##### Table of Contents



US Securities and Exchange Commission
 Washington, DC 20549
 Form 10-Q
 Quarterly Report Pursuant To Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2008
 Commission File Number 0001366367
 Yadkin Valley Financial Corporation
 (Exact name of registrant specified in its charter)
 North Carolina
(State of Incorporation)
    
    20-4495993
(I.R.S. Employer Identification No.)
 209 North Bridge Street, Elkin, North Carolina 28621
(address of principal executive offices)
 336-526-6300
(Registrants telephone number, including area code)
 þ o
  Large accelerated filer
o
    
    Accelerated filer
þ
    
    Non-accelerated filer   o
(Do not check if a smaller reporting company)
    
    Smaller reporting company o
 o þ




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##### 



Part I. Financial InformationItem 1. Financial StatementsCondensed Consolidated Balance Sheets September 30, 2008 and December 31, 2007
    
    
    3Condensed Consolidated Statements of Income Three and Nine Months Ended September 30, 2008 and 2007
    
    
    4Condensed Consolidated Statements of Comprehensive Income Three and Nine Months Ended September 30, 2008 and 2007
    
    
    5Condensed Consolidated Statements of Stockholders Equity for the Nine Months Ended September 30, 2008 and 2007
    
    
    6Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007
    
    
    7Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    8-19Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    19-32Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 4. Controls and Procedures
    
    
    33-34Part II. Other InformationItem 6. Exhibit Index
    
    
    35Signatures
    
    
    36Exhibits
    
    
    37-39EX-31.1EX-31.2EX-32.1
    2




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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 SEPTEMBER 30,
    
    
    DECEMBER 31,2008
    
    
    2007*ASSETSCASH AND CASH EQUIVALENTSCash and due from banks
    
    $
    26,574,471
    
    
    $
    24,267,806Federal funds sold
    
    
    32,000
    
    
    
    Interest-bearing deposits
    
    
    12,514,761
    
    
    
    2,058,069TOTAL CASH AND CASH EQUIVALENTS
    
    
    39,121,232
    
    
    
    26,325,875SECURITIES AVAILABLE FOR SALE-At fair value
(Amortized cost $139,075,578 in 2008 and $141,439,626 in 2007)
    
    
    140,709,259
    
    
    
    142,483,720GROSS LOANS
    
    
    1,118,618,961
    
    
    
    898,753,056Less: Allowance for loan losses
    
    
    (16,526,439
    )
    
    
    (12,445,555
    )NET LOANS
    
    
    1,102,092,522
    
    
    
    886,307,501LOANS HELD FOR SALE
    
    
    44,840,692
    
    
    
    52,753,907ACCRUED INTEREST RECEIVABLE
    
    
    6,283,629
    
    
    
    6,054,982PREMISES AND EQUIPMENT, NET
    
    
    32,947,888
    
    
    
    26,779,889FORECLOSED REAL ESTATE
    
    
    3,000,515
    
    
    
    602,000FEDERAL HOME LOAN BANK STOCK, AT COST
    
    
    7,689,400
    
    
    
    2,557,300INVESTMENT IN BANK-OWNED LIFE INSURANCE
    
    
    23,386,362
    
    
    
    22,682,702GOODWILL
    
    
    54,148,728
    
    
    
    32,696,900CORE DEPOSIT INTANGIBLE (net of accumulated amortization
of $4,869,974 at September 30, 2008 and $4,218,393 at
December 31, 2007)
    
    
    4,885,513
    
    
    
    4,261,115OTHER ASSETS
    
    
    10,273,934
    
    
    
    7,571,350TOTAL ASSETS
    
    $
    1,469,379,674
    
    
    $
    1,211,077,241LIABILITIES AND STOCKHOLDERS EQUITYDEPOSITSNoninterest-bearing demand deposits
    
    $
    157,549,301
    
    
    $
    154,979,227Interest-bearing deposits:NOW, savings, and money market accounts
    
    
    278,827,325
    
    
    
    232,888,349Time certificates:Over $100,000
    
    
    285,162,132
    
    
    
    267,529,772Other
    
    
    386,356,443
    
    
    
    308,044,736TOTAL DEPOSITS
    
    
    1,107,895,201
    
    
    
    963,442,084SHORT-TERM BORROWINGS
    
    
    153,123,523
    
    
    
    66,425,129LONG-TERM BORROWINGS
    
    
    45,085,967
    
    
    
    37,774,000ACCRUED INTEREST PAYABLE
    
    
    3,370,058
    
    
    
    3,434,832OTHER LIABILITIES
    
    
    7,248,546
    
    
    
    6,732,202TOTAL LIABILITIES
    
    
    1,316,723,295
    
    
    
    1,077,808,247STOCKHOLDERS EQUITYCommon stock, $1.00 par value; authorized 20,000,000
shares; issued 11,533,299 shares in 2008 and 10,563,356
shares in 2007
    
    
    11,533,299
    
    
    
    10,563,356SURPLUS
    
    
    87,988,909
    
    
    
    70,986,684RETAINED EARNINGS
    
    
    52,139,305
    
    
    
    51,086,684ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
    
    
    994,866
    
    
    
    632,270TOTAL STOCKHOLDERS EQUITY
    
    
    152,656,379
    
    
    
    133,268,994TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,469,379,674
    
    
    $
    1,211,077,241
  
 *
    
    Derived from audited consolidated financial statements 
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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007INTEREST INCOMEInterest and fees on loans
    
    $
    17,552,428
    
    
    $
    17,368,558
    
    
    $
    50,989,199
    
    
    $
    50,693,524Interest on federal funds sold
    
    
    8,195
    
    
    
    99,381
    
    
    
    45,071
    
    
    
    267,569Interest on securities:Taxable
    
    
    1,334,959
    
    
    
    1,407,074
    
    
    
    3,984,590
    
    
    
    3,895,345Non-taxable
    
    
    381,658
    
    
    
    308,657
    
    
    
    1,123,390
    
    
    
    887,379Interest-bearing deposits
    
    
    161,331
    
    
    
    47,434
    
    
    
    300,443
    
    
    
    110,164Total interest income
    
    
    19,438,571
    
    
    
    19,231,104
    
    
    
    56,442,693
    
    
    
    55,853,981INTEREST EXPENSETime deposits of $100,000 or more
    
    
    2,950,752
    
    
    
    3,130,594
    
    
    
    8,633,227
    
    
    
    8,857,793Other deposits
    
    
    4,594,436
    
    
    
    4,873,263
    
    
    
