SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
x	Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended September 30, 2013.
or
o	Transition Report under Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the transition period from____________________to____________________.

Commission File No. 0-24172

Southeastern Bank Financial Corporation

(Exact name of registrant as specified in its charter)

	Georgia		58-2005097
(State of Incorporation)		(I.R.S. Employer Identification No.)

3530 Wheeler Road, Augusta, Georgia 30909

(Address of principal executive offices)

(706) 738-6990

(Issuer’s telephone number, including area code)

Not Applicable

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

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

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

Indicate by check mark whether the issuer 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.

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

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

APPLICABLE ONLY TO CORPORATE ISSUERS

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

          6,679,982 shares of common stock, $3.00 par value per share, outstanding as of October 24, 2013.

SOUTHEASTERN BANK FINANCIAL CORPORATION

FORM 10-Q

INDEX

			Page
Part I
	Item 1.	Financial Statements (Unaudited)
		Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012	3
		Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months ended September 30, 2013 and 2012	4
		Consolidated Statements of Cash Flows for the Nine Months ended September 30, 2013 and 2012	6
		Notes to Consolidated Financial Statements	8
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	50
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	75
	Item 4.	Controls and Procedures	75
Part II	Other Information
	Item 1.	Legal Proceedings	76
	Item 1A.	Risk Factors	76
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	76
	Item 3.	Defaults Upon Senior Securities	76
	Item 4.	Mine Safety Disclosures	76
	Item 5.	Other Information	76
	Item 6.	Exhibits	77
Signature			78
* No information submitted under this caption

1

PART I

FINANCIAL INFORMATION

2

SOUTHEASTERN BANK FINANCIAL CORPORATION
Consolidated Balance Sheets
(Dollars in thousands, except share data)
	September 30,
	2013			December 31,
Assets	(Unaudited)			2012
Cash and due from banks	$	62,302		$	39,566
Interest-bearing deposits in other banks		2,554			4,322
Cash and cash equivalents		64,856			43,888
Available-for-sale securities		655,525			654,739
Loans held for sale		13,817			30,051
Loans		886,769			871,447
Less allowance for loan losses		26,558			28,846
Loans, net		860,211			842,601
Premises and equipment, net		26,145			26,145
Accrued interest receivable		6,639			6,603
Bank-owned life insurance		35,455			34,825
Restricted equity securities		5,320			5,296
Other real estate owned		1,155			3,490
Prepaid FDIC assessment		-			2,024
Deferred tax asset		18,798			10,406
Other assets		3,053			2,434
	$	1,690,974		$	1,662,502
Liabilities and Stockholders’ Equity
Deposits
Noninterest-bearing	$	176,503		$	158,066
Interest-bearing:
NOW accounts		342,244			349,531
Savings		524,180			504,194
Money management accounts		18,756			18,033
Time deposits over $100		267,180			280,871
Other time deposits		112,799			110,577
		1,441,662			1,421,272
Securities sold under repurchase agreements		698			976
Advances from Federal Home Loan Bank		74,000			64,000
Accrued interest payable and other liabilities		17,592			18,924
Due to broker		3,636			-
Subordinated debentures		21,547			21,547
Total liabilities		1,559,135			1,526,719
Stockholders’ equity:
Preferred stock, no par value; 10,000,000 shares authorized; 0 shares outstanding in 2013 and 2012, respectively		-			-
Common stock, $3.00 par value; 10,000,000 shares authorized; 6,680,225 and 6,680,225 shares issued in 2013 and 2012, respectively; 6,679,426 and 6,675,000 shares outstanding in 2013 and 2012, respectively		20,041			20,041
Additional paid-in capital		62,858			62,835
Retained earnings		55,272			45,028
Treasury stock, at cost; 799 and 5,225 shares in 2013 and 2012, respectively		(11	)		(73	)
Accumulated other comprehensive income (loss), net		(6,321	)		7,952
Total stockholders’ equity		131,839			135,783
	$	1,690,974		$	1,662,502

See accompanying notes to consolidated financial statements.

3

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income (Loss)

(Dollars in thousands, except share data)

(Unaudited)
	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Interest income:
Loans, including fees	$	11,668		$	11,742		$	35,103		$	34,960
Investment securities		3,875			4,134			11,754			12,801
Interest-bearing deposits in other banks		13			15			50			62
Total interest income		15,556			15,891			46,907			47,823
Interest expense:
Deposits		1,637			2,227			5,150			7,318
Securities sold under repurchase agreements		4			1			6			9
Other borrowings		685			683			2,030			1,911
Total interest expense		2,326			2,911			7,186			9,238
Net interest income		13,230			12,980			39,721			38,585
Provision for loan losses		1,887			2,401			6,046			6,567
Net interest income after provision for loan losses		11,343			10,579			33,675			32,018
Noninterest income:
Service charges and fees on deposits		1,849			1,733			5,317			5,029
Gain on sales of loans		1,659			2,949			5,716			7,268
Gain on sale of fixed assets, net		-			4			21			10
Investment securities gains (losses), net (includes ($163) and ($37) for the three months ended Sept. 30, 2013 and 2012 and ($192) and $432 for the nine months ended Sept. 30, 2013 and 2012 accumulated other comprehensive income reclassifications for unrealized gains (losses) on available-for-sale securities)		(163	)		(37	)		(192	)		441
Other-than-temporary loss:
Total impairment loss		-			-			-			(13	)
Less loss recognized in other comprehensive income		-			-			-			(4	)
Net impairment loss recognized in earnings		-			-			-			(9	)
Retail investment income		557			420			1,545			1,447
Trust service fees		301			280			890			857
Earnings from cash surrender value of bank-owned life insurance		326			305			897			831
Miscellaneous income		333			169			708			535
Total noninterest income		4,862			5,823			14,902			16,409
Noninterest expense:
Salaries and other personnel expense		5,713			6,604			18,051			19,344
Occupancy expenses		940			1,014			2,814			3,111
Other real estate losses (gains), net		11			(97	)		628			1,252
Other operating expenses		3,550			3,166			9,769			9,445
Total noninterest expense		10,214			10,687			31,262			33,152
Income before income taxes		5,991			5,715			17,315			15,275
Income tax expense		1,789			1,839			5,334			4,736
Net income	$	4,202		$	3,876		$	11,981		$	10,539
Other comprehensive income (loss):
Unrealized gain (loss) on derivatives		179			30			1,304			(328	)
Unrealized gain (loss) on securities available-for-sale		(5,023	)		4,467			(24,857	)		9,194
Reclassification adjustment for realized (gain) loss on securities, net of OTTI		163			37			192			(432	)
Tax effect		1,821			(1,764	)		9,088			(3,281	)
Total other comprehensive income (loss)		(2,860	)		2,770			(14,273	)		5,153
Comprehensive income (loss)	$	1,342		$	6,646		$	(2,292	)	$	15,692

4

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Comprehensive Income (Loss)

(Dollars in thousands, except share data)

(Unaudited)
	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Basic net income per share	$	0.63	$	0.58	$	1.79	$	1.58
Diluted net income per share		0.63		0.58		1.79		1.58
Weighted average common shares outstanding		6,679,426		6,680,020		6,678,555		6,679,294
Weighted average number of common and common equivalent shares outstanding		6,679,426		6,680,020		6,678,555		6,679,294

See accompanying notes to consolidated financial statements.

5

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Nine Months Ended
	September 30,
	2013			2012
Cash flows from operating activities:
Net income	$	11,981		$	10,539
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation		1,394			1,621
Deferred income tax expense (benefit)		695			(308	)
Provision for loan losses		6,046			6,567
Net investment securities (gains) losses		192			(441	)
Other-than-temporary impairment losses		-			9
Net amortization of premiums on investment securities		4,113			3,809
Earnings from CSV of bank-owned life insurance		(897	)		(831	)
Bank-owned life insurance death benefits in excess of CSV		(150	)		-
Stock options compensation cost		4			33
Gain on disposal of premises and equipment		(21	)		(10	)
Loss on the sale of other real estate		80			648
Provision for other real estate valuation allowance		548			604
Gain on sales of loans		(5,716	)		(7,268	)
Real estate loans originated for sale		(188,813	)		(223,409	)
Proceeds from sales of real estate loans		210,763			231,126
Increase in accrued interest receivable		(36	)		(613	)
Decrease in other assets		1,405			1,012
(Decrease) increase in accrued interest payable and other liabilities		(28	)		1,656
Net cash provided by operating activities		41,560			24,744
Cash flows from investing activities:
Proceeds from sales of securities		133,380			107,302
Proceeds from maturities and calls of available-for-sale securities		82,847			164,173
Purchase of available-for-sale securities		(242,346	)		(338,419	)
Purchase of restricted equity securities		(900	)		(500	)
Proceeds from redemption of FHLB stock		876			290
Net increase in loans		(24,476	)		(21,793	)
Proceeds from bank-owned life insurance death benefits		417			-
Additions to premises and equipment		(1,456	)		(360	)
Proceeds from sale of other real estate		2,527			8,255
Proceeds from sale of premises and equipment		83			12
Net cash used in investing activities		(49,048	)		(81,040	)

6

SOUTHEASTERN BANK FINANCIAL CORPORATION

Consolidated Statements of Cash Flows

(Dollars in thousands)

(Unaudited)

	Nine Months Ended
	September 30,
	2013			2012
Cash flows from financing activities:
Net increase in deposits		20,390			17,121
Net decrease in securities sold under repurchase agreements		(278	)		(47	)
Payments of Federal Home Loan Bank advances		(10,000	)		(12,000	)
Advances from Federal Home Loan Bank		20,000			37,000
Purchase of treasury stock		-			(83	)
Payments on subordinated debentures		-			(1,400	)
Payment of cash dividends		(1,737	)		-
Proceeds from stock options exercised		43			-
Proceeds from Directors’ stock purchase plan		38			31
Net cash provided by financing activities		28,456			40,622
Net increase (decrease) in cash and cash equivalents		20,968			(15,674	)
Cash and cash equivalents at beginning of period		43,888			69,841
Cash and cash equivalents at end of period	$	64,856		$	54,167
Supplemental disclosures of cash paid during the period for:
Interest	$	7,427		$	9,305
Income taxes		5,380			4,316
Supplemental information on noncash investing activities:
Loans transferred to other real estate owned	$	820		$	7,365
Loans provided for sales of other real estate owned		29			941
Due to broker		3,636			-

See accompanying notes to consolidated financial statements.

7

SOUTHEASTERN BANK FINANCIAL CORPORATION

Notes to Consolidated Financial Statements

(Dollar amounts are expressed in thousands unless otherwise noted)

September 30, 2013

Note 1 – Summary of Significant Accounting Policies

(a) Basis of Presentation

The accompanying consolidated financial statements include the accounts of Southeastern Bank Financial Corporation (the “Company”), and its wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta (“GB&T”).  Significant intercompany transactions and accounts are eliminated in consolidation.  Dollar amounts are rounded to thousands except share and per share data.

The financial statements for the three and nine months ended September 30, 2013 and 2012 are unaudited and have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission.  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s annual report on Form 10-K for the year ended December 31, 2012.

In the opinion of management, all adjustments necessary to present fairly the financial position and the results of operations and cash flows for the interim periods have been made.  All such adjustments are of a normal recurring nature.  The results of operations for the three and nine months ended September 30, 2013 are not necessarily indicative of the results of operations which the Company may achieve for the entire year.

Some items in the prior period financial statements were reclassified to conform to the current presentation.

(b) Loans and Allowance for Loan Losses

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, net of deferred loan fees and costs, and an allowance for loan losses.  Interest income is accrued on the unpaid principal balance.  Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments.

8

Non-Accrual Loan Procedures:

Interest income on loans of all segments and classes are generally discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection.  Consumer loans are typically charged off no later than 120 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.  Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.   A loan is moved to non-accrual status in accordance with the Company’s policy, typically after 90 days of non-payment as measured from the loan’s contractual due date.

All interest, accrued but not received, for loans placed on nonaccrual is reversed against interest income.  Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Subsequent payments of interest are recognized on the cash basis as income when full collection of principal is expected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured and there is a period of at least 6 months of repayment performance (1 year for loans providing for quarterly or semi-annual payments) by the borrower in accordance with contractual terms.

Concentration of Credit Risk:

Most of the Company’s business activity is with customers located within the Augusta-Richmond County, GA-SC metropolitan statistical area.  Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in this area.  The Company also has a significant concentration of loans with real estate developers.

Allowance for Loan Losses:

The allowance for loan losses (ALLL) is a valuation allowance for probable incurred credit losses.  The allowance for loan losses is established through a provision for loan losses charged to expense.  Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed.  Subsequent recoveries, if any, are credited to the allowance.  Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off.  The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired.

9

Impaired Loans and Troubled Debt Restructurings:

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both principal and interest) according to the contractual terms of the loan agreement.  Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

All lending relationships over $500 are individually evaluated for impairment.  If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.  Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception.  If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral.  For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.

The following portfolio segments have been identified:

● Acquisition Development and Construction (“ADC”) – CSRA

● ADC – Other

● Commercial Real Estate – Non owner occupied

● Commercial Real Estate – Owner occupied

● 1-4 Family

● Consumer

The following is a discussion of the risks characteristics of these portfolio segments.

Acquisition, Development & Construction (ADC) – CSRA (Primary Market) – ADC lending carries all of the normal risks involved in lending including the changing nature of borrower and guarantor financial conditions and the knowledge that the sale of the completed lots and/or structures is likely the sole source of repayment as opposed to other forms of borrower cash flow. In addition, this type of lending carries several additional risk factors including: (1) timely project completion (contractor financial condition, commodity prices, weather delays, prospective tenant financial condition); (2) market factors (changing economic conditions, unemployment rates, end-user financing availability, interest rates); (3) competition (similar product availability, bank foreclosed properties); and (4) end-product price stability.

10

ADC – Other – ADC lending in all other markets carries all of the ADC risks outlined for the CSRA plus the additional risk of lending outside of the Company’s traditional market area where our knowledge of these markets may not be as well developed.

Commercial Real Estate – Non Owner Occupied – This lending category includes loans for multi-family, office, warehouse, retail, hotel/motel and other non-owner occupied properties. Loans in this category carry more risk than owner-occupied properties because the property’s cash flow is not derived from the owner of the property’s business, but from unrelated tenants. These outside tenants are each subject to their own set of business risks depending upon their own financial situation, competitors, industry segment and general economic conditions. Therefore, the cash flow from the property in the form of rent may not be as stable as a one-user, owner-occupied property.

Commercial Real Estate – Owner Occupied – This portfolio segment includes loans to finance office buildings, retail establishments, warehouses, convenience stores, churches, schools, daycare facilities, restaurants, health care facilities, golf courses and other owner-occupied properties. Loans in this category generally carry less risk than non-owner occupied properties because the cash flow to service the property’s debt is derived from the owner of the property’s business as opposed to unrelated third-party tenants. The cash flows and property values for one-user, owner-occupied properties tend to be more stable because they are based upon the operation of the owner’s business as opposed to rent from a variety of smaller tenants (each of which carries its own set of business and market risks).

1-4 Family – This lending category includes loans secured by improved residential real estate. Loans in this category are affected by local real estate markets, local & national economic factors affecting borrowers’ employment prospects & income levels, and levels & movement of interest rates and the general availability of mortgage financing.

Consumer – This portfolio segment includes loans secured by consumer goods (e.g. vehicles, recreational products, equipment, etc.), but also may be unsecured. Similar to the 1-4 family category, this segment of the loan portfolio depends on a variety of local & national economic factors affecting borrowers’ employment prospects, income levels and overall economic sentiment.

