SouthCrest Financial Group, Inc. (SCSG) 10-K 2008 FY Annual report

Exhibit 13.2

SouthCrest Financial Group, Inc. and Subsidiaries

Consolidated Balance Sheets

December 31, 2008 and 2007

(Dollars in thousands, except per share data)

Assets	2008			2007
Cash and due from banks	$	18,267		$	16,060
Interest-bearing deposits in other banks		16,763			10,637
Federal funds sold		7,776			9,316
Securities available for sale		78,110			79,208
Securities held to maturity (fair value $40,302 and $58,632)		40,039			58,885
Restricted equity securities, at cost		2,294			2,008
Loans held for sale		349			229
Loans, net of unearned income		395,788			373,825
Less allowance for loan losses		7,285			4,952
Loans, net		388,503			368,873
Bank-owned life insurance		16,997			16,302
Premises and equipment, net		19,373			18,093
Goodwill		6,397			14,255
Intangible assets, net		2,577			4,792
Other real estate owned		5,592			256
Other assets		7,514			7,095
Total assets	$	610,551		$	606,009
Liabilities, Redeemable Common Stock, and Stockholders' Equity
Liabilities:
Deposits:
Noninterest-bearing	$	75,912		$	80,685
Interest-bearing		443,789			433,246
Total deposits		519,701			513,931
Short-term borrowed funds		15,115			3,055
Long-term borrowed funds		1,667			6,555
Other liabilities		9,546			9,656
Total liabilities		546,029			533,197
Commitments and contingencies
Redeemable common stock held by ESOP		494			1,091
Stockholders' equity
Common stock, par value $1; 10,000,000 shares authorized, 3,931,528 and 3,931,528 issued		3,932			3,932
Additional paid in capital		49,812			49,707
Retained earnings		9,700			17,881
Unearned compensation - ESOP		(326	)		(349	)
Accumulated other comprehensive income		910			550
Total stockholders' equity		64,028			71,721
Total liabilities, redeemable common stock, and stockholders' equity	$	610,551		$	606,009

See Notes to Consolidated Financial Statements.

F-1

SouthCrest Financial Group, Inc. and Subsidiaries

Consolidated Statements of Operations

December 31, 2008, 2007, and 2006

(Dollars in thousands, except per share data)

	2008			2007		2006
Interest income:
Loans	$	27,836		$	29,455	$	23,314
Securities - taxable		5,296			5,695		4,859
Securities - nontaxable		900			830		551
Federal funds sold		248			497		509
Interest-bearing deposits in other banks		559			382		191
Total interest income		34,839			36,859		29,424
Interest expense:
Deposits		12,597			13,681		9,608
Borrowed funds		441			626		625
Total interest expense		13,038			14,307		10,233
Net interest income		21,801			22,552		19,191
Provision for loan losses		4,002			639		839
Net interest income after provision for loan losses		17,799			21,913		18,352
Other income:
Service charges on deposit accounts		3,979			3,846		3,304
Other service charges and fees		1,592			1,336		1,104
Net gain on sales and calls of securities available for sale		78			-		-
Impairment charge on investments		(570	)		-		-
Net gain on sale of loans		298			423		159
Income on bank-owned life insurance		695			594		340
Other operating income		508			598		457
Total other income		6,580			6,797		5,364
Other expenses:
Salaries and employee benefits		11,386			10,543		8,073
Equipment and occupancy expenses		2,507			2,120		1,643
Amortization of intangibles		1,095			926		807
Impairment of intangibles		9,121			-		-
Other operating expenses		6,254			6,045		4,644
Total other expenses		30,363			19,634		15,167
Income (loss) before income taxes		(5,984	)		9,076		8,549
Income tax expense		15			2,776		2,775
Net income (loss)	$	(5,999	)	$	6,300	$	5,774
Basic and diluted earnings (loss) per share	$	(1.53	)	$	1.60	$	1.58

See Notes to Consolidated Financial Statements.

F-2

SouthCrest Financial Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss)

Years Ended December 31, 2008, 2007, and 2006

(Dollars in thousands)

	2008			2007		2006
Net income (loss)	$	(5,999	)	$	6,300	$	5,774
Other comprehensive income (loss):
Unrealized holding gain on securities available for sale arising during period, net of taxes of $406, $436, and $144		666			721		328
Reclassification adjustment for gains included in net income, net of tax of $(186), $-0-, and $-0-		(306	)		-		-
Comprehensive income (loss)	$	(5,639	)	$	7,021	$	6,102

See Notes to Consolidated Financial Statements.

F-3

SouthCrest Financial Group, Inc. and Subsidiaries

Consolidated Statements of Stockholders' Equity

December 31, 2008, 2007 and 2006

(Dollars in thousands, except per share data)

													Accumulated
							Additional						Other Com-			Unearned			Total
	Common Stock						Paid In			Retained			prehensive			Compensation			Stockholders'
	Shares			Par Value			Capital			Earnings			Income (Loss)			(ESOP)			Equity
Balance, December 31, 2005		3,581,193		$	3,581		$	40,846		$	9,528		$	(499	)	$	-		$	53,456
Net income		-			-			-			5,774			-			-			5,774
Adjustment resulting from adoption of Staff Accounting Bulletin Number 108		-			-			-			233			-			-			233
Cash dividends declared, $.50 per share		-			-			-			(1,791	)		-			-			(1,791	)
Shares issued in business combination		371,135			371			9,093			-			-			-			9,464
Stock compensation		-			-			95			-			-			-			95
Adjustment for shares owned by ESOP		-			-			-			(4	)		-			-			(4	)
Unrealized gain on securities available for sale		-			-			-			-			328			-			328
Balance, December 31, 2006		3,952,328		$	3,952		$	50,034		$	13,740		$	(171	)	$	-		$	67,555
Net income		-			-			-			6,300			-			-			6,300
Cash dividends declared,
$.52 per share		-			-			-			(2,056	)		-			-			(2,056	)
Stock compensation		-			-			106			-			-			-			106
Purchase and retirement of stock		(20,800	)		(20	)		(433	)		-			-			-			(453	)
Adjustment for shares owned by ESOP		-			-			-			(103	)		-			-			(103	)
Change in unearned compensation - ESOP		-			-			-			-			-			(349	)		(349	)
Unrealized gain on securities available for sale		-			-			-			-			721			-			721
Balance, December 31, 2007		3,931,528		$	3,932		$	49,707		$	17,881		$	550		$	(349	)	$	71,721
Adjustment resulting from initial adoption of EITF Issue 06-4		-			-			-			(735	)		-			-			(735	)
Net loss		-			-			-			(5,999	)		-			-			(5,999	)
Cash dividends declared,$.52 per share		-			-			-			(2,044	)		-			-			(2,044	)
Stock compensation		-			-			105			-			-			-			105
Adjustment for shares owned by ESOP		-			-			-			597			-			-			597
Principal reduction of ESOP debt		-			-			-			-			-			23			23
Unrealized gain on securities available for sale		-			-			-			-			360			-			360
Balance, December 31, 2008		3,931,528		$	3,932		$	49,812		$	9,700		$	910		$	(326	)	$	64,028

See Notes to Consolidated Financial Statements.

F-4

SouthCrest Financial Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

For The Years Ended December 31, 2008, 2007, and 2006

(Dollars in thousands)

	2008			2007			2006
OPERATING ACTIVITIES
Net income (loss)	$	(5,999	)	$	6,300		$	5,774
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		1,228			1,097			824
Amortization of intangibles		1,095			926			807
Impairment charge on intangibles		9,121			-			-
Other amortization		118			234			113
Provision for loan losses		4,002			639			839
Stock compensation expense		105			106			95
Deferred compensation expense		831			470			251
Impairment loss on investment securities		570			-			-
Gain on sale of securities available for sale		(78	)		-			-
Deferred income taxes		(1,415	)		(320	)		(312	)
Income on bank-owned life insurance		(695	)		(594	)		(340	)
Decrease (increase) in interest receivable		962			(113	)		(421	)
Decrease in income taxes payable		(618	)		(28	)		(198	)
Decrease in interest payable		(1,048	)		(360	)		1,069
Net gain on sale of loans		(298	)		(423	)		(159	)
Originations of mortgage loans held for sale		(14,475	)		(12,046	)		(15,323	)
Proceeds from sales of mortgage loans held for sale		14,510			12,420			15,341
Loss on disposal of equipment		-			25			-
Loss on sale of other real estate		179			-			-
Decrease (increase) in other assets		223			167			(1,266	)
Increase (decrease) in other liabilities		(419	)		(605	)		136
Net cash provided by operating activities		7,899			7,895			7,230
INVESTING ACTIVITIES
Purchases of securities held to maturity		(5,113	)		-			-
Proceeds from maturities of securities held to maturity		23,944			8,319			10,947
Purchases of securities available for sale		(37,320	)		(23,701	)		(11,243	)
Proceeds from calls, maturities, and sales of securities available for sale		38,456			31,312			8,725
Net (increase) decrease in restricted equity securities		(286	)		278			362
Net (increase) decrease in interest-bearing deposits in other banks		(6,126	)		(5,575	)		254
Net increase in loans		(30,439	)		(13,481	)		(24,529	)
Purchase of premises and equipment		(2,508	)		(2,982	)		(3,393	)
Proceeds from sale of other real estate owned		1,337			584			630
Purchase of bank-owned life insurance		-			-			(5,495	)
Net cash equivalents (used in) acquired in business combination		-			(6,147	)		9,144
Net cash (used in) investing activities		(18,055	)		(11,393	)		(14,598	)

See Notes to Consolidated Financial Statements.

