First Security (FSGI) 10-Q 2006 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

S QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

OR

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES AND EXCHANGE ACT OF 1934

For the transition period from ____________________ to _____________________.

COMMISSION FILE NO. 000-49747

FIRST SECURITY GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

Tennessee	58-2461486
(State of Incorporation)	(I.R.S. Employer Identification No.)

817 Broad Street, Chattanooga, TN	37402
(Address of principal executive offices)	(Zip Code)

(423) 266-2000

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address, and former fiscal year, if changed since last report)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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   S No   £

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.

See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer £ Accelerated filer S Non-accelerated filer £

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes   £ No   S

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Common Stock, $0.01 par value:

17,746,278 shares outstanding and issued as of November 2, 2006

First Security Group, Inc. and Subsidiary

Form 10-Q

INDEX

PART I.	FINANCIAL INFORMATION	Page No.
Item 1.	Financial Statements
	Consolidated Balance Sheets - September 30, 2006, December 31, 2005 and September 30, 2005	1
	Consolidated Income Statements - Three months and nine months ended September 30, 2006 and 2005	3
	Consolidated Statement of Stockholders’ Equity - Nine months ended September 30, 2006	4
	Consolidated Statements of Cash Flows - Nine months ended September 30, 2006 and 2005	5
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	37
Item 4.	Controls and Procedures	38
Part II	OTHER INFORMATION
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 6.	Exhibits	40
SIGNATURES		41

PART I - FINANCIAL INFORMATION

ITEM 1. Financial Statements

First Security Group, Inc. and Subsidiary

Consolidated Balance Sheets

	September 30, 2006		December 31, 2005		September 30, 2005
(in thousands)	(unaudited)				(unaudited)
ASSETS
Cash and Due from Banks	$	25,500	$	23,917	$	23,743
Federal Funds Sold and Securities Purchased under Agreements to Resell		-		17,835		48,800
Cash and Cash Equivalents		25,500		41,752		72,543
Interest Bearing Deposits in Banks		2,888		1,153		9,090
Securities Available For Sale		159,727		155,993		148,132
Loans Held for Sale		5,125		4,244		6,597
Loans		820,620		744,415		735,653
Total Loans		825,745		748,659		742,250
Less: Allowance for Loan Losses		9,862		10,121		10,519
		815,883		738,538		731,731
Premises and Equipment, net		33,939		31,604		30,698
Goodwill		27,156		27,032		24,314
Intangible Assets		4,441		5,431		5,712
Other Assets		40,531		39,189		39,779
TOTAL ASSETS	$	1,110,065	$	1,040,692	$	1,061,999

(See Accompanying Notes to Consolidated Financial Statements)

1

First Security Group, Inc. and Subsidiary

Consolidated Balance Sheets

	September 30, 2006			December 31, 2005			September 30, 2005
(in thousands, except share data)	(unaudited)						(unaudited)
LIABILITIES AND STOCKHOLDERS’ EQUITY
LIABILITIES
Deposits
Noninterest Bearing Demand	$	176,544		$	153,278		$	160,844
Interest Bearing Demand		66,541			75,123			77,557
		243,085			228,401			238,401
Savings and Money Market Accounts		137,859			152,901			158,186
Time Deposits:
Certificates of Deposit of $100 thousand or more		193,758			156,134			140,269
Certificates of Deposit of less than $100 thousand		251,939			234,501			224,892
Brokered Certificates of Deposit		86,944			89,570			92,328
		532,641			480,205			457,489
Total Deposits		913,585			861,507			854,076
Federal Funds Purchased and Securities Sold under Agreements to Repurchase		30,377			16,894			18,797
Security Deposits		4,170			4,094			3,738
Other Borrowings		8,141			10,150			13,153
Other Liabilities		12,248			9,658			34,191
Total Liabilities		968,521			902,303			923,955
STOCKHOLDERS’ EQUITY
Common stock - $.01 par value - 50,000,000 shares authorized as of September 30, 2006; 20,000,000 shares authorized as of December 31, 2005 and September 30, 2005;
17,746,278 issued as of September 30, 2006; 17,653,833 issued as of December 31, 2005;
17,600,960 issued as of September 30, 2005		123			122			122
Paid-In Surplus		124,097			122,545			122,877
Unallocated ESOP Shares		(5,562	)		(91	)		-
Retained Earnings		24,264			17,392			15,571
Accumulated Other Comprehensive Loss		(1,378	)		(1,579	)		(526	)
Total Stockholders’ Equity		141,544			138,389			138,044
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,110,065		$	1,040,692		$	1,061,999

(See Accompanying Notes to Consolidated Financial Statements)

2

First Security Group, Inc. and Subsidiary

Consolidated Income Statements

(Unaudited)

	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share data)	2006		2005		2006		2005
INTEREST INCOME
Loans, including fees	$	17,611	$	13,117	$	50,002	$	35,796
Debt securities -taxable		1,330		914		3,920		2,509
Debt securities -non-taxable		397		302		1,166		796
Other		46		243		258		337
Total Interest Income		19,384		14,576		55,346		39,438
INTEREST EXPENSE
Interest Bearing Demand Deposits		142		123		464		276
Savings Deposits and Money Market Accounts		759		511		2,111		1,441
Certificates of Deposit of $100 thousand or more		2,276		1,081		5,870		2,716
Certificates of Deposit of less than $100 thousand		2,742		1,471		7,378		3,659
Brokered Certificates of Deposit		936		862		2,690		2,146
Other		373		137		743		368
Total Interest Expense		7,228		4,185		19,256		10,606
NET INTEREST INCOME		12,156		10,391		36.090		28,832
Provision for Loan Losses		600		693		1.743		2,679
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		11,556		9,698		34,347		26,153
NONINTEREST INCOME
Service Charges on Deposit Accounts		1,229		1,113		3,594		2,979
Other		1,547		1,275		4,284		3,504
Total Noninterest Income		2,776		2,388		7,878		6,483
NONINTEREST EXPENSES
Salaries and Employee Benefits		5,654		5,100		16,769		14,262
Expense on Premises and Fixed Assets, net of rental income		1,655		1,449		5,045		4,096
Other		2,722		2,605		8,332		6,974
Total Noninterest Expenses		10,031		9,154		30,146		25,332
INCOME BEFORE INCOME TAX PROVISION		4,301		2,932		12,079		7,304
Income Tax Provision		1,395		1,009		3,883		2,380
NET INCOME BEFORE EXTRAORDINARY ITEM		2,906		1,923		8,196		4,924
Extraordinary Gain on Business Combination, net of tax		-		2,385		-		2,385
NET INCOME	$	2,906	$	4,308	$	8,196	$	7,309
PER SHARE DATA:
Net Income Per Share Before Extraordinary Item - basic	$	0.17	$	0.13	$	0.47	$	0.36
Extraordinary Item - basic	$	-	$	0.15	$	-	$	0.18
Net Income Per Share - basic	$	0.17	$	0.28	$	0.47	$	0.54
Net Income Per Share Before Extraordinary Item - diluted	$	0.16	$	0.12	$	0.46	$	0.35
Extraordinary Item - diluted	$	-	$	0.16	$	-	$	0.18
Net Income Per Share - diluted	$	0.16	$	0.28	$	0.46	$	0.53
Dividends Declared Per Common Share	$	0.03	$	-	$	0.08	$	-

(See Accompanying Notes to Consolidated Financial Statements)

3

First Security Group, Inc. and Subsidiary

Consolidated Statement of Stockholders’ Equity

	Common Stock					Paid-In			Retained			Accumulated Other Comprehensive			Unallocated
(in thousands)	Shares			Amount		Surplus			Earnings			Loss			ESOP Shares			Total
Balance - December 31, 2005		17,654		$	122	$	122,545		$	17,392		$	(1,579	)	$	(91	)	$	138,389
Issuance of Stock		35					255									(5,471	)		(5,216	)
Issuance of Stock to ESOP (170,147 shares)		170			1		1,876												1,877
Comprehensive income -
Net Income (unaudited)										8,196									8,196
Change in Net Unrealized
Loss on Securities Available
for Sale, net of tax (unaudited)													201						201
Dividends Paid ($0.025 per share)										(1,324	)								(1,324	)
Stock-based Compensation							437												437
Forfeited non-vested restricted stock		(26	)				(99	)											(99	)
Repurchase and Retirement of
Common Stock (87,420 shares)		(87	)				(917	)											(917	)
Balance - September 30, 2006 (unaudited)		17,746		$	123	$	124,097		$	24,264		$	(1,378	)	$	(5,562	)	$	141,544

(See Accompanying Notes to Consolidated Financial Statements)

4

First Security Group, Inc. and Subsidiary

Consolidated Statements of Cash Flow

(unaudited)

	Nine Months Ended September 30,
(in thousands)	2006			2005
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income	$	8,196		$	7,309
Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities -
Provided by (Used In) Operating Activities -
Provision for Loan Losses		1,743			2,679
Write-down of License Agreement		-			308
Amortization, net		1,182			804
Stock-Based Compensation		338			-
Depreciation		1,856			1,506
(Loss) Gain on Sale of Premises and Equipment		(65	)		5
(Loss) Gain on Sale of Other Real Estate and Repossessions, net		(30	)		14
Write-down of Other Real Estate and Repossessions		343			103
Accretion of Fair Value Adjustment, net		(680	)		-
Changes in Operating Assets and Liabilities -
Loans Held for Sale		881
Interest Receivable		(191	)		(1,235	)
Other Assets		(630	)		(1,226	)
Interest Payable		2,008			1,725
Other Liabilities		555			23,266
Net Cash Provided by Operating Activities		15,506			35,258
CASH FLOWS FROM INVESTING ACTIVITIES
Net Change in Interest Bearing Deposits in Banks		(1,735	)		(7,874	)
Activity in Available-for-Sale-Securities
Maturities, Prepayments, and Calls		13,186			40,771
Purchases		(16,808	)		(37,779	)
Loan Originations and Principal Collections, net		(82,337	)		(48,767	)
Purchase of Bank-Owned Life Insurance		-			(17,250	)
Proceeds from Sale of Premises and Equipment		723			-
Proceeds from Sales of Other Real Estate and Repossessions		2,328			4,161
Additions to Premises and Equipment		(4,933	)		(635	)
Acquisition of Business, net of cash acquired		-			(22,578	)
Capital Improvements to Repossessions		(233	)		(304	)
Net Cash Used in Investing Activities		(89,809	)		(90,255	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net Increase in Deposits		52,157			73,141
Net Increase (Decrease) in Federal Funds Purchased and
Securities Sold Under Agreements to Repurchase		13,483			(4,458	)
Repayments of Other Borrowings		(2,009	)		(2,008	)
Proceeds from Issuance of Common Stock		-			44,734
Proceeds from Issuance of Common Stock under Stock Option Plan		255			196
Repurchase and Retirement of Common Stock		(917	)		-
Purchase of ESOP Shares		(5,471	)		-
Proceeds from Sale of Stock to ESOP		1,877			-
Dividends Paid on Common Stock		(1,324	)		-
Net Cash Provided by Financing Activities		58,051			111,605
NET CHANGE IN CASH AND CASH EQUIVALENTS		(16,252	)		56,608
CASH AND CASH EQUIVALENTS - beginning of period		41,752			15,935
CASH AND CASH EQUIVALENTS - end of period	$	25,500		$	72,543

(See Accompanying Notes to Consolidated Financial Statements)

5

	Nine Months Ended September 30,
(in thousands)	2006		2005
SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Change in Unrealized Appreciation (Depreciation) of Securities, net of Deferred Taxes of $103 for 2006 and $(328) for 2005	$	201	$	(640	)
Foreclosed Properties and Repossessions	$	3,472	$	3,143
Purchase Accounting Adjustment to Goodwill	$	84	$	-
SUPPLEMENTAL SCHEDULE OF CASH FLOWS
Interest Paid	$	17,248	$	8,881
Income Taxes Paid	$	4,800	$	4,302
ACQUISITIONS
Assets (Non-cash) Acquired in Business Combination	$	-	$	185,648
Liabilities Assumed in Business Combination	$	-	$	152,371

(See Accompanying Notes to Consolidated Financial Statements)

6

FIRST SECURITY GROUP, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

NOTE A - BASIS OF PRESENTATION

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair statement of financial condition and the results of operations have been included. All such adjustments were of a normal recurring nature.

