MidSouth Bancorp, Inc. (the "Company") is a single-bank holding company that conducts substantially all of its business through its wholly-owned subsidiary bank, MidSouth Bank, N. A. (the "Bank"), headquartered in Lafayette, Louisiana. The Company merged its two wholly-owned banking subsidiaries, MidSouth Bank, N.A. (Louisiana) and MidSouth Bank Texas, N.A. into MidSouth Bank, N.A., at the end of the first quarter of 2008. The purpose of this discussion and analysis is to focus on significant changes in the financial condition of the Company and on its results of operations during 2008, 2007, and 2006. This discussion and analysis is intended to highlight and supplement information presented elsewhere in this annual report on Form 10-K, particularly the consolidated financial statements and related notes appearing in Item 8.

The Private Securities Litigation Act of 1995 provides a safe harbor for disclosure of information about a company's anticipated future financial performance. This act protects a company from unwarranted litigation if actual results differ from management expectations. This management's discussion and analysis reflects management's current views and estimates of future economic circumstances, industry conditions, and the Company's performance and financial results based on reasonable assumptions. A number of factors and uncertainties could cause actual results to differ materially from the anticipated results and expectations expressed in the discussion. These factors and uncertainties include, but are not limited to:
· changes in interest rates and market prices that could affect the net interest margin, asset valuation, and expense levels;

· changes in local economic and business conditions that could adversely affect customers and their ability to repay borrowings under agreed upon terms and/or adversely affect the value of the underlying collateral related to the borrowings;

· increased competition for deposits and loans which could affect rates and terms;

· changes in the levels of prepayments received on loans and investment securities that adversely affect the yield and value of the earning assets;

· a deviation in actual experience from the underlying assumptions used to determine and establish the Allowance for Loan Losses ("ALL");

· changes in the availability of funds resulting from reduced liquidity or increased costs;

· the timing and impact of future acquisitions, the success or failure of integrating operations, and the ability to capitalize on growth opportunities upon entering new markets;

· the ability to acquire, operate, and maintain effective and efficient operating systems;

· increased asset levels and changes in the composition of assets which would impact capital levels and regulatory capital ratios;

· loss of critical personnel and the challenge of hiring qualified personnel at reasonable compensation levels;

· changes in government regulations applicable to financial holding companies and banking; and

· acts of terrorism, weather, or other events beyond the Company's control.

Certain critical accounting policies affect the more significant judgments and estimates used in the preparation of the consolidated financial statements. The Company's significant accounting policies are described in the notes to the consolidated financial statements included in this report. The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States of America ("GAAP") and general banking practices. The Company's most critical accounting policy relates to its allowance for loan losses, which reflects the estimated losses resulting from the inability of its borrowers to make loan payments. If the financial condition of its borrowers were to deteriorate, resulting in an impairment of their ability to make payments, the Company's estimates would be updated and additional provisions for loan losses may be required. See Asset Quality - Allowance for Loan Losses.

Another of the Company's critical accounting policies relates to its goodwill and intangible assets. Goodwill represents the excess of the purchase price over the fair value of net assets acquired. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, goodwill is not amortized, but is evaluated for impairment annually. If the fair value of an asset exceeds the carrying amount of the asset, no charge to goodwill is made. If the carrying amount exceeds the fair value of the asset, goodwill will be adjusted through a charge to earnings.

Compliance with accounting for stock-based compensation requires that management make assumptions including stock price volatility and employee turnover that are utilized to measure compensation expense. The fair value of stock options granted is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions.

Given the current instability of the economic environment, it is reasonably possible that the methodology of the assessment of potential loan losses, goodwill impairment, and other fair value measurements could change in the near-term or could result in impairment going forward.

The Company's growth strategy is focused on three principal components: internal growth through strategic de novo branching, technological upgrades, and continual staff development. The Company focuses on internal growth and identification of de novo branch opportunities that enhance franchise value. Each retail region operates with a regional president accountable for the Company's performance in their market. The Company will also continue its focus on attracting key new hires and on ongoing development of existing staff.

On January 2, 2009, the Company paid its regular quarterly dividend of $0.07 per share and an additional $0.04 special dividend to its common shareholders of record as of December 14, 2008.

On January 9, 2009, the Company's participation in the CPP of the Treasury offered under the EESA added $20.0 million in liquidity and capital for the purpose of funding loans.

