Tennessee Commerce Bancorp, Inc.
BUSINESS   1
RISK FACTORS   16
UNRESOLVED   STAFF COMMENTS   20
PROPERTIES   21
LEGAL   PROCEEDINGS   21
SUBMISSION   OF MATTERS TO A VOTE OF SECURITY HOLDERS   21           PART II
MARKET FOR   REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES   OF EQUITY SECURITIES   21
SELECTED   FINANCIAL DATA   24
MANAGEMENT’S   DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION      Forward-Looking Statements   Management’s discussion of the Corporation and management’s analysis of the Corporation’s operations and prospects, and other matters, may include forward-looking statements within the meaning of the provisions of various federal and state securities laws.  Although the Corporation believes that the assumptions underlying such forward-looking statements contained in this Report are reasonable, any of the assumptions could be inaccurate and, accordingly, there can be no assurance that the forward-looking statements included herein will prove to be accurate. The use of such words as expect, anticipate, forecast, and comparable terms should be understood by the reader to indicate that the statement is “forward-looking” and thus subject to change in a manner that can be unpredictable.  Factors that could cause actual results to differ from the results anticipated, but not guaranteed, in this Report, include (without limitation) economic and social conditions, competition for loans, mortgages, and other financial services and products, changes in interest rates, unforeseen changes in liquidity, results of operations, and financial conditions affecting the Corporation’s customers, as well as other risks that cannot be accurately quantified or completely identified.  Many factors affecting the Corporation’s financial condition and profitability, including changes in economic conditions, the volatility of interest rates, political events and competition from other providers of financial services simply cannot be predicted and because these factors are unpredictable and beyond the Corporation’s control, earnings may fluctuate from period to period.  The purpose of this type of information is to provide readers with information relevant to understanding and assessing the financial condition and results of operations of the Corporation, and not to predict the future or to guarantee results.  The Corporation is unable to predict the types of circumstances, conditions, and factors that can cause anticipated results to change.  The Corporation undertakes no obligation to publish revised forward-looking statements to reflect the occurrence of changes or unanticipated events, circumstances, or results.   Overview   (dollars in thousands except share data in the remainder of this Item 7)   The results of operations for the year 2005 compared to 2004 reflected an 84.09% increase in net income and a 64.15% increase in earnings per share, assuming dilution.  The increase in earnings resulted primarily from a 52.77% increase in net interest income due to higher average loan balances.  The net interest margin for 2005 was 4.44%. The increased revenue was partially offset by increases in non-interest expense and the provision for loan losses.  The year 2005 reflected a continuation of the Bank’s trend of rapid asset growth.  The asset growth is a result of the strength of the Middle Tennessee economy and the success of the Corporation’s Business Bank operating strategy.   The Corporation’s growth in assets is a result of growth in the market area and effective marketing. The improvement in results including net income and earnings per share is a result of the business focus of the Bank. From 2000 to 2005, the Bank’s market area experienced explosive growth. In Williamson County, demographic information shows a 16.61% growth in the number of households from 2000 to 2005.  Estimates are that by 2010 the number of households will have grown by another 13.74%. Although estimates of growth are not guaranteed and actual growth may be affected by factors beyond the Corporation’s control, Management believes that the projected growth of our market area will positively impact the Bank’s future growth.   The Bank has also grown by marketing to business owners that have been left without a long standing banking relationship. The Middle Tennessee area has experienced several bank mergers or acquisitions in the last ten years resulting in many long standing relationships being terminated. These acquisitions also resulted in loan funding decisions being made out of state creating confusion for local lending personnel and uncertainty for local businesses. The Bank has taken advantage of this confusion by offering loans at a fair rate and funded locally in a timely manner. Management believes the competitive advantage created by this environment will continue to positively impact results from operations.   26        The Business Bank operating strategy has enabled management to focus on managing results. Rather than focusing on building a multi-branch infrastructure including hiring and construction of buildings, management focuses on managing net interest margin aggressively and controlling non-interest expense. This has resulted in a 24.02% increase in the net interest margin from 2001 to 2005. Non-interest expense is controlled by efficiently staffing the Bank’s operations. In 2005, that resulted in $9.8 million in assets per employee at year end. Management believes that the Business Bank operating strategy will continue to be an effective model in the future.   Changes in Results of Operations   (dollars in thousands except share data)   Net Income - - Net income for 2005 was $3,067, an increase of $1,401 or 84.09%, compared to the $1,666 earned in 2004. The increase is attributable to a 52.77% increase in net interest income from $8,920 in 2004 to $13,627 in 2005. The increase of $4,707 in net interest income was the result of higher average loan balances. Non-interest income increased by $511 from $800 to $1,311, or 63.88%, primarily due to gains on loan sales. These positive effects were partially offset by a 52.89% increase in the provision for loan losses, from $2,420 in 2004 to $3,700 in 2005 and an increase of $1,694 in non-interest expense, up 37.21% to $6,246 in 2005 compared to $4,552 in 2004. The increase in the provision for loan losses was the result of funding the loan loss reserve to match the growth in the loan portfolio and loan charge-offs. The increase in non-interest expense was due to the increase in personnel and general operating expenses due to the Corporation’s growth.   Net income for 2004 was $1,666 an increase of $767 or 85.32%, compared to the $899 earned in 2003.  The increase is attributable to a 70.59% increase in net interest income from $5,229 in 2003 to $8,920 in 2004.  The increase of $3,691 in net interest income was the result of higher average loan balances.  Non-interest income increased by $368 from $432 to $800, or 85.19%, primarily due to gains on loan sales.  These positive effects were partially offset by a 117.04% increase in the provision for loan losses, from $1,115 in 2003 to $2,420 in 2004 and an increase of $1,093 in non-interest expense, up 31.60% to $4,552 in 2004 compared to $3,459 in 2003.  The increase in the provision for loan losses was the result of funding the loan loss reserve to match the growth in the loan portfolio and loan charge-offs.  The increase in non-interest expense was due to the increase in personnel and general operating expenses due to the Corporation’s growth.   Net Interest Income - The primary source of earnings for the Bank is net interest income which is the difference between the interest earned on interest earning assets and the interest paid on interest bearing liabilities.  The major factors which affect net interest income are changes in volumes, the yield on earning assets, and the cost of interest bearing liabilities.  Management’s ability to respond to changes in interest rates by effective asset-liability management techniques is critical to maintaining the stability of the net interest margin and the momentum of the Bank’s primary source of earnings.   In mid-2004, the Federal Reserve Open Market Committee (FOMC) began a series of increases in short-term interest rates.  By year-end 2005, the FOMC had increased rates by 300 basis points. In anticipation of continued rising interest rates, management has placed the Bank in a moderately asset sensitive position.  This means that more assets are scheduled to reprice within the next year than liabilities, thereby taking advantage of the anticipated rise in interest rates. During 2005, $10,726 of the net loan growth occurred in floating rate construction loans and approximately 25% of the $94,100 increase in commercial loans were floating rate transactions. Management expects to continue its practice of competing for loans based on providing superior service rather than the lowest price.   Net interest income for 2005 was $13,627 compared to $8,920, a gain of $4,707 or 52.77%. The increase in net interest income was largely attributable to strong loan growth. Net loans increased from $213,326 at December 31, 2004 to $344,187 at December 31, 2005—an increase of $130,861, or 61.34%. Net interest income was favorably impacted by the increase in the Bank’s indirect funding program for small transactions. These loans, which are purchased at a minimum rate of 8%, increased from $50.3 million at year-end 2004 to $87.0 million at the end of 2005. The loan growth was matched by an increase in deposits from $221,394 at December 31, 2004 to $367,705 in 2005—an increase of $146,311 or 66.09%.   27        Net interest income for 2004 was $8,920 compared to $5,229 in 2003, a gain of $3,691 or 70.59%.  The increase in net interest income was largely attributable to strong loan growth.  Net loans increased from $133,187 at December 31, 2003 to $213,326 at December 31, 2004 — an increase of $80,139, or 60.17%. Net interest income was favorably impacted by the expansion of the Bank indirect funding program for small transactions. These loans, which are purchased at a minimum rate of 8%, increased from $27.4 million at year-end 2003 to $50.3 million at the end of 2004.  This high yielding portfolio is a key component in the stability and strength of net interest income.  The loan growth was matched by an increase in deposits from $142,293 at December 31, 2003 to $221,394 in 2004 — an increase of $79,101 or 55.59%.   Investments - - The Bank views the investment portfolio as a source of income and liquidity. Management’s investment strategy is to accept a lower immediate yield in the investment portfolio by targeting shorter term investments.   The Investment Policy requires a minimum portfolio level equal to 7.00% of total assets and a maximum portfolio level of 20.00% of total assets.  Management has maintained the portfolio at the lower end of the policy guidelines with the portfolio at 7.91%, 7.60% and 8.32% of total assets at end of year in 2005, 2004 and 2003 respectively.   The investment portfolio at December 31, 2005 was $31,992 compared to $18,690 at year end 2004. The interest earned on investments rose from $616 in 2004 to $967 in 2005. That was a result of higher average portfolio balances as well as increased yields. The average yield on the investment portfolio investments rose from 3.79% in 2004 to 4.19% in 2005 or 40 basis points.   The investment portfolio at December 31, 2004 was $18,690 compared to $12,898 at year-end 2003.    The average yield on the investment portfolio was 3.79% in 2004 compared to 3.58% in 2003.   Net Interest Margin Analysis -  The net interest margin is impacted by the average volumes of interest sensitive assets and interest sensitive liabilities and by the difference between the yield on interest sensitive assets and the cost of interest sensitive liabilities (spread).  Loan fees collected at origination represent an additional adjustment to the yield on loans. The Bank’s spread can be affected by economic conditions, the competitive environment, loan demand, and deposit flows.  The net yield on earning assets is an indicator of the effectiveness of a bank’s ability to manage the net interest margin by managing the overall yield on assets and the cost of funding those assets.   The two factors that make up the spread are the interest rates received on loans and the interest rates paid on deposits. The Bank has been disciplined in raising interest rates on deposits only as the market demanded and thereby managing the cost of funds. Also, the Bank has not competed for new loans on interest rate alone but has relied on effective marketing to business customers. Business customers are not influenced by interest rates alone but are influenced by other factors such as timely funding. By working to positively impact both factors that make up the spread, the Bank has been able to improve its net interest margin by 0.86% from the end of 2001 to the end of 2005. That is an improvement of 24.02% over a four-year period. While the Bank continues to strive to improve its net interest margin, it is not reasonable to assume that the spread will continue to improve at the same rate.   The net interest margin declined from 4.56% in 2004 to 4.44% in 2005 due to the cost of funds rising faster than the yield on earning assets during the year. Interest income increased by $10,448, or 79.24%, from $13,185 in 2004 to $23,633 in 2005. The increase was primarily due to increased volume. Average earning assets increased from $195,449 in 2004 to $ 306,765 in 2005, an increase of $111,316 or 56.95%. The increase in earning assets was due to loan growth. Average loans increased $103,522 or 59.39%. The average yield on earning assets increased from 6.74% in 2004 to 7.70% in 2005 or 96 basis points. The increase in the Bank’s indirect funded small loan portfolio favorably impacted the average yield on earning assets. The average yield on this type of loan in 2005 was 9.10%. These loans increased 73.02% from $50.3 million at year-end 2004 to $87.1 million at the end of 2005.   Interest expense increased from $4,265 in 2004 to $10,006 in 2005. The $5,741, or 134.60%, increase in expense was due to increases in the volume of deposits as well as an increase in the cost of funds. Average deposits increased from $167,647 in 2004 to $273,040 in 2005, an increase of $105,393 or 62.86%. The cost of funds increased from 2.54% in 2004 to 3.66% in 2005 or 112 basis points.   28        The net interest margin improved from 4.22% in 2003 to 4.56% in 2004 due to an improved yield on earning assets and a lower cost of funding.  Interest income increased by $4,980, or 60.69%, from $8,205 in 2003 to $13,185 in 2004.  The increase was primarily due to increased volume.  Average earning assets increased from $123,888 in 2003 to $195,449 in 2004, an increase of $71,561 or 57.76%.  The increase in earning assets was due to loan growth. Average loans increased $68,463 or 64.68%.  The average yield on earning assets increased from 6.62% in 2003 to 6.74% in 2004 or 12 basis points. The net interest margin was favorably impacted by the expansion of the Bank’s indirect funded small loan portfolio.  These loans increased from $27.4 million at year-end 2003 to $50.3 million at the end of 2004.  This high yielding portfolio is a key component in the strength of the net interest margin. During 2004, a period of historically low interest rates, the market for quality loans was highly competitive.  Management emphasized pricing discipline throughout the year to ensure that growth was not achieved by competing on reduced pricing. The Bank will continue to focus its marketing efforts on customers who are more sensitive to service than price.   Interest expense increased from $4,265 in 2004 to $10,006 in 2005.  The $5,741, or 134.61%, increase in expense was due to increases in the volume of deposits as well as interest rates. Average interest bearing deposits increased from $167,647 in 2004 to $273,040 in 2005, an increase of $105,393 or 62.87%. Additionally, the cost of funds increased from 2.54% in 2004 to 3.66% in 2005.   Interest expense increased from $2,976 in 2003 to $4,265 in 2004.  The $1,289, or 43.31%, increase in expense was due to increases in the volume of deposits.   Average interest bearing deposits increased from $108,140 in 2003 to $167,647 in 2004, an increase of $59,507 or 55.02%.  Despite the fact that rates started increasing in the last half of 2004, management was aggressive in lowering interest rates on savings accounts and other products during the year.  As a result, the cost of funds was reduced from 2.75% in 2003 to 2.54% in 2004, a decline of 21 basis points. The local deposit market is highly competitive and rates tend to lead national averages.  The Bank partially offsets the higher cost of local deposits by acquisition of wholesale funding in the national market.   Provision for Loan Losses - Management assesses the adequacy of the allowance for loan losses with a combination of qualitative and quantitative factors.  At inception, each loan is assigned a risk rating that ranges from “RR1 to RR4”.  An RR1 assignment indicates a “Superior” credit, RR2 represents an “Excellent” credit, RR3 represents an “Above-Average” loan, and RR4 designates an “Average” credit.  The assignment of a risk rating is based on an evaluation of the credit risk in the transaction.  The evaluation includes consideration of the borrower’s financial capacity, collateral, cash flows, liquidity, and alternative sources of repayment.  If a loan deteriorates and the level of risk increases, management downgrades the loan to RR5-”Watch”, RR6-”Criticized”, or RR7-”Substandard”, depending on the circumstances.  A review by an independent accounting firm of the assigned risk ratings is an integral part of the Bank’s external Loan Review program.   Management reviews the loan portfolio regularly to determine if loans should be placed on non-accrual for revenue recognition. If a loan is placed on non-accrual, all interest earned since the last current payment is immediately reversed.  