The allowance is an amount that management believes will be adequate to absorb probable incurred losses on existing loans that become uncollectible, based on evaluations of the collectability of loans.  The evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s ability to pay. The allowance is evaluated on a regular basis utilizing estimated loss factors for specific types of loans.  Such loss factors are periodically reviewed and adjusted as necessary based on actual losses.

11

While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may advise the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

The process of assessing the adequacy of the allowance is necessarily subjective.  Further, and particularly in terms of economic downturns, it is reasonably possible that future credit losses may exceed historical loss levels and may also exceed management’s current estimates of probable incurred credit losses inherent within the loan portfolio.  As such, there can be no assurance that future loan charge-offs will not exceed management’s current estimate of the allowance for loan losses.

ALLL Methodology:

The Company’s approach to ALLL reserve calculation uses two distinct perspectives, the guidelines of using Financial Accounting Standards ASC 450 (Accounting for Contingencies) and ASC 310 (Accounting by Creditors for Impairment of a Loan, for individual loans). The process is generally as follows and methodology applies to all classes of loans within the portfolio segments:

● Loans are grouped in categories of similar risk characteristics (portfolio segments)

● For each loan category, a four year average rolling historical net loss rate is calculated, with the loss rate more heavily weighted to the most recent two years loss history.  The historical loss ratios are adjusted for internal and external qualitative factors within each loan category.  The qualitative factor adjustment may be further increased for loan classifications of watch rated and substandard within each category.  Factors include:

o levels and trends in delinquencies and impaired/classified/graded loans;

o changes in the quality of the loan review system;

o trends in volume and terms of loans;

o effects of changes in risk selection and underwriting standards, and other changes in lending policies, procedures and practices;

o experience, ability, and depth of lending management and other relevant staff;

o national and local economic trends and conditions;

o changes in the value of underlying collateral;

o other external factors-competition, legal and regulatory requirements;

12

o effects of changes in credit concentrations

● The resultant loss factor is applied to each respective loan pool to calculate the ALLL for each loan pool.

● The total of each loan pool is then added to the ALLL determined for individual loans evaluated for impairment in accordance with ASC 310.

There have been no changes to the methodology during 2013 and 2012.

Loans Held for Sale:

Mortgage loans held for sale are generally sold with servicing rights released.  The Company originates mortgages to be held for sale only for loans that have been individually pre-approved by the investor.  Mortgage loans originated and intended for sale in the secondary market are carried at fair value, as determined by outstanding commitments from investors.

Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

The Company bears minimal interest rate risk on these loans and only holds the loans temporarily until documentation can be completed to finalize the sale to the investor.

Commitments to fund mortgage loans (interest rate locks) to be sold into the secondary market and forward commitments for the future delivery of these mortgage loans are accounted for as free standing derivatives.  Fair values of these mortgage derivatives are estimated based on changes in mortgage interest rates from the date the interest on the loan is locked.  The Company enters into forward commitments for the future delivery of mortgage loans when interest rate locks are entered into, in order to hedge the change in interest rates resulting from its commitments to fund the loans.  Changes in the fair values of these derivatives are included in net gains on sales of loans.  Fair values of these derivatives were $130 and $19 as of September 30, 2013 and December 31, 2012, respectively.

(c) Derivatives

At the inception of a derivative contract, the Company designates the derivative as one of three types based on the Company’s intentions and belief as to likely effectiveness as a hedge.  These three types are (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair value hedge”), (2) a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”), or (3) an instrument with no hedging designation (“stand-alone derivative”).  For a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item, are recognized in current earnings as fair values change.  For a cash flow hedge, the gain or loss on the derivative is reported in other comprehensive income and is reclassified into earnings in the same periods during which the hedged transaction affects earnings.  For both types of hedges, changes in the fair value of derivatives that are not highly effective in hedging the changes in fair value or expected cash flows of the hedged item are recognized immediately in current earnings.  Changes in the fair value of derivatives that do not qualify for hedge accounting are reported currently in earnings, as noninterest income. 

13

Net cash settlements on derivatives that qualify for hedge accounting are recorded in interest income or interest expense, based on the item being hedged.  Net cash settlements on derivatives that do not qualify for hedge accounting are reported in noninterest income.  Cash flows on hedges are classified in the cash flow statement the same as the cash flows of the items being hedged.

The Company formally documents the relationship between derivatives and hedged items, as well as the risk-management objective and the strategy for undertaking hedge transactions at the inception of the hedging relationship.  This documentation includes linking fair value or cash flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions.  The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivative instruments that are used are highly effective in offsetting changes in fair values or cash flows of the hedged items.  The Company discontinues hedge accounting when it determines that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative is settled or terminates, a hedged forecasted transaction is no longer probable, a hedged firm commitment is no longer firm, or treatment of the derivative as a hedge is no longer appropriate or intended.

When hedge accounting is discontinued, subsequent changes in fair value of the derivative are recorded as noninterest income.  When a fair value hedge is discontinued, the hedged asset or liability is no longer adjusted for changes in fair value and the existing basis adjustment is amortized or accreted over the remaining life of the asset or liability.  When a cash flow hedge is discontinued but the hedged cash flows or forecasted transactions are still expected to occur, gains or losses that were accumulated in other comprehensive income are amortized into earnings over the same periods which the hedged transactions will affect earnings.

(d) Recent Accounting Pronouncements

In February 2013, the FASB amended existing guidance to require an entity to provide information about amounts reclassified out of other comprehensive income by component.  In addition, an entity is required to present, either on the face of the income statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under United States generally accepted accounting principles to be reclassified to net income in its entirety in the same reporting period.  For all other amounts, an entity is required to cross-reference to other disclosures that provide additional details about these amounts.  The guidance is effective for all interim and annual reporting periods beginning after December 15, 2012.  The adoption of the guidance did not have a material impact on the Company’s results of operation or financial position but did require expansion of the Company’s disclosures.

14

(e) Reclassifications

Some items in the prior period financial statements were reclassified to conform to the current presentation.  Reclassifications had no effect on prior period net income or shareholders’ equity.

Note 2 – Investment Securities

The following tables summarize the amortized cost and fair value of the available-for-sale investment securities portfolio at September 30, 2013 and December 31, 2012 and the corresponding amounts of unrealized gains and losses therein.

	September 30, 2013
			Gross		Gross
	Amortized		unrealized		unrealized			Estimated
	cost		gains		losses			fair value
Available-for-sale	(Dollars in thousands)
Obligations of U.S. Government agencies	$	238,579		709		(8,288	)		231,000
Obligations of states and political subdivisions		127,291		1,831		(3,031	)		126,091
Mortgage backed securities
U.S. GSE’s* MBS - residential		125,427		1,429		(2,234	)		124,622
U.S. GSE’s CMO		67,330		759		(524	)		67,565
Corporate bonds		106,133		1,478		(1,364	)		106,247
	$	664,760		6,206		(15,441	)		655,525
* Government sponsored entities

	December 31, 2012
			Gross		Gross
	Amortized		unrealized		unrealized			Estimated
	cost		gains		losses			fair value
Available-for-sale	(Dollars in thousands)
Obligations of U.S. Government agencies	$	230,609		1,726		(279	)		232,056
Obligations of states and political subdivisions		127,913		8,269		(193	)		135,989
Mortgage backed securities
U.S. GSE’s MBS - residential		106,757		3,373		(10	)		110,120
U.S. GSE’s CMO		78,101		1,590		(93	)		79,598
Other CMO		1,915		28		(195	)		1,748
Corporate bonds		94,013		2,162		(947	)		95,228
	$	639,308		17,148		(1,717	)		654,739

15

As of September 30, 2013, in addition to the U.S. Government agencies and government sponsored entities, there were four issuers who represented 10% or more of stockholders’ equity within the investment portfolio.  The Company’s holdings of investment securities issued by JP Morgan Chase totaled $14,700 or 11.15% of stockholders’ equity at September 30, 2013.  The Company also had holdings of investment securities issued by Wells Fargo totaling $13,547 or 10.28% of stockholders’ equity, GE Capital totaling $15,603 or 11.83% of stockholders’ equity and Goldman Sachs totaling $13,612 or 10.32% of stockholders’ equity at September 30, 2013.

As of December 31, 2012, in addition to the U.S. Government agencies and government sponsored entities, there were two issuers who represented 10% or more of stockholders’ equity within the investment portfolio.  The Company’s holdings of investment securities issued by SunTrust Banks totaled $15,414 or 11.35% of stockholders’ equity at December 31, 2012.  The Company also had holdings of investment securities issued by Wells Fargo totaling $13,931 or 10.26% of stockholders’ equity at December 31, 2012.

Proceeds from sales of securities available-for-sale and the associated gains (losses), excluding gains (losses) on called securities, for the three and nine months ended September 30, 2013 and 2012 were as follows:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2013			2012			2013			2012
	(Dollars in thousands)						(Dollars in thousands)
Proceeds	$	59,165		$	44,982		$	133,380		$	107,302
Gross Gains		780			616			1,571			1,204
Gross Losses		(970	)		(655	)		(1,801	)		(778	)

The amortized cost and fair value of the investment securities portfolio excluding equity securities are shown by expected maturity.  Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties.

	September 30, 2013
	Amortized		Estimated
	cost		fair value
	(Dollars in thousands)
Available-for-sale:
One year or less	$	2,017		2,035
After one year through five years		71,895		73,142
After five years through ten years		156,980		153,198
After ten years		433,868		427,150
	$	664,760		655,525

16

The following tables summarize the investment securities with unrealized losses at September 30, 2013 and December 31, 2012, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position.

	September 30, 2013
	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	fair value		loss		fair value		loss		fair value		loss
Temporarily impaired	(Dollars in thousands)
Obligations of U.S. Government agencies	$	168,202		8,092		2,204		196		170,406		8,288
Obligations of states and political subdivisions		55,611		2,773		4,499		258		60,110		3,031
Mortgage backed securities
U.S. GSE’s MBS - residential		71,362		2,168		1,756		66		73,118		2,234
U.S. GSE’s CMO		29,731		524		—		—		29,731		524
Corporate bonds		46,070		964		4,620		400		50,690		1,364
	$	370,976		14,521		13,079		920		384,055		15,441

	December 31, 2012
	Less than 12 months				12 months or longer				Total
	Estimated		Unrealized		Estimated		Unrealized		Estimated		Unrealized
	fair value		loss		fair value		loss		fair value		loss
Temporarily impaired	(Dollars in thousands)
Obligations of U.S. Government agencies	$	68,680		279		—		—		68,680		279
Obligations of states and political subdivisions		14,202		193		—		—		14,202		193
Mortgage backed securities
U.S. GSE’s MBS - residential		2,047		10		—		—		2,047		10
U.S. GSE’s CMO		10,658		93		—		—		10,658		93
Other CMO		—		—		1,309		195		1,309		195
Corporate bonds		20,226		205		13,971		742		34,197		947
	$	115,813		780		15,280		937		131,093		1,717

Other-Than-Temporary Impairment – September 30, 2013

Management evaluates securities for other-than-temporary impairment (“OTTI”) at least on a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation.  Investment securities classified as available-for-sale or held-to-maturity are generally evaluated for OTTI under the provisions of ASC 320-10, Investments – Debt and Equity Securities. In determining OTTI, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the entity has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery.  The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to management at a point in time.

17

When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether an entity intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis.  If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date.  If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors.  The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings.  The amount of the total OTTI related to other factors is recognized in other comprehensive income or loss, net of applicable taxes.  The previous amortized cost basis less the OTTI recognized in earnings becomes the new amortized cost basis of the investment.

As of September 30, 2013, the Company’s security portfolio consisted of 399 securities, 203 of which were in an unrealized loss position.  Of these securities with unrealized losses, 26.70% were related to the Company’s mortgage-backed and corporate securities as discussed below.

Mortgage-backed Securities

At September 30, 2013, all of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support.  Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2013.

During the nine month period ended September 30, 2012, one of the Company’s non-agency collateralized mortgage obligations was considered to be other-than-temporarily impaired with an OTTI loss of $13, of which $9 was recognized in earnings.

Corporate Securities

The Company holds forty-five corporate securities totaling $106,247, of which twenty-three had an unrealized loss of $1,364 at September 30, 2013. The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities.  At September 30, 2013, two securities to two issuers were not rated.  None of the issuers were in default, but in January of 2011 the Company was notified that one trust preferred security totaling $250 to one issuer not rated had elected to defer interest payments.  The issuer is a bank holding company with operations in the Southeast.  The Company considered several factors including the financial condition and near term prospects of the issuer and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual security.  The Company has considered the capital position of the subsidiary banks, the liquidity of the holding company, the existence and severity of publicly available regulatory agreements, and the fact that these deferrals are coming after the most severe impact of the national and regional recession.  The prospect of capital formation in the current market, improving operating results of the industry overall have caused the Company to conclude that a return to normal subsidiary dividends and thus interest payments on the debt for this issuer is reasonably assured at this time.  Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2013.

18

At September 30, 2013, the fair value of one corporate security totaling $109 was measured using Level 3 inputs because the market for it has become illiquid, as indicated by few, if any, trades during the period.  The discount rate used in the valuation model was based on a yield of 10% that the market would require for corporate debt obligations with maturities and risk characteristics similar to the subordinated debenture being measured.

The following table presents a rollforward of the credit losses recognized in earnings for the nine month period ended September 30, 2013 and September 30, 2012.

	2013			2012
Beginning balance, January 1	$	586		$	673
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized		-			-
Additions/Subtractions
Amounts realized for securities sold during the period		(586	)		-
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis		-			-
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security		-			-
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized		-			9
Ending balance, September 30	$	-		$	682

Total other-than-temporary impairment recognized in accumulated other comprehensive income was $0 and $4 for the nine month period ended September 30, 2013 and September 30, 2012.

19

Other-Than-Temporary Impairment – December 31, 2012

As of December 31, 2012, the Company’s security portfolio consisted of 385 securities, 65 of which were in an unrealized loss position.  Of these securities with unrealized losses, 72.51% were related to the Company’s mortgage backed and corporate securities as discussed below.

Mortgage-backed Securities

At December 31, 2012, $189,718 or approximately 99.09% of the Company’s mortgage-backed securities were issued by U.S. government-sponsored entities and agencies, primarily the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and the Government National Mortgage Association (“Ginnie Mae”), institutions which the government has affirmed its commitment to support.  Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2012.

The Company’s mortgage-backed securities portfolio also includes four non-agency collateralized mortgage obligations with a market value of $1,748, of which three had unrealized losses of approximately $195 at December 31, 2012.  These non-agency securities were rated AAA at purchase.

At December 31, 2012, three of these non-agency securities were rated below investment grade and a cash flow analysis was performed to evaluate OTTI.  The assumptions used in the model include expected future default rates, loss severity and prepayments.  The model also takes into account the structure of the security including credit support.  Based on these assumptions, the model calculates and projects the timing and amount of interest and principal payments expected for the security.  In addition, the model was used to “stress” each security, or make assumptions more severe than expected activity, to determine the degree to which assumptions could deteriorate before the security could no longer fully support repayment.  Upon completion of the December 31, 2012 analysis, our model indicated that none of these securities were other-than-temporarily impaired.  During the second quarter of 2012, one of these securities was considered to be other-than-temporarily impaired with an OTTI loss of $13, of which $9 was recognized in earnings.  This security remains classified as available-for-sale at December 31, 2012.

At December 31, 2012, the fair values of these three collateralized mortgage obligations totaling $1,576 were measured using Level 3 inputs because the market for them has become illiquid, as indicated by few, if any, trades during the period.  The discount rates used in the valuation model were based on a yield of 10% that the market would require for collateralized mortgage obligations with maturities and risk characteristics similar to the securities being measured.

