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

General

First Bancshares, Inc. (the "Company") is a unitary savings and loan holding company whose primary assets are First Home Savings Bank and SCMG, Inc. The Company was incorporated on September 30, 1993, for the purpose of acquiring all of the capital stock of First Home Savings Bank in connection with Bank's conversion from a state-charted mutual to a state-chartered stock form of ownership. The transaction was completed on December 22, 1993.

On September 30, 2008, the Company had total assets of $244.0 million, net loans receivable of $158.3 million, total deposits of $189.3 million and stockholders' equity of $27.3 million. The Company's common shares trade on The Nasdaq Global Market of The NASDAQ Stock Market LLC under the symbol "FBSI."

The following discussion focuses on the consolidated financial condition of the Company and its subsidiaries, at September 30, 2008, compared to June 30, 2008, and the consolidated results of operations for the three-month period ended September 30, 2008, compared to the three-month period ended September 30, 2007, respectively. This discussion should be read in conjunction with the Company's consolidated financial statements, and notes thereto, for the year ended June 30, 2008.

Recent Developments and Corporate Overview

Recent events in the U.S. and global financial markets, including the deterioration of the worldwide credit markets, have created significant challenges for financial institutions such as First Home Savings Bank. Dramatic declines in the housing market during the past year, marked by falling home prices and increasing levels of mortgage foreclosures, have resulted in significant write-downs of asset values by many financial institutions, including government-sponsored entities and major commercial and investment banks. In addition, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions, as a result of concern about the stability of the financial markets and the strength of counterparties.

In response to the crises affecting the U.S. banking system and financial markets and attempt to bolster the distressed economy and improve consumer confidence in the financial system, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the "Stabilization Act"). The Stabilization Act authorizes the Secretary of the U.S. Treasury and the Federal Deposit Insurance Corporation (the "FDIC") to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system. Pursuant to the Stabilization Act, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.

On October 14, 2008, the U.S. Treasury announced that it will purchase equity stakes in eligible financial institutions that wish to participate. This program, known as the Capital Purchase Program, allocates $250 billion from the $700 billion authorized by the Stabilization Act to the U.S. Treasury for the purchase of senior preferred shares from qualifying financial institutions. Eligible institutions will be able to sell equity interests to the U.S. Treasury in amounts equal to between 1% and 3% of the institution's risk-weighted assets. In conjunction with the purchase of preferred stock, the U.S. Treasury will receive warrants to purchase common stock from the participating institutions with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the U.S. Treasury's standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds equity issued under the Capital Purchase Program. Many financial institutions have already announced that they will participate in the Capital Purchase Program. We have not applied to participate in the Capital Purchase Program.



Also on October 14, 2008, using the systemic risk exception to the FDIC Improvement Act of 1991, the U.S. Treasury authorized the FDIC to provide a 100% guarantee of newly-issued senior unsecured debt and deposits in non-interest bearing accounts at FDIC insured institutions. Initially, all eligible financial institutions will automatically be covered under this program, known as the Temporary Liquidity Guarantee Program, without incurring any fees for a period of 30 days. Coverage under the Temporary Liquidity Guarantee Program after the initial 30-day period is available to insured financial institutions at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for non-interest bearing deposits. After the initial 30-day period, institutions will continue to be covered under the Temporary Liquidity Guarantee Program unless they inform the FDIC that they have decided to opt out of the program. We have determined that we will participate in the insurance program covering the non-interest bearing deposits. Neither the Company nor the Bank have unsecured senior debt.

Under the Troubled Asset Auction Program, another initiative based on the authority granted by the Stabilization Act, the U.S. Treasury, through a newly-created Office of Financial Stability, will purchase certain troubled mortgage-related assets from financial institutions in a reverse-auction format. Troubled assets eligible for purchase by the Office of Financial Stability include residential and commercial mortgages originated on or before March 14, 2008, securities or obligations that are based on such mortgages, and any other financial instrument that the Secretary of the U.S. Treasury determines, after consultation with the Chairman of the Board of Governors of the Federal Reserve System, is necessary to promote financial market stability. The U.S. Treasury has not issued any definitive guidance regarding this program and we have not determined whether or not we will participate.

