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 -
      2Consolidated
      Balance SheetsDecember
      31, 2009 and 2008
                F
      - 3Consolidated
      Statements of Income for the YearsEnded
      December 31, 2009, 2008 and 2007
                F
      - 4Consolidated
      Statements of Changes in Shareholders'Equity
      for the Years Ended December 31, 2009, 2008 and 2007
                F
      - 5Consolidated
      Statements of Cash Flows for the YearsEnded December
      31, 2009, 2008 and 2007
                F
      - 6Notes to
      Consolidated Financial Statements
                F
      - 7Management's
      Discussion and Analysis of FinancialCondition
      and Results of Operations
                F
      - 30Selected
      Five-Year Financial Data -- 2005-2009Selected
      Financial Condition Highlights
                F
      - 30Selected
      Operating Highlights
                F
      - 31Selected
      Quarterly Data
                F
      - 32Market
      for Registrant's Common Equity andRelated
      Shareholder Matters
                F
      - 32Stock
      Performance Graph
                F
      - 33Introduction
                F
      - 34Critical
      Accounting Estimates
                F
      - 35Results
      of Operations2009
      Compared with 2008
                F
      - 392008
      Compared with 2007
                F
      - 40Financial
      Condition and Capital Resources
                F
      - 41Loan
      Concentrations
                F
      - 41Liquidity
      and Interest Rate Sensitivity Management
                F
      - 42Off-Balance
      Sheet Arrangements
                F
      - 43Forward
      Looking Statements
                F
      - 44Cash
      Flow/Maturity Gap and Repricing Data
                F
      - 45Average
      Balance Sheet and Rate/Volume Analysis -- 2009 and
    2008
                F
      - 46Average
      Balance Sheet and Rate/Volume Analysis -- 2008 and
    2007
                F
      - 47








F - 1
 The
Savannah Bancorp, Inc. - 2009 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 subsidiaries as of December 31, 2009 and 2008 and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of  the three years in the period ended December 31,
2009.  These financial statements are the responsibility of the
Company’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, 2009 and 2008 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2009, in conformity with accounting principles generally accepted
in the United States of America.
 
 We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), The Savannah Bancorp, Inc. and its
subsidiaries’ internal control over financial reporting as of December 31, 2009,
based oncriteria
established inInternal
Control - Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) and our report dated
March 15, 2010,expressed an unqualified opinion.
   /s/
Mauldin & Jenkins, LLC






Albany,
Georgia


March 15,
2010


F -
2
 The
Savannah Bancorp, Inc. - 2009 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Balance Sheets


($ in
thousands, except share data)








December
      31,2009
            
            2008AssetsCash
      and due from banks
            $     19,253
            
            $     15,088Federal
      funds sold
            8,575
            
            9,701Interest-bearing
      deposits in banks
            12,707
            
            3,312Cash
      and cash equivalents
            40,535
            
            28,101Securities
      available for sale, at fair value (amortizedcost
      of $86,596 and $79,447)
            87,919
            
            81,619Loans
      held for sale
            -
            
            291Loans,
      net of allowance for loan losses of $17,678
              and
      $13,300
            866,208
            
            851,674Premises
      and equipment, net
            15,574
            
            11,107Other
      real estate owned
            8,329
            
            8,100Bank-owned
      life insurance
            6,434
            
            6,216Goodwill
      and other intangible assets, net
            2,498
            
            2,642Other
      assets
            23,011
            
            17,534Total
      assets
            $
      1,050,508
            
            $
      1,007,284LiabilitiesDeposits:Noninterest-bearing
            $     82,557
            
            $     82,723Interest-bearing
      demand
            143,559
            
            128,965Savings
            16,893
            
            14,370Money
      market
            228,124
            
            199,194Time
      deposits
            413,436
            
            406,763Total
      deposits
            884,569
            
            832,015Short-term
      borrowings
            39,553
            
            55,636Other
      borrowings
            15,988
            
            12,151Federal
      Home Loan Bank advances – long-term
            15,664
            
            10,169Subordinated
      debt to nonconsolidated subsidiaries
            10,310
            
            10,310Other
      liabilities
            5,398
            
            6,071Total
      liabilities
            971,482
            
            926,352Commitments
      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:  shares
authorized20,000,000,
      issued 5,933,789
            5,934
            
            5,934Additional
      paid-in capital
            38,605
            
            38,516Retained
      earnings
            33,383
            
            33,552Treasury
      stock, at cost, 1,443 and 318 shares
            (4)
            
            (4)Accumulated
      other comprehensive income, net
            1,108
            
            2,934Total
      shareholders' equity
            79,026
            
            80,932Total
      liabilities and shareholders' equity
            $
      1,050,508
            
            $
      1,007,284





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




F -
3
 The
Savannah Bancorp, Inc. - 2009 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Statements of Income


($ in
thousands, except per share data)





For
      the Years Ended December 31,2009
            
            2008
            
            2007Interest
      and dividend incomeLoans,
      including fees
            $
      47,081
            
            $
      53,259
            
            $
      59,435Loans
      held for sale
            -
            
            60
            
            98Investment
      securities:Taxable
            3,220
            
            2,803
            
            2,594Tax-exempt
            154
            
            87
            
            95Dividends
            45
            
            191
            
            218Federal
      funds sold
            18
            
            133
            
            472Deposits
      with banks
            45
            
            149
            
            346Total
      interest and dividend income
            50,563
            
            56,682
            
            63,258Interest
      expenseDeposits
            16,454
            
            21,842
            
            26,415Short-term
      and other borrowings
            1,140
            
            1,661
            
            2,612Federal
      Home Loan Bank advances
            302
            
            294
            
            413Subordinated
      debt
            362
            
            642
            
            842Total
      interest expense
            18,258
            
            24,439
            
            30,282Net
      interest income
            32,305
            
            32,243
            
            32,976Provision
      for loan losses
            13,065
            
            6,000
            
            4,675Net
      interest income after provision for loan losses
            19,240
            
            26,243
            
            28,301Noninterest
      incomeTrust
      and asset management fees
            2,351
            
            2,832
            
            1,513Service
      charges on deposit accounts
            1,809
            
            1,881
            
            1,383Mortgage
      related income, net
            432
            
            295
            
            615Other
      operating income
            1,238
            
            1,216
            
            1,242Gain
      on hedges
            873
            
            1,288
            
            -Gain
      on sale of securities
            2,119
            
            163
            
            -Total
      noninterest income
            8,822
            
            7,675
            
            4,753Noninterest
      expenseSalaries
      and employee benefits
            12,146
            
            13,584
            
            11,846Occupancy
      and equipment
            3,716
            
            3,884
            
            3,294FDIC
      deposit insurance
            1,886
            
            653
            
            251Information
      technology
            1,810
            
            1,633
            
            1,616Amortization
      of client list
            144
            
            144
            
            48Loss
      on sale and write-downs of foreclosed assets
            2,566
            
            228
            
            44Other
      operating expense
            4,710
            
            4,616
            
            4,084Total
      noninterest expense
            26,978
            
            24,742
            
            21,183Income
      before income taxes
            1,084
            
            9,176
            
            11,871Income
      tax expense
            155
            
            3,170
            
            4,235Net
      income
            $    929
            
            $   6,006
            
            $   7,636Net
      income per share:Basic
            $
      0.16
            
            $
      1.01
            
            $
      1.31Diluted
            $
      0.16
            
            $
      1.01
            
            $
      1.29Dividends
      per share
            $
      0.185
            
            $
      0.50
            
            $
      0.48Average
      basic shares (000s)
            5,933
            
            5,930
            
            5,850Average
      diluted shares (000s)
            5,936
            
            5,947
            
            5,922


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


F -
4
 The
Savannah Bancorp, Inc. - 2009 Annual Report


The Savannah Bancorp, Inc. and
Subsidiaries


Consolidated
Statements of Changes in Shareholders' Equity


($ in thousands, except share
data)





For
      the Years Ended December 31,2009
            2008
            2007Common
      shares issuedShares,
      beginning of year
            5,933,789
            5,923,797
            5,781,381Common
      stock issued
            -
            6,211
            78,006Exercise
      of options
            -
            3,781
            64,410Shares,
      end of year
            5,933,789
            5,933,789
            5,923,797Treasury
      shares ownedShares,
      beginning of year
            318
            318
            318Unvested
      restricted stock
            1,125
            -
            -Shares,
      end of year
            1,443
            318
            318Common
      stockBalance,
      beginning of year
            $   5,934
            $   5,924
            $   5,781Common
      stock issued
            -
            6
            78Exercise
      of options
            -
            4
            65Balance,
      end of year
            5,934
            5,934
            5,924Additional
      paid-in capitalBalance,
      beginning of year
            38,516
            38,279
            35,747Common
      stock issued, net of issuance costs
            -
            68
            1,702Stock-based
      compensation expense, net
            89
            137
            147Exercise
      of options
            -
            32
            683Balance,
      end of year
            38,605
            38,516
            38,279Retained
      earningsBalance,
      beginning of year
            33,552
            30,512
            25,681Net
      income
            929
            6,006
            7,636Dividends
      paid
            (1,098)
            (2,966)
            (2,805)Balance,
      end of year
            33,383
            33,552
            30,512Treasury
      stockBalance,
      beginning of year
            (4)
            (4)
            (4)Exercise
      of options
            -
            -
            -Balance,
      end of year
            (4)
            (4)
            (4)Accumulated
      other comprehensive income, netBalance,
      beginning of year
            2,934
            1,561
            (631)Change
      in unrealized gains/losses on securitiesavailable
      for sale, net of reclassification adjustment
            (531)
            842
            662Change
      in fair value and gains on termination ofderivative
      instruments, net of tax
            (1,295)
            531
            1,530Balance,
      end of year
            1,108
            2,934
            1,561Total
      shareholders' equity
            $
      79,026
            $
      80,932
            $
      76,272




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




See Note
1 for other comprehensive income disclosures.




F -
5
 The
Savannah Bancorp, Inc. - 2009 Annual Report


The
Savannah Bancorp, Inc. and Subsidiaries


Consolidated
Statements of Cash Flows





For
      the Years Ended December 31,($
      in thousands)
            2009
            2008
            2007Operating
      activitiesNet
      income
            $      929
            $   6,006
            $   7,636Adjustments
      to reconcile net income to cashprovided
      by operating activities:Provision
      for loan losses
            13,065
            6,000
            4,675Loans
      originated for sale
            -
            (10,255)
            (24,834)Proceeds
      from sale of loans originated for sale
            291
            10,202
            25,715Net
      amortization (accretion) of securities
            432
            (95)
            (122)Depreciation
      and amortization
            1,513
            1,383
            1,118Accretion
      of gain on termination of derivatives
            (1,962)
            (2,670)
            -Proceeds
      from termination of derivatives
            1,299
            3,225
            -Non
      cash stock-based compensation expense
            144
            221
            184(Increase)
      decrease in deferred income taxes, net
            (1,748)
            621
            (677)Gain
      on sale of loans and securities, net
            (2,119)
            (221)
            (147)Loss
      on sale and write-downs of foreclosed assets
            2,566
            228
            44Equity
      in net income of nonconsolidated subsidiary
            (43)
            (94)
            (89)Disposition
      of premises and equipment
            305
            -
            -Increase
      in CSV of bank-owned life insurance policies
            (218)
            (231)
            (225)Increase
      in prepaid FDIC deposit insurance assessment
            (5,037)
            -
            -Change
      in other assets and other liabilities, net
            395
            1,209
            3,232Net
      cash provided by operating activities
            9,812
            15,529
            16,510Investing
      activitiesActivity
      in available for sale securitiesPurchases
            (88,741)
            (44,616)
            (29,356)Sales
            62,076
            5,248
            -Maturities,
      calls and paydowns
            21,203
            20,420
            23,400Loan
      originations and principal collections, net
            (35,442)
            (71,955)
            (90,451)Proceeds
      from sale of other real estate owned
            5,048
            3,852
            342Investment
      in low income housing tax credits
            -
            -
            (2,000)Distribution
      from nonconsolidated subsidiary
            -
            350
            -Purchase
      of consolidated subsidiary
            -
            -
            (1,901)Additions
      to premises and equipment
            (6,141)
            (5,516)
            (1,450)Net
      cash used in investing activities
            (41,997)
            (92,217)
            (101,416)Financing
      activitiesNet
      decrease in noninterest-bearing deposits
            (166)
            (5,780)
            (12,653)Net
      increase in interest-bearing deposits
            52,720
            73,577
            70,047Net
      (decrease) increase in short-term borrowings
            (16,083)
            (14,963)
            29,912Net
      increase in other borrowings
            3,837
            12,151
            -Net
      increase (decrease) in FHLB advances – long-term
            5,495
            7,196
            (10,336)Payment
      on note payable
            (86)
            (1,840)
            -Dividends
      paid
            (1,098)
            (2,966)
            (2,805)Exercise
      of options and issuance of common stock
            -
            110
            748Net
      cash provided by financing activities
            44,619
            67,485
            74,913Increase
      (decrease) in cash and cash equivalents
            12,434
            (9,203)
            (9,993)Cash
      and cash equivalents, beginning of year
            28,101
            37,304
            47,297Cash
      and cash equivalents, end of year
            $
      40,535
            $
      28,101
            $
      37,304