20

Corporate Securities

The Company holds thirty-eight corporate securities totaling $95,228, of which sixteen had an unrealized loss of $947 at December 31, 2012.  The Company’s unrealized losses on corporate securities relate primarily to its investment in single issuer corporate and corporate trust preferred securities.  At December 31, 2012, three securities to two issuers were not rated.  None of the issuers were in default, but in January of 2011 the Company was notified that one trust preferred security totaling $250 to one issuer not rated had elected to defer interest payments.  The issuer is a bank holding company with operations in the Southeast.  The Company considered several factors including the financial condition and near term prospects of the issuer and concluded that the decline in fair value was primarily attributable to temporary illiquidity and the financial crisis affecting these markets and not necessarily the expected cash flows of the individual security.  The Company has considered the capital position of the subsidiary banks, the liquidity of the holding company, the existence and severity of publicly available regulatory agreements, and the fact that these deferrals are coming after the most severe impact of the national and regional recession.  The prospect of capital formation in the current market, improving operating results of the industry overall have caused the Company to conclude that a return to normal subsidiary dividends and thus interest payments on the debt for this issuer is reasonably assured at this time.  Because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2012.

At December 31, 2012, the fair value of one corporate security totaling $108 was measured using Level 3 inputs because the market for it has become illiquid, as indicated by few, if any, trades during the period.  The discount rates used in the valuation model was based on a yield of 10% that the market would require for corporate debt obligations with maturities and risk characteristics similar to the subordinated debenture being measured.

The table below presents a rollforward of the credit losses recognized in earnings for the year ended December 31, 2012:

Beginning balance, January 1, 2012	$	673
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized		—
Additions/Subtractions
Amounts realized for securities sold during the period		(96	)
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis		—
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security		—
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized		9
Ending balance, December 31, 2012	$	586

Total other-than-temporary impairment recognized in accumulated other comprehensive income for the year ended December 31, 2012 was $4.

21

Note 3 – Loans

The following table summarizes loans at September 30, 2013 and December 31, 2012.

	September 30, 2013			December 31, 2012
	(Dollars in thousands)
Commercial, financial, and agricultural	$	185,030			174,553
Real estate:
Commercial		350,443			343,663
Residential		171,690			168,039
Acquisition, development
and construction		165,960			171,750
Consumer installment		13,487			13,392
	$	886,610			871,397
Less allowance for loan losses		26,558			28,846
Less deferred loan origination fees (costs)		(159	)		(50	)
	$	860,211			842,601

The following tables present the activity in the allowance for loan losses by portfolio segment as of and for the three and nine month periods ended September 30, 2013 and September 30, 2012.

	Three Months Ended September 30, 2013
	Commercial,
	Financial, and			CRE - Owner			CRE - Non Owner			Residential			ADC			ADC
	Agricultural			Occupied			Occupied			Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	4,779			7,035			3,218			5,465			4,394			1,805			558			27,254
Charge-offs		(1	)		(417	)		(10	)		(194	)		(1,487	)		(751	)		(169	)		(3,029	)
Recoveries		14			—			—			82			206			82			62			446
Provision		(9	)		535			(179	)		(242	)		641			1,041			100			1,887
Ending balance	$	4,783			7,153			3,029			5,111			3,754			2,177			551			26,558
	Three Months Ended September 30, 2012
	Commercial,
	Financial, and			CRE - Owner			CRE - Non Owner			Residential			ADC			ADC
	Agricultural			Occupied			Occupied			Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	4,785			6,702			3,867			5,821			4,118			3,636			623			29,552
Charge-offs		(127	)		(622	)		(175	)		(973	)		(711	)		(315	)		(149	)		(3,072	)
Recoveries		39			41			12			12			19			27			71			221
Provision		(411	)		182			652			1,080			776			223			(101	)		2,401
Ending balance	$	4,286			6,303			4,356			5,940			4,202			3,571			444			29,102

22

	Nine Months Ended September 30, 2013
	Commercial,
	Financial, and			CRE - Owner			CRE - Non Owner			Residential			ADC			ADC
	Agricultural			Occupied			Occupied			Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	4,368			6,825			4,047			5,677			4,533			2,903			493			28,846
Charge-offs		(320	)		(3,276	)		(85	)		(985	)		(2,662	)		(1,486	)		(465	)		(9,279	)
Recoveries		72			8			13			117			256			194			285			945
Provision		663			3,596			(946	)		302			1,627			566			238			6,046
Ending balance	$	4,783			7,153			3,029			5,111			3,754			2,177			551			26,558

	Nine Months Ended September 30, 2012
	Commercial,
	Financial, and			CRE - Owner			CRE - Non Owner			Residential			ADC			ADC
	Agricultural			Occupied			Occupied			Real Estate			CSRA			Other			Consumer			Total
	(Dollars in thousands)
Allowance for loan losses:
Beginning balance	$	4,183			6,285			4,476			5,607			4,236			3,819			440			29,046
Charge-offs		(785	)		(1,671	)		(543	)		(1,583	)		(969	)		(1,025	)		(622	)		(7,198	)
Recoveries		218			43			19			79			41			28			259			687
Provision		670			1,646			404			1,837			894			749			367			6,567
Ending balance	$	4,286			6,303			4,356			5,940			4,202			3,571			444			29,102

The following tables present the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of September 30, 2013 and December 31, 2012.

	September 30, 2013
	Commercial,
	Financial, and		CRE - Owner		CRE - Non Owner		Residential		ADC		ADC
	Agricultural		Occupied		Occupied		Real Estate		CSRA		Other		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses:
Ending balance attributable to loans:
Individually evaluated for impairment	$	—		—		—		—		—		319		—		319
Collectively evaluated for impairment		4,783		7,153		3,029		5,111		3,754		1,858		551		26,239
	$	4,783		7,153		3,029		5,111		3,754		2,177		551		26,558
Loans:
Individually evaluated for impairment		619		801		11,630		4,114		4,672		6,530		—		28,366
Collectively evaluated for impairment		184,411		218,666		119,346		167,576		131,863		22,895		13,487		858,244
	$	185,030		219,467		130,976		171,690		136,535		29,425		13,487		886,610

23

	December 31, 2012
	Commercial,
	Financial, and		CRE - Owner		CRE - Non Owner		Residential		ADC		ADC
	Agricultural		Occupied		Occupied		Real Estate		CSRA		Other		Consumer		Total
	(Dollars in thousands)
Allowance for loan losses:
Ending balance attributable to loans:
Individually evaluated for impairment	$	—		—		—		—		—		—		—		—
Collectively evaluated for impairment		4,368		6,825		4,047		5,677		4,533		2,903		493		28,846
	$	4,368		6,825		4,047		5,677		4,533		2,903		493		28,846
Loans:
Individually evaluated for impairment		1,067		298		12,619		5,467		8,098		1,968		9		29,526
Collectively evaluated for impairment		173,486		206,083		124,663		162,572		136,514		25,170		13,383		841,871
	$	174,553		206,381		137,282		168,039		144,612		27,138		13,392		871,397

The following tables present loans individually evaluated for impairment by class of loans as of September 30, 2013 and December 31, 2012.

24

	September 30, 2013
	Unpaid				Allowance for		Average
	Principal		Recorded		Loan Losses		Recorded
	Balance		Investment (2)		Allocated		Investment
	(Dollars in thousands)
With no related allowance recorded: (1)
Commercial, financial, and agricultural:
Commerical	$	584		350		—		405
Financial		—		—		—		—
Agricultural		308		269		—		287
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		865		801		—		763
Non Owner occupied		12,043		11,630		—		11,514
Residential real estate:
Secured by first liens		5,452		3,928		—		3,497
Secured by junior liens		257		186		—		191
Acquisition, development and construction:
Residential		—		—		—		—
Other		20,514		10,253		—		12,883
Consumer		—		—		—		—
		40,023		27,417		—		29,540
With an allowance recorded:
Commercial, financial, and agricultural:
Commerical		—		—		—		—
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		—		—		—		—
Non Owner occupied		—		—		—		—
Residential real estate:
Secured by first liens		—		—		—		—
Secured by junior liens		—		—		—		—
Acquisition, development and construction:
Residential		—		—		—		—
Other		949		949		319		949
Consumer		—		—		—		—
		949		949		319		949
	$	40,972		28,366		319		30,489
(1) No specific allowance for credit losses is allocated to these loans since they are sufficiently collateralized or had charge-offs
(2) Excludes accrued interest receivable and loan origination fees, net due to immateriality

25

	December 31, 2012
	Unpaid				Allowance for		Average
	Principal		Recorded		Loan Losses		Recorded
	Balance		Investment (2)		Allocated		Investment
	(Dollars in thousands)
With no related allowance recorded: (1)
Commercial, financial, and agricultural:
Commerical	$	449		179		—		319
Financial		—		—		—		—
Agricultural		333		307		—		332
Equity lines		581		581		—		579
Other		—		—		—		—
Commercial real estate:
Owner occupied		304		298		—		323
Non Owner occupied		13,019		12,619		—		12,934
Residential real estate:
Secured by first liens		7,408		5,242		—		5,856
Secured by junior liens		292		225		—		242
Acquisition, development and construction:
Residential		—		—		—		—
Other		15,191		10,066		—		12,977
Consumer		14		9		—		21
		37,591		29,526		—		33,583
With an allowance recorded:
Commercial, financial, and agricultural:
Commerical		—		—		—		—
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		—		—		—		—
Non Owner occupied		—		—		—		—
Residential real estate:
Secured by first liens		—		—		—		—
Secured by junior liens		—		—		—		—
Acquisition, development and construction:
Residential		—		—		—		—
Other		—		—		—		—
Consumer		—		—		—		—
		—		—		—		—
	$	37,591		29,526		—		33,583
(1) No specific allowance for credit losses is allocated to these loans since they are sufficiently collateralized or had charge-offs
(2) Excludes accrued interest receivable and loan origination fees, net due to immateriality

26

The following tables present interest income on impaired loans for the three and nine months ended September 30, 2013 and September 30, 2012.

	Three Months Ended Sept. 30, 2013				Nine Months Ended Sept. 30, 2013
	Interest		Cash Basis		Interest		Cash Basis
	Income		Interest Income		Income		Interest Income
	Recognized		Recognized		Recognized		Recognized
	(Dollars in thousands)				(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	—		—		—		—
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		4		4		4		4
Non Owner occupied		530		530		728		728
Residential real estate:
Secured by first liens		6		6		14		14
Secured by junior liens		—		—		3		3
Acquisition, development and construction:
Residential		—		—		—		—
Other		9		9		29		29
Consumer		—		—		—		—
	$	549		549		778		778

	Three Months Ended Sept. 30, 2012				Nine Months Ended Sept. 30, 2012
	Interest		Cash Basis		Interest		Cash Basis
	Income		Interest Income		Income		Interest Income
	Recognized		Recognized		Recognized		Recognized
	(Dollars in thousands)				(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	—		—		—		—
Financial		—		—		—		—
Agricultural		—		—		—		—
Equity lines		—		—		—		—
Other		—		—		—		—
Commercial real estate:
Owner occupied		4		4		9		9
Non Owner occupied		37		37		80		80
Residential real estate:
Secured by first liens		2		2		2		2
Secured by junior liens		2		2		4		4
Acquisition, development and construction:
Residential		—		—		—		—
Other		—		—		—		—
Consumer		—		—		—		—
	$	45		45		95		95

27

Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.

The following tables present the aging of the recorded investment in past due loans as of September 30, 2013 and December 31, 2012 by class of loans.

	September 30, 2013
	30 - 89 Days		90 Days or		Nonaccrual		Total		Loans Not
	Past Due		More Past Due		Loans		Past Due		Past Due		Total
	(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	411		—		87		498		112,772		113,270
Financial		—		—		—		—		6,193		6,193
Agricultural		—		—		270		270		10,461		10,731
Equity lines		104		—		305		409		33,414		33,823
Other		39		—		75		114		20,899		21,013
Commercial real estate:
Owner occupied		63		—		715		778		218,689		219,467
Non Owner occupied		1,543		—		4,703		6,246		124,730		130,976
Residential real estate:
Secured by first liens		1,485		—		4,583		6,068		157,173		163,241
Secured by junior liens		419		—		294		713		7,736		8,449
Acquisition, development and construction:
Residential		—		—		—		—		50,742		50,742
Other		98		—		10,996		11,094		104,124		115,218
Consumer		14		—		119		133		13,354		13,487
	$	4,176		—		22,147		26,323		860,287		886,610

28

	December 31, 2012
	30 - 89 Days		90 Days or		Nonaccrual		Total		Loans Not
	Past Due		More Past Due		Loans		Past Due		Past Due		Total
	(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	151		—		341		492		108,673		109,165
Financial		—		—		—		—		2,854		2,854
Agricultural		—		—		639		639		7,366		8,005
Equity lines		165		—		1,291		1,456		36,319		37,775
Other		—		—		87		87		16,667		16,754
Commercial real estate:
Owner occupied		1,053		—		776		1,829		204,552		206,381
Non Owner occupied		820		—		10,960		11,780		125,502		137,282
Residential real estate:
Secured by first liens		3,848		—		5,923		9,771		150,365		160,136
Secured by junior liens		69		—		368		437		7,466		7,903
Acquisition, development and construction:
Residential		168		—		68		236		45,104		45,340
Other		811		—		9,644		10,455		115,955		126,410
Consumer		66		—		100		166		13,226		13,392
	$	7,151		—		30,197		37,348		834,049		871,397

Troubled Debt Restructurings:

The Company has troubled debt restructurings (TDRs) with a balance of $9,521 and $2,711 included in impaired loans at September 30, 2013 and December 31, 2012, respectively.  No specific reserves were allocated to customers whose loan terms had been modified in TDRs as of September 30, 2013 and December 31, 2012.  The Company is not committed to lend additional amounts as of September 30, 2013 and December 31, 2012 to customers with outstanding loans that are classified as TDRs.  The following tables present TDRs as of September 30, 2013 and December 31, 2012.

29

	September 30, 2013
	Number of
	Loans		Recorded Investment
	(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, and agricultural:
Commerical		1	$	350
Financial		-		-
Agricultural		-		-
Equity lines		-		-
Other		-		-
Commercial real estate:
Owner occupied		3		801
Non Owner occupied		5		6,377
Residential real estate:
Secured by first liens		10		1,736
Secured by junior liens		2		186
Acquisition, development and construction:
Residential		-		-
Other		1		71
Consumer		-		-
		22	$	9,521

	December 31, 2012
	Number of
	Loans		Recorded Investment
	(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, and agricultural:
Commerical		1	$	127
Financial		-		-
Agricultural		-		-
Equity lines		-		-
Other		-		-
Commercial real estate:
Owner occupied		1		178
Non Owner occupied		3		835
Residential real estate:
Secured by first liens		8		1,374
Secured by junior liens		2		197
Acquisition, development and construction:
Residential		-		-
Other		-		-
Consumer		-		-
		15	$	2,711

30

During the periods ended September 30, 2013 and 2012, the terms of certain loans were modified as TDRs.  The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

Modifications involving a reduction of the stated interest rate of the loan were for rate reductions ranging from 2.00% to 6.00%.  Modifications involving an extension of the maturity date were for periods ranging from 2 months to 172 months.

The following table presents loans by class modified as TDRs that occurred during the three and nine months ended September 30, 2013 and 2012.

