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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended: September 30, 2009
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934.
For the transition period from                      to                     
Commission File Number: 000-51957
FGBC BANCSHARES, INC.
(Exact name of registrant as specified in its charter)
     
Georgia   20 - 02743161
     
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification Number)
101 Main Street, Franklin, Georgia 30217
 
(Address of principal executive office)
(678) 839-4510
 
(Issuer’s telephone number)
N/A
 
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yes þ     No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
     Yes o     No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer o Accelerated filer o  Non-accelerated filer o
(Do not check if a smaller reporting company)
Smaller reporting company þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o     No þ
There were 13,974,090 shares of common stock outstanding as of November 1, 2009.
 
 

 


 

INDEX
             
        Page  
 
           
Part I. FINANCIAL INFORMATION     4  
 
           
  Financial Statements     4  
  Management’s Discussion and Analysis of Financial Condition and Results of Operations     13  
  Quantitative and Qualitative Disclosures About Market Risk     21  
  Controls and Procedures     22  
 
           
Part II. OTHER INFORMATION     22  
 
           
  Legal Proceedings     22  
  Risk Factors     23  
  Unregistered Sales of Equity Securities and Use of Proceeds     23  
  Defaults Upon Senior Securities     23  
  Submission of Matters to a Vote of Security Holders     23  
  Other Information     23  
  Exhibits     23  
 EX-31.1
 EX-31.2
 EX-32

 


Table of Contents

CAUTIONARY STATEMENT ABOUT FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (this “Report”) contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements include or relate to our future results, including certain projections and business trends. Assumptions relating to forward-looking statements involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. When used in this Report, the words “estimate,” “project,” “intend,” “believe” and “expect” and similar expressions identify forward-looking statements. Although we believe that assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate, and we may not realize the results contemplated by the forward-looking statement. Management decisions are subjective in many respects and susceptible to interpretations and periodic revisions based on actual experience and business developments, the impact of which may cause us to alter our business strategy that may, in turn, affect our results of operations. In light of the significant uncertainties inherent in the forward-looking information included in this Report, you should not regard the inclusion of this information as our representation that we will achieve any strategy, objectives or other plans. The forward-looking statements contained in this Report speak only as of the date of the Report and we undertake no obligation to update or revise any of these forward-looking statements.
The forward-looking statements that we make in this Report, as well as other statements that are not historical facts, are based largely on management’s current expectations and assumptions and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those contemplated by forward-looking statements. These risks and uncertainties include, among other things, the risks and uncertainties described in Item 1A of our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 2, 2009 and in Item 1A of Part II to this Quarterly Report on Form 10-Q.

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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
FGBC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2009 AND DECEMBER 31, 2008
                 
    September 30,     December 31,  
    2009     2008  
    (unaudited)     (audited)  
Assets
               
 
               
Cash and due from banks
  $ 12,772,301     $ 8,858,796  
Interest-bearing deposits in banks
    31,686,020       11,042,345  
Federal funds sold
          722,000  
Securities available-for-sale, at fair value
    48,955,117       71,764,629  
Restricted equity securities, at cost
    2,694,000       2,053,400  
 
               
Loans
    634,853,596       683,177,685  
Less allowance for loan losses
    15,230,085       11,013,996  
 
           
Loans, net
    619,623,511       672,163,689  
 
           
 
               
Premises and equipment
    37,517,639       37,898,122  
Foreclosed assets
    14,714,558       6,041,163  
Deferred tax asset, net
    8,157,055       4,441,757  
Accrued interest receivable
    3,391,107       3,880,284  
Other assets
    1,720,243       2,519,436  
 
           
 
               
Total assets
  $ 781,231,551     $ 821,385,621  
 
           
 
               
Liabilities and Stockholders’ Equity
               
 
               
Liabilities
               
Deposits:
               
Noninterest-bearing
  $ 43,396,896     $ 34,959,706  
Interest-bearing
    674,224,830       702,131,988  
 
           
Total deposits
    717,621,726       737,091,694  
Other borrowings
    4,000,000       16,750,000  
Accrued interest payable
    588,285       953,088  
Other liabilities
    1,682,548       777,044  
 
           
Total liabilities
    723,892,559       755,571,826  
 
           
 
               
Stockholders’ equity
               
Preferred stock, par value $0; 10,000,000 shares authorized; 0 shares issued and outstanding
           
Common stock, par value $0; 100,000,000 shares authorized; 13,974,090 and 12,492,206 shares issued and outstanding, respectively
    77,338,707       71,907,920  
Accumulated deficit
    (20,348,720 )     (5,692,364 )
Accumulated other comprehensive income (loss)
    349,005       (401,761 )
 
           
Total stockholders’ equity
    57,338,992       65,813,795  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 781,231,551     $ 821,385,621  
 
           
See Notes to Consolidated Financial Statements.

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FGBC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Interest income:
                               
Loans, including fees
  $ 9,205,976     $ 10,586,518     $ 28,022,612     $ 31,134,079  
Taxable securities
    415,401       752,249       1,491,470       2,394,566  
Nontaxable securities
    139,889       151,873       428,591       466,499  
Federal funds sold
    5,990       26,288       19,821       104,910  
Other interest income
    58,539       14,645       153,255       60,917  
 
                       
Total interest income
    9,825,795       11,531,573       30,115,749       34,160,971  
 
                       
 
                               
Interest expense:
                               
Deposits
    3,936,107       5,878,593       14,078,986       17,704,580  
Other borrowings
    11,015       161,836       448,779       324,102  
 
                       
Total interest expense
    3,947,122       6,040,429       14,527,765       18,028,682  
 
                       
 
                               
Net interest income
    5,878,673       5,491,144       15,587,984       16,132,289  
Provision for loan losses
    11,796,831       2,151,138       18,048,008       4,576,217  
 
                       
Net interest income (expense) after provision for loan losses
    (5,918,158 )     3,340,006       (2,460,024 )     11,556,072  
 
                       
 
                               
Other income:
                               
Service charges on deposit accounts
    538,105       582,466       1,530,876       1,669,434  
Mortgage origination fees
    212,108       281,633       848,691       1,000,737  
Net gain on sale of securities available for sale
    1,896             723,227       629,987  
Net gain on sale of premises and equipment
          12,167             182,305  
Other operating income
    62,206       45,392       207,008       180,648  
 
                       
Total other income
    814,315       921,658       3,309,802       3,663,111  
 
                       
 
                               
Other expenses:
                               
Salaries and employee benefits
    2,785,035       3,201,367       8,812,187       10,159,410  
Equipment and occupancy expenses
    846,834       888,266       2,533,235       2,529,068  
Net loss on sale of foreclosed assets
    474,261       145,217       813,873       320,958  
Write down of foreclosed assets
    549,613             1,106,859        
Foreclosed asset expenses
    822,634       42,006       1,410,107       120,366  
FDIC insurance premiums
    445,409       128,520       1,613,626       351,159  
Other operating expenses
    1,365,445       1,374,975       3,941,814       4,106,321  
 
                       
Total other expenses
    7,289,231       5,780,351       20,231,701       17,587,282  
 
                       
 
                               
Loss before income taxes
    (12,393,074 )     (1,518,687 )     (19,381,923 )     (2,368,099 )
 
                               
Income tax benefit
    (2,068,347 )     (591,070 )     (4,725,565 )     (966,671 )
 
                       
 
                               
Net loss
    (10,324,727 )     (927,617 )     (14,656,358 )     (1,401,428 )
 
                       
 
                               
Basic losses per share
  $ (0.76 )   $ (0.08 )   $ (1.14 )   $ (0.11 )
 
                       
 
                               
Diluted losses per share
  $ (0.76 )   $ (0.08 )   $ (1.14 )   $ (0.11 )
 
                       
 
                               
Cash dividends per share
  $     $     $     $  
 
                       
See Notes to Consolidated Financial Statements.

