Exhibit 13


The
Savannah Bancorp, Inc. and Subsidiaries
 Financial
Statement Section
 Index


PageNumberIndex
      to Financial Statement Section
              F -
      1Report
      of Independent Registered Public Accounting Firm
              F -
      2Report
      of Independent Registered Public Accounting Firm
              F -
      3Consolidated
      Balance SheetsDecember
      31, 2008 and 2007
              F
      - 4Consolidated
      Statements of Income for the YearsEnded
      December 31, 2008, 2007 and 2006
              F
      - 5Consolidated
      Statements of Changes in Shareholders'Equity
      for the Years Ended December 31, 2008, 2007 and 2006
              F
      - 6Consolidated
      Statements of Cash Flows for the YearsEnded December
      31, 2008, 2007 and 2006
              F
      - 7Notes to
      Consolidated Financial Statements
              F
      - 8Management's
      Discussion and Analysis of FinancialCondition
      and Results of Operations
              F -
      29Selected
      Five-Year Financial Data -- 2004-2008Selected
      Financial Condition Highlights
              F -
      29Selected
      Operating Highlights
              F
      - 30Selected
      Quarterly Data
              F
      - 31Market
      for Registrant's Common Equity andRelated
      Shareholder Matters
              F
      - 31Stock
      Performance Graph
              F
      - 32Introduction
              F
      - 33Critical
      Accounting Estimates
              F
      - 34Results
      of Operations2008
      Compared with 2007
              F
      - 372007
      Compared with 2006
              F
      - 38Financial
      Condition and Capital Resources
              F -
      39Loan
      Concentrations
              F -
      39Liquidity
      and Interest Rate Sensitivity Management
              F
      - 40Off-Balance
      Sheet Arrangements
              F
      - 41Forward
      Looking Statements
              F
      - 42Cash
      Flow/Maturity Gap and Repricing Data
              F
      - 43Average
      Balance Sheet and Rate/Volume Analysis -- 2008 and
    2007
              F
      - 44Average
      Balance Sheet and Rate/Volume Analysis -- 2007 and
    2006
              F
      - 45


F - 1
 The
Savannah Bancorp, Inc. - 2008 Annual Report




Report
of Independent Registered Public Accounting Firm











To the
Board of Directors and Shareholders


of The
Savannah Bancorp, Inc.:





We have
audited the accompanying consolidated balance sheets of The Savannah Bancorp,
Inc. and its subsidiaries as of December 31, 2008 and 2007 and the related
consolidated statements of income, changes in shareholders’ equity and cash
flows for the years then ended.  These consolidated financial
statements are the responsibility of The Savannah Bancorp, Inc.’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audits to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  Our
audits of the financial statements included examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation.  We believe
that our audits provide a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of The Savannah
Bancorp, Inc. and its subsidiaries as of December 31, 2008 and 2007 and the
results of its operations and its cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.





We have also audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United
States), the effectiveness of The Savannah Bancorp, Inc. and its subsidiaries’
internal control over financial reporting as of December 31, 2008, based on
criteria established in Internal Control - Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission and our report
dated March 13, 2009, expressed an unqualified opinion.











/s/
Mauldin & Jenkins, LLC





Albany,
Georgia


March 13,
2009







F
- 2
 The
Savannah Bancorp, Inc. - 2008 Annual Report




Report
of Independent Registered Public Accounting Firm











To the
Board of Directors and Shareholders


of The
Savannah Bancorp, Inc.:





We have
audited the accompanying consolidated statements of income, changes in
shareholders’ equity and cash flows of The Savannah Bancorp, Inc. and its
subsidiaries for the year ended December 31, 2006.  These consolidated
financial statements are the responsibility of The Savannah Bancorp, Inc.’s
management.  Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.





We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation.  We believe that our audit
provides a reasonable basis for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the results of operations and cash flows of The
Savannah Bancorp, Inc. and its subsidiaries for the year ended December 31, 2006
in conformity with accounting principles generally accepted in the United States
of America.











/s/ BDO
Seidman, LLP





Atlanta,
Georgia


March 8,
2007




F
- 3
 The
Savannah Bancorp, Inc. - 2008 Annual Report





The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Balance Sheets


($ in
thousands, except share data)








December
      31,2008
                      
                      2007AssetsCash
      and due from banks
                      $ 
      15,088
                      
                      $   12,721Federal
      funds sold
                      9,701
                      
                      4,435Interest-bearing
      deposits in banks
                      3,312
                      
                      20,148Cash
      and cash equivalents
                      28,101
                      
                      37,304Securities
      available for sale, at fair value (amortizedcost
      of $79,447 and $60,241)
                      81,619
                      
                      61,057Loans
      held for sale
                      291
                      
                      180Loans,
      net of allowance for loan losses of $13,300
                        and
      $12,864
                      851,674
                      
                      795,787Premises
      and equipment, net
                      11,107
                      
                      6,830Other
      real estate owned
                      8,100
                      
                      2,112Bank-owned
      life insurance
                      6,216
                      
                      5,985Goodwill
      and other intangible assets, net
                      2,642
                      
                      2,806Other
      assets
                      17,534
                      
                      20,398Total
      assets
                      $
      1,007,284
                      
                      $
      932,459LiabilitiesDeposits:Noninterest-bearing
                      $   82,723
                      
                      $   88,503Interest-bearing
      demand
                      128,965
                      
                      127,902Savings
                      14,370
                      
                      16,168Money
      market
                      199,194
                      
                      176,615Time
      deposits
                      406,763
                      
                      355,030Total
      deposits
                      832,015
                      
                      764,218Short-term
      borrowings
                      67,787
                      
                      70,599Federal
      Home Loan Bank advances – long-term
                      10,169
                      
                      2,973Subordinated
      debt to nonconsolidated subsidiaries
                      10,310
                      
                      10,310Other
      liabilities
                      6,071
                      
                      8,087Total
      liabilities
                      926,352
                      
                      856,187Commitments
      and contingencies (Notes 15 and 18)Shareholders'
      equityPreferred
      stock, par value $1 per share:authorized
      10,000,000 shares, none issued
                      -
                      
                      -Common
      stock, par value $1 per share:  authorized20,000,000
      shares; issued 5,933,789 and 5,923,797 shares
                      5,934
                      
                      5,924Additional
      paid-in capital
                      38,516
                      
                      38,279Retained
      earnings
                      33,552
                      
                      30,512Treasury
      stock, 318 shares
                      (4)
                      
                      (4)Accumulated
      other comprehensive income, net
                      2,934
                      
                      1,561Total
      shareholders' equity
                      80,932
                      
                      76,272Total
      liabilities and shareholders' equity
                      $
      1,007,284
                      
                      $
      932,459





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







F
- 4
 The
Savannah Bancorp, Inc. - 2008 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Statements of Income


($ in
thousands, except per share data)





For
      the Years Ended December
      31,2008
                              
                              2007
                              
                              2006Interest
      and dividend incomeLoans,
      including fees
                              $
      53,259
                              
                              $
      59,435
                              
                              $
      51,541Loans
      held for sale
                              60
                              
                              98
                              
                              558Investment
      securities:Taxable
                              2,803
                              
                              2,594
                              
                              1,912Tax-exempt
                              87
                              
                              95
                              
                              123Dividends
                              191
                              
                              218
                              
                              205Federal
      funds sold
                              133
                              
                              472
                              
                              557Deposits
      with banks
                              149
                              
                              346
                              
                              293Total
      interest and dividend income
                              56,682
                              
                              63,258
                              
                              55,189Interest
      expenseDeposits
                              21,842
                              
                              26,415
                              
                              19,342Short-term
      borrowings
                              1,661
                              
                              2,612
                              
                              1,802Federal
      Home Loan Bank advances
                              294
                              
                              413
                              
                              778Subordinated
      debt
                              642
                              
                              842
                              
                              815Total
      interest expense
                              24,439
                              
                              30,282
                              
                              22,737Net
      interest income
                              32,243
                              
                              32,976
                              
                              32,452Provision
      for loan losses
                              6,000
                              
                              4,675
                              
                              1,585Net
      interest income after provision for loan losses
                              26,243
                              
                              28,301
                              
                              30,867Noninterest
      incomeTrust
      and asset management fees
                              2,832
                              
                              1,513
                              
                              658Service
      charges on deposit accounts
                              1,881
                              
                              1,383
                              
                              1,526Mortgage
      related income, net
                              295
                              
                              615
                              
                              886Other
      operating income
                              1,216
                              
                              1,242
                              
                              1,233Gain
      on hedges
                              1,288
                              
                              -
                              
                              -Gain
      on sale of securities
                              163
                              
                              -
                              
                              -Total
      noninterest income
                              7,675
                              
                              4,753
                              
                              4,303Noninterest
      expenseSalaries
      and employee benefits
                              13,584
                              
                              11,846
                              
                              10,852Occupancy
      and equipment
                              3,884
                              
                              3,294
                              
                              2,920Information
      technology
                              1,633
                              
                              1,616
                              
                              1,525Amortization
      of client list
                              144
                              
                              48Loss
      on sale of other real estate owned
                              142
                              
                              44
                              
                              -Other
      operating expense
                              5,355
                              
                              4,335
                              
                              4,656Total
      noninterest expense
                              24,742
                              
                              21,183
                              
                              19,953Income
      before income taxes
                              9,176
                              
                              11,871
                              
                              15,217Income
      tax expense
                              3,170
                              
                              4,235
                              
                              5,215Net
      income
                              $   6,006
                              
                              $   7,636
                              
                              $
      10,002Net
      income per share:Basic
                              $
      1.01
                              
                              $
      1.31
                              
                              $
      1.73Diluted
                              $
      1.01
                              
                              $
      1.29
                              
                              $
      1.70Dividends
      per share
                              $
      0.50
                              
                              $
      0.48
                              
                              $
      0.45Average
      basic shares (000s)
                              5,930
                              
                              5,850
                              
                              5,765Average
      diluted shares (000s)
                              5,947
                              
                              5,922
                              
                              5,876


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







F
- 5
 The
Savannah Bancorp, Inc. - 2008 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Statements of Changes in Shareholders' Equity


($ inthousands, except share
data)





For
      the Years Ended December
      31,2008
                            2007
                            2006Common
      shares issuedShares,
      beginning of year
                            5,923,797
                            5,781,381
                            4,591,339Common
      stock issued
                            6,211
                            78,006
                            -Stock
      split / dividend
                            -
                            -
                            1,155,564Exercise
      of options
                            3,781
                            64,410
                            34,478Shares,
      end of year
                            5,933,789
                            5,923,797
                            5,781,381Treasury
      shares ownedShares,
      beginning of year
                            318
                            318
                            267Stock
      split / dividend or issuance
                            -
                            -
                            63Stock
      options exercised
                            -
                            -
                            (12)Shares,
      end of year
                            318
                            318
                            318Common
      stockBalance,
      beginning of year
                            $   5,924
                            $   5,781
                            $   4,591Common
      stock issued
                            6
                            78
                            -Stock
      split / dividend
                            -
                            -
                            1,156Stock
      options exercised
                            4
                            65
                            34Balance,
      end of year
                            5,934
                            5,924
                            5,781Additional
      paid-in capitalBalance,
      beginning of year
                            38,279
                            35,747
                            36,257Common
      stock issued, net of issuance costs
                            68
                            1,702
                            -Stock
      split / dividend
                            -
                            -
                            (1,156)Stock-based
      compensation expense, net
                            137
                            147
                            191Stock
      options exercised
                            32
                            683
                            272Tax benefit
      of option exercises and expense
                            -
                            -
                            183Balance,
      end of year
                            38,516
                            38,279
                            35,747Retained
      earningsBalance,
      beginning of year
                            30,512
                            25,681
                            18,272Net
      income
                            6,006
                            7,636
                            10,002Dividends
      paid
                            (2,966)
                            (2,805)
                            (2,593)Balance,
      end of year
                            33,552
                            30,512
                            25,681Treasury
      stockBalance,
      beginning of year
                            (4)
                            (4)
                            (4)Stock
      options exercised
                            -
                            -
                            -Balance,
      end of year
                            (4)
                            (4)
                            (4)Accumulated
      other comprehensive income (loss), netBalance,
      beginning of year
                            1,561
                            (631)
                            (573)Change
      in unrealized gains/losses on securitiesavailable
      for sale, net of tax
                            842
                            662
                            178Change
      in fair value of derivative instruments, net of tax
                            531
                            1,530
                            (236)Balance,
      end of year
                            2,934
                            1,561
                            (631)Total
      shareholders' equity
                            $
      80,932
                            $
      76,272
                            $
      66,574




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




See Note
1 for other comprehensive income disclosures.







F
- 6
 The
Savannah Bancorp, Inc. - 2008 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows





For
      the Years Ended December 31,($
      in thousands)
                          2008
                          2007
                          2006Operating
      activitiesNet
      income
                          $   6,006
                          $   7,636
                          $
      10,002Adjustments
      to reconcile net income to cashprovided
      by operating activities:Provision
      for loan losses
                          6,000
                          4,675
                          1,585Loans
      originated for sale
                          (10,255)
                          (24,834)
                          (34,195)Proceeds
      from sale of loans originated for sale
                          10,202
                          25,715
                          44,067Net
      (accretion) amortization of securities
                          (95)
                          (122)
                          29Depreciation
      and amortization
                          1,383
                          1,118
                          976Accretion
      of gain on termination of derivatives
                          (2,670)
                          -
                          -Proceeds
      from termination of derivatives
                          3,225
                          -
                          -Non
      cash stock-based compensation expense
                          221
                          184
                          299Decrease
      (increase) in deferred income taxes, net
                          621
                          (677)
                          (728)Gain
      on sale of loans and securities, net
                          (221)
                          (147)
                          (313)Loss
      on sale of foreclosed assets
                          142
                          44
                          -Write-down
      of other real estate owned
                          86
                          -
                          -Equity
      in net income of nonconsolidated subsidiary
                          (94)
                          (89)
                          (109)Increase
      in CSV of bank-owned life insurance policies
                          (231)
                          (225)
                          (209)Change
      in other assets and other liabilities, net
                          1,209
                          3,232
                          (5,281)Net
      cash provided by operating activities
                          15,529
                          16,510
                          16,123Investing
      activitiesActivity
      in available for sale securitiesPurchases
                          (44,616)
                          (29,356)
                          (20,380)Sales
                          5,248
                          -
                          -Maturities
      and calls
                          20,420
                          23,400
                          11,161Loan
      originations and principal collections, net
                          (71,955)
                          (90,451)
                          (110,040)Proceeds
      from sale of other real estate owned
                          3,852
                          342
                          1,800Investment
      in low income housing tax credits
                          -
                          (2,000)
                          -Distribution
      from nonconsolidated subsidiary
                          350
                          -
                          1,300Purchase
      of consolidated subsidiary
                          -
                          (1,901)
                          -Additions
      to premises and equipment
                          (5,516)
                          (1,450)
                          (2,376)Net
      cash used in investing activities
                          (92,217)
                          (101,416)
                          (118,535)Financing
      activitiesNet
      (decrease) increase in noninterest-bearing deposits
                          (5,780)
                          (12,653)
                          8,074Net
      increase in interest-bearing deposits
                          73,577
                          70,047
                          98,240Net
      (decrease) increase in short-term borrowings
                            to
      repurchase and federal funds purchased
                          (2,812)
                          29,912
                          20,785Net
      increase (decrease) in FHLB advances – long-term
                          7,196
                          (10,336)
                          (7,167)Payment
      on note payable
                          (1,840)
                          -
                          (479)Dividends
      paid
                          (2,966)
                          (2,805)
                          (2,593)Exercise
      of options and issuance of common stock
                          110
                          748
                          381Net
      cash provided by financing activities
                          67,485
                          74,913
                          117,241(Decrease)
      increase in cash and cash equivalents
                          (9,203)
                          (9,993)
                          14,829Cash
      and cash equivalents, beginning of year
                          37,304
                          47,297
                          32,468Cash
      and cash equivalents, end of year
                          $
      28,101
                          $
      37,304
                          $
      47,297





Supplemental
      disclosures of cash flow informationCash
      paid during the year for:Interest
      on deposits and other borrowings
                  $
      25,920
                  $
      29,865
                  $
      22,115Income
      taxes
                  2,595
                  5,560
                  6,038Non
      cash investing activity:Transfer
      to other real estate owned from loans
                  (10,068)
                  (1,953)
                  (2,735)Increase
      in unrealized gains/losses on investmentsecurities
      available for sale, net of tax
                  842
                  662
                  178Increase
      (decrease) in unrealized gains/losses onderivatives,
      net of tax
                  531
                  1,530
                  (236)


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







F -
7
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
1 - Organization and Summary of Significant Accounting Policies





Principles of
Consolidation- The consolidated
financial statements include the accounts of The Savannah Bancorp, Inc. (“the
Company”) and its wholly-owned subsidiaries, The Savannah Bank, N.A.
(“Savannah”), Bryan Bank & Trust (“Bryan”), Harbourside Community Bank
(“Harbourside”) and Minis & Co., Inc. (“Minis”), a registered investment
advisory firm acquired on August 31, 2007.  The Company formed a new
subsidiary, SAVB Holdings, LLC (“SAVB Holdings”), in the third quarter 2008 for
the purpose of holding problems loans and other real estate.  The
three bank subsidiaries, together, are referred to as the “Subsidiary
Banks”.  All significant intercompany balances and transactions have
been eliminated in consolidation.  Certain prior year balances have
been reclassified to conform to the current year presentation.





Nature of
Operations - The Company is a holding company that owns three banks
and a registered investment advisory firm.  Through the subsidiaries,
the Company offers a full range of lending, deposit, residential mortgage
origination, fiduciary, trust and investment advisory products.  The
primary service area of the Company is the city of Savannah, Georgia,
surrounding Chatham County, Richmond Hill, Georgia (20 miles south of downtown
Savannah), Bryan County, Hilton Head Island, South Carolina and southern
Beaufort County.  In 2005, the Company formed a nonconsolidated
subsidiary, SAVB Properties, LLC, which purchased a 50 percent interest in two
real estate partnerships that own the Company’s headquarters building and the
adjacent parking lot.  This investment is accounted for using the
equity method of accounting.  Minis was acquired on August 31, 2007
and additional information regarding the acquisition is included in Note
2.  In the third quarter of 2008, the Company hired lenders in the
Brunswick / St. Simons Island, Georgia market and opened a loan production
office.