	Three Months Ended September 30, 2013						Three Months Ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number of		Outstanding		Outstanding		Number of		Outstanding		Outstanding
	Loans		Recorded Investment		Recorded Investment		Loans		Recorded Investment		Recorded Investment
	(Dollars in thousands)						(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, and agricultural:
Commerical		1	$	590	$	350		-	$	-	$	-
Financial		-		-		-		-		-		-
Agricultural		-		-		-		-		-		-
Equity lines		-		-		-		-		-		-
Other		-		-		-		-		-		-
Commercial real estate:
Owner occupied		1		292		290		-		-		-
Non Owner occupied		2		3,152		3,096		-		-		-
Residential real estate:
Secured by first liens		-		-		-		1		130		91
Secured by junior liens		-		-		-		-		-		-
Acquisition, development and construction:
Residential		-		-		-		-		-		-
Other		-		-		-		-		-		-
Consumer		-		-		-		-		-		-
		4	$	4,034	$	3,736		1	$	130	$	91

31

	Nine Months Ended September 30, 2013						Nine Months Ended September 30, 2012
			Pre-Modification		Post-Modification				Pre-Modification		Post-Modification
	Number of		Outstanding		Outstanding		Number of		Outstanding		Outstanding
	Loans		Recorded Investment		Recorded Investment		Loans		Recorded Investment		Recorded Investment
	(Dollars in thousands)						(Dollars in thousands)
Troubled Debt Restructurings:
Commercial, financial, and agricultural:
Commerical		1	$	590	$	350		-	$	-	$	-
Financial		-		-		-		-		-		-
Agricultural		-		-		-		-		-		-
Equity lines		-		-		-		-		-		-
Other		-		-		-		-		-		-
Commercial real estate:
Owner occupied		2		762		637		-		-		-
Non Owner occupied		3		5,780		5,706		1		208		197
Residential real estate:
Secured by first liens		2		552		412		1		130		91
Secured by junior liens		-		-		-		1		185		130
Acquisition, development and construction:
Residential		-		-		-		-		-		-
Other		1		130		71		-		-		-
Consumer		-		-		-		1		80		33
		9	$	7,814	$	7,176		4	$	603	$	451

A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.  During the nine months ended September 30, 2013, one residential real estate loan with a recorded investment of $492 defaulted during the second quarter of 2013 and the default occurred within the twelve month period following the loan modification.  During the nine months ended September 30, 2012, one consumer loan with a recorded investment of $18 prior to default resulted in an $18 charge-off during the first quarter of 2012 and the default occurred within the twelve month period following the loan modification.  As of September 30, 2013, all other TDRs are performing according to their modified terms.

The TDRs described in the table above increased the allowance for loan losses by $145 and $296 and resulted in charge-offs of $145 and $296 for the three and nine months ended September 30, 2013, respectively.

For the three and nine months ended September 30, 2012, the TDRs described in the table above increased the allowance for loan losses by $39 and $118 and resulted in charge-offs of $39 and $118 for the three and nine months ended September 30, 2012, respectively.

Charge-offs on such loans are factored into the rolling historical loss rate, which is used in the calculation of the allowance for loan losses.

The terms of certain other loans were modified during the nine month period ended September 30, 2013 and 2012 that did not meet the definition of a TDR.  These loans have a total recorded investment as of September 30, 2013 and 2012 of $12,022 and $8,894 respectively.  The modification of these loans involved either a modification of the terms of a loan to borrowers who were not experiencing financial difficulties or a delay in a payment that was considered to be insignificant.

32

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification.  This evaluation is performed under the Company’s internal underwriting policy.

Certain loans which were modified during the nine month period ended September 30, 2013 and 2012 and did not meet the definition of a TDR, as the modification was a delay in a payment that was considered to be insignificant, had delays in payment ranging from 30 days to 2 months in 2013 and 30 days to 3 months in 2012.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors.  The Company, through its originating account officer, places an initial credit risk rating on every loan.  An annual review and analysis of loan relationships (irrespective of loan types included in the overall relationship) with total related exposure of $500 or greater is performed by the Credit Administration department in order to update risk ratings given current available information.

Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (Watch grade) or classified (Substandard & Doubtful grades) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (Watch or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for their criticized credit relationships.

The Company uses the following definitions for risk ratings.

Watch: Loans classified as watch have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

33

Substandard:  Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.  As of September 30, 2013 and December 31, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows.

	September 30, 2013
	Pass		Watch		Substandard		Doubtful
	(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	97,928		10,198		5,144		—
Financial		6,193		—		—		—
Agricultural		9,762		—		969		—
Equity lines		32,822		495		506		—
Other		20,576		323		114		—
Commercial real estate:
Owner occupied		200,434		12,488		6,545		—
Non Owner occupied		112,123		5,711		13,142		—
Residential real estate:
Secured by first liens		144,712		11,897		6,632		—
Secured by junior liens		7,572		513		364		—
Acquisition, development and construction:
Residential		50,462		280		—		—
Other		86,498		16,444		12,276		—
Consumer		13,096		213		178		—
	$	782,178		58,562		45,870		—

34

	December 31, 2012
	Pass		Watch		Substandard		Doubtful
	(Dollars in thousands)
Commercial, financial, and agricultural:
Commerical	$	98,380		7,885		2,900		—
Financial		—		2,854		—		—
Agricultural		6,382		—		1,623		—
Equity lines		35,021		1,259		1,495		—
Other		16,303		325		126		—
Commercial real estate:
Owner occupied		183,290		14,076		9,015		—
Non Owner occupied		115,151		8,339		13,792		—
Residential real estate:
Secured by first liens		142,061		10,029		8,046		—
Secured by junior liens		7,044		420		439		—
Acquisition, development and construction:
Residential		44,463		810		67		—
Other		90,460		18,422		17,528		—
Consumer		12,987		246		159		—
	$	751,542		64,665		55,190		—

Note 4 – Fair Value Measurements

Fair value is the exchange price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. The fair value hierarchy 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 values:

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 market 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 company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

35

In determining the appropriate levels, the Company used the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Investment Securities:  The fair values for investment securities are determined by quoted market prices, if available (Level 1).  For securities where quoted prices are not available, fair values are calculated based on matrix pricing which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities, but rather by relying on the securities relationship to other benchmark quoted securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other non-observable market indicators (Level 3).  The fair values of Level 3 investment securities are determined by an independent third party.   These valuations are then reviewed by the Company’s Controller and CFO.  Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model.  Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Interest Rate Swap Derivatives:  The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date (Level 2 inputs).  The fair value adjustment is included in other liabilities.

Mortgage Banking Derivatives:  The fair value of mortgage banking derivatives is determined by individual third party sales contract prices for the specific loans held at each reporting period end (Level 2 inputs).  The fair value adjustment is included in other assets.

Loans Held for Sale:  Loans held for sale are carried at fair value, as determined by outstanding commitments, from third party investors (Level 2).

Impaired Loans:  The fair value of collateral dependent impaired loans is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.  Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in Level 3 fair value classification.  Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other Real Estate Owned:  Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  The fair value of other real estate owned is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.  Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

36

Appraisals for both collateral dependent impaired loans and other real estate owned are performed by certified general appraisers, certified residential appraisers or state licensed appraisers whose qualifications and licenses are annually reviewed and verified by the Company.  Once received, a member of the Real Estate Valuation Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value and determines if reasonable.   Appraisals for collateral dependent impaired loans and other real estate owned are updated annually.  On an annual basis the Company compares the actual selling costs of collateral that has been liquidated to the selling price to determine what additional adjustment should be made to the appraisal value.  The most recent analysis performed indicated that an additional discount of 10% should be applied to properties with appraisals performed within 12 months.

Assets and Liabilities Measured on a Recurring Basis

The following tables present the balances of assets and liabilities measured at fair value on a recurring basis by level within the hierarchy as of September 30, 2013 and December 31, 2012.

	Sept. 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2013		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S. Government agencies	$	231,000		142,280		88,720		-
Obligations of states and political subdivisions		126,091		-		126,091		-
Mortgage-backed securities
U.S. GSE’s MBS - residential		124,622		-		124,622		-
U.S. GSE’s CMO		67,565		-		67,565		-
Corporate bonds		106,247		-		106,138		109
Total available-for-sale securities	$	655,525		142,280		513,136		109
Loans held for sale		13,817		-		13,817		-
Mortgage banking derivatives		130		-		130		-
	$	669,472		142,280		527,083		109
Liabilities:
Interest rate swap derivatives		1,112		-		1,112		-
	$	1,112		-		1,112		-

37

	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2012		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Available-for-sale securities
Obligations of U.S. Government agencies	$	232,056		128,907		103,149		-
Obligations of states and political subdivisions		135,989		-		135,989		-
Mortgage-backed securities
U.S. GSE’s MBS - residential		110,120		-		110,120		-
U.S. GSE’s CMO		79,598		-		79,598		-
Other CMO		1,748		-		172		1,576
Corporate bonds		95,228		-		95,120		108
Total available-for-sale securities	$	654,739		128,907		524,148		1,684
Loans held for sale		30,051		-		30,051		-
Mortgage banking derivatives		19		-		19		-
	$	684,809		128,907		554,218		1,684
Liabilities:
Interest rate swap derivatives		2,416		-		2,416		-
	$	2,416		-		2,416		-

The Company’s policy is to recognize transfers into or out of a level as of the end of the reporting period.

Transfers between Level 1 and Level 2:

No securities were transferred between Level 1 and Level 2 during the nine months ended September 30, 2013.  In the third quarter of 2012, four U.S. agency securities were transferred out of Level 2 and into Level 1.  These four securities with a market value of $13,533 as of September 30, 2012 were transferred on September 30, 2012.

Transfers between Level 2 and Level 3:

No securities were transferred between Level 2 and Level 3 during the nine months ended September 30, 2013.  In the second quarter of 2012, one corporate security was transferred out of Level 3 and into Level 2 based on observable market data for this security due to increased market activity for this security.  This security with a market value of $927 as of June 30, 2012 was transferred on June 30, 2012.

The tables below present a reconciliation and income statement classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as of September 30, 2013 and 2012.

38

	Fair Value Measurements Using Significant Unobservable
	Inputs (Level 3)
	Total			Other CMO			Corporate bonds
	(Dollars in thousands)
Beginning balance, January 1, 2013	$	1,684		$	1,576		$	108
Total gains or losses (realized/unrealized)
Included in earnings
Gain (loss) on sales		129			129			-
Other-than-temporary impairment		-			-			-
Included in other comprehensive income		41			40			1
Purchases, sales, issuances and settlements
Purchases		-			-			-
Sales, Calls		(1,620	)		(1,620	)		-
Issuances		-			-			-
Settlements		-			-			-
Principal repayments		(125	)		(125	)		-
Transfers into Level 3		-			-			-
Transfers out of Level 3		-			-			-
Ending balance, September 30, 2013	$	109		$	-		$	109

	Fair Value Measurements Using Significant Unobservable
	Inputs (Level 3)
	Total			Other CMO			Corporate bonds
	(Dollars in thousands)
Beginning balance, January 1, 2012	$	4,349		$	1,908		$	2,441
Total gains or losses (realized/unrealized)
Included in earnings
Gain (loss) on sales		-			-			-
Other-than-temporary impairment		(9	)		(9	)		-
Included in other comprehensive income		308			215			93
Purchases, sales, issuances and settlements
Purchases		-			-			-
Sales, Calls		(1,500	)		-			(1,500	)
Issuances		-			-			-
Settlements		-			-			-
Principal repayments		(357	)		(357	)		-
Transfers into Level 3		-			-			-
Transfers out of Level 3		(927	)		-			(927	)
Ending balance, September 30, 2012	$	1,864		$	1,757		$	107

The Company uses an independent third party to value its U.S. government agencies, mortgage-backed securities, and corporate bonds.  Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets, as well as using cash flow information when necessary.  These inputs are observable, either directly or indirectly in the market place for similar assets.  The Company considers these valuations to be Level 2 pricing.

39

The fair value of the Company’s municipal securities is determined by another independent third party.  Their approach uses relevant information generated by transactions that have occurred in the market place that involve similar assets.  These inputs are observable, either directly or indirectly in the market place for similar assets.  The Company considers these valuations to be Level 2 pricing.

For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows (Level 3 pricing) as determined by an independent third party.  The significant unobservable inputs used in the valuation model include prepayment rates, constant default rates, loss severity and yields.

On a quarterly basis, the Company selects a random sample of investment security valuations, as determined by the independent third party, to validate pricing and level assignments.

The following table presents quantitative information about level 3 fair value measurements at September 30, 2013 and 2012.

	Sept. 30,	Valuation	Unobservable	Range
	2013	Technique	Inputs	(Weighted Avg)
	(Dollars in thousands)
Available-for-sale securities
Corporate bonds	109	discounted cash flow	yield	10.00%

Sept. 30,	Valuation	Unobservable	Range
2012	Technique	Inputs	(Weighted Avg)
(Dollars in thousands)

Available-for-sale securities
Mortgage-backed securities
Other CMO	1,757	discounted cash flow	voluntary prepayment rate	5.00% - 10.00% (5.99%)
			constant default rate	31.18% - 8.96% (16.70%)
			loss severity	55.00%
			yield	10.00%
Corporate bonds	107	discounted cash flow	yield	10.00%

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage-backed securities are prepayment rates, constant default rates, loss severity and yields that the market would require for mortgage-backed securities with similar maturities and risk characteristics.  Significant increases/(decreases) in any of those inputs in isolation would result in a significantly lower/(higher) fair value measurement.  Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

40

The significant unobservable inputs used in the fair value measurement of the Company’s corporate bonds are yields that the market would require for corporate debt obligations with similar maturities and risk characteristics.

The table below summarizes changes in unrealized gains and losses recorded in earnings for the nine months ended September 30, 2013 and 2012 for Level 3 assets that are still held at September 30, 2013 and 2012.

	Other CMO
	2013		2012
	(Dollars in thousands)
Changes in unrealized gains (losses) included in earnings	$	-	$	(9	)
Other changes in fair value		-		-
	$	-	$	(9	)

Assets and Liabilities Measured on a Non-Recurring Basis

Assets and liabilities measured at fair value on a non-recurring basis as of September 30, 2013 and December 31, 2012 are summarized below.

	Sept. 30,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2013		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans (1)
Commercial, financial, and agricultural	$	349		-		-		349
Real estate:
Commercial		955		-		-		955
Residential		1,951		-		-		1,951
Acquisition, development and construction		8,515		-		-		8,515
	$	11,770		-		-		11,770

(1) Includes loans directly charged down to fair value.

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	December 31,		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	2012		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Assets:
Impaired loans
Commercial, financial, and agricultural	$	179		-		-		179
Real estate:
Commercial		1,702		-		-		1,702
Residential		3,769		-		-		3,769
Acquisition, development and construction		7,101		-		-		7,101
Consumer installment		9		-		-		9
	$	12,760		-		-		12,760
Other real estate owned
Real estate:
Commercial		2,102		-		-		2,102
Acquisition, development and construction		393		-		-		393
	$	2,495		-		-		2,495
	$	15,255		-		-		15,255

The following represents impairment charges recognized during the period:

Impaired loans, which are measured for impairment using the fair value of collateral for collateral dependent loans, had a recorded investment of $12,089, with a valuation allowance of $319, resulting in an additional provision for loan losses of $2,430 and $7,257 for the three and nine months ended September 30, 2013.

As of December 31, 2012, impaired loans had a recorded investment of $12,760, resulting in an additional provision for loan losses of $5,527 for the year ending 2012.

Other real estate owned, which is carried at fair value less costs to sell, resulted in a write down of $548 for the nine months ended September 30, 2013.

As of December 31, 2012, other real estate owned was $2,495 which consisted of the outstanding balance of $3,582, less a valuation allowance of $1,087, resulting in a write down of $1,150 for the year ending 2012.

42

The following table presents quantitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2013 and December 31, 2012.