F-5

SouthCrest Financial Group, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (continued)

For The Years Ended December 31, 2008, 2007,and  2006

(Dollars in thousands)

	2008			2007			2006
FINANCING ACTIVITIES
Net increase in deposits	$	5,672		$	1,637		$	32,692
Increases in short-term borrowed funds		7,870			-			-
Principal repayments on short-term borrowed funds		(3,055	)		(110	)		(15,110	)
Increases in long-term borrowed funds		2,500			5,775			6,280
Principal repayments on long-term borrowed funds		(143	)		(5,000	)		(5,500	)
Purchase and retirement of stock		-			(453	)		-
Change in unearned compensation - ESOP		23			(349	)		-
Dividends paid		(2,044	)		(2,056	)		(1,791	)
Net cash provided by (used in) financing activities		10,823			(556	)		16,571
Net increase (decrease) in cash and due from banks		667			(4,054	)		9,203
Cash and cash equivalents at beginning of year		25,376			29,430			20,227
Cash and cash equivalents at end of year	$	26,043		$	25,376		$	29,430
SUPPLEMENTAL DISCLOSURES
Cash paid for:
Interest	$	12,273		$	14,207		$	9,164
Income taxes		1,718			2,982			3,156
NONCASH TRANSACTIONS
Principal balances of loans transferred to other real estate owned	$	6,852		$	704		$	506
Increase (decrease) in redeemable common stock held by ESOP		(597	)		103			4
Unrealized gain on securities available for sale, net		360			721			328
Adjustment for initial adoption of EITF 06-4		(735	)		-			-
BUSINESS COMBINATION
Cash and due from banks	$	-		$	3,103		$	8,497
Federal funds sold		-			8,100			3,204
Interest-bearing deposits in other banks		-			181			1,096
Securities available for sale		-			24,046			13,451
Restricted equity securities		-			257			121
Loans, net		-			26,344			33,229
Bank-owned life insurance		-			3,187			2,117
Premises and equipment		-			909			1,500
Goodwill		-			5,198			6,392
Core deposit intangible		-			715			1,052
Other assets		-			1,254			808
Total assets	$	-		$	73,294		$	71,467
Deposits	$	-		$	49,672		$	52,030
Short-term borrowed funds		-			3,000			-
Other liabilities		-			3,272			2,416
Total liabilities assumed		-			55,944			54,446
Purchase price	$	-		$	17,350		$	17,021

See Notes to Consolidated Financial Statements.

F-6

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Operations

SouthCrest Financial Group, Inc. (the “Company”) is a bank holding company whose principal activity is the ownership and management of its wholly-owned subsidiary banks (the “Banks”), Bank of Upson (“Upson”), First National Bank of Polk County (“FNB Polk”), Peachtree Bank (“Peachtree”), and Bank of Chickamauga (“Chickamauga”). Upson is a commercial bank located in Thomaston, Upson County, Georgia with seven branches located in Thomaston, Manchester, Warm Springs, Luthersville, Fayetteville, and Tyrone, Georgia. Upson provides a full range of banking services in its primary market area of Upson, Meriwether, Fayette and the surrounding counties. FNB Polk is a commercial bank located in Cedartown, Polk County, Georgia with two branches in Cedartown and one in Rockmart, Georgia. FNB Polk provides a full range of banking services in its primary market area of Polk and the surrounding counties.  Peachtree is a commercial bank located in Maplesville, Chilton County, Alabama and operates one branch in Maplesville and one in Clanton, Alabama.  Chickamauga is a commercial bank located in Chickamauga, Walker County, Georgia where it operates two branches.  The Company considers its banking services to represent a single reporting segment.

Basis of Presentation and Accounting Estimates

The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany transactions and balances have been eliminated in consolidation.

In preparing the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, the valuation of foreclosed real estate and contingent assets and liabilities. The determination of the adequacy of the allowance for loan losses is based on estimates that are susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans and the valuation of foreclosed real estate, management obtains independent appraisals for significant collateral.

Cash, Due from Banks and Cash Flows

For purposes of reporting cash flows, cash and due from banks include cash on hand, cash items in process of collection, amounts due from banks and federal funds sold. Cash flows from loans, interest-bearing deposits in other financial institutions, and deposits are reported net.

The Company’s subsidiaries are required to maintain reserve balances in cash or on deposit with the Federal Reserve Bank, based on a percentage of deposits. The total of those reserve balances was approximately $5,064,000 and $2,857,000 at December 31, 2008 and 2007, respectively.

Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as available for sale and recorded at fair value  with unrealized gains and losses excluded from earnings and reported in accumulated other comprehensive income, net of the related deferred tax effect. Equity securities, including restricted equity securities, without a readily determinable fair value are

recorded at cost.

F-7

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Securities (Continued)

The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the life of the securities. Realized gains and losses, determined on the basis of the cost of specific securities sold, are included in earnings on the settlement date. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

Loans

Loans are reported at their outstanding principal balances less unearned income, net deferred fees, and the allowance for loan losses. Loans held for sale are reported at the lower of cost or fair value, computed using outstanding commitments to sell loans.  Interest income is accrued on the outstanding principal balance. Loan fees collected and certain costs incurred related to loan originations are deferred and amortized as an adjustment to interest income over the life of the related loans using a method that approximates a constant yield.  Deferred fees and costs are recorded as an adjustment to loans outstanding.

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due, unless the loan is well-secured. All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income, unless management believes that the accrued interest is recoverable through the liquidation of collateral. Interest income on nonaccrual loans is recognized on the cash-basis or cost-recovery method, until the loans are returned to accrual status. Loans are returned to accrual status when all the principal and interest amounts are brought current and future payments are reasonably assured.

A loan is considered impaired when it is probable, based on current information and events, that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Impaired loans are measured by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The amount of impairment, if any, and any subsequent changes are included in the allowance for loan losses. Interest on accruing impaired loans is recognized as long as such loans do not meet the criteria for nonaccrual status.

Upson services mortgage loans that it originates and sells to the Federal Home Loan Mortgage Corporation (“Freddie Mac”). Upson’s servicing obligations include receiving payments, maintaining escrow accounts and paying hazard insurance, mortgage insurance, and taxes from such accounts, collecting past due fees, resolving payment problems and disputes, generating coupon payment books, and reporting loan balances to the Freddie Mac each month. Upson normally receives servicing fees of one quarter of one percent (.0025) of the outstanding loan balance of the loan servicing portfolio from the Freddie Mac. Upson accounts for loan servicing revenues by booking such revenues as they are received. The Company amortizes mortgage servicing rights over the estimated life of the loans.

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the allowance.

The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. This evaluation also takes into

F-8

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Allowance for Loan Losses (Continued)

consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, concentrations and current economic conditions that may affect the borrower’s ability to pay. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as either doubtful, substandard or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Premises and Equipment

Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed principally by the straight-line method over the estimated useful lives of the assets. The range of estimated useful lives is as follows:

Building and improvements	20–40 Years
Leasehold improvements	5–10 Years
Furniture and equipment	5–10 Years
Computer and software	3–5 Years

Other Real Estate Owned

Other real estate owned represents properties acquired through or in lieu of loan foreclosure and is initially recorded at fair value less estimated costs to sell. Any write-down to fair value at the time of transfer to other real estate owned is charged to the allowance for loan losses. Costs of improvements are capitalized, whereas costs relating to holding other real estate owned and subsequent adjustments to the value are expensed. The carrying amount of other real estate owned at December 31, 2008 and 2007 was $5,592,000 and $256,000.

Intangible Assets

Intangible assets consist of goodwill, core deposit premiums, and mortgage servicing rights.  Goodwill and core deposit premiums are acquired in connection with business combinations.  The core deposit premium is initially recognized based on a valuation performed as of the consummation date. The core deposit premium is amortized over the average remaining life of the acquired customer deposits, normally 8 to 12 years, using an accelerated or straight-line method, depending on the results of the initial valuation of the specific intangibles.  Mortgage servicing rights are recognized initially at fair value as loans are sold into the secondary market with servicing rights retained and are amortized over the estimated life of underlying loans.  All intangible assets, including goodwill, are tested annually for potential impairment.  During 2008, the Company recorded impairment charges of $7,858,000 related to goodwill and $1,263,000 related to core deposit intangible.  No impairment charges were recorded in 2007 and 2006.

Income Taxes

Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the

F-9

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes (Continued)

book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.  A valuation allowance may be recorded to reduce net deferred tax assets if it is more likely than not that some portion or all of the deferred tax asset will not be realized.  Such valuation allowances were not required as of December 31, 2008 or 2007.

Stock-Based Compensation

At the Company’s annual shareholders’ meeting held May 12, 2005, shareholders approved the adoption of the SouthCrest Financial Group, Inc. 2005 Stock Incentive Plan (the “Stock Incentive Plan”), which provides for up to 549,000 shares of the Company’s stock to be awarded in the form of stock options.

The Company adopted SFAS No. 123(R), Accounting for Stock-Based Compensation, on January 1, 2006 which requires that the estimated fair value of such equity instruments be recognized as expense as services are performed.

Profit-Sharing Plan

Profit-sharing plan costs are based on a percentage of individual employee’s salary, not to exceed the amount that can be deducted for Federal income tax purposes.

Earnings Per Share

Basic earnings per share are computed by dividing net income by the weighted-average number of shares of common stock outstanding. In calculating the weighted-average shares outstanding, shares secured by the Company’s loan to its Employee Stock Ownership Plan (the “ESOP”) are subtracted from shares outstanding.  Dilutive potential common shares are calculated in accordance with the treasury stock method, which assumes that proceeds from the exercise of all warrants and options are used to repurchase common stock at market value.  The amount of shares remaining after the proceeds are exhausted represents the potentially dilutive effect of the securities.  If the price at which the option may be exercised is greater than the average market price of the stock, then the option is assumed to be nondilutive and therefore is not included in the computation of diluted earnings per share.  In 2005, the Company issued 183,500 options under the SouthCrest Financial Group, Inc. 2005 Stock Incentive Plan (the “Stock Incentive Plan”), and in 2006 issued an additional 7,900 options.  The options granted were nondilutive for 2006, 2007 and 2008.  The Stock Incentive Plan is explained more fully in Note 10.  The weighted average number of shares outstanding for the years ended December 31, 2008, 2007, and 2006 was 3,916,707, 3,946,689, and 3,643,218, respectively.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.  The Company’s only component of comprehensive income is unrealized gains and losses on available for sale securities.

