Exhibit 13

2009

ANNUAL REPORT

TO

SHAREHOLDERS

HAWTHORN BANCSHARES, INC.

Lee’s Summit, Missouri

March 15, 2010

Dear Investors:

Hawthorn is very much a part of the communities in which our 24 branches are located and as such, our performance is directly tied to the local economies in which we operate. 2009 proved to be a challenging economic environment for the entire country and more specifically, the banking industry. However, despite significant increases in FDIC insurance costs ($2.3 million over 2008) and a continued larger than normal loan loss provision ($8.4 million for 2009 compared to $8.2 million and $1.2 million for 2008 and 2007, respectively), our core operations remained strong as we realized increases in both net interest income and non-interest income.

As Chairman, I recognize that the sustainability of a bank is centered on 1) asset quality, 2) capital strength and 3) liquidity. At Hawthorn, our credit portfolio has experienced moderate deterioration as evidenced by the spike in non-performing loans of 4.27% of total loans compared to 2.46% for 2008. Despite deterioration in asset quality, the level of problem assets is manageable. Capital levels for Hawthorn continue to far exceed regulatory requirements and even increased during 2009 due to earnings retention and lowering the quarterly common dividend.

The common dividend was reduced to $0.11 per share on July 1, 2009 due to lower earnings. Recognizing the potential long term capital erosion effect of paying out more in dividends than is earned and due to uncertainty in the financial markets, it was prudent to lower the cash dividend. To offset the lower cash dividend, the Board was pleased to declare a 4% stock dividend which provided investors with additional opportunity to directly share in Hawthorn’s growth.

In spite of the impact of the current recession, in 2009 we did have positive earnings and we continued to pay dividends. Many banks in Missouri and across the nation are unable to say this. Net income for 2009 of $5.0 million was greatly improved over 2008’s net loss of $30.6 million which included a $40.3 million non-cash goodwill impairment charge. Exclusive of the impairment charge, the increase over 2008 is primarily attributed to a stronger net interest margin and increased residential refinancing activity. 2009’s net interest margin increased to 3.50% from 3.42% for 2008 which contributed an additional $2.4 million to earnings. Gains from residential refinancing activity contributed an additional $2.0 million for 2009.

I am often asked about management’s plans to continue participation in the U.S. Treasury’s capital purchase program. Your Board of Directors met on several occasions to evaluate the benefits of continuing in the program and after much analysis, management feels it remains practical for Hawthorn to retain higher than normal capital levels to protect shareholder value.

In summary, Hawthorn is a well capitalized, liquid organization which has the ability to endure the challenging operating environment which everyone is experiencing. Your continued support as we move forward to 2010 is much appreciated!

Sincerely,

James E. Smith
Chairman & Chief Executive Officer

Hawthorn Bancshares | 300 S.W. Longview Blvd. | Lee’s Summit, MO 64081-2101 | T 816.268.6318 | F 816.268.6318 | NASDAQ:HWBK

A WORD CONCERNING FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of our Company and its subsidiaries, including, without limitation:

•		statements that are not historical in nature, and
•		statements preceded by, followed by or that include the words “believes,” “expects,” “may,” “will,” “should,” “could,” “anticipates,” “estimates,” “intends” or similar expressions.

Forward-looking statements are not guarantees of future performance or results. They involve risks, uncertainties and assumptions. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the following factors:

•		competitive pressures among financial services companies may increase significantly,
•		changes in the interest rate environment may reduce interest margins,
•		general economic conditions, either nationally or in Missouri, may be less favorable than expected and may adversely affect the quality of our loans and other assets,
•		increases in non-performing assets in our loan portfolios and adverse economic conditions may necessitate increases to our provisions for loan losses,
•		costs or difficulties related to the integration of the business of Hawthorn and its acquisition targets may be greater than expected,
•		legislative or regulatory changes may adversely affect the business in which Hawthorn and its subsidiaries are engaged, and
•		changes may occur in the securities markets.

     We have described under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2009, and in other reports that we file with the SEC from time to time, additional factors that could cause actual results to be materially different from those described in the forward-looking statements. Other factors that we have not identified in this report could also have this effect. You are cautioned not to put undue reliance on any forward-looking statement, which speak only as of the date they were made.

HAWTHORN BANCSHARES, INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
CONSOLIDATED FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

     Through its branch network, our Company, Hawthorn Bancshares, Inc., provides a broad range of commercial and personal banking services, including certificates of deposit, individual retirement and other time deposit accounts, checking and other demand deposit accounts, interest checking accounts, savings accounts, and money market accounts. We also provide a wide range of lending services, including real estate, commercial, installment, and other consumer loans. Other financial services that we provide include automatic teller machines, trust services, credit related insurance, and safe deposit boxes. The geographic areas in which we provide our products and services include the communities in and surrounding Jefferson City, Clinton, Warsaw, Springfield, Branson and Lee’s Summit, Missouri. The products and services are offered to customers primarily within these geographical areas.

     Our Company’s primary source of revenue is net interest income derived primarily from lending and deposit taking activities. A secondary source of revenue is investment income. Our Company also derives income from trust, brokerage, credit card and mortgage banking activities and service charge income.

     Much of our Company’s business is commercial, commercial real estate development, and mortgage lending. Our Company has experienced continued strong loan demand in the communities within which we operate even during the current economic slowdown. Our Company’s income from mortgage brokerage activities is directly dependent on mortgage rates and the level of home purchases and refinancings.

     The successes of our Company’s growth strategy depends primarily on the ability of our banking subsidiary to generate an increasing level of loans and deposits at acceptable risk levels and on acceptable terms without significant increases in non-interest expenses relative to revenues generated. Our Company’s financial performance also depends, in part, on our ability to manage various portfolios and to successfully introduce additional financial products and services by expanding new and existing customer relationships, utilizing improved technology, and enhancing customer satisfaction. Furthermore, the success of our Company’s growth strategy depends on our ability to maintain sufficient regulatory capital levels during general economic conditions and during economic conditions that are beyond our control.

     Our subsidiary Bank is a full service bank conducting a general banking business, offering its customers checking and savings accounts, debit cards, certificates of deposit, safety deposit boxes and a wide range of lending services, including commercial and industrial loans, residential real estate loans, single payment personal loans, installment loans and credit card accounts. In addition, our Bank provides trust services.

     The deposit accounts of our Bank are insured by the Federal Deposit Insurance Corporation or “FDIC” to the extent provided by law. The operations of our Bank are supervised and regulated by the FDIC and the Missouri Division of Finance. Periodic examinations of our Bank are conducted by representatives of the FDIC and the Missouri Division of Finance. Such regulations, supervision and examinations are principally for the benefit of depositors, rather than for the benefit of shareholders. Hawthorn Bancshares is subject to supervision and examination by the Federal Reserve Board.

     Except as otherwise provided herein, references herein to “Hawthorn” or our “Company” include Hawthorn and its consolidated subsidiaries, and references herein to our “Bank” refers to Hawthorn Bank and its constituent predecessors.