The Company's net income for the year ended December 31, 2008 totaled $5.5 million compared to $8.8 million for the year ended December 31, 2007, a decrease of $3.3 million, or 36.9%. Basic earnings per share were $0.84 and $1.34 for the years ended December 31, 2008 and 2007, respectively. Diluted earnings per share were $0.83 for the year ended December 31, 2008 compared to $1.32 per share earned for the year ended December 31, 2007. Total provision for loan loss increased $3.4 million in year-to-date comparison. The increase in provision expense was primarily driven by an increase of $1.9 million in net charge-offs, credit downgrades identified in the loan portfolio during the year, and an increase in average loan volume of $39.6 million (see Asset Quality). Net interest income increased $2.8 million, or 7.6%, in 2008, primarily attributable to the lower cost of interest-bearing liabilities. Interest expense decreased $4.4 million for the year ended December 31, 2008, as compared to the same period ended December 31, 2007, as the Company adjusted deposit rates in response to the 400 basis point drop in interest rates by the Federal Open Market Committee ("FOMC") during 2008. Total interest income decreased $1.7 million, despite an $83.8 million increase in average earning assets, primarily due to a 104 basis points decrease in the average loan yield.

Other noninterest income increased $869,000, or 6.1%, primarily due to increases of $384,000 in service charges on deposit accounts, $635,000 in debit card and ATM transaction fee income, and a $131,000 one-time payment recorded in other noninterest income in the first quarter of 2008 related to VISA's mandatory redemption of a portion of its Class B shares outstanding in connection with an initial public offering. These increases were partially offset by a decrease of $205,000 in mortgage processing fee income. Noninterest expense increased $5,340,000 due to increases in salaries and benefits costs ($1,005,000), occupancy expenses ($1,810,000), professional fees ($410,000), marketing expenses ($414,000), FDIC insurance premiums ($349,000), data processing expenses ($287,000), ATM and debit card processing fees ($268,000), corporate development expenses ($283,000), and losses on other assets repossessed ($299,000).

The results for the year ended December 31, 2008 were positively impacted by a lower effective tax rate of 7.50% for 2008 as compared to 20.62% in 2007 that reduced income tax expense by $1.8 million. The lower effective tax rate resulted from decreased pretax earnings due to the $3.4 million increase in the provision for loan losses combined with sustained interest income from tax exempt municipal securities within the investment portfolio. Additionally, the Work Opportunity Tax Credit was applied to the tax expense for the years ended December 31, 2008 and 2007, which reduced the expense by $149,000 and $99,000, respectively.

The Company's total consolidated assets increased $82.8 million, or 9.7%, from $854.0 million at December 31, 2007, to $936.8 million at December 31, 2008. Total loans grew $39.5 million, or 6.9%, from $569.5 million at December 31, 2007 to $609.0 million at December 31, 2008, primarily in commercial credits and real estate mortgage loans. Total deposits grew $33.2 million, or 4.5%, from $733.5 million at December 31, 2007, to $766.7 million at December 31, 2008. The Company maintained a strong noninterest-bearing deposit portfolio of $199.9 million, or 26.1% of total deposits, and grew interest-bearing deposits primarily in consumer Platinum checking and business checking accounts.

Nonperforming assets, including loans 90 days or more past due and still accruing ("loans past due"), totaled $11.0 million at December 31, 2008 compared to $3.0 million at December 31, 2007. Nonaccrual loans increased $7.8 million from 2007 to 2008, primarily attributable to one loan relationship totaling $7.4 million in the Baton Rouge market secured by commercial real estate. Loans past due increased $25,000 in annual comparison, from $980,000 at December 31, 2007 to $1,005,000 at December 31, 2008. As a percentage of total assets, nonperforming assets increased from 0.35% at December of 2007 to 1.17% at December of 2008.

Net loan charge-offs for 2008 were $2.4 million, or 0.40% of average loans, compared to $540,000, or 0.10% of average loans, recorded a year earlier. The Company provided $4.6 million for loan losses in 2008 compared to $1.2 million in 2007 to bring the ALL as a percentage of total loans to 1.25% at year-end 2008 compared to 0.99% at year-end 2007. The increase in provision expense was primarily driven by an increase of $1.9 million in net charge-offs, credit downgrades identified in the loan portfolio, and an increase in average loan volume of $39.6 million during the year ending December 31, 2008.

