10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)


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

For the fiscal year ended December 31, 2008


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 number: 000-49912

MOUNTAIN NATIONAL BANCSHARES, INC.

(Exact name of registrant as specified in its charter)


Tennessee		75-3036312

(State or other jurisdiction		(I.R.S. Employer Identification No.)
of incorporation or organization)

300 East Main Street, Sevierville, Tennessee		37862
(Address of principal executive offices)		(Zip code)

(865) 428-7990
(Registrant’s telephone number, including area code)

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

Common Stock, $1.00 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 þ

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

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company þ
		(Do not check if a smaller reporting company)

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $57,947,692.

There were 2,631,611 shares of Common Stock outstanding as of February 28, 2009.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the 2009 Annual Meeting of Shareholders (the “2009 Proxy Statement”) are incorporated by reference into Part III of this Report. Other than those portions of the 2009 Proxy Statement specifically incorporated by reference herein pursuant to Part III, no other portions of the 2009 Proxy Statement shall be deemed so incorporated.

PART I

ITEM 1. BUSINESS

Forward-Looking Statements

Certain of the statements made herein under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere, including information incorporated herein by reference to other documents, are “forward-looking statements” within the meaning and subject to the protections of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).

Forward-looking statements include statements with respect to our beliefs, plans, objectives, goals, expectations, anticipations, assumptions, estimates, intentions, and future performance, and involve known and unknown risks, uncertainties and other factors, which may be beyond our control, and which may cause the actual results, performance or achievements of Mountain National Bancshares, Inc. (“Mountain National” or the “Company”) to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements.

All statements other than statements of historical fact are statements that could be forward-looking statements. You can identify these forward-looking statements through our use of words such as “may,” “will,” “anticipate,” “assume,” “should,” “indicate,” “seek,” “attempt,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” “plan,” “point to,” “project,” “could,” “intend,” “target,” “potential” and other similar words and expressions of the future. These forward-looking statements may not be realized due to a variety of factors, including, without limitation, those set forth in Item 1A. Risk Factors below and the following factors:

	•		the effects of future economic or business conditions (including in the residential and commercial real estate construction and development segment of the economy) nationally and in our local market;

	•		lack of sustained growth in the economy in the Sevier County and Blount County, Tennessee area;

	•		governmental monetary and fiscal policies, as well as legislative and regulatory changes, including changes in banking, securities and tax laws and regulations;

	•		the risks of changes in interest rates on the levels, composition and costs of deposits, loan demand, and the values of loan collateral, securities and interest sensitive assets and liabilities;

	•		credit risks of borrowers;

	•		the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;

	•		the failure of assumptions underlying the establishment of reserves for possible loan losses and other estimates;

	•		the risks of mergers, acquisitions and divestitures, including, without limitation, the related time and costs of implementing such transactions, integrating operations as part of these transactions and the possible failure to achieve expected gains, revenue growth and/or expense savings from such transactions;

	•		changes in accounting policies, rules and practices;

	•		changes in technology or products that may be more difficult, or costly, or less effective, than anticipated;

	•		the effects of war or other conflict, acts of terrorism or other catastrophic events that may affect general economic conditions; and

	•		other factors and risks described in any of our subsequent reports that we make with the Securities and Exchange Commission (the “Commission”) under the Exchange Act.

All written or oral forward-looking statements that are made by or are attributable to us are expressly qualified in their entirety by this cautionary notice. Except as required by the federal securities laws we do not undertake to update, revise or correct any of the forward-looking statements after the date of this report, or after the respective dates on which such statements otherwise are made.

The Company

Mountain National is a bank holding company registered with the Board of Governors of the Federal Reserve System (“Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHC Act”). The Company provides a full range of banking services through its banking subsidiary, Mountain National Bank (the “Bank”).

For the purposes of the discussions in this report, the words “we,” “us,” and “our” refer to the combined entities of the Company and the Bank unless otherwise indicated or evident. The Company’s main office is located at 300 East Main Street, Sevierville, Tennessee 37862. The Company was incorporated as a business corporation in March 2002 under the laws of the State of Tennessee for the purpose of acquiring 100% of the issued and outstanding shares of common stock of the Bank. Effective July 1, 2002, the Company and the Bank entered into a reorganization pursuant to which the Company acquired 100% of the outstanding shares of the Bank and the shareholders of the Bank became the shareholders of the Company. In June 2003, the Company received approval from the Federal Reserve Bank of Atlanta to become a bank holding company.

At December 31, 2008, the assets of the Company consisted primarily of its ownership of the capital stock of the Bank.

The Company is authorized to engage in any activity permitted by law to a corporation, subject to applicable federal and state regulatory restrictions on the activities of bank holding companies. The Company’s holding company structure provides it with greater flexibility than the Bank would otherwise have relative to expanding and diversifying its business activities through newly formed subsidiaries or through acquisitions. While management of the Company has no present plans to engage in any other business activities, management may from time to

time study the feasibility of establishing or acquiring subsidiaries to engage in other business activities to the extent permitted by law.

The Bank

The Bank is organized as a national banking association. The Bank applied to the Office of the Comptroller of the Currency (the “OCC”), and the Federal Deposit Insurance Corporation, (the “FDIC”), on February 16, 1998, to become an insured national banking association. The Bank received approval from the OCC to organize as a national banking association on June 16, 1998 and commenced business on November 23, 1998. The Bank’s principal business is to accept demand and savings deposits from the general public and to make residential mortgage, commercial and consumer loans.

Our Banking Business

General. Our banking business consists primarily of traditional commercial banking operations, including taking deposits and originating loans. We conduct our banking activities from our main office located in Sevierville, Tennessee and through seven additional branch offices in Sevier County, Tennessee, as well as a regional headquarters and two branch offices in Blount County, Tennessee. We operate two branch offices in Gatlinburg, two branch offices in Pigeon Forge, a branch office in Seymour, a branch office in Kodak, a branch office in Sevierville, all in Sevier County, and two branch offices and our Blount County regional headquarters that opened during January 2009 in Maryville, Blount County, Tennessee. The retail nature of our commercial banking operations allows for diversification in the number of our depositors and borrowers, and we do not believe that we are dependent on a single or a few customers.

We offer a variety of retail banking services. We seek savings and other time and demand deposits from consumers and businesses in our primary market area by offering a full range of deposit accounts, including savings, demand deposit, retirement, including individual retirement accounts, or “IRA’s,” and professional and checking accounts, as well as certificates of deposit. We use the deposit funds we receive to originate mortgage, commercial and consumer loans, and to make other authorized investments. In addition, we currently maintain 20 full-service ATMs throughout our market area. Because the Bank is a member of a number of payment systems networks, Bank customers may also access banking services through ATMs and point of sale terminals throughout the world. In addition to traditional deposit-taking and lending services, we also provide a variety of checking accounts, savings programs, night depository services, safe deposit facilities and credit card plans.

The banking industry is significantly affected by prevailing economic conditions, as well as government policies and regulations concerning, among other things, monetary and fiscal affairs, the housing industry and financial institutions. Deposits at commercial banks are influenced by economic conditions, including interest rates and competing investment instruments, levels of personal income and savings, among others. Lending activities are also influenced by a number of economic factors, including demand for and supply of housing, conditions in the construction industry, local economic and seasonal factors and availability of funds. Our primary sources of funding for lending activities include savings and demand

deposits, income from investments, loan principal payments and borrowings. For additional information relating to our deposits and loans, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Market Areas. Our primary market areas are Sevier and Blount Counties, contiguous counties located in eastern Tennessee. We intend to continue our focus on these primary market areas in the future. Additionally, even with our current market area focus, some of our business may come from other areas contiguous to our primary market area.

Lending Activities

General. We concentrate on developing a diversified loan portfolio consisting of first mortgage loans secured by residential properties, loans secured by commercial properties and other commercial and consumer loans.

Real Estate Lending. We originate permanent and construction loans having terms in the case of the permanent loans of up to 30 years that are typically secured by residential real estate comprised of single-family dwellings and multi-family dwellings of up to four units. All of our residential real estate loans consist of conventional loans that are not insured or guaranteed by government agencies. We also originate and hold in our portfolio traditional fixed-rate mortgage loans in appropriate circumstances.

Consumer Lending. We originate consumer loans that typically fall into the following categories:

	•		loans secured by junior liens on real estate, including home improvement and home equity loans, which have an average maturity of about three years and generally are limited to 80% of appraised value;

	•		loans secured by personal property, such as automobiles, recreational vehicles or boats, which typically have 36 to 60 month maturities;

	•		loans to our depositors secured by their time deposit accounts or certificates of deposit;

	•		unsecured personal loans and personal lines of credit; and

	•		credit card loans.

Consumer loans generally entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or that are secured by rapidly depreciating assets such as automobiles. Where consumer loans are unsecured or secured by depreciating assets, the absence of collateral or the insufficiency of any repossessed collateral to serve as an adequate source of repayment of the outstanding loan balance poses greater risk of loss to us. When a deficiency exists between the outstanding balance of a defaulted loan and the value of collateral repossessed, the borrower’s financial instability and life situations that led to the default (which may include job loss, divorce, illness or personal bankruptcy, among other things) often do not warrant substantial further collection efforts. Furthermore, the application of various federal and state laws, including federal bankruptcy and state insolvency laws, may limit the amount that we can recover in the event a consumer defaults on an unsecured or undersecured loan.

Construction Lending. We offer single-family residential construction loans to borrowers for construction of one-to-four family residences in our primary market area. Generally, we limit our construction lending to construction-permanent loans and make these loans to individuals building their primary residences. We also originate construction loans to selected local builders for construction of single-family dwellings.

Our construction loans may have fixed or adjustable interest rates and are underwritten in accordance with the same standards that we apply to permanent mortgage loans, with the exception that our construction loans generally provide for disbursement of the loan amount in stages during a construction period of up to 12 months, during which period the borrower is required to make monthly payments of accrued interest on the outstanding loan balance. We typically require a maximum loan-to-value ratio of 80% on construction loans we originate. While our construction loans generally convert to permanent loans following construction, the construction loans we extend to builders generally require repayment in full upon the completion of construction, or, alternatively, may be assumed by the borrower.

Construction lending affords us the opportunity to earn higher interest rates and fees with shorter terms to maturity than does single-family permanent mortgage lending. Construction lending, however, is generally considered to involve a higher degree of risk than single-family permanent mortgage lending because of the inherent difficulty in estimating both a property’s value at completion of the project and the projected cost of the project. If the estimate of construction cost proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to complete the project. If the estimate of value upon completion proves inaccurate, we may be confronted at, or prior to, the maturity of the loan with collateral of insufficient value to assure full repayment. Construction projects may also be jeopardized by downturns in the economy or demand in the area where the project is being undertaken, disagreements between borrowers and builders and by the failure of builders to pay subcontractors. Loans to builders to construct homes for which no purchaser has been identified carry more risk because the builder’s ability to repay the loan is often dependent on the builder’s ability to sell the property prior to the time the construction loan becomes due.

Commercial Lending. We originate secured and unsecured loans for commercial, corporate, business and agricultural purposes, and we engage in commercial real estate activities consisting of loans for hotels, motels, restaurants, retail store outlets and service providers such as insurance agencies. Currently, we concentrate our commercial lending efforts on originating loans to small businesses for purposes of providing working capital, capital improvements, and construction and leasehold improvements. These loans typically have one-year maturities, if they are unsecured loans, or, in the case of small business loans secured by real estate, have an average maturity of five years. We also participate in the Small Business Administration’s guaranteed commercial loan program.

Commercial lending, while generally considered to involve a higher degree of credit risk than long-term financing of residential properties, generally provides higher yields and greater interest rate sensitivity than do residential mortgage loans. Commercial loans are generally adjustable rate loans or loans that have short-term maturities of one to three years. The higher risks inherent in commercial lending include risks specific to the business venture, delays in leasing the collateral and excessive collateral dependency, vacancy, delays in obtaining or inability to obtain permanent financing and difficulties we may experience in exerting influence

over or acquiring the collateral following a borrower’s default. Moreover, commercial loans often carry larger loan balances to single borrowers or groups of related borrowers than do residential real estate loans. With respect to commercial real estate lending, the borrower’s ability to make principal and interest payments on loans secured by income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be subject to a greater extent to adverse conditions in the real estate market or in the economy generally. We attempt to mitigate the risks inherent in commercial lending by, among other things, securing our loans with adequate collateral and extending commercial loans only to persons located in our primary market area.

Creditworthiness and Collateral. We require each prospective borrower to complete a detailed loan application which we use to evaluate the applicant’s creditworthiness. All loan applications are reviewed and approved or disapproved in accordance with guidelines established by the Bank’s Board of Directors. We also require that loan collateral be appraised by an in house evaluation or by independent appraisers approved by the Bank’s Board of Directors and require borrowers to maintain fire and casualty insurance on collateral in accordance with guidelines established by the Bank’s Board of Directors. Title insurance is required for most real property collateral.

Loan Originations. We originate loans primarily for our own portfolio but, subject to market conditions, we may sell certain loans we originate in the secondary market. Initially, most of our loans are originated based on referrals and to walk-in customers. We also use various methods of local advertising to stimulate originations.

Secondary Market Activities. We engage in secondary mortgage market activities, principally the sale of certain residential mortgage loans on a servicing released basis, subject to market conditions. Secondary mortgage market activities permit us to generate fee income and sale income to supplement our principal source of income — net interest income resulting from the interest margin between the yield on interest-earning assets like loans and investment securities and the interest paid on interest-bearing liabilities such as savings deposits, time deposit certificates and funds borrowed by the Bank.

From time to time we originate a limited number of permanent, conventional residential mortgage loans that we sell on a servicing-released basis to private institutional investors such as savings institutions, banks, life insurance companies and pension funds. We originate these loans on terms and conditions similar to those required for sale to the Federal Home Loan Mortgage Corporation (“FHLMC”), and the Federal National Mortgage Association (“FNMA”), except that we occasionally offer these loans with higher dollar limits than are permissible for FHLMC or FNMA-eligible loans.

The loan-to-value ratios we require for the residential mortgage loans we originate are determined based on guidelines established by the Bank’s Board of Directors pursuant to applicable law.

Income from Lending Activities. Our lending activities generate interest and loan origination fee income. Loan origination fees are calculated as a percentage of the principal amount of the mortgage loans we originate and are charged to the borrower by the Bank for originating the loan. We also receive loan fees and charges related to existing loans, which include late charges and assumption fees.

Loan Delinquencies and Defaults. When a borrower fails to make a required loan payment for 30 days, we classify the loan as delinquent. If the delinquency exceeds 90 days and is not cured through the Bank’s normal collection procedures, we institute more formal recovery efforts. If a foreclosure action is initiated and the loan is not reinstated, paid in full or refinanced, the property is sold at a judicial or trustee sale at which, in some instances, the Bank acquires the property. Thereafter, such acquired property is recorded in the Bank’s records as “other real estate owned” until the property is sold. In some cases, we may finance sales of other real estate owned, which may involve our origination of “loans to facilitate” that typically involve a lower down payment or a longer term.

Investment Activities

Our investment securities portfolio is an integral part of our total assets and liabilities management strategy. We use our investments, in part, to further our interest rate risk management objective of reducing our sensitivity to interest-rate fluctuations. Our primary objective in making investment determinations with respect to our securities portfolio is to achieve a high degree of maturity and rate matching between these assets and our interest-bearing liabilities. In order to achieve this goal, we concentrate our investments, which constituted approximately 20.4% of our total assets at December 31, 2008, in U.S. government securities or other securities of similar low risk. The U.S. government and other investment-grade securities in which we invest typically have maturities ranging from 30 days to 30 years.

Sources of Funds

General. Deposits are the primary source of funds we use to support our lending activities and other general business activities. Other sources of funds include loan repayments, loan sales and borrowings. Although deposit activity is significantly influenced by fluctuations in interest rates and general market conditions, loan repayments are a relatively stable source of funds. We also use short-term borrowings to compensate in periods where our normal funding sources are insufficient to satisfy our funding needs. We use long-term borrowings to support extended activities and to extend the term of our liabilities.

Deposits. We offer a variety of programs designed to attract both short-term and long-term deposits from the general public in our market areas. These programs include savings accounts, NOW accounts, demand deposit accounts, money market deposit accounts, fixed-rate and variable-rate certificate of deposit accounts of varying maturities, retirement accounts and certain other accounts. We particularly focus on promoting long-term deposits, such as IRA accounts and certificates of deposit. Additionally, we use brokered deposits that are comparable to our traditional certificates of deposit.

Borrowings. The Bank became a member of the Federal Home Loan Bank of Cincinnati (the “FHLB of Cincinnati”) in December 2001. The FHLB of Cincinnati functions as a central

reserve bank that provides credit for member institutions. As a member, the Bank is required to own capital stock in the FHLB of Cincinnati. Membership in the FHLB of Cincinnati entitles the Bank, provided certain standards related to creditworthiness have been met, to apply for advances on the security of the FHLB of Cincinnati stock it holds as well as on the security of certain of its residential mortgage loans, commercial loans and other assets (principally, its investment securities that are obligations of, or guaranteed by, the United States). The FHLB of Cincinnati makes advances to the Bank pursuant to several different credit programs. Each credit program has its own interest rate and range of maturities. Interest rates on FHLB of Cincinnati advances are generally variable and adjust to reflect actual conditions existing in the credit markets. The uses for which we may employ funds received pursuant to FHLB of Cincinnati advances are prescribed by the various lending programs, which also prescribe borrowing limitations. Acceptable uses prescribed by the FHLB of Cincinnati have included expansion of residential mortgage lending and funding short-term liquidity needs. Depending on the particular credit program under which we borrow, borrowing limitations are generally based on the FHLB of Cincinnati’s assessment of our creditworthiness. The FHLB of Cincinnati is required to review the credit limitations and standards to which we are subject at least once every six months.

Financing. In August of 1998, the Bank completed an offering of common stock which yielded proceeds of $12,000,000. On November 7, 2003, the Company completed the sale, through its wholly owned statutory trust subsidiary, MNB Capital Trust I, of $5,500,000 of trust preferred securities, which we refer to as “Capital Securities I,” which mature on December 31, 2033, and have a liquidation amount of $50,000 per Capital Security. Interest on the Capital Securities I is to be paid quarterly on the last day of each March, June, September and December and is reset quarterly based on the three-month LIBOR plus 305 basis points. The Company used the net proceeds from the offering of Capital Securities I to pay off an outstanding line of credit.

On June 20, 2006, the Company completed the sale, through its wholly owned statutory trust subsidiary, MNB Capital Trust II, of $7,500,000 of trust preferred securities, which we refer to as “Capital Securities II,” which mature on July 7, 2036, and have a liquidation amount of $1,000 per Capital Security. Interest on the Capital Securities II is to be paid quarterly on the seventh day of each January, April, July and October and is reset quarterly based on the three-month LIBOR plus 160 basis points. The Company used the net proceeds from the offering of Capital Securities II to increase regulatory capital for the Company and for operating funds for the Bank.

During the third quarter of 2005, the Company sold 416,500 shares of common stock. This sale resulted in an increase in common stock and surplus of approximately $9,896,500. In connection with the offering, there were 416,500 warrants issued, one warrant for each share of stock sold, that had an exercise price of $25.20 per warrant. The warrants could be exercised beginning after one year from the date of the sale of the common stock, and had to be exercised no later than two years from the date of the sale. The final day to exercise the common stock warrants was September 7, 2007. During the period in which they could be exercised, 476,194 out of 482,151 (adjusted for 5% stock dividends) warrants were exercised at a weighted average exercise price of $21.77 (adjusted for 5% stock dividends). The total corresponding increase to shareholders’ equity from the conversion of the stock warrants to common stock from September 7, 2006 to September 7, 2007, the period the warrants could be exercised, was approximately $10,367,000.

Competition

We face significant competition in our primary market areas from a number of sources, including eight commercial banks and one savings institution in Sevier County and twelve commercial banks and one savings institution in Blount County. As of June 30, 2008, there were 54 commercial bank branches and three savings institutions branches located in Sevier County and 51 commercial bank branches and one savings institution branch located in Blount County.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and other recent federal and state laws have resulted in increased competition from both conventional banking institutions and other businesses offering financial services and products. Mortgage banking firms, finance companies, real estate investment trusts, insurance companies, leasing companies and certain government agencies provide additional competition for loans and for certain financial services. We also compete for deposit accounts with a number of other financial intermediaries, including securities brokerage firms, money market mutual funds, government and corporate securities and credit unions. The primary criteria on which institutions compete for deposits and loans are interest rates, loan origination fees and range of services offered.

As evidenced by our deposit and loan growth, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” we have been able to compete with our larger, more established competitors by attracting customers from existing financial institutions as well as from growth in our communities by focusing on providing a high level of customer service and by providing the products most important to our customers. During our operating history, we have been successful in hiring a staff with significant local bank experience that shares our commitment to providing our customers with the highest levels of customer service. While focusing on customer service, we are also able to offer our customers most of the banking services offered by our local competitors, including Internet banking, investment services and sweep accounts.

Employees

We currently employ a total of 179 employees, including 175 full time employees. We are not a party to any collective bargaining agreements with our employees, and we consider relations with our employees to be good.

Seasonality

Due to the predominance of the tourism industry in Sevier County, a significant portion of our commercial loan portfolio is concentrated within that industry. The predominance of the tourism industry also makes our business more seasonal in nature than may be the case with banks and financial institutions in other market areas. Deposit growth generally slows during the first quarter each year and then increases during each of the last three quarters. Our cost of funds tends to increase during the first quarter each year due to our dependence on borrowed funds that typically have a higher interest rate than our core deposits. The tourism industry in Sevier County has remained strong during recent years and we anticipate that this trend will continue.

Supervision and Regulation

Supervision and Regulation

Bank holding companies and banks are extensively regulated under federal and state law. This discussion is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below and is not intended to be a complete description of the statutes or regulations applicable to the Company’s and the Bank’s business. Supervision, regulation, and examination of the Company and the Bank and their respective subsidiaries by the bank regulatory agencies are intended primarily for the protection of bank depositors rather than holders of Company capital stock. Any change in applicable law or regulation may have a material effect on the Company’s business.

Bank Holding Company Regulation

The Company, as a bank holding company, is subject to supervision and regulation by the Board of Governors of the Federal Reserve under the BHC Act. Bank holding companies are generally limited to the business of banking, managing or controlling banks, and other activities that the Federal Reserve determines to be so closely related to banking, or managing or controlling banks, as to be a proper incident thereto. The Company is required to file with the Federal Reserve periodic reports and such other information as the Federal Reserve may request. The Federal Reserve examines the Company and may examine non-bank subsidiaries the Company may acquire.

The BHC Act requires prior Federal Reserve approval for, among other things, the acquisition by a bank holding company of direct or indirect ownership or control of more than 5% of the voting shares or substantially all the assets of any bank, or for a merger or consolidation of a bank holding company with another bank holding company. With certain exceptions, the BHC Act prohibits a bank holding company from acquiring direct or indirect ownership or control of voting shares of any company which is not a bank or bank holding company, and from engaging directly or indirectly in any activity other than banking or managing or controlling banks or performing services for its authorized subsidiaries. A bank holding company, may, however, engage in or acquire an interest in a company that engages in activities which the Federal Reserve has determined by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto.

The Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) substantially revised the statutory restrictions separating banking activities from certain other financial activities. Under the GLB Act, bank holding companies that are “well-capitalized” and “well-managed”, as defined in Federal Reserve Regulation Y, which have and maintain “satisfactory” Community Reinvestment Act (“CRA”) ratings, and meet certain other conditions, can elect to become “financial holding companies”. Financial holding companies and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting, travel agency activities, broad insurance agency activities, merchant banking, and other activities that the Federal Reserve determines to be financial in nature or complementary thereto. In addition, under the merchant banking authority added by the GLB Act and Federal Reserve regulation, financial holding companies are authorized to invest in

companies that engage in activities that are not financial in nature, as long as the financial holding company makes its investment with the intention of limiting the term of its investment and does not manage the company on a day-to-day basis, and the invested company does not cross-market with any of the financial holding company’s controlled depository institutions. Financial holding companies continue to be subject to the overall oversight and supervision of the Federal Reserve, but the GLB Act applies the concept of functional regulation to the activities conducted by subsidiaries. For example, insurance activities would be subject to supervision and regulation by state insurance authorities. While the Company has no present plans to become a financial holding company, it may elect to do so in the future in order to exercise the broader activity powers provided by the GLB Act. The GLB Act also includes consumer privacy provisions, and the federal bank regulatory agencies have adopted extensive privacy rules implementing the GLB Act.

The Company is a legal entity separate and distinct from the Bank. Various legal limitations restrict the Bank from lending or otherwise supplying funds to the Company. The Company and the Bank are subject to Section 23A of the Federal Reserve Act and Federal Reserve Regulation W thereunder. Section 23A defines “covered transactions”, which include extensions of credit, and limits a bank’s covered transactions with any affiliate to 10% of such bank’s capital and surplus. All covered and exempt transactions between a bank and its affiliates must be on terms and conditions consistent with safe and sound banking practices, and banks and their subsidiaries are prohibited from purchasing low-quality assets from the bank’s affiliates. Finally, Section 23A requires that all of a bank’s extensions of credit to its affiliates be appropriately secured by acceptable collateral, generally United States government or agency securities. The Company and the Bank also are subject to Section 23B of the Federal Reserve Act, which generally limits covered and other transactions among affiliates to be on terms, including credit standards, that are substantially the same or at least as favorable to the bank or its subsidiary as those prevailing at the time for similar transactions with unaffiliated companies.

The BHC Act permits acquisitions of banks by bank holding companies, such that Mountain National and any other bank holding company located in Tennessee may now acquire a bank located in any other state, and any bank holding company located outside Tennessee may lawfully acquire any bank based in another state, subject to certain deposit-percentage, age of bank charter requirements, and other restrictions. Federal law also permits national and state-chartered banks to branch interstate through acquisitions of banks in other states. Under Tennessee law, in order for an out-of-state bank or bank holding company to establish a branch in Tennessee, the bank or bank holding company must purchase an existing bank, bank holding company, or branch of a bank in Tennessee which has been in existence for at least three years. De novo interstate branching is permitted under Tennessee law on a reciprocal basis. The Bank is eligible to be acquired by any bank or bank holding company, whether inter-or intrastate, since it has now been in existence for three years.

Federal Reserve policy requires a bank holding company to act as a source of financial strength and to take measures to preserve and protect bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. In addition, under the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”), where a bank holding company has more than one bank or thrift subsidiary, each of the bank holding company’s subsidiary depository institutions are responsible for any losses to the FDIC as a result of an affiliated depository institution’s failure. As a result, a bank holding company may

be required to loan money to its subsidiaries in the form of capital notes or other instruments that qualify as capital under regulatory rules. However, any loans from the holding company to such subsidiary banks likely will be unsecured and subordinated to such bank’s depositors and perhaps to other creditors of the bank.

Bank Regulation

The Bank is subject to supervision, regulation, and examination by the OCC which monitors all areas of the operations of the Bank, including reserves, loans, mortgages, issuances of securities, payment of dividends, establishment of branches, capital adequacy, and compliance with laws. The Bank is a member of the FDIC and, as such, its deposits are insured by the FDIC to the maximum extent provided by law. See “FDIC Insurance Assessments”.

While the OCC has authority to approve branch applications, national banks are required by the National Bank Act to adhere to branching laws applicable to state chartered banks in the states in which they are located. With prior regulatory approval, Tennessee law permits banks based in the state to either establish new or acquire existing branch offices throughout Tennessee and in other states on a reciprocal basis. Mountain National and any other national or state-chartered bank generally may branch across state lines by merging with banks in other states if allowed by the applicable states’ laws. Tennessee law, with limited exceptions, currently permits branching across state lines either through interstate merger or branch acquisition. Tennessee, however, only permits an out-of-state bank, short of an interstate merger, to branch into Tennessee through branch acquisition if the home state of the out-of-state bank permits Tennessee-based banks to acquire branches there.

The OCC has adopted a series of revisions to its regulations, including expanding the powers exercisable by operating subsidiaries of the Bank. These changes also modernize and streamline corporate governance, investment and fiduciary powers. The OCC also has the ability to preempt state laws purporting to regulate the activities of national banks.

The OCC has adopted the Federal Financial Institutions Examination Council’s (“FFIEC”) rating system and assigns each financial institution a confidential composite rating based on an evaluation and rating of six essential components of an institution’s financial condition and operations including Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to market risk, as well as the quality of risk management practices. For most institutions, the FFIEC has indicated that market risk primarily reflects exposures to changes in interest rates. When regulators evaluate this component, consideration is expected to be given to: (i) management’s ability to identify, measure, monitor, and control market risk; (ii) the institution’s size; (iii) the nature and complexity of its activities and its risk profile; and (iv) the adequacy of its capital and earnings in relation to its level of market risk exposure. Market risk is rated based upon, but not limited to, an assessment of the sensitivity of the financial institution’s earnings or the economic value of its capital to adverse changes in interest rates, foreign exchange rates, commodity prices, or equity prices; management’s ability to identify, measure, monitor, and control exposure to market risk; and the nature and complexity of interest rate risk exposure arising from nontrading positions.

The GLB Act requires banks and their affiliated companies to adopt and disclose privacy policies regarding the sharing of personal information they obtain from their customers with

third parties. The GLB Act also permits bank subsidiaries to engage in “financial activities” through subsidiaries similar to those permitted to financial holding companies. See the discussion regarding the GLB Act in “Bank Holding Company Regulation” above.

Community Reinvestment Act

The Company and the Bank are subject to the CRA and the federal banking agencies’ regulations. Under the CRA, all banks and thrifts have a continuing and affirmative obligation, consistent with their safe and sound operation to help meet the credit needs for their entire communities, including low and moderate income neighborhoods. The CRA requires a depository institution’s primary federal regulator, in connection with its examination of the institution, to assess the institution’s record of assessing and meeting the credit needs of the communities served by that institution, including low- and moderate-income neighborhoods. The regulatory agency’s assessment of the institution’s record is made available to the public. Further, such assessment is required of any institution which has applied to: (i) charter a national bank; (ii) obtain deposit insurance coverage for a newly-chartered institution; (iii) establish a new branch office that accepts deposits; (iv) relocate an office; (v) merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution, or (vi) expand other activities, including engaging in financial services activities authorized by the GLB Act. A less than satisfactory CRA rating will slow, if not preclude, expansion of banking activities and prevent a company from becoming a financial holding company. The Bank has a satisfactory CRA rating.

The GLB Act and federal bank regulations have made various changes to the CRA. Among other changes, CRA agreements with private parties must be disclosed and annual CRA reports must be made to a bank’s primary federal regulator. A bank holding company will not be permitted to become or remain a financial holding company and no new activities authorized under the GLB Act may be commenced by a holding company or by a bank financial subsidiary if any of its bank subsidiaries received less than a “satisfactory” CRA rating in its latest CRA examination. Under current OCC regulations, the Bank has intermediate small bank status. The requirements for an intermediate small bank to meet its CRA objectives are more stringent than those for a small bank, but less so than those for large banks.

The Bank is also subject to, among other things, the provisions of the Equal Credit Opportunity Act (the “ECOA”) and the Fair Housing Act (the “FHA”), both of which prohibit discrimination based on race or color, religion, national origin, sex, and familial status in any aspect of a consumer or commercial credit or residential real estate transaction. In 1994, the Department of Housing and Urban Development, the Department of Justice (the “DOJ”), and the federal banking agencies issued an Interagency Policy Statement on Discrimination in Lending in order to provide guidance to financial institutions in determining whether discrimination exists, how the agencies will respond to lending discrimination, and what steps lenders might take to prevent discriminatory lending practices. The DOJ has also increased its efforts to prosecute what it regards as violations of the ECOA and FHA.

Sarbanes-Oxley Act

We are required to comply with various corporate governance and financial reporting requirements under the Sarbanes-Oxley Act of 2002, as well as rules and regulations adopted by

the SEC and the Public Company Accounting Oversight Board thereunder. In particular, we are required to include management reports on internal controls as part of our annual report for the year ended December 31, 2008, pursuant to Section 404 of the Sarbanes-Oxley Act. We have spent significant amounts of time and money on compliance with these rules and anticipate a similar burden going forward. We completed our assessment of our internal controls in a timely manner and management’s report on internal controls is included in Item 9A of this report. Our failure to comply with these internal control rules may materially adversely affect our reputation, our ability to obtain the necessary certifications to our financial statements, and the values of our securities.

Emergency Economic Stabilization Act

On October 3, 2008, Congress passed the Emergency Economic Stabilization Act of 2008 (the “EESA”), which provides the U. S. Secretary of the Treasury with broad authority to implement certain actions to help restore stability and liquidity to U.S. markets. Several programs have been initiated by the U.S. Treasury, the Board of Governors of the Federal Reserve and the FDIC to stabilize the financial system. The U.S. Treasury’s Troubled Asset Relief Program and Capital Purchase Program (the “TARP/CPP”) was created to invest up to $250 billion into banks and savings institutions of all sizes. The program is voluntary and requires an institution to comply with a number of restrictions and provisions, including limits on executive compensation, stock redemptions and declaration of dividends. The Company decided, after very careful consideration, not to participate in this program. The Company and the Bank are both well-capitalized and management believes the Company and the Bank will continue to be well-capitalized going forward. The FDIC also began to temporarily provide a 100% guarantee of the senior debt of all FDIC insured institutions, as well as deposits in noninterest-bearing deposit accounts under its Temporary Liquidity Guarantee Program (the “TLGP”). The Bank is participating in the transaction account guarantee component of the TLGP as discussed in more detail under “FDIC Insurance Assessments” below.

Payments of Dividends

The Company is a legal entity separate and distinct from its bank. The prior approval of the OCC is required if the total of all dividends declared by a national bank (such as the Bank) in any calendar year will exceed the sum of such bank’s net profits for the year and its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits any national bank from paying dividends that would be greater than such bank’s undivided profits after deducting statutory bad debts in excess of such bank’s allowance for possible loan losses.

In addition, the Company and the Bank are subject to various general regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authority is authorized to determine under certain circumstances relating to the financial condition of a national or state member bank or a bank holding company that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. The OCC and the Federal Reserve have indicated that paying dividends that deplete a national or state member bank’s capital base to an inadequate level would be an unsound and unsafe banking practice. The OCC

and the Federal Reserve have each indicated that depository institutions and their holding companies should generally pay dividends only out of current operating earnings.

Capital

The Federal Reserve and the OCC have risk-based capital guidelines for bank holding companies and national banks, respectively. These guidelines require a minimum ratio of capital to risk-weighted assets (including certain off-balance-sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must consist of common equity, retained earnings and a limited amount of qualifying preferred stock, less goodwill and certain core deposit intangibles (“Tier 1 capital”). Voting common equity must be the predominant form of capital. The remainder may consist of non-qualifying preferred stock, qualifying subordinated, perpetual, and/or mandatory convertible debt, term subordinated debt and intermediate term preferred stock and up to 45% of pretax unrealized holding gains on available for sale equity securities with readily determinable market values that are prudently valued, and a limited amount of any loan loss allowance (“Tier 2 capital” and, together with Tier 1 capital, “Total Capital”).

In addition, the Federal Reserve and the OCC have established minimum leverage ratio guidelines for bank holding companies and national banks, which provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets (“leverage ratio”) equal to 3%, plus an additional cushion of 1.0% to 2.0%, if the institution has less than the highest regulatory rating. The guidelines also provide that institutions experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Higher capital may be required in individual cases depending upon a bank holding company’s risk profile. All bank holding companies and banks are expected to hold capital commensurate with the level and nature of their risks, including the volume and severity of their problem loans. Lastly, the Federal Reserve’s guidelines indicate that the Federal Reserve will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or new activity. The Federal Reserve and OCC have not advised the Company or the Bank of any specific minimum leverage ratio or tangible Tier 1 leverage ratio applicable to them.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), among other things, requires the federal banking agencies to take “prompt corrective action” regarding depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, and “critically undercapitalized”. A depository institution’s capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation.

All of the federal banking agencies have adopted regulations establishing relevant capital measures and relevant capital levels. The relevant capital measures are the Total Capital ratio, Tier 1 capital ratio, and the leverage ratio. Under the regulations, a national bank will be (i) well capitalized if it has a Total Capital ratio of 10% or greater, a Tier 1 capital ratio of 6% or greater, and a leverage ratio of at least 5%, and is not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure, (ii) adequately capitalized if it has a Total Capital ratio of 8% or greater, a Tier 1 capital ratio of 4% or greater, and a leverage ratio of

4% or greater (3% in certain circumstances), (iii) undercapitalized if it has a Total Capital ratio of less than 8%, or a Tier 1 capital ratio of less than 4% (3% in certain circumstances), (iv) significantly undercapitalized if it has a total capital ratio of less than 6% or a Tier I capital ratio of less than 3%, or a leverage ratio of less than 3%, or (v) critically undercapitalized if its tangible equity is equal to or less than 2% of average quarterly tangible assets.

On March 1, 2005, the Federal Reserve adopted changes to its capital rules that permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25% of core capital, net of goodwill and intangibles. The Company expects that it will continue to treat its $13 million of trust preferred securities as Tier 1 capital subject to the limits listed above.

As of December 31, 2008, the consolidated capital ratios of the Company and Bank were as follows:


	Regulatory Minimum to be
	Adequately Capitalized		Company			Bank
Tier 1 capital ratio		4.0%		13.34	%		13.19	%
Total capital ratio		8.0%		14.44	%		14.29	%
Leverage ratio		3.0-5.0%		10.51	%		10.41	%

FDICIA

FDICIA directs that each federal banking regulatory agency prescribe standards for depository institutions and depository institution holding companies relating to internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth compensation, a maximum ratio of classified assets to capital, minimum earnings sufficient to absorb losses, a minimum ratio of market value to book value for publicly traded shares, and such other standards as the federal regulatory agencies deem appropriate.

FDICIA generally prohibits a depository institution from making any capital distribution (including payment of a dividend) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit a capital restoration plan for approval. For a capital restoration plan to be acceptable, the depository institution’s parent holding company must guarantee that the institution will comply with such capital restoration plan. The aggregate liability of the parent holding company is limited to the lesser of 5% of the depository institution’s total assets at the time it became undercapitalized and the amount necessary to bring the institution into compliance with applicable capital standards.

FDICIA also contains a variety of other provisions that may affect the operations of the Company and the Bank, including reporting requirements, regulatory standards for real estate lending, “truth in savings” provisions, the requirement that a depository institution give 90 days’ prior notice to customers and regulatory authorities before closing any branch, and a prohibition on the acceptance or renewal of brokered deposits by depository institutions that are not well

capitalized or are adequately capitalized and have not received a waiver from the FDIC. The Company and the Bank are considered “well capitalized,” and brokered deposits are not restricted.

Enforcement Policies and Actions

The Federal Reserve and the OCC monitor compliance with laws and regulations. Violations of laws and regulations, or other unsafe and unsound practices, may result in these agencies imposing fines or penalties, cease and desist orders, or taking other enforcement actions. Under certain circumstances, these agencies may enforce these remedies directly against officers, directors, employees and others participating in the affairs of a bank or bank holding company.

Fiscal and Monetary Policy

Banking is a business that depends on interest rate differentials. In general, the difference between the interest paid by a bank on its deposits and its other borrowings, and the interest received by a bank on its loans and securities holdings, constitutes the major portion of a bank’s earnings. Thus, the earnings and growth of Mountain National and the Bank are subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the United States and its agencies, particularly the Federal Reserve. The Federal Reserve regulates the supply of money through various means, including open market dealings in United States government securities, the discount rate at which banks may borrow from the Federal Reserve, and the reserve requirements on deposits. The nature and timing of any changes in such policies and their effect on Mountain National and its subsidiary cannot be predicted. During 2008, the Federal Reserve reduced the targeted federal funds rate seven times for a total of 4.00 - 4.25%. The year-end targeted federal funds rate was expressed as a range from 0.00 — 0.25%. During 2008, the Federal Reserve also reduced the discount rate eight times for a total of 4.25%.

FDIC Insurance Assessments

The FDIC has adopted a risk-based assessment system for insured depository institutions that takes into account the risks attributable to different categories and concentrations of assets and liabilities. In early 2006, Congress passed the Federal Deposit Insurance Reform Act of 2005, which made certain changes to the Federal deposit insurance program. These changes included merging the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund, increasing retirement account coverage to $250,000 and providing for inflationary adjustments to general coverage beginning in 2010, providing the FDIC with authority to set the fund’s reserve ratio within a specified range, and requiring dividends to banks if the reserve ratio exceeds certain levels. The new statute grants banks an assessment credit based on their share of the assessment base on December 31, 1996, and the amount of the credit can be used to reduce assessments in any year subject to certain limitations. Because it was not organized until 1998, the Bank will not be eligible to receive this one-time assessment credit.

Beginning in October 2008, the FDIC temporarily increased FDIC deposit insurance coverage per separately insured depositor to $250,000 through December 31, 2009. On January

1, 2010, the standard coverage limit is scheduled to return to $100,000 for all deposit accounts, except for certain retirement accounts.

The Bank is subject to FDIC deposit insurance assessments (“DIF assessments”). The FDIC assesses deposits under a risk-based premium schedule. Each financial institution is assigned to one of three capital groups, “well capitalized,” “adequately capitalized” or “undercapitalized,” and further assigned to one of three subgroups within a capital group, on the basis of supervisory evaluations by the institution’s primary federal and, if applicable, state regulators and other information relevant to the institution’s financial condition and the risk posed to the applicable insurance fund. The actual assessment rate applicable to a particular institution, therefore, depends in part upon the risk assessment classification so assigned to the institution by the FDIC.

In addition to DIF assessments, all FDIC-insured depository institutions must pay an annual assessment to provide funds for the repayment of debt obligations of the Financing Corporation (“FICO”). The FICO is a government-sponsored entity that was formed to borrow the money necessary to carry out the closing and ultimate disposition of failed thrift institutions by the Resolution Trust Corporation. The FICO assessments are set quarterly and ranged from 1.22 basis points in the first quarter of 2007 to 1.14 basis points in the last quarter of 2007 and from 1.12 basis points in the first quarter of 2008 to 1.14 basis points in the last quarter of 2008. The FICO assessment rate for the first quarter of 2009 is 1.04 basis points.

During the two years ended December 31, 2008 and 2007, the Bank paid $48,733.99 and $44,815.83, respectively, in FICO assessments. The Bank paid $254,246.14 during 2008 for FDIC deposit insurance premiums.

In October 2008, the FDIC introduced the TLGP, a program designed to improve the functioning of the credit markets and to strengthen capital in the financial system during this period of economic distress. The TLGP has two components: 1) a debt guarantee program, guaranteeing newly issued senior unsecured debt, and 2) a transaction account guarantee program, providing a full guarantee of noninterest-bearing deposit transaction accounts, Negotiable Order of Withdrawal (or “NOW”) accounts paying less than 0.5% annual interest, and Interest on Lawyers Trust Accounts, regardless of the amount. The Bank is not participating in the debt guarantee program. The Bank is presently participating in the transaction account guarantee program and, as such, all funds in covered accounts held through December 31, 2009 will be covered with a full guarantee. In connection with this guarantee, a 10 basis point annual rate surcharge will be assessed on amounts in covered accounts exceeding $250,000.

In order to restore reserves and ensure that the DIF assessments will be able to adequately cover losses from future bank failures, the FDIC, in October 2008, proposed amendments to its deposit insurance rules to alter the way the assessment system differentiates risks among insured institutions and to change assessment rates, including base assessment rates, in order to increase assessment revenue. A uniform assessment increase for the first quarter of 2009 was adopted as a final rule in December 2008. The FDIC has also proposed further base rate assessment adjustments effective April 1, 2009. We cannot currently provide any assurance as to the amount of any proposed increase in the Bank’s deposit insurance premium rate, should there be an increase, because any increase would be dependent upon a number of factors, some of which are beyond the Bank’s control.

Other Laws and Regulations

The International Money Laundering Abatement and Anti-Terrorism Funding Act of 2001 specifies “know your customer” requirements that obligate financial institutions to take actions to verify the identity of the account holders in connection with opening an account at any U.S. financial institution. Banking regulators will consider compliance with this Act’s money laundering provisions in acting upon acquisition and merger proposals, and sanctions for violations of this Act can be imposed in an amount equal to twice the sum involved in the violating transaction, up to $1 million.

Under the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA PATRIOT Act”), financial institutions are subject to prohibitions against specified financial transactions and account relationships as well as to enhanced due diligence and “know your customer” standards in their dealings with foreign financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures, and controls generally require financial institutions to take reasonable steps:

	•		to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

	•		to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

	•		to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and

	•		to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

The USA PATRIOT Act requires financial institutions to establish anti-money laundering programs, and sets forth minimum standards for these programs, including:

	•		the development of internal policies, procedures, and controls;

	•		the designation of a compliance officer;

	•		an ongoing employee training program; and

	•		an independent audit function to test the programs.

In addition, the USA PATRIOT Act authorizes the Secretary of the Treasury to adopt rules increasing the cooperation and information sharing between financial institutions, regulators, and law enforcement authorities regarding individuals, entities and organizations

engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities.

Statistical Information

Certain statistical and financial information (as required by Guide 3, “Statistical Disclosure by Bank Holding Companies” of the Exchange Act Industry Guides) is included in response to Item 7 of this Annual Report on Form 10-K.

ITEM 1A. RISK FACTORS

Recent negative developments in the financial services industry and U.S. and global credit markets may adversely impact the Company’s operations and results.

Negative developments in the latter half of 2007 and throughout 2008 in the capital markets have resulted in uncertainty in the financial markets in general with the general economic downturn continuing into 2009. Loan portfolio performances have deteriorated at many institutions, including the Bank, resulting from, amongst other factors, a weak economy and a decline in the value of the collateral supporting their loans. The competition for the Company’s deposits has increased significantly due to liquidity concerns at many of these same institutions. Stock prices of bank holding companies, like the Company, have been negatively affected by the current condition of the financial markets, as has the Company’s ability, if needed, to raise capital or borrow in the debt markets compared to recent years. As a result, there is a potential for new federal or state laws and regulations regarding lending and funding practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact the Company’s operations by restricting its business operations, including its ability to originate or sell loans, and adversely impact the Company’s financial performance. In addition, industry, legislative or regulatory developments may cause the Company to materially change its existing strategic direction, capital strategies, compensation or operating plans.

We have a concentration of credit exposure to borrowers dependent on the tourism industry.