SELECTED CONSOLIDATED FINANCIAL DATA

     The following table presents selected consolidated financial information for our Company as of and for each of the years in the five-year period ended December 31, 2009. The selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements of our Company, including the related notes, presented elsewhere herein.

Income Statement Data
(In thousands, except per share data)		2009				2008				2007				2006				2005
Interest income		$	63,562			$	69,715			$	74,207			$	71,423			$	57,340
Interest expense			22,974				31,599				37,175				32,766				23,673
Net interest income			40,588				38,116				37,032				38,657				33,667
Provision for loan losses			8,354				8,211				1,154				1,326				1,322
Net interest income after provision for loan losses			32,234				29,905				35,878				37,331				32,345
Non-interest income			10,702				9,294				10,223				8,618				7,290
Security gains (losses), net			606				3				(2	)			(18	)			(25	)
Total non-interest income			11,308				9,297				10,221				8,600				7,265
Non-interest expense			36,730				75,975				35,054				30,148				25,368
Income (loss) before income taxes			6,812				(36,773	)			11,045				15,783				14,242
Income taxes (benefit)			1,856				(6,146	)			3,245				4,908				4,327
Net income (loss)			4,956				(30,627	)			7,800				10,875				9,915
Less: preferred stock dividends			1,994				66				—				—				—
Net income available to common shareholders		$	2,962			$	(30,693	)		$	7,800			$	10,875			$	9,915
Dividends on Common Stock
Declared		$	2,270			$	3,486			$	3,504			$	3,503			$	3,503
Paid			2,666				3,486				3,504				3,503				3,378
Ratio of total dividends declared to net income			76.64	%			N.M.				44.92	%			32.21	%			35.33	%
Per Share Data
Basic earnings (loss) per common share		$	0.69			$	(7.10	)		$	1.80			$	2.51			$	2.29
Diluted earnings (loss) per common share			0.69				(7.10	)			1.78				2.49				2.27
Basic weighted average shares of common stock outstanding			4,301,955				4,321,979				4,338,438				4,336,641				4,336,641
Diluted weighted average shares of common stock outstanding			4,301,955				4,321,979				4,376,096				4,369,795				4,363,857

(In thousands, except per share data)		2009				2008				2007				2006				2005
Balance Sheet Data (at period end)
Total assets		$	1,236,471			$	1,279,699			$	1,195,804			$	1,142,712			$	1,126,470
Loans			991,614				1,009,104				911,278				812,312				813,535
Investment securities			152,927				149,401				151,742				183,566				173,389
Total deposits			956,323				955,296				921,257				899,865				881,455
Subordinated notes			49,486				49,486				49,486				49,486				49,486
Other borrowed money			79,317				129,057				77,915				47,368				52,180
Common stockholders’ equity			79,406				78,530				111,199				104,945				96,733
Total stockholders’ equity			107,771				106,418				111,199				104,945				96,733
Balance Sheet Data (average balances)
Total assets		$	1,258,381			$	1,251,496			$	1,156,500			$	1,146,150			$	1,083,746
Loans			1,002,830				963,252				848,771				824,706				743,382
Investment securities			151,907				156,870				171,179				182,902				201,995
Total deposits			977,826				914,218				921,257				899,865				982,360
Subordinated notes			49,486				49,486				49,486				49,486				44,614
Other borrowed money			78,626				124,025				53,626				56,757				48,430
Common stockholders’ equity			79,828				112,307				108,052				100,821				94,663
Total stockholders’ equity			107,938				113,375				108,052				100,821				94,663
Key Ratios
Earnings Ratios
Return (loss) on average total assets			0.39	%			(2.45)	%			0.67	%			0.95	%			0.91	%
Return (loss) on average common stockholders’ equity			3.71				(27.33	)			7.22				10.79				10.47
Efficiency ratio (3)			71.66				160.25				74.18				63.80				61.98
Asset Quality Ratios
Allowance for loan losses to loans			1.49				1.26				1.02				1.11				1.12
Nonperforming loans to loans (1)			4.27				2.46				0.67				0.62				1.11
Allowance for loan losses to nonperforming loans (1)			34.94				50.94				152.54				177.95				100.39
Nonperforming assets to loans and foreclosed assets (2)			5.08				3.21				0.92				0.96				1.30
Net loan charge-offs to average loans			0.62				0.50				0.10				0.17				0.15
Capital Ratios
Average stockholders’ equity to average total assets			8.58	%			9.06	%			9.34	%			8.80	%			8.73	%
Period-end common stockholders’ equity to period-end assets			6.42				6.14				9.30				9.18				8.59
Period-end tangible common stockholders’ equity to period-end tangible assets			6.15				5.89				5.81				5.42				6.07
Period-end stockholders’ equity to period-end assets			8.72				8.32				9.30				9.18				8.59
Total risk-based capital ratio			16.49				16.01				13.24				13.84				12.70
Tier 1 risk-based capital ratio			14.01				13.55				11.08				11.28				9.83
Leverage ratio			11.35				10.80				9.12				8.77				7.88

CRITICAL ACCOUNTING POLICIES

     The following accounting policies are considered most critical to the understanding of our Company’s financial condition and results of operations. These critical accounting policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. Because these estimates and judgments are based on current circumstances, they may change over time or prove to be inaccurate based on actual experiences. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition and/or results of operations could reasonably be expected. The impact and any associated risks related to our critical accounting policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” where such polices affect our reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 1 of our consolidated financial statements.

Allowance for Loan Losses

     We have identified the accounting policy related to the allowance for loan losses as critical to the understanding of our Company’s results of operations, since the application of this policy requires significant management assumptions and estimates that could result in materially different amounts to be reported if conditions or underlying circumstances were to change. The impact and any associated risks related to these policies on our business operations are discussed in the “Lending and Credit Management” section below.

Income Taxes

     Income taxes are accounted for under the asset / liability method by recognizing the amount of taxes payable or refundable for the current period and deferred tax assets and liabilities for future tax consequences of events that been that have been recognized in an entity’s financial statements or tax returns. Judgment is required in addressing our Company’s future tax consequences of events that have been recognized in our consolidated financial statements or tax returns such as realization of the effects of temporary differences, net operating loss carry forward, and changes in tax laws or interpretations thereof. A valuation allowance is established when in the judgment of management, it is more likely than not that such deferred tax assets will not become realizable. In this case, our Company would adjust the recorded value of our deferred tax asset, which would result in a direct charge to income tax expense in the period that the determination was made. Likewise, our Company would reverse the valuation allowance when the realization of the deferred tax asset is expected. In addition, our Company is subject to the continuous examination of our tax returns by the Internal Revenue Service and other taxing authorities. Our Company accrues for interest related to income taxes in income tax expense. Total interest expense recognized was $53,000 and $77,000 in 2009 and 2008, respectively. As of December 31, 2009 and 2008, total accrued interest was $94,000 and $131,000, respectively.

Goodwill and Intangible Assets

     Goodwill and intangible assets that have indefinite useful lives are not amortized, but tested annually for impairment. Intangible assets that have finite useful lives, such as core deposit intangibles and mortgage servicing rights, are amortized over their estimated useful lives. Core deposit intangibles are amortized over periods of 7 to 8 years representing their estimated lives using straight line and accelerated methods. Mortgage servicing rights are amortized over the shorter of 7 years or the life of the loan.

