##### 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 March 31, 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 
March 31, 2008 and December 31, 2007
    
    
    3Condensed Consolidated Statements of Income 
Three Months Ended March 31, 2008 and 2007
    
    
    4Condensed Consolidated Statements of Comprehensive Income 
Three Months Ended March 31, 2008 and 2007
    
    
    5Condensed
Consolidated Statement of Stockholders Equity for the
Three Months Ended March 31, 2008
    
    
    6Condensed
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2008 and 2007
    
    
    7Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    8-16Item 2. Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    16-24Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    25-26Part II. Other InformationItem 6. Exhibit Index
    
    
    27Signatures
    
    
    28Exhibits
    
    
    29-31Exhibit 31.1Exhibit 31.2Exhibit 32.1
  
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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
 MARCH 31,
    
    
    DECEMBER 31,*2008
    
    
    2007ASSETSCASH AND CASH EQUIVALENTSCash and due from banks
    
    $
    31,975,577
    
    
    $
    24,267,806Federal funds sold
    
    
    17,361,000
    
    
    
    Interest-bearing deposits
    
    
    17,157,483
    
    
    
    2,058,069TOTAL CASH AND CASH EQUIVALENTS
    
    
    66,494,060
    
    
    
    26,325,875SECURITIES AVAILABLE FOR SALE-At fair value
(Amortized cost $141,752,799 in 2008 and $141,439,626 in 2007)
    
    
    144,464,907
    
    
    
    142,483,720GROSS LOANS
    
    
    1,041,481,098
    
    
    
    898,753,056Less: Allowance for loan losses
    
    
    (14,568,368
    )
    
    
    (12,445,555
    )NET LOANS
    
    
    1,026,912,730
    
    
    
    886,307,501LOANS HELD FOR SALE
    
    
    51,689,032
    
    
    
    52,753,907ACCRUED INTEREST RECEIVABLE
    
    
    6,192,895
    
    
    
    6,054,982PREMISES AND EQUIPMENT, NET
    
    
    32,914,978
    
    
    
    26,779,889FEDERAL HOME LOAN BANK STOCK, AT COST
    
    
    4,269,900
    
    
    
    2,557,300INVESTMENT IN BANK-OWNED LIFE INSURANCE
    
    
    22,915,702
    
    
    
    22,682,702GOODWILL
    
    
    52,567,976
    
    
    
    32,696,900CORE DEPOSIT INTANGIBLE (net of accumulated amortization
of $4,405,901 at March 31, 2008 and $4,218,393 at December
31, 2007)
    
    
    5,211,343
    
    
    
    4,261,115OTHER ASSETS
    
    
    11,578,212
    
    
    
    8,173,350TOTAL ASSETS
    
    $
    1,425,211,735
    
    
    $
    1,211,077,241LIABILITIES AND STOCKHOLDERS EQUITYDEPOSITSNoninterest-bearing demand deposits
    
    $
    163,642,971
    
    
    $
    154,979,227Interest-bearing deposits:NOW, savings, and money market accounts
    
    
    289,433,746
    
    
    
    232,888,349Time certificates:Over $100,000
    
    
    279,306,609
    
    
    
    267,529,772Other
    
    
    380,050,879
    
    
    
    308,044,736TOTAL DEPOSITS
    
    
    1,112,434,205
    
    
    
    963,442,084SHORT-TERM BORROWINGS
    
    
    84,954,776
    
    
    
    66,425,129LONG-TERM BORROWINGS
    
    
    40,093,472
    
    
    
    37,774,000ACCRUED INTEREST PAYABLE
    
    
    3,524,409
    
    
    
    3,434,832OTHER LIABILITIES
    
    
    33,433,572
    
    
    
    6,732,202TOTAL LIABILITIES
    
    
    1,274,440,434
    
    
    
    1,077,808,247STOCKHOLDERS EQUITYCommon stock, $1.00 par value; authorized 20,000,000
shares; issued 11,452,948 shares in 2008 and 10,563,356
shares in 2007 (see note 3)
    
    
    11,452,948
    
    
    
    10,563,356SURPLUS
    
    
    87,116,691
    
    
    
    70,986,684RETAINED EARNINGS
    
    
    50,543,563
    
    
    
    51,086,684ACCUMULATED OTHER COMPREHENSIVE INCOME
    
    
    1,658,099
    
    
    
