period divided by average assets reduced by average goodwill and other intangible assets. Our management includes these measures because it believes that they are important when measuring CapitalSouth's performance against entities with varying levels of goodwill and other intangibles. These measures are used by many investors as part of their analysis of the Company's performance.
"Average tangible equity to average tangible assets" is defined as average total equity reduced by recorded average intangible assets divided by average total assets reduced by recorded average intangible assets. This measure is important to many investors in the marketplace who are interested in the equity to assets ratio exclusive of the effect of changes in average intangible assets on average equity and average total assets.
"Tangible book value per share" is defined as total equity reduced by recorded intangible assets divided by total common shares outstanding. This measure is important to many investors in the marketplace who are interested in changes from period to period in book value per share exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing total book value while not increasing the tangible book value of the Company.
These disclosures should not be viewed as a substitute for results determined in accordance with GAAP, and are not necessarily comparable to non-GAAP performance measures which may be presented by other bank holding companies. The following reconciliation table provides a more detailed analysis of these non-GAAP performance measures.

                                                  For the Three Months Ended                For the Nine Months Ended
                                                        September 30,                             September 30,
                                                   2008                  2007                2008                 2007
                                                        (Dollar amounts in thousands, except per share amounts)
Book value of equity                          $       24,180          $   62,551         $      24,180          $  62,551
Intangible assets                                        745              28,825                   745             22,825

Book value of tangible equity                 $       23,435          $   33,726         $      23,435          $  33,726

Average assets                                $      712,346          $  578,522         $     744,642          $ 524,890
Average intangible assets                                786               5,978                 7,191              2,861

Average tangible assets                       $      711,560          $  572,544         $     737,451          $ 522,029

Return on average assets                               (2.96 %)             0.19 %               (3.83 %)            0.48 %
Effect of average intangible assets                     0.00 %              0.00 %               (0.04 %)            0.00 %

Return on average tangible assets                      (2.96 %)             0.19 %               (3.87 %)            0.48 %

Average equity                                $       30,007          $   46,852         $      41,357          $  43,830
Average intangible assets                                786               5,978                 7,191              2,861

Average tangible equity                       $       29,221          $   40,874         $      34,166          $  40,969

Return on average equity                              (70.15 %)             2.33 %              (69.01 %)            5.73 %
Effect of average intangible assets                    (1.90 %)             0.35 %              (14.52 %)            0.40 %

Return on average tangible equity                     (72.05 %)             2.68 %              (83.53 %)            6.13 %

Average equity to average assets                       16.76 %             32.13 %                7.42 %            11.16 %
Effect of average intangible assets                    (0.42 %)            (3.81 %)              (1.23 %)           (0.67 %)

Average tangible equity to average
tangible assets                                        16.34 %             28.32 %                6.19 %            10.49 %

Net (loss) income before goodwill
impairment charge                             $       (5,292 )        $      276         $     (12,002 )        $   1,879
Goodwill impairment charge                                 -                   -                 9,363                  -

Net (loss) income                             $       (5,292 )        $      276         $     (21,365 )        $   1,879

Per common share:
Book value                                    $         5.81          $    15.45         $        5.81          $   15.45
Effect of intangible assets                             0.19                7.12                  0.19               7.12

Tangible book value                           $         5.63          $     8.33         $        5.63          $    8.33

percentages are annualized
Critical Accounting Policies
The accounting and financial policies of the Company conform to accounting principles generally accepted in the United States and to general practices within the banking industry. The allowance for loan losses, valuation of other real estate owned, deferred tax valuation, and goodwill impairment are accounting policies applied by the Company which are deemed critical. Critical accounting policies are defined as policies which are important to the portrayal of the Company's financial condition and results of operations and require management's most difficult, subjective or complex judgments. These estimates and judgments involve significant uncertainties and are susceptible to change. If different conditions exist or occur, depending upon the magnitude of the changes, our actual financial condition and financial results could differ significantly.

Other real estate owned, consisting of properties obtained through foreclosure or in satisfaction of loans, is reported at the lower of cost or fair value, determined on the basis of current appraisals, comparable sales, and other estimates of value obtained principally from independent sources, adjusted for estimated selling costs. At the time of foreclosure, any excess of the loan balance over the fair value of the real estate held as collateral is treated as a charge against the allowance for loan losses. Gains or losses on sale and any subsequent adjustments in value are recorded as a component of non-interest expense.
With the deterioration of goodwill and the subsequent write-down of all remaining goodwill on the Company's balance sheet, goodwill impairment ceased to be a critical accounting policy for the Company after the second quarter of 2008. For a more detailed discussion on these critical accounting policies, see "Critical Accounting Policies and Estimates" on page 31 of the Company's Annual Report on Form 10-K for the year ended December 31, 2007. Recent Developments
Effective November 4, 2008, the Company and the Bank consented to the issuance of a formal enforcement action by the Board of Governors of the Federal Reserve System and the Alabama State Department of Banking in the form of a Cease and Desist order to the Company and the Bank. The Company has already begun taking steps consistent with meeting these requirements. The order provides that:
• we are required to provide an acceptable capital plan for the Company and the Bank, which we anticipate will require us to raise additional capital;