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FGBC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
THREE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
AND NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Net loss
  $ (10,324,727 )   $ (927,617 )   $ (14,656,358 )   $ (1,401,428 )
 
                               
Other comprehensive loss:
                               
Reclassification adjustment for net losses on sales of securities included in net income, net of tax of $720 and $0 for (three months) and $274,826 and $239,394 for (nine months)
    (1,175 )           (448,401 )     (390,593 )
 
                               
Net unrealized holding gains (losses) on securities available for sale arising during period, net of tax benefit of $890,196 and $536,529 for (three months) and $734,974 and $36,673 for (nine months)
    1,452,424       875,388       1,199,167       59,836  
 
                       
Other comprehensive gain (loss)
    1,451,249       875,388       750,766       (330,757 )
 
                       
 
                               
Comprehensive loss
  $ (8,873,478 )   $ (52,229 )   $ (13,905,592 )   $ (1,732,185 )
 
                       
See Notes to Consolidated Financial Statements.

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FGBC BANCSHARES, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008
(Unaudited)
                 
    2009     2008  
OPERATING ACTIVITIES
               
Net loss
  $ (14,656,358 )   $ (1,401,428 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Depreciation
    1,463,020       1,461,562  
Amortization and accretion of securities
    142,593       18,571  
Provision for loan losses
    18,048,008       4,576,217  
Writedown of foreclosed assets
    1,106,859        
Stock compensation expense
    232,107       269,095  
Deferred taxes
    (3,715,298 )     (1,410,066 )
Net gain on sale of securities available for sale
    (723,227 )     (629,987 )
Net loss on sale of foreclosed assets
    813,873       320,958  
Net gain on sale of premises and equipment
          (182,305 )
Increase (decrease) in income taxes payable
    857,613       (117,397 )
Decrease in interest receivable
    489,177       532,067  
Decrease in interest payable
    (364,803 )     (68,212 )
Net other operating activities
    387,022       (568,194 )
 
           
Net cash provided by operating activities
    4,080,586       2,800,881  
 
           
 
               
INVESTING ACTIVITIES
               
Increase in interest bearing deposits in banks
    (20,643,675 )     (6,151 )
Purchases of securities available for sale
    (28,253,010 )     (42,954,149 )
Proceeds from maturities of securities available for sale
    14,567,298       9,224,781  
Proceeds from sales of securities available for sale
    38,286,770       42,197,663  
Purchases of restricted equity securities
    (640,600 )     (944,100 )
Decrease in federal funds sold
    722,000       2,582,000  
Net (increase) decrease in loans
    17,198,676       (156,925,283 )
Purchase of premises and equipment
    (1,082,537 )     (5,632,963 )
Proceeds from sale of foreclosed assets
    6,870,083       1,262,293  
Proceeds from sale of premises and equipment
          1,018,997  
Additions to other real estate owned
    (170,798 )     (270,549 )
 
           
Net cash provided by (used in) investing activities
    26,854,207       (150,447,461 )
 
           
 
               
FINANCING ACTIVITIES
               
Net increase (decrease) in deposits
    (19,469,968 )     128,978,973  
Net increase in (repayments of) other borrowings
    (12,750,000 )     16,750,000  
Proceeds from sale of common stock
    5,056,667       3,601,650  
Proceeds from exercise of stock options
    142,013       182,953  
Purchase of fractional shares of common stock
          (7,944 )
 
           
Net cash provided by (used in) financing activities
    (27,021,288 )     149,505,632  
 
           
 
               
Net increase in cash and due from banks
    3,913,505       1,859,052  
 
               
Cash and due from banks, beginning of period
    8,858,796       6,112,287  
 
           
 
               
Cash and due from banks, end of period
  $ 12,772,301     $ 7,971,339  
 
           
 
               
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid during period for:
               
Interest
  $ 14,545,691     $ 18,167,101  
Income taxes
  $     $ 336,000  
 
               
NONCASH TRANSACTIONS
               
Financed sales of foreclosed assets
  $ 4,331,163     $  
Loans transferred to foreclosed assets
  $ 21,624,657     $ 4,413,848  
See Notes to Consolidated Financial Statements.

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FGBC BANCSHARES, INC.
AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2009
(Unaudited)
NOTE 1. BASIS OF PRESENTATION
The financial information contained herein is unaudited. Accordingly, the information does not include all the information and footnotes required by generally accepted accounting principles for complete financial statements, however, such information reflects all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary for a fair statement of results for the interim periods
Operating results for the three and nine-month periods ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. These statements should be read in conjunction with the financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008.
NOTE 2. LOSSES PER COMMON SHARE
The Company is required to report earnings (losses) per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants on the face of the statements of operations. Earnings (losses) per common share are based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings (losses) per share. Presented below is a summary of the components used to calculate basic and diluted earnings (losses) per common share.
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
                               
Basic earnings (losses) per share:
                               
Weighted average common shares outstanding
    13,575,392       12,326,820       12,876,424       12,238,873  
 
                       
 
                               
Net income (loss)
  $ (10,324,727 )   $ (927,617 )   $ (14,656,358 )   $ (1,401,428 )
 
                       
 
                               
Basic earnings (losses) per share
  $ (0.76 )   $ (0.08 )   $ (1.14 )   $ (0.11 )
 
                       
 
                               
Diluted earnings (losses) per share:
                               
Weighted average common shares outstanding
    13,575,392       12,326,820       12,876,424       12,238,873  
 
                       
 
                               
Net effect of the assumed exercise of stock options based on the treasury stock method using average market prices for the year
                       
 
                       
 
                               
Total weighted average common shares and common stock equivalents outstanding
    13,575,392       12,326,820       12,876,424       12,238,873  
 
                       
 
                               
Net income (loss)
  $ (10,324,727 )   $ (927,617 )   $ (14,656,358 )   $ (1,401,428 )
 
                       
 
                               
Diluted earnings (losses) per share
  $ (0.76 )   $ (0.08 )   $ (1.14 )   $ (0.11 )
 
                       
Potential common shares totaling 1,309,066 and 1,099,319 for the three and nine-months ended September 30, 2009 respectively were anti-dilutive and not included in the computation of diluted earnings per share.