Due to the predominance of the tourism industry in Sevier County, Tennessee, which is adjacent to the Great Smoky Mountains National Park and the home of the Dollywood theme park, a significant portion of the Bank’s commercial loan portfolio is concentrated within that industry. The predominance of the tourism industry also makes our business more seasonal in nature than may be the case with banks in other market areas. The Bank maintains ten primary concentrations of credit by industry, of which five are directly related to the tourism industry. At December 31, 2008, approximately $180 million in loans, representing approximately 43% of our total loans, were to businesses and individuals whose ability to repay depends to a significant extent on the tourism industry in the markets we serve. We also have additional loans that would be considered related to the tourism industry in addition to the five categories included in the industry concentration amounts noted above. The tourism industry in Sevier County has remained strong during recent years and we anticipate that this trend will continue; however, if

the tourism industry experiences an economic slowdown and, as a result, the borrowers in this industry are unable to perform their obligations under their existing loan agreements, our earnings could be negatively impacted, causing the value of our common stock to decline.

A portion of our loan portfolio is secured by homes that are being built for sale as vacation homes or as second homes for out of market investors or homes that are used to generate rental income.

Our borrowers rely to some extent upon rental income to service real estate loans secured by rental properties, or they rely upon sales of the property for construction and development loans secured by homes that have been built for sale to investors living outside of our market area as investment properties, second homes or as vacation homes. If tourism levels in our market area were to decline significantly, the rental income that some of our borrowers utilize to service their obligations to us may decline as well and these borrowers may have difficulty meeting their obligations to us which could adversely impact our results of operations. In addition, sales of vacation homes and second homes to investors living outside of our market area have slowed and are expected to remain at reduced levels throughout 2009. Borrowers that are developers or builders whose loans are secured by these vacation and second homes and whose ability to repay their obligations to us is dependent on the sale of these properties may have difficulty meeting their obligations to us if these properties are not sold timely or at values in excess of their loan amount which could adversely impact our results of operations.

Our business is subject to local real estate market and other local economic conditions.

Adverse market or economic conditions in the State of Tennessee may disproportionately increase the risk our borrowers will be unable to timely make their loan payments. In addition, the market value of the real estate securing loans as collateral could be adversely affected by unfavorable changes in market and economic conditions. As of December 31, 2008, approximately 89% of our loans were secured by real estate. Of this amount, approximately 30% were commercial real estate loans, 32% were residential real estate loans and 38% were construction and development loans. Any sustained period of increased payment delinquencies, foreclosures or losses caused by adverse market or economic conditions in the markets we serve or in the State of Tennessee, like those we are currently experiencing, could adversely affect the value of our assets, our revenues, results of operations and financial condition. In addition, construction and development lending is generally considered to have more complex credit risks than traditional single-family residential lending because the principal is concentrated in a limited number of loans with repayment dependent on the successful operation of the related real estate project. Consequently, these loans are more sensitive to adverse conditions in the real estate market or the general economy. These loans are generally less predictable and more difficult to evaluate and monitor and collateral may be difficult to dispose of in a market decline. If we experience significant construction loan loss because the cost and value of a construction loan project is inaccurately estimated or because of a general economic downturn, our results of operations could be adversely impacted and our net book value could be reduced.

We are geographically concentrated in Sevier County and Blount County, Tennessee, and changes in local economic conditions impact our profitability.

We operate primarily in Sevier County and Blount County, Tennessee, and substantially all of our loan customers and most of our deposit and other customers live or have operations in Sevier and Blount Counties. Accordingly, our success significantly depends upon the growth in population, income levels, deposits and housing starts in both counties, along with the continued attraction of business ventures to the area. Our profitability is impacted by the changes in general economic conditions in this market. Additionally, unfavorable local or national economic conditions could reduce our growth rate, affect the ability of our customers to repay their loans to us and generally affect our financial condition and results of operations.

We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of diversified economies. Moreover, we cannot give any assurance that we will benefit from any market growth or favorable economic conditions in our primary market areas if they do occur.

Our continued growth may require the need for additional capital and further regulatory approvals which, if not obtained, could adversely impact our profitability and implementation of our current business plan.

To continue to grow, we will need to provide sufficient capital to the Bank through earnings generation, additional equity offerings, the issuance of additional trust preferred securities or borrowed funds or any combination of these sources of funds. Should we incur indebtedness, we could be required to obtain certain regulatory approvals beforehand if we are not well-capitalized under regulatory standards. Should our growth exceed our expectations, we may need to raise additional capital over our projected capital needs. However, 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 our ability to raise additional capital if needed on terms acceptable to us. If we cannot raise additional capital when needed, our ability to further expand and grow our operations could be materially impaired. Should we not be able to obtain such approvals or otherwise not be able to grow our asset base, our ability to attain our long-term profitability goals will be more difficult.

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings will decrease.

If loan customers with significant loan balances fail to repay their loans according to the terms of these loans, our earnings would suffer. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of any collateral securing the repayment of our loans. We maintain an allowance for loan losses in an attempt to cover the inherent risks associated with lending. In determining the size of this allowance, we rely on an analysis of our loan portfolio based on volume and types of loans, internal loan classifications, trends in classifications, volume and trends in delinquencies, nonaccruals and charge-offs, national and local economic conditions, other factors and other pertinent information. If our assumptions are inaccurate, our current allowance may not be sufficient to cover potential loan losses, and additional provisions may be necessary which would decrease our earnings.

In addition, federal and state regulators periodically review our loan portfolio and may require us to increase our provision for loan losses or recognize loan charge-offs. Their conclusions about the quality of our loan portfolio may be different than ours. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory agencies could have a negative effect on our operating results.

Competition with other banking institutions could adversely affect our profitability.

We face significant competition in our primary market areas from a number of sources, currently including eight commercial banks and one savings institution in Sevier County and twelve commercial banks and one savings institution in Blount County. As of June 30, 2008, there were 54 commercial bank branches and three savings institutions branches located in Sevier County and 51 commercial bank branches and one savings institution branch located in Blount County. Most of our competitors have been in existence for a longer period of time, are better established, have substantially greater financial resources and have more extensive facilities than we do. Because of the size and established presence of our competitors in our market area, these competitors have longer-term customer relationships than we maintain and are able to offer a wider range of services than we offer.

Fluctuations in interest rates could reduce our profitability.

Changes in interest rates may affect our level of interest income, the primary component of our gross revenue, as well as the level of our interest expense, our largest recurring expenditure. Interest rate fluctuations are caused by many factors which, for the most part, are not under our direct control. For example, national monetary policy plays a significant role in the determination of interest rates. Additionally, competitor pricing and the resulting negotiations that occur with our customers also impact the rates we collect on loans and the rates we pay on deposits.

As interest rates change, we expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” may work against us, and our earnings may be negatively affected.

Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. A decline in the market value of our assets may limit our ability to borrow additional funds or result in our lenders requiring additional collateral from us under our loan agreements. As a result, we could be required to sell some of our loans and investments under adverse market conditions, upon terms that are not favorable to us, in order to maintain our liquidity. If those sales are made at prices lower than the amortized costs of the investments, we will incur losses.

Our common stock is currently traded on the over-the-counter, or OTC, bulletin board and has substantially less liquidity than the average stock quoted on a national securities exchange.

Although our common stock is publicly traded on the OTC bulletin board, our common stock has substantially less daily trading volume than the average trading market for companies quoted on the Nasdaq Global Market, or any national securities exchange. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control.

The market price of our common stock may fluctuate in the future, and these fluctuations may be unrelated to our performance. General market price declines or overall market volatility in the future could adversely affect the price of our common stock, and the current market price may not be indicative of future market prices.

Loss of our senior executive officers or other key employees could impair our relationship with our customers and adversely affect our business.

We have assembled a senior management team which has substantial background and experience in banking and financial services and in the Sevier County and Blount County, Tennessee banking markets. Loss of the services of any of these key personnel could negatively impact our business because of their skills, years of industry experience, customer relationships and the potential difficulty of promptly replacing them.

Our business is dependent on technology, and an inability to invest in technological improvements may adversely affect our results of operations and financial condition.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven products and services. In addition to better serving customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. We have made significant investments in data processing, management information systems and internet banking accessibility. Our future success will depend in part upon our ability to create additional efficiencies in our operations through the use of technology, particularly in light of our past and projected growth strategy. Many of our competitors have substantially greater resources to invest in technological improvements. There can be no assurance that our technological improvements will increase our operational efficiency or that we will be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.

We are subject to various statutes and regulations that may limit our ability to take certain actions.

We operate in a highly regulated industry and are subject to examination, supervision, and comprehensive regulation by various regulatory agencies. Our compliance with these regulations is costly and restricts 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 capitalization guidelines established by our regulators, which require us to maintain adequate capital to support our growth. As economic conditions deteriorate, our regulators may review our operations with more scrutiny and we may be subject to increased regulatory oversight which could adversely affect our operations.

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 enactment of Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 may not be able to stabilize the U.S. financial system or the economy and may significantly affect the Company’s financial condition, results of operation or liquidity.

On October 3, 2008, President Bush signed into law the EESA. The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress on September 20, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (“ARRA”) in an effort to stimulate the economy and provide for broad infrastructure, energy, health, and education needs. The U.S. Treasury and banking regulators are implementing a number of programs under this legislation to address capital and liquidity issues in the banking system. There can be no assurance, however, as to the actual impact that the EESA or ARRA will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA or ARRA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially affect the Company’s business, financial condition, results of operations, access to credit or the trading price of the Company’s common stock.

There have been numerous actions undertaken in connection with or following EESA and ARRA by the Federal Reserve Board, Congress, the Treasury, the FDIC, the SEC and others in efforts to address the current liquidity and credit crisis in the financial industry that followed the sub-prime mortgage market meltdown which began in late 2007. These measures include homeowner relief that encourages loan restructuring and modification; the establishment of significant liquidity and credit facilities for financial institutions and investment banks; the lowering of the federal funds rate; emergency action against short selling practices; a temporary guaranty program for money market funds; the establishment of a commercial paper funding facility to provide back-stop liquidity to commercial paper issuers; and coordinated international efforts to address illiquidity and other weaknesses in the banking sector. The purpose of these legislative and regulatory actions is to help stabilize the U.S. banking system. EESA, ARRA and the other regulatory initiatives described above may not have their desired effects. If the volatility in the markets continues and economic conditions fail to improve or worsen, the Company’s business, financial condition and results of operations could be materially and adversely affected.

Stress on the Federal Home Loan Bank system may cause our results of operations and financial condition to be adversely affected.

In recent months, the financial media has disclosed that the nation’s FHLB system may be under stress due to deterioration in the financial markets, particularly in relation to valuation of mortgage securities. Several FHLB institutions have announced impairment charges of these and other assets and as such their capital positions have deteriorated to the point that they may suspend dividend payments to their members. We are a member of the FHLB of Cincinnati which continues to pay dividends. However, should financial conditions continue to weaken, the FHLB system (including FHLB of Cincinnati) in the future may have to, not only suspend dividend payments, but also curtail advances to member institutions like us. Should the FHLB system deteriorate to the point of not being able to fund future advances to banks, including the Bank, this would place increased pressure on other funding sources, which may negatively impact our net interest margin and results of operations.

If a change in control or change in management is delayed or prevented, the market price of our common stock could be negatively affected.

Certain federal and state regulations may make it difficult, and expensive, to pursue a tender offer, change in control or takeover attempt that our board of directors opposes. As a result, our shareholders may not have an opportunity to participate in such a transaction, and the trading price of our stock may not rise to the level of other institutions that are more vulnerable to hostile takeovers.

ITEM 2. PROPERTIES

The Bank currently operates from its main office in Sevierville, Tennessee and nine branch offices located in Gatlinburg, Pigeon Forge, Seymour, Kodak and Maryville, Tennessee. Additionally, during the first quarter of 2009, the Bank opened its Blount County regional headquarters in Maryville, Tennessee. The main office, which is located at 300 East Main, Sevierville, Tennessee 37862, contains approximately 24,000 square feet and is owned by the Bank.

The Blount County regional headquarters opened for business during the first quarter of 2009 and is located at 1820 W. Broadway, Maryville, Tennessee. The building contains approximately 12,000 square feet and is owned by the Bank.

The first Gatlinburg branch was built in 1999 and is located at 960 E. Parkway. It contains approximately 4,800 square feet. The Bank leases the land at this location. The lease expires in 2013 and includes renewal options for twelve additional five-year terms.

The second Gatlinburg branch is a walk-up branch leased by the Bank located at 745 Parkway, which lies in the heart of the Gatlinburg tourist district. The lease expires in 2010 and includes two five-year renewal options through 2020.

The Pigeon Forge branch, owned by the Bank, contains approximately 3,800 square feet and is located at 3104 Teaster Lane, Pigeon Forge, Tennessee.

The second Pigeon Forge branch, owned by the Bank, contains approximately 3,800 square feet and is located at 242 Wears Valley Road, Pigeon Forge, Tennessee.

The Seymour branch, owned by the Bank, contains approximately 3,800 square feet and is located on Chapman Highway, Seymour, Tennessee.

The Kodak branch, owned by the Bank, contains approximately 3,800 square feet and is located on Winfield Dunn Parkway — Highway 66, Sevierville, Tennessee.

The Collier Drive branch, owned by the Bank, contains approximately 3,800 square feet and is located at 470 Collier Drive, Sevierville, Tennessee.

The West Maryville branch, owned by the Bank, contains approximately 4,800 square feet and is located at 2403 US Highway 411 South, Maryville, Tennessee.

The Justice Center branch opened for business during the second quarter of 2008 and is located on land leased by the Bank at 1002 E. Lamar Alexander Parkway, Maryville, Tennessee. The branch contains approximately 3,900 square feet. The lease expires in 2013 and includes renewal options for six additional five-year terms.

The Operations Center, owned by the Bank, contains approximately 40,000 square feet and is located on Red Bank Road in Sevierville, Tennessee. We completed construction of a 16,000 square foot addition, which is included in the 40,000 square foot total, during the first quarter of 2009.

In addition to our twelve existing locations including the Operations Center, we began construction of a branch in Sevier County during the third quarter of 2008 with an anticipated completion date during the second quarter of 2009. We will have twelve branches when this one is completed, including the Main and Regional offices. Additionally, we hold one property in Knox County, Tennessee, which we intend to use as a future branch site.

Management believes that the physical facilities maintained by the Bank are suitable for its current operations and that all properties are adequately covered by insurance.

ITEM 3. LEGAL PROCEEDINGS

The Company is not aware of any material pending legal proceedings to which the Company or the Bank is a party or to which any of their properties are subject, other than ordinary routine legal proceedings incidental to the business of the Bank.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of the Company’s shareholders, through the solicitation of proxies or otherwise, during the fourth quarter of 2008.

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

There is not a large market for the Company’s shares, which are quoted on the OTC Bulletin Board under the symbol “MNBT” and are not traded on any national exchange. Trading is generally limited to private transactions and, therefore, there is limited reliable information available as to the number of trades or the prices at which our stock has traded. Management has reviewed the limited information available regarding the range of prices at which the Company’s common stock has been sold. The following table sets forth, for the calendar periods indicated, the range of high and low reported sales prices. This data is provided for information purposes only and should not be viewed as indicative of the actual or market value of our common stock:


	Market Price Range
	Per Share
Yeart/Period	High		Low
2008:	$	24.46	$	16.20
First Quarter		23.30		19.82
Second Quarter		24.46		19.81
Third Quarter		21.53		18.10
Fourth Quarter		17.61		16.20

2007:	$	28.57	$	22.00
First Quarter		26.67		25.71
Second Quarter		27.67		25.71
Third Quarter		28.57		27.43
Fourth Quarter		27.43		22.00

On March 9, 2009, the last reported sale price for the common stock was $11.75 per share.

These quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not represent actual transactions. They have been adjusted to reflect the five percent stock dividends issued February 2007 and March 2008.

As of the date of this filing, the Company has approximately 2,000 holders of record of its common stock. The Company has no other class of securities issued or outstanding.

Dividends from the Bank are the Company’s primary source of funds to pay dividends on its capital stock. Under the National Bank Act, the Bank may, in any calendar year, without the approval of the OCC, pay dividends to the extent of net profits for that year, plus retained net profits for the preceding two years (less any required transfers to surplus). The need to maintain adequate capital in the Bank also limits dividends that may be paid to the Company. The OCC and Federal Reserve have the general authority to limit the dividends paid by insured banks and bank holding companies, respectively, if such payment may be deemed to constitute an unsafe or unsound practice. If, in the particular circumstances, the OCC determines that the payment of

dividends would constitute an unsafe or unsound banking practice, the OCC may, among other things, issue a cease and desist order prohibiting the payment of dividends. This rule is not expected to adversely affect the Bank’s ability to pay dividends to the Company. Additional information regarding restrictions on the ability of the Bank to pay dividends to the Company is contained in this report under “Item 1 — Business- Supervision and Regulation.”

On February 28, 2007, we issued a five percent stock dividend to stockholders of record as of February 15, 2007. In lieu of fractional shares, we made a total cash payment of $29,557, based on a price of $26.19 per share, adjusted to reflect the five percent stock dividend issued during March 2008. The total number of shares issued pursuant to the dividend was 96,361.

On March 7, 2008, we issued a five percent stock dividend to stockholders of record as of February 15, 2008. In lieu of fractional shares, we made a cash payment totaling $17,802, based on a price of $24.00 per share. The total number of shares issued pursuant to the dividend was 124,718.

During November 2008, the Board of Directors approved a special cash dividend of $0.38 per issued and outstanding share of Common Stock for stockholders of record as of November 26, 2008. The dividend totaling approximately $1,013,000 was paid on December 15, 2008.

Issuer Purchases of Equity Securities

On July 6, 2007, the Company announced the authorization by the Board of Directors of a repurchase plan of up to $500,000 of the Company’s common stock prior to June 27, 2008. On July 7, 2008, the Company announced the first expansion of this share repurchase plan. Under the expansion, an additional $300,000 in repurchases of Company common stock was authorized, over and above the initial $500,000 authorization. On October 24, 2008, the Company announced a second expansion of the share repurchase program. The second expansion authorizes the repurchase of an additional $700,000 of Company common stock, bringing the total amount of the repurchase plan including all expansions to $1,500,000. The expiration date of the ongoing repurchase plan was extended to June 27, 2009. However, during the fourth quarter of 2008, the authorized repurchase amount was exhausted. The stock repurchases were accomplished in private or open-market purchases and the timing of the repurchases and the number of shares of common stock purchased were dependent upon prevailing market conditions, share price, and other factors.

The following table provides certain information for the fourth quarter ended December 31, 2008 with respect to the Company’s repurchase of common stock.


					Total Number
					of Shares		Approximate Dollar
					Purchased as		Value of Shares
	Total Number				Part of Publicly		That May Yet Be
	of Shares		Average Price		Announced Plans		Purchased Under
	Purchased		Paid per Share		or Programs		the Plans or Programs
October 1-31, 2008		—	$	—		—	$	859,325
November 1-30, 2008		31,650		17.74		31,650		297,850
December 1-31, 2008		17,402		17.11		17,402		—


Total		49,052	$	17.48		49,052	$	—

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

To better understand financial trends and performance, our management analyzes certain key financial data in the following pages. This analysis and discussion reviews our results of operations for the two-year period ended December 31, 2008, and our financial condition at December 31, 2007 and 2008. We have provided comparisons of financial data as of and for the fiscal years ended December 31, 2007 and 2008, to illustrate significant changes in performance and the possible results of trends revealed by that historical financial data. The following discussion should be read in conjunction with our consolidated audited financial statements, including the notes thereto, and the selected consolidated financial data presented elsewhere in this Annual Report on Form 10-K.

Overview

We conduct our business, which consists primarily of traditional commercial banking operations, through our wholly owned subsidiary, Mountain National Bank. Through the Bank we offer a broad range of traditional banking services from our corporate headquarters in Sevierville, Tennessee, our regional headquarters in Maryville, TN, and through nine additional branches in Sevier County and Blount County, Tennessee. Our banking operations primarily target individuals and small businesses in Sevier and Blount Counties and the surrounding area. The retail nature of the Bank’s commercial banking operations allows for diversification of depositors and borrowers, and we believe that the Bank is not dependent upon a single or a few customers. But, due to the predominance of the tourism industry in Sevier County, a significant portion of the Bank’s commercial loan portfolio is concentrated within that industry, including the residential real estate segment of that industry. The predominance of the tourism industry also makes our business more seasonal in nature, particularly with respect to deposit levels, than may be the case with banks in other market areas. The tourism industry in Sevier County has remained strong during recent years and we anticipate that this trend will continue.

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 accepted

within the banking industry. Our significant accounting policies are described in the notes to our consolidated financial statements. Certain accounting policies require management to make significant estimates and assumptions that have a material impact on the carrying value of certain assets and liabilities, and we consider these to be critical accounting policies. The estimates and assumptions used are based on historical experience and other factors that management believes to be reasonable under the circumstances. Actual results could differ significantly from these estimates and assumptions, which could have a material impact on the carrying value of assets and liabilities at the balance sheet dates and on our results of operations for the reporting periods.

We believe the following are the critical accounting policies that require the most significant estimates and assumptions and that are particularly susceptible to a significant change in the preparation of our financial statements.

Valuation of Investment Securities

Management conducts regular reviews to assess whether the values of our investments are impaired and whether any such impairment is other than temporary. If management determines that the value of any investment is other-than-temporarily impaired, we record a charge against earnings equal to the amount of the impairment. The determination of whether other-than-temporary impairment has occurred involves significant assumptions, estimates and judgments by management. Changing economic conditions — global, regional or related to industries of specific issuers — could adversely affect these values. We recorded no other than temporary impairment of our investment securities during 2007 or 2008.

Allowance and Provision for Loan Losses

The allowance and provision for loan losses are based on management’s assessments of amounts that it deems to be adequate to absorb losses inherent in our existing loan portfolio. The allowance for loan losses is established through a provision for losses based on management’s evaluation of current economic conditions, volume and composition of the loan portfolio, the fair market value or the estimated net realizable value of underlying collateral, historical charge-off experience, the level of nonperforming and past due loans, and other indicators derived from reviewing the loan portfolio. The evaluation includes a review of all loans on which full collection may not be reasonably assumed. Should the factors that are considered in determining the allowance for loan losses change over time, or should management’s estimates prove incorrect, a different amount may be reported for the allowance and the associated provision for loan losses. For example, if economic conditions in our market area undergo an unexpected and adverse change, a different amount may be reported for the allowance and the associated provision for loan losses. For example, if economic conditions in our market area undergo an unexpected and adverse change, we may need to increase our allowance for loan losses by taking a charge against earnings in the form of an additional provision for loan losses.

Results of Operations for the Years Ended December 31, 2008 and 2007

General Discussion of Our Results

Our principal source of revenue is net interest income at the Bank. Net interest income is the difference between:

	•		income received on interest-earning assets, such as loans and investment securities; and

	•		payments we make on our interest-bearing sources of funds, such as deposits and borrowings.

The level of net interest income is determined primarily by the average balances, or volume, of interest-earning assets and interest-bearing liabilities and the various rate spreads between the interest-earning assets and the Company’s funding sources. Changes in our net interest income from period to period result from, among other things:

	•		increases or decreases in the volumes of interest-earning assets and interest-bearing liabilities;

	•		increases or decreases in the average rates earned and paid on those assets and liabilities;

	•		our ability to manage our interest-earning asset portfolio, which includes loans;

	•		the availability and costs of particular sources of funds, such as non-interest bearing deposits; and

	•		our ability to “match” liabilities to fund assets of similar maturities at a profitable spread of rates earned on assets over rates paid on liabilities.