The Company's leverage ratio was 8.38% at December 31, 2008, compared to 8.67% at December 31, 2007. Return on average common equity was 7.79% for 2008 compared to 13.83% for 2007. Return on average assets was 0.60% compared to 1.06% for the same periods, respectively.

Table 1
Summary of Return on Equity and Assets
                                         2008        2007        2006
Return on average assets                   0.60 %      1.06 %      1.08 %
Return on average common equity            7.79 %     13.83 %     14.68 %
Dividend payout ratio on common stock     38.14 %     19.97 %     18.14 %
Average equity to average assets           7.75 %      7.69 %      7.35 %

Net Interest Income
The primary source of earnings for the Company is net interest income, which is the difference between interest earned on loans and investments and interest paid on deposits and other interest-bearing liabilities. Changes in the volume and mix of earning assets and interest-bearing liabilities combined with changes in market rates of interest greatly affect net interest income. The Company's net interest margin on a taxable equivalent basis, which is net interest income as a percentage of average earning assets, was 4.93%, 5.10%, and 4.90% for the years ended December 31, 2008, 2007, and 2006, respectively. Tables 2 and 3 analyze the changes in net interest income for each of the three year periods ended December 31, 2008, 2007, and 2006.

Table 2
Consolidated Average Balances, Interest, and Rates
(in thousands)
                                                                             Year Ended December 31,
                                         2008                                          2007                                         2006
                        Average                       Average         Average                       Average         Average                      Average
                        Volume       Interest       Yield/ Rate       Volume       Interest       Yield/ Rate       Volume       Interest      Yield/ Rate
       Assets
Investment
securities1
Taxable                $  97,363     $   4,381              4.50 %   $  85,999     $   4,089              4.75 %   $  98,173     $   4,459            4.54 %
Tax-exempt2              112,801         6,100              5.41 %     110,256         5,846              5.30 %      93,918         4,803            5.11 %
Other investments          4,172           136              3.26 %       3,533           156              4.42 %       2,377            80            3.37 %
Total investments        214,336        10,617              4.95 %     199,788        10,091              5.05 %     194,468         9,342            4.80 %
Federal funds sold        29,406           669              2.24 %      15,554           788              5.00 %      23,528         1,134            4.75 %
Loans
Commercial and real
estate                   461,382        35,404              7.67 %     426,038        38,314              8.99 %     376,827        32,894            8.73 %
Installment              113,973        10,128              8.89 %     109,688         9,651              8.80 %      97,693         8,251            8.45 %
Total loans3             575,355        45,532              7.91 %     535,726        47,965              8.95 %     474,520        41,145            8.67 %
Other earning assets      15,892           447              2.81 %         118             7              5.93 %         205            12            5.85 %
Total earning assets     834,989        57,265              6.86 %     751,186        58,851              7.83 %     692,721        51,633            7.45 %
Allowance for loan
losses                    (5,910 )                                      (5,079 )                                      (4,686 )
Nonearning assets         88,808                                        79,327                                        73,568
Total assets           $ 917,887                                     $ 825,434                                     $ 761,603

  Liabilities and
shareholders' equity
NOW, money market,
and savings            $ 453,531     $   7,958              1.75 %   $ 419,983     $  13,017              3.10 %   $ 388,880     $  12,084            3.11 %
Time deposits            146,272         5,952              4.07 %     121,238         5,089              4.20 %     117,149         4,053            3.46 %
Total
interest-bearing
deposits                 599,803        13,910              2.32 %     541,221        18,106              3.35 %     506,029        16,137            3.19 %
Borrowings:
   Securities sold
under agreements to
repurchase and
federal funds
purchased                 35,999           875              2.39 %      13,880           531              3.77 %       4,014           184            4.52 %
   FHLB advances             452            16              3.48 %       8,309           500              5.94 %           -             -               -
  FRB Discount
Window                     4,491            65              1.45 %           -             -                 -             -             -               -
     Total
borrowings                40,942           956              2.30 %      22,189         1,031              4.58 %       4,014           184            4.52 %
   Junior
subordinated
debentures                15,465         1,219              7.75 %      15,465         1,397              8.91 %      15,465         1,371            8.74 %
   Total
interest-bearing
liabilities              656,210        16,085              2.45 %     578,875        20,534              3.55 %     525,508        17,692            3.37 %
Demand deposits          185,113                                       178,933                                       176,353
Other liabilities          5,466                                         4,158                                         3,733
Shareholders' equity      71,098                                        63,468                                        56,009
Total liabilities
and shareholders'
equity                 $ 917,887                                     $ 825,434                                     $ 761,603

