CNBW CNB Corporation (CE)

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
FORM 10-Q
(Mark One)
[ X ]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended                            June 30, 2008
OR
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                                       to
Commission file number:    000-24523
CNB Corporation
(Exact name of registrant as specified in its charter)
South Carolina		57-0792402
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1400 Third Avenue, Conway, S.C.		29526
(Address of principal executive offices)		(Zip Code)
(Registrant's telephone number, including area code):   (843) 248-5721
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes   X   .   No       .
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [  ]			Accelerated filer [ X ]
Non-accelerated filer  [  ](Do not check if a smaller reporting company)			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  [ X ]  No.
State the number of shares outstanding of each of the issuer's classes of common equity as of the latest practical date:  833,168 shares of common stock, par value $10 per share, August 1, 2008.

 

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CNB Corporation
	Page
Forward-Looking Statements	1
PART I.    FINANCIAL INFORMATION
Item 1.       Financial Statements:
Condensed Consolidated Balance Sheets as of June 30, 2008, December 31, 2007, and June 30, 2007	2
Condensed Consolidated Statements of Income for the Three and Six Months Ended June 30, 2008 and 2007	3
Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2008 and 2007	4
Condensed Consolidated Statements of Changes in Stockholders' Equity for the Six Months Ended June 30, 2008 and 2007	5
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2008 and 2007	6
Notes to Consolidated Financial Statements	7-16
Item 2.     Management's Discussion and Analysis of Financial                  Condition and Results of Operations	16-25
Item 3.     Quantitative and Qualitative Disclosures About Market Risk	26
Item 4.     Controls and Procedures	26
PART II.   OTHER INFORMATION
Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds	27
Item 4.     Submission of Matters to a Vote of Securities Holders	27
Item 6.     Exhibits	28
SIGNATURE	28

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CAUTIONARY NOTICE WITH RESPECT TO
FORWARD LOOKING STATEMENTS

          This report contains "forward-looking statements" within the meaning of the securities laws.  The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements.  In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company's actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company's forwarding-looking statements.

           All statements that are not historical facts are statements that could be "forward-looking statements." You can identify these forward-looking statements through the use of words such as "may," "will," "should," "could," "would," "expect," "anticipate," "assume," indicate," "contemplate," "seek," "plan," "predict," "target," "outlook," "potential," "believe," "intend," "estimate," "project, " "continue," or other similar words.  Forward-looking statements include, but are not limited to, statements regarding the Company's future business prospects, revenues, working capital, liquidity, capital needs, interest costs, income, business operations and proposed services.

          These forward-looking statements are based on current expectations, estimates and projections about the banking industry, management's beliefs, and assumptions made by management.  Such information includes, without limitation, discussions as to estimates, expectations, beliefs, plans, strategies, and objectives concerning future financial and operating performance.  These statements are not guarantees of future performance and are subject to risks, uncertainties and assumptions that are difficult to predict. Therefore, actual results may differ materially from those expressed or forecasted in such forward-looking statements.  The risks and uncertainties include, but are not limited to:

All forward-looking statements are expressly qualified in their entirety by this cautionary notice.  The Company has no obligation, and does not undertake, to update, revise or correct any of the forward-looking statements after the date of this report.  The Company has expressed its expectations, beliefs and projections in good faith and believes they have a reasonable basis.  However, there is no assurance that these expectations, beliefs or projections will result or be achieved or accomplished.

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CNB CORPORATION AND SUBSIDIARY (The "Company")

CNB CORPORATION (The "Parent")

THE CONWAY NATIONAL BANK (The "Bank")

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All Dollar Amounts in Thousands)

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Net income per share - Net income per share is computed on the basis of the weighted average number of common shares outstanding resulting in 841,100 shares for the six-month period ended June 30, 2008 and 863,321 shares for the six-month period ended June 30, 2007, adjusted for the effect of a 10% stock dividend issued in September 2007.