Under the Stabilization Act, the U.S. Treasury is also required to establish a program that will guarantee principal of, and interest on, troubled assets originated or issued prior to March 14, 2008, including mortgage-backed securities. The program may take any form and may vary by asset class, but it must be voluntary and self-funding. The U.S. Treasury has the authority to set premiums to reflect the credit risk characteristics of the insured assets. The U.S. Treasury has solicited requests for comments on how the program should be structured but no program has been implemented to date. The Stabilization Act also temporarily increases the amount of insurance coverage of deposit accounts held at FDIC-insured depository institutions, including First Home Savings Bank, from $100,000 to $250,000. The increased coverage is effective during the period from October 3, 2008 until December 31, 2009.

It is not clear at this time what impact the Stabilization Act, the Capital Purchase Program, the Temporary Liquidity Guarantee Program, the Troubled Asset Auction Program, other liquidity and funding initiatives of the Federal Reserve and other agencies that have been previously announced, and any additional programs that may be initiated in the future will have on our future financial condition and results of operations.

The preceding is a summary of recently enacted laws and regulations that could materially impact our results of operations or financial condition. This discussion is qualified in its entirety by reference to such laws and regulations and should be read in conjunction with "Regulation of First Home" discussion contained in our 2008 Annual Report on Form 10-K.

The Savings Bank continues to operate under a Memorandum of Understanding (the "MOU") with the Office of Thrift Supervision (the "OTS"). The MOU was entered into during the December 31, 2006 quarter. The MOU resulted from issues noted during the examination of the Savings Bank conducted by the OTS, the report on which was dated in July 2006, and included deficiencies in lending policies and procedures, recent operating losses, and the need to revise both the business plan and the budget to enhance profitability. The corrective actions required to be taken by the Savings Bank under the MOU include, among others:
(1) developing procedures concerning ongoing credit administration and monitoring; (2) continuing to identify, track and correct credit and collateral documentation exceptions and loan policy exceptions; (3) preparing and submitting to the Savings Bank's Board of Directors an accurate and complete loan-to-one borrower report; (4) preparing and



updating, where appropriate, a workout plan for each classified asset over $250,000; (5) adopting a revised loan loss allowance policy; (6) amending the Savings Bank's appraisal policy to require written review of all appraisals prior to final loan approval; (7) adopting a revised loan policy that provides for underwriting guidelines, loan documentation, and credit administration procedures for unsecured loans; (8) either request the consent of the FDIC for the Savings Bank's subsidiary, FYBAR Service Corporation, to hold real estate for investment or approve a plan for divestiture of such investment by June 30, 2007; (9) implementing corrective actions with respect to the previously conducted independent information technology audit; and (10) preparing, adopting and submitting to the OTS a comprehensive three year business plan and budget. The Company believes that the Savings Bank has satisfactorily addressed all of the issues raised by the MOU. During July 2007, the OTS performed an on-site review of the progress made on resolving the issues discussed in the MOU. The Savings Bank did not receive a formal report from the OTS on the results of this review.

Since the end of fiscal 2008, the Company and the Bank have had changes in senior management. On September 23, 2008, as was noted in the Company's Annual Report to the SEC on Form 10-K, filed on September 26, 2008, Adrian C. Rushing, the Bank's Chief Operating Officer, resigned his position to pursue another opportunity. The Bank is in the process of reviewing the position description for the Chief Operating Officer, to determine what, if any, changes should be made, prior to interviewing candidates.

On October 28, 2008, Daniel P. Katzfey, President and Chief Executive Officer of both the Company and the Bank, and a director of both the Company and the Bank, resigned his positions.

The Company appointed Thomas M. Sutherland, Chairman of the Company's and Bank's Boards of Directors, to serve as the interim Chief Executive Officer of the Company and the Bank. Mr. Sutherland has served as Chairman of the Board of the Company's and Bank's Boards of Directors since 2005. In addition, the Company appointed Lannie E. Crawford, a Senior Vice President of the Bank, to serve as interim President of the Company and the Bank. Mr. Crawford joined the Bank in November 2007 and has more than 30 years of experience with financial institutions. The interim appointments of Mr. Sutherland as Chief Executive Officer of the Company and the Bank, and of Mr. Crawford as President of the Company and the Bank, were made permanent at the organizational meeting of the board of the Company and a special board meeting of the Bank on November 6, 2008.