Use of
Estimates- In
preparing consolidated financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
date of the balance sheet and reported amounts of revenues and expenses during
the reporting period.  Actual results could differ from those estimates.
 Material estimates that are particularly susceptible to significant change
in the near term relate to the determination of the allowance for loan losses
and the evaluation of the realization of deferred tax assets.





Cash and Cash
Equivalents - For purposes of the consolidated statements of cash flows,
cash and cash equivalents include cash and balances due from banks, federal
funds sold and interest-bearing deposits in banks, all of which mature within
ninety days.





Securities
Available for Sale- Management has
classified the entire investment securities portfolio as available for
sale.  Securities available for sale are carried at estimated fair
value with unrealized gains and losses, net of deferred income taxes, recorded
as a separate component of shareholders' equity.  Purchase premiums
and discounts are recognized in interest income using the interest method over
the life of the securities.  Gains and losses on the sale of
securities are recorded on the trade date and are determined using the specific
identification method.





Securities
available for sale are reviewed quarterly for possible other than temporary
impairment. The review includes an analysis of the facts and circumstances
of each individual investment such as the severity of loss, the length of time
the fair value has been below cost, the expectation for that security’s
performance, the creditworthiness of the issuer and management’s intent and
ability to hold the security to recovery.





Loans Held For
Sale - Loans originated and intended for sale in the secondary market are
carried at the lower of cost or estimated fair value in the
aggregate.  Net unrealized losses, if any, are recognized through a
valuation allowance by charges to income.  In estimating fair value,
consideration is given to commitments from investors and prevailing market
prices.  Loan origination fees applicable to mortgage loans held for
sale, net of certain direct origination costs, are deferred and recognized as an
adjustment to the related gain or loss on subsequent sale of the
loan.  In 2008, the Company discontinued the origination of mortgage
loans on a correspondent basis and is now exclusively brokering mortgage
loans.







F -
8
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
1 - Organization and Summary of Significant Accounting Policies
(continued)





Loans and Loan
Fees - The Subsidiary Banks underwrite mortgage, commercial and consumer
loans to customers.  A substantial portion of the loan portfolio
consists of real estate secured loans throughout the coastal Georgia and South
Carolina areas.  Loans that management has the intent and ability to
hold for the foreseeable future or until maturity or pay-off are generally
reported at their outstanding unpaid principal balances adjusted for
charge-offs, the allowance for loan losses, and any deferred fees or origination
costs.  Interest income is accrued on the unpaid principal
balance.  Loan origination fees, net of certain direct origination
costs, are deferred and recognized as an adjustment of the related loan yield on
a straight-line basis, which approximates the interest method.





The
accrual of interest on mortgage and commercial loans is discontinued at the time
the loan is 90 days past due unless the credit is well-secured and in process of
collection.  Revolving credit loans and other personal loans are
typically charged-off when payments are 120 days past due.  Past due
status is based on the contractual terms of the loan.  Loans are
placed on nonaccrual status or charged-off at an earlier date if collection of
principal or interest in full becomes doubtful.





All
interest accrued in the current year but not collected for loans that are placed
on nonaccrual status or charged-off is reversed against interest income.
 The interest on these loans is accounted for on the cash-basis or
cost-recovery method until qualifying for return to accrual.  Loans
are returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably
assured.





Allowance for
LoanLosses- The
allowance for loan losses is based on estimates and maintained at a level
considered adequate to provide for potential losses inherent in the portfolio
based on the current environment.  The adequacy of the allowance is
based on management's continuing evaluation of the loan portfolio considering
current economic conditions, underlying collateral value securing loans and
other relevant qualitative and quantitative factors that deserve recognition in
estimating loan losses.  Actual future losses may be different from
estimates due to unforeseen events.  Loans that are determined to be
uncollectible are charged-off against the allowance.





The
adequacy of the allowance for loan losses is evaluated on a regular basis by
management and reported quarterly to the Audit Committee of the Board of
Directors (“Board”).  The evaluation is based upon management’s
periodic review of the collectability of specific loans, adverse situations that
may affect specific borrowers’ ability to repay, the estimated value of any
underlying collateral, the composition and size of the loan portfolio and
prevailing economic conditions.  This evaluation is inherently subjective
as it requires estimates that are susceptible to significant revision as more
information becomes available.





The
allowance consists of specific and general reserve components.  The
specific component relates to loans that are deemed to be impaired.  For
such loans that are classified as impaired, an allowance is established when the
discounted cash flows (or value of related collateral or observable market
price) of the impaired loan is lower than the carrying value of that loan.
 The general component covers doubtful or substandard loans not considered
impaired and non-classified loans.  The general reserve components are
based on historical loss experience adjusted for qualitative
factors.





A loan is
considered impaired when, based on current information and events, it is
probable that the Company will be unable to collect the scheduled payments of
principal or interest when due according to the contractual terms of the loan
agreement.  Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due.  Loans that
experience insignificant payment delays and payment shortfalls generally are not
classified as impaired.  Management determines the significance of
payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower’s
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed.  Impairment is measured on a loan by loan
basis by either the present value of expected future cash flows discounted at
the loan’s effective interest rate, the loan’s obtainable market price, or the
fair value of the collateral if the loan is collateral
dependent.  Management charges down the loan or establishes a
valuation allowance when management determines the value is less than the
carrying amount.










F -
9
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
1 - Organization and Summary of Significant Accounting Policies
(continued)





Premises and
Equipment - Buildings, furniture, banking equipment and leasehold
improvements are stated at cost less accumulated depreciation and
amortization.  Depreciation and amortization of these assets are
computed using the straight-line method over the estimated useful lives or
estimated lease terms including expected lease renewals, ranging from three to
fifty years, of the respective assets for financial reporting purposes and
accelerated methods for income tax purposes.  Additions and major
improvements are capitalized, while routine maintenance and repairs and gain or
loss on dispositions are recognized currently.





Other Real Estate
Owned - Assets acquired through loan foreclosure are held for sale and
are initially recorded at fair value less estimated disposal costs at the date
of foreclosure, establishing a new cost basis.  Subsequent to
foreclosure, valuations are periodically performed by management and the assets
are carried at the lower of carrying amount or fair value less estimated
disposal costs.  Valuation allowances are established when subsequent
valuations are less than current carrying amounts.  Expenses from
operations and changes in the valuation allowance and net expenses from holding
these assets are included in noninterest expense.





Bank-Owned Life
Insurance- Bank-owned life insurance policies are recorded at the net
realizable value of the underlying insurance contracts.  The change in
contract value during the year represents the contract earnings during the
period less the mortality costs and administrative costs of the underlying life
insurance contracts.  The increase in cash surrender value from
bank-owned life insurance contracts is included as a component of other
operating income and the mortality costs and administrative fees are recorded as
noninterest expense.





Intangible
Assets-Intangible assets include goodwill and other identifiable assets, such as
customer lists, resulting from our acquisition of Minis.  Customer
list intangibles are amortized on a straight-line basis over an estimated useful
life of ten years and evaluated for impairment whenever events or changes in
circumstances indicate the carrying amount of the assets may not be
recoverable.  Goodwill is not amortized but tested annually for
impairment or at any time an event occurs or circumstances change that may
trigger a decline in the value of the reporting unit.  Examples of
such events or circumstances include adverse change in operations, legal
factors, business climate, unanticipated competition, change in regulatory
environment, or loss of key personnel.





The
intangible assets were tested for impairment in accordance with Statement of
Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible
Assets” as of August 31, 2008.  There was no impairment
noted.





Income
Taxes - Deferred income tax assets and liabilities are determined using
the liability (or balance sheet) method.  Deferred tax assets and
liabilities arise from temporary differences between the carrying amounts of
assets and liabilities for financial reporting and income tax
purposes.  They are reflected at currently enacted income tax rates
applicable to the period in which the deferred tax assets or liabilities are
expected to be realized or settled.  As changes in tax laws or rates
are enacted, deferred tax assets and liabilities are adjusted through income tax
expense.





Earnings Per
Share - Basic earnings per share represent net income divided by the
weighted average number of common shares outstanding during the
period.  Diluted earnings per share reflect additional common shares
that would have been outstanding if dilutive potential common shares had been
issued, as well as any adjustment to income that would result from the assumed
issuance.  Potential common shares that may be issued by the Company
relate solely to outstanding stock options, and are determined using the
treasury stock method.  Earnings per common share have been computed
based on the following:





(amounts
      in thousands)Years
      Ended December 31,
                  2008
                  2007
                  2006Average
      number of common shares outstanding - basic
                  5,930
                  5,850
                  5,765Effect
      of dilutive options
                  17
                  72
                  111Average
      number of common shares outstanding - diluted
                  5,947
                  5,922
                  5,876





Stock
option shares in the amount of 192,022, 102,602 and 10,716 for the years
ended 2008, 2007 and 2006, respectively, were excluded from the diluted earnings
per share calculation due to their anti-dilutive effect.







F -
10
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
1 - Organization and Summary of Significant Accounting Policies
(continued)





Derivative
Instruments and Hedging Activities - SFAS No. 133, “Accounting for
Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended and
interpreted, establishes accounting and reporting standards for derivatives and
hedging activities.  As required by SFAS 133, the Company records all
derivatives at fair value on the balance sheet as either other assets or other
liabilities.  The Company uses derivative instruments including
interest rate collars as part of its overall asset and liability duration and
interest rate risk management strategy.  These instruments enable the
Company to manage desired asset and liability duration and to reduce exposure to
interest rate movements.





Other
Comprehensive Income (Loss) - Comprehensive income (loss) is the change
in the Company’s equity during the period from transactions and other events and
circumstances from non-owner sources.





($
      in thousands)
                  2008
                  2007
                  2006Net
      income
                  $
      6,006
                  $
      7,636
                  $
      10,002Change
      in unrealized gains/losses onsecurities
      available for sale, net of tax
                  842
                  662
                  178Change
      in fair value of derivativeinstruments,
      net of tax
                  531
                  1,530
                  (236)Other
      comprehensive income
                  $
      7,379
                  $
      9,828
                  $   9,944





Accounting for
Stock-Based Compensation-On January 1, 2006, the Company adopted the revised SFAS
No. 123, “Share-Based Payment,” (“SFAS 123R”) using the modified
prospective method.  In accordance with SFAS 123R, the Company
measures the cost of employee services received in exchange for an award of
equity instruments based on the fair value of the award on the grant
date.  That cost is recognized over the period during which an
employee is required to provide service in exchange for the award – the
requisite service period.  No compensation cost is recognized for
equity instruments for which employees do not render the requisite
service.  The Company determines the fair value of employee stock
options using the Black-Scholes option pricing model.





The 1995
Incentive Stock Option Plan (“1995 Plan”) authorized the Company to issue both
incentive and non-qualified stock options to certain key officers for the
purchase of shares at the fair market value of the stock at the date of
grant.  In 2000, the shareholders authorized additional option shares
under the 1995 Plan.  All authorized shares have been awarded from the
1995 Plan.





In 2005,
shareholders approved the 2005 Omnibus Stock Ownership and Long-Term Incentive
Plan (“2005 Omnibus Plan”) and authorized 250,000 option or restricted shares to
be available for issuance.  The total number of remaining options or
awards available for issuance at December 31, 2008 under the 2005 Omnibus Plan
was 148,271 shares of common stock.  Options granted under both plans
have a term of ten years and generally become fully vested over periods ranging
from three to ten years.  Performance based options granted to
directors vest over three quarters from the date of grant.





The
following table summarizes compensation costs related to the Company’s
stock-based compensation plans for the years ended December 31:





($
      in thousands)
                      2008
                      2007
                      2006Salaries
      and employee benefits
                      $
      189
                      $
      143
                      $
      200Directors'
      stock-based compensation
                      32
                      41
                      99Pre-tax
      stock-based compensation expense
                      221
                      184
                      299Income
      tax benefit
                      (84)
                      (37)
                      (108)Total
      stock-based compensation expense, net of tax
                      $
      137
                      $
      147
                      $
      191





During
2008 no income tax benefits were realized on stock option
exercises.  In 2007 and 2006, the Company realized $15,000 and
$48,000, respectively, in income tax benefit associated with certain stock
option exercises.







F -
11
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements




Note
1 - Organization and Summary of Significant Accounting Policies
(continued)




The
Company recognizes stock-based compensation expense using the graded vesting
attribution method.  The remaining unrecognized compensation cost
related to unvested incentive stock option and restricted share awards at
December 31, 2008 is approximately $125,000.  The weighted-average
period of time over which this cost will be recognized is approximately 2.9
years.  This amount does not include the cost of any additional
options that may be granted in future periods nor any reduction in cost for
potential forfeitures.





The
Company implemented an improved Black-Scholes methodology for calculating
stock-based compensation in 2006.  The fair value of each option grant
is estimated on the date of grant using the Black-Scholes option pricing model
with the following assumptions.





2008
                  2007
                  2006Weighted
      average fair value of options granted
                  $
      4.29
                  $
      7.71
                  $
      8.89Expected
      volatility
                  31.4%
                  28.6%
                  27.7%Dividend
      yield
                  2.87%
                  1.90%
                  1.53%Risk-free
      interest rate
                  2.48%
                  4.92%
                  4.90%Expected
      life
                  6.0
      years
                  6.0
      years
                  6.0
      years





Risks and
Uncertainties-In the normal course of its business, we encounter two significant types
of risk: economic and regulatory.  There are three main components of
economic risk: interest rate risk, credit risk and market risk. We are subject
to interest rate risk to the degree that our interest-bearing liabilities mature
or reprice at different speeds, or on different indexes, than our
interest-earning assets.  Credit risk is the risk of default on our
loan portfolio that results from borrowers’ inability or unwillingness to make
contractually required payments.  Market risk reflects changes in the
value of collateral underlying loans receivable, the valuation of real estate we
hold, and the valuation of loans held for sale, investments and mortgage-backed
securities available for sale and mortgage servicing rights.





We are
subject to the regulations of various government agencies.  These
regulations can and do change significantly from period to period.  We
also undergo periodic examinations by the regulatory agencies, which may subject
us to further changes with respect to asset valuations, amounts of required loss
allowances and operating restrictions resulting from the regulators’ judgments
on information available to them at the time of their examination.





Recent
Accounting Pronouncements





In
September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS
157”).  SFAS 157 defines fair value, establishes a framework for
measuring fair value under generally accepted accounting principles, and expands
disclosures about fair value measurements.  This statement applies
under other accounting pronouncements that require or permit fair value
measurements; accordingly, this statement does not require any new fair value
measurements.  SFAS 157 is effective for fiscal years beginning after
November 15, 2007.  The Company adopted SFAS 157 as of January 1,
2008, and the adoption had no material effect on its financial assets and
liabilities, including its derivative financial instruments.





On
February 15, 2007, the FASB issued SFAS No. 159, “The Fair Value
Opinion for Financial Assets and Financial Liabilities” (“SFAS 159”) which
permits companies to report selected financial assets and liabilities at fair
value.  Subsequent unrealized gains and losses on those items will be
reported in earnings.  SFAS 159 also requires entities to display the
fair value of those assets and liabilities for which the entity has chosen to
use fair value on the face of the balance sheet.  SFAS 159 does not
eliminate disclosure requirements included in other accounting
standards.  SFAS 159 is effective for fiscal years beginning after
November 15, 2007.  As the Company did not elect to apply FAS 159
to any of its existing eligible items as of January 1, 2008, the adoption of
SFAS 159 did not have an impact on the Company’s financial
statements.







F -
12
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
1 - Organization and Summary of Significant Accounting Policies
(continued)





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interest in
Consolidated Financial Statements” (“SFAS 160”).  SFAS 160’s objective
is to improve the relevance, comparability, and transparency of the financial
information that a reporting entity provides in its consolidated financial
statements by establishing accounting and reporting standards for the
noncontrolling interest in a subsidiary and for deconsolidation of a subsidiary.
SFAS 160 shall be effective for fiscal years and interim periods within those
fiscal years, beginning on or after December 15, 2008.  We do not
expect the implementation of SFAS 160 to have a material impact on our
consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 141(R), “Business Combinations – a
replacement of FASB No. 141” (“SFAS 141R”).  SFAS 141R replaces SFAS
No. 141, “Business Combinations” (“SFAS 141”), and applies to all transactions
and other events in which one entity obtains control over one or more other
businesses.  SFAS 141R requires an acquirer, upon initially obtaining
control of another entity, to recognize the assets, liabilities and any
non-controlling interest in the acquiree at fair value as of the acquisition
date.  Contingent consideration is required to be recognized and
measured at fair value on the date of acquisition rather than at a later date
when the amount of that consideration may be determinable beyond a reasonable
doubt.  This fair value approach replaces the cost allocation process
required under SFAS 141 whereby the cost of an acquisition was allocated to the
individual assets acquired and liabilities assumed based on their estimated fair
value.  SFAS 141R requires acquirers to expense acquisition-related
costs as incurred rather than allocating such costs to the assets acquired and
liabilities assumed, as was previously the case under SFAS 141.  Under
SFAS 141R, the requirements of SFAS No. 146, “Accounting for Costs Associated
with Exit or Disposal Activities,” would have to be met in order to accrue for a
restructuring plan in purchase accounting.  Pre-acquisition
contingencies are to be recognized at fair value, unless it is a non-contractual
contingency that is not likely to materialize, in which case, nothing should be
recognized in purchase accounting and, instead, that contingency would be
subject to the probable and estimable recognition criteria of SFAS No. 5,
“Accounting for Contingencies.”  SFAS 141R is expected to have a
significant impact on the Company’s accounting for business combinations closing
on or after January 1, 2009.