		Sept. 30,	Valuation	Unobservable	Range
		2013	Techniques	Inputs	(Weighted Avg)
		(Dollars in thousands)
Impaired loans
	Commercial, financial, and agricultural	349	sales comparison	adjustment for	10.00% - 45.01% (27.51%)
				differences between
				the comparable sales
			income approach	capitalization rate	8.50%
	Real estate:
	Commercial	955	sales comparison	adjustment for	0.00% - 70.99% (16.68%)
				differences between
				the comparable sales
			income approach	capitalization rate	9.00%
	Residential	1,951	sales comparison	adjustment for	0.00% - 35.13% (8.11%)
				differences between
				the comparable sales
	Acquisition, development and
	construction	8,515	sales comparison	adjustment for	0.00% - 50.41% (18.13%)
				differences between
				the comparable sales
			income approach	discount rate	10.00% - 17.00% (14.51%)
			income approach	capitalization rate	7.60%

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		Dec. 31,	Valuation	Unobservable	Range
		2012	Techniques	Inputs	(Weighted Avg)
		(Dollars in thousands)
Impaired loans
	Commercial, financial, and agricultural	179	liquidation value
	Real estate:
	Commercial	1,702	sales comparison	adjustment for	0.00% - 70.99% (21.12%)
				differences between
				the comparable sales
			income approach	capitalization rate	8.50% - 10.00% (9.40%)
	Residential	3,769	sales comparison	adjustment for	0.04% - 49.15% (12.28%)
				differences between
				the comparable sales
	Acquisition, development and
	construction	7,101	sales comparison	adjustment for	0.00% - 63.33% (13.97%)
				differences between
				the comparable sales
			income approach	discount rate	12.00% - 17.00% (14.89%)
	Consumer installment	9	liquidation value
Other real estate owned
	Real estate:
	Commercial	2,102	sales comparison	adjustment for	7.99% - 22.86% (15.43%)
				differences between
				the comparable sales
	Acquisition, development and
	construction	393	sales comparison	adjustment for	0.00% - 39.95% (21.09%)
				differences between
				the comparable sales

Disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value is required.  Fair value estimates are made at a specific point in time, based on relevant market information and 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 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 and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision.  Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet 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.  In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates.

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The assumptions used in the estimation of the fair value of the Company’s financial instruments are explained below.  Where quoted market prices are not available, fair values are based on estimates using discounted cash flow and other valuation techniques.  Discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  The following fair value estimates cannot be substantiated by comparison to independent markets and should not be considered representative of the liquidation value of the Company’s financial instruments, but rather a good-faith estimate of the fair value of financial instruments held by the Company. Certain financial instruments and all nonfinancial instruments are excluded from disclosure requirements.

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

(a) Cash and Cash Equivalents

Fair value equals the carrying value of such assets due to their nature and is classified as Level 1.

(b) Loans, net

The fair value of loans is calculated using discounted cash flows by loan type resulting in a Level 3 classification.  The discount rate used to determine the present value of the loan portfolio is an estimated market rate that reflects the credit and interest rate risk inherent in the loan portfolio without considering widening credit spreads due to market illiquidity. The estimated maturity is based on the Company’s historical experience with repayments adjusted to estimate the effect of current market conditions.  The carrying amount of related accrued interest receivable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed.  The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.  The allowance for loan losses is considered a reasonable discount for credit risk.  The methods utilized to estimate the fair value of loans do not necessarily represent an exit price.

(c) Restricted Equity Securities

The fair value of Federal Home Loan Bank (“FHLB”) stock was not practicable to determine due to restrictions placed on its transferability.

(d) Deposits

Fair values for certificates of deposit have been determined using discounted cash flows.  The discount rate used is based on estimated market rates for deposits of similar remaining maturities and are classified as Level 2.  The carrying amounts of all other deposits, due to their short-term nature, approximate their fair values and are classified as Level 1.  The carrying amount of related accrued interest payable, due to its short-term nature, approximates its fair value, is not significant and is not disclosed.

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(e) Securities Sold Under Repurchase Agreements

Fair value approximates the carrying value of such liabilities due to their short-term nature and is classified as Level 1.

(f) Advances from FHLB

The fair value of the FHLB advances is obtained from the FHLB and is calculated by discounting contractual cash flows using an estimated interest rate based on the current rates available to the Company for debt of similar remaining maturities and collateral terms resulting in a Level 2 classification.

(g) Subordinated debentures

The fair value for subordinated debentures is calculated using discounted cash flows based upon current market spreads to LIBOR for debt of similar remaining maturities and collateral terms resulting in a Level 3 classification.

(h) Commitments

The difference between the carrying values and fair values of commitments to extend credit are not significant and are not disclosed.

The carrying amounts and estimated fair values of the Company’s financial instruments at September 30, 2013 and December 31, 2012 are as follows:

	September 30, 2013
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	64,856		64,856		64,856		-		-
Loans, net		848,441		848,430		-		-		848,430
Restricted equity securities		5,320		N/A
Financial liabilities:
Deposits with stated maturities		379,979		381,274		-		381,274		-
Deposits without stated maturities		1,061,683		1,061,683		1,061,683		-		-
Securities sold under repurchase agreements		698		698		698		-		-
Advances from FHLB		74,000		78,790		-		78,790		-
Subordinated debentures		21,547		16,214		-		-		16,214

46

	December 31, 2012
	Carrying		Fair Value Measurements
	amount		Total		Level 1		Level 2		Level 3
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	43,888		43,888		43,888		-		-
Loans, net		827,786		828,301		-		-		828,301
Restricted equity securities		5,296		N/A
Financial liabilities:
Deposits with stated maturities		391,448		392,944		-		392,944		-
Deposits without stated maturities		1,029,824		1,029,824		1,029,824		-		-
Securities sold under repurchase agreements		976		976		976		-		-
Advances from FHLB		64,000		70,802		-		70,802		-
Subordinated debentures		21,547		16,097		-		-		16,097

Note 5 – Interest Rate Swap Derivatives

The Company utilizes interest rate swap agreements as part of its asset liability management strategy to help manage its interest rate risk position.  The notional amount of the interest rate swaps does not represent amounts exchanged by the parties.  The amount exchanged is determined by reference to the notional amount and the other terms of the individual interest rate swap agreements.

During May 2011, the Company entered into two interest rate swaps with notional amounts totaling $10,000 which were designated as cash flow hedges of certain subordinated debentures and were determined to be fully effective during all periods presented.  As such, no amount of ineffectiveness has been included in net income.  Therefore, the aggregate fair value of the swaps is recorded in other liabilities with changes in fair value recorded in other comprehensive income.  The Company expects the hedges to remain highly effective during the remaining terms of the swaps.

Summary information about the interest rate swaps designated as cash flow hedges as of September 30, 2013 and December 31, 2012 is as follows:

	September 30, 2013			December 31, 2012
	(Dollars in thousands)
Notional Amounts	$	10,000		$	10,000
Weighted average pay rates		5.35	%		5.35	%
Weighted average receive rates		1.65	%		1.71	%
Weigted average maturity	15.33 years			16.08 years
Unrealized losses	$	1,112		$	2,416

The swaps were forward starting and had effective dates of March 15, 2012 and June 15, 2012.  Interest expense recorded on these swap transactions totaled $278 at September 30, 2013 and is reported as a component of interest expense in other borrowings.

47

If the fair value falls below specified levels, the Company is required to pledge collateral against these derivative contract liabilities.  As of September 30, 2013, the Company had pledged $1,253 with the counterparty.  Under certain circumstances, including a downgrade of its credit rating below specified levels, the counterparty is required to pledge collateral against these derivative contract liabilities.  As of September 30, 2013, no collateral had been received from the counterparty.

Note 6 – Other Comprehensive Income (Loss)

Other comprehensive income (loss) for the Company consists of changes in net unrealized gains and losses on investment securities available-for-sale and interest rate swap derivatives.  The following tables present a summary of the accumulated other comprehensive income balances, net of tax, as of September 30, 2013 and 2012.

	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Securities			Accumulated Other Comprehensive Income (Loss)
	(Dollars in thousands)
Balance, December 31, 2012	$	(1,476	)	$	9,428		$	7,952
Current Year change		797			(15,070	)		(14,273	)
Balance, September 30, 2013	$	(679	)	$	(5,642	)	$	(6,321	)

	Unrealized Gain (Loss) on Derivatives			Unrealized Gain (Loss) on Securities		Accumulated Other Comprehensive Income (Loss)
	(Dollars in thousands)
Balance, December 31, 2011	$	(1,382	)	$	5,018	$	3,636
Current Year change		(200	)		5,353		5,153
Balance, September 30, 2012	$	(1,582	)	$	10,371	$	8,789

48

The following tables present reclassifications out of accumulated other comprehensive income.

	Three Months Ended September 30,
	2013			2012
Details about Accumulated Other Comprehensive Income Components	Amount reclassified from Accumulated Other Comprehensive Income			Amount reclassified from Accumulated Other Comprehensive Income			Affected line item in the Statement where Net Income is presented
(Dollars in thousands)
Unrealized gains and losses on available-for-sale securities
	$	(163	)	$	(37	)	Realized loss on sale of securities
		-			-		Impairment expense
		(163	)		(37	)	Total before tax
	$	49		$	12		Tax benefit
	$	(114	)	$	(25	)	Net of tax

	Nine Months Ended September 30,
		2013			2012
Details about Accumulated Other Comprehensive Income Components	Amount reclassified from Accumulated Other Comprehensive Income			Amount reclassified from Accumulated Other Comprehensive Income			Affected line item in the Statement where Net Income is presented
(Dollars in thousands)
Unrealized gains and losses on available-for-sale securities
	$	(192	)	$	441		Realized gain (loss) on sale of securities
		-			(9	)	Impairment expense
		(192	)		432		Total before tax
	$	59		$	(134	)	Tax (expense) benefit
	$	(133	)	$	298		Net of tax

Note 7 – Dividends

On April 24, 2013, the Company declared a quarterly cash dividend of $0.13 per share on outstanding shares.  The dividend was paid on May 17, 2013 to shareholders of record as of May 3, 2013.

On July 17, 2013, the Company declared a quarterly cash dividend of $0.13 per share on outstanding shares.  The dividend was paid on August 16, 2013 to shareholders of record as of August 2, 2013.

On October 17, 2013, the Company declared a quarterly cash dividend of $0.13 per share on outstanding shares.  The dividend is payable on November 15, 2013 to shareholders of record as of November 1, 2013.

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

(Dollar amounts are expressed in thousands unless otherwise noted)

Overview

Southeastern Bank Financial Corporation (the “Company”) is a Georgia corporation that is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “BHCA”).  Southeastern Bank Financial Corporation (OTCQB: SBFC) trades on OTCQB, the marketplace for companies that are current in their reporting with a U.S. regulator.  Investors can find Real-Time quotes and market information for the Company on www.otcmarkets.com.  The Company’s wholly-owned subsidiary, Georgia Bank & Trust Company of Augusta (“GB&T”), primarily does business in the Augusta-Richmond County, GA-SC metropolitan area.  GB&T was organized by a group of local citizens and commenced business on August 28, 1989, with one branch location.  Today, it is Augusta’s largest community banking company, operating nine full service branches in Augusta, Martinez, and Evans, Georgia.  GB&T also operates three full service branches in North Augusta and Aiken, South Carolina under the name “Southern Bank & Trust, a division of Georgia Bank & Trust Company of Augusta.”  Mortgage origination offices are located in Augusta and Savannah, Georgia and in Aiken, South Carolina.  The Company’s Operations Center is located in Martinez, Georgia.

The Company’s primary market includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA).  The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade.  Augusta is one of the leading medical centers in the Southeast.

The Company’s services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans.  The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits.  In its primary market area, the Augusta-Richmond County, GA-SC metropolitan area, the Company had 18.96% of all deposits and was the second largest depository institution and the largest locally based institution at June 30, 2013, as cited from the Federal Deposit Insurance Corporation’s (“FDIC”) website.  Securities sold under repurchase agreements are also offered.  Additional services include wealth management, trust, retail investment, and mortgage.  As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies.  The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on its customer relationship management philosophy.  The Company is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

50

The Company’s primary source of income is from its lending activities, followed by interest income from its investment activities, gain on sales of mortgage loans in the secondary market and service charges and fees on deposits.  Interest income on loans increased $143 or 0.41% for the first nine months of 2013 as compared to the first nine months of 2012 and was due primarily to increased volume offset by decreased loan yields.  Interest income on investment securities decreased $1,047 or 8.18% and was due primarily to declining yields somewhat offset by a larger investment portfolio.  Service charges and fees on deposits increased $288 or 5.73% and resulted primarily from increases in non-sufficient funds (“NSF”) income on commercial checking accounts due to increased activity, and also from increased ATM/Debit card income for the first nine months of 2013.  Gain on sales of loans decreased $1,552 or 21.35% due to reduced mortgage originations and refinancing activity during the first nine months of the year.

Table 1 - Selected Financial Data

	September 30,			December 31,			September 30,
	2013			2012			2012
	(Dollars in thousands)
Assets	$	1,690,974		$	1,662,502		$	1,673,105
Investment securities		655,525			654,739			676,089
Loans		886,769			871,447			853,927
Deposits		1,441,662			1,421,272			1,436,343
Annualized return on average total assets		0.95	%		0.87	%		0.85	%
Annualized return on average equity		11.78	%		11.40	%		11.32	%

The Company continues to focus on the net interest margin, regulatory capital levels, liquidity management, asset quality and the generation of loans to offset declining investment portfolio yields.  Asset levels have increased slightly and resulted from increased loan portfolio balances over the comparable periods in an effort to maintain net interest income. In addition, cash balances increased.

Annualized return on average total assets and annualized return on average equity have improved moderately in 2013 as compared to 2012.  The increased returns were due primarily to increased net interest income, reduced provision for loan losses and reduced non-interest expense, offset in part by lower gain on sales of loans and investment securities losses. Net income for the nine months ended September 30, 2013 was $11,981 compared to $10,539 for the same period in 2012.

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The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments from mortgage-backed securities, and draws on lines of credit.  Additionally, liquidity can be managed through structuring deposit and loan maturities.  The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit.  During inflationary periods, interest rates generally increase and operating expenses generally rise.  When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise.  The Company monitors its interest rate risk as it applies to net interest income in a ramp up and down annually 400 basis points (4.00%) scenario and as it applies to economic value of equity in a shock up and down 400 basis points (4.00%) scenario.  The Company monitors operating expenses through responsibility center budgeting.

Forward-Looking Statements

Southeastern Bank Financial Corporation may, from time to time, make written or oral forward-looking statements, including statements contained in the Company’s filings with the Securities and Exchange Commission (the “Commission”) and its reports to shareholders.  Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties.  Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management pursuant to “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.  The Company’s actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company’s local economies, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company’s business into new markets; changes in governmental regulation relating to the banking industry, including but not limited to the Dodd-Frank Wall Street Reform and Consumer Protection Act; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors.  The Company cautions that such factors are not exclusive.  The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

Critical Accounting Estimates

The accounting and financial reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry.  Of these policies, management has identified the allowance for loan losses, determining the fair values of financial instruments including other real estate owned, interest rate swap derivatives, investment securities, and other-than-temporary impairment as critical accounting estimates that requires difficult, subjective judgment and are important to the presentation of the financial condition and results of operations of the Company.

52

Allowance for Loan Losses

The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company’s earnings directly.  Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.  Subsequent recoveries are added to the allowance.  The allowance is an amount that reflects management’s estimate of the level of probable incurred losses in the portfolio.  Factors considered by management in determining the adequacy of the allowance include, but are not limited to: (1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels; (4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; and (6) management’s assessment of economic conditions.  The Company’s Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors.

The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses.  The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits.  Management continues to review these policies and procedures and makes further improvements as needed.  The adequacy of the Company’s allowance for loan losses and the effectiveness of the Company’s internal policies and procedures are also reviewed periodically by the Company’s regulators and the Company’s internal loan review personnel.  The Company’s regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

The Company continues to refine the methodology on which the level of the allowance for loan losses is based by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.