Loans may remain on non-accrual status until the underlying collateral is repossessed and valued or until the amount of loss in the credit can be reasonably determined.  Once collateral is repossessed and appraised, the collateral is recorded as a repossession at the lower fair value or the investment in the related loan.  Any difference between the estimated fair value of the collateral and the loan balance is charged off.  Variances in fair value estimates are recorded as a gain or loss on sale when the collateral is sold.   Non-accrual loans totaled $2,928, $2,161 and $1,136 at year-end 2005, 2004 and 2003.  These amounts represented 0.85%, 1.01% and 0.85% of net loans at the end of each year.   Management uses the weighted average risk rating to monitor the overall credit quality and trends in the loan portfolio. At December 31, 2005, the weighted average risk rating of the $344,187 net loan portfolio was 3.62. At December 31, 2004, the weighted average risk rating of the $213,326 net loan portfolio was 3.63.  The Board of Directors reviews the weighted average risk rating of loans booked during the previous month.  In addition, the Board reviews all credits classified RR5 or higher monthly.  Management closely monitors other key loan quality indicators including delinquencies, changes in the portfolio mix and general economic conditions.  These actions provide a degree of objectivity in assessing the risk in the portfolio and establishing an adequate loan loss reserve.  To the extent that actual and anticipated losses differ, adjustments are made to the loan loss provision or to the level of the allowance for loan losses. At December 31, 2005, the loan loss reserve of $4,399 was 1.26% of gross loans of $348,586.   29        The provision for loan losses in 2005 was $3,700, an increase of $1,280, or 52.89%, above the provision of $2,420 expensed in 2004. $1,558 of the provision, or 42.11%, was attributable to loan growth recorded during 2005. The remainder of the loan loss provision in 2005 funded net charge offs of $2,142.   The provision for loan losses in 2004 was $2,420, an increase of $1,305, or 117.04%, above the provision expensed in 2003.  $841 of the provision, or 34.75%, was attributable to maintaining a general reserve for the loan growth recorded during 2004.  The remainder of the loan loss provision in 2004 funded net charge offs of $1,579 of which $819 was attributable to a single loan. On the collateral for this loan, the Bank’s recovery was minimal and far below the cost and the appraised value of the equipment.   The Bank targets small and medium sized businesses as loan customers. Because of their size, these borrowers may be less able to withstand competitive or economic pressures than larger borrowers in periods of economic weakness. If loan losses occur to a level where the loan loss reserve is not sufficient to cover actual loan losses, the Bank’s earnings will decrease. The Bank uses an independent accounting firm to review our loans quarterly for quality in addition to the reviews that may be conducted by bank regulatory agencies as part of their usual examination process.   The following table presents information regarding non-accrual, past due and restructured loans at December 31, 2005, 2004, 2003, 2002 and 2001:              December 31,                 2005       2004       2003       2002       2001                 ($ in thousands)         Non-accrual loans                                                 Number       46       17       12       10       5         Amount       $   2,928       $   2,161       $   1,136       $   1,104       $   990                                                           Accruing loans which are contractually past   due 90 days or more as to principal and interest payments:                                                 Number       9       4       6       —       —         Amount       $   352       $   111       $   308       $   —       $   —                                                           Loans defined as “troubled debt   restructurings”                                                 Number       3       2       1       —       —         Amount       $   1,144       $   1,544       $   1,101       $   —       $   —                                                           Gross interest income lost on the above   loans       $   133       $   82       $   193       $   158       $   78                                                           Interest income included in net income on   the above loans       $   31       $   48       $   29       $   24       $   87          As of December 31, 2005, there are no loans classified for regulatory purposes as doubtful or substandard that have not been disclosed in the above table, which (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.   30        The Bank had no tax-exempt loans during the period ended December 31, 2005.  The Bank had no loans outstanding to foreign borrowers at December 31, 2005.   An analysis of the Bank’s loss experience is furnished in the following table for December 31, 2005, 2004, 2003, 2002 and 2001, and the periods then ended (dollars in thousands):               December 31,         ($ in thousands)       2005       2004       2003       2002       2001                                                           Allowance for loan losses at beginning of   period       $   2,841       $   2,000       $   1,103       $   919       $   736         Charge-offs:                                                 Real estate:                                                 Construction       —       —       —       —       —         1 to 4 family residential       —       101       —       —       —         Other       —       131       —       —       —         Commercial, financial and agricultural       2,379       1,366       235       105       641         Consumer       32       57       48       31       —         Other       —       —       —       —       —         Total Charge-offs       2,411       1,655       283       136       641                                                           Recoveries:                                                 Real estate:                                                 Construction       —       —       —       —       —         1 to 4 family residential       1       —       —       —       —         Other       —       3       —       —       —         Commercial, financial and agricultural       245       68       64       3       9         Consumer       23       5       1       —       —         Other       —       —       —       —       —         Total Recoveries       269       76       65       3       9                                                           Net Charge-offs       2,142       1,579       218       133       632                                                           Provision for loan losses charged to   expense       3,700       2,420       1,115       317       815                                                           Allowance for loan losses at end of period       $   4,399       $   2,841       $   2,000       $   1,103       $   919                     December 31,                 2005       2004       2003       2002       2001                                                           Net charge-offs as a percentage of average   total loans outstanding during the year       0.76   %   0.89   %   0.20   %   0.23   %   1.56   %                                                       Ending allowance for loan losses as a   percentage of total loans outstanding at end of year       1.26   %   1.31   %   1.48   %   1.43   %   2.04   %      The allowance for loan losses is established by charges to operations based on management’s evaluation of the loan portfolio, past due loan experience, collateral values, current economic conditions and other factors considered necessary to maintain the allowance at an adequate level. Management feels that the allowance is adequate at December 31, 2005.   31        At December 31, 2005, 2004, 2003, 2002 and 2001, the allowance was allocated as follows (dollars in thousands):              2005       2004       2003       2002       2001         ($ in thousands)       Amount       Percentage   of loans in   each   category to   total loans       Amount       Percentage   of loans in   each   category to   total loans       Amount       Percentage   of loans in   each   category to   total loans       Amount       Percentage   of loans in   each   category to   total loans       Amount       Percentage   of loans in   each   category to   total loans         Real estate:                                                                                         Construction       $   383       10.98   %   $   175       10.55   %   $   71       7.68   %   $   83       8.59   %   $   52       9.21   %     1 to 4 family   residential       225       5.27   %   75       7.38   %   57       10.00   %   167       17.28   %   121       21.54   %     Other       504       14.45   %   265       15.59   %   331       14.85   %   131       13.59   %   108       19.32   %     Commercial,   financial and agricultural       3,197       67.11   %   2,272       64.68   %   1,510       65.03   %   697       58.00   %   619       46.63   %     Consumer       45       .90   %   54       1.80   %   31       2.44   %   25       2.54   %   19       3.30   %     Other       45       1.29   %   —       0.00   %   —       0.00   %   —       0.00   %   —       0.00   %                                                                                               Total       $   4,399       100.00   %   $   2,841       100.00   %   $   2,000       100.00   %   $   1,103       100.00   %   $   919       100.00   %                                    Non-interest Income - Non-interest income is income that is not related to interest-earning assets.  In a typical retail bank, non-interest income consists primarily of service charges and fees on deposit accounts and mortgage origination fees.  Due to the business focus of the Bank and the lack of a large retail customer base, revenues from these traditional sources will remain modest.   The Bank earned $105 in mortgage origination fees in 2005 compared to $130 earned in 2004, a decline of $25 or 19.23%. The decline in mortgage loan demand and mortgage origination income is attributed to the continued rising interest rates in 2005. Management believes that rates will continue to rise for part of 2006 and that the mortgage unit will provide a value-added service with modest revenue results.   The Bank earned $1,106 in 2005 on a series of loan sale transactions compared to $504 in 2004. The Bank is located in a vibrant market area and can generate quality assets at a faster rate than it can adequately fund them. In addition to lending in the local marketplace, the Bank provides collateral-based loans to business borrowers in other states through two types of indirect funding programs. During 2004, management identified a network of community banks eager to purchase quality assets, and four loan sale transactions were completed that year.  Management has installed appropriate systems and processes to sell assets to other banks located in slower growing markets and believes that loan sales will be a recurring source of revenue.   In 2004, the Bank earned $504 on a series of loan sale transactions, the first year of this activity.  The Bank earned $130 in mortgage origination fees in 2004 compared to $148 earned in 2003, a decline of $18 or 12.16%.  The decline in mortgage origination income is attributed to rising interest rates starting in mid-2004 and the slowing of refinancing activity.  Income earned in the form of service charges on deposits totaled $24, a gain of $7, or 41.18% above the $17 earned in 2003.  Gain on sales of securities declined by $99 or 75.00% from $132 in 2003 to $33 in 2004.  This decline was due to the rise in interest rates in 2004 and the subsequent lack of opportunities to recognize market gains in the investment portfolio.   Non-interest Expense - Non-interest expense includes salaries and benefits expense, occupancy costs, and other operating expenses including data processing, professional fees, supplies, postage, telephone, and other items.  Management views the control of operating expense as a critical element in the success of the Business Bank strategy.  The Bank operates more efficiently than peer banks because it conducts business from a single location and does not provide banking services for many retail customers with high transaction volume.   Management targets $7.5 million in assets per full time employee as a measure of staffing efficiency. Management believes that the growth of the Bank will offer additional opportunities to leverage personnel resources.  The Bank does expect to hire employees in 2006 so salaries and benefits expense will increase, but the target for Average Assets per Employee will remain at $7.5 million per employee.   32        Non-interest expense for 2005 was $6,246, an increase of $1,694 or 37.21%, over the $4,552 expensed in 2004. Approximately 65% of the increase was due to the addition of new employees during the year. The Bank ended 2005 with 41 full time employees. Assets per employee was $9.8 million at year-end 2005 compared to $7.7 million at year-end 2004.   Non-interest expense for 2004 was $4,552, an increase of $1,093 or 31.60%, over the $3,459 expensed in 2003.  Approximately half of the increase was due to the addition of five new employees during the year.  The Bank ended 2004 with 32 full time employees.  Assets per employee was $7.7 million at year-end 2004 and $5.8 million at year-end 2003.   Income Taxes - The Corporation’s effective tax rate in 2005 was 38.56% compared to 39.37% in 2004 and 17.30% in 2003.  The change in the applicable tax rate reflects the Corporation’s progression from initial operating losses to current profits.  Management anticipates that tax rates in future years will approximate the rates paid in 2005.   Changes in Financial Condition   (dollars in thousands except share data)   Assets - - Total assets at December 31, 2005, were $404,040, an increase of $158,123 or 64.29%, over total assets of $245,917 at December 31, 2004. Average assets for 2005 were $315,974, an increase of $114,835, or 57.09% over average assets in 2004. Loan growth was the primary reason for the increase. Year-end 2005 net loans were $344,187, up $130,861, or 61.34% over the year-end 2004 total net loans of $213,326.   Total assets at December 31, 2004, were $245,917, an increase of $89,842 or 57.56%, over total assets of $156,075 at December 31, 2003.  Average assets for 2004 were $201,139, an increase of $73,072, or 57.05% over average assets in 2003.  Loan growth was the primary reason for the increase.  Year-end 2004 net loans were $213,326, up $80,139, or 60.17% over the year-end 2003 total net loans of $133,187.   The Bank’s Business Bank model of operation results in a higher level of earning assets than peer banks.  Earning assets are defined as assets which earn interest income.  Earning assets include short-term investments, the investment portfolio, and net loans.  The Bank maintains a higher level of earning assets because fewer assets are allocated to facilities, cash, and due-from bank accounts used for transaction processing. Earning assets at December 31, 2005, were $388,714, or 96.20% of total assets of $404,040. Earning assets at December 31, 2004, were $238,598, or 97.02% of total assets of $245,917.  Management targets an earning asset to total asset ratio of 97% or higher. This ratio is expected to generally continue at these levels although this may be affected by economic factors beyond the Bank’s control.   Liabilities - - The Bank relies on increasing its deposit base to fund loan and other asset growth.  The Williamson County marketplace is highly competitive with 20 financial institutions and 72 banking facilities (as of June 30, 2005). The Bank competes for local deposits by offering attractive products with premium rates.  The Bank expects to have a higher average cost of funds for local deposits than competitor banks due to its single location and lack of a branch network.  Management’s strategy is to offset the higher cost of funding with a lower level of operating expense and firm pricing discipline for loan products.  The Bank has promoted electronic banking services by providing them without charge and by offering in-bank customer training.   The Bank also obtains funding in the wholesale deposit market which is accessed by means of an electronic bulletin board.  This electronic market links banks and sellers of deposits to deposit purchasers such as credit unions, school districts, labor unions, and other organizations with excess liquidity.  Deposits may be raised in ninety-nine thousand dollar ($99,000) or one hundred thousand dollar ($100,000) increments in maturities from two weeks to five years.  Management believes the utilization of the electronic bulletin board is highly efficient and the average rate has been generally less than rates paid in the local market. Participants in the electronic market pay a modest annual licensing fee and there are no transaction charges.  Management has established policies and procedures to govern the acquisition of funding through the wholesale market.  Wholesale deposits are categorized as “Purchased Time Deposits” on the detail of deposits shown in this Item 7. Management may also, from time to time, engage the services of a deposit broker to raise a block of funding at a specified maturity date.   33        Total average deposits in 2005 were $284,977, an increase of $103,417, or 56.96% over the total average deposits of $181,560 in 2004. Average non-interest bearing deposits increased by $4,471, or 31.28%, from $14,292 in 2004 to $18,763 in 2005. Average savings deposits decreased by $11,721 from $34,506 in 2004 to $22,785 in 2005. Average purchased deposits increased by $47,811, or 48.53%, from $98,515 in 2004 to $146,326 in 2005. The average rate paid on purchased deposits in 2005 was 3.55% compared to 2.68% in 2004. Purchased time deposit funding represented 51.34% of total funding in 2005 compared to 54.26% in 2004.   