TNCC Tennessee Commerce Bancorp (TN) (MM)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-K

(Mark One)

For the transition period from                      to                    .

Commission file number 000-51281

Tennessee Commerce Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code (615) 599-2274

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

(Title of each class)

Indicate by check mark if the registrant is a well-known, seasoned issuer, as defined in Rule 405 of the Securities Act. Yes   o    No   x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes   o    No   x

Indicate by check mark whether registrant (1) has filed 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    x    No    o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    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 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    x         Non-accelerated filer    o           Smaller reporting company    o

(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o    No   x

The aggregate market value of the registrant’s voting stock held by non-affiliates of the registrant at June 30, 2008 was $65.8 million, based upon the average sale price on that date.

As of March 14, 2009, there were 4,731,696 shares of the registrant’s common stock outstanding.

Documents Incorporated by Reference:

Part III information is incorporated herein by reference, pursuant to Instruction G of Form 10-K, to registrant’s Definitive Proxy Statement for its 2009 Annual Meeting of shareholders to be held on May 19, 2009, which will be filed with the Commission no later than April 29, 2009 (the Proxy Statement). Certain Part II information required by Form 10-K is incorporated by reference to the registrant’s Annual Report to Shareholders, but the Annual Report to Shareholders shall not be deemed filed with the Commission.

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PART I

ITEM 1 .                                                      BUSINESS

General

Tennessee Commerce Bancorp, Inc. (the “Corporation” or “we” or “us”) is a bank holding company formed as a Tennessee corporation to own the shares of Tennessee Commerce Bank (the “Bank”). The Bank commenced operations January 14, 2000, and is a full service financial institution located in Franklin, Tennessee, 15 miles south of Nashville. Franklin is in Williamson County, one of the most affluent and rapidly growing counties in the nation and the Bank conducts business from a single location in the Cool Springs commercial area of Franklin. The Bank had total assets at December 31, 2008 of $1.2 billion. Although the Bank offers a full range of banking services and products, it operates with a focused “Business Bank” strategy.  The Business Bank strategy emphasizes banking services for small- to medium-sized businesses, entrepreneurs and professionals in the local market. The Bank competes by combining the personal service and appeal of a community bank institution with the sophistication and flexibility of a larger bank. This strategy distinguishes the Bank from its competitors in efforts to attract loans and deposits of local businesses. In addition, the Bank accesses a national market through a network of financial service companies and vendor partners that provide indirect funding opportunities for the Bank nationwide.

The Bank does not compete based on the traditional definition of “convenience” and does not have a branch network for that purpose. Business is conducted from a single office with no teller line, drive-through window or extended banking hours.  The Bank competes by providing responsive and personalized service to meet customer needs.  Convenience is created by technology and by a free courier service which transports deposits directly from the local business location to the Bank.  The Bank provides free electronic banking and cash management tools and on-site training for business customers.  The Bank competes for local consumer business by providing superior products, attractive deposit rates, free Internet Banking services and access to a third party regional automated teller machine (“ATM”) network. The Bank targets service, manufacturing and professional customers and avoids retail businesses with high transaction volume.

The Bank offers a full range of competitive retail and commercial banking services.  The deposit services offered include various types of checking accounts, savings accounts, money market investment accounts, certificates of deposits and retirement accounts.  Lending services include consumer installment loans, various types of mortgage loans, personal lines of credit, home equity loans, credit cards, real estate construction loans, commercial loans to small-and-medium size businesses and professionals, and letters of credit. The Bank issues VISA credit cards and is a merchant depository for cardholder drafts under VISA credit cards.  The Bank also offers check cards and debit cards.  The Bank offers its local customers courier services, access to third-party ATMs and state of the art electronic banking. The Bank has trust powers but does not have a trust department.

The Business Bank strategy is evident in differences between the financial statements of the Bank and more traditional financial institutions.   The Business Bank model creates a high degree of leverage.  By avoiding the investment and maintenance costs of a typical branch network, the Bank is able to maintain earning assets at a higher level than peer institutions.  Management targets a minimum earning asset ratio of 97% compared to the average of 85%, as of September 30, 2008, for all banks insured by the Federal Deposit Insurance Corporation (“FDIC”). Assets of the Bank are centered in the loan portfolio which consists primarily of commercial and industrial loans.  Management targets a loan mix of 60% commercial loans and 40% real estate.  At December 31, 2008, the composition of the $1.04 billion loan portfolio was 56.86% commercial, 37.68% secured by real estate (both commercial and consumer) and 5.46% in consumer and credit card loans.

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In addition to lending in the local marketplace, the Bank generates assets in the national market by providing collateral-based loans to business borrowers located in other states through two types of indirect funding programs. In both programs, the transactions are originated by a third party, such as an equipment vendor or financial services company, who provides the Bank with a borrower’s financial information and arranges for a borrower’s execution of loan documentation. The Bank funds these transactions earning strong yields and has no servicing expense or residual risk in any transaction originated by these financial service companies and vendors. The Bank has management and personnel who are experienced in this type of transaction and are able to evaluate and partner effectively with the companies who originate these transactions. All indirect funding is secured by the business asset financed, and is subject to the Bank’s minimum credit score and documentation standards.  These national market transactions provide geographic and collateral diversity for the portfolio and represent 31.06% of the total loan portfolio at December 31, 2008.

The two national market funding programs fund different size loans through two different networks. In the first type, the Bank uses an established network of financial service companies and vendor partners that provide the Bank funding opportunities to national middle-market and investment grade companies. At December 31, 2008, the average size of this type of loan in the loan portfolio was approximately $322,000 and earned an average yield of 7.60%. Funding under this program represents approximately 14.33% of the $1.04 billion total loan portfolio.  In the second program, the Bank partners with a second network of financial service companies and vendors located in Tennessee, Alabama, Georgia, California and Michigan. This program is for smaller transactions. These loans that finance business assets are less than $125,000 at origination. Management has installed a standardized credit approval process that delivers quick responsive service. At December 31, 2008, the average size of this type of loan in the loan portfolio was approximately $46,000, and the average yield on these loans was 8.05%. Funding under this program represents 16.94% of the $1.04 billion total loan portfolio.

Management believes the Business Bank model is highly efficient.  The Bank targets the non-retail sector of the commercial market, which is characterized by lower levels of transactions and processing costs.  The commercial customer mix and the strategic outsourcing of certain administrative functions, such as data processing, allow the Bank to operate with a smaller, more highly trained staff.  Management targets an average asset per employee ratio of $7.5 million compared to the average of less than $4.50 million in assets per employee for Tennessee state-chartered banks at the end of September 30, 2008, as reported by the FDIC. The Bank also promotes the use of technology, both internally and externally, to maximize the efficiency of operations.  Management targets an operating efficiency ratio (total operating expense divided by total revenue) of 40% to 45%.

The Bank is subject to the regulatory authority of the Department of Financial Institutions of the State of Tennessee (“TDFI”) and the FDIC.

The Bank’s principal executive offices are located at 381 Mallory Station Road, Suite 207, Franklin, Tennessee 37067, and its telephone number is (615) 599-2274.

The Corporation was incorporated on March 22, 2000, for the purpose of acquiring 100% of the shares of the Bank by means of a share exchange, and becoming a registered bank holding company under the Federal Reserve Act.  The share exchange was completed on May 31, 2000.  The Corporation’s activities are subject to the supervision of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).  The Corporation’s offices are the same as the principal office of the Bank.  On March 29, 2005, the Corporation formed a wholly owned subsidiary, Tennessee Commerce Bank Statutory Trust I (the “Trust I”).  In June 2008, the Corporation formed a wholly owned subsidiary, Tennessee Commerce Bank Statutory Trust II (the “Trust II”) and in July 2008, the Corporation formed a wholly owned subsidiary, TCB Commercial Asset Services, Inc (“TCB”). As of December 31, 2008, the Bank, the Trust I, the Trust II and TCB were the only subsidiaries of the Corporation. The accompanying consolidated financial statements include the accounts of the Corporation, the Bank and TCB. The Trust I and the Trust II are not consolidated in accordance with Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R) (revised December 2003), “Consolidation of Variable Interest Entities.” Material intercompany accounts and transactions have been eliminated. The Bank commenced operations as a Tennessee state chartered bank on January 14, 2000, and is headquartered in Franklin, Tennessee.

Corporation Overview

The Corporation, headquartered in Franklin, Tennessee, is the bank holding company for the Bank.  Organized in January 2000, the Bank has a focused strategy that serves the banking needs of small to medium-sized businesses, entrepreneurs and professionals in the Nashville metropolitan statistical area, or the Nashville MSA, as well as the funding needs of certain national and regional equipment vendors and financial services companies.  The Corporation calls this strategy its Business Bank strategy. The Corporation primarily conducts business from a single location in the Cool Springs commercial area of Franklin, Tennessee, 15 miles south of Nashville. The Corporation also operates three loan production offices - one in each of Birmingham, Alabama, Minneapolis, Minnesota and Atlanta, Georgia, the latter two of which were opened in April and May 2008, respectively. Each of the two new offices is staffed with one senior lending officer.

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The Corporation offers a full range of competitive retail and commercial banking services to local customers in the Nashville MSA.  The Corporation’s deposit services include a broad offering of checking accounts, savings accounts, money market investment accounts, certificates of deposits and retirement accounts.  Lending services include consumer installment loans, various types of mortgage loans, personal lines of credit, home equity loans, credit cards, real estate construction loans, commercial loans to small and medium-sized businesses and professionals, and letters of credit. The Corporation issues VISA credit cards and is a merchant depository for cardholder drafts under VISA credit cards.  The Corporation also offers check cards and debit cards and offers its local customers free courier services, access to third-party automated teller machines, or ATMs, and state-of-the-art electronic banking. The Corporation has trust powers but does not have a trust department.

Employees

At December 31, 2008, the Corporation employed no persons and the Bank employed 83 persons on a full-time basis. The Bank’s employees are not represented by any union or other collective bargaining agreement and management of the Bank believes its employee relations are satisfactory.

Supervision and Regulation

Bank Holding Company Regulation

The Corporation is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “Holding Company Act”), and is registered with the Federal Reserve Board. The Corporation’s banking subsidiary is subject to restrictions under federal law which limit the transfer of funds by the Bank to the Corporation, whether in the form of loans, extensions of credit, investments or asset purchases. Such transfers by any subsidiary bank to its holding company or any non-banking subsidiary are limited in amount to 10% of the subsidiary bank’s capital and surplus and, with respect to the Corporation and the Bank, to an aggregate of 20% of the Bank’s capital and surplus.  Furthermore, such loans and extensions of credit are required to be secured in specified amounts.  The Holding Company Act also prohibits, subject to certain exceptions, a bank holding company from engaging in or acquiring direct or indirect control of more than 5% of the voting stock of any company engaged in non-banking activities.  An exception to this prohibition is for activities expressly found by the Federal Reserve Board to be so closely related to banking or managing or controlling banks as to be a proper incident thereto or financial in nature.

As a bank holding company, the Corporation is required to file with the Federal Reserve Board semiannual reports and such additional information as the Federal Reserve Board may require.  The Federal Reserve Board also makes examinations of the Corporation at its discretion.

According to Federal Reserve Board policy, bank holding companies are expected to act as a source of financial strength to each subsidiary bank and to commit resources to support each such subsidiary.  This support may be required at times when a bank holding company may not be able to provide such support.  Furthermore, in the event of a loss suffered or anticipated by the FDIC — either as a result of default of the Bank or related to FDIC assistance provided to a subsidiary in danger of default — the Bank may be assessed for the FDIC’s loss, subject to certain exceptions.