Supplemental
      disclosures of cash flow informationCash
      paid during the year for:Interest
      on deposits and other borrowings
            $
      18,826
            $
      25,920
            $
      29,865Income
      taxes
            550
            2,595
            5,560Non
      cash investing activity:Transfer
      to other real estate owned from loans
            (7,843)
            (10,068)
            (1,953)


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




F
- 6
 The
Savannah Bancorp, Inc. - 2009 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”), 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 two 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 bank holding company headquartered in
Savannah, Georgia that owns two banks and a registered investment advisory firm.
The Company has ten banking offices and twelve ATMs in Savannah, Garden City,
Skidaway Island, Whitemarsh Island, Pooler, and Richmond Hill, Georgia and
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 addition, the Company
has a loan production office on St. Simons Island, Georgia.  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 Chatham County
and Bryan County, Georgia and southern Beaufort County in South
Carolina.  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.  Effective September 30, 2009, the Company merged the
charter of Harbourside Community Bank, its wholly-owned subsidiary, into
Savannah.





Use of
Estimates- In
preparing consolidated financial statements in conformity with generally
accepted accounting principles (“GAAP”) in the United States, 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, the valuation of foreclosed
assets, fair value of financial instruments, other-than-temporary impairment
analysis 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.





The
Financial Accounting Standards Board (“FASB”) recently issued accounting
guidance related to the recognition and presentation of other-than-temporary
impairment.  See the “Recent Accounting Pronouncements” section for
additional information.  Prior to the adoption of the recent
accounting guidance on April 1, 2009, management considered, in determining
whether other-than-temporary impairment exists, (1) the length of time and the
extent to which the fair value has been less than cost, (2) the financial
condition and near-term prospects of the issuer, and (3) the intent and ability
of the Company to retain its investment in the issuer for a period of time
sufficient to allow for any anticipated recovery in fair value.





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
- 7
 The
Savannah Bancorp, Inc. - 2009 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.





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.





Allowance for
Loan Losses- 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 or the loan is charged-down 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.




F
- 8
 The
Savannah Bancorp, Inc. - 2009 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 or the asset is
written-down when subsequent valuations are less than current carrying
amounts.  Expenses from operations, changes in the valuation
allowance, write-downs 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 the 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 goodwill and intangible
assets were evaluated for impairment as of August 31, 2009 and based on that
evaluation it was determined that there was no impairment.





Income
Taxes - The income tax accounting guidance results in two components of
income tax expense: current and deferred.  Current income tax expense
reflects taxes to be paid or refunded for the current period by applying the
provisions of the enacted tax law to the taxable income or excess of deductions
over revenues.  The Company determines deferred income taxes using the
liability (or balance sheet) method.  Under this method, the net
deferred tax asset or liability is based on the tax effects of the differences
between the book and tax bases of assets and liabilities, and enacted changes in
tax rates and laws are recognized in the period in which they
occur.





Deferred
income tax expense results from changes in deferred tax assets and liabilities
between periods.  Deferred tax assets are recognized if it is more
likely than not, based on the technical merits, that the tax position will be
realized or sustained upon examination.  The term more likely than not
means a likelihood of more than 50 percent; the terms examined and upon
examination also include resolution of the related appeals or litigation
processes, if any.  A tax position that meets the more-likely-than-not
recognition threshold is initially and subsequently measured as the largest
amount of tax benefit that has a greater than 50 percent likelihood of being
realized upon settlement with a taxing authority that has full knowledge of all
relevant information.  The determination of whether or not a tax
position has met the more-likely-than-not recognition threshold considers the
facts, circumstances, and information available at the reporting date and is
subject to management’s judgment.  Deferred tax assets may be reduced
by deferred tax liabilities and a valuation allowance if, based on the weight of
evidence available, it is more likely than not that some portion or all of a
deferred tax asset will not be realized.





On
January 1, 2009, the Company adopted the recent accounting guidance related to
accounting for uncertainty in income taxes, which sets out a consistent
framework to determine the appropriate level of tax reserves to maintain for
uncertain tax positions.





F
- 9
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





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,
            2009
            2008
            2007Average
      number of common shares outstanding - basic
            5,933
            5,930
            5,850Effect
      of dilutive options
            3
            17
            72Average
      number of common shares outstanding - diluted
            5,936
            5,947
            5,922





Stock
option shares in the amount of 194,814, 192,022 and 102,602 for the years ended
2009, 2008 and 2007, respectively, were excluded from the diluted earnings per
share calculation due to their anti-dilutive effect.





Derivative
Instruments and Hedging Activities – Accounting principles provide the
disclosure requirements for derivatives and hedging activities with the intent
to provide users of financial statements with an enhanced understanding of: (a)
how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows.  Accounting principles require
qualitative disclosures about objectives and strategies for using derivatives,
quantitative disclosures about the fair value of and gains and losses on
derivative instruments, and disclosures about credit-risk-related contingent
features in derivative instruments.





As
required by accounting principles, 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, whether the
Company has elected to designate a derivative in a hedging relationship and
apply hedge accounting and whether the hedging relationship has satisfied the
criteria necessary to apply hedge accounting.  Derivatives designated
and qualifying as a hedge of the exposure to changes in the fair value of an
asset, liability, or firm commitment attributable to a particular risk, such as
interest rate risk, are considered fair value hedges.  Derivatives
designated and qualifying as a hedge of the exposure to variability in expected
future cash flows, or other types of forecasted transactions, are considered
cash flow hedges.  Hedge accounting generally provides for the
matching of the timing of gain or loss recognition on the hedging instrument
with the recognition of the changes in the fair value of the hedged asset or
liability that are attributable to the hedged risk in a fair value hedge or the
earnings effect of the hedged forecasted transactions in a cash flow
hedge.  The Company may enter into derivative contracts that are
intended to economically hedge certain of its risk, even though hedge accounting
does not apply or the Company elects not to apply hedge accounting.





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)
            2009
            2008
            2007Net
      income
            $    929
            $
      6,006
            $
      7,636Change
      in unrealized gains/losses on securitiesavailable
      for sale, net of reclassification adjustment
            (531)
            842
            662Change
      in fair value and gains on termination ofderivative
      instruments, net of tax
            (1,295)
            531
            1,530Other
      comprehensive income (loss)
            $
      (897)
            $
      7,379
            $
      9,828





F
- 10
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





Accounting for
Stock-Based Compensation-Accounting principles require that the compensation cost relating to
share-based payment transactions be recognized in financial
statements.  That cost will be measured based on the grant date fair
value of the equity or liability instruments issued.  The stock
compensation accounting guidance covers a wide range of share-based compensation
arrangements including stock options, restricted share plans, performance-based
awards, share appreciation rights, and employee share purchase
plans.





The stock
compensation accounting guidance requires that compensation cost for all stock
awards be calculated and recognized over the employees’ service period,
generally defined as the vesting period.  For awards with
graded-vesting, compensation cost is recognized on a straight-line basis over
the requisite service period for the entire award.  A Black-Scholes
model is used to estimate the fair value of stock options, while the market
price of the Company’s common stock at the date of grant is used for restricted
stock awards and stock grants.





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, 2009 under the 2005 Omnibus Plan
was 128,980 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)
            2009
            2008
            2007Salaries
      and employee benefits
            $  94
            $
      189
            $
      143Directors'
      stock-based compensation
            50
            32
            41Pre-tax
      stock-based compensation expense
            144
            221
            184Income
      tax benefit
            (55)
            (84)
            (37)Total
      stock-based compensation expense, net of tax
            $  89
            $
      137
            $
      147





During
2009 and 2008 no income tax benefits were realized on stock option
exercises.  In 2007, the Company realized $15,000 in income tax
benefit associated with certain stock option exercises.





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, 2009 is approximately $196,000.  The weighted-average
period of time over which this cost will be recognized is approximately 2.8
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 fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions.





2009
            2008
            2007Weighted
      average fair value of options granted
            $
      1.87
            $
      4.29
            $
      7.71Expected
      volatility
            39.1%
            31.4%
            28.6%Dividend
      yield
            2.67%
            2.87%
            1.90%Risk-free
      interest rate
            1.82%
            2.48%
            4.92%Expected
      life
            6.0
      years
            6.0
      years
            6.0
      years





F
- 11
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





Risks and
Uncertainties-In the normal course of its business, the Company encounters two
significant types of risk: economic and regulatory.  There are three
main components of economic risk: interest rate risk, credit risk and market
risk. The Company is 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 the 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 and the
valuation of other real estate owned, investment securities available for sale
and mortgage servicing rights.





The
Company is subject to the regulations of various government
agencies.  These regulations can and do change significantly from
period to period.  The Company also undergoes periodic examinations by
the regulatory agencies, which may subject the Company 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





Effective
July 1, 2009, the Company adopted a new accounting guidance related to U.S. GAAP
[FASB Accounting Standards Codification (“ASC”) 105, Generally Accepted Accounting
Principles].  This guidance establishes FASB ASC as the source
of authoritative U.S. GAAP recognized by FASB to be applied by nongovernmental
entities.  Rules and interpretive releases of the Securities and
Exchange Commission (“SEC”) under authority of federal securities laws are also
sources of authoritative U.S. GAAP for SEC registrants.  FASB ASC
supersedes all existing non-SEC accounting and reporting
standards.  All other nongrandfathered, non-SEC accounting literature
not included in the ASC has become nonauthoritative.  FASB will no
longer issue new standards in the form of Statements, FASB Staff Positions, or
Emerging Issues Task Force Abstracts.  Instead, it will issue
Accounting Standards Updates (“ASU”), which will serve to update the ASC,
provide background information about the guidance, and provide the basis for
conclusions on the changes to the ASC.  The ASC is not intended to
change U.S. GAAP or any requirements of the SEC.  This guidance is
effective for the Company as of December 31, 2009.





Effective
April 1, 2009, the Company adopted new accounting guidance related to
recognition and presentation of other-than-temporary impairment (ASC
320-10).  This recent accounting guidance amends the recognition
guidance for other-than-temporary impairments of debt securities and expands the
financial statement disclosures for other-than-temporary impairment losses on
debt and equity securities.  The recent guidance replaced the “intent
and ability” indication in current guidance by specifying that (a) if a company
does not have the intent to sell a debt security prior to recovery and (b) it is
more likely than not that it will not have to sell the debt security prior to
recovery, the security would not be considered other-than-temporarily impaired
unless there is a credit loss.  When an entity does not intend to sell
the security, and it is more likely than not, the entity will not have to sell
the security before recovery of its cost basis, it will recognize the credit
component of an other-than-temporary impairment of a debt security in earnings
and the remaining portion in other comprehensive income.  For
held-to-maturity debt securities, the amount of an other-than-temporary
impairment recorded in other comprehensive income for the noncredit portion of a
previous other-than-temporary impairment should be amortized prospectively over
the remaining life of the security on the basis of the timing of future
estimated cash flows of the security.





The
Company adopted accounting guidance related to fair value measurements and
disclosures (ASC 820, Fair
Value Measurements and Disclosures).  This guidance defines
fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements.  This guidance establishes
a fair value hierarchy about the assumptions used to measure fair value and
clarifies assumptions about risk and the effect of a restriction on the sale or
use of an asset.  The effect of adoption was not
material.





