,727,904 | ) |
| Purchase of land for  future development                                           |       | —                                     |       | — |   | (563,362 | ) |
| Additions to premises  and equipment                                               |       | (277,442                                   | )          | (191,907 | ) | (828,053 | ) |
| Net cash provided by  (used in) investing activities                               |       | (13,108,105                                | )          | 8,509,654 |   | (6,119,319 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          | ** ** | ** **                                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in deposits  (non-time deposits)                                        |       | 7,128,687                                  |       | 7,891,977 |   | 4,768,779 |   |
| Net change in time  deposits                                                       |       | 671,677                                    |       | (11,576,516 | ) | 156,682 |   |
| Proceeds from  securitized borrowings                                              |       | 4,388,371                                  |       | — |   | — |   |
| Repayment of securitized  borrowings                                               |       | (1,289,280                                 | )          | — |   | — |   |
| Federal Home Loan Bank  advances                                                   |       | 75,000                                     |       | — |   | 276,462 |   |
| Federal Home Loan Bank  repayments                                                 |       | (1,885,893                                 | )          | (180,294 | ) | (171,221 | ) |
| Issuance of common stock                                                           |       | —                                     |       | 13,316 |   | 36,664 |   |
| Net cash provided by  (used in) financing activities                               |       | 9,088,562                                  |       | (3,851,517 | ) | 5,067,366 |   |
| Net change in cash and  cash equivalents                                           |       | (2,785,430                                 | )          | 5,115,326 |   | 859,546 |   |
| Cash and cash  equivalents at beginning of year                                    |       | 18,273,842                                 |       | 13,158,516 |   | 12,298,970 |   |
| Cash and cash  equivalents at end of year                                          |       | $                                          | 15,488,412 |   | $ | 18,273,842 |   | $ | 13,158,516 |   |
| **SUPPLEMENTARY CASH FLOW INFORMATION:**                                           |       |                                       |       |   |   |   |   |
| Interest paid on  deposits and borrowed funds                                      |       | $                                          | 2,497,136  |   | $ | 1,964,685 |   | $ | 1,428,238 |   |
| Income taxes paid                                                                  |       | $                                          | 102,000    |   | $ | 148,090 |   | $ | 87,431 |   |
| **SUPPLEMENTAl SCHEDULE OF NON-CASH ACTIVITIES:**                                  |       |                                       |       |   |   |   |   |
| Foreclosed assets sold  during the year and financed through loans                 |       | $                                          | 184,350    |   | $ | 65,412 |   | $ | 255,177 |   |
| Transfer of loans to foreclosed assets                                             |       | $                                          | 208,607    |   | $ | 950,795 |   | $ | 83,383 |   |

 

The accompanying notes are an integral part of these consolidated financial statements.

F-5

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**BG FINANCIAL GROUP, INC. AND SUBSIDIARY**

**Greeneville,Tennessee**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

**Note 1.   Operationsand Summary of Significant Accounting Policies**

***Principles of Consolidation***

The consolidated financialstatements include the accounts of BG Financial Group, Inc. and Bank ofGreeneville, a wholly-owned subsidiary of BG Financial Group, Inc. Allsignificant intercompany balances and transactions have been eliminated.

***Nature of Business***

BG Financial Group, Inc.(“the Holding Company”) is a bank holding company whose business is conductedby its wholly-owned subsidiary, Bank of Greeneville (“the Bank”) (collectively,“the Company”). The Bank is engaged in the business of originating loansprimarily within its lending area, Greeneville and Greene County in Tennessee. TheBank obtains deposits both inside and outside of its primary lending area. TheHolding Company was organized in November 2003. The Holding Company hadminimal assets, liabilities or operations until January, 2004, when it acquiredthe Bank in a Plan of Share Exchange whereby the stockholders exchanged theirshares of ownership in the Bank for shares of ownership in the Holding Companyon a one-for-one basis. As a part of the Plan of Share Exchange, the Bankbecame a wholly-owned subsidiary of the Holding Company.

***Use of Estimates***

The preparation of consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America requires management to make estimates and assumptions thataffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the consolidated financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptibleto significant change relate to the determination of the allowance for loanlosses, the valuation of assets acquired in connection with foreclosures or insatisfaction of loans, and realization of deferred tax assets.

The ultimate collectibility of a substantial portionof the Company’s loan portfolio and the recovery of a substantial portion ofthe carrying amount of foreclosed assets are susceptible to changes in localmarket conditions.

While management usesavailable information to estimate losses on loans and foreclosed assets, futureadditions to the allowances may be necessary based on changes in local economicconditions. In addition, regulatory agencies, as an integral part of theirexamination process, periodically review the Bank’s allowances for losses onloans and foreclosed assets. Such agencies may require the Company to recognizeadditions to the allowances based on their judgments about information availableto them at the time of their examination. Because of these factors, it isreasonably possible that the estimated allowances for loan losses andforeclosed assets may change materially in the near term.

***Cash and Cash Equivalents***

Cash and cash equivalentsinclude cash and balances due from banks and federal funds sold.

F-6

----

***Trading Securities***

Government bonds heldprincipally for resale in the near term, and mortgage-backed securities heldfor sale in conjunction with the Company’s mortgage banking activities, areclassified as trading account securities and recorded at their fair values. Unrealizedgains and losses on trading account securities are included immediately inother income. However, at December 31, 2006 and 2005 the Company did nothave any trading securities.

***Debt Securities***

Certain debt securities that management has thepositive intent and ability to hold to maturity are classified as “held tomaturity” and recorded at amortized cost. Securities not classified as held tomaturity or trading, including equity securities with readily determinable fairvalues, are classified as “available for sale” and recorded at fair value, withunrealized gains and losses excluded from earnings and reported in othercomprehensive income. There were no securities classified as “held to maturity”or “available for sale” as of December 31, 2006 and 2005.

Purchase premiums anddiscounts are recognized in interest income using the interest method over theterms of the securities. Declines in the fair value of held-to-maturity andavailable-for-sale securities below their cost that are deemed to be other thantemporary are reflected in earnings as realized losses. In estimating otherthen temporary impairment losses, management considers (1) the length oftime and the extent to which the fair value has been less than cost, (2) thefinancial condition and near-term prospects of the issuer, and (3) theintent and ability of the Company to retain its investment in the issuer for aperiod of time sufficient to allow for any anticipated recovery in fair value. Gainsand losses on the sale of securities are recorded on the trade date and aredetermined using the specific identification method.

***Loans***

Loans that management has the intent and ability tohold for the foreseeable future or until maturity or pay-off generally arereported at their outstanding unpaid principal balances adjusted forcharge-offs, the estimated allowance for loan losses, and any deferred fees orcosts on originated loans. Interest income is accrued on the unpaid principalbalance. Any loan origination fees, net of certain direct origination costs,are deferred and recognized as an adjustment of the related loan yield usingthe interest method. There were no net loan origination fees considered to bematerial for deferral at December 31, 2006 or 2005.

The accrual of interest on mortgage and commercialloans is discontinued at the time the loan is 90 days past due unless thecredit is well-secured and in process of collection. Past due status is basedon contractual terms of the loan. In all cases, loans are placed on non-accrualbasis or charged-off at an earlier date if collection of principal or interestis considered doubtful.

All interest accrued butnot collected for loans that are placed on a non-accrual basis or charged offis reversed against interest income. The interest on these loans is accountedfor on the cash-basis or cost-recovery method, until qualifying for return toaccrual. Loans are returned to accrual status when all the principal and interestamounts contractually due are brought current and future payments arereasonably assured.

***Estimated Allowance for Loan Losses***

The estimated allowance for loan losses is establishedas losses are estimated to have occurred through a provision for loan lossescharged to earnings. Loan losses are charged against the estimated allowancewhen management believes the uncollectibility of a loan balance is confirmed. Subsequentrecoveries, if any, are credited to the allowance.

F-7

----

The estimated allowance for loan losses is evaluatedon a regular basis by management and is based upon management’s periodic reviewof the collectibility of the loans in light of historical experience, thenature and volume of the loan portfolio, the Bank’s evaluation of its lendingand underwriting policies, adverse situations that may affect the borrower’sability to repay, estimated value of any underlying collateral and prevailingeconomic conditions. This evaluation is inherently subjective as it requiresestimates that are susceptible to significant revision as more informationbecomes available.

The estimated allowance consists of specific andgeneral components. The specific component relates to loans that are consideredto be impaired. A specific allowance is established when the discounted cashflows (or collateral value or observable market price) of the impaired loan islower than the carrying value of that loan.

A loan is considered impaired when, based on currentinformation and events, it is probable that the Company will be unable tocollect the scheduled payments of principal or interest when due according tothe contractual terms of the loan agreement. Factors considered by managementin evaluating impairment include payment status, collateral value, and theprobability of collecting scheduled principal and interest payments when due. During2005, the Bank modified its methodology to also specifically evaluate allcommercial and real estate loans classified as substandard or doubtful over$100,000 for impairment (see Note 5). Loans that experience insignificantpayment delays and payment shortfalls generally are not classified as impaired.Management determines the significance of payment delays and payment shortfallson a case-by-case basis, taking into consideration all of the circumstancessurrounding the loan and the borrower, including the length of the delay, thereasons for the delay, the borrower’s prior payment record, and the amount ofthe shortfall in relation to the principal and interest owed. Impairment ismeasured on a loan by loan basis for commercial and real estate loans by eitherthe present value of expected future cash flows discounted at the loan’seffective interest rate, the loan’s obtainable market price, or the fair valueof the collateral if the loan is collateral dependent.