    632,270TOTAL STOCKHOLDERS EQUITY
    
    
    150,771,301
    
    
    
    133,268,994TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    1,425,211,735
    
    
    $
    1,211,077,241
  
 *
    
    Derived from audited consolidated financial statements 
 3




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YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)  THREE MONTHS ENDED MARCH 31, 2008 AND 2007
 Three Months EndedMarch 31,2008
    
    
    2007INTEREST INCOMEInterest and fees on loans
    
    $
    16,213,686
    
    
    $
    16,409,149Interest on federal funds sold
    
    
    10,646
    
    
    
    39,943Interest on securities:Taxable
    
    
    1,305,463
    
    
    
    1,226,452Non-taxable
    
    
    368,596
    
    
    
    286,912Interest-bearing deposits
    
    
    4,741
    
    
    
    13,313Total interest income
    
    
    17,903,132
    
    
    
    17,975,769INTEREST EXPENSETime deposits of $100,000 or more
    
    
    2,955,989
    
    
    
    2,718,469Other deposits
    
    
    4,525,502
    
    
    
    4,492,074Borrowed funds
    
    
    1,064,644
    
    
    
    548,430Total interest expense
    
    
    8,546,135
    
    
    
    7,758,973NET INTEREST INCOME
    
    
    9,356,997
    
    
    
    10,216,796PROVISION FOR LOAN LOSSES
    
    
    450,000
    
    
    
    300,000NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    
    
    8,906,997
    
    
    
    9,916,796NONINTEREST INCOMEService charges on deposit accounts
    
    
    1,009,167
    
    
    
    980,415Other service fees
    
    
    863,867
    
    
    
    842,121Net gain on sales of mortgage loans
    
    
    1,772,295
    
    
    
    1,410,702Income on investment in bank owned life insurance
    
    
    233,000
    
    
    
    216,769Mortgage banking income
    
    
    9,757
    
    
    
    79,286Bank owned life insurance death benefit
    
    
    
    
    
    
    481,940Other income (loss)
    
    
    41,356
    
    
    
    67,395Total noninterest income
    
    
    3,929,442
    
    
    
    4,078,628NONINTEREST EXPENSESalaries and employee benefits
    
    
    4,867,976
    
    
    
    4,838,601Occupancy and equipment expenses
    
    
    976,449
    
    
    
    1,014,908Printing and supplies
    
    
    184,977
    
    
    
    143,505Data processing
    
    
    112,420
    
    
    
    100,927Communication expense
    
    
    208,471
    
    
    
    249,309Amortization of core deposit intangible
    
    
    187,508
    
    
    
    197,469Other
    
    
    2,104,880
    
    
    
    1,719,689Total noninterest expense
    
    
    8,642,681
    
    
    
    8,264,408INCOME BEFORE INCOME TAXES
    
    
    4,193,758
    
    
    
    5,731,016INCOME TAXES
    
    
    1,279,445
    
    
    
    1,818,610NET INCOME
    
    $
    2,914,313
    
    
    
    3,912,406NET INCOME PER COMMON SHARE:Basic
    
    $
    0.28
    
    
    
    0.37Diluted
    
    $
    0.27
    
    
    
    0.36CASH DIVIDENDS PER COMMON SHARE
    
    $
    0.13
    
    
    $
    0.12
  
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YADKIN VALLEY FINANCIAL CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
 Three Months EndedMarch 31,2008
    
    
    2007NET INCOME
    
    $
    2,914,313
    
    
    $
    3,912,406OTHER
COMPREHENSIVE INCOME, BEFORE TAX:Unrealized holding gains on securities available for sale
    
    
    1,668,014
    
    
    
    536,649Tax effect
    
    
    (642,185
    )
    
    
    (206,611
    )OTHER
COMPREHENSIVE INCOME, NET OF TAX
    
    
    1,025,829
    
    
    
    330,038TOTAL COMPREHENSIVE INCOME
    
    $
    3,940,142
    
    
    $
    4,242,444
  
 5




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YADKIN VALLEY FINANCIAL CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENT
OF STOCKHOLDERS EQUITY (UNAUDITED)
FOR THE THREE MONTHS ENDED MARCH 31, 2007 AND 2008
 Accumulated OtherComprehensive
    