Recently Issued Accounting Pronouncements - The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and/or disclosure of financial information by the Company.

In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations," ("SFAS 141(R)") which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.

In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements - an amendment of ARB No. 51" ("SFAS 160"). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent's equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent's ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 is effective for the Company on January 1, 2009.   Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS No. 161, "Disclosures about Derivative Instruments and Hedging Activities" ("SFAS 161").  SFAS 161 requires enhanced disclosures about an entity's derivative and hedging activities, thereby improving the transparency of financial reporting.  It is intended to enhance the current disclosure framework in SFAS 133 by requiring that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. This disclosure better conveys the purpose of derivative use in terms of the risks that the entity intends to manage. SFAS 161 is effective for the Company on January 1, 2009. This pronouncement does not impact accounting measurements but will result in additional disclosures if the Company is involved in material derivative and hedging activities at that time.

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In February 2008, the FASB issued FASB Staff Position No. 140-3, "Accounting for Transfers of Financial Assets and Repurchase Financing Transactions" ("FSP 140-3").  This FSP provides guidance on accounting for a transfer of a financial asset and the transferor's repurchase financing of the asset.  This FSP presumes that an initial transfer of a financial asset and a repurchase financing are considered part of the same arrangement (linked transaction) under SFAS No. 140. However, if certain criteria are met, the initial transfer and repurchase financing are not evaluated as a linked transaction and are evaluated separately under Statement 140.  FSP 140-3 will be effective for financial statements issued for fiscal years beginning after November 15, 2008, and interim periods within those fiscal years and earlier application is not permitted. Accordingly, this FSP is effective for the Company on January 1, 2009.  The Company is currently evaluating the impact, if any, the adoption of FSP 140-3 will have on its financial position, results of operations and cash flows.

In April 2008, the FASB issued FASB Staff Position No. 142-3, "Determination of the Useful Life of Intangible Assets" ("FSP 142-3").  This FSP amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, "Goodwill and Other Intangible Assets".  The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under SFAS No. 141(R), "Business Combinations,"and other U.S. generally accepted accounting principles.  This FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years and early adoption is prohibited.  Accordingly, this FSP is effective for the Company on January 1, 2009.  The Company does not believe the adoption of FSP 142-3 will have a material impact on its financial position, results of operations or cash flows.

In May, 2008, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 162, "The Hierarchy of Generally Accepted Accounting Principles," ("SFAS No. 162").  SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy).  SFAS No. 162 will be effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board's amendments to AU Section 411, "The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles."  The FASB has stated that it does not expect SFAS No. 162 will result in a change in current practice. The application of SFAS No. 162 will have no effect on the Company's financial position, results of operations or cash flows.

The FASB issued FASB Staff Position No. APB 14-1, "Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)," ("FSP No. APB 14-1"). The Staff Position specifies that issuers of convertible debt instruments that may be settled in cash upon conversion should separately account for the liability and equity components in a manner that will reflect the entity's nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods.  FSP No. APB 14-1 provides guidance for initial and subsequent measurement as well as derecognition provisions.  The Staff Position is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted.  The adoption of this Staff Position will have no material effect on the Company's financial position, results of operations or cash flows.

In June, 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities," ("FSP EITF 03-6-1").  The Staff Position provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are participating securities and must be included in the earnings per share computation.  FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those years. All prior-period earnings per share data presented must be adjusted retrospectively. Early application is not permitted.  The adoption of this Staff Position will have no material effect on the Company's financial position, results of operations or cash flows.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company's financial position, results of operations and cash flows.

NOTE 2 - RESTRICTIONS ON CASH AND DUE FROM BANKS

The Bank is required to maintain average reserve balances either at the Bank or on deposit with the Federal Reserve Bank.  The average amounts of these reserve balances for the six-month period ended June 30, 2008 and for the year ended December 31, 2007 were approximately $2,854 and $10,486, respectively.