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NOTE 3. ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
In April 2009, the FASB issued three related accounting pronouncements to provide further application guidance and enhanced disclosures of fair value measurements and impairments of securities. These pronouncements provide guidance for making fair value measurements more consistent with existing accounting principles when the volume and level of activity for the asset or liability have significantly decreased. The pronouncements also enhance consistency in reporting by increasing the frequency of fair value disclosures and modifies existing general accounting standards for and disclosure of other-than-temporary impairment (“OTTI”) losses for impaired debt securities.
The fair value measurement guidance of these pronouncements reaffirms the need for entities to use judgment in determining if a formerly active market has become inactive and in determining fair values when markets have become inactive. Prior to these pronouncements, fair value disclosures for instruments covered by the pronouncements were required for annual statements only. These disclosures are now required in interim financial statements. The general standards of accounting for OTTI losses were changed to require the recognition of an OTTI loss in earnings only when an entity (1) intends to sell the debt security; (2) more likely than not will be required to sell the security before recovery of its amortized cost basis; or (3) does not expect to recover the entire amortized cost basis of the security. When an entity intends to sell or more likely than not will be required to sell a security, the entire OTTI loss must be recognized in earnings. In all other situations, only the portion of the OTTI losses representing the credit loss must be recognized in earnings, with the remaining portion being recognized in other comprehensive income, net of deferred taxes.
All three pronouncements were effective for interim and annual reports ending after June 15, 2009. Early adoption was permitted for interim and annual periods ending after March 15, 2009, but concurrent adoption of all three was required. The Company adopted the provisions of these pronouncements for the quarter ending June 30, 2009. The adoption of these provisions did not have an impact on the consolidated financial statements.
In May 2009, the FASB issued an accounting pronouncement establishing general standards of accounting for and disclosure of subsequent events. The pronouncement defines “recognized subsequent events” as those that give evidence of conditions that existed at the balance-sheet date and “non-recognized subsequent events” as those that provide evidence about conditions that arose after the balance-sheet date but prior to the issuance of the financial statements. Entities must recognize in the financial statements the effect of recognized subsequent events, but cannot recognize the effects in the financial statements of non-recognized subsequent events. This pronouncement also requires entities to disclose the date through which subsequent events have been evaluated. This pronouncement was effective for interim and annual periods ending after June 30, 2009. The Company adopted this pronouncement for the quarter ended June 30, 2009, and adoption did not have an impact on the consolidated financial statements.
In June 2009, the FASB issued an accounting pronouncement establishing the FASB “Accounting Standards CodificationTM” (the “ASC”) as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities. This pronouncement was effective for financial statements issued for interim and annual periods ending after September 30, 2009. On the effective date, this pronouncement superseded all then-existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification became non-authoritative. The Company adopted this new accounting pronouncement effective September 30, 2009. There was no impact on the consolidated financial statements from the adoption of this pronouncement.
NOTE 4. FAIR VALUE MEASUREMENT
Measurement of fair value under United States generally accepted accounting principles (“US GAAP”) establishes a hierarchy that prioritizes observable and unobservable inputs used to measure fair value, as of the measurement date, into three broad levels, which are described below:
Level 1:    Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.
 
Level 2:    Observable prices that are based on inputs not quoted on active markets, but corroborated by market data.
 
Level 3:    Unobservable inputs are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible, as well as considers counterparty credit risk in its assessment of fair value.
Securities — Where quoted prices are available in an active market, securities are classified within level 1 of the hierarchy. Level 1 securities include highly liquid government securities such as U.S. Treasuries and exchange-traded equity securities. For securities traded in secondary markets for which quoted market prices are not available, the Company generally relies on prices obtained from independent vendors. Securities measured with these techniques are

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classified within Level 2 of the hierarchy and often involve using quoted market prices for similar securities, pricing models or discounted cash flow calculations using inputs observable in the market where available. Examples include U.S. government agency securities, mortgage-backed securities, obligations of states and political subdivisions, and certain corporate, asset-backed and other securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified in Level 3 of the hierarchy.
Impaired Loans — Impaired loans are measured and reported at fair value when full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate or the fair value of the collateral if the loan is collateral-dependent. Impaired loans are subject to nonrecurring fair value adjustment. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.
Foreclosed Assets — Foreclosed assets are adjusted to fair value upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
The following table presents the fair value hierarchy of the Company’s financial assets and financial liabilities measured at fair value as of September 30, 2009:
                                 
    (In Thousands)  
    Quoted Prices in     Significant              
    Active Markets     Other     Significant        
    for Identical     Observable     Unobservable        
    Assets     Inputs     Inputs        
    (Level 1)     (Level 2)     (Level 3)     Total  
         
Assets measured on a recurring basis:
                               
Available for sale securities
  $     $ 48,955     $     $ 48,955  
 
                       
Total assets at fair value
  $     $ 48,955     $     $ 48,955  
 
                       
 
                               
Assets measured on a nonrecurring basis:
                               
Impaired loans
  $     $ 15,107     $ 10,904     $ 26,011  
Foreclosed assets
          6,651       8,063       14,714  
 
                       
Total assets at fair value
  $     $ 21,758     $ 18,967     $ 40,725  
 
                       
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. 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. Current US GAAP excludes certain financial instruments and all nonfinancial instruments from its fair value disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The carrying amount and estimated fair value of the Company’s financial instruments, including those that are not measured and reported at fair value on a recurring basis or non-recurring basis, at September 30, 2009 and December 31, 2008 were as follows:

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    September 30, 2009   December 31, 2008
    Carrying           Carrying    
    Amount   Fair Value   Amount   Fair Value
    (In Thousands)   (In Thousands)
Financial Assets:
                               
Cash and cash equivalents
  $ 44,458     $ 44,458     $ 20,623     $ 20,623  
Securities available-for-sale
    48,955       48,955       71,764       71,764  
Restricted equity securities
    2,694       2,694       2,053       2,053  
Loans, net
    619,624       615,957       672,164       667,130  
Accrued interest receivable
    3,391       3,391       3,880       3,880  
 
                               
Financial Liabilities:
                               
Deposits
  $ 717,622     $ 722,553     $ 737,092     $ 741,079  
Other borrowings
    4,000       4,000       16,750       17,010  
Accrued interest payable
    588       588       953       953  
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statements of financial condition for cash and cash equivalents approximate those assets’ fair values.
Securities available-for-sale: Fair values for investment securities are based on quoted market prices.
Restricted Equity Securities: The carrying value of restricted equity securities with no readily determinable fair value approximates fair value.
Loans: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable.
Deposits: The carrying amount of demand deposits, savings deposits, and variable-rate certificates of deposit approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar maturities.
Other Borrowings: Other borrowings are daily rate credits, which reprice daily and are carried on the statements of financial condition at fair value.
Accrued Interest: The carrying amount of accrued interest approximates fair value.
NOTE 5. SECURITIES AVAILABLE-FOR-SALE
The amortized cost and fair value of securities available-for-sale with gross unrealized gains and losses are summarized on the following page:

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            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
September 30, 2009:
                               
U.S. Government sponsored agency securities
  $ 11,342,824     $ 75,372     $ (15,031 )   $ 11,403,165  
Mortgage-backed securities
    21,658,449       426,387       (32,285 )     22,052,551  
State, county and municipals
    12,847,708       398,272       (122,666 )     13,123,314  
Corporate securities
    2,543,224             (167,137 )     2,376,087  
 
                       
 
  $ 48,392,205     $ 900,031     $ (337,119 )   $ 48,955,117  
 
                       
 
                               
December 31, 2008:
                               
U.S. Government sponsored agency securities
  $ 20,478,647     $ 647,993     $     $ 21,126,640  
Mortgage-backed securities
    34,199,020       696,568       (76,228 )     34,819,360  
State, county and municipals
    15,187,226       2,170       (1,648,137 )     13,541,259  
Corporate securities
    2,547,738       7,500       (277,868 )     2,277,370  
 
                       
 
  $ 72,412,631     $ 1,354,231     $ (2,002,233 )   $ 71,764,629  
 
                       
Securities with a carrying value of $7,026,256 and $20,744,709 as of September 30, 2009 and December 31, 2008, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.
The tables below show the gross unrealized losses and fair value of securities, aggregated by category and length of time that securities have been in a continuous unrealized loss position.
                                 