     When facts and circumstances indicate potential impairment of amortizable intangible assets, our Company evaluates the recoverability of the carrying value based upon future cash flows expected to result from the use of the underlying asset and its eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) is less than the carrying value of the underlying asset, the Company recognizes an impairment loss. The impairment loss recognized represents the amount by which the carrying value of the underlying asset exceeds the fair value of the underlying asset. As a result of the 2008 annual review, our Company determined that goodwill was fully impaired and recorded an impairment charge of $40,323,775, before tax.

RESULTS OF OPERATIONS ANALYSIS

     Our Company has prepared all of the consolidated financial information in this report in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). In preparing the consolidated financial statements in accordance with U.S. GAAP, our Company makes estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurances that actual results will not differ from those estimates.

														$ Change								% Change
(Dollars in thousands)		2009				2008				2007				‘09-‘08				‘08-‘07				‘09-‘08				‘08-‘07
Net interest income (loss)		$	40,588			$	38,116			$	37,032			$	2,472			$	1,084				6.5	%			2.9	%
Provision for loan losses			8,354				8,211				1,154				143				7,057				1.7				611.5
Noninterest income			10,702				9,294				10,223				1,408				(929	)			15.1				(9.1	)
Investment securities gains (losses), net			606				3				(2	)			603				5			NM					(250.0	)
Noninterest expense			36,730				75,975				35,054				(39,245	)			40,921				(51.7	)			116.7
Income (loss) before income taxes			6,812				(36,773	)			11,045				43,585				(47,818	)			118.5				(432.9	)
Income taxes (benefit)			1,856				(6,146	)			3,245				8,002				(9,391	)			130.2				(289.4	)
Net income (loss)		$	4,956			$	(30,627	)		$	7,800			$	35,583			$	(38,427	)			116.2	%			(492.7	)%
Less: preferred dividends			1,994				66				—				1,928				66				—				—
Net income (loss) available to common shareholders		$	2,962			$	(30,693	)		$	7,800			$	33,655			$	(38,493	)			109.7	%			(493.5	)%

     Our Company’s consolidated net income of $4,956,000 for the year ended December 31, 2009 increased $35,583,000 compared to a loss of $(30,627,000) for the year ended December 31, 2008. Our Company recorded preferred stock dividends of $1,994,000 for the year ended December 31, 2009, resulting in $2,962,000 of net income available to common shareholders, or $0.69 per diluted common share, compared to a net loss of $(30,693,000), or $(7.10) per diluted common share for the year ended December 31, 2008. This $33,655,000 increase from 2008 is primarily due to a one time $40,324,000 ($33,211,000 after tax) goodwill impairment charge to income taken in the fourth quarter of 2008. Excluding this one time goodwill impairment charge, net income available for the common shareholders increased $444,000 from $2,518,000 to $2,962,000. This non-GAAP measure of operating results is discussed more fully below. Our Company did experience substantial real estate refinancing activity in 2009, which contributed additional revenues of approximately $2,001,000. However, this was offset by an industry-wide increase in FDIC insurance assessments. Our Company paid $2,519,000 during 2009 in comparison to $204,000 during 2008. Net interest margin increased 0.08% from 3.42% to 3.50%. Net interest income, on a tax equivalent basis, increased $2,353,000 or 6.0% from 2008 to 2009. Total assets at December 31, 2009 were $1,236,471,000, compared to $1,279,699,000 at December 31, 2008, a decrease of $43,228,000, or 3.4%. The return on average assets was 0.39%, the return on average common shareholders’ equity was 3.71%, and the efficiency ratio was 71.6%.

     Our Company’s consolidated net loss of $(30,627,000) for the year ended December 31, 2008 decreased $(38,427,000) compared to net income of $7,800,000 for the year ended December 31, 2007. Our Company recorded preferred stock dividends of $66,000 for the year ended December 31, 2008, resulting in a $(30,693,000) net loss available for common shareholders, or $(7.10) per diluted common share, compared to net income of $7,800,000, or $1.78 per diluted common share for the year ended December 31, 2007. This $38,493,000 decrease from 2007 is a result of a one time $40,324,000 goodwill impairment charge to income. Excluding this one time goodwill impairment charge, $33,211,000 after tax, net income would have been $2,518,000, or $0.58 per diluted common share. This non-GAAP measure of operating results is discussed more fully below. The largest component of the decline in net income was a $8,211,000 provision for loan losses in 2008 compared with a provision of $1,154,000 in 2007. In addition, a lower net interest margin of 3.4% compared to 3.7% at December 31, 2007, was offset by an $114,481,000 increase in average loans increasing net interest income, on a tax equivalent basis, $958,000, or 2.5%, over 2007. Total assets at December 31, 2008 were $1,279,699,000, compared to $1,195,804,000 at December 31, 2007, an increase of $83,895,000, or 7.0%. The return on average assets was (2.45)%, the return on average common shareholders’ equity was (27.33)%, and the efficiency ratio was 160.2%.

Comparison of GAAP and Non-GAAP Information

     As a supplement to our U.S. GAAP financial results, our Company has provided non-GAAP operating results for the year ended December 31, 2009. Our Company believes that these non-GAAP financial measures are useful because they allow investors to assess, on a consistent basis, our Company’s performance exclusive of items management believes are not indicative of the operations of our Company. Management uses non-GAAP financial measures to evaluate financials results and to establish operational goals. These non-GAAP financial measures should be considered a supplement to, and not a substitute for, financial measures determined in accordance with GAAP. The non-GAAP measures presented below exclude the non-recurring pre-tax charge to write-off our entire goodwill in the fourth quarter of 2008 which is explained in more detail in the “Non-interest Income and Expense” section of this discussion and Note 8 of the consolidated financial statements.

														$ Change								% Change
(Dollars in thousands)		2009				2008				2007				‘09-‘08				‘08-‘07				‘09-‘08				‘08-‘07
Non-interest expense (GAAP)		$	36,730			$	75,975			$	35,054			$	(39,245	)		$	40,921				(51.7	)%			1.2	%
Goodwill impairment			—				(40,324	)			—				40,324				(40,324	)			N.M				N.M
Non-interest expense (non-GAAP)			36,730				35,651				35,054				1,079				597				3.0				1.7
Net income (loss) (GAAP)		$	4,956			$	(30,627	)		$	7,800			$	35,583			$	(38,427	)			(116.2	)%			(492.7	)%
Goodwill impairment, net of tax effect			—				33,211				—				(33,211	)			33,211				N.M				N.M
Less: preferred dividends			1,994				66				—				1,928				66				N.M				N.M
Net income available to common shareholders (non-GAAP)		$	2,962			$	2,518			$	7,800			$	444			$	(5,282	)			17.6	%			(67.7	)%
GAAP basis:
Basic earnings (loss) per share		$	0.69			$	(7.10	)		$	1.80			$	7.79			$	(8.90	)			(109.7	)%			(494.4	)%
Diluted earnings (loss) per share			0.69				(7.10	)			1.78				7.79				(8.88	)			(109.7	)			(498.9	)
Return (loss) on average assets			0.39	%			(2.45	)%			0.67	%
Return (loss) on average common equity			3.71	%			(27.33	)%			7.22	%
Efficiency ratio			71.66	%			160.25	%			74.18	%
Non-GAAP basis:
Basic earnings per share		$	0.69			$	0.58			$	1.80			$	0.11			$	(1.22	)			19.0	%			(67.8	)%
Diluted earnings per share			0.69				0.58				1.78				0.11				(1.20	)			19.0				(67.4	)
Return on average assets			0.39	%			0.20	%			0.67	%
Return on average common equity			3.71	%			2.24	%			7.22	%
Efficiency ratio			71.66	%			75.20	%			74.18	%