    14,104,850
    
    
    
    14,122,831Borrowed funds
    
    
    1,268,265
    
    
    
    499,702
    
    
    
    3,349,410
    
    
    
    1,519,931Total interest expense
    
    
    8,813,453
    
    
    
    8,503,559
    
    
    
    26,087,487
    
    
    
    24,500,555NET INTEREST INCOME
    
    
    10,625,118
    
    
    
    10,727,545
    
    
    
    30,355,206
    
    
    
    31,353,426PROVISION FOR LOAN LOSSES
    
    
    1,334,000
    
    
    
    300,000
    
    
    
    3,492,000
    
    
    
    800,000NET INTEREST INCOME AFTER PROVISION FOR LOAN
LOSSES
    
    
    9,291,118
    
    
    
    10,427,545
    
    
    
    26,863,206
    
    
    
    30,553,426NONINTEREST INCOMEService charges on deposit accounts
    
    
    1,171,772
    
    
    
    1,002,897
    
    
    
    3,246,318
    
    
    
    2,937,543Other service fees
    
    
    858,162
    
    
    
    863,393
    
    
    
    2,598,978
    
    
    
    2,719,193Net gain on sales of mortgage loans
    
    
    1,872,365
    
    
    
    1,337,985
    
    
    
    5,429,043
    
    
    
    4,394,351Net gain (loss) on investment securities
    
    
    (966,251
    )
    
    
    44,674
    
    
    
    (972,826
    )
    
    
    44,674Income on investment in bank owned life
insurance
    
    
    237,759
    
    
    
    255,000
    
    
    
    706,221
    
    
    
    785,343Mortgage banking income (loss)
    
    
    (10,878
    )
    
    
    63,916
    
    
    
    67,229
    
    
    
    276,183Bank owned life insurance death benefit
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    481,940Other income (loss)
    
    
    (105,238
    )
    
    
    (11,399
    )
    
    
    (40,747
    )
    
    
    108,381Total noninterest income
    
    
    3,057,691
    
    
    
    3,556,466
    
    
    
    11,034,216
    
    
    
    11,747,608NONINTEREST EXPENSESalaries and employee benefits
    
    
    5,136,319
    
    
    
    4,624,760
    
    
    
    15,051,823
    
    
    
    14,452,777Occupancy and equipment expenses
    
    
    1,307,042
    
    
    
    984,639
    
    
    
    3,577,635
    
    
    
    2,987,256Printing and supplies
    
    
    176,085
    
    
    
    126,734
    
    
    
    556,617
    
    
    
    409,404Data processing
    
    
    217,010
    
    
    
    104,856
    
    
    
    600,420
    
    
    
    315,495Communication expense
    
    
    271,657
    
    
    
    337,269
    
    
    
    757,975
    
    
    
    934,343Amortization of core deposit intangible
    
    
    228,717
    
    
    
    194,149
    
    
    
    651,582
    
    
    
    589,086Other
    
    
    2,423,953
    
    
    
    1,643,874
    
    
    
    7,360,096
    
    
    
    5,275,400Total noninterest expense
    
    
    9,760,783
    
    
    
    8,016,281
    
    
    
    28,556,148
    
    
    
    24,963,761INCOME BEFORE INCOME TAXES
    
    
    2,588,026
    
    
    
    5,967,730
    
    
    
    9,341,274
    
    
    
    17,337,273INCOME TAXES
    
    
    795,271
    
    
    
    2,045,373
    
    
    
    2,907,282
    
    
    
    5,716,111NET INCOME
    
    $
    1,792,755
    
    
    $
    3,922,357
    
    
    $
    6,433,992
    
    
    $
    11,621,162NET INCOME PER COMMON SHARE:Basic
    
    $
    0.16
    
    
    $
    0.37
    
    
    $
    0.57
    
    
    $
    1.10Diluted
    
    $
    0.15
    
    
    $
    0.37
    
    
    $
    0.57
    
    
    $
    1.08CASH DIVIDENDS PER COMMON SHARE
    
    $
    0.13
    
    
    $
    0.13
    
    
    $
    0.39
    
    
    $
    0.38
  
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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007NET INCOME
    
    $
    1,792,755
    
    
    $
    3,922,357
    
    
    $
    6,433,992
    
    
    $
    11,621,162OTHER COMPREHENSIVE INCOME, BEFORE TAX:Unrealized holding gains on securities available for sale
    
    
    1,315,130
    
    
    
    2,045,595
    
    
    
    (383,240
    )
    
    
    616,202Tax effect
    
    
    (506,324
    )
    
    
    (798,047
    )
    
    
    147,548
    
    
    
    (242,120
    )Unrealized holding gains on securities available for sale, net of tax
    
    
    808,806
    
    
    
    1,247,548
    
    
    
    (235,692
    )
    
    
    374,082Reclassification
adjustment for realized losses (gains)
    
    
    966,251
    
    
    
    (44,674
    )
    
    
    972,826
    
    
    
    (44,674
    )Tax effect
    
    
    (372,007
    )
    
    
    17,199
    
    
    
    (374,538
    )
    
    
    17,199Reclassification
adjustment for realized losses (gains), net of tax
    
    
    594,244
    
    
    
    (27,475
    )
    
    
    598,288
    
    
    
    (27,475
    )OTHER COMPREHENSIVE INCOME, NET OF TAX
    
    
    1,403,050
    
    
    
    1,220,073
    
    
    
    362,596
    
    
    
    346,607COMPREHENSIVE INCOME
    
    $
    3,195,805
    
    
    $
    5,142,430
    
    
    $
    6,796,588
    
    
    $
    11,967,769
  
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YADKIN VALLEY FINANCIAL CORPORATION  CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY (UNAUDITED)  FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007 and 2008
 AccumulatedOther
    
    
    TotalComprehensive
    
    
    StockholdersCommon Stock
    
    
    Surplus
    
    
    Retained Earnings
    
    
    Income
    
    
    EquityBalance, December 31, 2006
    
    $
    10,611,052
    
    
    $
    71,151,626
    
    
    $
    43,107,431
    
    
    $
    (470,968
    )
    
    $
    124,399,141Net income
    
    
    
    
    
    
    
    
    
    
    11,621,162
    
    
    
    
    
    
    
    11,621,162Shares issued under stock option plan*
    
    
    67,894
    
    
    
    467,811
    
    
    
    
    
    
    
    
    
    
    
    535,705Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (4,026,260
    )
    
    
    
    
    
    
    (4,026,260
    )Stock repurchased
    
    
    (106,097
    )
    