    
    Total 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
    
    
    
    
    
    
    
    
    
    
    3,912,406
    
    
    
    
    
    
    
    3,912,406Shares
issued under stock option plan
    
    
    23,911
    
    
    
    167,418
    
    
    
    
    
    
    
    
    
    
    
    191,329Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (1,272,631
    )
    
    
    
    
    
    
    (1,272,631
    )Stock
repurchased
    
    
    (29,706
    )
    
    
    (124,449
    )
    
    
    (425,993
    )
    
    
    
    
    
    
    (580,148
    )Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    330,038
    
    
    
    330,038Balance,
March 31, 2007
    
    $
    10,605,257
    
    
    $
    71,194,595
    
    
    $
    45,321,213
    
    
    $
    (140,930
    )
    
    $
    126,980,135Balance,
December 31, 2007**
    
    $
    10,563,356
    
    
    $
    70,986,684
    
    
    $
    51,086,684
    
    
    $
    632,270
    
    
    $
    133,268,994Net income
    
    
    
    
    
    
    
    
    
    
    2,914,313
    
    
    
    
    
    
    
    2,914,313Shares
issued under stock option plan
    
    
    5,092
    
    
    
    24,775
    
    
    
    
    
    
    
    
    
    
    
    29,867Stock option compensation
    
    
    
    
    
    
    11,043
    
    
    
    
    
    
    
    
    
    
    
    11,043Tax benefit from exercise of stock options
    
    
    
    
    
    
    173,189
    
    
    
    
    
    
    
    
    
    
    
    173,189Cumulative
effect of adoption of new accounting standard (note 10)
    
    
    
    
    
    
    
    
    
    
    (1,966,465
    )
    
    
    
    
    
    
    (1,966,465
    )Cash dividends declared
    
    
    
    
    
    
    
    
    
    
    (1,490,969
    )
    
    
    
    
    
    
    (1,490,969
    )Shares issued in
acquisition of Cardinal State Bank
    
    
    884,500
    
    
    
    15,921,000
    
    
    
    
    
    
    
    
    
    
    
    16,805,500Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,025,829
    
    
    
    1,025,829Balance, March 31, 2008
    
    $
    11,452,948
    
    
    $
    87,116,691
    
    
    $
    50,543,563
    
    
    $
    1,658,099
    
    
    $
    150,771,301
  
 **
    
    Derived from audited consolidated financial statements 
 6




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YADKIN VALLEY FINANCIAL CORPORATION
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
THREE MONTHS ENDED MARCH 31, 2008 AND 2007
 2008
    
    
    2007CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    2,914,313
    
    
    $
    3,912,406Adjustments
to reconcile net income to net cash provided by (used in)
operating activities:Net amortization of premiums on investment securities
    
    
    (6,792
    )
    
    
    23,231Provision for loan losses
    
    
    450,000
    
    
    
    300,000Net gain on sales of mortgage loans held for sale
    
    
    (1,772,295
    )
    
    
    (1,410,702
    )(Increase) decrease in investment in Bank owned life insurance
    
    
    (233,000
    )
    
    
    (216,769
    )Depreciation and amortization
    
    
    421,584
    
    
    
    502,715Net gain on sale of premises and equipment
    
    
    (800
    )
    
    
    (7,951
    )Gain on
Bank-owned life insurance
    
    
    
    
    
    
    (481,940
    )Amortization of core deposit intangible
    
    
    187,508
    
    
    
    197,469Deferred tax (benefit) provision
    
    
    (1,187,476
    )
    
    
    Stock based
compensation expense
    
    
    11,043
    
    
    
    Originations of mortgage loans held-for-sale
    
    
    (258,770,800
    )
    
    
    (233,476,439
    )Proceeds
from sales of mortgage loans held-for-sale
    
    
    261,607,970
    
    
    
    225,142,139(Increase) decrease in accrued interest receivable
    
    
    496,706
    
    
    
    (68,708
    )(Increase) decrease in other assets
    
    
    27,154
    
    
    
    (1,388,418
    )Increase (decrease) in accrued interest payable
    
    
    (511,842
    )
    
    
    162,563Increase in other liabilities
    
    
    24,419,102
    
    
    
    145,112Net cash provided by (used in) operating activities
    
    
    28,041,332
    
    
    