The consolidated financial statements include the accounts of First Security Group, Inc. and its subsidiary, which is wholly-owned. All significant intercompany balances and transactions have been eliminated.

Operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006 or any other period. These interim financial statements should be read in conjunction with the Company’s latest annual consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.

NOTE B - COMPREHENSIVE INCOME

In accordance with Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standard (SFAS) No. 130, Reporting Comprehensive Income, the Company is required to report “comprehensive income,” a measure of all changes in equity, not only reflecting net income but certain other changes as well. Comprehensive income for the three and nine month periods ended September 30, 2006 and 2005, respectively, was as follows:

	Three Months Ended September 30,					Nine Months Ended September 30,
	2006		2005			2006		2005
	(in thousands)
Net income	$	2,906	$	4,308		$	8,196	$	7,309
Unrealized gain (loss) on securities, net of tax		1,643		(225	)		201		(640	)
Comprehensive income, net of tax	$	4,549	$	4,083		$	8,397	$	6,669

7

NOTE C - EARNINGS PER SHARE

The difference in basic and diluted weighted average shares is due to the assumed conversion of outstanding options using the treasury stock method. The computation of basic and diluted earnings per share is as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2006		2005		2006		2005
	(in thousands, except per share data)
Net income	$	2,906	$	4,308	$	8,196	$	7,309
Denominator:
Weighted average common shares outstanding		17,218		15,353		17,349		13,612
Equivalent shares issuable upon exercise of stock options		411		308		392		287
Diluted shares		17,629		15,661		17,741		13,899
Net income per share:
Basic	$	0.17	$	0.28	$	0.47	$	0.54
Diluted shares	$	0.16	$	0.28	$	0.46	$	0.53

NOTE D - STOCK-BASED COMPENSATION

As of September 30, 2006, the Company has two stock-based compensation plans, the 2002 Long-Term Incentive Plan (2002 LTIP) and the 1999 Long-Term Incentive Plan (1999 LTIP). The plans are administered by the Compensation Committee of the Board of Directors (the Committee), which selects persons eligible to receive awards and determines the number of shares and/or options subject to each award, the terms, conditions and other provisions of the award. The plans are described in further detail below.

The 2002 LTIP was approved by the shareholders of the Company at the 2002 annual meeting and subsequently amended by the shareholders of the Company at the 2004 annual meeting to increase the number of shares available for issuance under the 2002 LTIP by 480 thousand shares. Eligible participants include eligible employees, officers, consultants and directors of the Company or any affiliate. Pursuant to the 2002 LTIP, the total number of shares of stock authorized for awards was 768 thousand, of which not more than 20% may be granted as awards of restricted stock. The exercise price per share of a stock option granted may not be less than the fair market value as of the grant date. The exercise price must be at least 110% of the fair market value at the grant date for options granted to individuals, who at grant date, are 10% owners of the Company’s voting stock (10% owner). Restricted stock may be awarded to participants with terms and conditions determined by the Committee. The term of each award is determined by the Committee, provided that the term of any incentive stock option may not exceed ten years (five years for 10% owners) from its grant date. Each option award vests in approximately equal percentages each year over a period of not less than three years (with the exception of a restricted stock grant as described below) from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 2002 LTIP or as provided in any award agreement.

Participation in the 1999 LTIP is limited to eligible employees. The total number of shares of stock authorized for awards was 936 thousand, of which not more than 10% could be granted as awards of restricted stock. Under the terms of the 1999 LTIP, incentive stock options to purchase shares of the Company’s common stock were granted at a price not less than the fair market value of the stock as of the date of the grant. Options were to be exercised within ten years from the date of grant subject to conditions specified by the 1999 LTIP. Restricted stock could also be awarded by the Committee in accordance with the 1999 LTIP. Each award vests in approximately equal percentages each year over a period of not less than three years (with the exception of five grants for a total of 168 thousand shares which vested in approximately equal percentages at 6 months, 18 months and 30 months) from the date of grant as determined by the Committee subject to accelerated vesting under terms of the 1999 LTIP or as provided in any award agreement.

8

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised), Share-Based Payment (SFAS 123(R)) utilizing the modified prospective approach. Prior to the adoption of SFAS No. 123 (R) the Company accounted for stock option grants in accordance with APB Opinion No. 25, Accounting for Stock Issued to Employees (the intrinsic value method), and accordingly, recognized no compensation expense for stock option grants.

Under the modified prospective approach, SFAS No. 123 (R) applies to new awards and to awards that were outstanding on January 1, 2006 that are subsequently modified, repurchased or cancelled. Under the modified prospective approach, compensation cost recognized in 2006 includes compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on grant date fair value estimated in accordance with the original provisions of SFAS 123, and compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with SFAS 123 (R). Prior periods were not restated to reflect the impact of adopting the new standard.

For the three and nine months ended September 30, 2006, the Company recorded compensation expense related to stock options that reduced income before taxes by $98 thousand and $298 thousand and net income by $61 thousand and $185 thousand, respectively. Basic net income per share was not impacted for the three months ended September 30, 2006. Basic net income per share was reduced by $0.01 for the nine months ended September 30, 2006. Diluted net income per share was reduced by $0.01 for the three and nine months ended September 30, 2006.

The stock options granted to employees under the Company’s long-term incentive plans qualify as incentive stock options as defined by the Internal Revenue Code (IRC) Section 422 (b) and have not resulted in tax deductions to the Company. Stock options granted to directors of the Company under the long-term incentive plans qualify as nonqualified stock options under IRC 422 (b). As of September 30, 2006, the Company had not received tax deductions related to nonqualified stock options granted.

Net cash proceeds received from the exercise of options were $255 thousand for the nine months ended September 30, 2006.

The following table illustrates the effect on operating results and per share information had the Company accounted for stock-based compensation in accordance with SFAS 123 (R) for the three and nine months ended September 30, 2005. For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option pricing model and amortized to expense over the options’ vesting periods.

	Three Months Ended			Nine Months Ended
	September 30, 2005
	(in thousands, except per share data)
Net income, as reported	$	4,308		$	7,309
Compensation expense, net of tax		(73	)		(218	)
Pro forma net income	$	4,235		$	7,091
Basic net income per share:
As reported	$	0.28		$	0.54
Pro forma	$	0.28		$	0.52
Diluted net income per share:
As reported	$	0.28		$	0.53
Pro forma	$	0.27		$	0.51

9

Stock Options

The Company uses the Black-Scholes option pricing model to estimate fair value of stock-based awards, which uses the assumptions indicated in the table below. Expected volatility is based on the implied volatility of the Company’s stock price. The Company uses historical data to estimate option exercises and employee terminations used in the model. The expected term of options granted is derived using the “simplified” method as permitted under the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 107 and represents the period of time options granted are expected to be outstanding. The risk-free interest rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The table below provides the assumptions used to determine the fair value of stock option grants during the nine months ended September 30, 2006 and 2005.

	Nine Months Ended September 30, 2006	Nine Months Ended September 30, 2005
Dividend yield	0.90%	1.00%
Expected volatility	17.14%	13.00%
Risk-free interest rate	4.94%	4.08%
Expected life of options (in years)	6.5	7.0

The weighted average grant-date fair value of stock options granted during the three and nine months ended September 30, 2006 was $3.22 and $2.98, respectively, compared to $2.26 for both the comparable periods in 2005. At September 30, 2006, there was $602 thousand of unrecognized compensation expense related to share-based payments, which are expected to be recognized over a weighted average period of 2.17 years.

The following table represents stock option activity for the period ended September 30, 2006:

	Number of Shares (in thousands)			Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)
Outstanding, beginning of period		1,164		$	7.35
Granted		65			11.05
Exercised		(36	)		7.14
Forfeited		(41	)		8.71
Outstanding, end of period		1,152		$	7.52		6.74
Options exercisable, end of period		814		$	6.63		5.79

As of September 30, 2006, shares available for future option grants to employees and directors under existing plans were 26 thousand shares and 215 thousand shares for the 1999 LTIP and 2002 LTIP, respectively. At September 30, 2006 the aggregate intrinsic value of options outstanding was $4.6 million and the aggregate intrinsic value of options exercisable was $4.0 million. Total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $74 thousand and $150 thousand, respectively, and $0 thousand and $92 thousand for the comparable periods in 2005.

10

The following table summarizes nonvested stock option activity for the period ended September 30, 2006:

	Number of Shares (in thousands)			Weighted Average Exercise Price
Nonvested, beginning of period		457		$	8.66
Granted		65			11.05
Vested		(149	)		7.42
Forfeited		(35	)		8.91
Nonvested, end of period		338		$	9.64

Restricted Stock

The plans described above allow for the issuance of restricted stock awards that may not be sold or otherwise transferred until certain restrictions have lapsed. The unearned stock-based compensation related to these awards is amortized to compensation expense over the period the restrictions lapse. The share-based expense for these awards was determined based on the market price of the Company’s stock at the grant date applied to the total number of shares that were anticipated to fully vest and then amortized over the vesting period. As of September 30, 2006, the Company had unearned stock-based compensation of $179 thousand associated with these awards. For the three and nine months ended September 30, 2006, the Company recognized $31 thousand and $40 thousand of compensation expense, net of forfeitures, related to the amortization of deferred compensation that was included in salaries and benefits in the accompanying consolidated statements of operations. The Company granted 44,124 shares in a restricted stock award during the third quarter of 2005, of which 30,624 had been forfeited as of September 30, 2006.

As of September 30, 2006, the Company had restricted stock awards outstanding of 31,500 shares. Of the total shares outstanding, 13,500 shares allow for the recipients to vest and receive shares of common stock in equal installments on each of the first three anniversaries of the date of grant. The remaining 18,000 shares awarded cliff vest 26 months from the date of grant as provided for in the award agreement. The Company did not grant any restricted stock during the first three quarters of 2006.

NOTE E - GUARANTEES

The Company, as part of its ongoing business operations, issues financial guarantees in the form of financial and performance standby letters of credit. Standby letters of credit are contingent commitments issued by the Company to guarantee the performance of a customer to a third-party. A financial standby letter of credit is a commitment to guarantee a customer’s repayment of an outstanding loan or debt instrument. In a performance standby letter of credit, the Company guarantees a customer’s performance under a contractual nonfinancial obligation for which it receives a fee. The maximum potential amount of future payments the Company could be required to make under its stand-by letters of credit at September 30, 2006, December 31, 2005, and September 30, 2005 was $14.9 million, $12.7 million and $12.2 million, respectively. The Company’s outstanding standby letters of credit generally have a term of one year and some may have renewal options. The amount of collateral, if any, the Company obtains on an extension of credit is based on the Company’s credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.

11

NOTE F - STOCKHOLDER’S EQUITY

On July 20, 2006, the Company completed its share repurchase program with the repurchase of 500,000 shares at an average price of $10.80. The majority of the stock (329,853 shares) was purchased directly by the First Security Group, Inc. 401(k) and Employee Stock Ownership Plan (ESOP), and the balance (170,147 shares) was purchased by the Company. On July 20, the Company sold all 170,147 shares purchased to the ESOP for $11.03 per share in a private sale under Section 4(2) of the Securities Act of 1933, as amended; this transaction resulted in a net increase to stockholders’ equity of approximately $163 thousand. The Company originally purchased the 170,147 shares at an average price of $10.07 per share. Following this transaction, the ESOP owns 500,000 shares which will be used to match employee 401(k) contributions as well as incentive driven ESOP profit sharing opportunities.

On September 18, 2006, the Company paid its third quarter cash dividend of $0.025 per share or $439 thousand to shareholders of record on September 1, 2006. On October 25, 2006 the Board of Directors approved the fourth quarter cash dividend of $0.05 per share payable on December 18, 2006 to shareholders of record on December 1, 2006.

On October 27, 2005, the Company’s shareholders approved an amendment, as proposed by the Board of Directors, to its articles of incorporation to increase the number of authorized shares of common stock from 20 million to 50 million. Amended and restated articles were filed with the Tennessee Secretary of State to effect this change on March 7, 2006.