In 2008 and 2007, our other principal sources of revenue were service charges on deposit accounts and credit/debit card related income. During 2008, other noninterest income included a significant gain on sale of property discussed in more detail under “Noninterest Income” below.

Net Income

The following is a summary of our results of operations (dollars in thousands except per share amounts):


	Years Ended December 31,				Dollar Change			Percent Change
	2008		2007		2008 to 2007			2008 to 2007
Interest income	$	35,193	$	36,714	$	(1,521	)		-4.14	%
Interest expense		16,934		19,028		(2,094	)		-11.00	%

Net interest income		18,259		17,686		573			3.24	%
Provision for loan losses		2,275		982		1,293			131.67	%

Net interest income after provision for loan losses		15,984		16,704		(720	)		-4.31	%
Noninterest income		4,453		3,742		711			19.00	%
Noninterest expense		16,330		15,240		1,090			7.15	%

Net income before income taxes		4,107		5,206		(1,099	)		-21.11	%
Income tax expense		827		1,294		(467	)		-36.09	%

Net income	$	3,280	$	3,912	$	(632	)		-16.16	%


Total revenues	$	39,646	$	40,456
Total expenses		36,366		36,544

Basic earnings per share		1.24		1.68
Diluted earnings per share		1.24		1.61

The decrease in net income in 2008 as compared with 2007 was primarily attributable to the increase in the provision for loan losses as well as compression in the Company’s net interest margin. The increase in the provision for loan losses was primarily due to the increasing risk inherent in our loan portfolio during the current economic climate, primarily within the real estate construction and development segment of the portfolio. The increase in the provision was also necessary due to growth in our loan portfolio during 2008. Total average loans increased approximately $43,887,000 from December 31, 2007 to December 31, 2008. While the average balance of our loan portfolio increased, the average rate earned on these loans decreased 148 basis points during 2008 from 8.65% at December 31, 2007, to 7.17% at December 31, 2008. These opposing factors resulted in an overall decrease in interest income earned on loans of approximately $2,346,000. The increase in the average balance of our securities portfolio, approximately $21,811,000 during 2008, resulted in an increase in the related interest income of approximately $1,030,000. This increase was primarily related to the increase in volume. The average interest rate earned on investment securities decreased 4 basis points from 4.92% at December 31, 2007, to 4.88% at December 31, 2008. Despite the net decrease in interest income, net interest income increased during 2008. The increase in net interest income is due to the relatively more significant decrease in interest expense. The average balance of interest-bearing deposits increased approximately $46,859,000 during the year, however; the average rate paid on those deposits decreased from 4.53% at December 31, 2007, to 3.40% at December 31, 2008, a decrease of 113 basis points. The resulting decrease in interest expense related to deposits was approximately $2,157,000. Additionally, the average balance of FHLB advances and other borrowings increased approximately $22,054,000 from 2007 to 2008. The average rate paid on these borrowings decreased 84 basis points during the year, but the increase in volume was enough to offset the benefit derived from the lower rate. Interest expense on these borrowed funds increased approximately $315,000 from 2007 to 2008. The considerable decreases in the

rates earned on interest-earning assets and the rates paid on interest-bearing liabilities are rooted in the numerous rate cuts enacted by the Federal Reserve’s Federal Open Market Committee (“FOMC”) beginning in the third quarter of 2007 and continuing through December 2008. The FOMC decreased the target federal funds rate ten times during that period resulting in a total decrease of 400-425 basis points. In December 2008, the final rate cut resulted in a target funds rate expressed as a range from 0.00-0.25%. The increase in noninterest expense, which exceeded the increase in noninterest income, also contributed to the decrease in net income. The components of noninterest income and noninterest expense are discussed under the headings “Noninterest Income” and “Noninterest Expense” below.

During 2007, management anticipated the downward pressure on interest rates would continue into 2008. As a result, the Bank continued to increase the fixed rate loan portfolio during the first two quarters of 2008 utilizing interest rate floors in an attempt to somewhat mitigate the effect of the decreasing rate environment. As the FOMC continued to decrease the federal funds rate during the third and fourth quarters of 2008, the Bank began to make loans tied to prime adjusting daily, with interest rate floors exceeding the prime rate in most instances. The fixed rate loans and the interest rate floors have positively impacted our results of operations during 2007 and 2008. If rates begin to rise during 2009, our shift to loans tied to prime repricing daily will have an even more significant positive impact on our results of operations as the interest rates on those loans begin to exceed their rate floors.

Basic and diluted earnings per share were $1.24 and $1.24, respectively, for 2008, compared to $1.68 and $1.61, respectively, for 2007 reflecting the decrease in net income from 2007 to 2008 as well as an increase in the average number of shares outstanding as a result of option exercises as well as payment of a 5% stock dividend, offset, in part, by share repurchases. See “Note 14 Stock Options and Warrants” for a more detailed discussion of shares issued.

The Bank’s net interest margin, the difference between the yields on earning assets, including loan fees, and the rate paid on funds to support those assets, declined 34 basis points from 3.81% at December 31, 2007, to 3.47% at December 31, 2008. Management anticipated narrowing margins during 2008, however; the magnitude of the compression was greater than expected due to the unprecedented actions by the FOMC. See the section titled “Interest Expense and Net Interest Margin,” below for a more detailed discussion.

The following chart illustrates our net income for the periods indicated. The changes below were impacted by changes in rate as well as changes in volume:


	2008		2007
First Quarter	$	790,580	$	901,478
Second Quarter		929,137		1,026,037
Third Quarter		868,204		1,006,677
Fourth Quarter		692,287		977,902

Annual Total	$	3,280,208	$	3,912,094

The following discussion and analysis describes, in greater detail, the specific changes in each income statement component.

Average Balance Sheet and Analysis of Net Interest Income
for the Years Ended December 31, 2008 and 2007
(in thousands, except rates)


	Average Balance				Income/Expense				Yield/Rate
	2008		2007		2008		2007		2008			2007
*Interest-earning assets:*
Loans (1)(2)	$	417,124	$	373,237	$	29,921	$	32,267		7.17	%		8.65	%
Investment Securities: (3)
Available for sale		101,035		80,168		4,917		3,915		4.87	%		4.88	%
Held to maturity		2,073		1,916		96		92		4.63	%		4.80	%
Equity securities		3,974		3,187		210		186		5.28	%		5.84	%

Total securities		107,082		85,271		5,223		4,193		4.88	%		4.92	%
Federal funds sold and other		2,147		5,116		49		254		2.28	%		4.96	%

Total interest-earning assets		526,353		463,624		35,193		36,714		6.69	%		7.92	%
*Nonearning assets*		56,617		45,361

Total Assets	$	582,970	$	508,985


*Interest-bearing liabilities:*
Interest bearing deposits:
Interest bearing demand deposits		142,020		127,704		3,067		4,949		2.16	%		3.88	%
Savings deposits		13,815		8,673		269		91		1.95	%		1.05	%
Time deposits		224,055		196,654		9,579		10,032		4.28	%		5.10	%

Total interest bearing deposits		379,890		333,031		12,915		15,072		3.40	%		4.53	%
Securities sold under agreements to repurchase		5,093		5,815		129		158		2.53	%		2.72	%
Federal Home Loan Bank advances and other borrowings		83,024		60,970		3,127		2,812		3.77	%		4.61	%
Subordinated debt		13,403		13,403		763		986		5.69	%		7.36	%

Total interest-bearing liabilities		481,410		413,219		16,934		19,028		3.52	%		4.60	%
*Noninterest-bearing deposits*		48,331		53,336		—		—

Total deposits and interest- bearings liabilities		529,741		466,555		16,934		19,028		3.20	%		4.08	%

Other liabilities		2,616		2,565
*Shareholders’ equity*		50,613		39,865

	$	582,970	$	508,985

*Net interest income*					$	18,259	$	17,686

Net interest spread (4)										3.17	%		3.32	%
Net interest margin (5)										3.47	%		3.81	%


(1)		Interest income from loans includes total fee income of approximately $1,786,000 and $2,138,000 for the years ended December 31, 2008 and 2007, respectively.

(2)		For the purpose of these computations, non-accrual loans are included in average loans.

(3)		Tax-exempt income from investment securities is not presented on a tax-equivalent basis.

(4)		Yields realized on interest-earning assets less the rates paid on interest-bearing liabilities.

(5)		Net interest margin is the result of net interest income divided by average interest-earning assets for the period.

As mentioned above the increase in net interest income was attributable to changes in both rate and volume during 2008. Although net interest income increased during 2008, in a stable interest rate environment, the Company would typically experience a more substantial increase in interest income if it was able to grow its interest-earning assets, particularly the loan portfolio. However, during 2008, the growth of our interest-earning assets that generally would have resulted in an increase in interest income was largely offset by the reduction in yields earned on those interest-earning assets. The largest factor contributing to our growth in net interest income during 2008 was the reduction in rates paid on interest-bearing deposit accounts, particularly the 172 basis point decrease in the average rate paid on interest bearing demand deposits that resulted in a large decrease in interest expense. Additionally, the 82 basis point decrease in the rate paid on time deposits created a net reduction in interest expense related to time deposits. The expense reductions in both categories of deposits were recognized in spite of significant increases in the average balances outstanding from 2007 to 2008.

The second largest factor contributing to the growth in our net interest income during 2008 was the approximately $22,000,000 growth in the average balance of our portfolio of securities, which was funded primarily by the approximately $25,000,000 growth in average public funds deposits. These public funds consist of NOW accounts and certificates of deposit. Interest income related to our securities was slightly affected by a modest decline in the average rate earned on these investments.

The interest income we earn on loans is the largest component of net interest income and the Bank’s net interest margin. Despite the approximately $44,000,000 increase in average loans outstanding during 2008, the related interest income decreased for the year due to the 148 basis point decrease in the average yield on loans. Certain loan terms and conditions such as repricing frequency, rate floors and fixed interest rates have been used by the Bank in an attempt to limit exposure in a depressed rate environment.

Rate and Volume Analysis

The following table sets forth the extent to which changes in interest rates and changes in volume of interest-earning assets and interest-bearing liabilities have affected our interest income and interest expense during the years indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) change in volume (change in volume multiplied by previous year rate); (2) change in rate (change in rate multiplied by current year volume); and (3) a combination of change in rate and change in volume. The changes in interest income and interest expense attributable to both volume and rate have been allocated proportionately to the change due to volume and the change due to rate.

ANALYSIS OF CHANGES IN NET INTEREST INCOME
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
(dollars in thousands)


	2008 Compared to 2007
	Increase (decrease)
	due to change in
	Rate			Volume			Total
Income from interest-earning assets:
Interest and fees on loans	$	(6,142	)	$	3,796		$	(2,346	)
Interest on securities		(43	)		1,073			1,030
Interest on Federal funds sold and other		(58	)		(147	)		(205	)

Total interest income		(6,243	)		4,722			(1,521	)

Expense from interest-bearing liabilities:
Interest on interest-bearing deposits		(2,424	)		720			(1,704	)
Interest on time deposits		(1,851	)		1,398			(453	)
Interest on other borrowings		(989	)		1,052			63

Total interest expense		(5,264	)		3,170			(2,094	)


Net interest income	$	(979	)	$	1,552		$	573

Provision for Loan Losses

The provision for loan losses is based on management’s evaluation of economic conditions, volume and composition of the loan portfolio, historical charge-off experience, the level of nonperforming and past due loans, and other indicators derived from reviewing the loan portfolio. Management performs such reviews quarterly and makes appropriate adjustments to the level of the allowance for loan losses as a result of these reviews.

The increase in the provision for loan losses during 2008 as compared to 2007 was based on management’s evaluation of the overall allowance for loan losses relative to management’s assessment of the risk of losses inherent in our loan portfolio. Total loans increased approximately $21 million during 2008 as compared to an increase of approximately $53 million during 2007. Management has continued to focus on maintaining our allowance for loan losses at levels that reflect the risk associated with the loan portfolio.

Management believes that its current credit-granting and administration processes follow a comprehensive and disciplined approach that mitigates risk and lowers the likelihood of significant increases in charge-offs and non-performing loans, although all credit-granting processes require subjective judgments and estimates. For additional information refer to the discussion under “Discussion of Financial Condition – Allowance for Loan Losses.”

Noninterest Income

The following table presents the major components of noninterest income for 2008 and 2007 (dollars in thousands).


	Years Ended December 31,				Dollar Change			Percent Change
	2008		2007		2008 to 2007			2008 to 2007
Service charges on deposit accounts	$	1,424	$	1,414	$	10			0.71	%
Other fees and commissions		1,222		1,153		69			5.98	%
Gain on sale of mortgage loans		163		323		(160	)		-49.54	%
Gain on sale of securities		179		—		179			100.00	%
Other noninterest income		1,465		852		613			71.95	%

Total noninterest income	$	4,453	$	3,742	$	711			19.00	%

The principal components of noninterest income during 2008 and 2007 were service charges on deposits, fees associated with credit/debit cards included in “other fees and commissions”, and income resulting from the increase in the cash surrender value of bank owned life insurance (“BOLI”). Additionally, during 2008, we sold two pieces of excess Bank property resulting in a total gain on sale of approximately $882,000. During 2007, property held in other real estate owned was sold for a total gain of approximately $274,000. The approximately $53,000 increase in credit/debit card income for 2008, was due to the increase in the Bank’s customer base and their continued increased usage of debit and credit cards. The decrease in gain on sale of mortgage loans during 2008 was due to a further reduction in staff of the mortgage department and a continued general downturn in the home sales market in the Sevier and Blount County market areas during the year. In addition to the property transaction gains mentioned above, the increase in other noninterest income included an increase of approximately $93,000 from the cash surrender value of BOLI partially resulting from the Bank’s investment of an additional $2,000,000 in BOLI during February 2008. Other noninterest income also increased approximately $36,000 for 2008 due to the income generated from the Bank’s investment in Appalachian Fund for Growth II, an LLC the Bank invested in during the first quarter of 2006 that invests in low income areas and which generates tax credits for its members like the Company.

Interest Expense and Net Interest Margin

The decrease in interest expense during 2008 as compared to 2007 was primarily due to the general decrease in interest rates paid on deposits, primarily demand deposit accounts and time deposits (including brokered deposits), as well as subordinated debt. The increases in the average balance of time deposits of approximately $27 million and interest-bearing demand deposits of approximately $14 million were not large enough to counteract the effects of the lower rates paid. Savings deposits was the only component of interest-bearing liabilities that had an increase in the average rate paid during the year. The average rate paid on savings deposits increased 90 basis points from 1.05% at December 31, 2007 to 1.95% at December 31, 2008. This increase was the result of the continued success of a new competitive rate savings product. Interest expense on subordinated debt decreased during 2008 due exclusively to the 167 basis point decrease in the average rate paid on this debt which is priced at a spread above 3-month

LIBOR. Interest expense on Federal Home Loan Bank advances and other borrowings increased during the year due to the approximately $22,054,000 increase in volume, offset in part by the 84 basis point decrease in the average rate paid.

Even as our cost of interest-bearing deposits has declined due to the actions of the FOMC, the local competition for deposits, in some instances, has and could continue to cause interest rates paid on deposits to remain above market levels during 2009.

Our net interest margin, the difference between the yield on earning assets, including loan fees, and the rate paid on funds to support those assets, averaged 3.47% during 2008 versus 3.81% in 2007, a decrease of 34 basis points. The decrease in our net interest margin reflects a decrease in the average spread in 2008 between the rates we earned on our interest-earning assets, which had a decrease in overall yield of 123 basis points to 6.69% at December 31, 2008, as compared to 7.92% at December 31, 2007, and the rates we paid on interest-bearing liabilities, which had a slightly less substantial decrease of 108 basis points in the overall rate to 3.52% at December 31, 2008, versus 4.60% at December 31, 2007. Our interest-earning assets, including approximately $140,000,000 in loans tied to prime that reprice immediately, reprice more quickly than our interest-bearing liabilities, particularly time deposits and borrowings with a fixed rate and term. Therefore, during the continuous, declining interest rate environment that began in the third quarter of 2007 and continued throughout 2008, our net interest margin has been compressed as our interest-sensitive assets and liabilities reprice at their expected speeds. Our interest-earning assets are likely much closer to their current rate environment yield levels than are our interest-bearing liabilities. As these interest-bearing liabilities continue to reprice, our margin should begin to expand. When market interest rates begin to increase, our net interest margin should also begin to increase. Additionally, our net interest margin was negatively impacted by the approximately $12 million decrease in noninterest-bearing demand deposits during 2008. This negative effect will continue as long as and to the extent that the balance of noninterest-bearing demand deposits is reduced.

Noninterest Expenses

The following table presents the major components of noninterest expense for 2008 and 2007 (dollars in thousands).


	Years Ended December 31,				Dollar Change		Percent Change
	2008		2007		2008 to 2007		2008 to 2007
Salaries and employee benefits	$	9,232	$	8,992	$	240		2.67	%
Occupancy expenses		1,324		1,080		244		22.59	%
Other operating expenses		5,774		5,167		607		11.75	%

Total noninterest expense	$	16,330	$	15,239	$	1,091		7.16	%

The largest component of our non-interest expense continues to be the cost of salaries and employee benefits, which increased by approximately $240,000 during 2008. However, the most significant increase in noninterest expenses during 2008 was related to other operating expenses, including an increase in FDIC assessments of approximately $208,000, an increase in loss on other real estate owned of approximately $128,000, an increase in ATM/Debit card expense of

approximately $107,000 reflecting the expense of implementing a new debit card reward points program as well as an increase in the volume of cardholders and transactions and an increase in furniture, fixtures and equipment depreciation expense of approximately $95,000 reflecting our expansion. During 2007 and 2008, the Bank continued the expansion of its branch network. This expansion created the need for additional staff in the new branches as well as in support areas. The increase in salaries and employee benefits would have been more significant, but during December 2008, we reversed approximately $438,000 of expense accrued throughout 2008 for an incentive bonus that is paid out if the Bank’s net income for the year exceeds management’s projected budget. It became apparent during December that the budget figure would not be reached. The comparable expense included in total salary expense for 2007 is approximately $525,000. During 2009, we anticipate opening only one additional branch. Accordingly, construction expenses and personnel costs are expected to stabilize. We do, however, expect our FDIC assessments to continue to increase in 2009 when compared to 2008 levels as the FDIC seeks to replenish its reserve funds and as a result of our participation in the TLGP transaction account guarantee program. This increase may be significant. We may also experience an increase in the loss on sale of other real estate owned in 2009 and increased expenses to hold, market and dispose of other real estate owned, particularly if the amount of other real estate owned continues to increase.

Income Taxes

Our provision for income taxes and effective tax rates for 2008 and 2007 were as follows:

Provision for Income Taxes and Effective Tax Rates
(dollars in thousands)


	Provision		Effective Tax Rates
2008	$	827		20.14	%
2007		1,294		24.86	%

The Bank’s effective tax rate decreased during 2008 due primarily to the continuing tax benefits generated from the formation of MNB Real Estate, Inc., which is a real estate investment trust subsidiary formed during the second quarter of 2005. Additionally, during 2006 the Bank became a partner in Appalachian Fund for Growth II, LLC with three other Tennessee banking institutions. This partnership invested in a program that generated a federal tax credit in the amount of approximately $200,000 per year during 2007 and 2008. Additionally, the partnership generated a single $200,000 State of Tennessee tax credit for tax year 2006 that can be utilized over a maximum of 20 years to offset state tax liabilities. Increased tax-exempt income generated from municipal bonds and bank owned life insurance also contributed to the lower effective tax rate in 2008.

Discussion of Financial Condition

General Discussion of Our Financial Condition

The following is a summary comparison of selected major components of our financial condition for the periods ended December 31, 2008 and 2007 (dollars in thousands):


	2008			2007			$ change			% change
Cash and equivalents	$	14,590		$	16,329		$	(1,739	)		-10.65	%
Loans		420,429			397,674			22,755			5.72	%
Allowance for loan losses		5,292			3,974			1,318			33.17	%
Investment securities		126,695			83,162			43,533			52.35	%
Premises and equipment		31,484			25,427			6,057			23.82	%
Other real estate owned		9,444			1,329			8,115			610.61	%


Total assets		621,373			541,496			79,877			14.75	%

Noninterest-bearing demand deposits		44,652			56,307			(11,655	)		-20.70	%
Interest-bearing demand and savings deposits		163,565			139,319			24,246			17.40	%
Time deposits		246,449			208,748			37,701			18.06	%


Total deposits		454,666			404,374			50,292			12.44	%

Federal funds purchased		22,580			1,300			21,280			1636.92	%
Federal Home Loan Bank advances		72,900			65,356			7,544			11.54	%
Subordinated debentures		13,403			13,403			—			0.00	%


Total liabilities		570,379			492,548			77,831			15.80	%

Accumulated other comprehensive loss		(148	)		(279	)		131			46.95	%
Total shareholders’ equity	$	50,994		$	48,948		$	2,046			4.18	%

Loans

At December 31, 2007 and 2008, loans comprised 80.8% and 76.1% of our total earning assets, respectively. This decrease was caused by the more significant, relative increase in our investment securities portfolio which was driven primarily by increased pledging requirements related to an increase in public funds deposits. Total earning assets as a percent of total assets, were 88.9% at December 31, 2008, compared to 90.8% at December 31, 2007. This decrease in total earning assets relative to total assets in 2008 was attributable to the increase in premises and equipment related to expansion and the construction of new branches and the expansion of our operations center as well as the increase in other real estate owned. The increase in securities as a percentage of our total earning assets could negatively impact our results of operations in 2009 as securities typically generate a lower yield than loans.

Loan Portfolio. Our loan portfolio consisted of the following loan categories and amounts as of the dates indicated:


	At December 31,
	2008		2007		2006		2005		2004
					(in thousands)
Commercial, financial, agricultural	$	37,632	$	35,929	$	26,062	$	15,375	$	9,870
Real estate — construction, development		142,370		150,844		137,989		80,719		55,618
Real estate — mortgage		231,999		201,011		173,085		144,898		134,272
Consumer and other		8,428		9,890		7,572		7,872		9,418

Less allowance for loan losses		5,292		3,974		3,524		2,634		2,281
Loans, net	$	415,137	$	393,700	$	341,184	$	246,230	$	206,897

Commercial and consumer loans tend to be more risky than loans that are secured by real estate, however, the Bank seeks to control this risk with adherence to quality underwriting standards. Real estate construction and development loans do, however, involve risk and if the underlying collateral, which in the case of acquisition and development loans may involve large parcels of real property, is not equal to the value of the loan, we may suffer losses if the borrower defaults on its obligation to us.

Maturities and Sensitivities of Loan Portfolio to Changes in Interest Rates. Total loans as of December 31, 2008 are classified in the following table according to maturity or scheduled repricing:


	One year		Over one year		Over three years		Over five
	or less		through three years		through five years		years
			(in thousands)
Commercial, financial, agricultural	$	14,358	$	8,274	$	7,984	$	7,016
Real estate — construction, development		101,661		21,089		15,622		3,999
Real estate — mortgage		97,839		89,167		30,855		14,137
Consumer and other		5,262		1,676		1,234		256

Total	$	219,120	$	120,206	$	55,695	$	25,408

Of our loans maturing more than one year after December 31, 2008, approximately $93,508,000 had fixed rates of interest and approximately $107,801,000 had variable rates of interest. At December 31, 2008, loans to sub-dividers/developers were 15.9% of total loans. No other concentrations of credit exceeded ten percent of our total loans.