Comparison of years ending 2009 and 2008 Non-GAAP results:

     Based on non-GAAP operating results as shown above, our Company’s diluted earnings per common share were $0.69 in 2009 compared to $0.58 in 2008, an increase of 19.0%. Consolidated net income for 2009 was $2,962,000, compared to $2,518,000 in 2008. Return on average total assets increased from 0.20% in 2008 to 0.24% in 2009, and return on average common equity decreased from 2.24% in 2008 to 1.40% in 2009. The efficiency ratio was 71.66% in 2009 compared with 75.20% in 2008.

Comparison of years ending 2008 and 2007 Non-GAAP results:

     Based on non-GAAP operating results as shown above, our Company’s diluted earnings per common share were $0.58 in 2008 compared to $1.78 in 2007, a decrease of 67.4%. Consolidated net income for 2008 was $2,518,000, compared to $7,800,000 in 2007. Return on average total assets decreased from 0.67% in 2007 to 0.20% in 2008, and return on average common equity decreased from 7.22% in 2007 to 2.24% in 2008. The efficiency ratio was 75.20% in 2008 compared with 74.18% in 2007.

Net Interest Income

     Net interest income is the largest source of revenue resulting from our Company’s lending, investing, borrowing, and deposit gathering activities. It is affected by both changes in the level of interest rates and changes in the amounts and mix of interest earning assets and interest bearing liabilities.

Average Balance Sheets

     The following table presents average balance sheets, net interest income, average yields of earning assets, average costs of interest bearing liabilities, net interest spread and net interest margin on a fully taxable equivalent basis for each of the years in the three year period ended December 31, 2009.

(Dollars In thousands)	2009													2008												2007
						Interest				Rate								Interest				Rate								Interest				Rate
		Average				Income/				Earned/				Average				Income/				Earned/				Average				Income/				Earned/
		Balance				Expense(1)				Paid(1)				Balance				Expense(1)				Paid(1)				Balance				Expense(1)				Paid(1)
ASSETS
Loans: (2) (4)		$	1,002,830			$	57,514				5.74	%		$	963,252			$	62,766				6.52	%		$	848,771			$	65,636				7.73	%
Investment in securities: (3)
Government sponsored enterprises			112,091				4,417				3.94				110,840				4,917				4.44				117,208				5,614				4.79
State and municipal			39,816				2,166				5.44				46,030				2,503				5.44				53,971				2,969				5.50
Restricted Investements			8,817				164				1.86				8,440				316				3.74				5,883				312				5.30
Federal funds sold			309				—				—				2,925				60				2.05				11,313				615				5.44
Interest bearing deposits in other financial institutions			18,807				53				0.28				8,738				24				0.27				1,128				58				5.14
Total interest earning assets			1,182,670				64,314				5.44				1,140,225				70,586				6.19				1,038,274				75,204				7.24
All other assets			89,108												121,373												127,336
Allowance for loan losses			(13,397	)											(10,102	)											(9,110	)
Total assets		$	1,258,381											$	1,251,496											$	1,156,500
LIABILITIES AND STOCKHOLDERS’ EQUITY
NOW accounts		$	138,456			$	1,131				0.82	%		$	117,487			$	1,317				1.12	%		$	110,658			$	1,482				1.34	%
Savings			46,464				139				0.30				44,253				226				0.51				46,634				260				0.56
Money market			175,894				1,747				0.99				168,418				3,340				1.98				159,767				5,668				3.55
Time deposits of $100,000 and over			140,502				3,862				2.75				142,713				5,698				3.99				141,645				7,045				4.97
Other time deposits			351,597				10,543				3.00				319,919				12,872				4.02				318,469				14,826				4.66
Total time deposits			852,913				17,422				2.04				792,790				23,453				2.96				777,173				29,281				3.77
Federal funds purchased and securities sold under agreements to repurchase			33,923				88				0.26				41,633				869				2.09				31,061				1,381				4.45
Interest — bearing demand notes to U.S. Treasury			—				—				—				—				—				—				205				11				5.37
Subordinated notes			49,486				2,447				4.94				49,486				3,046				6.16				49,486				3,617				7.31
Other borrowed money			78,626				3,017				3.84				124,025				4,231				3.41				53,626				2,885				5.38
Total interest bearing liabilities			1,014,948				22,974				2.26				1,007,934				31,599				3.14				911,551				37,175				4.08
Demand deposits			124,913												121,428												126,708
Other liabilities			10,582												8,759												10,189
Total liabilities			1,150,443												1,138,121												1,048,448
Stockholders’ equity			107,938												113,375												108,052
Total liabilities and stockholders’ equity		$	1,258,381											$	1,251,496											$	1,156,500
Net interest income (FTE)						$	41,340											$	38,987											$	38,029
Net interest spread											3.18	%											3.05	%											3.16	%
Net interest margin											3.50	%											3.42	%											3.66	%

Comparison of Years ended December 31, 2009 and 2008

     Financial results for 2009 compared to 2008 included an increase in net interest income, on a tax equivalent basis, of $2,353,000, or 6.0%. Average interest-earning assets increased $42,445,000, or 3.7% to $1,182,670,000 at December 31, 2009 compared to $1,140,225,000 at December 31, 2008 and average interest bearing liabilities increased $7,014,000, or 0.7%, to $1,014,948,000 at December 31, 2009 compared to $1,007,934,000 at December 31, 2008.

     Average loans outstanding increased $39,578,000 or 4.1% to $1,002,830,000 for 2009 compared to $963,252,000 for 2008. The following is a summary of the changes in average loan balance by major category:

										$ Change				% Change
(Dollars in thousands)		2009				2008				‘09-‘08				‘09-‘08
Average loans:
Commercial		$	149,694			$	151,342			$	(1,648	)			(1.1	)%
Real estate construction — residential			42,307				68,728				(26,421	)			(38.4	)
Real estate construction — commercial			74,969				80,918				(5,949	)			(7.4	)
Real estate mortgage — residential			238,012				223,093				14,919				6.7
Real estate mortgage — commercial			463,391				406,697				56,694				13.9
Consumer			34,457				32,474				1,983				6.1
Total		$	1,002,830			$	963,252			$	39,578				4.1	%

See the “Lending and Credit Management” section of this discussion for further discussion of changes in the composition of our lending portfolio.