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NOTE 3 - INVESTMENT SECURITIES

Investment securities with a par value of approximately $164,707 at June 30, 2008 and $182,651 at December 31, 2007 were pledged to secure public deposits and for other purposes required by law.

The following summaries reflect the book value, unrealized gains and losses, approximate market value, and tax-equivalent yields of investment securities listed by type of issuer and maturity at June 30, 2008 and at December 31, 2007.
 

As of June 30, 2008, the Bank did not hold any securities of an issuer that exceeded 10% of stockholders' equity. The net unrealized holding losses on available-for-sale securities component of capital is $(312) as of June 30, 2008.

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NOTE 3 - INVESTMENT SECURITIES (Continued)

(1) Tax equivalent adjustment based on a 34% tax rate

As of December 31, 2007, the Bank did not hold any securities of an issuer that exceeded 10% of stockholders' equity. The net unrealized holding gains on available-for-sale securities component of capital was $1,025 as of December 31, 2007.

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NOTE 4 - LOANS AND ALLOWANCE FOR LOAN LOSSES

     The following is a summary of loans at June 30, 2008 and December 31, 2007 by major classification:

       Changes in the allowance for loan losses for the quarters ended June 30, 2008 and 2007, and the year ended December 31, 2007 are summarized as follows:

The entire balance of the allowance for loan losses is available to absorb future loan losses.

At June 30, 2008 and June 30, 2007 and December 31, 2007 loans on which no interest was being accrued totaled approximately $718, $606, and $861, respectively.  The Company had $79 of foreclosed real estate at June 30, 2008, $46 of foreclosed real estate at June 30, 2007, and $64 of foreclosed real estate at December 31, 2007.  Loans 90 days past due and still accruing interest totaled $199, $257, and $147 at June 30, 2008, June 30, 2007, and December 31, 2007, respectively.

At June 30, 2008, June 30, 2007, and December 31, 2007 classified assets, the majority consisting of classified loans, were $17,666, $12,630, and $15,180, respectively.  At June 30, 2008,  June 30, 2007, and December 31, 2007 classified assets represented 19.61%, 15.00% and 17.63% of total capital (the sum of Tier 1 Capital and the Allowance for Loan Losses), respectively.

 

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NOTE 5 - PREMISES AND EQUIPMENT

     Property at June 30, 2008 and December 31, 2007 is summarized as follows:

     Depreciation and amortization of bank premises and equipment charged to operating expense was $710 for the six-month period ended June 30, 2008, and $1,285 for the year ended December 31, 2007.  The construction in progress is primarily related to renovations to the Company's Main Office in Conway, South Carolina; the construction of a branch office located in Little River, South Carolina; the renovation of the Company's Red Hill branch office located in Conway, South Carolina; and the land improvements and installation of an automated teller machine (ATM) at the Company's Carolina Forest site located in Myrtle Beach, South Carolina.  There are no remaining costs to be incurred associated with the Main Office renovation or the Little River branch office construction.  Remaining construction and equipment costs associated with the Red Hill branch office and the Carolina Forest ATM are estimated at approximately $20 and $233, respectively.

NOTE 6 - CERTIFICATES OF DEPOSIT IN EXCESS OF $100,000

     At June 30, 2008 and December 31, 2007, certificates of deposit of $100,000 or more included in time deposits totaled approximately $214,134 and $201,855, respectively.  Interest expense on these deposits was approximately $4,704 for the six-month period ended June 30, 2008 and $8,944 for the year ended December 31, 2007.

NOTE 7 - SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

     At June 30, 2008 and December 31, 2007, securities sold under repurchase agreements totaled $49,835 and $60,936, respectively.  Securities with a book value of $64,105 ($64,062 fair value) and $74,717 ($76,064 fair value), respectively, were used as collateral for the agreements.  The weighted-average interest rate of these agreements was 2.12 percent and 4.20 percent at June 30, 2008 and December 31, 2007, respectively.