Allowance for Loan Losses

The allowance for loan losses represents management’s assessment and estimates of the risks associated with extending credit and its evaluation of the quality of our loan portfolio. Management analyzes the loan portfolio to determine the adequacy of the allowance for loan losses and the appropriate provision required to maintain the allowance for loan losses at a level believed to be adequate to absorb anticipated loan losses. In assessing the adequacy of the allowance, management reviews the size, quality and risk of loans in the portfolio. Management

also considers such factors as the Bank’s loan loss experience, the amount of past due and nonperforming loans, impairment of loans, specific known risks, the status, amounts and values of nonperforming assets (including loans), underlying collateral values securing loans, current and anticipated economic conditions and other factors which affect the allowance for potential credit losses. Based on an analysis of the credit quality of the loan portfolio prepared by the Bank’s loan review officer, the CFO presents a quarterly analysis of the adequacy of the allowance for loan losses for review by our board of directors.

Our allowance for loan losses is also subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the level of risk in the loan portfolio. During their routine examinations of banks, regulatory agencies may advise the bank to make additional provisions to its allowance for loan losses, which would negatively impact a bank’s results of operations, when the opinion of the regulators regarding credit evaluations and allowance for loan loss methodology differ materially from those of the bank’s management.

Concentrations of credit risk typically involve loans to one borrower, an affiliated group of borrowers, borrowers engaged in or dependent upon the same industry, or a group of borrowers whose loans are secured by the same type of collateral. Our most significant concentration of credit risks lies in the high proportion of our loans to businesses and individuals dependent on the tourism industry and loans to subdividers and developers of land. The Bank assesses loan risk by primary concentrations of credit by industry and loans directly related to the tourism industry are monitored carefully. At December 31, 2008, approximately $180 million in loans, or 43% of total loans, were to businesses and individuals whose ability to repay depends to a significant extent on the tourism industry in the markets we serve as compared to approximately $179 million in loans, or 45% of total loans, at December 31, 2007. The most significant increase in this category was for sub-dividers/developers which increased approximately $8 million to approximately $66 million. This increase was somewhat offset by the decrease in loans to hotel & motel franchise operators of approximately $5 million to approximately $25 million.

While it is the Bank’s policy to charge off in the current period loans for which a loss is considered confirmed, there are additional risks of losses which cannot be quantified precisely or attributed to particular loans or classes of loans. Because the risk of loss includes unpredictable factors, such as the state of the economy and conditions affecting individual borrowers, management’s judgments regarding the appropriate size of the allowance for loan losses is necessarily approximate and imprecise, and involves numerous estimates and judgments that may result in an allowance that is insufficient to absorb all incurred loan losses.

Non-accrual loans as a percentage of total loans increased from 0.04% at December 31, 2007 to 2.79% at December 31, 2008 while the ratio of nonperforming assets (loans past due 90 days or more and still accruing, loans on nonaccrual and other real estate owned) to total loans increased from 0.38% at December 31, 2007 to 5.06% at December 31, 2008. The increases in nonaccrual loans and nonperforming assets are related primarily to the reduced sales volume of real estate in Sevier County of land, vacation homes and second homes to investors living outside the county. Although sales volume for these types of properties fell approximately 35% during 2008 as compared to 2007, average sales prices fell by only approximately 5% for the same periods. The tourist industry in Sevier County remained relatively stable during 2008 as compared to 2007 with portions of the industry showing modest declines while others had

modest increases. Management expects these trends to continue during 2009, however; if sales of vacation homes or second homes continue to decline, borrowers whose loans are secured by these types of properties may experience difficulty in meeting their obligations to us. Properties included in the other real estate owned category are not expected to create material losses during future periods. Approximately 68% of this category is one income producing hotel and the Bank has hired a hotel management firm to operate it until it is sold. Additionally, loans on nonaccrual are reviewed and current appraisals indicate losses on loans secured by real estate are not expected to cause a material impact on the Bank’s operating results.

Our allowance for loan losses at December 31, 2008 was approximately $5,292,000, a net increase of approximately $1,318,000 for the year. The allowance for loan losses as a percentage of total loans, non-accrual loans and non-performing assets at December 31, 2008 was 1.26%, 45.19% and 24.86%, respectively, compared to 1.00%, 2,225.54% and 260.41%, respectively, at December 31, 2007. Net charge-offs during 2008 increased from approximately $532,000 in 2007 to approximately $957,000 in 2008, representing a net charge-off ratio of 0.23% in 2008 compared to 0.15% in 2007. Management continues to evaluate and adjust our allowance for loan losses, and presently believes the allowance for loan losses is adequate to provide for probable losses inherent in the loan portfolio.

The following table sets forth, as of the dates indicated, the aggregate value of non-performing loans for the following categories:


	At December 31,
	2008		2007		2006		2005		2004
			(in thousands)
Loans accounted for on a nonaccrual basis	$	11,711	$	179	$	—	$	92	$	161

Loans contractually past due ninety days or more as to interest or principal payments and still accruing		128		19		470		342		21

Loans, the terms of which have been renegotiated to provide a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower		2,296		—		—		—		—

Loans now current about which there are serious doubts as to the ability of the borrower to comply with present loan repayment terms	$	2,858	$	170	$	30	$	95	$	15

Management is not aware of any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been identified which (1) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (2) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

The following table sets forth the reduction in interest income we experienced in 2007 and 2008 as a result of non-performance of certain loans during the year:


	2008		2007
	(in thousands)
Interest income that would have been recorded on nonaccrual loans under original terms	$	748	$	7

Interest income that was recorded on nonaccrual loans		2		41

The purpose of placing a loan on non-accrual is to prevent the Bank from overstating its income. The decision to place a loan on non-accrual is made by the Executive Committee based on a monthly review. The Executive Committee also reviews any loans recommended by management to be placed on non-accrual that are: (1) being maintained on a cash basis because of deterioration in the financial position of the borrower; or (2) for which payment in full of interest or principal is not expected.

Generally, the Bank does not accrue interest on any loan when principal or interest are in default for 90 days or more unless the loan is well secured and in the process of collection. Consumer loans and residential real estate loans secured by 1-4 family dwellings are ordinarily not subject to those guidelines.

The Board of Directors may restore a non-accruing loan to an accruing status when principal and interest is no longer due and unpaid, or it otherwise becomes both well secured and in the process of collection. All loans on non-accrual are reported on the Bank’s watch loan list.

The following table summarizes our loan loss experience and related adjustments to the allowance for loan losses as of the dates and for the periods indicated:


	At December 31,
	2008			2007			2006			2005			2004
	(dollars in thousands)
Average balance of loans outstanding	$	417,124		$	373,237		$	292,950		$	227,910		$	188,481

Balance of allowance for loan losses at beginning of year		3,974			3,524			2,634			2,281			2,142
Charge-offs:
Commercial, financial, agricultural		198			43			—			—			—
Real estate — construction, development		686			158			1			24			—
Real estate — mortgage		41			250			25			40			325
Consumer and other		98			110			23			45			42

Recoveries:
Commercial, financial, agricultural		43			—			—			—			—
Real estate — construction, development		—			—			1			—			17
Real estate — mortgage		11			15			18			10			21
Consumer and other		12			14			5			6			—

Net charge-offs		957			532			25			93			329
Additions to allowance charges to operations		2,275			982			915			446			468
Balance of allowance for loan losses at end of year		5,292			3,974			3,524			2,634			2,281
Ratio of net loan charge-offs during the year to average loans outstanding during the year		0.23	%		0.14	%		0.01	%		0.04	%		0.17	%

The following table presents our allocation of the allowance for loan losses to the categories of loans in our loan portfolio as of the dates indicated:


	At December 31,
	2008					2007					2006					2005					2004
			Loan					Loan					Loan					Loan					Loan
			Catergory as					Catergory as					Catergory as					Catergory as					Catergory as
			% of Total					% of Total					% of Total					% of Total					% of Total
	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
	(dollars in thousands)
Commercial	$	1,289		8.95	%	$	968		9.03	%	$	418		7.56	%	$	225		3.16	%	$	226		4.72	%
Real estate — construction, development		2,131		33.86	%		1,600		37.93	%		1,331		40.03	%		837		32.43	%		584		26.59	%
Real estate — mortgage		1,599		55.18	%		1,201		50.55	%		1,669		50.21	%		1,502		58.23	%		1,411		64.19	%
Consumer, other		273		2.01	%		205		2.49	%		106		2.20	%		70		6.18	%		60		4.50	%

Total	$	5,292		100.00	%	$	3,974		100.00	%	$	3,524		100.00	%	$	2,634		100.00	%	$	2,281		100.00	%

Securities

Our investment securities portfolio consists of mortgage-backed securities, municipal securities and securities of U.S. government agencies. The investment securities portfolio is the second largest component of our earning assets and represented 22.91% of total earning assets and 20.36% of total assets at year-end 2008. As an integral component of our asset/liability

management strategy, we manage our investment securities portfolio to maintain liquidity, balance interest rate risk and augment interest income. We also use our investment securities portfolio to meet pledging requirements for deposits and borrowings. The average yield on our investment securities portfolio during 2008 was 4.88% versus 4.92% for 2007, a decrease of 4 basis points. Net unrealized losses on securities available for sale, included in accumulated other comprehensive income/(loss), decreased by $131,403, net of income taxes, during 2008.

The growth in our investment securities portfolio during 2008 was seen primarily in mortgage-backed securities, which increased 69%, and was attributable to deposit inflows of public funds that are required to be collateralized with these investments. The average yields on these investments generally exceeded the cost of the interest-bearing deposits and borrowings that funded them during 2008. However, the cost of these deposits and the lower yield associated with these securities, when compared to loans, could negatively impact our net interest margin. As interest rates began to fall during the last quarter of 2007 and into 2008, many of our U.S. government agency securities, which were structured as callable investments, were called at the option of the issuing agencies. Included in our investment securities portfolio as of December 31, 2008, was approximately $24,341,000 in tax-exempt municipal securities.

The carrying amounts of securities at the dates indicated are summarized as follows:


	At December 31,
	2008		2007		2006
	(in thousands)
Securities available for sale:
U.S. Treasury and government agencies and corporations	$	5,751	$	9,179	$	9,535
Corporate securities		175		175		—
Mortgage-backed securities		98,045		57,975		51,367
Obligations of states and political subdivisions		20,607		13,812		13,612

Total		124,578		81,141		74,514
Securities held to maturity:
Obligations of states and political subdivisions		2,117		2,021		1,480

The following table contains the contractual maturity distribution, carrying value, and weighted-average yield to maturity of our investment securities.


	Maturity
			Weighted					Weighted					Weighted					Weighted					Weighted
			Average Tax			After 1		Average Tax			After 5		Average Tax					Average Tax					Average Tax
	1 year		Equivalent			Year - 5		Equivalent			Years - 10		Equivalent			Over 10		Equivalent					Equivalent
	or less		Yield			Years		Yield			Years		Yield			Years		Yield			Total		Yield
	(dollars in thousands)
Securities available for sale:
U.S. Treasury and government agencies	$	5,252		2.80	%	$	—		—		$	—		—		$	500		5.01	%	$	5,752		2.99	%
Corporate securites		—		—			—		—			—		—			115		3.09	%		115		3.09	%
Mortgage-backed securities		—		—			406		4.71	%		8,149		5.08	%		89,489		5.44	%		98,044		5.40	%
Obligations of states and political subdivisions		304		4.53	%		1,108		4.94	%		3,801		6.31	%		15,394		5.86	%		20,607		5.87	%

Total available for sale		5,556		2.90	%		1,514		4.88	%		11,950		5.47	%		105,498		5.49	%		124,518		5.37	%

Securities held to maturity:
U.S. Treasury and government agencies		—		—			—		—			—		—			—		—			—		—
Mortgage-backed securities		—		—			—		—			—		—			—		—			—		—
Obligations of states and political subdivisions		—		—			—		—			659		6.56	%		1,458		4.62	%		2,117		5.23	%

Total held to maturity		—		—			—		—			659		6.56	%		1,458		4.62	%		2,117		5.23	%

Total securities		5,556		2.90	%		1,514		4.88	%		12,609		5.53	%		106,956		5.48	%		126,635		5.37	%

We did not hold any securities from a single issuer that exceeded 10% of total shareholders’ equity as of December 31, 2008, except for mortgage-backed securities issued by government sponsored entities that had a carrying value of approximately $98,045,000 and $57,975,000 at December 31, 2008 and 2007, respectively.

Deposits

Asset growth during 2008 was funded primarily by the increase in deposits, federal funds purchased and FHLB advances for the periods ended December 31, 2008 and 2007.

The balance in total deposits was distributed as follows:


	2008		2007		$ change			% change
Noninterest-bearing demand deposits	$	44,652	$	56,307	$	(11,655	)		-20.70	%

Total noninterest-bearing deposits		44,652		56,307		(11,655	)		-20.70	%

NOW accounts		110,420		87,380		23,040			26.37	%
Money market accounts		37,167		42,959		(5,792	)		-13.48	%
Savings		15,978		8,980		6,998			77.93	%
Brokered deposits		62,478		48,210		14,268			29.60	%
Time deposits		183,971		160,538		23,433			14.60	%

Total interest-bearing deposits		410,014		348,067		61,947			17.80	%

Total deposits	$	454,666	$	404,374	$	50,292			12.44	%

Brokered deposits are certificates of deposit acquired from approved brokers on terms that are substantially similar to deposits acquired in the local market. Brokered deposits

increased approximately $14,000,000 at December 31, 2008 as compared to December 31, 2007. The Bank will continue to rely upon these brokered deposits going forward to fund loan demand and supplement other sources of liquidity due to the relative ease at which these deposits can be acquired and replaced upon maturity and their comparability to local market rates. The average cost of our brokered deposits at December 31, 2008 was 4.36%. During 2009, maturing brokered deposits are being replaced at an average rate of 1.66%, a 270 basis point decrease from the 2008 average, with maturities ranging from 3 to 24 months.

The average balances of deposit accounts by category and the average rates paid thereon are presented below for the periods indicated:


	2008					2007					2006
	Amount		Rate			Amount		Rate			Amount		Rate
	(dollars in thousands)
Noninterest-bearing demand deposits	$	48,331		0	%	$	53,336		0	%	$	54,163		0	%
Interest-bearing demand deposits		142,020		2.16	%		127,704		3.88	%		120,268		3.72	%
Savings deposits		13,815		1.95	%		8,673		1.05	%		7,860		0.61	%
Time deposits		224,055		4.28	%		196,654		5.10	%		146,014		4.28	%


Total	$	428,221				$	386,367				$	328,305

The balances in time certificates of deposit issued in amounts of $100,000 or more as of December 31, 2008, are shown below by time remaining until maturity:


	(dollars in thousands)
Three months or less	$	56,944
Over three months through six months		49,298
Over six months through 12 months		47,706
Over 12 months		18,354

Total	$	172,302

The average balance of interest-bearing demand and savings deposits increased approximately $19,458,000 during 2008 The average rate paid on these interest-bearing demand and savings deposits in 2008 was 2.14%, down from 3.70% in 2007.

We also continue to experience high demand for our certificate of deposit accounts. We offer certificate of deposit accounts on a wide range of terms in order to achieve sustained growth in a market area where there is strong competition for new deposits. Our total average cost of interest-bearing deposits (including demand, savings and certificate of deposit accounts) for 2008 was 3.40%, down from 4.53% in the prior year.

Shareholders’ Equity

The increase in shareholders’ equity was primarily the result of the exercise of stock options, offset in part by share repurchases, as discussed in more detail under

“Item 1 — Business,” as well as the impact of net earnings of approximately $3,280,000. Accumulated other comprehensive loss, which represents the net unrealized losses on securities available-for-sale, decreased approximately $131,000 for 2008 to approximately $148,000.

Interest Rate Sensitivity Management

Interest rate risk is the risk to earnings or market value of equity from the potential movement in interest rates. The primary purpose of managing interest rate risk is to reduce the effects of interest rate volatility and achieve reasonable stability of earnings from changes in interest rates and preserve the value of our equity. Changes in interest rates affect, among other things, our net interest income, volume of loan production and the fair value of financial instruments and our loan portfolio. A key component of our interest rate risk management policy is the maintenance of an appropriate mix of assets and liabilities.

It is our objective to manage assets and liabilities to control the impact of interest rate fluctuations on earnings and to provide a satisfactory, consistent level of profitability within the framework of established cash, loan, investment, borrowing, and capital policies. Certain officers within the Bank are charged with the responsibility for monitoring policies and procedures that are designed to ensure acceptable composition of the asset/liability mix.

The Bank’s asset/liability mix is monitored on a regular basis and a report reflecting the interest rate sensitive assets and interest rate sensitive liabilities is prepared and presented to our Board of Directors and management’s asset/liability committee on a quarterly basis. The key objective of our asset/liability management policy is to monitor and adjust the mix of interest rate sensitive assets and liabilities so as to minimize the impact of substantial movements in interest rates on earnings by matching rates and maturities of our interest-earning assets to those of our interest-bearing liabilities. An asset or liability is considered to be interest rate-sensitive if it will reprice or mature within the time period analyzed, usually one year or less.

We use interest rate sensitivity gap analysis to achieve the appropriate mix of interest rate-sensitive assets and liabilities. The interest rate-sensitivity gap is the difference between the interest-earning assets and interest-bearing liabilities scheduled to mature or reprice within a given time period. A gap is considered positive when the amount of interest rate-sensitive assets exceeds the amount of interest rate-sensitive liabilities. A gap is considered negative when the amount of interest rate-sensitive liabilities exceeds the amount of interest rate-sensitive assets. During a period of rising interest rates, a negative gap would tend to adversely affect net interest income, while a positive gap would tend to result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income, while a positive gap would tend to adversely affect net interest income. If our assets and liabilities were equally flexible and moved concurrently, the impact of any increase or decrease in interest rates on net interest income would be minimal.

A simple interest rate “gap” analysis by itself may not be an accurate indicator of how net interest income will be affected by changes in interest rates. Accordingly, we also evaluate how the repayment of particular assets and liabilities is impacted by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, unpredictable variables such as the magnitude and duration of changes in interest rates may have a significant impact on net

interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types of assets and liabilities may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps”), that limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the interest rate gap.

The following table summarizes our interest-sensitive assets and liabilities as of December 31, 2008. Adjustable rate loans are included in the period in which their interest rates are scheduled to adjust. Fixed rate loans are included in the periods in which they are anticipated to be repaid based on scheduled maturities and anticipated prepayments. Investment securities are included in the period in which they are scheduled to mature while mortgage backed securities are included according to expected repayment. Certificates of deposit are presented according to contractual maturity dates.


	Analysis of Interest Sensitivity
	As of December 31, 2008
	*(dollars in thousands)*
	0 – 3			3 – 12			1 – 3			Over three
	months			months			years			years			Total
Federal funds sold	$	576		$	—		$	—		$	—		$	576
Securities		2,640			13,063			20,139			90,853			126,695
Loans (1)		205,596			75,006			90,961			48,866			420,429

Total interest-earning assets		208,812			88,069			111,100			139,719			547,700


Interest-bearing liabilities:
Interest-bearing demand deposits		147,587			—			—			—			147,587
Savings		15,978			—			—			—			15,978
Time deposits		68,480			143,993			29,106			4,870			246,449
Other borrowings		36,912			—			7,700			55,200			99,812

Total interest-bearing liabilities		268,957			143,993			36,806			60,070			509,826


Interest rate sensitivity gap	$	(60,145	)	$	(55,924	)	$	74,294		$	79,649		$	37,874


Cumulative interest rate sensitivity gap	$	(60,145	)	$	(116,069	)	$	(41,775	)	$	37,874


Interest rate sensitivity gap ratio		-28.80	%		-63.50	%		66.87	%		57.01	%

Cumulative interest rate sensitivity gap ratio		-28.80	%		-39.10	%		-10.24	%		6.92	%


(1)		Includes nonaccrual loans

Beginning in the third quarter of 2007, the Federal Reserve reduced the targeted federal funds rate ten times, for a total of 5.00-5.25% and reduced the discount rate twelve times during the same period, for a total of 5.75%. In December 2008, the final federal funds rate cut resulted in a target rate expressed as a range from 0.00-0.25%.

At December 31, 2008, the Bank’s cumulative one-year interest rate sensitivity gap ratio was (39.10%), which would tend to indicate that our interest-earning assets will re-price during this period at a rate slower than our interest-bearing liabilities. In a declining interest rate environment that is approaching its trough, this would be expected as our interest-earning assets reprice more quickly than our interest-bearing liabilities and would have more closely followed the magnitude and direction of the changing interest rates. Our interest-earning assets are likely much closer to their current interest rate environment yield levels than a significant portion of our interest-bearing liabilities, particularly time deposits and other longer term borrowings, which should continue to reprice downward as outstanding liabilities originated during periods of higher interest rates mature and get replaced at lower rates. Additionally, the effects of certain categories of interest-bearing liabilities, primarily interest-bearing demand deposits and overnight federal funds purchased, tend to be overstated in our gap analysis and we believe that the spread between our interest-earning assets and interest-bearing liabilities will not be affected as much by the repricing period for these deposits as they will by the current interest rate environment. These particular shorter term liabilities, like our interest-earning assets, are probably at or much closer to their current rate environment yield levels than other longer-term liabilities mentioned above.

Return on Assets and Equity

The following table summarizes our return on average assets and return on average equity as well as our dividend payout ratio for the years ended December 31, 2008, 2007 and 2006:


	For the Years Ended
	At December 31,
	2008			2007			2006
Return on average assets		0.56	%		0.77	%		0.95	%
Return on average equity		6.48	%		9.81	%		11.26	%
Average equity as a percentage of average assets		8.68	%		7.83	%		8.48	%
Cash dividend payout ratio		30.65	%		0.00	%		0.00	%

Capital Adequacy and Liquidity

Our funding sources primarily include customer-based core deposits and customer repurchase accounts. The Bank, being situated in a market that relies on tourism as its principal industry, can be subject to periods of reduced deposit funding because tourism in Sevier County is seasonably slow in the winter months. The Bank manages seasonal deposit outflows through its secured Federal Funds lines of credit at several correspondent banks. Those lines totaled $39 million as of December 31, 2008, and are available on one day’s notice. The Bank also has a cash management line of credit in the amount of $100 million from the FHLB of Cincinnati that the Bank uses to meet short-term liquidity demands.

Capital adequacy is important to the continued financial safety and soundness and growth of the Bank and the Company. Our banking regulators have adopted risk-based capital and leverage guidelines to measure the capital adequacy of national banks and bank holding

companies. Based on these guidelines, management believes the Bank and the Company are “well capitalized.”

Regulatory Capital Requirements

The Bank and Company are subject to minimum capital standards as set forth by federal bank regulatory agencies.

Capital for regulatory purposes differs from equity as determined under generally accepted accounting principles. Generally, “Tier 1” regulatory capital will equal capital as determined under generally accepted accounting principles less any unrealized gains or losses on securities available for sale, while “Tier 2” capital includes the allowance for loan losses up to certain limitations. Total risk based capital is the sum of Tier 1 and Tier 2 capital.

Total capital at the Bank also has an important effect on the amount of FDIC insurance premiums paid. Institutions not considered well capitalized are subject to higher rates for FDIC insurance.

