This discussion is intended to present a review of the major factors affecting the financial condition of Britton & Koontz Capital Corporation (the "Company") and its wholly-owned subsidiary, Britton & Koontz Bank, N.A. (the "Bank"), as of September 30, 2008, as compared to the Company's financial condition as of December 31, 2007, and the results of operations of the Company for the three and nine month periods ended September 30, 2008, as compared to the corresponding periods of 2007.

SUMMARY

The Company's net income for the three months ended September 30, 2008, decreased to $943 thousand, or $.45 per diluted share, compared to $1.0 million, or $.47 per diluted share, for the quarter ended September 30, 2007. For the nine month period ended September 30, 2008, net income and earnings per share were $2.6 million and $1.25 per diluted share, respectively, compared to $2.0 million and $0.96 per diluted share, respectively, for the same period in 2007. The lower quarterly and increased year-to-date earnings compared to 2007 were primarily the result of adjustments made in 2007 in the Company's trading investment portfolio and losses on the sale of approximately $35 million in its available-for-sale investment securities in 2007.

The Company's net interest income increased in both the quarterly and year-to-date comparisons. The lower interest rate environment in 2008 played a significant role in this improvement as the decline in funding costs outweighed the decline in asset yields.

Total assets increased $19.2 million from $368.3 million at December 31, 2007 to $387.5 million at September 30, 2008. The increase in total assets is primarily due to increases in the investment portfolio of $21.6 million offset by $1.9 million in reductions in the loan portfolio. Cash and due from banks decreased to $7.2 million at September 30, 2008, from $8.7 million at December 31, 2007. Other real estate owned increased $643 thousand over the same period due primarily to the foreclosure of two 1-4 residential mortgage loans. Since December 31, 2007, total deposits have decreased $9.3 million to $237.0 million at September 30, 2008, while borrowings have increased $28.0 million over the same period primarily to cover the purchase of investment securities. Total stockholders' equity increased $1.1 million to $36.9 million at September 30, 2008 from $35.8 million at December 31, 2007.

Overall asset quality for the Company at September 30, 2008, deteriorated slightly compared to December 31, 2007. The ratio of non-performing assets to loans and foreclosed real estate increased to 1.61% at September 30, 2008, as compared to .92% at December 31, 2007, but this ratio decreased from 1.86% at June 30, 2008.

Financial Condition

Investment Securities

The Company's investment securities portfolio at September 30, 2008, primarily consists of mortgage-backed and municipal securities. Investment securities that are deemed to be held-to-maturity are accounted for by the amortized cost method while securities in the available-for-sale category are accounted for at fair value with valuation adjustments recorded in the equity section through other comprehensive income/ (loss).

Management determines the classification of its securities at acquisition. Total held-to-maturity and available-for-sale investment securities were $144.7 million at September 30, 2008, representing an increase of $21.6 million since December 31, 2007. The increase in securities resulted from investing public demand deposits received after a successful bid on local county deposits. Additionally, the improved securities market during the first nine months of 2008 allowed the Company to prefund future cash flows that are expected from the current portfolio. Under its prefunding strategy, the Company obtains short-term funding, typically from the Federal Home Loan Bank ("FHLB"), to acquire investment securities and then uses the cash flows generated by such securities in the subsequent one to two quarters to repay the short-term funding. The Company employs this prefunding strategy from time to time to take advantage of favorable interest rate spreads between the short-term funding and the investment securities purchased with such funding. Equity securities increased $839 thousand due to the purchase of FHLB stock by the Company which was required due to the increase in FHLB borrowings in connection with the above described prefunding strategy. Equity securities are comprised primarily of Federal Reserve Bank stock of $522 thousand, FHLB stock of $2.5 million, the Company's investment in its statutory trust of $155 thousand and ECD Investments, LLC membership interests of $99 thousand.

The amortized cost of the Bank's investment securities at September 30, 2008, and December 31, 2007, are summarized below.