Recent Accounting Standards

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets-an amendment of FASB Statement No. 140. This statement requires that an entity recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset, and that the servicing assets and servicing liabilities be initially measured at fair value. The statement also permits an entity to choose a subsequent measurement method for each class of separately recognized servicing assets and servicing liabilities. The Company has elected to amortize its mortgage servicing rights.  SFAS No. 156 is effective as of the beginning of the first fiscal year that begins after September 15, 2006. The Company adopted SFAS No. 156 as of January 1, 2007 and it did not have a material impact on the Company’s financial condition or results of operations.

F-10

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Standards (Continued)

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. The interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in financial statements and requires the impact of a tax position to be recognized in the financial statements if that position is more likely than not of being sustained by the taxing authority.  The years 2004 through 2006 are still subject to audit for the Company’s Federal, Georgia, and Alabama income tax returns.  The Company adopted FIN 48 effective January 1, 2007, and its adoption did not have a material effect on the Company’s consolidated financial position or results of operation.  It is the Company’s policy to recognize interest and penalties associated with uncertain tax positions as components of income taxes.  There were no material interest or penalties accrued during the years ended December 31, 2008 and 2007.  No material tax uncertainties exist as of December 31, 2008 and 2007.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements.  SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 does not require any new fair value measurements, but clarifies and standardizes some divergent practices that have emerged since prior guidance was issued. SFAS No. 157 creates a three-level hierarchy under which individual fair value estimates are to be ranked based on the relative reliability of the inputs used in the valuation. This hierarchy is the basis for the disclosure requirements, with fair value estimates based on the least reliable inputs requiring more extensive disclosures about the valuation method used and the gains and losses associated with those estimates. The Company adopted SFAS No. 157 on January 1, 2008, with no material impact on the Company’s financial condition, results of operations, or liquidity.

In September 2006, the FASB ratified EITF Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF Issue 06-4 addresses accounting for split-dollar life insurance arrangements after the employer purchases a life insurance policy on the covered employee. This Issue states that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits. Under Issue EITF 06-4, the obligation is not settled upon entering into an insurance arrangement. Since the obligation is not settled, a liability should be recognized in accordance with applicable authoritative guidance. Issue EITF 06-4 is effective for fiscal years beginning after December 15, 2007. In adopting EITF Issue 06-4, the Company recorded a liability of $735,000 as of January 1, 2008 with a corresponding offset against retained earnings, and recorded compensation expense in 2008 of approximately $100,000 relating to these obligations.

In September 2006, the FASB ratified EITF Issue 06-5, Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin (“FTB”) No. 85-4, Accounting for Purchases of Life Insurance. This Issue addresses how an entity should determine the amount that could be realized under the insurance contract at the balance sheet date in applying FTB 85-4 and if the determination should be on an individual or group policy basis. EITF Issue 06-5 is effective for fiscal years beginning after December 15, 2006. The adoption of EITF Issue 06-5 did not have a material effect on the Company’s financial statements.

In September 2006, the SEC issued SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 was issued to clarify the appropriate treatment of misstatements in audited financial statements.  There are two methods for quantifying the effects of financial statement misstatements.  The “rollover” method focuses primarily on the impact of the misstatement on the income statement and, in some cases, considers the impact of reversing prior year misstatements.  However, if the cause of the misstatement does not reverse in the following year, the rollover method would result in the accumulation of misstatements on the balance sheet.  The “iron curtain” method focuses on the impact of the misstatements on the balance sheet.

F-11

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Standards (Continued)

SAB 108 establishes an approach that requires quantification of effects of the financial statement misstatements on the company’s financial statements and related disclosures.  This dual approach requires consideration of the impact of financial statement misstatements using both the iron curtain and the rollover methods.  SAB 108 permits companies to either restate prior period financial statements to reflect the dual approach method or to record the cumulative effect of initially applying the dual approach by adjusting the carrying value of assets and liabilities as of January 1, 2006 with an offsetting adjustment to the opening balance of retained earnings.

Prior to the adoption of SAB 108, the Company quantified the impact of misstatements using the rollover method and management determined the impact of those misstatements was not material to the consolidated financial statements.  The prior misstatements resulted from not capitalizing loan servicing rights on mortgage loans sold when future servicing rights were retained.  The Company adopted SAB 108 effective January 1, 2006 and elected to record the cumulative effect of the change, which resulted in the recognition of mortgage servicing rights of $375,000, a $142,000 adjustment to deferred income tax liabilities, and a $233,000 adjustment to retained earnings.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Liabilities.  SFAS No. 159 allows an entity to elect to measure certain financial assets and liabilities at fair value with changes in fair value recognized in the income statement each period.  The statement also requires additional disclosures to identify the effects of an entity’s fair value election on its earnings.  The Company adopted SFAS No. 159 on January 1, 2008, with no material impact on the financial condition, results of operations, or liquidity.   The Company did not elect fair value accounting on any assets or liabilities.

In November 2007, the SEC issued Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings (“SAB No. 109”). SAB No. 109 rescinds SAB No. 105’s prohibition on inclusion of expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. SAB No. 109 applies to any loan commitments for which fair value accounting is elected under SFAS No. 159. SAB No. 109 is effective prospectively for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. SAB No. 109 did not have a material impact on the Company’s financial condition or results of operations.

In March 2007, the FASB ratified EITF No. 06-10, Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements. One objective of EITF No. 06-10 is to determine whether a liability for future benefits under a collateral assignment split-dollar life insurance arrangement that provides a benefit to an employee that extends into postretirement periods should be recognized in accordance with SFAS No. 106 or APB Opinion 12, as appropriate, based on the substantive agreement with the employee. Another objective of EITF No. 06-10 is to determine how the asset arising from a collateral assignment split-dollar life insurance arrangement should be recognized and measured. EITF No. 06-10 is effective for fiscal years beginning after December 15, 2007. The Company adopted the provisions of EITF No. 06-10 in the first quarter of 2008. The adoption of EITF No. 06-10 did not have a material impact on the Company’s financial condition or results of operations.

In December 2007, the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) will significantly change how entities apply the acquisition method to business combinations. The most significant changes affecting how the Company will account for business combinations under this Statement include: the acquisition date will be date the acquirer obtains control; all (and only) identifiable assets acquired, liabilities assumed, and noncontrolling interests in the acquiree will be stated at fair value on the acquisition date; assets or liabilities arising from noncontractual contingencies will be measured at their acquisition date fair value only if it is more likely than not that they meet the definition of an asset or liability on the acquisition date; adjustments subsequently made to the provisional amounts recorded on the acquisition date will be made retroactively during a measurement period not to exceed one year; acquisition-related restructuring costs that do not meet the criteria in SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities, will be expensed as incurred; transaction costs will be expensed as incurred; reversals of deferred income tax valuation allowances and income tax contingencies will be recognized in earnings subsequent to the measurement period; and the allowance for loan

F-12

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

Recent Accounting Standards (Continued)

losses of an acquiree will not be permitted to be recognized by the acquirer. Additionally, SFAS No. 141(R) will require new and modified disclosures surrounding subsequent changes to acquisition-related contingencies, contingent consideration, noncontrolling interests, acquisition-related transaction costs, fair values and cash flows not expected to be collected for acquired loans, and an enhanced goodwill rollforward.

The Company will be required to prospectively apply SFAS No. 141(R) to all business combinations completed on or after January 1, 2009. Early adoption is not permitted. For business combinations in which the acquisition date was before the effective date, the provisions of SFAS No. 141(R) will apply to the subsequent accounting for deferred income tax valuation allowances and income tax contingencies and will require any changes in those amounts to be recorded in earnings. At December 31, 2008, the Company had no acquired deferred income tax valuation allowances and income tax contingencies.  Management is currently evaluating the effects that SFAS 141(R) will have on the financial condition, results of operations, liquidity, and the disclosures that will be presented in the consolidated financial statements.

Reclassification of Certain Items

Certain reclassifications to the prior year’s consolidated balance sheets and statements of income have been made to conform to current classification.  These reclassifications have no impact on net income, stockholders’ equity, or cash flows from operations, investing activities, or financing activities as previously reported.

NOTE 2. BUSINESS COMBINATIONS

On July 1, 2007 the Company completed its acquisition of Bank of Chickamauga pursuant to the definitive agreement entered into on February 23, 2007.  Bank of Chickamauga is a community bank located in the City of Chickamauga, Walker County, Georgia where it maintains two offices.  The City of Chickamauga is located in the Chattanooga, Tennessee metropolitan area, and completing this merger allows the Company to enter a new market.  Under terms of the definitive agreement, the shareholders of Chickamauga were to receive $18 million cash, less certain costs related to the merger and the termination of the Chickamauga defined benefit plan, in exchange for 100% of the voting stock of Bank of Chickamauga.  At the completion of the acquisition, Chickamauga shareholders received $17.2 million in cash with an additional $687,000 being placed in a reserve account to fund the costs related to terminating the Chickamauga defined benefit plan that are in excess of the $568,500 that was recorded on the books of Chickamauga as accrued pension expense but not yet transferred into the pension plan.  The reserve account is recorded as a liability in the financial statements.  Any funds remaining after the termination of the defined benefit plan will be distributed to the Chickamauga shareholders.  In February 2009, the Company received approval by the Internal Revenue Service for the Chickamauga pension plan’s termination which is scheduled for June 2009.

The merger was accounted for under the purchase method of accounting. Accordingly, results of operations for Bank of Chickamauga are included in the results of operations of SouthCrest prospectively from the date of merger, and the purchase price of $17.35 million, which includes merger costs of $150,000, was allocated to the fair values of Chickamauga’s assets and liabilities.  As a result, the Company initially recorded a core deposit intangible of $715,000 and goodwill of $5,198,000.  The core deposit intangible is being amortized on an accelerated basis over the estimated life of the deposits.  During the year ended December 31, 2008, the Company recorded impairment charges of $3,803,000 relating to the Chickamauga goodwill and $493,000 relating to the Chickamauga core deposit intangible based on a fair value determination.