    Less Than Twelve Months     Twelve Months or More  
            Gross             Gross  
            Unrealized             Unrealized  
    Fair Value     Losses     Fair Value     Losses  
    (In Thousands)  
September 30, 2009:
                               
U.S. Government sponsored agencies
  $ 11,403,165     $ (15,031 )   $     $  
Mortgage-backed securities
    22,052,551       (32,285 )            
State, county and municipal securities
    11,608,606       (104,075 )     1,514,708       (18,591 )
Corporate securities
    930,000       (70,000 )     1,446,087       (97,137 )
 
                       
 
  $ 45,994,322     $ (221,391 )   $ 2,690,795     $ (115,728 )
 
                       
 
                               
December 31, 2008:
                               
U.S. Government sponsored agencies
  $     $     $     $  
Mortgage-backed securities
    6,336,827       (73,011 )     971,055       (3,217 )
State, county and municipal securities
    12,365,148       (1,492,817 )     888,316       (155,320 )
Corporate securities
    1,269,870       (277,868 )            
 
                       
 
  $ 19,981,845     $ (1,843,696 )   $ 1,859,371     $ (158,537 )
 
                       
Unrealized gains and losses within the investment portfolio are determined to be temporary. The Company has performed an evaluation of its investments at September 30, 2009 and no other than temporary impairment was identified. Our corporate securities consist solely of two trust preferred securities of financial institution holding companies who continue to make their contractual interest payments. Management has no specific intent to sell any securities and it is more likely than not that the Company will not have to sell any security before recovery of its cost basis.
The amortized cost and fair value of debt securities as of September 30, 2009 by contractual maturity are shown on the following page. Actual maturities may differ from contractual maturities of mortgage-backed securities because the mortgages underlying the securities may be called or repaid without penalty. Therefore, these securities are not included in the maturity categories in the following summary.

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    Amortized     Fair  
    Cost     Value  
Due from one to five years
  $ 285,534     $ 305,115  
Due from five to ten years
    4,622,742       4,682,210  
After ten years
    21,825,480       21,915,241  
Mortgage-backed securities
    21,658,449       22,052,551  
 
           
 
  $ 48,392,205     $ 48,955,117  
 
           
The gross gains and losses realized by the Company from sales of available-for-sale securities for the three and nine months ended September 30, 2009 and 2008 respectively were as follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
 
Gross gains realized
  $ 1,896     $     $ 723,227     $ 655,643  
Gross losses realized
                      (25,656 )
 
                       
Net realized gains
  $ 1,896     $     $ 723,227     $ 629,987  
 
                       
NOTE 6. SUBSEQUENT EVENTS
The Company has evaluated all subsequent events through November 23, 2009, the filing date of this Form 10-Q with the Securities and Exchange Commission, to ensure that this Form 10-Q includes appropriate disclosure of events both recognized in the financial statements as of September 30, 2009, and events which occurred subsequent to September 30, 2009 but were not recognized in the financial statements. As of November 23, 2009, there were no subsequent events which required recognition or disclosure.
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following is management’s discussion and analysis of certain significant factors which have affected our financial position and operating results during the periods included in the accompanying consolidated financial statements.
Overview
We experienced a net loss for the nine months ended September 30, 2009 of $14.7 million, an increase in loss of $13.3 million as compared with the $1.4 million net loss we experienced in the corresponding period in 2008. The net loss for the three months ended September 30, 2009 was $10.3 million compared to a net loss of $928,000 for the same period in 2008, which is an increase of $9.4 million. Our net losses per diluted share for the third quarter and first nine months of 2009 were $(0.76) and $(1.14), respectively, which compares to net losses per diluted share of $(0.08) and $(0.11) for the corresponding periods in 2008. The net loss for the third quarter and first nine months of 2009 is primarily attributable to continued asset quality deterioration in our loan portfolio. The weak economy, and particularly the weak real estate markets, have led to increased delinquencies, charge-offs and foreclosed property. Additionally, due to our recent significant losses, we are unable to conclude that we will generate sufficient net income in the near term to realize the full value of our deferred tax assets. Therefore, we established a $2.5 million deferred tax asset valuation allowance in the third quarter of 2009 as a part of our quarterly review of the need for such an allowance. As a result, any further losses will not have an associated tax benefit until we can show that it is more likely than not that we will realize those tax benefits. Moreover, unless we generate sufficient future taxable income we may need to increase the valuation allowance in future periods. As of September 30, 2009 we have deferred taxes of $8.2 million, which is net of the $2.5 million valuation allowance.
On June 25, 2009, we began a campaign to raise capital by issuing common stock through a private placement offering to a limited group of selected accredited individuals. Through November 23, 2009 we sold 1,485,905 shares of common stock for aggregate proceeds of $5,106,167.50 and issued warrants to purchase an additional 364,700 shares for $3.50 per share. Even so, as a result of the unprecedented and prolonged difficult economic environment, the regulatory capital levels of our bank and holding company have decreased. We intentionally decreased our asset size by approximately $40 million since December 31, 2008 in an effort to positively impact our capital ratios. With our lowered capital levels our funding sources have diminished and thus we have increased our cash and due from banks (both interest bearing and non-