FASB
issued ASU 2009-05 (ASC 820) which describes the valuation techniques companies
should use to measure the fair value of liabilities for which there is limited
observable market data.  If a quoted price in an active market is not
available for an identical liability, an entity should use one of the following
approaches: (1) the quoted price of the identical liability when traded as an
asset, (2) quoted prices for similar liabilities or similar liabilities
when





F
- 12
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





traded as
an asset, or (3) another valuation technique that is consistent with the
accounting guidance in the ASC for fair value measurements and
disclosures.  When measuring the fair value of liabilities, this
guidance reiterates that companies should apply valuation techniques that
maximize the use of relevant observable inputs, which is consistent with
existing accounting provisions for fair value measurements.  In
addition, this guidance clarifies when an entity should adjust quoted prices of
identical or similar assets that are used to estimate the fair value of
liabilities.  This guidance is effective as of December 31, 2009 with
adoption applied prospectively.





In
addition, the following accounting pronouncement was issued by FASB, but is not
yet effective:





FASB
issued accounting guidance (FASB Statement No. 166) which modifies certain
guidance contained in the Transfers and Servicing topic
of the ASC (ASC 860).  This standard eliminates the concept of
qualifying special purpose entities, provides guidance as to when a portion of a
transferred financial asset can be evaluated for sale accounting, provides
additional guidance with regard to accounting for transfers of financial assets,
and requires additional disclosures.  This guidance is effective for
the Company as of January 1, 2010, with adoption applied prospectively for
transfers that occur on or after the effective date.








Note
2 - 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 $339,000 and $507,000 are required
as of December 31, 2009 and 2008, respectively.  The Company pledges
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
are $11,500,000 and $2,000,000 at December 31, 2009 and 2008,
respectively.








Note
3 - Securities Available for Sale





The
aggregate amortized cost and fair value of securities available for sale as of
December 31, 2009 and 2008 are as follows:





2009($
      in thousands)
            Amortized
            Unrealized
            Unrealized
            FairCost
            Gains
            Losses
            ValueInvestment
      securities:U.S.
      government-sponsored enterprises (“GSE”)
            $   1,727
            $    136
            $         -
            $   1,863Mortgage-backed
      securities - GSE
            73,203
            1,205
            (120)
            74,288State
      and municipal securities
            7,906
            108
            (6)
            8,008Restricted
      equity securities
            3,760
            -
            -
            3,760Total
      investment securities
            $
      86,596
            $
      1,449
            $
      (126)
            $
      87,9192008($
      in thousands)
            Amortized
            Unrealized
            Unrealized
            FairCost
            Gains
            Losses
            ValueInvestment
      securities:U.S.
      government-sponsored enterprises
            $
      17,417
            $    828
            $    -
            $
      18,245Mortgage-backed
      securities - GSE
            55,597
            1,220
            (4)
            56,813State
      and municipal securities
            2,719
            128
            -
            2,847Restricted
      equity securities
            3,714
            -
            -
            3,714Total
      investment securities
            $
      79,447
            $
      2,176
            $
      (4)
            $
      81,619




F
- 13
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
3 - Securities Available for Sale (continued)





The
distribution of securities by contractual maturity at December 31, 2009 is shown
below.  Actual maturities may differ from contractual maturities
because issuers may have the right to call or prepay obligations with or without
call or prepayment penalties.





($
      in thousands)
            Amortized
              Cost
            Fair
      ValueSecurities
      available for sale:Due
      in one year or less
            $           -
            $           -Due
      after one year through five years
            1,920
            2,001Due
      after five years through ten years
            1,999
            2,089Due
      after ten years
            5,714
            5,781Mortgage-backed
      securities
            73,203
            74,288Restricted
      equity securities
            3,760
            3,760Total
      investment securities
            $
      86,596
            $
      87,919





At
December 31, 2009 and 2008, investment securities with a carrying value of
$60,260,000 and $58,205,000, respectively, are pledged as collateral to secure
public funds, securities sold under repurchase agreements and FHLB
borrowings.





Gains and
losses on sales of securities available for sale consist of the following for
the years ended December 31:





($
      in thousands)
            2009
            2008
            2007Gross
      gains
            $
      2,170
            $
      163
            $   -Gross
      losses
            (51)
            -
            -Net
      realized gains
            $
      2,119
            $
      163
            $   -





The
restricted equity securities consist of the following at December
31:





($
      in thousands)
            2009
            2008FHLB
      stock
            $
      3,205
            $
      3,159FRB
      stock
            555
            555Total
            $
      3,760
            $
      3,714





The
unrealized losses on the Company’s investment in GSE mortgage-backed securities
were caused by interest rate increases.  The Company purchased those
investments at a premium relative to their face amount, and the contractual cash
flows of those investments are guaranteed by an agency of the U.S.
Government.  Accordingly, it is expected that the securities would not
be settled at a price less than the amortized cost bases of the Company’s
investments.  Because the decline in market value is attributable to
changes in interest rates and not credit quality, and because the Company does
not intend to sell the investments and it is not more likely than not that the
Company will be required to sell the investments before recovery of their
amortized cost bases, which may be maturity, the Company does not consider those
investments to be other-than-temporarily impaired at December 31,
2009.





F
- 14
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note 4 -
Loans





The
composition of the loan portfolio at December 31, 2009 and 2008 is presented
below:





($
      in thousands)
            
            Percent
            
            Percent2009
            of
      Total
            2008
            of
      TotalCommercial
            $   89,380
            10.1%
            $   81,396
            9.5%Real
      estate - construction and development
            61,476
            7.0
            99,809
            11.5Real
      estate - mortgage
            718,060
            81.2
            666,075
            77.0Installment
      and other consumer
            14,970
            1.7
            17,694
            2.0Gross
      loans
            883,886
            100.0%
            864,974
            100.0%Allowance
      for loan losses
            (17,678)
            
            (13,300)Net
      loans
            $
      866,208
            
            $
      851,674





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





($
      in thousands)
            2009
            2008
            2007Balance,
      beginning of year
            $
      13,300
            $
      12,864
            $   8,954Provision
      for loan losses
            13,065
            6,000
            4,675Charge-offs
            (8,893)
            (5,714)
            (874)Recoveries
            206
            150
            109Balance,
      end of year
            $
      17,678
            $
      13,300
            $
      12,864





A loan is
considered impaired, in accordance with the impairment accounting guidance, when
based on current information and events, it is probable that the Company will be
unable to collect all amounts due from the borrower in accordance with the
contractual term of the loan.  Impaired loans include loans modified
in troubled debt restructurings where concessions have been granted to borrowers
experiencing financial difficulties.  These concessions could include
a reduction in the interest rate on the loan, payment extensions, forgiveness of
principal, forbearance or other actions intended to maximize
collection.





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





($
      in thousands)
            2009
            2008Impaired
      loans without a valuation allowance
            $
      15,887
            $
      19,289Impaired
      loans with a valuation allowance
            38,167
            18,441Total
      impaired loans
            $
      54,054
            $
      37,730Valuation
      allowance related to impaired loans
            $   6,129
            $   2,796Average
      investment in impaired loans
            $
      45,892
            $
      26,197Interest
      income recognized on impaired loans
            $      957
            $      659





Impaired
loans with a valuation allowance include pools of impaired loans.  At
December 31, 2009 and 2008, loans on nonaccrual status amounted to approximately
$32,545,000 and $26,277,000, respectively, and loans past due 90 days or more
and still accruing interest were $1,570,000 and $1,326,000,
respectively.





The
Company has granted loans to certain directors and executive officers of the
Company and to their related interests.  The aggregate amount of loans
was $37,933,000 and $31,325,000 at December 31, 2009 and 2008,
respectively.  During 2009, new loans of $16,292,000 were made and
repayments of $9,484,000 were received.  Also, related party loan
totals decreased by an additional $200,000 during 2009 due to changes in related
party status.  Unfunded commitments of credit available to related
parties aggregated $2,515,000 and $4,295,000 at December 31, 2009 and 2008,
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
- 15
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
5 - Premises and Equipment





Premises
and equipment at December 31, 2009 and 2008 are summarized as
follows:





($
      in thousands)
            Depreciable
      Lives
            2009
            2008Land
            -
            $   2,635
            $   2,635Buildings
      and improvements
            5 -
      50
            11,334
            5,361Furniture
      and banking equipment
            3 -
      15
            7,637
            7,420Leasehold
      improvements
            5 -
      32
            1,710
            2,277Total
      cost
            
            23,316
            17,693Less
      accumulated depreciation and
              amortization
            
            7,742
            6,586Premises
      and equipment, net
            
            $
      15,574
            $
      11,107





Depreciation
expense was $1,369,000, $1,239,000, and $1,070,000 for the years ended December
31, 2009, 2008 and 2007, respectively.  In 2009, buildings and
improvements includes approximately $5.7 million for the purchase of the
Company’s previously leased building on Hilton Head Island.








Note
6 - Other Real Estate Owned





Other
real estate owned at December 31, 2009 and 2008 is summarized as
follows:





($
      in thousands)
            2009
            2008Balance,
      beginning of year
            $  8,100
            $  2,112Additions
            7,843
            10,068Disposals
            (6,772)
            (3,994)Additional
      write-downs
            (842)
            (86)Balance,
      end of year
            $  8,329
            $  8,100








Note
7 - Deposits





The
aggregate amount of time deposits in denominations of $100,000 or more at
December 31, 2009 and 2008 is $261,795,000 and $204,650,000,
respectively.  At December 31, 2009, brokered time deposits mature as
follows: 2010 - $100,252,000; 2011 - $1,874,000; and 2012 -
$387,000.  Additionally, $69,368,000 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.





The
scheduled maturities of time deposits at December 31, 2009 are as
follows:





($
      in thousands)
            Total2010
            $
      368,3832011
            23,9112012
            7,0832013
            2,7812014
      and thereafter
            11,278Total
            $
      413,436





F
- 16
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
8 - Short-Term Borrowings





Short-term
borrowings at December 31, 2009 and 2008 consist of federal funds purchased,
securities sold under agreements to repurchase, and FHLB and FRB short-term
advances:





($
      in thousands)
            Federal
      Funds
              Purchased
            Securities
              Sold
      Under
              Repurchase
              Agreements
            FHLB
              and
      FRB
              Short-Term
              Advances2009Balance
      at December 31
            $
      1,320
            $
      12,233
            $
      26,000Maximum
      indebtedness at any month end
            3,247
            18,459
            34,000Daily
      average indebtedness outstanding
            1,045
            14,835
            18,496Average
      rate paid for the year
            0.34%
            0.53%
            0.75%Average
      rate paid on period-end borrowings
            0.20%
            0.50%
            0.41%2008Balance
      at December 31
            $
      2,066
            $
      20,520
            $
      33,050Maximum
      indebtedness at any month end
            2,066
            27,137
            71,000Daily
      average indebtedness outstanding
            1,322
            22,656
            40,852Average
      rate paid for the year
            2.23%
            1.76%
            2.61%Average
      rate paid on period-end borrowings
            0.69%
            0.50%
            1.11%





The
maximum amount of short-term borrowings outstanding at the end of any month was
$52,819,000 and $94,266,000 during 2009 and 2008, respectively.  At
December 31, 2009, federal funds borrowingarrangements aggregating
$­29,000,000 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.  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. The Subsidiary
Banks were approved by the FRB under the borrower-in-custody of collateral
(“BIC”) arrangement. This temporary liquidity arrangement allows collateral to
be maintained at the Subsidiary Banks rather than being delivered to the FRB or
a third party custodian.  At December 31, 2009, the Company had
secured borrowing capacity of $83.8 million with the FRB and $10.0 million
outstanding.








Note
9 - Other Borrowings





Other
borrowings consist of a note payable due to related parties (directors) of
$15,988,000.  The proceeds were used to fund SAVB
Holdings.  Principal payments are due monthly based on repayments,
sales, charge-offs or other activity in the assets held by SAVB
Holdings.  At December 31, 2009, interest is at prime plus two percent
with a floor of 7.5 percent and is due monthly.  The note requires a
cumulative remaining principal pay down of $1.7 million by September 30, 2010
and $5.5 million by September 30, 2011, with all indebtedness due and payable by
September 30, 2012.  The agreement includes customary performance
covenants and a guarantee of the Company.  One of the covenants is
that the Company’s dividend payout ratio will not exceed 50 percent on a
quarterly basis.