On
October 10, 2008, the FASB issued Staff Position (“FSP”) No. 157-3
“Determining the Fair Value of a Financial Asset When the Market for That Asset
is Not Active” (“FSP 157-3”).  FSP 157-3 clarifies the application of
SFAS 157 in a market that is not active and provides an example to illustrate
key considerations in determining the fair value of a financial asset when the
market for that financial asset is not active.  FSP 157-3 was
effective immediately upon issuance, and includes prior periods for which
financial statements have not been issued.  We applied the guidance
contained in FSP 157-3 in determining fair values at December 31, 2008, although
it did not have a material impact on our financial condition, results of
operations, or liquidity.








Note
2 - Acquisitions





The
Company acquired all of the net assets of Minis as of August 31,
2007.  The net assets of Minis were incorporated into a new,
wholly-owned subsidiary of the Company which will continue to operate under the
name of Minis & Co., Inc.  The acquisition was accounted for using
the purchase method of accounting, and accordingly, the results of Minis’
operations have been included in the consolidated financial statements beginning
September 1, 2007.  Minis is a registered investment advisor based in
Savannah, Georgia, offering a full line of investment management
services.  Minis’ assets under management at September 1, 2007
were approximately $500 million.





The
aggregate purchase price was $3.80 million, consisting of 71,000 shares of
the Company’s common stock valued at $1.78 million, $1.853 million in cash,
net of $118,000 in cash received at closing, and approximately $48,000 in direct
acquisition costs, primarily consisting of external legal and accounting
fees.  The value of the common shares issued was determined based on
the average market price of the Company’s common stock on the day before and the
day on which the terms of the acquisition were publicly announced.







F -
13
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
2 - Acquisitions (continued)





The terms
of the asset purchase agreement provide for contingent earn-out consideration to
the former Minis shareholders.  Such consideration will be based on
actual revenue earned from existing clients at August 31, 2007 as compared to a
target level of revenues through June 30, 2010.  Based on the
assumptions at the time the asset purchase agreement was executed, the Company
expected that the aggregate contingent consideration, including interest, would
be approximately $2.2 million payable as near as practicable to the June
30, 2010 determination date.  However, if Minis does not generate
revenue at the agreed upon level a lower contingent consideration will be paid
to the former Minis shareholders.





The
purchase price allocation relating to the Minis acquisition was as
follows:





($
      in thousands)
                    September
      1, 2007Assets
      acquiredCash
                    $    118Accounts
      receivable
                    53Premises
      and equipment
                    85Prepaid
      expense
                    4Deferred
      income tax benefits
                    876Intangible
      assets
                    1,400Goodwill,
      net of tax benefits
                    1,435Total
      assets acquired
                    3,971Liabilities
      assumedUnearned
      revenue
                    171Total
      liabilities assumed
                    171Net
      assets acquired
                    $
      3,800





Of the
$2.835 million of acquired intangible assets, $1.435 million was allocated to
goodwill and $1.4 million to identifiable intangible assets (customer
contracts).  The customer contracts have an estimated weighted-average
useful life of 10 years.  The goodwill and the customer contracts
intangible assets will be deductible for tax purposes over a 15-year period.
 Any additional earn-out consideration to be paid will be accounted for as
additional purchase price under the terms of the agreement and will be added to
goodwill when determined to be payable.





Russell
W. Carpenter, a shareholder of Minis who owned 40 percent of its shares, has
served as a director of the Company since 1989 and expects to continue in such
role until April 2011.








Note
3 - Restrictions on Cash and Demand Balances Due from Banks and Interest-Bearing
Bank Balances





The
Subsidiary Banks are required by the Federal Reserve Bank (“FRB”) to maintain
minimum cash reserves based upon reserve requirements calculated on their
deposit balances.  Cash reserves of $507,000 and $469,000 were
required as of December 31, 2008 and 2007, respectively.  The Company
has pledged interest-bearing cash balances at the Federal Home Loan Bank of
Atlanta (“FHLB”) in addition to investment securities to secure public fund
deposits and securities sold under repurchase agreements.  Pledged
cash balances were $2,000,000 and $18,500,000 at December 31, 2008 and 2007,
respectively.







F -
14
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
4 - Securities Available for Sale





The
aggregate amortized cost and fair value of securities available for sale as of
December 31, 2008 and 2007 were as follows:





2008($
      in thousands)
                                        Amortized
                                        Unrealized
                                        Unrealized
                                        FairCost
                                        Gains
                                        Losses
                                        ValueInvestment
      securities:U.
      S. government-sponsored agencies
                                        $
      17,417
                                        $    828
                                        $    -
                                        $
      18,245Mortgage-backed
      securities
                                        55,597
                                        1,220
                                        (4)
                                        56,813State
      and municipal
                                        2,719
                                        128
                                        -
                                        2,847Restricted
      equity securities
                                        3,714
                                        -
                                        -
                                        3,714Total
      investment securities
                                        $
      79,447
                                        $
      2,176
                                        $
      (4)
                                        $
      81,6192007($
      in thousands)
                                        Amortized
                                        Unrealized
                                        Unrealized
                                        FairCost
                                        Gains
                                        Losses
                                        ValueInvestment
      securities:U.
      S. government-sponsored agencies
                                        $
      28,227
                                        $
      700
                                        $     (4)
                                        $
      28,923Mortgage-backed
      securities
                                        24,624
                                        156
                                        (122)
                                        24,658State
      and municipal
                                        2,926
                                        86
                                        -
                                        3,012Restricted
      equity securities
                                        4,464
                                        -
                                        -
                                        4,464Total
      investment securities
                                        $
      60,241
                                        $
      942
                                        $
      (126)
                                        $
      61,057





The
distribution of securities by contractual maturity at December 31, 2008 is shown
below.  Maturities may differ from contractual maturities in
mortgage-backed securities because the mortgages underlying the securities may
be called or repaid without any penalties.  Mortgage-backed securities
are shown separately from the other debt securities in the following maturity
summary.





($
      in thousands)
                      Amortized
                        Cost
                      Fair
      ValueSecurities
      available for sale:Due
      in one year or less
                      $   5,411
                      $   5,496Due
      after one year through five years
                      6,921
                      7,198Due
      after five years through ten years
                      7,804
                      8,398Mortgage-backed
      securities
                      55,597
                      56,813Restricted
      equity securities
                      3,714
                      3,714Total
      investment securities
                      $
      79,447
                      $
      81,619





At
December 31, 2008 and 2007, investment securities with a carrying value of
$58,205,000 and $48,621,000, respectively, were pledged as collateral to secure
public funds, securities sold under repurchase agreements and FHLB
borrowings.













F -
15
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
5 - Loans





The
composition of the loan portfolio at December 31, 2008 and 2007 is presented
below:





($
      in thousands)
                      
                      Percent
                      
                      Percent2008
                      of
      Total
                      2007
                      of
      TotalCommercial
                      $   81,396
                      9.5%
                      $   71,370
                      8.8%Real
      estate - construction and development
                      99,809
                      11.5
                      134,110
                      16.6Real
      estate - mortgage
                      666,075
                      77.0
                      584,477
                      72.3Installment
      and other consumer
                      17,694
                      2.0
                      18,694
                      2.3Gross
      loans
                      864,974
                      100.0%
                      808,651
                      100.0%Allowance
      for loan losses
                      (13,300)
                      
                      (12,864)Net
      loans
                      $
      851,674
                      
                      $
      795,787





Changes
in the allowance for loan losses are summarized as follows:





($
      in thousands)
                  2008
                  2007
                  2006Balance,
      beginning of year
                  $   12,864
                  $   8,954
                  $
      7,813Provision
      for loan losses
                  6,000
                  4,675
                  1,585Charge-offs
                  (5,714)
                  (874)
                  (506)Recoveries
                  150
                  109
                  62Balance,
      end of year
                  $
      13,300
                  $
      12,864
                  $
      8,954





The
following is a summary of information pertaining to impaired loans as of and for
the years ended December 31, 2008 and 2007:





($
      in thousands)
                  2008
                  2007Impaired
      loans without a valuation allowance
                  $
      19,289
                  $      193Impaired
      loans with a valuation allowance
                  18,441
                  14,470Total
      impaired loans
                  $
      37,730
                  $
      14,663Valuation
      allowance related to impaired loans
                  $   2,796
                  $   2,241Average
      investment in impaired loans
                  $
      26,197
                  $   7,744Interest
      income recognized on impaired loans
                  $      659
                  $      731





At
December 31, 2008 and 2007, loans on nonaccrual status amounted to approximately
$26,277,000 and $14,663,000, respectively, and loans past due 90 days or more
and still accruing interest were $1,326,000 and $2,761,000,
respectively.





The
Company has granted loans to certain directors and executive officers of the
Company and to their related interests.  The aggregate amounts of
loans were $31,325,000 and $32,253,000 at December 31, 2008 and 2007,
respectively.  During 2008, new loans of $18,192,000 were made and
repayments of $20,186,000 were received.  Also, related party loan
totals increased by an additional $1,066,000 during 2008 due to changes in
related party status.  Unfunded commitments of credit available to
related parties aggregated $4,295,000 and $3,385,000 at December 31, 2008 and
2007, respectively.  Related party loans are made on substantially the
same terms, including interest rates and collateral, as those prevailing at the
time for comparable transactions with unrelated persons and do not involve more
than normal risk of collection.







F -
16
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
6 - Premises and Equipment





Premises
and equipment at December 31, 2008 and 2007 are summarized as
follows:





($
      in thousands)
                  Depreciable
      Lives
                  2008
                  2007Land
                  -
                  $  2,635
                  $     698Buildings
      and improvements
                  5 -
      50
                  5,361
                  2,980Furniture
      and banking equipment
                  3 -
      15
                  7,420
                  7,404Leasehold
      improvements
                  5 -
      32
                  2,277
                  2,286Total
      cost
                  
                  17,693
                  13,368Less
      accumulated depreciation andamortization
                  
                  6,586
                  6,538Premises
      and equipment, net
                  
                  $
      11,107
                  $  6,830





Depreciation
expense was $1,239,000, $1,070,000, and $976,000 for the years ended December
31, 2008, 2007 and 2006, respectively.  In 2008, buildings and
improvements includes approximately $2.7 million for a new Bryan banking office
and Company operations center.  In 2007, approximately $332,000 was
included in construction in progress.








Note
7 - Other Real Estate Owned





Other
real estate owned at December 31, 2008 and 2007 is summarized as
follows:





($
      in thousands)
                  2008
                  2007Balance,
      beginning of year
                  $  2,112
                  $    545Additions
                  10,068
                  1,953Disposals
                  (3,994)
                  (386)Additional
      write-downs
                  (86)
                  -Balance,
      end of year
                  $  8,100
                  $
      2,112








Note
8 - Deposits





Total
time deposits mature as follows: 2009 - $335,772,000; 2010 - $58,525,000; 2011 -
$4,948,000; 2012 - $3,946,000 and 2013 - $3,454,000 and thereafter -
$118,000.  Brokered time deposits mature as follows: 2009 -
$121,398,000; 2010 - $1,316,000; 2011 - $361,000; and 2012 -
$75,000.  Additionally, $98,597,000 of non-maturity institutional
money market accounts are considered brokered deposits because the deposits are
from customers of brokerage firms up to a maximum of $250,000 per
depositor.  A fee is paid for these deposits in addition to the
interest.





The
following table indicates the amount of the Company's time deposits of $100,000
or more at December 31, 2008 by time remaining until maturity.





Maturity
      Period ($ in thousands)
                    TotalThree
      months or less
                    $   68,698Over
      three through six months
                    41,019Over
      six through twelve months
                    59,161Over
      twelve months
                    35,772Total
                    $
      204,650










F -
17
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
9 - Short-Term Borrowings





Short-term
borrowings at December 31, 2008 and 2007 consist of federal funds purchased,
securities sold under agreements to repurchase, FHLB and FRB short-term advances
and notes payable:





($
      in thousands)
              Federal
      Funds Purchased
              Securities
                Sold
      Under Repurchase Agreements
              FHLB
                and
      FRB
                Short-Term
      Advances
              Notes
                Payable2008Balance
      at December 31
              $
      2,066
              $
      20,520
              $
      33,050
              $
      12,151Maximum
      indebtedness at any month end
              2,066
              27,137
              71,000
              12,500Daily
      average indebtedness outstanding
              1,322
              22,656
              40,852
              3,149Average
      rate paid for the year
              2.23%
              1.76%
              2.61%
              6.30%Average
      rate paid on period-end borrowings
              0.69%
              0.50%
              1.11%
              6.00%2007Balance
      at December 31
              $
      1,857
              $
      18,742
              $
      50,000
              $         -Maximum
      indebtedness at any month end
              2,347
              25,402
              50,000
              -Daily
      average indebtedness outstanding
              1,565
              20,434
              30,797
              -Average
      rate paid for the year
              5.18%
              4.58%
              5.17%
              -Average
      rate paid on period-end borrowings
              4.05%
              3.75%
              4.44%
              N/A





As of
December 31, 2008 and 2007, the Company had short-term borrowings totaling
$67,787,000 and $70,599,000, respectively.  The average interest rates
were 2.49 percent and 4.95 percent during the years ended 2008 and 2007,
respectively.  The interest rates on short-term borrowings ranged from
0.50 percent to 6.00 percent at December 31, 2008 and from 3.75 percent to 4.44
percent at December 31, 2007.The maximum amount
outstanding at the end of any month was $94,266,000 and $70,599,000 during 2008
and 2007, respectively.  The note payable is due to a related party
(director) and the proceeds were used to fund SAVB
Holdings.  Principal payments are due monthly based on repayments,
sales or other activity in the assets held by SAVB Holdings.  Interest
is due monthly.  The note requires a cumulative remaining principal
pay down of $2.1 million by September 30, 2009, with all indebtedness due and
payable by September 30, 2010.  The agreement includes customary
performance covenants and a guarantee of the Company.  One of the
covenants is that the Company’s dividends paid shall not exceed 50 percent
of the Company's after tax net income on an annualized basis.  At
December 31, 2008, the Company did not meet certain covenants contained in the
loan agreement; however the Company obtained a waiver.  At December
31, 2008 federal funds borrowingarrangements aggregating
$­40,300,000 were available to the Subsidiary Banks from correspondent
banking institutions.  There are no commitment fees and no
requirements for compensating balances.  These unused lines
principally serve as temporary liquidity back-up lines and are subject to
availability of funds and other specific limitations of the correspondent
banks.





Savannah
is a member and shareholder of the FRB of Atlanta and has access to borrowings
at the FRB discount window.  Bryan and Harbourside have also been
approved to access the FRB discount window.  During 2008, Savannah and
Bryan were approved by the FRB under the borrower-in custody of collateral
(“BIC”) arrangement.  This temporary liquidity arrangement allows
collateral to be maintained at Savannah and Bryan rather than being delivered to
the FRB or a third-party custodian.  The eligible collateral includes
consumer loans, commercial loans, commercial real estate loans, agricultural
loans and certain participated loans with other financial
institutions.  The BIC arrangement is subject to independent audit
review, inspections and periodic reporting under the FRB
guidelines.  At December 31, 2008, Savannah had a $10,000,000
borrowing outstanding with the FRB.







F -
18
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
10 - Federal Home Loan Bank Advances – Long-Term





Convertible Advances - The
Company had convertible fixed rate advances of $10,000,000 and $1,000,000 at
December 31, 2008 and 2007, respectively.  The weighted-average
interest rates on convertible advances were 2.26 percent and 6.39 percent at
December 31, 2008 and 2007, respectively.  The $10,000,000 advances
mature in 2018.  The advances are convertible each quarter beginning
in 2010 at the option of the FHLB to an advance with an interest rate equal to
the current three-month LIBOR.





Long-term Advances -
Long-term advances from the FHLB totaled $169,000 and $1,973,000 at December 31,
2008 and 2007, respectively.  The weighted-average interest rates on
the long-term advances were 0.50 and 4.76 percent at December 31, 2008 and 2007,
respectively.  Aggregate maturities are $169,000 in 2014 and
thereafter.  Interest is generally payable monthly and scheduled
principal reductions are made quarterly, semi-annually or at
maturity.  The long-term advances include prepayment penalties for
each advance.





FHLB Advance Borrowing Capacity
- The Subsidiary Banks are shareholders of the FHLB and have access to
secured borrowings from the FHLB under Blanket Floating Lien
Agreements.  Under these agreements, the Subsidiary Banks have credit
lines up to 75 percent of the FHLB qualifying collateral value of their 1-4
family first mortgage loans and up to 50 percent of the FHLB qualifying
collateral value of their home equity lines of credit, second mortgage
residential loans and certain commercial real estate loans.  The
Subsidiary Banks’ individual borrowing limits range from 10 to 25 percent of
assets.  In aggregate, the Subsidiary Banks had secured borrowing
capacity of approximately $141.2 million of which $33.2 million was advanced at
December 31, 2008.  These credit arrangements serve as a core funding
source as well as liquidity backup for the Subsidiary
Banks.  Additional advances are subject to review and approval by the
FHLB.








Note
11 - Subordinated Debt to Nonconsolidated Subsidiaries





During
the third quarters 2003 and 2004, the Company formed SAVB Capital Trust I and
SAVB Capital Trust II (the “Trusts”), nonconsolidated subsidiaries whose sole
purpose was to issue $6,000,000 and $4,000,000, respectively, in Trust Preferred
Securities through investment pools sponsored by two national brokerage
firms.  The Trust Preferred Securities have maturities of 30 years and
are redeemable at the Company’s option on any quarterly interest payment date
after five years.  There are certain events (as defined in the Trust
agreements) in which the securities may be redeemed within the first five years
at the Company’s option.  At December 31, 2008, the interest rates on
the securities were 7.67 and 4.20 percent, respectively, with quarterly resets
at the three-month LIBOR plus 2.85 and 2.20 percent,
respectively.  The Company’s liabilities to the nonconsolidated Trusts
are recorded as liabilities of $6.186 million and $4.124 million and investments
of $186,000 and $124,000, respectively, in the consolidated balance
sheet.  Subject to certain limitations, the securities qualify as Tier
1 capital for regulatory capital purposes under FRB regulations.