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Various federal and state statutory provisions limit the amount of dividends the subsidiary banks can pay to their holding companies without regulatory approval.  The payment of dividends by any bank also may be affected by other factors, such as the maintenance of adequate capital for such subsidiary bank.  In addition to the foregoing restrictions, the Federal Reserve Board has the power to prohibit dividends by bank holding companies if their actions constitute unsafe or unsound practices.  The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the Federal Reserve Board’s view that a bank holding company experiencing earnings weaknesses should not pay cash dividends that exceed its net income or that could only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing.  Furthermore, the TDFI also has authority to prohibit the payment of dividends by a Tennessee bank when it determines such payment to be an unsafe and unsound banking practice.

A bank holding company and its subsidiaries are also prohibited from acquiring any voting shares of, or interest in, any banks located outside of the state in which the operations of the bank holding company’s subsidiaries are located, unless the acquisition is specifically authorized by the statutes of the state in which the target is located.  Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with the extension of credit or provision of any property or service.  Thus, an affiliate of a bank holding company may not extend credit, lease or sell property, or furnish any services or fix or vary the consideration for these on the condition that (i) the customer must obtain or provide some additional credit, property or services from or to its bank holding company or subsidiaries thereof or (ii) the customer may not obtain some other credit, property or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended.

In approving acquisitions by bank holding companies of banks and companies engaged in the banking-related activities described above, the Federal Reserve Board considers a number of factors, including the expected benefits to the public such as greater convenience, increased competition, or gains in efficiency, as weighed against the risks of possible adverse effects such as undue concentration of resources, decreased or unfair competition, conflicts of interest, or unsound banking practices.  The Federal Reserve Board is also empowered to differentiate between new activities and activities commenced through the acquisition of a going concern.

The Attorney General of the United States may, within 30 days after approval by the Federal Reserve Board of an acquisition, bring an action challenging such acquisition under the federal antitrust laws, in which case the effectiveness of such approval is stayed pending a final ruling by the courts.  Failure of the Attorney General to challenge an acquisition does not, however, exempt the holding company from complying with both state and federal antitrust laws after the acquisition is consummated or immunize the acquisition from future challenge under the anti-monopolization provisions of the Sherman Act.

Bank Regulation

The Bank is a Tennessee state-chartered bank and is subject to the regulations of and supervision by the FDIC as well as the Commissioner of the TDFI (the “Commissioner”), Tennessee’s state banking authority.  The Bank is also subject to various requirements and restrictions under federal and state law, including without limitation restrictions on permitted activities, requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon and limitations on the types of investments that may be made and the types of services that may be offered.  Various consumer laws and regulations also affect the operations of the Bank.  In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Federal Reserve Board as it attempts to control the money supply and credit availability in order to influence the economy.

The FDIC and the Commissioner periodically conduct examinations of the Bank.  If, as a result of an examination of the Bank, the FDIC determines that the financial condition, capital resources, asset quality, earnings prospects, management, liquidity or other aspects of the Bank’s operations are unsatisfactory or that the Bank or its management is violating or has violated any law or regulation, various remedies are available to the FDIC.  Such remedies include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in capital, to restrict the growth of the Bank, to assess civil monetary penalties, to remove officers and directors and ultimately to terminate a Bank’s deposit insurance.  The Commissioner has many of the same remedial powers, including the power to take possession of a bank whose capital becomes impaired.  As of December 31, 2008, the Bank was not the subject of any such action by the FDIC or the Commissioner.

The deposits of the Bank are insured by the FDIC in the manner and to the extent provided by law.  For this protection, the Bank pays a quarterly statutory assessment.

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Although the Bank is not a member of the Federal Reserve System, it is nevertheless subject to certain regulations of the Federal Reserve Board.

Tennessee law contains limitations on the interest rates that may be charged on various types of loans and restrictions on the nature and amount of loans that may be granted and on the types of investments that may be made.  The operations of banks are also affected by various consumer laws and regulations, including those relating to equal credit opportunity and regulation of consumer lending practices.  All Tennessee banks must become and remain insured banks under the Federal Deposit Insurance Act (the “FDIA”).

Capital Requirements

The Federal Reserve Board has risk-based capital requirements for bank holding companies and member banks, and the FDIC adopted risk-based capital requirements for banks and bank holding companies effective after December 31, 1990. The risk-based capital guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets.  Assets and off-balance sheet items are assigned to broad risk categories each with appropriate weights.  The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items.  The guidelines require all federally regulated banks to maintain a minimum risk-based total capital ratio of 8%, of which at least 4% must be Tier I Capital (as defined below).  Under the guidelines, the minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet items, such as standby letters of credit) is 8%.  To be considered a “well capitalized” bank or bank holding company under the guidelines, a bank or bank holding company must have a total risk based capital ratio in excess of 10% (in addition to meeting other requirements).

At least half of the total capital of a bank is to be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, after subtracting goodwill and certain other adjustments (“Tier I Capital”).  The remainder may consist of perpetual debt, mandatory convertible debt securities, a limited amount of subordinated debt, other preferred stock not qualifying for Tier I Capital and a limited amount of loan loss reserves (“Tier II Capital”).  Under the risk-based capital requirements, total capital consists of Tier I Capital, which is generally common shareholders’ equity less goodwill, and Tier II Capital, which is primarily a portion of the allowance for loan losses and certain qualifying debt instruments.  In determining risk-based capital requirements, assets are assigned risk-weights of 0% to 100%, depending primarily on the regulatory assigned levels of credit risk associated with such assets.  Off-balance sheet items are considered in the calculation of risk-adjusted assets through conversion factors established by the regulators.  The framework for calculating risk-based capital requires banks and bank holding companies to meet the regulatory minimums of 4% Tier I Capital and 8% total risk-based capital.

The Federal Reserve Board and the FDIC have adopted a minimum leverage ratio of 4%.  Generally, banking organizations are expected to operate well above the minimum required capital level of 4% unless they meet certain specified criteria, including having the highest regulatory ratings. Most banking organizations are required to maintain a leverage ratio of 4%, plus an additional cushion of at least 1% to 2%.  State regulatory authorities and the FDIC encourage most community banks to maintain a leverage ratio of 6.5% to 7.0%. The FDIC has a regulation requiring certain banking organizations to maintain additional capital of 1% to 2% above a 4% minimum Tier I leverage capital ratio (ratio of Tier I Capital, less intangible assets, to total assets).  In order for an institution to operate at or near the minimum Tier I leverage capital requirement of 3%, the FDIC expects that such institution would have well-diversified risk, no undue rate risk exposure, excellent asset quality, high liquidity and good earnings.  In general, the Bank would have to be considered a strong banking organization, rated in the highest category under the bank rating system and have no significant plans for expansion.  Higher Tier I leverage capital ratios of up to 5% will generally be required if all of the above characteristics are not exhibited or if the institution is undertaking expansion, seeking to engage in new activities or otherwise faces unusual or abnormal risks.  The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance upon intangible assets.  The Bank’s Tier I leverage capital ratio at December 31, 2008 was 9.26%.

Under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), failure to meet the capital guidelines could subject a banking institution to a variety of enforcement remedies available to federal regulatory authorities, including the termination of deposit insurance by the FDIC.  Institutions not in compliance with the capital guidelines are expected to be operating in compliance with a capital plan or agreement with the regulator.  If they do not do so, they are deemed to be engaging in an unsafe and unsound practice and may be subject to enforcement action.  In addition, failure by an institution to maintain capital of at least 2% of assets constitutes an unsafe and unsound practice and may subject the institution to enforcement action and termination of FDIC insurance.

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In 1999, the Basel Committee on Banking Supervision (“Basel Committee”) launched its efforts to develop an improved capital adequacy framework by issuing its proposals to revise the 1988 Basel Capital Accord.  In June 2004, the Basel Committee issued its final framework.  The new capital framework (“Basel II”) consists of minimum capital requirements, a supervisory review process and the effective use of market discipline.  Basel II seeks to ensure that a bank’s capital position is consistent with its overall risk profile and strategy, encourages early supervisory intervention when a bank’s capital position deteriorates and calls for detailed disclosure of a bank’s capital adequacy and how it evaluates its own capital adequacy.

In September 2006, the U.S. regulators published a revised Notice of Proposed Rulemaking (“NPR”) for Basel II.  The Final Rule on Advanced Capital Adequacy Framework—Basel II (the “Final Rule”), has been approved by all regulatory agencies and took effect on April 1, 2008. The Final Rule currently applies only to certain core banks with total assets of $250 billion or more, but allows non-core banks to opt in.  Under the Final Rule, the Bank is considered to be a non-core bank. For those non-core banks that do not opt in, a NPR was issued in December 2006, known as Basel IA, which proposed certain revisions to the current Basel I capital rules.

The agencies have proposed a NPR that would provide non-core banks the option of adopting the Standardized Approach of the Basel II Framework.  The Basel II Standardized NPR is expected to replace the Basel IA NPR.

Payment of Dividends

The Corporation is a legal entity separate and distinct from its banking and other subsidiaries.  The principal source of cash flow of the Corporation, including cash flow to pay dividends to holders of trust preferred securities of the Corporation’s trusts, holders of the Fixed Rate Cumulative Perpetual Preferred Stock of the Corporation Series A (“Series A Preferred Stock”) and to the Corporation’s common stock shareholders, will be dividends that the Bank pays to the Corporation as its sole shareholder. Under Tennessee law, the Corporation is not permitted to pay dividends if, after giving effect to such payment, the Corporation would not be able to pay the Corporation’s debts as they become due in the usual course of business or the Corporation’s total assets would be less than the sum of the Corporation’s total liabilities plus any amounts needed to satisfy any preferential rights if the Corporation were dissolving. In addition, in deciding whether or not to declare a dividend of any particular size, the Corporation’s board of directors must consider the Corporation’s current and prospective capital, liquidity, and other needs.

In addition to the limitations on the Corporation’s ability to pay dividends under Tennessee law, the Corporation’s ability to pay dividends on the Corporation’s common stock is also limited by the Corporation’s participation in the Troubled Asset Relief Program (“TARP”) Capital Purchase Program (“CPP”) and by certain statutory or regulatory limitations. Prior to December 19, 2011, unless the Corporation has redeemed the Series A Preferred Stock or U.S. Department of the Treasury (“Treasury”)  has transferred the Series A Preferred Stock to a third party, the consent of the Treasury must be received before the Corporation can declare or pay any dividend or make any distribution on the Corporation’s common stock. Furthermore, if the Corporation is not current in the payment of quarterly dividends on the Series A Preferred Stock, the Corporation cannot pay dividends on the Corporation’s common stock.

Moreover, the terms of the Series A Preferred Stock include a restriction against increasing the Corporation’s common stock dividends from levels at the time of the initial investment by Treasury and prevent the Corporation from redeeming, purchasing or otherwise acquiring its common stock other than for certain stated exceptions. Historically, the Corporation has paid no dividends on its common stock. Therefore, the Corporation would have to seek Treasury’s consent to pay any dividends on shares of Corporation common stock. These restrictions will terminate on the earlier of the third anniversary of the date of issuance of the Series A Preferred Stock to Treasury and the date on which the Series A Preferred Stock issued to Treasury has been redeemed in whole or Treasury has transferred all of its Series A Preferred Stock to third parties.  In addition, the Corporation will be unable to declare or pay dividends or distributions on, or repurchase, redeem or otherwise acquire for consideration, shares of its common stock or other stock ranking junior to, or in parity with, the Series A Preferred Stock if the Corporation fails to declare and pay full dividends (or declare and set aside a sum sufficient for payment thereof) on its Series A Preferred Stock.