Statement of Position 03-03, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-03”) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor's initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality.  It includes loans acquired in purchase business combinations.  The SOP does not apply to loans originated by the entity.  At July 1, 2007 the Company identified $559,000 in loans to which the application of the provisions of SOP 03-03 was required.  The carrying amount of these loans was

F-13

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. BUSINESS COMBINATIONS (Continued)

reduced to $376,000 at July 1, 2007, representing a nonaccretable adjustment of $183,000.  Because the Company could not reasonably estimate cash flows expected to be collected from these loans, interest income is only recognized when cash payments are received on such loans.  The purchase accounting adjustments reflect a reduction in loans for $183,000 related to Chickamauga’s impaired loans, thus reducing the carrying value of these loans to $376,000 as of July 1, 2007.  At December 31, 2008, the carrying value of these loans had been reduced to $267,000 due to foreclosures and cash payments received from the borrowers.  Interest income recognized on such loans is not material for the six months ended December 31, 2007 and the year ended December 31, 2008.

To fund the payments to the Chickamauga shareholders, the Company’s subsidiary banks paid $15 million in special dividends to the parent.  Additionally, the Company received an increase in its line of credit from $5.5 million to $8.0 million on the same terms and conditions as previously existed on the loan.  The interest rate for the line of credit is Prime minus 0.50%.  The Company drew $4 million on this line in connection with the merger.

On October 31, 2006, the Company completed its merger with Maplesville Bancorp. (“Maplesville”), a Maplesville, Alabama based bank holding company and the parent company of Peachtree Bank (“Peachtree”).  In connection with this merger, shareholders of Maplesville received approximately 371,135 shares of SouthCrest stock and $7,557,000 in cash.  The merger was accounted for using the purchase method of accounting.  Accordingly, results of operations for Peachtree Bank are included in the results of operations of SouthCrest prospectively from the date of merger, and the purchase price of $17.3 million, which includes merger costs of $254,000, was allocated to the fair values of Maplesville’s assets and liabilities.  As a result, the Company initially recorded a core deposit intangible of $1,052,000 and goodwill of $6,392,000.  The core deposit intangible was being amortized on an accelerated basis over the estimated life of the deposits. During the year ended December 31, 2008, the Company recorded impairment charges of $3,394,000 relating to the Peachtree goodwill and $771,000 relating to the Peachtree core deposit intangible based on a fair value determination.

The Company incurred certain merger costs related to the acquisitions of Maplesville and Chickamauga.  Presented in the table below is the activity in accrued merger costs related to Maplesville and Chickamauga:

	Beginning		Purchase		Charged to		Amounts		Ending
(Dollars in thousands)	Balance		Adjustments		Expense		Paid		Balance
Year ended December 31, 2008
Personnel costs	$	973	$	-	$	-	$	224	$	749
Professional fees		54		-		-		30		24
Data processing costs		545		-		-		545		-
Total	$	1,572	$	-	$	-	$	799	$	773
Year ended December 31, 2007
Severence and related costs	$	-	$	1,068	$	-	$	95	$	973
Professional fees		54		216		-		216		54
Data processing costs		150		585		-		190		545
Other		14		15		-		29		-
Total	$	218	$	1,884	$	-	$	530	$	1,572

The majority of the remaining accrued merger costs reflected above are expected to be paid out during 2009.   Personnel costs include change in control payments and the reserve for the termination of the Chickamauga defined benefit pension plan.  Professional fees primarily relate to investment banker fees, actuarial fees, legal fees and transfer agent fees. Data processing costs include fees paid for the early termination of service contracts with various data processing providers of the acquired banks and fees paid to SouthCrest’s data processing provider to convert the banks to SouthCrest’s data processing  system.

The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition including subsequent adjustments to the allocation of purchase price:

F-14

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 2. BUSINESS COMBINATIONS (continued)

Assets Acquired and Liabilities Assumed
(Dollars in thousands)
	Chickamauga		Maplesville
Cash and due from banks	$	3,103	$	8,497
Federal funds sold		8,100		3,204
Interest bearing deposits in other banks		181		1,096
Securities available for sale		24,046		13,451
Restricted equity securities		257		121
Loans, net		26,344		33,229
Bank-owned life insurance		3,187		2,117
Premises and equipment		909		1,500
Goodwill		5,198		6,392
Intangible assets		715		1,052
Other assets		1,254		808
Total assets acquired	$	73,294	$	71,467
Deposits	$	49,672	$	52,030
Short-term borrowed funds		3,000		-
Other liabilities		3,272		2,416
Total liabilities assumed		55,944		54,446
Purchase price	$	17,350	$	17,021

NOTE 3. SECURITIES

The amortized cost and fair value of securities are summarized as follows:

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollars in thousands)	Cost		Gains		Losses			Value
Securities Available for Sale
December 31, 2008:
U.S. Government and agency securities	$	24,703	$	509	$	-		$	25,212
State and municipal securities		16,824		285		(135	)		16,974
Mortgage-backed securities		32,035		1,090		(27	)		33,098
Corporate bonds and equity securities		3,083		22		(279	)		2,826
	$	76,645	$	1,906	$	(441	)	$	78,110
December 31, 2007:
U.S. Government and agency securities	$	30,254	$	305	$	(4	)	$	30,555
State and municipal securities		17,958		276		(8	)		18,226
Mortgage-backed securities		28,350		371		(120	)		28,601
Equity securities		1,763		90		(27	)		1,826
	$	78,325	$	1,042	$	(159	)	$	79,208

F-15

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3. SECURITIES (Continued)

			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(Dollars in thousands)	Cost		Gains		Losses			Value
Securities Held to Maturity
December 31, 2008:
U.S. Government and agency	$	2,989	$	28	$	-		$	3,017
State and municipal securities		6,403		105		(98	)		6,410
Mortgage-backed securities		29,647		369		(187	)		29,829
Corporate bonds		1,000		46		-			1,046
	$	40,039	$	548	$	(285	)	$	40,302
December 31, 2007:
U.S. Government and agency securities	$	20,289	$	45	$	(143	)	$	20,191
State and municipal securities		6,773		142		(18	)		6,897
Mortgage-backed securities		30,823		56		(388	)		30,491
Corporate bonds		1,000		53		-			1,053
	$	58,885	$	296	$	(549	)	$	58,632

The amortized cost and fair value of securities held to maturity and securities available for sale as of December 31, 2008 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Securities Available For Sale				Securities Held To Maturity
	Amortized		Fair		Amortized		Fair
(Dollars in thousands)	Cost		Value		Cost		Value
Due within one year	$	5,600	$	5,682	$	310	$	313
Due from one to five years		22,229		22,750		1,379		1,402
Due from five to ten years		10,223		10,368		5,347		5,486
Due after ten years		3,475		3,386		3,356		3,272
Mortgage-backed securities		32,035		33,098		29,647		29,829
Equity securities and corporate bonds		3,083		2,826		-		-
	$	76,645	$	78,110	$	40,039	$	40,302

Securities with a carrying value of $71,525,000 and $72,884,000 at December 31, 2008 and 2007, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

The following table shows the gross unrealized losses and fair value of securities, aggregated by category and length of time that securities have been in a continuous unrealized loss position at December 31, 2008.

F-16

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 3. SECURITIES (Continued)

(Dollars in thousands)	Less Than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of securities	Value		Losses			Value		Losses			Value		Losses
State and municipal securities	$	2,940	$	(147	)	$	364	$	(86	)	$	3,304	$	(233	)
Mortgage-backed securities		6,587		(71	)		5,858		(143	)		12,445		(214	)
Equity securities		1,021		(102	)		-		-			1,021		(102	)
Corporate bonds		767		(177	)		-		-			767		(177	)
Total	$	11,315	$	(497	)	$	6,222	$	(229	)	$	17,537	$	(726	)

The following table shows the gross unrealized losses and fair value of securities, aggregated by category and length of time that securities have been in a continuous unrealized loss position at December 31, 2007.

(Dollars in thousands)	Less Than 12 Months					12 Months or More						Total
	Fair		Unrealized			Fair			Unrealized			Fair		Unrealized
Description of securities	Value		Losses			Value			Losses			Value		Losses
U.S. Government and agency securities	$	1,987	$	(2	)	$	12,835	��	$	(145	)	$	14,822	$	(147	)
State and municipal securities		703		(8	)		627			(18	)		1,330		(26	)
Mortgage-backed securities		4,645		(27	)		30,234			(481	)		34,879		(508	)
Equity securities		613		(27	)		-			-			613		(27	)
Total	$	7,948	$	(64	)	$	43,696		$	(644	)	$	51,644	$	(708	)

These unrealized losses are considered temporary because of acceptable investment grades on each security,  the likelihood of the market value increasing to the initial cost basis of the security, and the intent and ability of the Company to hold these securities until recovery of the market values.  During the third quarter of 2008, the Company recorded an impairment charge of $570,000 on $640,000 of Federal National Mortgage Association (“Fannie Mae”) perpetual preferred stock. The reclassification of an unrealized mark-to-market loss on these securities to an other-than-temporary was based on the fair market value of the stock on at the time that the United States government took Fannie Mae into receivership.  Previous losses on the securities were recognized in the equity section of the balance sheet.  In order to take advantage of the tax benefit of the loss, the Company sold the securities in the fourth quarter of 2008 at an additional loss of $62,000 which is included in net gains on sale and calls of securities available for sale.  There were no sales of securities in 2007 and 2006.

NOTE 4. LOANS

The composition of loans is summarized as follows:

	December 31,
(Dollars in thousands)	2008			2007
Commercial, financial, and agricultural	$	18,740		$	22,595
Real estate – construction		74,095			66,069
Real estate – mortgage		261,866			241,316
Consumer		35,552			38,834
Other		5,547			5,162
		395,800			373,976
Unearned income		(12	)		(151	)
Allowance for loan losses		(7,285	)		(4,952	)
Loans, net	$	388,503		$	368,873

F-17

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 4. LOANS (Continued)

Loans serviced for others totaled $86,976,000, $83,856,000, and $79,680,000 at December 31, 2008, 2007 and 2006, respectively.