NOTE 8 - LINES OF CREDIT

     At June 30, 2008, the Bank had unused short-term lines of credit to purchase Federal Funds from unrelated banks totaling $37,000.  These lines of credit are available on a one to seven day basis for general corporate purposes of the Bank.  All of the lenders have reserved the right to withdraw these lines at their option.

     The Bank has a demand note through the U.S. Treasury, Tax and Loan system with the Federal Reserve Bank of Richmond.  The Bank may borrow up to $7,000 under the arrangement at a variable interest rate.  The note is secured by bonds with a market value of $3,944 at June 30, 2008.  The amount outstanding under the note totaled $3,345 and $2,377 at June 30, 2008 and December 31, 2007, respectively.

     The Bank also has a line of credit from the Federal Home Loan Bank of Atlanta for $89,749 secured by a lien on the Bank's 1-4 family mortgages. Allowable terms range from overnight to twenty years at varying rates set daily by the FHLB.  There were no borrowings under the agreement at June 30, 2008 and $15,000 at December 31, 2007.

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NOTE 9 - INCOME TAXES

     Income tax expense for the quarters ended June 30, 2008 and June 30, 2007 on pretax income of $3,177 and $3,889 totaled $1,040 and $1,359, respectively.   The provision for federal income taxes is calculated by applying the 34% statutory federal income tax rate and increasing or reducing this amount due to any tax-exempt interest, state bank tax (net of federal benefit), business credits, surtax exemption, tax preferences, alternative minimum tax calculations, or other factors.  A summary of income tax components and a reconciliation of income taxes to the federal statutory rate are included in fiscal year-end reports.

     The Company accounts for income taxes in accordance with Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes," and FASB Interpretation No. 48 (FIN48), Accounting for Uncertainty in Income Taxes - an Interpretation of SFAS No. 109."

NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES

     From time to time the Bank is a party to various litigation matters, both as plaintiff and as defendant, arising from its normal operations.  No material losses are anticipated in connection with any of these matters at June 30, 2008.

     In the normal course of business, the Bank is a party to financial instruments with off-balance-sheet risk including commitments to extend credit and standby letters of credit.  Such instruments have elements of credit risk in excess of the amount recognized in the balance sheet.  The exposure to credit loss in the event of nonperformance by the other parties to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of those instruments.  Generally, the same credit policies used for on-balance-sheet instruments, such as loans, are used in extending loan commitments and standby letters of credit.

     Following are the off-balance-sheet financial instruments whose contract amounts represent credit risk:  

     Loan commitments involve agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and some involve payment of a fee.  Many of the commitments are expected to expire without being fully drawn.  Therefore, the total amount of loan commitments does not necessarily represent future cash requirements.  Each customer's creditworthiness is evaluated on a case-by-case basis.  The amount of collateral obtained, if any, upon extension of credit is based on management's credit evaluation of the borrower.  Collateral held varies but may include certificates of deposit or other negotiable collateral, commercial and residential real properties, accounts receivable, inventory and equipment.

     Standby letters of credit are conditional commitments to guarantee the performance of a customer to a third party.  The credit risk involved in issuing standby letters of credit is the same as that involved in making loan commitments to customers. Many letters of credit will expire without being drawn upon and do not necessarily represent future cash requirements.

     Management believes that its various sources of liquidity provide the resources necessary for the bank subsidiary to fund the loan commitments and to perform under standby letters of credit, if the need arises.  Neither the Company nor the Bank are involved in other off-balance sheet contractual relationships or transactions that could result in liquidity needs or other commitments or significantly impact earnings.