    (6,665,292
    )CASH FLOWS FROM INVESTING ACTIVITIES:Purchases of available for sale securities
    
    
    (11,896,221
    )
    
    
    (13,215,100
    )Proceeds from sales of available for sale securities
    
    
    3,751,714
    
    
    
    4,807,258Proceeds from maturities of available for sale securities
    
    
    8,345,000
    
    
    
    2,100,000Net change in loans
    
    
    8,864,648
    
    
    
    6,638,615Acquisition
of Cardinal State Bank, net of cash acquired
    
    
    12,619,714
    
    
    
    Purchases of premises and equipment
    
    
    (243,832
    )
    
    
    (646,231
    )Proceeds from redemption of Federal Home Loan Bank stock
    
    
    283,500
    
    
    
    850,300Purchases of Federal Home Loan Bank stock
    
    
    (1,444,900
    )
    
    
    Proceeds from sale of premises and equipment
    
    
    800
    
    
    
    8,060Proceeds
from death benefit from bank owned life insurance
    
    
    
    
    
    
    1,277,376Net cash provided by investing activities
    
    
    20,280,423
    
    
    
    1,820,278CASH FLOWS FROM FINANCING ACTIVITIES:Net increase (decrease) in checking, NOW, money market
and savings accounts
    
    
    (787,249
    )
    
    
    4,843,035Net increase (decrease) in time certificates
    
    
    (21,801,060
    )
    
    
    12,808,247Net increase (decrease) in borrowed funds
    
    
    15,711,609
    
    
    
    (5,556,594
    )Purchases of common stock
    
    
    
    
    
    
    (580,148
    )Dividends paid
    
    
    (1,490,969
    )
    
    
    (1,272,631
    )Tax benefit from exercise of stock options
    
    
    173,189
    
    
    
    Proceeds from exercise of stock options
    
    
    29,867
    
    
    
    191,329Net cash provided by (used in) financing activities
    
    
    (8,153,570
    )
    
    
    10,433,238NET INCREASE IN CASH AND CASH
EQUIVALENTS
    
    
    40,168,185
    
    
    
    5,588,224CASH AND CASH EQUIVALENTS:Beginning of period
    
    
    26,325,875
    
    
    
    44,056,134End of period
    
    $
    66,494,060
    
    
    $
    49,644,358
  
 7




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



3. Business Combination
   Fair ValueAssets:Cash and cash equivalents
    
    $
    18,028,591Federal funds sold
    
    
    18,047,000Loans, net
    
    
    149,947,952Premises and equipment, net
    
    
    6,312,841Other tangible assets acquired
    
    
    4,955,927Goodwill
    
    
    19,870,976Core deposit intangible
    
    
    1,137,736Liabilities:Deposits
    
    
    (170,689,695
    )Other liabilities
    
    
    (6,945,466
    )Total net assets acquired/consideration given
    
    $
    40,665,862
   March 31, 2007
    
    
    March 31, 2008Net interest expense
    
    $
    11,833,981
    
    
    $
    10,715,098Noninterest income
    
    
    4,203,088
    
    
    
    4,384,262Total Revenue
    
    
    16,037,069
    
    
    
    15,099,360Provision for loan loss
    
    
    57,900
    
    
    
    415,000Other noninterest expense
    
    
    9,939,542
    
    
    
    10,165,567Income before taxes
    
    
    6,039,627
    
    
    
    4,518,793Income tax expense
    
    
    1,818,610
    
    
    
    1,395,571Net Income
    
    
    4,221,017
    
    
    
    3,123,222Basic earnings per share
    
    $
    0.37
    
    
    $
    0.27Diluted earnings per share
    
    
    0.36
    
    
    
    0.27
 
 9




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##### Table of Contents



4. Commitments and Contingencies
   5. Subsequent Events
   6. Earnings per share
  Three Months EndedMarch 31,2008
    
    2007Basic EPS denominator:Weighted average number of common
shares outstanding
    
    
    10,573,889
    
    
    
    10,614,120Dilutive effect arising from
assumed exercise of stock options
    
    
    60,364
    
    
    
    207,606Diluted EPS denominator
    
    
    10,634,253
    
    
    