NOTE G - RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157) to clarify how to measure fair value and to expand disclosures about fair value measurements. The expanded disclosures include the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value on earnings and is applicable whenever other standards require (or permit) assets and liabilities to be measured at fair value. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company believes this Statement will not have a material impact on the Company’s consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes (FIN 48). The Interpretation provides guidance for recognition and measurement of uncertain tax positions that are “more likely than not” of being sustained upon audit, based on the technical merits of the position. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The effective date is for fiscal years beginning after December 15, 2006. The Company believes this Interpretation will not have a material impact on the Company’s consolidated financial statements.

In December 2005, the FASB issued FASB Staff Position (FSP) SOP 94-6-1, Terms of Loan Products That May Give Rise to a Concentration of Credit Risk. This FSP was issued in response to inquiries from constituents and discussions with the SEC staff and regulators of financial institutions to address the circumstances in which the terms of loan products give rise to a concentration of credit risk as that term is used in SFAS No. 107, Disclosures about Fair Value of Financial Instruments, and what disclosures apply to entities who deal with loan products whose terms may give rise to a concentration of credit risk. An entity shall provide the disclosures required by SFAS No. 107 for either an individual loan product type or a group of loan products with similar features that are determined to represent a concentration of credit risk in accordance with the guidance of SOP 94-6-1 for all periods presented in financial statements. This SOP is effective for interim and annual periods ending after December 19, 2005. The adoption of FSP SOP 94-6-1 did not have a material impact on the Company’s financial position or results of operations.

12

In November 2005, the FASB issued a FSP on FAS No. 115-1 and FAS No. 124-1 (“the FSP”), The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination of when an investment is considered impaired; whether the impairment is other-than-temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance on Emerging issues Task Force (EITF) Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations. Under the FSP, losses arising from impairment deemed to be other-than-temporary, must be recognized in earnings at an amount equal to the entire difference between the securities cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also required that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The adoption of this statement did not have a material impact on the Company’s consolidated financial statements.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS No. 154), Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3, which eliminates the requirement to reflect changes in accounting principles as cumulative adjustments to net income in the period of the change and requires retrospective application to prior periods’ financial statements for voluntary changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. If it is impracticable to determine the cumulative effect of the change to all prior periods, SFAS No. 154 requires that the new accounting principle be adopted prospectively. For new accounting pronouncements, the transition guidance in the pronouncement should be followed. Retrospective application refers to the application of a different accounting principle to previously issued financial statements as if that principle had always been used. SFAS 154 did not change the guidance for reporting corrections of errors, changes in estimates or for justification of a change in accounting principle on the basis of preferability. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on the Company’s consolidated financial statements.

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment, (SFAS No. 123R). This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. Under APB No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. SFAS No. 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period which is usually the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. For public entities that do not file as small business issuers, SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The adoption of SFAS No. 123R resulted in compensation expense recorded to the Company’s financial statements as disclosed in Note D above.

NOTE H- RECLASSIFICATIONS

Certain reclassifications have been made to the financial statements presented for prior periods to conform to the 2006 presentation.

13

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

In this Form 10-Q, “First Security,” “we,” “us,” “the Company” and “our” refer to First Security Group, Inc.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain of the statements made under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere throughout this Form 10-Q are forward-looking statements for purposes of the Securities Act of 1933 and the Securities Exchange Act of 1934. Forward-looking statements relate to future events or our future financial performance and may involve known or unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of First Security to be materially different from future results, performance, or achievements expressed or implied by such forward-looking statements. Forward-looking statements include statements using the words such as “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “intend,” “seeks,” or other similar words and expressions of the future.

These forward-looking statements involve risks and uncertainties, and may not be realized due to a variety of factors, including, without limitation: the effects of future economic conditions, governmental monetary and fiscal policies, as well as legislative and regulatory changes; the risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities, and interest sensitive assets and liabilities; the costs of evaluating possible acquisitions and the risks inherent in integrating acquisitions; the effects of competition from other commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds and other financial institutions operating in First Security’s market area and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, computer and the Internet; and, the failure of assumptions underlying the establishment of reserves for possible loan losses. All written or oral forward-looking statements attributable to First Security are expressly qualified in their entirety by this Special Note.

THIRD QUARTER 2006 AND RECENT EVENTS

The following discussion and analysis sets forth the major factors that affected results of operations and financial condition reflected in the unaudited financial statements for the three and nine month periods ended September 30, 2006 and 2005. Such discussion and analysis should be read in conjunction with our Consolidated Financial Statements and the notes attached thereto.

OVERVIEW

As of September 30, 2006, we had total consolidated assets of $1.1 billion, total loans of $825.7 million, total deposits of $913.6 million and stockholders’ equity of $141.5 million.

Net income for the three months ended September 30, 2006, was $2.9 million, or $0.17 and $0.16 per basic and diluted share, respectively, compared to net income of $4.3 million, or $0.28 per share (basic and diluted) for the comparative period of 2005. Net income for the nine months ended September 30, 2006, was $8.2 million, or $0.47 and $0.46 per basic and diluted share, respectively, compared to net income of $7.3 million, or $0.54 and $0.53 per share basic and diluted, respectively, for the comparative period of 2005. Net income on a quarterly and year-to-date basis in 2005 reflects the recognition of an extraordinary gain of $2.4 million (net of tax). The gain contributed $0.15 and $0.16 per basic and diluted share, respectively, for the third quarter and $0.18 per share (basic and diluted) on a year-to-date basis for 2005. Excluding the gain, earnings per share increased 30.8% and 33.3%, basic and diluted, respectively, for the quarter and 30.6% and 31.4%, basic and diluted, respectively, on a year-to-date basis.

14

The extraordinary gain was recognized as a result of a purchase accounting adjustment related to the acquisition of our leasing companies in October 2004. The gain resulted from the elimination of a tax liability when it became increasingly evident after ongoing discussions with the seller and the preparation of our respective tax returns for 2004, that the obligation for the payment was too remote to be carried on our books as a specific obligation.

Net interest income and noninterest income for the nine month period increased $7.3 million and $1.4 million, respectively, while noninterest expense, including the provision for loan losses, increased by $3.9 million as compared to the same period in 2005. Income increases outpaced expense increases as a result of the additional earning assets purchased through our acquisition of Jackson Bank & Trust (Jackson Bank) and gathered through our branching activity during 2005 and the first three quarters of 2006.

Our efficiency ratio improved in the third quarter of 2006 to 67.2% as compared to 71.6% in the same period of 2005. We expect to continue achieving further efficiencies by growing our operating revenue faster than our expenses. In the second half of 2005, we opened two de novo branches in Cleveland, Tennessee and Varnell, Georgia. During the first quarter of 2006, we purchased a plot of land located in the greater Cookeville, Tennessee vicinity at 614 West Main Street, Algood, Putnam County, Tennessee where we intend to build a banking facility in 2007. In addition, we expect the completion of our corporate headquarters in downtown Chattanooga, Tennessee in the fourth quarter of 2006.

Net interest margin in the third quarter of 2006 was 5.05% or 6 basis points lower than the prior year period of 5.11%. The third quarter of 2006 is our eighth consecutive quarter with a net interest margin greater than 5.00%.

On July 20, 2006, we completed our share repurchase program with the repurchase of 500,000 shares at an average price of $10.80. The majority of the stock (329,853 shares) was purchased directly by our ESOP, although a portion (170,147 shares) was purchased by the Company. On July 20, the Company sold all 170,147 shares purchased to the ESOP for $11.03 per share in a private sale under Section 4(2) of the Securities Act of 1933, as amended; this transaction resulted in a net increase to stockholders’ equity of approximately $163 thousand. The Company originally purchased the 170,147 shares at an average price of $10.07 per share. Following this transaction, the ESOP owns 500,000 shares which will be used to match employee 401(k) contributions as well as incentive driven ESOP profit sharing opportunities.

On October 25, 2006 the Board of Directors approved the fourth quarter cash dividend of $0.05 per share payable on December 18, 2006 to shareholders of record on December 1, 2006. The dividend per share doubles previous quarterly dividends of $0.025 per share. The increase is a result of our continued growth in net income and provides an increased return to shareholders.

RESULTS OF OPERATIONS

We reported net income for the three and nine month periods ended September 30, 2006 of $2.9 million and $8.2 million versus net income for the same periods in 2005 of $4.3 million and $7.3 million, respectively. In the third quarter of 2006, basic and diluted net income per share was $0.17 and $0.16 on approximately 17.2 million and 17.6 million weighted average shares outstanding, respectively. On a year-to-date basis, basic and diluted net income per share was $0.47 and $0.46 on approximately 17.3 million and 17.7 million weighted average shares outstanding, respectively.

Excluding the 2005 extraordinary item, net income on a quarterly and year-to-date basis in 2006 was above the 2005 level as a result of the acquisition of Jackson Bank on August 31, 2005 combined with our organic growth. Our overhead also increased in 2006 because of our acquisition and the addition of two new full service bank branches. As of September 30, 2006 we had 37 banking offices, including the headquarters, two leasing offices and 360 full time equivalent employees. Although, we expect to continue to expand our branch network and our employee force in 2006, we are mindful of the fact that growth and increasing the number of branches adds expenses (such as administrative costs and occupancy, salaries and benefits expenses) before earnings.

15

 The following table summarizes the components of income and expense and the changes in those components for the three and nine month periods ended September 30, 2006 as compared to the same periods in 2005.

	For the Three Months Ended		Change from the Prior Year						For the Nine Months Ended		Change from the Prior Year
	September 30, 2006		Amount			%			September 30, 2006		Amount			%
	(in thousands, except percentages)
Gross interest income	$	19,384	$	4,808			33.0	%	$	55,346	$	15,908			40.3	%
Gross interest expense		7,228		3,043			72.7	%		19,256		8,650			81.6	%
Net interest income		12,156		1,765			17.0	%		36,090		7,258			25.2	%
Provision for loan losses		600		(93	)		-13.4	%		1,743		(936	)		-34.9	%
Net interest income after provision for loan losses		11,556		1,858			19.2	%		34,347		8,194			31.3	%
Noninterest income		2,776		388			16.3	%		7,878		1,395			21.5	%
Noninterest expense		10,031		877			9.6	%		30,146		4,814			19.0	%
Income before income taxes		4,301		1,369			46.7	%		12,079		4,775			65.4	%
Income tax provision		1,395		386			38.3	%		3,883		1,503			63.2	%
Income before extraordinary item		2,906		983			51.1	%		8,196		3,272			66.5	%
Extraordinary gain on business combination, net of tax		-		(2,385	)		-100.0	%		-		(2,385	)		-100.0	%
Net income	$	2,906	$	(1,402	)		-32.5	%	$	8,196	$	87			12.1	%

Net Interest Income

Net interest income (the difference between the interest earned on assets, such as loans and investment securities, and the interest paid on liabilities, such as deposits and other borrowings) is our primary source of operating income. For the three months ended September 30, 2006, net interest income increased by $1.8 million, or 17.0%, to $12.2 million for the third quarter of 2006 compared to $10.4 million for the same period in 2005. For the nine months ended September 30, 2006, net interest income increased by $7.3 million, or 25.2%, to $36.1 million for the period ended September 30, 2006 compared to $28.8 million for the same period in 2005.

We monitor and evaluate the effects of certain risks on our earnings and seek balance between the risks assumed and returns sought. Some of these risks include interest rate risk, credit risk and liquidity risk.

The level of net interest income is determined primarily by the average balances (volume) of interest earning assets and the various rate spreads between our interest-earning assets and our funding sources. Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest bearing liabilities, increases or decreases in the average interest rates earned and paid on such assets and liabilities, the ability to manage the interest-earning asset portfolio (which includes loans), and the availability of particular sources of funds, such as noninterest bearing deposits.

Interest income for the third quarter of 2006 was $19.4 million, a 33.0% increase as compared to the same period in 2005. Interest income for the nine month period ended September 30, 2006 was $55.3 million, a 40.3% increase as compared to the same period in 2005. The increase in interest income on a quarter and year-to-date basis is due to increases in the average balance of earning assets and increasing yields. For the three months ended September 30, 2006, average earning assets increased $152.5 million, or 18.6% to $974.0 million compared to $821.5 million for the same period in 2005. On a year-to-date basis, average earning assets increased $191.0 million, or 25.2% to $949.1 million compared to $758.1 million for the same period in 2005. Our earning assets increased in the third quarter of 2006 on a comparative basis due to the deposit gathering activities of FSGBank, the acquisition of Jackson Bank and the use of the proceeds from our initial public offering. Deposits raised and proceeds from our public offering were used to fund or acquire earning assets, including our acquisition of Jackson Bank on August 31, 2005. These additional earning assets have enabled us to earn more interest income.