COMPOSITION OF INVESTMENT PORTFOLIO (Amortized Cost)

                               09/30/08          12/31/07
Mortgage-Backed Securities   $ 106,354,026     $  84,741,030
Obligations of State and
Political Subdivisions          38,473,898        38,004,634
       Total                 $ 144,827,924     $ 122,745,664

Loans

Gross loans decreased $1.9 million during the first nine months of 2008. Increases in loans of $8.2 million in the Company's Baton Rouge, Louisiana market partially offset a decrease in loans of $4.1 million in the Company's Vicksburg, Mississippi market and a decrease of $6.0 million in loans in the Company's Natchez, Mississippi market. Further declines are expected to occur in the residential real estate portfolio, primarily in the Natchez market, as management plans to replace cash flows from these loans with higher yielding commercial loans. Given the current weak demand for commercial loans in the Natchez and Vicksburg markets, the Baton Rouge market provides our greatest opportunity for commercial lending. Although management has been implementing this shift from residential real estate loans to commercial real estate loans for some time and believes that loan yield should improve in the process, it is aware that this transition will place pressure on loan volumes and in fact total loan volumes may continue to decline during the remainder of the year.

The ratio of net loans to total assets decreased to 56.6% at September 30, 2008, compared to 60.0% at December 31, 2007. At September 30, 2008, the loan to deposit ratio was 92.5% compared to 89.7% at December 31, 2007. The following table presents the Bank's loan portfolio composition at September 30, 2008, and December 31, 2007.

COMPOSITION OF LOAN PORTFOLIO
                                         09/30/08          12/31/07
Commercial, financial & agricultural   $  24,859,000     $  25,884,000
Real estate-construction                  19,513,000        19,908,000
Real estate-1-4 family residential        62,890,000        68,041,000
Real estate-other                        107,282,000       101,709,000
Installment                                6,501,000         7,550,000
Other                                        449,000           261,000
Total loans                            $ 221,494,000     $ 223,353,000

The Company's loan portfolio at September 30, 2008, had no significant concentrations of loans other than in the categories presented in the table above.

Bank Premises

There have been no material changes in the Company's premises since year-end.

Asset Quality

Non-performing assets ("NPA's"), which include non-accrual loans, loans 90 days or more delinquent and foreclosed other real estate, increased $1.5 million to $3.6 million at September 30, 2008, from $2.1 million at December 31, 2007. Non-accrual loans increased $270 thousand due to one relationship totaling $205 thousand being classified as non-accrual in the second quarter of 2008. The increase of $591 thousand in loans 90 days or more delinquent is due primarily to one commercial relationship in the amount of $400 thousand which was renewed to a current status and termed out after the end of the quarter. Although accrued interest on loans 90 days or more delinquent is included in income, management does not believe that any reclassification of these loans to non-accrual status will have a material impact on the Company's interest income. Foreclosed other real estate increased $643 thousand due primarily to the foreclosure on two 1-4 family residential properties valued at approximately $830 thousand. Management has signed a contract to sell one of these properties for $418 thousand by the end of November.

The ratio of non-performing loans to net loans increased to .98% at September 30, 2008, from .59% at December 31, 2007. While the ratio for the nine months ended September 30, 2008, increased compared to the end of 2007, the ratio declined from 1.68% at June 30, 2008 primarily due to decreases in non-accrual loans. Even though there has been some increase in NPA's during the year, overall asset quality issues remain at acceptable levels. The Company believes that its portfolio management process, including its underwriting standards and early involvement in problem loans, will allow it to identify in a timely manner any further weakening of asset quality during the current economic downturn.

A breakdown of nonperforming assets at September 30, 2008, and December 31, 2007, is shown below.