    10,821,726
 
 10




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##### Table of Contents



7. Stockholders Equity
   8. Business Segment Information
  March 31, 2008
 Bank
    
    
    Sidus
    
    
    Other
    
    
    TotalInterest income
    
    $
    17,282,737
    
    
    $
    620,395
    
    
    $
    
    
    
    $
    17,903,132Interest expense
    
    
    8,144,622
    
    
    
    317,978
    
    
    
    83,535
    
    
    
    8,546,135Net interest income
    
    
    9,138,115
    
    
    
    302,417
    
    
    
    (83,535
    )
    
    
    9,356,997Provision for loan losses
    
    
    450,000
    
    
    
    
    
    
    
    
    
    
    
    450,000Net interest income after
provision for loan losses
    
    
    8,688,115
    
    
    
    302,417
    
    
    
    (83,535
    )
    
    
    8,906,997Net gain (loss) on sale
of investment
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income
    
    
    2,144,403
    
    
    
    1,772,295
    
    
    
    12,744
    
    
    
    3,929,442Other expense
    
    
    7,193,651
    
    
    
    1,411,243
    
    
    
    37,787
    
    
    
    8,642,681Income before income taxes
    
    
    3,638,867
    
    
    
    663,469
    
    
    
    (108,578
    )
    
    
    4,193,758Income taxes (2)
    
    
    1,020,692
    
    
    
    258,753
    
    
    
    
    
    
    
    1,279,445Net income
    
    $
    2,618,175
    
    
    $
    404,716
    
    
    $
    (108,578
    )
    
    $
    2,914,313Total assets (3)
    
    $
    1,458,543,547
    
    
    $
    58,229,229
    
    
    $
    (86,617,169
    )
    
    $
    1,425,211,735Net loans
    
    
    1,026,912,730
    
    
    
    
    
    
    
    
    
    
    
    1,026,912,730Loans held for sale
    
    
    910,700
    
    
    
    50,778,332
    
    
    
    
    
    
    
    51,689,032Goodwill
    
    
    47,624,104
    
    
    
    4,943,872
    
    
    
    
    
    
    
    52,567,976
 
 11




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##### Table of Contents



March 31, 2007
 Bank
    
    
    Sidus
    
    
    Other
    
    
    TotalInterest income (1)
    
    $
    17,420,739
    
    
    $
    625,772
    
    
    $
    (70,742
    )
    
    $
    17,975,769Interest expense
    
    
    7,306,565
    
    
    
    523,150
    
    
    
    (70,742
    )
    
    
    7,758,973Net interest income
    
    
    10,114,174
    
    
    
    102,622
    
    
    
    
    
    
    
    10,216,796Provision for loan losses
    
    
    300,000
    
    
    
    
    
    
    
    
    
    
    
    300,000Net interest income after provision
for loan losses
    
    
    9,814,174
    
    
    
    102,622
    
    
    
    
    
    
    
    9,916,796Net gain (loss) on sale of investment
Securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other income
    
    
    2,667,926
    
    
    
    1,410,702
    
    
    
    
    
    
    
    4,078,628Other expense
    
    
    7,004,303
    
    
    
    1,239,046
    
    
    
    21,059
    
    
    
    8,264,408Income before income taxes
    
    
    5,477,797
    
    
    
    274,278
    
    
    
    (21,059
    )
    
    
    5,731,016Income taxes (2)
    
    
    1,711,642
    
    
    
    106,968
    
    
    
    
    
    
    
    1,818,610Net income
    
    $
    3,766,155
    
    
    $
    167,310
    
    
    $
    (21,059
    )
    
    $
    3,912,406Total assets
    
    $
    1,133,919,233
    
    
    $
    59,248,495
    
    
    $
    (58,076,190
    )
    
    $
    1,135,091,538Net loans
    
    
    797,142,356
    
    
    
    
    
    
    
    
    
    
    
    797,142,356Loans held for sale
    
    
    72,000
    
    
    
    52,023,917
    
    
    
    
    
    
    
    52,095,917Goodwill
    
    
    27,753,028
    
    
    
    4,943,872
    
    
    
    
    
    
    
    32,696,900
 
 (1)
    
    Note: The Bank allocated interest expense to Sidus based on the Banks cost of funds plus
an additional charge of 87.5 basis points during 2007 only. The additional basis points charge,
reflected in interest income to the Bank and interest expense to Sidus, is eliminated in the
Other column.(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), the Banks A/R from Sidus ($172,277 in 2008 and $230,873 in 2007), and Sidus
Goodwill account ($4,943,872 in 2008 and $4,943,872 in 2007). Also included in this column are
Holding Company assets ($1,555,108 in 2008 and $154,683 in 2007) and Holding Company income and
expenses. 9. Reclassifications
  10. New Accounting Standards
  
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.
 