There are state and federal statutory and regulatory limitations on the payment of dividends by the Bank to the Corporation, as well as by the Corporation to its shareholders. Under the FDIA, the Bank may not make any capital distributions (including the payment of dividends) or pay any management fees to its holding company or pay any dividend if it is undercapitalized or if such payment would cause it to become undercapitalized.  In addition, the Bank is restricted from paying dividends under certain circumstance by the Tennessee Banking Act. The payment of dividends by any bank is dependent upon its earnings and financial condition and subject to the statutory power of certain federal and state regulatory agencies to act to prevent what they deem unsafe or unsound banking practices.  The payment of dividends could, depending upon the financial condition of the Bank, be deemed to constitute such an unsafe or unsound banking practice.  Under Tennessee law, the board of directors of a state bank may not declare dividends in any calendar year that exceeds the total of its retained net income of the preceding two (2) years without the prior approval of the TDFI.  The FDIA prohibits a state bank, the deposits of which are insured by the FDIC, from paying dividends if it is in default in the payment of any assessments due the FDIC.  The Bank is also subject to the minimum capital requirements of the FDIC which impact the Bank’s ability to pay dividends.  If the Bank fails to meet these standards, it may not be able to pay dividends or to accept additional deposits because of regulatory requirements.

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If, in the opinion of the FDIC or the Federal Reserve Board, a depository institution or a holding company is engaged in or is about to engage in an unsafe or unsound practice (which, depending on the financial condition of the depository institution or holding company, could include the payment of dividends), such authority may require that such institution or holding company cease and desist from such practice.  The FDIC and the Federal Reserve Board have indicated that paying dividends that deplete a depository institution’s or holding company’s capital base to an inadequate level would be such an unsafe and unsound banking practice. Moreover, the Federal Reserve Board and the FDIC have issued policy statements which provide that bank holding companies and insured depository institutions generally should only pay dividends out of current operating earnings.

Under Tennessee law, the Corporation is not permitted to pay dividends if, after giving effect to such payment, it would not be able to pay its debts as they become due in the usual course of business or the Corporation’s total assets would be less than the sum of its total liabilities plus any amounts needed to satisfy any preferential rights if the Corporation was dissolving.  In addition, in deciding whether or not to declare a dividend of any particular size, the Corporation’s Board must consider the Corporation’s current and prospective capital, liquidity, and other needs.

The payment of dividends by the Corporation and the Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines and debt covenants.

FIRREA

FIRREA provides that a depository institution insured by the FDIC can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC after August 9, 1989 in connection with (i) the default of a commonly controlled FDIC-insured depository institution or (ii) any assistance provided by the FDIC to a commonly controlled FDIC-insured depository institution in danger of default.  FIRREA provides that certain types of persons affiliated with financial institutions can be fined by the federal regulatory agency having jurisdiction over a depository institution with federal deposit insurance (such as the Bank) up to $1 million per day for each violation of certain regulations related (primarily) to lending to and transactions with executive officers, directors, principal shareholders and the interests of these individuals.  Other violations may result in civil money penalties of $5,000 to $30,000 per day or in criminal fines and penalties.  In addition, the FDIC has been granted enhanced authority to withdraw or to suspend deposit insurance in certain cases.

FDICIA

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires, among other things, the federal banking regulators to take “prompt corrective action” in respect of FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers - “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” Under applicable regulations, a FDIC-insured depository institution is well capitalized if it maintains a Leverage Ratio of at least 5%, a risk adjusted Tier 1 Capital Ratio of at least 6% and a Total Capital Ratio of at least 10% and is not subject to a directive, order or written agreement to meet and maintain specific capital levels.  An insured depository institution is adequately capitalized if it meets all of the minimum capital requirements as described above.  In addition, an insured depository institution will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it is significantly below such measure and critically undercapitalized if it fails to maintain a level of tangible equity equal to not less than 2% of total assets.  An insured depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if it receives an unsatisfactory examination rating.

The capital-based prompt corrective action provisions of FDICIA and their implementing regulations apply to FDIC-insured depository institutions and are not directly applicable to holding companies that control such institutions.  However, the Federal Reserve Board has indicated that, in regulating bank holding companies, it will take appropriate action at the holding company level based on an assessment of the effectiveness of supervisory actions imposed upon subsidiary depository institutions pursuant to such provisions and regulations.

Undercapitalized depository institutions are subject to restrictions on borrowing from the Federal Reserve System.  In addition, undercapitalized depository institutions are subject to growth limitations and are required to submit capital restoration plans.  A depository institution’s holding company must guarantee the capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan.  The federal banking agencies may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital.  If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

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Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks.  Critically undercapitalized depository institutions are subject to appointment of a receiver or conservator generally within 90 days of the date on which they became critically undercapitalized.

FDICIA contains numerous other provisions, including accounting, audit and reporting requirements, termination of the “too big to fail” doctrine except in special cases, limitations on the FDIC’s payment of deposits at foreign branches, new regulatory standards in such areas as asset quality, earnings and compensation and revised regulatory standards for, among other things, powers of state banks, real estate lending and capital adequacy.  FDICIA also requires that a depository institution provide 90 days prior notice of the closing of any branches.

Riegle-Neal Interstate Banking and Branching Efficiency Act

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (“Interstate Act”), among other things and subject to certain conditions and exceptions, permits on an interstate basis (i) bank holding company acquisitions commencing one year after enactment of banks of a minimum age of up to five years as established by state law in any state, (ii) mergers of national and state banks after May 31, 1997 unless the home state of either bank has opted out of the interstate bank merger provision, (iii) branching de novo by national and state banks if the host state has opted-in to this provision of the Interstate Act, and (iv) certain bank agency activities one year after enactment.  The Interstate Act contains a 30% intrastate deposit cap, except for the initial acquisition in the state, a restriction that applies to certain interstate acquisitions unless a different intrastate cap has been adopted by the applicable state pursuant to the provisions of the Interstate Act and a 10% national deposit cap restriction.  Tennessee has opted-in to the Interstate Act.  Management cannot predict the extent to which the business of the Bank may be affected by the Interstate Act.  Tennessee has also adopted legislation allowing banks to acquire branches across state lines subject to certain conditions, including the availability of similar legislation in the other state.

Brokered Deposits and Pass-Through Insurance

The FDIC has adopted regulations under FDICIA governing the receipt of brokered deposits and pass-through insurance.  Under the regulations, a bank cannot accept or rollover or renew brokered deposits unless (i) it is well capitalized or (ii) it is adequately capitalized and receives a waiver from the FDIC.  A bank that cannot receive brokered deposits also cannot offer “pass-through” insurance on certain employee benefit accounts.  Whether or not it has obtained such a waiver, an adequately capitalized bank may not pay an interest rate on any deposits in excess of 75 basis points over certain index prevailing market rates specified by regulation.  There are no such restrictions on a bank that is well capitalized.  The FDIC has proposed an amendment to this regulation that would change the comparison rate from a specific market rate to a prevailing national average rate, as published by the FDIC.  Because it believes that the Bank was well capitalized as of December 31, 2008, management of the Bank believes the brokered deposits regulation will have no material effect on the funding or liquidity of the Bank.

FDIC Insurance Premiums

The Bank is required to pay semiannual FDIC deposit insurance assessments to the Deposit Insurance Fund (“DIF”).  The FDIC merged the Bank Insurance Fund and the Savings Association Insurance Fund to form the DIF on March 31, 2006 in accordance with the Federal Deposit Insurance Reform Act of 2005.  The FDIC maintains the DIF by assessing depository institutions an insurance premium.  The amount each institution is assessed is based upon statutory factors that include the balance of insured deposits as well as the degree of risk the institution poses to the insurance fund.  The FDIC uses a risk-based premium system that assesses higher rates on those institutions that pose greater risks to the DIF.

As of January 1, 2007, the previous nine risk categories utilized in the risk matrix were condensed into four risk categories which continue to be distinguished by capital levels and supervisory ratings. In an effort to restore capitalization levels and to ensure the DIF will adequately cover projected losses from future bank failures, the FDIC, in October 2008, proposed a rule to alter the way in which it differentiates for risk in the risk-based assessment system and to revise deposit insurance assessment rates, including base assessment rates.  The FDIC also proposed to introduce three adjustments that could be made to an institution’s initial base assessment rate, including (i) a potential decrease of up to two basis points for long-term unsecured debt, including senior and subordinated debt, (ii) a potential increase for secured liabilities in excess of 15% of domestic deposits and (iii) for certain institutions, a potential increase for brokered deposits in excess of 10% of domestic deposits. In addition, the FDIC proposed raising the current rates uniformly by seven basis points for the assessment for the first quarter of 2009. The proposal for first quarter 2009 assessment rates was adopted as a final rule in December 2008.  Effective April 1, 2009, the FDIC will make additional changes to assessment rates.  In addition, on February 27, 2009, the FDIC adopted an interim rule imposing a 20 basis point emergency special assessment on June 30, 2009, to be collected on September 30, 2009.  The interim rule also permits an emergency special assessment after June 30, 2009 of up to ten basis points.  The interim rule is subject to public comment.  The increases in deposit insurance described above, as well as the recent increase and anticipated additional increase in the number of bank failures, is expected to result in an increase in deposit insurance assessments for all banks.

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Under the FDIA, insurance of deposits may be terminated by the FDIC upon a finding that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by a federal bank regulatory agency.

Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act of 1999 (the “GLBA”) ratified new powers for banks and bank holding companies, especially in the areas of securities and insurance.  The GLBA also includes requirements regarding the privacy and protection of customer information held by financial institutions, as well as many other providers of financial services.  There are provisions providing for functional regulation of the various services provided by institutions among different regulators.  There are other provisions which limit the future expansion of unitary thrift holding companies.  Finally, among many other sections of the GLBA, there is some relief for small banks from the regulatory burden of the Community Reinvestment Act.  The regulatory agencies have been adopting many new regulations to implement the GLBA.

USA Patriot Act

The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) contains the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “IMLAFA”).  The IMLAFA substantially broadened existing anti-money laundering legislation and the extraterritorial jurisdiction of the United States, imposed new compliance and due diligence obligations, created new crimes and penalties, compelled the production of documents located both inside and outside the United States, including those of foreign institutions that have a correspondent relationship in the United States, and clarified the safe harbor from civil liability to customers.  The U.S. Treasury Department has issued a number of regulations implementing the USA Patriot Act that apply certain of its requirements to financial institutions such as the Bank. The regulations imposed new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.

The IMLAFA required all “financial institutions,” as defined therein, to establish anti-money laundering compliance and due diligence programs no later than April 2003.  Such programs must include, among other things, adequate policies, the designation of a compliance officer, employee training programs, and an independent audit function to review and test the program.  The Bank has established anti-money laundering compliance and due diligence programs which management believes comply with the IMLAFA.

Depositor Preference

The Omnibus Budget Reconciliation Act of 1993 provides that deposits and certain claims for administrative expenses and employee compensation against an insured depositary institution would be afforded a priority over other general unsecured claims against such an institution, including federal funds and letters of credit, in the “liquidation or other resolution” of such an institution by any receiver.

Emergency Economic Stabilization Act

In response to recent, unprecedented market turmoil, Congress enacted the Emergency Economic Stabilization Act (“EESA”) on October 3, 2008. EESA authorizes the Secretary of Treasury (the “Secretary”) to purchase up to $700 billion in troubled assets from financial institutions under TARP. Troubled assets include residential or commercial mortgages and related instruments originated prior to March 14, 2008 and any other financial instrument the purchase of which the Secretary determines, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, is necessary to promote financial stability.  The Secretary was authorized to purchase up to $250 billion in troubled assets immediately and up to $350 billion upon request by the President, subject to action by Congress.  EESA also increased the maximum deposit insurance amount up to $250,000 until December 31, 2009.  Pursuant to his authority under EESA, the Secretary created the TARP CPP under which Treasury is investing up to $250 billion in senior preferred stock of U.S. banks and savings associations or their holding companies.