F
- 17
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
10 - Federal Home Loan Advances – Long-Term





Convertible Advances - The
Company had convertible fixed rate advances of $10,000,000 at December 31, 2009
and 2008.  The weighted-average interest rates on convertible advances
were 2.26 percent at December 31, 2009 and 2008.  The advances mature
in 2018 and 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 $5,664,000 and $169,000 at December 31,
2009 and 2008, respectively.  The weighted-average interest rates on
the long-term advances were 1.95 and 0.50 percent at December 31, 2009 and 2008,
respectively.  Aggregate maturities are $2,000,000 in 2011, $3,500,000
in 2012 and $164,000 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 pledged
certain 1-4 family first mortgage loans, commercial real estate loans, home
equity lines of credit and second mortgage residential loans.  The
Subsidiary Banks’ individual borrowing limits range from 20 to 25 percent of
assets.  In aggregate, the Subsidiary Banks had secured borrowing
capacity of approximately $122.9 million of which $31.7 million was advanced at
December 31, 2009.  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, 2009, the interest rates on
the securities were 3.13 and 2.45 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)
            2009
            2008
            2007Current
      federal
            $
      1,861
            $
      2,757
            $
      5,355Current
      state
            42
            310
            418Total
      current
            1,903
            3,067
            5,773Deferred
      federal
            (1,417)
            88
            (1,364)Deferred
      state
            (331)
            15
            (174)Total
      deferred
            (1,748)
            103
            (1,538)Income
      tax expense
            $   155
            $
      3,170
            $
      4,235





Investments
in federal and state low-income housing tax credit partnerships reduced federal
and state income tax expense approximately $113,000, $145,000 and $265,000 in
2009, 2008 and 2007, respectively.




F
- 18
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements
 
 Note
12 - Income Taxes (continued)





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)
            2009
            2008
            2007Tax
      provision at 34%
            $
      369
            $
      3,120
            $
      4,036State
      tax, net of federal tax benefit
            46
            196
            212Benefit
      of tax-exempt income, net
            (141)
            (127)
            (121)Other
            (119)
            (19)
            108Income
      tax expense
            $
      155
            $
      3,170
            $
      4,235





Deferred
income tax assets and liabilities are comprised of the following at December 31,
2009 and 2008:





($
      in thousands)
            2009
            2008Deferred
      tax assets:Allowance
      for loan losses
            $
      6,455
            $
      4,947Tax-deductible
      goodwill
            741
            800Write-down
      of foreclosed assets
            319
            -Unamortized
      loan fees
            179
            193Unamortized
      non-compete costs
            23
            28Deferred
      compensation expense
            452
            397Stock-compensation
      expense
            114
            76Other
            84
            184Total
      deferred tax assets
            8,367
            6,625Deferred
      tax liabilities:Depreciation
            616
            460Unrealized
      gains on securities
            502
            821Deferred
      costs on loans and deposits
            129
            187Unrealized
      gains on derivatives
            177
            970Other
            16
            120Total
      deferred tax liabilities
            1,440
            2,558Net
      deferred tax assets
            $
      6,927
            $
      4,067





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
128,980 authorized option shares remaining under the 2005 Omnibus Plan at
December 31, 2009.  The options granted in the chart below generally
vest 20 percent each year over five years and are exercisable over ten years
except for 51,870 option shares granted to directors 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
- 19
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





Changes
in stock options outstanding for the years ended December 31, 2009, 2008 and
2007 are as follows.





2009
            2008
            2007Shares
            Weighted
              Average
              Exercise
              Price
            Shares
            Weighted
              Average
              Exercise
              Price
            Shares
            Weighted
              Average
              Exercise
              PriceOutstanding
      at beginningof
      year
            192,022
            $
      18.28
            210,484
            $
      17.76
            271,230
            $
      15.58Granted
            19,291
            8.74
            9,850
            17.44
            24,733
            25.39Exercised
            -
            -
            (3,781)
            10.23
            (64,410)
            11.63Forfeited
            (16,499)
            21.12
            (24,531)
            14.72
            (21,069)
            5.52Outstanding
      at end of year
            194,814
            $
      17.09
            192,022
            $
      18.28
            210,484
            $
      17.76Exercisable
      at end of year
            175,625
            $
      16.75
            150,307
            $
      17.30
            148,013
            $
      16.30





At
December 31, 2009, there is no aggregate intrinsic value for the outstanding or
exercisable stock options.





Options
outstanding at December 31, 2009 are as follows:





Outstanding
            ExercisableOutstanding
      Common Options
            Remaining
      Contractual
              Number
            Weighted
              Average
              Life
            Weighted
              Average
              Price
            Number
            Weighted
              Average
              PriceRange
      of exercise prices$8.74
      - $12.00
            40,088
            4.87
            $   9.44
            35,274
            $   9.54$12.01
      - $15.00
            20,622
            2.54
            13.02
            20,622
            13.02$15.01
      - $20.00
            76,240
            4.61
            16.83
            76,250
            16.83$20.01
      - $25.00
            33,405
            5.14
            22.32
            28,030
            22.35$25.00
      - $28.56
            24,449
            6.98
            26.76
            15,449
            27.60Total
      outstanding
            194,814
            4.83
            $
      17.09
            175,625
            $
      16.75





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 2009 and 2008, 1,500 shares did not vest or were
forfeited.  Unrecognized compensation cost for restricted stock awards
was $189,000 at December 31, 2009.





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 $290,000, $339,000 and $354,000 for the years
ended December 31, 2009, 2008 and 2007, 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
- 20
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
14 - Capital Ratios and Dividend Restrictions (continued)





As of
December 31, 2009, 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 Community Bank (“Harbourside”) was
consolidated with Savannah in 2009.  In prior years Harbourside was a
separately chartered institution.





Banking
regulations restrict the amount of cash dividends that banks may pay without
obtaining regulatory approval.  At December 31, 2009, approximately
$6.8 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.





Management
believes that the Company and the Subsidiary Banks meet all capital adequacy
requirements to which they are subject as of December 31, 2009.  The
following tables show the capital amounts and ratios for the Company and the
Subsidiary Banks at December 31, 2009 and 2008:





($
      in thousands)
            Company
            
            Savannah
            
            Bryan2009
            
            2008
            
            2009
            
            2008
            
            2009
            
            2008Qualifying CapitalTier
      1 capital
            $
      85,420
            
            $
      85,356
            
            $
      60,461
            
            $
      54,665
            
            $
      21,672
            
            $
      20,553Total
      capital
            95,880
            
            95,767
            
            68,061
            
            61,434
            
            24,255
            
            23,176Leverage RatiosTier
      1 capital to average assets
            8.25%
            
            8.63%
            
            7.93%
            
            8.39%
            
            8.57%
            
            8.62%Risk-based RatiosTier
      1 capital to risk-weighted assets
            10.30%
            
            10.28%
            
            10.02%
            
            10.13%
            
            10.57%
            
            9.80%Total
      capital to risk-weighted assets
            11.56%
            
            11.54%
            
            11.28%
            
            11.38%
            
            11.83%
            
            11.05%








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%








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: 2010 -
$597,000; 2011 - $849,000; 2012 - $752,000; 2013 - $640,000; 2014 and thereafter
is $3,247,000.  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.  Future minimum payments due under the Company’s
long-term data processing contract are as follows: 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 $636,000 in
2009, $1,452,000 in 2008 and $1,169,000 in 2007.  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
- 21
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
16 - Other Operating Expense





The
components of other operating expense for the years ended December 31, 2009,
2008 and 2007 are as follows:





($
      in thousands)
            2009
            2008
            2007Professional
      and directors fees
            $
      1,114
            $   957
            $   854Loan
      costs
            1,107
            605
            209Regulatory
      assessments and audit fees
            592
            536
            625Postage
      and courier
            310
            321
            277Stationery
      and supplies
            253
            332
            300Taxes
      and licenses
            244
            237
            203Advertising
      and sales promotion
            233
            425
            433Telephone
            175
            209
            203Dues
      and subscriptions
            115
            135
            116Insurance
            95
            65
            77Correspondent
      bank charges
            50
            101
            123Other
      expense
            422
            693
            664Total
      other operating expense
            $
      4,710
            $
      4,616
            $
      4,084








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





Risk
Management Objective of Using Derivatives





The
Company is exposed to certain risks arising from both its business operations
and economic conditions.  The Company principally manages its
exposures to a wide variety of business and operational risks through management
of its core business activities. The Company manages economic risks, including
interest rate, liquidity, and credit risk, primarily by managing the amount,
sources, and duration of its assets and liabilities and through the use of
derivative financial instruments.  Specifically, the Company enters
into derivative financial instruments to manage exposures that arise from
business activities that result in the receipt or payment of future known and
uncertain cash amounts, the value of which are determined by interest
rates.  The Company’s derivative financial instruments are used to
manage differences in the amount, timing, and duration of the Company’s known or
expected cash receipts principally related to certain variable rate loan
assets.





Fair
Values of Derivative Instruments on the Balance Sheet





The table
below presents the fair value of the Company’s derivative financial instruments
at December 31:





2009
            
            2008Fair
      Value
            
            Fair
      Value($
      in thousands)
            
            
            Asset
            Liability
            
            Asset
            LiabilityDerivatives
      designated as hedging instruments:Interest
      rate products
            
            
            $    -
            $    -
            
            $    922
            $    -Derivatives
      not designated as hedging instruments:Interest
      rate products
            
            
            32
            20
            
            553
            -Total
            
            
            $
      32
            $
      20
            
            $
      1,475
            $    -





F
- 22
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





Cash
Flow Hedges of Interest Rate Risk





The
Company’s objectives in using interest rate derivatives are to add stability to
interest income and expense and to manage its exposure to interest rate
movements. To accomplish this objective, the Company has historically used
interest rate swaps, collars, and floors as part of its interest rate risk
management strategy.  Interest rate swaps designated as cash flow
hedges involve the receipt of variable amounts from a counterparty in exchange
for the Company making fixed payments over the life of the agreements without
exchange of the underlying notional amount.  Interest rate collars
designated as cash flow hedges involve the receipt of variable-rate amounts from
a counterparty if interest rates fall below the strike rate on the purchased
floor and the payment of variable-rate amounts if interest rates rise above the
cap rate on the sold floor.  Interest rate floors designated as cash
flow hedges involve the receipt of variable-rate amounts from a counterparty if
interest rates fall below the strike rate on the contract in exchange for an up
front premium.  As of December 31, 2009 the Company had no outstanding
derivatives that were designated as cash flow hedging
relationships.





During
the year ended December 31, 2009, the Company had a $40 million interest rate
collar which was used to hedge the cash inflows associated with then-existing
pools of Prime-based loan assets.  This interest rate collar hedging
the Company’s variable cash inflows associated with Prime-based loan pools
failed to qualify for hedge accounting due to the mismatch in the collar
notional and designated loan principal; accordingly, all changes in fair value
of the collars from the date of failure through the date of termination were
recorded directly in earnings.  Refer to amounts disclosed under the
sections entitled “Derivatives Not Designated as Hedging Instruments” throughout
this footnote.  No hedge ineffectiveness was recognized during the
year ended December 31, 2009.





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.  During 2010, the Company estimates
that $464,000 will be reclassified as an increase to interest
income.  During the twelve months ended December 31, 2009, the Company
accelerated the reclassification of amounts in other comprehensive income to
earnings as a result of a portion of the hedged forecasted transactions related
to the Company’s interest rate swaps, collars and interest rate floor becoming
probable not to occur.  The accelerated amount for the twelve months
ended December 31, 2009 was a gain of $794,000.





