PCBN Piedmont Community Bank Group Inc (CE)

The following is our discussion and analysis of certain significant factors which have affected the Company’s financial position and operating results during the periods included in the accompanying consolidated financial statements.

Forward Looking Statements

Certain of the statements made herein are forward-looking statements for purposes of the Securities Act of 1933 (the “Securities Act”) and the Securities Exchange Act of 1934 (the “Exchange Act”), and as such may involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. Such forward looking statements include statements using the words such as “may,” “will,” “anticipate,” “should,” “would,” “believe,” “contemplate,” “expect,” “estimate,” “continue,” or “intend,” or other similar words and expressions of the future. Our actual results may differ significantly from the results we discuss in these forward-looking statements.

These forward-looking statements involve risks and uncertainties and may not be realized due to a variety of factors, including, without limitation:

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Introduction

Through our bank subsidiary we perform banking services customary for full service banks of similar size and character. The Bank offers personal and business checking accounts, interest-bearing checking accounts, savings accounts and various types of certificates of deposit. The Bank also offers commercial loans, installment and other consumer loans, home equity loans, home equity lines of credit, construction loans and mortgage loans. In addition, the Bank provides such services as official bank checks and traveler’s checks, direct deposit and United States Savings Bonds. The Bank provides other customary banking services including ATM services, safe deposit facilities, internet banking, money transfers, and individual retirement accounts.

Overview

Management continuously monitors our financial condition in order to protect depositors, increase undivided profits and protect current and future earnings. Further discussion of significant items affecting our financial condition is discussed in detail below.

Critical Accounting Policies

We have adopted various accounting policies which govern the application of accounting principles generally accepted in the United States of America in the preparation of our consolidated financial statements. Our significant accounting policies are described in the footnotes to the consolidated financial statements at December 31, 2006 as filed in our annual report on Form 10-KSB.

Certain accounting policies involve significant judgments and assumptions by us which have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgments and assumptions we make, actual results could differ from these judgments and estimates which could have a material impact on our carrying values of assets and liabilities and our results of operations.

We believe the allowance for loan losses is a critical accounting policy that requires the most significant judgments and estimates used in preparation of our consolidated financial statements. Refer to the portion of this discussion that addresses asset quality for a description of our processes and methodology for determining our allowance for loan losses.

Asset Quality

A major key to long-term earnings growth is the maintenance of a high-quality loan portfolio. Our directive in this regard is carried out through our policies and procedures for extending credit to our customers. The goal and result of these policies and procedures is to provide a sound basis for new credit extensions and an early recognition of problem assets to allow the most flexibility in their timely disposition. Additions to the allowance for loan losses will be made periodically to maintain the allowance at an appropriate level based upon management’s analysis of potential risk in the loan portfolio. The amount of the allowance for loan losses is determined by an evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, the amount of actual losses charged to the allowance in a given period, and assessment of present economic conditions.

The allowance for loan losses increased by $134,600 and $452,600 for the third quarter and the first nine months of 2007, respectively as compared to an increase of $57,483 and $234,323 for the third quarter and the first nine months of 2006, respectively. The amounts provided are due primarily to loan growth and our assessment of inherent risk in the loan portfolio. The allowance for loan losses as a percentage of total loans was 1.05% and 1.04% at September 30, 2007 and December 31, 2006, respectively. Based upon our evaluation of the loan portfolio, we believe the allowance for loan losses to be adequate to absorb losses on existing loans that may become uncollectible.

The allowance for loan losses is established and adjusted through a provision for loan losses charged to expense. Loan losses are charged against the allowance when management believes the collectibility of the principal is unlikely. Subsequent recoveries are credited to the allowance.

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The allowance is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectibility of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, concentrations and current economic conditions that may affect the borrower’s ability to pay. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses, and may require us to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

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

Information with respect to nonaccrual, past due and restructured loans is as follows:

Potential problem loans are defined as loans about which we have serious doubts as to the ability of the borrower to comply with the present loan repayment terms and which may cause the loan to be placed on nonaccrual status, to become past due more than ninety days, or to be restructured. Two relationships were added to potential problems loans in the third quarter of 2007.