The Corporation applied for, and Treasury approved, a capital purchase in the amount of $30 million under the CPP.  The Corporation entered into a Letter Agreement with Treasury, pursuant to which the Corporation issued and sold to Treasury, for an aggregate purchase price of $30 million in cash, (i) 30,000 shares of Series A Preferred Stock having a liquidation preference of $1,000, and (ii) a ten-year warrant to purchase up to 461,538 shares of common stock, at an exercise price of $9.75 per share, subject to certain anti-dilution and other adjustments.  The Series A Preferred Stock will pay cumulative dividends at a rate of 5% per annum for the first five years and 9% per annum thereafter.  The CCP transaction closed on December 19, 2008.

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On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”). The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary (after consultation with the President), as an initiative to counter the system-wide crisis in the nation’s financial sector. Under the TLG Program, the FDIC will (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions on or after October 14, 2008, and before June 30, 2009 and (ii) provide full FDIC deposit insurance coverage for non-interest bearing transaction deposit accounts held at participating FDIC-insured institutions through December 31, 2009. The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt. The fee assessment for deposit insurance coverage is ten basis points per quarter on amounts in covered accounts exceeding $250,000. The TLG Program is in effect for all eligible entities that did not opt out on or before December 5, 2008.  The Corporation did not opt out of the TLG Program.

American Recovery and Reinvestment Act of 2009

The American Recovery and Reinvestment Act of 2009 (“ARRA”) was signed into law on February 17, 2009.  ARRA contains a wide variety of programs intended to stimulate the economy and provide for extensive infrastructure, energy, health and education needs.  In addition, ARRA imposes certain new executive compensation and corporate expenditure limits on all current and future TARP recipients until they have repaid Treasury, which is permitted under ARRA without the need to raise new capital, subject to Treasury consulting with the recipient’s appropriate regulatory agency.

Effect of Governmental Policies

The Corporation and the Bank are affected by the policies of regulatory authorities, including the Federal Reserve System. An important function of the Federal Reserve System is to regulate the national money supply.  Among the instruments of monetary policy used by the Federal Reserve are: (i) purchases and sales of U.S. Government securities in the marketplace; (ii) changes in the discount rate, which is the rate any depository institution must pay to borrow from the Federal Reserve; (iii) and changes in the reserve requirements of depository institutions.  These instruments are effective in influencing economic and monetary growth, interest rate levels and inflation.

The monetary policies of the Federal Reserve System and other governmental policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.  Because of changing conditions in the national economy and in the money market, as well as the result of actions by monetary and fiscal authorities, it is not possible to predict with certainty future changes in interest rates, deposit levels, loan demand or the business and earnings of the Bank or whether the changing economic conditions will have a positive or negative effect on operations and earnings.

Bills are pending before the United States Congress and the Tennessee General Assembly and proposed regulations are pending before the various state and federal regulatory agencies that could affect the business of the Corporation and the Bank, and there are indications that other similar bills and proposed regulations may be introduced in the future.  It cannot be predicted whether or in what form any of these or future proposals will be adopted or the extent to which the business of the Corporation and the Bank may be affected thereby.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 represents a comprehensive revision of laws affecting corporate governance, accounting obligations and corporate reporting. The Sarbanes-Oxley Act is applicable to all companies with equity securities registered, or that file reports, under the Securities Exchange Act of 1934, as amended.  In particular, the act established (i) requirements for audit committees, including independence, expertise and responsibilities; (ii) responsibilities regarding financial statements for the chief executive officer and chief financial officer of the reporting company and new requirements for them to certify the accuracy of periodic reports; (iii) standards for auditors and regulation of audits; (iv) disclosure and reporting obligations for the reporting company and its directors and executive officers; and (v) civil and criminal penalties for violations of the federal securities laws. The legislation also established a new accounting oversight board to enforce auditing standards and restrict the scope of services that accounting firms may provide to their public company audit clients

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Availability of Information

The Corporation files periodic reports with the SEC. The SEC maintains an internet website, www.sec.gov that contains reports, proxy and information statements, and other information regarding the Corporation that it files electronically with the SEC.  The Corporation makes its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports available free of charge on the Bank’s website at www.tncommercebank.com under the “Investor Relations” heading.

ITEM 1A.           RISK FACTORS

Recent negative developments in the financial services industry and U.S. and global credit markets may adversely impact our operations and results.

Negative developments in the latter half of 2007 and throughout 2008 in the capital markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2009. Loan portfolio performances have deteriorated at many institutions resulting from, among other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for our deposits has increased significantly as a result of liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like ours, have been negatively affected by the current condition of the financial markets, as has our ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions.

Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our financial performance by restricting our operations, including our ability to originate or sell loans.

Dramatic declines in the housing market, with decreasing home prices and increasing delinquencies and foreclosures, have negatively impacted the credit performance of mortgage and construction loans and resulted in significant write-downs of assets by many financial institutions.  In addition, the values of real estate collateral supporting many loans have declined and may continue to decline. General downward economic trends, reduced availability of commercial credit and increasing unemployment have negatively affected the credit performance of commercial and consumer credit, resulting in additional write-downs.  Concerns over the stability of the financial markets and the economy have resulted in decreased lending by financial institutions to their customers and to each other.  This market turmoil and tightening of credit has led to increased commercial and consumer delinquencies, lack of customer confidence, increased market volatility and widespread reduction in general business activity.  Competition among depository institutions for deposits has increased significantly. Financial institutions have experienced decreased access to deposits and/or borrowings.  The resulting economic pressure on consumers and businesses and the lack of confidence in the financial markets may adversely affect our business, financial condition and results of operations.

Liquidity needs could adversely affect our results of operations and financial condition.

The primary source of our funds is customer deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in general economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, returns available to customers on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. These sources include Federal Home Loan Bank advances and federal funds lines of credit from correspondent banks. While our management believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should these sources not be adequate.

Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.

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An inadequate allowance for loan losses would reduce our earnings.

The risk of credit losses on loans varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower over the term of the loan and, in the case of a collateralized loan, the value and marketability of the collateral for the loan. Management maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and judgments about the ultimate collectability of the loan portfolio and provides an allowance for loan losses based upon a percentage of the outstanding balances and takes a charge against earnings with respect to specific loans when their ultimate collectability is considered questionable. If management’s assumptions and judgments prove to be incorrect and the allowance for loan losses is inadequate to absorb losses, or if the bank regulatory authorities require us to increase the allowance for loan losses as a part of their examination process, our earnings and capital could be significantly and adversely affected.

Our ability to maintain adequate capital may restrict our activities.

Our continued pace of growth may require us to raise additional capital in the future, but that capital may not be available when it is needed.  We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations, so we may at some point need to raise additional capital to support any continued growth.

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance. Accordingly, we cannot assure our shareholders that we will be able to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to continue our growth could be materially impaired.

We may be required to pay significantly higher FDIC premiums in the future.

Recent insured institution failures, as well as deterioration in banking and economic conditions, have significantly increased FDIC loss provisions, resulting in a decline in the designated reserve ratio to historical lows. The FDIC expects a higher rate of insured institution failures in the next few years compared to recent years.  Therefore, thus, the reserve ratio may continue to decline. In addition, EESA temporarily increased the limit on FDIC coverage to $250,000 through December 31, 2009. These developments will cause the premiums assessed to us by the FDIC to increase.

Effective April 1, 2009, the FDIC will modify the way its assessment system differentiates risk, making corresponding changes to assessment rates beginning with the second quarter of 2009. Potentially higher FDIC assessment rates and special assessments could have an adverse impact on our results of operations.

Recent legislative and regulatory initiatives to address difficult market and economic conditions may not stabilize the U.S. banking system.

EESA and ARRA followed, and have been followed by, numerous actions by the Board of Governors of the Federal Reserve System, Congress, Treasury, the FDIC, the SEC and others to address the current liquidity and credit crisis that has followed the sub-prime meltdown that commenced in 2007.  These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to stabilize the U.S. banking system. These initiatives may not have their desired effects.  If the volatility in the markets continues and economic conditions fail to improve or worsen, our business, financial condition and results of operations could be materially and adversely affected.

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Our issuance of securities to the Treasury may limit our ability to return capital to our shareholders and is dilutive to the holders of our common stock and may result in other restrictions to our operations.

In connection with our sale of $30 million of Series A Preferred Stock to the Treasury on December 19, 2008, we also issued to the Treasury a warrant to purchase 461,538 shares of our common stock. The terms of the transaction with the Treasury will result in limitations on our ability to pay dividends and repurchase our shares. Until December 19, 2011 or until the Treasury no longer holds any shares of the Series A Preferred Stock, we will not be able to pay dividends nor repurchase any of our shares without the approval of the Treasury, with limited exceptions. In addition, we will not be able to pay any dividends at all on our common stock unless we are current on our dividend payments on the Series A Preferred Stock. These restrictions, as well as the dilutive impact of the warrant, may have a negative effect on the market price of our common stock and may be dilutive of our earnings per share.  In addition, we are required to pay cumulative dividends at a rate of 5% per annum for the first five years, and thereafter at a rate of 9% per annum. Depending on our financial condition at the time, these dividends could have a negative effect on our liquidity. The shares of Series A Preferred Stock will receive preferential treatment in the event of our liquidation, dissolution or winding up. The transaction also subjects us to additional executive compensation restrictions.

Holders of the Series A Preferred Stock may, under certain circumstances, have the right to elect two directors to our board of directors.

In the event that we fail to pay dividends on the Series A Preferred Stock for an aggregate of six quarterly dividend periods or more (whether or not consecutive), the authorized number of directors then constituting our board of directors will be increased by two. Holders of the Series A Preferred Stock, together with the holders of any outstanding parity stock with like voting rights voting as a single class, will then be entitled to elect the two additional members of our board of directors at the next annual meeting (or at a special meeting called for the purpose of electing such directors prior to the next annual meeting) and at each subsequent annual meeting until all accrued and unpaid dividends for all past dividend periods have been paid in full.

Holders of the Series A Preferred Stock have limited voting rights.

Except as otherwise required by law and in connection with the election of directors to our board of directors in the event that we fail to pay dividends on the Series A Preferred Stock for an aggregate of at least six quarterly dividend periods (whether or not consecutive), holders of the Series A Preferred Stock have limited voting rights. So long as shares of the Series A Preferred Stock are outstanding, in addition to any other vote or consent of shareholders required by law or our amended and restated charter, the vote or consent of holders owning at least 66 2/3% of the shares of Series A Preferred Stock outstanding is required for (i) any authorization or issuance of shares ranking senior to the Series A Preferred Stock, (2) any amendment to the rights of the Series A Preferred Stock so as to adversely affect the rights, preferences, privileges or voting power of the Series A Preferred Stock or (3) consummation of any merger, share exchange or similar transaction unless the shares of Series A Preferred Stock remain outstanding, or if we are not the surviving entity in such transaction, such shares are converted into or exchanged for preference securities of the surviving entity and the shares of Series A Preferred Stock remaining outstanding or such preference securities have such rights, preferences, privileges and voting power as are not materially less favorable to the holders than the rights, preferences, privileges and voting power of the shares of Series A Preferred Stock.

Our business is subject to the success of the local economies where we operate.

Our success significantly depends upon the growth in population, income levels, deposits and new businesses in the Nashville MSA and our other market areas. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally are unfavorable, our business may not succeed. Adverse economic conditions in our specific market areas could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

National market funding outside of the Nashville MSA has different risks.