Effect
of Derivative Instruments on the Income Statement





The table
below presents the effect of the Company’s derivative financial instruments on
the income statement for the twelve months ended December 31, 2009 ($ in
thousands):





Cash
      Flow Hedging Relationships
            Gain
      Recognized in OCI on Derivative (Effective Portion)
            
            Location
      of Gain Reclassified from Accumulated OCI into Income (Effective
      Portion)
            Gain
      Reclassified from Accumulated OCI into Income (Effective
      Portion)Interest
      Rate Products
            $    -
            
            Interest
      income
            $
      1,205Noninterest
      income
            794Total
            $    -
            
            
            $
      1,999





In the
first quarter of 2009, the Company terminated a $15 million interest rate collar
position for net proceeds of $512,000.  In April 2009, the Company
terminated a $25 million interest rate collar position for net proceeds of
$787,000.  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.




F
- 23
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements
 
 Note
17 - On-Balance Sheet Derivative Instruments and Hedging Activities
(continued)





Non-designated
Hedges





The
Company does not use derivatives for trading or speculative
purposes.  Derivatives not designated as hedges are used to manage the
Company’s exposure to interest rate movements and other identified risks but do
not meet the strict hedge accounting requirements.  Changes in the
fair value of derivatives not designated in hedging relationships are recorded
directly in earnings.  As noted under “Cash Flow Hedges of Interest
Rate Risk,” collars hedging the Company’s variable cash inflows associated with
Prime-based loans disqualified for hedge accounting as of December 31, 2008 and
March 31, 2009; accordingly, the changes in fair value of the collars were
subsequently recognized directly in earnings through the date of
termination.  The Company recognized a loss of $10,000 relating to the
changes in fair value of these interest rate collars during the year ended
December 31, 2009.





As of
December 31, 2009 none of the Company’s outstanding derivatives are designated
in qualifying hedging relationships.  Derivatives not designated as
hedges are not speculative and result from a service the Company provides to
certain customers.  The Company executes interest rate swaps with
commercial banking customers to facilitate their respective risk management
strategies.  Those interest rate swaps are simultaneously hedged by
executing offsetting interest rate swaps that the Company executes with a third
party, such that the Company minimizes its net risk exposure resulting from such
transactions.  As the interest rate swaps associated with this program
do not meet the strict hedge accounting requirements, changes in the fair value
of both the customer swaps and the offsetting swaps are recognized directly in
earnings.  As of December 31, 2009, the Company had two interest rate
swaps with an aggregate notional amount of $5,347,625 related to this
program.  During the year ended December 31, 2009, the Company
recognized a net gain of $12,000 related to changes in fair value of these
swaps.





Credit-risk-related
Contingent Features





The
Company has an agreement with one of its derivative counterparties that contains
a provision where if the Company defaults on any of its indebtedness,
including default where repayment of the indebtedness has not been
accelerated by the lender, then the Company could also be declared in
default on its derivative obligations.





As of
December 31, 2009 the fair value of derivatives in a net liability position,
which includes accrued interest but excludes any adjustment for nonperformance
risk, related to these agreements was $10,000.  As of December 31,
2009, the Company has minimum collateral posting thresholds with certain of its
derivative counterparties and has posted collateral of $54,000 against its
obligations under these agreements.  If the Company had breached any
of these provisions at December 31, 2009, it would have been required to settle
its obligations under the agreements at the termination value.








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 in excess of the
amount recognized in the balance sheets.  The majority of all
commitments to extend credit and standby letters of credit are variable rate
instruments.





The
Company's exposure to credit losses is represented by the contractual amounts of
those instruments.  The Company uses the same credit policies in
making commitments and conditional obligations as it does for on-balance sheet
instruments.





F
- 24
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





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





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, 2009 and 2008 unfunded
commitments to extend credit and unfunded lines of credit were $87,480,000 and
$118,088,000, of which some were subject to interest rate lock
commitments.  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 amount of collateral obtained
by the Company upon extension of credit, if deemed necessary, is based on
management's credit evaluation of the customer.  Collateral may
include cash, securities, accounts receivable, inventory, equipment, and real
estate.





Letters
of credit are conditional commitments issued by the Company to guarantee the
performance of a customer to a third party.  The letters of credit are
primarily issued to support public and private borrowing
arrangements.  At December 31, 2009 and 2008, commitments under
letters of credit aggregated approximately $2,175,000 and $7,733,000,
respectively.








Note
19 - Fair Value of Financial Instruments





Determination
of Fair Value





The
Company uses fair value measurements to record fair value adjustments to certain
assets and liabilities and to determine fair value disclosures.  In
accordance with the accounting standards for fair value measurements and
disclosure, the fair value of a financial instrument is the price that would be
received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date.  Fair
value is best determined based upon quoted market prices.  However, in
many instances, there are no quoted market prices for the Company’s various
financial instruments.  In cases where quoted market prices are not
available, fair values are based on estimates using present value or other
valuation techniques.  Those techniques are significantly affected by
the assumptions used, including the discount rate and estimates of future cash
flows.  Accordingly, the fair value estimates may not be realized in
an immediate settlement of the instrument.





The
recent fair value guidance provides a consistent definition of fair value, which
focuses on exit price in an orderly transaction (that is, not a forced
liquidation or distressed sale) between market participants at the measurement
date under current market conditions.  If there has been a significant
decrease in the volume and level of activity for the asset or liability, a
change in valuation technique or the use of multiple valuation techniques may be
appropriate.  In such instances, determining the price at which
willing market participants would transact at the measurement date under current
market conditions depends on the facts and circumstances and requires the use of
significant judgment.  The fair value is a reasonable point within the
range that is most representative of fair value under current market
conditions.





In
accordance with this guidance, the Company groups its financial assets and
financial liabilities generally measured at fair value in three levels, based on
the markets in which the assets and liabilities are traded and the reliability
of the assumptions used to determine 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 are supported by little or no market
activity for the asset or liability.  Level 3 assets and liabilities
include financial instruments whose value is determined using pricing models,
discounted cash flow methodologies, or similar techniques, as well as
instruments for which determination of fair value requires significant
management judgment or estimation.




F
- 25
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
19 - Fair Value of Financial Instruments (continued)





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 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.





Derivative instruments: Our
derivative instruments consist of loan level swaps.  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 on a recurring basis are summarized below
as of December 31:





Fair
      Value Measurements at December 31, 2009 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
            $
      87,919
            $        -
            $
      84,159
            $
      3,760Derivative
      asset positions
            32
            -
            32
            -Derivative
      liability positions
            20
            -
            20
            -





Carrying
            Fair
      Value Measurements at December 31, 2008 Using($
      in thousands)
            Value
            Level
      1
            Level
      2
            Level
      3Investment
      securities
            $
      81,619
            $        -
            $
      77,905
            $
      3,714Loans
      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 and other real estate
owned (“OREO”):  Impaired loans and OREO are evaluated and
valued at the time the loan or OREO 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 for impaired loans 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 and OREO are reviewed and evaluated on
at least a quarterly basis for additional impairment and adjusted accordingly,
based on the same factors identified above.  Impaired loans measured
on a nonrecurring basis do not include pools of impaired loans.




F
- 26
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
19 - Fair Value of Financial Instruments (continued)





Assets
and liabilities with an impairment charge during the current year and measured
at fair value on a nonrecurring basis are summarized below as of December
31:





Carrying
      Values at December 31,
      2009($
      in thousands)
            Total
            Level
      1
            Level
      2
            Level
      3
            Total
              gain
      (loss)Impaired
      loans
            $
      14,021
            $     -
            $     -
            $
      14,021
            $
      (5,613)OREO
            3,390
            -
            -
            3,390
            (841)





Carrying
      Values at December 31, 2008($
      in thousands)
            Total
            Level
      1
            Level
      2
            Level
      3
            Total
              gain
      (loss)Impaired
      loans
            $
      21,021
            $     -
            $     -
            $
      21,021
            $
      (3,754)





Fair
Value Disclosures





Accounting
standards require the disclosure of the estimated fair value of financial
instruments including those financial instruments for which the Company did not
elect the fair value option.  The fair value represents management’s
best estimates based on a range of methodologies and assumptions.





Cash and
due from banks, federal funds sold, loans held for sale, accrued interest
receivable, all non-maturity deposits, short-term borrowings, subordinated debt
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.  Restricted equity securities are
carried at cost because no market value is available.




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 estimated using the discounted value of contractual
cash flows based on current rates offered for deposits of similar remaining
maturities.




FHLB advances –
long-term:  The fair value is estimated using the discounted
value of contractual cash flows based on current rates offered for debt of
similar remaining maturities and/or termination values provided by the
FHLB.




F
- 27
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements





Note
19 - Fair Value of Financial Instruments (continued)





The
carrying amounts and estimated fair values of the Company’s financial
instruments are as follows as of December 31:





2009
            
            2008($
      in thousands)
            
            Estimated
            
            
            EstimatedCarrying
            Fair
            
            Carrying
            FairValue
            Value
            
            Value
            ValueFinancial
      assets:Cash
      and federal funds sold
            $   27,828
            $   27,828
            
            $   24,789
            $   24,789Interest-bearing
      deposits
            12,707
            12,707
            
            3,312
            3,312Securities
      available for sale
            87,919
            87,919
            
            81,619
            81,619Loans
      held for sale
            -
            -
            
            291
            291Loans,
      net of allowance for loan losses
            866,208
            873,705
            
            851,674
            856,799Accrued
      interest receivable
            3,923
            3,923
            
            4,292
            4,292Derivative
      asset positions
            32
            32
            
            1,475
            1,475Financial
      liabilities:Deposits
            884,569
            887,969
            
            832,015
            840,383Short-term
      borrowings
            39,553
            39,553
            
            55,636
            55,523Other
      borrowings
            15,988
            15,988
            
            12,151
            12,135FHLB
      advances – long-term
            15,664
            16,094
            
            10,169
            9,883Subordinated
      debt to nonconsolidated subsidiaries
            10,310
            10,310
            
            10,310
            10,310Accrued
      interest payable
            1,628
            1,628
            
            2,195
            2,195Derivative
      liability positions
            20
            20
            
            -
            -
































REMAINDER
OF PAGE INTENTIONALLY LEFT BLANK




F
- 28
 The
Savannah Bancorp, Inc. - 2009 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,
2009 and 2008:





2009
            2008AssetsCash
      on deposit
            $        65
            $        54Interest-bearing
      deposits
            197
            1,230Investment
      in subsidiaries
            86,399
            87,407Premises
      and equipment
            831
            1,172Investment
      in nonconsolidated subsidiary
            1,394
            1,351Other
      assets
            1,953
            1,752Total
      assets
            $
      90,839
            $
      92,966LiabilitiesSubordinated
      debt
            $
      10,310
            $
      10,310Other
      liabilities
            1,503
            1,724Total
      liabilities
            11,813
            12,034Shareholders'
      equityCommon
      stock
            5,934
            5,934Additional
      paid-in capital
            38,605
            38,516Retained
      earnings
            33,383
            33,552Treasury
      stock
            (4)
            (4)Accumulated
      other comprehensive income, net
            1,108
            2,934Total
      shareholders’ equity
            79,026
            80,932Total
      liabilities and equity
            $
      90,839
            $
      92,966




F
- 29
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements
 
 Note 20 - The Savannah Bancorp, Inc.
(Parent Company Only) Financial Information
(continued)   ($ in thousands)
  The
operating results of the Parent Company are shown below for the three years
ended December 31:





2009
            2008
            2007Dividends
      from subsidiaries
            $
      4,200
            $
      3,450
            $
      7,500Interest
      income
            4
            15
            27Interest
      expense
            362
            642
            842Net
      interest and dividend income
            3,842
            2,823
            6,685Other
      income
            29
            35
            38Processing
      / management fees
            5,267
            5,468
            5,090Total
      income
            9,138
            8,326
            11,813Corporate
      expenses
            733
            669
            618Processing
      / management costs
            5,342
            5,543
            5,165Other
      expenses
            6,075
            6,212
            5,783Income
      before income taxes and (distributions in excess of
    earnings)equity
      in undistributed net income of subsidiaries
            3,063
            2,114
            6,030Income
      tax benefit
            395
            415
            415Income
      before (distributions in excess of earnings)equity
      in undistributed net income of subsidiaries
            3,458
            2,529
            6,445(Distributions
      in excess of earnings)equity
      in undistributed net income of subsidiaries
            (2,529)
            3,477
            1,191Net
      income
            $   929
            $
      6,006
            $
      7,636





F
- 29a
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Notes to Consolidated Financial
Statements




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





The cash
flows of the Parent Company are shown below for the three years ended December
31:





2009
            2008
            2007Operating
      activitiesNet
      income
            $    929
            $
      6,006
            $
      7,636Adjustments
      to reconcile net income to cashprovided
      by operating activities:Distributions
      in excess of earnings (equity inundistributed
      net income) of subsidiaries
            2,529
            (3,477)
            (1,191)Depreciation
      of equipment
            449
            445
            369Non
      cash stock-based compensation expense
            144
            221
            184Change
      in other assets and liabilities, net
            (477)
            60
            (141)Net
      cash provided byoperating
      activities
            3,574
            3,255
            6,857Investing
      activitiesDistribution
      from nonconsolidated subsidiary
            -
            350
            -Investment
      in consolidated subsidiary
            -
            -
            (1,970)Purchase
      of equipment and software
            (108)
            (545)
            (437)Capital
      contribution to consolidated subsidiaries
            (3,390)
            -
            (2,000)Net
      cash used ininvesting
      activities
            (3,498)
            (195)
            (4,407)Financing
      activitiesDividends
      paid
            (1,098)
            (2,966)
            (2,805)Issuance
      of common stock
            -
            74
            -Exercise
      of options
            -
            36
            748Net
      cash used infinancing
      activities
            (1,098)
            (2,856)
            (2,057)(Decrease)
      increase in cashand
      cash equivalents
            (1,022)
            204
            393Cash,
      beginning of year
            1,284
            1,080
            687Cash,
      end of year
            $    262
            $
      1,284
            $
      1,080





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 adjacent
parking lot.