Changes in the allowance for loan losses are as follows:

	Years Ended December 31,
(Dollars in thousands)	2008			2007			2006
Balance, beginning of year	$	4,952		$	4,480		$	3,477
Provision for loan losses		4,002			639			839
Loans charged off		(2,244	)		(1,142	)		(903	)
Recoveries of loans previously charged off		575			611			436
Balance acquired in business combination		-			364			631
Balance, end of year	$	7,285		$	4,952		$	4,480

The following is a summary of information pertaining to impaired loans:

	As of and for the Years Ended
	December 31,
(Dollars in thousands)	2008		2007		2006
Impaired loans without a valuation allowance	$	-	$	-	$	-
Impaired loans with a valuation allowance		9,164		1,633		479
Total impaired loans	$	9,164	$	1,633	$	479
Valuation allowance related to impaired loans	$	1,603	$	245	$	72
Average investment in impaired loans	$	5,920	$	507	$	659

Interest income recognized on impaired loans for the years ended December 31, 2008, 2007, and 2006 was immaterial.

There were $9,164,000 and $1,633,000 in loans on nonaccrual status at December 31, 2008 and 2007, respectively.  Loans of $779,000 and $247,000 were past due ninety days or more and still accruing interest at December 31, 2008 and 2007, respectively.

In the ordinary course of business, the Company has granted loans to certain related parties, including executive officers, directors and their affiliates. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan. Changes in related party loans for the year ended December 31, 2008 are as follows:

(Dollars in thousands)
Balance, beginning of year	$	1,108
Advances		106
Repayments		(392	)
Balance, end of year	$	822

F-18

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 5. PREMISES AND EQUIPMENT

Premises and equipment are summarized as follows:

	December 31,
(Dollars in thousands)	2008			2007
Land	$	3,226		$	3,125
Buildings		14,513			12,720
Leasehold improvements		532			532
Construction in progress		243			393
Equipment		6,714			5,845
		25,228			22,615
Accumulated Depreciation		(5,855	)		(4,522	)
	$	19,373		$	18,093

Construction in progress amounts at December 31, 2008 relates to the construction of a branch facility to replace an existing branch at the Bank of Chickamauga in Chickamauga, Georgia, and at December 31, 2007 to the construction of the Company’s operations center in Thomaston, Georgia.  In 2007 the Company began operating a branch office in a leased facility in Tyrone, Fayette County, Georgia which is subject to a ten year lease.  Leasehold improvements for the office amounted to $513,000.

Leases:

In 2004 the Company leased a branch office location in Fayetteville, Fayette County, Georgia under a five year lease that will expire in August, 2009.  Effective April 30, 2009 the Company will consolidate its Fayette County banking operations at the Tyrone branch.  The Tyrone branch was opened in 2007 in a facility subject to a lease having a term of ten years with certain renewal options.

Rental expense under all operating leases amounted to $143,000, $114,000, and $91,000 for the years ended December 31, 2008, 2007 and 2006, respectively. Commitments for lease obligations are as follows:

(Dollars in thousands)
2009	$	121
2010		77
2011		79
2012		81
2013		82
Thereafter		315
	$	755

F-19

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. INTANGIBLE ASSETS

Following is a summary of information related to intangible assets:

	As of December 31, 2008					As of December 31, 2007
	Gross					Gross
	Carrying		Accumulated			Carrying		Accumulated
(Dollars in thousands)	Amount		Amortization			Amount		Amortization
Goodwill	$	6,397		-		$	14,255		-
Core deposit intangible	$	9,441	$	(7,389	)	$	9,441	$	(5,159	)
Mortgage servicing rights		1,006		(481	)		863		(353	)
Total other intangible assets	$	10,447	$	(7,870	)	$	10,304	$	(5,512	)

Goodwill impairment testing is performed annually or more frequently if events or circumstances indicate possible impairment.  The evaluation of goodwill for impairment uses both the income and market approaches to value the reporting units of the Company.  The income approach consists of discounting projected long-term future cash flows (earnings), which are derived from internal forecasts and economic expectations for the Company and its reporting units.  The significant inputs to the income approach include the long-term target tangible equity to tangible assets ratio and the discount rate, which is determined utilizing the Company’s cost of capital adjusted for a company-specific risk factor.   The company-specific risk factor is used to address the uncertainty of growth estimates and earnings projections of management.  Under the market approach, a value is calculated from an analysis of comparable acquisition transactions based on earnings, book value, assets and deposit premium multiples from the sale of similar financial institutions.  The Company’s goodwill testing for 2008, which was updated as of December 31, 2008, indicated that the intangible assets recorded at the time of acquisition of FNB Polk, Peachtree and Chickamauga were impaired based on the substantial decline in the Company’s common stock price and the economic outlook for the Company’s industry.  As a result, the Company recorded goodwill impairment charges of $7,858,000 and core deposit intangible impairment charges of $1,263,000 for the year ended December 31, 2008.  If the Company’s stock price continues to decline, if the Company does not produce anticipated cash flows, or if comparable banks begin selling at significantly lower prices than in the past, the Company’s goodwill may be further impaired in the future.

Amortization expense for the core deposit intangibles was $967,000, $926,000, and $807,000 for the years ended December 31, 2008, 2007, and 2006, respectively.  Amortization expense for the mortgage servicing rights was $128,000 and $131,000 for the year ended December 31, 2008 and 2007.  The estimated amortization expense of all intangible assets in future years is as follows:

(Dollars in thousands)
2009	$	863
2010		618
2011		304
2012		285
2013		273
Thereafter		234
	$	2,577

The following reflects the activity in our mortgage servicing assets:

F-20

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 6. INTANGIBLE ASSETS (continued)

(Dollars in thousands)	2008			2007
Beginning balance	$	510		$	375
Amounts recognized upon sales		143			266
Amortization		(128	)		(131	)
Ending balance	$	525		$	510

The fair value of mortgage servicing rights for loans originated during the year ended December 31, 2006 approximated $153,000.

NOTE 7. DEPOSITS

Deposits are as follows:

	December 31,
(Dollars in thousands)	2008		2007
Noninterest bearing deposits	$	75,912	$	80,685
Interest checking		95,979		83,742
Money market		54,545		55,687
Savings		42,651		41,997
Certificates of deposit		250,614		251,820
		519,701		513,931

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2008 and 2007 was $87,184,000 and $84,616,000, respectively. The scheduled maturities of time deposits at December 31, 2008 are as follows:

(Dollars in thousands)
2009	$	185,476
2010		29,796
2011		17,006
2012		8,186
2013		9,949
Thereafter		201
	$	250,614

Overdraft demand deposits reclassified to loans totaled $321,000 and $272,000 at December 31, 2008 and 2007, respectively.

F-21

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8. BORROWED FUNDS

Other borrowed funds consist of the following:

	December 31,
(Dollars in thousands)	2008		2007
Short-term borrowings
Federal Home Loan Bank line of credit with a maturity of August 13, 2009.  Interest is payable at a floating rate based on the daily rate credit.  The interest rate as of December 31, 2008 was 0.46%	$	7,870	$	-
Federal Home Loan Bank advance with a maturity of March 26, 2008.  Interest is payable monthly at a rate of 5.51%.		-		3,000
Current portion of Federal Home Loan Bank advance with a maturity of March 5, 2008.  Interest is payable monthly at a rate of 6.25%.  Principal is due in semi-annual installments of $55,000.		-		55
Current portion of Federal Home Loan Bank advance with a maturity of October 6, 2011.  Interest is payable monthly at a rate of 3.53%.  Principal is due in quarterly installments of $208,333.		833		-
Line of credit maturing October 1, 2018 secured by common stock of subsidiary banks.  Principal balance outstanding at October 16, 2008 is due in quarterly payments for a period of ten years beginning January 1, 2009.  Interest is payable quarterly at Prime minus 0.50%.		6,412		-
Total short-term borrowings		15,115		3,055
Long-term borrowings
Federal Home Loan Bank advance with a maturity of October 6, 2011.  Interest is payable monthly at a rate of 3.53%.  Principal is due in quarterly installments of $208,333.		1,667		-
Line of credit maturing October 1, 2018 secured by common stock of subsidiary banks.  Principal balance of outstanding at October 16, 2008 is due in quarterly payments for a period of ten years beginning January 1, 2009.  Interest is payable quarterly at Prime minus 0.50%		-		6,555
Total long-term borrowings		1,667		6,555
Total borrowings	$	16,782	$	9,610

Advances are collateralized by a blanket floating lien on qualifying first mortgages, pledges of certain securities and the Company’s Federal Home Loan Bank stock. The terms of the line of credit contain certain restrictive covenants including, among others, a requirement of each subsidiary bank to maintain certain minimum capital levels as well as maximum ratios related to the levels of nonperforming assets, to be measured quarterly.  At the inception of the loan, the restriction relative to maximum levels of nonperforming assets required that these assets not exceed 1% of each subsidiary’s total assets.  The Company was in violation of this covenant for the second and third quarters of 2008 for which it received waivers from the lender.  The Company and the lender agreed to amend the covenants such that each subsidiary’s nonperforming assets may not exceed 5% of total assets as of December 31, 2008 and for each quarter of 2009.  Thereafter, this ratio would reduce by 1% during each quarter in 2010 so that the maximum ratio returns to 1% of

F-22

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 8. BORROWED FUNDS (Continued)

total assets by December 31, 2010.  At December 31, 2008, as a result of the impairment of its goodwill and core deposit intangible assets, the Company was not in compliance with its covenant to maintain a minimum debt service coverage ratio, defined as net income of subsidiary banks multiplied by 50%, divided by the annual debt service of the Company.  The Company is working with Silverton Bank to obtain a waiver of this covenant.  If the Company remains outside this covenant and is unable to obtain a waiver or amendment of the loan agreement, Silverton Bank would have the right to give notice of default. If the Company is unable to cure the default within fifteen days of notice, then Silverton Bank would have the right to declare the entire balance of the loan due and payable, which could have a material adverse effect on the Company's liquidity and ability to pay dividends. Management intends to continue to vigorously pursue a favorable resolution to this issue, which in addition to the alternatives above, would include repayment of the loan through a payment of special dividends from the subsidiary banks, obtaining financing from another lender, or a combination of the two.