Approximately 31.06% of our loan portfolio is composed of national market funding loans to non-Middle Tennessee businesses referred to us by a small network of equipment vendors and financial service companies. These loans account for approximately 38.74% and 32.72%, respectively, of the increase in total loans at December 31, 2008 and 2007, over the prior year. This lending causes us to have somewhat different risks than those typical for community banks generally. Our loan portfolio is more geographically diverse, and as a result the loan collateral is also more widely dispersed geographically. This may result in longer time periods to locate collateral and higher costs to dispose of collateral in the event that the collateral is used to satisfy the loan obligation. This part of our portfolio also provides geographic risk diversification by reducing the adverse impact of a regional downturn in the economy.

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Our ability to attract deposits may restrict growth.

We derive a substantial portion of our deposits through internet-based wholesale funding alternatives. In the event that we are no longer able to sell our deposits easily to institutional and retail investors, our ability to fund our loan portfolio could be adversely affected. We post rates to an internet-based program that retail and institutional investors nationwide subscribe to in order to invest funds. Our wholesale funding portfolio is therefore geographically dispersed and generally made up of deposits in FDIC insured amounts of $100,000 or less.

Changes in monetary policy could adversely affect operating results.

Like all regulated financial institutions, we are affected by monetary policies implemented by the Federal Reserve Board and other federal instrumentalities.  A primary instrument of monetary policy employed by the Federal Reserve Board is the restriction or expansion of the money supply through open market operations.  This instrument of monetary policy frequently causes volatile fluctuations in interest rates, and it can have a direct, adverse effect on the operating results of financial institutions.  Borrowings by the United States government to finance the government debt may also cause fluctuations in interest rates and have similar effects on the operating results of such institutions.

Changes in interest rates could adversely affect our results of operations and financial condition.

Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense. Interest rates are highly sensitive to many factors that are beyond our control, including general economic conditions and the policies of various governmental and regulatory authorities.  Accordingly, changes in interest rates could decrease our net interest income.  Changes in the level of interest rates also may negatively affect our ability to originate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affects our earnings.

We could sustain losses if our asset quality declines.

Our earnings are affected by our ability to properly originate, underwrite and service loans.  We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner.  Problems with asset quality could cause our interest income and net interest margin to decrease and our provision for loan losses to increase, which could adversely affect our results of operations and financial condition.

We are subject to extensive regulation that could limit or restrict our activities.

We operate in a highly regulated industry and are subject to examination, supervision and comprehensive regulation by various federal and state agencies including the Federal Reserve Board, the FDIC and the TDFI. Our regulatory compliance is costly and restricts certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, and interest rates paid on deposits. We are also subject to capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and The NASDAQ Stock Market that are applicable to us, have increased the scope, complexity and cost of our corporate governance, reporting and disclosure practices. As a result, we have experienced, and may continue to experience, greater compliance costs.

As a result of the recent global financial crisis, the potential exists for new federal or state laws and regulations regarding lending and funding practices and liquidity standards to be promulgated, and bank regulatory agencies are expected to be active in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement orders. Negative developments in the financial industry and the domestic and international credit markets, and the impact of new legislation in response to those developments, may adversely affect our operations by restricting our business operations, including our ability to originate or sell loans, and may adversely impact our financial condition.

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Holders of our subordinated debentures have rights that are senior to those of our common shareholders.

In 2005 and 2008, we supported our continued growth through the issuance of trust preferred securities from an affiliated special purpose trust and accompanying subordinated debentures. At December 31, 2008, we had outstanding trust preferred securities and accompanying subordinated debentures totaling $23.2 million. Our board of directors may also decide to issue additional tranches of trust preferred securities in the future. We conditionally guarantee payments of the principal and interest on the trust preferred securities. Further, the accompanying subordinated debentures we issued to the trust are senior to our shares of common stock. As a result, we must make payments on the subordinated debentures before any dividends can be paid on our common stock and, in the event of our bankruptcy, dissolution or liquidation, the holders of the subordinated debentures must be satisfied before any distributions can be made on our common stock. We have the right to defer distributions on our subordinated debentures (and the related trust preferred securities) for up to five years (from the date of issuance) during which time we may not pay dividends on our common stock.

We rely heavily on the services of key personnel.

We depend substantially on the strategies and management services of our executive officers – Arthur F. Helf, Chairman and Chief Executive Officer, Michael R. Sapp, President, Frank Perez, Chief Financial Officer, and H. Lamar Cox, Chief Administrative Officer. The loss of the services of any of these executive officers could have a material adverse effect on our business, results of operations and financial condition. We are also dependent on certain other key officers who have important customer relationships or are instrumental to our operations. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition and results of operations.  We believe that our future results will also depend in part upon our attracting and retaining highly skilled and qualified management, as well as sales and marketing personnel. Competition for such personnel is intense, and we cannot assure you that we will be successful in attracting or retaining such personnel.

Our ability to continue to engage in and grow our national market funding programs depends on stable business relationships.

Our ability to continue to grow the national market funding portion of our portfolio is dependent upon our retaining those members of our senior management and those loan officers who have experience and relationships with those equipment vendors and financial services companies who originate the underlying lease transactions. In the event that any of these members of senior management, particularly President Mike Sapp, were to terminate his or her employment with us, or in the event that our relationships with any of these vendor/brokers were to be discontinued, our ability to continue to increase our national market funding portfolio could be adversely affected.

We could sustain losses if our asset quality declines.

Our earnings are affected by our ability to properly originate, underwrite and service loans.  We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner.  Problems with asset quality could cause our interest income and net interest margin to decrease and our provision for loan losses to increase, which could adversely affect our results of operations and financial condition.

Our business strategy includes the continuation of growth plans, and our financial condition and results of operations could be negatively affected if our business strategies are not effectively executed.

We intend to continue pursuing a growth strategy for our business through organic growth of the loan portfolio. Our prospects must be considered in light of the risks, expenses and difficulties that can be encountered by financial service companies in rapid growth stages, which include the risks associated with the following:

·       maintaining loan quality;

·       maintaining adequate management personnel and information systems to oversee such growth;

·       maintaining adequate control and compliance functions; and

·       securing capital and liquidity needed to support our anticipated growth.

There can be no assurance that we will maintain or achieve deposit levels, loan balances or other operating results necessary to avoid losses or produce profits. Our growth will cause growth in overhead expenses as we routinely add staff. As a result, historical results may not be indicative of future results. Failure to successfully address these issues identified above could have a material adverse effect on our business, future prospects, financial condition or results of operations.

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Competition from financial institutions and other financial service providers may adversely affect our profitability.

The banking business is highly competitive and we experience competition in our markets from many other financial institutions.  We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other mutual funds, as well as other community banks and super-regional and national financial institutions that operate in the Nashville MSA and elsewhere.  We not only compete with these companies in the Nashville MSA, but also in the regional and national markets in which we engage in our indirect funding programs.

Additionally, in the Nashville MSA, we face competition from de novo community banks, including those with senior management who were previously affiliated with other local or regional banks or those controlled by investor groups with strong local business and community ties. These de novo community banks may offer higher deposit rates or lower cost loans in an effort to attract our customers, and may attempt to hire our management and employees.

We compete with these other financial institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base in the Nashville MSA from consumers with an existing relationship with other financial institutions and from new residents.  We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to successfully compete with an array of financial institutions in the Nashville MSA and regionally and nationally with respect to our indirect funding programs.

Material fluctuations in non-interest income may occur.

A substantial portion of our non-interest income is derived from the sale of loans, particularly loans generated for our national market funding portfolio. The timing and extent of these loan sales may not be predictable, and could cause material variation in our non-interest income on a quarter to quarter basis.

Our ability to declare and pay dividends on our common stock is limited by law and we may be unable to pay future dividends.

We derive our income solely from dividends on the shares of common stock of the bank. The bank’s ability to declare and pay dividends to us is limited by its obligations to maintain sufficient capital and by other general restrictions on its dividends that are applicable to banks that are regulated by the FDIC and the TDFI. The Federal Reserve Board may also impose restrictions on our ability to pay dividends on our common stock. In addition, we must make payments on the subordinated debentures before any dividends can be paid on our common stock, and we may not pay dividends while we are deferring interest payments on our trust preferred securities and the related subordinated debentures. As a result, we cannot assure our shareholders that we will declare or pay dividends on shares of our common stock in the future.

The success and growth of our business will depend on our ability to adapt to technological changes.

The banking industry and the ability to deliver financial services is becoming more dependent on technological advancement, such as the ability to process loan applications over the Internet, accept electronic signatures, provide process status updates instantly and offer on-line banking capabilities and other customer expected conveniences that are cost efficient to our business processes. As these technologies are improved in the future, we may, in order to remain competitive, be required to make significant capital expenditures.

Even though our common stock is currently listed on The NASDAQ Global Market, the trading volume of our common stock has been low and the sale of substantial amounts of our common stock in the public market could depress the price of our common stock.

While our common stock is listed on The NASDAQ Global Market, the trading volume of our common stock is relatively low and we cannot be certain when a more active and liquid trading market for our common stock will develop or be sustained. Because of this, our shareholders may not be able to sell their shares at the volumes, prices or times that they desire.

We cannot predict the effect, if any, that future sales of our common stock in the market, or availability of shares of our common stock for sale in the market, will have on the market price of our common stock. We, therefore, can give no assurance that sales of substantial amounts of our common stock in the market, or the potential for large amounts of sales in the market, would not cause the price of our common stock to decline or impair our ability to raise capital through sales of our common stock.

The market price of our common stock may fluctuate in the future, and these fluctuations may be unrelated to our performance. General market price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

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We may issue additional common stock or other equity securities in the future which could dilute the ownership interest of existing shareholders.

In order to maintain our capital at desired levels or required regulatory levels, or to fund future growth, our board of directors may decide from time to time to issue additional shares of common stock, or securities convertible into, exchangeable for or representing rights to acquire shares of our common stock. The sale of these securities may significantly dilute our shareholders’ ownership interest as a shareholder and the market price of our common stock. New investors of other equity securities issued by us in the future may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders.

Our recent results may not be indicative of our future results.

We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent growth may distort some of our historical financial ratios and statistics. In the future, we may not have the benefit of several recently favorable factors, a strong local business environment, and relationships with an extensive group of equipment vendors and financial services companies. Various factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to grow.

ITEM 1B.               UNRESOLVED STAFF COMMENTS

None.

ITEM 2.                PROPERTIES

The Corporation’s main office is located in Williamson County at 381 Mallory Station Road, Suite 207, Franklin, Tennessee 37067, which is also the main office of the Bank.  This location is centrally located and in a high traffic/exposure area. The Bank leases 34,956 square feet at a competitive rate and the term of the lease expires in December 2017.  The Bank provides services throughout the community by use of a network of couriers, third party ATMs and state-of-the-art electronic banking. The Bank also operates loan production offices located at One Chase Corporate Center, Suite 400, Birmingham, Alabama 35244, at 7900 International Drive, Suite 200, Bloomington, Minnesota 55425 and at 125 TownPark Drive, Suite 300, Kennesaw, Georgia 30144 . All three loan production office facilities are leased.

ITEM 3.                LEGAL PROCEEDINGS

The Corporation is party to proceedings arising from the May 6, 2008 termination of its former Chief Financial Officer, George Fort. Those proceedings include a complaint filed by Mr. Fort under the Sarbanes-Oxley Act of 2002 (“SOX”) with the United States Department of Labor (the “SOX Complaint”) and a lawsuit styled George Fort v. Tennessee Commerce Bancorp, Inc. and Tennessee Commerce Bank (Case No. 3:08-cv-0668), filed on July 9, 2008 in the United States District Court for the Middle District of Tennessee (the “Federal Litigation”).