Note
12 - Income Taxes





Income
tax expense is composed of the following for each of the years ended December
31:





($
      in thousands)
                  2008
                  2007
                  2006Current
      federal
                  $
      2,757
                  $
      5,355
                  $
      5,537Current
      state
                  310
                  418
                  411Total
      current
                  3,067
                  5,773
                  5,948Deferred
      federal
                  88
                  (1,364)
                  (629)Deferred
      state
                  15
                  (174)
                  (104)Total
      deferred
                  103
                  (1,538)
                  (733)Income
      tax expense
                  $
      3,170
                  $
      4,235
                  $
      5,215





F -
19
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements




Note
12 - Income Taxes (continued)





Investments
in federal and state low-income housing tax credit partnerships reduced federal
and state income tax expense approximately $145,000, $265,000 and $227,000 in
2008, 2007 and 2006, respectively.





A
reconciliation between income tax expense and the amounts computed by applying
the U.S. federal tax rate of 34 percent to income before income taxes is as
follows:





($
      in thousands)
                  2008
                  2007
                  2006Tax
      provision at 34%
                  $
      3,120
                  $
      4,036
                  $
      5,173State
      tax, net of federal tax benefit
                  196
                  212
                  199Benefit
      of tax-exempt income, net
                  (127)
                  (121)
                  (129)Other
                  (19)
                  108
                  (28)Income
      tax expense
                  $
      3,170
                  $
      4,235
                  $
      5,215





Deferred
income tax assets and liabilities are comprised of the following at December 31,
2008 and 2007:





($
      in thousands)
                  2008
                  2007Deferred
      tax assets:Allowance
      for loan losses
                  $
      4,947
                  $
      4,748Tax-deductible
      goodwill
                  800
                  856Unamortized
      loan fees
                  193
                  269Unamortized
      non-compete costs
                  28
                  34Deferred
      compensation expense
                  397
                  311Stock-compensation
      expense
                  76
                  31Other
                  184
                  378Total
      deferred tax assets
                  6,625
                  6,627Deferred
      tax liabilities:Depreciation
                  460
                  408Deferred
      costs on loans and deposits
                  187
                  93Unrealized
      gains on securities
                  821
                  285Unrealized
      gains on derivatives
                  970
                  644Other
                  120
                  165Total
      deferred tax liabilities
                  2,558
                  1,595Net
      deferred tax assets
                  $
      4,067
                  $
      5,032





The net
deferred tax assets are included in the consolidated balance sheets in other
assets.  The Company files a consolidated Federal tax return and a
consolidated Georgia return for the Georgia-based parent and
subsidiaries.








Note
13 - Stock Option and Employee Benefit Plans





As
discussed in Note 1, the Company has two stock option plans.  All
authorized shares have been awarded from the 1995 Plan.  There are
148,271 authorized option shares remaining under the 2005 Omnibus Plan at
December 31, 2008.  The options granted in the chart below generally
vest 20 percent each year over five years and are exercisable over ten years
except for 32,579 option shares granted to directors in 2008, 2007 and 2006
which vest within one year and 18,310 restricted share awards which vest from
three to ten years.  Some of the executive officer option shares also
include minimum performance triggers as a condition of vesting.










F -
20
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
13 - Stock Option and Employee Benefit Plans (continued)





Changes
in stock options outstanding for the three years ended December 31, 2008, 2007
and 2006 are as follows.





2008
                      2007
                      2006Shares
                      Weighted
                        Average
                        Exercise
                        Price
                      Shares
                      Weighted
                        Average
                        Exercise
                        Price
                      Shares
                      Weighted
                        Average
                        Exercise
                        PriceOutstanding
      at beginningof
      year
                      210,484
                      $
      17.76
                      271,230
                      $
      15.58
                      304,046
                      $
      14.49Granted
                      9,850
                      17.44
                      24,733
                      25.39
                      10,716
                      28.56Exercised
                      (3,781)
                      10.23
                      (64,410)
                      11.63
                      (35,976)
                      10.28Forfeited
                      (24,531)
                      14.72
                      (21,069)
                      5.52
                      (7,556)
                      15.99Outstanding
      at end of year
                      192,022
                      $18.28
                      210,484
                      $
      17.76
                      271,230
                      $
      15.58Exercisable
      at end of year
                      150,307
                      $17.30
                      148,013
                      $
      16.30
                      182,254
                      $
      14.12





At
December 31, 2008, there was no aggregate intrinsic value for the outstanding or
exercisable stock options.





Options
outstanding at December 31, 2008 were as follows:





Outstanding
                    ExercisableOutstanding
      Common Options
                    Remaining
      Contractual
                      Number
                    Weighted
                      Average
                      Life
                    Weighted
                      Average
                      Price
                    Number
                    Weighted
                      Average
                      PriceRange
      of exercise prices$9.98
      - $12.00
                    20,797
                    1.75
                    $
      10.10
                    20,797
                    $
      10.10$12.01
      - $15.00
                    26,121
                    3.07
                    12.96
                    26,121
                    12.96$15.01
      - $20.00
                    76,250
                    5.61
                    16.83
                    61,285
                    16.60$20.01
      - $25.00
                    33,405
                    6.14
                    22.32
                    22,655
                    22.38$25.00
      - $28.56
                    35,449
                    8.16
                    26.31
                    19,449
                    27.13Total
      outstanding
                    192,022
                    5.41
                    $
      18.28
                    150,307
                    $
      17.30





Restricted Stock - In 2007
and 2006, the Board granted 18,310 shares of restricted stock under the 2005
Omnibus Plan which awards certain officers common shares of the
Company.  The cost of these shares is being amortized against earnings
using the vesting schedule over the three and ten year vesting
periods.  In 2008, 1,500 shares did not vest or were
forfeited.  Unrecognized compensation cost for restricted stock awards
was $112,000 at December 31, 2008.





The
Company sponsors a 401(k) employee savings and profit sharing plan in which
substantially all full-time employees are eligible to
participate.  The plan allows eligible employees to save a portion of
their salary on a pre-tax basis.  Contributions by the Company to the
plan are discretionary.  Contributions and administrative expenses
related to the plan aggregated $339,000, $354,000 and $356,000 for the years
ended December 31, 2008, 2007 and 2006, respectively.








Note
14 - Capital Ratios and Dividend Restrictions





The
Subsidiary Banks’ primary regulators have adopted capital requirements that
specify the minimum capital level for which no prompt corrective action is
required.  In addition, the Federal Deposit Insurance Corporation
(“FDIC”) has adopted FDIC insurance assessment rates based on certain
“well-capitalized” risk-based and equity capital ratios.  Failure to
meet minimum capital requirements can result in the initiation of certain
actions by the regulators that, if undertaken, could have a material effect on
the Company’s and the Subsidiary Banks’ financial statements.




F -
21
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements




Note
14 - Capital Ratios and Dividend Restrictions (continued)





Management
believes that the Company and the Subsidiary Banks meet all capital adequacy
requirements to which they are subject as of December 31, 2008.  The
following tables show the capital ratios for the Company and the Subsidiary
Banks at December 31, 2008 and 2007:





($
      in thousands)
                          Company
                          
                          Savannah
                          
                          Bryan
                          
                          Harbourside2008
                          
                          2007
                          
                          2008
                          
                          2007
                          
                          2008
                          
                          2007
                          
                          2008
                          
                          2007QualifyingCapitalTier
      1 capital
                          $85,356
                          
                          $81,049
                          
                          $54,665
                          
                          $50,433
                          
                          $20,553
                          
                          $18,045
                          
                          $6,128
                          
                          $8,681Total
      capital
                          95,767
                          
                          90,748
                          
                          61,434
                          
                          56,864
                          
                          23,176
                          
                          20,328
                          
                          6,942
                          
                          9,612Leverage RatiosTier
      1 capital to average assets
                          8.63%
                          
                          8.93%
                          
                          8.39%
                          
                          8.29%
                          
                          8.62%
                          
                          8.62%
                          
                          7.49%
                          
                          10.11%Risk-based RatiosTier
      1 capital to risk-weighted assets
                          10.28%
                          
                          10.49%
                          
                          10.13%
                          
                          9.84%
                          
                          9.80%
                          
                          9.88%
                          
                          9.57%
                          
                          11.86%Total
      capital to risk-weighted assets
                          11.54%
                          
                          11.74%
                          
                          11.38%
                          
                          11.09%
                          
                          11.05%
                          
                          11.13%
                          
                          10.84%
                          
                          13.13%





Well-Required
      Regulatory Capital Ratios:
                  
                  
                  Minimum
                  
                  CapitalizedTier
      1 capital to average assets
                  
                  
                  4.00%
                  
                  5.00%Tier
      1 capital to risk-weighted assets
                  
                  
                  4.00%
                  
                  6.00%Total
      capital to risk-weighted assets
                  
                  
                  8.00%
                  
                  10.00%





As of
December 31, 2008, the Subsidiary Banks were categorized as well-capitalized
under the regulatory framework for prompt corrective action in the most
recent notification from the FDIC.  There are no conditions or events
since the notification that management believes have changed the institutions’
categories.  Harbourside must maintain a minimum 8.00 percent tangible
equity to asset ratio through March 2009 under the terms of its de novo charter
which became effective in March 2006.  The tangible equity to capital
ratio was 7.88 percent at December 31, 2008.  Harbourside has
communicated the actual percentage to its regulators and has taken steps to
bring the percentage into compliance with the requirement.





Banking
regulations restrict the amount of cash dividends that banks may pay without
obtaining regulatory approval.  At December 31, 2008, approximately
$13.4 million in retained earnings of the Subsidiary Banks was available for the
payment of dividends, subject to maintaining adequate capital ratios in the
Subsidiary Banks.  The Company is not subject to any regulatory
restrictions on the payment of dividends to its shareholders.








Note
15 - Leases and Commitments





Future
minimum payments under non-cancelable land and office space operating leases
with remaining terms in excess of one year are presented as follows: 2009
- $1,038,000; 2010 - $875,000; 2011 - $856,000; 2012 - $792,000; 2013 -
$686,000; 2014 and thereafter is $7,498,000.  The land and office
space leases contain customary escalation clauses.  The Company or the
Subsidiary Banks are responsible for taxes, insurance and maintenance during the
lease term under certain leases.  During 2007, the Company
renegotiated its long-term data processing contract.  Future minimum
payments are as follows: 2009 - $1,187,000; 2010 - $1,222,000; 2011 -
$1,259,000; and 2012 - $216,000.  The contract contains customary
escalation and buyout clauses.





The net
rental expense for all office space operating leases amounted to $1,452,000 in
2008, $1,169,000 in 2007 and $1,006,000 in 2006.  The leases on the
office space have five to twenty-year renewal options and
require increased rental payments under consumer price index escalation
clauses.




F -
22
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements




Note
16 - Other Operating Expense





The
components of other operating expense for the years ended December 31, 2008,
2007 and 2006 were as follows:





($
      in thousands)
                  2008
                  2007
                  2006Regulatory
      assessments and audit fees
                  $  1,189
                  $   876
                  $   832Professional
      and directors fees
                  957
                  854
                  959Loan
      costs
                  691
                  209
                  185Advertising
      and sales promotion
                  425
                  433
                  463Stationery
      and supplies
                  332
                  300
                  301Postage
      and courier
                  321
                  277
                  265Taxes
      and licenses
                  237
                  203
                  204Telephone
                  209
                  203
                  173Dues
      and subscriptions
                  135
                  116
                  110Correspondent
      bank charges
                  101
                  123
                  155Insurance
                  65
                  77
                  90Pre-opening
      expenses
                  -
                  -
                  263Other
      expense
                  837
                  712
                  656Total
      other operating expense
                  $
      5,499
                  $
      4,383
                  $
      4,656








Note
17 - On-Balance Sheet Derivative Instruments and Hedging Activities





SFAS 133,
as amended and interpreted, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, and for hedging activities.  As required by SFAS 133,
the Company records all derivatives on the balance sheet at fair value. 
The accounting for changes in the fair value of derivatives depends on the
intended use of the derivative and the resulting
designation.  Derivatives used to hedge the exposure to variability in
expected future cash flows, or other types of forecasted transactions, are
considered cash flow hedges.  To qualify for hedge accounting, the
Company must comply with the detailed rules and strict documentation
requirements at the inception of the hedge, and hedge ineffectiveness is
assessed at inception and periodically throughout the life of each hedging
relationship.





The
Company’s objective in using derivatives is to add stability to interest income
and to manage its exposure to changes in interest rates.  To accomplish
this objective, the Company primarily uses interest rate floors, collars or
swaps.  The interest rate derivatives hedge the variable cash flows
associated with existing variable-rate loan assets that are based on the prime
rate.  For accounting purposes, the derivatives are designated as cash
flow hedges of the overall changes in cash flows on the first prime rate-based
interest payments received by the Company each calendar month during the term of
the hedge that, in aggregate for each period, are interest payments on principal
from specified portfolios equal to the notional amount of the
derivatives.





Prepayments
in hedged loan portfolios are treated in a manner consistent with the guidance
in Statement 133 Implementation Issue No. G25, “Cash Flow Hedges: Using the
First-Payments-Received Technique in Hedging the Variable Interest Payments on a
Group of Non-Benchmark-Rate-Based Loans,” which allows the designated forecasted
transactions to be the variable, prime rate-based interest payments on a
rolling portfolio of prepayable interest-bearing loans using the
first-payments-received technique, thereby allowing interest payments from loans
that prepay to be replaced with interest payments from new loan
originations.





For
quarterly assessments of effectiveness and the measurement of hedge
ineffectiveness for options, the Company uses the “Hypothetical Derivative
Method” described in Statement 133 Implementation Issue No. G20, “Cash Flow
Hedges: Assessing and Measuring the Effectiveness of a Purchased Option Used in
a Cash Flow Hedge.”  For swaps, the company uses the “Change in
Variable Cash Flow Method” described in Statement 133 Implementation Issue
No. G7, “Measuring the Ineffectiveness of a Cash Flow Hedge under Paragraph
30(b) When the Shortcut Method Is Not Applied,” when performing quarterly
assessments of effectiveness and the measurement of
ineffectiveness.










F -
23
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
17 - On-Balance Sheet Derivative Instruments and Hedging Activities
(continued)





The
effective portion of changes in the fair value of the derivative is initially
reported in other comprehensive income (outside of earnings) and subsequently
reclassified to earnings when the hedged transactions affect
earnings.  Ineffectiveness resulting from the hedge is recorded as a
gain or loss in the consolidated statement of income as part of noninterest
income.  The Company also monitors the risk of counterparty default on
an ongoing basis.





Selected
information with respect to notional amounts, recorded fair values, and maturity
dates of derivative instruments is summarized as follows as of December
31.





2008
                2007
                2008
                
                2007Notional
                Notional
                Fair
      Value
                
                Fair
      Value($
      in thousands)
                Maturity
                Amount
                Amount
                Asset
                Liability
                
                Asset
                LiabilityCash
      flow hedges:Interest
      rate swap
                Nov
      2010
                $   50,000
                $   50,000
                $         -
                $    -
                
                $
      1,514
                $    -6%/9%
      Interest rate collar
                June
      2010
                25,000
                40,000
                922
                -
                
                284
                -6%
      Interest rate floor
                June
      2010
                35,000
                35,000
                -
                -
                
                264
                -Mark
      to market:6%/9%
      Interest rate collar
                June
      2010
                15,000
                -
                553
                -
                
                -
                -Total
                
                $
      125,000
                $
      125,000
                $
      1,475
                $    -
                
                $
      2,062
                $    -





For the
years ended December 31, 2008 and 2007, the net change in fair value of
derivative instruments designated as cash flow hedges reported in the
consolidated statements of changes in shareholders’ equity was $531,000 and
$1,530,000, respectively.





Amounts
reported in accumulated other comprehensive income related to derivatives will
be reclassified to interest income as interest payments are received on the
Company’s variable-rate assets.  The change in net unrealized gains
(losses) on cash flow hedges reflects a reclassification of $1,154,000 and
($299,000) of net unrealized gains (losses) from accumulated other comprehensive
income to interest income during 2008 and 2007,
respectively.  Additionally, $645,000 was reclassified out of other
comprehensive income into earnings due to missed forecasted transactions on
terminated or discontinued hedging relationships.  During 2009, the
Company estimates that $1,664,000 will be reclassified as an increase to
interest income.





In 2008,
the Company recognized gains of $328,000 for hedge ineffectiveness due to a
mismatch between the notional amount of designated derivatives and the aggregate
principal of the designated loan pools, which is reported in noninterest
income.  Hedge accounting was discontinued in 2008 for one derivative
because of a large reduction in a designated loan pool.  Gains of
$315,000 were recorded in noninterest income as that derivative was marked to
market through earnings.  That derivative was terminated in the first
quarter 2009.





In 2008,
the Company terminated $50 million of interest rate swap positions for net
proceeds of $2,369,000.  The Company also terminated $35 million of an
interest rate floor for net proceeds of $856,000.  The amounts in
other comprehensive income related to the terminated transactions will be
reclassified into earnings over the remaining lives of the original hedged
transactions.








Note
18 - Financial Instruments with Off-Balance Sheet Risk





The
Company is a party to financial instruments with off-balance sheet risk in the
normal course of business in order to meet the financing needs of its
customers.  These financial instruments include commitments to extend
credit and standby letters of credit.  These instruments involve, to
varying degrees, elements of credit and interest rate risk.










F -
24
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
18 - Financial Instruments with Off-Balance Sheet Risk (continued)





The
Company's exposure to loan losses in the event of nonperformance by the other
party to the financial instrument for commitments to extend credit and standby
letters of credit is represented by the contractual amounts of those
instruments.  The credit risk involved is essentially the same as
that involved in extending loan facilities to customers.  The Company
uses the same credit policies in making commitments and conditional obligations
as it does for on-balance sheet instruments.  The Company evaluates
each customer's credit worthiness on a case-by-case basis.  The amount
of collateral obtained by the Company upon extension of credit, if deemed
necessary, is based on management's credit evaluation of the
borrower.  Collateral may include cash, securities, accounts
receivable, inventory, equipment, and real estate.