The table below set forth the Company’s capital ratios as of the periods indicated:


	December 31, 2008
Tier 1 Risk-Based Capital		13.34	%
Regulatory minimum		4.00	%

Total Risk-Based Capital		14.44	%
Regulatory minimum		8.00	%

Tier 1 Leverage		10.51	%
Regulatory minimum		4.00	%

The table below sets forth the Bank’s capital ratios as of the periods indicated:


	December 31, 2008			December 31, 2007
Tier 1 Risk-Based Capital		13.19	%		13.10	%
Regulatory minimum		4.00	%		4.00	%
Well-capitalized		6.00	%		6.00	%

Total Risk-Based Capital		14.29	%		13.97	%
Regulatory minimum		8.00	%		8.00	%
Well-capitalized		10.00	%		10.00	%

Tier 1 Leverage		10.41	%		11.24	%
Regulatory minimum		4.00	%		4.00	%
Well-capitalized		5.00	%		5.00	%

In November 2003, the Company formed a wholly owned Delaware statutory trust subsidiary, MNB Capital Trust I. This subsidiary issued approximately $5.5 million in trust preferred securities, guaranteed by the Company on a junior subordinated basis. In June 2006, the Company formed a wholly owned Delaware statutory trust subsidiary, MNB Capital Trust II. This subsidiary issued approximately $7.5 million in trust preferred securities, guaranteed by the Company on a junior subordinated basis. The Company obtained the proceeds from the trusts’ sale of trust preferred securities by issuing junior subordinated debentures to the trusts. Under the Financial Accounting Standards Board’s revised Interpretation No. 46 (“FIN 46R”), the trust subsidiaries must be deconsolidated with the Company for accounting purposes. As a result of this accounting pronouncement, the Federal Reserve adopted changes to its capital rules with respect to the regulatory capital treatment afforded to trust preferred securities. The Federal Reserve’s current rules permit qualified trust preferred securities and other restricted capital elements to be included as Tier 1 capital up to 25% of core capital, net of goodwill and intangibles. The Company believes that its trust preferred securities qualify under these revised regulatory capital rules and expects that it will continue to treat the eligible portion of its $13,000,000 of trust preferred securities as Tier 1 capital.

The Company’s sale of 416,500 shares of common stock during the third quarter of 2005 resulted in an increase in capital of approximately $9,896,500. In connection with the offering, there were 416,500 warrants issued, one warrant for each share of stock sold, that had an exercise price of $25.20 per warrant. The warrants could be exercised beginning after one year from the date of the sale of the common stock, and had to be exercised no later than two years from the date of the sale. The final day to exercise the common stock warrants was September 7, 2007. During their one year outstanding, 476,194 out of 482,151 (adjusted for 5% stock dividends) warrants were exercised at a weighted average exercise price of $21.77 (adjusted for 5% stock dividends). The total corresponding increase to shareholders’ equity from September 30, 2006 to September 30, 2007, was approximately $10,367,000. The increase in shareholder’s equity should keep both the Company and the Bank well-capitalized under regulatory standards and allow for future growth for approximately three to five years.

Liquidity is the ability of a company to convert assets into cash or cash equivalents without significant loss. Our liquidity management involves maintaining our ability to meet the day-to-day cash flow requirements of our customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, we would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the production and growth needs of the communities we serve.

The primary function of asset and liability management is not only to assure adequate liquidity in order for us to meet the needs of our customer base, but also to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that we can also meet the investment objectives of our shareholders. For additional information relating to our interest rate sensitivity management, refer to the discussion above under the heading “Interest Rate Sensitivity Management.” Daily monitoring of the sources and uses of funds is necessary to maintain an acceptable cash position that meets both the needs of our customers and the objectives of our shareholders. In a banking environment, both assets and liabilities are considered sources of liquidity funding and both are therefore monitored on a daily basis.

Off-Balance Sheet Arrangements

Our only material off-balance sheet arrangements consist of commitments to extend credit and standby letters of credit issued in the ordinary course of business to facilitate customers’ funding needs or risk management objectives.

Commitments and Lines of Credit

In the ordinary course of business, the Bank has granted commitments to extend credit and standby letters of credit to approved customers. Generally, these commitments to extend credit have been granted on a temporary basis for seasonal or inventory requirements and have been approved by the Bank’s loan committee. These commitments are recorded in the financial statements as they are funded. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitment amounts expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The following is a summary of the Bank’s commitments outstanding at December 31, 2008 and 2007.


	2008		2007
	(dollars in thousands)
Commitments to extend credit	$	82,097	$	125,475
Standby letters of credit		9,885		5,824

Totals	$	91,982	$	131,299

Commitments to extend credit include unused commitments for open-end lines secured by 1-4 family residential properties, commitments to fund loans secured by commercial real estate, construction loans, land development loans, and other unused commitments. Commitments to fund commercial real estate, construction, and land development loans decreased approximately $46,075,000 during 2008, reflecting current economic conditions in our market.

Effects of Inflation

Our consolidated financial statements and related data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operational results in terms of historic dollars, without considering changes in the relative purchasing power of money over time due to inflation.

Inflation generally increases the costs of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant effect on the performance of a financial institution than the effects of general levels of inflation. In addition, inflation affects financial institutions’ cost of goods and services purchased, the cost of salaries and benefits, occupancy expense, and similar items. Inflation and related increases in interest rates generally decrease the market value of investments and loans held and may adversely affect liquidity,

earnings, and stockholders’ equity. Mortgage originations and refinancings tend to slow as interest rates increase, and likely will reduce the Bank’s volume of such activities and the income from the sale of residential mortgage loans in the secondary market.

Significant Accounting Changes

The information appearing under “Note 18. Recent Accounting Pronouncements” in the 2008 notes to the financial statements is incorporated herein by reference.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements of the Company, including notes thereto, and the reports of the Company’s independent registered public accounting firm are included in this Annual Report on Form 10-K beginning at page F-1 and are incorporated herein by reference.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company’s reports and other information filed with the Commission, under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms, and that such information is accumulated and communicated to the management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

The Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon the foregoing, the Chief Executive Officer along with the Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective.

Changes in Internal Control over Financial Reporting

During the fourth quarter of 2008 there were no changes in the Company’s internal control over financial reporting that have materially affected, or that are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Management’s Annual Report on Internal Control over Financial Reporting

Management of the Company is responsible for establishing and maintaining effective internal control over financial reporting. Internal control is designed to provide reasonable

assurance to the Company’s management and board of directors regarding the preparation of reliable published financial statements. Internal control over financial reporting includes self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.

Because of inherent limitations in any system of internal control, no matter how well designed, misstatements due to error or fraud may occur and not be detected, including the possibility of the circumvention or overriding of controls. Accordingly, even effective internal control over financial reporting can provide only reasonable assurance with respect to financial statement preparation. Further, because of changes in conditions, internal control effectiveness may vary over time.

Management assessed the Company’s internal control over financial reporting as of December 31, 2008. This assessment was based on criteria for effective internal control over financial reporting described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, the Chief Executive Officer and Chief Financial Officer concluded that the Company maintained effective internal control over financial reporting as of December 31, 2008 based on the specified criteria.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.

ITEM 9B. OTHER INFORMATION

None.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information appearing under the headings “Proposal #1 Election of Directors,” “Additional Information Concerning the Company’s Board of Directors and Committees” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement (the “2009 Proxy Statement”) relating to the annual meeting of shareholders of the Company, scheduled to be held on May 5, 2009, is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The information appearing under the heading “Proposal #1 Election of Directors” and “Compensation of Named Executive Officers and Directors” in the 2009 Proxy Statement is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information appearing under the heading “Outstanding Voting Securities of the Company and Principal Holders Thereof” in the 2009 Proxy Statement is incorporated herein by reference.

The information appearing under “Note 14. Stock Options and Warrants” in the 2008 notes to the financial statements is incorporated herein by reference.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information appearing under the headings “Certain Relationships and Transactions” and “Proposal #1 Election of Directors” in the 2009 Proxy Statement is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information appearing under the caption “Proposal #2 — Ratification of Independent Registered Public Accounting Firm” in the 2009 Proxy Statement is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES


		(a)(1)		Financial statements. See Item 8.

		(a)(2)		Financial statement schedules. Inapplicable.

		(a)(3)		The following exhibits are filed as a part of or incorporated by reference in this report:


Exhibit No.		Description of Exhibit

2.1		Plan of Reorganization dated March 28, 2003, by and between the Registrant and Mountain National Bank (included as Exhibit 2.1 to the Report on Form 8-K12G3 of the Registrant, dated July 12, 2003 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference).

2.2		Amendment to Plan of Reorganization dated July 1, 2003 (included as Exhibit 2.2 to the Report on Form 8-K12G3 of the Registrant, dated July 12, 2003 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference).

3.1		Charter of Incorporation of the Registrant, as amended (included as Exhibit 3.1 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference).


Exhibit No.		Description of Exhibit

3.2		Bylaws of the Registrant, as amended (included as Exhibit 3.2 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference).

10.1		Stock Option Plan of the Registrant, as amended (included as Exhibit 10.1 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference)*

10.2		Stock Option Agreement of Dwight B. Grizzell (assumed by Registrant) (included as Exhibit 10.3 to the Registrant’s Form 10-KSB for the year ended December 31, 2002 and incorporated herein by reference)*

10.3		Summary Description of Director and Named Executive Officer Compensation Arrangements*

10.4		Form of Warrant Agreement (included as Exhibit 10.5 to the Registrant’s Form SB-2/A filed with the Commission on August 23, 2005)

10.5		Employment Agreement dated as of May 18, 2006 by and between Mountain National Bancshares, Inc. and Dwight Grizzell (included as Exhibit 10.2 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference)*

10.6		Employment Agreement dated as of May 18, 2006 by and between Mountain National Bancshares, Inc. and Grace McKinzie (included as Exhibit 10.3 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference)*

10.7		Employment Agreement dated as of May 18, 2006 by and between Mountain National Bancshares, Inc. and Michael Brown (included as Exhibit 10.4 to the Report on Form 8-K of the Registrant, dated May 19, 2006 (File No. 000-49912), previously filed with the Commission and incorporated herein by reference)*

10.8		Amended and Restated Salary Continuation Agreement, dated January 19, 2007, by and between Mountain National Bank and Dwight Grizzell. (included as Exhibit 10.8 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*

10.9		Amendment, dated November 19, 2007, to Amended and Restated Salary Continuation Agreement, by and between Mountain National Bank and Dwight Grizzell. (included as Exhibit 10.9 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*


Exhibit No.		Description of Exhibit

10.10		Amended and Restated Salary Continuation Agreement, dated January 19, 2007, by and between Mountain National Bank and Michael Brown. (included as Exhibit 10.10 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*

10.11		Amendment, dated November 19, 2007, to Amended and Restated Salary Continuation Agreement, by and between Mountain National Bank and Michael Brown. (included as Exhibit 10.11 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*

10.12		Amended and Restated Salary Continuation Agreement, dated January 19, 2007, by and between Mountain National Bank and Grace McKinzie. (included as Exhibit 10.12 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*

10.13		Amendment, dated November 19, 2007, to Amended and Restated Salary Continuation Agreement, by and between Mountain National Bank and Grace McKinzie. (included as Exhibit 10.13 to the Registrant’s Form 10-K for the year ended December 31, 2007 and incorporated herein by reference)*

21		Subsidiaries of the Registrant

23		Consent of Independent Registered Public Accounting Firm

31.1		Certificate of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certificate of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1		Certificate of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2		Certificate of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


*		Denotes management contract or compensatory plan or arrangement.

The Company is a party to certain agreements entered into in connection with the offering by MNB Capital Trust I of an aggregate of $5,500,000 in trust preferred securities and the offering by MNB Capital Trust II of an aggregate of $7,500,000 in trust preferred securities, as more fully described in this Annual Report on Form 10-K. In accordance with Item 601(b)(4)(iii) of Regulation S-K, and because the total amount of the trust preferred securities is not in excess of 10% of the Company’s total assets, the Company has not filed the various

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


				MOUNTAIN NATIONAL BANCSHARES, INC.
				(Registrant)

		By:		/s/ Dwight B. Grizzell Dwight B. Grizzell
				President and Chief Executive Officer
				Date: March 31, 2009

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


/s/ Dwight B. Grizzell		Date: March 31, 2009

Dwight B. Grizzell, President, Chief Executive Officer and Director

/s/ Richard A. Hubbs		Date: March 31, 2009

Richard A. Hubbs, Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

/s/ James E. Bookstaff		Date: March 31, 2009

James E. Bookstaff, Director

/s/ Gary A. Helton		Date: March 31, 2009

Gary A. Helton, Director

/s/ Charlie R. Johnson		Date: March 31, 2009

Charlie R. Johnson, Director

/s/ Sam L. Large		Date: March 31, 2009

Sam L. Large, Director

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders
Mountain National Bancshares, Inc.

We have audited the accompanying consolidated balance sheets of Mountain National Bancshares, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2008 and 2007, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.

/s/ Crowe Horwath LLP
Brentwood, Tennessee
March 31, 2009

F-1

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

December 31, 2008 and 2007


	2008			2007
ASSETS

Cash and due from banks	$	14,013,675		$	13,011,580
Federal funds sold		576,000			3,317,000


Total cash and cash equivalents		14,589,675			16,328,580

Securities available for sale		124,578,359			81,140,512
Securities held to maturity, fair value $1,813,410 in 2008 and $2,040,376 in 2007		2,117,044			2,021,327
Restricted investments, at cost		3,862,518			3,656,618
Loans, net of allowance for loan losses of $5,292,028 in 2008 and $3,974,354 in 2007		415,137,230			393,699,847
Investment in partnership		4,117,962			4,095,085
Premises and equipment		31,484,233			25,427,243
Accrued interest receivable		2,737,819			2,701,402
Cash surrender value of life insurance		11,078,708			8,649,793
Other real estate owned		9,444,150			1,328,798
Other assets		2,225,501			2,446,821


Total assets	$	621,373,199		$	541,496,026


LIABILITIES AND SHAREHOLDERS’ EQUITY

Deposits:
Noninterest-bearing demand deposits	$	44,652,008		$	56,307,457
NOW accounts		110,420,061			87,380,047
Money market accounts		37,166,820			42,958,868
Savings accounts		15,977,609			8,980,122
Time deposits		246,449,448			208,747,717


Total deposits		454,665,946			404,374,211


Federal funds purchased		22,580,000			1,300,000
Securities sold under agreements to repurchase		4,331,865			5,441,515
Accrued interest payable		1,022,921			1,240,117
Subordinated debentures		13,403,000			13,403,000
Federal Home Loan Bank advances		72,900,000			65,356,418
Other liabilities		1,475,714			1,432,312


Total liabilities		570,379,446			492,547,573


Commitments and contingencies

Shareholders’ equity:
Common stock, $1.00 par value; 10,000,000 shares authorized; issued and outstanding 2,631,611 shares at December 31, 2008 and 2,499,629 shares at December 31, 2007		2,631,611			2,499,629
Additional paid-in capital		41,952,632			39,426,881
Retained earnings		6,557,097			7,300,933
Accumulated other comprehensive income (loss)		(147,587	)		(278,990	)


Total shareholders’ equity		50,993,753			48,948,453


Total liabilities and shareholders’ equity	$	621,373,199		$	541,496,026

See accompanying Notes to Consolidated Financial Statements

F-2

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31, 2008 and 2007


	2008		2007
INTEREST INCOME
Loans	$	29,920,558	$	32,267,281
Taxable securities		4,434,395		3,575,785
Tax-exempt securities		788,792		616,277
Federal funds sold and deposits in other banks		49,246		254,274


Total interest income		35,192,991		36,713,617

INTEREST EXPENSE
Deposits		12,914,535		15,071,725
Federal funds purchased		314,216		213,222
Repurchase agreements		129,080		157,734
Federal Home Loan Bank advances		2,813,163		2,599,215
Subordinated debentures		763,196		986,037


Total interest expense		16,934,190		19,027,933


Net interest income		18,258,801		17,685,684

Provision for loan losses		2,275,000		981,900


Net interest income after provision for loan losses		15,983,801		16,703,784


NONINTEREST INCOME
Service charges on deposit accounts		1,424,062		1,414,005
Other fees and commissions		1,222,454		1,152,851
Gain on sale of mortgage loans		162,740		322,906
Gain on sale of securities available for sale, net		179,274		—
Other noninterest income		1,464,867		852,381


Total noninterest income		4,453,397		3,742,143


NONINTEREST EXPENSE
Salaries and employee benefits		9,232,079		8,992,172
Occupancy expenses		1,323,860		1,080,632
Other operating expenses		5,774,264		5,166,693


Total noninterest expense		16,330,203		15,239,497


Income before income taxes		4,106,995		5,206,430

Income taxes		826,787		1,294,336


Net income	$	3,280,208	$	3,912,094


EARNINGS PER SHARE
Basic	$	1.24	$	1.68
Diluted	$	1.24	$	1.61

See accompanying Notes to Consolidated Financial Statements

F-3

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

Years Ended December 31, 2008 and 2007


												Accumulated
						Additional						Other			Total
	Comprehensive		Common			Paid-in			Retained			Comprehensive			Shareholders’
	Income		Stock			Capital			Earnings			Income/(Loss)			Equity
BALANCE, January 1, 2007			$	1,943,428		$	27,096,848		$	6,068,324		$	(697,737	)		34,410,863
Exercise of stock options, 32,216 shares				32,216			276,473									308,689
Exercise of stock warrants, 437,896 shares				437,896			9,578,237									10,016,133
Share repurchase program, 10,272 shares				(10,272	)		(289,967	)								(300,239	)
5% stock dividend				96,361			2,553,567			(2,679,485	)					(29,557	)
Share-based compensation							138,596									138,596
Tax benefit from exercise of options							73,127									73,127
Comprehensive income:
Net income	$	3,912,094								3,912,094						3,912,094
Other comprehensive income, net of tax:
Unrealized holding gain on securities available for sale, net of reclassification adjustment		418,747		—			—			—			418,747			418,747

Total comprehensive income		4,330,841


BALANCE, December 31, 2007				2,499,629			39,426,881			7,300,933			(278,990	)		48,948,453

Exercise of stock options, 72,914 shares				72,914			504,716									577,630
Share repurchase program, 65,650 shares				(65,650	)		(1,136,372	)								(1,202,022	)
5% stock dividend				124,718			2,868,514			(3,011,034	)					(17,802	)
Cash dividend ($0.38 per share)										(1,013,010	)					(1,013,010	)
Share-based compensation							86,000									86,000
Tax benefit from exercise of options							202,893									202,893
Comprehensive income:
Net income		3,280,208								3,280,208						3,280,208
Other comprehensive income, net of tax:
Unrealized holding gain on securities available for sale, net of reclassification adjustment		131,403		—			—			—			131,403			131,403

Total comprehensive income	$	3,411,611


BALANCE, December 31, 2008			$	2,631,611		$	41,952,632		$	6,557,097		$	(147,587	)	$	50,993,753

See accompanying Notes to Consolidated Financial Statements

F-4

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31, 2008 and 2007


	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,280,208		$	3,912,094
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,248,204			1,058,203
Net realized gains on securities available for sale		(179,274	)		—
Net amortization on securities		124,466			148,110
Activity in held-to-maturity securities:
Increase due to accretion		(95,717	)		(92,419	)
Provision for loan losses		2,275,000			981,900
(Gain)/loss on sale of other real estate		62,120			(271,614	)
Gain on sale of land		(821,096	)		—
Deferred income taxes		(611,624	)		(460,168	)
Gross mortgage loans originated for sale		(19,015,218	)		(33,096,725	)
Gross proceeds from sale of mortgage loans		19,381,754			34,585,892
Gain on sale of mortgage loans		(162,740	)		(322,906	)
Increase in cash surrender value of life insurance		(428,915	)		(335,625	)
Investment in partnership		(22,877	)		(1,857	)
Share-based compensation		86,000			138,596
Tax benefit from exercise of options		(202,893	)		(73,127	)
Change in operating assets and liabilities:
Accrued interest receivable		(36,417	)		(63,183	)
Accrued interest payable		(217,196	)		283,893
Other assets and liabilities		929,901			(2,283,894	)


Net cash provided by operating activities		5,593,686			4,107,170


CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available-for-sale securities:
Proceeds from sales, maturities, and calls		44,204,574			17,602,342
Purchases		(87,456,210	)		(23,783,142	)
Activity in held-to-maturity securities:
Purchases		—			(449,288	)
Purchases of other investments		(205,900	)		(1,210,451	)
Loan originations and principal collections, net		(32,618,031	)		(54,663,567	)
Purchase of premises and equipment		(7,802,054	)		(6,540,962	)
Proceeds from sale of land		1,317,955			—
Purchase of life insurance		(2,000,000	)		—
Proceeds from sale of other real estate		673,719			1,204,893


Net cash used in investing activities		(83,885,947	)		(67,840,175	)


CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		50,291,735			42,644,918
Proceeds from Federal Home Loan Bank advances		27,000,000			60,000,000
Matured Federal Home Loan Bank advances		(19,456,418	)		(31,353,794	)
Net increase/(decrease) in federal funds purchased		21,280,000			(14,275,000	)
Net decrease in securities sold under agreements to repurchase		(1,109,650	)		(418,871	)
Proceeds from issuance of common stock, including warrants and options		577,630			10,324,822
Tax benefit from exercise of options		202,893			73,127
Purchase of common stock		(1,202,022	)		(300,239	)
Cash dividends		(1,030,812	)		(29,557	)


Net cash provided by financing activities		76,553,356			66,665,406


NET (DECREASE)/INCREASE IN CASH AND CASH EQUIVALENTS		(1,738,905	)		2,932,401

CASH AND CASH EQUIVALENTS, beginning of year		16,328,580			13,396,179


CASH AND CASH EQUIVALENTS, end of year	$	14,589,675		$	16,328,580

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid for:
Interest	$	17,151,386		$	18,744,040
Income taxes		1,165,000			1,450,000
Non-cash investing and financing activities:
Transfers from loans to other real estate owned		8,701,852			1,843,467

See accompanying Notes to Consolidated Financial Statements

F-5

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies

The accounting and reporting policies of Mountain National Bancshares, Inc. and its subsidiaries (the “Company”) conform to generally accepted accounting principles in the United States of America and practices within the banking industry. The policies that materially affect financial position and results of operations are summarized as follows:

Nature of operations and geographic concentration:

The Company is a bank-holding company which owns all of the outstanding common stock of Mountain National Bank (the “Bank”). The Bank provides a variety of financial services through its branch offices located in Sevier and Blount County, Tennessee. The Bank’s primary deposit products are demand deposits, savings accounts, and certificates of deposit. Its primary lending products are commercial loans, real estate loans, and installment loans.

Principles of consolidation:

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. The Company’s principal subsidiary is Mountain National Bank. All material inter-company accounts and transactions have been eliminated in consolidation.

Use of estimates:

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates and such differences could be material to the financial statements.

The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral.

The Bank’s loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on local economic conditions.

F-6

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Use of estimates: (continued)

While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated losses on loans. Such agencies may advise the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated.

Statements of cash flows:

The Company considers all cash and amounts due from depository institutions with maturities under 90 days and Federal Funds sold to be cash equivalents for purposes of the statements of cash flows. Net cash flows are reported for customer loan and deposit transactions, interest bearing deposits in other financial institutions, federal funds purchased and repurchase agreements.

Investment Securities:

Debt securities are classified as held to maturity when the Bank has the positive intent and ability to hold the securities to maturity. Securities held to maturity are carried at amortized cost.

Debt securities not classified as held to maturity are classified as available for sale. Securities available for sale are carried at fair value with unrealized gains and losses, net of taxes, reported in other comprehensive income. Realized gains (losses) on securities available for sale are included in other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Realized gains and losses on sales of securities are recorded in non-interest income on the trade date and are determined on the specific-identification method.