Contractual maturities of other borrowings as of December 31, 2008 are as follows:

2009	$	15,115
2010		833
2011		834
2012		-
2013		-
Thereafter		-
	$	16,782

NOTE 9. EMPLOYEE BENEFIT PLANS

The Company maintains two defined contribution retirement plans (the “Plans”) for its officers and employees:  the SouthCrest Financial Group, Inc. 401(k) and Profit-Sharing Plan (the “401(k) Plan”) and the SouthCrest Financial Group, Inc. Employee Stock Ownership Plan (the “ESOP”).  Annually, the Company makes a determination of the  total funds it will contribute to the Plans.  Once determined, funds are first contributed to the 401(k) plan with the remainder contributed to the ESOP.  For the years ended December 31, 2008, 2007, and 2006 the total funds contributed approximated 8% of compensation less amounts paid as incentives and bonuses.

401(k) and Profit Sharing Plan

The 401(k) Plan is available to all eligible employees, subject to certain minimum age and service requirements. For the years ended December 31, 2008, 2007 and 2006, the Company contributed 6% of an employee’s compensation to the Plan without regard to an employee’s level of participation.  The contributions expensed were $538,000, $445,000, and $391,000 for the years ended December 31, 2008, 2007 and 2006, respectively.  These expenses are included in salaries and employee benefits expense in the accompanying statements of income.

Employee Stock Ownership Plan

The ESOP is available to all eligible employees, subject to certain age and service requirements.  For the years ended December 31, 2008, 2007 and 2006, the Company contributed $203,000, $182,000, and $143,000  respectively, to the ESOP. These expenses are included in salaries and employee benefits expense in the accompanying statements of income.

In accordance with the ESOP, the Company is expected to honor the rights of certain participants to diversify their account balances or to liquidate their ownership of the common stock in the event of termination. The purchase price of the common stock would be based on the fair market value of the Company’s common stock as of the annual valuation date, which precedes the date the put option is exercised. No participant has exercised their right to diversify their account balances since the inception of the ESOP, and no significant cash outlay is expected during 2009. However, since the redemption of common stock is outside the control of the Company, the Company’s

F-23

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 9. EMPLOYEE BENEFIT PLANS (continued)

maximum cash obligation based on the approximate market prices of common stock as of the reporting date has been presented outside stockholders’ equity. The amount presented as redeemable common stock held by the ESOP in the consolidated balance sheet represents the Company’s maximum cash obligation and has been reflected as a reduction of retained earnings.

At December 31, 2008 and 2007, the ESOP held 69,388 and 66,666 shares of the Company stock. Shares held by the ESOP considered outstanding for purposes of calculating the Company’s earnings per share were 54,315 and 50,786 shares as of December 31, 2008 and 2007, respectively.  In November 2007, the ESOP purchased 15,880 shares funded by a $349,000 direct loan from the Company.  At December 31, 2008 and 2007, the balance of the loan was $326,000 and $349,000, respectively, and is reported on the balance sheet as “Unearned Compensation – ESOP” and is a reduction of stockholders’ equity.  This loan carries an interest rate of Prime minus 0.50% and is to be repaid over a term of fifteen years.  As principal reductions are made to the loan, shares are released from the loan as collateral and allocated to participant accounts.  The number of shares originally secured by the loan and allocated to participant accounts totaled 1,059 at December 31, 2008.  No shares were allocated to participant accounts at December 31, 2007.  Shares secured by the loan are not allocated to participant accounts and therefore are not considered outstanding for purposes of computing earnings per share.

Deferred Compensation Plan

The Company has a deferred compensation plan for death and retirement benefits for certain key officers. The estimated amounts to be paid under the compensation plan have been funded through the purchase of life insurance policies on the officers. The balance of the policy cash surrender values included in other assets at December 31, 2008 and 2007 is $16,997,000 and $16,302,000, respectively. Income recognized on the policies amounted to $695,000, $594,000, and $340,000 for the years ended December 31, 2008, 2007, and 2006, respectively. The balance of deferred compensation included in other liabilities at December 31, 2008 and 2007 is $4,871,000 and $4,139,000, respectively. Expense recognized for deferred compensation amounted to $776,000, $470,000, and $251,000 for the years ended December 31, 2008, 2007, and 2006, respectively.  In connection with its October 31, 2006 merger with Maplesville, the Company acquired bank-owned life insurance contracts with a fair value of $2,117,000 and assumed $1,483,000 in deferred compensation liabilities.  In connection with its July 1, 2007 merger with Chickamauga, the Company acquired bank-owned life insurance contracts with a fair value of $3,187,000 and assumed $927,000 in deferred compensation liabilities.

Defined Benefit Plan

In its July 1, 2007 acquisition of Bank of Chickamauga, the Company assumed the Bank of Chickamauga Defined Benefit Plan (the “Chickamauga Plan”).  In accordance with the Merger Agreement, the Chickamauga Plan  was terminated effective November 1, 2007.  The Company received Internal Revenue Service approval of the plan termination on February 19, 2009, and the final distribution is anticipated to be June 1, 2009.  When the Chickamauga Plan is terminated, participants will have the option of receiving a lump sum cash distribution or a private annuity that provides substantially the same benefit as they would have received under the Chickamauga Plan.   At December 31, 2007, the most recent period for which information is available, the Accumulated Benefit Obligation of the Chickamauga Plan was $2,510,000 and the plan assets were $1,879,000, leaving a plan shortfall of $631,000.  The Accumulated Benefit Obligation was calculated in accordance with IRS regulations governing plan terminations which will be in effect in 2008 when the Chickamauga Plan is terminated.  These regulations will require the use of multiple discount rates correlating to various durations of the estimated plan participant liabilities, resulting in an average discount rate of 4.85%.  At December 31, 2008 the Company had recorded on its books accrued pension expense totaling $568,500 to be used to fund any shortfall in plan assets at the time of the plan termination.  Any legal, actuarial, administrative or benefit costs to terminate the plan in excess of this amount will be funded from the $687,000 which was escrowed at the date of merger.  As of December 31, 2008, the balance of the escrowed account was $640,000.

F-24

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10. STOCK COMPENSATION PLAN

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, (“SFAS No. 123(R)”) which was issued by the Financial Accounting Standards Board in December 2004. SFAS No. 123(R) revises SFAS No. 123, Accounting for Stock Based Compensation (“SFAS 123”), and supersedes APB No. 25, Accounting for Stock Issued to Employees, (“APB No. 25”) and its related interpretations. SFAS No. 123(R) requires recognition of the cost of employee services received in exchange for an award of equity instruments in the financial statements over the period the employee is required to perform the services in exchange for the award (presumptively the vesting period). SFAS No. 123(R) also requires measurement of the cost of employee services received in exchange for an award based on the grant-date fair value of the award. SFAS No. 123(R) also amends SFAS No. 95, Statement of Cash Flows, to require that excess tax benefits be reported as financing cash inflows, rather than as a reduction of taxes paid, which is included within operating cash flows.

The Company adopted SFAS No. 123(R) using the modified prospective application as permitted under SFAS No. 123(R).  Accordingly, prior period amounts have not been restated. Under this application, the Company is required to record compensation expense for all awards granted after the date of adoption and for the unvested  portion of previously granted awards that remain outstanding at the date of adoption.  For the years ended December 31, 2008, 2007 and 2006, the Company recorded compensation expense related to stock options of $105,000, $106,000 and $95,000, respectively.

Prior to the adoption of SFAS No. 123(R), the Company used the intrinsic value method as prescribed by APB No. 25 and thus recognized no compensation expense for options granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant.

The Company maintains the SouthCrest Financial Group, Inc. 2005 Stock Incentive Plan (the “Stock Incentive Plan”), which provides for up to 549,000 shares of the Company’s stock to be awarded in the form of stock options.  Both incentive stock options and non-qualified options may be granted under the Plan.  The exercise price of each option equals the market price of the Company’s stock on the date of grant.  The incentive stock options generally vest at the rate of 20% per year over five years, and expire after ten years from the date of grant.  The Company immediately vested a grant of 104,000 stock options in 2005.  At December 31, 2008, 363,600 shares remained available for future grant.  Compensation cost that has been charged against income was approximately $105,000,  $106,000 and $95,000 for the years ended December 31, 2008, 2007 and 2006, respectively.  Because all options that are subject to expensing under SFAS No. 123(R) are tax qualifying, it is not expected that recognized compensation expense relating to these stock options will result in future tax benefits.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model.  The Company granted 7,900 stock options during the year ended December 31, 2006 which had a fair value of $6.48 for each option.  No options were granted for the years ended December 31, 2008 and 2007.  The following table presents the assumptions for the Black-Scholes model used in determining the fair value of options granted to employees in December, 2006:

	2006
Dividend yield		2.16	%
Risk-free interest rate		4.58	%
Expected life	6.5 years
Volatility		26.34	%

A summary of activity in the Stock Incentive Plan is presented below:

F-25

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 10. STOCK COMPENSATION PLAN (Continued)

					Weighted
			Weighted		Average
			Average		Remaining	Aggregate
			Exercise		Contractual	Intrinsic
	Options		Price		Term	Value
Outstanding at December 31, 2005		183,500	$	23.45
Granted		7,900	$	23.10
Exercised		-
Forfeited		-
Outstanding at December 31, 2006		191,400	$	23.44
Granted		-
Exercised		-
Forfeited		-
Outstanding at December 31, 2007		191,400	$	23.44
Granted		-
Exercised		-
Forfeited		6,000	$	23.39
Outstanding at December 31, 2008		185,400	$	23.44	7 years	$	-
Options exercisable at December 31, 2008		148,700	$	23.39	7 years	$	-

Since the inception of the Stock Incentive Plan, no options have been exercised.  Because the end of period stock price was less than or equal to the exercise prices of options outstanding, the options outstanding and exercisable at December 31, 2008 had no intrinsic value.  As of December 31, 2008, there was $204,000 of total unrecognized compensation cost related to non-vested share-based compensation arrangements, which is expected to be recognized over a weighted average life of 2.1 years.