16

Supplementing the additional earnings from increased volumes was the increase in yield on earning assets. The tax equivalent yield on earning assets increased 86 basis points for the quarter ended September 30, 2006 to 7.99% from 7.13% for the same period in 2005. On a year-to-date basis, the tax equivalent yield on earning assets increased 86 basis points to 7.90% compared to 7.04% for the same period in 2005. The changes in the yield relate to our changing the mix of earning assets and the Federal Reserve Board changing the target federal funds rate and discount rate.

Total interest expense was $7.2 million in the third quarter of 2006, or 72.7% higher, as compared to the same period in 2005. Year-to-date interest expense was $19.3 million, or 81.6% higher, as compared to the same period in 2005. The increase in interest expense on a quarterly and year-to-date basis in 2006 is primarily due to the additional volume of interest bearing liabilities combined with rising interest rates. Average interest bearing liabilities increased $136.4 million, or 21.4% and $158.9 million, or 26.6% for the three and nine months ended September 30, 2006, respectively, compared to the same period in 2005. The year-over-year significant increase in interest bearing liabilities was due to our market penetration, the acquisition of Jackson Bank and the issuance of brokered CDs. We primarily use brokered CDs to match fund our leasing portfolio. Total deposits grew $59.5 million, or 7.0% to $913.6 million for the period ended September 30, 2006 compared to the same period in 2005. The average rate paid on interest bearing liabilities increased 110 basis points to 3.70% from 2.60% for the quarter ended September 30, 2006 and 2005, respectively and 103 basis points to 3.40% from 2.37% for the nine months ended September 30, 2006 and 2005, respectively. The increase is primarily due to the Federal Reserve rate increase initiative.

The banking industry uses two key ratios to measure profitability of net interest income: net interest rate spread and net interest margin. The net interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The net interest rate spread does not consider the impact of noninterest bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest income as a percentage of total average earning assets and takes into account the positive effects of investing noninterest bearing deposits in earning assets.

Our net interest rate spread (on a tax equivalent basis) was 4.29% for the quarter ended September 30, 2006 compared to 4.53% for the same period in 2005. Net interest margin (on a tax equivalent basis) was 5.05% for the quarter ended September 30, 2006 compared to 5.11% for the same period in 2005. On a year-to-date basis, our net interest spread and net interest margin were 4.49% and 5.18% for the period ended September 30, 2006, compared to 4.67% and 5.17% for the same period in 2005, respectively. The net interest spread for the quarter and year-to-date basis decreased as the average rate on interest bearing liabilities increased at a faster rate than the yield on earning assets. The greater increase in rates for deposits is primarily due to (1) competitive pricing pressure, (2) the Federal Reserve rate increase initiative and the current flat to inverted yield curve and (3) a shift in consumer behavior to higher rate time deposits. Our rising cost of funding is also the primary reason for the decrease in the net interest margin for the third quarter of 2006 as compared to the same period in 2005. The net interest margin on a year-to-date basis remained steady with a 1 basis point increase to 5.18 for the period ended September 30, 2006. Noninterest bearing funding sources contributed 69 basis points to the spread for the nine month period ending September 30, 2006, as compared to 50 basis points in the comparable period in 2005. Average noninterest bearing demand deposits increased $31.3 million or 24.7% to $157.7 million from $126.5 million for the nine months ended September 30, 2006 and 2005, respectively.

Average interest bearing liabilities as a percentage of average earning assets was 79.5% for the quarter ended September 30, 2006 compared to 77.7% for the same period in 2005. On a year-to-date basis, average interest bearing liabilities as a percentage of average earning assets was 79.7% for the period ended September 30, 2006 compared to 78.8% for the same period in 2005. Average noninterest bearing funding sources as a percentage of average earning assets was 16.9% and 16.6% for the quarter and year-to-date periods ended September 30, 2006 compared to 16.8% and 16.7% for the same periods in 2005.

Through November 9, 2006, the Federal Reserve has raised the target federal funds rate by 100 basis points to 5.25% from the 4.25% rate as of January 1, 2006. Throughout the remainder of 2006, we believe our net interest margin will remain steady or decrease depending on the competitive deposit pricing pressure in our market and Federal Reserve target rate decreases, if any.

17

The following table summarizes net interest income and average yields and rates paid for the quarters ended September 30, 2006 and 2005.

Average Consolidated Balance Sheets and Net Interest Analysis

Fully Tax-Equivalent Basis

	For the Three Months Ended September 30,
	2006								2005
	Average Balance			Income/ Expense		Yield/ Rate			Average Balance			Income/ Expense		Yield/ Rate
	(in thousands, except percentages)
Assets
Earning assets:
Loans, net of unearned income	$	812,611		$	17,617		8.60	%	$	668,040		$	13,119		7.79	%
Debt securities - taxable		114,868			1,354		4.68	%		92,245			931		4.00	%
Debt securities - non-taxable		42,654			609		5.66	%		33,600			463		5.47	%
Other earning assets		3,817			46		4.78	%		27,595			243		3.49	%
Total earning assets		973,950			19,626		7.99	%		821,480			14,756		7.13	%
Allowance for loan losses		(10,392	)							(9,730	)
Intangible assets		31,635								20,113
Cash & due from banks		26,446								22,501
Premises & equipment		33,124								27,346
Other assets		39,711								33,355
TOTAL ASSETS	$	1,094,474							$	915,065
Liabilities and Stockholders’ Equity
Interest bearing liabilities:
Interest bearing demand deposits	$	68,304			142		0.82	%	$	65,783			123		0.74	%
Money market accounts		105,378			687		2.59	%		105,545			464		1.74	%
Savings deposits		38,226			72		0.75	%		34,701			47		0.54	%
Time deposits > $100		189,663			2,276		4.76	%		125,849			1,081		3.41	%
Time deposits < $100		247,369			2,742		4.40	%		184,354			1,471		3.17	%
Brokered CDs		84,646			936		4.39	%		94,022			862		3.64	%
Federal funds purchased		13,152			186		5.61	%		4,455			40		3.56	%
Repurchase agreements		19,541			112		2.27	%		17,424			37		0.84	%
Other borrowings		8,142			75		3.65	%		5,853			60		4.07	%
Total interest bearing liabilities		774,421			7,228		3.70	%		637,986			4,185		2.60	%
Net interest spread				$	12,398		4.29	%				$	10,571		4.53	%
Noninterest bearing demand deposits		164,153								138,353
Accrued expenses and other liabilities		16,028								24,859
Stockholders’ equity		142,270								114,403
Unrealized loss on securities		(2,398	)							(536	)
Total liabilities and shareholders’ equity	$	1,094,474							$	915,065
Impact of noninterest bearing sources and other changes in balance sheet composition							0.76	%							0.58	%
Net interest margin							5.05	%							5.11	%

18

The following table presents the relative impact on net interest income to changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by us on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amount of the change in each category.

Change in Interest Income and Expense on a Tax Equivalent Basis

	For the Three Months Ended September 30, 2006 Compared to 2005 Increase (Decrease) in Interest Income and Expense Due to Changes in:
	Volume			Rate			Total
	(in thousands)
Interest earning assets:
Loans, net of unearned income	$	2,839		$	1,659		$	4,498
Debt securities - taxable		228			195			423
Debt securities - non-taxable		125			21			146
Other earning assets		(209	)		12			(197	)
Total earning assets		2,983			1,887			4,870
Interest bearing liabilities:
Interest bearing demand deposits		5			14			19
Money market accounts		(1	)		224			223
Savings deposits		5			20			25
Time deposits > $100		548			647			1,195
Time deposits < $100		503			768			1,271
Brokered CDs		(86	)		160			74
Federal funds purchased		78			68			146
Repurchase agreements		4			71			75
Other borrowings		23			(8	)		15
Total interest bearing liabilities		1,079			1,964			3,043
Increase in net interest income	$	1,904		$	(77	)	$	1,827

19

Average Consolidated Balance Sheets and Net Interest Analysis

Fully Tax-Equivalent Basis

	For the Nine Months Ended September 30,
	2006								2005
	Average Balance			Income/ Expense		Yield/ Rate			Average Balance			Income/ Expense		Yield/ Rate
	(in thousands, except percentages)
Assets
Earning assets:
Loans, net of unearned income	$	784,185		$	50,020		8.53	%	$	630,697		$	35,802		7.59	%
Debt securities - taxable		115,060			3,992		4.64	%		85,419			2,555		4.00	%
Debt securities - non-taxable		41,941			1,788		5.70	%		29,687			1,221		5.50	%
Other earning assets		7,910			258		4.36	%		12,337			337		3.65	%
Total earning assets		949,096			56,058		7.90	%		758,140			39,915		7.04	%
Allowance for loan losses		(10,320	)							(9,136	)
Intangible assets		31,772								16,792
Cash & due from banks		26,055								20,849
Premises & equipment		32,387								26,490
Other assets		39,290								23,281
Total assets	$	1,068,280							$	836,416
Liabilities and shareholders’ equity
Interest bearing liabilities:
Interest bearing demand deposits	$	71,919			464		0.86	%	$	60,181			276		0.61	%
Money market accounts		107,687			1,902		2.36	%		111,009			1,325		1.60	%
Savings deposits		38,752			209		0.72	%		33,212			116		0.47	%
Time deposits > $100		177,109			5,870		4.43	%		115,779			2,716		3.14	%
Time deposits < $100		241,610			7,378		4.08	%		168,225			3,659		2.91	%
Brokered CDs		85,793			2,690		4.19	%		83,335			2,146		3.44	%
Federal funds purchased		6,790			260		5.12	%		7,161			162		3.02	%
Repurchase agreements		18,355			260		1.89	%		15,023			88		0.78	%
Other borrowings		8,240			223		3.62	%		3,470			118		4.55	%
Total interest bearing liabilities		756,255			19,256		3.40	%		597,395			10,606		2.37	%
Net interest spread				$	36,802		4.49	%				$	29,309		4.67	%
Noninterest bearing demand deposits		157,721								126,462
Accrued expenses and other liabilities		14,745								16,657
Shareholders’ equity		141,662								96,246
Unrealized loss on securities		(2,103	)							(344	)
Total liabilities and shareholders’ equity	$	1,068,280							$	836,416
Impact of noninterest bearing sources and other changes in balance sheet composition							0.69	%							0.50	%
Net interest margin							5.18	%							5.17	%

20

Change in Interest Income and Expense on a Tax Equivalent Basis

	For the Nine Months Ended September 30, 2006 Compared to 2005 Increase (Decrease) in Interest Income and Expense Due to Changes in:
	Volume			Rate			Total
	(in thousands)
Interest earning assets:
Loans, net of unearned income	$	8,713		$	5,505		$	14,218
Debt securities - taxable		887			550			1,437
Debt securities - non-taxable		504			63			567
Other earning assets		(121	)		42			(79	)
Total earning assets		9,983			6,160			16,143
Interest bearing liabilities:
Interest bearing demand deposits		54			134			188
Money market accounts		(40	)		617			577
Savings deposits		19			74			93
Time deposits > $100		1,439			1,715			3,154
Time deposits < $100		1,596			2,123			3,719
Brokered CDs		63			481			544
Federal funds purchased		(8	)		106			98
Repurchase agreements		20			152			172
Other borrowings		162			(57	)		105
Total interest bearing liabilities		3,305			5,345			8,650
Increase in net interest income	$	6,678		$	815		$	7,493

Provision for Loan Losses

The provision for loan losses charged to operations during the three months ended September 30, 2006 was $600 thousand compared to $693 thousand in the same period of 2005. Net charge-offs for the third quarter of 2006 were $914 thousand compared to net charge-offs of $600 thousand for the same period in 2005. The provision for loan losses for the nine months ended September 30, 2006 and 2005 was $1.7 million and $2.7 million, respectively. Net charge-offs for the nine months ended September 30, 2006 and 2005 were $1.9 million and $1.7 million, respectively. Annualized net charge-offs as a percentage of average loans were 0.45% for the three months ended September 30, 2006 compared to 0.36% for the same period in 2005. Our peer group’s average (as reported in the June 30, 2006 Uniform Bank Performance Report) was 0.10%.