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interest bearing) balances by $24.6 million and have increased our liquidity and contingency funding monitoring frequency.
We expect that our loan portfolio size will stabilize or slightly contract for the remainder of 2009. Management has shifted its focus towards attracting loans that are collateralized by assets other than commercial real estate in an effort to lessen our current concentration of this collateral type. Earlier in the year we saw some evidence that real estate markets may have been improving. However, the third quarter did not show the anticipated improvement. Instead, demand for property declined as consumers and investors anticipated further declines in real estate values due to continued foreclosures and the tax credit for first time home buyers was nearing expiration. We are hopeful that the demand for residential real estate will increase in light of the extension of the first time home-buyer tax credit and the relaxation of criteria for those who qualify. Additionally, current economic forecasts indicate a weak recovery for fourth quarter of 2009 and for 2010.
Foreclosed assets increased from $6,041,163 at December 31, 2008 to $14,714,558 at September 30, 2009, which is a result of moving loans from non-performing to actual foreclosure. Related to this increase, foreclosed asset expense increased by $780,628 and $1,289,741 for the third quarter and first nine months of 2009 as compared to the corresponding periods of 2008 as we incurred expenses for the upkeep of properties, legal fees, taxes and other holding costs. Additionally, write-downs of foreclosed properties totaled $1,106,859 for the nine months ended September 30, 2009 with no expense for the same period in 2008. For the nine months ended September 30, 2009, we sold $11,201,246 of foreclosed property at a loss of $813,873. At September 30, 2009 we had 15 properties under contract to sell for an aggregate agreed upon price of $1,914,272.
Non-performing loans also negatively impacted our net interest income as accrued interest is backed out of income when loans become non-accrual. Our non-accrual loans increased from $12,776,980 at September 30, 2008 to $22,377,626 at September 30, 2009. A majority of our non-accrual loans are real estate loans.
As previously reported, to help reduce the effects of the net loss, management has made a conscious effort to aggressively identify and reduce or eliminate any “non-essential” expenses such as directors fees, social club dues, marketing, salaries, employee benefits, bonuses and other employee-related expenses. During the fourth quarter of 2008 and again in the first quarter of 2009, the bank conducted a reduction-in-force eliminating a total of 24 positions across the company and reducing salaries for several other positions. An additional reduction-in-force is anticipated before December 31, 2009. Salaries and employee benefits have decreased $1,347,223 for the nine months ended September 30, 2009 as compared to the same period in 2008. We suspended our incentive program during 2008 (for which bonuses would have been paid in the first quarter of 2009) and the program remains suspended for 2009 and 2010. Additionally, the board of directors voted to significantly reduce board fees early in 2009 and eliminated entirely effective December 1, 2009. We expect to see the effect of all these efforts more fully as the year continues.
Our reductions in non-interest expense have been masked by increases in foreclosed asset expenses and by the rising cost of deposit insurance. Our deposit insurance expense for the nine months ended September 30, 2009 was $1,613,626, which reflects an increase of $1,262,467 compared to the same period in 2008. Included in our 2009 expense is a special assessment of $367,050 that was required by the FDIC to assist in rebuilding the fund.
Critical Accounting Policies
The accounting and financial policies of the Company conform to accounting principles generally accepted in the United States and to general practices within the banking industry. To prepare consolidated financial statements in conformity with accounting principles generally accepted in the United States, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses, valuation of foreclosed real estate and fair value of financial instruments are particularly significant to us and particularly subject to change. Information concerning our accounting policies with respect to these items is available in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 as filed with the SEC on April 2, 2009.
Liquidity and Capital Resources
We consider our liquidity to be adequate to meet operating and loan funding requirements at September 30, 2009. Our bank’s liquidity ratio at September 30, 2009 (i.e. cash, short-term assets, marketable assets and available lines of credit divided by deposits and other borrowings) was approximately 13% and the loan to deposit ratio was approximately 88%. We manage our liquidity to ensure adequate cash for deposit withdrawals, credit commitments and repayments of borrowed funds. Liquidity needs are met through loan repayments, cash flows received from pay downs on mortgage-backed securities, net interest and fee income and the sale or maturity of existing assets. In addition, liquidity is

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continuously provided through the acquisition of new deposits, the renewal of maturing deposits and external borrowings. Management regularly monitors deposit flow and evaluates alternate pricing structures to retain and grow deposits as needed. Historically, to the extent needed, traditional local deposit funding sources were supplemented by the use of FHLB borrowings, brokered deposits and other wholesale deposit sources outside our immediate market area. The Bank’s ability to use brokered deposits, however, is currently restricted due to our less than well-capitalized position. We consider management of liquidity important during this time of uncertainty in terms of forward earnings and capital levels. We maintain a liquid position that is adequate to meet the needs of our customer base. A Contingency Funding Team comprised of independent directors and executive management meets frequently to measure our liquidity position and make adjustments as deemed necessary.
Requirements by banking regulators include the monitoring of risk-based capital guidelines for banks and holding companies that are designed to make capital requirements more sensitive to differences in risk profiles and account for off-balance sheet items. The Company and the Bank must meet minimum risk-based capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Under certain circumstances, the regulators may impose higher minimum capital levels or otherwise adjust an institution’s capital category based on market conditions. Banks that are not “well capitalized” can be subject to higher rates for FDIC insurance and other restrictions and limitations. Management monitors these ratios on a continuous basis.
In accordance with U.S. GAAP, we evaluate our deferred income taxes quarterly to determine if a valuation allowance is required or should be adjusted. U.S. GAAP requires that companies assess whether valuation allowances should be established against their deferred tax assets based on all available evidence, both positive and negative, using a “more likely than not” standard. This assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the duration of statutory carry-back and carry-forward periods, the Company’s experience with tax attributes expiring unused and tax planning alternatives.
A valuation allowance of $2,477,501 has been established based on the “more likely than not” threshold for the Company’s net deferred income tax asset. Our ability to realize our deferred tax asset depends on our ability to generate sufficient taxable income within the carry-back or carry-forward period provided for in the tax law. We have considered the following possible sources of taxable income when assessing the realization of our deferred tax assets:
    Future reversals of existing taxable temporary differences;
 
    Future taxable income exclusive of reversing temporary differences and carry-forwards;
 
    Taxable income in prior carry-back years; and
 
    Tax planning strategies.
     As of September 30, 2009, we disallowed approximately $5,677,000 of deferred tax assets for our regulatory capital computations. The standard minimum capital requirements and the actual capital ratios on a consolidated and bank-only basis as of September 30, 2009 were as follows:
                                 
                            Regulatory
                            Minimum
                    Regulatory   Requirement for
    Actual   Minimum   Well Capitalized
    Consolidated   Bank   Requirement   Status
 
                               
Leverage capital ratio
    6.58 %     6.50 %     4.00 %     5.00 %
Risk-based capital ratios:
                               
Tier I capital
    8.31 %     8.21 %     4.00 %     6.00 %
Total capital
    9.57 %     9.48 %     8.00 %     10.00 %
We continually monitor our regulatory capital position and intend to focus on achieving and maintaining our ratios above the minimums for “well capitalized” status. On June 25, 2009, we began a campaign to raise capital by issuing common stock through a private placement offering to a limited group of selected accredited investors. Through November 23, 2009 we sold 1,458,905 shares of common stock for aggregate proceeds of $5,106,167.50 and issued warrants to purchase an additional 364,700 shares for $3.50 per share. Unfortunately, our losses have more than offset this additional capital. One impact of not being “well capitalized” is that it could limit our bank’s ability to acquire needed funding through sources such as brokered deposits, FHLB advances and unsecured federal funds credit lines and could further impact liquidity through damages to our reputation in our market areas.

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Off-Balance Sheet Risk
We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets.
Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. A summary of our commitments is as follows:
         
    September 30, 2009  
    (Dollars in Thousands)  
Commitments to extend credit
  $ 43,928  
Letters of credit
    822  
 
     
 
  $ 44,750  
 
     
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. 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, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer.
Standby letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral is required in instances which we deem necessary.
Financial Condition
The following is a summary of our balance sheets at the dates indicated:
                 
    September 30,     December 31,  
    2009     2008  
    (Dollars in Thousands)  
Cash and due from banks
  $ 12,772     $ 8,859  
Interest-bearing deposits in banks
    31,686       11,042  
Federal funds sold
          722  
Securities
    51,649       73,818  
Loans, net
    619,624       672,164  
Premises and equipment
    37,518       37,898  
Foreclosed assets
    14,715       6,041  
Deferred tax asset, net
    8,157       4,020  
Accrued interest receivable
    3,391       3,880  
Other assets
    1,720       2,942  
 
           
 
  $ 781,232     $ 821,386  
 
           
 
               
Deposits
  $ 717,622     $ 737,092  
Other borrowings
    4,000       16,750  
Accrued interest payable
    588       953  
Other liabilities
    1,683       777  
Stockholders’ equity
    57,339       65,814  
 
           
 
