ASFN Atlantic Southern Financial Grp., Inc. (MM)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.  20549

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES AND EXCHANGE ACT OF 1934

(Mark One)

x       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

OR

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                 to                 

Commission File No. 000-51112

ATLANTIC SOUTHERN FINANCIAL GROUP, INC.

(Exact Name of Registrant as Specified in its Charter)

(478) 476-2170

(Registrant’s telephone number, including area code)

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, no par value

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

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x No o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or such shorter period that the Registrant was required to submit and post such files). Yes o No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

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

The aggregate market value of the registrant’s outstanding common stock held by nonaffiliates of the registrant as of June 30, 2009, was approximately $21,220,856.  There were 4,211,780 shares of the registrant’s common stock outstanding as of March 26, 2010.

DOCUMENTS INCORPORATED BY REFERENCE

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

The statements contained in this report on Form 10-K that are not historical facts including, without limitation, matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation,” are “forward-looking statements” subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.  We caution readers of this report that such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of us to be materially different from those expressed or implied by such forward-looking statements.  Although we believe that our expectations of future performance is based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations.

Factors which could cause actual results to differ from expectations include, among other things, the following:

·                   deterioration in the financial condition of borrowers resulting in significant increase in loan losses and provisions for those losses;

·                   the potential that loan charge-offs may exceed the allowance for loan losses or that such allowance will be increased as a result of factors beyond our control or the failure of assumptions underlying the establishment of reserves for possible loan losses;

·                   changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments;

·                   our dependence on senior management;

·                   competition from existing financial institutions, including commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, operating in our market areas and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet;

·                   changes in political and economic conditions, including the political and economic effects of the current economic downturn and other major developments, including the ongoing war on terrorism and potential adverse conditions in the stock market, the public debt market, and other capital markets (including changes in interest rate conditions);

·                   changes in deposit rates, the net interest margin, and funding sources;

·                   inflation, interest rate, market, and monetary fluctuations;

·                   risks inherent in making loans including repayment risks and value of collateral;

·                   the strength of the United States economy in general and the strength of the local economies in which we conduct operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on our loan portfolio and allowance for loan losses;

·                   changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including, without limitation, reduced rates of business formation and growth, commercial and residential real estate development, and fluctuations in consumer spending and saving habits;

·                   the demand for our products and services;

·                   technological changes;

·                   the challenges and uncertainties in the implementation of any future expansion and development strategies;

·                   the ability to increase market share with respect to deposits;

·                   the adequacy of expense projections and estimates of impairment loss;

·                   the impact of changes in accounting policies by the Securities and Exchange Commission;

·                   unanticipated regulatory or judicial proceedings;

·                   future legislation affecting financial institutions and changes to governmental monetary and fiscal policies (including without limitation laws concerning taxes, banking, securities, and insurance);

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·                   the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

·                   the timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet;

·                   other factors described in this report and in other reports we have filed with the Securities and Exchange Commission; and

·                   our success at managing the risks involved in the foregoing.

All written or oral forward-looking statements attributable to us are expressly qualified in their entirety by this Cautionary Note.  Our actual results may differ significantly from those we discuss in these forward-looking statements.

For other factors, risks and uncertainties that could cause our actual results to differ materially from estimates and projections contained in these forward-looking statements, please read the “Risk Factors” section of this Annual Report beginning on page 18.

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PART I

Item 1.                                   Business

Unless otherwise indicated, all references to “Atlantic Southern,” “Company,” we,” “us,” and “our” in this Annual Report on Form 10-K refer to Atlantic Southern Financial Group, Inc. and our wholly-owned subsidiary, Atlantic Southern Bank.

BUSINESS

Atlantic Southern Financial Group, Inc.

We are a bank holding company headquartered in Macon, Georgia and, through our wholly-owned subsidiary, Atlantic Southern Bank (the “Bank”), we operate nine banking locations in the central Georgia markets of Macon, Warner Robins, Roberta, Lizella, Bonaire and Byron, five in the coastal Georgia markets of Savannah, Darien, Rincon and Brunswick, Georgia, one location in the south Georgia market of Valdosta, Georgia and one banking location in Jacksonville, Florida. We serve the banking and financial needs of various communities in central, coastal and southern Georgia and northern Florida.

Our business is focused upon serving the needs of small to medium-sized business borrowers and individuals in the metropolitan areas we serve. Through Atlantic Southern Bank, we offer a range of lending services, of which some are secured by single and multi-family real estate, residential construction and owner-occupied commercial buildings. Although, we primarily make loans to small and medium-sized businesses, we also make loans to consumers for a variety of purposes. Our principal source of funds for loans and investing in securities are deposits. We offer a wide range of deposit services, including checking, savings, money market accounts and certificates of deposit. We actively pursue business relationships by utilizing the business contacts of our Board of Directors, senior management and local bankers, thereby capitalizing on our knowledge of the local marketplace.

On January 31, 2007, Atlantic Southern completed its acquisition of First Community Bank of Georgia (“FCB”), which had three branches in Bibb, Peach and Crawford counties.  In the acquisition, FCB shareholders received approximately 0.742555 share of Atlantic Southern common stock, for each share of First Community Bank common stock they held.

On November 30, 2007, Atlantic Southern completed its acquisition of CenterState Bank Mid Florida (“CenterState”). The main purpose of our acquisition was to facilitate the establishment of a branch office in Florida which, due to regulatory restrictions on branching, can only occur in a limited number of ways.  See “Supervision and Regulation — Atlantic Southern Bank — Branching,” on page 9.  We paid $1,093,878, including acquisition costs, in connection with the CenterState merger, and no shares of Atlantic Southern common stock were issued in connection with the transaction.

As a result of the extraordinary effects of what may ultimately be the worst economic downturn since the Great Depression, the Company’s and the Bank’s capital have been significantly depleted.  The Company recorded a net loss of $59.2 million in 2009, which was primarily the result of significant increases in the provision for credit losses, the recognition of goodwill impairment and the establishment of a valuation allowance against the Company’s deferred tax asset.  The impact of the current financial crisis in the U.S. and abroad is having far-reaching consequences and it is difficult to say at this point when the economy will begin to recover.  As a result, we cannot assure you that we will be able to resume profitable operations in the near future, if at all.

The Company and the Bank are required by federal regulatory authorities to maintain adequate levels of capital to support their operations.  On September 11, 2009, the Bank entered into an Order to Cease and Desist (the “Order”) with the Georgia Department of Banking and Finance (the “DBF”) and the FDIC. As part of the Order, the Bank is required to increase its capital and maintain certain regulatory capital ratios.  To comply with the Order, the Bank is required to have Tier 1 capital in such an amount as to equal or exceed 8% of the Bank’s total assets and total risk-based capital in an amount to equal or exceed 10% of the Bank’s risk-weighted assets.  The Company’s existing capital resources may not satisfy the requirements for the foreseeable future and may not be sufficient to offset any problem assets.  Further, should erosion to the Bank’s asset quality continue and require significant additional provision for credit losses, resulting in consistent net operating losses at the Bank, the Bank’s

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capital levels will decline and the Company will need to raise additional capital to satisfy the Order. The Company’s ability to raise additional capital will depend on conditions in the capital markets at that time, which are outside its control, and on its financial performance.  Accordingly, the Company cannot be certain of its ability to raise additional capital on terms acceptable to them.  The Company’s inability to raise capital or comply with the terms of the Order raises substantial doubt about its ability to continue as a going concern.

The Company’s Board of Directors is seeking all strategic alternatives to enhance the stability of the Company including a capital investment.  There can be no assurance, however, that the Company will succeed in this endeavor and be able to comply with regulatory requirements.  In addition, a transaction, which would likely involve equity financing, would result in substantial dilution to our current stockholders and could adversely affect the price of our common stock.  As a result of the Bank’s financial condition, the regulators are continually monitoring its liquidity and capital adequacy.  Based on their assessment of the Bank’s ability to continue to operate in a safe and sound manner, including its ability to comply with established capital requirements, the regulators may take further enforcement actions against the Company or the Bank, including placing the Bank into conservatorship or receivership, to protect the interests of depositors.

The consolidated financial statements, which are included in this annual report, have been prepared on a going concern basis.  As a result, the consolidated financial statements contemplate the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future and, consequently, do not include any adjustments to reflect the possible future effects on the recoverability or classification of assets and the amounts or classification of liabilities that may result from the outcome of any regulatory action, which would affect our ability to continue as a going concern.

The Company anticipates that it will enter into a written agreement (the “Agreement”) with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and the DBF, pursuant to which we expect to be prohibited from declaring or paying dividends without prior written consent from our regulators.  In addition, pursuant to the anticipated Agreement, without the prior written consent from our regulators, we expect to be prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank; paying interest, principal or other sums on subordinated debentures; incurring, increasing or guaranteeing any debt; redeeming any shares of our common stock; and increasing salaries or bonuses paid to executive officers.  The Company anticipates that all salaries, bonuses and fees, excluding the reimbursement of expenses valued at less than $500 in the aggregate per month per executive officer, must be preapproved by the Board of Directors on a regular basis.  In appointing any new director or any executive officer, the Company believes it will be required to notify regulatory authorities and comply with restrictions on indemnification and severance.  The Company expects to be required to submit a capital plan to maintain sufficient capital and a plan to reimburse the Bank for any payments made for the Company’s activities.

As of December 31, 2009, we had total assets of approximately $948.4 million, total deposits of approximately $861.2 million and shareholders’ equity of approximately $29.6 million.

Atlantic Southern Bank

Atlantic Southern Bank began its banking operations on December 10, 2001, after receiving final approval from the Georgia Department and the FDIC to organize as a state-chartered commercial bank with federally insured deposits.

The Bank is a full-service commercial bank specializing in meeting the financial needs of individuals and small- to medium-sized businesses and professional concerns in Bibb, Houston, Crawford, Peach, Effingham, McIntosh, Glynn, Lowndes and Chatham Counties in Georgia and Duval County in Florida. We focus on community involvement and personal service while providing customers with sophisticated financial products. We offer a broad array of competitively priced deposit services, including interest-bearing and non-interest bearing checking accounts, savings accounts, money market deposits, certificates of deposit and individual retirement accounts. In addition we complement our lending and deposit products by offering ATM and debit cards, official checks, credit cards, direct deposit, automatic transfer, savings bonds, night depository, stop payments, collections, wire transfers, overdraft protection, non-profit accounts, telephone banking, and 24-hour Internet banking.

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On September 11, 2009, the Bank entered into an Order to Cease and Desist with the DBF and the FDIC.  The Order is based on the findings of the DBF during an on-site examination conducted as of February 17, 2009.

Under the terms of the Order, the Bank is required to prepare and submit written plans and/or reports to the regulators that address the following items: raising sufficient capital at the Bank; improving the Bank’s liquidity position and contingent funding practices; reducing adversely classified items; revising its written lending, underwriting and collection policy; reducing concentrations of credit; limiting the use of loan interest reserves; reducing adversely classified loans and other extensions of credit to insiders; eliminating reliance on brokered deposits; and revising and implementing a profitability plan and comprehensive budget to improve and sustain the Bank’s earnings.  While the Order remains in place, the Bank may not extend new credit to anyone who has caused a loss on the Bank and may not pay cash dividends or bonuses without the prior written consent of its regulators. The Bank must also continue to increase the participation of the Board of Directors, address and correct all violations of law and regulation and contraventions of policy addressed in the report of examination, increase its Tier 1 capital ratio to at least 8% and total capital ratio of 10%, and charge off all assets classified as a loss.  The Bank is required to correct all exceptions listed on the “Asset with Credit Data or Collateral Documentation Exceptions” in the report of examination.  The Bank’s management team and Board of Directors have taken aggressive steps to address the requirements of the Order and the findings of the on-site examination, including but not limited to submitting a capital plan; reporting and maintaining the Bank’s liquidity position; reducing classified assets and concentrations; and reviewing and revising, where appropriate, the Bank’s policies and procedures in the areas identified above. At December 31, 2009, however, the Bank had Tier I capital at 4.73% and total risk-based capital at 6.19%, and, as a result, was not in compliance with the capital requirements set forth in the Order.