Net interest income
and net interest
spread                               $  41,180              4.41 %                 $  38,317              4.28 %                 $  33,941            4.08 %
Net yield on
interest earning
assets                                                      4.93 %                                        5.10 %                                      4.90 %

Table 3
Changes in Taxable-Equivalent Net Interest Income
(in thousands)
                                 2008 Compared to 2007                        2007 Compared to 2006
                           Total                 Change                 Total                 Change
                          Increase           Attributable To          Increase           Attributable To
                         (Decrease)       Volume         Rates       (Decrease)        Volume         Rates
Taxable-equivalent
earned on:
Investment securities
and interest-bearing
deposits
Taxable                 $        292     $     519     $    (227 )   $      (370 )   $     (571 )   $     201
Tax-exempt                       254           137           117           1,043            861           182
Other investments                (20 )          25           (45 )            76             46            30
Federal funds sold              (119 )         468          (587 )          (346 )         (372 )          26
Loans, including fees         (2,433 )       3,387        (5,820 )         6,820          5,445         1,375
Other earning assets             440           444            (4 )            (5 )           (5 )           -
Total                         (1,586 )       4,980        (6,566 )         7,218          5,404         1,814

Interest paid on:
Interest-bearing
deposits                      (4,196 )       1,804        (6,000 )         1,969          1,155           814
Securities sold under
agreements to
repurchase and
federal funds
purchased                        344           657          (313 )           347            355            (8 )
FHLB Advances                   (484 )        (366 )        (118 )           500            500             -
FRB Discount Window               65            33            32               -              -             -
Junior subordinated
debentures                      (178 )           -          (178 )            26              -            26
Total                         (4,449 )       2,128        (6,577 )         2,842          2,010           832
Taxable-equivalent
net interest income     $      2,863     $   2,852     $      11     $     4,376     $    3,394     $     982

NOTE: Changes due to both volume and rate have generally been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts to the changes in each.

Net interest income on a taxable-equivalent basis increased $2.9 million for 2008 over 2007 and $4.4 million for 2007 over 2006. Average earning assets increased $83.8 million, or 11.2%, from $751.2 million at December 31, 2007, to $835.0 million at December 31, 2008. The yield on average earning assets decreased 97 basis points, from 7.83% to 6.86% in annual comparison. Average loan yields decreased 104 basis points, from 8.95% at December 31, 2007, to 7.91% at December 31, 2008, primarily due to the Company's variable rate loans that adjusted with Prime. The Prime rate decreased 400 basis points during the course of the year, from 7.25% to 3.25% at year end. An increase in loan volume of $39.6 million, or 7.4%, partially offset the decrease in rates and resulted in a $2.4 million decrease in interest earned on loans for 2008. Rate decreases on earning assets offset volume increases and resulted in a decrease of $1.6 million in taxable-equivalent interest income. The $1.6 million decrease was offset by a $4.4 million decrease in interest paid on interest-bearing liabilities. Interest paid on average interest-bearing deposits decreased $4.2 million due to a 103 basis point decrease in the average rate from 3.35% at December 31, 2007 to 2.32% at December 31, 2008. The decrease in average cost of deposits was partially offset by a $58.6 million increase in average interest-bearing deposit volume. The cost of total interest-bearing liabilities decreased 110 basis points from 3.55% at December 31, 2007 to 2.45% at December 31, 2008.

In 2007, a 12.9% increase in the average volume of loans combined with 28 basis points of improvement in average loan yields contributed greatly to the $4.4 million increase in taxable-equivalent net interest income. The average yield on the loan portfolio increased from 8.67% in 2006 to 8.95% in 2007. Loan yields improved as the Company's variable-rate loans remained stable with a flat Prime rate for most of the year. Prime increased 100 basis points to 8.25% by mid-year 2006 and held steady until mid-September 2007, when it began its descent to 7.25% at year-end. A $7.2 million improvement in taxable-equivalent interest income was partially offset by a $2.8 million increase in interest expense resulting primarily from a 7.0% increase in the average volume of interest-bearing deposits and an increase of 16 basis points in the average rate paid on interest-bearing deposits in 2007.