  $ 781,232     $ 821,386  
 
           
Our total assets decreased by $40,154,070, or 4.89%, to $781,231,551 for the first nine months of 2009, which is due to a combination of a decrease in gross loans of $48,324,089, securities available for sale of $22,168,912, other assets of $1,221,300 and federal funds sold of $722,000. These declines were partially offset by increases of interest-bearing deposits in other banks of $20,643,675, foreclosed assets of $8,673,395, net deferred tax assets of $4,137,405 and cash and due from banks of $3,913,505, as compared to December 31, 2008. These changes reflect management’s intent to reduce the bank’s asset size in order to improve its capital ratios and increase liquidity during challenging economic times. Changes to premises and equipment and accrued interest receivable were not significant for these same periods. For the first nine months of 2009 as compared to December 31, 2008, total liabilities decreased by $31,679,267 and deposits

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decreased by $19,469,968. Additionally, at September 30, 2009 we borrowed $4,000,000 of daily rate credit funds with a cost of 36 basis points after prepaying $16,750,000 of fixed-rate FHLB borrowings with an average cost of 348 basis points, an average maturity of 57 months, and a $324,300 prepayment penalty during the first quarter. Changes to other liabilities and accrued interest payable were not significant. Stockholders’ equity decreased by $8,474,803 due to our loss of $14,656,358 for the first nine months of 2009, an increase in other comprehensive income of $750,766 and an increase to common stock from common stock sold of $5,106,667. Additionally, we recognized $232,107 of stock compensation expense and $140,013 for stock options exercised and a tax refund related to stock options for these same periods. On September 30, 2009 we had no contractual purchase obligations for premises and equipment. Our loan to deposit ratio decreased to 88% at September 30, 2009 from 93% at December 31, 2008.
Results of Operations for the Three and Nine Months Ended September 30, 2009 and 2008
The following is a summary of our operations for the periods indicated:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2009     2008     2009     2008  
    (Dollars in Thousands)  
Interest income
  $ 9,826     $ 11,531     $ 30,116     $ 34,161  
Interest expense
    (3,947 )     (6,040 )     (14,528 )     (18,029 )
 
                       
Net interest income
    5,879       5,491       15,588       16,132  
Provision for loan losses
    (11,797 )     (2,151 )     (18,048 )     (4,576 )
Other income
    814       921       3,310       3,663  
Other expense
    (7,289 )     (5,780 )     (20,232 )     (17,587 )
 
                       
Pretax income (loss)
    (12,393 )     (1,519 )     (19,382 )     (2,368 )
Income tax expense (benefit)
    (2,068 )     (591 )     (4,726 )     (967 )
 
                       
Net income (loss)
  $ (10,325 )   $ (928 )   $ (14,656 )   $ (1,401 )
 
                       
Our net interest income for the three months ended September 30, 2009 was $5,878,673, which is an increase of $387,529 as compared to the same period for 2008. Between the fourth quarter of 2007 and the first quarter of 2009 we experienced compression in our net interest margin due to a falling interest rate environment and stiff competition for deposits. Since the first quarter of 2009, however, we have seen some improvement in our net interest margin, due to a combination of our loan yields increasing and deposits repricing to lower rates. Our quarterly net interest margins for the last two years are as follows:
         
    Net interest
Period   margin
September, 2009
    2.83 %
June, 2009
    2.61 %
March, 2009
    2.32 %
December, 2008
    2.88 %
September, 2008
    3.08 %
June, 2008
    3.17 %
March, 2008
    3.32 %
December, 2007
    3.69 %
Our net interest income for the nine months ended September 30, 2009 was $15,587,984, which represented a decrease of $544,305 as compared to the same period in 2008. The decrease in net interest income for the nine months ended September 30, 2009 versus the same period in 2008 is due to a combination of a declining rate environment and an increase in non-performing loans, which negatively impact our net interest income. Our non-accrual loans increased from $12,776,980 at September 30, 2008 to $22,377,626 at September 30, 2009.
Provision and Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in the provision for loan losses. Once a loan is classified as impaired, it continues to be classified as impaired unless it is brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance.
Management determines the allowance for loan loss by first dividing the loan portfolio into two major categories: (1) satisfactory and past due loans, and (2) impaired loans. For purposes of evaluation, satisfactory and past due loans are further segmented into the following categories: commercial and government guaranteed loans, commercial 1-4 family

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construction and acquisition and development projects, consumer residential real estate and other consumer loans. Management uses an annualized eight-quarter moving average net loan charge-off/recovery experience rate (net charge-off percentage of total loans.) Loan loss reserves are calculated primarily based upon this historical loss experience by segment and adjusted for qualitative factors including changes in the nature and volume of the loan portfolio, overall portfolio quality, changes in levels of non-performing loans, significant shifts in real estate values, changes in levels of collateralization, trends in staff lending experience and turnover, loan concentrations and current economic conditions that may affect the borrower’s ability to pay.
A loan is generally classified as impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Impaired loans are measured 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. A large portion of our impaired loans are collateral dependent, which has caused larger amounts to be included in our allowance for loan losses due to recent declines in real estate values. Impaired loans with balances in excess of $50,000 are evaluated individually, while impaired loans with balances of $50,000 or less are evaluated as a group. No additional funds are committed to be advanced in connection with impaired loans.
The allocation of the allowance to the respective loan categories is an approximation and not necessarily indicative of future losses. The entire allowance is available to absorb losses occurring in the loan portfolio. Management regularly monitors trends with respect to non-accrual, restructured and potential problems loans. Subsequent negative changes in these loans have led management to increase its qualitative adjustment in the allowance for loan loss to accommodate these trends. In management’s opinion, the loan loss allowance is considered adequate at September 30, 2009.
The following table summarizes the allocation of the allowance for loan losses to types of loans as of the indicated dates. The allowance for loan loss allocation is based on a subjective judgment and estimates and therefore is not necessarily indicative of the specific amounts or loan categories in which charge-offs may ultimately occur. In addition, there will be allowance amounts that are allocated based on evaluation of individual loans considered to be impaired by management.
                                 
    September 30, 2009     December 31, 2008  
            Percentage             Percentage  
            of loans in             of loans in  
            each             each  
    Amount     category     Amount     category  
            (Dollars in Thousands)          
Commercial and industrial
  $ 871       6.78 %   $ 632       7.26 %
Real estate — construction
    5,583       23.90 %     5,452       29.64 %
Real estate — mortgage
    8,056       65.54 %     4,578       58.95 %
Installment loans to individuals
    720       3.78 %     351       4.15 %
 
                       
 
  $ 15,230       100 %   $ 11,013       100 %
 
                       
Information with respect to non-accrual, past due and restructured loans at September 30, 2009 and 2008 is as follows:

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    September 30,     December 31,  
    2009     2008  
    (Dollars in Thousands)  
Non-accrual loans:
               
Commercial and industrial
  $ 506     $ 1,048  
Real estate — construction
    10,302       23,858  
Real estate — mortgage
    11,390       11,632  
Installment loans to individuals
    180       323  
 
           
Total non-accrual loans
  $ 22,378     $ 36,861  
 
               
Loans contractually past due ninety days or more as to interest or principal payments and still accruing
  $     $  
 
               
Restructured loans in compliance with terms:
               
Commercial and industrial
  $ 3,756     $  
Real estate — construction
    4,082       4,640  
Real estate — mortgage
    1,409       215  
Installment loans to individuals
           