Our deposits are fully insured by the FDIC to the maximum amount permitted by law. We operate sixteen full-service banking offices in Macon, Warner Robins, Roberta, Lizella, Byron, Darien, Rincon, Brunswick, Valdosta and Savannah, Georgia, and Jacksonville, Florida. After the completion of the Sapelo acquisition in December 2006, the branches in McIntosh and Glynn Counties began to operate under the name “Sapelo Southern Bank”; however, we continue to operate the remaining branches located in other counties under the name “Atlantic Southern Bank.”

Market Area and Competition

We draw most of our customer deposits and conduct most of our lending transactions from and within our primary service areas, which encompass all of Bibb, Houston, Crawford, Peach, Effingham, McIntosh, Lowndes, Glynn and Chatham Counties in Georgia and Duval County, Florida.  The greater Macon metropolitan area is the focal point of our central Georgia service area, which consists of operations in Bibb and Crawford counties within the Macon Metropolitan Statistical Area (“MSA”), and in the adjacent counties of Houston and Peach.  The focal point of our coastal region includes the greater Brunswick, Darien and Savannah, Georgia metropolitan areas.  The primary service area of our south Georgia market includes all of the Valdosta, Georgia metropolitan area.  The focal point of our northern Florida market is the Jacksonville metropolitan area.

The table below shows our deposit market share in Bibb, Chatham, Crawford, Effingham, Glynn, Houston, Lowndes, McIntosh and Peach Counties, Georgia, and Duval County, Florida markets, as of June 30, 2009.

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Lending Activities

Primarily we make loans to small and medium-sized commercial businesses. In addition, we originate loans secured by single and multi-family real estate, residential construction and owner-occupied commercial buildings, as well as to consumers for a variety of purposes.

Our loan portfolio at December 31, 2009 was comprised by purpose code categories as follows:

In addition, we have entered into contractual obligations, via lines of credit and standby letters of credit, to extend approximately $34.7 million in credit as of December 31, 2009. We use the same credit policies in making these commitments as we do for our other loans. At December 31, 2009, our contractual obligations to extend credit were comprised as follows:

Commercial.  We make loans to small to medium-sized businesses whose demand for funds falls within our legal lending limits. This category of loans includes loans made to individual, partnership or corporate borrowers, and are obtained for a variety of business purposes. Risks associated with these loans can be significant and include, but are not limited to, fraud, bankruptcy, economic downturn, deteriorating or non-existing collateral and changes in interest rates.

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Construction Loans.  We make and hold real estate loans, consisting primarily of single-family residential construction loans for one-to-four unit family structures. We require a first lien position on the land associated with the construction project and offer these loans to professional building contractors and homeowners. Loan disbursements require on-site inspections by building inspectors independent of the loan decision to assure the project is on budget and that the loan proceeds are being used for the construction project and not being diverted to another project. The loan-to-value ratio for these loans is predominantly 80% of the lower of the as-built appraised value. Loans for construction can present a high degree of risk to the lender, depending upon, among other things, whether the builder can sell the home to a buyer, whether the buyer can obtain permanent financing, and the nature of changing economic conditions.

Pursuant to the Order, the Bank revised its policy on the use of interest reserves.  The revised policy limits the use of interest reserves to properly underwritten construction loans where development plans have specific timetables that commence within a reasonable time of the loan’s approval.

With respect to accounting, interest that has been added to the balance of a loan through the use of an interest reserve should not be recognized as income if its collectability is not reasonably assured.  The accrual of uncollected interest and its capitalization into the loan balance will not be appropriate when the loan becomes troubled and the full collection of contractual principal and interest is no longer expected.

When it is determined the collectability of a loan with an interest reserve component is not reasonably assured, the loan is placed in a non-accruing status and any unpaid accrued interest is reversed.  The decision to establish a loan funded interest reserve upon origination of an acquisition, development or construction loan is determined based on the feasibility of the project, the creditworthiness of the borrower and guarantors, and the protection provided by the real estate and other collateral.  The total cost of the project, including the interest reserve, is considered when determining the equity injection required from the borrower.

Interest reserves are required on all construction and development loans unless it is clearly established that the borrower has the capacity to pay the interest during the initial stages of the development from alternative resources on the proposed contractual basis of payment.  The reserve is included in the construction budget.  Interest is collected from the interest reserve on a monthly basis.  The interest is capitalized and added to the loan balance.  No restructured loans include an interest reserve component.

Commercial Real Estate.  The Bank offers both owner-occupied and income-producing commercial real estate loans. In addition, we offer land acquisition and development loans for subdivision, office, and industrial projects. The bank requires a first lien on the real estate associated with the commercial projects. Additionally, the borrower is required to assign the leases and rents on each project to the bank. The loan-to-value of these projects is approximately 80% for improved property and approximately 75% for development loans. We generally require the debtor cash flow to exceed 1.2% of monthly debt service obligations.

Consumer.  We make a variety of loans to individuals for personal, family and household purposes, including secured and unsecured installment and term loans, home equity loans and lines of credit. Consumer loan repayments depend upon the borrower’s financial stability and are more likely to be adversely affected by divorce, job loss, illness and personal hardships. Because depreciable assets such as boats, cars and trailers secure many consumer loans, we amortize these loans over the useful life of the asset. To minimize the risk that the borrower cannot afford the monthly payments, fixed monthly obligations are limited to no more than 40% of the borrower’s gross monthly income. The borrower should also be employed for at least 12 months prior to obtaining the loan. The loan officer reviews the borrower’s past credit history, past income level, debt history and, when applicable, cash flows to determine the impact of all of these factors on the borrower’s ability to make future payments as agreed.

Credit Risks.  The fundamental economic risk associated with each category of the loans we make is the creditworthiness of the borrower. General economic conditions and the strength of the services and retail market segments are factors that affect borrower creditworthiness. Risks associated with real estate loans also include fluctuations in the value of real estate, new job creation trends, tenant vacancy rates and, in the case of commercial borrowers, the quality of the borrower’s management team. Fluctuations in the value of real estate, as well as other factors arising after a loan has been made, could negatively affect a borrower’s cash flow, creditworthiness and ability to repay the loan. In addition, a commercial borrower’s ability both to properly evaluate changes in the

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supply and demand characteristics affecting its markets for products and services and to respond effectively to these changes are significant factors in the creditworthiness of a commercial borrower. General economic factors affecting a borrower’s ability to repay include interest, inflation and employment rates, as well as other factors affecting a borrower’s customers, suppliers and employees.

Lending Policies.  We seek credit-worthy borrowers within our primary service area. Our primary lending function is to make loans to small- to medium-sized businesses. In addition to commercial loans, we make installment loans, home equity loans, real estate loans and second mortgage loans to individual consumers.

Pursuant to the Order, the Bank was required to revise its written lending, underwriting and collection policy to provide effective guidance on its lending function, particularly with respect to acquisition, development and construction loans and commercial real estate lending. Management reviewed existing policies and adopted the following new policies: Real Estate Lending Policy, Non-Accrual Loan Policy, Allowance for Loan Losses Policy and Other Real Estate Owned Policy.  The new policies addressed the issues addressed in the Order.

Lending Approval and Review.  Under our loan approval process each lending officer is granted authority to extend loans up to an amount assigned and approved by the Board of Directors.  Loans that exceed an individual lending officer’s authority must obtain approval by the senior credit officer, the chief credit officer or the president, if the requested loan amount is within the senior credit officer, the chief credit officer or the president’s respective authority. If the requested loan amount is outside the senior credit officer, the chief credit officer or the president’s authority, the Board of Director’s Loan Committee must meet to provide the necessary approval. The Board of Director’s Loan Committee meets weekly to consider any lending requests exceeding the senior credit officer, the chief credit officer and president’s assigned lending authority.

Each Lending Officer is required to complete an annual review of the loans and the relationships that exceed a specified dollar amount.  The annual review analyzes all current financial and company information to insure the continued repayment ability and continued viability of the customer. Any negative change in the financial status of the customer is reported to the Directors’ Loan Committee on a quarterly basis.

Lending Limits.  Our legal lending limits are 15% of our unimpaired capital and surplus for unsecured loans and 25% of our unimpaired capital and surplus for loans secured by readily marketable collateral. As of December 31, 2009, our legal lending limit for unsecured loans was approximately $5.7 million, and our legal lending limit for secured loans was approximately $9.5 million. Due to the deterioration of capital at the Bank during the fourth quarter of 2009, the Bank currently has 18 loan relationships that exceed the Bank’s legal lending limit. However, pursuant to an amendment to the Georgia legal lending limit statute effective as of February 11, 2010, the Bank is permitted to renew maturing loans without violating the legal lending limit statute. While we generally employ more conservative lending limits, the Board of Directors has discretion to lend up to its legal lending limits.

Deposits

Our principal source of funds for loans and investing in securities are deposits. We utilize a comprehensive marketing plan, a broad product line and competitive products and services to attract deposits. We offer a wide range of deposit services, including checking, savings, money market accounts and certificates of deposit. The primary sources of deposits are the residents of the market areas we serve and local businesses and their employees. We believe that the rates we offer for core deposits are competitive with those offered by other financial institutions in our market areas. We are, however, prohibited from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, except in very limited circumstances where the FDIC permits use of a higher local market rate. The FDIC has determined that our Georgia markets are currently high rate market areas, and as a result, as of March 1, 2010, we are required to limit interest rates paid on deposits to no more than 75 basis points in excess of the local market averages, as calculated by FDIC requirements, for each market.  However, in our Jacksonville market, we are required to limit interest rates paid on deposits to no more than 75 basis points above a national average rate for deposits, as calculated by the FDIC.

Secondary sources of funding include advances from the Federal Home Loan Bank (FHLB), subordinated debt and other borrowings. Although the Bank is a member of the Federal Home Loan Bank, we do not have any further borrowing capacity at this time.  Currently, a portion of our deposits, brokered deposits, are from outside our market. Our brokered CDs represented 27.43% of total deposits as of December 31, 2009. Pursuant to the Order, and as a result of our classification as undercapitalized, the Company is prohibited from accepting, rolling over or renewing any brokered deposits without a brokered deposit waiver granted by the FDIC. In addition, pursuant to the Order, the

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Bank has completed, adopted and is in the process of implementing its plan to eliminate its reliance on brokered deposits.

Other Banking Services

Given customer demand for increased convenience and account access, we offer a range of products and services, including 24-hour Internet banking, direct deposit, safe deposit boxes, United States savings bonds and automatic account transfers. We earn fees for most of these services. We also receive ATM fees from transactions performed by our customers participating in a shared network of automated teller machines and a debit card system that our customers can use throughout the United States.

Investments

After establishing necessary cash reserves and funding loans, we invest our remaining liquid assets in securities allowed under banking laws and regulations. We invest primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States government, other taxable securities and in certain obligations of states and municipalities. We also invest excess funds in federal funds with our correspondent banks. The sale of federal funds represents a short-term loan from us to another bank. Risks associated with our investments include, but are not limited to, interest rate fluctuation, maturity and concentration.