Total average deposits in 2004 were $181,560, an increase of $65,282, or 56.14% over the total average deposits of $116,278 in 2003.  Average non-interest bearing deposits increased by $5,916, or 70.63%, from $8,376 in 2003 to $14,292 in 2004.  Average savings deposits grew by $7,508 from $26,998 in 2003 to $34,506 in 2004.  Average purchased deposits increased by $41,393, or 72.46%, from $57,122 in 2003 to $98,515 in 2004.  The average rate paid on purchased time deposits in 2004 was 2.68% compared to 2.90% in 2003.  Purchased time deposit funding represented 54.26% of total funding in 2004 compared to 49.13% in 2003.   Off-balance sheet arrangements - The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet.  The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in those particular financial instruments.   The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments.  The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.   Financial instruments whose contract amounts represent credit risk:              2005       2004       2003         ($ in thousands)       Fixed   Rate       Variable   Rate       Fixed   Rate       Variable   Rate       Fixed   Rate       Variable   Rate                                                                   Commitments   to extend credit       $   2,404       $   38,859       $   4,014       $   29,638       $   2,605       $   15,529         Standby   letters of credit       —       5,686       —       2,139       —       1,558                                Commitments to make loans are generally made for periods of one year or less.  The fixed rate loan commitments have interest rates ranging from 5.75% to 10.00% and maturities ranging from 6 months to 5 years.   Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee.  Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  The Bank evaluates each customer’s creditworthiness on a case–by-case basis.  The amount of collateral obtained if deemed necessary by the Bank upon extension of credit is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.   Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party.  Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions.  All letters of credit are due within one year or less of the original commitment date.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.   34        The Bank primarily serves customers located in Middle Tennessee.  As such, the Bank’s loans, commitments and letters of credit have been granted to customers in that area.   Contractual Obligations — At December 31, 2005, the Bank had certain contractual obligations as shown below.               Payments due by Period                 Total       LessThan   1 Year       1-3   Years       3-5   Years       More than   5 Years                 (dollars in thousands)         Contractual Obligations (1)                                                 Deposits without a stated maturity       $   113,361       $   113,361       $   —       $   —       $   —         Certificates of deposit       255,350       151,948       59,377       44,025       —         Subordinated long term debt       8,248       —       —       —       8,248         Capital lease obligations       —       —       —       —       —         Operating lease obligations       1,326       247       526       553       —         Purchase obligations       —       —       —       —       —         Other long term liabilities       —       —       —       —       —         Total       $   378,285       $   265,556       $   59,903       $   44,578       $   8,248           (1)    excludes interest   35        Financial Tables   The following financial information regarding the Corporation and the Bank should be read in conjunction with the Corporation’s financial statements included in Item 8 of this Report.   Average Balance Sheets, Net Interest Income and Changes in Interest Income and Interest Expense   The following tables show the average monthly balances of each principal category of assets, liabilities and stockholders’ equity of the Bank, and an analysis of net interest revenue, and the change in interest income and interest expense segregated into amount attributable to changes in volume and changes in rates.  The table is presented on taxable equivalent basis, if applicable.              12 months Ended December 31, 2005         (dollars in thousands)       Average   Balance       Interest       Average   Rate         ASSETS                                                                   Interest earning assets                                 Securities                                 Taxable (1)       $   23,034       $   980       4.19   %     Tax-exempt       —       —       —         Total securities       23,034       980       4.19   %                                       Loans (2) (3)       277,821       22,488       8.09   %     Federal funds sold       5,910       165       2.79   %     Total interest earning assets       306,765       23,633       7.70   %                                       Non-interest earning assets                                 Cash and due from banks       4,097                         Net fixed assets and equipment       731                         Accrued interest and other assets       4,381                                                           Total assets       $   315,974                                      36           LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                   Interest bearing liabilities                                 Deposits (other than demand)       $   266,214       9,568       3.59   %     Federal funds purchased       589       22       3.74   %     Subordinated debt       6,237       416       6.68   %     Total interest bearing liabilities       273,040       10,006       3.66   %                                       Non-interest bearing liabilities                                 Non-interest bearing demand deposits       16,489                         Other liabilities       1,481                         Shareholders’ equity       24,964                                                           Total liabilities and shareholders’ equity       $   315,974                             Net Interest Spread       4.03   %                       Net Interest Margin       4.44   %       (1)   Unrealized loss of $357 is excluded from yield calculation. (2)   Non-accrual loans are included in average loan balances and loan fees of $1,438 are included in interest income. (3)   Loans are presented net of allowance for loan loss              12 months Ended December 31, 2004                 Average       Average                 (dollars in thousands)       Balance       Interest       Rate         ASSETS                                                                   Interest   earning assets                                 Securities                                 Taxable (1)       $   15,987       $   616       3.79   %     Tax-exempt       —       —       —         Total securities       15,987       616       3.79   %                                       Loans (2)   (3)       174,296       12,496       7.17   %     Federal   funds sold       5,166       73       1.41   %     Total   interest earning assets       195,449       13,185       6.74   %                                       Non-interest   earning assets                                 Cash and due from banks       3,045                         Net fixed assets and equipment       644                         Accrued interest and other assets       2,001                                                           Total assets       $   201,139                                      37           LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                   Interest   bearing liabilities                                 Deposits (other than demand)       $   167,268       4,257       2.55   %     Federal funds purchased       379       8       2.11   %     Total interest bearing liabilities       167,647       4,265       2.54   %                                       Non-interest   bearing liabilities                                 Non-interest bearing demand deposits       14,292                         Other liabilities       525                         Shareholders’ equity       18,675                                                           Total   liabilities and shareholders’ equity       $   201,139                             Net Interest   Spread       4.20   %                       Net Interest   Margin       4.56   %       (1)   Unrealized loss of $253 is excluded from yield calculation. (2)   Non-accrual loans are included in average loan balances and loan fees of $858 are included in interest income. (3)   Loans are presented net of allowance for loan loss              12 months Ended December 31, 2003                 Average               Average         (dollars in thousands)       Balance       Interest       Rate         ASSETS                                                                   Interest   earning assets                                 Securities                                 Taxable (1)       $   13,562       $   486       3.58   %     Tax-exempt       —       —       —         Total securities       13,562       486       3.58   %                                       Loans (2)   (3)       105,833       7,654       7.23   %     Federal   funds sold       4,493       65       1.45   %     Total   interest earning assets       123,888       8,205       6.62   %                                       Non-interest   earning assets                                 Cash and due from banks       2,151                         Net fixed assets and equipment       552                         Accrued interest and other assets       1,476                                                           Total assets       $   128,067                                      38           LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                   Interest   bearing liabilities                                 Deposits (other than demand)       $   107,902       2,973       2.76   %     Federal funds purchased       238       3       1.26   %     Total interest bearing liabilities       108,140       2,976       2.75   %                                       Non-interest   bearing liabilities                                 Non-interest bearing demand deposits       8,376                         Other liabilities       309                         Shareholders’ equity       11,242                                                           Total   liabilities and shareholders’ equity       $   128,067                             Net Interest   Spread       3.87   %                       Net Interest   Margin       4.22   %       (1)   Unrealized loss of $2 is excluded from yield calculation. (2)   Non-accrual loans are included in average loan balances and loan fees of $561are included in interest income. (3)   Loans are presented net of allowance for loan loss   The following Tables outline the components of the net interest margin for the years 2005, 2004, and 2003 and identifies the impact of changes in volume and the changes in rate.              December 31, 2005 change from                 December 31, 2004 due to:         (dollars in thousands)       Volume       Rate       Total         Interest   income                                 Loans       $   8,209       $   1,783       $   9,992         Securities – taxable       290       74       364         Federal funds sold       12       80       92         Total   interest income       8,511       1,937       10,448                                           Interest   expense                                 Deposits (other than demand)       3,130       2,181       5,311         Federal funds purchased       6       8       14         Subordinated debt       416       —       416         Total   interest expense       3,552       2,189       5,741                                           Net interest   income       $   4,959       $   (252   )   $   4,707          39                   December 31, 2004 change from                 December 31, 2003 due to:         (dollars in thousands)       Volume       Rate       Total         Interest   income                                 Loans       $   4,909       $   (66   )   $   4,843         Securities – taxable       91       39       130         Federal funds sold       9       (2   )   7         Total   interest income       5,009       (29   )   4,980                                           Interest   expense                                 Deposits (other than demand)       1,526       (242   )   1,284         Federal funds purchased       2       3       5         Total   interest expense       1,528       (239   )   1,289                                           Net interest   income       $   3,481       $   210       $   3,691          Liability and Asset Management   The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring an institution’s interest rate sensitivity “gap.”  An asset or liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the difference between the dollar amount of rate sensitive assets repricing during a period and the volume of rate sensitive liabilities repricing during the same period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income.  During a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to adversely affect net interest income.   The Bank’s asset liability and investment committee, which consists of the Executive Officers, Arthur F. Helf, Michael R. Sapp, H. Lamar Cox and George W. Fort, is charged with monitoring the liquidity and funds position of the Bank.  The Committee regularly reviews (a) the rate sensitivity position on a three-month, six-month, and one-year time horizon; (b) loans to deposit ratios; and (c) average maturity for certain categories of liabilities.  The Bank operates an asset/liability management model.  At December 31, 2005, the Bank had a positive cumulative repricing gap within one year of approximately $27,081 or approximately  6.97% of total year end earning assets. See Quantitative and Qualitative Analysis of Market Risk for additional information.   40        Deposits   The Bank’s primary sources of funds are interest-bearing deposits. The following tables present the average amount of and average rate paid on each of the following deposit categories for 2005, 2004 and 2003:   Deposits              Year Ended December 31,                 2005       2004       2003                         Average               Average               Average         (dollars in thousands)       Average   Balance       Rate   Paid       Average   Balance       Rate   Paid       Average   Balance       Rate   Paid         Types of   Deposits                                                         Non-interest-bearing   demand deposits       $   18,763       —       $   14,292       —       $   8,376       —         Interest-bearing   demand deposits       3,097       1.90   %   1,640       0.24   %   1,266       0.02   %     Money market   accounts       39,485       3.88   %   16,316       2.07   %   6,324       0.88   %     Savings   accounts       22,785       2.61   %   34,506       2.43   %   26,998       2.84   %     IRA accounts       2,183       4.31   %   1,040       3.56   %   874       3.99   %     Purchased   time deposits       146,326       3.55   %   98,515       2.68   %   57,122       2.90   %     Time   deposits       52,338       4.00   %   15,251       2.65   %   15,318       3.01   %     Total deposits       $   284,977               $   181,560               $   116,278                  The following table indicates amount outstanding of time certificates of deposit of $100,000 or more and respective maturities as of December 31, 2005 (in thousands):              2005                           Three months   or less       $   29,504                           Over three   through twelve months       34,778                           More than   twelve months       58,722         Total       $   123,004          41        Investment Portfolio   At year end 2005, obligations of the United States Government or its agencies and collateralized mortgage obligations represented 100% of the investment portfolio. The Bank’s investment portfolio at December 31, 2005, 2004 and 2003 consisted of the following (dollars in thousands):                      Gross       Gross       Estimated                 Amortized       Unrealized       Unrealized       Market                 Cost       Gain       Loss       Value         As of December 31, 2005                                         Securities available for sale                                         U.S. Government agencies       $   22,195       $   7       $   (411   )   $   21,791         Mortgage-backed securities       8,059       —       (254   )   7,805         Corporate debt securities       1,958       —       (22   )   1,936         Other       380       80       —       460         Total       $   32,592       $   87       $   (687   )   $   31,992                                                   As of December 31, 2004                                         Securities available for sale                                         U.S. Government agencies       $   9,958       $   5       $   (111   )   $   9,852         Mortgage-backed securities       8,569       —       (111   )   8,458         Other       380       —       —       380         Total       $   18,907       $   5       $   (222   )   $   18,690                                                   As of December 31, 2003                                         Securities available for sale                                         U.S. Government agencies       $   5,477       $   1       $   (135   )   $   5,343         Mortgage-backed securities       6,163       1       (77   )   6,087         Corporate debt securities       1,160       8       —       1,168         Other       380       —       —       380         Total       $   13,180       $   10       $   (212   )   $   12,978          42        The following schedule presents the estimated maturities and weighted average yields of investment securities of the Bank at December 31, 2005:                      Estimated       Weighted                 Amortized       Market       Average                 Cost       Value       Yield         Obligations   of U.S. Government agencies                                 Due in one year or less       $   —       $   —       0.00   %     Due after one through five years       8,257       8,109       3.71   %     Due after five through ten years       13,938       13,682       4.88   %     Due after ten years       —       —       0.00   %     Total   obligations of U.S. Government agencies       22,195       21,791                                                   Mortgage-backed   securities       8,059       7,805       3.77   %                                       Corporate   debt securities                                 Due in one year or less       417       399       4.94   %     Due after one through five years       —       —       0.00   %     Due after five through ten years       1,541       1,537       4.94   %     Due after ten years       —       —       0.00   %     Total   corporate debt securiites       1,958       1,936                                                   Other   securities       380       460       0.00   %     Total   securities available for sale       $   32,592       $   31,992                  The Bank owned no tax-exempt securities during the period ended December 31, 2005.   