In the investment portfolio, the Company reinvested cash flows from the portfolio into quality tax-exempt municipal bonds and agency-backed Collateralized Mortgage Obligations ("CMOs") in 2008. The average volume of investment securities increased $14.5 million in 2008, from $199.8 million in 2007 to $214.3 million. Average taxable-equivalent yields on investment securities decreased 10 basis points, from 5.05% in 2007 to 4.95% in 2008. Accordingly, the taxable-equivalent interest income on investment securities increased $526,000 in 2008 as compared to 2007. In 2007, the average volume of investment securities increased $5.3 million, from $194.5 million in 2006 to $199.8 million in 2007, while federal funds sold volume decreased $8.0 million. Average taxable-equivalent yields on investment securities increased to 5.05% in 2007, up 25 basis points from 4.80% in 2006. Improvement in investment volume and yields increased taxable-equivalent interest income on investment securities $749,000 for 2007.

From 2007 to 2008, the average volume of federal funds sold and other earning assets increased $13.9 million and $15.8 million, respectively. In comparing average volume of assets and liabilities, the $64.8 million increase in deposits exceeded the $39.6 million increase in loans resulting in $25.2 million of excess funds. These funds were invested in federal funds overnight and other interest-earning assets, the majority of which were time deposits held with other banks. The increase in average volume of federal funds sold was offset by a 276 basis points decrease in the average yield from 5.00% to 2.24%, which reduced interest earned by $119,000 in yearly comparison. Interest earned on other interest-earning assets increased $440,000 as the volume increase was partially offset by a 312 basis points reduction in average yield.

The Company maintained its strong core noninterest-bearing deposit base with 23.6% of average total deposits in 2008 compared to 24.8% in 2007 and 25.8% in 2006. The interest-bearing deposit mix consisted of 57.8% in NOW, money market, and savings deposits, and 18.6% in time deposits, primarily due to growth in the Company's Platinum checking accounts. The Platinum accounts offer competitive market rates to the Company's depositors. The average rate paid on NOW, money market, and savings dollars decreased 135 basis points to 1.75% in 2008, down from 3.10% in 2007. Of total average deposits in 2007, the mix of average total interest-bearing deposits was 58.4% NOW, money market and savings deposits, and 16.8% certificates of deposit. These two categories of interest-bearing deposits were 57.0% and 17.2% of average total deposits, respectively, in 2006. The Company typically offers certificates of deposit at mid-to-low market rates, but a special promotional rate of 5.13% on a 13 month certificate of deposit was offered in the fourth quarter of 2006 in all markets. The promotional rate was continued in selected Louisiana markets and the Texas market for part of 2007 and contributed to a 74 basis points increase in the average yield on certificates of deposit in 2007, from 3.46% in 2006 to 4.20%.

Interest expense on the Company's junior subordinated debentures decreased 116 basis points, from 8.91% in 2007 to 7.75% in 2008 due to decreases in the variable rate paid on the $8.2 million in debentures. The $8.2 million in debentures, issued on September 20, 2004, carry a floating rate equal to the 3-month LIBOR plus 2.50%, adjustable and payable quarterly. The rate on these debentures at December 31, 2008 was 4.03%. In 2007, the yield on the junior subordinated debentures increased 17 basis points, from 8.74% at December 31, 2006 to 8.91% at December 31, 2007. The $8.2 million in debentures mature on September 20, 2034 and, under certain circumstances, are subject to repayment on September 20, 2009 or thereafter. On February 22, 2001, the Company issued the $7.2 million of junior subordinated debentures. The $7.2 million in debentures carry a fixed interest rate of 10.20% and mature on February 22, 2031 and, under certain circumstances, are subject to repayment on February 22, 2011, or thereafter.

NonInterest Income
Service charges and fees on deposit accounts represent the primary source of noninterest income for the Company. Income from service charges and fees on deposit accounts, including insufficient funds fees ("NSF" fees), increased $384,000 in 2008 compared to a $1.1 million increase in 2007. Income on ATM and debit card transactions increased $635,000 in 2008 and $414,000 in 2007 as the result of an increase in transactions processed. Other noninterest income decreased $150,000 in 2008 and increased $335,000 in 2007. The decrease in 2008 was the result of a reduction in mortgage processing fee income of $205,000, . . .