• our ability to incur indebtedness, pay subordinated indebtedness or purchase or redeem any capital stock at the holding company level will require regulatory approval;

• we are required to retain an independent party or staff to provide ongoing review of loans;

• we are required to provide plans to strengthen oversight of management; to assess management and staffing needs, qualifications and performance, particularly in loan underwriting, credit administration, work-out, other-real-estate-owned disposition, and asset/liability management; to strengthen credit practices in these areas, and to revise lending and credit administration policies;

• we have limitations on renewing or extending loans to any borrower or related parties who have loans classified as loss, doubtful or substandard;

• we are required to provide a business plan to improve earnings and overall condition for 2009;

• we are required to provide notice in connection with appointing new directors or senior executive officers;

• we are required to charge off or collect all assets classified as "loss" not previously charged and review and revise the Bank's methodology for determining its allowance for loan and lease losses;

• we are required to develop plans to improve collection of certain group of loans;

• we may not pay or declare dividends by the Company without prior regulatory approval; and

• regulatory authorities reserve the right to impose additional limitations, requirements or restrictions on the Company and the Bank.

The foregoing description of the cease and desist order is qualified in its entirety by reference to the cease and desist order issued to the Company and the Bank, which is attached to this Quarterly Report on Form 10-Q as Exhibit 10.1.
The Company has filed a registration statement for a rights offering for shares of its common stock. The registration statement relating to these securities has been declared effective by the Securities and Exchange Commission. The Company anticipates closing the rights offering prior to year end. Any shares of common stock remaining following expiration of the rights offering will be offered to the public at the $2.00 per share subscription price. The public reoffer of remaining shares is set to expire on January 20, 2009.
In consideration of current conditions in the mortgage industry and the overall economy, CapitalSouth Bank has decided to close its subsidiary Mortgage Lion, Inc. The Bank expects the process of closing Mortgage Lion to be complete by year end.

Financial Condition
Investment Securities and Federal Funds Sold
Investment securities totaled $77,555,000 at September 30, 2008 and $83,027,000
at December 31, 2007. The following table shows the amortized cost of the
Company's securities by their stated maturities (this maturity schedule excludes
security prepayment and call features), as well as the tax equivalent yields for
each maturity range.
               Maturity of Investment Securities - Amortized Cost
                               September 30, 2008

                                          Less than         One year to          Five years to          More than
                                          one year           five years            ten years            ten years            Total
U. S. Government agency securities       $ 1,999,361        $ 24,991,505        $    15,824,480        $ 1,139,065        $ 43,954,411
Mortgage-backed securities                         -           7,947,773              2,302,081          1,004,342          11,254,196
Collateralized mortgage obligations                -                   -              2,536,933          3,746,577           6,283,510
Municipal securities                         779,856           2,251,709             10,952,562          2,175,621          16,159,748
Corporate securities                               -           1,020,311                      -                  -           1,020,311

Total                                    $ 2,779,217        $ 36,211,298        $    31,616,056        $ 8,065,605        $ 78,672,176

Tax equivalent yield                            3.59 %              3.70 %                 4.35 %             3.93 %

On a quarterly basis, the Company makes an assessment to determine whether there have been any events or economic circumstances to indicate that a security on which there is an unrealized loss is impaired on an other-than-temporary basis. The Company considers many factors including the severity and duration of the impairment; the intent and ability of the Company to hold the security for a period of time sufficient for a recovery in value; recent events specific to the issuer or industry; and for debt securities, external credit ratings and recent downgrades. Securities on which there is an unrealized loss that is deemed to be other-than-temporary are written down to fair value with the write-down recorded as a realized loss in securities gains (losses). Gross unrealized losses at September 30, 2008 are primarily caused by interest rate changes. The Company does not consider any other securities to be other-than-temporarily impaired. However, without recovery in the near term, such that liquidity returns to the markets and spreads return to levels that reflect underlying credit characteristics, additional other-than-temporary impairments may occur in future periods.
All securities held are traded in liquid markets. As of September 30, 2008, the Company owned securities from four issuers in which the aggregate book value from these issuers exceeded 10% of stockholders' equity. As of September 30, 2008, the book value and fair value of the securities from each of these issuers was as follows:

                                                   Book Value       Fair Value
        Federal National Mortgage Association    $ 18,433,551     $ 18,319,721
        Federal Home Loan Mortgage Corporation     12,808,295       12,840,096
        Federal Home Loan Bank                     18,760,477       18,480,580
        Federal Farm Credit Banks                   7,743,218        7,431,368

At September 30, 2008, the Company had $5,652,000 in federal funds sold compared with $230,000 in federal funds sold at December 31, 2007. Loans
Total loans were $560,806,000 at September 30, 2008, a decrease of $61,305,000, or 9.9%, over total loans of $622,111,000 at December 31, 2007. Due to the general deterioration in the real estate sector, the Company has tightened its credit criteria for loans secured by real estate. The Company is no longer approving new acquisition and development loans on speculative projects. The Company is actively reducing its concentration of construction loans and land acquisition and development loans. Accordingly, the Company has reduced balances outstanding in these type loans by $52,314,000, or 26.6%, since year-end.