Seasonality and Cycles

We do not consider our commercial banking business to be seasonal.

Employees

On December 31, 2009, we had 162 full-time employees. We consider our employee relations to be good, and we have no collective bargaining agreements with any employees.

Website Address

Our corporate website addresses are www.atlanticsouthernbank.com and www.sapelosouthernbank.com. From either website, select the “Investor Information” link followed by selecting “SEC Filings.” This is a direct link to our filings with the Securities and Exchange Commission (SEC), including, but not limited to, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and any amendments to these reports. These reports are accessible soon after we file them with the SEC.

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SUPERVISION AND REGULATION

We are subject to extensive state and federal banking regulations that impose restrictions on and provide for general regulatory oversight of our operations.  These laws generally are intended to protect depositors and not shareholders.  Legislation and regulations authorized by legislation influence, among other things:

·                  how, when and where we may expand geographically;

·                  into what product or service market we may enter;

·                  how we must manage our assets; and

·                  under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.

Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions.  The following summary is qualified by reference to the statutory and regulatory provisions discussed.  Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative changes and the policies of various regulatory authorities may significantly affect our operations.  We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.

Atlantic Southern Financial Group, Inc.

Because we own all of the capital stock of Atlantic Southern Bank, we are a bank holding company under the federal Bank Holding Company Act of 1956, as amended (the “Bank Holding Company Act”).  As a result, we are primarily subject to the supervision, examination and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve Board.  As a bank holding company located in Georgia, the DBF also regulates and monitors all significant aspects of our operations.

Acquisitions of Banks .  The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before:

·                  acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

·                  acquiring all or substantially all of the assets of any bank; or

·                  merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve Board may not approve any of these transactions if it would result in or tend to create a monopoly, substantially lessen competition or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served.  The Federal Reserve Board is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served.  The Federal Reserve Board consideration of financial resources generally focuses on capital adequacy, which is discussed below.

Under the Bank Holding Company Act, if we were adequately capitalized and adequately managed, we or any other bank holding company located in Georgia may purchase a bank located outside of Georgia.  Conversely, an adequately capitalized and adequately managed bank holding company located outside of Georgia may purchase a bank located inside of Georgia.  In each case, however, restrictions may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.  Currently, Georgia law prohibits acquisitions of banks that have been chartered for less than three years.  Because the Bank has been chartered for more than three years, this restriction would not limit our ability to sell.

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Change in Bank Control .  Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve Board approval prior to any person or company acquiring “control” of the bank holding company.  Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company.  Control is also rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:

·                  the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934, as amended; or

·                  no other person owns a greater percentage of that class of voting securities immediately after the transaction.

Our common stock is registered under Section 12 of the Securities Exchange Act of 1934, as amended.  The regulations provide a procedure for challenging rebuttable presumptions of control.

Permitted Activities .  The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve Board to be closely related to banking or managing or controlling banks as to be a proper incident thereto.  Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company.  Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity.  Those activities include, among other activities, certain insurance and securities activities.

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.”  Additionally, the Company must file an election with the Federal Reserve Board to become a financial holding company and must provide the Federal Reserve Board with 30 days’ written notice prior to engaging in a permitted financial activity.  The Company does not meet the qualification standards applicable to financial holding companies at this time.

Federal Reserve Board Debt Restrictions .   The Company expects that pursuant to its anticipated Agreement with the Federal Reserve Board and the DBF, it will be required to receive prior written approval of the Federal Reserve Board before it incurs additional debt.  These restrictions will likely prohibit us from paying dividends or redeeming or repurchasing shares of our capital stock without the prior written approval of the Federal Reserve Board.

Support of Subsidiary Institutions .  Under Federal Reserve Board policy, we are expected to act as a source of financial strength and commit resources to support the Bank.  This support may be required at times when, without this Federal Reserve Board policy, we might not be inclined to provide it.  In addition, any capital loans made by us to Bank will be repaid only after its deposits and various other obligations are repaid in full. In the event of our bankruptcy, any commitment we would give to a federal banking regulator to maintain the capital of the Bank would be assumed by the bankruptcy trustee and entitled to a priority of payment.

Atlantic Southern Bank

Because the Bank is a commercial bank chartered under the laws of the State of Georgia, we are primarily subject to the supervision, examination and reporting requirements of the FDIC and the DBF.  The FDIC and the DBF regularly examine the Bank’s operations and have the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions.  Both regulatory agencies have the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law.  Additionally, our deposits are insured by the FDIC to the maximum extent provided by law.  We are also subject to numerous state and federal statutes and regulations that affect our business, activities and operations.

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Branching .  Under current Georgia law, we may open branch offices throughout Georgia with the prior approval of the DBF.  In addition, with prior regulatory approval, we may acquire branches of existing banks located in Georgia.  The Bank and any other national or state-chartered bank generally may branch across state lines only if allowed by the applicable states’ laws.  Georgia law, with limited exceptions, currently permits branching across state lines only through interstate mergers.

With our acquisition of CenterState Banks Mid Florida and the opening of our Jacksonville branch location, we obtained the right under Florida law to establish an additional branch or additional branches in the State of Florida to the same extent that any Florida bank may establish an additional branch or additional branches within the State of Florida. Under current Florida law, we may open branch offices throughout Florida with the prior approval of the Division of Financial Institutions of the Florida Office of Financial Regulation. In addition, with prior regulatory approval, we may acquire branches of existing banks located in Florida.

Under the Federal Deposit Insurance Act, states may “opt-in” and allow out-of-state banks to branch into their state by establishing a new start-up branch in the state.  Currently, Georgia has not opted-in to this provision.  Therefore, interstate merger is the only method through which a bank located outside of Georgia may branch into Georgia.  This provides a limited barrier of entry into the Georgia banking market, which protects us from an important segment of potential competition.  However, because Georgia has elected not to opt-in, our ability to establish a new start-up branch in another state may be limited.  Many states that have elected to opt-in have done so on a reciprocal basis, meaning that an out-of-state bank may establish a new start-up branch only if their home state has also elected to opt-in.  Consequently, until Georgia changes its election, the only way we will be able to branch into states that have elected to opt-in on a reciprocal basis will be through interstate merger.

Prompt Corrective Action .  The Federal Deposit Insurance Corporation Improvement Act of 1991 establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions.  Under this system, the federal banking regulators have established five capital categories in which all institutions are placed:  Well Capitalized, Adequately Capitalized, Undercapitalized, Significantly Undercapitalized and Critically Undercapitalized.

As a bank’s capital condition deteriorates, federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories.  The severity of the action depends upon the capital category in which the institution is placed.  As of December 31, 2009, the Bank was considered undercapitalized.

A “well-capitalized” bank is one that exceeds all of its required capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6% and a tier 1 leverage ratio of at least 5%.  Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action.  However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices or has not adequately corrected a prior deficiency.

An “adequately capitalized” bank meets the required minimum level for each relevant capital measure, including a total risk-based capital ratio of at least 8%, a tier 1 risk-based capital ratio of at least 4% and a tier 1 leverage ratio of at least 4%.  A bank that is adequately capitalized is prohibited from directly or indirectly accepting, renewing or rolling over any brokered deposits, absent applying for and receiving a waiver from the FDIC.  Institutions that are not well-capitalized are also prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC.  In addition, an adequately capitalized bank may be forced to comply with certain operating restrictions similar to those placed on undercapitalized banks.

An “undercapitalized” bank fails to meet the required minimum level for any relevant capital measure.  A bank that reaches the undercapitalized level is likely subject to a consent order and other formal supervisory sanctions.  An undercapitalized bank must submit a capital restoration plan to regulatory authorities; be closely monitored by regulatory authorities regarding its capital restoration plan, financial condition and operational restrictions; restrict asset growth in accordance with an approved capital restoration plan; and obtain prior regulatory

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approval for acquisitions, branching and new lines of business.  In addition, an undercapitalized bank becomes subject to additional discretionary safeguards that may be imposed by its regulatory authorities, which may:

·                  prohibit capital distributions;

·                  prohibit payment of management fees to a controlling person;

·                  require a capital restoration plan within 45 days of becoming undercapitalized;

·                  restrict or prohibit asset growth, or require a bank to shrink;

·                  require prior approval by the primary federal regulator for acquisitions, branching and new lines of business;

·                  require sale of securities, or, if grounds for conservatorship or receivership exist, direct the bank to merge or be acquired;

·                  restrict affiliate transactions;

·                  restrict or prohibit all activities that are determined to pose an excessive risk to the bank;

·                  require the institution to elect new directors, dismiss directors or senior executive officer or employ qualified senior executive officers to improve management;

·                  prohibit the acceptance of deposits from correspondent banks;

·                  require prior approval of capital distributions by holding companies;

·                  require holding company divestiture of the bank, bank divestiture of subsidiaries, and/or holding company divestiture of other affiliates;

·                  require the bank to take any other action the federal regulator determines will “better achieve” prompt corrective action objectives;

·                  prohibit material transactions outside the usual course of business;

·                  prohibit amending the bylaws/charter of the bank;

·                  prohibit any material changes in accounting methods; and

·                  prohibit golden parachute payments, excessive compensation and bonuses.

See “—Regulatory Order” for specific requirements imposed on the Bank by its regulatory authorities.

A “significantly undercapitalized” bank, in addition to being subject to the restrictions applicable to undercapitalized institutions, is subject to additional restrictions on the compensation it is able to pay to its senior executive officers.

A “critically undercapitalized” bank, in addition to being subject to the restrictions applicable to undercapitalized and significantly institutions, is further prohibited from doing any of the following without the prior written approval of the FDIC:

·                  entering into any material transaction other than in the ordinary course of business;

·                  extending credit for any highly leveraged transaction;

·                  amending the institution’s charter or bylaws, except to the extent necessary to carry out any other requirement of any law, regulation or order;

·                  making any material change in accounting methods;

·                  engaging in certain types of transactions with affiliates;

·                  paying excessive compensation or bonuses;

·                  paying interest on new or renewed liabilities at a rate that would increase the institution’s weighted average cost of funds to a level significantly exceeding the prevailing rates of its competitors;

·                  making any principal or interest payment on subordinated debt 60 days or more after becoming critically undercapitalized;

In addition, the FDIC may impose additional restrictions on critically undercapitalized institutions consistent with the intent of the prompt corrective action regulations.  Once an institution has become critically undercapitalized, the FDIC will, subject to certain narrow exceptions such as a material capital remediation, initiate the resolution of the institution.

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Regulatory Order .  On September 11, 2009, the Bank entered into an Order to Cease and Desist with the DBF and the FDIC.  The Order is based on the findings of the DBF during an on-site examination conducted as of February 17, 2009.

Under the terms of the Order, the Bank is required to prepare and submit written plans and/or reports to the regulators that address the following items: raising sufficient capital at the Bank; improving the Bank’s liquidity position and contingent funding practices; reducing adversely classified items; revising its written lending, underwriting and collection policy; reducing concentrations of credit; limiting the use of loan interest reserves; reducing adversely classified loans and other extensions of credit to insiders; eliminating reliance on brokered deposits; and revising and implementing a profitability plan and comprehensive budget to improve and sustain the Bank’s earnings.  While the Order remains in place, the Bank may not extend new credit to anyone who has caused a loss on the Bank and may not pay cash dividends or bonuses without the prior written consent of its regulators. The Bank must also continue to increase the participation of the Board of Directors, address and correct all violations of law and regulation and contraventions of policy addressed in the report of examination, increase its Tier 1 capital ratio to at least 8% and total capital ratio of 10%, and charge off all assets classified as a loss.  The Bank is required to correct all exceptions listed on the “Asset with Credit Data or Collateral Documentation Exceptions” in the report of examination.  The Bank’s management team and Board of Directors have taken aggressive steps to address the requirements of the Order and the findings of the on-site examination, including but not limited to submitting a capital plan; reporting and maintaining the Bank’s liquidity position; reducing classified assets and concentrations; and reviewing and revising where appropriate the Bank’s policies and procedures in the areas identified above.