F
- 29b
 The
Savannah Bancorp, Inc. - 2009 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)
            2009
            2008
            2007
            2006
            2005Selected Average BalancesAssets
            $
      1,018,470
            $
      960,260
            $
      869,026
            $
      769,917
            $
      685,163Total
      interest-earning assets
            935,617
            898,295
            830,900
            734,470
            655,632Loans
      held for sale
            -
            765
            1,299
            7,842
            23,033Loans,
      net of unearned fees
            841,033
            821,673
            754,490
            658,750
            565,131Securities
            81,282
            62,019
            58,910
            50,600
            41,300Other
      interest-earning assets
            13,302
            13,838
            16,201
            17,278
            26,168Interest-bearing
      deposits
            777,763
            701,045
            628,310
            542,375
            487,493Borrowed
      funds
            71,967
            88,553
            70,939
            62,255
            55,255Total
      interest-bearing liabilities
            849,730
            789,598
            699,249
            604,630
            542,748Noninterest-bearing
      deposits
            82,406
            83,678
            91,367
            96,113
            89,386Total
      deposits
            860,169
            784,723
            719,677
            638,488
            576,879Shareholders'
      equity
            79,804
            78,998
            71,516
            61,766
            47,428Loan
      to deposit ratio – average
            98%
            105%
            105%
            103%
            98%Selected Financial Data at
      Year-EndAssets
            $
      1,050,508
            $
      1,007,284
            $
      932,459
            $
      843,514
            $
      717,901Interest-earning
      assets
            959,219
            931,448
            878,992
            803,927
            685,531Loans
      held for sale
            -
            291
            180
            914
            10,473Loans,
      net of unearned fees
            883,886
            864,974
            808,651
            720,918
            613,667Deposits
            884,569
            832,015
            764,218
            706,824
            600,510Interest-bearing
      liabilities
            883,527
            837,558
            759,597
            669,974
            558,116Shareholders'
      equity
            79,026
            80,932
            76,272
            66,574
            58,543Loan
      to deposit ratio
            100%
            104%
            106%
            102%
            102%Shareholders'
      equity to total assets
            7.52%
            8.03%
            8.18%
            7.89%
            8.15%Dividend
      payout ratio
            118.19%
            49.38%
            36.73%
            25.92%
            25.53%Risk-based
      capital ratios:Tier
      1 capital to risk-weighted assets
            10.30%
            10.28%
            10.49%
            11.09%
            11.52%Total
      capital to risk-weighted assets
            11.56%
            11.54%
            11.74%
            12.34%
            12.77%Loan Quality DataNonperforming
      assets
            $
      42,444
            $
      35,703
            $
      19,535
            $
      2,776
            $
      1,357Nonperforming
      loans
            34,115
            27,603
            17,424
            2,231
            1,357Nonaccruing
      loans
            32,545
            26,277
            14,663
            825
            1,313Loans
      past due 90 days - accruing
            1,570
            1,326
            2,761
            1,406
            44Net
      charge-offs
            8,687
            5,564
            765
            444
            76Allowance
      for loan losses
            17,678
            13,300
            12,864
            8,954
            7,813Allowance
      for loan losses to total loans
            2.00%
            1.54%
            1.59%
            1.24%
            1.27%Nonperforming
      loans to loans
            3.86%
            3.19%
            2.15%
            0.31%
            0.22%Nonperforming
      assets to assets
            4.04%
            3.54%
            2.09%
            0.33%
            0.19%Net
      charge-offs to average loans
            1.03%
            0.68%
            0.10%
            0.07%
            0.01%Per Share Data at
      Year-End  (a)Book
      value
            $
      13.32
            $
      13.64
            $
      12.88
            $
      11.52
            $
      10.20Tangible
      book value
            $
      12.90
            $
      13.19
            $
      12.40
            $
      11.52
            $
      10.20Common
      stock closing price (NASDAQ)
            $   8.00
            $   8.85
            $
      17.14
            $
      27.25
            $
      28.38Common
      shares outstanding (000s)
            5,932
            5,934
            5,924
            5,781
            5,739




(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. - 2009 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)
            2009
            2008
            2007
            2006
            2005Summary
      of operationsInterest
      income - taxable equivalent
            $
      50,595
            $
      56,714
            $
      63,414
            $
      55,347
            $
      42,544Interest
      expense
            18,258
            24,439
            30,282
            22,737
            14,679Net
      interest income - taxable equivalent
            32,337
            32,275
            33,132
            32,610
            27,865Taxable
      equivalent adjustment
            (32)
            (32)
            (156)
            (158)
            (186)Net
      interest income
            32,305
            32,243
            32,976
            32,452
            27,679Provision
      for loan losses
            13,065
            6,000
            4,675
            1,585
            1,500Net
      interest income after
              provision
      for loan losses
            19,240
            26,243
            28,301
            30,867
            26,179Noninterest
      incomeTrust
      and asset management fees
            2,351
            2,832
            1,513
            658
            501Service
      charges on deposits accounts
            1,809
            1,881
            1,383
            1,526
            1,622Mortgage
      related income, net
            432
            295
            615
            886
            1,292Other
      operating income
            1,238
            1,216
            1,242
            1,233
            979Gain
      on hedges
            873
            1,288
            -
            -
            -Gain
      on sale of securities
            2,119
            163
            -
            -
            -Total
      noninterest income
            8,822
            7,675
            4,753
            4,303
            4,394Noninterest
      expenseSalaries
      and employee benefits
            12,146
            13,584
            11,846
            10,852
            9,530Occupancy
      and equipment
            3,716
            3,884
            3,294
            2,920
            2,199FDIC
      deposit insurance
            1,886
            653
            251
            78
            72Information
      technology
            1,810
            1,633
            1,616
            1,525
            1,244Amortization
      of client list
            144
            144
            48
            -
            -Loss
      on sale and write-downs offoreclosed
      assets
            2,566
            228
            44
            -
            7Other
      operating expense
            4,710
            4,616
            4,084
            4,578
            3,601Total
      noninterest expense
            26,978
            24,742
            21,183
            19,953
            16,653Income
      before income taxes
            1,084
            9,176
            11,871
            15,217
            13,920Income
      tax expense
            155
            3,170
            4,235
            5,215
            4,880Net
      income
            $      929
            $   6,006
            $   7,636
            $
      10,002
            $   9,040Net income per share:(a)Basic
            $   0.16
            $
      1.01
            $
      1.31
            $
      1.73
            $
      1.68Diluted
            $   0.16
            $
      1.01
            $
      1.29
            $
      1.70
            $
      1.63Cash
      dividends paid per share
            $
      0.185
            $
      0.50
            $
      0.48
            $
      0.45
            $
      0.43Average
      basic shares outstanding (000s)
            5,933
            5,930
            5,850
            5,765
            5,396Average
      diluted shares outstanding (000s)
            5,936
            5,947
            5,922
            5,876
            5,531Performance
      ratios (averages)Net
      interest margin
            3.46%
            3.58%
            3.99%
            4.44%
            4.25%Return
      on average assets
            0.09%
            0.63%
            0.88%
            1.30%
            1.32%Return
      on average equity
            1.16%
            7.60%
            10.68%
            16.19%
            19.06%Efficiency
      ratio
            65.60%
            61.98%
            56.15%
            54.29%
            51.92%





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




F
- 31
 The
Savannah Bancorp, Inc. - 2009 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 2009 and
2008:
 
 2009
                            
                            2008Fourth
                            Third
                            Second
                            First
                            
                            Fourth
                            Third
                            Second
                            FirstNet
      interest income
                            $8,315
                            $8,240
                            $8,084
                            $7,666
                            
                            $7,535
                            $8,251
                            $8,386
                            $8,071Provision
      for loan losses
                            2,560
                            3,560
                            3,225
                            3,720
                            
                            2,270
                            1,505
                            1,155
                            1,070Net
      interest income after provisionfor loan losses
                            5,755
                            4,680
                            4,859
                            3,946
                            
                            5,265
                            6,746
                            7,231
                            7,001Noninterest
      income
                            2,680
                            2,227
                            1,906
                            2,009
                            
                            1,958
                            2,021
                            1,791
                            1,763Noninterest
      expense
                            7,288
                            6,476
                            6,739
                            6,475
                            
                            6,065
                            6,234
                            6,151
                            6,150Income
      (loss) before income taxes
                            1,147
                            431
                            26
                            (520)
                            
                            1,158
                            2,533
                            2,871
                            2,614Income
      tax expense (benefit)
                            385
                            85
                            (80)
                            (235)
                            
                            380
                            895
                            985
                            910Net
      income (loss)
                            $  762
                            $ 
      346
                            $106
                            $
      (285)
                            
                            $  778
                            $1,638
                            $1,886
                            $1,704Per share:(a)Net
      income (loss) – basic
                            $
      0.13
                            $
      0.06
                            $
      0.02
                            $
      (0.05)
                            
                            $
      .13
                            $
      .28
                            $
      .32
                            $
      .29Net
      income (loss) – diluted
                            $
      0.13
                            $
      0.06
                            $
      0.02
                            $
      (0.05)
                            
                            $
      .13
                            $
      .28
                            $
      .32
                            $
      .29Dividends
                            $
      .020
                            $
      .020
                            $
      .020
                            $
      .125
                            
                            $
      .125
                            $
      .125
                            $
      .125
                            $
      .125Average
      shares (000s)Basic
                            5,932
                            5,932
                            5,932
                            5,933
                            
                            5,933
                            5,930
                            5,931
                            5,928Diluted
                            5,937
                            5,936
                            5,936
                            5,933
                            
                            5,942
                            5,943
                            5,952
                            5,951
  (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 2009 and 2008 are
listed below.  There were approximately 640 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, 2009.





2009
            
            2008Closing
      Market Prices
            Fourth
            Third
            Second
            First
            
            Fourth
            Third
            Second
            FirstHigh
            $  9.25
            $
      8.50
            $
      10.93
            $
      10.00
            
            $
      13.35
            $
      15.00
            $
      18.73
            $
      18.49Low
            7.00
            6.65
            6.65
            6.00
            
            8.57
            11.89
            12.75
            15.76Close
            8.00
            8.10
            6.65
            7.01
            
            8.85
            13.25
            13.00
            17.50







F
- 32
 The
Savannah Bancorp, Inc. - 2009 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, 2004 through December 31, 2009.  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
            2004
            2005
            2006
            2007
            2008
            2009The
      Savannah Bancorp, Inc.
            100.00
            133.43
            130.11
            83.45
            44.59
            41.18NASDAQ
      Composite
            100.00
            101.37
            111.03
            121.92
            72.49
            104.31SNL
      $500M-$1B Bank Index
            100.00
            104.29
            118.61
            95.04
            60.90
            58.00




Source
: SNL Financial LC, Charlottesville,
VA          ©
2010




F
- 33
 The
Savannah Bancorp, Inc. - 2009 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 2009 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 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 and Bryan 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 9 and 10 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, 2009, had
ten banking offices and twelve ATMs in Savannah, Garden City, Skidaway Island,
Whitemarsh Island, Pooler, and Richmond Hill, Georgia and 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 addition, the Company has a loan
production office on St. Simons Island, Georgia.