Large groups of smaller balance homogeneous loans arecollectively evaluated for impairment. Accordingly, the Company does notseparately identify individual consumer and residential loans for impairmentdisclosures.

For large groups of smaller homogeneous loans, theallowance is determined by calculating the following components:  historical loss experience, adjustments toreflect the effect of current conditions, and adjustments for other factors. Eachof these components is explained in more detail below.

The year ended December 31, 2006 represents theBank’s fifth full year of operations. In determining the component forhistorical loss experience, the Bank has considered the average of the lastfive years’ experience. Management has considered whether the historical lossexperience needs to be adjusted for other factors, including:  past due trends, classified asset trends,recovery trends, loan volume increases or decreases, loan underwriting/riskmanagement, lending staff experience, local employment conditions, and creditconcentrations.

Loans collectively assessed for impairment areconsumer, residential, and smaller-balance commercial and commercial realestate loans. The credit risk characteristics within each such grouping isconsidered to be consistent with prior experience, and thus the credit riskevaluation process is based on historical experience as adjusted for thefactors described above.

At December 31,2006, the objective evidence used in measuring each component of loans isprimarily as follows:

(a)          Impaired loans underFinancial Accounting Standards Board (FASB) Statement No. 114: *Accounting by Creditors for Impairment of a Loan*—delinquencyinformation and estimates of future collections

F-8

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(b)         Loanscollectively assessed under FASB Statement No. 5: (a) historicalcomponent: loan balances and average losses over the last five years in eachcategory; (b) adjustments to historical loss experience based on the otherfactors discussed above.

***Advertising***

The Company’s policy is toexpense advertising costs as the costs are incurred.

***P***remises and Equipment

Landis carried at cost. Company premises and equipment are carried at cost lessaccumulated depreciation. Depreciation is computed using the straight-linemethod over the following estimated useful lives:

| ** **                  | ** ** | **Years**  | ** ** |
|-----------------------------|------------|------------|------------|
| Buildings and  improvements |       | 311¤2 |       |
| Furniture and equipment     |       | 3-10       |       |

 

Maintenance and repairsare expensed as incurred while major additions and improvements are capitalized.Gains and losses on dispositions are included in current operations.

***Foreclosed Assets***

Assets acquired through,or in lieu of, loan foreclosure are held for sale and are initially recorded atfair value at the date of foreclosure, establishing a new cost basis. Subsequentto foreclosure, valuations are annually performed by management and the assetsare reported at the lower of carrying amount or fair value less estimated costto sell. Any changes in the valuation allowance are included in noninterestexpense. There was no valuation allowance at December 31, 2006 and 2005.

***Income Taxes***

Income taxes are providedfor the tax effects of the transactions reported in the financial statementsand consist of taxes currently due plus deferred taxes related primarily todifferences between the basis of the estimated allowance for loan losses andaccumulated depreciation. Deferred income tax assets and liabilities aredetermined using the liability (or balance sheet) method. Under this method,the net deferred tax asset or liability is determined based on the tax effectsof the temporary differences between the book and tax bases of the variousbalance sheet assets and liabilities and gives current recognition to changesin tax rates and laws.

***Off-Balance Sheet Credit Related Financial Instruments***

In the ordinary course of business, the Company hasentered into commitments to extend credit, including commitments undercommercial lines of credit, and standby letters of credit. Such financialinstruments are recorded when they are funded.

F-9

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***Stock-Based Compensation Plan***

In December 2004, the Financial AccountingStandards Board (“FASB”) issued Statement 123 (revised 2004), *Share-Based Payment*. SFAS No. 123(R) requires thatthe compensation cost relating to share-based payment transactions be recognizedin financial statements. That cost is measured based on the fair value of theequity or liability instruments issued. SFAS 123(R) covers a wide range ofshare-based compensation arrangements including stock options, restricted shareplans, performance-based awards, share appreciation rights, and employee sharepurchase plans. SFAS 123(R) is a replacement of SFAS No. 123, *Accounting for Stock-Based Compensation*, and supersedes APBOpinion No. 25, *Accounting for StockIssued to Employees*, and its related interpretive guidance. Theeffect of the Statement is to require entities to measure the cost of employeeservices received in exchange for stock options based on the grant-date fairvalue of the award, and to recognize the cost over the period the employee isrequired to provide services for the award. SFAS 123(R) permits entitiesto use any option-pricing model that meets the fair value objective in theStatement.

On July 1, 2005, theCompany adopted the provisions of SFAS No. 123(R). In anticipation ofadopting SFAS No. 123(R), the Board of Directors approved that allnon-vested employee stock options granted to become fully vested andexercisable as of May 17, 2005 in order to avoid recognition ofcompensation costs in the consolidated statements of income in future periods.Accordingly, no compensation cost was recognized prior to the adoption of SAFS No. 123(R) onJuly 1, 2005. No additional options have been granted after July 1,2005; therefore, no compensation cost is recognized in the consolidatedstatements of income.

***Earnings Per Common Share***

Basic earnings per sharerepresents income available to common stockholders divided by theweighted-average number of common shares outstanding during the period. Dilutedearnings per share reflects additional common shares that would have beenoutstanding if dilutive potential common shares had been issued, as well as anyadjustment to income that would result from the assumed issuance. Potentialcommon shares that may be issued by the Company relate solely to outstandingstock options and are determined using the treasury stock method.

***Recent Accounting Pronouncements***

In March 2006, the Financial Account StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 156,*Accounting for Servicing of Financial Assets*,an Amendment of FASB Statement No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*, (“SFAS 140”) which requires that all separatelyrecognized servicing assets and liabilities be initially measured at fairvalue, if practicable, and requires entities to elect either fair valuemeasurement with changes in fair value reflected in earnings or theamortization and impairment requirements of Statement 140 for subsequent measurement.SFAS 156 is effective as of the beginning of an entity’s first fiscal year thatbegins after September 15, 2006. The Company plans to adopt SFAS 156 on January 1,2007. The adoption of SFAS 156 is not expected to have any material impact onthe Company’s consolidated financial condition or results of operations.

In July 2006, FASB issued Interpretation No. 48,*Accounting for Uncertainty in Income Taxes*,(“FIN 48”). FIN 48 is effective for fiscal years beginning after December 15,2006. FIN 48 applies to all income tax positions subject to FASB Statement No. 109,*Accounting for Income Tax* (“SFAS 109”),including tax positions considered to be routine and those with a high degreeof uncertainty. FIN 48 is not expected to have a material impact on the Company’sconsolidated financial statements.

F-10

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In September 2006, the FASB issued SFAS No. 157, *Fair Value Measurements* (“SFAS 157”). SFAS 157 definesfair value, establishes a framework for measuring fair value and expandsdisclosures about fair value measurements. SFAS 157 will be appliedprospectively and is effective for fiscal years beginning after November 15,2007 and interim periods within those fiscal years. SFAS 157 is not expected tohave a material impact on the Company’s consolidated financial statements.

FASB Staff Position on FAS No. 115-1 andFAS No. 124-1 (“the FSP”), *The Meaning ofOther-Than-Temporary Impairment and Its Application to Certain Investments*,was issued in November 2005 and addresses the determination of when aninvestment is considered impaired; whether the impairment isother-than-temporary; and how to measure an impairment loss. The FSP alsoaddresses accounting considerations subsequent to the recognition of another-than-temporary impairment on a debt security, and requires certaindisclosures about unrealized losses that have not been recognized asother-than-temporary impairments. The FSP replaces the impairment guidance onEmerging Issues Task Force (EITF) Issue No. 03-1 with references toexisting authoritative literature concerning other-than-temporarydeterminations. Under the FSP, losses arising from impairment deemed to beother-than-temporary, must be recognized in earnings at an amount equal to theentire difference between the security’s cost and its fair value at thefinancial statement date, without considering partial recoveries subsequent tothat date. The FSP also required that an investor recognize another-than-temporary impairment loss when a decision to sell a security hasbeen made and the investor does not expect the fair value of the security tofully recover prior to the expected time of sale. The FSP was effective forreporting periods beginning after December 15, 2005. The adoption of thisstatement did not have a material impact on the Company’s consolidatedfinancial statements.

In December 2004, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) No. 123 (revised 2004), *Share-Based Payment* (“SFAS No. 123R”), which revisedSFAS No. 123, *Accounting for Stock-BasedCompensation*. This statement supercedes APB Opinion No. 25, “Accountingfor Stock Issued to Employees.”  Therevised statement addresses the accounting for share-based payment transactionswith employees and other third parties, eliminates the ability to account forshare-based compensation transactions using APB 25 and requires that thecompensation costs relating to such transactions be recognized in theconsolidated statement of income. The revised statement was effective for theCompany as of the first interim or annual period beginning after September 15,2005. In anticipation of adopting SFAS No. 123R, the Company elected toimmediately vest all remaining stock options during 2005 to avoid therecognition of compensation costs in the consolidated statements of income in futureperiods.