FDIC Insurance Assessments. The Bank’s deposits are insured by the Deposit Insurance Fund (the “DIF”) of the FDIC up to the amount permitted by law. The Bank is thus subject to FDIC deposit insurance premium assessments. The FDIC uses a risk-based assessment system that assigns insured depository institutions to one of four risk categories based on three primary sources of information — supervisory risk ratings for all institutions, financial ratios for most institutions, and long-term debt issuer ratings for large institutions that have such ratings. In February 2009, the FDIC issued new risk based assessment rates that took effect April 1, 2009. For insured depository institutions in the lowest risk category, the annual assessment rate ranges from 7 to 77.5 cents for every $100 of domestic deposits. For institutions assigned to higher risk categories, the new assessment rates range from 17 to 43 cents per $100 of domestic deposits. These ranges reflect a possible downward adjustment for unsecured debt outstanding and possible upward adjustments for secured liabilities and, in the case of institutions outside the lowest risk category, brokered deposits.

The FDIC’s assessment rates are intended to result in a reserve ratio of at least 1.15%. As of December 31, 2008, the ratio had fallen well below this floor.  The FDIC is required to return the DIF to its statutorily mandated minimum reserve ratio of 1.15 percent within eight years, and has undertaken several initiatives to satisfy this requirement.

On September 30, 2009, the FDIC collected a one-time special assessment of five basis points of an institution’s assets minus tier 1 capital as of June 30, 2009. The amount of the special assessment could not exceed ten basis points times the institution’s assessment base for the second quarter 2009.  In addition, on November 12, 2009, the FDIC adopted a rule that required nearly all FDIC-insured depository institutions to prepay their DIF assessments for the fourth quarter of 2009 and for the next three years.  The FDIC has indicated that the prepayment of DIF assessments will be in lieu of additional special assessments, although there can be no guarantee that continued pressures on the DIF will not result in additional special assessments being collected by the FDIC in the future.

The FDIC also collects a deposit-based assessment from insured financial institutions on behalf of The Financing Corporation (“FICO”). The funds from these assessments are used to service debt issued by FICO in its capacity as a financial vehicle for the Federal Savings & Loan Insurance Corporation. The FICO assessment rate is set quarterly and in 2009 ranged from 1.14 cents to 1.02 cents per $100 of assessable deposits. These assessments will continue until the debt matures in 2017 through 2019.

The FDIC may, without further notice-and-comment rulemaking, adopt rates that are higher or lower than the stated base assessment rates, provided that the FDIC cannot (i) increase or decrease the total rates from one quarter to the next by more than three basis points, or (ii) deviate by more than three basis points from the stated

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assessment rates. The FDIC has proposed maintaining current assessment rates through December 31, 2010, followed by a uniform increase in risk-based assessment rates of three basis points effective January 1, 2011.

The FDIC may terminate its insurance of deposits if it finds that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order, or condition imposed by the FDIC.

FDIC Temporary Liquidity Guarantee Program.  On October 14, 2008, the FDIC announced that its Board of Directors, under the authority to prevent “systemic risk” in the U.S. banking system, approved the Temporary Liquidity Guarantee Program (“TLGP”). The purpose of the TLGP is to strengthen confidence and encourage liquidity in the banking system.  The TLGP is composed of two components, the Debt Guarantee Program and the Transaction Account Guarantee Program, and institutions had the opportunity, prior to December 5, 2008, to opt-out of either or both components of the TLGP.

The Debt Guarantee Program :  Under the Temporary Liquidity Guarantee Program, the FDIC is permitted to guarantee certain newly issued senior unsecured debt issued by participating financial institutions.  The annualized fee that the FDIC will assess to guarantee the senior unsecured debt varies by the length of maturity of the debt.  For debt with a maturity of 180 days or less (excluding overnight debt), the fee is 50 basis points; for debt with a maturity between 181 days and 364 days, the fee is 75 basis points, and for debt with a maturity of 365 days or longer, the fee is 100 basis points.  The Bank did not opt-out of the Debt Guarantee component of the TLGP; however, it currently does not have any debt outstanding pursuant to this program.

The Transaction Account Guarantee Program : Under the TLGP, the FDIC is permitted to fully insure non-interest bearing deposit accounts held at participating FDIC-insured institutions, regardless of dollar amount. The temporary guarantee was originally set to expire on June 30, 2009, but was subsequently extended to June 30, 2010.  For the eligible noninterest-bearing transaction deposit accounts (including accounts swept from a noninterest bearing transaction account into an noninterest bearing savings deposit account), a 10 basis point annual rate surcharge will be applied to noninterest-bearing transaction deposit amounts over $250,000. Institutions will not be assessed on amounts that are otherwise insured.  The Bank chose not to opt-out of the Transaction Account Guarantee component of the TLGP.

Community Reinvestment Act .  The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal banking regulators shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods.  These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility.  Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank.  Additionally, we must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Allowance for Loan and Lease Losses .  The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Bank’s financial statements and regulatory reports.  Because of its significance, the Bank has developed a system by which it develops, maintains and documents a comprehensive, systematic and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses.  The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the Bank’s stated policies and procedures, management’s best judgment and relevant supervisory guidance.  Consistent with supervisory guidance, the Bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio.  The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the collectability of the portfolio as of the evaluation date.  See “Management’s Discussion and Analysis — Control Accounting Policies.”

Commercial Real Estate Lending .  The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans.  On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations.  CRE loans generally include land development, construction loans, and

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loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property.  The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:

·                  total reported loans for construction, land development and other land represent 100% or more of the institution’s total capital, or

·                  total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.

Other Regulations .  Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates.  Our loan operations will be subject to federal laws applicable to credit transactions, such as the:

·                  Federal Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

·                  Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

·                  Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

·                  Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;

·                  Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

·                  Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended by the Servicemembers’ Civil Relief Act, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the United States military;

·                  Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for consumer loans to military service members and their dependents; and

·                  rules and regulations of the various federal banking regulators charged with the responsibility of implementing these federal laws.

The Bank’s deposit operations are subject to federal laws applicable to depository accounts, such as the:

·                  Truth-In-Savings Act, requiring certain disclosures of consumer deposit accounts:

·                  Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

·                  Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

·                  rules and regulations of the various federal banking regulators charged with the responsibility of implementing these federal laws.

Capital Adequacy

We are required to comply with the capital adequacy standards established by the Federal Reserve Board.  The Federal Reserve Board has established a risk-based and a leverage measure of capital adequacy for member banks and bank holding companies.

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets.  Assets and off-balance-sheet items, such as letters of credit

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and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights.  The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

The minimum guideline for the ratio of total capital to risk-weighted assets, and classification as adequately capitalized, is 8%.  A bank that fails to meet the required minimum guidelines is classified as undercapitalized and subject to operating and managerial restrictions.  A bank, however, that exceeds its capital requirements and maintains a ratio of total capital to risk-weighted assets of 10% is classified as well capitalized.

Total capital consists of two components:  Tier 1 Capital and Tier 2 Capital.  Tier 1 Capital generally consists of common shareholders’ equity, minority interests in the equity accounts of consolidated subsidiaries, qualifying noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets.  Tier 1 Capital must equal at least 4% of risk-weighted assets.  Tier 2 Capital generally consists of subordinated debt, other preferred stock and hybrid capital, and a limited amount of loan loss reserves.  The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital.

The Bank’s ratio of total capital to risk-weighted assets and ratio of Tier 1 Capital to risk-weighted assets were 6.19% and 4.73%, respectively, as of December 31, 2009.  As a result of our regulatory capital ratios, we were considered “undercapitalized” by our bank regulatory authorities on December 31, 2009.  As described above, an undercapitalized bank is subject to extensive operational restrictions on its operations.

The Federal Reserve Board has similarly established minimum leverage ratio guidelines for bank holding companies.  These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve Board risk-based capital measure for market risk.  All other bank holding companies generally are required to maintain a leverage ratio of at least 4%.  At December 31, 2009, our leverage ratio was 3.44%.  The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets.  The Federal Reserve Board considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

Failure to meet capital guidelines can subject a bank and a bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits and certain other restrictions on its business.  As described above and elsewhere throughout this report, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.  See, “Supervision and Regulation — Atlantic Southern Bank — Prompt Corrective Action,” above, for a summary of the restrictions to which we may become subject due to our capital condition.

Payment of Dividends

The Company is a legal entity separate and distinct from the Bank  The principal sources of our cash flow, including cash flow to pay dividends to our shareholders, are dividends that we receive from the Bank.  Statutory and regulatory limitations apply to the payment of dividends by a subsidiary bank to its bank holding company.

The Bank is generally required to obtain prior approval of the Georgia Department if the total of all dividends declared by the Bank in any year will exceed 50% of the Bank’s net income for the prior year.  These same limitations apply to a bank holding company’s payment of dividends to its shareholders.  Our payment of dividends may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines.  In addition, administrative agreements with or actions taken by our primary regulators may impose additional restrictions on our ability to pay dividends.

If, in the opinion of the federal banking regulator, the Bank was engaged in or about to engage in unsafe or unsound practice, the federal banking regulator could require, after notice and a hearing, that we stop or refrain from engaging in the practice it considers unsafe or unsound.  The federal banking regulators have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice.  Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository

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institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized.  Moreover, the federal banking regulators have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

As of the date of this annual report on Form 10-K, the Bank could not pay cash dividends without prior regulatory approval.  In addition, pursuant to the expected Agreement with the Federal Reserve Board and the DBF, it is likely that the Company will be unable to pay and declare dividends, or take payment from the Bank representing a reduction in capital, without prior regulatory consent.  The Company anticipates that any request for prior approval will need to be consistent with the Board of Governors’ Policy Statement on the Payment of Cash Dividends by State Member Banks and Bank Holding Companies, dated November 14, 1985, and the Georgia Department Statement of Policies.

Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on many of the statutory and regulatory factors mentioned above.

Restrictions on Transactions with Affiliates

The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act.  Section 23A places limits on the amount of:

·                  a bank’s loans or extensions of credit to affiliates;

·                  a bank’s investment in affiliates;

·                  assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve Board;

·                  loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

·                  a bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus.  In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements.  We must also comply with other provisions designed to avoid the taking of low-quality assets.

We are subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

We are subject to restrictions on extensions of credit to our executive officers, directors, principal shareholders and their related interests.  These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Proposed Legislation and Regulatory Action

New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating and doing business in the United States.  We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Effect of Governmental Monetary Policies

The Bank’s earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies.  The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession.  The

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monetary policies of the Federal Reserve Board affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks, and its influence over reserve requirements to which member banks are subject.  We cannot predict the nature or impact of future changes in monetary and fiscal policies.

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Item 1A.                          Risk Factors

An investment in our common stock involves risks. The risks described below, should be considered in conjunction with the other information, including our consolidated financial statements and related notes. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and shareholders may lose all or part of their investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

Our independent registered public accounting firm’s report discloses a going concern issue for the Company .