    
    (637,150
    )
    
    
    (1,198,618
    )
    
    
    
    
    
    
    (1,941,865
    )Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    346,607
    
    
    
    346,607Balance, September 30, 2007
    
    $
    10,572,849
    
    
    $
    70,982,287
    
    
    $
    49,503,715
    
    
    $
    (124,361
    )
    
    $
    130,934,490Balance, December 31, 2007
    
    $
    10,563,356
    
    
    $
    70,986,684
    
    
    $
    51,086,684
    
    
    $
    632,270
    
    
    $
    133,268,994Net income
    
    
    
    
    
    
    
    
    
    
    6,433,992
    
    
    
    
    
    
    
    6,433,992Shares issued under stock option plan*
    
    
    86,254
    
    
    
    510,854
    
    
    
    
    
    
    
    
    
    
    
    597,108Stock option compensation
    
    
    
    
    
    
    47,669
    
    
    
    
    
    
    
    
    
    
    
    47,669Tax benefit from exercise of stock options
    
    
    
    
    
    
    252,250
    
    
    
    
    
    
    
    
    
    
    
    252,250Cumulative
effect of adoption of new accounting standard (Note 10)
    
    
    
    
    
    
    
    
    
    
    (897,253
    )
    
    
    
    
    
    
    (897,253
    )Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (4,484,118
    )
    
    
    
    
    
    
    (4,484,118
    )Fractional purchased
    
    
    (58
    )
    
    
    2
    
    
    
    
    
    
    
    
    
    
    
    (56
    )Shares issued in
acquisition of Cardinal State Bank
    
    
    883,747
    
    
    
    16,191,450
    
    
    
    
    
    
    
    
    
    
    
    17,075,197Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    362,596
    
    
    
    362,596Balance, September 30, 2008
    
    $
    11,533,299
    
    
    $
    87,988,909
    
    
    $
    52,139,305
    
    
    $
    994,866
    
    
    $
    152,656,379
  
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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30, 2008 AND 2007
 2008
    
    
    2007CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    6,433,992
    
    
    $
    11,621,162Adjustments to reconcile net income to net cash provided by
operating activities:Net amortization (accretion) premiums (discounts) on investment securities
    
    
    (30,840
    )
    
    
    68,439Provision for loan losses
    
    
    4,122,000
    
    
    
    800,000Net gain on sales of mortgage loans held for sale
    
    
    (5,429,043
    )
    
    
    (4,394,351
    )Net loss on available for sale securities
    
    
    972,800
    
    
    
    Net (gain) loss on sales of available for sale securities
    
    
    26
    
    
    
    (44,674
    )Increase in investment in Bank owned life insurance
    
    
    (706,221
    )
    
    
    (785,343
    )Depreciation and amortization
    
    
    1,511,501
    
    
    
    1,455,675Net gain (loss) on sale of premises and equipment
    
    
    50,029
    
    
    
    (76,823
    )Gain on bank owned life insurance
    
    
    
    
    
    
    (481,940
    )Amortization of core deposit intangible
    
    
    651,582
    
    
    
    589,086Deferred tax (benefit) provision
    
    
    (1,419,553
    )
    
    
    Stock based compensation expense
    
    
    47,669
    
    
    
    Originations of mortgage loans held-for-sale
    
    
    (772,639,226
    )
    
    
    (690,149,132
    )Proceeds from sales of mortgage loans
    
    
    785,981,484
    
    
    
    700,844,096(Increase) decrease in accrued interest receivable
    
    
    405,972
    
    
    
    (616,221
    )(Increase) decrease in other assets
    
    
    (1,831,365
    )
    
    
    731,348Increase (decrease) in accrued interest payable
    
    
    (666,193
    )
    
    
    460,851Decrease in other liabilities
    
    
    (696,712
    )
    
    
    (2,048,451
    )Net cash provided by operating activities
    
    
    16,757,902
    
    
    
    17,973,722CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of available for sale securities
    
    
    (30,762,451
    )
    
    
    (40,163,656
    )Proceeds from sales of available for sale securities
    
    
    13,067,292
    
    
    
    22,911,510Proceeds from maturities of available for sale securities
    
    
    19,624,095
    
    
    
    2,935,000Net change in loans
    
    
    (69,987,144
    )
    
    
    (37,103,404
    )Acquisition of Cardinal State Bank, net of cash
    
    
    11,979,969
    
    
    
    Purchases of premises and equipment
    
    
    (1,703,824
    )
    
    
    (2,655,612
    )Proceeds from redemption of Federal Home Loan Bank stock
    
    
    1,161,100
    
    
    
    850,300Purchases of Federal Home Loan Bank stock
    
    
    (5,742,000
    )
    
    
    Proceeds from sale of premises and equipment
    
    
    287,136
    
    
    
    1,625,807Proceeds from death benefit from bank owned life insurance
    
    
    2,561
    
    
    
    1,277,376Net cash used in investing activities
    
    
    (62,073,266
    )
    
    
    (50,322,679
    )CASH FLOWS FROM FINANCING ACTIVITIES:Net decrease in checking, NOW, money market
and savings accounts
    
    
    (17,487,340
    )
    
    
    (2,427,220
    )Net increase (decrease) in time certificates
    
    
    (9,639,973
    )
    
    
    43,638,889Net increase (decrease) in borrowed funds
    
    
    88,872,850
    
    
    
    (24,369,067
    )Fractional shares retired
    
    
    (56
    )Purchases of common stock
    
    
    
    
    
    
    (1,941,865
    )Dividends paid
    
    
    (4,484,118
    )
    
    
    (4,026,260
    )Tax benefit from exercise of stock options
    
    
    252,250
    
    
    
    Proceeds from exercise of stock options
    
    
    597,108
    
    
    
    535,705Net cash provided by financing activities
    
    
    58,110,721
    
    
    
    11,410,182NET INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS
    
    
    12,795,357
    
    
    
    (20,938,775
    )CASH AND CASH EQUIVALENTS:Beginning of period
    
    
    26,325,875
    
    
    
    44,056,134End of period
    
    $
    39,121,232
    
    
    $
    23,117,359
  
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##### Table of Contents



Notes to Unaudited Condensed Consolidated Financial Statements
 1. Significant Accounting Policies
 Basis of Presentation
   2. Stock-based Compensation
      