The FASB issued a FASBStaff Position (FSP) on December 15, 2005, “SOP 94-6-1—Termsof Loan Products That May Give Rise to a Concentration of Credit Risk”which addresses the disclosure requirements for certain nontraditional mortgageand other loan products the aggregation of which may constitute a concentrationof credit risk under existing accounting literature. Pursuant to this FSP, theFASB’s intentions were to reemphasize the adequacy of such disclosures andnoted that the recent popularity of certain loan products such as negativeamortization loans, high loan-to-value loans, interest only loans, teaser rateloans, option adjusted rate mortgage loans and other loan product types mayaggregate to the point of being a concentration of credit risk to an issuer andthus may require enhanced disclosures under existing guidance. This FSP waseffective immediately. The adoption of this FSP did not have a material impacton the consolidated financial statements.

***Reclassifications***

Certain prior year amountshave been reclassified to conform with current year presentations.

F-11

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**Note 2.**        RestrictionsOn Cash and Due From Banks

Under agreements withcorrespondent banks, the Company maintains deposit balances with thecorrespondents to cover various bank processing charges. In addition, theCompany must maintain an average reserve balance related to customers’ depositbalances as required by the Federal Reserve. At December 31, 2006 and2005, approximately $25,000 was required to be on hand by the Federal Reserveas a minimum reserve balance.

**Note 3.**        FederalHome Loan Bank Stock

As a member of the FederalHome Loan Bank (FHLB), the Company is required to maintain stock in an amountequal to at least .15% of total assets and 4% of outstanding FHLB advances. FederalHome Loan Bank stock is carried at cost. Federal Home Loan Bank stock ismaintained by the Company at par value of $100 per share.

**Note 4.**        Loans

Thecomposition of the net loans is as follows:

| ** **                           | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Consumer installment                 |       | $                     | 4,579,391  |                  | $          | 4,642,731 |   |
| Commercial                           |       | 17,305,221            |       | 19,322,800            |       |
| Commercial real  estate              |       | 38,504,482            |       | 25,782,176            |       |
| Residential  mortgage                |       | 17,288,690            |       | 15,003,931            |       |
|                                 |       | 77,677,784            |       | 64,751,638            |       |
| Less:                                |       |                  |       |                  |       |
| Estimated  allowance for loan losses |       | (617,956              | )          | (697,013              | )          |
| Loans, net                           |       | $                     | 77,059,828 |                  | $          | 64,054,625 |   |

 

Thefollowing is a summary of information pertaining to impaired and non-accrualloans:

| ** **                                                    | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                    | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Impaired loans  with a specific valuation allowance           |       |                  | $          | 1,155,496             |       |   |   | $ | 1,652,034 |   |   |
| Total  specifically evaluated impaired loans                  |       |                  | $          | 1,155,496             |       |   |   | $ | 1,652,034 |   |   |
| Specific  valuation allowance related to impaired loans       |       |                  | $          | 54,428                |       |   |   | $ | 90,662 |   |   |
| Past-due loans  ninety days or more and still accruing        |       |                  | $          | —                |       |   |   | $ | 78,509 |   |   |
| Total non-accrual  loans                                      |       |                  | $          | 1,526,880             |       |   |   | $ | 2,094,311 |   |   |
| Average investment in specifically evaluated  impaired loans  |       |                  | $          | 1,209,424             |       |   |   | $ | 1,685,714 |   |   |
| Interest income  recognized on impaired loans                 |       |                  | $          | 27,556                |       |   |   | $ | 27,344 |   |   |
| Interest income  recognized on a cash basis on impaired loans |       |                  | $          | 27,556                |       |   |   | $ | 27,344 |   |   |

 

Interest income that would have accrued on non-accrualloans if they were on a current basis was $130,651 and $155,347 in 2006 and2005, respectively.

The Bank collectively evaluates large groups ofsmaller balance homogeneous loans for impairment. Loans collectively evaluatedfor impairment, with a classification of substandard or doubtful, as of December 31,2006 and 2005, were $270,068 and $365,352, respectively.

F-12

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Thefollowing table is a summary of loans as of December 31, 2006:

| ** **              | ** ** | ** **          | ** ** | **Variable** | ** ** | ** ** | ** ** |
|-------------------------|------------|---------------------|------------|--------------|------------|------------|------------|
| ** **              | ** ** | **Fixed Rate** | ** ** | **Rate**     | ** ** | **Total**  | ** ** |
| Installment             |       | $                   | 3,364,918  |         | $          | 1,214,473  |       | $ | 4,579,391 |   |
| Commercial              |       | 2,903,269           |       | 14,401,952   |       | 17,305,221 |       |
| Commercial real  estate |       | 12,654,705          |       | 25,849,777   |       | 38,504,482 |       |
| Mortgage                |       | 9,815,344           |       | 7,473,346    |       | 17,288,690 |       |
| Total                   |       | $                   | 28,738,236 |         | $          | 48,939,548 |       | $ | 77,677,784 |   |

 

Theschedule of maturities for loans at December 31, 2006 by fixed andvariable rates are shown below:

| ** **                             | ** ** | ** **          | ** ** | **Variable** | ** ** | ** ** | ** ** |
|----------------------------------------|------------|---------------------|------------|--------------|------------|------------|------------|
| ** **                             | ** ** | **Fixed Rate** | ** ** | **Rate**     | ** ** | **Total**  | ** ** |
| Due in one year  or less               |       | $                   | 9,110,955  |         | $          | 19,627,056 |       | $ | 28,738,011 |   |
| Due after one  year through five years |       | 19,496,586          |       | 23,331,590   |       | 42,828,176 |       |
| Due after five  years                  |       | 130,695             |       | 5,980,902    |       | 6,111,597  |       |
| Total                                  |       | $                   | 28,738,236 |         | $          | 48,939,548 |       | $ | 77,677,784 |   |

 

**Note 5.**   EstimatedAllowance for Loan Losses

Changesin the estimated allowance for loan losses for the Bank are as follows:

| ** **                                 | ** ** | **Year Ended**   | ** ** | **Year Ended**   | ** ** | **Year Ended**   | ** ** |
|--------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **December 31,** | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                 | ** ** | **2006**              | ** ** | **2005**              | ** ** | **2004**              | ** ** |
| Balance,  beginning                        |       |                  | $          | 697,013               |       |                  |       | $ | 1,607,559 |   |   |   | $ | 1,350,266 |   |   |
| Provision for (benefit from) loan losses   |       |                  | (23,758    | )                     |       |                  | (555,222   | ) |   |   | 615,251 |   |   |
| Recoveries of loans previously charged-off |       |                  | 400        |                  |       |                  | 9,855      |   |   |   | 143,821 |   |   |
|                                       |       |                  | 673,655    |                  |       |                  | 1,062,192  |   |   |   | 2,109,338 |   |   |
| Loans charged-off                          |       |                  | 55,699     |                  |       |                  | 365,179    |   |   |   | 501,779 |   |   |
| Balance, ending                            |       |                  | $          | 617,956               |       |                  |       | $ | 697,013 |   |   |   | $ | 1,607,559 |   |   |

 

The year 2006 represents the Bank’s fifth full year ofoperations. Prior to 2006, the Bank had adjusted its historical loss experienceby adding 25 basis points for a lack of historical experience. In 2006, theBank removed this factor from its estimate of the allowance for loan losses. Theremoval of this factor accounts for the majority of the benefit from thereduction of the estimated allowance for loan losses in 2006.

During 2005, the Bankrecognized a benefit of $555,222 from the reduction of the allowance for loanlosses. One factor was that several loans, which were classified as specialmention, substandard or doubtful as of December 31, 2004, were paid outduring 2005 with minimal losses. In addition, the Bank’s loan portfolio as awhole, as of December 31, 2005, had decreased by approximately $9,200,000(includes classified loans from 2004 that paid out in 2005) since December 31,2004. Another factor is that the Bank modified its methodology to evaluate morespecific loans for impairment (see Note 1). This change in methodology provideda benefit of approximately $163,000 in 2005. Given the fact that many of theBank’s loans are considered to be well collateralized by real estate, the Bankhas estimated minimal exposure on its specifically-evaluated impaired loans asof December 31, 2006 and 2005.

F-13

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**Note 6.**   Premisesand Equipment

Themajor classes of premises and equipment and the total accumulated depreciationare as follows:

| ** **                      | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Land                            |       | $                     | 1,170,363  |                  | $          | 1,170,363 |   |
| Land for future  development    |       | 564,712               |       | 564,712               |       |
| Premises and  improvements      |       | 1,420,548             |       | 1,420,548             |       |
| Furniture and  equipment        |       | 1,827,363             |       | 1,597,621             |       |
| Construction in  process        |       | 78,763                |       | 31,063                |       |
|                            |       | 5,061,749             |       | 4,784,307             |       |
| Less: Accumulated  depreciation |       | (1,262,230            | )          | (1,006,326            | )          |
|                            |       | $                     | 3,799,519  |                  | $          | 3,777,981 |   |

 

Depreciation and amortization expense of premises andequipment for 2006 and 2005 was $255,904 and $304,513, respectively. Theconstruction in progress was completed in early 2007 with minimal additionalcosts.