Our financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.  However, due to our financial results, the substantial uncertainty throughout the U.S. banking industry and other matters discussed in this report, our independent public accountants have expressed, in their opinion, on our Consolidated Financial Statements, included in this report, that a substantial doubt exists regarding the Company’s ability to continue as a going concern.  Continued operations may depend on our ability to comply with the terms of the Order, the terms of the expected written agreement with the Federal Reserve Board and the DBF , and the infusion of additional capital, which may be unavailable or available only on unacceptable terms.  Our audited financial statements were prepared under the assumption that we will continue our operations on a going concern basis, which contemplated the realization of assets and the discharge of liabilities in the normal course of business.  Our financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  If we are unable to continue as a going concern, you could lose some, if not all, of your investment.

We are subject to heightened regulatory scrutiny and are currently under a Cease and Desist Order and anticipate becoming subject to a written agreement, both of which impose additional requirements and restrictions on our business.

The Bank is primarily regulated by the FDIC and the DBF .  Our compliance with FDIC and DBF regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices.  The Bank is also subject to capital requirements of our regulators.

Based on the results of our February 17, 2009 regulatory examination, particularly with respect to our levels of capital and classified assets, the DBF and FDIC have required us to enter into a Cease and Desist Order. The Order includes provisions requiring reductions in classified assets, improvements in liquidity and funds management practices, maintenance of an appropriate allowance for loan losses and specified capital ratios, dividend and bonus restrictions, amendments to our policies and frequent progress reports to regulatory authorities, as well as other provisions to help us improve our financial condition and profitability.  Under the Order, the Bank must achieve and maintain total risk-based capital at or above 10% of total risk-weighted assets, and Tier 1 capital at or above 8% of total assets.  If we do not comply with the terms of this order, we could face additional regulatory sanctions or civil money penalties.  See “Supervision and Regulation—Regulatory Order” for a further description of the Order.

The Company is subject to the supervision of the Federal Reserve Board and the Georgia Department, pursuant to which we anticipate that we will be required to execute an Agreement with our regulators that will prohibit us from declaring or paying dividends without prior written consent, and such request for consent must be in compliance with the Board of Governor’s Policy Statement on the Payment of Cash Dividends by State Member Bank Holding Companies, dated November 14, 1985, and Georgia Department Statement of Policies.  Moreover, we anticipate that pursuant to the Agreement, without prior written consent from our regulators, the Company will be prohibited from taking dividends, or any other form of payment representing a reduction in capital from, the Bank; paying interest, principal or other sums on subordinated debentures; incurring, increasing or guaranteeing any debt; redeeming any shares of our capital stock; and increasing salaries or bonuses paid to executive officers.  We anticipate that the expected Agreement will require all salaries, bonuses and fees to be paid to executive officers, excluding the reimbursement of documented, reasonable expenses, limited to an aggregate of $500 per month per officer, must be preapproved by the Board on a regular basis.  In appointing any new director or any executive officer, we expect to be required to notify our regulators and comply with regulatory restrictions on indemnification and severance

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payments.  Finally, the Company, pursuant to the expected Agreement, anticipates being required to submit a capital plan to maintain sufficient capital and a plan to reimburse the Bank for payments made for the Company’s activities.

Compliance with the Order and the expected Agreement will require significant time and attention from our management team, which may increase costs, impede efficiency of our internal business processes and adversely affect our profitability in the near-term.  If we are unable to implement our plans in a timely manner or otherwise comply with our commitments outlined above, or if we fail to adequately resolve any other matters any of our regulators may require us to address in the future, we could become subject to more stringent supervisory actions.  The terms of any such supervisory action could have a material negative effect on our business, operating flexibility, or financial condition.

We have incurred operating losses and cannot assure you that we will be profitable in the future.

We have incurred a net operating loss of $59.2 million, or $14.05 loss per share, for the year ended December 31, 2009 and a net loss of $643 thousand, or $0.15 loss per share, for the year ended December 31, 2008, due in both cases primarily to credit losses and associated costs, including a significant provision for loan losses. Although we have taken steps to reduce our credit exposure, we likely will continue to have a higher than normal level of non-performing assets and charge-offs through 2010 and into 2011, which would continue to adversely impact our overall financial condition and results of operations.

We may experience increased delinquencies and credit losses, which could have a material adverse effect on our capital, financial condition and results of operations.

Like other lenders, we face the risk that our customers will not repay their loans. A customer’s failure to repay us is usually preceded by missed monthly payments. In some instances, however, a customer may declare bankruptcy prior to missing payments, and, following a borrower filing bankruptcy, a lender’s recovery of the credit extended is often limited. Since our loans are secured by collateral, we may attempt to seize the collateral when and if customers default on their loans. However, the value of the collateral may not equal the amount of the unpaid loan, and we may be unsuccessful in recovering the remaining balance from our customers. Rising delinquencies and rising rates of bankruptcy in our market area generally and among our customers specifically can be precursors of future charge-offs and may require us to increase our allowance for loan and lease losses. Higher charge-off rates and an increase in our allowance for loan and lease losses may hurt our overall financial performance if we are unable to increase revenue to compensate for these losses and may also increase our cost of funds.

The impact of the current economic environment on market performance of other financial institutions in our primary market area, actions taken by our competitors to address the current economic downturn, and public perception of and confidence in the economy generally, and the banking industry specifically, may present significant challenges for us and could adversely affect our financial condition and results of operations.

We are operating in a challenging and uncertain economic environment, including generally uncertain national conditions and local conditions in our markets. Financial institutions continue to be affected by sharp declines in the real estate market and constrained financial markets. While we are taking steps to decrease and limit our exposure to commercial real estate, and construction, acquisition and development loans, we nonetheless retain direct exposure to these markets, and we are affected by the current economic downturn. Continued declines in real estate values and financial stress on borrowers as a result of the uncertain economic environment, including job losses, could have an adverse effect on our borrowers or their customers, which could adversely affect our financial condition and results of operations. The impact of recent events relating to housing and commercial real estate markets has not been limited to those directly involved in the real estate industry, but rather it has impacted a number of related businesses such as building materials suppliers, equipment leasing firms, and real estate attorneys, among others. All of these affected businesses have banking relationships and when their businesses suffer from recession, the banking relationship suffers as well.

In addition, the market value of the real estate securing our loans as collateral has been adversely affected by the slowing economy and unfavorable changes in economic conditions in our market areas and could be further adversely affected in the future. As of December 31, 2009, approximately 92.0% of our loans receivable were secured by real estate. Any sustained period of increased payment delinquencies, foreclosures or losses caused by the adverse market and economic conditions, including the downturn in the real estate market, in our markets will

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continue to adversely affect the value of our assets, revenues, results of operations and financial condition. Currently, we are experiencing such an economic downturn, and if it continues, our earnings could be further adversely affected.

The overall deterioration in economic conditions may subject us to increased regulatory scrutiny in the current environment. In addition, further deterioration in national and local economic conditions in our markets could drive losses beyond that which is provided for in our allowance for loan losses, resulting in the following other consequences: increased loan delinquencies, problem assets and foreclosures; decline in demand for our products and services; decrease in deposits, adversely affecting our liquidity position; and decline in value of collateral, reducing our customers’ borrowing power and the value of assets and collateral associated with our existing loans. As a community bank, we are less able to spread the risk of unfavorable economic conditions than larger or more regional banks. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas even if they do occur.

Recent negative developments in the financial industry and the domestic and international credit markets may adversely affect our operations and results.

Negative developments during 2008 and 2009 in the global credit and the derivative markets have resulted in uncertainty in the financial markets in general with the expectation of the general economic downturn continuing into 2010. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Global securities markets in general, and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets compared to recent years. If these negative developments continue, our business operations and financial results will continue to be negatively affected.

We make and hold in our portfolio a significant number of commercial real estate (“CRE”) and land acquisition, development and construction loans, which pose more credit risk than other types of loans typically made by financial institutions.

CRE lending and acquisition, development and construction lending usually involve higher credit risks than that of single-family residential lending. These types of loans involve larger loan balances to a single borrower or groups of related borrowers. As of December 31, 2009, approximately $253.0 million, or 35.17% of our total loan portfolio, consisted of CRE loans, and approximately $297.0 million, or 41.28% of our total loan portfolio, represented construction or land development loans.

CRE loans may be affected to a greater extent than residential loans by adverse conditions in real estate markets or the economy because CRE borrowers’ ability to repay their loans depends on the successful development of their properties, as well as the factors affecting residential real estate borrowers. These loans also involve greater risk because they generally are not fully amortizing over the loan period, but have a balloon payment due at maturity. A borrower’s ability to make a balloon payment typically will depend on being able to either refinance the loan or sell the underlying property in a timely manner. Risk of loss on a construction loan depends largely upon whether our initial estimate of the property’s value at completion of construction equals or exceeds the cost of the property construction (including interest) and the availability of permanent take-out financing. During the construction phase, a number of factors can result in delays and cost overruns. If estimates of value are inaccurate or if actual construction costs exceed estimates, the value of the property securing the loan may be insufficient to ensure full repayment when completed through a permanent loan or by seizure of collateral.

CRE and acquisition, development and construction loans are more susceptible to a risk of loss during a downturn in the business cycle. Our underwriting, review, and monitoring cannot eliminate all of the risks related to these loans.  Further, we could also be required to further increase our allowance for possible loan losses and capital levels as a result of CRE lending exposures, which could have an adverse impact on our results of operations and our financial condition. Moreover, if the losses that were initially associated with the residential mortgage market continue to spread to commercial real estate credits, then we may be forced to take greater losses or retain more non-performing assets, which could require us to increase our allowance for possible loan losses and have an adverse impact on our results of operations and financial condition.

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Ongoing deterioration in the housing market and the homebuilding industry may lead to increased losses and further worsening of delinquencies and non-performing assets in our loan portfolios. Consequently, our results of operations may be adversely impacted.

There has been substantial industry concern and publicity over asset quality among financial institutions due in large part to issues related to subprime mortgage lending, declining real estate values and general economic concerns. As of December 31, 2009, our non-performing assets had increased significantly to $137.0 million, or 18.5%, of our loan portfolio plus other real estate owned. Furthermore, the housing and the residential mortgage markets recently have experienced a variety of difficulties and changed economic conditions. If market conditions continue to deteriorate, they may lead to additional valuation adjustments on our loan portfolios and real estate owned as we continue to reassess the market value of our loan portfolio, the losses associated with the loans in default, and the net realizable value of real estate owned.

The homebuilding industry has experienced a significant and sustained decline in demand for new homes and an oversupply of new and existing homes available for sale in various markets, including some of the markets in which we lend. Our customers who are builders and developers face greater difficulty in selling their homes in markets where these trends are more pronounced. Consequently, we are facing increased delinquencies and non-performing assets as these builders and developers are forced to default on their loans with us. We do not know when the housing market will improve, and accordingly, additional downgrades, provisions for loan losses, and charge-offs related to our loan portfolio may occur.

The amount of other real estate owned (“OREO”) may increase significantly, resulting in additional losses, and costs and expenses that will negatively affect our operations.

At December 31, 2008, we had a total of $10.2 million of OREO, and at December 31, 2009, we had a total of $21.1 million of OREO, reflecting a $10.9 million or 106.6% increase from year-end 2008 to year-end 2009. These increases in OREO are due, among other things, to the continued deterioration of the real estate market and the tightening of the credit market. As the amount of OREO increases, our losses, and the costs and expenses to maintain the real estate likewise increase. Due to the ongoing economic crisis, the amount of OREO may continue to increase throughout 2010. Any additional increase in losses, and maintenance costs and expenses due to OREO may have material adverse effects on our business, financial condition, and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory, which may make the disposition of OREO properties more difficult, increase maintenance costs and expenses, and may reduce our ultimate realization from any OREO sales.