 8




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##### Table of Contents



2. Stock-based Compensation (continued)
   3. Business Combinations
   Fair ValueAssets:Cash and cash equivalents
    
    $
    18,028,591Federal funds sold
    
    
    18,047,000Loans, net
    
    
    149,947,952Premises and equipment, net
    
    
    6,312,841Other assets acquired
    
    
    4,844,351Goodwill
    
    
    21,451,828Core deposit intangible
    
    
    1,275,979Liabilities:Deposits
    
    
    (170,689,695
    )Other liabilities
    
    
    (6,945,466
    )Total net assets acquired/consideration given
    
    $
    42,273,381
  
 9




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##### Table of Contents



3. Business Combinations (continued)
  Three Months EndedSeptember 30, 2007
    
    
    September 30, 2008Net interest income
    
    $
    12,209,161
    
    
    $
    10,625,118Noninterest income
    
    
    3,674,536
    
    
    
    3,057,691Total revenue
    
    
    15,883,697
    
    
    
    13,682,809Provision for loan losses
    
    
    376,100
    
    
    
    1,334,000Other noninterest expense
    
    
    9,773,507
    
    
    
    9,760,783Income before taxes
    
    
    5,734,090
    
    
    
    2,588,026Income tax expense
    
    
    379,178
    
    
    
    795,271Net income
    
    
    5,354,912
    
    
    
    1,792,755Basic earnings per share
    
    $
    0.47
    
    
    $
    0.16Diluted earnings per share
    
    
    0.46
    
    
    
    0.15
 Nine Months EndedSeptember 30, 2007
    
    
    September 30, 2008Net interest income
    
    $
    36,181,355
    
    
    $
    31,677,322Noninterest income
    
    
    12,155,906
    
    
    
    11,159,850Total revenue
    
    
    48,337,261
    
    
    
    42,837,172Provision for loan losses
    
    
    622,900
    
    
    
    3,457,000Other noninterest expense
    
    
    30,083,624
    
    
    
    30,051,405Income before taxes
    
    
    17,630,737
    
    
    
    9,328,767Income tax expense
    
    
    4,049,916
    
    
    
    2,903,030Net income
    
    
    13,580,821
    
    
    
    6,425,737Basic earnings per share
    
    $
    1.18
    
    
    $
    0.56Diluted earnings per share
    
    
    1.16
    
    
    
    0.55
   
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4. Investment Securities
  Less Than 12 Months
    
    
    12 Months or More
    
    
    TotalFair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedSeptember 30, 2008
    
    value
    
    
    losses
    
    
    value
    
    
    losses
    
    
    value
    
    
    lossesSecurities available for sale:U.S. government agencies
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    U.S. Treasury securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Mortgage backed securities
    
    
    13,135,087
    
    
    
    255,971
    
    
    
    2,099,346
    
    
    
    77,666
    
    
    
    15,234,433
    
    
    
    333,637State and municipal securities
    
    
    10,494,484
    
    
    
    315,592
    
    
    
    393,309
    
    
    
    1,691
    
    
    
    10,887,793
    
    
    
    317,283Total temporarily impaired securities
    
    $
    23,629,571
    
    
    $
    571,563
    
    
    $
    2,492,655
    
    
    $
    79,357
    
    
    $
    26,122,226
    
    
    $
    650,920
 Fair
    
    
    Unrealized
    
    
    Fair
    
    
    Unrealized
    
    
    Fair
    
    
    UnrealizedSeptember 30, 2007
    
    value
    
    
    losses
    
    
    value
    
    
    losses
    
    
    value
    
    
    lossesSecurities available for sale:U.S. government agencies
    
    $
    3,969,400
    
    
    $
    420
    
    
    $
    20,396,555
    
    
    $
    100,401
    
    
    $
    24,365,955
    
    
    $
    100,821U.S. Treasury securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Mortgage backed securities
    
    
    6,588,769
    
    
    
    49,861
    
    
    
    14,774,460
    
    
    
    358,722
    
    
    
    21,363,229
    
    
    
    408,583State and municipal securities
    
    
    4,599,041
    
    
    
    28,115
    
    
    
    15,749,417
    
    
    
    325,026
    
    
    
    20,348,458
    
    
    
    353,141Other securities
    
    
    
    
    
    
    
    
    
    
    880,701
    
    
    
    9,615
    
    
    
    880,701
    
    
    
    9,615Total temporarily impaired securities
    
    $
    15,157,210
    
    
    $
    78,396
    
    
    $
    51,801,133
    
    
    $
    793,764
    
    
    $
    66,958,343
    
    
    $
    872,160
  5. Commitments and Contingencies
  
 11




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5. Commitments and Contingencies (continued)
   6. Earnings per share
  Three Months Ended September 30,
    
    Nine Months Ended September 30,2008
    
    2007
    
    2008
    
    2007Basic EPS denominator:Weighted average
number of common
shares outstanding
    
    
    11,525,277
    
    
    
    10,584,092
    
    
    
    11,198,506
    
    
    
    10,603,937Dilutive effect
arising from assumed
exercise of stock
options
    
    
    57,465
    
    
    
    136,997
    
    
    
    77,440
    
    
    
    178,428Diluted EPS denominator
    
    
    11,582,742
    
    
    
    10,721,089
    
    
    
    11,275,946
    
    
    
    10,782,365
 
 12




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##### Table of Contents



6. Earnings per share (continued)
  7. Stockholders Equity
   8. Business Segment Information
  September 30, 2008
    
    Bank
    
    
    Sidus
    
    
    Other
    
    
    TotalInterest income
    
    $
    54,496,332
    
    
    $
    1,946,361
    
    
    $
    
    
    
    $
    56,442,693Interest expense
    
    
    24,381,777
    
    
    
    772,921
    
    
    
    932,789
    
    
    
    26,087,487Net interest income
    
    
    30,114,555
    
    
    
    1,173,440
    
    
    
    (932,789
    )
    
    
    30,355,206Provision for loan losses
    
    
    3,492,000
    
    
    
    
    
    
    
    
    
    
    
    3,492,000Net interest income after
provision
for loan losses
    
    
    26,622,555
    
    
    
    1,173,440
    
    
    
    (932,789
    )
    
    
    26,863,206Net loss on investment
securities
    
    
    (972,826
    )
    
    
    
    
    
    
    
    
    
    
    (972,826
    )Other income
    
    
    6,064,168
    
    
    
    5,429,043
    
    
    
    513,831
    
    
    
    12,007,042Other expense
    
    
    23,675,432
    
    
    
    4,725,828
    
    
    
    154,888
    
    
    
    28,556,148Income before income taxes
    
    
    8,038,465
    
    
    