It is our policy to discontinue the accrual of interest income when, in the opinion of management, collection of interest becomes doubtful. We will generally discontinue the accrual of interest when (1) there is a significant deterioration in the financial condition of the borrower and full repayment of principal and interest is not expected and (2) the principal or interest is more than ninety days past due, unless the loan is both well-secured and in the process of collection.

Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been included in the table above do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity or capital resources. These classified loans do not 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.

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Information regarding certain loans and allowance for loan loss data is as follows:

Liquidity and Capital Resources

Liquidity management involves the matching of the cash flow requirements of customers, who may be either depositors desiring to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs, and our ability to meet those needs. We strive to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-bearing liabilities so that the balance we have in short-term investments at any given time will adequately cover any reasonably anticipated immediate need for funds. Additionally, we maintain relationships with correspondent banks, which could provide funds to the Bank on short notice, if needed.

Our liquidity and capital resources are monitored daily by management and on a periodic basis by state and federal regulatory authorities. As determined under guidelines established by these regulatory authorities, our liquidity ratio at September 30, 2007 was considered satisfactory. At that date, our short-term investments and available Federal Funding were adequate to cover any reasonably anticipated immediate need for funds. At September 30, 2007, we had unused available Federal Fund lines of $12,500,000 and unused Federal Home Loan Bank borrowing capacity of approximately $1,530,000.

Our consolidated financial statements, as of September 30, 2007, evidenced a decrease in liquidity position as total cash and due from banks amounted to $1,382,000 representing 0.73% of total assets as compared to 1.18% as of December 31, 2006. Investment securities available for sale amounted to $10,002,000 and interest bearing deposits in banks amounted to $2,933,000, representing 5.27% and 1.55% of total assets, respectively. These securities provide a secondary source of liquidity since they can be converted into cash in a timely manner.

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Our ability to maintain and expand our deposit base and borrowing capabilities is a source of liquidity. For the nine-month period ended September 30, 2007, total deposits increased from $112.1 million at December 31, 2006 to $158.4 million at September 30, 2007. Of this total, however, approximately $78.5 million, or 49.6%, represent time deposits that are scheduled to mature within one year. Furthermore, we intend to continue to rely heavily on short-term time deposits as a primary source of funding for the foreseeable future. If we are unable to offer a competitive rate as these deposits mature, we could lose a substantial amount of deposits within a short period of time, which would strain our liquidity. While we consider this scenario to be unlikely, our net interest income and profitability would be negatively affected if we have to increase rates to maintain deposits.

Management is committed to maintaining capital at a level sufficient to protect depositors, provide for reasonable growth, and fully comply with all regulatory requirements. Our capital ratios have declined over the last couple of years largely because of our rapid growth. We have filed a registration statement with the Securities and Exchange Commission for an offering of up to $6 million in common stock. We expect that our capital ratios will improve as proceeds from this offering are collected and will then decline as these proceeds are invested in loans or used to expand our branch network. If we are successful in implementing our expansion program, we expect our profitability to increase, which would improve our capital position. The table below illustrates our bank’s regulatory capital ratios at September 30, 2007.

Off-Balance Sheet Risk

We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amount recognized in the balance sheets.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. A summary of our commitments is as follows:

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. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the customer.

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

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Financial Condition

Our total assets grew by 34.50% for the first nine months of 2007. Deposit growth of $46.3 million and additional FHLB borrowings of $4 million were used to fund net loan growth of $42.3 million and the increase in total securities of $5.5 million. Loan demand continues to be strong in our primary market areas of Jones, Baldwin, Bibb, Monroe, Houston, Greene and Putnam counties. Our loan to deposit ratio has decreased from 106.1% as of December 31, 2006 to approximately 101.7% as of September 30, 2007 as our deposit growth outpaced our loan growth during the first nine months of the year. Stockholders’ equity has increased by $743,000 due to net income of $521,000, recognition of stock based employee compensation cost of $208,000, and the decrease in unrealized losses on investment securities of $14,000.