Commitments
to extend credit are agreements to lend to a customer as long as there is no
violation of any condition established in the contract.  Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee.  At December 31, 2008 and 2007 unfunded
commitments to extend credit and unfunded lines of credit were $118,088,000 and
$136,480,000, of which some were subject to interest rate lock
commitments.  Since many of these commitments are expected to expire
without being drawn upon, these amounts do not necessarily represent future cash
requirements.





Letters
of credit are conditional commitments issued by the Company to guarantee payment
or performance by a customer to a third party.  At December 31, 2008
and 2007, commitments under letters of credit aggregated approximately
$7,733,000 and $7,916,000, respectively.








Note
19 - Fair Value of Financial Instruments





Fair
Value Measurements





SFAS 157
defines fair value as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most
advantageous market for the asset or liability in an orderly transaction between
market participants on the measurement date.  In October of 2008, the
FASB issued FSP 157-3 to clarify the application of SFAS 157 in a market that is
not active and to provide key considerations in determining the fair value of a
financial asset when the market for that financial asset is not
active.





SFAS 157
also establishes a fair value hierarchy which requires an entity to maximize the
use of observable inputs and minimize the use of unobservable inputs when
measuring fair value.  The statement describes three levels of inputs that
may be used to measure fair value:





Level 1:
Quoted prices (unadjusted) for identical assets or liabilities in active markets
that the entity has the ability to access as of the measurement
date.





Level 2:
Significant other observable inputs other than Level 1 prices, such as quoted
prices for similar assets or liabilities, quoted prices in markets that are not
active, and other inputs that are observable or can be corroborated by
observable market data.





Level 3:
Significant unobservable inputs that reflect a company’s own assumptions about
the assumptions that market participants would use in pricing an asset or
liability.





Recurring Fair Value
Changes





Following
is a description of the valuation methodologies used for instruments measured at
fair value on a recurring basis and recognized in the accompanying balance
sheet, as well as the general classification of such instruments pursuant to the
valuation hierarchy.





Investment securities: The
fair values of securities available for sale are determined by obtaining quoted
prices on nationally recognized securities exchanges or matrix pricing, which is
a mathematical technique used widely in the




F -
25
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements




Note
19 - Fair Value of Financial Instruments (continued)





industry
to value debt securities without relying exclusively on quoted prices for the
specific securities but rather by relying on the securities’ relationship to
other benchmark quoted securities.





Loans held for sale: The fair
value of loans held for sale is determined, when possible, using quoted
secondary-market prices.  If no such quoted price exists, the fair value of
a loan is determined using quoted prices for a similar asset or assets, adjusted
for the specific attributes of that loan.





Derivativeinstruments: Our derivative
instruments consist of interest rate collars.  As such, significant fair
value inputs can generally be verified and do not typically involve significant
judgments by management.





Assets
and liabilities measured at fair value under SFAS 157 on a recurring basis are
summarized below:





Fair
      Value Measurements at December 31, 2008 UsingQuoted
      Prices in
                Significant
      Other
                SignificantActive
      Markets for
                Observable
                UnobservableCarrying
                Identical
      Assets
                Inputs
                Inputs($
      in thousands)
                Value
                (Level
      1)
                (Level
      2)
                (Level
      3)Investment
      securities
                $
      81,619
                $        -
                $
      81,619
                $        -Loans
      held for sale
                291
                -
                291
                -Derivative
      asset positions
                1,475
                -
                1,475
                -





Nonrecurring Fair Value
Changes





Certain
assets and liabilities are measured at fair value on a nonrecurring
basis.  These instruments are not measured at fair value on an ongoing
basis, but subject to fair value in certain circumstances, such as when there is
evidence of impairment that may require write-downs.  The write-downs
for the Company’s more significant assets or liabilities measured on a
nonrecurring basis are based on the lower of amortized or estimated fair
value.





Impaired loans:
 Impaired loans are evaluated and valued at the time the loan is identified
as impaired, at the lower of cost or market value.  Market value is
measured based on the value of the collateral securing these loans and is
classified at a Level 3 in the fair value hierarchy.  Collateral may be
real estate and/or business assets, including equipment, inventory and/or
accounts receivable.  Its fair value is generally determined based on
real estate appraisals or other independent evaluations by qualified
professionals.  Impaired loans are reviewed and evaluated on at least
a quarterly basis for additional impairment and adjusted accordingly, based on
the same factors identified above.





Assets
and liabilities measured at fair value under SFAS 157 on a nonrecurring basis
are summarized below:





Carrying
      Values at December 31, 2008($
      in thousands)
                Total
                (Level
      1)
                (Level
      2)
                (Level
      3)Impaired
      loans
                $
      37,730
                -
                -
                $
      37,730








($
      in thousands)
                        Impaired
      loansBalance
      at December 31, 2007
                        $
      14,663Total
      net gains for the year
                        -Net
      transfers in/out Level 3
                        23,067Balance
      at December 31, 2008
                        $
      37,730







F -
26
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note
19 - Fair Value of Financial Instruments (continued)





Fair
Value Disclosures





Under
SFAS No. 107, “Disclosures about Fair Value of Financial Instruments” (“SFAS
107”), the Company is required to disclose the estimated fair value of other
financial instruments that are not subject to the requirements of SFAS
157.  As with most financial institutions, the majority of the
Company’s assets and liabilities are considered financial
instruments.  Many of the financial instruments, however, lack an
available trading market as characterized by a willing buyer and willing seller
engaging in an exchange transaction.  Therefore, significant estimates
and present value calculations are used for the purpose of this
disclosure.  Such estimates involve judgments as to economic
conditions, risk characteristics and future expected loss experience of various
financial instruments and other factors that cannot be determined with
precision.





Cash and
due from banks, federal funds sold, accrued interest receivable, all
non-maturity deposits and accrued interest payable have carrying amounts which
approximate fair value primarily because of the short repricing opportunities of
these instruments.





Following
is a description of the methods and assumptions used by the Company to estimate
the fair value of its financial instruments:





Investment securities:Fair
value is based upon quoted market prices, if available.  If a quoted
market price is not available, fair value is estimated using quoted market
prices for similar securities.




Loans: The fair value is
estimated for portfolios of loans with similar financial
characteristics.  Loans are segregated by type, such as commercial,
mortgage, and consumer loans.  The fair value of the loan portfolio is
calculated by discounting contractual cash flows using estimated market discount
rates which reflect the credit and interest rate risk inherent in the
loan.  The estimated fair value of the Subsidiary Banks' off-balance
sheet commitments is nominal since the committed rates approximate current rates
offered for commitments with similar rate and maturity characteristics and since
the estimated credit risk associated with such commitments is not
significant.




Derivative instruments: The
fair value of derivative instruments, consisting of interest rate contracts, is
equal to the estimated amount that the Company would receive or pay to terminate
the derivative instruments at the reporting date, taking into account current
interest rates and the credit-worthiness of the counterparties.




Deposit liabilities:The fair
value of time deposits is based on the discounted value of contractual cash
flows.  The discount rate is based on the LIBOR swap
curve.




The
carrying amounts and estimated fair values of all the Company’s financial
instruments covered by SFAS 107 and SFAS 157 are as follows as of December
31:





2008
                
                2007($
      in thousands)
                
                Estimated
                
                
                EstimatedCarrying
                Fair
                
                Carrying
                FairValue
                Value
                
                Value
                ValueFinancial
      assets:Cash
      and federal funds sold
                $   24,789
                $   24,789
                
                $   17,156
                $   17,156Interest-bearing
      deposits
                3,312
                3,312
                
                20,148
                20,148Securities
      available for sale
                81,619
                81,619
                
                61,057
                61,057Loans
      held for sale
                291
                291
                
                180
                180Loans,
      net of allowance for loan losses
                851,674
                856,799
                
                795,787
                803,012Accrued
      interest receivable
                4,292
                4,292
                
                5,772
                5,772Derivative
      asset positions
                1,475
                1,475
                
                2,062
                2,062Financial
      liabilities:Deposits
                832,015
                840,383
                
                764,218
                766,102Short-term
      borrowings
                67,787
                67,658
                
                70,599
                70,503FHLB
      advances – long-term
                10,169
                9,883
                
                2,973
                2,942Subordinated
      debt to nonconsolidated subsidiaries
                10,310
                10,310
                
                10,310
                10,310Accrued
      interest payable
                2,195
                2,195
                
                2,612
                2,612







F -
27
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements


Note 20 - The Savannah Bancorp, Inc.
(Parent Company Only) Financial Information   ($ in
thousands)





The
following are condensed balance sheets of the Parent Company at December 31,
2008 and 2007:





2008
                      2007AssetsCash
      on deposit
                      $        54
                      $        40Interest-bearing
      deposits
                      1,230
                      1,040Investment
      in subsidiaries
                      87,407
                      82,652Premises
      and equipment
                      1,172
                      1,072Investment
      in nonconsolidatedsubsidiary
                      1,351
                      1,607Other
      assets
                      1,752
                      1,483Total
      assets
                      $
      92,966
                      $
      87,894LiabilitiesSubordinated
      debt
                      $
      10,310
                      $
      10,310Other
      liabilities
                      1,724
                      1,312Total
      liabilities
                      12,034
                      11,622Shareholders'
      equityCommon
      stock
                      5,934
                      5,924Capital
      surplus
                      38,516
                      38,279Retained
      earnings
                      33,552
                      30,512Treasury
      stock
                      (4)
                      (4)Accumulated
      othercomprehensive
      income
                      2,934
                      1,561Total
      shareholders’ equity
                      80,932
                      76,272Total
      liabilities and equity
                      $
      92,966
                      $
      87,894




The
operating results of the Parent Company are shown below for the three years
ended December 31:





2008
                  2007
                  2006Dividends
      from subsidiaries
                  $
      3,450
                  $
      7,500
                  $ 
      3,700Interest
      income
                  15
                  27
                  59Interest
      expense
                  642
                  842
                  881Net
      interest and dividend income
                  2,823
                  6,685
                  2,878Other
      income
                  35
                  38
                  30Processing
      / management fees
                  5,468
                  5,090
                  4,352Total
      income
                  8,326
                  11,813
                  7,260Corporate
      expenses
                  669
                  618
                  721Processing
      / management costs
                  5,543
                  5,165
                  4,427Other
      expenses
                  6,212
                  5,783
                  5,148Income
      before income taxesand
      equity in undistributednet
      income of subsidiaries
                  2,114
                  6,030
                  2,112Income
      tax benefits
                  415
                  415
                  550Income
      before equity inundistributed
      net incomeof
      subsidiaries
                  2,529
                  6,445
                  2,662Equity
      in undistributed netincome
      of subsidiaries
                  3,477
                  1,191
                  7,340Net
      income
                  $
      6,006
                  $
      7,636
                  $ 10,002





F -
28
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Notes to Consolidated Financial
Statements
  The cash
flows of the Parent Company are shown below for the three years ended
December 31:





2008
                      2007
                      2006Operating
      activitiesNet
      income
                      $
      6,006
                      $
      7,636
                      $
      10,002Adjustments
      to reconcile netincome
      to cash provided byoperating
      activities:Equity
      in undistributed netincome
      of subsidiaries
                      (3,477)
                      (1,191)
                      (7,340)Depreciation
      of equipment
                      445
                      369
                      306Non
      cash stock-basedcompensation
      expense
                      137
                      147
                      299Change
      in other assets andliabilities,
      net
                      144
                      (104)
                      364Net
      cash provided byoperating
      activities
                      3,255
                      6,857
                      3,631Investing
      activitiesDistribution
      fromnonconsolidated
      subsidiary
                      350
                      -
                      1,300Investment
      in consolidatedsubsidiary
                      -
                      (1,970)
                      -Purchase
      of equipment andsoftware
                      (545)
                      (437)
                      (353)Capital
      contribution toconsolidated subsidiaries
                      -
                      (2,000)
                      (10,000)Net
      cash used ininvesting
      activities
                      (195)
                      (4,407)
                      (9,053)Financing
      activitiesNet
      decrease inshort-term
      borrowings
                      -
                      -
                      (2,000)Dividends
      paid
                      (2,966)
                      (2,805)
                      (2,593)Issuance
      of common stock
                      74
                      -
                      -Exercise
      of options
                      36
                      748
                      381Net
      cash used infinancing
      activities
                      (2,856)
                      (2,057)
                      (4,212)Increase
      (decrease) in cashand
      cash equivalents
                      204
                      393
                      (9,634)Cash,
      beginning of year
                      1,080
                      687
                      10,321Cash,
      end of year
                      $
      1,284
                      $
      1,080
                      $    687





The
Parent Company financial statements include the following intercompany items:
interest-bearing deposits on the balance sheets; dividend income, interest
income and processing / management fees on the statements of income.  The
investment in the nonconsolidated subsidiary on the balance sheet represents 50
percent ownership in two limited partnerships which own the headquarters
building at 25 Bull Street, Savannah, GA and the associated parking
lot.







F
- 28a
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations
  For a
comprehensive presentation of the Company’s financial condition and results of
operations, the following selected financial data and analysis should be
reviewed along with the consolidated financial statements and the accompanying
notes to the consolidated financial statements.





Table
1 - Selected Financial Condition Highlights – Five-Year Comparison




($
      in thousands, except share data)
                            2008
                            2007
                            2006
                            2005
                            2004SelectedAverage
      BalancesAssets
                            $
      960,260
                            $
      869,026
                            $
      769,917
                            $ 685,163
                            $ 557,474Loans
      held for sale
                            765
                            1,299
                            7,842
                            23,033
                            27,209Loans
      - net of unearned fees
                            821,673
                            754,490
                            658,750
                            565,131
                            441,421Securities
                            62,019
                            58,910
                            50,600
                            41,300
                            40,703Other
      interest-earning assets
                            13,838
                            16,201
                            17,278
                            26,168
                            22,383Total
      interest-earning assets
                            898,295
                            830,900
                            734,470
                            655,632
                            531,716Interest-bearing
      deposits
                            701,045
                            628,310
                            542,375
                            487,493
                            371,877Borrowed
      funds
                            88,553
                            70,939
                            62,255
                            55,255
                            67,353Total
      interest-bearing liabilities
                            789,598
                            699,249
                            604,630
                            542,748
                            439,230Noninterest-bearing
      deposits
                            83,678
                            91,367
                            96,113
                            89,386
                            76,593Total
      deposits
                            784,723
                            719,677
                            638,488
                            576,879
                            448,470Shareholders'
      equity
                            78,998
                            71,516
                            61,766
                            47,428
                            38,126Loan
      to deposit ratio – average
                            105%
                            105%
                            103%
                            98%
                            98%Selected Financial Data at
      Year-EndAssets
                            $
      1,007,284
                            $
      932,459
                            $
      843,514
                            $ 717,901
                            $ 617,341Interest-earning
      assets
                            931,448
                            878,992
                            803,927
                            685,531
                            593,035Loans
      held for sale
                            291
                            180
                            914
                            10,473
                            26,471Loans
      - net of unearned fees
                            864,974
                            808,651
                            720,918
                            613,667
                            499,868Deposits
                            832,015
                            764,218
                            706,824
                            600,510
                            506,120Interest-bearing
      liabilities
                            837,558
                            759,597
                            669,974
                            558,116
                            488,546Shareholders'
      equity
                            80,932
                            76,272
                            66,574
                            58,543
                            40,071Loan
      to deposit ratio
                            104%
                            106%
                            102%
                            102%
                            99%Shareholders'
      equity to total assets
                            8.03%
                            8.18%
                            7.89%
                            8.15%
                            6.49%Dividend
      payout ratio
                            49.38%
                            36.73%
                            25.92%
                            25.53%
                            37.69%Risk-based
      capital ratios:Tier
      1 capital to risk-weighted assets
                            10.28%
                            10.49%
                            11.09%
                            11.52%
                            9.95%Total
      capital to risk-weighted assets
                            11.54%
                            11.74%
                            12.34%
                            12.77%
                            11.20%LoanQuality
      DataNonperforming
      assets
                            $
      35,703
                            $
      19,535
                            $
      2,776
                            $
      1,357
                            $   998Nonperforming
      loans
                            27,603
                            17,424
                            2,231
                            1,357
                            538Nonaccruing
      loans
                            26,277
                            14,663
                            825
                            1,313
                            210Loans
      past due 90 days - accruing
                            1,326
                            2,761
                            1,406
                            44
                            328Net
      charge-offs
                            5,564
                            765
                            444
                            76
                            128Allowance
      for loan losses
                            13,300
                            12,864
                            8,954
                            7,813
                            6,389Nonperforming
      loans to loans
                            3.19%
                            2.15%
                            0.31%
                            0.22%
                            0.11%Nonperforming
      assets to loans
                              and
      other real estate owned
                            4.09%
                            2.41%
                            0.39%
                            0.22%
                            0.20%Net
      charge-offs to average loans
                            0.68%
                            0.10%
                            0.07%
                            0.01%
                            0.03%Allowance
      for loan losses to total loans
                            1.54%
                            1.59%
                            1.24%
                            1.27%
                            1.28%Per Share Data at
      Year-End  (a)Book
      value
                            $
      13.64
                            $
      12.88
                            $
      11.52
                            $
      10.20
                            $   7.80Tangible
      book value
                            $
      13.19
                            $
      12.40
                            $
      11.52
                            $
      10.20
                            $   7.80Common
      stock closing price (NASDAQ)
                            $  8.85
                            $
      17.14
                            $
      27.25
                            $
      28.38
                            $
      21.64Common
      shares outstanding (000s)
                            5,934
                            5,924
                            5,781
                            5,739
                            5,140




(a) Share
      and per share amounts have been restated to reflect the effect of a
      5-for-4 stock split in December
2006.