The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the level-yield method over the period to maturity, without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated.

Restricted equity securities include common stock of the Federal Home Loan Bank of Cincinnati, Silverton Bank stock and Federal Reserve Bank stock. These securities are carried at cost.

F-7

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Investment Securities: (continued)

Declines in the market value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers the length of time and the extent to which the market value has been less than cost, the financial condition and near-term prospects of the issuer. Any decision by management to sell a security classified as available for sale would be based on factors such as, but not limited to, liquidity requirements, changes in pledging requirements or changes in funding sources and terms.

Securities sold under agreements to repurchase:

The Bank enters into sales of securities under agreements to repurchase identical securities the next day.

Loans:

Loans are stated at unpaid principal balances, less the allowance for loan losses. Interest income is accrued on the unpaid principal balance.

The accrual of interest on real estate and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in process of collection. Installment loans and other personal loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Loans held for sale:

Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage servicing rights are sold with the related loan. Loans held for sale totaled $188,800 and $392,596 at December 31, 2008 and 2007, respectively, and are included with loans on the balance sheet.

F-8

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Allowance for loan losses:

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan 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. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Although management uses available information to recognize losses on loans, because of uncertainties associated with local economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that a material change could occur in the allowance for loan losses in the near term. However, the amount of the change that is reasonably possible cannot be estimated. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses.

Loans considered to be impaired are determined under Statement of Financial Accounting Standards (“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan,” paragraph eight. This paragraph states, in part, “A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement.” The Bank, through its normal loan review process, determines impairment of loans and records any impaired loans at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of the collateral if the loan is collateral dependent. This loan review may result in a portion of the allowance for loan losses being allocated to the loans.

Reserve for unfunded commitments:

The reserve for unfunded commitments represents the estimate for probable credit losses inherent in these commitments to extend credit. Unfunded commitments to extend credit include standby letters of credit and commitments to fund available lines of credit. The process used to determine the reserve for unfunded commitments is consistent with the process for determining the allowance for loan losses and the reserve, if any, is included in other liabilities.

Investment in Partnership:

The Bank is a partner in Appalachian Fund for Growth II, LLC with three other Tennessee banking institutions. This partnership involves a “new markets tax credit” which is generated from a tax credit allocation from the Community Development Financial Institutions Fund (“CDFI”). The purposes of the partnership are (a) to have the primary mission of providing investment capital, solely in the form of loans, to low-income

F-9

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Investment in Partnership: (continued)

communities in accordance with the New Markets Tax Credit Program and (b) to make loans that are qualified low-income community investment loans. This partnership is accounted for using the equity method of accounting.

Premises and equipment:

Land is carried at cost. Other premises and equipment are carried at cost net of accumulated depreciation. Depreciation is computed using the straight-line and the declining balance methods based on the estimated useful lives of the assets. Useful lives range from three to forty years for premises and improvements, and from three to ten years for furniture and equipment. Maintenance and repairs are expensed as incurred while major additions and improvements are capitalized. Gains and losses on dispositions are included in current operations.

Other real estate owned:

Real estate properties acquired through or in lieu of loan foreclosure are initially recorded at the fair value less estimated selling cost at the date of foreclosure. Any write-downs based on the asset’s fair value at the date of acquisition are charged to the allowance for loan losses. Valuations are periodically performed by management, and any subsequent write-downs are recorded as a charge to operations, if necessary, to reduce the carrying value of a property to fair value less cost to sell. Other real estate owned also includes excess Bank property not utilized when subdividing land acquired for the construction of Bank branches. Costs of significant property improvements are capitalized. Costs relating to holding property are expensed. Other real estate owned totaled $9,444,150 and $1,328,798 at December 31, 2008 and 2007, respectively.

Income taxes:

The Company files consolidated federal and state income tax returns with the Bank and its subsidiaries. Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred income taxes related primarily to differences between the basis of the allowance for loan losses and accumulated depreciation. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected using enacted income tax rates. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

F-10

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Income taxes: (continued)

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), as of January 1, 2007. A tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax positions not meeting the “more likely than not” test, no tax benefit is recorded. The adoption had no effect on the Company’s financial statements.

Advertising costs:

The Company expenses all advertising costs as incurred. Advertising expense was $332,989 and $455,453 for the years ended December 31, 2008 and 2007, respectively.

Company owned life insurance:

The Company has purchased life insurance policies on certain key executives. In accordance with EITF 06-05, Company owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Long-term assets:

Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Loan commitments and related financial instruments:

Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Retirement plans:

Employee 401(k) and profit sharing plan expense is the amount of matching contributions made by the Company pursuant to the Company’s 401(k) benefit plan. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service.

F-11

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Earnings per common share:

Basic earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share includes the dilutive effect of additional potential common shares issuable under stock options and stock warrants. Any shares having an antidilutive effect are excluded from the calculation. Earnings and dividends per share are restated for all stock splits and dividends through the date of issue of the financial statements.

Comprehensive income:

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which is also recognized as a separate component of equity.

Loss contingencies:

Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are now such matters that will have a material effect on the financial statements.

Restrictions on cash:

Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements. Beginning October 1, 2008, the Federal Reserve was authorized to pay interest on these balances based on a spread to the average target federal funds rate. These balances did not earn interest prior to that date.

Equity:

Stock dividends in excess of 20% of the Company’s outstanding shares are reported by transferring the par value of the stock issued from retained earnings to common stock. Stock dividends for 20% or less of the Company’s outstanding shares are reported by transferring the fair value, as of the ex-dividend date, of the stock issued from retained earnings to common stock and additional paid-in capital. Fractional share amounts are paid in cash with a reduction in retained earnings.

Dividend restriction:

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders. (See “Note 15 — Regulatory Matters” for more specific disclosure.)

F-12

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 1. Summary of Significant Accounting Policies (continued)

Stock-based compensation:

Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. At December 31, 2008, the Company has a stock-based compensation plan, which is described more fully in “Note 14 — Stock Options and Warrants.”

Segment reporting:

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”) provides for the identification of reportable segments on the basis of discreet business units and their financial information to the extent such units are reviewed by an entity’s chief decision maker (which can be an individual or group of management persons). SFAS 131 permits aggregation or combination of segments that have similar characteristics. In the Company’s operations, each branch is viewed by management as being a separately identifiable business or segment from the perspective of monitoring performance and allocation of financial resources. Although the branches operate independently and are managed and monitored separately, each is substantially similar in terms of business focus, type of customers, products and services. Accordingly, the Company’s consolidated financial statements reflect the presentation of segment information on an aggregated basis in one reportable segment.

Note 2. Securities

Securities have been classified in the balance sheet according to management’s intent as securities held to maturity or securities available for sale. The amortized cost and approximate fair value of securities at December 31, 2008 and 2007 are as follows:

F-13

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 2. Securities (continued)


	2008
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

Securities available for sale:
U. S. Government securities	$	254,253	$	2,545	$	—		$	256,798

U. S. Government agencies		5,453,229		42,086		—			5,495,315

Obligations of states and political subdivisions		22,224,441		21,075		(1,638,780	)		20,606,736

Corporate securities		175,000		—		(60,147	)		114,853

Mortgage-backed securities		96,720,773		1,435,106		(51,222	)		98,104,657


	$	124,827,696	$	1,500,812	$	(1,750,149	)	$	124,578,359


Securities held to maturity:
Obligations of states and political subdivisions	$	2,117,044	$	—	$	(303,634	)	$	1,813,410


	2007
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		Losses			Value

Securities available for sale:
U. S. Government securities	$	247,708	$	1,902	$	—		$	249,610

U. S. Government agencies		8,880,411		48,892		(592	)		8,928,711

Obligations of states and political subdivisions		13,833,607		42,239		(64,000)			13,811,846

Corporate securities		175,000		—		—			175,000

Mortgage-backed securities		58,451,192		183,853		(659,700)			57,975,345


	$	81,587,918	$	276,886	$	(724,292)		$	81,140,512


Securities held to maturity:
Obligations of states and political subdivisions	$	2,021,327	$	34,490	$	(15,441)		$	2,040,376

F-14

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 2. Securities (continued)

Securities with unrealized losses at December 31, 2008 and 2007, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

December 31, 2008:


	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securties	Value		Loss			Value		Loss			Value		Loss
U. S. Government securities	$	—	$	—		$	—	$	—		$	—	$	—

U. S. Government agencies		—		—			—		—		$	—	$	—

Obligations of states and political subdivisions		18,671,408		(1,787,779	)		985,140		(154,636	)	$	19,656,548	$	(1,942,415	)

Corporate securities		114,853		(60,147	)		—		—		$	114,853	$	(60,147	)

Mortgage-backed securities		6,008,515		(37,907	)		3,781,650		(13,314	)	$	9,790,165	$	(51,221	)


Total temporarily impaired	$	24,794,776	$	(1,885,833	)	$	4,766,790	$	(167,950	)	$	29,561,566	$	(2,053,783	)

December 31, 2007:


	Less than 12 Months					12 Months or More					Total
	Fair		Unrealized			Fair		Unrealized			Fair		Unrealized
Description of Securties	Value		Loss			Value		Loss			Value		Loss
U. S. Government securities	$	—	$	—		$	—	$	—		$	—	$	—

U. S. Government agencies		—		—			998,440		(592	)	$	998,440	$	(592	)

Obligations of states and political subdivisions		4,406,227		(59,279	)		1,595,476		(20,162	)	$	6,001,703	$	(79,441	)

Mortgage-backed securities		3,009,017		(30,117	)		30,736,827		(629,583	)	$	33,745,844	$	(659,700	)


Total temporarily impaired	$	7,415,244	$	(89,396	)	$	33,330,743	$	(650,337	)	$	40,745,987	$	(739,733	)

Unrealized losses on obligations of states and political subdivisions and mortgage-backed securities have not been recognized into income because the issuer(s)’ bonds are of high credit quality, management has the intent and ability to hold for the foreseeable future, as discussed below, and the decline in fair value is largely due to changes in interest rates and other market conditions. The fair value is expected to recover as the securities approach maturity. As a result, the Company does not believe that gross unrealized losses as of December 31, 2008 represent an other-than-temporary impairment.

F-15

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 2. Securities (continued)

The gross unrealized losses reported for investment securities relate primarily to mortgage-backed securities issued by the Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and investment securities issued by state and local municipalities. Total gross unrealized losses, which represent 1.62% of the amortized cost basis of the Company’s total investment securities, were primarily attributable to changes in interest rates and other market conditions and not due to the credit quality of the investment securities. The Bank assesses impairment at the individual security level. The Bank’s dependence upon its investment portfolio to provide liquidity during certain periods could, on occasion, create the need to sell an investment security at a price below cost. As noted in FASB Staff Position FAS 115-1 and 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments, paragraph 14, the Company will base its decision to consider an impaired available-for-sale security to be other-than-temporarily impaired in the period in which the decision to sell is made. At this time, the Company has the ability and intent to hold these investments until a recovery of fair value occurs, which may be maturity.

At December 31, 2008 and 2007, securities with a carrying value of approximately $106,808,000 and $60,949,000, respectively, were pledged to secure public deposits and for other purposes required or permitted by law. At December 31, 2008 and 2007, the carrying amount of securities pledged to secure repurchase agreements was approximately $6,095,000 and $7,757,000, respectively.

The amortized cost and estimated fair value of securities at December 31, 2008, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	Securities Available for Sale				Securities Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Due in one year or less	$	5,508,619	$	5,556,138	$	—	$	—
Due more than one year through five years		1,101,036		1,107,642		—		—
Due more than five years through ten years		3,942,166		3,801,101		658,660		581,920
Due after ten years		17,555,102		16,008,821		1,458,384		1,231,490
Mortgage-backed securities		96,720,773		98,104,657		—		—


	$	124,827,696	$	124,578,359	$	2,117,044	$	1,813,410

F-16

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 2. Securities (continued)

Proceeds from the sale of securities available for sale were $18,016,077 for 2008 and $0 for 2007. Gross gains realized on those sales were $179,382 in 2008 and $0 in 2007. Gross losses on those sales were $108 in 2008 and $0 in 2007. Proceeds from securities called were $6,750,000 for 2008 and $500,000 for 2007. Gross gains realized on those calls were $6,261 in 2008 and $0 in 2007. Gross losses on securities called were $0 in 2008 and 2007.

We did not hold any securities from a single issuer that exceeded 10% of total shareholders’ equity as of December 31, 2008, except for securities of the U.S. Government or U.S. Government agencies and except for mortgage-backed securities issued by government sponsored entities that had a carrying value of approximately $98,045,000 and $57,975,000 at December 31, 2008 and 2007, respectively.

Note 3. Loans and Allowance for Loan Losses

At December 31, 2008 and 2007, the Bank’s loans consisted of the following:


	2008			2007
Mortgage loans on real estate:
Residential 1-4 family	$	75,921,024		$	57,539,569
Residential multifamily		6,587,643			4,554,549
Commercial		113,734,280			107,652,176
Construction		142,369,956			150,843,738
Second mortgages		6,058,854			4,712,743
Equity lines of credit		29,697,498			26,551,874


		374,369,255			351,854,649


Commercial loans		37,631,830			35,929,294


Consumer installment loans:
Personal		6,233,261			7,863,684
Credit cards		2,194,912			2,026,574


		8,428,173			9,890,258


Total loans		420,429,258			397,674,201
Less: Allowance for loan losses		(5,292,028	)		(3,974,354	)


Loans, net	$	415,137,230		$	393,699,847

F-17

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 3. Loans and Allowance for Loan Losses (continued)

A summary of transactions in the allowance for loan losses for the years ended December 31, 2008 and 2007 is as follows:


	2008			2007
Balance, beginning of year	$	3,974,354		$	3,524,374
Provision for loan losses		2,275,000			981,900
Loans charged-off		(1,023,366	)		(561,315	)
Recoveries of loans previously charged-off		66,040			29,395


Balance, end of year	$	5,292,028		$	3,974,354

The Bank had a concentration of credit at December 31, 2008 in real estate loans, which totaled approximately $374,369,000. While real estate loans accounted for 89% of total loans, these loans were primarily residential mortgage loans, commercial loans secured by commercial properties and consumer loans. A large portion of these loans are for construction, land acquisition and development. Substantially all real estate loans are secured by properties located in Tennessee.

Loans to executive officers, principal shareholders, and directors and their affiliates were approximately $18,613,000 and $16,108,000 at December 31, 2008 and 2007, respectively. For the year ended December 31, 2008, the activity in these loans included new borrowings of approximately $4,692,000 and repayments of approximately $2,187,000.

Individually impaired loans were as follows:


	2008		2007
Year-end loans with allocated allowance for loan losses	$	2,807,562	$	368,164
Year-end loans with no allocated allowance for loan losses		539,263		877,166
Allowance for loan losses on impaired loans		561,250		222,691
Average of individually impaired loans during the year		4,600,602		625,973

Nonperforming loans were as follows:


	2008		2007
Loans past due over 90 days still on accrual	$	128,620	$	18,806

Nonaccrual loans		11,711,449		178,579

F-18

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 3. Loans and Allowance for Loan Losses (continued)

Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified as impaired loans.

Interest income recognized, on both an accrual and cash basis, on impaired loans was insignificant to total interest income on loans for each of the years ended December 31, 2008 and 2007.

Note 4. Bank Premises and Equipment

A summary of Bank premises and equipment at December 31, 2008 and 2007, is as follows:


	2008			2007
Land	$	9,047,710		$	9,424,151
Buildings and improvements		21,154,187			14,919,662
Furniture, fixtures and equipment		7,585,050			6,136,612

		37,786,947			30,480,425
Accumulated depreciation		(6,302,714	)		(5,053,182	)

	$	31,484,233		$	25,427,243

Depreciation expense for the years ended December 31, 2008 and 2007 amounted to $1,248,204 and $1,058,203, respectively.

At December 31, 2008 and 2007, construction in process totaled $5,328,854 and $1,742,754, respectively, and is included in the buildings and improvements line item above. At December 31, 2008, the balance consisted primarily of costs associated with the construction of our Blount County Regional Headquarters and Operations Center expansion in Sevier County.

Note 5. Deposits

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2008, was approximately $172,302,000.

F-19

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 5. Deposits (continued)

At December 31, 2008, the scheduled maturities of time deposits for each of the five years subsequent to December 31, 2008 were as follows:


2009	$	213,097,000
2010		23,887,574
2011		4,600,227
2012		4,461,846
2013		402,801

Total	$	246,449,448

Deposits of employees, officers and directors totaled approximately $7,923,000 at December 31, 2008 and $9,063,000 at December 31, 2007.

Note 6. Income Taxes

Income tax expense in the statements of income for the years ended December 31, 2008 and 2007, consists of the following:


	2008			2007
Current tax expense	$	1,438,411		$	1,754,504
Deferred tax expense (benefit)		(611,624	)		(460,168	)

Income tax expense	$	826,787		$	1,294,336

Income tax expense differs from amounts computed by applying the Federal income tax statutory rates of 34% in 2008 and 2007 to income before income taxes. A reconciliation of the differences for the years ended December 31, 2008 and 2007 is as follows:


	2008			2007
Expected tax at statutory rates	$	1,396,000		$	1,770,000
Increase (decrease) resulting from tax effect of:
State income taxes, net of federal tax		(90,328	)		(94,889	)
Increase in cash surrender value of life insurance		(145,831	)		(114,113	)
Tax exempt interest		(258,597	)		(200,153	)
General business credits, net of basis reduction		(132,000	)		(132,000	)
Other		57,543			65,491


Income tax expense	$	826,787		$	1,294,336

F-20

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 6. Income Taxes (continued)

Significant components of the Company’s deferred tax assets and liabilities at December 31, 2008 and 2007, were as follows:


	2008			2007
Deferred tax assets:
Allowance for loan losses	$	1,779,980		$	1,254,945
Deferred compensation		303,785			203,238
Unrealized loss on securities available for sale		101,750			168,417
Net operating loss		199,477			138,250
Other		265,017			114,046


Total deferred tax assets		2,650,009			1,878,896


Deferred tax liabilities:
Accelerated depreciation		(619,000	)		(371,932	)
Income from subsidiary		(46,973	)		(225,682	)
Investment in partnership		(204,000	)		(136,227	)
Other		(208,745	)		(118,721	)


Total deferred tax liabilities		(1,078,718	)		(852,562	)


Total net deferred tax assets	$	1,571,291		$	1,026,334

The Bank has a Tennessee net operating loss carryforward of approximately $1,590,000 which will expire in 2021, $1,630,000 which will expire in 2022 and $1,563,000 which will expire in 2023 if not offset by future taxable income.

The Company currently has no unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in future periods. The Company does not expect any unrecognized tax benefits to significantly increase or decrease in the next twelve months. It is the Company’s policy to recognize any interest accrued related to unrecognized tax benefits in interest expense, with any penalties recognized as operating expenses.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Tennessee. The Company is no longer subject to examination by taxing authorities for tax years before 2005.

F-21

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 7. Federal Home Loan Bank Advances

The Bank has an agreement with the Federal Home Loan Bank of Cincinnati (“FHLB”) that provides short-term and long-term funding to the Bank in an amount up to $100,000,000. The Bank’s portfolio of one to four single-family mortgages, commercial real estate, home equity lines of credit and multi-family mortgages have been pledged as collateral for any advances based upon an agreement requiring a collateral-to-loan ratio of 135%, 300%, 300% and 125%, respectively. Maturities of the notes payable for each of the years subsequent to December 31, 2008 are as follows: $10,000,000 in 2009, $200,000 in 2010, $7,500,000 in 2011, $5,200,000 in 2012, $5,000,000 in 2014, $5,000,000 in 2015 and $40,000,000 in 2017. These advances are subject to prepayment penalties that vary according to the type of advance.

FHLB advances consisted of the following at December 31, 2008 and 2007:


	2008		2007
Short-term advance requiring monthly interest payments at 0.54% variable, principal due in February 2009	$	10,000,000	$	—

Long-term advance requiring monthly interest payments at 4.47% fixed, principal due in December 2012		200,000		200,000

Long-term advance requiring monthly interest payments at 4.32% fixed, principal due in June 2010		200,000		200,000

Long-term advance requiring monthly interest payments at 4.83% fixed, principal due in October 2008		—		3,000,000

Long-term advance requiring monthly principal and interest payments at 4.20% fixed, remaining principal due in July 2008		—		1,756,418

Long-term advance requiring monthly interest payments at 4.15% fixed, principal due in June 2008		—		2,500,000

Long-term advance requiring monthly interest payments at 4.12% fixed, principal due in June 2008		—		200,000

Long-term callable advance requiring monthly interest payments at 4.39% fixed, principal due in November 2011		7,500,000		7,500,000

Long-term callable advance requiring monthly interest payments at 4.25% fixed, principal due in January 2017		10,000,000		10,000,000

Long-term callable advance requiring monthly interest payments at 4.15% fixed, principal due in April 2017		10,000,000		10,000,000

F-22

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 7. Federal Home Loan Bank Advances (continued)


	2008		2007
Long-term callable advance requiring monthly interest payments at 4.27% fixed, principal due in May 2017		10,000,000		10,000,000

Long-term callable advance requiring monthly interest payments at 4.68% fixed, principal due in June 2017		10,000,000		10,000,000

Long-term callable advance requiring monthly interest payments at 3.36% fixed, principal due in December 2012		5,000,000		5,000,000

Long-term callable advance requiring monthly interest payments at 3.46% fixed, principal due in December 2014		5,000,000		5,000,000

Long-term callable advance requiring monthly interest payments at 3.13% fixed, principal due in January 2015		5,000,000		—


	$	72,900,000	$	65,356,418

Note 8. Subordinated Debentures

On November 7, 2003, we established MNB Capital Trust I and on June 9, 2006, we established MNB Capital Trust II (“Trust I” and “Trust II” or collectively, the “Trusts”). Both are wholly-owned statutory business trusts. The Company is the sole sponsor of the Trusts and acquired each Trust’s common securities for $171,000 and $232,000, respectively. The Trusts were created for the exclusive purpose of issuing 30-year capital trust preferred securities (“Trust Preferred Securities”) in the aggregate amount of $5,500,000 for Trust I and $7,500,000 for Trust II and using the proceeds to acquire junior subordinated debentures (“Subordinated Debentures”) issued by the Company. The sole assets of the Trusts are the Subordinated Debentures. The Company’s aggregate $403,000 investment in the Trusts is included in other assets in the accompanying consolidated balance sheets and the $13,403,000 obligation of the Company is reflected as subordinated debt.

The Trust I Preferred Securities bear a floating interest rate based on a spread over 3-month LIBOR and was 7.103% at December 31, 2008 which is set each quarter and mature on December 31, 2033. The Trust II Preferred Securities bear a floating interest rate based on a spread over 3-month LIBOR and was 6.419% at December 31, 2008 which is set each quarter and mature on July 7, 2036. Distributions are payable quarterly. The Trust Preferred Securities are subject to mandatory redemption upon repayment of the Subordinated Debentures at their stated maturity date or their earlier redemption in an amount equal to their liquidation amount plus accumulated and unpaid distributions to the date of redemption. The Company guarantees the payment of distributions and payments for redemption or liquidation of the Trust Preferred Securities to the extent of funds held by the Trusts. The Company’s obligations under the Subordinated Debentures together with the guarantee and other back-up obligations, in the aggregate, constitute a full and unconditional

F-23

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 8. Subordinated Debentures (continued)

guarantee by the Company of the obligations of the Trusts under the Trust Preferred Securities.