In the SOX Complaint, Mr. Fort alleges that his March 7, 2008 placement on administrative leave and his subsequent termination on May 6, 2008 were in retaliation for his raising various alleged weaknesses in the Company’s internal controls to the Audit Committee of the Company’s Board of Directors. In the Federal Litigation, Mr. Fort alleges that his termination constituted a breach of his Employment Agreement (the “Employment Agreement”) with the Bank and retaliation under the Tennessee Public Protection Act and the Federal Deposit Insurance Corporation Improvement Act. Mr. Fort also asserts a claim for libel based upon certain press releases issued by the Company in connection with his former employment. The Company has brought a counter-claim against Mr. Fort that he engaged in misfeasance and malfeasance as the Company’s Chief Financial Officer, in breach of his fiduciary duty as an officer of the Company under Tennessee law.

The Company denies any liability to Mr. Fort or violation of any law, contract or otherwise and intends to contest all matters brought by Mr. Fort vigorously. In summary, the Company maintains that (i) Mr. Fort did not engage in protected activity, because his report did not involve any of the specific activities enumerated in Section 806 of SOX, (ii) it placed Mr. Fort on administrative leave so that he could focus his attention on addressing the issues he raised to the Audit Committee after he refused to participate in good faith in such efforts and (iii) Mr. Fort grossly neglected his duties in the implementation of the Company’s SOX program based on reports from external auditors that revealed that, despite Mr. Fort’s assurances that SOX implementation was “on track,” it was not. The Company further maintains that the terms of the Employment Agreement created an at-will employment relationship as a matter of law and that, regardless, Mr. Fort’s gross neglect of his duties constituted cause for termination under the Employment Agreement.

ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matter was submitted to a vote of security holders during the fourth quarter of 2008 through the solicitation of proxies or otherwise.

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PART II

ITEM 5.               MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Corporation’s common stock has been listed on The NASDAQ Global Market since June 2006. Prior to that,  it was traded on the Over-The-Counter Bulletin Board from December 16, 2005, and prior to that time, it was not traded through an organized exchange. The number of shareholders of record at March 14, 2009, was 411. The table below shows the quarterly range of high and low sale prices for our common stock during the fiscal years 2008 and 2007. These sale prices represent known transactions and do not necessarily represent all trading transactions for the periods.

Dividends

The Corporation has never declared or paid dividends on its common stock. The payment of cash dividends is subject to the discretion of the Board of Directors, the Bank’s ability to pay dividends and the priority of holders of the Corporation’s subordinated debentures and Series A Preferred Stock.  The Bank’s ability to pay dividends is restricted by applicable regulatory requirements. For more information on these restrictions, see ITEM 1 “BUSINESS – Supervision and Regulation – Payment of Dividends” of this Annual Report on Form 10-K.  No assurances can be given that any dividend will be declared or, if declared, what the amount of such dividend would be or whether such dividends would continue in the future.

Recent Sales of Unregistered Securities

During 2008, an employee of the Bank exercised options to purchase 7,500 shares of Corporation common stock in one transaction, at an exercise price of $5.00 per share for an aggregate price of $37,500. The Corporation issued these shares of our common stock in reliance upon the exemption from the registration requirements of the Securities Act of 1933, as amended, as set forth in Section 4(2) under the Securities Act and Rule 701 of Regulation D promulgated thereunder relating to sales by an issuer not involving any public offering, to the extent an exemption from such registration was required.

Purchases of Equity Securities by the Registrant and Affiliated Purchasers

The Corporation made no repurchases of its equity securities, and no Affiliated Purchasers (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934) purchased any shares of the Corporation’s equity securities during the fourth quarter of the fiscal year ended December 31, 2008.

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ITEM 6.                                            SELECTED FINANCIAL DATA

The following selected financial data for the years ended December 31, 2008, 2007, 2006, 2005 and 2004 should be read in conjunction with the financial statements included in Item 8 of this Annual Report on Form 10-K:

(1) Operating expenses divided by average assets.

(2) Operating expenses divided by net interest income and noninterest income.

(3) Nonperforming assets are made up of non-accruing loans, accruing loans 90 days past due and other real estate owned.

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Forward-Looking Statements

Certain statements contained in this report may not be based on historical facts and are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may be identified by reference to a future period or by the use of forward-looking terminology, such as “expect,” “anticipate,” “believe,” “estimate,” “foresee,” “may,” “might,” “will,” “intend,” “could,” “would,” “plan,” “target,” “predict,” “should,” or future or conditional verb tenses and variations or negatives of such terms. These forward-looking statements include, without limitation, those relating to our operating results and financial condition, our earning asssets ratio, recent developments in the financial services industry, vesting of stock-based awards, recently adopted accounting standards, fair value measurements, allowance for loan losses, asset quality, Business Bank strategy, management’s review of the loan portfolio, loan classifications, loan commitments, interest rate risk, economic value of equity model, loan sale transactions, fluctuations in non-interest income, tax rates, liquidity, inflation, legislative and regulatory changes affecting banks or bank holding companies, FDIC insurance premiums, monetary policies of the Federal Reserve, rate sensitivity gap analysis, maturities of debt securities, growth of our market area, the impact of the economic environment, competition for loans, non-interest income, revenue provided by our mortgage unit, hiring of employees, ratio of earning assets to total assets, cost of funds, loan loss reserve, capital adequacy, net interest margin, cash flows, lease payments, tax benefits and credits, internal control over financial reporting and our future growth and profitability. We caution you not to place undue reliance on the forward-looking statements contained in this report because actual results could differ materially from those indicated in such forward-looking statements as a result of a variety of factors. These factors include, but are not limited to, changes in economic conditions, competition for loans, mortgages and other financial services and products, changes in interest rates, concentrations within our loan portfolio, our ability to maintain credit quality, the effectiveness of our risk monitoring systems, changes in consumer preferences, the ability of our borrowers to repay loans, the availability of and costs associated with maintaining and/or obtaining adequate and timely sources of liquidity, changes in our operating strategy, our ability to meet regulatory capital adequacy requirements, our ability to collect amounts due under loan agreements and to attract deposits, our ability to attract, train and retain qualified personnel, the geographic concentration of our assets, our ability to operate and integrate new technology, our ability to provide market competitive products and services, our ability to diversify revenue, our ability to fund growth with lower cost liabilities, laws and regulations affecting financial institutions in general and other factors detailed from time to time in our press releases and filings with the Securities and Exchange Commission. We undertake no obligation to update these forward-looking statements to reflect the occurrence of changes or unanticipated events, circumstances or results that occur after the date of this report.

Overview

(Dollars in thousands except share data in this Item 7.)

The results of operations for the year 2008 compared to 2007 reflected a 12.44% increase in net income and a 13.48% increase in diluted earnings per share.  The increase in earnings resulted primarily from a 28.16% increase in net interest income because of higher average loan balances.  The net interest margin for 2008 was 3.43%. The increased revenue was partially offset by increases in non-interest expense and the provision for loan losses.  The year 2008 reflected a continuation of the Bank’s trend of rapid asset growth, increasing by $317,931 or 35.32% from $900,153 at December 31, 2007 to $1,218,084 at December 31, 2008. Net loans increased by 30.52% or $239,270 from December 31, 2007 to December 31, 2008, while total deposits increased by 31.17% or $254,090 during that same period.

The Corporation’s growth in assets was a result of growth in the market area and effective marketing. The improvement in results including net income and earnings per share was a result of the business focus of the Bank. From 2000 to 2008, the Bank’s market area experienced explosive growth. In Williamson County, demographic information shows a 34.75% growth in the number of households from 2000 to 2008.  Estimates from SNL Financial LC show that by 2013 the number of households in this county will have grown by another 21.89%. Although estimates of growth are not guaranteed and actual growth may be affected by factors beyond the Corporation’s control, management believes that the projected growth of the Bank’s market area will positively impact the Bank’s future growth.

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The Bank has also grown by marketing to business owners that have been left without a long standing banking relationship. The Middle Tennessee area has experienced several bank mergers or acquisitions in the last ten years resulting in the termination of many long standing relationships. These acquisitions also resulted in loan funding decisions being made out-of-state, creating unpredictability for local lending personnel and uncertainty for local businesses. The Bank has taken advantage of this uncertainty by offering loans at a fair rate and funded locally in a timely manner. Management believes the competitive advantage created by this environment will continue to positively impact results from operations.

The Business Bank operating strategy has enabled management to focus on managing results. Rather than focusing on building a multi-branch infrastructure including hiring and construction of buildings, management focuses on managing net interest margin aggressively and controlling non-interest expense. This has resulted in a 1.13% decrease in the net interest margin from 2004 to 2008. Non-interest expense is controlled by efficiently staffing the Bank’s operations. In 2008, that resulted in $14.7 in assets per employee at year end. Management believes that the Business Bank operating strategy will continue to be an effective model in the future.

Changes in Results of Operations

Net Income - Net income for 2008 was $7,754, an increase of $858, or 12.44%, compared to $6,896 for 2007. The increase was primarily attributable to a 28.16% increase in net interest income from $27,272 in 2007 to $34,951 in 2008. The increase of $7,679 in net interest income was the result of higher average loan balances. Non-interest income increased by $1,414 from $2,880 to $4,294, or 49.10%, primarily a result of gains on loan sales. These positive effects were partially offset by a 43.48% increase in the provision for loan losses, from $6,350 in 2007 to $9,111 in 2008, and an increase of $4,345 in non-interest expense, up 32.76% to $17,608 in 2008 compared to $13,263 in 2007. The increase in the provision for loan losses was the result of funding the loan loss reserve to match the growth in the loan portfolio and loan charge-offs. The increase in non-interest expense was a result of the increase in personnel and general operating expenses attributable to the Corporation’s growth.

Net income for 2007 was $6,896, an increase of $2,147, or 45.21%, compared to the $4,749 earned in 2006. The increase was attributable to a 40.74% increase in net interest income from $19,377 in 2006 to $27,272 in 2007. The increase of $7,895 in net interest income was the result of higher average loan balances. Non-interest income increased by $1,117, from $1,763 to $2,880, or 63.36%, primarily a result of gains on loan sales. These positive effects were partially offset by a 45.98% increase in the provision for loan losses, from $4,350 in 2006 to $6,350 in 2007, and an increase of $4,207 in non-interest expense, up 46.46% to $13,263 in 2007 compared to $9,056 in 2006. The increase in the provision for loan losses was the result of funding the loan loss reserve to match the growth in the loan portfolio and loan charge-offs. The increase in non-interest expense was a result of the increase in personnel and general operating expenses attributable to the Corporation’s growth.

Net Interest Income - The primary source of earnings for the Bank is net interest income, which is the difference between the interest earned on interest earning assets and the interest paid on interest bearing liabilities.  The major factors which affect net interest income are changes in volumes and yield on earning assets as well as the volumes and the cost of interest bearing liabilities.  Management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Bank’s primary source of earnings.

During 2008, the Federal Reserve Open Market Committee (“FOMC”) decreased short-term interest rates by 400 basis points. During 2008, $52,293 of the Corporation’s net loan growth occurred in floating rate construction loans and approximately 39.46% of the $132,520 increase in commercial loans was related to floating rate transactions. Management expects to continue its practice of competing for loans based on providing superior service rather than the lowest price.

Net interest income for 2008 was $34,951 compared to $27,272 for 2007, a gain of $7,679 or 28.16%. The increase in net interest income was largely attributable to strong loan growth. Net loans increased from $784,001 at December 31, 2007 to $1,023,271 at December 31, 2008, an increase of $239,270 or 30.52%.  Net interest income was favorably impacted by the increase in the Bank’s indirect funding program for small transactions. These loans, which are purchased at a minimum rate of 8%, increased from $153,140 at year-end 2007 to $173,438 at the end of 2008. The loan growth was matched by an increase in deposits from $815,053 at December 31, 2007 to $1,069,143 in 2008, an increase of $254,090 or 31.17%.