The decrease in our provision for loan losses on a quarterly and year-to-date basis in 2006 compared to 2005 was as a result of our analysis of inherent risks in the loan portfolio in relation to the portfolio’s growth, the level of past due, charged-off, classified and nonperforming loans as well as general economic conditions. As a result of our analysis, we determined that our credit quality was improving, and as such we reduced the provision expense. We will reanalyze the allowance for loan losses on at least a quarterly basis, and the next review will be at December 31, 2006, or sooner if necessary and the provision expense will be adjusted accordingly, if necessary.

21

For the nine months ended September 30, 2006, our loan portfolio increased by $77.1 million due to organic growth compared to an increase of $195.5 million in the same period in 2005. Of the prior year growth, $45.6 million was organic and $149.9 million was acquired with Jackson Bank. Year-over-year, the loan portfolio increased by $83.5 million from September 30, 2005 to September 30, 2006. All of the year-over-year growth was organic.

The allowance for loan losses reflects our assessment and estimate of the risks associated with extending credit and its evaluation of the quality of the loan portfolio. We regularly analyze our loan portfolio in an effort to establish an allowance for loan losses that we believe will be adequate in light of anticipated risks and loan losses. In assessing the adequacy of the allowance, we review the size, quality and risk of loans in the portfolio. We also consider such factors as:

° our loan loss experience;

° specific known risks;

° the status and amount of past due and nonperforming assets;

° underlying estimated values of collateral securing loans;

° current and anticipated economic conditions; and

° other factors which we believe affect the allowance for potential credit losses.

An analysis of the credit quality of the loan portfolio and the adequacy of the allowance for loan losses is prepared by our credit administration department and presented to our Board of Directors or the Directors’ Loan Committee on at least a quarterly basis. In addition, our loan review department performs a regular review of the quality of the loan portfolio and adequacy of the allowance. Based on our analysis, which includes risk factors such as charge-off rates, past dues, and loan growth, we may determine that our future provision expense may need to increase or decrease in order for us to remain adequately reserved for probable loan losses.

Our allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance for loan losses and the size of the allowance for loan losses compared to a group of peer banks. During their routine examinations of banks, the regulators may require a bank to make additional provisions to its allowance for loan losses when, in the opinion of the regulators, their credit evaluations and allowance for loan loss methodology differ materially from ours.

While it is our policy to charge off in the current period loans for which a loss is considered probable, there are additional risks of future losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because these risks include the state of the economy, our judgment as to the adequacy of the allowance is necessarily approximate and imprecise.

Noninterest Income

Noninterest income totaled $2.8 million for the third quarter of this year, an increase of $388 thousand, or 16.2%, from the same period in 2005. On a year-to-date basis, noninterest income totaled $7.9 million, an increase of $1.4 million, or 21.5%. Of the increase, Jackson Bank contributed $101 thousand, or 26.0%, and $670 thousand, or 48.0%, for the third quarter and year-to-date periods, respectively.

22

The following table presents the components of noninterest income for the three and nine month periods ended September 30, 2006 and 2005.

NONINTEREST INCOME

	Three Months Ended September 30,							Nine Months Ended September 30,
	2006		Percent Change			2005		2006		Percent Change			2005
	(in thousands, except percentages)
NSF fees	$	978		10.9	%	$	882	$	2,866		25.6	%	$	2,282
Service charges on deposit accounts		251		8.7	%		231		728		4.4	%		697
Mortgage loan and related fees		405		-3.3	%		419		1,071		-3.8	%		1,113
Bank-owned life insurance income		218		5.8	%		206		668		114.8	%		311
Other income		924		42.2	%		650		2,545		22.4	%		2,080
Total noninterest income	$	2,776		16.2	%	$	2,388	$	7,878		21.5	%	$	6,483

Our largest sources of noninterest income are service charges and fees on deposit accounts. Total service charges, including non-sufficient funds (NSF) fees, were $1.2 million for the third quarter of 2006, an increase of $116 thousand, or 10.4%, from the same period in 2005. On a year-to-date basis, total service charges, including NSF fees, were $3.6 million, an increase of $615 thousand, or 20.6%. NSF fees, excluding the $71 thousand positive impact of Jackson Bank, increased $25 thousand, or 3.1%, on an organic basis for the third quarter 2006 compared to the same period in 2005. On a year-to-date basis NSF fees, excluding the $429 thousand positive impact of Jackson Bank, increased $155 thousand, or 7.0%, on an organic basis. The increase can be attributed to our growing deposit base. Our transaction and savings accounts were 42,293 at September 30, 2006 compared to 42,281 at September 30, 2005. Despite our consistent deposit base, service charges on deposit accounts decreased on an organic basis by 6.4% and 10.1% for the quarter and year-to-date 2006, respectively. This is primarily due to (1) an increase in “free checking” due to competitive pressures and (2) a reduction in commercial account analysis charges due to increases in the crediting rate which often occurs in a rising interest rate environment.

Mortgage loan and related fees for the third quarter of 2006 decreased $14 thousand, or 3.3 %, to $405 thousand compared to $419 thousand in the third quarter of 2005. Our process to originate and sell a conforming mortgage in the secondary market typically takes 30 to 60 days from the date of mortgage origination to the date the mortgage is sold to an investor in the secondary market. Due to the normal processing time, we will have a certain amount of held for sale loans at any time. Mortgages originated for sale in the secondary market totaled $24.4 million and $70.0 million for the third quarter and first nine months of 2006. Mortgages sold in the secondary market totaled $27.8 million and $68.1 million for the quarter and nine months ending September 30, 2006. Mortgage originations totaled $26.6 million and $61.6 million for the third quarter and first nine months of 2005. During the third quarter of 2005, we hired an experienced mortgage broker to grow our mortgage business. We have also centralized the mortgage department to gain efficiencies since the first quarter of 2005. During 2006, our mortgage department began originating adjustable rate mortgages (ARMs) to be held for investment. Income from ARM loans totaled $282 thousand and $487 thousand for the quarter and first nine months of 2006. The income from ARM loans is included in interest income and fees from loans. The rising interest rate market has impacted the volume of the mortgages originated and sold in the secondary market, but the addition of the ARM products has resulted in the continual increase of income from the mortgage department on a quarterly and year-to-date basis. We are optimistic that the mortgage fee income will increase with the fourth quarter addition of a new mortgage origination office in Marietta, Georgia, but the impact of higher interest rates and the housing market could negatively impact the earnings from the mortgage origination and sales.

23

Bank-owned life insurance income increased $12 thousand, or 5.8% and $357 thousand, or 114.8% on a quarterly and year-to-date basis, respectively, in 2006 as compared to the same periods in 2005. During the first nine months of 2005, we invested $17.3 million in bank-owned life insurance contracts. The Company is the owner and beneficiary of these contracts. The income generated by the cash value of the insurance policies accumulates on a tax-deferred basis and is tax-free to maturity. In addition, the insurance death benefit will be a tax free payment to the Company. This tax advantaged asset enables us to provide benefits to our employees. On a fully tax-equivalent basis, the weighted average interest rate earned on the policies was 6.91% at September 30, 2006. In addition to the $17.3 million investment made in 2005, we have $3.8 million as of September 30, 2006 in life insurance contracts through our acquisitions of First State Bank in 2002 and Jackson Bank in 2005.

Other income for the third quarter of 2006 increased $274 thousand, or 42.2%, to $924 thousand, compared to $650 thousand for the same period in 2005. For the nine months ended, other income increased $465 thousand, or 22.4%, to $2.5 million, compared to $2.1 million for the period ended September 30, 2006 and 2005, respectively. The components of other income primarily consist of point-of-sale fees on debit cards, credit card fee income, ATM fee income, gains on sales of other real estate, repossessions, premises and equipment and leased equipment, underwriting revenue, safe deposit box fee income, and trust fee income. The increase in other income on a quarterly basis is primarily due to increases in point-of-sale fees, trust fee income and gains on sales of leased equipment. On a year-to-date basis, other income increased primarily due to an increase in point-of-sale fees and trust fee income combined with the acquisition of Jackson Bank, which contributed a net increase of $83 thousand to other income in 2006.

Noninterest Expense

Noninterest expense for the third quarter of 2006 increased $877 thousand, or 9.6% to $10.0 million compared to $9.2 million for the same period in 2005. On a year-to-date basis, noninterest expense increased $4.8 million, or 19.0% to $30.1 million compared to $25.3 million for the same period in 2005. The increase in noninterest expense primarily reflects additional investment to support corporate growth and the net increase of approximately $623 thousand and $2.7 million in Jackson Bank expenses on a quarter and year-to-date basis, respectively. Unless indicated otherwise in the discussion below, we anticipate increases in noninterest expense throughout 2006 and into 2007 as a result of our branching activities.

The following table represents the components of noninterest expense for the three and nine month periods ended September 30, 2006 and 2005.

NONINTEREST EXPENSE

	Three Months Ended September 30,							Nine months Ended September 30,
	2006		Percent Change			2005		2006		Percent Change			2005
	(in thousands, except percentages)
Salaries & benefits	$	5,654		10.9	%	$	5,100	$	16,769		17.6	%	$	14,262
Occupancy		781		12.1	%		697		2,372		20.8	%		1,964
Furniture and equipment		874		16.2	%		752		2,673		25.4	%		2,132
Professional fees		540		43.2	%		377		1,397		41.3	%		989
Data processing		305		2.3	%		298		962		13.0	%		851
Printing & supplies		116		-27.0	%		159		403		2.5	%		393
Communications		181		15.3	%		157		586		31.1	%		447
Advertising		118		-5.6	%		125		339		-23.5	%		443
Intangible asset amortization		323		27.7	%		253		990		66.4	%		595
Other expense		1,139		-7.8	%		1,236		3,655		12.3	%		3,256
Total noninterest expense	$	10,031		9.6	%	$	9,154	$	30,146		19.0	%	$	25,332

24

Salaries and benefits for the third quarter of 2006 increased 10.9% as compared to the same period in 2005 and 17.6% on a year-to-date basis. The increase in salaries and benefits is primarily related to the inclusion of Jackson Bank, increases in our benefit expenses, including but not limited to incentive compensation accruals, the rising cost of health insurance and compensation expense associated with the expensing of stock options in accordance with Statement of Financial Accounting Standard (SFAS) No. 123R, Accounting for Stock-Based Compensation. As of September 30, 2006, we had 360 full time equivalent employees and operated 37 full service banking offices and two leasing offices. We anticipate the completion of our new corporate headquarters building located at 531 Broad Street, Chattanooga, Tennessee during the fourth quarter of 2006. We have begun the construction phase of a de novo branch in Cookeville, Tennessee with an opening date of early 2007.

Occupancy expense increased for the third quarter of 2006 by 12.1% as compared to the same period in 2005 and 20.8% on a year-to-date basis. The increase on a quarterly and year-to-date basis was due to our opening two de novo branches (both in the fourth quarter of 2005) and the five branches acquired with Jackson Bank (August 2005). As of September 30, 2006, First Security leased nine branches, two office facilities and the land for four branches. As a result, current period occupancy expense is higher than if we owned these facilities, including the real estate, but due to market conditions, property availability and favorable lease terms, we leased these locations to execute our growth strategy. Furthermore, we have been able to deploy the capital into earning assets rather than capital expenditures for facilities.

Similar to occupancy expense, furniture and equipment expense and communications expense increased on a quarterly and year-to-date basis due to adding two new branches and the acquisition of Jackson Bank. We expect these expenses to continue to increase for the remainder of 2006 and into 2007 with the completion of our corporate headquarters in the fourth quarter of 2006 and de novo branching activity in 2007.

Professional fees increased 43.2% for the third quarter of 2006 as compared to the same period in 2005 and 41.3% on a year-to-date basis. Professional fees include fees related to investor relations, outsourcing internal audit, compliance and information technology audits to Professional Bank Services, as well as external audit (including testing under Section 404 of the Sarbanes Oxley Act of 2002), tax services and legal and accounting advice related to, among other things, potential acquisitions, investment securities, trademarks and intangible properties. The increase in 2006 on a quarterly and year-to-date basis, primarily relates to investor relations fees associated with being a NASDAQ listed company, internal and external audit, tax services and legal fees.