R.J. Breidenthal had been selected to fill the vacancy created on the Boards of Directors of Company and the Bank by Mr. Katzfey's resignation. Mr. Breidenthal has served as an advisory director of the Company and the Bank since December 2006. Mr. Breidenthal serves on the Bank's Loan Committee. Mr. Breidenthal is the first cousin of Thomas M. Sutherland, the Chairman of the Board and Interim Chief Executive Officer of the Company and the Bank.

Financial Condition

As of September 30, 2008, First Bancshares, Inc. had assets of $244.0 million, compared to $249.2 million at June 30, 2008. The decrease in total assets of $5.3 million, or 2.1%, was primarily the result of a decrease in loans receivable of $8.7 million and a decrease in cash and cash equivalents of $518,000. These decreases were partially offset by an increase in securities of $4.3 million during the quarter ended September 30, 2008. In addition, the Company experienced decreases in deposits and retail repurchase agreements of $5.3 million and $275,000, respectively, during the quarter. At September 30, 2008, there were $635,000 in loans originated for sale which were not yet funded by the purchasers. Advances from the Federal Home Loan Bank of Des Moines remained constant during the quarter.

Loans receivable, net totaled $158.3 million at September 30, 2008, a decrease of $8.7 million from $167.0 million at June 30. 2008. The decrease in loans is the result of a decrease in loan originations for all types of loans during the quarter ended September 30, 2008, and an effort by management to encourage certain borrowers, whose financial status did not meet the Company's current requirements, to move their loans to other lenders. The



level of uncertainty in the economy, both locally and nationally, initially brought about by problems in the sub-prime mortgage market, increased during the quarter. Measurements of economic health such as housing sales, both new and existing, consumer confidence and others have deteriorated over the last several months. There remain opportunities for new lending primarily as a result of the lower interest rate environment and the fact that the Company's primary market area for loans, namely Springfield, Missouri, has remained relatively strong. Management, however, has decided to be less aggressive in its attempts to attract new borrowers.

The Company's deposits decreased by $5.3 million from $194.6 million at June 30, 2008 to $189.3 million at September 30, 2008. The decrease in deposits is the result of the Company taking a conservative stance in the interest rates being offered on its deposit products. While we continue to offer competitive products and specials, as to rates and terms, on certificates of deposit, we generally price our products at or below the mid-point among the institutions with whom we compete. The balance of the Company's retail repurchase agreements, first introduced during fiscal 2007, decreased by $275,000 from $4.6 million at June 30, 2008 to $4.4 million at September 30, 2008.

As of September 30, 2008 the Company's stockholders' equity totaled $27.3 million, compared to $27.1 million as of June 30, 2008. The increase of $204,000 was due to net income of $245,000 during the first three months of the fiscal year and a positive change in the unrealized gain on available-for-sale securities, net of taxes, of $101,000 on the Company's available for sale securities portfolio. In addition, there was a $13,000 increase resulting from the accounting treatment of stock based compensation. There was a dividend of $0.10 per share of common stock, which totaled $155,000, paid during the quarter ended September 30, 2008 and, although the Company currently has a stock repurchase program in place, no shares of common stock were purchased during the quarter.

Non-performing Assets and Allowance for Loan Losses

Generally, when a loan becomes delinquent 90 days or more, or when the collection of principal or interest becomes doubtful, the Company will place the loan on non-accrual status and, as a result of this action, previously accrued interest income on the loan is reversed against current income. The loan will remain on non-accrual status until the loan has been brought current or until other circumstances occur that provide adequate assurance of full repayment of interest and principal.

Non-performing assets increased from $3.9 million, or 1.6% of total assets, at June 30, 2008 to $5.4 million, or 2.2% of total assets at September 30, 2008. The Bank's non-performing assets consist of non-accrual loans, past due loans over 90 days, impaired loans not past due or past due less than 60 days, real estate owned and other repossessed assets. The increase in non-performing assets consisted of an increase of $542,000 in non-accrual loans, an increase of $734,000 in loans 90 days or more delinquent and still accruing interest, and an increase of $222,000 in real estate owned and other repossessed assets. The increase in non-accrual loans consisted of increases of $328,000 in non-accrual residential mortgages, $529,000 in non-accrual land loans, $163,000 in non-accrual second mortgages, $290,000 in non-accrual commercial business loans and $33,000 in non-accrual consumer loans. These increases were partially offset by a decrease of $800,000 in non-accrual commercial real estate loans. There were three loans totaling $360,000 past due 90 days or more and still accruing at June 30, 2008. All three became non-accrual loans during the quarter ended September 30, 2008. At September 30, 2008, loans 90 days past due and still accruing consisted of $337,000 in residential mortgages, $336,000 in commercial real estate loans, $406,000 in commercial business loans and $14,000 in consumer loans. Almost all of the loans that were moved to non-accrual or became 90 days or more delinquent and still accruing as of September 30, 2008, were loans that had been on the Company's list of watch credits as of June 30, 2008. The increase in non-performing assets is primarily the result of the current economic crisis which has negatively impacted individuals and businesses in the Company's primary market areas. As discussed below, management believes the allowance for loan losses as of September 30, 2008, was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date.