The following table details the change in the loan portfolio composition, including loans held-for-sale, for the periods ending September 30, June 30, and March 31, 2008 and December 31, 2007:

                         September 30, 2008              June 30, 2008               March 31, 2008              December 31, 2007
                        Amount           %           Amount           %           Amount           %           Amount           %
                                                               (Dollar amounts in thousands)
Construction and
land development      $  144,144         25.53 %    $ 168,491         28.43 %    $ 186,819         30.31 %    $ 196,458         31.21 %
Farmland                   8,175          1.45          7,871          1.33         10,573          1.72          7,909          1.26
1-4 family
residential              134,438         23.81        134,768         22.74        138,080         22.40        144,520         22.96
Multifamily               25,155          4.45         25,657          4.33         29,155          4.73         30,009          4.77
Nonfarm
nonresidential           150,199         26.60        148,396         25.04        140,534         22.80        141,240         22.44
Commercial &
industrial                94,168         16.68         99,665         16.82        103,414         16.78        101,652         16.15
Consumer                   8,422          1.49          7,733          1.30          7,779          1.26          7,742          1.23

Total loans &
loans
held-for-sale         $  564,701        100.00 %    $ 592,581        100.00 %    $ 616,354        100.00 %    $ 629,530        100.00 %

Asset Quality
Management's policy is to maintain the allowance for loan losses at a level deemed adequate to absorb probable credit losses from identified and otherwise inherent risks in the loan portfolio as of the balance sheet date. In assessing the adequacy of the allowance, management ensures periodic detailed reviews are performed on its loan portfolio to ascertain its overall quality and its repayment ability. Current accounting standards require that loan losses be recorded when management determines it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. This requires management to predict borrowers' likelihood or capacity to repay along with distinguishing between losses incurred as of a balance sheet date and losses expected to be incurred in the future. Accordingly, this is a highly subjective process and requires significant judgment since it is often difficult to determine when specific losses may actually occur. The allowance for loan losses is increased by the provision for loan losses and recoveries and is decreased by charged-off loans.
Loan portfolio reviews to assess overall loan portfolio quality and repayment ability are coordinated between staff independent of the lending function and an experienced loan review company. The review results are taken into consideration by the credit administration department who is charged with analyzing the adequacy of the allowance for loan losses. The methodology used to determine the adequacy of the allowance for loan losses includes the loan review results along with the following:
• Specific known risks;

• Historic loan loss experience;

• Adverse situations that may affect a borrower's ability to repay;

• The status and amount of past due and nonperforming loans;

• Underlying estimated values of collateral securing loans;

• Current and anticipated economic conditions; and

• Other factors which management believes affect the allowance for loan losses.

Each month credit administration presents the results of the allowance for loan losses analysis to our subsidiary bank's board of directors. Included in the presentation is a recommendation of a loan loss provision amount necessary to maintain the allowance for loan losses at an adequate level.
Management holds weekly meetings to review problem credits with the respective loan officers. Changes in the markets and the borrower's status are discussed. These updates are utilized in our evaluation of the adequacy of specific reserves established on these credits and in the determination of the appropriate means for resolving the problem credit.
During the third quarter, the bank expanded the historical loss component of its allowance for loan losses analysis to include historical losses of peer banks located in its markets. Banks chosen as peer banks exhibited loan portfolio characteristics similar to those of CapitalSouth. This was done to better reflect the current economic conditions regarding this component in the overall analysis due to CaptialSouth's average net loss to average total loans for the three years ending December 31, 2008 was .07% compared to the peer banks of 0.21% for the same time period.
While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses and methodology may be necessary if economic or other conditions differ substantially from the assumptions used in making the estimates or, if required by regulators, based upon information at the time of their

examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels vary from previous estimates.
All loans have a risk grade assigned at the time the loan is booked. These risk grades are evaluated periodically for appropriateness based on the performance of the borrower and as new financial and other information is obtained on the borrower. Loans with acceptable or passing risk grades are segmented based on similar credit risk characteristics and evaluated on a pool basis. For a loan to a borrower with an unacceptable risk grade, substandard, doubtful or loss, an individual allowance evaluation is made and a specific allowance is assigned. Accordingly, changes in classifications of a loan may change the amount of the allowance allocated for that loan. The allowance for loan losses is replenished through provisions to loan losses charged against earnings. As a result, variations in the allowance directly affect our earnings.
The Company recorded annualized net charge-offs, as a percentage of average loans, of 1.02% in the third quarter of 2008 compared with net recoveries of 0.01% in the third quarter of 2007 and 0.95% in net charge-off's year to date compared with 0.01% net recoveries year to date 2007. Approximately 40.9% of the charge-offs taken in the first nine months of 2008 were associated with marking assets to market value as they moved to be categorized as Other Real Estate Owned ("OREO") based on updated valuations. We have experienced a marked increase in the level of nonperforming assets during the nine month period ended September 30, 2008. Accordingly, management reacted swiftly to strengthen the . . .