Data processing fees increased 2.3% for the third quarter of 2006 as compared to the same period in 2005 and 13.0% on a year-to-date basis. On March 10, 2006, we converted the data processing activities of Jackson Bank to our external data processing system, which is Fidelity Integrated Financial Solutions (formerly Intercept) located in Lenexa, Kansas. The monthly fees associated with data processing are based primarily on transaction volume. Therefore, as we grow, we believe that data processing costs will increase correspondingly.

Intangible asset amortization expense increased 27.7% in the third quarter of 2006 as compared to the same period in 2005 and 66.4% on a year-to-date basis. The increase is due to a non-compete agreement and a core deposit intangible asset, which resulted in net additional expense of $103 thousand for the third quarter of 2006 and $506 thousand for the nine months ended 2006 as compared to the same periods in 2005. Both intangible assets are associated with the acquisition of Jackson Bank. This increase is offset by a decline in amortization expense related to core deposit assets other than Jackson Bank, as these amortize on an accelerated basis in which the expense recognized declines over the estimated useful life of ten years.

Other expense decreased 7.8% in the third quarter of 2006 as compared to the same period in 2005 and increased 12.3% on a year-to-date basis. The decrease on a quarterly basis is primarily due to an impairment on long-lived assets in the third quarter of 2005. The increase for the year-to-date basis is primarily a function of our increased branching activities as well as the addition of Jackson Bank.

25

Income Taxes

We recorded income tax expense of $1.4 million for the third quarter of 2006 compared to $1.0 million for the same period in 2005. Our effective tax rate for the third quarter of 2006 was 32.4% compared to 34.4% for the same period in 2005. On a year-to-date basis, we recorded income tax expense of $3.9 million compared to $2.4 million. Our effective tax rate for the nine months ended 2006 was 32.1% compared to 32.6% for the same period in 2005.

STATEMENT OF FINANCIAL CONDITION

Our total assets were $1.1 billion at September 30, 2006, $1.0 billion at December 31, 2005, and $1.1 billion at September 30, 2005. Our asset growth in loans and investment securities is directly related to deposit growth and the funds available to us for investment.

Throughout the fourth quarter of 2006 and continuing into 2007, we expect our assets to continue to grow as we plan to further leverage our existing banking branches, build a de novo branch and actively pursue additional acquisitions of existing banks and bank branches.

Loans

Our loan demand continues to be strong. Total loans increased 10.3% (13.7% annualized) at September 30, 2006 as compared to December 31, 2005 and 11.2% as compared to September 30, 2005. The increase in loans in the first three quarters of 2006 can be attributed to an increase in our construction and land development loans of $39.8 million, or 33.9%, an increase in commercial real estate of $13.9 million, or 8.7%, and an increase in our 1-4 family residential loans of $18.6 million, or 8.4%. Loan growth, entirely organic, was $83.5 million, or 11.2%, over the twelve-month period ended September 30, 2006. The loan categories with the largest increases over the past twelve months were (1) construction/land development loans, up $47.3 million, or 43.0%, to $157.2 million, (2) residential mortgage loans, up $19.9 million, or 9.0%, to $239.4 million, (3) commercial and industrial increased $14.8 million, or 14.5%, to $117.5 million and (4) commercial real estate increased $12.8 million, or 7.9%, to $174.4 million

We believe that our general loan growth will remain strong. Funding of future loan growth may be restricted by our ability to raise core deposits, although we will use alternative funding sources if necessary and cost effective. Loan growth may also be restricted by the necessity for us to maintain appropriate capital levels, as well as adequate liquidity.

Asset Quality

We consider our asset quality to be of primary importance. At September 30, 2006, our loan portfolio was 74.4% of total assets. Over the past few years, we have improved our commercial and retail underwriting standards, developed a detailed loan policy, established better warning and early detection procedures, additional credit-related management and director reporting and developed a more comprehensive analysis of our allowance for loan losses. We also recently completed comprehensive retail loan underwriting training in conjunction with the implementation of the Baker Hill software platform. We believe our implementation of the Baker Hill software will enhance our ability to produce credit risk and production management information for both the commercial and retail portfolios.

The allowance for loan losses represents our estimate of an amount adequate in relation to the risk of losses inherent in the loan portfolio. We analyze the loan portfolio regularly to identify potential problems. We undertake this analysis in conjunction with the establishment of our allowance for loan losses to provide a basis for determining the adequacy of our loan loss reserves to absorb losses that we estimate might be experienced. Furthermore, our policy requires regularly scheduled problem-asset meetings in which past due and classified loans are thoroughly analyzed. These analyses are thoroughly reviewed by our credit administration group. In addition to these analyses of existing loans, we consider our loan growth, historical loan losses, past due and non-performing loans, current economic conditions, underlying loan collateral values and other factors which may affect probable loan losses.

26

As a result of our acquisition of Jackson Bank, we assumed their allowance for loan losses of $1.3 million, which related to loans that were not subject to the provisions of SOP 03-3. We believe that 2006 charge-offs, as a percent of average loans, will be less than our 2005 level as a result of our continuing efforts to improve our loan underwriting, approval process, servicing, problem identification and problem resolution.

Our asset quality ratios were consistent or improved in the third quarter of 2006 as compared to the same period in 2005. As of September 30, 2006, our allowance for loan losses as a percentage of total loans was 1.19%, annualized net charge-offs as a percentage of average loans were 45 basis points and non-performing assets as a percentage of total assets were 41 basis points. As of September 30, 2006, non-performing assets, including 90 days past due, had improved to $6.1 million, or 55 basis points of total assets, from $5.8 million, or 56 basis points, and $7.5 million, or 70 basis points, as of December 31, 2005 and September 30, 2005, respectively. In the fourth quarter of 2005, we engaged a consultant to evaluate our repossessed assets. As a result of this evaluation, we incurred a $454 thousand fair value write-down on repossessions held for sale longer than 90 days at Kenesaw Leasing. We have implemented new leasing policies addressing repossessions and are also more actively marketing repossessions in order to maximize their value and minimize their carrying cost. Additionally, in April 2006, we hired an experienced special assets officer to manage our special assets, collections, recoveries, other real estate and repossessions. The focus of this new position will be to initiate a formal recovery program and improve overall past due management by centralizing our loan collection process. We are also implementing a collection and recovery management software system to strengthen our management of other real estate owned, repossessed assets, past dues loans and classified loans.

27

The following table presents an analysis of the changes in the allowance for loan losses for the nine months ended September 30, 2006 and 2005. The provision for loan losses of $1.7 million in the table below does not include our provision accrual for unfunded commitments of $90 thousand as of September 30, 2006. The reserve for unfunded commitments is included in other liabilities in the accompanying consolidated balance sheets.

ANALYSIS OF CHANGES IN ALLOWANCE FOR LOAN LOSSES

	For the nine months ended September 30,
	2006			2005
Allowance for loan losses -	(in thousands, except percentages)
Beginning of period	$	10,121		$	8,312
Provision for loan losses		1,653			2,679
Additions due to business combination		-			1,261
Sub-total		11,774			12,252
Charged off loans:
Commercial - leases		336			760
Commercial - loans		879			439
Real estate - construction		11			31
Real estate - residential mortgage		677			251
Consumer and other		400			558
Total charged off		2,303			2,039
Recoveries of charged-off loans:
Commercial - leases		5			17
Commercial - loans		78			55
Real estate - construction		-			-
Real estate - residential mortgage		94			89
Consumer and other		214			145
Total recoveries		391			306
Net charged-off loans		1,912			1,733
Allowance for loan losses - end of period	$	9,862		$	10,519
Total loans-end of period	$	825,745		$	742,250
Average loans	$	784,185		$	630,697
Net loans charged-off to average loans, annualized		0.33	%		0.37	%
Provision for loan losses to average loans, annualized*		0.30	%		0.57	%
Allowance for loan losses as a percentage of:
Period end loans		1.19	%		1.42	%
Non-performing assets		217.56	%		231.44	%
*Provision for loan losses as reported in the consolidated income statements.

28

The following table presents the allocation of the allowance for loan losses for each respective loan category with the corresponding percent of loans in each category to total loans. The comprehensive allowance analysis developed by our credit administration group enables us to allocate the allowance based on risk elements within the portfolio.

Allocation of the Allowance for Loan Losses

	As of September 30,
	2006					2005
	Amount		Percent of loans in each category to total loans			Amount		Percent of loans in each category to total loans
	(in thousands, except percentages)
Commercial-leases	$	1,639		6.9	%	$	2,289		7.4	%
Commercial-loans		2,404		14.3	%		2,914		21.3	%
Real estate-construction		1,040		19.0	%		598		16.2	%
Real estate-mortgage		3,605		51.2	%		3,883		46.9	%
Consumer		906		8.6	%		731		8.2	%
Unallocated		268		0.0	%		104		0.0	%
Total	$	9,862		100	%	$	10,519		100	%

We believe that the allowance for loan losses at September 30, 2006 is sufficient to absorb losses inherent in the loan portfolio based on our assessment of the information available. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examinations of FSGBank, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant. The unallocated reserve is available as a general reserve against the entire loan portfolio and is related to factors such as current economic conditions which are not directly associated with a specific loan pool. See “Provision for Loan Losses” for a description of our methodology for determining the adequacy of the allowance for loan losses.

Nonperforming Assets

Nonperforming assets include nonaccrual loans, restructured loans, other real estate under contract for sale and repossessed assets. We place loans on non-accrual status when we have concerns relating to our ability to collect the loan principal and interest, and generally when such loans are 90 days or more past due. Nonaccrual loans totaled $679 thousand at September 30, 2006, $1.3 million at December 31, 2005, and $1.1 million at September 30, 2005. The nonaccrual loans at September 30, 2006 included $34 thousand of commercial loans, $27 thousand of consumer loans and $618 thousand of real-estate secured loans. There are no commitments to lend additional funds to customers with loans on non-accrual status at September 30, 2006.

Loans 90 days past due and still accruing were $1.6 million at September 30, 2006, compared to $1.0 million at December 31, 2005 and $2.9 million at September 30, 2005. Of these past due loans at September 30, 2006, $670 thousand were secured by real estate, $9 thousand were commercial loans, $22 thousand were consumer loans and $892 thousand were leases.

At September 30, 2006 we owned other real estate in the amount of $2.3 million, which consisted of $835 thousand in construction/land development property, $302 thousand in residential real estate and $1.2 million in commercial real estate. All of these properties have been written down to their respective fair values.

29

At September 30, 2006, we owned repossessed assets, which have been written down to their fair values, in the amount of $1.6 million, compared to $1.9 million at December 31, 2005 and $2.0 million at September 30, 2005.

Nonperforming assets for the third quarter of 2006 were $4.5 million compared to $4.8 million at December 31, 2005 and $4.5 million at September 30, 2005. The decline in our non-performing assets over the past twelve months reflects our enhanced processes, controls and policies. At September 30, 2006, nonperforming loans (nonaccrual loans and loans past due 90 days or more) were 0.28% of total outstanding loans compared to 0.48% for our peer group. The ratio of nonperforming loans to the allowance for loan losses was 23.04% compared to 39.94% for our peer group. The ratio of nonperforming loans to equity capital was 1.61% compared to 3.41% for our peer group. The ratio of nonperforming loans and other real estate owned to total loans and other real estate owned was 0.55% compared to 0.55% for our peer group.

Investment Securities and Other Earning Assets

The composition of our securities portfolio reflects our investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. Our securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for investing available funds, furnishing liquidity and supplying securities to pledge as required collateral for certain deposits and borrowed funds. We use two categories to classify our securities: “held to maturity” or “available for sale.” Currently, none of our investments are classified as held to maturity. While we have no plans to liquidate a significant amount of any securities, the securities classified as available-for-sale may be used for liquidity purposes should we deem it to be in our best interest.