As of June 30, 2008, there were twelve foreclosed properties held for sale totaling $1.2 million. During the quarter ended September 30, 2008 two properties with a book value of $65,000 were sold resulting in a gain of $6,000, and six properties totaling $295,000 were foreclosed and added to real estate owned. At September 30, 2008, there were sixteen foreclosed properties held for sale totaling $1.4 million.

Classified assets. Federal regulations provide for the classification of loans and other assets as "substandard", "doubtful" or "loss", based on the level of weakness determined to be inherent in the collection of the principal and interest. When loans are classified as either substandard or doubtful, the Company may establish general allowances for loan losses in an amount deemed prudent by management. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem loans. When assets are classified as loss, the Company is required either to establish a specific allowance for loan losses equal to 100% of that portion of the loan so classified, or to charge-off such amount. The Company's determination as to the classification of its loans and the amount of its allowances for loan losses are subject to review by its regulatory authorities, which may require the establishment of additional general or specific allowances for loan losses.

On the basis of management's review of its loans and other assets, at September 30, 2008, the Company had classified $4.7 million of its assets as substandard, $876,000 as doubtful and none as loss. This compares to classifications at June 30, 2008 of $5.1 million substandard, $718,000 doubtful and none as loss. This reduction in classified loans to $5.5 million from $5.8 million is the result of transfers to real estate owned and other repossessed assets of loans totaling $295,000 and to loan write-offs of $40,000 during the three month period. In addition, classified assets at September 30, 2008 and June 30, 2008 included real estate owned and other repossessed assets of $1.4 million and $1.2 million, respectively.

In addition to the classified loans, the Bank has identified an additional $6.0 million of credits at September 30, 2008 on its internal watch list compared to $4.8 million at June 30, 2008. Management has identified these loans as high risk credits and any deterioration in their financial condition could increase the classified loan totals. The increase in the internal watch list is primarily the result of the current state of the economy which had a negative impact on cash flows for both individuals and businesses. This, along with stricter internal policies, which have been in place during the last year, relating to the identification and monitoring of problem loans, has resulted in an increase in the number and the total dollar amount of loans identified as problem loans. During the three months ended September 30, 2008, twelve loans totaling $858,000 were removed from the watch list as a result the resolution of the reasons they were on the watch list.

Allowance for loan losses. The Company establishes its provision for loan losses, and evaluates the adequacy of its allowance for loan losses based upon a systematic methodology consisting of a number of factors including, among others, historic loss experience, the overall level of classified assets and non-performing loans, the composition of its loan portfolio and the general economic environment within which the Bank and its borrowers operate.

At September 30, 2008, the Company has established an allowance for loan losses of $2.9 million compared to $2.8 million at June 30, 2008. The allowance represents approximately 73.1% and 103.9% of the total non- performing loans at September 30, 2008 and June 30, 2008, respectively.

The allowance for loan losses reflects management's best estimate of probable losses inherent in the portfolio based on currently available information. The Company believes that the allowance for loan losses as of September 30, 2008 was adequate to absorb the known and inherent risks of loss in the loan portfolio at that date. While the Company believes the estimates and assumptions used in the determination of the adequacy of the allowance are reasonable, there can be no assurance that such estimates and assumptions will not be proven incorrect in the future, or that the actual amount of future provisions will not exceed the amount of past provisions or that any increased provisions that may be required will not adversely impact the Company's financial condition and results of operations. Future additions to the allowance may become necessary based upon changing economic conditions,



increased loan balances or changes in the underlying collateral of the loan portfolio. In addition, the determination of the amount of the Bank's allowance for loan losses is subject to review by bank regulators as part of the routine examination process, which may result in the establishment of additional reserves based upon their judgment of information available to them at the time of their examination.