    1,876,655
    
    
    
    (573,846
    )
    
    
    9,341,274Income taxes (2)
    
    
    2,175,387
    
    
    
    731,895
    
    
    
    
    
    
    
    2,907,282Net income
    
    $
    5,863,079
    
    
    $
    1,144,760
    
    
    $
    (573,846
    )
    
    $
    6,433,992
 
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##### Table of Contents



8. Business Segment Information (continued)
 September 30, 2008
    
    Bank
    
    Sidus
    
    Other
    TotalTotal assets (3)
    
    $
    1,503,292,786
    
    
    $
    44,840,692
    
    
    $
    (86,308,207
    )
    
    $
    1,469,379,674Net loans
    
    
    1,102,792,522
    
    
    
    
    
    
    
    
    
    
    
    1,102,092,522Loans held for sale
    
    
    
    
    
    
    52,395,095
    
    
    
    
    
    
    
    44,840,692Goodwill
    
    
    49,204,856
    
    
    
    4,943,872
    
    
    
    
    
    
    
    54,148,728
 September 30, 2007
    
    Bank
    
    
    Sidus
    
    
    Other
    
    
    TotalInterest income (1)
    
    $
    54,101,239
    
    
    $
    1,911,454
    
    
    $
    (158,712
    )
    
    $
    55,853,981Interest expense
    
    
    23,147,701
    
    
    
    1,511,566
    
    
    
    (158,712
    )
    
    
    24,500,555Net interest income
    
    
    30,953,538
    
    
    
    399,888
    
    
    
    
    
    
    
    31,353,426Provision for loan losses
    
    
    800,000
    
    
    
    
    
    
    
    
    
    
    
    800,000Net interest income after provision
for loan losses
    
    
    30,153,538
    
    
    
    399,888
    
    
    
    
    
    
    
    30,553,426Net gain on sale of investment
Securities
    
    
    44,674
    
    
    
    
    
    
    
    
    
    
    
    44,674Other income
    
    
    7,308,583
    
    
    
    4,394,351
    
    
    
    
    
    
    
    11,702,934Other expense
    
    
    21,219,884
    
    
    
    3,743,877
    
    
    
    
    
    
    
    24,963,761Income before income taxes
    
    
    16,286,911
    
    
    
    1,050,362
    
    
    
    
    
    
    
    17,337,273Income taxes (2)
    
    
    5,306,470
    
    
    
    409,641
    
    
    
    
    
    
    
    5,716,111Net income
    
    $
    10,980,441
    
    
    $
    640,721
    
    
    $
    
    
    
    $
    11,621,162Total assets (3)
    
    $
    1,158,959,829
    
    
    $
    42,926,785
    
    
    $
    (57,920,290
    )
    
    $
    1,143,966,324Net loans
    
    
    840,384,375
    
    
    
    
    
    
    
    
    
    
    
    840,384,375Loans held for sale
    
    
    
    
    
    
    36,050,302
    
    
    
    
    
    
    
    36,050,302Goodwill
    
    $
    27,753,028
    
    
    $
    4,943,872
    
    
    $
    
    
    
    $
    32,696,900
 
 (1)
    
    Note: In 2007, the Bank allocated interest expense to Sidus based on the Banks cost of
funds plus an additional charge of 87.5 basis points. The additional basis points charge,
reflected in interest income to the Bank and interest expense to Sidus, is eliminated in the
Other column. In 2008, the Bank allocated interest expense based on its cost of funds as a
change in approach to report segment results.(2)
    
    Note: Income tax expense has been allocated to the Sidus business segment for comparative
purposes. As an LLC, Sidus passes its pre-tax income through to its single member, the Bank, which
is taxed on that income.(3)
    
    Note: The Other column includes asset eliminations representing the Banks Due from Sidus
account ($85,000,000 in 2008 and $55,000,000 in 2007), the Banks Investment in Sidus ($3,000,000
in 2008 and 2007), and the Banks A/R from Sidus ($144,337 in 2008 and $229,777 in 2007). Also
included in this column are Holding Company assets ($1,836,130 in 2008 and $309,487 in 2007) and
Holding Company income and expenses. 
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9. Reclassifications
  10. New Accounting Standards
     
 15




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10. New Accounting Standards (continued)
   .
 
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10. New Accounting Standards (continued)
  11. Fair Value
  Fair Value Hierarchy
  Level 1
    
    Valuation is based upon quoted prices for identical instruments traded in active markets.Level 2
    
    Valuation is based upon quoted prices for similar instruments in active markets, quoted
prices for identical or similar instruments in markets that are not active, and
model-based valuation techniques for which all significant assumptions are observable in
the market.Level 3
    
    Valuation is generated from model-based techniques that use at least one significant
assumption not observable in the market. These unobservable assumptions reflect
estimates of assumptions that market participants would use in pricing the asset or
liability. Valuation techniques include use of option pricing models, discounted cash
flow models and similar techniques.
  Available-for-Sale Investment Securities
  
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11. Fair Value (continued)
  Interest Rate Locks and Forward Sale Loan Commitments
  Mortgage Servicing Rights
   Fair Value
    
    Level 1
    
    Level 2
    
    Level
    3Available for sale securities
    
    $
    140,709,259
    
    
    $
    54,921
    
    
    $
    140,654,338
    
    
    $
    Mortgage servicing rights
    
    $
    1,733,380
    
    
    $
    
    
    
    $
    
    
    
    $
    1,733,380
  Fair Value
    
    
    Level 3Balance, beginning of period
    
    $
    2,000,770
    
    
    $
    2,000,770Losses included in earnings
    
    
    (325,250
    )
    
    
    (325,250
    )Net transfers
    
    
    57,860
    
    
    
    57,860Balance, end of period
    
    $
    1,733,380
    
    
    $
    1,733,380
 Mortgage Loans Held for Sale
  Loans Held for Investment
  
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11. Fair Value (continued)
   Fair Value
    
    Level 1
    
    Level 2
    
    Level 3Impaired loans
    
    $
    11,663,589
    
    
    
    
    
    
    
    
    
    
    $
    11,663,589
 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
   
    
    significant increases in competitive pressure in the banking and financial services
industries;
    
    the risk that the businesses of Yadkin Valley and American Community will not be
integrated successfully following the merger or such integration may be more difficult,
time-consuming or costly than expected;
    
    changes in the interest rate environment which could reduce anticipated or actual
margins;
    
    changes in political conditions or the legislative or regulatory environment;
    
    general economic conditions, either nationally or regionally and especially in primary
service area, becoming less favorable than expected resulting in, among other things, a
deterioration in credit quality;
    
    changes occurring in business conditions and inflation;
    
    changes in technology;
    
    changes in deposit flows;
    
    the level of allowance for loan loss;
    
    the rate of delinquencies and amounts of charge-offs;
    
    the rates of loan growth;
    
    adverse changes in asset quality and resulting credit risk-related losses and expenses;
    
    changes in monetary and tax policies;
    
    loss of consumer confidence and economic disruptions resulting from terrorist
activities;
    
    changes in the securities markets; and
    
    other risks and uncertainties detailed from time to time in our filings with the
Securities and Exchange Commission.
 