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##### Table of Contents



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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Interest Rate Locks and Forward Sale Loan Commitments
  Mortgage
Servicing Rights
   Fair Value
    
    Level 1
    
    Level 2
    
    Level 3Available for sale securities
    
    $
    144,464,907
    
    
    $
    47,454
    
    
    $
    144,417,453
    
    
    
    Mortgage servicing rights
    
    $
    1,903,604
    
    
    
    
    
    
    
    
    
    
    $
    1,903,604
 Mortgage
Loans Held for Sale
  Loans Held for Investment
   Fair Value
    
    Level 1
    
    Level 2
    
    Level 3Impaired loans
    
    $
    1,628,964
    
    
    
    
    
    
    
    
    
    
    $
    1,628,964
 
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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;
    
    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
 
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
    
    other risks and uncertainties detailed from time to time in our filings with the
Securities and Exchange Commission.
  Overview
       
 17




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Changes in Financial Position
       
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Liquidity, Interest Rate Sensitivity and Market Risk
     
 19




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Results of Operations
   Net Interest Income
   
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Average Balance Sheets and Net Interest Income Analysis(Dollars in Thousands)March 31, 2008
    
    
    March 31, 2007(Unaudited)
    
    Average
    
    
    
    
    
    
    Yield/
    
    
    Average
    
    
    
    
    
    
    Yield/Three Months Ended:
    
    Balance
    
    
    Interest
    
    
    Rate
    
    
    Balance
    
    
    Interest
    
    
    RateINTEREST EARNING ASSETSFederal funds sold
    
    $
    1,365
    
    
    $
    11
    
    
    
    3.23
    %
    
    $
    2,352
    
    
    $
    40
    
    
    
    6.90
    %Interest bearing deposits
    
    
    2,303
    
    
    
    5
    
    
    
    0.87
    %
    
    
    1,889
    
    
    
    13
    
    
    
    2.79
    %Investment securities (1)
    
    
    142,310
    
    
    
    1,836
    
    
    
    5.17
    %
    
    
    129,935
    
    
    
    1,640
    
    
    
    5.12
    %Total loans (1,2)
    
    
    931,869
    
    
    
    16,254
    
    
    
    7.00
    %
    
    
    839,988
    
    
    
    16,445
    
    
    
    7.94
    %Total average earning assets (1)
    
    
    1,077,847
    
    
    
    18,106
    
    
    
    6.74
    %
    
    
    974,164
    
    
    
    18,138
    
    
    
    7.55
    %Noninterest earning assets
    
    
    113,911
    
    
    
    
    
    
    
    
    
    
    
    112,099Total average assets
    
    $
    1,191,758
    
    
    
    
    
    
    
    
    
    
    $
    1,086,263INTEREST BEARING LIABILITIESNOW and money market
    
    $
    198,273
    
    
    $
    995
    
    
    
    2.01
    %
    
    $
    187,540
    
    
    $
    1,019
    
    
    
    2.20
    %Savings
    
    
    35,563
    
    
    
    61
    
    
    
    0.69
    %
    
    
    36,745
    
    
    
    90
    
    
    
    0.99
    %Time certificates
    
    
    560,585
    
    
    
    6,425
    
    
    
    4.60
    %
    
    
    522,512
    
    
    
    6,102
    
    
    
    4.74
    %Total interest bearing deposits
    
    
    794,421
    
    
    
    7,481
    
    
    
    3.78
    %
    
    
    746,797
    
    
    
    7,211
    
    
    
    3.92
    %Repurchase agreements sold
    
    
    47,651
    
    
    
    365
    
    
    
    3.07
    %
    
    
    36,095
    
    
    
    298
    
    
    
    3.35
    %Borrowed funds
    
    
    59,683
    
    
    
    700
    
    
    
    4.70
    %
    
    
    21,543
    
    
    
    250
    
    
    
    4.71
    %Total interest bearing liabilities
    
    
    901,755
    
    
    