Investment Policy   The objective of the Bank’s investment policy is to invest funds not otherwise needed to meet the loan demand of its market area to earn the maximum return for the Bank, yet still maintain sufficient liquidity to meet fluctuations in the Bank’s loan demand and deposit structure.  In doing so, the Bank balances the market and credit risks against the potential investment return, makes investments compatible with the pledge requirements of the Bank’s deposits of public funds, maintains compliance with regulatory investment requirements, and assists the various public entities with their financing needs.  The asset liability and investment committee has full authority over the investment portfolio and makes decisions on purchases and sales of securities.  The entire portfolio, along with all investment transactions occurring since the previous Board of Director’s meeting, is reviewed by the Board at its next monthly meeting.  The investment policy allows portfolio holdings to include short-term securities purchased to provide the Bank’s needed liquidity and longer term securities purchased to generate level income for the Bank over periods of interest rate fluctuations.   43        Loan Portfolio   The Bank had total loans of $349 million at December 31, 2005.  As the loan portfolio is concentrated in Davidson County and Williamson County, there is risk that the borrowers’ ability to repay the loans could be affected by changes in local economic conditions.   The following schedule details the loans of the Bank at December 31, 2005, 2004, 2003, 2002 and 2001:      (dollars   in thousands)       2005       2004       2003       2002       2001         Real estate                                                 Construction       $   38,279       $   22,813       $   10,386       $   6,646       $   4,146         1-4 family residential       18,358       15,963       13,520       13,372       9,701         Other       50,371       33,694       20,072       10,513       8,702         Commercial,   financial and agricultural       233,948       139,799       87,908       44,867       21,000         Consumer       3,149       3,898       3,301       1,963       1,487         Other       4,481       —       —       —       —                                                           Total loans       348,586       216,167       135,187       77,361       45,036         Less:   allowance for loan losses       (4,399   )   (2,841   )   (2,000   )   (1,103   )   (919   )                                                       Net loans       $   344,187       $   213,326       $   133,187       $   76,258       $   44,117          Composition of loan portfolio by type              As of December 31,         (dollars in thousands)       2005       2004       2003       2002       2001         Real estate:                                                 Construction       10.98   %   10.55   %   7.68   %   8.59   %   9.21   %     1 to 4 family residential       5.27   %   7.38   %   10.00   %   17.28   %   21.54   %     Other       14.45   %   15.59   %   14.85   %   13.59   %   19.32   %     Commercial,   financial and agricultural       67.11   %   64.68   %   65.03   %   58.00   %   46.63   %     Consumer       0.90   %   1.80   %   2.44   %   2.54   %   3.30   %     Other       1.29   %   0.00   %   0.00   %   0.00   %   0.00   %     Total       100   %   100   %   100   %   100   %   100   %      Composition of commercial loan portfolio by funding program type              As of December 31,                 2005       2004       2003         (dollars in thousands)       Amount       %       Amount       %       Amount       %         Commercial, financial and agricultural:                                                         Direct funding       $   94,742       40.50   %   $   60,471       43.26   %   $   54,835       62.38   %     Indirect funding                                                         Large       52,144       22.29   %   29,010       20.75   %   5,602       6.37   %     Small       87,062       37.21   %   50,318       35.99   %   27,471       31.25   %     Total       233,948       100.00   %   139,799       100.00   %   87,908       100.00   %                         44        The following schedule details maturities and sensitivity to interest rates changes for commercial loans of the Bank at December 31, 2005:              Due in 1       Due in 1       Due after                 Type of Loan (1)       year or less       to 5 years       5 Years       Total                 ($ in thousands)         Real estate:                                         Construction       $   30,736       $   7,543       $   —       $   38,279         1 to 4 family residential       6,901       11,159       298       18,358         Other       18,088       28,702       3,581       50,371         Commercial,   financial and agricultural       58,554       172,899       2,495       233,948         Consumer       1,176       1,815       158       3,149         Other       —       —       4,481       4,481         Total       $   115,455       $   222,118       $   11,013       $   348,586                                                   Less:   allowance for loan loss                               (4,399   )                                               Net loans                               $   344,187                                                   Interest   rate sensitivity:                                         Fixed interest rates       14,899       221,504       10,332       246,735         Floating or adjustable rates       100,556       614       681       101,851                                                   Total       $   115,455       $   222,118       $   11,013       $   348,586           (1) includes non-accrual loans   ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK   Quantitative and Qualitative Analysis of Market Risk   Like all financial institutions, the Corporation is subject to market risk from changes in interest rates.  Interest rate risk is inherent in the balance sheet due to the mismatch between the maturities of rate sensitive assets and rate sensitive liabilities.  If rates are rising, and the level of rate sensitive liabilities exceed the level of rate sensitive assets, the net interest margin will be negatively impacted.  Conversely, if rates are falling, and the level of rate sensitive liabilities is greater than the level of rate sensitive assets, the impact on the net interest margin will be favorable.  Managing interest rate risk is further complicated by the fact that all rates do not change at the same pace, in other words, short term rates may be rising while longer term rates remain stable.  In addition, different types of rate sensitive assets and rate sensitive liabilities react differently to changes in rates.   To manage interest rate risk, the Corporation must take a position on the expected future trend of interest rates.  Rates may rise, fall, or remain the same.  The Asset-Liability Committee develops its view of future rate trends by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of the Corporation’s Balance Sheet.   The Corporation’s annual budget reflects the anticipated rate environment for the next twelve months.  The Asset Liability Committee conducts a quarterly analysis of the rate sensitivity position.  The results of the analysis are reported to the board.   The Asset Liability Committee uses a computer model to analyze the maturities of rate sensitive assets and liabilities.  The model measures the “gap” which is defined as the difference between the dollar amount of rate sensitive assets repricing during a period and the volume of rate sensitive liabilities repricing during the same period. Gap is also expressed as the ratio of rate sensitive assets divided by rate sensitive liabilities.  If the ratio is greater than “one”, the dollar value of assets exceeds the dollar value of liabilities; the balance sheet is “asset sensitive”.   45        Conversely, if the value of liabilities exceeds the value of assets, the ratio is less than one and the balance sheet is “liability sensitive”.  Policy requires management to maintain the gap within a range of 0.75 to 1.25.   The model measures scheduled maturities in periods of three months, four to twelve months, one to five years, and over five years. The chart below illustrates the rate sensitive position of the Corporation at December 31, 2005. Management uses the one year gap as the appropriate time period for setting strategy.    Rate Sensitivity Gap Analysis   Maturities:      (dollars   in thousands)       Floating       1-3   Months       4-12   Months       1-5   Years       Over   5 years       Total         Interest Earnings Assets                                                         Federal Funds sold       $   12,535       $   —       $   —       $   —       $   —       $   12,535                                                                   Securities                                                         U.S. government agencies       —       —       —       8,109       15,519       23,628         Mortgage-backed securities       —       1,000       3,049       2,851       1,304       8,204         Total securities       —       1,000       3,049       10,960       16,823       31,832                                                                   Total loans       96,249       42,678       102,501       101,089       6,069       348,586                                                                   Total Interest Earning Assets       108,784       43,678       105,550       112,049       22,892       392,953                                                                   Other Assets       —       —       —       —       11,087       11,087                                                                   Total Assets       $   108,784       $   43,678       $   105,550       $   112,049       $   33,979       $   404,040                                                                   Interest Bearing Liabilities                                                         Deposits                                                         Interest checking       $   6,112       $   —       $   —       $   —       $   —       $   6,112         Money market and savings       73,077       —       —       —       —       73,077         Time deposits       —       53,601       98,141       103,402       —       255,144         Total deposits       79,189       53,601       98,141       103,402       —       334,333                                                                   Subordinated long term debt       —       —       —       —       8,248       8,248                                                                   Total Interest Bearing Liabilities       79,189       53,601       98,141       103,402       8,248       342,581                                                                   Other Liabilities       —       —       —       —       35,029       35,029         Shareholders’ Equity       —       —       —       —       26,430       26,430                                                                   Total Liabilities and Shareholders’ Equity       $   79,189       $   53,601       $   98,141       $   103,402       $   69,707       $   404,040                                                                   Rate Sensitive Gap by Period       $   29,595       $   (9,923   )   $   7,409       $   8,647       $   14,644                                                                           Cumulative Gap               $   19,672       $   27,081       $   35,728       $   50,372                                                                           Cumulative Gap as a Percent of Total Assets               4.87   %   6.70   %   8.84   %   12.47   %                                                                       Rate sensitive assets/Rate sensitive   liabilities (cumulative)       1.37       1.15       1.12       1.11       1.15                  46        In mid-2004, the Federal Reserve Open Market Committee began a series of interest rate increases which the FOMC indicated would continue “at a measured pace”.  From mid year 2004 to the end of 2005, short term interest rates had increased by 300 basis points.  Management has positioned the Corporation for a rising rate environment by maintaining a moderately “asset sensitive” balance sheet in which more assets will reprice than liabilities.  Management achieved this position during fourth quarter, 2004, by offering higher rates of interest on deposit liabilities in the two to three year maturity range.  At year-end 2005, the Corporation’s one year GAP ratio was 1.12.   The interest rate risk model that defines the gap position also performs a “rate shock” test of the balance sheet.  The rate shock procedure measures the impact on the economic value of equity (EVE) which is a measure of long term interest rate risk. EVE is the difference between the market value of the assets and the liabilities and is the liquidation value of the bank. In this analysis, the model calculates the discounted cash flow or market value of each category on the balance sheet. The percent change in EVE is a measure of the volatility of risk. Regulatory guidelines specify a maximum change of 30% for a 200bps rate change. At December 31, 2005, the percent change at plus or minus 200bps is well within that range at 13.6% and 8.2% respectively.   The chart below identifies the EVE impact of a shift in rates of 100, 200 and 300 basis points in either direction.   Economic Value of Equity Under Rate Shock (dollars in thousands)   At December 31, 2005      Rate Change       -300bp       -200bp       -100bp       0bp       +100bp       +200bp       +300bp                                                                           Economic   value of equity       $   29,544       $   28,587       $   27,608       $   26,430       $   24,790       $   22,827       $   20,827                                                                           Actual   dollar change       3,114       2,157       1,178       —       (1,640   )   (3,603   )   (5,603   )                                                                       Percent   change       11.8   %   8.2   %   4.5   %   —       (6.2   )%   (13.6   )%   (21.2   )%                               Although the one year gap of 1.12 indicates that the Bank would show an increase in net interest income in a rising rate environment, the EVE rate shock shows that the EVE would decline in a rising rate environment. This is because the EVE model does not simulate activity so that maturing balances are replaced with new balances at new rate levels or repricing balances are adjusted to the new rate shock level but is a measure of long term interest rate risk applied in a static model which provides information only at a certain point in time. Given that limitation, it is still useful is assessing the impact of an unanticipated movement in interest rates.   The above analysis may not on its own be an entirely accurate indicator of how net interest income or EVE will be affected by changes in interest rates. Income associated with interest earning assets and costs associated with interest bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. The Asset-Liability Committee develops its view of future rate trends by monitoring economic indicators, examining the views of economists and other experts, and understanding the current status of the Corporation’s Balance Sheet and conducts a quarterly analysis of the rate sensitivity position.  The results of the analysis are reported to the board.   47
QUANTITATIVE AND QUALITATIVE DISCLOSURES   ABOUT MARKET RISK   45
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA      The report of Independent Accountants, Consolidated Financial Statements and supplementary data required by Item 8 are set forth on pages F-1 through F-28 of this Report and are incorporated herein by reference.   Index to Financial Statements      REPORT OF   INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   F-1               FINANCIAL STATEMENTS                   CONSOLIDATED BALANCE   SHEETS   F-2               CONSOLIDATED   STATEMENTS OF INCOME   F-3               CONSOLIDATED   STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY   F-4               CONSOLIDATED   STATEMENTS OF CASH FLOWS   F-5               NOTES TO   CONSOLIDATED FINANCIAL STATEMENTS   F-6
CHANGES IN AND DISAGREEMENTS WITH   ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE      None.