Options outstanding at December 31, 2008 were as follows:

		Outstanding					Exercisable
						Weighted					Weighted
				Weighted		Average			Weighted		Average
				Average		Remaining			Average		Remaining
		Number of		Exercise		Contractual	Number of		Exercise		Contractual
Exercise Price		Options		Price		Term	Options		Price		Term
$	23.10		6,900	$	23.10	8 years		-	$	23.10	8 years
$	23.45		178,500	$	23.45	7 years		148,700	$	23.45	7 years
Total			185,400					148,700

F-26

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11. INCOME TAXES

The components of income tax expense are as follows:

	Years Ended December 31,
(Dollars in thousands)	2008			2007			2006
Current
Federal	$	1,378		$	2,803		$	2,764
State		52			293			323
Total current		1,430			3,096			3,087
Deferred
Federal		(1,191	)		(276	)		(281	)
State		(224	)		(44	)		(31	)
Total deferred		(1,415	)		(320	)		(312	)
	$	15		$	2,776		$	2,775

The Company’s income tax expense differs from the amounts computed by applying the Federal income tax statutory rates to income before income taxes. A reconciliation of the differences is as follows:

	Years Ended December 31,
(Dollars in thousands)	2008			2007			2006
Tax provision at statutory rate	$	(2,035	)	$	3,086		$	2,907
State income taxes, net of Federal benefit		(114	)		164			193
Tax-exempt income		(599	)		(504	)		(358	)
Goodwill impairment		2,672			-			-
Stock option expense		36			36			33
Other		55			(6	)		-
Income tax expense	$	15		$	2,776		$	2,775

The components of deferred income taxes are as follows:

F-27

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 11. INCOME TAXES (Continued)

	December 31,
(Dollars in thousands)	2008		2007
Deferred tax assets:
Loan loss reserves	$	2,611	$	1,686
Deferred compensation		1,847		1,434
Security impairment		-		136
Intangibles		209		674
Purchase accounting		318		-
		4,985		3,930
Deferred tax liabilities
Purchaes accounting		-		535
Securities available for sale		555		334
Mortgage servicing rights		198		192
Depreciation		647		479
		1,400		1,540
Net deferred tax assets	$	3,585	$	2,390

The years 2005 through 2008 are still subject to audit for the Company’s Federal, Georgia, and Alabama income tax returns.  No material tax uncertainties exist as of December 31, 2008 or 2007.

NOTE 12. COMMITMENTS AND CONTINGENCIES

Loan Commitments

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. They involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets. The majority of all commitments to extend credit and standby letters of credit are variable rate instruments.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. A summary of the Company’s commitments is as follows:

	December 31,
(Dollars in thousands)	2008		2007
Commitments to extend credit	$	29,842	$	33,929
Credit card commitments		8,545		9,323
Commercial letters of credit		926		1,282
	$	39,313	$	44,534

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit

F-28

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 12. COMMITMENTS AND CONTINGENCIES (Continued)

evaluation of the party. Collateral held varies, but may include accounts receivable, crops, livestock, inventory, property and equipment, residential real estate and income-producing commercial properties.

Credit card commitments are unsecured.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies and is required in instances which the Company deems necessary.

Contingencies

In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management, any liability resulting from such proceedings would not have a material adverse effect on the Company’s financial statements.

NOTE 13. CONCENTRATIONS OF CREDIT

The Company originates primarily commercial, residential, and consumer loans to customers in its respective markets. The ability of the majority of the Company’s customers to honor their contractual loan obligations is dependent on the economy in the Company’s primary market area.

Eighty five percent of the Company’s loan portfolio is concentrated in loans secured by real estate of which a substantial portion is secured by real estate in the Company’s primary market area. Accordingly, the ultimate collectibility of the loan portfolio is susceptible to changes in market conditions in the Company’s primary market area. The other significant concentrations of credit by type of loan are set forth in Note 4.

The Company, as a matter of policy, does not extend credit to any single borrower or group of related borrowers in excess of regulatory limits, or approximately $6,273,000 for Upson, $3,228,000 for FNB Polk, $1,989,000 for Peachtree, and $1,414,000 for Chickamauga.

NOTE 14. REGULATORY MATTERS

The Company’s bank subsidiaries are subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 2008, approximately $868,000 of retained earnings was available for dividend declaration without regulatory approval.

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

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Banks to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets, as defined, and of Tier I capital to average assets, as defined. Management believes, as of December 31, 2008 and 2007, the Company and the Banks met all capital adequacy requirements to which they are subject.

As of December 31, 2008, the most recent notification from the Federal Deposit Insurance Corporation categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that

F-29

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 14. REGULATORY MATTERS (Continued)

management believes have changed the Banks’ category. Prompt corrective action provisions are not applicable to bank holding companies.

The Company and the Banks’ actual capital amounts and ratios are presented in the following table.

(Dollars in thousands)	Actual					For Capital Adequacy Purposes					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2008
Total Capital to Risk Weighted Assets
Consolidated	$	60,623		13.90	%	$	34,898		8	%	$	N/A		N/A
Bank of Upson		32,662		13.70	%		19,078		8	%		23,848		10	%
FNB Polk County		20,612		19.03	%		8,667		8	%		10,834		10	%
Peachtree Bank		6,268		13.34	%		3,759		8	%		4,699		10	%
Bank of Chickamauga		6,111		16.94	%		2,885		8	%		3,606		10	%
Tier 1 Capital to Risk Weighted Assets
Consolidated	$	55,150		12.64	%	$	17,449		4	%	$	N/A		N/A
Bank of Upson		29,675		12.44	%		9,539		4	%		14,309		6	%
FNB Polk County		19,252		17.77	%		4,334		4	%		6,500		6	%
Peachtree Bank		5,680		12.09	%		1,880		4	%		2,819		6	%
Bank of Chickamauga		5,658		15.69	%		1,443		4	%		2,164		6	%
Tier 1 Capital to Average Assets
Consolidated	$	55,150		9.02	%	$	24,109		4	%	$	N/A		N/A
Bank of Upson		29,675		9.55	%		12,424		4	%		15,530		5	%
FNB Polk County		19,252		11.61	%		6,631		4	%		8,289		5	%
Peachtree Bank		5,680		8.31	%		2,734		4	%		3,418		5	%
Bank of Chickamauga		5,658		8.00	%		2,829		4	%		3,536		5	%
As of December 31, 2007
Total Capital to Risk Weighted Assets
Consolidated	$	59,423		14.51	%	$	32,770		8.00	%	$	N/A		N/A
Bank of Upson		31,746		14.53	%		17,480		8.00	%		21,850		10.00	%
FNB Polk County		20,891		18.84	%		8,871		8.00	%		11,089		10.00	%
Peachtree Bank		6,083		13.72	%		3,547		8.00	%		4,434		10.00	%
Bank of Chickamauga		5,911		16.68	%		2,834		8.00	%		3,543		10.00	%
Tier 1 Capital to Risk Weighted Assets
Consolidated	$	54,604		13.33	%	$	16,385		4.00	%	$	N/A		N/A
Bank of Upson		29,304		13.41	%		8,740		4.00	%		13,110		6.00	%
FNB Polk County		19,504		17.59	%		4,436		4.00	%		6,653		6.00	%
Peachtree Bank		5,536		12.49	%		1,774		4.00	%		2,660		6.00	%
Bank of Chickamauga		5,468		8.75	%		1,417		4.00	%		2,126		6.00	%
Tier 1 Capital to Average Assets
Consolidated	$	54,604		9.14	%	$	23,883		4.00	%	$	N/A		N/A
Bank of Upson		29,304		9.94	%		11,796		4.00	%		14,745		5.00	%
FNB Polk County		19,504		11.65	%		6,694		4.00	%		8,368		5.00	%
Peachtree Bank		5,536		8.75	%		2,531		4.00	%		3,164		5.00	%
Bank of Chickamauga		5,468		7.61	%		2,873		4.00	%		3,591		5.00	%

As a result of the business combinations with Maplesville Bancorp in 2006 and First Polk Bankshares in 2004, the Company recorded additions to its capital representing the fair value of the shares issued to Maplesville and First Polk shareholders. For regulatory capital purposes, the Company, as well as Peachtree Bank and FNB Polk County, must deduct from its regulatory capital the net book value of any intangible assets recorded in connection with the merger. The effect of the purchase accounting adjustments on the regulatory capital calculations is included above.

F-30

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair value is based on discounted cash flows or other valuation techniques. These techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No. 107, Disclosure about Fair Values of Financial Instruments, excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following methods and assumptions were used by the Company, in estimating the fair value of its financial instruments:

Cash, Due From Banks, Interest-Bearing Deposits at Other Banks and Federal Funds Sold:  The carrying amount of cash, due from banks, interest-bearing deposits at other banks and federal funds sold approximates fair value.

Securities: Fair value of securities is based on available quoted market prices. The carrying amount of equity securities with no readily determinable fair value, including restricted equity securities, approximates fair value.

Loans: The carrying amount of variable-rate loans that reprice frequently and have no significant change in credit risk approximates fair value. The fair value of fixed-rate loans is estimated based on discounted contractual cash flows, using interest rates currently being offered for loans with similar terms to borrowers with similar credit quality. The fair value of impaired loans is estimated based on discounted contractual cash flows or underlying collateral values, where applicable.

Deposits: The carrying amount of demand deposits, savings deposits, and variable-rate certificates of deposit approximates fair value. The fair value of fixed-rate certificates of deposit is estimated based on discounted contractual cash flows using interest rates currently being offered for certificates of similar remaining maturities.

Short-Term and Long-Term Borrowed Funds: The carrying amount of variable-rate notes payable and short-term Federal Home Loan Bank advances approximates fair value. The fair value of fixed rate Federal Home Loan Bank advances are estimated based on discounted contractual cash flows using the current incremental borrowing rates for similar type borrowing arrangements.

Accrued Interest: The carrying amount of accrued interest approximates fair value.

Bank-Owned Life Insurance: The cash surrender value of bank-owned life insurance approximates its fair value.

Off-Balance Sheet Instruments: The carrying amount of commitments to extend credit and standby letters of credit approximates fair value. The carrying amount of the off-balance sheet financial instruments is based on fees charged to enter into such agreements.