 
           
Total restructured loans in compliance with terms
  $ 9,247     $ 4,855  
 
               
Potential problem loans:
               
Commercial and industrial
  $ 324     $  
Real estate — construction
    745        
Real estate — mortgage
    1,952        
Installment loans to individuals
    800        
 
           
 
               
Total potential problem loans
  $ 3,821     $  
 
               
Interest income that would have been recorded on non-accrual loans under original terms
  $ 2,626          
Interest income that was recorded on non-accrual loans
    (2,098 )        
 
             
Reduction in interest income
  $ 528          
 
             
Our levels of non-performing loans have increased due to a combination of the declining real estate market and increased unemployment in our market areas. The declining real estate market primarily affects two segments of borrowers: 1) builders and acquisition/development customers who are not able to sell their inventory and thus cannot generate cash flow and make loan payments; and 2) consumers who have lost equity in their residences related to foreclosures and are unable to access this liquidity source or refinance into lower rate mortgages. Increased unemployment rates in our market areas have increased our non-performing loans because borrowers no longer have the necessary cash flow to pay their loan obligations. Additionally, the economic downturn and increased unemployment rates has made an impact on retail and other commercial businesses, which may affect their ability to perform on obligations. The downturn may be exacerbated if energy and food prices increase, equity markets decrease or credit tightens. Current economic forecasts indicate a weak recovery for fourth quarter of 2009 and for 2010.
Loans greater than 90 days past due are automatically placed on non-accrual status. Additionally, we may place loans that are not greater than 90 days past due on non-accrual status if we determine that the full collection of principal and interest comes into doubt. In making that determination we consider all of the relevant facts and circumstances and take into consideration the judgment of responsible lending officers, our loan committee and the regulatory agencies that review the loans as part of their regular examination process. If we determine that a larger allowance to loan losses is necessary then we will make an increase to the allowance through a provision.
At September 30, 2009, we had $22,377,626 of non-accrual loans, which is a decrease of $14,483,733 from December 31, 2008. The decrease is primarily the result of real estate construction loans being charged-off or collateral related to these loans being foreclosed upon and moving into other real estate. This process caused the level of our non-accrual real estate construction loans to decrease by $13.6 million. Additionally, the level of our non-accrual commercial, real estate mortgage and installment loans decreased by approximately $542,000, $242,000 and $143,000 respectively during the first nine months of 2009. At September 30, 2009, no accrued interest on non-accrual loans had been recognized.
In the opinion of management, any loans classified by regulatory authorities as doubtful, substandard or special mention that have not been disclosed above do not (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (2) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms. In the event of non-performance by the borrower,

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these loans have collateral pledged which we believe would prevent the recognition of substantial losses. Any loans classified by regulatory authorities as loss have been charged off.
Restructured loans are loans for which the terms have been negotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. Restructured loans identified in the table above consist of four loan relationships that we are actively managing.
Potential problem loans are defined as loans about which we have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may cause the loan to be placed on non-accrual status, to become past due more than ninety days, or to be restructured.
Information regarding certain loans and allowance for loan loss data through September 30, 2009 and 2008 is as follows:
                 
    Nine Months Ended  
    September 30,  
    2009     2008  
    (Dollars in Thousands)  
Average amount of loans outstanding
  $ 657,497     $ 613,487  
 
           
Balance of allowance for loan losses at beginning of period
  $ 11,013     $ 6,267  
 
           
 
               
Loans charged off
               
Commercial and industrial
    (952 )     (475 )
Real estate — construction
    (6,464 )     (253 )
Real estate — mortgage
    (5,872 )     (287 )
Installment loans to individuals
    (604 )     (281 )
 
           
 
    (13,892 )     (1,296 )
 
           
 
               
Loans recovered
               
Commercial and industrial
    5       13  
Real estate — construction
    5        
Real estate — mortgage
    33       4  
Installment loans to individuals
    18       42  
 
           
 
    61       59  
 
           
Net charge-offs
    (13,831 )     (1,237 )
 
           
 
               
Additions to allowance charged to operating expense during period
    18,048       4,567  
 
           
 
               
Balance of allowance for loan losses at end of period
  $ 15,230     $ 9,606  
 
           
 
               
Ratio of net loans charged off during the period to average loans outstanding
    2.10 %     .20 %
 
           
We anticipate the level of charge-offs to decline in the fourth quarter and for the coming year as forecasts indicate a weak recovery for fourth quarter of 2009 and for 2010.
Other Income and Expenses
Other income decreased by $107,343 and $353,309 during the third quarter and first nine months of 2009 as compared to the corresponding period in 2008. We experienced a $44,361 and $138,558 decrease in service charges on deposits accounts, primarily from a reduction in the quantity of NSF fees as it appears consumers are more carefully monitoring their account balances due to the tightening economy for the third quarter and first nine months of 2009 as compared to the same periods for 2008. We also had a $69,525 and $152,046 decrease in secondary-market mortgage origination fees due to the slowing real estate market for the third quarter and first nine months of 2009 as compared to the same periods in 2008. We had a $1,896 and $93,240 increase in the net gain on the sale of securities available for sale when compared to the same periods in 2008, which resulted from management’s desire to improve liquidity and restructure maturities. Our other operating income modestly increased by $16,814 and $26,360 during the third quarter and first nine months of 2009 when compared to the corresponding periods in 2008 primarily from rental income on our foreclosed assets. Lastly we had a decrease in net gain on the sale of premises and equipment of $12,167 and $182,305 for the third quarter and first nine months of 2009 as compared to the corresponding periods in 2008 because there were no sales during 2009.
Other expenses increased by $1,508,880 and $2,644,419 during the third quarter and first nine months of 2009 as compared to the corresponding periods in 2008. Foreclosed asset expenses increased by $780,628 and $1,289,741 for the third quarter and first nine months of 2009 as compared to the corresponding periods in 2008 and include expenses such as property taxes, maintenance, insurance, utilities and environmental protection paid for all foreclosed assets. Write downs