     Average investment securities and federal funds sold decreased $7,579,000 or 4.7% to $152,216,000 for 2009 compared to $159,795,000 for 2008. Average interest bearing deposits increased $10,069,000 to $18,807,000 at December 31, 2009 compared to $8,738,000 at December 31, 2008. This increase was a result of changing our Company’s overnight investment of excess funds from federal funds sold to interest bearing reserve balances held at the Federal Reserve Bank.

     Average time deposits increased $60,123,000, or 7.6%, to $852,913,000 at December 31, 2009 compared to $792,790,000 at December 31, 2008. The increase was primarily a result of increased public fund deposits. Product specials promoting interest bearing checking accounts and certificate of deposits also contributed to new deposits.

     Average federal funds purchased and securities sold under agreements to repurchase decreased $7,710,000 or 18.5% to $33,923,000 for 2009 compared to $41,633,000 for 2008. This reflects a $5,387,000 decrease in repurchase agreements for public funds and a $2,323,000 decrease in federal funds purchased from 2008 to 2009.

Average other borrowed money decreased $45,399,000 or 36.6% to $78,626,000 for 2009 compared to $124,025,000 for 2008. The decrease in 2009 reflects a net decrease in Federal Home Loan Bank advances.

Comparison of Years ended December 31, 2008 and 2007

     Financial results for 2008 compared to 2007 included growth in net interest income. Average interest-earning assets increased $101,951,000, or 9.8% to $1,140,225,000 at December 31, 2008 compared to $1,038,274,000 at December 31, 2007. This increase to net interest income was offset by a higher provision for loan loss and an increase to non-interest expense including a goodwill impairment charge of $40,324,000. Net interest income, on a tax equivalent basis, increased $958,000, or 2.5%, reflecting growth in average loan balances.

     Average loans outstanding increased $114,481,000 or 13.5% to $963,252,000 for 2008 compared to $848,771,000 for 2007. Average commercial loans outstanding decreased approximately $1,837,000 or 1.2% for 2008 compared to 2007. Average real estate loans outstanding increased approximately $113,555,000 or 17.0% for 2008 compared to 2007. Average consumer loans outstanding decreased approximately $1,032,000 or 3.0% for 2008 compared to 2007. See the “Lending and Credit Management” section of this discussion for further discussion of changes in the composition of our lending portfolio.

     Average investment securities and federal funds sold decreased $22,697,000 or 12.4% to $159,795,000 for 2008 compared to $182,492,000 for 2007. The decrease in average investment securities during 2008 and 2007 reflects the use of investment liquidity to fund our Company’s growth in the loan portfolio.

     Average interest bearing liabilities increased $96,383,000, or 10.6%, to $1,007,934,000 at December 31, 2008 compared to $911,551,000 at December 31, 2007. Average time deposits increased $15,617,000 or 2.0% to $792,790,000 for 2008 compared to $777,173,000 for 2007. The increase was primarily a result of a marketing campaign during the third quarter designed to attract new deposits and establish new customer relationships.

     Average federal funds purchased and securities sold under agreements to repurchase increased $10,572,000 or 34.0% to $41,633,000 for 2008 compared to $31,061,000 for 2007. This reflects an increase in public funds received during 2008 over 2007. Average other borrowed money increased $70,399,000 or132.2% to $124,025,000 for 2008 compared to $53,626,000 for 2007. The increase in 2008 reflects a net increase in Federal Home Loan Bank advances to fund loan growth.

Rate and volume analysis

     The following table summarizes the changes in net interest income on a fully taxable equivalent basis, by major category of interest earning assets and interest bearing liabilities, indentifying changes related to volumes and rates for the years ended December 31, 2009, compared to December 31, 2008 and for the years ended December 31, 2008 compared to December 31, 2007. The change in interest due to the combined rate/volume variance has been allocated to rate and volume changes in proportion to the absolute dollar amounts of change in each.

	2009													2008
						Change due to												Change due to
		Total				Average				Average				Total				Average				Average
(Dollars In thousands)		Change				Volume				Rate				Change				Volume				Rate
Interest income on a fully taxable equivalent basis:
Loans: (1) (3)		$	(5,252	)		$	2,508			$	(7,760	)		$	(2,870	)		$	8,212			$	(11,082	)
Investment securities:
Government sponsored entities			(500	)			55				(555	)			(697	)			(295	)			(402	)
State and municipal(2)			(337	)			(338	)			1				(466	)			(433	)			(33	)
Restricted Investments			(152	)			13				(165	)			4				112				(108	)
Federal funds sold			(60	)			(28	)			(32	)			(555	)			(302	)			(253	)
Interest bearing deposits in other financial institutions			29				29				—				(34	)			67				(101	)
Total interest income			(6,272	)			2,239				(8,511	)			(4,618	)			7,361				(11,979	)
Interest expense:
NOW accounts			(186	)			211				(397	)			(165	)			88				(253	)
Savings			(87	)			10				(97	)			(34	)			(13	)			(21	)
Money market			(1,593	)			143				(1,736	)			(2,328	)			292				(2,620	)
Time deposits of 100,000 and over			(1,836	)			(88	)			(1,748	)			(1,347	)			53				(1,400	)
Other time deposits			(2,329	)			1,187				(3,516	)			(1,954	)			68				(2,022	)
Federal funds purchased and securities sold under agreements to repurchase			(781	)			(136	)			(645	)			(512	)			373				(885	)
Interest-bearing demand notes to U.S. Treasury			—				—				—				(11	)			(5	)			(6	)
Subordinated notes			(599	)			—				(599	)			(571	)			—				(571	)
Other borrowed money			(1,214	)			(1,695	)			481				1,346				2,708				(1,362	)
Total interest expense			(8,625	)			(368	)			(8,257	)			(5,576	)			3,564				(9,140	)
Net interest income on a fully taxable equivalent basis		$	2,353			$	2,607			$	(254	)		$	958			$	3,797			$	(2,839	)

     Net interest income on a fully taxable equivalent basis increased $2,353,000 or 6.0% to $41,340,000 for 2009 compared to $38,987,000 for 2008 and followed a $958,000 or 2.5% increase for 2008 compared to 2007. Measured as a percentage of average earning assets, the net interest margin (expressed on a fully taxable equivalent basis) decreased from 3.66% for 2007 to 3.42% for 2008, and increased to 3.50% for 2009. Our Company’s net interest spread increased to 3.18% in 2009 from 3.05% in 2008 and 3.16% in 2007.

     While our Company was able to decrease the rate paid on interest bearing liabilities to 2.26% in 2009 from 3.14% in 2008, this decrease was partially offset by the decrease in the rates earned on interest bearing assets from 6.19% in 2008 to 5.44% in 2009.

Provision for loan losses

     The provision for loan losses for 2009 was $8,354,000, compared to $8,211,000 for 2008, and $1,154,000 for 2007. Loans charged off, net of recoveries, for 2009 were $6,224,000 compared to $4,826,000 for 2008 and $887,000 for 2007. Approximately $1,191,000 of the 2009 net charge-offs is represented by various commercial loans, $1,457,000 is represented by increased real estate construction losses, $3,336,000 is represented by real estate mortgage loans and approximately $240,000 is represented by various consumer loans.