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Net interest income for 2007 was $27,272 compared to $19,377, a gain of $7,895 or 40.74%. The increase in net interest income was largely attributable to strong loan growth. Net loans increased from $538,550 at December 31, 2006 to $784,001 at December 31, 2007, an increase of $245,451 or 45.58%.  Net interest income was favorably impacted by the increase in the Bank’s indirect funding program for small transactions. These loans, which are purchased at a minimum rate of 8%, increased from $113,400 at year-end 2006 to $153,100 at the end of 2007. The loan growth was matched by an increase in deposits from $560,567 at December 31, 2006 to $815,053 in 2007, an increase of $254,486 or 45.40%.

Investments - The Bank views the investment portfolio as a source of income and liquidity. Management’s investment strategy is to accept a lower immediate yield in the investment portfolio by targeting shorter term investments.   The Bank’s investment policy requires a minimum portfolio level equal to 7% of total assets and a maximum portfolio level of 20% of total assets.  Management has maintained the portfolio at the lower end of the policy guidelines with the portfolio at 8.32%, 8.19% and 9.13% of total assets at year-end in 2008, 2007 and 2006, respectively.

The investment portfolio at December 31, 2008 was $101,290 compared to $73,753 at year-end 2007. The interest earned on investments rose from $3,492 in 2007 to $4,717 in 2008, as a result of higher average portfolio balances as well as increased yields. The average yield on the investment portfolio investments rose from 5.43% in 2007 to 5.59% in 2008, or 16 basis points.

The investment portfolio at December 31, 2007 was $73,753, compared to $56,943 at year-end 2006. The average yield on the investment portfolio was 5.43% in 2007 compared to 4.91% in 2006.

Net Interest Margin Analysis - The net interest margin is impacted by the average volumes of interest sensitive assets and interest sensitive liabilities and by the difference between the yield on interest sensitive assets and the cost of interest sensitive liabilities (spread).  Loan fees collected at origination represent an additional adjustment to the yield on loans. The Bank’s spread can be affected by economic conditions, the competitive environment, loan demand and deposit flows.  The net yield on earning assets is an indicator of the effectiveness of a bank’s ability to manage the net interest margin by managing the overall yield on assets and the cost of funding those assets.

The two factors that make up the spread are the interest rates received on loans and the interest rates paid on deposits. The Bank has been disciplined in raising interest rates on deposits only as the market demands and thereby managing the cost of funds. Also, the Bank has not competed for new loans on interest rate alone but has relied on effective marketing to business customers. Business customers are not influenced by interest rates alone but are influenced by other factors such as timely funding.

The net interest margin declined from 3.72% in 2007 to 3.43% in 2008 because the yield on earning assets decreased faster than the cost of funds, resulting in a compression on the yield on earning assets during 2008. Interest income increased by $13,772, or 22.14%, from $62,206 in 2007 to $75,978 in 2008. The increase was primarily a result of increased loan volume. Average earning assets increased from $731,749 in 2007 to $1,019,887 in 2008, an increase of $288,138 or 39.38%. The increase in earning assets was a result of loan growth. Average loans increased $272,298 or 41.50% from 2007 to 2008. The average yield on earning assets decreased from 8.50% in 2007 to 7.45% in 2008, or 105 basis points. The decrease in the Bank’s federal funds sold unfavorably impacted the average yield on earning assets. The average yield on this type of asset in 2008 was 2.17%. These federal funds sold decreased 36.98% from $11,701 at year-end 2007 to $7,374 at the end of 2008.   Interest expense increased from $34,934 in 2007 to $41,027 in 2008. The $6,093, or 17.44%, increase in expense was a result of increases in the volume of deposits. Average deposits increased from $685,063 in 2007 to $949,005 in 2008, an increase of $263,942 or 38.53%. The cost of funds decreased from 5.18% in 2007 to 4.17% in 2008, or 101 basis points.

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The net interest margin declined from 3.98% in 2006 to 3.72% in 2007 because the cost of funds rose faster than the yield on earning assets during 2007.  Interest income increased by $20,961, or 50.82%, from $41,245 in 2006 to $62,206 in 2007. The increase was primarily a result of increased loan volume.  Average earning assets increased from $486,668 in 2006 to $731,749 in 2007, an increase of $245,081 or 50.36%. The increase in earning assets was a result of loan growth. Average loans increased $228,024 or 53.25% from 2006 to 2007.  The average yield on earning assets increased from 8.46% in 2006 to 8.50% in 2007, or 4 basis points. The net interest margin was favorably impacted by the expansion of the Bank’s indirect funded small loan portfolio.  The average yield on this type of loan in 2007 was 8.75%. These loans increased 35.01% from $113,400 at year-end 2006 to $153,100 at the end of 2007.   Interest expense increased from $21,868 in 2006 to $34,934 in 2007. The $13,066, or 59.75%, increase in expense was a result of increases in the volume of deposits as well as an increase in the cost of funds. Average deposits increased from $451,235 in 2006 to $685,063 in 2007, an increase of $233,828 or 51.82%. The cost of funds increased from 4.94% in 2006 to 5.18% in 2007, or 24 basis points.

Provision for Loan Losses - Management assesses the adequacy of the allowance for loan losses with a combination of qualitative and quantitative factors.  At inception, each loan is assigned a risk rating that ranges from “RR1 to RR4.”  An RR1 assignment indicates a “Superior” credit, RR2 represents an “Excellent” credit, RR3 represents an “Above-Average” credit, and RR4 designates an “Average” credit.  The assignment of a risk rating is based on an evaluation of the credit risk in the transaction.  The evaluation includes consideration of the borrower’s financial capacity, collateral, cash flows, liquidity, and alternative sources of repayment.  If a loan deteriorates and the level of risk increases, management downgrades the loan to RR5–“Watch,” RR6–“Criticized,” or RR7–“Substandard,” depending on the circumstances.  A review by an independent accounting firm of the assigned risk ratings is an integral part of the Bank’s external loan review program.

Management reviews the loan portfolio regularly to determine if loans should be placed on non-accrual for revenue recognition. If a loan is placed on non-accrual, all interest earned since the last current payment is immediately reversed.  Loans may remain on non-accrual status until the underlying collateral is repossessed and valued or until the amount of loss in the credit can be reasonably determined.  Once collateral is repossessed and appraised, the collateral is recorded as a repossession at the lower of fair value or the investment in the related loan.  Any difference between the estimated fair value of the collateral and the loan balance is charged off.  Variances in fair value estimates are recorded as a gain or loss on sale when the collateral is sold.   Non-accrual loans totaled $11,603, $6,465 and $2,689 at year-end 2008, 2007 and 2006, respectively.  These amounts represented 1.13%, 0.82% and 0.50%, respectively, of net loans at the end of each year.

Management uses the weighted average risk rating to monitor the overall credit quality and trends in the loan portfolio. At December 31, 2008, the weighted average risk rating of the $1,023,271 net loan portfolio was 3.49. At December 31, 2007, the weighted average risk rating of the $784,001 net loan portfolio was 3.56.  The Board of Directors reviews the weighted average risk rating of loans booked during the previous month.  In addition, the Board reviews monthly all credits classified RR5 or higher.  Management closely monitors other key loan quality indicators including delinquencies, changes in the portfolio mix and general economic conditions.  These actions provide a degree of objectivity in assessing the risk in the portfolio and establishing an adequate loan loss reserve.  To the extent that actual and anticipated losses differ, adjustments are made to the loan loss provision or to the level of the allowance for loan losses. At December 31, 2008, the loan loss reserve of $13,454 was 1.30% of gross loans of $1,036,725.

The provision for loan losses in 2008 was $9,111, an increase of $2,761, or 43.48%, above the provision of $6,350 expensed in 2007. Of this provision, $3,133, or 34.39%, was attributable to loan growth recorded during 2008. The remainder of the loan loss provision in 2008 funded net charge-offs of $5,978.

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The provision for loan losses in 2007 was $6,350, an increase of $2,000, or 45.98%, above the provision of $4,350 expensed in 2006. Of this provision, $3,353, or 52.80%, was attributable to loan growth recorded during 2007. The remainder of the loan loss provision in 2007 funded net charge offs of $2,997.

The Bank targets small and medium sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. If loan losses occur to a level where the loan loss reserve is not sufficient to cover actual loan losses, the Bank’s earnings will decrease. The Bank uses an independent accounting firm to review its loans quarterly for quality in addition to the reviews that may be conducted by bank regulatory agencies as part of their usual examination process.

The following table presents information regarding non-accrual, past due and restructured loans at December 31, 2008, 2007, 2006, 2005 and 2004:

(1)           Accruing loans that are contractually past due 90 days or more as to principal and interest payments are inflated by $16,500, because of three loans 92 days past due. Management has resolved this issue in the first quarter of 2009. The ratio of allowance for loan losses to non-performing assets, less these three loans, would have been 68.45% versus the ratio of 37.21% reported in Item 6 of this Annual Report on Form 10-K.

As of December 31, 2008, there were no loans classified for regulatory purposes as doubtful or substandard that have not been disclosed in the above table, which (i) represent or result from trends or uncertainties that management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) 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.

The Bank had no tax-exempt loans during the years ended December 31, 2008 and December 31, 2007. The Bank had no loans outstanding to foreign borrowers at December 31, 2008 and December 31, 2007.

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An analysis of the Bank’s loss experience is furnished in the following table for December 31, 2008, 2007, 2006, 2005 and 2004, and the years then ended:

The allowance for loan losses is established by charges to operations based on management’s evaluation of the loan portfolio, past due loan experience, collateral values, current economic conditions and other factors considered necessary to maintain the allowance at an adequate level. Management believes that the allowance was adequate at December 31, 2008.

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At December 31, 2008, 2007, 2006, 2005 and 2004, the allowance for loan losses was allocated as follows:

Non-interest Income - Non-interest income is income that is not related to interest-earning assets.  In a typical retail bank, non-interest income consists primarily of service charges and fees on deposit accounts and mortgage origination fees.  Because of the business focus of the Bank and its lack of a large retail customer base, revenues from these traditional sources will remain modest.

The Bank earned $31 in mortgage origination fees in 2008 compared to $76 earned in 2007, a decline of $45 or 59.21%. The decline in mortgage loan demand and mortgage origination income was attributed to the disruption in the mortgage market in 2008. Management believes that in 2009 the mortgage unit will provide a value-added service with modest revenue results.

The Bank earned $3,750 in 2008 on a series of loan sale transactions compared to $2,687 in 2007. In addition to lending in the local marketplace, the Bank provides collateral-based loans to business borrowers in other states through two types of indirect funding programs. Management has identified a network of community banks eager to purchase quality assets. Management has installed appropriate systems and processes to sell assets to other banks located in slower growing markets and believes that loan sales will be a recurring source of revenue.

In 2007, the Bank earned $2,687 on a series of loan sale transactions.  The Bank earned $76 in mortgage origination fees in 2007 compared to $89 earned in 2006, a decline of $13 or 14.61%.  The decline in mortgage origination income was attributed to rising interest rates in 2007.  Income earned in the form of service charges on deposits totaled $132, a gain of $20, or 17.86% above the $112 earned in 2006.  Gain on sales of securities increased by $662 or 32.69% from $2,025 in 2006 to $2,687 in 2007.

Non-interest Expense - Non-interest expense includes salaries and benefits expense, occupancy costs and other operating expenses including data processing, professional fees, supplies, postage, telephone and other items. Management views the control of operating expense as a critical element in the success of the Business Bank strategy.  The Bank operates more efficiently than most peer banks because it conducts business from a single location and does not provide banking services for many retail customers with high transaction volume.