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on foreclosed assets increased by $549,613 and $1,106,859 for the third quarter and first nine months of 2009 as compared to the same periods in 2008. Net loss on the sale of foreclosed assets increased by $329,044 and $492,915 for the third quarter and first nine months as compared to the same periods in 2008. FDIC insurance premiums increased $316,889 and $1,262,467 for the third quarter and first nine months of 2009 compared to the same periods of 2008. We expect to continue incurring large levels of FDIC insurance premiums resulting from the need to replenish the insurance fund due to recent economic events. Salaries and employee benefits have decreased by $416,332 and $1,347,223 for the third quarter and first nine months of 2009 as compared to the same periods in 2008 due to the previously mentioned reduction-in-force and management’s decision to eliminate the employee bonus program for 2009 and 2010 as a result of worsening economic conditions. We expect to see a continued decrease in our employee-related expenses for 2010 as the full effect our position reductions is realized. Occupancy and equipment expenses decreased by $41,432 for the third quarter of 2009 as compared to the comparable period in 2008 but had a negligible increase of $4,167 for the first nine months of 2009 as compared to the same period in 2008. Other operating expenses decreased by $9,530 and $164,507 for the third quarter and first nine months of 2009 as compared to the corresponding periods in 2008.
We recorded income tax benefits of $2,068,347 and $4,725,565 during the third quarter and first nine months of 2009 as compared to tax benefits of $591,070 and $966,671 for the comparable periods in 2008. As of September 30, 2009 after a management evaluation of future taxable income we recorded a $2,477,501 valuation allowance against our deferred tax asset.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
It is our objective to manage assets and liabilities to provide a satisfactory, consistent level of profitability within the framework of established cash, loan, investment, borrowing, and capital policies. Certain of our officers are charged with the responsibility for monitoring policies and procedures that are designed to ensure acceptable composition of the asset/liability mix.
Our asset/liability mix is monitored on a regular basis with a report reflecting the interest rate sensitive assets and interest rate sensitive liabilities being prepared and presented to the board of directors and management’s asset/liability committee on a quarterly basis. The objective is to monitor interest rate sensitive assets and liabilities so as to minimize the impact of substantial movements in interest rates on earnings. An asset or liability is considered to be interest rate sensitive if it will reprice or mature within the time period analyzed, usually one year or less. The interest rate-sensitivity gap is the difference between the interest-earning assets and interest-bearing liabilities scheduled to mature or reprice within such time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. If our assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would be minimal.
A simple interest rate “gap” analysis by itself may not be an accurate indicator of how net interest income will be affected by changes in interest rates. Accordingly, we also evaluate how the repayment of particular assets and liabilities is impacted by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the interest rate gap. The ability of many borrowers to service their debts also may decrease in the event of an interest rate increase.
The table that follows summarizes our interest sensitive assets and liabilities as of September 30, 2009. Adjustable rate loans are included in the period in which their interest rates are scheduled to adjust. Fixed rate loans are included in the periods in which they are anticipated to be repaid based on scheduled maturities and anticipated prepayments. Investment securities are included in their period of maturity while mortgage backed securities are included according to expected repayment. Certificates of deposit are presented according to contractual maturity.

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Analysis of Interest Sensitivity
As of September 30, 2009
(Dollars in Thousands)
                                 
    0-3   3-12   Over 1    
    Months   Months   Year   Total
Interest-earning assets:
                               
Interest-bearing deposits in banks
    31,686                   31,686  
Securities
                48,955       48,955  
Restricted equity securities (1)
    2,694                   2,694  
Federal funds sold
                       
Loans (2)
    189,521       141,971       281,128       612,620  
 
                               
Total interest-earning assets
    223,901       141,971       330,083       695,955  
 
                               
 
                               
Interest-bearing liabilities:
                               
Interest-bearing demand deposits
    85,436                   85,436  
Savings and money markets
    189,325                   189,325  
Time deposits
    94,570       248,136       56,758       399,464  
Federal Home loan Bank borrowings
    4,000                   4,000  
 
                               
Total interest-bearing liabilities
    373,331       248,136       56,758       678,225  
 
                               
 
                               
Interest rate sensitivity gap
    (149,430 )     (106,165 )     273,325       17,730  
 
                               
 
                               
Cumulative interest rate sensitivity gap
    (149,430 )     (255,595 )     17,730          
 
                               
 
                               
Interest rate sensitivity gap ratio
    .60       0.57       5.82          
 
                               
 
                               
Cumulative interest rate sensitivity gap ratio
    .60       0.59       1.03          
 
                               
 
(1)   Restricted equity securities did not pay dividends during the first two quarters of 2009.
 
(2)   Excludes non-accrual loans totaling approximately $22,378,000 and deferred fees of approximately $145,000.
At September 30, 2009 our cumulative one-year interest rate sensitivity gap ratio was .59. Our targeted ratio is 0.8 to 1.2. This indicates that the interest-earning assets will reprice during this period at a rate slower than the interest-bearing liabilities. Our experience, however, has been that not all liabilities shown as being subject to repricing will in fact reprice with changes in market rates. We have a base of core deposits consisting of interest-bearing checking accounts and savings accounts whose average balances and rates paid thereon will not fluctuate with changes in the levels of market interest rates.
Item 4. Controls and Procedures
Our management carried out an evaluation, under the supervision and with the participation of our Chief Executive Officer and Chief Financial Officer, of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of the end of the quarterly period covered by this Form 10-Q and based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective. There were no changes in our internal control over financial reporting during the third quarter of 2009 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are not a party to any material legal proceedings other than ordinary routine litigation that is incidental to our business.

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Item 1A. Risk Factors
Our business involves a high degree of risk. The following paragraphs set forth certain risk factors that should be read together with and in addition to the risk factors set forth in Item 1A to Part I of our Annual Report on Form 10-K, which are incorporated herein by reference.
We may face liquidity constraints and experience higher costs of funding if we are unable to regain and thereafter maintain a “well-capitalized” regulatory status.
During the third quarter of 2009 our bank’s capital ratios declined significantly as a result of the loan losses we sustained and significant additional provisions to our allowance for loan losses. While our bank’s ratios were still above levels required to be considered “adequately capitalized” at September 30, 2009, it was not considered “well-capitalized” under regulatory guidelines. The impact of not maintaining a “well-capitalized” status is of concern in that it could jeopardize our bank’s ability to acquire needed funding through sources such as brokered deposits, Federal Home Loan Bank advances or unsecured federal funds credit lines, and could tighten our liquidity through damages to our reputation in our deposit service areas. This could also lead to increased scrutiny by regulatory agencies and possible sanctions. In response to our declining capital position, we could improve our capital position with additional issuances of equity securities. We may also limit or postpone future asset growth, or even shrink our assets in order to maintain appropriate regulatory capital levels. These efforts, however, may not be successful.
Current and future restrictions on the conduct of our business could adversely impact our ability to attract deposits.
Because our bank is no longer considered “well capitalized” for regulatory purposes, it is, among other restrictions, prohibited from paying rates in excess of 75 basis points above the local market average on deposits of comparable maturity. Effective January 1, 2010, financial institutions that are not “well capitalized” will be prohibited from paying yields for deposits in excess of 75 basis points above a new national average rate for deposits of comparable maturity, as calculated by the FDIC, except in very limited circumstances where the FDIC permits use of a higher local market rate. The national rate may be lower than the prevailing rates in our local markets, and our bank (if it is unable to regain “well capitalized” status) may not be able to secure the permission of the FDIC to use a local market rate. If restrictions on the rates our bank is able to pay on deposit accounts negatively impacts its ability to compete for deposits in our market area, our bank may be unable to attract or maintain core deposits, and its liquidity and ability to support demand for loans could be adversely affected.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
The Company commenced a private placement offering on June 25, 2009. Please refer to Item 3.02 of the Company’s Current Report on Form 8-K filed with the Commission on June 30, 2009, which is incorporated herein by reference. In the third quarter of 2009 the Board voted to increase the size of the offering from $5,000,002 to $7,500,003. Through November 23, 2009 the Company had sold 1,458,905 shares of common stock for aggregate proceeds of $5,106,167.50 and issued warrants to purchase an additional 364,700 shares for $3.50 per share.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
The following exhibits are included with this report:
31.1   Certificate of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
31.2   Certificate of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
32   Certificate of CEO and CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  FGBC BANCSHARES, INC.
 
 
Date: November 23, 2009  /s/ Jackie L. Reed    
  Jackie L. Reed   
  President and CEO   
 
     
Date: November 23, 2009  /s/ Teresa L. Martin    
  Teresa L. Martin   
  Chief Financial Officer   
 

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