BREAKDOWN OF NONPERFORMING ASSETS
                                                                     09/30/08        12/31/07
                                                                     (dollars in thousands)
Non-accrual loans by type:
Real estate                                                        $      1,493     $      992
Installment                                                                  79             87
Commercial and all other loans                                                0            223
Total non-accrual loans                                                   1,572          1,302
Loans past due 90 days or more                                              603             12
Total nonperforming loans                                                 2,175          1,314
Other real estate owned (net)                                             1,390            747
Total nonperforming assets                                         $      3,565     $    2,061
Nonperforming loans as a percent of loans, net of unearned
interest and loans held for sale                                            .98 %          .59 %

Allowance for Possible Loan Losses

The allowance for loan losses is established as losses are estimated through a provision for loan losses charged against operations and is maintained at a level that management considers adequate to absorb losses in the loan portfolio. The allowance is subject to change as management reevaluates the adequacy of the allowance. Management's judgment in determining the adequacy of the allowance is inherently subjective and is based on the evaluation of individual loans, the known and inherent risk characteristics and size of the loan portfolios, the assessment of current economic and real estate market conditions, estimates of the current value of underlying collateral, past loan loss experience, review of regulatory authority examination reports and evaluations of specific loans and other relevant factors. Each loan is assigned a risk rating between one and nine with a rating of "one" being the least risk and a rating of "nine" reflecting the most risk or a complete loss. Risk ratings are assigned by the originating loan officer or loan committee at the initiation of the transactions and are reviewed and changed, when necessary, during the life of the loan.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are considered impaired. Loan loss reserve factors are multiplied against the balances in each risk rating category to arrive at the appropriate level for the allowance for loan losses. Loans assigned a risk rating of "five" or above are monitored more closely by management. The general component of the allowance for loan losses groups loans with similar characteristics and allocates a percentage based upon historical losses and the inherent risks within each category. The unallocated portion of the allowance reflects management's estimate of probable but undetected losses inherent in the portfolio; such estimates are influenced by uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition, difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. The methodology for determining the adequacy of the allowance for loan losses is consistently applied; however, revisions may be made to the methodology and assumptions based on historical information related to charge-off and recovery experience and management's evaluation of the current loan portfolio.

Based upon this evaluation, management believes the allowance for loan losses of $2.3 million at September 30, 2008, which represents 1.03% of gross loans held to maturity, is adequate under prevailing economic conditions, to absorb probable losses on existing loans. At September 30, 2008, total reserves included specific reserves of $524 thousand, general reserves of $1.1 million and unallocated economic reserves of $680 thousand. At December 31, 2007, the allowance for loan loss was $2.4 million, or 1.09% of gross loans held to maturity.

The provision for possible loan losses is a charge to earnings to maintain the allowance for possible loan losses at a level consistent with management's assessment of the loan portfolio in light of current and expected economic conditions. During the nine month period ended September 30, 2008, the Company's provision for loan losses increased by $40 thousand to $360 thousand compared to the same period in 2007. This increase is in response to higher net charge-offs during the nine months ended September 30, 2008, compared to the same period in 2007. Net charge-offs during 2008 amounted to $499 thousand compared to $174 thousand in 2007.

The Company regularly reviews the allowance in an effort to maintain it at an adequate level and provide necessary data to maintain a proper provision expense to earnings. Based upon this evaluation, and considering the net charge-offs in the first nine months and possible charge-offs in the fourth quarter of 2008, management currently intends to maintain the provision for possible loan losses at $40 thousand per month for the remainder of the year but will consider increasing the provision as necessary to address increases in NPA's in the 4th quarter. The following table details allowance activity for the nine months ended September 30, 2008, and September 30, 2007.

ACTIVITY OF ALLOWANCE FOR POSSIBLE LOAN LOSSES


                                                                     09/30/08        09/30/07
                                                                     (dollars in thousands)
Balance at beginning of period                                     $      2,431     $    2,344
Charge-offs:
Real Estate                                                                (474 )         (121 )
Commercial                                                                 (303 )          (87 )
Installment and other                                                       (34 )          (42 )
Recoveries:
Real Estate                                                                  19              4
Commercial                                                                  221             40
Installment and other                                                        72             32
Net (charge-offs)/recoveries                                               (499 )         (174 )
Provision charged to operations                                             360            320
Balance at end of period                                           $      2,292     $    2,490
Allowance for loan losses as a percent of loans, net of unearned
interest & loans held for sale                                             1.03 %         1.06 %
Net charge-offs as a percent of average loans                               .22 %          .07 %

Potential Problem Loans

At September 30, 2008, the Company had no loans, other than those identified with reserves set aside and balances incorporated in the above tables, which management had significant doubts as to the ability of the borrower to comply with current repayment terms.