Effective
September 30, 2009, the Company merged the charter of Harbourside Community Bank
(“Harbourside”) into Savannah.  The two branches of Harbourside
increase the total number of Savannah branches to eight.





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
growth and much slower commercial and residential growth.  Coastal
Georgia and South Carolina continue to be desired retiree residential
destinations as well as travel destinations.  The Savannah MSA and
Coastal South Carolina markets have both experienced some level of devaluation
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 the slow down in real estate activity has
negatively impacted the Company.  The Company operates in 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
- 34
 The
Savannah Bancorp, Inc. - 2009 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,
2009.  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 and nonperforming loans, recent
charge-off levels, 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 amount of the allowance.





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 $17,678,000 or 2.00 percent of total loans at
December 31, 2009.  This is compared to an allowance of $13,300,000 or
1.54 percent of total loans at December 31, 2008.  For 2009, the
Company reported net charge-offs of $8,687,000 or 1.03 percent of average
loans.  This is compared to net charge-offs of $5,564,000 or 0.68
percent of average loans for 2008.  The significantly higher level of
charge-offs resulted primarily from continued weakness in the Company’s local
residential real estate markets particularly in the Bluffton / Hilton Head
Island, South Carolina (“Bluffton/HHI”) area.  During 2009 and 2008, a
provision for loan losses of $13,065,000 and $6,000,000, respectively, was added
to the allowance for loan losses.  Growth in the loan portfolio, real
estate-related charge-offs, continued weakness in the Company’s local real
estate markets, and level or declining real estate values provide the basis for
the higher provision for loan losses.





The
Company's nonperforming assets consist of loans on nonaccrual status, loans
which are contractually past due 90 days or more on which interest is still
being accrued, and other real estate owned.  Nonaccrual loans of
$32,545,000 and loans past due 90 days or more and still accruing interest of
$1,570,000 totaled $34,115,000, or 3.86 percent of gross loans, at December 31,
2009.  Nonaccrual loans of $26,277,000 and loans past due 90 days or
more and still accruing interest of $1,326,000 totaled $27,603,000, or 3.19
percent of gross loans, at December 31, 2008.  Generally, loans are
placed on nonaccrual status when the collection of the principal or interest in
full becomes doubtful.  Management typically writes down loans through
a charge to the allowance when it determines they are
impaired.  Nonperforming assets also included $8,329,000 and
$8,100,000 of other real estate owned at December 31, 2009 and 2008,
respectively.  Management is aggressively pricing and marketing the
other real estate owned.





Impaired
loans, which include loans modified in troubled debt restructurings, totaled
$54,054,000 and $37,730,000 at December 31, 2009 and 2008,
respectively.




F
- 35
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations


At
December 31, 2009 nonperforming loans consisted primarily of $14.6 million of
improved real estate-secured loans and $13.1 million of land, lot and
construction and development related loans.  Less than one percent of
the nonperforming loans were unsecured.  The largest nonperforming
relationship consists of four loans for $7.6 million to a residential developer
in the Bluffton/HHI market.  The loans are secured by residential land
and lots.  Approximately $1,097,000 of the allowance was allocated to
this relationship as a general reserve.  The next largest
nonperforming relationship included nine loans for $3.0 million to a residential
homebuilder in the Bluffton/HHI market.  The collateral is completed
or nearly completed 1-4 family properties as well as residential
lots.  The Company charged-off $1,139,000 in 2009 and has $287,000
specifically allocated in the allowance for this relationship.





The
Company continues to devote significant internal and external resources to
managing the past due and classified loans.  The Company has performed
extensive internal and external loan review procedures and analyses on the loan
portfolio.  The Company charges-down loans as appropriate before the
foreclosure process is complete and often before they are past due.





If the
allowance for loan losses had changed by five percent, the effect on net income
would have been approximately $575,000.  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 2005 through 2009 are summarized as
follows:





($
      in thousands)
            2009
            2008
            2007
            2006
            2005Balance
      at the beginning of the year
            $
      13,300
            $
      12,864
            $  8,954
            $
      7,813
            $
      6,389Charge-offs
      – commercial
            (459)
            (387)
            (150)
            -
            (22)Charge-offs
      – consumer
            (210)
            (85)
            (103)
            (125)
            (82)Charge-offs
      – real estate
            (8,224)
            (5,242)
            (621)
            (381)
            (48)Charge-offs
      – total
            (8,893)
            (5,714)
            (874)
            (506)
            (152)Recoveries
      – commercial
            22
            13
            6
            6
            7Recoveries
      – consumer
            29
            28
            43
            54
            53Recoveries
      – real estate
            155
            109
            60
            2
            16Recoveries
      – total
            206
            150
            109
            62
            76Net
      charge-offs
            (8,687)
            (5,564)
            (765)
            (444)
            (76)Provision
      for loan losses
            13,065
            6,000
            4,675
            1,585
            1,500Balance
      at the end of the year
            $
      17,678
            $
      13,300
            $
      12,864
            $
      8,954
            $
      7,813Ratio
      of net charge-offs to average loans
            1.03%
            0.68%
            0.10%
            0.07%
            0.01%





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
- 36
 The
Savannah Bancorp, Inc. - 2009 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)
            2009
            2008
            2007
            2006
            2005Commercial
            $   1,184
            $    760
            $    750
            $   900
            $   700Real
      estate-constructionand
      development
            6,020
            5,291
            4,150
            4,350
            3,750Real
      estate-mortgage
            10,200
            7,061
            6,750
            2,350
            1,900Consumer
            225
            188
            200
            400
            350Unallocated
            49
            -
            1,014
            954
            1,113Total
      allowance forloan
      losses
            $
      17,678
            $
      13,300
            $
      12,864
            $
      8,954
            $
      7,813





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





($
      in thousands)
            2009
            2008
            2007
            2006
            2005Commercial
            10.1%
            9.5%
            8.8%
            8.0%
            7.4%Real
      estate-constructionand
      development
            7.0
            11.5
            16.6
            23.1
            23.6Real
      estate-mortgage
            81.2
            77.0
            72.3
            66.6
            66.7Consumer
            1.7
            2.0
            2.3
            2.3
            2.3Total
      loans
            100.0%
            100.0%
            100.0%
            100.0%
            100.0%





Impairment of
Loans





The
Company measures 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.  A loan is considered 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.  A loan is not considered impaired during a period of delay
in payment if the ultimate collection of all amounts due is
expected.  The Company maintains a valuation allowance or charges-down
the loan balance 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
- 37
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Table
6 – Allowance for Loan Losses and Nonperforming Assets





2009
            2008Fourth
            Third
            Second
            First
            Fourth($
      in thousands)
            Quarter
            Quarter
            Quarter
            Quarter
            QuarterAllowance
      for loan lossesBalance
      at beginning of period
            $
      16,880
            $
      15,597
            $
      15,309
            $
      13,300
            $
      12,390Provision
      for loan losses
            2,560
            3,560
            3,225
            3,720
            2,270Net
      charge-offs
            (1,762)
            (2,277)
            (2,937)
            (1,711)
            (1,360)Balance
      at end of period
            $
      17,678
            $
      16,880
            $
      15,597
            $
      15,309
            $
      13,300As
      a % of loans
            2.00%
            1.95%
            1.81%
            1.77%
            1.54%As
      a % of nonperforming loans
            51.77%
            64.92%
            56.99%
            63.27%
            48.18%As
      a % of nonperforming assets
            41.62%
            46.56%
            46.22%
            47.05%
            37.25%Net
      charge-offs as a % of average loans (a)
            0.83%
            1.07%
            1.41%
            0.82%
            0.65%Risk
      element assetsNonaccruing
      loans
            $
      32,545
            $
      25,694
            $
      24,994
            $
      23,927
            $
      26,277Loans
      past due 90 days – accruing
            1,570
            307
            2,374
            268
            1,326Total
      nonperforming loans
            34,115
            26,001
            27,368
            24,195
            27,603Other
      real estate owned
            8,329
            10,252
            6,377
            8,342
            8,100Total
      nonperforming assets
            $
      42,444
            $
      36,253
            $
      33,745
            $
      32,537
            $
      35,703Loans
      past due 30-89 days
            $
      5,182
            $
      8,122
            $
      6,670
            $
      16,906
            $
      8,269Nonperforming
      loans as a % of loans
            3.86%
            3.00%
            3.17%
            2.80%
            3.19%Nonperforming
      assets as a % of loansand
      other real estate owned
            4.76%
            4.13%
            3.88%
            3.73%
            4.09%Nonperforming
      assets as a % of assets
            4.04%
            3.48%
            3.31%
            3.25%
            3.54%(a)
      Annualized




F
- 38
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Results
of Operations





2009
Compared with 2008





Net
income for 2009 was $929,000, a decrease of 85 percent from $6,006,000 in
2008.  Net income per diluted share was $0.16 and $1.01 in 2009 and
2008, respectively, a decrease of 84 percent.  The earnings decrease
was primarily attributable to a higher provision for loan losses, higher FDIC
insurance premiums and a higher loss on sale of foreclosed assets partially
offset by a higher gain on sale of securities.  Return on average
equity was 1.16 percent, return on average assets was 0.09 percent and the
efficiency ratio was 65.60 percent in 2009.





Average
interest-earning assets increased 4.2 percent to $936 million in 2009 from $898
million in 2008.  Net interest income was $32.3 million in 2009
compared to $32.2 million in 2008.  Average loans were $841 million
for 2009, 2.3 percent higher when compared to $822 million in
2008.  Shareholders’ equity decreased to $79 million at December 31,
2009 from $81 million at December 31, 2008 due solely to a decrease in
accumulated other comprehensive income.  The Company’s total capital
to risk-weighted assets ratio was 11.56 percent at December 31, 2009, which
exceeds the 10 percent required by the regulatory agencies to maintain
well-capitalized status.  The net interest margin decreased to 3.46
percent in 2009 from 3.58 percent in 2008.  As shown in Table 9, the
decline in net interest margin was primarily due to higher levels of
noninterest-earning assets.  The interest rate spread increased five
basis points in 2009.  As shown in Table 8, the Company’s balance
sheet continues to be 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.  In addition the
Company has instituted interest rate floors on many variable rate loans such
that the loans will not reprice in a rising rate environment until the floating
rate exceeds the floor.





The
provision for loan losses was $13,065,000 for 2009, compared to $6,000,000 in
2008.  Loan growth was $19 million in 2009 compared to $56 million in
2008.  The higher provision for loan losses in 2009 as compared to
2008 is mainly attributable to real estate-related charge-offs and continued
weakness in the Company’s local real estate markets.  Net charge-offs
were $8,687,000 in 2009 as compared to $5,564,000 in 2008.  The
significant increase in charge-offs resulted primarily from continued weakness
in the Company’s local residential real estate markets particularly in the
Bluffton/HHI area.





Noninterest
income was $8,822,000 in 2009 compared to $7,675,000 in 2008, an increase of
$1,147,000 or 15 percent.  The increase was the result of a $2,119,000
gain on sale of securities, partially offset by $481,000 lower trust and asset
management fees and $415,000 lower gain on hedges.





Noninterest
expense was $26,978,000 in 2009 compared to $24,742,000 in 2008, an increase of
$2,236,000, or 9.0 percent. Noninterest expense included a $2,338,000 higher
loss on the sale and write-down of foreclosed assets, $1,233,000 of higher FDIC
insurance premiums, a 188 percent increase, partially offset by $1,438,000 in
lower salaries and employee benefits, or 11 percent decrease.





Income
tax expense was $155,000 in 2009 and $3,170,000 in 2008.  The combined
effective federal and state tax rates were 14.3 percent and 34.5 percent,
respectively.  The lower income tax rate in 2009 was due to the impact
of tax credits on lower taxable income.  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
- 39
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and 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 10, 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.