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Recent
Government Actions
 http://www.ustreas.gov
   
 
  Overview
   
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Changes in Financial Position
     
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Liquidity, Interest Rate Sensitivity and Market Risk
     Results of Operations
  
 23




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Net Interest Income
      
 24




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Average Balance Sheets and Net Interest Income Analysis
(Dollars in Thousands)
 Nine Months Ended:
 September 30, 2008
    
    
    September 30, 2007Average
    
    
    
    
    
    
    Yield/
    
    
    Average
    
    
    
    
    
    
    Yield/Balance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    RateINTEREST EARNING ASSETSFederal funds sold
    
    $
    4,294
    
    
    $
    45
    
    
    
    1.40
    %
    
    $
    6,626
    
    
    $
    268
    
    
    
    5.41
    %Interest bearing deposits
    
    
    11,095
    
    
    
    300
    
    
    
    3.60
    %
    
    
    3,162
    
    
    
    110
    
    
    
    4.65
    %Investment securities (1)
    
    
    142,817
    
    
    
    5,603
    
    
    
    5.23
    %
    
    
    135,703
    
    
    
    5,174
    
    
    
    5.10
    %Total loans (1,2)
    
    
    1,057,970
    
    
    
    51,104
    
    
    
    6.43
    %
    
    
    855,011
    
    
    
    50,808
    
    
    
    7.94
    %Total average earning assets (1)
    
    
    1,216,176
    
    
    
    57,052
    
    
    
    6.25
    %
    
    
    1,000,502
    
    
    
    56,360
    
    
    
    7.53
    %Noninterest earning assets
    
    
    129,706
    
    
    
    
    
    
    
    
    
    
    
    110,521Total average assets
    
    $
    1,345,882
    
    
    
    
    
    
    
    
    
    
    $
    1,111,258INTEREST BEARING LIABILITIESNOW and money market
    
    $
    232,443
    
    
    $
    3,010
    
    
    
    1.73
    %
    
    $
    187,946
    
    
    $
    3,118
    
    
    
    2.22
    %Savings
    
    
    36,942
    
    
    
    155
    
    
    
    0.56
    %
    
    
    36,445
    
    
    
    273
    
    
    
    1.00
    %Time certificates
    
    
    619,681
    
    
    
    19,572
    
    
    
    4.21
    %
    
    
    545,262
    
    
    
    19,590
    
    
    
    4.80
    %Total interest bearing deposits
    
    
    889,066
    
    
    
    22,737
    
    
    
    3.41
    %
    
    
    769,653
    
    
    
    22,981
    
    
    
    3.99
    %Repurchase agreements sold
    
    
    50,005
    
    
    
    922
    
    
    
    2.46
    %
    
    
    34,681
    
    
    
    866
    
    
    
    3.34
    %Borrowed funds
    
    
    94,158
    
    
    
    2,428
    
    
    
    3.44
    %
    
    
    18,912
    
    
    
    654
    
    
    
    4.62
    %Total interest bearing liabilities
    
    
    1,033,229
    
    
    
    26,087
    
    
    
    3.36
    %
    
    
    823,246
    
    
    
    24,501
    
    
    
    3.98
    %Noninterest bearing deposits
    
    
    155,585
    
    
    
    
    
    
    
    
    
    
    
    152,976Stockholders equity
    
    
    146,134
    
    
    
    
    
    
    
    
    
    
    
    128,579Other liabilities
    
    
    10,934
    
    
    
    
    
    
    
    
    
    
    
    6,457Total average liabilities and
stockholders equity
    
    $
    1,345,882
    
    
    
    
    
    
    
    
    
    
    $
    1,111,258NET INTEREST INCOME/
YIELD (3,4)
    
    
    
    
    
    $
    30,965
    
    
    
    3.39
    %
    
    
    
    
    
    $
    31,859
    
    
    
    4.26
    %INTEREST SPREAD (5)
    
    
    
    
    
    
    
    
    
    
    2.89
    %
    
    
    
    
    
    
    
    
    
    
    3.55
    %
 
 1.
    
    Interest income and yields related to securities and loans exempt from Federal income taxes are stated on a fully tax equivalent
basis, assuming a Federal income tax rate of 34%, reduced by the nondeductible portion of interest expense2.
    
    The loan average includes loans on which accrual of interest has been discontinued.3.
    
    Net interest income is the difference between income from earning assets and interest expense.4.
    
    Net interest yield is net interest income divided by total average earning assets.5.
    
    Interest spread is the difference between the average interest rate received on earning assets and the average
rate paid on interest bearing liabilities. Provisions and Allowance for Loan Losses
  
 25




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Three Months
    
    
    Nine MonthsBalance, beginning of period
    
    $
    15,879
    
    
    $
    12,445Charge offs
    
    
    (739
    )
    
    
    (1,462
    )Recoveries
    
    
    39
    
    
    
    393Provision
for loan losses
    
    
    1,334
    
    
    
    3,492Acquisition of Cardinal
    
    
    13
    
    
    
    1,658Allowance
for Loan Losses, end of period
    
    $
    16,526
    
    
    $
    16,526
 
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Three Months
    
    
    Nine MonthsBalance, beginning of period
    
    $
    11,276
    
    
    $
    10,829Charge offs
    
    
    (394
    )
    
    
    (612
    )Recoveries
    
    
    47
    
    
    
    212Provision
for loan losses
    
    
    300
    
    
    
    800Allowance
for Loan Losses, end of period
    
    $
    11,229
    
    
    $
    11,229
  September 30,
    
    
    December 31,2008
    
    
    2007Impaired
loans without a related allowance for loan losses
    
    $
    4,820,559
    
    
    $
    1,610,836Impaired
loans with a related allowance for loan losses
    
    
    6,843,030
    
    
    