F
- 29
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


Table
2 - Selected Operating Highlights – Five-Year Comparison





($
      in thousands, except share data)
                          2008
                          2007
                          2006
                          2005
                          2004Summary
      of operationsInterest
      income - taxable equivalent
                          $
      56,714
                          $
      63,414
                          $
      55,347
                          $ 42,544
                          $
      28,947Interest
      expense
                          24,439
                          30,282
                          22,737
                          14,679
                          8,427Net
      interest income - taxable equivalent
                          32,275
                          33,132
                          32,610
                          27,865
                          20,520Taxable
      equivalent adjustment
                          (32)
                          (156)
                          (158)
                          (186)
                          (240)Net
      interest income
                          32,243
                          32,976
                          32,452
                          27,679
                          20,280Provision
      for loan losses
                          6,000
                          4,675
                          1,585
                          1,500
                          1,450Net
      interest income after
                            provision
      for loan losses
                          26,243
                          28,301
                          30,867
                          26,179
                          18,830Noninterest
      incomeTrust
      and asset management fees
                          2,832
                          1,513
                          658
                          501
                          442Service
      charges on deposits accounts
                          1,881
                          1,383
                          1,526
                          1,622
                          1,598Mortgage
      related income, net
                          295
                          615
                          886
                          1,292
                          1,079Other
      operating income
                          1,216
                          1,242
                          1,233
                          979
                          981Gain
      on hedges
                          1,288
                          -
                          -
                          -
                          -Gain
      on sale of securities
                          163
                          -
                          -
                          -
                          -Total
      noninterest income
                          7,675
                          4,753
                          4,303
                          4,394
                          4,100Noninterest
      expenseSalaries
      and employee benefits
                          13,584
                          11,846
                          10,852
                          9,530
                          8,362Occupancy
      and equipment
                          3,884
                          3,294
                          2,920
                          2,199
                          1,963Information
      technology
                          1,633
                          1,616
                          1,525
                          1,244
                          1,049Loss
      on sale of other real estate owned
                          142
                          44
                          -
                          7
                          -Other
      operating expense
                          5,499
                          4,383
                          4,656
                          3,673
                          2,880Total
      noninterest expense
                          24,742
                          21,183
                          19,953
                          16,653
                          14,254Income
      before income taxes
                          9,176
                          11,871
                          15,217
                          13,920
                          8,676Income
      tax expense
                          3,170
                          4,235
                          5,215
                          4,880
                          2,940Net
      income
                          $   6,006
                          $   7,636
                          $
      10,002
                          $ 
      9,040
                          $ 
      5,736Net income per share:(a)Basic
                          $
      1.01
                          $
      1.31
                          $
      1.73
                          $
      1.68
                          $
      1.12Diluted
                          $
      1.01
                          $
      1.29
                          $
      1.70
                          $
      1.63
                          $
      1.09Cash
      dividends paid per share
                          $
      0.50
                          $
      0.48
                          $
      0.45
                          $
      0.43
                          $
      0.42Average
      basic shares outstanding (000s)
                          5,930
                          5,850
                          5,765
                          5,396
                          5,136Average
      diluted shares outstanding (000s)
                          5,947
                          5,922
                          5,876
                          5,531
                          5,261Performance
      ratios (averages)Net
      interest margin
                          3.58%
                          3.99%
                          4.44%
                          4.25%
                          3.86%Return
      on average assets
                          0.63%
                          0.88%
                          1.30%
                          1.32%
                          1.03%Return
      on average equity
                          7.60%
                          10.68%
                          16.19%
                          19.06%
                          15.04%Efficiency
      ratio
                          61.98%
                          56.15%
                          54.29%
                          51.92%
                          58.47%







(a) Share
and per share amounts have been restated to reflect the effect of a 5-for-4
stock split in December 2006.









F
- 30
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Table 3 - Selected
Quarterly Data




The
following is a summary of unaudited quarterly results for 2008 and
2007:





2008
                      
                      2007Fourth
                      Third
                      Second
                      First
                      
                      Fourth
                      Third
                      Second
                      FirstNet
      interest income
                      $7,535
                      $8,251
                      $8,386
                      $8,071
                      
                      $8,080
                      $8,308
                      $8,412
                      $8,176Provision
      for loan losses
                      2,270
                      1,505
                      1,155
                      1,070
                      
                      3,145
                      635
                      395
                      500Net
      interest income after provisionfor loan losses
                      5,265
                      6,746
                      7,231
                      7,001
                      
                      4,935
                      7,673
                      8,017
                      7,676Noninterest
      income
                      1,958
                      2,021
                      1,791
                      1,763
                      
                      1,493
                      1,164
                      1,000
                      1,052Noninterest
      expense
                      6,065
                      6,234
                      6,151
                      6,150
                      
                      5,790
                      5,176
                      5,026
                      5,147Income
      before income taxes
                      1,158
                      2,533
                      2,871
                      2,614
                      
                      638
                      3,661
                      3,991
                      3,581Income
      tax expense
                      380
                      895
                      985
                      910
                      
                      285
                      1,280
                      1,400
                      1,270Net
      income
                      $  778
                      $1,638
                      $1,886
                      $1,704
                      
                      $  353
                      $2,381
                      $2,591
                      $2,311Per share:(a)Net
      income – basic
                      $
      .131
                      $
      .276
                      $
      .318
                      $
      .287
                      
                      $
      .060
                      $
      .406
                      $
      .445
                      $
      .400Net
      income – diluted
                      $
      .131
                      $
      .276
                      $
      .317
                      $
      .286
                      
                      $
      .059
                      $
      .402
                      $
      .439
                      $
      .392Dividends
                      $
      .125
                      $
      .125
                      $
      .125
                      $
      .125
                      
                      $
      .120
                      $
      .120
                      $
      .120
                      $
      .120Average
      shares (000s)Basic
                      5,933
                      5,930
                      5,931
                      5,928
                      
                      5,923
                      5,862
                      5,824
                      5,782Diluted
                      5,942
                      5,943
                      5,952
                      5,951
                      
                      5,968
                      5,928
                      5,899
                      5,890




(a)   The
      summation of quarterly earnings per share may not agree with annual
      earnings per share.










Table
4 - Market for Registrant's Common Equity and Related Shareholder
Matters





The
Company's common stock is traded on NASDAQ under the symbol SAVB.  The
quarterly high, low and closing stock trading prices for 2008 and 2007 are
listed below.  There were approximately 650 holders of record of
Company common stock and, according to information provided to the Company,
approximately 1,150 additional shareholders in street name through brokerage
accounts at December 31, 2008.





2008
                    
                    2007Closing
      Market Prices
                    Fourth
                    Third
                    Second
                    First
                    
                    Fourth
                    Third
                    Second
                    FirstHigh
                    $
      13.35
                    $
      15.00
                    $
      18.73
                    $
      18.49
                    
                    $ 24.69
                    $ 25.97
                    $
      27.20
                    $ 28.07Low
                    8.57
                    11.89
                    12.75
                    15.76
                    
                    17.10
                    23.00
                    24.71
                    27.00Close
                    8.85
                    13.25
                    13.00
                    17.50
                    
                    17.14
                    24.69
                    25.10
                    27.00












F
- 31
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Table
5 - Stock Performance Graph





The
following table provides a graphic comparison of the cumulative total
shareholder return on the common stock of the Company for the five year period
from December 31, 2003 through December 31, 2008.  It includes the
cumulative total return on the NASDAQ Market Index, the SNL $500M-$1B Bank Index
and assumes the re-investment of all dividends over the same
period.  All cumulative returns assume an initial investment of
$100.










For
      the Years Ended December 31,Index
                    2003
                    2004
                    2005
                    2006
                    2007
                    2008The
      Savannah Bancorp, Inc.
                    100.00
                    119.31
                    159.19
                    155.24
                    99.56
                    53.20NASDAQ
      Composite
                    100.00
                    108.59
                    110.08
                    120.56
                    132.39
                    78.72SNL
      $500M-$1B Bank Index
                    100.00
                    113.32
                    118.18
                    134.41
                    107.71
                    69.02




Source: SNL Financial LC,
Charlottesville, VA          ©
2008






F
- 32
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Introduction





Management's
Discussion and Analysis of Financial Condition and Results of Operations (“MD
& A”) provides supplemental information which sets forth the major factors
that have affected the Company's financial condition and results of
operations.  These discussions should be read in conjunction with the
Consolidated Financial Statements and related notes.  The MD & A
is divided into subsections entitled:





Selected
Financial Data Tables 1 - 5 (preceding pages)


Introduction


Critical
Accounting Estimates


Results
of Operations


Financial
Condition and Capital Resources


Liquidity
and Interest Rate Sensitivity Management


Off-Balance
Sheet Arrangements


Forward
Looking Statements





These
discussions should facilitate a better understanding of the major factors and
trends that affect the Company's earnings performance and financial condition
and how the Company's performance during 2008 compared with prior years.
 Throughout this section, The Savannah Bancorp, Inc. and its subsidiaries,
collectively, are referred to as "SAVB" or the "Company." The Savannah Bank,
N.A. is referred to as "Savannah," Bryan Bank & Trust is referred to as
“Bryan” and Harbourside Community Bank is referred to as
“Harbourside”.  Harbourside opened and began offering full service
banking activities on March 1, 2006.  Minis & Co., Inc. is
referred to as “Minis.”  The operations of Minis, a registered
investment advisor and wholly-owned subsidiary, are included beginning September
1, 2007. The Company formed a new subsidiary, SAVB Holdings, LLC in the third
quarter 2008 for the purpose of holding problems loans and other real
estate.   SAVB Holdings, LLC is referred to as “SAVB
Holdings”.  Collectively, Savannah, Bryan and Harbourside are referred
to as the “Subsidiary Banks.”





The
averages used in this report are the averages of daily balances for each
respective period.  See Tables 8 and 9 for average balances and
interest rates presented on an annual basis.  All share and per share
amounts have been restated to reflect the effect of a 5-for-4 stock split in
December 2006.  Certain prior year balances have been reclassified to
conform to the current year presentation.





The
Company is headquartered in Savannah, Georgia and, as of December 31, 2008, had
ten banking offices and twelve ATMs in Savannah and surrounding Chatham County,
Richmond Hill, Georgia, Hilton Head Island and Bluffton, South
Carolina.  The Company also has mortgage lending offices in Savannah,
Richmond Hill and Hilton Head Island and an investment management office in
Savannah.  In September 2006, Savannah opened a new office adjacent to
the Landings community in Savannah.  In December 2007, Harbourside
opened its second office in Bluffton, South Carolina.  In July 2008,
Bryan opened its second office in Richmond Hill.  The Company also
relocated its regional banking operations center to this facility from
previously leased space.  In the third quarter Savannah opened a loan
production office on St. Simons Island, Georgia.





Savannah
and Bryan are located in the relatively diverse and growing Savannah
Metropolitan Statistical Area (“Savannah MSA”).  The diversity of
major employers includes manufacturing, port related transportation,
construction, military, healthcare, tourism, education, warehousing and the
supporting services and products for each of these major
employers.   The real estate market is experiencing moderate
government and commercial growth and slower residential growth. Coastal Georgia
and South Carolina continue to be desired retiree residential
destinations.





Harbourside
specifically targets real estate lending and related full service banking
opportunities in the coastal South Carolina market.  During 2006 and
2007, the business strategy changed resulting in a significant reduction in the
sale of loans on a servicing retained basis.  Harbourside’s primary
market has continued to show deterioration in real estate prices.





The
primary risks to the Company include trends or events that would cause or result
in a significant decline in local employment, real estate values, loans or core
deposits.  The events in the national economy have filtered down to
the Company’s local markets and further slowing in real estate activity will
negatively impact the Company.  The Company operates in very
competitive markets with the related
challenges of competitive pricing on loans, deposits and other banking
services.  Competition for the best talent is also a strategic
challenge faced in competitive markets.






F
- 33
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




The
primary strategic objectives of the Company are growth in loans, deposits,
assets under management, product lines and service quality in existing markets,
and quality expansion into new markets, within acceptable risk parameters, which
results in enhanced shareholder value.  The Company believes that the
management team and the operational and internal control infrastructure are
largely in place to execute the Board of Directors’ (“Board”) objectives over
the long term.





Critical
Accounting Estimates





Allowance for Loan
Losses





The
Company considers its policies regarding the allowance for loan losses to be its
most critical accounting estimate due to the significant degree of management
judgment involved.  The allowance for loan losses is established through
charges to earnings in the form of a provision for loan losses based on
management's continuous evaluation of the loan portfolio.  Loan losses
and recoveries are charged or credited directly to the allowance.  The
amount of the allowance reflects management's opinion of an adequate level to
absorb probable losses inherent in the loan portfolio at December 31, 2008.
 The amount charged to the provision and the level of the allowance is
based on management's judgment and is dependent upon growth in the loan
portfolio, the total amount of past due loans and nonperforming loans, known
loan deteriorations and concentrations of credit.  Other factors affecting
the allowance include market interest rates, loan sizes, portfolio maturity and
composition, collateral values and general economic conditions.  Finally,
management's assessment of probable losses, based upon internal credit grading
of the loans and periodic reviews and assessments of credit risk associated with
particular loans, is considered in establishing the allowance
amount.





No
assurance can be given that the Company will not sustain loan losses which would
be sizable in relationship to the amount reserved or that subsequent evaluation
of the loan portfolio, in light of conditions and factors then prevailing, will
not require significant changes in the allowance for loan losses by future
charges or credits to earnings.  The allowance for loan losses is also
subject to review by various regulatory agencies through their periodic
examinations of the Subsidiary Banks.  Such examinations could result in
required changes to the allowance for loan losses.  No adjustment in the
allowance or significant adjustments to the Subsidiary Banks’ internally
classified loans were made as a result of their most recent regulatory
examinations.





The
allowance for loan losses totaled $13,300,000 or 1.54 percent of total loans at
December 31, 2008.  This is compared to an allowance of $12,864,000 or 1.59
percent of total loans at December 31, 2007.  For 2008, the Company
reported net charge-offs of $5,564,000 or 0.68 percent of average loans for
2008.  This is compared to net charge-offs of $765,000 or 0.10 percent
of average loans for 2007.  The significantly higher level of
charge-offs resulted primarily from nonperforming residential real
estate-related loans in the Bluffton / Hilton Head Island, South Carolina
(“Bluffton/HHI”) area.  During 2008 and 2007, a provision for loan
losses of $6,000,000 and $4,675,000, respectively, was added to the allowance
for loan losses.  Growth in the loan portfolio, charge-offs, a
continued weak residential real estate market, level or declining real estate
values and tighter credit markets provide the basis for the higher provision for
loan losses.





The
Company's nonperforming assets consist of other real estate owned, loans on
nonaccrual status and loans which are contractually past due 90 days or more on
which interest is still being accrued.  Nonaccrual loans of
$26,277,000 and loans past due 90 days or more of $1,326,000 totaled
$27,603,000, or 3.19 percent of gross loans, at December 31,
2008.  Nonaccrual loans of $14,663,000 and loans past due 90 days or
more of $2,761,000 totaled $17,424,000, or 2.15 percent of gross loans, at
December 31, 2007. Generally, loans are placed on nonaccrual status when
the collection of the principal or interest in full becomes
doubtful.  Nonperforming assets also included $8,100,000 and
$2,112,000 of other real estate owned at December 31, 2008 and 2007,
respectively.  Management is aggressively pricing and marketing the
other real estate owned.





Impaired
loans under Statement of Financial Accounting Standards (“SFAS”) No. 114 totaled
$37,730,000 and $14,663,000 at December 31, 2008 and 2007,
respectively.






F
- 34
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




The $27.6
million in nonperforming loans were primarily loans made in or related to the
Bluffton/HHI market and includes 100 loans.  The loans consist of
$13.8 million in 30 completed residential properties, $10.9 million in 32 lot,
construction and land loans, $1.5 million in seven commercial properties and
$1.4 million in 31 in other loans.  In the first quarter 2009, the
Company successfully settled its largest single nonperforming loan of
approximately $4 million.  The Company recovered the full principal
and interest due on the loan.





During
2008, the Bluffton/HHI real estate market continued to slow.  The
Company has also experienced some slow down in the Savannah MSA real estate
market.





The
Company continues to devote significant internal and external resources to
managing the past due and classified loans.  The Company has performed
extensive internal loan review procedures and analyses on the loan
portfolio.  As noted in prior years, higher risk characteristics were
identified, primarily in the speculative and non-owner occupied Bluffton/HHI
residential real estate loans that were originated in 2004-2006 in a much
stronger real estate market.  Many of the loans are not currently
delinquent or past due but are properly graded so that the appropriate attention
can be provided.  The Company has proactively charged-down loans as
appropriate before the foreclosure process is complete and often before they are
past due.  Management believes that adequate provisions and allowances
for loan losses have been recorded in accordance with expanded regulatory
guidance that became effective in 2007.





If the
allowance for loan losses had changed by five percent, the effect on net income
would have been approximately $435,000.  If the allowance had to be
increased by this amount, it would not have changed the Subsidiary Banks’ status
as well-capitalized financial institutions.





Changes
in the allowance for loan losses from 2004 through 2008 are summarized as
follows:





($
      in thousands)
                      2008
                      2007
                      2006
                      2005
                      2004Balance
      at the beginning of the year
                      $12,864
                      $  8,954
                      $
      7,813
                      $
      6,389
                      $
      5,067Charge-offs
      – commercial
                      (387)
                      (150)
                      -
                      (22)
                      (143)Charge-offs
      – consumer
                      (85)
                      (103)
                      (125)
                      (82)
                      (112)Charge-offs
      – real estate
                      (5,242)
                      (621)
                      (381)
                      (48)
                      --Charge-offs
      – total
                      (5,714)
                      (874)
                      (506)
                      (152)
                      (255)Recoveries
      – commercial
                      13
                      6
                      6
                      7
                      26Recoveries
      – consumer
                      28
                      43
                      54
                      53
                      68Recoveries
      – real estate
                      109
                      60
                      2
                      16
                      33Recoveries
      – total
                      150
                      109
                      62
                      76
                      127Net
      charge-offs
                      (5,564)
                      (765)
                      (444)
                      (76)
                      (128)Provision
      for loan losses
                      6,000
                      4,675
                      1,585
                      1,500
                      1,450Balance
      at the end of the year
                      $
      13,300
                      $
      12,864
                      $
      8,954
                      $
      7,813
                      $
      6,389Ratio
      of net charge-offs to average loans
                      0.68%
                      0.10%
                      0.07%
                      0.01%
                      0.03%





The
allowance for loan losses is allocated by loan category based on management's
assessment of risk within the various categories of loans.  Loans are
segregated by category and by credit risk rating within each
category.  The allowance for loan losses is allocated to each category
by applying reserve percentages to each category.  These percentages
are based upon management's assessment of risk inherent within each category and
the historical and anticipated loss rates within each category.