Rental expense under operating leases for 2006 and2005 was $40,952 and $23,599, respectively.

Futureminimum rental payments required under noncancelable operating leases forequipment and data processing fees under operating agreements were as follows:

| 2007       |   | $      | 38,987  |   |
|------------|--------|--------|---------|--------|
| 2008       |   | 37,521 |    |
| 2009       |   | 33,548 |    |
| 2010       |   | 30,237 |    |
| 2011       |   | 26,957 |    |
| Thereafter |   | 25,724 |    |
|       |   | $      | 192,974 |   |

 

**Note 7.   FederalHome Loan Bank Advances**

Pursuantto collateral agreements with Federal Home Loan Bank (FHLB), the advances arecollateralized by specific first mortgage loans. The             FHLB’s required unpaid principal balance of eligiblemortgages was $3,192,605 at December 31, 2006. The advances at December 31,2006, have maturity dates as follows:

| **Maturity Date** | ** ** | ** ** | ** ** | **Interest Rate** | ** ** | **December 31, 2006** | ** ** |
|------------------------|------------|------------|------------|------------------------|------------|---------------------------------|------------|
| 12/01/07               |       |       | 3.11       | %                      |       |                            | $          | 8,930 |   |   |
| 12/01/07               |       |       | 3.83       |                   |       |                            | 456,250    |   |   |
| 01/01/08               |       |       | 3.50       |                   |       |                            | 15,743     |   |   |
| 12/20/07               |       |       | 3.60       |                   |       |                            | 30,000     |   |   |
| 04/01/10               |       |       | 3.56       |                   |       |                            | 637,877    |   |   |
| 05/01/08               |       |       | 2.64       |                   |       |                            | 26,492     |   |   |
| 06/01/08               |       |       | 3.28       |                   |       |                            | 687,266    |   |   |
| 08/01/08               |       |       | 2.85       |                   |       |                            | 34,887     |   |   |
| 08/01/08               |       |       | 2.99       |                   |       |                            | 61,108     |   |   |
| 11/01/08               |       |       | 3.54       |                   |       |                            | 100,240    |   |   |
| 03/01/07               |       |       | 2.91       |                   |       |                            | 234,366    |   |   |
| 03/20/09               |       |       | 5.18       |                   |       |                            | 75,000     |   |   |
|                   |       |       |       |                   |       |                            | $          | 2,368,159 |   |   |

 

F-14

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As of December 31,2006, the Company had $100,000 available in unfunded letters of credit with theFHLB.

**Note 8.   Securitizations**

During 2006, the Companysold commercial real estate and equipment loans in securitization transactions.In all those securitizations, the Company retained servicing responsibilitiesand subordinated interests. The investors have no recourse to the Company’sother assets for failure of debtors to pay when due. The Company’s retainedinterests are subordinated to investor’s interests. Their value is subject tocredit, prepayment, and interest rate risks on the transferred financialassets.

**Note 9.   IncomeTax Matters**

Netdeferred tax assets consist of the following components as of December 31,2006 and 2005:

| ** **                                                           | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|----------|------------|
| Deferred Tax  Assets:                                                |       |     |       |     |       |
| Allowance for loan losses                                            |       | $        | 236,616    |     | $          | 266,886 |   |
| Amortization of intangibles, start-up cost and organizational  costs |       | 25,374   |       | 59,630   |       |
| Interest on non-accrual loans                                        |       | 53,913   |       | 68,536   |       |
| Other                                                                |       | 17,001   |       | 3,561    |       |
|                                                                 |       | 332,904  |       | 398,613  |       |
| Deferred Tax  Liabilities:                                           |       |     |       |     |       |
| Depreciable assets                                                   |       | 166,359  |       | 161,870  |       |
| Net deferred tax  assets                                             |       | $        | 166,545    |     | $          | 236,743 |   |

 

The provision forincome taxes charged to income for the years ended December 31, 2006,2005, and 2004 consists of the following:

| ** **                     | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Current tax  expense (benefit) |       | $        | 248,433    |     | $          | (21,583  | )          | $ | 222,724 |   |
| Deferred tax  expense          |       | 70,198   |       | 364,564  |       | 4,831    |       |
| Total income tax expense       |       | $        | 318,631    |     | $          | 342,981  |       | $ | 227,555 |   |

 

Theincome tax provision differs from the amount of income tax determined byapplying the U.S. federal income tax rate to pretax income for the years ended December 31,2006, 2005, and 2004, due to the following:

| ** **                                 | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Computed  “expected” tax expense |       | $        | 276,874    |     | $          | 315,313  |       | $ | 248,778 |   |
| State income tax,  net of federal benefits |       | 34,935   |       | 39,785   |       | 31,390   |       |
| Other, net                                 |       | 6,822    |       | (12,117  | )          | (52,613  | )          |
|                                       |       | $        | 318,631    |     | $          | 342,981  |       | $ | 227,555 |   |

 

**Note 10.   Deposits**

The aggregate amount of time deposits in denominationsof $100,000 or more at December 31, 2006 and 2005 was $15,314,271 and$7,878,835, respectively.

F-15

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AtDecember 31, 2006, the scheduled maturities of time deposits are asfollows:

| 2007                 |   | $         | 42,070,834 |   |
|----------------------|--------|-----------|------------|--------|
| 2008                 |   | 2,422,813 |       |
| 2009                 |   | 150,924   |       |
| 2010 and  Thereafter |   | 35,000    |       |
|                 |   | $         | 44,679,571 |   |

 

The Bank’s executive officers, directors, and theiraffiliates maintain certain deposit accounts with the Bank which are, inmanagement’s opinion, offered on the same terms and rates as all otherdepositors.

**Note11**.             Minimum RegulatoryCapital Requirements

The Company is subject to various regulatory capitalrequirements administered by the federal banking agencies. Failure to meetminimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material affect on the Company and the consolidated financialstatements. Under capital adequacy guidelines and the regulatory framework forprompt corrective action, the Company must meet specific capital guidelinesthat involve quantitative measures of the Company’s assets, liabilities, andcertain off-balance sheet items as calculated under regulatory accountingpractices. The Company’s capital amounts and classification are also subject toqualitative judgments by the regulators about components, risk weightings, andother factors. Prompt corrective action provisions are not applicable to bankholding companies.

Quantitative measures established by regulation toensure capital adequacy require the Company to maintain minimum amounts andratios (set forth in the table below) of total and Tier I capital (as definedin the regulations) to risk-weighted assets (as defined), and of Tier I capital(as defined) to average assets (as defined). Management believes, as of December 31,2006 and 2005, that the Company meets all capital adequacy requirements towhich it is subject.

As of December 31,2006, the Company was categorized as well capitalized under the regulatoryframework for prompt corrective action according to the most recentnotification dated May 22, 2006, from the Federal Deposit InsuranceCorporation. To be categorized as well capitalized, the Bank must maintainminimum total risk-based, Tier I risk-based, and Tier I leverage ratios as setforth in the table below. There are no conditions or events since thenotification that management believes has changed the institution’s category.

F-16

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The Company’s actual capital amounts and ratios are asfollows:

| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                  | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                  | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| As of December 31, 2006 (in Thousands) |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *Tier 1 Capital (To Average assets):*       | * *   | * *   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Consolidated                                |       |       | $          | 8,837                      |       |                       | 9.80       | % 3                   |       | $                     | 3,607      | 3 |   |   | 4 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                         |       |       | $          | 8,803                      |       |                       | 9.76       | % 3                   |       | $                          | 3,606      | 3 |   |   | 4 | % 3 |   |   | $  | 4,508 | 3 |   |   | 5 | % |   |
| *Tier 1 Capital (To Risk Weighted Assets):* | * *   | * *   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Consolidated                                |       |       | $          | 8,837                      |       |                       | 11.69      | % 3                   |       | $                     | 3,024      | 3 |   |   | 4 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                         |       |       | $          | 8,803                      |       |                       | 11.65      | % 3                   |       | $                          | 3,024      | 3 |   |   | 4 | % 3 |   |   | $  | 4,535 | 3 |   |   | 6 | % |   |
| *Total Capital (To Risk Weighted Assets):*  | * *   | * *   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * *                   | * *   | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * | * * |
| Consolidated                                |       |       | $          | 9,454                      |       |                       | 12.51      | % 3                   |       | $                     | 6,048      | 3 |   |   | 8 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank of Greeneville                         |       |       | $          | 9,420                      |       |                       | 12.46      | % 3                   |       | $                          | 6,047      | 3 |   |   | 8 | % 3 |   |   | $  | 7,559 | 3 |   |   | 10 | % |   |