CONTROLS AND PROCEDURES      a)             Evaluation of Disclosure Controls and Procedures. The Corporation maintains disclosure controls and procedures, as defined in Rule 13a-15(a) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed by it in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms and that such information is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer and Chief Financial Officer. The Corporation carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this report.  Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure control and procedures were effective.   b)            Changes in Internal Controls and Procedures. There were no changes in the Corporation’s internal control over financial reporting during the Corporation’s fiscal quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, its internal control over financial reporting.
OTHER INFORMATION      None.   48        PART III
DIRECTORS AND EXECUTIVE OFFICERS OF THE   REGISTRANT      Information relating to our directors and executive officers will be contained in a definitive Proxy Statement involving the election of directors at the annual meeting of shareholders to be held May 3, 2006, and such information is incorporated herein by reference.
EXECUTIVE COMPENSATION      Information relating to executive compensation will be contained in the Proxy Statement referred to above in Item 10, and such information is incorporated herein by reference.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL   OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS      Information relating to security ownership of certain beneficial owners and management will be contained in the Proxy Statement referred to above in Item 10, and such information is incorporated herein by reference.
CERTAIN RELATIONSHIPS AND RELATED   TRANSACTIONS      Information relating to certain relationships and related transactions will be contained in the Proxy Statement referred to above in Item 10, and such information is incorporated herein by reference.
PRINCIPAL ACCOUNTANT FEES AND SERVICES      Information relating to the principal accountant fees and services will be contained in the Proxy Statement referred to above in Item 10, and such information is incorporated herein by reference.   PART IV
EXHIBITS AND   FINANCIAL STATEMENT SCHEDULES      (a)(1)       Financial Statements:   (2)           Schedules required by Article 12 of Regulation S-X are either omitted because they are not applicable or because the required information is shown in the financial statements or the notes thereto.   (3)           Exhibits:      Exhibit No.       Description                   2.1           Articles of Share Exchange of Tennessee Commerce Bank and Tennessee   Commerce Bancorp, Inc. *                       2.2           Plan of Share Exchange of Tennessee Commerce Bank and Tennessee   Commerce Bancorp, Inc. *                       3.1           Charter of Tennessee Commerce Bancorp, Inc. *                       3.2           Bylaws of Tennessee Commerce Bancorp, Inc. *                       4.1           Shareholders’ Agreement *                       10.1           Tennessee Commerce Bancorp, Inc. Stock Option Plan - Employees *      49           10.2           Tennessee Commerce Bancorp, Inc. 1999 Stock Option - Directors *                       10.3           Tennessee Commerce Bancorp, Inc. 1999 Stock Option - Incorporators *                       10.4           Tennessee commerce Bancorp, Inc. 2003 Stock Option - Directors *                       10.5           Tennessee Commerce Bancorp, Inc. 1999 Stock Option Agreement with   Arthur F. Helf *                       10.6           Tennessee Commerce Bancorp, Inc. 1999 Stock Option Agreement with   Michael R. Sapp *                       10.7           Tennessee Commerce Bancorp, Inc. 1999 Stock Option Agreement with H.   Lamar Cox *                       10.8           Employment Agreement between Tennessee Commerce Bancorp, Inc. and   Arthur F. Helf *                       10.9           Employment Agreement between Tennessee Commerce Bancorp, Inc. and   Michael R. Sapp *                       10.10           Employment Agreement between Tennessee Commerce Bancorp, Inc. and H.   Lamar Cox *                       21.1           Subsidiaries *                       23.1           Report of Independent Registered Public Accounting Firm                       31.1           Certification pursuant to Rule   13a-14a/15d-14(a)                       31.2           Certification pursuant to Rule   13a-14a/15d-14(a)                       32.1           Certification pursuant to Rule 18 USC   Section 1350-Sarbanes-Oxley Act of 2002                       32.2           Certification pursuant to Rule 18 USC   Section 1350-Sarbanes-Oxley Act of 2002       *  Previously filed as an exhibit to Tennessee Commerce Bancorp, Inc.’s Registration Statement on Form 10, as filed with the Securities and Exchange Commission on April 29, 2005.   50        Signatures   Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.          TENNESSEE COMMERCE BANCORP, INC.                             By:   /s/ Arthur F. Helf             Arthur F. Helf, Chairman and Chief Executive Officer         Date:   March 28, 2006              Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant in their capacities as directors.        By:   /s/ Dorris E. (Eli) Bennett       By:   /s/ H. Lamar Cox     Dorris E. (Eli) Bennett       H. Lamar Cox     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Paul W. Dierksen       By:   /s/ Dennis L. Grimaud     Paul W. Dierksen       Dennis L. Grimaud     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Arthur F. Helf       By:   /s/ Winston C. Hickman     Arthur F. Helf       Winston C. Hickman     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Fowler H. Low       By:   /s/ William W. McInnes     Fowler H. Low       William W. McInnes     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Thomas R. Miller       By:   /s/ Darrel Reifschneider     Thomas R. Miller       Darrel Reifschneider     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Michael R. Sapp       By:   /s/ Regg E. Swanson     Michael R. Sapp       Regg E. Swanson     Date: March 28, 2006       Date: March 28, 2006                                 By:   /s/ Dr. Paul A. Thomas             Dr. Paul A. Thomas                           Date:  March 28, 2006              51        TENNESSEE COMMERCE BANCORP, INC.   CONSOLIDATED FINANCIAL STATEMENTS   December 31, 2005 and 2004          CONSOLIDATED FINANCIAL STATEMENTS December 31, 2005 and 2004   CONTENTS      REPORT OF INDEPENDENT REGISTERED   PUBLIC ACCOUNTING FIRM   F-1               FINANCIAL STATEMENTS                   CONSOLIDATED BALANCE SHEETS   F-2               CONSOLIDATED STATEMENTS OF   INCOME   F-3               CONSOLIDATED STATEMENTS OF   CHANGES IN SHAREHOLDERS’ EQUITY   F-4               CONSOLIDATED   STATEMENTS OF CASH FLOWS   F-5               NOTES   TO CONSOLIDATED FINANCIAL STATEMENTS   F-6                  REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   The Board of Directors Tennessee Commerce Bancorp, Inc. Franklin, Tennessee   We have audited the consolidated balance sheet of Tennessee Commerce Bancorp, Inc. (the “Corporation”) and subsidiaries as of December 31, 2005, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for the year then ended. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of the Corporation for the years ended December 31, 2004 and 2003 were audited by other auditors whose report dated March 31, 2005, expressed an unqualified opinion on those statements.   We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.   In our opinion, the 2005 financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tennessee Commerce Bancorp, Inc. and subsidiaries as of December 31, 2005, and the consolidated results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States of America.      /s/   KraftCPAs PLLC        Nashville, Tennessee January 20, 2006     555 Great Circle Road, Suite 200 • Nashville, TN 37228 • Phone 615-242-7351 • Fax 615-256-1952 • www.kraftcpas.com 610 North Garden St. Suite 200, Columbia, Tennessee 38401 • Phone 931-388-3711 105 Bay Court, Lebanon, Tennessee 37087 • Phone 615-449-2334 An independently owned member of the RSM McGladrey Network   F-1        TENNESSEE COMMERCE BANCORP, INC. CONSOLIDATED BALANCE SHEETS December 31, 2005 and 2004      (dollars in thousands except   share data)       2005       2004         ASSETS                         Cash and due from   financial institutions       $   6,877       $   3,838         Federal funds sold       12,535       6,582         Cash and cash equivalents       19,412       10,420                                   Securities available   for sale       31,992       18,690         Loans       348,586       216,167         Allowance for loan   losses       (4,399   )   (2,841   )     Net loans       344,187       213,326                                   Premises and equipment,   net       769       609         Accrued interest   receivable       2,148       1,103         Restricted equity   securities       383       241         Deferred tax asset       490       598         Other assets       4,659       930                                   Total assets       $   404,040       $   245,917                                   LIABILITIES AND SHAREHOLDERS’   EQUITY                         Liabilities                         Deposits                         Non-interest bearing       $   33,372       $   15,239         Interest bearing       334,333       206,155         Total deposits       367,705       221,394                                   Subordinated long term debt       8,248       —         Accrued interest payable       1,126       445         Accrued bonuses       430       125         Other liabilities       101       353         Total liabilities       377,610       222,317                                   Shareholders’ equity                         Preferred stock, no par value. Authorized 1,000,000 shares;   none issued       —       —         Common stock, $0.50 par value. Authorized 5,000,000 shares;   issued 3,238,674 in 2005 and 2004       1,619       1,619         Additional paid-in capital       21,401       21,401         Retained Earnings       3,781       714         Accumulated other comprehensive loss       (371   )   (134   )     Total shareholders’ equity       26,430       23,600                                   Total liabilities and shareholders’ equity       $   404,040       $   245,917          See accompanying notes to consolidated financial statements.   F-2        TENNESSEE COMMERCE BANCORP, INC. CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2005, 2004, and 2003      (dollars in thousands except   share data)       2005       2004       2003         Interest income                                 Loans, including fees       $   22,488       $   12,497       $   7,655         Securities       967       616       486         Federal funds sold and other       178       72       64         Total interest income       23,633       13,185       8,205                                           Interest expense                                 Deposits       9,567       4,257       2,974         Other       439       8       2         Total interest expense       10,006       4,265       2,976                                           Net interest income       13,627       8,920       5,229                                           Provision for loan   losses       3,700       2,420       1,115                                           Net interest income   after provision for loan losses       9,927       6,500       4,114                                           Non-interest income                                 Service charges on deposit accounts       114       24       17         Mortgage banking       105       130       148         Securities gains       4       33       132         Gain on sale of loans       1,106       504       —         Other       (18   )   109       135         Total non-interest income       1,311       800       432                                           Non-interest expense                                 Salaries and employee benefits       3,700       2,604       2,006         Occupancy and equipment       629       473       440         Data processing fees       474       350       242         Professional fees       398       314       250         Other       1,045       811       521         Total non-interest expenses       6,246       4,552       3,459                                           Income before income   taxes       4,992       2,748       1,087                                           Income tax expense       1,925       1,082       188                                           Net income       $   3,067       $   1,666       $   899                                           Earnings per share   (EPS):                                 Basic EPS       $   0.95       $   0.57       $   0.40         Diluted EPS       0.87       0.53       0.38                                           Weighted average shares   outstanding:                                 Basic       3,238,674       2,933,818       2,253,928         Diluted       3,517,408       3,166,794       2,379,861          See accompanying notes to consolidated financial statements.   F-3        TENNESSEE COMMERCE BANCORP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY Years Ended December 31, 2005, 2004, and 2003                                      Accumulated                                 Additional       Retained       Other       Total                 Common       Paid-In       Earnings       Comprehensive       Shareholders’         (dollars   in thousands except share data)       Stock       Capital       (Deficit)       Income (Loss)       Equity                                                           Balance at January 1, 2003       $   1,010       $   9,508       $   (1,851   )   $   133       $   8,800         Comprehensive income                                                 Net income       —       —       899       —       899         Other comprehensive income, net of income taxes                                                 Unrealized losses on securities available for sale   during the period       —       —       —       (177   )   (177   )     Reclassification adjustment for gains included in   net income, net of $50 in tax       —       —       —       (82   )   (82   )                                                       Total comprehensive income                                       640                                                           Issuance of 437,346 common shares       219       3,718       —       —       3,937                                                           Exercise of stock options to purchase  3,000 common shares       1       20       —       —       21                                                           Balance at December 31, 2003       1,230       13,246       (952   )   (126   )   13,398         Comprehensive income                                                 Net income       —       —       1,666       —       1,666                                                           Other comprehensive income, net of income taxes                                                 Unrealized gains on securities available for sale   during the period       —       —       —       12       12                                                           Reclassification adjustment for gains included in   net income, net of $13 in tax       —       —       —       (20   )   (20   )                                                       Total comprehensive income                                       1,658                                                           Issuance of 775,000 common shares       388       8,137       —       —       8,525                                                           Exercise of stock options to purchase 3,000 common   shares       1       18       —       —       19                                                           Balance at December 31, 2004       1,619       21,401       714       (134   )   23,600         Comprehensive income                                                 Net income       —       —       3,067       —       3,067                                                           Other comprehensive income, net of income taxes                                                 Unrealized losses on securities available for sale   during the period       —       —       —       (234   )   (234   )                                                       Reclassification adjustment for gains included in   net income, net of $1 in tax       —       —       —       (3   )   (3   )                                                       Total comprehensive   income                                       2,830                                                           Balance at   December 31, 2005       $   1,619       $   21,401       $   3,781       $   (371   )   $   26,430          See accompanying notes to consolidated financial statements.   