Management targets $10,000 in assets per full-time employee as a measure of staffing efficiency. Management believes that the growth of the Bank will offer additional opportunities to leverage personnel resources.  The Bank does not expect to hire employees in 2009, so salaries and benefits expense may increase slightly, but the target for assets per employee will remain at $10,000.

Non-interest expense for 2008 was $17,608, an increase of $4,345 or 32.76%, over the $13,263 expensed in 2007. Approximately 28.38% of the increase was attributable to the increase in professional fees (audit, legal, and accounting), and approximately 25.85% of the increase was attributable to the addition of new employees during the year. The Bank ended 2008 with 83 full-time employees. Assets per employee were $14,676 at year-end 2008 compared to $14,060 at year-end 2007.

Non-interest expense for 2007 was $13,263, an increase of $4,207 or 46.46%, over the $9,056 expensed in 2006. Approximately 70% of the increase was attributable to the addition of new employees during the year. The Bank ended 2007 with 64 full-time employees. Assets per employee were $14,060 at year-end 2007 compared to $12,500 at year-end 2006.

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Income Taxes — The Corporation’s effective tax rate in 2008 was 38.10% compared to 34.57% in 2007 and 38.60% in 2006. Management anticipates that tax rates in future years will approximate the rates paid in 2008.

Changes in Financial Condition

Assets - Total assets at December 31, 2008 were $1,218,084, an increase of $317,931 or 35.32%, over total assets of $900,153 at December 31, 2007. Average assets for 2008 were $1,055,859, an increase of $300,605, or 39.80% over average assets in 2007. Loan growth was the primary reason for these increases. Year-end 2008 net loans were $1,023,271, up $239,270, or 30.52% over the year-end 2007 total net loans of $784,001.

Total assets at December 31, 2007 were $900,153, an increase of $276,635 or 44.37%, over total assets of $623,518 at December 31, 2006. Average assets for 2007 were $755,254, an increase of $253,276, or 50.46% over average assets in 2006. Loan growth was the primary reason for the increases. Year-end 2007 net loans were $784,001, up $245,451, or 45.58% over the year-end 2006 total net loans of $538,550.

The Bank’s Business Bank model of operation results in a higher level of earning assets than most peer banks.  Earning assets are defined as assets that earn interest income.  Earning assets include short-term investments, the investment portfolio and net loans.  The Bank maintains a relatively high level of earning assets because few assets are allocated to facilities, cash and due-from bank accounts used for transaction processing. Earning assets at December 31, 2008 were $1,160,099, or 95.24% of total assets of $1,218,084. Earning assets at December 31, 2007 were $867,327, or 96.35% of total assets of $900,153.  Management targets an earning asset to total asset ratio of 97% or higher. This ratio is expected to generally continue at these levels, although it may be affected by economic factors beyond the Bank’s control.

Liabilities - The Bank relies on increasing its deposit base to fund loan and other asset growth.  The Williamson County marketplace is highly competitive with 28 financial institutions and 91 banking facilities (as of June 30, 2008). The Bank competes for local deposits by offering attractive products with premium rates.  The Bank expects to have a higher average cost of funds for local deposits than most competitor banks because of its single location and lack of a branch network.  Management’s strategy is to offset the higher cost of funding with a lower level of operating expense and firm pricing discipline for loan products.  The Bank has promoted electronic banking services by providing them without charge and by offering in-bank customer training.

The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board.  This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity.  Deposits may be raised in $99 or $100 increments in maturities from two weeks to five years.  Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges.  Management has established policies and procedures to govern the acquisition of funding through the wholesale market.  Wholesale deposits are categorized as “Purchased Time Deposits” on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.

Total average deposits in 2008 were $949,005, an increase of $263,942, or 38.53% over the total average deposits of $685,063 in 2007. Average non-interest bearing deposits increased by $2,097, or 9.87%, from $21,247 in 2007 to $23,344 in 2008. Average savings deposits decreased by $724 from $7,255 in 2007 to $6,531 in 2008. Average purchased deposits increased by $200,443, or 78.73%, from $254,611 in 2007 to $455,054 in 2008. The average rate paid on purchased deposits in 2008 was 4.50% compared to 5.28% in 2007. Purchased time deposit funding represented 47.95% of total funding in 2008 compared to 37.27% in 2007.

Total average deposits in 2007 were $685,063, an increase of $233,828, or 51.82% over the total average deposits of $451,235 in 2006. Average non-interest bearing deposits increased by $2,922, or 15.95%, from $18,325 in 2006 to $21,247 in 2007. Average savings deposits decreased by $5,423 from $12,678 in 2006 to $7,255 in 2007. Average purchased deposits increased by $62,547, or 32.57%, from $192,064 in 2006 to $254,611 in 2007. The average rate paid on purchased deposits in 2007 was 5.28% compared to 4.82% in 2006. Purchased time deposit funding represented 37.27% of total funding in 2007 compared to 33.96% in 2006.

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Information regarding the Corporation’s return on assets, return on equity and equity to asset ratio is located in Item 6 of this Annual Report on Form 10-K.

Loan Policy - Lending activity is conducted under guidelines defined in the Bank’s Loan Policy.  The Loan Policy establishes guidelines for analyzing financial transactions including an evaluation of a borrower’s credit history, repayment capacity, collateral value, and cash flow.  Loans may be at a fixed or variable rate, with the maximum maturity of fixed rate loans set at five years.

All lending activities of the Bank are under the direct supervision and control of the Officers Loan Committee, the Executive Committee of the Board and, in some cases, the full Board of Directors. The Officers Loan Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox, and approves loans up to $1,000. The Executive Committee consists of Arthur F. Helf, Michael R. Sapp and H. Lamar Cox and two outside directors, and approves loans up to 15% of Tier I Capital. The full Board of Directors approves all loans above those limits. The full Board of Directors also approves loan authorizations, if any, for any executive officer. The Bank’s established maximum loan volume to deposits is 100%. The Executive Committee of the Board makes a monthly review of loans that are 90 days or more past due and the full Board of Directors makes a quarterly review of loans that are 90 days or more past due.

Management of the Bank periodically reviews the loan portfolio, particularly non-accrual and renegotiated loans.  The review may result in a determination that a loan should be placed on a non-accrual status for income recognition.  In addition, to the extent that management identifies potential losses in the loan portfolio, it reduces the book value of such loans, through charge-offs, to their estimated collectible value.  The Bank’s policy is that accrual of interest is discontinued on a loan when management of the Bank determines that collection of interest is doubtful based on consideration of economic and business factors affecting collection efforts.

When a loan is classified as non-accrual, any unpaid interest is reversed against current income.  Interest is included in income thereafter only to the extent received in cash.  The loan remains in a non-accrual classification until such time as the loan is brought current, when it may be returned to accrual classification.  When principal or interest on a non-accrual loan is brought current, if in management’s opinion future payments are questionable, the loan would remain classified as non-accrual.  After a non-accrual or renegotiated loan is charged off, any subsequent payments of either interest or principal are applied first to any remaining balance outstanding, then to recoveries and lastly to income.

The Bank’s underwriting guidelines are applied to four major categories of loans, commercial and industrial, consumer, agricultural and real estate which includes residential, construction and development and certain other real estate loans.  The Bank requires its loan officers and loan committee to consider the borrower’s character, the borrower’s financial condition, the economic environment in which the loan will be repaid, as well as, for commercial loans, the borrower’s management capability and the borrower’s industry. Before approving a loan, the loan officer or committee must determine that the borrower is creditworthy, is a capable manager, understands the specific purpose of the loan, understands the source and plan of repayment, and determine that the purpose, plan and source of repayment as well as collateral are acceptable, reasonable and practical given the normal framework within which the borrower operates.

The maintenance of an adequate loan loss reserve is one of the fundamental concepts of risk management for every financial institution.  Management is responsible for ensuring that controls are in place to monitor the adequacy of the loan loss reserve in accordance with generally accepted accounting principles (“GAAP”), the Bank’s stated policies and procedures, and regulatory guidance.  Quantification of the level of reserve which is prudently conservative, but not excessive, involves a high degree of judgment.

Management’s assessment of the adequacy of the loan loss reserve considers a wide range of factors including portfolio growth, mix, collateral and geographic diversity, and terms and structure.  Portfolio performance trends, including past dues and charge-offs, are monitored closely.  Management’s assessment includes a continuing evaluation of current and expected market conditions and the potential impact of economic events on borrowers.  Management’s assessment program is monitored by an ongoing loan review program conducted by an independent accounting firm and periodic examinations by bank regulators.

Management uses a variety of financial methods to quantify the level of the loan loss reserve.  At inception, each loan transaction is assigned a risk rating that ranges from “RR1—Excellent” to “RR4—Average.”  The risk rating is determined by an analysis of the borrower’s credit history and capacity, collateral, and cash flow.  The weighted average risk rating of the portfolio provides an indication of overall risk and identifies trends.  The portfolio is additionally segmented by loan type, collateral, and purpose.  Loan transactions that have exhibited signs of increased risk are downgraded to a “Watch,” “Critical,” or “Substandard” classification, i.e., RR5, RR6 and RR7, respectively.  These loans are closely monitored for rehabilitation or potential loss and the loan loss reserve is adjusted accordingly.

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It is management’s intent to maintain a loan loss reserve that is adequate to absorb current and estimated losses which are inherent in a loan portfolio.  The historical loss ratio (net charge-offs as a percentage of average loans) was 0.64%, 0.45% and 0.41% for the years ended December 31, 2008, 2007 and 2006, respectively.  The year-end loan loss reserve as a percentage of the end of period loans was 1.30%, 1.30% and 1.28%, respectively, for the same years.  Because of the commercial emphasis of the Bank’s operation, management has kept a reserve level in excess of historical results.

The provision for loan losses for 2008 was $9,111, an increase of $2,761 over the $6,350 provision for 2007.  In 2008, expenses reflected the impact of $5,978 in charge-offs during the year and the incremental provision required as a result of the $239,270 increase in loan volume.

Credit Risk Management and Reserve for Loan Losses

Credit risk and exposure to loss are inherent parts of the banking business.  Management seeks to manage and minimize these risks through its loan and investment policies and loan review procedures.  Management establishes and continually reviews lending and investment criteria and approval procedures that it believes reflect the risk sensitive nature of the Bank.  The loan review procedures are set to monitor adherence to the established criteria and to ensure that on a continuing basis such standards are enforced and maintained.  Management’s objective in establishing lending and investment standards is to manage the risk of loss and provide for income generation through pricing policies.

The Bank targets small- and medium-sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. If loan losses occur to a level where the loan loss reserve is not sufficient to cover actual loan losses, the Bank’s earnings will decrease. The Bank uses an independent accounting firm to review its loans for quality in addition to the reviews that may be conducted by bank regulatory agencies as part of their usual examination process.

Management regularly reviews the loan portfolio and determines the amount of loans to be charged-off.  In addition, management considers such factors as the Bank’s previous loan loss experience, prevailing and anticipated economic conditions, industry concentrations and the overall quality of the loan portfolio. While management uses available information to recognize losses on loans and real estate owned, future additions to the allowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the allowances for losses on loans and real estate owned.  Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available at the time of their examinations.  In addition, any loan or portion thereof which is classified as a “loss” by regulatory examiners is charged-off.

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Financial Tables

The financial information below regarding the Corporation and the Bank should be read in conjunction with the Corporation’s financial statements included in Item 8 of this Annual Report on Form 10-K.

Average Balance Sheets, Net Interest Income and Changes in Interest Income and Interest Expense

The following tables present the average yearly balances of each principal category of assets, liabilities and stockholders’ equity of the Corporation and the Bank. The tables are presented on a taxable equivalent basis, as applicable.