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 Bluffton/HHI
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
- 40
 The
Savannah Bancorp, Inc. - 2009 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 6.3 percent to $1.02 billion in 2009 from $960 million in
2008.  Total assets were $1.05 billion and $1.01 billion at December
31, 2009 and 2008, respectively, an increase of 4.0 percent.  The
increase in loans of $19 million and securities of $6 million during 2009 was
funded by $53 million in deposit growth.  Additionally cash and cash
equivalents increased $12 million and the Company had a $5 million prepaid FDIC
assessment included in other assets.





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 were obtained from local
customers.  Over the past several years funding sources have been
expanded to include non-local deposits and more frequent use of advances from
the FHLB.  Total deposits included brokered time deposits and
institutional money market accounts of $172 million at December 31, 2009 and
$222 million at December 31, 2008.  At December 31, 2009 and 2008,
brokered time deposits include $38 million of reciprocal deposits from the
Company’s local customers that are classified as brokered because they are
placed in the CDARS network for deposit insurance purposes.





Loans





The
following table shows the composition of the loan portfolio at December 31, 2009
and 2008, including a more detailed breakdown of real estate secured loans by
collateral type and purpose.





Table
7 - Loan Concentrations





($ in thousands)
            2009
            %
      of Total
            2008
            %
      of Total
            %
      Change ($)Non-residential
      real estateOwner-occupied
            $
      137,439
            16
            $
      137,742
            16
            -Non
      owner-occupied
            159,091
            18
            124,502
            14
            28Construction
            5,352
            1
            26,965
            3
            (80)Commercial
      land and lot development
            47,080
            5
            42,590
            5
            11Total
      non-residential real estate
            348,962
            40
            331,799
            38
            5Residential
      real estateOwner-occupied
      – 1-4 family
            95,741
            11
            89,774
            10
            7Non
      owner-occupied – 1-4 family
            158,172
            18
            147,396
            17
            7Construction
            27,061
            3
            43,431
            5
            (38)Residential
      land and lot development
            92,346
            10
            98,715
            12
            (7)Home
      equity lines
            57,527
            6
            55,092
            6
            4Total
      residential real estate
            430,847
            48
            434,408
            50
            (1)Total
      real estate loans
            779,809
            88
            766,207
            88
            2Commercial
            89,379
            10
            81,348
            10
            10Consumer
            14,971
            2
            17,628
            2
            (15)Unearned
      fees, net
            (273)
            -
            (209)
            -
            31Total
      loans, net of unearned fees
            $
      883,886
            100
            $
      864,974
            100
            2






F
- 41
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Capital
Resources





The
Office of the Comptroller of the Currency has 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, 2009, the Subsidiary Banks and the Company
exceeded the minimum requirements necessary to be classified as
“well-capitalized.”





Total
equity capital for the Company was $79.0 million, or 7.52 percent of total
assets, at December 31, 2009.  Tier 1 capital was 10.30 percent of
risk-weighted assets at the same date.  Tier 1 capital at December 31,
2009 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.








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
2009, portfolio loans increased $19 million to $884 million and deposits
increased $53 million to $885 million.  The loan to deposit ratio was
100 and 104 percent at December 31, 2009 and 2008, 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 pledged
certain 1-4 family first mortgage loans, commercial real estate loans, home
equity lines of credit and second mortgage residential loans.  The
Subsidiary Banks’ individual borrowing limits range from 20 to 25 percent of
assets.  In aggregate, the Subsidiary Banks had secured borrowing
capacity of approximately $122.9 million of which $31.7 million was advanced at
December 31, 2009.  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 $15 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.  The Subsidiary Banks were approved by the
FRB under the borrower-in-custody of collateral (“BIC”)
arrangement.  This temporary liquidity arrangement allows collateral
to be maintained at the Subsidiary Banks rather than being delivered to the FRB
or a third-party custodian.  At December 31, 2009, the Company had
secured borrowing capacity of $83.8 million with the FRB and $10.0 million
outstanding.





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.




F
- 42
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations
 
 The
Company’s cash flow, maturity and repricing gap at December 31, 2009 was $53
million at one year, or 5.5 percent of total interest-earning
assets.  At December 31, 2008 the gap at one year was $29 million, or
3.1 percent of total interest-earning assets.  Interest-earning assets
with maturities over five years totaled approximately $48 million, or 5.0
percent of total interest-earning assets.  See Table 8 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 increased level of
nonaccrual loans and other noninterest-earning assets has negatively impacted
net interest income and the net interest margin.





The Company has implemented various
strategies to reduce its asset-sensitive position, primarily through the
increased use of fixed rate loans, interest rate floors on variable rate loans,
short maturity funding sources and hedging strategies such as interest rate
floors, collars and swaps.  These actions have reduced the Company’s
exposure to falling interest rates.  In the first quarter of 2009, the
Company terminated a $15 million interest rate collar position for net proceeds
of $512,000.  In April 2009, the Company terminated a $25 million
interest rate collar position for net proceeds of $787,000.  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.





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.








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, 2009, the Company had unfunded commitments
to extend credit of $87.5 million and outstanding standby letters of credit of
$2.2 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 making commitments and conditional obligations 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
- 43
 The
Savannah Bancorp, Inc. - 2009 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
- 44
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Table
8 - Cash Flow/Maturity Gap and Repricing Data





The
following is the cash flow/maturity and repricing data for the Company as of
December 31, 2009:





($
      in thousands)
            
            0 -
      3
            3 -
      12
            1 -
      3
            3 -
      5
            Over
      5Immediate
            Months
            Months
            Years
            Years
            Years
            TotalInterest-earning
      assetsInvestment
      securities
            $           -
            $    6,783
            $   14,227
            $   36,992
            $  9,173
            $
      19,421
            $   86,596Federal
      funds sold
            8,575
            -
            -
            -
            -
            -
            8,575Interest-bearing
      deposits
            11,895
            80
            255
            477
            -
            -
            12,707Loans
      - fixed rates
            -
            105,542
            146,450
            161,623
            47,484
            28,359
            489,458Loans
      - variable rates
            -
            346,063
            9,110
            3,970
            2,027
            713
            361,883Total
      interest-earning assets
            20,470
            458,468
            170,042
            203,062
            58,684
            48,493
            959,219Interest-bearing
      liabilitiesNOW
      and savings **
            -
            8,022
            16,045
            40,113
            48,136
            48,136
            160,452Money
      market accounts **
            -
            93,181
            55,565
            31,751
            47,627
            -
            228,124Time
      deposits
            -
            134,409
            235,344
            29,711
            13,815
            157
            413,436Short-term
      borrowings
            39,553
            -
            -
            -
            -
            -
            39,553Other
      borrowings
            -
            1,000
            3,000
            11,988
            -
            -
            15,988FHLB
      advances - long-term
            -
            -
            -
            2,016
            3,511
            10,137
            15,664Subordinated
      debt
            -
            10,310
            -
            -
            -
            -
            10,310Total
      interest-bearing liabilities
            39,553
            246,922
            309,954
            115,579
            113,089
            58,430
            883,527GAP-Excess
      assets (liabilities)
            (19,083)
            211,546
            (139,912)
            87,483
            (54,405)
            (9,937)
            75,692GAP-Cumulative
            $
      (19,083)
            $
      192,463
            $   52,551
            $
      140,034
            $
      85,629
            $
      75,692
            $
      75,692Cumulative sensitivity
      ratio *
            0.52
            1.67
            1.09
            1.20
            1.10
            1.09
            1.09




*   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, 2009 the Company had unfunded loan commitments and unfunded lines
of credit totaling $87.5 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 $91
million.  Additionally, further sources of funding include FRB
advances, brokered time deposits and certain other non-local
deposits.




F
- 45
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Table
9 - Average Balance Sheet and Rate/Volume Analysis - 2009 and 2008




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 2009 and 2008.





Taxable-Equivalent
            
            (a)
      VarianceAverage
      Balance
            Average
      Rate
            
            
            Interest
      (b)
            Vari-
            Attributable
      to2009
            2008
            2009
            2008
            
            
            2009
            2008
            ance
            Rate
            Volume($
      in thousands)
            (%)
            
            
            ($
      in thousands)
            
            ($
      in thousands)Assets$   5,963
            $   7,033
            0.75
            2.11
            
            Interest-bearing
      deposits
            $      45
            $     149
            $  (104)
            $      (96)
            $   (8)77,844
            60,136
            4.20
            4.98
            
            Investments
      - taxable
            3,273
            3,002
            271
            (469)
            7403,438
            1,883
            4.94
            5.46
            
            Investments
      - non-taxable
            170
            103
            67
            (10)
            777,339
            6,805
            0.25
            1.95
            
            Federal
      funds sold
            18
            133
            (115)
            (116)
            1-
            765
            -
            7.82
            
            Loans
      held for sale
            -
            60
            (60)
            -
            (60)841,033
            821,673
            5.60
            6.47
            
            Loans
      (c)
            47,089
            53,267
            (6,178)
            (7,149)
            971935,617
            898,295
            5.41
            6.30
            
            Total
      interest-earning assets
            50,595
            56,714
            (6,119)
            (7,995)
            1,87682,853
            61,965
            
            
            
            Noninterest-earning
      assets$1,018,470
            $960,260
            
            
            
            Total
      assetsLiabilities
      and equityDeposits$123,715
            $120,661
            0.46
            1.15
            
            NOW
      accounts
            572
            1,396
            (824)
            (833)
            916,071
            15,488
            0.65
            0.88
            
            Savings
      accounts
            104
            137
            (33)
            (36)
            3131,402
            128,826
            1.74
            2.38
            
            Money
      market accounts
            2,281
            3,079
            (798)
            (824)
            2686,044
            68,464
            1.48
            2.66
            
            MMA
      - institutional
            1,272
            1,827
            (555)
            (808)
            253157,923
            147,576
            3.32
            4.52
            
            CDs,
      $100M or more
            5,239
            6,685
            (1,446)
            (1,771)
            325117,120
            85,790
            2.01
            3.49
            
            CDs,
      broker
            2,356
            2,998
            (642)
            (1,270)
            628145,488
            134,240
            3.18
            4.25
            
            Other
      time deposits
            4,630
            5,720
            (1,090)
            (1,436)
            346777,763
            701,045
            2.12
            3.11
            
            Total
      interest-bearing deposits
            16,454
            21,842
            (5,388)
            (6,940)
            1,15247,675
            67,979
            2.39
            2.44
            
            Short-term/other
      borrowings
            1,140
            1,661
            (521)
            (34)
            (487)13,982
            10,264
            2.16
            2.86
            
            FHLB
      advances – long-term
            302
            294
            8
            (72)
            8010,310
            10,310
            3.51
            6.21
            
            Subordinated
      debt
            362
            642
            (280)
            (278)
            (2)Total
      interest-bearing849,730
            789,598
            2.15
            3.09
            
            liabilities
            18,258
            24,439
            (6,181)
            (7,422)
            1,24182,406
            83,678
            
            
            
            Noninterest-bearing
      deposits6,530
            7,986
            
            
            
            Other
      liabilities79,804
            78,998
            
            
            
            Shareholders'
      equity$1,018,470
            $960,260
            
            
            
            Liabilities
      and equity3.26
            3.21
            
            Interest
      rate spread3.46
            3.58
            
            Net
      interest marginNet
      interest income
            $
      32,337
            $
      33,275
            $      62
            $
      (573)
            $   635$  85,887
            $108,697
            
            
            
            Net
      earning assets$860,169
            $784,723
            
            
            
            Average
      deposits1.91
            2.78
            
            Average
      cost of deposits98%
            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 2009 and in 2008 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
- 46
 The
Savannah Bancorp, Inc. - 2009 Annual Report
 
 Management's Discussion and Analysis
of Financial Condition and Results of Operations





Table
10 - 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)
            2,29467,979
            52,796
            2.44
            4.95
            
            Short-term/other
      borrowings
            1,661
            2,612
            (951)
            (1,329)
            37810,264
            7,833
            2.86
            5.27
            
            FHLB
      advances – long-term
            294
            413
            (119)
            (189)
            7010,310
            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 in noninterest-earning
assets.




The Savannah
Bancorp, Inc. - 2009 Annual Report