F
- 35
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


The
Company’s allocation of the allowance for loan losses is presented in the
following table:





($
      in thousands)
                  2008
                  2007
                  2006
                  2005
                  2004Commercial
                  $    760
                  $    750
                  $   900
                  $   700
                  $   650Real
      estate-constructionand
      development
                  5,291
                  4,150
                  4,350
                  3,750
                  2,750Real
      estate-mortgage
                  7,061
                  6,750
                  2,350
                  1,900
                  1,750Consumer
                  188
                  200
                  400
                  350
                  400Unallocated
                  -
                  1,014
                  954
                  1,113
                  839Total
      allowance forloan
      losses
                  $
      13,300
                  $
      12,864
                  $
      8,954
                  $
      7,813
                  $
      6,389





The
composition of the loan portfolio as a percentage of total loans is presented
below:





Loan
      Categories
                  2008
                  2007
                  2006
                  2005
                  2004Commercial
                  9.4%
                  8.8%
                  8.0%
                  7.4%
                  7.3%Real
      estate-constructionand
      development
                  16.4
                  16.6
                  23.1
                  23.6
                  19.4Real
      estate-mortgage
                  72.2
                  72.3
                  66.6
                  66.7
                  69.9Consumer
                  2.0
                  2.3
                  2.3
                  2.3
                  3.4Total
      loans
                  100.0%
                  100.0%
                  100.0%
                  100.0%
                  100.0%





Impairment of
Loans





We
measure impaired loans based on the present value of expected future cash flows
discounted at the loan’s effective interest rate, the loan’s obtainable market
price, or the fair value of the collateral if the loan is collateral
dependent.  We consider a loan impaired when it is probable that the
Company will be unable to collect the scheduled payments of principal or
interest when due according to the contractual terms of the loan
agreement.  We do not consider a loan impaired during a period of
delay in payment if we expect the ultimate collection of all amounts
due.  We maintain a valuation allowance to the extent that the measure
of value of an impaired loan is less than the recorded investment.





Other Real Estate
Owned





Assets
acquired through, or in lieu of, loan foreclosure are held for sale and are
initially recorded at fair value less costs to sell at the date of foreclosure,
establishing a new cost basis.  Subsequent to foreclosure, management
periodically performs valuations of the foreclosed assets based on updated
appraisals, general market conditions, length of time the properties have been
held, and our ability and intention with regard to continued ownership of the
properties.  The Company may incur additional write-downs of
foreclosed assets to fair value less costs to sell if valuations indicate a
further other than temporary deterioration in market conditions.









F
- 36
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Results
of Operations




2008
Compared with 2007





Net
income for 2008 was $6,006,000, a decrease of 21 percent from $7,636,000 in
2007.  Net income per diluted share was $1.01 and $1.29 in 2008 and
2007, respectively.  The earnings decrease was primarily attributable
to a lower net interest margin, a higher provision for loan losses and higher
noninterest expense partially offset by an increase in noninterest
income.  Return on average equity was 7.60 percent, return on average
assets was 0.63 percent and the efficiency ratio was 61.98 percent in
2008.





Average
interest-earning assets increased 8.1 percent to $898 million in 2008 from $831
million in 2007.  Net interest income was $32,243,000 in 2008 compared
to $32,976,000 in 2007, a decrease of 2.2 percent.  Average loans were
$822 million for 2008, 9.0 percent higher when compared to $754 million in
2007.  Shareholders’ equity increased 6.6 percent to $81 million at
December 31, 2008 from $76 million at December 31, 2007.  The
Company’s total capital to risk-weighted assets ratio was 11.54 percent at
December 31, 2008, well in excess of the 10 percent required by the regulatory
agencies to maintain well-capitalized status.  The net interest margin
decreased to 3.58 percent in 2008 from 3.99 percent in 2007.  As shown
in Table 8, the decline in net interest margin was primarily due to the increase
in noninterest-earning assets, a decrease in noninterest-bearing deposits and a
decrease in interest rate spread.  While the prime rate declined 400
basis points in 2008, the interest rate spread only decreased nine basis
points.  As shown in Table 7, the Company’s balance sheet is
asset-sensitive since the interest-earning assets reprice faster than
interest-bearing liabilities.  Rising interest rates favorably impact
the net interest margin of an asset-sensitive balance sheet and falling rates
adversely impact the net interest margin. However, when the prime rate
stops decreasing, the interest rates on time deposits, certain non-maturity
deposits and other funding sources will continue to decline due to the
re-pricing lag associated with those liabilities.





The
provision for loan losses was $6,000,000 for 2008, compared to $4,675,000 in
2007.  Loan growth was $56 million in 2008 compared to $88 million in
2007.  The higher provision for loan losses in 2008 as compared to
2007 is mainly attributable to higher nonperforming loans and net charge-offs as
a result of the continued weakness in the real estate market.  Net
charge-offs were $5,564,000 in 2008 as compared to $765,000 in
2007.  The significant increase in charge-offs resulted primarily from
the nonperforming residential real estate-related loans in the Hilton Head
Island / Bluffton, South Carolina market and continued weakness in the overall
real estate market.





Noninterest
income was $7,675,000 in 2008 compared to $4,753,000 in 2007, an increase of
$2,922,000 or 61 percent.  The increase was the result of higher trust
and asset management fees of $1,319,000 primarily due to Minis, a gain on hedges
of $1,288,000 and an increase in service charges on deposits of $498,000
partially offset by a decrease of $320,000 in net mortgage related
income.  The higher service charges were primarily due to a new
payment optimization program started in the first quarter 2008.





Noninterest
expense was $24,742,000 in 2008 compared to $21,183,000 in 2007, an increase of
$3,559,000, or 17 percent.  The increase included a full year of Minis
expenses of $1,399,000 in 2008 compared to four months of expenses of $455,000
in 2007.  Salaries and employee benefits increased $1,738,000 or 15
percent due to Minis, additional employees in new markets and normal salary and
benefit increases.  Occupancy and equipment expense increased
$590,000, or 18 percent, primarily due to new banking offices that were added in
2007 and 2008.  Other operating expenses increased $1,116,000, or 25
percent and included $402,000 in higher FDIC insurance premiums and $483,000 in
higher expenses related to other real estate and loan costs.





Income
tax expense was $3,170,000 in 2008 and $4,235,000 in 2007.  The
combined effective federal and state tax rates were 34.5 percent and 35.7
percent, respectively.  Lower taxable income in the 35 percent tax
bracket and higher low income housing tax credits were the primary contributors
to the lower effective tax rate in 2008.  The Company has never
recorded a valuation allowance against deferred tax assets.  All
significant deferred tax assets are considered to be realizable due to expected
future taxable income.









F
- 37
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


2007
Compared with 2006





Net
income for 2007 was $7,636,000, a decrease of 24 percent from $10,002,000
in 2006.  Net income per diluted share was $1.29 and $1.70 in 2007 and
2006, respectively.  Higher interest income resulting from solid
growth in interest-earning assets was offset by higher interest expense on
interest-bearing liabilities and a much higher provision for loan
losses.  Return on average equity was 10.68 percent, return on average
assets was 0.88 percent and the efficiency ratio was 56.15 percent in
2007.





Average interest-earning
assets increased 13 percent to $831 million in 2007 from $734 million in
2006.  Net interest income was $32,976,000 in 2007 compared to
$32,452,000 in 2006, an increase of $524,000 or 1.6 percent.  Average
loans were $754 million for 2007, 14 percent higher when compared to $659
million in 2006.  The net interest margin decreased to 3.99 percent in
2007 from 4.44 percent in 2006.  As shown in Table 9, the decline in net
interest margin was primarily due to the rise in deposit and other borrowing
costs over the prior 12 months and changes in the deposit mix.  The
increase in the yield on interest-earning assets was more than offset by
increasing costs of interest-bearing liabilities.





The
provision for loan losses was $4,675,000 for 2007, compared to $1,585,000 for
2006.  Changes in the provision are impacted as discussed in detail
under the "Allowance for Loan Losses" section above.  Loan growth was
$88 million in 2007, primarily in real estate-secured loans, compared to
$107 million in 2006.  The higher provision for loan losses in
2007 as compared to 2006 is attributable to significantly higher nonperforming
loans resulting from a weaker overall real estate market, higher interest rates
and much tighter availability of funding for larger residential real estate
loans.





Noninterest
income was $4,753,000 in 2007 compared to $4,303,000 in 2006, an increase of
$450,000, or 10 percent.  Trust and asset management fees were
$855,000 higher, but were offset by lower mortgage related income and
service charges on deposit accounts.  Mortgage banking related income,
net of direct origination costs, was $615,000 in 2007 compared to $886,000 for
the same period in 2006, a decrease of $271,000 or 31
percent.  The mortgage related income was impacted negatively
by lower mortgage origination volumes resulting from slowing residential
real estate sales, higher credit standards in the secondary market for borrowers
and higher mortgage loan rates, particularly on larger loans.





Noninterest
expense was $21,183,000 in 2007 compared to $19,953,000 in 2006, an increase of
$1,230,000, or 6.2 percent.  The increase included four months of
Minis expenses of $455,000 in 2007.  Salaries and employee benefits
increased $994,000 or 9.2 percent.  Occupancy, equipment and
information technology expenses increased approximately $465,000, or 11
percent.  Other operating expense decreased $273,000, or 5.9 percent,
primarily due to nonrecurring pre-opening expenses related to the opening of
Harbourside in 2006 and nonrecurring first year Sarbanes-Oxley costs incurred in
the first quarter 2006.





Income
tax expense was $4,235,000 in 2007 and $5,215,000 in 2006.  The
combined effective federal and state tax rates were 35.7 percent and 34.3
percent in 2007 and 2006, respectively.  The increase was primarily
due to lower tax-exempt income for state tax purposes in 2007 and tax benefits
related to the exercise and sale of incentive stock options in
2006.  The Company has never recorded a valuation allowance against
deferred tax assets.  All significant deferred tax assets are
considered to be realizable due to expected future taxable income.









F
- 38
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


Financial
Condition and Capital Resources





Balance
Sheet Activity





The major
changes in the Company’s assets and liabilities for the current and prior period
are shown in the consolidated statements of cash flows.  Average total
assets increased 10 percent to $960 million in 2008 from $869 million in
2007.  Total assets were $1 billion and $932 million at December 31,
2008 and 2007, respectively, an increase of 7.3 percent.  The increase
in loans and securities of $56 million and $21 million, respectively, during
2008 was funded primarily by $68 million in deposit growth and $7 million in
additional FHLB long-term borrowings.





The
Company has classified all investment securities as available for
sale.  Lower short-term interest rates resulted in an overall net
unrealized gain in the investment portfolio.  The unrealized gain or
loss amounts are recorded in shareholders’ equity as accumulated other
comprehensive income (loss), net of tax.





Historically,
deposits at the Subsidiary Banks have been obtained from local
customers.  Over the past several years funding sources have been
expanded to include non-local deposits and more frequent use of short-term
advances from the FHLB.  Total deposits included brokered time
deposits and institutional money market accounts of $222 million at December 31,
2008 and $127 million at December 31, 2007.  At December 31, 2008,
brokered time deposits include $38 million of deposits from our local customers
that is classified as brokered because it is included in the CDARS network for
deposit insurance purposes.





Loans





The
following table shows the composition of the loan portfolio at December 31, 2008
and 2007, including a more detailed breakdown of real estate secured loans by
collateral type and purpose.





Table
6 - Loan Concentrations





($ in thousands)
                  2008
                  %
      of
                    Total
                  2007
                  %
      of
                    Total
                  %
      Change
                    ($)Non-residential
      real estateOwner-occupied
                  $
      137,742
                  16
                  $
      118,714
                  15
                  16Non
      owner-occupied
                  124,502
                  14
                  118,904
                  15
                  5Construction
                  26,965
                  3
                  33,923
                  4
                  (21)Commercial
      land and lot development
                  42,590
                  5
                  38,127
                  5
                  12Total
      non-residential real estate
                  331,799
                  38
                  309,668
                  39
                  7Residential
      real estateOwner-occupied
      – 1-4 family
                  89,774
                  10
                  83,828
                  10
                  7Non
      owner-occupied – 1-4 family
                  147,396
                  17
                  114,992
                  14
                  28Construction
                  43,431
                  5
                  57,541
                  7
                  (25)Residential
      land and lot development
                  98,715
                  12
                  109,718
                  14
                  (10)Home
      equity lines
                  55,092
                  6
                  43,322
                  5
                  27Total
      residential real estate
                  434,408
                  50
                  409,401
                  50
                  6Total
      real estate loans
                  766,207
                  88
                  719,069
                  89
                  7Commercial
                  81,348
                  10
                  71,370
                  9
                  14Consumer
                  17,628
                  2
                  18,692
                  2
                  (6)Unearned
      fees, net
                  (209)
                  -
                  (480)
                  -
                  (56)Total
      loans, net of unearned fees
                  $
      864,974
                  100
                  $
      808,651
                  100
                  7









F
- 39
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


Capital
Resources





The
Office of the Comptroller of the Currency and Office of Thrift Supervision
have adopted capital requirements that specify the minimum capital level for
which no prompt corrective action is required.  In addition, the FDIC
assesses FDIC insurance premiums based on certain “well-capitalized” risk-based
and equity capital ratios.  As of December 31, 2008, the Subsidiary
Banks and the Company exceeded the minimum requirements necessary to be
classified as “well-capitalized.”





Total
equity capital for the Company was $80.9 million, or 8.03 percent of total
assets, at December 31, 2008.  Tier 1 capital was 10.28 percent of
risk-weighted assets at the same date.  Tier 1 capital at December 31,
2008 includes $10.0 million of trust preferred debt issued by the Company’s
nonconsolidated subsidiaries.





Under
Federal Reserve Bank holding company capital regulations, trust preferred debt
qualifies for Tier 1 capital treatment up to a limit of 25 percent of tangible
equity capital plus trust preferred debt.  All of the Company’s trust
preferred debt qualifies as Tier 1 capital.  At December 31, 2008, the
Company has the capacity to issue approximately $16 million in additional
qualifying trust preferred debt which would qualify as Tier 1
capital.





During
the fourth quarter of 2008, the Company applied to participate in the TARP
Capital Purchase Program offered by the U.S. Treasury Department.  The
Company is eligible to issue up to $24 million of preferred stock under the
guidelines of the program.








Liquidity
and Interest Rate Sensitivity Management





The
objectives of balance sheet management include maintaining adequate liquidity
and preserving reasonable balance between the repricing of interest sensitive
assets and liabilities at favorable interest rate spreads.  The
objective of liquidity management is to ensure the availability of adequate
funds to meet the loan demands and the deposit withdrawal needs of
customers.  This is achieved through maintaining a combination of
sufficient liquid assets, core deposit growth and unused capacity to purchase
and borrow funds in the money markets.





During
2008, portfolio loans increased $56 million to $865 million and deposits
increased $68 million to $832 million.  The loan to deposit ratio was
104 and 106 percent at December 31, 2008 and 2007,
respectively.





In
addition to local deposit growth, primary funding and liquidity sources include
borrowing capacity with the FHLB, temporary federal funds purchased lines with
correspondent banks and non-local institutional and brokered
deposits.  Contingency funding and liquidity sources include the
ability to sell loans, or participations in certain loans, to investors and
borrowings from the Federal Reserve Bank (“FRB”) discount window.





The Subsidiary
Banks have Blanket Floating Lien Agreements with the FHLB.  Under
these agreements, the Subsidiary Banks have credit lines up to 75 percent of the
FHLB qualifying collateral value of their 1-4 family first mortgage loans
and up to 50 percent of the FHLB qualifying collateral value of their home
equity lines of credit, second mortgage residential loans and certain commercial
real estate loans.  The Subsidiary Banks individual borrowing limits
range from 10 to 25 percent of assets.  In aggregate, the Subsidiary
Banks had secured borrowing capacity of approximately $141.2 million of which
$33.2 million was advanced at December 31, 2008.  These credit
arrangements serve as a core funding source as well as liquidity backup for
the Subsidiary Banks.  The Subsidiary Banks also have conditional
federal funds borrowing lines available from correspondent banks that management
believes can provide up to $20 million of funding needs for 30-60
days.  The Subsidiary Banks have been approved to access the FRB
discount window to borrow on a secured basis at 25 basis points over the Federal
Funds Target Rate.  The amount of credit available is subject to the
amounts and types of collateral available when borrowings are
requested.  Savannah and Bryan were approved by the FRB under the
borrower-in custody of collateral (“BIC”) arrangement.  This temporary
liquidity arrangement allows collateral to be maintained at Savannah and Bryan
rather than being delivered to the FRB or a third-party custodian.  At
December 31, 2008, Savannah had a $10 million borrowing outstanding with the
FRB.






F
- 40
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




A
continuing objective of interest rate sensitivity management is to maintain
appropriate levels of variable rate assets, including variable rate loans and
shorter maturity investments, relative to interest rate sensitive liabilities,
in order to control potential negative impacts upon earnings due to changes in
interest rates.  Interest rate sensitivity management requires
analyses and actions that take into consideration volumes of assets and
liabilities repricing and the timing and magnitude of their price changes to
determine the effect upon net interest income.  The Company utilizes
hedging strategies to reduce interest rate risk as noted below.





The
Company’s cash flow, maturity and repricing gap at December 31, 2008 was $29
million at one year, or 3.1 percent of total interest-earning
assets.  At December 31, 2007 the gap at one year was $61 million, or
6.9 percent of total interest-earning assets.  Interest-earning assets
with maturities over five years totaled approximately $83 million, or 8.9
percent of total interest-earning assets.  See Table 7 for cash flow,
maturity and repricing gap. The gap position between one and five years is
of less concern because management has time to respond to changing financial
conditions and interest rates with actions that reduce the impact of the
longer-term gap positions on net interest income.  However,
interest-earning assets with maturities and/or repricing dates over five years
may include significant rate risk and market value of equity concerns in the
event of significant interest rate increases.