Fair Value of Financial Instruments

A significant portion of the Company’s assets are financial instruments carried at fair value. This includes securities available-for-sale, loans held for sale, certain impaired loans, mortgage banking derivatives and other real estate owned.  At September 30, 2013 and December 31, 2012 the percentage of total assets measured at fair value was 40.29% and 42.23%, respectively. The majority of assets carried at fair value are based on either quoted market prices or market prices for similar instruments. At September 30, 2013, 1.74% of assets measured at fair value were based on significant unobservable inputs. This consisted primarily of available-for-sale securities, impaired loans and other real estate and represents approximately 0.70% of the Company’s total assets. See Note 4 “Fair Value Measurements” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.

53

Other Real Estate Owned

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when acquired, establishing a new cost basis.  These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell.  If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense.  Operating costs after acquisition are expensed.  Costs related to the development and improvement of real estate owned are capitalized.

Interest Rate Swap Derivatives

The fair value of interest rate swap derivatives is determined based on discounted cash flow valuation models using observable market data as of the measurement date.  The fair value adjustment is included in other liabilities.  See Note 1 “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements” herein for additional disclosures regarding the fair value of financial instruments.

Investment Securities

The fair values for available-for-sale securities are generally based upon quoted market prices or observable market prices for similar instruments. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment. The Company conducts periodic reviews to identify and evaluate each available-for-sale security that has an unrealized loss for other-than-temporary impairment. An unrealized loss exists when the fair value of an individual security is less than its amortized cost basis. The primary factors the Company considers in determining whether an impairment is other-than-temporary are the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether the Company intends to sell the security or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis.  As of September 30, 2013, the Company had approximately $109 of available-for-sale securities, which is approximately 0.01% of total assets, valued using unobservable inputs (Level 3). These securities were primarily non-agency mortgage-backed securities and single issuer subordinated debentures issued by financial institutions.

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Results of Operations

Net income for the first nine months of 2013 was $11,981, an increase of $1,442 or 13.68% compared with net income of $10,539 for the first nine months of 2012.  The change in net income was primarily due to increased net interest income and reduced non-interest expense offset in part by lower gain on sales of loans and investment securities gains.

Total other comprehensive loss for the first nine months of 2013 was $14,273 compared to other comprehensive income of $5,153 in the first nine months 2012. The change was due primarily to a decrease in the unrealized gain (loss) on securities available-for-sale which was due to a sharp rise in interest rates which caused a decline in market value of the portfolio.

Noninterest income decreased $1,507 or 9.18% for the nine months ended September 30, 2013 and resulted primarily from decreased gain on sales of loans and investment securities of $1,552 and $633 respectively.  Service charges and fees on deposits, trust service fees and cash surrender value of bank-owned life insurance increased slightly over the comparable periods.  Investment securities losses year to date are $192 as compared to net securities gains of $432 in 2012.

Noninterest expense totaled $31,262 for the nine months ended September 30, 2013, a decrease of $1,890, or 5.70% compared to the same period ended September 30, 2012.  Notable changes included a decrease of $624 in other real estate losses and a decrease in salaries and other personnel expenses of $1,293.

Table 2 - Selected Balance Sheet Data

	September 30,		December 31,		Variance
	2013		2012		Amount			%
	(Dollars in thousands)
Cash, due from banks and interest-bearing deposits	$	64,856	$	43,888	$	20,968			47.78	%
Investment securities		655,525		654,739		786			0.12	%
Loans		886,769		871,447		15,322			1.76	%
Other real estate owned		1,155		3,490		(2,335	)		(66.91	%)
Deferred tax asset		18,798		10,406		8,392			80.65	%
Assets		1,690,974		1,662,502		28,472			1.71	%
Deposits		1,441,662		1,421,272		20,390			1.43	%
Securities sold under repurchase agreements		698		976		(278	)		(28.48	%)
Advances from Federal Home Loan Bank		74,000		64,000		10,000			15.63	%
Liabilities		1,559,135		1,526,719		32,416			2.12	%
Stockholders’ equity		131,839		135,783		(3,944	)		(2.90	%)

55

Table 2 highlights significant changes in the balance sheet at September 30, 2013 as compared to December 31, 2012.  Total assets increased $28,472 and reflect an increase in cash and cash equivalents of $20,968, an increase in deferred tax assets of $8,392, and an increase in loans of $15,322. Loans held for sale decreased $16,234, other real estate owned decreased $2,335 and prepaid FDIC assessment decreased $2,024. The deferred tax asset increased primarily due to the tax effect of the change in value of unrealized gains and losses on securities available-for-sale recognized through other comprehensive income.  Loans held for sale decreased due to lower mortgage origination activity. Other real estate decreased due to sales. Total liabilities increased $32,416 and reflect an increase in deposits of $20,390 and Federal Home Loan Bank Advances of $10,000.  Stockholders’ equity decreased $3,944 and was due primarily to a $14,273 decrease in accumulated other comprehensive income offset by net earnings retention of approximately $10,244.
 

The Company has continued to maintain a relatively high level of liquid funds in light of current economic conditions but has elected to invest a portion of these funds and funds obtained through deposit growth into the investment portfolio. Investments increased $786 or 0.12% from December 31, 2012 to September 30, 2013.  Loans increased in the third quarter and resulted in a minor year-to date increase of $15,322 or 1.76%.

The $20,390 net increase in deposits was marked by shifts in deposit categories. Noninterest-bearing demand and savings accounts increased $18,437 and $19,986 respectively.  In addition, brokered deposits increased $6,663 and totaled $160,353 at September 30, 2013 compared to $153,690 at December 31, 2012.  Over the same period, non brokered time deposits decreased $18,132 and NOW accounts decreased $7,287.

The annualized return on average assets for the Company was 0.95% for the nine months ended September 30, 2013, compared to 0.85% for the same period last year.

The annualized return on average stockholders’ equity was 11.78% for the nine months ended September 30, 2013, compared to 11.32% for the same period last year.

Net Interest Income

The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings.  The following tables show the average balances of interest-earning assets and interest-bearing liabilities, annualized average yields earned and rates paid on those respective balances, and the actual interest income and interest expense for the periods indicated.  Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

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Table 3 - Average Balances, Income and Expenses, Yields and Rates

	Three Months Ended Sept 30, 2013							Three Months Ended Sept 30, 2012
	Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned		Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned
	(Dollars in thousands)
Interest-earning assets:
Loans	$	878,707		5.13	%	$	11,484	$	845,989		5.36	%	$	11,534
Loans held for sale		18,317		3.99	%		184		29,812		2.77	%		208
Investment securities
Taxable		581,161		2.18	%		3,172		567,698		2.46	%		3,491
Tax-exempt		88,243		3.19	%		703		76,842		3.35	%		643
Interest-bearing deposits in other banks		11,311		0.46	%		13		11,112		0.54	%		15
Total interest-earning assets	$	1,577,739		3.89	%	$	15,556	$	1,531,453		4.09	%	$	15,891
Interest-bearing liabilities:
Deposits	$	1,263,964		0.51	%	$	1,637	$	1,265,737		0.70	%	$	2,227
Securities sold under repurchase agreements		1,974		0.81	%		4		728		0.41	%		1
Other borrowings		87,612		3.10	%		685		83,938		3.23	%		683
Total interest-bearing liabilities	$	1,353,550		0.68	%	$	2,326	$	1,350,403		0.86	%	$	2,911
Net interest margin/income:				3.31	%	$	13,230				3.34	%	$	12,980

Table 4 - Average Balances, Income and Expenses, Yields and Rates

	Nine Months Ended Sept 30, 2013							Nine Months Ended Sept 30, 2012
	Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned		Average Amount		Annualized Average Yield or Rate			Amount Paid or Earned
	(Dollars in thousands)
Interest-earning assets:
Loans		876,226		5.22	%		34,566		842,938		5.38	%		34,378
Loans held for sale		23,989		2.99	%		537		26,664		2.91	%		582
Investment securities
Taxable		568,428		2.25	%		9,609		558,787		2.61	%		10,934
Tax-exempt		85,948		3.33	%		2,145		72,551		3.43	%		1,867
Interest-bearing deposits in other banks		13,947		0.48	%		50		19,689		0.42	%		62
Total interest-earning assets	$	1,568,538		3.96	%	$	46,907	$	1,520,629		4.16	%	$	47,823
Interest-bearing liabilities:
Deposits	$	1,272,350		0.54	%	$	5,150	$	1,271,807		0.77	%	$	7,318
Securities sold under repurchase agreements		1,453		0.55	%		6		1,961		0.61	%		9
Other borrowings		86,243		3.15	%		2,030		78,381		3.25	%		1,911
Total interest-bearing liabilities	$	1,360,046		0.71	%	$	7,186	$	1,352,149		0.91	%	$	9,238
Net interest margin/income:				3.35	%	$	39,721				3.35	%	$	38,585

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Third Quarter 2013 compared to Third Quarter 2012:

Net interest income increased $250 (1.93%) during the three month period as compared to the same period in 2012 and resulted primarily from lower rates paid on deposits offset in part by lower yields on loans and investments.

Loan interest income decreased $74 (0.63%) in the three month period as compared to the same period in the prior year. The change resulted primarily from a $32,718 increase in average loans but was offset by lower yields, which decreased from 5.36% to 5.13%.  Nonaccrual loans resulted in the reversal of $25 in interest income compared to $24 in the same period in 2012.

Deposit interest expense decreased $590 (26.49%) in the three month period as compared to the same period in the prior year, primarily as a result of lower rates paid on the Company’s checking and savings account products.  Due to these reductions and the low interest rate environment, the annualized average rate of interest bearing liabilities decreased from 0.86% at September 30, 2012 to 0.68% at September 30, 2013.

The Company’s net interest margin for the quarter decreased 3bp to 3.31% compared to 3.34% for the 2012 quarter.  The minor decrease in the net interest margin was due to asset yields declining slightly faster than liability costs. In addition, the Company increased the tax exempt investment securities portfolio. Average tax exempt investment securities increased $11,401 (14.84%) while the average yield decreased from 3.35% to 3.19%.  Average interest bearing deposits were relatively unchanged but the average rate paid decreased from 0.70% to 0.51%. Average other borrowings increased $3,674 (4.38%) and was due primarily to an increase in advances from the Federal Home Loan Bank.  The average cost declined from 3.23% to 3.10%.

Nine Months Ended 2013 compared to Nine Months Ended 2012:

Net interest income increased $1,136 (2.94%) during the nine month period as compared to the same period in 2012 and resulted primarily from lower rates paid on deposits.

Loan interest income was essentially unchanged, increasing $143 (0.41%) in the nine month period. The change resulted primarily from a $33,288 increase in average loans but was offset by lower yields, which decreased from 5.38% to 5.22%.  Nonaccrual loans resulted in the reversal of $132 in interest income compared to $225 in 2012.

Deposit interest expense decreased $2,168 (29.63%) in the nine month period as compared to the same period in the prior year, primarily as a result of lower rates paid on the Company’s checking and savings account products.  Due to these reductions and the low interest rate environment, the annualized average rate of interest bearing liabilities decreased from 0.91% at September 30, 2012 to 0.71% at September 30, 2013.

58

The Company’s net interest margin for the nine months ended September 30, 2013 was unchanged at 3.35% as compared to the nine months ended September 30, 2012.  The net interest margin remained unchanged due to interest bearing liability costs declining at the same rate as asset yields. The Company added to both its taxable and tax exempt investment securities portfolios. Average taxable investment securities increased $9,641 (1.73%) while the average yield decreased from 2.61% to 2.25%. Average tax exempt investment securities increased $13,397 (18.47%) while the average yield decreased from 3.43% to 3.33%.  Average interest bearing deposits were relatively unchanged and increased $543 (0.04%) while the average rate paid decreased from 0.77% to 0.54%. Average other borrowings increased $7,862 (10.03%) and was due primarily to an increase in advances from Federal Home Loan Bank. The average cost declined from 3.25% to 3.15%.

Changes in net interest income from period to period result from increases or decreases in the volume of interest-earning assets and interest-bearing liabilities, increases or decreases in the average rates earned and paid on such assets and liabilities, the ability to manage the earning asset portfolio, and the availability of particular sources of funds, such as noninterest-bearing deposits.  The following tables present the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have impacted the Company’s interest income and interest expense during the periods indicated.  Information is provided in each category with respect to changes attributable to change in volume (change in volume multiplied by prior rate), changes attributable to change in rate (change in rate multiplied by prior volume), and changes in rate/volume (change in rate multiplied by change in volume).

Table 5 - Rate/Volume Analysis

	Three Months Ended
	Sept 30, 2013 compared to Sept 30, 2012
	Increase (Decrease) due to
	Volume			Rate			Combined			Total
Interest-earning assets:	(Dollars in thousands)
Loans		446			(478	)		(18	)		(50	)
Loans held for sale		(80	)		91			(35	)		(24	)
Investment securities
Taxable		83			(392	)		(10	)		(319	)
Tax-exempt		95			(31	)		(4	)		60
Interest-bearing deposits in other banks		-			(2	)		-			(2	)
Total interest-earning assets		544			(812	)		(67	)		(335	)
Interest-bearing liabilities:
Deposits		(3	)		(588	)		1			(590	)
Securities sold under repurchase agreements		2			-			1			3
Other borrowings		30			(27	)		(1	)		2
Total interest-bearing liabilities		29			(615	)		1			(585	)
Net change in net interest income										$	250

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Table 6- Rate/Volume Analysis

	Nine Months Ended
	Sept 30, 2013 compared to Sept 30, 2012
	Increase (Decrease) due to
	Volume			Rate			Combined			Total
Interest-earning assets:	(Dollars in thousands)
Loans		1,357			(1,125	)		(44	)		188
Loans held for sale		(58	)		15			(2	)		(45	)
Investment securities
Taxable		189			(1,488	)		(26	)		(1,325	)
Tax-exempt		345			(57	)		(10	)		278
Interest-bearing deposits in other banks		(18	)		9			(3	)		(12	)
Total interest-earning assets		1,815			(2,646	)		(85	)		(916	)
Interest-bearing liabilities:
Deposits		3			(2,170	)		(1	)		(2,168	)
Securities sold under repurchase agreements		(2	)		(1	)		-			(3	)
Other borrowings		192			(66	)		(7	)		119
Total interest-bearing liabilities		193			(2,237	)		(8	)		(2,052	)
Net change in net interest income										$	1,136

Provision for Loan Losses

The provision for loan losses is the charge to operating earnings necessary to maintain the allowance for loan losses at a level which, in management’s estimate, is adequate to cover the estimated amount of probable incurred losses in the loan portfolio.  The provision for loan losses totaled $1,887 for the three months ended September 30, 2013 compared to $2,401 for the three months ended September 30, 2012 and $6,046 for the nine months ended September 30, 2013 compared to $6,567 for the same period in 2012.  See “Allowance for Loan Losses” for further analysis of the provision for loan losses.