 

| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **To Be Well**   | ** ** |
|---------------------------------------------|------------|------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | ** **                 | ** ** | ** **                 | ** ** | **Capitalized Under** | ** ** |
| ** **                                  | ** ** | ** ** | ** ** | ** **                 | ** ** | **For Capital**       | ** ** | **Prompt Corrective** | ** ** |
| ** **                                  | ** ** | **Actual** | ** ** | **Adequacy Purposes** | ** ** | **Action Provisions** | ** ** |
| ** **                                  | ** ** | **Amount** | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio**                  | ** ** | **Amount**                 | ** ** | **Ratio** | ** ** |
| As of December 31, 2005 (in Thousands) |       |       |       |                       |       |                       |       |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| *Tier 1 Capital (To Average assets):*       | * *   |       |       |                       | * *   | * *                   | * *   |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                |       |       | $          | 8,345                      |       |                       | 9.65       | % 3                   |       | $                          | 3,459      | 3 |   |   | 4 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank  of Greeneville                        |       |       | $          | 8,317                      |       |                       | 9.62       | % 3                   |       | $                          | 3,458      | 3 |   |   | 4 | % 3 |   |   | $ | 4,322 | 3 |   |   | 5 | % |   |
| *Tier 1 Capital (To Risk Weighted Assets):* | * *   |       |       |                       | * *   | * *                   | * *   |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                |       |       | $          | 8,345                      |       |                       | 12.12      | % 3                   |       | $                          | 2,756      | 3 |   |   | 4 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank  of Greeneville                        |       |       | $          | 8,317                      |       |                       | 12.08      | % 3                   |       | $                          | 2,754      | 3 |   |   | 4 | % 3 |   |   | $ | 4,132 | 3 |   |   | 6 | % |   |
| *Total Capital (To Risk Weighted Assets):*  | * *   |       |       |                       | * *   | * *                   | * *   |                       |       |                       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Consolidated                                |       |       | $          | 9,042                      |       |                       | 13.13      | % 3                   |       | $                          | 5,511      | 3 |   |   | 8 | % 3 |   |   | N/A |   |   |   | N/A |   |   |
| Bank  of Greeneville                        |       |       | $          | 9,014                      |       |                       | 13.09      | % 3                   |       | $                          | 5,509      | 3 |   |   | 8 | % 3 |   |   | $ | 6,886 | 3 |   |   | 10 | % |   |

 

**Note12.**             Commitmentsand Contingencies

***Financial Instruments with Off-Balance-Sheet Risk***

In the normal course of business, the Company hasentered into off-balance sheet financial instruments which include commitmentsto extend credit (i.e., including unfunded lines of credit) and standby lettersof credit. Commitments to extend credit are usually the result of lines ofcredit granted to existing borrowers under agreements that the totaloutstanding indebtedness will not exceed a specific amount during the term ofthe indebtedness. Typical borrowers are commercial concerns and their totaloutstanding indebtedness may fluctuate during any time period based on theseasonality of their business and the resultant timing of their cash flows. Othertypical lines of credit are related to home equity loans granted to consumers. Commitmentsto extend credit generally have fixed expiration dates or other terminationclauses and may require payment of a fee.

F-17

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Standby letters of credit are generally issued onbehalf of an applicant to a specifically named beneficiary and are the resultof a particular business arrangement that exists between the applicant and thebeneficiary. Standby letters of credit have fixed expiration dates and areusually for terms of two years or less unless terminated beforehand due tocriteria specified in the standby letter of credit. A typical arrangementinvolves the applicant routinely being indebted to the beneficiary for suchitems as inventory purchases, insurance, utilities, lease guarantees or otherthird party commercial transactions. The standby letter of credit would permitthe beneficiary to obtain payment from the Company under certain prescribedcircumstances. Subsequently, the Company would then seek reimbursement from theapplicant pursuant to the terms of the standby letter of credit.

The Company follows the same credit policies andunderwriting practices when making these commitments as it does for on-balancesheet instruments. Each customer’s creditworthiness is evaluated on acase-by-case basis and the amount of collateral obtained, if any, is based onmanagement’s credit evaluation of the customer.

Collateral varies but may include cash, real estateand improvements, marketable securities, accounts receivable, inventory,equipment, and personal property.

The contractual amounts of these commitments are notreflected in the consolidated financial statements and would only be reflectedif drawn upon. Since many of the commitments are expected to expire withoutbeing drawn upon, the contractual amounts do not necessarily represent futurecash requirements. However, should the commitments be drawn upon and should thecustomers default on their resulting obligation, the Company’s maximum exposureto credit loss, without consideration of collateral, is represented by thecontractual amount of those instruments.

Asummary of the Company’s total contractual amount for all off-balance sheetcommitments at December 31, 2006 is as follows:

| Commitments to  extend credit |   | $ | 12,102,294 |   |
|-------------------------------|--------|---|------------|--------|
| Standby letters of  credit    |   | $ | 466,000    |   |

 

***Significant Concentrations of Credit Risk***

All of the Company’sloans, commitments to extend credit, and standby letters of credit have beengranted to customers primarily in the Company’s market area. The concentrationsof credit by type of loan are set forth in  Note4. Standby letters of credit were granted primarily to commercial borrowers. TheCompany is not permitted to extend credit to any single borrower or group ofrelated borrowers in excess of 25% of capital.

***Contingencies***

In the normal course ofbusiness, the Company is involved in various legal proceedings. In the opinionof management, any liability resulting from such proceedings would not have amaterial adverse effect on the Company’s financial statements.

F-18

----

**Note13.**             Fair Value ofFinancial Instruments

The fair value of afinancial instrument is the current amount that would be exchanged betweenwilling parties, other than in a forced liquidation. Fair value is bestdetermined based upon quoted market prices. However, in many instances, thereare no quoted market prices for the Company’s various financial instruments. Incases where quoted market prices are not available, fair values are based onestimates using present value or other valuation techniques. Those techniquesare significantly affected by the assumptions used, including the discount rateand estimates of future cash flows. Accordingly, the fair value estimates maynot be realized in an immediate settlement of the instrument. Statement ofFinancial Accounting Standards (SFAS) No. 107 excludes certain financialinstruments and all non-financial instruments from its disclosure requirements.Accordingly, the aggregate fair value amounts presented may not necessarilyrepresent the underlying fair value of the Company.

The following methods andassumptions were used by the Company in estimating fair value disclosures forfinancial instruments:

***Cash and Cash Equivalents***

The carrying amounts ofcash and federal funds sold approximate fair values.

***Interest-Bearing Deposits in Banks***

The carrying amounts ofany interest-bearing deposits maturing within ninety days approximate their fairvalues. Fair values of any other interest-bearing deposits are estimated usingdiscounted cash flow analyses based on current rates for similar types ofdeposits. There were no interest-bearing deposits with other banks as of December 31,2006 and 2005.

***Trading Assets***

Fair values for tradingaccount securities, which also are the amounts recognized in the consolidatedbalance sheets, are based on quoted market prices, where available. If quotedmarket prices are not available, fair values are based on quoted market pricesof comparable instruments.

***Securities***

Fair values forsecurities, excluding Federal Home Loan Bank stock, are based on quoted marketprices. The carrying value of Federal Home Loan Bank stock approximates fairvalue based on the redemption provisions of the Federal Home Loan Bank.

***Loans Receivable***

For variable-rate loansthat reprice frequently and with no significant change in credit risk, fairvalues are based on carrying values. Fair values for fixed-rate loans(including non-performing loans) are estimated using discounted cash flowanalyses, using interest rates currently being offered for loans with similarterms to borrowers of similar credit quality.

***Accrued Interest Receivable***

The carrying amounts ofaccrued interest receivable approximate fair value.

F-19

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***Deposit Liabilities***

The fair values disclosedfor demand deposits (e.g., interest and non-interest checking, passbooksavings, and certain types of money market accounts) are, by definition, equalto the amount payable on demand at the reporting date (i.e., their carryingamounts). The carrying amounts of variable-rate, fixed-term money marketaccounts and certificates of deposit approximate their fair values at thereporting date. Fair values for fixed-rate certificates of deposit areestimated using a discounted cash flow calculation that applies interest ratescurrently being offered on certificates to a schedule of aggregated expectedmonthly maturities on time deposits.

***Short-Term Borrowings***

The carrying amounts offederal funds purchased, borrowings under repurchase agreements, and othershort-term borrowings maturing within ninety days approximate their fairvalues. Fair values of other short-term borrowings are estimated usingdiscounted cash flow analyses based on the Company’s current incremental borrowingrates for similar types of borrowing arrangements.

***Long-Term Borrowings***

The fair values of theCompany’s long-term borrowings are estimated using discounted cash flowanalyses based on the Company’s current incremental borrowing rates for similartypes of borrowing arrangements.

***Securitized Borrowings***

The carrying amounts ofsecuritized borrowings approximate fair value.

***Accrued Interest Payable***

The carrying amounts ofaccrued interest payable approximate fair value.

***Off-Balance Sheet Credit-Related Instruments***

Commitments toextend credit and standby letters of credit do not represent a significantvalue to the Company until such commitments are funded.