NOTE 11 - EMPLOYEE BENEFIT PLAN

     The Bank has a defined contribution pension plan covering all employees who have attained age twenty-one and have a minimum of one year of service.  Upon ongoing approval of the Board of Directors, the Bank matches one-hundred percent of employee contributions up to three percent of employee salary deferred and fifty percent of employee contributions in excess of three percent and up to five percent of salary deferred.  The Board of Directors may also make discretionary contributions to the Plan.  For the three-month and six-month periods ended June 30, 2008 and the year ended December 31, 2007, $190, $283, and $712, respectively, was charged to operations under the plan.

 

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NOTE 12 - REGULATORY MATTERS

     The Bank and the Company are subject to various regulatory capital requirements administered by the federal banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the financial statements.  The regulations require the Bank and the Company to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The capital classification is also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

     Quantitative measures established by regulation to ensure capital adequacy require the maintenance of minimum amounts and ratios (set forth in the tables below) of Tier 1 capital to adjusted total assets (Leverage Capital ratio) and minimum ratios of Tier 1 and total capital to risk-weighted assets.  To be considered adequately capitalized under the regulatory framework for prompt corrective action, the Company and the Bank must maintain minimum Tier 1 leverage, Tier 1 risk-based and total risked-based ratios as set forth in the tables below.  The Company's and the Bank's actual capital ratios are presented in the tables below as of June 30, 2008:

 

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NOTE 13 - FAIR VALUE MEASUREMENTS

Effective January 1, 2008, the Company adopted SFAS No. 157, "Fair Value Measurements" ("SFAS 157") which provides a framework for measuring and disclosing fair value under generally accepted accounting principles. SFAS 157 requires disclosures about the fair value of assets and liabilities recognized in the balance sheet in periods subsequent to initial recognition, whether the measurements are made on a recurring basis (for example, available-for-sale investment securities) or on a nonrecurring basis (for example, impaired loans).

SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

The Company has no assets or liabilities whose fair values are measured using level 1 inputs.

The Company's available-for-sale investment securities ($182,350 at June 30, 2008) include debt securities of U.S. government sponsored enterprises, municipal bonds, and mortgage backed securities.  The Company considers the market quoted prices of these instruments to be equivalent to debt securities that are traded less frequently than exchange-traded instruments and therefore classifies them as Level 2 inputs.  Also, the Company predominantly makes loans for the purposes of real estate acquisition, construction, agriculture, commercial and industrial needs, and consumer expenditures.  The majority of the Company's loans are real estate secured.  Loans which are deemed to be impaired are primarily valued at the fair values of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be level 2 inputs. The aggregate carrying amount of impaired loans at June 30, 2008 was $367.  The Company's available-for-sale investment securities and impaired loans are the only assets whose fair values the Company measures on a recurring basis using level 2 inputs.  The Company has no liabilities whose fair values are measured using level 2 inputs.

The Company has no assets or liabilities whose fair values are measured using level 3 inputs.

FASB Staff Position No. FAS 157-2 delays the implementation of SFAS 157 until the first quarter of 2009 with respect to goodwill, other intangible assets, real estate and other assets acquired through foreclosure and other non-financial assets measured at fair value on a nonrecurring basis.

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NOTE 14 - CONDENSED FINANCIAL INFORMATION

     Following is condensed financial information of CNB Corporation (parent company only):

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(All dollar amounts in thousands, except per share data.)

Management's Discussion and Analysis is provided to afford a clearer understanding of the major elements of the Company's results of operations, financial condition, liquidity, and capital resources. The following discussion should be read in conjunction with the Company's financial statements and notes thereto and other detailed information appearing elsewhere in this report.  In addition, the results of operations for the interim periods shown in this report are not necessarily indicative of results to be expected for the fiscal year.  The accompanying consolidated financial statements include all accounts of the Company and the Bank.  All significant intercompany accounts and transactions have been eliminated in consolidation.  The accompanying unaudited consolidated financial statements at June 30, 2008 and for the three and six-month periods ending June 30, 2008 and 2007 have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and with the instructions to Form 10-Q of the Securities and Exchange Commission.  Accordingly, they do not include all information and footnotes required by GAAP for complete financial statements.  However, in the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