    6,191,025Total impaired loans
    
    $
    11,663,589
    
    
    $
    7,801,861Allowance
for loan losses related to impaired loans
    
    $
    2,620,531
    
    
    $
    2,022,764
 
 Noninterest Income
  
    
    Service charges on deposit accounts
 o
    
    Quarter-to-date service charges in the aggregate on deposit accounts increased $169,000
or 16.8% due mainly to income from the Cardinal region of $81,000.
Aggregate NSF fees income
increased $125,000. Not sufficient funds (NSF) fees excluding Cardinal increased
$66,000. Automated Teller Machine (ATM) fee income increased $32,000, and
without Cardinal the increase was $27,000.o
    
    Year-to-date increases of $309,000 or 10.5% included income from
Cardinal of $179,000 and an increase in NSF fees excluding Cardinal, of $149,000.
Partially offsetting the aggregate increases, overdraft protection chargeoffs, net of
recoveries, increased which can be attributed to the weakening economy. Although
gross chargeoffs declined by $4,000, recoveries decreased by $28,000, resulting in
a $24,000 net decrease in income. ATM fee income increased $46,000, and without
Cardinal the increase was $19,000.
 
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
    
    Other service fee income
 o
    
    Quarter-to-date other service fee income decreased by approximately
$5,000 or 0.6%. Commission income earned from mortgage originations decreased by
$82,000. Offsetting the decrease was income from Cardinal of $5,000, an increase
in investment fees earned by the brokerage division, Main Street Investment
Services, Inc. of $37,000, and an increase in merchant fee income and credit card
user fees of $17,000.o
    
    Year-to-date other service fee income decreased approximately $120,000
or 4.4%. Mortgage fees were down by $272,000 as number of mortgages
originated by the Bank decreased. Mortgage origination fees collected
by Sidus are included in the gain on sales of mortgage loans as
discussed below. Investment fee income, earned by the brokerage
division, Main Street Investment Services, Inc., increased by approximately
$119,000. Cardinal contributed $14,000 to the aggregate increase in other service
fee income.
 
    
    Gain on sale of mortgages
 o
    
    Quarter-to-date results show that net gain on sales of mortgage loans
increased by approximately $534,000 or 39.9%. Total loans originated increased by
$48.6 million and total loans sold increased by $45.7 million. The adjustment
resulting from earlier implementation of SAB 109 accounted for a $65,000 increase
in income as mortgage interest rate lock commitments increased from $80.1 million
at June 30, 2008 to $162.7 million at September 30, 2008. As discussed in Note 5 to
the financial statements, mortgage interest rate lock commitments are under best
efforts contracts to sell mortgages to agencies and other investors. The increase
in loans sold and originated is due in part to the expansion into the New England
states as discussed earlier.o
    
    Year-to-date, gain on sale of mortgage loans increased $1.0 million or
23.6%. The year-to-date SAB 109 adjustment resulted in an approximate increase in
income of $227,000. SAB 109 was implemented in the first quarter of 2008. Year to
date, loan closings increased by $72.8 million and loans sold increased by $79.7
million.
 
    
    Net loss on sale of investments for quarter to date and year to date is represented
largely by a loss of $972,800 from the write-down of the FHLMC preferred stock during the
third quarter. Refer to Note 4 for additional information.
    
    Income on investment in bank-owned life insurance (BOLI) decreased by $17,000 for the
quarter and $79,000 for the year as the cash surrender value continued to increase, but at
a slower pace than prior quarters
    
    Mortgage banking income decreased approximately $75,000, or 117.0%, for the quarter and
$209,000 or 75.7% for the year to date due in part to the valuation adjustment to mortgage
servicing rights (MSR)as the MSR was marked to fair value. The reduction in fair value
was due mainly to a steady decline in the average serviced mortgage balances. In addition,
there was a decrease in the servicing fees received. Average year-to-date serviced
mortgage loans fell from $222.1 million to $196.6 million from September 30, 2007 to
September 30, 2008.
    
    Other income decreased by approximately $94,000 for the quarter and $149,000 for the
year mainly due to losses on the sale of other real estate owned and the reduction of the
check cashing fees.
 
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Noninterest Expense
   
    
    Salaries and benefits
 o
    
    Quarter-to-date aggregated salaries and employee benefit
expenses increased by $512,000 or 11.1%. Cardinals expenses, included in that
amount, were $537,000. Accruals for the bonus incentive plan decreased
$196,000 based on performance measures. Salaries and benefits associated with
loan originations caused a reduction of expenses by $576,000 due to increased
deferrals which were a product of increases in (1) loan volume and (2) cost per
loan (held for investment) that was deferred. Salaries and wages increased by
$420,000, excluding the $500,000 allocated to the Cardinal region. Aggregated
other personnel expenses increased by $164,000, primarily for (1)
post-retirement benefit accruals from split-dollar policies and for (2)
expenses associated with operating the Cardinal division after its acquisition.
In the aggregate, employee group insurance expense increased by $182,000,
payroll taxes by $67,000, and 401(k) matching contributions by $10,000. Most
of the increases in these categories were associated with the addition of
previous Cardinal employees. Commission expenses decreased by $61,000 as
mortgage origination production at the Bank declined.o
    
    Year-to-date salaries and employee benefit expenses in the
aggregate were up by $599,000 or 4.1%, with Cardinal providing $632,000 of that
increase. Cardinals portion of the increases was in the following categories:
salaries (increase $1.05 million), employee insurance (increase $114,000),
miscellaneous personnel expense (increase $39,000) and payroll tax expense
(increase $68,000). Excluding the expenses of the Cardinal region, incentive
bonus expense was down $806,000, employee insurance was up $136,000, salaries
were up $93,000, and FASB loan costs that were deferred (on held for sale
loans) were up $1.1 million. Miscellaneous personnel expense increased by
$263,000 as a result of the post-retirement benefit as explained in Note 10.
 
    
    Occupancy expenses
 o
    
    Quarter-to-date occupancy and equipment expenses increased by
$322,000 or 32.7%. The increase attributable to the addition of the Cardinal
branches was $303,000, with the remaining 1.9% increase attributable to normal
recurring increases in costs.o
    
    Year-to-date increases in occupancy and equipment expenses
increased by $590,000 or 19.8% with the Cardinal region providing $597,000 of
the increase.
 
    
    Printing and supplies
 o
    
    Printing and supplies increased by $49,000, or 38.9%, comparing
third quarter 2008 with third quarter 2007 with the Cardinal region
contributing $24,000 of the increase. Supplies for the new offices opened or
acquired after the first quarter of 2008 created additional expenses along with
the normal increase in the price of supplies.
 