Theestimated fair values of the Company’s financial instruments are as follows at December 31:

| ** **                          | ** ** | **2006**     | ** ** | **2005**   | ** ** |
|-------------------------------------|------------|--------------|------------|------------|------------|
| ** **                          | ** ** | **Carrying** | ** ** | **Fair**   | ** ** | **Carrying** | ** ** | **Fair** | ** ** |
| ** **                          | ** ** | **Amount**   | ** ** | **Value**  | ** ** | **Amount** | ** ** | **Value** | ** ** |
| **Financial  Assets:**              |       |         |       |       |       |   |   |   |   |
| Cash and cash equivalents           |       | $            | 15,488,412 |       | $          | 15,488,412 |   | $ | 18,273,842 |   | $ | 18,273,842 |   |
| Federal Home Loan Bank stock        |       | 258,800      |       | 258,800    |       | 244,500 |   | 244,500 |   |
| Loans and loans held for sale,  net |       | 77,059,828   |       | 76,758,427 |       | 64,054,625 |   | 63,844,692 |   |
| Accrued interest receivable         |       | 506,906      |       | 506,906    |       | 418,329 |   | 418,329 |   |
| **Financial Liabilities:**          |       |         |       |       |       |   |   |   |   |
| Deposits                            |       | 82,503,052   |       | 82,511,613 |       | 74,702,688 |   | 74,634,942 |   |
| Accrued interest payable            |       | 698,825      |       | 698,825    |       | 353,534 |   | 353,534 |   |
| Securitized borrowings              |       | 3,099,091    |       | 3,099,091  |       | — |   | — |   |
| Federal Home Loan Bank advances     |       | 2,368,159    |       | 2,370,544  |       | 4,179,052 |   | 4,136,131 |   |
|                                     |            |              |            |            |            |  |  |  |  |  |  |  |  |

 

F-20

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**Note 14.**   TransactionsWith Related Parties

The Company has had, and may be expected to have inthe future, banking transactions in the ordinary course of business withdirectors, principal officers, their immediate families and affiliatedcompanies in which they are principal stockholders (commonly referred to asrelated parties), all of which have been, in the opinion of management, on thesame terms, including interest rates and collateral, as those prevailing at thetime for comparable transactions with others.

The amounts of loans duedirectly from officers and directors of the Company or indirectly fromcorporations, partnerships or ventures in which these individuals have aninterest were $847,430 and $1,005,289 at December 31, 2006 and 2005,respectively. During the years ended December 31, 2006 and 2005, totalprincipal additions were $2,377,740 and $767,970, respectively, and totalprincipal payments were $2,535,599 and $430,354, respectively.

**Note 15.   EmployeeBenefit Plans**

The Company has aretirement savings 401(k) plan in which all employees may participate. Tobe eligible, an employee must complete six (6) months of service and reachtheir entry date. An entry date is the first day of the Plan Year quartercoinciding with or following the date that satisfies the Plan’s eligibilityrequirements. For 2006, employees may make pretax, voluntary contributions inamounts up to $15,000 (age 49 or less) and $20,000 (age 50 and older). TheCompany may make discretionary matching contributions equal to a uniform percentageof tiered salary deferrals. This percentage will be determined each year. The Company’s expense for the plan was$31,328 and $46,144 for the years ended December 31, 2006 and 2005,respectively.

**Note 16.   StockCompensation Plan**

The Company has an employee Stock Option Plan (thePlan) under which certain employees may be granted options to purchase sharesof the Company’s authorized but unissued common stock. The maximum number ofshares of the Company’s common stock available for issuance under the Plan is375,000 shares. As of December 31, 2006 and 2005, the maximum number ofshares available for future grants under the Plan was 73,700 shares. Under thePlan, the option exercise price is equal to the fair market value of theCompany’s common stock at the date of the grant. The options expire on thetenth anniversary of the date of the option. As discussed in Note 1, managementelected to vest all remaining stock options during 2005. Proceeds received bythe Company from exercises of the stock options are credited to common stockand additional paid-in capital.

Additionalinformation with respect to the Plan’s stock option activity is as follows:

| ** **                                     | ** ** | **Number of** | ** ** | **Weighted Average** | ** ** |
|------------------------------------------------|------------|--------------------|------------|---------------------------|------------|
| ** **                                     | ** ** | **Shares**         | ** ** | **Exercise Price**   | ** ** |
| Outstanding at  December 31, 2004         |       |               | 246,125    |                      |       |   | $ | 5.06 |   |   |
| Granted                                        |       |               | 700        |                      |       |   | 17.00 |   |   |
| Forfeited                                      |       |               | (200       | )                         |       |   | 17.00 |   |   |
| Exercised                                      |       |               | (3,996     | )                         |       |   | 3.33 |   |   |
| Outstanding at  December 31, 2005         |       |               | 242,629    |                      |       |   | $ | 5.12 |   |   |
| Granted                                        |       |               | —     |                      |       |   | — |   |   |
| Forfeited                                      |       |               | —     |                      |       |   | — |   |   |
| Exercised                                      |       |               | —     |                      |       |   | — |   |   |
| Outstanding at  December 31, 2006         |       |               | 242,629    |                      |       |   | $ | 5.12 |   |   |
| Options  exercisable at December 31, 2005 |       |               | 242,629    |                      |       |   | $ | 5.12 |   |   |
| Options exercisable at  December 31, 2006 |       |               | 242,629    |                      |       |   | $ | 5.12 |   |   |

 

F-21

----

Thefollowing tables summarize the information about the stock options outstandingand exercisable at December 31, 2006:

| ** **              | ** ** | **Stock Options Outstanding** | ** ** |
|-------------------------|------------|-----------------------------------------|------------|
| ** **              | ** ** | ** **                              | ** ** | **Weighted Average** | ** ** |
| ** **              | ** ** | **Number of**                      | ** ** | **Remaining** | ** ** |
| ** **              | ** ** | **Options**                             | ** ** | **Contractual** | ** ** |
| **Exercise Price** | ** ** | ** **                              | ** ** | **Outstanding** | ** ** | **Life in Years** | ** ** |
| $  3.33       |       |                                    | 174,429    |   |   |   | 4.5 |   |   |
| $  5.33       |       |                                    | 15,000     |   |   |   | 5.0 |   |   |
| $  7.33       |       |                                    | 15,300     |   |   |   | 5.7 |   |   |
| $  7.67       |       |                                    | 3,900      |   |   |   | 5.8 |   |   |
| $  8.00       |       |                                    | 15,000     |   |   |   | 5.9 |   |   |
| $13.00                  |       |                                    | 1,400      |   |   |   | 6.8 |   |   |
| $17.00                  |       |                                    | 1,000      |   |   |   | 7.6 |   |   |
| $17.00                  |       |                                    | 900        |   |   |   | 7.7 |   |   |
| $17.00                  |       |                                    | 15,000     |   |   |   | 7.7 |   |   |
| $19.00                  |       |                                    | 700        |   |   |   | 8.3 |   |   |
|                    |       |                                    | 242,629    |   |   |   | 5.0 |   |   |
|                         |            |                                         |            |  |  |  |  |  |  |  |  |

 

Thefollowing table illustrates the effect on the Company’s net income and earningsper share if the Company had applied the fair value recognition provision ofSFAS No. 123 to stock-based employee compensation prior to the adoption ofSFAS No. 123(R):

| ** **                          | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------|------------|----------|------------|----------|------------|
| Net earnings (loss):                |       |     |       |     |       |
| As reported                         |       | $        | 495,705    |     | $          | 584,410 |   |
| Pro forma, net of related taxes     |       | $        | 495,705    |     | $          | 458,735 |   |
| Basic earnings  (loss) per share:   |       |     |       |     |       |
| As reported                         |       | $        | 0.21       |     | $          | 0.25 |   |
| Pro forma, net of related taxes     |       | $        | 0.21       |     | $          | 0.20 |   |
| Diluted earnings  (loss) per share: |       |     |       |     |       |
| As reported                         |       | $        | 0.20       |     | $          | 0.24 |   |
| Pro forma, net of  related taxes    |       | $        | 0.20       |     | $          | 0.18 |   |

 

Theweighted-average estimated fair value of stock options granted during 2005 was$8.12 per share. This amount was determined using the Black-Scholesoption-pricing model, which values options based on the stock price at thegrant date, the expected life of the option, the estimated volatility of thestock, the expected dividend payments, and the risk-free interest rate over theexpected life of the option. The assumptions used in the Black-Scholes modelwere as follows for the stock options granted in 2005:

| ** **                           | ** ** | **2005**   | ** ** |
|--------------------------------------|------------|------------|------------|
| Risk-free  interest rate             |       | 4.21       | %          |
| Expected  volatility of common stock |       | 27.40      | %          |
| Dividend yield                       |       | 0.00       | %          |
| Expected life of options             |       | 10.0 years |       |

 

F-22

----

The Black-Scholes option valuationmodel was developed for estimating the fair value of traded options that haveno vesting restrictions and are fully transferable. Because option valuationmodels require the use of subjective assumptions, changes in these assumptionscan materially affect the fair value of the options, and as the Company’soptions do not have the characteristics of traded options, the option valuationmodels do not necessarily provide a reliable measure of the fair value of itsoptions.