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DISTRIBUTION OF ASSETS AND LIABILITIES

The Company has historically maintained a conservative approach in determining the distribution of assets and liabilities.  Loans increased 6.2% from $555,184 at June 30, 2007 to $589,410 at June 30, 2008, and increased 2.7%, from $573,751 at December 31, 2007 to $589,410 at June 30, 2008.  Loans increased as a percentage of total assets from 65.9% to 68.7% from June 30, 2007 to June 30, 2008 and increased from 66.3% to 68.7% from December 31, 2007 to June 30, 2008.  Loan demand in our market area slowed to a moderate pace during 2007. This trend has continued throughout the first half of 2008 and is expected to continue through the remainder of 2008. Securities and federal funds sold decreased as a percentage of total assets from 26.6% at June 30, 2007 to 25.3% at June 30, 2008. Securities and federal funds sold decreased from 28.0% of total assets at December 31, 2007 to 25.3% at June 30, 2008, a reflection of continued moderate loan demand coupled with a lower level of percentage growth in deposits and a decline in repurchase agreements sold. The level of investments and federal funds sold provides for a more than adequate supply of liquidity.

Management has sought to build the deposit base with stable, relatively non-interest-sensitive deposits by offering the small to medium deposit account holders a wide array of deposit instruments at competitive rates. Non-interest-bearing demand deposits decreased as a percentage of total assets from 16.2% at June 30, 2007 to 13.8% at June 30, 2008, and increased from 13.0% at December 31, 2007 to 13.8% at June 30, 2008.  As more customers, both business and personal, are attracted to interest-bearing deposit accounts, we expect the percentage of non-interest bearing demand deposits to decline over the long-term.  Interest-bearing deposits increased from 64.8% of total assets at June 30, 2007 to 69.4% at June 30, 2008, and increased from 67.0% at December 31, 2007 to 69.4% at June 30, 2008. Securities sold under agreement to repurchase decreased from 8.2% at June 30, 2007 to 5.8% at June 30, 2008.  Securities sold under agreement to repurchase decreased from 7.0% of total assets at December 31, 2007 to 5.8% at June 30, 2008.  Other short-term borrowings decreased from 2.0% of total assets at December 31, 2007 to .5% at June 30, 2008 due to a decline in FHLB advances. Other short-term borrowings increased from .2% at June 30, 2007 to .5% at June 30, 2008 due to an increase in short-term borrowings in the second quarter of 2008.

The following table sets forth the percentage relationship to total assets of significant components of the Company's balance sheets as of June 30, 2008 and June 30, 2007 and December 31, 2007:

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RESULTS OF OPERATIONS

Earnings for the three-month periods ended June 30, 2008 and 2007 were $2,137 and $2,530, respectively, resulting in a return on average assets of 1.00% and 1.20% and a return on average stockholders' equity of 10.13% and 12.55%, respectively.

Earnings for the six-month periods ended June 30, 2008 and 2007 were $4,677 and $4,971, respectively, resulting in a return on average assets of 1.08% and 1.18% and a return on average stockholders' equity of 11.17% and 12.53%, respectively.

The earnings were primarily attributable to net interest income in each period (see Net Income-Net Interest Income). Other factors include management's ongoing effort to maintain other income at adequate levels (see Net Income - Other Income) and to control other expenses (see Net Income - Other Expenses). This level of earnings, coupled with a moderate dividend policy, has supplied the necessary capital funds to support growth in total assets. Total assets increased $16,069 or 1.9% to $858,291 at June 30, 2008 from $842,222 at June 30, 2007. The following table sets forth the financial highlights for the three and six-month periods ending at June 30, 2008 and June 30, 2007:

         (1)       Adjusted for the effect of the 10% Stock Dividend paid in September 2007.