Securities totaled $159.7 million at September 30, 2006, $156.0 million at December 31, 2005 and $148.1 million at September 30, 2005. The growth in the securities portfolio year-over-year occurred as a result of our efforts to maintain a certain level of liquid assets in correlation to our overall asset growth. At September 30, 2006, the securities portfolio had unrealized net losses of approximately $1.4 million, net of tax. All investment securities purchased to date have been classified as available-for-sale. Our securities portfolio at September 30, 2006 consisted of tax-exempt municipal securities, federal agency bonds, federal agency issued Real Estate Mortgage Investment Conduits (REMICs), federal agency issued pools and asset-backed securities and collateralized mortgage obligations (CMOs). The following table provides the amortized cost of our securities by their stated maturities (this maturity schedule excludes security prepayment and call features), as well as the tax equivalent yields for each maturity range.

MATURITY OF INVESTMENT SECURITIES - AMORTIZED COST

	Less than One Year			One to Five Years			Five to Ten Years			More than Ten Years
	(in thousands, except percentages)
Municipal-tax exempt	$	1,250		$	5,847		$	22,587		$	13,510
Agency bonds		4,631			36,540			1,982			-
Agency issued REMICs		1,004			36,184			-			-
Agency issued pools		192			25,422			4,329			311
Asset backed & CMOs		-			7,026			-			-
Other		-			-			-			1,000
Total	$	7,077		$	111,019		$	28,898		$	14,821
Tax Equivalent Yield		5.01	%		4.51	%		5.45	%		6.17	%

30

We currently have the ability and intent to hold our available-for-sale investment securities to maturity. However, should conditions change, we may sell unpledged securities. We consider the overall quality of the securities portfolio to be high. All securities held are traded in liquid markets, except for one bond. This $250 thousand investment is a Qualified Zone Academy Bond (within the meaning of Section 1379E of the Internal Revenue Code of 1986, as amended) issued by The Health, Educational and Housing Facility Board of the County of Knox under the authority from the State of Tennessee. As of September 30, 2006, we owned securities from issuers in which the aggregate amortized cost from such issuers exceeded 10% of our stockholders’ equity. As of the third quarter ended 2006, the amortized cost and market value of the securities from each such issuer are as follows:

	Book Value		Market Value
	(in thousands)
Fannie Mae	$	30,711	$	30,602
FHLMC*	$	67,436	$	67,332

* Federal Home Loan Mortgage Corporation

At September 30, 2006 we held no federal funds sold compared to $17.8 million at December 31, 2005 and $48.8 million at September 30, 2005. The decrease in federal funds sold is the result of strong loan demand and our efforts to invest these federal funds into loans to improve our average yield on earning assets.

As of September 30, 2006, we held $198 thousand in certificates of deposit at other FDIC insured financial institutions. At September 30, 2006, we held $22.1 million in bank-owned life insurance, $3.3 million of which was assumed through our acquisition of Jackson Bank, compared to $21.4 million at December 31, 2005 and $20.9 million at September 30, 2005.

Deposits and Other Borrowings

As of September 30, 2006, deposits increased by 6.0% (8.0% annualized) from December 31, 2005 and by 7.0% from September 30, 2005. The year-over-year growth is organic and is due to our sales team drawing customers away from other financial institutions and our branching efforts. On a year-to-date basis, the fastest growing sector of our core deposit base was noninterest bearing demand deposits which grew 15.2% (20.3% annualized) and outpaced our total deposit growth. We define our core deposits to include interest bearing and noninterest bearing demand deposits, savings and money market accounts, as well as retail certificates of deposits with denominations less than $100,000. We consider our retail CDs to be a stable source of funding because they are in-market, relationship oriented deposits. Core deposit growth is an important tenant to our business strategy. We believe that by improving our branching network, we will provide more convenient opportunities for customers to bank with us, and thus improve our core deposit funding. For this reason, in 2006 we plan to open another downtown branch at the new headquarters building in Chattanooga, Tennessee. As a result of this future branch and branches opened in recent periods, we anticipate that our deposits will continue to increase throughout 2006.

Federal funds purchased and securities sold under agreements to repurchase were $30.4 million as of September 30, 2006, compared to $16.9 million and $18.8 million as of December 31, 2005 and September 30, 2005 respectively. The increase in federal funds purchased and repurchase agreements has been used as a source to fund the growth in our loan portfolio.

31

The following table details the maturities and rates of the term borrowings from the Federal Home Loan Bank of Cincinnati as of September 30, 2006.

Date	Type	Principal	Term	Rate	Maturity
12/4/2003*	Fixed rate advance	$2,666,000	48 months	3.17%	1/24/07
12/6/2004*	Fixed rate advance	2,667,000	48 months	3.34%	1/25/08
12/6/2005*	Fixed rate advance	2,667,000	48 months	4.11%	1/26/09
6/18/1996*	Fixed rate advance	1,881	180 months	7.70%	7/1/11
9/16/1996*	Fixed rate advance	3,523	180 months	7.50%	10/1/11
9/9/1997*	Fixed rate advance	4,325	180 months	7.05%	10/1/12
		$8,009,729

Aggregate composite rate 3.54%

48 month composite rate 3.54%

180 month composite rate 7.34%

* Assumed as part of the acquisition of Jackson Bank.

Liquidity

Liquidity refers to our ability to adjust future cash flows to meet the needs of our daily operations. We rely primarily on management fees from FSGBank to fund our daily operations’ liquidity needs. Our cash balance on deposit with FSGBank, which totaled approximately $1.9 million as of September 30, 2006, is available for funding activities for which FSGBank would not receive direct benefit, such as acquisition due diligence, shareholder relations and holding company operations. These funds should adequately meet our cash flow needs. If we determine that our cash flow needs will be satisfactorily met, we may deploy a portion of the funds into FSGBank or use them in an acquisition in order to support continued growth. If our cash flow needs are not satisfactorily met, we may, as the sole shareholder, cause FSGBank to declare and pay a cash dividend, subject to regulatory limitations.

The liquidity of FSGBank refers to the ability or financial flexibility to adjust its future cash flows to meet the needs of depositors and borrowers and to fund operations on a timely and cost effective basis. The primary sources of funds for FSGBank are cash generated by repayments of outstanding loans, interest payments on loans and new deposits. Additional liquidity is available from the maturity and earnings on securities and liquid assets, as well as the ability to liquidate securities available for sale.

At September 30, 2006, our liquidity ratio (defined as cash, due from banks, federal funds sold, and investment securities less securities pledged to secure liabilities divided by short-term funding liabilities less liabilities secured by pledged securities) was 19.1% (excluding anticipated loan repayments). As of December 31, 2005 and September 30, 2005, the liquidity ratios were 22.0% and 24.5% respectively.

FSGBank is a member of the Federal Home Loan Bank of Cincinnati and has attained borrowing capability secured by a blanket lien on its 1-4 family residential mortgage loan portfolio, as well as the commercial real estate loan portfolio. As of September 30, 2006, the outstanding term debt in FHLB borrowings was $8.0 million. FSGBank also used its borrowing capacity at FHLB to purchase a letter of credit that we pledged to the State of Tennessee Bank Collateral Pool. The letter of credit allows us to release investment securities from the Collateral Pool and thus improve our liquidity ratio. Additionally, FSGBank could increase its borrowing capacity at FHLB, subject to more stringent collateral requirements, by pledging loans other than 1-4 family residential mortgage and commercial real estate loans. As of September 30, 2006 our unused borrowing capacity (using 1-4 family residential mortgage and commercial real estate loans) at FHLB was $90.2 million. FHLB maintains standards for loan collateral files. Therefore, our borrowing capacity may be restricted if our collateral files have exceptions.

32

FSGBank also had unsecured federal funds lines in the aggregate amount of $99.5 million, with $90.8 million available, at September 30, 2006 under which it can borrow funds to meet short-term liquidity needs. Another source of funding is loan participations sold to other commercial banks (in which we retain the service rights). As of quarter end, we had $7.0 million in loan participations sold. FSGBank may continue to sell loan participations as a source of liquidity. An additional source of short-term funding would be to pledge investment securities against a line of credit at a commercial bank. As of quarter-end, FSGBank had no borrowings against our investment securities, except for repurchase agreements and public-fund deposits attained in the ordinary course of business. During 2004, FSGBank entered the brokered deposits market as a source of funding, generating approximately $65 million in new monies in order to fund additional interest earning assets, specifically the acquisition of Kenesaw Leasing and J&S Leasing. As of September 30, 2006 FSGBank had $86.9 million in brokered CDs outstanding with a weighted average remaining life of approximately 12.5 months, a weighted average coupon rate of 4.23% and a weighted average all-in cost (which includes fees paid to deposit brokers) of 4.48%. Our certificates of deposit greater than $100 thousand were generated in FSGBank’s communities and are considered relatively stable. We believe that FSGBank’s liquidity sources are adequate to meet its operating needs.

We also have contractual cash obligations and commitments, which include certificates of deposit, other borrowings, operating leases and loan commitments. Unfunded loan commitments totaled $268.1 million at September 30, 2006. The following table illustrates our significant contractual obligations at September 30, 2006 by future payment period.

CONTRACTUAL OBLIGATIONS

		Total		Less than One Year		One to Three Years		Three to Five Years		More Than Five Years
		(in thousands)
Certificates of deposit	(1)	$	532,641	$	425,560	$	94,703	$	12,378	$	-
Federal funds purchased and securities sold under agreements to repurchase	(2)		30,377		30,377		-		-		-
FHLB borrowings	(3)		8,010		2,666		5,334		2		8
Operating lease obligations	(4)		5,817		909		1,695		1,284		1,929
Note payable	(5)		131		12		26		31		62
Total		$	576,976	$	459,524	$	101,758	$	13,695	$	1,999

_____

¹ Certificates of deposit give customers rights to early withdrawal. Early withdrawals may be subject to penalties. The penalty amount depends on the remaining time to maturity at the time of early withdrawal. For more information regarding certificates of deposit, see “Deposits and Other Borrowings.”

² We expect securities repurchase agreements to be re-issued and, as such, do not necessarily represent an immediate need for cash.

³ For more information regarding FHLB borrowings, see “Deposits and Other Borrowings.”

⁴ Operating lease obligations include existing and future property and equipment non-cancelable lease commitments.

⁵ This note payable is a mortgage on the land of our branch facility located at 2905 Maynardville Highway, Maynardville, Tennessee.

Net cash provided by operations during the first nine months of 2006 totaled $15.5 million compared to $35.3 million for the same period in 2005. The change can be attributed to a decease in other liabilities. Net cash used in investing activities remained consistent with $89.8 million as compared to $90.3 million primarily due the increase in our loan portfolio combined with capital expenditures associated with the construction of our new corporate headquarters. Net cash provided by financing activities decreased to $58.1 million compared to $111.6 million in 2005. The decrease is primarily due to the 2005 offering, a reduction in brokered CDs combined with an increase in federal funds purchased and the initiation of our share repurchase program, which was approved by the Board of Directors in October 2005 and completed in July 2006.

33

Off-Balance Sheet Arrangements

We are party to credit-related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.

Our exposure to credit loss is represented by the contractual amount of these commitments. We follow the same credit policies in making commitments as we do for on-balance-sheet instruments.

Our maximum exposure to credit risk for unfunded loan commitments and standby letters of credit at September 30, 2006 and 2005 was as follows:

	As of September 30,
	2006		2005
	(in thousands)
Commitments to Extend Credit	$	268,062	$	219,959
Standby Letters of Credit	$	14,917	$	12,160

Commitments to extend credit are agreements to lend to customers. Commitments generally have fixed expiration dates or other termination clauses and may require payment of fees. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral, if any, we obtain on an extension of credit is based on our credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property and equipment and income-producing commercial properties.

Capital Resources

Banks and bank holding companies, as regulated institutions, must meet required levels of capital. The Comptroller of the Currency and the Federal Reserve, the primary federal regulators for FSGBank and First Security, respectively, have adopted minimum capital regulations or guidelines that categorize components and the level of risk associated with various types of assets. Financial institutions are expected to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines. First Security and FSGBank both maintain capital levels exceeding the minimum capital levels required in addition to exceeding those capital requirements for well capitalized banks and holding companies under applicable regulatory guidelines.