F-4        TENNESSEE COMMERCE BANCORP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS      (dollars in thousands except   share data)       2005       2004       2003         Cash flows from operating   activities                                 Net income       $   3,067       $   1,666       $   899         Adjustments to reconcile net income to net cash   provided by operating activities                                 Depreciation       171       165       131         Provision for loan losses       3,700       2,420       1,115         FHLB stock dividends       (17   )   (9   )   (6   )     Deferred income taxes       254       56       178         Net amortization of investment securities       40       52       106         Gain on sales of securities       (4   )   (33   )   (132   )     Change in:                                 Accrued interest receivable       (1,045   )   (481   )   (195   )     Accrued interest payable       681       276       (18   )     Other assets       (3,729   )   (837   )   93         Other liabilities       53       264       185         Net cash provided by activities       3,171       3,539       2,356                                           Cash flows from investing activities                                 Purchases of securities available for sale       (17,315   )   (13,938   )   (18,647   )     Proceeds from sales of securities available for sale       1,489       4,909       12,992         Proceeds from maturities, prepayments and calls of   securities available for sale       2,104       3,284       7,772         Net change in loans       (134,561   )   (82,559   )   (58,044   )     Purchases of Federal Home Loan Bank stock       (125   )   (82   )   (15   )     Net purchases of premises and equipment       (330   )   (101   )   (384   )     Net cash used in investing activities       (148,738   )   (88,487   )   (56,326   )                                       Cash flows from financing activities                                 Net change in deposits       146,311       79,101       55,032         Net change in federal funds purchased       —       —       (1,500   )     Proceeds from long term debt       8,248       —       —         Proceeds from issuance of common stock       —       8,525       3,936         Proceeds from exercise of stock options       —       19       21         Net cash provided by financing activities       154,559       87,645       57,489                                           Net change in cash and cash equivalents       8,992       2,697       3,519                                           Cash and cash equivalents at beginning of year       10,420       7,723       4,204                                           Cash and cash equivalents at end of year       $   19,412       $   10,420       $   7,723                                           Supplemental cash flow information:                                 Cash paid during year for interest       $   9,325       $   3,989       $   2,994         Cash paid during year for income taxes       2,089       780       38          See accompanying notes to consolidated financial statements.   F-5        TENNESSEE COMMERCE BANCORP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS   NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES   The accounting principles followed and the methods of applying those principles conform with accounting principles generally accepted in the United States of America and to general practices in the banking industry. The significant policies are summarized as follows:   Principles of Consolidation:  The accompanying consolidated financial statements include the accounts of Tennessee Commerce Bancorp, Inc. (the Corporation) and its wholly-owned subsidiary, Tennessee Commerce Bank (the Bank). Tennessee Commerce Statutory Trust I is not consolidated and is accounted for under the equity method. Material intercompany accounts and transactions have been eliminated.   Nature of Operations:  Tennessee Commerce Bancorp, Inc. was formed in July 2000. Tennessee Commerce Bank received its charter as a state bank and opened for business in January 2000. Substantially all of the assets, liabilities, and operations presented in the consolidated financial statements are attributable to Tennessee Commerce Bank. The Bank provides a variety of banking services to individuals and businesses in Middle Tennessee. Its primary deposit products are demand and savings deposits and certificates of deposit, and its primary lending products are commercial, lease financing, real estate mortgage and installment loans.   The Bank’s loans are generally secured by specific items of collateral including real property, consumer assets, and business assets. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors’ ability to honor their contracts is dependent on local economic conditions.   Use of Estimates:  To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ. The allowance for loan losses and fair value of financial instruments are particularly subject to change.   Statement of Cash Flows:  For purposes of presentation in the statements of cash flows, cash and cash equivalents include amounts due from financial institutions and federal funds sold. Net cash flows are reported for loan and deposit transactions.   Securities:  In accordance with Statement of Financial Accounting Standards No. 115, Accounting for Certain Debt and Equity Securities (SFAS 115), all securities are classified as available for sale. The Corporation currently has no trading securities or held to maturity securities.   Securities classified as available for sale may be sold in response to changes in interest rates, liquidity needs, and for other purposes. Available for sale securities are reported at fair value and include securities not classified as held to maturity or trading.   F-6        Unrealized holding gains and losses for available for sale securities are reported in other comprehensive income. Realized gains (losses) on securities available for sale are included in other income (expense) and, when applicable, are reported as a reclassification adjustment, net of tax, in other comprehensive income. Gains and losses on sales of securities are determined on the specific-identification method.   Interest income includes amortization of purchase premium or discount. Gains and losses on sales are based on the amortized cost of the security sold. Securities are written down to fair value when a decline in fair value is not temporary. Any such losses are charged to earnings.   Mortgage Banking Activities:  The Bank originates mortgage loans for sale and these loans are carried at the lower of cost or fair value, determined on an aggregate basis. Generally, a commitment is obtained from investors at origination in order to minimize market risk directly related to interest rate movements. Origination fees are recorded as income when the loans are sold to third party investors. At the end of the year for each period presented there were no loans held for sale.   Loans:  Loans that the Bank has the positive intent and ability to hold to maturity are stated at the principal amount outstanding. Interest on loans is computed daily based on the principal amount outstanding. Loan origination fees are deferred, to the extent they exceed direct origination costs, and recognized over the life of the related loans as yield adjustments.   Loans are generally placed on nonaccrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other nonaccrual loans is recognized only to the extent of interest payments received.   Allowance for Loan Losses:  The allowance for loan losses is maintained at a level that, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with the regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near term. The allowance is increased by the provision for loan losses and reduced by charge-offs, net of recoveries.   F-7        The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors.   Management periodically reviews the loan portfolio. A loan is placed on non-accrual status when it is 90 days or more past due and immediate collection is doubtful. The non-accrual loans are reviewed periodically for impairment. A loan is impaired when full payment under the loan terms is not expected. Commercial and commercial real estate loans 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.   Premises and Equipment:  Premises and equipment are stated at cost, less accumulated depreciation and amortization. The provision for depreciation is computed principally on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the lease term or useful life of the asset. Costs of major additions and improvements are capitalized. Expenditures for maintenance and repairs are charged to operations as incurred.   Other Real Estate:  Real estate acquired by foreclosure is carried at the lower of the recorded investment in the property or its fair value at the date of foreclosure, determined by appraisal. Declines in value indicated by reappraisals as well as losses resulting from disposition are charged to operations.   Gain on Sale of Loans: The Bank records a transfer of financial assets as a sale when it surrenders control over those financial assets to the extent that consideration other than beneficial interests in the assets is received in exchange. The Bank considers control surrendered when all conditions prescribed by Statement of Financial Accounting Standards No. 140, Accounting For Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of SFAS No. 125, are met. These conditions focus on whether the transferred financial assets are isolated beyond the reach of the Bank and its creditors, the constraints on the transferee or beneficial interest holders, and the Bank’s rights or obligations to reacquire transferred financial assets. In accordance with SFAS No. 140, the Bank records the transfer by allocating the carrying amount of the financial asset between the assets sold, and the retained interests, if any, based on their relative fair values at the date of transfer. Estimates of expected future cash flows are used to determine fair value on the date of transfer. The gain on sale is presented as a component of non-interest income.   F-8        Interest-Only Strips Receivable:  Interest-only strips receivable are related to loans originated and sold to others, and represent the difference between the loan’s coupon rate and the rate “passed through” to investors. The initial amount recorded as interest-only strips receivable (I/O) is computed by applying present value factors to the investors’ expected cash flows compared to expected cash flows from the borrowers. I/Os are carried at fair value and unrealized losses or gains are recognized into income. I/Os are included in other assets on the balance sheet.   Servicing Asset: In accordance with Statement of Financial Accounting Standards No. 140 - Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities, servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. When the Bank sells loans to others that it continues to service, a servicing asset is recorded at fair value. Capitalized servicing rights are reported in other assets and are amortized over the life of the loan being serviced.   Stock-Based Compensation:  Employee compensation expense under stock options is reported using the intrinsic value method. No stock-based compensation cost is reflected in net income, as all options granted had an exercise price equal to or greater than the market price of the underlying common stock at date of grant. The following table illustrates the effect on net income and earnings per share if expense was measured using the fair value recognition provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation.      (dollars in thousands except   share data)       2005       2004       2003                                           Net income as reported       $   3,067       $   1,666       $   899         Deduct: Stock-based compensation expense determined   under fair value based method       245       141       615                                           Pro forma net income       $   2,822       $   1,525       $   284                                           Basic earnings per   share as reported       $   0.95       $   0.57       $   0.40         Pro forma basic   earnings per share       0.87       0.52       0.13                                           Diluted earnings per   share as reported       0.87       0.53       0.38         Pro forma diluted   earnings per share       0.80       0.48       0.12          The pro forma effects are computed using option pricing models, using the following weighted-average assumptions as of grant date.              2005       2004       2003                                           Risk-free interest rate       3.96   %   3.23   %   3.82   %     Expected option life       5 years       7 years       7 years         Dividend yield       0.0   %   0.0   %   0.0   %      The weighted average fair value of options granted during the year was $4.03 for 2005, $2.23 for 2004 and $2.29 for 2003.   F-9        Stock Issuance: In 2004, the Corporation offered 775,000 shares for sale at a price of $11.00. The offering expired July 31, 2004 with all shares sold pursuant to the offering.   Income Taxes:  Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.   Advertising Costs:  Advertising costs are generally charged to operations in the year incurred and totaled $140,000, $35,000, and $37,000 in 2005, 2004, and 2003.   Off-Balance Sheet Financial Instruments:  Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.   Restrictions on Cash:  Cash on hand or on deposit with other banks of $101,000 and $19,000 was required to meet regulatory reserve and clearing requirements at year-end 2005 and 2004 respectively. These balances do not earn interest.   Dividend Restrictions:  Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank.   Comprehensive Income:  Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale which are also recognized as separate components of equity.   Fair Value of Financial Instruments:  Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.   F-10        Recently Issued accounting Standards: The Financial Accounting Standards Board (FASB) recently issued new accounting on share-based payments (FAS 123R). The Accounting Standards Executive Committee issued a new accounting standard on purchased loans (Statement of Position 03-3). FAS 123R addresses accounting for share-based payments, including the Corporation’s stock option plan. The Corporation will adopt FAS 123R in the first quarter 2006, as required by the standard. Compensation expense will be based on the fair value of options granted, determined at the date of grant, spread over the vesting or service period. Under previous rules, compensation expense was based on the intrinsic value of options granted. Previously reported net income and earnings per share will not be restated.   Management does not believe that any of the recently issued but not yet effective accounting standards, except for FAS 123R, will have a material effect on the Corporation’s financial position or results of operation.   Operating Segments:  While the chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a Corporation-wide basis. Accordingly, all of the financial service operations are considered by management to be aggregated in one reportable operating segment.   Reclassifications:  Some items in the prior year financial statements were reclassified to conform to the current presentation.   F-11        NOTE 2 - SECURITIES   The fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:                      Gross       Gross                 Fair       Unrealized       Unrealized         (dollars in thousands)       Value       Gains       Losses                                           2005                                                                   U.S. Government agencies       $   21,791       $   7       $   (411   )     Mortgage-backed securities       7,805       —       (254   )     Corporate debt securities       399       —       (18   )     Corporate bonds       1,537       —       (4   )     Other       460       80       —                                                   $   31,992       $   87       $   (687   )                                       2004                                                                   U.S. Government agencies       $   9,851       $   5       $   (111   )     Mortgage-backed securities       8,459       —       (111   )     Other       380       —       —                                                   $   18,690       $   5       $   (222   )      Contractual maturities of debt securities at December 31, 2005 are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties.      (dollars in thousands)       Fair   Value                           Due after one through five years       $   8,304         Due after five through ten years       15,423         Due after ten years       460         Mortgage-backed securities       7,805                                   $   31,992          Gross gains of $4,000, $33,000, and $132,000 on sales of securities were recognized in 2005, 2004, and 2003. Securities carried at $7,112,000 and $7,433,000 at December 31, 2005 and 2004 were pledged to secure deposits and for other purposes as required or permitted by law.   Restricted equity securities consist of securities which are restricted as to transferability. These securities are recorded at cost.      (dollars in thousands)       2005       2004                                   Federal Home Loan Bank   stock       $   383       $   241                    F-12        Securities with unrealized losses at year-end 2005 and 2004, and the length of time they have been in continuous loss positions are as follows:              Less than 12 Months       12 Months or More       Total                 Fair       Unrealized       Fair       Unrealized       Fair       Unrealized         (dollars in thousands)       Value       Loss       Value       Loss       Value       Loss                                                                   2005                                                                                                                   U.S.Government agencies       $   14,558       $   155       $   7,233       $   256       $   21,791       $   411         Corporate Bonds       1,537       4       —       —       1,537       4         Corporate Debt   Securities       —       —       399       18       399       18         Mortgage-backed   securities       1,873       35       5,932       219       7,805       254                                                                   Total temporarily   impaired       $   17,968       $   194       $   13,564       $   493       $   31,532       $   687                                                                   2004                                                                                                                   U.S.Government agencies       $   5,426       $   48       $   2,429       $   63       $   7,855       $   111         Mortgage-backed   securities       5,712       57       2,522       54       8,234       111                                                                   Total temporarily impaired       $   11,138       $   105       $   4,951       $   117       $   16,089       $   222          Unrealized losses on securities have not been recognized into income because the securities are backed by the U.S. government or its agencies, management has the intent and ability to hold for the foreseeable future, and the decline in fair value is largely due to increases in market interest rates. The fair value is expected to recover as the securities approach their maturity dates and/or market rates decline.   