     Further discussion of managements’ methodology related to the allowance and provision for loan losses may be found in the “Lending and Credit Management” section of this report.

Non-interest Income and Expense

Non-interest income for the years ended December 31, 2009, 2008, and 2007 were as follows:

														$ Change								% Change
(Dollars in thousands)		2009				2008				2007				‘09-‘08				‘08-‘07				‘09-‘08				‘08-‘07
Non-interest Income
Service charges on deposit accounts		$	5,864			$	6,164			$	5,707			$	(300	)		$	457				(4.9)	%			8.0	%
Trust department income			815				827				968				(12	)			(141	)			(1.5	)			(14.6	)
Gain on sales of mortgage loans			2,974				973				666				2,001				307				205.7				46.1
Other			1,049				1,330				2,882				(281	)			(1,552	)			(21.1	)			(53.9	)
Total non-interest income		$	10,702			$	9,294			$	10,223			$	1,408			$	(929	)			15.1	%			(9.1	)%
Investment securities gains (losses), net		$	606			$	3			$	(2	)		$	603			$	5			NM %					(250.0	)%
Non-interest income as a % of total revenue *			20.9	%			19.6	%			21.6	%
Total revenue per full time equivalent employee		$	147.4			$	137.8			$	135.4

Years Ended December 31, 2009 and 2008

     Noninterest income increased $1,408,000 or 15.1% to $10,702,000 for 2009 compared to $9,294,000 for 2008. The increase was primarily the result of a $2,001,000 increase in the gains on sales of mortgage loans due to increased refinancing activity. Our Company was servicing $269,475,000 of mortgage loans at December 31, 2009 compared to $213,074,000 at December 31, 2008. This increase was partially offset by a $300,000 decrease in service charge income and a $281,000 decrease in other income. The decrease in other income includes an $112,000 increase in 2009 real estate servicing fees offset by a $275,000 increase in amortization of mortgage loan servicing rights, and a $71,000 decrease in brokerage and credit card income. Our Company recognized $606,000 in gain on sales and calls of debt securities during the 2009 compared to $3,000 during 2008.

Years Ended December 31, 2008 and 2007

     Noninterest income decreased $929,000 or 9.1% to $9,294,000 for 2008 compared to $10,223,000 for 2007. Service charge income increased $457,000 or 8.0%. Trust department income decreased $141,000 or 14.6%. Mortgage loan servicing fees decreased $206,000 or 21.2%. This decrease in servicing fees was the result of an increase in the amortization of mortgage servicing rights due to increased refinancing of existing mortgage loans.

However, gain on sales of mortgage loans increased $307,000 or 46.2% as a result of increased refinancing activity. Our Company was servicing $213,074,000 of mortgage loans at December 31, 2008 compared to $209,734,000 at December 31, 2007. Our Company recognized $3,000 in gain on sales and calls of debt securities during the 2008 compared to losses of $2,000 during 2007. Other income decreased $1,346,000 or 53.0% to $1,195,000. $1,200,000 of the decrease represents the amount received from the sales of Osage Valley Bank, Bank 10, and Exchange National Bank’s bank charters in 2007 and $254,000 of the decrease reflects recovery of prior years’ legal and collection costs as a result of settlement of a lawsuit in our Company’s favor in 2007.

Non-interest expense for the years ended December 31, 2009, 2008, and 2007 were as follows:

														$ Change								% Change
(Dollars in thousands)		2009				2008				2007				‘09-‘08				‘08-‘07				‘09-‘08				‘08-‘07
Non-interest Expense
Salaries		$	13,253			$	14,099			$	14,261			$	(846	)		$	(162	)			(6.0	)			% (1.1	)%
Employee benefits			4,204				4,151				4,472				53				(321	)			1.3				(7.2	)
Goodwill impairment			—				40,324				—				(40,324	)			N.M				N.M				N.M
Occupancy expense, net			2,335				2,440				2,202				(105	)			238				(4.3	)			10.8
Furniture and equipment expense			2,286				2,437				2,879				(151	)			(442	)			(6.2	)			(15.4	)
FDIC insurance assessment			2,519				204				97				2,315				107				1,134.8				110.3
Legal, examination, and professional fees			1,222				1,145				1,583				77				(438	)			6.7				(27.7	)
Advertising and promotion			1,272				1,166				1,196				106				(30	)			9.1				(2.5	)
Postage, printing, and supplies			1,168				1,221				1,297				(53	)			(76	)			(4.3	)			(5.9	)
Processing expense			3,420				3,102				1,470				318				1,632				10.3				111.0
Other real estate expense			1,189				862				681				327				181				37.9				26.6
Other			3,862				4,824				4,916				(962	)			(92	)			(19.9	)			(1.9	)
Total non-interest expense		$	36,730			$	75,975			$	35,054			$	(39,245	)		$	597				(51.7	)%			1.7	%
Efficiency ratio*			71.6	%			75.2	%			74.2	%
Salaries and benefits as a % of total non-interest expense *			47.5	%			51.2	%			53.4	%
Number of full-time equivalent employees			348				344				349

Years Ended December 31, 2009 and 2008

     Noninterest expense decreased $39,245,000, or 51.7%, to $36,730,000 for 2009 compared to $75,975,000 for 2008. This decrease is primarily a result of the $40,324,000 goodwill impairment charge taken during the fourth quarter of 2008. Other items such as salary expense decreased $846,000, or 6.0%, FDIC insurance assessment increased $2,315,000, real estate loan expense increased $327,000, or 37.9%, and other expenses decreased $962,000 or 19.9%. The decrease in salary expense includes a $362,000 decrease in salaries, a $393,000 reduction in incentive and deferred compensation expense, and a $101,000 decrease in stock option compensation expense. The increase in the FDIC insurance assessment is a result of higher regular and special assessment rates in effect for the current year as well as the depletion of the Bank’s one-time FDIC assessment credit. The increase in real estate loan expense reflects expenses incurred on the maintenance and preparation to sell the increase in foreclosed properties, including a $67,000 impairment charge on six of the properties. The decrease in other expenses primarily is a result of a $591,000 donation of a large parcel of other real estate owned and an abandoned branch to charitable organizations in 2008, a $100,000 final payment on a contract in 2008, a $89,000 decrease in correspondent bank charges, and a $33,000 decrease in insurance after further consolidating accounts from the 2007 Bank charter merger.

Years Ended December 31, 2008 and 2007

     Noninterest expense increased $40,921,000 or 116.7% to $75,975,000 for 2008 compared to $35,054,000 for 2007. $40,324,000 of the increase reflects a goodwill impairment charge taken during the fourth quarter of 2008. Based upon an analysis of the fair value of our Company’s net assets, it was determined that the entire carrying value of goodwill was impaired requiring the impairment charge to earnings. Salaries decreased $162,000 or 1.1%, employee benefits decreased $321,000 or 7.2%, occupancy expense increased $238,000 or 10.8%, furniture and equipment expense decreased $441,000 or 15.3%, legal and professional fees decreased $390,000 or 24.6%, processing expense increased $1,632,000 or 111.0% and donations increased $591,000 or 262.7.9%. The $162,000 decrease in salaries reflects a reduction in incentive compensation expense. The $321,000 decrease in employee benefits primarily represents reductions in profitsharing expense as a result of lower earnings. The $1,632,000 increase in processing expense reflects both the cost of outsourcing our data processing function as well as investment in new technologies including remote deposit capture and document imaging. The $591,000 increase in donations reflects the donation of a large parcel of other real estate owned and an abandoned branch location to charitable organizations.