The following table compares the required capital ratios maintained by First Security and FSGBank:

	Well Capitalized	Adequately Capitalized	First Security	FSGBank
September 30, 2006
Tier I capital to risk adjusted assets	6.0%	4.0%	12.1%	10.9%
Total capital to risk adjusted assets	10.0%	8.0%	13.2%	12.0%
Leverage ratio	5.0%	4.0%	10.5%	9.4%
December 31, 2005
Tier I capital to risk adjusted assets	6.0%	4.0%	12.0%	10.1%
Total capital to risk adjusted assets	10.0%	8.0%	13.2%	11.2%
Leverage ratio	5.0%	4.0%	10.6%	8.9%
September 30, 2005
Tier I capital to risk adjusted assets	6.0%	4.0%	12.6%	11.1%
Total capital to risk adjusted assets	10.0%	8.0%	13.6%	12.1%
Leverage ratio	5.0%	4.0%	10.6%	9.5%

34

The declaration and payment of dividends on our common stock will depend upon our earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to our common stock and other factors deemed relevant by our Board of Directors. In the first nine months of 2006, we paid total cash dividends of $0.075 per share or $1.3 million. On October 25, 2006 the Board of Directors approved the fourth quarter cash dividend of $0.05 per share payable on December 18, 2006 to shareholders of record on December 1, 2006. The fourth quarter dividend is a 100% increase from the previous quarterly dividends of $0.025.

On October 26, 2005, our Board of Directors also authorized a plan to buy back up to 500,000 shares of our common stock in open market transactions. On July 20, 2006, we completed the share repurchase program with 500,000 shares at an average purchase price of $10.80 per share. All 500,000 shares are now owned by our ESOP and will be used for our 401(k) match as well as incentive driven ESOP profit sharing opportunities.

EFFECTS OF INFLATION

Inflation generally increases the cost of funds and operating overhead, and, to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of our assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on our performance than the effects of general levels of inflation. Although interest rates do not necessarily move in the same direction, or to the same extent, as the prices of goods and services, increases in inflation generally have resulted in increased interest rates. If the Federal Reserve believes that the rate of inflation is likely to increase to undesired levels, its method of curbing inflation in the past has been to increase the interest rate charged on short-term federal borrowings.

In addition, inflation results in an increased cost of goods and services purchased, cost of salaries and benefits, occupancy expense and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect the earnings of our commercial banking and mortgage banking business and our stockholders’ equity. With respect to our mortgage banking business, mortgage originations and refinancings tend to slow as interest rates increase, and increased interest rates would likely reduce our earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (FAS 157) to clarify how to measure fair value and to expand disclosures about fair value measurements. The expanded disclosures include the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value, and the effect of fair value on earnings and is applicable whenever other standards require (or permit) assets and liabilities to be measured at fair value. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. Management believes this Statement will not have a material impact on our consolidated financial statements.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes” (FIN 48). The Interpretation provides guidance for recognition and measurement of uncertain tax positions that are “more likely than not” of being sustained upon audit, based on the technical merits of the position. FIN 48 also provides guidance on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The effective date is for fiscal years beginning after December 15, 2006. Management believes this Interpretation will not have a material impact on our consolidated financial statements.

35

In December 2005, the FASB issued FASB Staff Position (FSP) SOP 94-6-1, Terms of Loan Products That May Give Rise to a Concentration of Credit Risk. This FSP was issued in response to inquiries from constituents and discussions with the SEC staff and regulators of financial institutions to address the circumstances in which the terms of loan products give rise to a concentration of credit risk as that term is used in SFAS No. 107, Disclosures about Fair Value of Financial Instruments, and what disclosures apply to entities who deal with loan products whose terms may give rise to a concentration of credit risk. An entity shall provide the disclosures required by SFAS No. 107 for either an individual loan product type or a group of loan products with similar features that are determined to represent a concentration of credit risk in accordance with the guidance of SOP 94-6-1 for all periods presented in financial statements. This SOP is effective for interim and annual periods ending after December 19, 2005. The adoption of FSP SOP 94-6-1 did not have a material impact on our financial position or results of operations.

In November 2005, the FASB issued a FSP on FAS No. 115-1 and FAS No. 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, which addresses the determination of when an investment is considered impaired; whether the impairment is other-than-temporary; and how to measure an impairment loss. This FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance on Emerging issues Task Force (EITF) Issue No. 03-1 with references to existing authoritative literature concerning other-than-temporary determinations. Under the FSP, losses arising from impairment deemed to be other-than-temporary, must be recognized in earnings at an amount equal to the entire difference between the securities cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP also required that an investor recognize an other-than-temporary impairment loss when a decision to sell a security has been made and the investor does not expect the fair value of the security to fully recover prior to the expected time of sale. The FSP is effective for reporting periods beginning after December 15, 2005. The adoption of this statement did not have a material impact on our consolidated financial statements.

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154 (SFAS No. 154), Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3, which eliminates the requirement to reflect changes in accounting principles as cumulative adjustments to net income in the period of the change and requires retrospective application to prior periods’ financial statements for voluntary changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. If it is impracticable to determine the cumulative effect of the change to all prior periods, SFAS No. 154 requires that the new accounting principle be adopted prospectively. For new accounting pronouncements, the transition guidance in the pronouncement should be followed. Retrospective application refers to the application of a different accounting principle to previously issued financial statements as if that principle had always been used. SFAS 154 did not change the guidance for reporting corrections of errors, changes in estimates or for justification of a change in accounting principle on the basis of preferability. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of SFAS No. 154 did not have a material impact on our consolidated financial statements.

In December 2004, the Financial Accounting Standards Board issued SFAS No. 123R, Share-Based Payment, (SFAS No. 123R). This Statement is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation, and supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. Under APB No. 25, issuing stock options to employees generally resulted in recognition of no compensation cost. SFAS No. 123R requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards. The cost will be recognized over the period during which an employee is required to provide service in exchange for the award—the requisite service period which is usually the vesting period. No compensation cost is recognized for equity instruments for which employees do not render the requisite service. The grant-date fair value of employee share options and similar instruments will be estimated using option-pricing models adjusted for the unique characteristics of those instruments. If an equity award is modified after the grant date, incremental compensation cost will be recognized in an amount equal to the excess of the fair value of the modified award over the fair value of the original award immediately before the modification. For public entities that do not file as small business issuers, SFAS No. 123R is effective as of the beginning of the first annual reporting period that begins after June 15, 2005. The adoption of SFAS No. 123R resulted in compensation expense recorded to our financial statements as disclosed in Note D to the consolidated financial statements.

36

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk, with respect to us, is the risk of loss arising from adverse changes in interest rates and prices. The risk of loss can result in either lower fair market values or reduced net interest income. We manage several types of risk, such as credit, liquidity and interest rate. We consider interest rate risk to be a significant risk that could potentially have a large material effect on our financial condition. Further, we process hypothetical scenarios whereby we shock our balance sheet up and down for possible interest rate changes, we analyze the potential change (positive or negative) to net interest income, as well as the effect of changes in fair market values of assets and liabilities. We do not maintain a trading portfolio or deal in international instruments, and therefore are not exposed to risk inherent to trading activities and foreign currency.

Our interest rate risk management is the responsibility of the Asset/Liability Committee (ALCO). ALCO has established policies and limits to monitor, measure and coordinate our sources, uses and pricing of funds.

Interest rate risk represents the sensitivity of earnings to changes in interest rates. As interest rates change, the interest income and expense associated with our interest sensitive assets and liabilities also change, thereby impacting net interest income, the primary component of our earnings. ALCO utilizes the results of both static gap and income simulation reports to quantify the estimated exposure of net interest income to a sustained change in interest rates.

Our income simulation analysis projected net interest income based on both a rise and fall in interest rates of 200 basis points (i.e. 2.00%) over a twelve-month period. Given this scenario, we had, as of September 30, 2006, an exposure to falling rates and a benefit from rising rates. More specifically, our model forecasts a decline in net interest income of $2.6 million or 7.2%, as a result of a 200 basis point decline in rates. The model also predicts a $2.6 million increase in net interest income, or 7.3% as a result of a 200 basis point increase in rates. The forecasted results of the model are within the limits specified by ALCO. The following chart reflects our sensitivity to changes in interest rates as of September 30, 2006. The numbers are based on a static balance sheet, and the chart assumes that pay downs and maturities of both assets and liabilities are reinvested in like instruments at current interest rates, rates down 200 basis points, and rates up 200 basis points.

INTEREST RATE RISK

INCOME SENSITIVITY SUMMARY

	DOWN 200 BP			CURRENT			UP 200 BP
	(in thousands, except percentages)
Net interest income	$	33,481		$	36,090		$	38,717
$ change net interest income		(2,609	)		-			2,627
% change net interest income		-7.23	%		0.00	%		7.28	%

The preceding sensitivity analysis is a modeling analysis, which changes periodically and consists of hypothetical estimates based upon numerous assumptions including interest rate levels, shape of the yield curve, prepayments on loans and securities, rates on loans and deposits, reinvestments of paydowns and maturities of loans, investments and deposits, and other assumptions. In addition, there is no input for growth or a change in asset mix. While assumptions are developed based on the current economic and market conditions, we cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change.

37

As market conditions vary from those assumed in the sensitivity analysis, actual results will differ. Also, the sensitivity analysis does not reflect actions that we might take in responding to or anticipating changes in interest rates.

We use the Sendero Vision Asset/Liability system which is a comprehensive interest rate risk measurement tool that is widely used in the banking industry. Generally, it provides the user with the ability to more accurately model both static and dynamic gap, economic value of equity, duration and income simulations using a wide range of scenarios including interest rate shocks and rate ramps. The system also has the capability to model derivative instruments such as interest rate swap contracts.

ITEM 4. CONTROLS AND PROCEDURES

As of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer (CEO) and principal financial officer (CFO) have evaluated the effectiveness of our “disclosure controls and procedures” (Disclosure Controls). Disclosure Controls, as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act), are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Our management, including the CEO and CFO, does not expect that our Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based upon their controls evaluation, our CEO and CFO have concluded that our Disclosure Controls are effective at a reasonable assurance level.

There have been no significant changes in our internal control over financial reporting during our third fiscal quarter that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

As discussed in Management’s Report on Internal Controls over Financial Reporting in the Annual Report on Form 10-K for the year ended December 31, 2005, we elected to exclude from the scope of its assessment of internal control over financial reporting as of December 31, 2005, Jackson Bank which was acquired by First Security in a purchase business combination that was completed on August 31, 2005, and was integrated into our existing internal controls over financial reporting via a data conversion which occurred on March 10, 2006. Based on internal audits performed throughout the first three quarters of 2006, we are not aware of any facts that lead us to believe the data conversion of Jackson Bank constituted individually or collectively, a material weakness in our internal control over financial reporting.

38

PART II. OTHER INFORMATION

ITEM 1A. RISK FACTORS

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Period	Total Number of Shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July 1, 2006 - July 31, 2006	52,053	$   11.69	52,053	-
August 1, 2006 - August 31, 2006	-	-	-	-
September 1, 2006 - September 30, 2006	-	-	-	-
Total	52,053		52,053

On October 26, 2005, our Board of Directors authorized a plan to buy back up to 500,000 shares of our common stock in open market transactions; as of July 20, 2006, we had repurchased all 500,000 shares at a total average purchase price of $10.80 per share. The majority of the stock was purchased directly by our ESOP, although a portion was purchased by the Company. On July 20, 2006, the Company sold all 170,147 shares purchased to the ESOP for $11.03 per share in a private sale under Section 4(2) of the Securities Act of 1933, as amended; this transaction resulted in a net increase to stockholders’ equity of approximately $163 thousand. The Company originally purchased the 170,147 shares at an average price of $10.07 per share. Following this transaction, the ESOP owns 500,000 shares which will be used to match employee 401(k) contributions as well as incentive driven ESOP profit sharing opportunities.

39

ITEM 6. EXHIBITS

Exhibits:

EXHIBIT NUMBER DESCRIPTION

31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934

32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934

32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934

40

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed by the undersigned, thereunto duly authorized.

	FIRST SECURITY GROUP, INC.
	(Registrant)
November 9, 2006	/s/ Rodger B. Holley
	Rodger B. Holley
	Chairman, Chief Executive Officer & President
November 9, 2006	/s/ William L. Lusk, Jr.
	William L. Lusk, Jr.
	Secretary, Chief Financial Officer &
	Executive Vice President

41