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Noninterest Income

Table 7 - Noninterest Income
	Three Months Ended												Nine Months Ended
	September 30,						Variance						September 30,					Variance
	2013			2012			Amount			%			2013			2012		Amount			%
	(Dollars in thousands)												(Dollars in thousands)
Service charges and fees on deposits	$	1,849		$	1,733		$	116			6.69	%	$	5,317		$	5,029	$	288			5.73	%
Gain on sales of loans		1,659			2,949			(1,290	)		(43.74	%)		5,716			7,268		(1,552	)		(21.35	%)
Gain on sale of fixed assets, net		-			4			(4	)		(100.00	%)		21			10		11			110.00	%
Investment securities gains (losses), net of other-than-temporary impairment		(163	)		(37	)		(126	)		340.54	%		(192	)		432		(624	)		(144.44	%)
Retail investment income		557			420			137			32.62	%		1,545			1,447		98			6.77	%
Trust services fees		301			280			21			7.50	%		890			857		33			3.85	%
Earnings from cash surrender value of bank-owned life insurance		326			305			21			6.89	%		897			831		66			7.94	%
Miscellaneous income		333			169			164			97.04	%		708			535		173			32.34	%
Total noninterest income	$	4,862		$	5,823		$	(961	)		(16.50	%)	$	14,902		$	16,409	$	(1,507	)		(9.18	%)

Third Quarter 2013 compared to Third Quarter 2012:

Noninterest income decreased $961 (16.50%) during the three month period as compared to the same period in 2012.  The most significant decreases in income for the three month period was a decrease in gain on sales of loans of $1,290 (43.74%) due to lower volume of mortgage originations and investment securities losses which increased $126. Partially offsetting these declines were retail investment income and trust services fees which increased $137 and $21 respectively and included in miscellaneous income was $150 of bank owned life insurance death benefits in excess of cash surrender value. In addition, service charges and fees on deposits increased $116 and resulted from increased commercial and consumer overdraft fees of $66 and increased interchange fees of $42. Earnings from cash surrender value of bank-owned life insurance increased $21 and is due in part to an increase in bank-owned life insurance of $3,911 over the comparable period in 2012.

Nine Months Ended 2013 compared to Nine Months Ended 2012:

Noninterest income decreased $1,507 (9.18%) during the nine month period as compared to the same period in 2012.  The most significant decreases in income for the nine month period was a decrease in gain on sales of loans of $1,552 (21.35%) due to lower volume of mortgage originations and a decrease in investment securities (losses) gains which was a net loss of $192 in 2013 compared to a net of gain of $432 in 2012. Partially offsetting these declines were retail investment income and trust services fees which increased $98 and $33 respectively and included in miscellaneous income was $150 of bank owned life insurance death benefits in excess of cash surrender value. In addition, service charges and fees on deposits increased $288 and resulted from increased commercial and consumer overdraft fees of $186 and increased interchange fees of $90. Earnings from cash surrender value of bank-owned life insurance increased $66 and is due in part to an increase in bank-owned life insurance of $3,911 over the comparable period in 2012.

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Noninterest Expense

Table 8 - Noninterest Expense
	Three Months Ended											Nine Months Ended
	September 30,					Variance						September 30,				Variance
	2013		2012			Amount			%			2013		2012		Amount			%
	(Dollars in thousands)											(Dollars in thousands)
Salaries and other personnel expense	$	5,713	$	6,604		$	(891	)		(13.49	%)	$	18,051	$	19,344	$	(1,293	)		(6.68	%)
Occupancy expenses		940		1,014			(74	)		(7.30	%)		2,814		3,111		(297	)		(9.55	%)
Marketing & business development		507		422			85			20.14	%		1,416		1,199		217			18.10	%
Processing expense		539		519			20			3.85	%		1,587		1,439		148			10.28	%
Legal and professional fees		404		346			58			16.76	%		1,188		1,167		21			1.80	%
Data processing expense		423		359			64			17.83	%		1,159		1,092		67			6.14	%
FDIC insurance		183		398			(215	)		(54.02	%)		947		1,177		(230	)		(19.54	%)
Loss (gain) on sale of other real estate		11		(204	)		215			(105.39	%)		80		648		(568	)		(87.65	%)
Provision for other real estate losses		-		107			(107	)		(100.00	%)		548		604		(56	)		(9.27	%)
Loan costs (excluding OREO)		567		317			250			78.86	%		978		999		(21	)		(2.10	%)
Other operating expenses		927		805			122			15.16	%		2,494		2,372		122			5.14	%
Total noninterest expense	$	10,214	$	10,687		$	(473	)		(4.43	%)	$	31,262	$	33,152	$	(1,890	)		(5.70	%)

Third Quarter 2013 compared to Third Quarter 2012:

Noninterest expense decreased $473 (4.43%) during the three month period as compared to the same period in 2012. The most significant decreases in expense for the three month period were decreased salaries and other personnel expense which decreased $891 (13.49%) due primarily to reduced retirement and other benefit plan costs and reduced salaries due to costs deferred on loan originations. FDIC insurance decreased $215 (54.02%) and was due to a lower assessment rate and refunds received due to reclassification of certain corporate bonds for insurance assessment purposes. Occupancy expense decreased $74 (7.30%) and was primarily due to a $53 decrease in depreciation expense resulting from certain assets becoming fully depreciated.

Loan costs, excluding OREO, increased $250 (78.86%) due to an increase in estimated losses on mortgage loans sold to investors. Other real estate losses totaled $11 for the three month period as compared to a gain of $97 in the 2012 period.  The Company began to advertise at a higher level in 2013, causing marketing expense to increase. Other operating expense increased $122 (15.16%) due to an increase in debit card fraud losses.

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Nine Months Ended 2013 compared to Nine Months Ended 2012:

Noninterest expense decreased $1,890 (5.70%) during the nine month period as compared to the same period in 2012. The most significant decreases in expense for the three month period were decreased salaries and other personnel expense which decreased $1,293 (6.68%) due primarily to reduced retirement and other benefit plan costs and reduced salaries due to costs deferred on loan originations. FDIC insurance decreased $230 (19.54%) and was due to a lower assessment rate and refunds received due to reclassification of certain corporate bonds for insurance assessment purposes. Occupancy expense decreased $297 (9.55%) and was primarily due to a $227 decrease in depreciation expense resulting from certain assets becoming fully depreciated.

Other real estate losses decreased $624 to $628 for the nine month period as compared to $1,252 in the 2012 period.  Marketing expense increased $217 (9.55%) as the Company began to advertise at a higher level in 2013 focusing on lending opportunities in the local market. FDIC insurance decreased $230 (19.54%) and was due to a lower assessment rate and refunds received due to reclassification of certain corporate bonds for insurance assessment purposes. Other operating expense increased $122 (5.14%) due to an increase in debit card fraud losses.

Income Taxes

The Company recognized income tax expense of $1,789 and $5,334 for the three and nine months ended September 30, 2013 as compared to an income tax expense of $1,839 and $4,736 for the same periods in 2012.  The effective income tax rate for the three and nine months ended September 30, 2013 was 29.86% and 30.81% respectively.  The rates were affected in part by higher levels of tax-exempt  investment securities and the receipt of nontaxable proceeds from bank owned life insurance.

At September 30, 2013, the Company maintains net deferred tax assets of $18,798.  A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset.  In making this assessment, all sources of taxable income available to realize the deferred tax asset are considered including taxable income in prior carry-back years, future reversals of existing temporary differences, tax planning strategies and future taxable income exclusive of reversing temporary differences and carryforwards.  Based on management’s assessment, no valuation allowance was deemed necessary at September 30, 2013.

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Loans

The following table presents the composition of the Company’s loan portfolio as of September 30, 2013 and December 31, 2012.

Table 9 - Loan Portfolio Composition

	September 30, 2013					December 31, 2012
	Amount		%			Amount		%
	(Dollars in thousands)
Commercial financial and agricultural	$	185,030		20.87	%	$	174,553		20.03	%
Real estate
Commercial		350,443		39.52	%		343,663		39.44	%
Residential		171,690		19.36	%		168,039		19.28	%
Acquisition, development and construction		165,960		18.72	%		171,750		19.71	%
Total real estate		688,093		77.60	%		683,452		78.43	%
Consumer
Direct		12,869		1.44	%		12,785		1.47	%
Indirect		37		0.00	%		105		0.01	%
Revolving		581		0.07	%		502		0.05	%
Total consumer		13,487		1.51	%		13,392		1.53	%
Deferred loan origination costs (fees)		159		0.02	%		50		0.01	%
Total	$	886,769		100.00	%	$	871,447		100.00	%

At September 30, 2013, the loan portfolio is comprised of 77.60% real estate loans.  Commercial, financial and agricultural loans comprise 20.87%, and consumer loans comprise 1.51% of the portfolio.

Commercial real estate comprises 39.52% of the loan portfolio and consists of both non-owner occupied and owner occupied properties, where the operations of the commercial entity provide the necessary cash flow to service the debt.  For this portion of the real estate loan portfolio, repayment is generally not dependent upon the sale of the real estate held as collateral.  Acquisition, development and construction loans comprise 18.72% of the loan portfolio and the Company has recognized significant losses in this portfolio.  The Company carefully monitors the loans in this category since the repayment of these loans is generally dependent upon the sale of the real estate in the normal course of business and can be impacted by national and local economic conditions.  New construction and absorption of existing real estate inventory in the Company’s primary market area of the Augusta-Richmond County, GA-SC MSA have slowed and prices have declined but less than the national rate. The residential category, 19.36% of the portfolio, represents those loans that the Company chooses to maintain in its portfolio rather than selling into the secondary market for marketing and competitive reasons and commercial loans secured by residential real estate.

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The Company has no large loan concentrations to individual borrowers.  Unsecured loans at September 30, 2013 totaled $22,949.

Interest reserves are established for certain ADC (acquisition development and construction) loans based on the feasibility of the project, the timeframe for completion, the creditworthiness of the borrower and guarantors, and collateral.  An interest reserve allows the borrower’s interest cost to be capitalized and added to the loan balance.  As a matter of practice GB&T does not generally establish loan funded interest reserves on ADC loans; however, the Company’s loan portfolio includes three loans with interest reserves at September 30, 2013.  The following table details the loans and accompanying interest reserves as of September 30, 2013.

	September 30, 2013
			Reserves
	Balance		Original		Advanced		Remaining
	(Dollars in thousands)
Loan 1	$	4,968		330		70		260
Loan 2		-		250		-		250
Loan 3		2,145		82		5		77

These ADC loans have not been renewed or restructured and as of September 30, 2013, are not on nonaccrual.

Underwriting for ADC loans with interest reserves follows the same process as those loans without reserves.  In order for GB&T to establish a loan-funded interest reserve, the borrower must have the ability to repay without the use of a reserve and a history of developing and stabilizing similar properties.  All ADC loans, including those with interest reserves, are carefully monitored through periodic construction site inspections by bank employees or third party inspectors to ensure projects are moving along as planned.  Management assesses the appropriateness of the use of interest reserves during the entire term of the loan as well as the adequacy of the reserve.  Collateral inspections are completed before approval of advances.

Loan Review and Classification Process

The Company maintains a loan review and classification process which involves multiple officers of the Company and is designed to assess the general quality of credit underwriting and to promote early identification of potential problem loans. All loan officers are charged with the responsibility of risk rating all loans in their portfolios and updating the ratings, positively or negatively, on an ongoing basis as conditions warrant. Risk ratings are selected from an 8-point scale with ratings as follows: ratings 1- 4 Satisfactory (pass), rating 5 Watch (potential weakness), rating 6 Substandard (well-defined weakness), rating 7 Doubtful and rating 8 Loss.

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When a loan officer originates a new loan, he or she documents the credit file with an offering sheet summary, supplemental underwriting analyses, relevant financial information and if applicable, collateral evaluations. All of this information is used in the determination of the initial loan risk rating. Then, the Company’s Credit Administration department undertakes an independent credit review of that relationship in order to validate the lending officer’s rating. Lending relationships with total related exposure of $500 or greater are also placed into a tracking database and reviewed by Credit Administration personnel on an annual basis in conjunction with the receipt of updated borrower and guarantor financial information.  The individual loan reviews analyze such items as: loan type; nature, type and estimated value of collateral; borrower and/or guarantor estimated financial strength; most recently available financial information; related loans and total borrower exposure; and current/anticipated performance of the loan. The results of such reviews are presented to Executive Management.

Through the review of delinquency reports, updated financial statements or other relevant information in the normal course of business, the lending officer and/or Credit Administration review personnel may determine that a loan relationship has weakened to the point that a criticized (loan grade 5) or classified (loan grade 6 through 8) status is warranted. When a loan relationship with total related exposure of $200 or greater is adversely graded (5 or above), the lending officer is then charged with preparing a Classified/Watch report which outlines the background of the credit problem, current repayment status of the loans, current collateral evaluation and a workout plan of action. This plan may include goals to improve the credit rating, assisting the borrower in moving the loans to another institution and/or collateral liquidation. All such Classified/Watch reports are reviewed on a quarterly basis by members of Executive Management at a regularly scheduled meeting in which each lending officer presents the workout plans for their criticized credit relationships.

Depending upon the individual facts, circumstances and the result of the Classified/Watch review process, Executive Management may categorize the loan relationship as impaired. Once that determination has occurred, Executive Management in conjunction with Credit Administration personnel, will complete an evaluation of the collateral (for collateral-dependent loans) based upon appraisals on file adjusting for current market conditions and other local factors that may affect collateral value. This subjective evaluation may produce an initial specific allowance for placement in the Company’s Allowance for Loan Losses calculation. As soon as practical, updated appraisals on the collateral backing that impaired loan relationship are ordered. When the updated appraisals are received, Executive Management with assistance from Credit Administration department personnel reviews the appraisal, and updates the specific allowance analysis for each loan relationship accordingly. The Director’s Loan Committee reviews on a quarterly basis the Classified/Watch reports including changes in credit grades of 5 or higher as well as all impaired loans, the related allowances and other real estate owned.

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In general, once the specific allowance has been finalized, Executive Management will authorize a charge-off prior to the following calendar quarter-end in which that reserve calculation is finalized.

The review process also provides for the upgrade of loans that show improvement since the last review.

Nonperforming Assets

Non-performing assets include nonaccrual loans, loans past due 90 days or more, restructured loans and other real estate owned.  Table 10 shows the current and prior period amounts of non-performing assets.  Non-performing assets were $30,135 at September 30, 2013, compared to $34,602 at December 31, 2012 and $33,968 at September 30, 2012.  Significant changes from September 2012 to September 2013 included a $2,912 decrease in other real estate owned, a $6,972 decrease in nonaccrual commercial real estate loans, a decrease in nonaccrual commercial loans of $979 and a $2,043 increase in nonaccrual ADC loans.

There were no loans past due 90 days or more and still accruing at September 30, 2013, December 31, 2012 and September 30, 2012.

Troubled debt restructurings (TDRs) are troubled loans in which the original terms have been modified in favor of the borrower or either principal or interest has been forgiven due to deterioration in the borrower’s financial condition.  There were $9,521 in TDRs at September 30, 2013, of which $2,688 were on nonaccrual status.  TDRs totaled $2,711 at December 31, 2012, of which $1,796 were on nonaccrual status, and $2,055 at September 30, 2012, of which $1,129 were on nonaccrual status.

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Table 10 - Non-Performing Assets

	September 30, 2013			December 31, 2012			September 30, 2012
	(Dollars in thousands)
Nonaccrual loans:
Commercial financial and agricultural	$	737		$	2,358		$	1,716
Real Estate:
Commercial		5,418			11,736			12,390
Residential		4,877			6,291			5,794
Acquisition, development and construction		10,996			9,712			8,953
Consumer		119			100			122
Total Nonaccrual loans		22,147			30,197			28,975
Restructured loans (1)		6,833			915			926
Other real estate owned		1,155			3,490			4,067
Total Non-performing assets	$	30,135		$	34,602		$	33,968
Loans past due 90 days or more and still accruing interest	$	-		$	-		$	-
Non-performing assets to total assets		1.78	%		2.08	%		2.03	%
Non-performing assets to period end loans and OREO		3.39	%		3.95	%		3.96	%
Allowance for loan loss to period end nonaccrual loans		119.92	%		95.53	%		100.44	%

(1) Restructured loans on nonaccrual status at period end are included under nonaccrual loans in the table.

The ratio of non-performing assets to total loans and other real estate was 3.39% at September 30, 2013 compared to 3.95% at December 31, 2012 and 3.96% at September 30, 2012.  The ratio of allowance for loan losses to total nonaccrual loans was 119.92% at September 30, 2013 compared to 95.53% at December 31, 2012 and 100.44% at September 30, 2012.  The resolution of non-performing assets continues to be a priority of management.