Critical Accounting Policies

The Company's financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. The financial information contained within these statements is, to a significant extent, financial information that is based on approximate measures of the financial effects of transactions and events that have already occurred. Based on its consideration of accounting policies that involve the most complex and subjective decisions and assessments, management has identified its most critical accounting policy to be the policy related to the allowance for loan losses.

The Company's allowance for loan loss methodology incorporates a variety of risk considerations, both quantitative and qualitative, in establishing an allowance for loan loss that management believes is appropriate at each reporting date. Quantitative factors include the Company's historical loss experience, delinquency and charge-off trends, collateral values, changes in non-performing loans, and other factors. Quantitative factors also incorporate known information about individual loans, including borrowers' sensitivity to interest rate movements. Qualitative factors include the general economic environment in the Company's markets, including economic conditions throughout the Midwest and, in particular, the state of certain industries. Size and complexity of individual credits in relation to loan structure, existing loan policies, and pace of portfolio growth are other qualitative factors that are considered in the methodology. As the Company adds new products and increases the complexity of its loan portfolio it will enhance its methodology accordingly. Management may have reported a materially different amount for the provision for loan losses in the statement of operations to change the allowance for loan losses if its assessment of the above factors were different. This discussion and analysis should be read in conjunction with the Company's financial statements and the accompanying notes presented elsewhere herein, as well as the portion of this Management's Discussion and Analysis section entitled "Non-performing Assets and Allowance for Loan Losses." Although management believes the levels of the allowance as of September 30, 2008 and June 30, 2008 was adequate to absorb probable losses inherent in the loan portfolio, a decline in local economic conditions, or other factors, could result in increasing losses.

Results of Operations for the Three Months Ended September 30, 2008 Compared to the Three Months Ended September 30, 2007

General. For the three months ended September 30, 2008, the Company had net income of $245,000, or $0.16 diluted share, compared to net income of $225,000, or $0.15 per diluted share, for the same period in 2007. The increase in net income for the 2008 period included an increase in net interest income which was substantially offset by a decrease in non-interest income, and increases in the provision for loan losses, non-interest expense and income taxes.

Net interest income. The Company's net interest income for the three months ended September 30, 2008 was $1.9 million, compared to $1.7 million for the same period in 2007. The increase in net interest income reflects a $565,000 decrease in interest expense which was partially offset by a $328,000 decrease in interest income.

Interest income. Interest income for the three months ended September 30, 2008 decreased $328,000, or 8.8%, to $3.4 million compared to $3.7 million for the same period in 2007. Interest income from loans decreased $223,000 to $2.7 million from $3.0 million in 2007. This was attributable to a decrease in the yield on loans to 6.68% during the three months ended September 30, 2008 from 7.44% during the comparable period in 2007 which was partially offset by an increase in average loans to $162.1 million during the 2008 period from $157.4 million during the comparable 2007 period. The increase in average loans was the result of an increase in lending volume during the last three quarters of fiscal 2008, although the net loan portfolio shrank by $8.7 million during



the quarter ended September 30, 2008. The decrease in yield was the result of a downward trend in interest rates between the two periods, including several reductions in prime rate, which is the base from which many of our loan products are priced.

Interest income from investment securities and other interest-earning assets for the three months ended September 30, 2008 decreased $105,000 to $686,000 from $791,000 for the same period in 2007. The decrease was the result of a decrease in the yield on these assets to 4.32% for the 2008 period from 4.85% for the 2007 period and by a decrease in the average balance of these assets of $1.5 million to $63.1 million for the quarter ended September 30, 2008 from $64.6 million for the same period in 2007.

Interest expense. Interest expense for the three months ended September 30, 2008 decreased $565,000 or 27.3%, to $1.5 million from $2.1 million for the same period in 2007. Interest expense on deposits decreased $575,000 to $1.2 million in the three months ended September 30, 2008 from $1.7 million in the same period in 2007. The decrease resulted from a decrease in the average cost of deposits to 2.57% in the 2008 period from 3.83% in the 2007 period, and by a decrease in average interest-bearing deposit balances of $1.1 million to . . .