Income taxes

     Income taxes as a percentage of earnings (loss) before income taxes as reported in the consolidated financial statements were 27.3% for 2009 compared to 16.7% for 2008. The increase in the effective tax rate for 2009 in comparison to 2008 is due to the decrease in 2008 earnings resulting from the goodwill impairment charge. In addition, 2009 tax expense reflects the recognition of tax benefits as a result of the expiration of the statute of limitations on our Company’s 2005 state tax return during the fourth quarter of 2009.

     Income taxes as a percentage of earnings (loss) before income taxes as reported in the consolidated financial statements were 16.7% for 2008 compared to 29.4% for 2007. The decrease in the effective tax rate for 2008 is due to an increase in non-taxable income as a percentage of total income in the current year and a taxable loss before taxes. In addition, 2008 tax benefit reflects the recognition of tax benefits as a result of the expiration of the statute of limitations on our Company’s 2004 and 2005 federal tax returns during the year. The decrease in 2008 earnings was due to a $40,323,775 goodwill impairment charge in the fourth quarter and an additional $7,056,784 increase in the loan provision in comparison to the year ended 2007. While goodwill impairment is normally a non-tax deductible item, $16,916,000 of our goodwill was related to asset purchases and therefore deductible for book tax purposes.

Fourth Quarter Results for 2009

     Comparing fourth quarter 2009 to third quarter 2009:

     Our Company’s net income of $788,000 for the fourth quarter ended December 31, 2009 decreased $1,119,000, compared to net income of $1,907,000 for the third quarter ended September 30, 2009. Net interest income of $10,604,000 increased $168,000 from third quarter 2009 due to an increase in net interest margin to 3.66% for the fourth quarter compared to 3.57% for the third quarter.

     The fourth quarter 2009 provision for loan losses of $3,950,000 was $2,700,000 higher than third quarter 2009’s provision of $1,250,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end and as a result of increased nonperforming loans at year-end.

     Noninterest income of $3,135,000 for fourth quarter 2009 increased $534,000 from third quarter 2009’s noninterest income of $2,601,000. This increase was a result of $600,000 investment gains realized during the fourth quarter.

     Noninterest expense of $9,034,000 for fourth quarter 2009 decreased slightly by $6,000 from third quarter 2009’s noninterest expense of $9,040,000.

     Comparing fourth quarter 2009 to fourth quarter 2008:

     Our Company’s net income of $788,000 for the fourth quarter ended December 31, 2009 increased $35,833,000, compared to net loss of $(35,045,000) for same period in 2008. Net interest income of $10,605,000 increased $1,403,000 in the fourth quarter of 2009 compared to the fourth quarter of 2008 due to an increase in net interest margin to 3.66% for 2009 compared to 3.14% for the same period of 2008.

     The fourth quarter 2009 provision for loan losses of $3,950,000 was $311,000 less than the fourth quarter 2008 provision of $4,261,000 and was based upon management’s determination of the loan loss reserve required to cover probable losses in the loan portfolio at year-end and as a result of increased nonperforming loans at year-end.

     Noninterest income of $3,135,000 for fourth quarter 2009 increased by $849,000 from noninterest income of $2,286,000 for fourth quarter 2008. $249,000 of the increase reflects gains on sales of mortgage loans due to increased refinancing activity and $600,000 reflects investment gains realized during the fourth quarter.

     Noninterest expense of $9,034,000 for fourth quarter 2009 decreased $41,289,000 from fourth quarter 2008 noninterest expense of $50,323,000. The goodwill impairment charge of $40,324,000 represents the majority of the variance between periods.

Lending and Credit Management

     Interest earned on the loan portfolio is a primary source of interest income for our Company. Net loans represented 79.0% of total assets as of December 31, 2009 compared to 77.8% as of December 31, 2008.

     Lending activities are conducted pursuant to an established loan policy approved by our Bank’s Board of Directors. The Bank’s credit review process is comprised of a regional loan committee with an established approval limit. In addition, a senior loan committee reviews all credit relationships in aggregate over an established dollar amount. The senior loan committee meets weekly and is comprised of senior managers of the Bank.

     The following table shows the composition of the loan portfolio by major category and each category as a percentage of the total portfolio as of the dates indicated.

		Balance at December 31,
(In thousands)		2009								2008								2007								2006								2005
		Amount				%				Amount				%				Amount				%				Amount				%				Amount				%
Commercial, financial and agricultural		$	151,399				15.3	%		$	153,386				15.2	%		$	151,488				16.6	%		$	145,697				17.9	%		$	154,868				19.0	%
Real estate — Construction			116,778				11.8				129,639				12.9				147,432				16.2				150,891				18.6				139,316				17.1
Real estate — Mortgage			686,307				69.2				692,530				68.6				575,552				63.2				478,854				59.0				480,531				59.1
Installment loans to individuals			37,130				3.7				33,548				3.3				36,806				4.0				36,870				4.5				38,820				4.8
Total loans		$	991,614				100.0	%		$	1,009,103				100.0	%		$	911,278				100.0	%		$	812,312				100.0	%		$	813,535				100.0	%

     Our Company’s loan portfolio decreased $17,490,000, or 1.7% from 2008 to 2009. This decrease was primarily in our Bank’s commercial and real estate mortgage lending. Commercial loans decreased $1,987,000, or 1.3%, real estate construction loans decreased $12,861,000, or 9.9%, and real estate mortgage loans decreased $6,223,000 or 1.0%, from 2008 to 2009, respectively. Partially offsetting these decreases was an increase in consumer loans of $3,582,000 or 10.7%. During the current down-turn in the economy, management continues to focus on the improvement of asset quality. Management has tightened underwriting standards and is focused on lending to credit worthy borrowers with the capacity to service the debts. The decrease in lending activities in the real estate construction market also reflects the slow down in the housing industry and residential construction industry as well as foreclosures on various residential construction properties. Construction lending will continue to be closely monitored during 2010.

     Our Company experienced loan growth of $97,825,000 or 10.7% from 2007 to 2008. This growth was primarily in our Bank’s commercial and real estate mortgage lending. Commercial loans increased $1,898,000 or 1.3% from 2007 to 2008 and real estate mortgage loans increased $116,978,000 or 20.3%. Offsetting these increases were a decrease in real estate construction loans of $17,793,000 or 12.1% and a decrease in individual consumer loans of $3,258,000 or 8.9%. Although management tightened underwriting standards during the 2008, our Company continued to find opportunities to lend to credit worthy borrowers with the capacity to service the debts. This growth was not centered in any one industry, region or borrower and included a fairly diversified portfolio of loans ranging from owner occupied and regional retail properties to include some hospitality properties. Our growth in real estate loans was also partially the result of loans moving from construction to amortizing loans, thus contributing to the decrease in our construction portfolio. In addition, the decrease in lending activities in the real estate construction market also reflects the slow down in the housing industry and residential construction industry as well as foreclosures on various residential construction properties during 2008.