Our use of appraisals in deciding whether to make a loan on or secured by real property or how to value such loan in the future may not accurately describe the net value of the real property collateral that we can realize.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and, as real estate values in our market area have experienced changes in value in relatively short periods of time, this estimate might not accurately describe the net value of the real property collateral after the loan is closed. If the appraisal does not reflect the amount that may be obtained upon any sale or foreclosure of the property, we may not realize an amount equal to the indebtedness secured by the property. The valuation of the property may negatively impact the continuing value of such loan and could adversely affect our operating results and financial condition.

Our allowance for loan losses may not be adequate to cover actual loan losses, which may require us to materially increase our allowance, which would adversely impact our financial condition and results of operations.

We maintain an allowance for estimated loan losses that we believe is adequate for absorbing any probable losses in our loan portfolio. Management determines the provision for loan losses based upon an analysis of general market conditions, credit quality of our loan portfolio, and performance of our customers relative to their financial obligations with us. As a result of a difficult real estate market and the deterioration of asset quality since 2008, we have increased our allowance from 1.47% of outstanding portfolio loans as of December 31, 2008 to 2.99% as of December 31, 2009.  Further, it may be necessary for us to increase our allowance during 2010.  We employ an

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outside vendor specializing in credit risk management to evaluate our loan portfolio for risk grading, which can result in changes in our allowance for estimated loan losses. The determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires that significant estimates of current risk be made, using existing qualitative and quantitative information, all of which may undergo material changes.  The amount of future losses is susceptible to changes in economic, operating, and other conditions, including changes in interest rates, that may be beyond our control, and such losses may exceed the allowance for estimated loan losses. Significant increases to the provision for loan losses may be necessary if material adverse changes in general economic conditions occur or the performance of our loan portfolio deteriorates. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review the allowance for estimated loan losses. If these regulatory agencies require us to increase the allowance for estimated loan losses, it would have a negative effect on our results of operations and financial condition.  Although management believes that the allowance for estimated loan losses is adequate to absorb any probable losses on existing loans that may become uncollectable, we are consistently adjusting our loan portfolio and underwriting standards to reflect current market conditions.  We can provide no assurance that our methodology will not change and that the allowance will prove sufficient to cover actual loan losses in the future.

We are subject to liquidity risk in our operations and our reliance on time deposits, including out-of-market certificates of deposits, as a source of funds for loans and other liquidity needs, could have an adverse effect on our results of operations.

Liquidity risk is the possibility of being unable, at a reasonable cost and within acceptable risk tolerances, to pay obligations as they come due, to capitalize on growth opportunities as they arise, or to pay regular dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis.  Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses, and capital expenditures.  Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations and access to other funding sources.  Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general.  Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption in the financial markets or negative views and expectations about the prospects for the financial services industry as a whole, given the recent turmoil faced by banking organizations in the domestic and worldwide credit markets.

In addition, we are currently classified as “undercapitalized” for regulatory capital purposes.  As a result, we are subject to enhanced regulatory supervision, both under the Order described above and under FDIC regulations.  We are unable to accept, renew or roll over brokered deposits absent a waiver from the FDIC.  This limits our access to funding sources and could adversely affect our liquidity and net interest margin.  As of December 31, 2009, we had approximately $236.0 million in out of market deposits, including brokered deposits, which represented approximately 27.43% of our total deposits.  If we are unable to continue to attract deposits and maintain sufficient liquidity, our ability to meet our obligations, including the payout of deposit accounts would be adversely affected.  If our liquidity becomes severely impaired and we are unable to meet our financial obligations, including the payout of deposit accounts, or if our capital levels become unacceptable to our banking regulators, the Bank could be placed into receivership and you could lose the entire amount of your investment.

Because we are currently classified as less than well capitalized, we are also prohibited from paying rates in excess of 75 basis points above the local market average on deposits of comparable maturity in our Georgia markets.  In our Jacksonville market, however, we are prohibited from paying rates in excess of 75 basis points above the national average on deposits, as calculated by the FDIC.  Effective January 1, 2010, financial institutions that are not well capitalized are prohibited, except in very limited circumstances where the FDIC permits use of a higher local market rate, from paying yields for deposits in excess of 75 basis points above a national average rate for deposits of comparable maturity, as calculated by the FDIC.  This national rate may be lower than the prevailing rates in our local market, and although the FDIC has permitted us to use the local market rate in our Georgia markets, the FDIC could revoke this determination in the future.  The restrictions on the rates we are able to pay on deposit accounts may negatively impact our ability to compete for deposits in our market area and, as a result, we may be unable to attract or maintain core deposits, and our liquidity and ability to support demand for loans could be adversely affected.

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As a result of regulatory restrictions discussed above and the Order, our access to additional borrowed funds is currently limited and we may become subject to acute liquidity stress unless we are able to improve our regulatory status to remove these restrictions and regain access to brokered funds, replace maturing brokered deposits with core deposits or other non-brokered funding or otherwise reduce our liquidity needs.   If we are unable to meet our liquidity needs as a result of competition in the marketplace, regulatory restrictions to which we are subject, or for any other reason, our operations could be materially adversely affected.  If our liquidity position should become critically inadequate, our ability to continue as a going concern could be threatened.

We will realize additional future losses if the proceeds we receive upon liquidation of non-performing assets are less than the fair value of such assets.

Non-performing assets are recorded on our financial statements at fair value, as required under GAAP, unless these assets have been specifically identified for liquidation, in which case they are recorded at the lower of cost or estimated net realizable value. In current market conditions, we are likely to realize additional future losses if the proceeds we receive upon dispositions of non-performing assets are less than the recorded fair value of such assets.

Many of our borrowers have more than one loan or credit relationship with us.

Many of our borrowers have more than one CRE or commercial business loan outstanding with us. Consequently, an adverse development with respect to one commercial loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to, for example, a one-to-four family residential mortgage loan.

We could suffer loan losses from a decline in credit quality.

We could sustain losses if borrowers, guarantors and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies and revised such procedures pursuant to the Order, including the establishment and review of the allowance for credit losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.

Negative publicity about financial institutions, generally, or about the Bank or the Company, specifically, could damage our reputation and adversely impact our business operations and financial results.

Reputation risk, or the risk to our business from negative publicity, is inherent in our business.  Negative publicity can result from actual or alleged conduct of financial institutions, generally, or the Company or the Bank, specifically, in any number of activities, including corporate governance actions taken by government regulators in response to those activities.  Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action, any of which could negatively affect our business operations or financial results.

Our profitability is vulnerable to interest rate fluctuations.

Our profitability depends substantially upon our net interest income.  Net interest income is the difference between the interest earned on assets, such as loans and investment securities, and the interest paid for liabilities, such as savings and time deposits and out-of-market certificates of deposit.  Market interest rates for loans, investments, and deposits are highly sensitive to many factors beyond our control.  Recently, interest rate spreads have generally narrowed due to changing market conditions, policies of various government and regulatory authorities, and competitive pricing pressures, and we cannot predict whether these rate spreads will narrow even further.  This narrowing of interest rate spreads could adversely affect our financial condition and results of operations.

At December 31, 2009 we were in an asset sensitive position, which generally means that rising interest rates tend to be beneficial, in the near and long term.  Rising and declining interest rates, would typically have the opposite effect on net interest income in an asset-sensitive position.  In addition, we cannot predict whether interest rates will continue to remain at present levels.  Changes in interest rates may cause significant changes, up or down, in our net interest income. Accordingly, given the current mix and maturity of our assets and liabilities, it is possible that a

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rapid, significant and prolonged increase or decrease in interest rates could have an adverse impact on our net interest margin.

We may be required to pay significantly higher FDIC premiums or remit special assessments that could adversely affect our earnings.

Market developments have significantly depleted the FDIC’s Deposit Insurance Fund (“DIF”) and reduced its ratio of reserves to insured deposits. The FDIC’s assessment rates are intended to result in a reserve ratio of at least 1.15%. As of December 31, 2008, the ratio had fallen well below this floor.  The FDIC is required to return the DIF to its statutorily mandated minimum reserve ratio of 1.15 percent within eight years, and has undertaken several initiatives to satisfy this requirement.

On April 1, 2009, the FDIC modified the risk-based assessments to account for each institution’s unsecured debt, secured liabilities and use of brokered deposits.  Starting with the second quarter of 2009, assessment rates were increased and currently range from 7 to 77.5 basis points (annualized).

On September 30, 2009, the FDIC collected a one-time special assessment of five basis points of an institution’s assets minus tier 1 capital as of June 30, 2009. The amount of the special assessment could not exceed ten basis points times the institution’s assessment base for the second quarter of 2009.  In addition, on November 12, 2009, the FDIC adopted a final rule that requires nearly all FDIC-insured depository institutions to prepay their DIF assessments for the fourth quarter of 2009 and for the next three years.    If we are required to pay higher assessment premiums, due to our risk classification or emergency assessments, or additional special assessments in the future, our earnings could be adversely affected.

The Company’s ability to pay dividends is limited and we may be unable to pay future dividends.

We have suspended dividend payment on our common stock and make no assurances that we will pay any dividends in the future.  Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions, and other factors that our Board of Directors may deem relevant.  In addition, our ability to pay dividends is restricted by federal policies and regulations.  It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition.  Further, our principal source of funds to pay dividends is cash dividends that we receive from the Bank, and, pursuant to the Order, the Bank is prohibited from paying dividends without the prior written regulatory consent.  The Company also anticipates being prohibited from paying dividends to shareholders pursuant to the expected Agreement with the Federal Reserve Board and the DBF.

Adverse market conditions and future losses may require us to raise additional capital to support our operations, but that capital may not be available when it is needed, which could adversely affect our financial condition and results of operations.

We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations.  Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial performance.  Accordingly, we cannot assure you of our ability to raise additional capital, if needed, on terms acceptable to us or at all.  If we cannot raise additional capital when needed, our financial performance could be materially impaired and we could become subject to further regulatory restriction on our operations, which could in turn decrease significantly or eliminate the value of our securities.

Confidential customer information transmitted through the Bank’s online banking service is vulnerable  to security breaches and computer viruses, which could expose the Bank to litigation and adversely affect its reputation and ability to generate deposits.

The Bank provides its customers with the ability to bank online.  The secure transmission of confidential information over the Internet is a critical element of online banking.  The Bank’s network could be vulnerable to

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unauthorized access, computer viruses, phishing schemes, and other security problems.  The Bank may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses.  To the extent that the Bank’s  activities or the activities of its clients involve the storage and transmission of  confidential information, security breaches and viruses could expose the Bank to claims, litigation and other possible liabilities.  Any inability to prevent security breaches or computer viruses could also cause existing clients to lose confidence in the Bank’s systems and could adversely affect its reputation and its ability to generate deposits.

We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.

As a bank holding company, we are primarily regulated by the Federal Reserve Board.  Our subsidiary bank is primarily regulated by the FDIC and the DBF.  Our compliance with Federal Reserve Board, FDIC, and DBF regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices.  We are also subject to capital requirements of our regulators.

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

The rules and regulations promulgated by the SEC that currently apply to us, together with related exchange rules and regulations, have increased the scope, complexity and cost of our corporate governance, reporting, and disclosure practices.  Additional legislation or regulations, or amendments to current legislation or regulations, related to corporate governance, reporting, and disclosure may cause us to experience greater compliance costs.

Environmental liability associated with lending activities could result in losses.

In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances are discovered on any of these properties, we may be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site, even if we neither own no operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit the use of properties that we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.

If we fail to retain our key employees, our growth and profitability could be adversely affected.