F-13        NOTE 3 - LOANS   A summary of loans outstanding by category at December 31:      (dollars in thousands)       2005       2004         Real estate:                         Construction       $   38,279       $   22,813         1 to 4 family residential       18,358       15,963         Other       50,371       33,694         Commercial, financial and agricultural       233,948       139,799         Consumer       3,149       3,898         Other       4,481       —                 348,586       216,167         Less: Allowance for loan losses       (4,399   )   (2,841   )                               Net loans       $   344,187       $   213,326          The Bank records a transfer of financial assets as a sale when it surrenders control over those financial assets to the extent that consideration other than beneficial interests in the assets is received in exchange. The amount of the proceeds for loans that were transferred with recourse that were recorded as sales for each period follows.      (dollars in thousands)       2005       2004       2003                                           Proceeds from loans   transferred with recourse       $   19,571       $   2,302       $   —                       The Bank services loans for the benefit of others. The amount of loans being serviced for the benefit of others at year end for each period follows.                              December 31,         (dollars in thousands)       2005       2004       2003                                           Amount of loans being   serviced       $   36,094       $   19,157       $   4,363                       Certain parties (principally executive officers and directors of the Bank including their related interests) were customers of, and had loans with the Bank in the ordinary course of business. These loan transactions were made on substantially the same terms as those prevailing at the time for comparable loans to other persons. They did not involve more than the normal risk of collectibility or present other unfavorable features.   F-14        Loans to principal officers, directors, and their affiliates in 2005 were as follows.      (dollars in thousands)       2005                           Beginning balance       $   3,684         New loans       3,981                           Repayments       (1,200   )                       Ending balance       $   6,465          NOTE 4 – ALLOWANCE FOR LOAN LOSSES   Changes in the allowance for loan losses were as follows:      (dollars in thousands)       2005       2004       2003                                           Balance at beginning of year       $   2,841       $   2,000       $   1,103         Provision charged to operating expenses       3,700       2,420       1,115         Loans charged-off       (2,411   )   (1,655   )   (283   )     Recoveries       269       76       65                                           Balance at end of year       $   4,399       $   2,841       $   2,000          Impaired loans were as follows:      (dollars in thousands)       2005       2004                                   Loans with allocated   allowance for loan losses       $   2,928       $   1,344                                   Amount of the allowance   for loan losses allocated       $   942       $   202                     2005       2004       2003                                           Average of impaired   loans during the year       $   4,444       $   1,430       $   1,250                       The amount of interest income recognized for the time that these loans were impaired during 2005, 2004, and 2003 was not material to the financial statements.   Nonperforming loans were as follows:      (dollars in thousands)       2005       2004       2003                                           Loans past due over 90 days still on accrual       $   352       $   111       $   308         Nonaccrual loans       2,928       2,161       1,136                       Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.   F-15        NOTE 5 – PREMISES AND EQUIPMENT   The following is a summary of premises and equipment as of December 31, 2005 and 2004. Depreciation expense for 2005, 2004, and 2003 was $171,000, $165,000, and $131,000.      (dollars in thousands)       2005       2004                                   Leasehold improvements       $   440       $   272         Furniture and equipment       983       820                 1,423       1,092         Less: Allowance for depreciation       654       483                                           $   769       $   609          The Bank leases office space, furniture and equipment under operating leases. Rent expense recognized in 2005, 2004, and 2003 amounted to $268,000, $226,000, and $192,000. The remaining minimum lease payments related to the leases are as follows, before considering renewal options that generally are present.      (dollars in thousands)                 2006       $   247         2007       258         2008       268         2009       274         2010       279                                   $   1,326          NOTE 6 - DEPOSITS   Time deposits greater than $100,000 amounted to $122,798,000 in 2005 and $68,590,000 in 2004.   At December 31, 2005, scheduled maturities of time deposits are as follows:      (dollars in thousands)                                   2006       $   151,948         2007       26,279         2008       33,098         2009       13,986         2010       29,440         2011 and later       598                 Deposits held at the Bank by directors, executive officers, and their related interests were approximately $8,867,000 and $8,250,000 at December 31, 2005 and 2004.   F-16        NOTE 7 - ADVANCES FROM FEDERAL HOME LOAN BANK AND OTHER DEBT   The Federal Home Loan Bank (FHLB) of Cincinnati advances funds to the Bank with the requirement that the advances are secured by securities and qualifying loans, essentially home mortgages (1-4 family residential). The Bank has an available line of $8,838,000 with FHLB. To participate in this program, the Bank is required to be a member of the Federal Home Loan Bank and own stock in the FHLB. The Corporation has $383,000 of such stock at December 31, 2005 to satisfy this requirement.   At December 31, 2005, the Bank had received no advances from the FHLB and therefore had pledged no securities or qualifying loans.   The Bank has approximately $12,000,000 in available federal funds lines (or the equivalent thereof) with correspondent banks.   NOTE 8 – INCOME TAXES   Income tax expense (benefit) recognized in each year is made up of current and deferred Federal and State tax amounts shown below:      (dollars in thousands)       2005       2004       2003                                           Current Federal       $   1,385       $   852       $   —         Current State       286       174       10         Deferred Federal       213       46       148         Deferred State       41       10       30                                                   $   1,925       $   1,082       $   188          The tax effect of each type of temporary difference that results in net deferred tax assets and liabilities is as follows:      (dollars in thousands)       2005       2004         Asset (liability)                         Allowance for loan losses       $   936       $   675         Tax leases       (302   )   —         Unrealized loss on securities       228       82         Depreciation       (60   )   (85   )     SFAS 140 income adjustments       (382   )   (98   )     Other, net       70       24                                   Balance at end of year       $   490       $   598          F-17        A reconciliation of the amount computed by applying the federal statutory rate (34%) to pretax income with income tax expense (benefit) follows:      (dollars in thousands)       2005       2004       2003                                           Tax expense at statutory rate       $   1,698       $   934       $   370         Increase (decrease) in taxes resulting from   Change in valuation allowance for deferred tax assets       —       —       (237   )     State income tax effect       216       120       48         Other       11       28       7                                           Income tax expense       $   1,925       $   1,082       $   188          NOTE 9 – COMMITMENTS AND CONTINGENCIES   The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Bank has in those particular financial instruments.   The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments.   Financial instruments whose contract amounts represent credit risk:              2005       2004                 Fixed       Variable       Fixed       Variable         (dollars in thousands)       Rate       Rate       Rate       Rate                                                   Commitments to extend credit       $   2,404       $   38,859       $   4,014       $   29,638         Standby letters of credit       —       5,686       —       2,139                          Commitments to make loans are generally made for periods of 60 days or less. The fixed rate loan commitments have interest rates ranging from 5.75% to 10.00% and maturities ranging from 6 months to 5 years.   F-18        Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Bank upon extension of credit is based on management’s credit evaluation. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties.   Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. All letters of credit are due within one year or less of the original commitment date. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.   The Bank primarily serves customers located in Middle Tennessee. As such, the Bank’s loans, commitments and letters of credit have been granted to customers in that area. Concentration of credit by type of loan is presented in Note 3.   NOTE 10 – EMPLOYEE BENEFITS   The Bank maintains a 401(k) plan for all employees who have satisfied the minimum age and service requirements. The Bank may make discretionary contributions and employees vest in employer contributions over five years. The Bank made no contributions to the plan during 2005, 2004, and 2003.   F-19        NOTE 11 – REGULATORY MATTERS   Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and the Bank are required to meet specific capital adequacy guidelines that involve quantitative measures of a bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a material effect on the Bank’s financial condition.   The Corporation and the Bank’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The risk-based guidelines are based on the assignment of risk weights to assets and off-balance sheet items depending on the level of credit risk associated with them. In addition to minimum capital requirements, under the regulatory framework for prompt corrective action, regulatory agencies have specified certain ratios an institution must maintain to be considered “undercapitalized”, “adequately capitalized”, and “well capitalized”. As of December 31, 2005 and 2004, the most recent notification from the Bank’s regulatory authority categorized the Corporation and the Bank as “well capitalized”. There are no conditions or events since that notification that management believes have changed the Corporation and the Bank’s category.   The Bank and the Corporation’s capital amounts and ratios at December 31, 2005 and 2004 are as follows:                                              To Be Well                                                 Capitalized Under                                 For Capital       Prompt Corrective                 Actual       Adequacy Purposes       Action Provisions         (dollars in thousands)       Amount       Ratio       Amount       Ratio       Amount       Ratio                                                                   2005                                                                                                                   Total risk-based                                                         Bank       $   38,250       10.5   %   $   29,132       8.0   %   $   36,415       10.0   %     Corporation       $   39,201       10.8   %   $   29,111       8.0   %   n/a                                                                           Tier 1 to risk-based                                                         Bank       $   33,851       9.3   %   $   14,566       4.0   %   $   21,849       6.0   %     Corporation       $   34,802       9.6   %   $   14,566       4.0   %   n/a                                                                           Tier 1 leverage                                                         Bank       $   33,851       9.1   %   $   14,559       4.0   %   $   18,599       5.0   %     Corporation       $   34,802       9.3   %   $   14,969       4.0   %   n/a                                                                           2004                                                                                                                   Total risk-based                                                         Bank       $   26,251       12.0   %   $   17,559       8.0   %   $   21,949       10.0   %     Corporation       $   26,479       12.1   %   $   17,559       8.0   %   n/a                                                                           Tier 1 to risk-based                                                         Bank       $   23,506       10.7   %   $   8,780       4.0   %   $   13,169       6.0   %     Corporation       $   23,734       10.8   %   $   8,780       4.0   %   n/a                                                                           Tier 1 leverage                                                         Bank       $   23,506       9.7   %   $   9,693       4.0   %   $   12,116       5.0   %     Corporation       $   23,734       9.8   %   $   9,687       4.0   %   n/a                  F-20        NOTE 12 – STOCK OPTIONS   The following is a summary of certain rights and provisions of the options the Corporation has issued. All options and the related strike price reflect the impact of the two-for-one stock split on December 31, 2003. All options expire ten years from the date of grant.   The original fourteen incorporators and members of the Board of Directors were granted an aggregate of 122,500 options to purchase shares at $5.00 per share in connection with organization activities. 10,000 options were exercised in 2002, leaving 112,500 options outstanding to purchase shares. Each of the 122,500 options were immediately vested on the date of grant.   In August 2003, the Board of Directors approved an option plan for active directors and incorporators in recognition of their four years of service to the Bank without compensation. An aggregate of 320,000 options to purchase shares at a price of $10.50 per share were included in this plan. Each of the 320,000 options were immediately vested on the date of grant.   Pursuant to employment agreements, executive officers received options equal to 14% of the shares sold in the original offering at an exercise price of $5.00 per share. Based on the initial sale of 1,817,440 shares, executive officer options totaled 254,440 and vest over three years. Of this total, 24,232 options were exercised and 12,116 options were forfeited in 2002, and 2,000 options were exercised in 2004, leaving an outstanding balance of 216,092 options to purchase shares. In February 2003, three executive officers were granted 30,000 options each at an exercise price of $7.50 to vest over three years. In March 2004, three executive officers were granted 20,000 options each at an exercise price of $11.00. These options were immediately vested on the date of grant. In August 2005, one executive officer was granted 5,000 options. Of these 2,500 options immediately vested and the remaining 2,500 vest in August 2006. In November 2005, one executive officer was granted 6,250 options that immediately vested.   The Board of Directors has granted incentive options to various employees who are not executive officers. Incentive options are used for recruiting and retention purposes and to recognize performance. Employee incentive options include 13,000 options to purchase shares at $5.00 per share granted in 2000 and 2001. 5,000 options to purchase shares have been forfeited by former employees, 3,000 options were exercised on December 31, 2003, and 1,000 options were exercised in 2004. The remaining 4,000 are fully vested. 9,000 options to purchase shares at $7.50 per share were granted in March 2003. 31,000 options to purchase shares at $10.50 per share were granted in December 2003. Of these, 5,000 options were forfeited in 2004. All of these incentive options vest in two years. In July 2005 and August 2005, 69,000 and 10,000 options were granted respectively. On each grant date half immediately vested with the remaining options vesting one year later. In November 2005, 10,000 options were granted to employees and were immediately vested.   