     Our Company does not participate in extending credit to sub-prime residential real estate markets. While much publicity has been directed at this market during the past year, our Company extends credit to its local community market through traditional mortgage products.

     The contractual maturities of loan categories at December 31, 2009, and the break down of those loans between fixed rate and floating rate loans are as follows:

		Principal Payments Due
						Over One				Over
		One Year				Year Through				Five
		Or Less				Five Years				Years				Total
Commercial, financial, and agricultural		$	99,682			$	49,040			$	2,677			$	151,399
Real estate — construction			116,778				—				—				116,778
Real estate — mortgage			251,525				377,436				57,346				686,307
Installment loans to individuals			14,276				21,810				1,044				37,130
Total loans net of unearned income		$	482,261			$	448,286			$	61,067			$	991,614
Loans with fixed rates			294,260				391,788				14,131				700,179
Loans with floating rates			188,001				56,498				46,936				291,435
Total loans net of unearned income		$	482,261			$	448,286			$	61,067			$	991,614

     Our Company generally does not retain long-term fixed rate residential mortgage loans in its portfolio. Fixed rate loans conforming to standards required by the secondary market are offered to qualified borrowers, but are not funded until our Company has a non-recourse purchase commitment from the secondary market at a predetermined price. At December 31, 2009 our Company was servicing approximately $269,475,000 of loans sold to the secondary market.

     Mortgage loans retained in our Company’s portfolio generally include provisions for rate adjustments at one to three year intervals. Commercial loans and real estate construction loans generally have maturities of less than one year. Installment loans to individuals are primarily fixed rate loans with maturities from one to five years.

     The provision for loan losses is based on management’s evaluation of the loan portfolio in light of national and local economic conditions, changes in the composition and volume of the loan portfolio, changes in the volume of past due and nonaccrual loans, value of underlying collateral and other relevant factors. The allowance for loan losses which is reported as a deduction from loans is available for loan charge-offs. This allowance is increased by the provision charged to expense and is reduced by loan charge-offs net of loan recoveries.

     Management along with senior loan committee, and internal loan review, formally reviews all loans in excess of certain dollar amounts (periodically established) at least annually. Currently, loans in excess of $2,000,000 in aggregate and all adversely classified credits identified by management as containing more than usual risk are reviewed. On a monthly basis, the senior loan committee reviews and reports to the Board of Directors past due, classified, and watch list loans in order to classify or reclassify loans as loans requiring attention, substandard, doubtful, or loss. During this review, management also determines what loans should be considered impaired. Management follows the guidance provided in the FASB ASC Topic 310, Accounting by Creditors for Impairment of a Loan, in identifying and measuring loan impairment. If management determines that it is probable that all amounts due on a loan will not be collected under the original terms of the loan agreement, the loan is considered to

be impaired. Once a loan has been identified as impaired, management generally measures impairment based upon the fair value of the underlying collateral. Management believes, but there can be no assurance, that these procedures keep management informed of possible problem loans. Based upon these procedures, both the allowance and provision for loan losses are adjusted to maintain the allowance at a level considered adequate by management for probable losses inherent in the loan portfolio.

Allowance for Loan Losses

     The provision for loan losses increased $143,000 or 1.7% to $8,354,000 for 2009 compared to $8,211,000 for 2008 and followed a $7,057,000 or 611.4% increase for 2008 compared to 2007. The provision reflects the amounts management determined necessary to maintain the allowance for loan losses at a level that was adequate to cover probable losses in the loan portfolio. The allowance for loan losses totaled $14,797,000 or 1.5% of loans outstanding at December 31, 2009 compared to $12,667,000 or 1.3% of loans outstanding at December 31, 2008 and $9,282,000 or 1.0% of loans outstanding at December 31, 2007. The allowance for loan losses expressed as a percentage of nonperforming loans was 34.9% at December 31, 2009, 50.9% at December 31, 2008 and 152.5% at December 31, 2007.

The following table summarizes loan loss experience for the years indicated:

		Years Ended December 31,
(Dollars in thousands)		2009				2008				2007				2006				2005
Analysis of allowance for loan losses:
Balance beginning of year		$	12,667			$	9,282			$	9,015			$	9,085			$	7,496
Allowance for loan losses of acuired companies at date of acquisitions			—				—				—				—				1,418
Charge-offs:
Commercial, financial, and agricultural			1,404				3,571				524				809				589
Real estate — construction			1,462				681				56				84				185
Real estate — mortgage			3,401				532				413				474				286
Installment loans to individuals			534				656				314				484				261
Total charge-offs			6,801				5,440				1,307				1,851				1,321
Recoveries:
Commercial, financial, and agricultural			213				153				151				206				40
Real estate — construction			5				35				11				13				—
Real estate — mortgage			65				81				100				91				28
Installment loans to individuals			294				345				158				145				102
Total recoveries			577				614				420				455				170
Net charge-offs			6,224				4,826				887				1,396				1,151
Provision for loan losses			8,354				8,211				1,154				1,326				1,322
Balance at end of year		$	14,797			$	12,667			$	9,282			$	9,015			$	9,085
Loans outstanding:
Average		$	1,002,829			$	963,252			$	848,772			$	824,706			$	743,382
End of period			991,614				1,009,104				911,278				812,312				813,535
Allowance for loan losses to loans outstanding:
Average			1.48	%			1.32	%			1.09	%			1.09	%			1.22	%
End of period			1.49				1.26				1.02				1.11				1.12
Net charge-offs to average loans outstanding			0.62				0.50				0.10				0.17				0.15

The increased provision for loan losses during 2009 and 2008 was the result of an increased level of charged-off loans and an increase in the level of non-performing loans. As shown in the table above, our Company experienced net loan charge-offs of $6,224,000 during 2009 compared to $4,826,000 in 2008 and $887,000 in 2007.

The following table is a summary of the allocation of the allowance for loan losses as of the dates indicated:

		Years Ended December 31,
(Dollars in thousands)		2009				2008				2007				2006				2005
Allocation of allowance for loan losses at end of period:
Commercial, financial, and agricultural		$	2,644			$	1,712			$	3,762			$	3,114			$	2,687
Real estate — construction			3,802				2,490				590				755				764
Real estate — mortgage			6,596				6,571				3,873				3,526				4,138
Installment loans to individuals			380				391				419				529				473
Unallocated			1,375				1,503				638				1,091				1,023
Total		$	14,797			$	12,667			$	9,282			$	9,015			$	9,085
Percent of categories to total loans:
Commercial, financial, and agricultural			15.3				15.2	%			16.6	%			17.9	%			19.0	%
Real estate — construction			11.8				12.9				16.2				18.6				17.1
Real estate — mortgage			69.2				68.6				63.2				59.0				59.1
Installment loans to individuals			3.7				3.3				4.0				4.5				4.8
Total			100.0				100.0				100.0				100.0				100.0