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o
    
    Year-to-date increases in printing and supplies increased
$147,000 or 36.0% with Cardinal contributing $43,000 of the increase for
reasons discussed above and the additional expenses related to the training of
Cardinal and merger supplies.
 
    
    Data processing
 o
    
    Quarter-to-date data processing expense increased $112,000 or
107.0%, with $43,000 attributable to Cardinals outside processing expenses.
Additional in-house processing due to the acquisition of Cardinals accounts
and increases in users account for the rest of the increase.o
    
    Yearto-date data processing expense increased $285,000 or
90.3% with Cardinals outside data processing expenses contributing $103,000 to
the overall increase. The additional increase in expense was for the same
reasons as discussed above.
 
    
    Communications expense
 o
    
    Quarter-to-date communications expense decreased by $66,000 or
19.5% even with additional expenses contributed by the Cardinal region of
$39,000, as compared to the third quarter of 2007. The Company entered into a new
contract for data and voice services at lower rates during the last half of 2007.o
    
    Year-to-date communications expense decreased by $176,000 or 18.9%
compared with the same period of 2007 for the same reason discussed above.
 
    
    Amortization of the core deposit intangible
 o
    
    Amortization of the core deposit intangible, recognized with
the purchases of Main Street BankShares, Inc. in 2002, High Country Financial
Corporation in 2004, and Cardinal State Bank in 2008 increased $35,000, or
17.8%, for the quarter due to the intangible acquired in the purchase of
Cardinal on March 31, 2008. The CDI amortization is intended to match the
expected life of the related deposits. The amortization related to the
acquisition of Cardinal is $191,000 for the first twelve months and declines
annually to $128,000 per year in the fourth year. Thereafter the expense
remains constant until the amortization is completed in the second month of the
tenth year.o
    
    For the year, the amortization increased $62,000, or 10.6%, for
the same reason discussed above.
 
    
    Other operating expenses
 o
    
    Quarter to date, other operating expenses increased
approximately $780,000 or 47.4% with the Cardinal region contributing $157,000
of the increase. The largest increases were in the following categories:
attorney fees due to additional services provided (up $66,000); advertising (up
$309,000), FDIC assessments (up $155,000), and directors fees (up $40,000) due
to additional meeting expense and additional directors from the Cardinal
region. Decreases in this category include: ATM service fees (down $101,000)
due to change in service provider and miscellaneous expense (down $112,000) for
reduced accruals for lawsuits because accrued amounts were deemed to
be adequate based upon available information.o
    
    Year to date, other operating expenses increased $2.1 million
or 39.5% with the Cardinal region contributing $410,000. The largest increases
were in the following categories: accounting fees (up $258,000); ATM fees
(down $142,000); advertising (up $409,000); FDIC assessments (up
 
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$309,000);
taxes and licenses (up $132,000); outside service fees (up $180,000); attorney
fees (up $72,000); and miscellaneous expense (up $77,000) for various other
expenses including accrual for lawsuits.
 Income Tax Expense
    
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
 Item 4. Controls and Procedures
  
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Remediation Plan
   
    
    We have enhanced and re-emphasized the importance of procedures for underwriting, lien
perfection, and documentation for both residential and commercial loan renewals.
    
    We have emphasized the importance of risk grade completeness and accuracy at loan
origination and throughout the life of the loans. Lenders and loan operations personnel
have been informed of the requirement to assign risk grades to loans upon origination. The
importance of periodic review of risk grades has been emphasized to ensure that changes are
made as warranted due to the changes in the condition of the borrower, the collateral, or
general economic conditions. The controls over pre-and post-origination review of loans in
loan operations have been strengthened to ensure the accuracy and completeness of loan
data, including assignment of risk grades. The Chief Credit Officers complete authority
to assign risk grades was reiterated to management and loan officers. During second
quarter 2008, the Chief Credit Officer resigned and the Chief Lending Officer (CLO) who was
hired during the first quarter 2008 assumed responsibility for the credit function. The
CLOs responsibilities include assessing and managing risk in the loan portfolio. Further
plans for performing the credit function effectively were developed as discussed below in
the second and third quarters of 2008.
    
    We have modified the allowance for loan loss model to add support for assumptions and to
correct impaired loan data and charged-off loan balances.
    
    We will continue to assess current lending and credit administration policies and
procedures, and are revising them as necessary to develop and implement policies and
procedures that will promote a culture that expects reliability and integrity of data.
  
    
    Policies over loan approval and authority levels have been strengthened to ensure that
the proper level of management and committee oversight is in place based on the amount of
principal at risk.
    
    Information provided on payment delinquency reports has been added to provide more
complete data to management responsible for loan performance.
    
    The procedures over the communication process between line and staff in regard to
charging off loans has been enhanced to ensure that complete and accurate information is
available to decide whether to charge off loans on a timely basis.
 
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
    
    Executive management held a planning meeting to evaluate all policies and procedures
related to lending approval, loan documentation and servicing, developing recommendations
and execute changes.
  
    
    We have implemented our credit administration staffing recommendations and hired two
experienced credit officers to work with lenders in underwriting, structuring and risk
grading our credits. Our newly hired credit risk review officer is focused on lending
policy compliance, credit risk grading, and credit risk reviews on larger dollar exposures.
    
    We are currently implementing a monthly Criticized and Watch List Exposure Report
which will allow us to better manage this portion of our portfolio. Also, we are
centralizing appraisal engagement and review processes which should ensure better quality
control of these items.
    
    Executive management is evaluating and analyzing technology systems to better manage our
portfolios.
    
    Loan authorities and reporting structure were clarified.
   Changes in Internal Control over Financial Reporting
  
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Part II. Other Information
 
 Item 6. Exhibits
 Exhibit #
    
    Description10.1
    
    2008 OMNIBUS Stock Ownership and Long Term Incentive Plan (incorporated by reference to
Form S-8 filed September 5, 2008)31.1
    
    Rule 13a-14(a)/15d-14(a) Certification31.2
    
    Rule 13a-14(a)/15d-14(a) Certification32.1
    
    Section 1350 Certification
 
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Yadkin Valley Financial CorporationBY:
    
    /s/ William A. LongWilliam A. Long, President and Chief Executive Officer[Principal Executive Officer]BY:
    
    /s/ Edwin E. LawsEdwin E. Laws, Executive Vice President and Chief Financial Officer[Principal Financial Officer]November 10, 2008
 
 36