Deposits

Total deposits decreased $9.3 million from $246.4 million at December 31, 2007, to $237.0 million at September 30, 2008. The decrease in deposits is due primarily to the intentional decrease of brokered and higher cost jumbo wholesale deposits. The Company from time to time uses the brokered certificate of deposit market as an asset liability management tool. These deposits are generally gathered to position the Bank's funding more in line with asset maturities and to lock in fixed rates to help manage net interest income. As interest rates fell in 2008, the Company decided to use other means of funding such as FHLB borrowings.

COMPOSITION OF DEPOSITS

                                  09/30/08          12/31/07
Non-Interest Bearing            $  48,712,324     $  47,305,927
NOW Accounts                       26,807,302        24,056,081
Money Market Deposit Accounts      33,571,219        34,449,399
Savings Accounts                   17,590,332        17,310,284
Certificates of Deposit           110,367,115       123,272,459
Total Deposits                  $ 237,048,292     $ 246,394,150

Borrowings

Total bank borrowings, including FHLB advances, federal funds purchased and customer repurchase agreements, increased $28.0 million from $77.4 million at December 31, 2007, to $105.4 million at September 30, 2008. The majority of the increase was the result of the Company increasing its FHLB advances to finance the purchase of additional investment securities, as described earlier. Included in the increase were the Company's customer repurchase agreements which grew $2.1 million. Because of the nature of these agreements made with customers, the Bank must include these liabilities as borrowings rather than local customer deposits. These contracts are primarily made with local customers to sweep overnight funds from their deposit accounts. Management believes these accounts perform more like core deposits rather than wholesale borrowings.

Capital

Stockholders' equity totaled $36.9 million at September 30, 2008, compared to $35.8 million at December 31, 2007. The Company posted earnings of $2.6 million which were offset by $400 thousand through accumulated other comprehensive losses primarily in unrealized losses in the available-for-sale investment portfolio and $1.1 million in dividends paid.

Losses in the available-for-sale investment portfolio included in comprehensive income/(loss) are considered declines due to interest rates and are therefore only a temporary impairment of the security.

Components of comprehensive income are excluded from the calculation of capital ratios. The Company maintained a total capital to risk weighted assets ratio of 17.02%, a Tier 1 capital to risk weighted assets ratio of 16.13% and a leverage ratio of 10.82% at September 30, 2008. These levels substantially exceed the minimum requirements of bank regulatory agencies for well-capitalized institutions of 10.00%, 6.00% and 5.00%, respectively. The ratio of shareholders' equity to assets decreased to 9.52% at September 30, 2008, compared to 9.72% at December 31, 2007, primarily from the increase in total assets.

There have been no significant changes in the Company's off-balance sheet arrangements during the three months ended September 30, 2008. See Note B and Note E to the Company's consolidated financial statements for a description of the Company's off-balance sheet arrangements.

Results of Operations

Net Income

Net income for the three months ended September 30, 2008, decreased to $943 thousand, or $0.45 per diluted share, compared to $1.0 million, or $0.47 per diluted share, for the same period in 2007. Returns on average assets and average equity were .99% and 10.40%, respectively, for the three months ended September 30, 2008, compared to 1.10% and 11.79%, respectively, for the same period in 2007. The decrease reflects the recovery of $205 thousand in the third quarter of 2007 from losses previously recorded in the second quarter of 2007 in connection with marking the Company's trading portfolio to fair value.

For the nine months ended September 30, 2008, net income was $2.6 million, or $1.25 per diluted share, compared to $2.0 million, or $0.96 per diluted share, for the same period in 2007. This increase is primarily due to the loss recorded in 2007 in relation to the sale of available-for-sale investment securities and the mark-to-market investment portfolio losses experienced in the nine months ended September 30, 2007.

Net Interest Income and Net Interest Margin

One of the largest components of the Company's earnings is net interest income, which is the difference between the interest and fees earned on loans and investments and the interest paid for deposits and borrowed funds. The net interest margin is net interest income expressed as a percentage of average earning assets.