The Subordinated Debentures are unsecured, bear interest at a rate equal to the rates paid by the Trusts on the Trust Preferred Securities and mature on the same dates as those noted above for the Trust Preferred Securities. Interest is payable quarterly. The Company may defer the payment of interest at any time for a period not exceeding 20 consecutive quarters provided that deferral period does not extend past the stated maturity. During any such deferral period, distributions on the Trust Preferred Securities will also be deferred and the Company’s ability to pay dividends on its common shares will be restricted.

Subject to approval by the Federal Reserve Bank of Atlanta, if then required, the Trust Preferred Securities may be redeemed prior to maturity at the Company’s option on or after December 31, 2008, for Trust I and on or after July 7, 2011, for Trust II. The Trust Preferred Securities may also be redeemed at any time in whole (but not in part) in the event of unfavorable changes in laws or regulations that result in (1) the Trusts becoming subject to federal income tax on income received on the Subordinated Debentures, (2) interest payable by the Company on the Subordinated Debentures becoming non-deductible for federal tax purposes, (3) the requirement for the Trusts to register under the Investment Company Act of 1940, as amended, or (4) loss of the ability to treat the Trust Preferred Securities as “Tier 1 capital” under the Federal Reserve capital adequacy guidelines.

The Company’s investments in Trust I and Trust II are included in other assets. These investments are accounted for under the equity method and consist of 100% of the common stock of Trust I and Trust II.

Note 9. Securities Sold under Agreements to Repurchase

Securities sold under agreements to repurchase are variable rate financing arrangements with no fixed maturity. Upon cancellation of the agreement, the securities underlying the agreements are returned to the Company. Information concerning securities sold under agreements to repurchase is summarized as follows:


	2008			2007
Weighted average borrowing rate at year-end		2.20	%		2.72	%

Weighted average borrowing rate during the year		2.53	%		2.71	%

Average daily balance during the year	$	5,093,472		$	5,815,161

Maximum month-end balance during the year		7,413,995			8,602,461

Balance at year-end	$	4,331,865		$	5,441,515

F-24

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 10. Employee Benefit Plans

The Bank sponsors a 401(k) employee benefit plan covering substantially all employees who have completed at least six months of service and met minimum age requirements. The Bank’s contribution to the plan is discretionary and was $120,422 for 2008 and $127,580 for 2007.

The Company also has salary continuation agreements in place with certain key officers. Such agreements are structured with differing benefits based on the participants overall position and responsibility. These agreements provide the participants with a supplemental income upon retirement at age 65, additional incentive to remain with the Company in order to receive these deferred retirement benefits and a compensation package that is competitive in the market. These agreements vest over a ten year period, require a minimum number of years service and contain change of control provisions. All benefits would cease in the event of termination for cause, and if the participant’s employment were to end due to disability, voluntary termination or termination without cause, the participant would be entitled to receive certain reduced benefits based on vesting and other conditions.

The estimated cost of this obligation is being accrued over the service period for each officer. The Company recognized expense of $262,594 and $213,071 during 2008 and 2007, respectively, related to these agreements. The total amount accrued at December 31, 2008 and 2007 was $793,380 and $530,786, respectively.

Note 11. Leases

The Bank is leasing the land on which its Gatlinburg branch is located under a non-cancelable lease agreement that expires in 2013. This lease agreement contains renewal options for twelve additional five-year terms.

During 2007, the Bank entered into a long-term lease agreement for land in Blount County, Tennessee. The lease agreement expires in 2013 and contains renewal options for six additional five-year terms. The Bank completed construction of its Justice Center branch on this property during the second quarter of 2008.

In addition, the Bank is leasing the building in which its Gatlinburg walk-up facility is located and the property on which it has placed certain automated teller machines. These leases expire at various dates through 2010 and contain various renewal options. Total rental expense under all operating leases was $184,204 in 2008 and $152,240 in 2007.

F-25

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 11. Leases (continued)

The following is a schedule by years of future minimum rental payments required under operating leases that have initial or remaining non-cancelable lease terms in excess of one year as of December 31, 2008:


2009	$	167,718
2010		129,149
2011		101,745
2012		103,369
2013		78,270
Thereafter		—


Total	$	580,251

Note 12. Financial Instruments with Off-Balance-Sheet Risk

In the normal course of business, the Bank has outstanding commitments and contingent liabilities, such as commitments to extend credit and standby letters of credit, which are not included in the accompanying financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making such commitments as it does for instruments that are included in the balance sheet. At December 31, 2008, commitments under standby letters of credit and undisbursed loan commitments aggregated approximately $91,982,000, substantially all of which are carried at variable rates.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank’s policy for obtaining collateral, and the nature of

F-26

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 12. Financial Instruments with Off-Balance-Sheet Risk (continued)

such collateral, is essentially the same as that involved in making commitments to extend credit.

The Bank was not required to perform on any financial guarantees and did not incur any losses on its commitments during 2008 or 2007.

Note 13. Fair Value

SFAS No. 157 Fair Value Measurements (“SFAS 157”) establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Investment Securities Available for Sale — Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent service provider. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayments speeds, credit information and the securities’ terms and conditions, among other things.

F-27

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 13. Fair Value (continued)

Impaired Loans — Impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral and the loan balance exceeds the collateral value at the measurement date. Collateral values are estimated using Level 3 inputs based on internally customized discounting criteria.

Assets and Liabilities Measured on a Recurring Basis

The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of December 31, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:


	FairValue Measurements
	at December 31, 2008 Using
	Significant
	Other Observable
	Inputs
	(Level 2)
Assets:
Available for sale securities	$	124,578,359

Assets and Liabilities Measured on a Non-Recurring Basis

Certain financial assets and financial liabilities are measured at fair value on a nonrecurring basis, that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).


	Fair Value Measurements
	at December 31, 2008 Using
	Significant
	Unobservable
	Inputs
	(Level 3)
Assets:
Impaired loans	$	2,246,312

F-28

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 13. Fair Value (continued)

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $2,807,562, with a valuation allowance of $561,250 resulting in an additional provision for loan losses of $561,250.

Fair Value of Financial Instruments

Fair value estimates are made at a specific point in time, based on relevant market information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature; involve uncertainties and matters of judgment; and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the Company.

Fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and cash equivalents:

For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value.

Investment Securities:

The fair value of securities is estimated as previously described for securities available for sale, and in a similar manner for securities held to maturity.

Restricted investments:

Restricted investments consist of Federal Home Loan Bank, Federal Reserve Bank, and Silverton Bank stock. It is not practicable to determine the fair value due to restrictions placed on the transferability of the stock.

Loans:

The fair value of loans is calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates, adjusted for credit risk and servicing costs. The estimate of maturity is based on historical experience with repayments

F-29

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 13. Fair Value (continued)

for each loan classification, modified, as required, by an estimate of the effect of current economic and lending conditions. The allowance for loan losses is considered a reasonable discount for credit risk.

Deposits:

The fair value of deposits with no stated maturity, such as demand deposits, money market accounts, and savings deposits, is equal to the amount payable on demand. The fair value of time deposits is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities.

Federal funds purchased and securities sold under agreements to repurchase:

The estimated value of these liabilities, which are extremely short term, approximates their carrying value.

Subordinated debentures:

For the subordinated debentures with a floating interest rate tied to LIBOR, the fair value is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for subordinated debentures of similar amounts and remaining maturities.

Federal Home Loan Bank advances:

For FHLB advances the fair value is based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for FHLB advances of similar amounts and remaining maturities.

Accrued interest receivable and payable:

The carrying amounts of accrued interest receivable and payable approximate their fair value.

Commitments to extend credit, letters of credit and lines of credit:

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair values of these commitments are insignificant and are not included in the table below.

F-30

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 13. Fair Value (continued)

The carrying amount and estimated fair value of the Company’s financial instruments at December 31, 2008 and 2007, not previously presented, are as follows (in thousands):


	2008				2007
	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value
Assets:
Cash and cash equivalents	$	14,590	$	14,590	$	16,329	$	16,329
Investment securities held to maturity		2,117		1,813		2,021		2,040
Restricted investments		3,863		N/A		3,657		N/A
Loans, net		412,891		415,723		393,700		393,117
Accrued interest receivable		2,738		2,738		2,701		2,701

Liabilities:
Noninterest-bearing demand deposits	$	44,652	$	44,652	$	56,307	$	56,307
NOW accounts		110,420		110,420		87,380		87,380
Savings and money market accounts		53,144		53,144		51,939		51,939
Time deposits		246,449		248,356		208,748		210,089
Subordinated debentures		13,403		10,582		13,403		14,356
Federal funds purchased and securities sold under agreements to repurchase		26,912		26,912		6,742		6,742
Federal Home Loan Bank advances		72,900		80,517		65,356		67,435
Accrued interest payable		1,023		1,023		1,240		1,240

Note 14. Stock Options and Warrants

The Company has a stock option plan that is administered by the Board of Directors and provides for both incentive stock options and nonqualified stock options. The exercise price of each option shall not be less than 100 percent of the fair market value of the common stock on the date of grant. All options have been granted at the fair market value of the shares at the date of grant. The maximum term for each option is ten years. The maximum number of shares that can be issued under the plan is 724,239. The following table provides certain information about the Company’s equity compensation plan as of December 31, 2008:

F-31

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 14. Stock Options and Warrants (continued)

Number of

securities remaining

securities to be

available for

issued upon

future issuance under

exercise of

Weighted average

equity compensation

outstanding

exercise price of

plans (excluding

options, warrants

securities reflected

and rights

in column (a))

Plan Category

(a)

(b)

(c)

Equity compensation plans approved by security holders

121,717

21.64

381,689

Equity compensation plans not approved by security holders

—

The Company has granted incentive stock options to certain key officers and employees. The Company has also granted nonqualified stock options to non-employee organizers of the Bank. The stock option agreements state that upon termination of employment, employees have 90 days to exercise any stock options vested as of the termination date.

The Company issues new shares to satisfy option exercises from the authorized shares allocated to the employee stock option plan.

A summary of activity in the Company’s stock option plan for the year ended December 31, 2008, is as follows:


				Weighted		Weighted Average
	Number			Average		Remaining		Aggregate
	of Options			Exercise Price		Contractual Term		Intrinsic Value
Options outstanding, December 31, 2007		191,831		$	16.89
Options granted		9,646			20.41
Options exercised		(72,914	)		7.92
Options forfeited		(6,846	)		22.15


Options outstanding, December 31, 2008		121,717		$	21.64		7.04	$	—

Exercisable at December 31, 2008		50,277		$	16.58		5.61	$	112,332

All outstanding options are either fully vested or expected to vest. The weighted-average grant-date fair value of options granted during 2008 and 2007 was $6.60 per share and $7.95 per share, respectively. The total intrinsic value of options exercised during 2008 and 2007 was $764,852 and $577,539, respectively. Cash received from the exercise of options was $577,630 and $308,689 in 2008 and 2007, respectively. Tax benefits realized in 2008 and 2007 were $202,893 and $73,127, respectively.

F-32

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 14. Stock Options and Warrants (continued)

As of December 31, 2008, there was $415,045 of total unrecognized compensation cost related to non-vested share-based compensation arrangements granted under the stock option plan. The cost is expected to be recognized over a weighted-average period of 2.82 years.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model using the assumptions noted in the following table. Expected volatilities are based on historical exercise patterns, employee terminations and historical stock prices. The expected life of options granted represents the period of time that options granted are expected to be outstanding. The U.S. Treasury 10 year constant maturity rate in effect at the date of the grant is used to derive the risk-free interest rate for the contractual period of the options.


	2008			2007
Dividend yield		0.00	%		0.00	%
Expected life	9.5 years			7.2 years
Expected volatility		18	%		19	%
Risk-free interest rate		3.60	%		4.61	%

Note 15. Regulatory Matters

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

F-33

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 15. Regulatory Matters (continued)

Quantitative measures established by regulation to ensure capital adequacy require the Bank and Company to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). Management believes, as of December 31, 2008, that the Bank and Company met all capital adequacy requirements to which it is subject.

As of December 31, 2008, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s prompt corrective action category for bank capital.

The actual capital amounts and ratios are presented in the table. Dollar amounts are presented in thousands.


						For Capital
	Actual					Adequacy Purposes					Well-Capitalized
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2008:
Total capital to risk-weighted assets:
Consolidated	$	69,433		14.44	%	$	38,471		8.00	%		N/A		N/A
Mountain National Bank		68,725		14.29	%		38,462		8.00	%		48,078		10.00	%

Tier I capital to risk-weighted assets:
Consolidated		64,142		13.34	%		19,236		4.00	%		N/A		N/A
Mountain National Bank		63,433		13.19	%		19,231		4.00	%		28,847		6.00	%

Tier I capital to average assets:
Consolidated		64,142		10.51	%		24,403		4.00	%		N/A		N/A
Mountain National Bank		63,433		10.41	%		24,375		4.00	%		30,469		5.00	%

As of December 31, 2007:
Total capital to risk-weighted assets:
Mountain National Bank		63,777		13.97	%		36,531		8.00	%		45,663		10.00	%

Tier I capital to risk-weighted assets:
Mountain National Bank		59,803		13.10	%		18,265		4.00	%		27,398		6.00	%

Tier I capital to average assets:
Mountain National Bank		59,803		11.24	%		21,288		4.00	%		26,610		5.00	%

F-34

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 15. Regulatory Matters (continued)

Dividend restrictions:

The Company’s principal source of funds for dividend payments is dividends received from the Bank. Under applicable federal laws, the Comptroller of the Currency restricts the amount of dividends that may be paid without prior approval. Under these regulations, the amount of dividends that may be paid in any calendar year is limited to the current year’s net profits, combined with the retained net profits of the preceding two years, subject to the capital requirements described above. As of December 31, 2008, the Bank could, without prior approval, declare dividends of approximately $1,573,000.

Note 16. Other Comprehensive Income

Other comprehensive income (loss) consists of unrealized holding gains and losses on securities available for sale. A summary of other comprehensive income (loss) and the related tax effects for the years ended December 31, 2008 and 2007 is as follows:


				Tax
	Before-Tax			(Expense)			Net-of-Tax
	Amount			Benefit			Amount
Year ended December 31, 2008:
Unrealized holding gains/(losses) arising during the period	$	377,344		$	(134,791	)	$	242,553

Less reclassification adjustment for gains realized in net income		(179,274	)		68,124			(111,150	)


	$	198,070		$	(66,667	)	$	131,403


Year ended December 31, 2007:
Unrealized holding gains/(losses) arising during the period	$	510,480		$	(91,733	)	$	418,747

Less reclassification adjustment for gains realized in net income		—			—			—


Mountain National Bank	$	510,480		$	(91,733	)	$	418,747

F-35

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 17. Earnings Per Common Share

Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance.

Potential common shares that may be issued by the Company relate to outstanding stock options and warrants, determined using the treasury stock method.

Earnings per common share have been computed based on the following:


	2008		2007
Net income applicable to common stock	$	3,280,208	$	3,912,094


Average number of common shares outstanding		2,634,750		2,331,396
Dilutive effect of stock options		7,195		64,696
Dilutive effect of warrants		—		39,868

Average number of common shares outstanding used to calculate diluted earnings per common share		2,641,945		2,435,960

At December 31, 2008 and 2007, there were options for the purchase of 93,131 and 44,535 shares, respectively, outstanding that were antidilutive.

Note 18. Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS 157. This Statement defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. This Statement establishes a fair value hierarchy about the assumptions used to measure fair value and clarifies assumptions about risk and the effect of a restriction on the sale or use of an asset. The standard was effective for fiscal years beginning after November 15, 2007. In February 2008, the FASB issued Staff Position (“FSP”) 157-2, Effective Date of FASB Statement No. 157. This FSP delays the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. In October 2008, the FASB issued Staff Position 157-3, Determining the Fair Value of a Financial Asset when the Market for That Asset Is Not Active. This FSP clarifies the application of SFAS 157 in a market that is not active. The impact of adoption was not material. See “Note 13. Fair Value” for fair value disclosures.

F-36

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 18. Recent Accounting Pronouncements (continued)

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. The new standard was effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or financial liabilities as of January 1, 2008.

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants’ employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue was effective for fiscal years beginning after December 15, 2007. The impact of adoption was not material.

On November 5, 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 109, Written Loan Commitments Recorded at Fair Value through Earnings (“SAB 109”). Previously, SAB 105, Application of Accounting Principles to Loan Commitments (“SAB 105”), stated that in measuring the fair value of a derivative loan commitment, a company should not incorporate the expected net future cash flows related to the associated servicing of the loan. SAB 109 supersedes SAB 105 and indicates that the expected net future cash flows related to the associated servicing of the loan should be included in measuring fair value for all written loan commitments that are accounted for at fair value through earnings. SAB 105 also indicated that internally-developed intangible assets should not be recorded as part of the fair value of a derivative loan commitment, and SAB 109 retains that view. SAB 109 was effective for derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. The impact of adoption was not material.

In December 2007, the SEC issued SAB No. 110 (“SAB 110”), which expresses the views of the SEC regarding the use of a “simplified” method, as discussed in SAB No. 107, in developing an estimate of expected term of “plain vanilla” share options in accordance with SFAS 123(R), Share-Based Payment. The SEC concluded that a company could, under certain circumstances, continue to use the simplified method for share option grants after December 31, 2007. The Company does not use the simplified method for share options and therefore SAB 110 has no impact on the Company’s consolidated financial statements.

F-37

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 18. Recent Accounting Pronouncements (continued)

In December 2007, the FASB issued SFAS 141 (revised 2007), Business Combinations (“SFAS 141(R)”), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination. SFAS 141(R) was effective for fiscal years beginning on or after December 15, 2008. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

In December 2007, the FASB issued SFAS 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (“SFAS 160”), which will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity within the consolidated balance sheets. SFAS 160 was effective for the first fiscal year beginning on or after December 15, 2008. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of SFAS No. 133 (“SFAS 161”). SFAS 161 amends and expands the disclosure requirements of SFAS No. 133 for derivative instruments and hedging activities. SFAS 161 requires qualitative disclosure about objectives and strategies for using derivative and hedging instruments, quantitative disclosures about fair value amounts of the instruments and gains and losses on such instruments, as well as disclosures about credit-risk features in derivative agreements. SFAS 161 was effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. The adoption of this standard did not have a material effect on the Corporation’s results of operations or financial position.

Note 19. Dividends

During January 2007, the Board of Directors approved a 5% stock dividend for stockholders of record as of February 15, 2007. In lieu of fractional shares, certain stockholders received cash payments totaling $29,557. This stock dividend resulted in the issuance of 96,361 additional shares of common stock. All per share data included in the accompanying financial statements reflects this stock dividend.

During January 2008, the Board of Directors approved a 5% stock dividend for stockholders of record as of February 15, 2008. In lieu of fractional shares, certain stockholders received cash payments totaling $17,802. This stock dividend resulted in the issuance of 124,718 additional shares of common stock. All per share data included in the accompanying financial statements reflects this stock dividend.

F-38

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 19. Dividends (continued)

Note 20. Condensed Parent Information

BALANCE SHEETS


	December 31,
	2008		2007
ASSETS
Cash	$	463,884	$	2,183,860
Investment in subsidiary		63,285,236		59,524,171
Other assets		774,465		775,687

Total assets	$	64,523,585	$	62,483,718


LIABILITIES AND SHAREHOLDERS’ EQUITY
Subordinated debentures	$	13,403,000	$	13,403,000
Accrued interest payable		126,832		132,265

Total liabilities		13,529,832		13,535,265

Shareholders’ equity		50,993,753		48,948,453


Total liabilities and shareholders’ equity	$	64,523,585	$	62,483,718

STATEMENTS OF INCOME


	December 31,
	2008			2007
Dividends from subsidiaries	$	500,000		$	—
Interest expense		763,196			986,037
Other expense		145,184			131,953

Loss before equity in undistributed earnings of subsidiary		(408,380	)		(1,117,990	)

Equity in undistributed earnings of subsidiary		3,340,769			4,595,663
Income tax benefit		347,819			434,421

Net income	$	3,280,208		$	3,912,094

F-39

MOUNTAIN NATIONAL BANCSHARES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008 and 2007

Note 20. Condensed Parent Information (continued)

STATEMENTS OF CASH FLOWS


	December 31,
	2008			2007
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,280,208		$	3,912,094
Adjustments to reconcile net income to net cash provided by operating activities Equity in undistributed income of subsidiary		(3,340,769	)		(4,595,663	)
Other		(4,211	)		(127,423	)


Net cash used in operating activities		(64,772	)		(810,992	)


CASH FLOWS FROM INVESTING ACTIVITIES
Payments for investments in and advances to subsidiaries		—			(10,000,000	)


Net cash used in investing activities		—			(10,000,000	)


CASH FLOWS FROM FINANCING ACTIVITIES
Dividends		(1,030,812	)		(29,557	)
Proceeds from issuance of common stock		577,630			10,324,822
Purchase of common stock		(1,202,022	)		(300,239	)


Net cash (used)/provided by financing activities		(1,655,204	)		9,995,026


NET DECREASE IN CASH AND CASH EQUIVALENTS		(1,719,976	)		(815,966	)

CASH AND CASH EQUIVALENTS, beginning of year		2,183,860			2,999,826


CASH AND CASH EQUIVALENTS, end of year	$	463,884		$	2,183,860


SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest	$	768,630		$	988,574
Income taxes		(295,042	)		(272,133	)

F-40


Item		Page
Number		Number
12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		59

13.	Certain Relationships and Related Transactions, and Director Independence		59

14.	Principal Accountant Fees and Services		59

Part IV

15.	Exhibits and Financial Statement Schedules		59

	Signatures		63
EX-10.3
EX-21
EX-23
EX-31.1
EX-31.2
EX-32.1
EX-32.2


/s/ Jeffrey J. Monson		Date: March 31, 2009

Jeffrey J. Monson, Director

/s/ Linda N. Ogle		Date: March 31, 2009

Linda N. Ogle, Director

/s/ Michael C. Ownby		Date: March 31, 2009

Michael C. Ownby, Director

/s/ John M. Parker		Date: March 31, 2009

John M. Parker, Director

/s/ Ruth Reams		Date: March 31, 2009

Ruth Reams, Director


	Page
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM		F-1

CONSOLIDATED FINANCIAL STATEMENTS

Consolidated balance sheets		F-2
Consolidated statements of income		F-3
Consolidated statements of changes in shareholders’ equity		F-4
Consolidated statements of cash flows		F-5
Notes to consolidated financial statements		F-6 – F-40


Executive Officer	Current Salary		2008 Cash
Dwight B. Grizzell, President	$	220,000	$	0
Grace D. McKinzie	$	150,000	$	0
Michael Brown	$	150,000	$	0

–		Participate in the Company’s cash bonus plan;

–		Participate in the Company’s equity incentive programs, which currently involves the award of stock options pursuant to the Company’s Stock Option Plan; and

–		Participate in the Company’s broad-based benefit programs generally available to its employees, including health, disability and life insurance programs and the Company’s 401(k) Plan.


		/s/ Dwight B. Grizzell
		Dwight B. Grizzell
		President and Chief Executive Officer


		/s/ Richard A. Hubbs Richard A. Hubbs
		Senior Vice President and Chief Financial Officer

	(1)		The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


Dated: March 31, 2009				/s/ Dwight B. Grizzell
				Dwight B. Grizzell, Chief Executive Officer