**Note 17.   Restrictionson Payment of Dividends**

The payment of dividendsby BG Financial Group, Inc. depends to a great extent on the ability ofBank of Greeneville to pay dividends to BG Financial Group, Inc. The Bankis subject to the Tennessee Banking Act, which provides that dividends will bepaid out of undivided profits. The payment of dividends by any bank isdependent upon its earnings and financial condition and subject to thestatutory power of certain federal and state regulatory agencies to act toprevent what they deem unsafe or unsound banking practices. Moreover, theFederal Reserve Board, the Comptroller of the Currency and the FDIC have issuedpolicy statements which provide that bank holding companies and insureddepository institutions generally should only pay dividends out of currentoperating earnings. Under Tennessee law, the board of directors of a state bankmay not declare dividends in any calendar year that exceeds the total of itsnet income of that year combined with its retained net income of the precedingtwo (2) years without prior approval of the Tennessee Department ofFinancial Institutions (TDFI). The payment of dividends by the Company may alsobe affected or limited by other factors, such as the requirement to maintainadequate capital above regulatory guidelines.

**Note 18.   CapitalStructure**

***Common Stock***

The Board of Directors ofthe Holding Company is authorized to issue up to 6,000,000 shares of commonstock. Holders of common stock have unlimited voting rights and are entitled toreceive the net assets of the Holding Company upon dissolution.

***Preferred Stock***

The Board of Directors of the Holding Company isauthorized to issue up to 1,000,000 shares of preferred stock. Shares of thepreferred stock may be issued from time to time in one or more series, eachsuch series to be so designated as to distinguish the shares thereof from theshares of all other series and classes. The Board of Directors has theauthority to divide any or all classes of preferred stock into series and tofix and determine the relative rights and preferences of the shares of anyseries so established. The preferred stock is not redeemable.

F-23

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**Note 19. CondensedFinancial Statements of Parent Company**

Financialinformation pertaining only to BG Financial Group, Inc. is as follows:

**BalanceSheets**

| ** **                                                                                                                               | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                               | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Assets**                                                                                                                               |       |                  |       |                  |       |   |   |   |   |
| Cash and due from  banks                                                                                                                 |       |                  | $          | 2,616                 |       |   |   | $ | 601 |   |   |
| Investment in  Bank of Greeneville                                                                                                       |       |                  | 8,825,015  |                  |       |   | 8,317,664 |   |   |
| Other assets                                                                                                                             |       |                  | 8,997      |                  |       |   | 26,575 |   |   |
| Total assets                                                                                                                             |       |                  | $          | 8,836,628             |       |   |   | $ | 8,344,840 |   |   |
| **Liabilities  and Stockholders’ Equity**                                                                                           |       |                  |       |                  |       |   |   |   |   |
| Accounts payable                                                                                                                         |       |                  | $          | —                |       |   |   | $ | 3,293 |   |   |
| Accrued expenses                                                                                                                         |       |                  | 100        |                  |       |   | 724 |   |   |
| Total liabilities                                                                                                                        |       |                  | 100        |                  |       |   | 4,017 |   |   |
| **Stockholders’  Equity**                                                                                                           |       |                  |       |                  |       |   |   |   |   |
| Stock:                                                                                                                                   |       |                  |       |                  |       |   |   |   |   |
| Preferred stock,  no par value; authorized 1,000,000 shares; none issued and outstanding                                                 |       |                  |       |                  |       |   |   |   |   |
| Common stock, $0.333 par value; authorized 6,000,000  shares; issued and outstanding 2,310,771 shares in 2006; 2,310,771 shares in  2005 |       |                  | 770,256    |                  |       |   | 770,256 |   |   |
| Additional paid-in capital                                                                                                               |       |                  | 6,932,307  |                  | ** ** | ** ** | 6,932,307 |   |   |
| Retained earnings                                                                                                                        |       |                  | 1,133,965  |                  | ** ** | ** ** | 638,260 |   |   |
| Total Stockholders’ Equity                                                                                                          |       |                  | 8,836,528  |                  | ** ** | ** ** | 8,340,823 |   |   |
| Total Liabilities  and Stockholders’ Equity                                                                                         |       |                  | $          | 8,836,628             |       | ** ** | ** ** | $ | 8,344,840 |   |   |

 

**Statementof Income**

| ** **                                                                                        | ** ** | **Year Ended**   | ** ** | **Year Ended**   | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                        | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                        | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| **Income**                                                                                        |       |                  |       |                  |       |   |   |   |   |
| Dividends from  Bank of Greeneville                                                               |       |                  | $          | 47,500                |       |   |   | $ | — |   |   |
| Total income                                                                                      |       |                  | 47,500     |                  |       |   | — |   |   |
| **Operating  expenses**                                                                           |       |                  | 66,209     |                  |       |   | 63,037 |   |   |
| Income (loss)  before income taxes and equity in undistributed net income of Bank of  Greeneville |       |                  | (18,709    | )                     |       |   | (63,037 | ) |   |
| Applicable income  tax benefit                                                                    |       |                  | (7,063     | )                     |       |   | (20,468 | ) |   |
|                                                                                              |       |                  | (11,646    | )                     |       |   | (42,569 | ) |   |
| Equity in  undistributed net income                                                               | ** ** | ** **            | 507,351    |                  |       |   | 626,979 |   |   |
| **Net income**                                                                                    | ** ** | ** **            | $          | 495,705               |       |   |   | $ | 584,410 |   |   |

 

F-24

----

**Statementof Cash Flows**

| ** **                                                                                   | ** ** | **Year Ended**   | ** ** | **Year Ended,**  | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                   | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
| ** **                                                                                   | ** ** | **2006**              | ** ** | **2005**              | ** ** |
| Cash flows from  operating activities:                                                       |       |                  |       |                  |       |   |   |   |   |
| Net income                                                                                   |       |                  | $          | 495,705               |       |   |   | $ | 584,410 |   |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                  |       |                  |       |   |   |   |   |
| Equity in undistributed income of Bank of Greeneville                                        |       |                  | (507,351   | )                     |       |   | (626,979 | ) |   |
| Depreciation                                                                                 |       |                  | 146        |                  |       |   | 146 |   |   |
| Deferred income tax expense                                                                  |       |                  | 613        |                  |       |   | 4,129 |   |   |
| Decrease in other liabilities                                                                |       |                  | (3,818     | )                     |       |   | (5,974 | ) |   |
| Decrease in other assets                                                                     |       |                  | 16,720     |                  |       |   | — |   |   |
| Net cash provided (used in) operating activities                                             |       |                  | 2,015      |                  |       |   | (44,268 | ) |   |
| Cash flows from  financing activities:                                                       |       |                  |       |                  |       |   |   |   |   |
| Issuance of stock                                                                            |       |                  | —     |                  |       |   | 13,316 |   |   |
| Net cash provided by financing activities                                                    |       |                  | —     |                  |       |   | 13,316 |   |   |
| Net increase (decrease) in cash and cash equivalents                                         |       |                  | 2,015      |                  |       |   | (30,952 | ) |   |
| Cash and cash  equivalents at beginning of year                                              |       |                  | 601        |                  |       |   | 31,553 |   |   |
| Cash and cash  equivalents at end of year                                                    |       |                  | $          | 2,616                 |       |   |   | $ | 601 |   |   |

 

F-25

----

**Note 20. SubsidiaryBank Only Financial Information**

Condensed financial information pertaining only toBank of Greeneville is as follows:

**BalanceSheets**

| ** **                                                                               | ** ** | **As of**                  | ** ** | **As of**                  | ** ** |
|------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                                                               | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
| **ASSETS**                                                                               |       |                            |       |                            |       |   |   |   |   |
| Cash and due from  banks                                                                 |       |                            | $          | 3,263,969                       |       |   |   | $ | 4,716,153 |   |   |
| Federal funds  sold                                                                      |       |                            | 12,224,443 |                            |       |   | 13,557,689 |   |   |
| Cash and cash equivalents                                                                |       |                            | 15,488,412 |                            |       |   | 18,273,842 |   |   |
| Federal Home Loan  Bank stock, at cost                                                   |       |                            | 258,800    |                            |       |   | 244,500 |   |   |
| Loans, net of  estimated allowance for loan losses $617,956 in 2006 and $697,013 in 2005 |       |                            | 77,059,828 |                            |       |   | 64,054,625 |   |   |
| Premises and  equipment, net                                                             |       |                            | 3,799,421  |                            |       |   | 3,777,737 |   |   |
| Accrued income  receivable                                                               |       |                            | 506,906    |                            |       |   | 418,329 |   |   |
| Deferred tax  benefit                                                                    |       |                            | 165,422    |                            |       |   | 235,007 |   |   |
| Foreclosed assets                                                                        |       |                            | 393,900    |                            |       |   | 616,279 |   |   |
| Other assets                                                                             |       |                            | 70,995     |                            |       |   | 137,814 |   |   |
| Total Assets                                                                             |       |                            | $          | 97,743,684                      |       |   |   | $ | 87,758,133 |   |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                           |       |                            |       |                            |       |   |   |   |   |
| **LIABILITIES**                                                                          | ** ** |                            |       |                            |       |   |   |   |   |
| Deposits:                                                                                |       |                            |       |                            |       |   |   |   |   |
| Noninterest-bearing                                                                      |       |                            |       |                            |       |   |   |   |   |
| Demand                                                                                   |       |                            | $          | 9,329,163                       |       |   |   | $ | 8,624,411 |   |   |
| Interest-bearing                                                                         |       |                            |       |                            |       |   |   |   |   |
| Money market, interest checking and savings                                              |       |                            | 28,496,934 |                            |       |   | 22,070,984 |   |   |
| Time deposits                                                                            |       |                            | 44,679,571 |                            |       |   | 44,007,894 |   |   |
| Total Deposits                                                                           |       |                            | 82,505,668 |                            |       |   | 74,703,289 |   |   |
| Accrued interest                                                                         |       |                            | 698,825    |                            |       |   | 353,534 |   |   |
| Other liabilities                                                                        |       |                            | 246,926    |                            |       |   | 204,594 |   |   |
| Securitized borrowings                                                                   |       |                            | 3,099,091  |                            |       |   | — |   |   |
| Federal Home Loan Bank advances                                                          |       |                            | 2,368,159  |                            |       |   | 4,179,052 |   |   |
| Total Liabilities                                                                        |       |                            | 88,918,669 |                            |       |   | 79,440,469 |   |   |
| Stockholders’ Equity                                                                |       |                            | 8,825,015  |                            |       |   | 8,317,664 |   |   |
| Total Liabilities  and Stockholders’ Equity                                         |       |                            | $          | 97,743,684                      |       |   |   | $ | 87,758,133 |   |   |

 

F-26

----

**Statementsof Income**

| ** **                                                          | ** ** | **Twelve Months Ended December 31** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                          | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **Interest  and dividend income:**                                  | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loans, including fees                                               |       | $                                                       | 6,124,535  |   | $ | 5,149,519 |   | $ | 5,376,509 |   |
| Dividends on Federal Home Loan Bank stock                           |       | 14,520                                                  |       | 11,780 |   | 8,578 |   |
| Federal funds sold and other                                        |       | 547,278                                                 |       | 338,211 |   | 113,630 |   |
| Total interest and dividend income                                  |       | 6,686,333                                               |       | 5,499,510 |   | 5,498,717 |   |
| **Interest  expense:**                                              | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Deposits                                                            |       | 2,730,954                                               |       | 1,979,350 |   | 1,430,567 |   |
| Borrowed funds                                                      |       | 111,473                                                 |       | 139,599 |   | 144,632 |   |
| Total interest expense                                              |       | 2,842,427                                               |       | 2,118,949 |   | 1,575,199 |   |
| Net interest income before provision for loan losses                |       | 3,843,906                                               |       | 3,380,561 |   | 3,923,518 |   |
| **Provision for (benefit from) loan losses**                        |       | (23,758                                                 | )          | (555,222 | ) | 615,251 |   |
| Net interest income after provision for (benefit  from) loan losses |       | 3,867,664                                               |       | 3,935,783 |   | 3,308,267 |   |
| **Noninterest  income:**                                            | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service charges on deposit accounts                                 |       | 300,153                                                 |       | 310,935 |   | 272,611 |   |
| Fees from origination of mortgage loans sold                        |       | 97,710                                                  |       | 118,353 |   | 127,417 |   |
| Investment sales commissions                                        |       | 113,106                                                 |       | 100,066 |   | 97,313 |   |
| Other                                                               |       | 52,437                                                  |       | 35,905 |   | 34,336 |   |
| Total noninterest income                                            |       | 563,406                                                 |       | 565,259 |   | 531,677 |   |
| **Noninterest  expenses:**                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Salaries and benefits                                               |       | 1,834,310                                               |       | 1,880,425 |   | 1,577,832 |   |
| Occupancy expenses                                                  |       | 487,894                                                 |       | 481,667 |   | 400,405 |   |
| Advertising                                                         |       | 88,523                                                  |       | 121,858 |   | 143,267 |   |
| Data processing                                                     |       | 217,919                                                 |       | 191,202 |   | 191,748 |   |
| Legal and professional expense                                      |       | 297,991                                                 |       | 316,514 |   | 262,515 |   |
| Other operating expenses                                            |       | 623,888                                                 |       | 518,947 |   | 486,856 |   |
| Total noninterest expense                                           |       | 3,550,525                                               |       | 3,510,613 |   | 3,062,623 |   |
| **Income****before income taxes**                                   |       | 880,545                                                 |       | 990,429 |   | 777,321 |   |
| Income tax expense                                                  |       | 325,694                                                 |       | 363,450 |   | 244,923 |   |
| **Net  income**                                                     |       | $                                                       | 554,851    |   | $ | 626,979 |   | $ | 532,398 |   |

 

F-27

----

**Statementsof Cash Flows**

| ** **                                                                         | ** ** | **Twelve Months Ended December 31** | ** ** |
|------------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                         | ** ** | **2006**                                                | ** ** | **2005** | ** ** | **2004** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income                                                                         |       | $                                                       | 554,851    |   | $ | 626,979 |   | $ | 532,398 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities: |       |                                                    |       |   |   |   |   |
| Provision for (benefit from) loan losses                                           |       | (23,758                                                 | )          | (555,222 | ) | 615,251 |   |
| Write-down of foreclosed assets                                                    |       | 37,600                                                  |       | 19,149 |   | — |   |
| Depreciation                                                                       |       | 255,758                                                 |       | 304,367 |   | 259,018 |   |
| Realized loss on sales of premises and equipment                                   |       | —                                                  |       | 4,913 |   | — |   |
| Realized loss (gain) on sales of foreclosed assets                                 |       | 33,997                                                  |       | 8,543 |   | (8,919 | ) |
| Deferred income tax expense                                                        |       | 69,585                                                  |       | 360,436 |   | 7,734 |   |
| Federal Home Loan Bank stock dividends                                             |       | (14,300                                                 | )          | (18,000 | ) | (54,800 | ) |
| Net change in:                                                                     |       |                                                    |       |   |   |   |   |
| Accrued income receivable                                                          |       | (88,577                                                 | )          | (29,021 | ) | (2,051 | ) |
| Other assets                                                                       |       | 66,819                                                  |       | (8,343 | ) | (32,218 | ) |
| Other liabilities                                                                  |       | 42,332                                                  |       | (363,314 | ) | 500,916 |   |
| Accrued interest payable                                                           |       | 345,291                                                 |       | 150,970 |   | 147,842 |   |
| Net cash provided by operating activities                                          |       | 1,279,598                                               |       | 501,457 |   | 1,965,171 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Proceeds from sales of foreclosed assets                                           |       | 175,039                                                 |       | 731,061 |   | — |   |
| Loan originations and principal collections, net                                   |       | (13,005,702                                             | )          | 7,970,500 |   | (4,727,904 | ) |
| Purchase of land for future development                                            |       | —                                                  |       | — |   | (563,362 | ) |
| Additions to premises and equipment                                                |       | (277,442                                                | )          | (191,907 | ) | (827,614 | ) |
| Net cash provided by (used in) investing activities                                |       | (13,108,105                                             | )          | 8,509,654 |   | (6,118,880 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                          | ** ** | ** **                                              | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net change in deposits                                                             |       | 7,130,702                                               |       | 7,861,025 |   | 4,800,332 |   |
| Net change in time deposits                                                        |       | 671,677                                                 |       | (11,576,516 | ) | 156,682 |   |
| Proceeds from securitized borrowings                                               |       | 4,388,371                                               |       | — |   | — |   |
| Repayments of securitized borrowings                                               |       | (1,289,280                                              | )          | — |   | — |   |
| Federal Home Loan Bank advances                                                    |       | 75,000                                                  |       | — |   | 276,462 |   |
| Federal Home Loan Bank repayments                                                  |       | (1,885,893                                              | )          | (180,294 | ) | (171,221 | ) |
| Dividends paid                                                                     |       | (47,500                                                 | )          | — |   | (49,000 | ) |
| Net cash provided by (used in) financing activities                                |       | 9,043,077                                               |       | (3,895,785 | ) | 5,013,255 |   |
| Net change in cash and cash equivalents                                            |       | (2,785,430                                              | )          | 5,115,326 |   | 859,546 |   |
| Cash and cash equivalents at beginning of year                                     |       | 18,273,842                                              |       | 13,158,516 |   | 12,298,970 |   |
| Cash and cash equivalents at end of year                                           |       | $                                                       | 15,488,412 |   | $ | 18,273,842 |   | $ | 13,158,516 |   |
| **SUPPLEMENTAL SCHEDULE OF NON-CASH****ACTIVITIES:**                               |       |                                                    |       |   |   |   |   |
| Foreclosed assets sold during the year and financed  through loans                 |       | $                                                       | 184,350    |   | $ | 65,412 |   | $  | 255,177     |   |
| Loans moved to  foreclosed assets                                                  |       | $                                                       | 208,607    |   | $ | 950,795 |   | $ | 83,383 |   |

 

F-28

----