    8,546
    
    
    
    3.80
    %
    
    
    804,435
    
    
    
    7,759
    
    
    
    3.91
    %Noninterest bearing deposits
    
    
    144,838
    
    
    
    
    
    
    
    
    
    
    
    147,045Stockholders equity
    
    
    136,637
    
    
    
    
    
    
    
    
    
    
    
    126,588Other liabilities
    
    
    8,528
    
    
    
    
    
    
    
    
    
    
    
    8,195Total average liabilities and
stockholders equity
    
    $
    1,191,758
    
    
    
    
    
    
    
    
    
    
    $
    1,086,263NET INTEREST INCOME/
YIELD (3,4)
    
    
    
    
    
    $
    9,560
    
    
    
    3.56
    %
    
    
    
    
    
    $
    10,379
    
    
    
    4.32
    %INTEREST SPREAD (5)
    
    
    
    
    
    
    
    
    
    
    2.94
    %
    
    
    
    
    
    
    
    
    
    
    3.64
    %
 
 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
   
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##### Table of Contents



Balance,
beginning of year
    
    $
    12,445Charge offs
    
    
    (239
    )Recoveries
    
    
    254Provision
for loan loss
    
    
    450Acquisition
of Cardinal
    
    
    1,658Allowance
for Loan Loss, end of quarter
    
    $
    14,568
  March 31,
    
    December 31,2008
    
    2007Impaired loans
without a related allowance for loan loss
    
    $
    4,317,654
    
    
    $
    1,610,836Impaired loans
with a related allowance for loan loss
    
    
    3,308,063
    
    
    
    6,191,025Total impaired
loans
    
    
    7,625,717
    
    
    
    7,801,861
  Noninterest Income
  
 
 
 
 
 
 
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##### Table of Contents



Noninterest Expense
  
    
    Salaries and employee benefit expenses slightly increased by $29,375 or 0.6%.
Accruals for the bonus incentive plan were reduced due to sufficient amounts accrued in
previous quarters. Salaries expense increased by 5.5% due to normal annual increases and
branch growth.
    
    Occupancy and equipment expense decreased by $38,459 or 3.8%. The decrease was
attributable to lower occupancy expenses for Sidus and to lower depreciation expenses as
equipment and computer items were fully depreciated in the third quarter of 2007.
    
    Printing and supplies increased by $41,472 or 28.8%. Supplies for the quarter for the
new offices opened after first quarter of 2007 created additional expense along with the
normal increase in the price of supplies.
    
    Data processing expense increased $11,493 or 11.4% due mainly to rising costs related
to internet banking products.
    
    Amortization of the core deposit intangible, recognized with the purchases of Main
Street BankShares, Inc. in 2002 and High Country Financial Corporation in 2004, decreased
$9,961 or 5.0% in accordance with the scheduled amortization expense.
    
    Other operating expenses increased $385,190 or 22.4%. The largest increases were in
the following categories: accounting fees (up 179.0%) due to additional services
provided regarding loan and credit review; other outside services (up 27.0%) due to
additional year loan review; taxes and licenses up (105.8%) due to accrual of franchise
tax for holding company in addition to franchise tax for bank; advertising (up 131.6%)
for special promotions and projects; ATM service fees (up 123.6%) as a larger number of
debit cards are issued along with increased usage.
 Income Tax Expense
  
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
   
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Item 4. Controls and Procedures
   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
 
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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.
    
    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.
    
    Executive management held a planning meeting to evaluate all policies and procedures
related to lending approval, loan documentation and servicing, develop recommendations and
execute changes.
  Changes in Internal Control over Financial Reporting
  
 Part II. Other Information
  
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Item 6. Exhibits
 Exhibit #
    
    Description10.1
    
    
    Cardinal State Bank 2000 Incentive Stock Option Plan (incorporated by reference to
Exhibit 4.5 to
the Registration Statement on Form S-8 filed April 11, 2008)10.2
    
    
    Cardinal State Bank 2000 Nonstatutory Stock Option Plan (incorporated by reference to
Exhibit 4.6
to the Registration Statement on Form S-8 filed April 11, 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 OfficerBY:
    
    /s/ Edwin E. LawsEdwin E. Laws, Chief Financial OfficerMay 20, 2008
 
 28