The
Company is asset-sensitive within one year.  The 400 basis point
decrease in the prime rate from 7.25 percent to 3.25 percent during
2008 and the increased level of nonaccrual loans have negatively impacted
net interest income and the net interest margin.





Since
June 2005, the Company has implemented various strategies to reduce the
Company’s asset-sensitive position, primarily through the use of short maturity
funding sources, the increased use of fixed rate loans and hedging strategies
such as interest rate floors, collars and swaps.  In 2008, the Company
terminated $50 million of interest rate swap positions for net proceeds of
$2,369,000.  The Company also terminated $35 million of an interest
rate floor for net proceeds of $856,000.  The amounts in other
comprehensive income related to the terminated transactions will be reclassified
into earnings over the remaining lives of the original hedged
transactions.


These
actions have reduced the Company’s exposure to falling interest
rates.





Management
monitors interest rate risk quarterly using rate-sensitivity forecasting models
and other balance sheet analytical reports.  If and when projected
interest rate risk exposures are outside of policy tolerances or desired
positions, specific strategies to return interest rate risk exposures to desired
levels are developed by management, approved by the Asset-Liability Committee
and reported to the Board.  Management upgraded its interest rate risk
reporting systems by engaging outside balance sheet consultants during the
second quarter of 2005.  Better forecasting models are especially
valuable during periods of volatile interest rates, rapid growth and changing
interest rate yield curves.








Off-Balance
Sheet Arrangements





In order
to meet the financing needs of its customers, the Company is a party to
financial instruments with off-balance sheet risks in the normal course of
business.  At December 31, 2008, the Company had unfunded commitments
to extend credit of $118.1 million and outstanding stand-by letters of credit of
$7.7 million.  Since many of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.  The Company uses the same credit
policies in establishing commitments and issuing letters of credit as it does
for on-balance sheet instruments.  Management does not anticipate that
funding obligations arising from these financial instruments will adversely
impact its ability to fund future loan growth or deposit
withdrawals.






F
- 41
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


Forward
Looking Statements





This MD
& A and other Company communications and statements may contain
"forward-looking statements."  These forward-looking statements may
include, among others, statements about our beliefs, plans, objectives,
goals, expectations, estimates and intentions that are subject to
significant risks and uncertainties and which may change based on various
factors, many of which are beyond our control.  The words "may," "could,"
"should," "would," "believe," "anticipate," "estimate," "expect," "intend,"
"plan" and similar expressions are intended to identify forward-looking
statements.  The following factors, among others, could cause our financial
performance to differ materially from what is contemplated in those
forward-looking statements:





*
      The strength of the United States economy in general and the strength of
      the local economies in which we conduct operations may be different than
      expected resulting in, among other things, a deterioration in credit
      quality or a reduced demand for credit, including the resultant effect on
      our loan portfolio and allowance for loan
  losses;


*
      The effects of and changes in trade, monetary and fiscal policies and
      laws, including interest rate policies of the Board of Governors of the
      Federal Reserve System;


*
      Inflation, interest rate, market and monetary
  fluctuations;


*
      Adverse conditions in the stock market and other capital markets and the
      impact of those conditions on our capital markets and capital management
      activities, including our investment and wealth management advisory
      businesses;


*
      Changes in the cost and availability of funding due to changes in the
      deposit market and credit market, or the way in which the Company is
      perceived in such markets;


*
      The effects of harsh weather conditions, including
    hurricanes;


*
      Changes in U.S. foreign or military
policy;


*
      The timely development of competitive new products and services by us and
      the acceptance of those products and services by new and existing
      customers;


*
      The willingness of customers to accept third-party products marketed by
      us;


*
      The willingness of customers to substitute competitors' products and
      services for our products and services and vice
  versa;


*
      The impact of changes in financial services laws and regulations
      (including laws concerning taxes, banking, securities and
      insurance);


*
      Technological changes;


*
      Changes in consumer spending and saving
habits;


*
      The effect of corporate restructuring, acquisitions or dispositions,
      including the actual restructuring and other related charges and the
      failure to achieve the expected gains, revenue growth or expense savings
      from such corporate restructuring, acquisitions or
      dispositions;


*
      The growth and profitability of our noninterest or fee income being less
      than expected;


*
      Unanticipated regulatory or judicial
  proceedings;


*
      The impact of changes in accounting policies by the SEC or the Financial
      Accounting Standards Board;


*
      The limited trading activity or our common
  stock;


*
      The effects of our lack of a diversified loan portfolio, including the
      risks of geographic concentrations;


*
      Adverse changes in the financial performance and/or condition of our
      borrowers, which could impact the repayment of those borrowers'
      outstanding loans; and


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




We
caution that the foregoing list of important factors is not exhaustive. Also, we
do not undertake to update any forward-looking statements, whether written or
oral, that may be made from time to time by us or on our behalf except as may be
required by our disclosure obligations in filings we make with the SEC under
federal securities laws.









F
- 42
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Table
7 - Cash Flow/Maturity Gap and Repricing Data





The
following is the cash flow/maturity and repricing data for the Company as of
December 31, 2008:





($
      in thousands)
                  
                  0 -
      3
                  3 -
      12
                  1 -
      3
                  3 -
      5
                  Over
      5Immediate
                  Months
                  Months
                  Years
                  Years
                  Years
                  TotalInterest-earning
      assetsInvestment
      securities
                  $           -
                  $    7,369
                  $   17,254
                  $   17,765
                  $  16,807
                  $
      20,252
                  $   79,447Interest-bearing
      deposits
                  2,397
                  138
                  277
                  500
                  -
                  -
                  3,312Federal
      funds sold
                  9,701
                  -
                  -
                  -
                  -
                  -
                  9,701Loans
      held for sale
                  -
                  291
                  -
                  -
                  -
                  -
                  291Loans
      - fixed rates
                  -
                  53,215
                  145,238
                  144,845
                  37,585
                  50,627
                  431,510Loans
      - variable rates
                  -
                  369,097
                  13,239
                  8,029
                  5,020
                  11,802
                  407,187Total
      interest-earning assets
                  12,098
                  430,110
                  176,008
                  171,139
                  59,412
                  82,681
                  931,448Interest-bearing
      liabilitiesNOW
      and savings **
                  -
                  7,167
                  14,334
                  35,834
                  43,000
                  43,000
                  143,335Money
      market accounts **
                  -
                  113,687
                  35,209
                  20,119
                  30,179
                  -
                  199,194Time
      deposits
                  -
                  129,751
                  210,552
                  59,192
                  7,124
                  144
                  406,763Short-term
      borrowings
                  55,293
                  11,494
                  1,000
                  -
                  -
                  -
                  67,787FHLB
      advances - long-term
                  -
                  1
                  5
                  11
                  11
                  10,141
                  10,169Subordinated
      debt
                  -
                  10,310
                  -
                  -
                  -
                  -
                  10,310Total
      interest-bearing liabilities
                  55,293
                  272,410
                  261,100
                  115,156
                  80,314
                  53,285
                  837,558GAP-Excess
      assets (liabilities)
                  (43,195)
                  157,700
                  (85,092)
                  55,983
                  (20,902)
                  29,396
                  93,890GAP-Cumulative
                  $
      (43,195)
                  $
      114,505
                  $   29,413
                  $   85,396
                  $  64,494
                  $
      93,890
                  $
      93,890Cumulative
      sensitivity ratio *
                  0.22
                  1.35
                  1.05
                  1.12
                  1.08
                  1.11
                  1.11




*  
Cumulative interest-earning assets / cumulative interest-bearing
liabilities




**
Repricing of NOW, savings and local money market accounts based on estimated
percentages of market interest rate changes.




Note – At
December 31, 2008 the Company had unfunded loan commitments and unfunded lines
of credit totaling $118 million.  The Company believes the likelihood
of these commitments either being totally funded or funded at the same time is
low.  However, should a significant funding requirement occur, the
Company has available borrowing capacity from the FHLB of $108
million.  Additionally, further sources of funding include FRB
advances, brokered time deposits and certain other non-local
deposits.






F
- 43
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


Table
8 - Average Balance Sheet and Rate/Volume Analysis - 2008 and 2007


The
following table presents average balances of the Company and the Subsidiary
Banks on a consolidated basis, the taxable-equivalent interest earned and the
rate paid thereon during 2008 and 2007.





Taxable-Equivalent
                  
                  (a)
      VarianceAverage
      Balance
                  Average
      Rate
                  
                  Interest
      (b)
                  Vari-
                  Attributable
      to2008
                  2007
                  2008
                  2007
                  
                  2008
                  2007
                  ance
                  Rate
                  Volume($
      in thousands)
                  (%)
                  
                  ($
      in thousands)
                  
                  ($
      in thousands)Assets$   7,033
                  $   6,958
                  2.11
                  4.97
                  Interest-bearing
      deposits
                  $  149
                  $  346
                  $  (197)
                  $    (200)
                  $      360,136
                  56,851
                  4.98
                  5.01
                  Investments
      - taxable
                  3,002
                  2,848
                  154
                  (17)
                  1711,883
                  2,059
                  5.46
                  7.33
                  Investments
      - non-taxable
                  103
                  151
                  (48)
                  (39)
                  (9)6,805
                  9,243
                  1.95
                  5.11
                  Federal
      funds sold
                  133
                  472
                  (339)
                  (293)
                  (46)765
                  1,299
                  7.82
                  7.54
                  Loans
      held for sale
                  60
                  98
                  (38)
                  4
                  (42)821,673
                  754,490
                  6.47
                  7.89
                  Loans
      (c)
                  53,267
                  59,499
                  (6,232)
                  (10,743)
                  4,511898,295
                  830,900
                  6.30
                  7.63
                  Total
      interest-earning assets
                  56,714
                  63,414
                  (6,700)
                  (11,081)
                  4,38161,965
                  38,126
                  
                  
                  Noninterest-earning
      assets$960,260
                  $869,026
                  
                  
                  Total
      assetsLiabilities
      and equityDeposits$120,661
                  $114,053
                  1.15
                  2.00
                  NOW
      accounts
                  1,396
                  2,279
                  (883)
                  (972)
                  8915,488
                  17,831
                  0.88
                  0.99
                  Savings
      accounts
                  137
                  176
                  (39)
                  (20)
                  (19)128,826
                  120,898
                  2.38
                  4.43
                  Money
      market accounts
                  3,079
                  5,355
                  (2,276)
                  (2,485)
                  20968,464
                  46,989
                  2.66
                  3.85
                  MMA
      - institutional
                  1,827
                  1,809
                  18
                  (561)
                  579147,576
                  131,553
                  4.52
                  5.35
                  CDs,
      $100M or more
                  6,685
                  7,020
                  (335)
                  (1,082)
                  74785,790
                  74,234
                  3.49
                  4.83
                  CDs,
      broker
                  2,998
                  3,605
                  (607)
                  (1,020)
                  413134,240
                  122,752
                  4.25
                  5.03
                  Other
      time deposits
                  5,720
                  6,171
                  (451)
                  (960)
                  509701,045
                  628,310
                  3.11
                  4.20
                  Total
      interest-bearing deposits
                  21,842
                  26,415
                  (4,573)
                  (6,867)
                  2,29410,264
                  7,833
                  2.86
                  5.27
                  FHLB
      advances – long-term
                  294
                  413
                  (119)
                  (189)
                  7067,979
                  52,796
                  2.44
                  4.95
                  Short-term
      borrowings
                  1,661
                  2,612
                  (951)
                  (1,329)
                  37810,310
                  10,310
                  6.21
                  8.17
                  Subordinated
      debt
                  642
                  842
                  (200)
                  (203)
                  3Total
      interest-bearing789,598
                  699,249
                  3.09
                  4.33
                  liabilities
                  24,439
                  30,282
                  (5,843)
                  (8,694)
                  2,85183,678
                  91,367
                  
                  
                  Noninterest-bearing
      deposits7,986
                  6,894
                  
                  
                  Other
      liabilities78,998
                  71,516
                  
                  
                  Shareholders'
      equity$960,260
                  $869,026
                  
                  
                  Liabilities
      and equity3.21
                  3.30
                  Interest
      rate spread3.58
                  3.99
                  Net
      interest marginNet
      interest income
                  $ 33,275
                  $ 33,132
                  $
      (857)
                  $(2,387)
                  $1,530$108,697
                  $131,651
                  
                  
                  Net
      earning assets$784,723
                  $719,677
                  
                  
                  Average
      deposits2.78
                  3.67
                  Average
      cost of deposits105%
                  105%
                  
                  
                  Average
      loan to deposit ratio


(a)
      This table shows the changes in interest income and interest expense for
      the comparative periods based on either changes in average volume or
      changes in average rates for interest-earning assets and interest-bearing
      liabilities.  Changes which are not solely due to rate changes
      or solely due to volume changes are attributed to
  volume.


(b)
      The taxable equivalent adjustment of $32 in 2008 and $156 in 2007 results
      from tax exempt income less non-deductible TEFRA interest
      expense.


(c)
Average nonaccruing loans have been excluded from total average loans and included
innoninterest-earning
assets.






F
- 44
 The
Savannah Bancorp, Inc. - 2008 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations




Table
9 - Average Balance Sheet and Rate/Volume Analysis - 2007 and 2006


The
following table presents average balances of the Company and the Subsidiary
Banks on a consolidated basis, the taxable-equivalent interest earned and the
rate paid thereon during 2007 and 2006.





Taxable-Equivalent
                  
                  (a)
      VarianceAverage
      Balance
                  Average
      Rate
                  
                  Interest
      (b)
                  Vari-
                  Attributable
      to2007
                  2006
                  2007
                  2006
                  
                  2007
                  2006
                  ance
                  Rate
                  Volume($
      in thousands)
                  (%)
                  
                  ($
      in thousands)
                  
                  ($
      in thousands)Assets$   6,958
                  $ 
      5,969
                  4.97
                  4.91
                  Interest-bearing
      deposits
                  $   346
                  $   293
                  $   53
                  $     4
                  $    4956,851
                  48,190
                  5.01
                  4.47
                  Investments
      - taxable
                  2848
                  2,153
                  695
                  260
                  4352,059
                  2,410
                  7.33
                  7.47
                  Investments
      - non-taxable
                  151
                  180
                  (29)
                  (3)
                  (26)9,243
                  11,309
                  5.11
                  4.93
                  Federal
      funds sold
                  472
                  557
                  (85)
                  20
                  (105)1,299
                  7,842
                  7.54
                  7.12
                  Loans
      held for sale
                  98
                  558
                  (460)
                  33
                  (493)754,490
                  658,750
                  7.89
                  7.83
                  Loans
      (c)
                  59,499
                  51,606
                  7,893
                  395
                  7,498830,900
                  734,470
                  7.63
                  7.54
                  Total
      interest-earning assets
                  63,414
                  55,347
                  8,067
                  661
                  7,40638,126
                  35,447
                  
                  
                  Noninterest-earning
      assets$869,026
                  $769,917
                  
                  
                  Total
      assetsLiabilities
      and equityDeposits$114,053
                  $
      95,138
                  2.00
                  1.32
                  NOW
      accounts
                  2,279
                  1,254
                  1,025
                  647
                  37817,831
                  19,104
                  0.99
                  0.99
                  Savings
      accounts
                  176
                  190
                  (14)
                  -
                  (14)167,887
                  135,736
                  4.27
                  3.75
                  Money
      market accounts
                  7,164
                  5,093
                  2,071
                  706
                  1,365131,553
                  105,220
                  5.35
                  4.68
                  CDs,
      $100M or more
                  7,020
                  4,927
                  2,093
                  694
                  1,39974,234
                  81,084
                  4.83
                  3.98
                  CDs,
      broker
                  3,605
                  3,225
                  380
                  714
                  (334)122,752
                  106,093
                  5.03
                  4.39
                  Other
      time deposits
                  6,171
                  4,653
                  1,518
                  679
                  839628,310
                  542,375
                  4.20
                  3.57
                  Total
      interest-bearing deposits
                  26,415
                  19,342
                  7,073
                  3,417
                  3,6567,833
                  15,770
                  5.27
                  4.93
                  FHLB
      advances – long-term
                  413
                  778
                  (365)
                  54
                  (419)52,796
                  36,175
                  4.95
                  4.98
                  Short-term
      borrowings
                  2,612
                  1,802
                  810
                  (11)
                  82110,310
                  10,310
                  8.17
                  7.90
                  Subordinated
      debt
                  842
                  815
                  27
                  28
                  (1)Total
      interest-bearing699,249
                  604,630
                  4.33
                  3.76
                  liabilities
                  30,282
                  22,737
                  7,545
                  3,446
                  4,09991,367
                  96,113
                  
                  
                  Noninterest-bearing
      deposits6,894
                  7,408
                  
                  
                  Other
      liabilities71,516
                  61,766
                  
                  
                  Shareholders'
      equity$869,026
                  $769,917
                  
                  
                  Liabilities
      and equity3.30
                  3.78
                  Interest
      rate spread3.99
                  4.44
                  Net
      interest marginNet
      interest income
                  $ 33,132
                  $ 32,610
                  $
      522
                  $
      (2,785)
                  $ 3,307$131,651
                  $129,840
                  
                  
                  Net
      earning assets$719,677
                  $638,488
                  
                  
                  Average
      deposits3.67
                  3.03
                  Average
      cost of deposits105%
                  103%
                  
                  
                  Average
      loan to deposit ratio


(a)
      This table shows the changes in interest income and interest expense for
      the comparative periods based on either changes in average volume or
      changes in average rates for interest-earning assets and interest-bearing
      liabilities.  Changes which are not solely due to rate changes
      or solely due to volume changes are attributed to
  volume.


(b)
      The taxable equivalent adjustment of $156 in 2007 and $158 in 2006 results
      from tax exempt income less non-deductible TEFRA interest
      expense.


(c)
      Average nonaccruing loans have been excluded from total average loans and
      included in noninterest-earning
assets.




F
- 45


The Savannah Bancorp, Inc. - 2008
Annual Report