Net interest income for the three and nine months ended September 30, 2008, was $3.5 million and $10.3 million, a $77 thousand and $127 thousand increase, respectively, compared to the same periods in 2007. The improvement in net interest income is due primarily to the lower interest rate environment coupled with a $20 million increase in earning assets, which had a balance of $367 million at September 30, 2008. The restructure of the investment portfolio during 2007 resulted in increased net interest income in 2008 by providing higher average yields during the nine month period ended September 30, 2008, compared to the same period in 2007. The decrease in interest rates on both interest-earning assets and interest-bearing liabilities negatively affected other financial measures. Even as net interest income increased and interest spreads widened, our net interest margin declined .14% and .09% for the three and nine month periods ending September 30, 2008, respectively, as compared to corresponding periods in 2007. Net interest margin for the three and nine month periods ended September 30, 2008, was 3.86% and 3.79%, respectively, compared to 4.00% and 3.88% for the corresponding periods in 2007. Due to the lower interest rate environment, assets purchased during 2008 were at narrower spreads compared to the spreads experienced on existing assets.

Non-Interest Income

Non-interest income decreased $161 thousand to $719 thousand for the third quarter of 2008, and increased $892 thousand to $2.2 million for the nine months ended September 30, 2008, compared to the previous year periods. The variances are primarily due to adjustments made in 2007 on the Company's trading investment portfolio and losses on the sale of approximately $35 million in its available-for-sale investment securities in 2007. Excluding these entries, core non-interest income improved $44 thousand and $178 thousand for the quarter and year-to-date periods in 2008 as compared to corresponding periods in 2007.

Non-Interest Expense

Non-interest expense was $2.8 million and $8.5 million for the three and nine months ended September 30, 2008, decreasing $71 thousand and $69 thousand, respectively, compared to the same periods in 2007, mainly from lower equipment and other real estate costs.

Income Taxes

The Company recorded income tax expense of $404 thousand for the three months ended September 30, 2008, compared to $359 thousand for the same period in 2007.Income tax expense for the nine months ended September 30, 2008, was $980 thousand compared to $528 thousand during the same period in 2007. The increase in both periods was related to adjustments regarding the adoption of Statement of Financial Accounting Standards No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities," in 2007.

Liquidity and Capital Resources

The Company utilizes a funds management process to assist management in maintaining net interest income during times of rising or falling interest rates and in maintaining sufficient liquidity. Principal sources of liquidity for the Company are asset cash flows, customer deposits and the ability to borrow against investment securities and loans. Secondary sources of liquidity include the sale of investment and loan assets. All components of liquidity are reviewed and analyzed on a monthly basis.

The Company has established a liquidity contingency plan to guide the Bank in the event of a liquidity crisis. The plan describes the normal operating environment, prioritizes funding options and outlines management responsibilities and board notification procedures. As more emphasis has been directed to liquidity needs, the Company is continuing the process of enhancing its contingency plan to include stress levels, heightened reporting and monitoring along with testing to better understand and report its liquidity position.

The Company's cash and cash equivalents decreased $1.5 million to $7.2 million at September 30, 2008, from $8.7 million at December 31, 2007. For the nine months ended September 30, 2008, cash provided by operating and financing was $22.1 million and $17.5 million, respectively, while investing activities used $41.1 million.

At September 30, 2008, the Company had unsecured federal funds lines with correspondent banks of $44 million and maintained the ability to draw on its available line of credit with the FHLB in the amount of approximately $40 million. In addition to these lines of credit, the Bank had approximately $41 million in liquid assets including unencumbered investment securities available for collateralized borrowing. Management believes it maintains adequate liquidity for the Company's current needs.

Certain restrictions exist on the ability of the Bank to transfer funds to the Company in the form of dividends and loans. These restrictions are described in detail in Part II, Item 2, "Unregistered Sales of Equity Securities and Use of Proceeds." These restrictions have not had, and are not expected in the future to have, a material impact on the Company's ability to meet its anticipated cash obligations.

This Report includes "forward-looking statements" within the meaning of Section . . .