Our success is, and is expected to remain highly dependent on our executive management team, consisting of Edward P. Loomis, Mark A. Stevens, Carol W. Soto, and Brandon L. Mercer. This is particularly true because, as a community bank, we depend on our management team’s ties to the community to generate business. Our growth will continue to place significant demands on our management, and the loss of any such person’s services may have an adverse effect upon our growth and profitability.

Our corporate culture has contributed to our success, and if we cannot maintain this culture, we could lose the teamwork and increased productivity fostered by our culture, which could harm our business.

We believe that a critical contributor to our success has been our corporate culture, which we believe fosters teamwork and increased productivity. As our organization grows and we are required to implement more complex management structures, we may find it increasingly difficult to maintain the beneficial aspects of our corporate culture. This could negatively impact our future success.

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Competition from other financial institutions may adversely affect our profitability.

The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds and other financial institutions, which operate in our primary market areas and elsewhere. As of June 30, 2009, 31 commercial banks serve our central Georgia service area with a total of 98 branches, 47 banks serve our coastal Georgia service area with a total of 160 branches, 17 banks serve Lowndes County in Georgia with a total of 38 branches, and 33 banks serve Duval County in Florida with a total of 204 branches.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well-established and much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our markets, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification.

Although we compete by concentrating our marketing efforts in our primary market areas with local advertisements, personal contacts and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.

Hurricanes or other adverse weather events could negatively affect our local economies or disrupt our operations, which could have an adverse effect on our business or results of operations.

The economy in the coastal regions of Georgia and Florida are affected, from time to time, by adverse weather events, particularly hurricanes. Our coastal Georgia and northeast Florida market areas consist primarily of coastal communities, and we cannot predict whether, or to what extent, damage caused by future hurricanes will affect our operations, our customers or the economies in our banking markets. Weather events could cause a decline in loan originations, destruction or decline in the value of properties securing our loans, or an increase in the risks of delinquencies, foreclosures and loan losses, which would adversely affect our results of operations.

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Item 1B.                          Unresolved Staff Comments

Not applicable.

Item 2.                                   Properties

Our home office is located at 1701 Bass Road, Macon, Bibb County, Georgia. We own this facility, which contains approximately 12,000 square feet of space, and also serves as our corporate headquarters.   We began conducting operations out of this location on August 21, 2007.

The following table summarizes pertinent details of our banking offices and our operations center

(1) Atlantic Southern obtained this property upon the completion of its acquisition of Sapelo Bancshares, Inc. on December 15, 2006.

(2) Atlantic Southern obtained this property upon the completion of its acquisition of First Community Bank of Georgia on January 31, 2007.

All of the offices listed above are owned by the Bank unless otherwise indicated. The Holt Avenue location had an initial lease term of three years, but we are continuing to lease this location pursuant to a month-to-month arrangement. We own the building for the Cypress Mill Road location, however there is a long-term lease on the land.  The term of the long-term lease is renewed every ten years with the last year of the lease being 2031.  The Atlantic Boulevard location has a lease term of five years.  We believe that our banking offices are in good

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condition, are suitable to our needs and, for the most part, are relatively new. We are not aware of any environmental problems with the properties that we own that would be material, either individually, or in the aggregate, to our operations or financial condition.  We also own parcels of land in Bibb County and Glynn County for possible development as future branch locations, and a location in Chatham County, Georgia, on which we have completed development, but, in light of current market conditions, we have not requested or obtained regulatory approval to operate this location as a branch.

Item 3.                                   Legal Proceedings

Atlantic National Bank (“ANB”) has filed a trademark infringement and unfair competition action against the Bank in the United States District Court for the Southern District of Georgia, Brunswick Division.  ANB’s claim is that the Bank’s use of the Atlantic Southern name and associated trademarks in a five-county area in southeast Georgia violates ANB’s trademark rights in that area.  We operate several branches under the trade name Sapelo Southern Bank in the area referenced by ANB in its claim and we have identified each branch, pursuant to regulatory guidance, as being “a branch of Atlantic Southern Bank” in several advertisements, signage, correspondence with customers and legal filings regarding liens.  Such identification is the basis of ANB’s lawsuit.

We have engaged counsel, answered the Complaint and denied liability.  In addition, we filed a counterclaim for a declaratory judgment that the Bank’s use of the trademarks in southeast Georgia does not violate ANB’s trademark rights.  Discovery in the matter has concluded and the parties have filed competing motions of summary judgment on issues of liability and damages.  The motions are ripe for decision by the United States District Court.

There are no further material pending legal proceedings to which Atlantic Southern Financial Group or Atlantic Southern Bank are a party, or to which any of their properties are subject; nor are there material proceedings known to us or to be contemplated by any governmental authority; nor are there material proceedings known to us, pending or contemplated, in which any director, officer or affiliate or any principal security holder of Atlantic Southern Financial Group or any associate of any of the foregoing, is a party or has an interest adverse to Atlantic Southern Financial Group.

Item 4.                                   Reserved

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PART II

Item 5.                                   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

On June 12, 2006, Atlantic Southern closed its public offering of a total of 700,000 shares of common stock at a price of $30.00 per share.  On December 15, 2006, Atlantic Southern completed its acquisition of Sapelo Bancshares, Inc., whereby Sapelo shareholders received their pro rata portion of the merger consideration, which included 305,695 shares of Atlantic Southern common stock and approximately $6.24 million in cash.  Finally on January 31, 2007, Atlantic Southern completed its acquisition of First Community Bank of Georgia, whereby First Community Bank shareholders received their pro rata portion of 542,033 shares of Atlantic Southern common stock.

Our stock is listed on the NASDAQ Global Market exchange under the symbol “ASFN.”  The average daily volume for our stock during 2009 was 4,467 shares.  As of March 26, 2010, there were 4,211,780 shares issued and outstanding and 2,572 shareholders of record.  The last reported sale price of our common stock on March 26, 2010 was $1.60.

The following tables set forth for the periods indicated the high, low and closing quarter sale prices for our common stock as reported by NASDAQ during each quarter of 2008 and 2009.

Holders of our common stock are entitled to receive dividends when, as and if declared by our Board of Directors out of funds legally available for that purpose.  On January 10, 2008, we declared our first dividend of $0.03 per share to all shareholders as of February 1, 2008.  On April 11, 2008, we announced a second quarter dividend of $0.03 per share to shareholders of record as of May 1, 2008.  On July 1, 2008, we announced a third quarter dividend of $0.03 per share to shareholders of record as of August 1, 2008.  On October 24, 2008, however, we announced the indefinite suspension of our fourth quarter dividend.  While the dividends were small in comparison to overall earnings, we wanted to retain appropriate amounts of capital to support operations at the Bank.  We declared no dividends in 2009.  Any future determination relating to dividend policy will be made at the discretion of our Board of Directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects, regulatory restrictions and other factors that our Board of Directors may deem relevant.

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There are a number of restrictions on our ability to pay cash dividends. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries. For a foreseeable period of time, our principal source of cash would be dividends paid by the Bank with respect to its capital stock. There are certain restrictions, however, on the payment of these dividends imposed by banking laws, regulations and authorities. In addition, pursuant to the Order, the Bank is prohibited from paying dividends to the Company. Moreover, pursuant to the expected Agreement with the Federal Reserve Board and the DBF, the Company will likely be prohibited from declaring or paying a dividend, or taking payment from the Bank representing a reduction in capital, without prior regulatory approval. The Company anticipates that any request for regulatory approval will need to be consistent with the Board of Governors’ Policy Statement on the Payment of Cash Dividends by State Member Banks and Bank Holding Companies, dated November 14, 1985, and the Georgia Department Statement of Policies. See “Supervision and Regulation—Payment of Dividends” on page 15.

During the fourth quarter of 2009, we did not repurchase any of our securities or sell any of our securities without registration under the Securities Act of 1933, as amended.

Item 6.                                   Selected Financial Data .

Not applicable.

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Item 7.                                   Management’s Discussion and Analysis of Financial Condition and Results of Operation

ATLANTIC SOUTHERN FINANCIAL GROUP, INC.

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

The following discussion is intended to provide insight into the financial condition and results of operations of Atlantic Southern Financial Group, Inc. and its subsidiary and should be read in conjunction with the consolidated financial statements and accompanying notes.

Advisory Note Regarding Forward-Looking Statements

The statements contained in this report on Form 10-K that are not historical facts are forward-looking statements subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.  We caution readers of this report that such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements.  Although we believe our expectations of future performance is based on reasonable assumptions within the bounds of our knowledge of our business and operations, there can be no assurance that actual results will not differ materially from our expectations.

Factors which could cause actual results to differ from expectations include, among other things:

·                   deterioration in the condition of borrowers resulting in significant increase in loan losses and provisions for those losses;

·                   the potential that loan charge-offs may exceed the allowance for loan losses or that such allowance will be increased as a result of factors beyond our control or the failure of assumptions underlying the establishment of reserves for possible loan losses;

·                   changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or regulatory developments;

·                   our dependence on senior management;

·                   competition from existing financial institutions, including commercial banks, thrifts, mortgage banking firms, consumer finance companies, credit unions, securities brokerage firms, insurance companies, money market and other mutual funds, operating in our market areas and elsewhere, including institutions operating regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone and the Internet;

·                   changes in political and economic conditions, including the political and economic effects of the current economic downturn and other major developments, including the ongoing war on terrorism and potential adverse conditions in the stock market, the public debt market, and other capital markets (including changes in interest rate conditions);

·                   changes in deposit rates, the net interest margin, and funding sources;

·                   inflation, interest rate, market, and monetary fluctuations;

·                   risks inherent in making loans including repayment risks and value of collateral;

·                   the strength of the United States economy in general and the strength of the local economies in which we conduct operations may be different than expected resulting in, among other things, a deterioration in credit quality or a reduced demand for credit, including the resultant effect on our loan portfolio and allowance for loan losses;

·                   changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including, without limitation, reduced rates of business formation and growth, commercial and residential real estate development, and fluctuations in consumer spending and saving habits;

·                   the demand for our products and services;

·                   technological changes;

·                   the challenges and uncertainties in the implementation of our expansion and development strategies;

·                   the ability to increase market share;

·                   the adequacy of expense projections and estimates of impairment loss;

·                   the impact of changes in accounting policies by the Securities and Exchange Commission;

·                   unanticipated regulatory or judicial proceedings;

·                   future legislation affecting financial institutions and changes to governmental monetary and fiscal policies

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(including without limitation laws concerning taxes, banking, securities, and insurance);

·                   the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

·                   the timely development and acceptance of products and services, including products and services offered through alternative delivery channels such as the Internet;

·                   other factors described in this report and in other reports we have filed with the Securities and Exchange Commission; and

·                   our success at managing the risks involved in the foregoing.

Forward-looking statements speak only as of the date on which they are made.  We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made to reflect the occurrence of unanticipated events.

Organization

The Bank began operations on December 10, 2001 and operates as a state chartered bank in nine banking locations in the middle Georgia markets of Macon and Warner Robins, six locations in the coastal markets of Savannah, Darien, Brunswick, one location in the south Georgia market of Valdosta, Georgia and one location in the northeast Florida market of Jacksonville, Florida.

The Bank is focused on serving the needs of small to medium-sized business borrowers and individuals in the metropolitan areas we serve.  Through Atlantic Southern Bank, the Company specializes in commercial real estate and small business lending.  The Bank offers a range of lending services, of which some are secured by single and multi-family real estate, residential construction and owner-occupied commercial buildings.  Primarily, the Bank makes loans to small and medium-sized businesses; however, the Bank also makes loans to consumers for a variety of purposes.  The Bank’s principal source of funds for loans and investing in securities is time deposits, including out-of-market certificates of deposits and core deposits.  The Bank offers a wide range of deposit services including checking, savings, money market accounts and certificates of deposit.