F-21        A summary of the activity in the plan is as follows:              2005       2004       2003                         Weighted               Weighted               Weighted                         Average               Average               Average                         Exercise               Exercise               Exercise                 Shares       Price       Shares       Price       Shares       Price                                                                   Outstanding at   beginning of year       837,592       $   7.99       785,592       $   7.77       338,592       $   5.00         Granted       100,250       16.00       60,000       11.00       450,000       9.84         Exercised       —       0.00       (3,000   )   5.00       (3,000   )   5.00         Forfeited or expired       —       0.00       (5,000   )   10.50       —       —                                                                   Outstanding at end   of year       937,842       $   8.85       837,592       $   7.99       785,592       $   7.77                                                                   Options exercisable at   year-end       865,842               757,592               655,592                  Options outstanding at year-end 2005 were as follows:              Outstanding       Exerciseable                         Weighted                                         Average               Weighted                         Remaining               Average         Exercise               Contractual               Exercise         Prices       Number       Life       Number       Price                                                   $  5.00       332,592       4.0 years       332,592       $   5.00         $  7.50       99,000       7.0 years       69,000       $   7.50         $10.50       346,000       7.0 years       346,000       $   10.50         $11.00       60,000       8.0 years       60,000       $   11.00         $16.00       100,250       10.0 years       58,250       $   16.00                                                   Outstanding at year-end       937,842               865,842       $   8.85          F-22        NOTE 13 – FAIR VALUES OF FINANCIAL INSTRUMENTS   The methods and assumptions used to estimate fair value are described as follows:   Carrying amount is the estimated fair value for cash and due from financial institutions, federal funds sold and purchased, accrued interest receivable and payable, demand deposits, and variable rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issue. For fixed rate loans or deposits and for variable rate loans or deposits with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. The fair value of the subordinated long term debt is based on discounted cash flows using current market rates applied to the estimated life of the debt. Other assets and accrued liabilities are carried at fair value. The fair value of off-balance-sheet loan commitments is considered nominal.   The estimated fair values of the Bank’s financial instruments at December 31, 2005 and 2004 were as follows:              2005       2004                 Carrying       Fair       Carrying       Fair         (dollars in thousands)       Amount       Value       Amount       Value         Financial assets                                         Cash and due from financial institutions       $   6,877       $   6,877       $   3,838       $   3,838         Federal funds sold       12,535       12,535       6,582       6,582         Securities available for sale       31,992       31,992       18,690       18,690         Loans, net       344,187       347,646       213,326       210,806         Accrued interest receivable       2,148       2,148       1,103       1,103         Restricted equity securities       383       383       241       241         Financial liabilities                                         Deposits       $   367,705       $   367,544       $   221,394       $   221,621         Accrued interest payable       1,126       1,126       445       445         Subordinated long term debt       8,248       8,316       —       —          F-23        NOTE 14 – EMPLOYMENT AGREEMENTS   The Bank has entered into two-year automatically renewable employment agreements with four executive officers. In the event of a change in control of the Bank, or an officer is terminated without cause, the Bank has an obligation to pay 2.99 times the officer’s annual salary and bonus which combined is not to be less than the previous year’s salary and bonus.   NOTE 15 – SHAREHOLDERS’ EQUITY   The Corporation’s charter authorizes 1,000,000 shares of preferred stock, no par value. Shares of the preferred stock may be issued from time to time in one or more series, each such series to be so designated as to distinguish the shares from the shares of all other series and classes. The Board of Directors has the authority to divide any or all classes of preferred stock into series and to fix and determine the relative rights and preferences of the shares of any series so established. The Board currently has no intent to issue such preferred stock.   The Corporation’s charter authorizes 5,000,000 shares of common stock at a $.50 par value (after two-for-one stock split). A two-for-one stock split was distributed to shareholders of record on December 31, 2003 resulting in the issuance of 1,230,337 shares of common stock. The stock split increased the number of outstanding shares of Common Stock to 2,460,674 and reduced the par value per share to $0.50. Share data and all relevant portions of the presented financial statements and notes have been adjusted to reflect the stock split.   In January 2000, 1,819,440 common shares were issued at $5.00 per share. In December 2002, 166,656 common shares were issued at $7.50 per share and 34,232 common shares were purchased through the exercise of stock options. In June through August 2003, 437,346 common shares were issued at $9.00 per share and 3,000 common shares were purchased through the exercise of stock options. In March through August 2004, 775,000 common shares were issued at $11.00 per share and 3,000 common shares were purchased through the exercise of stock options. At December 31, 2005, 3,238,674 common shares are outstanding.   F-24        NOTE 16 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION   Condensed financial information of Tennessee Commerce Bancorp, Inc. follows.   CONDENSED BALANCE SHEETS              December 31,         (dollars in thousands)       2005       2004         ASSETS                         Cash and cash   equivalents       $   800       $   227         Investment in banking   subsidiary       33,479       23,373         Interest Receivable       1       —         Other       421       —                                   Total assets       $   34,701       $   23,600                                   LIABILITIES AND EQUITY                         Interest Payable       $   23       $   —                                   Subordinated long term   debt       8,248       —         Shareholders’ equity       26,430       23,600                                   Total liabilities and   equity       $   34,701       $   23,600          CONDENSED STATEMENTS OF INCOME              For Years ended December 31,                 2005       2004       2003                                           Dividend and interest   income       $   12       $   —       —         Interest expense       (416   )   —       —         Non-interest expense       (46   )   (34   )   (8   )                                       Income (loss) before   income tax and undistributed subsidiary income       (450   )   (34   )   (8   )     Income Tax (Expense)   Benefit       173                         Equity in undistributed   subsidiary income       3,344       1,700       907                                           Net income       $   3,067       $   1,666       $   899                       F-25        CONDENSED STATEMENTS OF CASH FLOWS              For Years ended December 31,                 2005       2004       2003         Cash flows from   operating activities                                 Net income       $   3,067       $   1,666       $   899         Adjustments:                                 Change in Other Assets and Liabilities       (150   )   —       —         Equity in undistributed subsidiary income       (3,344   )   (1,700   )   (907   )     Net cash from operating activities       (427   )   (34   )   (8   )                                       Cash flows from   investing activities                                 Investments in subsidiaries       (7,000   )   (8,325   )   (3,957   )     Other assets       (248   )   —       —                                           Net cash from investing activities       (7,248   )   (8,325   )   (3,957   )                                       Cash flows from   financing activities                                 Proceeds from subordinated long term debt       8,248       —       —         Proceeds from stock issue       —       8,525       3,936         Proceeds from exercise of stock options       —       19       21         Net cash from financing activities       8,248       8,544       3,957                                           Net change in cash and   cash equivalents       573       185       (8   )                                       Beginning cash and cash   equivalents       227       42       50                                           Ending cash and cash   equivalents       $   800       $   227       $   42          F-26        NOTE 17 – EARNINGS PER SHARE   The factors used in the earnings per share computation follow.      (dollars in thousands except share data)       2005       2004       2003         Basic                                 Net income       $   3,067       $   1,666       $   899                                           Weighted average common shares outstanding       3,238,674       2,933,818       2,253,928                                           Basic earnings per common share       $   0.95       $   0.57       $   0.40                                           Diluted                                 Net income       $   3,067       $   1,666       $   899                                           Weighted average common shares outstanding for basic   earnings per common share       3,238,674       2,933,818       2,253,928         Add: Dilutive effects of assumed exercises of stock   options       278,734       232,976       125,933                                           Average shares and dilutive potential common shares       3,517,408       3,166,794       2,379,861                                           Diluted earnings per common share       $   0.87       $   0.53       $   0.38                              No options were antidilutive for 2005, 2004 and 2003.   F-27        NOTE 18 – TRUST PREFERRED SECURITIES   In March 2005, the Corporation formed a financing subsidiary, Tennessee Commerce Statutory Trust I, a Delaware statutory trust (the Trust). In March 2005, the Trust issued and sold 8,000 of the Trust’s fixed/floating rate capital securities, with a liquidation amount of $1,000 per capital security, to First Tennessee Bank National Association. The securities pay a fixed rate of 6.73% payable quarterly for the first five years and a floating rate based on a 3 month Libor rate plus 1.98% thereafter. At the same time, the Corporation issued to the Trust $8,248,000 of fixed/floating rate junior subordinated deferrable interest debentures due 2035. The Corporation guarantees the payment of distributions and payments for redemptions or liquidation of the capital securities. The Trust Preferred Securities qualify as “Tier I Capital” under current regulatory definitions subject to certain limitations.   The debentures pay a fixed rate of 6.73% payable quarterly for the first five years and a floating rate based on a 3 month Libor rate plus 1.98% thereafter. The distributions on the capital securities are accounted for as interest expense by the Corporation. Interest payments on the debentures and the corresponding distributions on the capital securities may be deferred at any time at the election of the Corporation for up to 20 consecutive quarterly periods (5 years). The capital securities and debentures are redeemable at any time commencing in 2010 at par. The Corporation will report as liabilities the subordinated debentures issued by the Corporation and held by the Trust.   NOTE 19 – QUARTERLY FINANCIAL RESULTS (UNAUDITED)   A summary of selected consolidated quarterly financial data for the years ended December 31, 2005 and 2004 follows:              First       Second       Third       Fourth         (in thousands except share data)       Quarter       Quarter       Quarter       Quarter         2005                                         Interest income       $   4,673       $   5,548       $   6,373       $   7,039         Net interest income       3,048       3,342       3,606       3,631         Provision for loan   losses       650       1,150       1,000       900         Income before taxes       1,081       1,096       1,272       1,543         Net income       662       621       720       1,064         Basic earnings per   share       $   .20       $   .19       $   .22       $   .34         Diluted earnings per   share       $   .19       $   .18       $   .21       $   .29                                                   2004                                         Interest income       $   2,572       $   2,914       $   3,514       $   4,185         Net interest income       1,728       1,992       2,368       2,832         Provision for loan   losses       480       425       625       890         Income before taxes       410       545       778       1,015         Net income       250       328       473       615         Basic earnings per   share       $   .10       $   .12       $   .15       $   .20         Diluted earnings per   share       $   .10       $   .12       $   .15       $   .16                                     F-28         EX-23.1 2 a06-7703_1ex23d1.htm CONSENTS OF EXPERTS AND COUNSEL       Exhibit 23.1               Crowe Chizek and Company LLC         Member Horwath International      REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM   The Board of Directors Tennessee Commerce Bancorp, Inc. Franklin, Tennessee   We have audited the consolidated balance sheets of Tennessee Commerce Bancorp, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.   We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.   In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Tennessee Commerce Bancorp, Inc. as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles            /s/ Crowe Chizek and Company LLC             Crowe Chizek and Company LLC               Brentwood, Tennessee     March 31, 2005              EX-31.1 3 a06-7703_1ex31d1.htm 302 CERTIFICATION       Exhibit 31.1   TENNESSEE COMMERCE BANCORP, INC. CERTIFICATION – CHAIRMAN AND CHIEF EXECUTIVE OFFICER   I, Arthur F. Helf, certify that:   1.             I have reviewed this annual report on Form 10-K of Tennessee Commerce Bancorp, Inc.   2.             Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;   3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;   4.             The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and we have:   a)             designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and   b)            evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and   c)             disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.   5.             The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):   a)             all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and   b)            any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.      Date: March 28, 2006   Signature:   /s/ Arthur F. Helf             Arthur F. Helf             Chairman and Chief Executive Officer                    EX-31.2 4 a06-7703_1ex31d2.htm 302 CERTIFICATION       Exhibit 31.2   TENNESSEE COMMERCE BANCORP, INC. CERTIFICATION - CHIEF FINANCIAL OFFICER   I, George W. Fort, certify that:   1.             I have reviewed this annual report on Form 10-K of Tennessee Commerce Bancorp, Inc.   2.             Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;   3.             Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;   4.             The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15e and 15d-15e) for the registrant and we have:   a)             designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; and   b)            evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and   c)             disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting.   5.             The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):   a)             all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and   b)            any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.      Date: March 28, 2006   Signature:   /s/ George W. Fort             George W. Fort             Chief Financial Officer                                        EX-32.1 5 a06-7703_1ex32d1.htm 906 CERTIFICATION       Exhibit 32.1   CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002   In connection with the Annual Report of Tennessee Commerce Bancorp, Inc. (the “Corporation”) on Form 10-K for the period ending December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Arthur F. Helf, Chairman and Chief Executive Officer of the Corporation, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:   (1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and   (2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.          /s/ Arthur F. Helf             Arthur F. Helf         Chairman and Chief Executive Officer         Tennessee Commerce Bancorp, Inc.         March 28, 2006              EX-32.2 6 a06-7703_1ex32d2.htm 906 CERTIFICATION       Exhibit 32.2   CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002   In connection with the Annual Report of Tennessee Commerce Bancorp, Inc. (the “Corporation”) on Form 10-K for the period ending December 31, 2005, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, George W. Fort, Chief Financial Officer of the Corporation, certify, pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:   (1)           The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities and Exchange Act of 1934; and   (2)           The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Corporation.          /s/ George W. Fort             George W. Fort         Chief Financial Officer         Tennessee Commerce Bancorp, Inc.         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