         (2)       For the three-month period ended June 30, 2008, average total assets amounted to $851,199 with average stockholders
                    equity totaling $84,419 for the same period.

                    For the six-month period ended June 30, 2008, average total assets amounted to $865,249 with average stockholders'
                    equity totaling $83,721 for the same period.


 

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NET INCOME

Net Interest Income - Earnings are dependent to a large degree on net interest income, defined as the difference between gross interest and fees earned on earning assets, primarily loans and securities, and interest paid on deposits and borrowed funds.  Net interest income is affected by the interest rates earned or paid and by volume changes in loans, securities, deposits, and borrowed funds.

Interest rates paid on deposits and borrowed funds and earned on loans and investments have generally followed the fluctuations in market interest rates in 2008 and 2007.  However, fluctuations in market interest rates do not necessarily have a significant impact on net interest income, depending on the bank's rate sensitivity position.  A rate sensitive asset (RSA) is any loan or investment on which the interest rate can be re-priced either up or down within a certain time interval. A rate sensitive liability (RSL) is an interest paying deposit or other liability on which the interest rate can be re-priced either up or down within a certain time interval.  When a proper balance between RSA and RSL exists, market interest rate fluctuations should not have a significant impact on earnings. The larger the imbalance, the greater the interest rate risk assumed by the Bank and the greater the positive or negative impact of interest rate fluctuations on earnings.  The Bank seeks to manage its assets and liabilities in a manner that will limit interest rate risk and thus stabilize long-term earning power. Management believes that a 200 basis point rise or fall in interest rates will have less than a 10 percent effect on before-tax net interest income over a one-year period, which is within Bank guidelines.

The Bank has maintained net interest margins for the three-month and six-month periods ended June 30, 2008, of 3.91% and 3.92%, respectively, and 3.95% and 3.97%, respectively, for the same periods in 2007, as compared to management's long-term target of 4.20%.  Net interest margins have been compressed for the Bank and industry-wide as we experienced a flat to slightly inverted treasury yield curve during 2007.  Interest rate reductions by the Federal Reserve during the second half of 2007, improved this situation.  However, dramatic decreases in market interest rates during the first quarter of 2008 placed further significant pressure on net interest margins for the industry as a whole.  The resulting more historically upward-sloping yield curve should enhance the Bank's net interest margin in future periods.  Still, competition in the Bank's specific market remains significant, as new competitors seek market share and other competitors attempt to reduce their dependence on brokered deposits.  These factors tend to compress margins by driving the cost of deposits upward while driving the yields on loans downward. 

Fully-tax-equivalent net interest income for the three-month period ended June 30, 2008 was $7,909, an increase of 2.5% from the $7,714 attained for the three-month period ended June 30, 2007.  During the same period, total fully-tax-equivalent interest income decreased by 5.9% to $12,569 from $13,359 and total interest expense decreased by 17.4% to $4,660 from $5,645.  Fully-tax-equivalent net interest income as a percentage of average total earning assets decreased .04% to 3.91% for the three-month period ended June 30, 2008 from 3.95% for the three-month period ended June 30, 2007.

Fully-tax-equivalent net interest income showed a 3.8% increase at $16,036 for the six-month period ended June 30, 2008 as compared to $15,442 for the six-month period ended June 30, 2007.  During the same period, total fully-tax-equivalent interest income decreased by .75% to $26,390 from $26,590, and total interest expense decreased by 7.1% to $10,354 from $11,148.  Fully-tax-equivalent net interest income as a percentage of total earning assets decreased .05% to 3.92.% for the six-month period ended June 30, 2008 from 3.97% for the six-month period ended June 30, 2007.

The tables on the following four pages present an analysis of average balances, yields and rates for the interest sensitive segments of the Company's balance sheets for the three-month and six-month periods ended June 30, 2008 and 2007, and a summary of changes in net interest income resulting from changes in volume and changes in rate between the three-month and six-month periods ended June 30, 2008 and 2007.

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