Executive Summary and Recent Developments

Net loss for the year ended December 31, 2009 was $59.2 million compared to net loss of $643 thousand for the year ended December 31, 2008.  Diluted loss per share was $14.05 for the year ended December 31, 2009, down $13.90 per share when compared to diluted loss per share of $0.15 for the year ended December 31, 2008, and return on average equity was -79.43% as compared to -0.71% for 2008.  The decrease in the year-to-date net loss and return on average equity were attributable to reversing interest income from loans going on non-accrual status, additional provisions for allowance for loan losses to offset the increase in net charge-offs in 2009, the write off of goodwill and recording a deferred tax asset valuation allowance.

On May 27, 2009, the Company amended its Articles of Incorporation to eliminate par value per share with respect to its common stock from the previous $5.00 par value per share of its common stock.  Therefore, the paid-in capital surplus for the Company as of that date was included with the Company’s common stock.

On July 31, 2009, the Board of Directors promoted Edward P. Loomis, Jr. to the role of President and Chief Executive Officer of Atlantic Southern Bank.  Mark Stevens continues to serve as President and Chief Executive Officer of the holding company, Atlantic Southern Financial Group, Inc.

During the second quarter of 2009, the Company recognized a $19.5 million goodwill impairment charge to earnings.  The Company completed its annual goodwill impairment assessment during the fourth quarter of 2008.  At the time of the annual assessment, there was no impairment of goodwill. The Company continued to update its goodwill impairment assessment and found an impairment of goodwill during the second quarter of 2009.  Because goodwill is an intangible asset that cannot be sold separately or otherwise disposed of, it is not recognized in

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determining capital adequacy for regulatory purposes.  Therefore, the goodwill impairment charge had no effect on the Company’s regulatory capital ratios.

During the second quarter of 2009, the Company created a Special Assets Division to address problem credits and to assist in the collection efforts of problem loans and charged-off loans.  Senior Vice President, Randy Griffin manages this department of three people and will report directly to Edward P. Loomis, Jr., President and Chief Executive Officer of the Bank.

On September 11, 2009, the Bank consented to the issuance of an Order to Cease and Desist by the FDIC and the DBF.  Under the terms of the Order, the Bank cannot declare dividends without the prior written approval of the FDIC and the DBF .  Other material provisions of the Order require the Bank to: (i) strengthen its board of directors’ oversight of management and operations of the Bank, (ii) establish a committee consisting of at least four members, three of which must be independent, to oversee the Bank’s compliance with the Order, (iii) maintain specified liquidity ratios, (iv) improve the Bank’s lending and collection policies and procedures, particularly with respect to the origination and monitoring of commercial real estate and acquisition, development and construction loans, (v) eliminate from its books, by charge off or collection, all assets classified as “loss” and 50% of all assets classified as doubtful, (vi) perform risk segmentation analysis with respect to concentrations of credit, (vii) receive a brokered deposit waiver from the FDIC prior to accepting, rolling over or renewing any brokered deposits and submit a written plan for eliminating its reliance on brokered deposits, (viii) adopt and implement a policy limiting the use of loan interest reserves, (ix) formulate and fully implement a written plan and comprehensive budget for all categories of income and expense, and (x) prepare and submit progress reports to the FDIC and the DBF.  In addition, pursuant to the Order, the Bank is required to maintain Tier 1 capital equal to at least 8% of the Bank’s total assets and total risk-based capital equal to at least 10% of the Bank’s risk-weighted assets.  The FDIC order will remain in effect until modified or terminated by the FDIC and the DBF.

The Company anticipates that it will enter into a written agreement with the Federal Reserve Board and the DBF, pursuant to which we expect to be prohibited from declaring or paying dividends without prior written consent from our regulators.  In addition, pursuant to the anticipated Agreement, without the prior written consent from our regulators, we expect to be prohibited from taking dividends, or any other form of payment representing a reduction of capital, from the Bank; paying interest, principal or other sums on subordinated debentures and trust preferred securities; incurring, increasing or guaranteeing any debt; redeeming any shares of our common stock; and increasing salaries or bonuses paid to executive officers.  The Company anticipates that all salaries, bonuses and fees, excluding the reimbursement of expenses valued at less than $500 in the aggregate per month per executive officer, must be preapproved by the Board of Directors on a regular basis.  In appointing any new director or any executive officer, the Company believes it will be required to notify regulatory authorities and comply with restrictions on indemnification and severance.  The Company expects to be required to submit a capital plan to maintain sufficient capital and a plan to reimburse the Bank for any payments made for the Company’s activities.

Critical Accounting Policies

Our accounting and reporting policies are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Critical accounting policies include the initial adoption of an accounting policy that has a material impact on our financial presentation as well as accounting estimates reflected in our financial statements that require us to make estimates and assumptions about matters that were highly uncertain at the time. Disclosure about critical estimates is required if different estimates that we reasonably could have used in the current period would have a material impact on the presentation of our financial condition, changes in financial condition or results of operations.

Allowance for Loan Losses

Accounting policies related to the allowance for loan losses represent a critical accounting estimate.  The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses

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inherent in the loan portfolio.  The amount of the allowance is based on management’s evaluation of the collectibility of the portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, economic conditions and other risks inherent in the portfolio.  A loan is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Uncollateralized loans are measured for impairment based on the present value of expected future cash flows discounted at the historical effective interest rate, while all collateral-dependent loans are measured for impairment based on the fair value of the collateral. The Bank uses several factors in determining if a loan is impaired.  Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.  The internal asset classification procedures include a thorough review of significant loans and lending relationships and include the accumulation of related data. This data includes loan payment status, borrowers’ financial data, and borrowers’ operating factors such as cash flows and operating income or loss.

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance due to changes in the measurement of the impaired loans are included in the provision for loan losses. Loans continue to be classified as impaired unless they are brought fully current and the collection of scheduled interest and principal is considered probable. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance.

Management’s monthly evaluation of the adequacy of the allowance also considers impaired loans and takes into consideration the Bank’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrowers’ ability to repay, estimated value of any underlying collateral, and current economic conditions. While management believes it has established the allowance in accordance with generally accepted accounting principles and has taken into account the views of its regulators and the current economic environment, there can be no assurance that in the future the Bank’s regulators or its economic environment will not require further increases in the allowance.

Additional discussions on loan quality and the allowance for loan losses are included in the Asset Quality section of this report and in Note 1 to the Consolidated Financial Statements.

Income Taxes

Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements, as well as net operating loss carryforwards and tax credit carryforwards.  Deferred tax assets and liabilities are included in the consolidated financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.  In the event of changes in the tax laws, deferred tax assets and liabilities are adjusted in the period of the enactment of those changes, with the cumulative effects included in the current year’s income tax provision.  Net deferred tax assets, whose realization is dependent on taxable earnings of future years, are recognized when a more-likely-than-not criterion is met.  The Company records a valuation allowance for deferred tax balance when it is unlikely to generate sufficient income to support the deferred tax asset.

Additional discussions on income taxes are included the Income Taxes section of this report and in Note 1 and Note 16 to the Consolidated Financial Statements.

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Other Real Estate

Other real estate is carried at the lower of its recorded amount at the date of foreclosure or estimated fair value less costs to sell based on independent appraisals.  Any excess of the carrying value of the related loan over the fair value of the real estate at the date of foreclosure is charged against the allowance for loan losses.  Fair value is principally based on independent appraisals performed by local credentialed appraisers.  Any expense incurred in connection with holding such real estate or resulting from any writedowns subsequent to foreclosure is included in noninterest expense.

Additional discussions on other real estate are included the Nonperforming Assets section of this report and in Note 1 and Note 11 to the Consolidated Financial Statements.

Results of Operations

General

Our results of operations are determined by our ability to effectively manage interest income and expense, to minimize loan and investment losses, to generate noninterest income and to control noninterest expense.  Since interest rates are determined by market forces and economic conditions beyond the control of the Company, the ability to generate interest income is dependent upon the Bank’s ability to obtain an adequate spread between the rate earned on earning assets and the rate paid on interest-bearing liabilities.

The following table shows the significant components of results of operations for the past three years.

Net Interest Income

Our primary source of income is interest income from loans and investment securities.  Our profitability depends largely on net interest income, which is the difference between the interest received on interest-earning assets and the interest paid on deposits, borrowings and other interest-bearing liabilities.  Net interest income decreased approximately $6.9 million or 29% for 2009 compared to 2008.  Net interest income decreased approximately $4.0 million or 15% for 2008 compared to 2007.

Total interest and dividend income for 2009 decreased approximately $9.5 million or 17% when compared to 2008.  This decrease in 2009 is primarily due to the reversal of interest income from loans going on non-accrual status.  Additionally, the average yield on loans decreased during 2009 to 5.33% compared to an average yield of 6.56% for 2008.

Total interest and dividend income for 2008 decreased approximately $4.6 million or 8% when compared to 2007.  The decrease in 2008 is the result of the interest rate cuts by the Federal Reserve which impacted our interest-rate sensitive balance sheet, especially interest rates on loans.  Additionally, the average yield on loans decreased during 2008 to 6.56% compared to an average yield of 8.57% for 2007.

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Total interest expense for 2009 decreased approximately $2.6 million or 8% when compared to 2008.  Average deposit balances increased approximately $137.8 million when comparing 2009 to 2008.  This increase includes approximately $4.7 million in average non-interest bearing balances in regular demand deposit accounts and approximately $133.1 million in interest bearing deposits.  The average rate paid on the deposit portfolios for 2009 decreased to 3.02% from 3.91% when compared to 2008.  Average borrowing balances increased approximately $9.9 million when comparing 2009 to 2008.  Average interest rates paid on borrowings were 3.14% for 2009 compared to 3.73% for 2008.

Total interest expense for 2008 decreased approximately $547 thousand or 2% when compared to 2007.  Average deposit balances increased approximately $133.5 million when comparing 2008 to 2007.  This increase includes approximately $2.0 million in average non-interest bearing balances in regular demand deposit accounts and approximately $131.5 million in interest bearing deposits.  The average rate paid on the deposit portfolios for 2008 decreased to 3.91% from 4.75% when compared to 2007.  Average borrowing balances increased approximately $5.6 million when comparing 2008 to 2007.  Average interest rates paid on borrowings were 3.73% for 2008 compared to 5.42% for 2007.

The banking industry uses two key ratios to measure relative profitability of net interest income, which are net interest spread and net interest margin.  The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest-bearing liabilities.  The interest rate spread eliminates the impact of non-interest-bearing funding sources and gives a direct perspective on the effect of market interest rate movements.  The net interest margin is an indication of the profitability of our investments, and is defined as net interest revenue as a percentage of total average earning assets, which includes the positive impact of funding a portion of earning assets with customers’ non-interest-bearing deposits and with shareholders’ equity.

For 2009, 2008 and 2007, our tax equivalent net interest margin was 1.77%, 2.80% and 3.85%, respectively.  The net interest margin of the Company decreased due to our promotion of higher short-term yields on retail time deposits, which reduced our dependence on brokered time deposits, purchase of investment securities at a low interest rate, the loss of interest on non-accrual loans and the reduction of the short-term rates by the Federal Reserve, starting in the second quarter of 2007 and continuing through the fourth quarter of 2008, and its effect on the Company’s slightly asset-sensitive balance sheet.

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The following table shows the relationship between interest revenue and interest expense and the average balances of interest-earning assets and interest-earning liabilities.

Average Consolidated Balance Sheet and Net Interest Margin Analysis