Results of Operations For The Three and Nine Months Ended September 30, 2007 and 2006

Net Interest Income

Our profitability is determined by our ability to effectively manage interest income and expense, to minimize loan and security losses, to generate noninterest income, and to control operating expenses. Because interest rates are determined by market forces and economic conditions beyond our control, our ability to generate net interest income depends upon our ability to obtain an adequate net interest spread between the rate paid on interest-bearing liabilities and the rate earned on interest-earning assets. The increase in net interest income is due primarily to the increased volume of average loans outstanding. Our net interest margin was 3.50% for the nine months ended September 30, 2007, compared to 3.81% for the same period in 2006, a decrease of 31 basis points. Our yield on interest-earning assets was 8.19% for the first nine months of 2007 as compared to 7.75% for the first nine months of 2006, an increase of 44 basis points. Our cost of funds increased to 4.98% for the first nine months of 2007 as compared to 4.40% for the first nine months of 2006, an increase of 58 basis points. We continue to experience growth in loans and deposits while maintaining relatively competitive pricing.

Provisions for Loan Losses

The allowance for loan losses increased $452,600 from $1,235,044 as of December 31, 2006 to $1,687,644 as of September 30, 2007. The increase is due to provisions recorded in the first nine months of 2007, primarily as a result of the increase in loan volume. There were no charge-offs or recoveries in the first nine months of 2007.

Noninterest Income

Noninterest income decreased by approximately $14,000 and $89,000 for the third quarter and the first nine months of 2007, respectively, as compared to the same periods in 2006. Decreases in mortgage origination income accounted for the majority of the quarter and year-to-date decreases in noninterest income and was due to a slowdown in the residential housing market during the first nine months of 2007. The increase in other components of noninterest income is attributable to our overall growth in deposits and branch expansion.

Noninterest Expenses

Noninterest expenses increased by approximately $320,000 or 40.35% for the third quarter of 2007 compared to the same period in 2006. The increase is due largely to an increase in salaries and employee benefits expense of $141,000 associated with the opening of the Bass Road, Forsyth Road and Lake Oconee locations and normal increases in salaries and benefits. Net equipment and occupancy expenses and other operating expense increased $14,000 and $165,000, respectively, for the three month period due to opening new branches. Noninterest expenses increased by $945,000 or 44.95% for the nine months ended September 30, 2007 compared to the same period in 2006. The increase consists of increases in salaries and employee benefits expense of $420,000, net occupancy and equipment expenses of $95,000 and other operating expenses of $430,000. The salary and employee benefit increases were due to an increase in the number of full time equivalent employees which increased from 25 at September 30, 2006 to 36 at September 30, 2007, in addition to normal increases in salaries and benefits. The increases in other operating expenses were primarily attributable to growth and expenses related to the opening of our new branches in the past year.

Income Taxes

We have recorded a provision for income taxes of $153,000 and $388,000 for the three and nine months ended September 30, 2007, respectively. This represents 39.9% and 42.7% of income before provision for income taxes for the three and nine months ended September 30, 2007, respectively. The comparable effective tax rates for the same periods in 2006 were 31.3% and 32.6%, respectively. The increase in the effective tax rate and provision for income taxes for the nine months ended September 30, 2007 includes an adjustment of $32,945 related to the prior year.

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Regulatory Matters

From time to time, various bills are introduced in the United States Congress with respect to the regulation of financial institutions. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. We cannot predict whether any of these proposals will be adopted or, if adopted, how these proposals would affect us.

We are not aware of any current recommendation by our regulatory authorities which, if implemented, would have a material effect on our liquidity, capital resources, or results of operations.

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