Nonaccrual loans decreased $6,828 (23.57%) from September 30, 2012 due primarily to a decline in nonaccrual commercial, nonaccrual commercial real estate and nonaccrual residential real estate loans of $979, $6,972 and $917, respectively and offset in part by an increase of $2,043 in nonaccrual ADC loans.  The decrease in commercial real estate loans was due in part to an upgrade to accrual status on two hotel properties totaling approximately $5,658 that became categorized as a troubled debt restructure based on a repayment plan confirmed by bankruptcy court. Under the terms of the repayment plan, interest was capitalized to the loans in the amount of $380.  Other decreases were related to foreclosures, subsequent sales and write downs on several properties. The increase in nonaccrual ADC loans was due primarily to the addition of a $5,095 loan participation secured by retail centers offset in part by similar foreclosures, subsequent sales and write downs of other ADC loans. Although the exposure has declined, a significant portion of nonaccrual loans continues to be collateral-dependent ADC and commercial real estate loans.  The following table provides further information regarding the Company’s nonaccrual loans.

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Table 11 - Nonaccrual Loans

Nonaccrual

Appraisal

Appraised

Balance

Originated

Date

Trigger

Collateral

Allowance

Method

Date

Value

(Dollars in thousands)

ADC Loan - CSRA

2,375

03/29/11

03/11-11/11

financial condition

lots & land

-

collateral value

08/13

6,573

ADC Loan - Other

5,095

03/23/07

05/06/13

financial condition

retail centers

-

collateral value

9/11 - 10/11

5,599

Commercial Real Estate

3,405

08/29/08

11/18/11

bankruptcy

hotel

-

collateral value

12/12

4,275

ADC Loan - Other

949

12/30/08

09/23/13

financial condition

land

319

collateral value

11/08

1,540

ADC Loan - CSRA

1,776

12/28/11

12/28/12

financial condition

land

-

collateral value

03/13

2,573

$

13,600

Other, net

8,547

Nonaccrual loans at September 30, 2013

$

22,147

The following table presents a roll forward of other real estate owned for the nine month periods ended September 30, 2013 and 2012, respectively.

Table 12 - Other Real Estate Owned

	2013			2012
	(Dollars in thousands)
Beginning balance, January 1	$	3,490		$	6,209
Additions		820			7,365
Increase in valuation allowance		(548	)		(604	)
Sales		(2,527	)		(8,255	)
Loss on sale of OREO		(80	)		(648	)
Ending balance, September 30	$	1,155		$	4,067

The following table provides details of other real estate owned as of September 30, 2013, December 31, 2012 and September 30, 2012, respectively.

	September 30, 2013		December 31, 2012			September 30, 2012
	(Dollars in thousands)
Other Real Estate:
Real Estate
Commercial	$	257	$	2,838		$	3,059
Residential		290		180			112
Acquisition, development and construction		608		1,559			1,665
		1,155		4,577			4,836
Valuation allowance		-		(1,087	)		(769	)
	$	1,155	$	3,490		$	4,067

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The decrease in other real estate owned is due to the continuing process of resolving problem loans.  In the first nine months of 2013, additions to other real estate owned totaled $820 compared to $7,365 for the same period in 2012.  Proceeds from sales of other real estate totaled $2,527.  In addition, there was a $548 increase to the valuation allowance which was fully utilized through sales.

Allowance for Loan Losses

The allowance for loan losses represents an allocation for the estimated amount of probable incurred losses in the loan portfolio.  The adequacy of the allowance for loan losses is evaluated periodically based on a review of all significant loans, with particular emphasis on impaired, non-accruing, past due, and other loans that management believes require special attention.  The determination of the allowance for loan losses is considered a critical accounting estimate of the Company.  See “Critical Accounting Estimates.”

While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions.  In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses.  Such agencies may advise additions to the allowance based on their judgments about information available to them at the time of their examination.  Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result.

Additions to the allowance for loan losses are made periodically to maintain the allowance at an appropriate level based upon management’s analysis of risk in the loan portfolio.  Loans determined to be uncollectible are charged to the allowance for loan losses and subsequent recoveries are added to the allowance.  A provision for losses in the amount of $1,887 was charged to expense for the three months ended September 30, 2013 compared to $2,401 for the three months ended September 30, 2012 and $6,046 was charged to expense for the nine months ended September 30, 2013 compared to $6,567 for the nine months ended September 30, 2012.

At September 30, 2013 the ratio of allowance for loan losses to period end loans was 2.99% compared to 3.31% at December 31, 2012 and 3.41% at September 30, 2012. The lower overall level of allowance as a percentage of the portfolio is due in part to the decline in the average historical net loss rate (see Footnote 1 ALLL Methodology).  In addition the level was also affected by a decrease in substandard rated credits excluding impaired loans, which decreased $8,159 or 31.79%, and to a lesser degree a decrease in loans collectively evaluated for impairment which decreased $6,103 or 9.44%.

Net charge-offs totaled $8,335, of which $3,659 or 43.90% were related to acquisition development and construction loans, $3,268, or 39.21%, were related to commercial real estate loans, and $868 or 10.41% were related to residential mortgage real estate loans. The provisions for loan losses allocated to individual portfolio segments are affected by the calculation of average historical net loss rate factors and by the internal and external qualitative factors within each category.

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Management considers the current allowance for loan losses appropriate based upon its analysis of risk in the portfolio using the methods previously discussed. Management’s judgment is based upon a number of assumptions about events which are believed to be reasonable, but which may or may not prove correct.  While it is the Company’s policy to charge off in the current period the loans in which a loss is considered probable, there are additional risks of losses which cannot be quantified precisely or attributed to a particular loan or class of loans.  Because management evaluates such factors as changes in the nature and volume of the loan portfolio, historical loss rates, overall portfolio quality, review of specific problem loans, and current economic conditions and trends that may affect a borrower’s  ability to repay, management’s judgment as to the adequacy of the allowance is necessarily approximate and imprecise.  Thus, there can be no assurance that charge-offs in future periods will not exceed the allowance for loan losses or that additional increases in the allowance will not be required.

Liquidity and Capital Resources

The Company has maintained adequate liquidity to meet operating and loan funding requirements.  The loan to deposit ratio at September 30, 2013 was 61.51% compared to 61.31% at December 31, 2012 and 59.45% at September 30, 2012.  Deposits at September 30, 2013 and December 31, 2012 include $160,353 and $153,690 of brokered certificates of deposit, respectively.  GB&T has also utilized borrowings from the Federal Home Loan Bank.  GB&T maintains a line of credit with the Federal Home Loan Bank approximating 10% of its total assets.  Federal Home Loan Bank advances are collateralized by eligible first mortgage loans, commercial real estate loans and investment securities.  Federal Home Loan Bank advances totaled $74,000 at September 30, 2013.  GB&T maintains repurchase lines of credit with SunTrust Robinson Humphrey, Atlanta, Georgia, for advances up to $20,000, of which $0 was outstanding at September 30, 2013 and a $10,000 repurchase line of credit with Center State Bank, Orlando, Florida, of which $0 was outstanding at September 30, 2013.  GB&T has a federal funds purchased accommodation with SunTrust Bank, Atlanta, Georgia for advances up to $10,000, of which $0 was outstanding at September 30, 2013 and a federal funds purchased accommodation with Center State Bank, Orlando, Florida, for advances up to $10,000, of which $0 was outstanding at September 30, 2013.  The Company also maintains a borrowing facility at the Federal Reserve Bank, under the Borrower-In-Custody Program, of which $0 was outstanding at September 30, 2013.  Additionally, liquidity needs can be supplemented by the structuring of the maturities of investment securities and the pricing and maturities on loans and deposits offered to customers.  The Company also uses retail securities sold under repurchase agreements to fund operations.  Retail securities sold under repurchase agreements were $698 at September 30, 2013.

Stockholders’ equity to total assets was 7.80% at September 30, 2013 compared to 8.17% at December 31, 2012 and 7.93% at September 30, 2012.  The capital of the Company exceeded all required regulatory guidelines at September 30, 2013.  The Company’s Tier 1 risk-based, total risk-based and leverage capital ratios were 13.95%, 15.21%, and 9.36%, respectively, at September 30, 2013.

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The following table reflects the current regulatory capital levels in more detail, including comparisons to the regulatory minimums.

Table 13 - Regulatory Capital Requirements
Sept 30, 2013

	Actual					Required					Excess
	Amount		Percent			Amount		Percent			Amount		Percent
	(Dollars in thousands)
Southeastern Bank Financial Corporation
Risk-based capital:
Tier 1 capital	$	158,021		13.95	%		45,315		4.00	%		112,706		9.95	%
Total capital		172,335		15.21	%		90,630		8.00	%		81,705		7.21	%
Tier 1 leverage ratio		158,021		9.36	%		67,550		4.00	%		90,471		5.36	%
Georgia Bank & Trust Company
Risk-based capital:
Tier 1 capital	$	152,748		13.50	%		45,268		4.00	%		107,480		9.50	%
Total capital		167,047		14.76	%		90,535		8.00	%		76,512		6.76	%
Tier 1 leverage ratio		152,748		9.06	%		75,890		4.50	%		76,858		4.56	%

Georgia Bank & Trust Company is regulated by the Department of Banking and Finance of the State of Georgia (DBF).  The DBF requires that state banks in Georgia generally maintain a minimum ratio of Tier 1 capital to total assets of four and one-half percent (4.50%).

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank.  On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Federal Reserve.   The final rules implement the “Basel III” regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act.

The final rules include new risk-based capital and leverage ratios that will be phased in from 2015 to 2019.   The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Tier 2 risk-based capital requirements.   The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%.  The required minimum ratio of total capital to risk-weighted assets will remain 8.0%.   The new risk-based capital requirements (except for the capital conservation buffer) will become effective for the Company on January 1, 2015.  The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter.  Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers.

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The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital.  The final rules provide that depository holding companies with less than $15 billion in total assets as of December 31, 2009, such as the Company, may permanently include trust preferred securities and certain other non-qualifying instruments issued and included in Tier 1 or Tier 2 capital before May 19, 2010 in additional Tier 1 (subject to a maximum of 25% of Tier 1 capital) or Tier 2 capital until maturity or redemption

The final rules also set forth certain changes for the calculation of risk-weighted assets that the Company will be required to implement beginning January 1, 2015.  Management is currently evaluating the provisions of the final rules and their expected impact on the Company.  Based on the Company’s current capital composition and levels, management does not presently anticipate that the final rules present a material risk to the Company’s financial condition or results of operations.

Except as set forth above, management is not aware of any other events or uncertainties that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or operations.

Commitments and Contractual Obligations

The Company is party to lines of credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  Lines of credit are unfunded commitments to extend credit.  These instruments involve, in varying degrees, exposure to credit and interest rate risk in excess of the amounts recognized in the financial statements.  The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for unfunded commitments to extend credit and letters of credit is represented by the contractual amount of those instruments.  The Company evaluates acquisition, development and construction loans for the percentage completed before extending additional credit.  The Company follows the same credit policies in making commitments and contractual obligations as it does for on-balance sheet instruments.

Unfunded commitments to extend credit where contract amounts represent potential credit risk totaled $192,909 at September 30, 2013.  This includes standby letters of credit of $4,440 at September 30, 2013.  These commitments are primarily at variable interest rates.

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The Company’s commitments are funded through internal funding sources of scheduled repayments of loans and sales and maturities of investment securities available-for-sale or external funding sources through acceptance of deposits from customers or borrowings from other financial institutions.

The following table is a summary of the Company’s commitments to extend credit, commitments under contractual leases as well as the Company’s contractual obligations, consisting of deposits, FHLB advances, which are subject to early termination options, borrowed funds and benefit plans by contractual maturity date.

Table 14 - Commitments and Contractual Obligations

	Less than 1 Year		1 - 3 Years		3 - 5 Years		More than 5 Years
	(Dollars in thousands)
Lines of credit	$	188,469		-		-		-
Standby letters of credit		4,440		-		-		-
Lease agreements		216		364		77		-
Deposits		1,212,238		151,551		77,235		638
Securities sold under repurchase agreements		698		-		-		-
Salary continuation agreements		142		565		1,376		28,166
FHLB advances		10,000		-		45,000		19,000
Subordinated debentures		1,547		-		-		20,000
Total commitments and contractual obligations	$	1,417,750	$	152,480	$	123,688	$	67,804

Although management regularly monitors the balance of outstanding commitments to fund loans to ensure funding availability should the need arise, management believes that the risk of all customers fully drawing on all these lines of credit at the same time is remote.

Effects of Inflation and Changing Prices

Inflation generally increases the cost of funds and operating overhead, and to the extent loans and other assets bear variable rates, the yields on such assets.  Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature.  As a result, interest rates generally have a more significant impact on the performance of a financial institution than the effects of general levels of inflation.  Although interest rates do not necessarily move in the same direction and to the same extent as the prices of goods and services, increases in inflation generally have resulted in increased interest rates.  In addition, inflation can increase a financial institution’s 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 refinances tend to slow as interest rates increase, and can reduce the Company’s earnings from such activities and the income from the sale of residential mortgage loans in the secondary market.

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Item 3.  Quantitative and Qualitative Disclosures About Market Risk

As of September 30, 2013, there were no substantial changes in the interest rate sensitivity analysis or the sensitivity of market value of portfolio equity for various changes in interest rates calculated as of December 31, 2012.  A detailed discussion of market risk is provided in the Company’s 2012 Annual Report on Form 10-K.

Item 4.  Controls and Procedures

As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s President and Chief Executive Officer (principal executive officer) and its Group Vice President and Chief Financial Officer (principal 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 that evaluation, such officers concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) that is required to be included in the Company’s periodic filings with the Securities and Exchange Commission.  There have been no changes in the Company’s internal controls or, to the Company’s knowledge, in other factors during the quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

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Part II

OTHER INFORMATION

Item 1.	Legal Proceedings
	There are no material pending legal proceedings to which the Company or any of its subsidiaries is a party or of which any of their property is subject.
Item 1A.	Risk Factors
	In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012, which could materially affect its business, financial condition or future results. The risks described in the Annual Report on Form 10-K are not the only risks facing the Company.  Additional risks and uncertainties not currently known to management or that management currently deems to be immaterial also may materially adversely affect the Company’s business, financial condition and/or operating results.
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
	Issuer Purchases of Equity Securities
	On April 15, 2004, the Company announced the commencement of a stock repurchase program, pursuant to which it will, from time to time, repurchase up to 100,000 shares of its outstanding stock.  The program does not have a stated expiration date.  No stock repurchase programs were terminated during the third quarter of 2013 and there were no shares repurchased under the existing stock repurchase plan or otherwise during the third quarter.
Item 3.	Defaults Upon Senior Securities
	Not applicable
Item 4.	Mine Safety Disclosures
	Not applicable
Item 5.	Other Information
	None

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Item 6.	Exhibits
	31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2	Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1	Certification of Chief Executive Officer and Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	101	Interactive Data Files providing financial information from the Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 in XBRL (eXtensible Business Reporting Language).  Pursuant to Regulation 406T of Regulation S-T, these Interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, or Section 18 of the Securities Exchange Act of 1934, as amended, and are otherwise not subject to liability.

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SOUTHEASTERN BANK FINANCIAL CORPORATION

Form 10-Q Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		SOUTHEASTERN BANK FINANCIAL CORPORATION
Date:	October 25, 2013	By:	/s/ Darrell R. Rains
			Darrell R. Rains
			Group Vice President, Chief
			Financial Officer (Duly Authorized
			Officer of Registrant and Principal
			Financial Officer)

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