The estimated fair values and related carrying amounts of the Company’s financial instruments were as follows:

F-31

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

	2008				2007
	Carrying		Fair		Carrying		Fair
(Dollars in thousands)	Amount		Value		Amount		Value
Financial assets
Cash, due from banks, interest bearing deposits in other banks, and federal funds sold	$	42,806	$	42,806	$	36,013	$	36,013
Securities		118,149		118,412		138,093		137,840
Restricted equity securities		2,294		2,294		2,008		2,008
Loans and loans held for sale, net		396,136		399,408		369,102		378,367
Accrued interest receivable		2,939		2,939		3,901		3,901
Bank-owned life insurance		16,997		16,997		16,302		16,302
Financial liabilities
Deposits		519,701		524,136		513,931		517,638
Short-term borrowings		15,115		15,115		3,055		3,059
Long-term borrowings		1,667		1,684		6,555		6,555
Accrued interest payable		1,927		1,927		2,692		2,692

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements, (SFAS No. 157), which defines fair value, establishes a framework for measuring fair value under accounting principles generally accepted in the United States, and enhances disclosures about fair value measurements.  SFAS No. 157 clarifies that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions.

The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Available for sale securities are recorded at fair value on a recurring basis.  Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as loans held for sale, loans held for investment and certain other assets.  These nonrecurring fair value adjustments would typically involve application of lower of cost or market accounting or write-downs of individual assets.

SFAS 157 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value as follows:

Level 1  Observable inputs such as quoted prices in active markets;

Level 2  Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

Level 3  Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Following is a description of valuation methodologies used for assets recorded at fair value.

Investment Securities:  Securities available for sale and securities held to maturity are valued on a recurring basis at quoted market prices where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable securities.  Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds.  Level 2 securities include mortgage-backed securities and debentures issued by government sponsored entities, municipal bonds and corporate debt securities.  Securities classified as Level 3 include asset-backed securities in less liquid markets and some common stock not traded on a national exchange.    Securities held to maturity are valued at quoted market prices or dealer quotes, similar to securities available for sale.  The carrying value of Federal Reserve Bank and Federal Home Loan Bank stock approximates fair value based on their redemption provisions.

F-32

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

Loans Held for Sale:  Loans held for sale, consisting of mortgages to be sold in the secondary market, are carried at the lower of cost or market value.  The fair values of mortgage loans held for sale are based on commitments on hand from investors within the secondary market for loans with similar characteristics.  As such, the fair value adjustments for mortgage loans held for sale is nonrecurring Level 2.

Loans:  The Company does not record loans at fair value on a recurring basis. However, from time to time, a loan may be considered impaired and an allowance for loan losses may be established.  Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, (“SFAS No. 114”). The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows.  Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans.  At December 31, 2008, all of the total impaired loans were evaluated based on the fair value of the collateral.  In accordance with SFAS No. 157, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3.

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis.

			Fair Value Measurments at December 31, 2008 Using:
			Quoted Prices
			In Active		Significant
			Markets		Other		Significant
			for Identical		Observable		Unobservable
	Fair		Assets		Inputs		Inputs
(Dollars in thousands)	Value		(Level 1)		(Level 2)		(Level 3)
Securities available for sale	$	78,110	$	27	$	77,089	$	994

The securities measured as Level 3 include investment in the common stock of a bank holding company that is not listed on an exchange.  Its fair value is measured as a factor of book value.  There were no gains or losses for the year ended December 31, 2008  included in earnings that are attributable to the change in unrealized gains or losses of the Company’s securities available for sale at December 31, 2008.

For those securities available for sale with fair values that are determined by reliance on significant unobservable inputs, the following table identifies the factors causing the change in fair value for the year ended December 31, 2008:

F-33

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 15. FAIR VALUE OF FINANCIAL INSTRUMENTS (Continued)

	Investment
	Securities
	Available
	For Sale
Beginning balance, January 1, 2008	$	280
Total gains (losses) realized or unrealized
Included in earnings		-
Included in other comprehensive income		(139	)
Transfers in (out) of Level 3		853
Ending balance, December 31, 2008	$	994

The table below presents the recorded amount of assets and liabilities measured at fair value on a nonrecurring basis.

Fair Value Measurments at December 31, 2008 Using:

Quoted Prices

In Active

Significant

Markets

Other

Significant

for Identical

Observable

Unobservable

Fair

Assets

Inputs

Inputs

(Dollars in thousands)

Value

(Level 1)

(Level 2)

(Level 3)

Impaired loans

$

7,561

$

-

$

-

$

7,561

The values of loans held for sale are based on prices observed for similar pools of loans, appraisals provide by third parties and prices determined based on terms of investor purchase commitments. The value of impaired loans is determined by the estimated collateral value or by the discounted present value of the expected cash flows.

NOTE 16. SUPPLEMENTAL FINANCIAL DATA

Components of other operating expenses in excess of 1% of revenue are as follows:

	Years Ended December 31,
(Dollars in thousands)	2008		2007		2006
Data processing fees	$	1,486	$	1,454	$	1,222
Professional fees		740		620		439
Postage and supplies		707		692		527
Director fees		441		409		370

F-34

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17. PARENT COMPANY FINANCIAL INFORMATION

The following information presents the condensed balance sheets of SouthCrest Financial Group, Inc. as of December 31, 2008 and 2007 and the condensed statements of income and cash flows for each of the three years ended December 31, 2008:

CONDENSED BALANCE SHEETS
(Dollars in thousands)	2008		2007
Assets
Cash	$	1,008	$	1,001
Investment in subsidiaries		69,656		78,072
Securities available for sale		168		313
Other assets		256		152
Total assets	$	71,088	$	79,538
Liabilities, redeemable common stock and stockholders' equity
Short-term borrowed funds	$	6,412	$	6,555
Other liabilities		154		171
Redeemable common stock and stockholders' equity
Redeemable common stock held by ESOP		494		1,091
Stockholders' equity		64,028		71,721
Total liabilities, redeemable common stock and stockholders' equity	$	71,088	$	79,538

CONDENSED STATEMENTS OF INCOME
(Dollars in thousands)	2008			2007			2006
Dividend income from subsidiaries	$	2,873		$	17,942		$	9,120
Other income		76			-			-
Total income		2,949			17,942			9,120
Interest expense		307			191			4
Other expense		898			902			750
Total expenses		1,205			1,093			754
Income before income taxes and equity in undistributed income of subsidiaries		1,744			16,849			8,366
Income tax benefits		(389	)		(382	)		(250	)
Income before equity in undistributed income of subsidiaries		2,133			17,231			8,616
Equity in undistributed income (excess of distributions over income) of subsidiaries		(8,132	)		(10,931	)		(2,842	)
Net income (loss)	$	(5,999	)	$	6,300		$	5,774

F-35

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 17. PARENT COMPANY FINANCIAL INFORMATION (Continued)

CONDENSED STATEMENTS OF CASH FLOWS
(Dollars in thousands)	2008			2007			2006
OPERATING ACTIVITIES
Net income (loss)	$	(5,999	)	$	6,300		$	5,774
Adjustments to reconcile net income (loss) to net cash provided by operating activities
(Undistributed income) excess distributions over income of subsidiaries		8,132			10,931			2,842
Stock option expense		105			106			95
Change in other assets		(50	)		145			(167	)
Change in other liabilities		(17	)		83			115
Net cash provided by operating activities		2,171			17,565			8,659
INVESTING ACTIVITIES
Investment in subsidiaries		-			(2,250	)		-
Cash paid in business combination		-			(17,350	)		(7,987	)
Net cash used in investing activities		-			(19,600	)		(7,987	)
FINANCING ACTIVITIES
Proceeds from long-term borrowed funds		-			5,775			6,280
Repayment of long-term borrowed funds		(143	)		-			(5,500	)
(Increase) decrease in unearned compensation - ESOP		23			(349	)		-
Purchase and retirement of stock		-			(453	)		-
Dividends paid		(2,044	)		(2,056	)		(1,791	)
Net cash provided by (used in) financing activities		(2,164	)		2,917			(1,011	)
Net increase (decrease) in cash		7			882			(339	)
Cash at beginning of year		1,001			119			458
Cash at end of year	$	1,008		$	1,001		$	119
Noncash transactions:
Common stock issued in business combination	$	-		$	-		$	9,464
Unrealized gain (loss)  on securities available for sale		360			721			328

NOTE 18.  SUBSEQENT EVENTS

On January 27, 2009, the Company held its Special Meeting of Shareholders at which time the shareholders approved a proposal to amend its articles of incorporation to authorize a class of ten million (10,000,000)  of preferred stock, no par value.  This amendment would enable the Company to elect to participate in the U.S. Treasury’s TARP Capital Purchase Program if it is approved.

F-36

SOUTHCREST FINANCIAL GROUP, INC.

AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 18.  SUBSEQENT EVENTS (Continued)

On February 27, 2009, the Board of Directors of the Federal Deposit Insurance Corporation (FDIC) voted to amend the restoration plan for the Deposit Insurance Fund. The Board took action by imposing a special assessment on insured institutions of 20 basis points, implementing changes to the risk-based assessment system, and increased regular premium rates for 2009, which banks must pay on top of the special assessment. The 20 basis point special assessment on the industry will be as of June 30, 2009 payable on September 30, 2009. As a result of the special assessment and increased regular assessments, the Company projects it will experience an increase in FDIC assessment expense by approximately $1.5

 million from 2008 to 2009. The 20 basis point special assessment represents $1.0 million of this increase.

On March 5, 2009, the FDIC Chairman announced that the FDIC would consider lowering  the special assessment from 20 basis points to 10 basis points if Congress passes legislation that would expand the FDIC’s line of credit with the Treasury to $100 billion. Legislation to this end is currently before Congress.    If approved, the special assessment cost to the Company would be reduced by approximately $520,000.

 The assessment rates, including the special assessment, are subject to change at the discretion of the Board of Directors of the FDIC.

F-37

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

BOARD OF DIRECTORS AND STOCKHOLDERS

SOUTHCREST FINANCIAL GROUP, INC.

We have audited the accompanying consolidated balance sheets of SouthCrest Financial Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of operations, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  We were not engaged to perform an audit of the Company’s internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of SouthCrest Financial Group, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America.

As discussed in note 1 to the consolidated financial statements, effective January 1, 2008, the Company has adopted EITF Issue 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements.

/s/ Dixon Hughes PLLC

Atlanta, Georgia

April 3, 2009

 F-38