(Dollar amounts are expressed in thousands unless otherwise noted)
Overview
Southeastern Bank Financial Corporation (the "Company") operates two wholly-owned subsidiaries in the Augusta-Richmond County, GA-SC metropolitan area. Georgia Bank & Trust Company (the "Bank") was organized by a group of local citizens and commenced business on August 28, 1989, with one branch location. Today, it is Augusta's largest community banking company operating nine full service branches in Augusta, Martinez, and Evans, Georgia and one branch in Athens, Georgia. Mortgage origination offices are located in Augusta, Savannah and Athens, Georgia. SB&T Capital Corporation (the "LPO") a wholly-owned subsidiary of the Bank, was organized on August 16, 2007 and opened an office in Greenville, South Carolina. Southern Bank & Trust (the "Thrift"), a federally chartered thrift, was organized by the Company during 2005 and 2006 and opened its main office on September 12, 2006. Today it operates three full service branches in North Augusta and Aiken, South Carolina. The Company's Operations Center is located in Martinez, Georgia and services both subsidiaries.
The Company's primary market includes Richmond and Columbia Counties in Georgia and Aiken County in South Carolina, all part of the Augusta-Richmond County, GA-SC metropolitan statistical area (MSA). The 2007 population of the Augusta-Richmond County, GA-SA MSA was 528,519, the second largest in Georgia and fourth largest in South Carolina. The Augusta market area has a diversified economy based principally on government, public utilities, health care, manufacturing, construction, and wholesale and retail trade. Augusta is one of the leading medical centers in the Southeast. The Company entered the Athens, GA market in December 2005. The 2007 population for the Athens-Clarke County, GA MSA was 187,405, ranked fifth in the state of Georgia. The Athens market area has a diversified economy based primarily on government, retail services, tourism, manufacturing, other services, and health care, with the largest share of government jobs in the state. In August 2007, the Company entered the Greenville, SC market. The 2007 population for the Greenville-Mauldin-Easley, SC MSA was 613,828, ranked third in the state of South Carolina. The Greenville market area has a diversified economy based primarily on government, manufacturing, construction, retail services, and health care.
The Company's services include the origination of residential and commercial real estate loans, construction and development loans, and commercial and consumer loans. The Company also offers a variety of deposit programs, including noninterest-bearing demand, interest checking, money management, savings, and time deposits. In the primary market area, Augusta-Richmond County, GA-SC metropolitan area, the Company had 15.62% of all deposits and was the second largest depository institution at June 30, 2008, as cited from the Federal Deposit Insurance Corporation's website. Securities sold under repurchase agreements are also offered. Additional services include wealth management, trust, retail investment, and mortgage. As a matter of practice, most mortgage loans are sold in the secondary market; however, some mortgage loans are placed in the portfolio based on asset/liability management strategies. The Company continues to concentrate on increasing its market share through various new deposit and loan products and other financial services and by focusing on the customer relationship management philosophy. The Company is committed to building life-long relationships with its customers, employees, shareholders, and the communities it serves.

The Company's primary source of income is from its lending activities followed by interest income from its investment activities, service charges and fees on deposits, and gain on sales of mortgage loans in the secondary market. Interest income on loans decreased during the first three months of 2009 as compared to the first three months of 2008 due to lower interest rates and increased levels of loans placed on nonaccrual offset in part by increased volumes. Interest income on investment securities increased primarily due to increased volumes as well as slightly higher yields over 2008. The yield on the investment portfolio increased slightly due to the accretion of discount on certain agency securities called during the quarter. Service charges and fees on deposits decreased as a result of decreases in NSF income on both retail and business checking accounts due primarily to decreased economic activity and was partially offset by increases in ATM/Debit card income. Declining mortgage rates and a significant increase in mortgage refinancing activity resulted in an increase in gain on sales of loans for the first three months of 2009 as compared to the same period in 2008. Investment securities (losses) gains decreased due to a $908 impairment charge related to investments in the common stock and trust preferred securities of Silverton Financial Services, Inc., parent holding company of Silverton Bank, N.A., which was placed in receivership on May 1, 2009.

                                                   March 31,        December 31,        December 31,
                                                     2009               2008                2004
                                                                (Dollars in thousands)
Assets                                            $ 1,484,682      $    1,411,039      $      706,517
Loans                                                 997,647           1,005,786             494,170
Deposits                                            1,226,683           1,139,552             556,785

Annualized return on average total assets                0.02 %              0.57 %              1.29 %
Annualized return on average equity                      0.24 %              8.48 %             15.50 %

The Company continues to experience growth although at a slower rate as evidenced in Table 1 above. The Company has also achieved increases in deposits and continues to provide returns on assets and equity although on a reduced level as noted in the table above. Annualized return on average total assets and annualized return on average equity have declined recently due primarily to increased levels of non-performing assets which have resulted in higher loan loss provisions. Net income for the year ended 2004 was $8.7 million compared to net income of $7.6 million at year end 2008. Net income for the three months ended March 31, 2009 was $56 thousand compared to $2.6 million for the same period in 2008. Current market conditions along with increases to the provision for loan losses and impairment charges had a significant affect on net income for the quarter. The Company has paid cash dividends of $0.13 per share each quarter since 2004 but has elected to suspend dividends effective April 24, 2009 to conserve capital.

The Company meets its liquidity needs by managing cash and due from banks, federal funds purchased and sold, maturity of investment securities, principal repayments from mortgage-backed securities, and draws on lines of credit. Additionally, liquidity can be managed through structuring deposit and loan maturities. The Company funds loan and investment growth with core deposits, securities sold under repurchase agreements, Federal Home Loan Bank advances and other wholesale funding including brokered certificates of deposit. During inflationary periods, interest rates generally increase and operating expenses generally rise. When interest rates rise, variable rate loans and investments produce higher earnings; however, deposit and other borrowings interest expense also rise. The Company monitors its interest rate risk as it applies to net income in a ramp up and down annually 200 basis points (2%) scenario and as it applies to economic value of equity in a shock up and down 200 (2%) basis points scenario. The Company monitors operating expenses through responsibility center budgeting.
Forward-Looking Statements
Southeastern Bank Financial Corporation may, from time to time, make written or oral forward-looking statements, including statements contained in the Company's filings with the Securities and Exchange Commission (the "Commission") and its reports to shareholders. Statements made in such documents, other than those concerning historical information, should be considered forward-looking and subject to various risks and uncertainties. Such forward-looking statements are made based upon management's belief as well as assumptions made by, and information currently available to, management pursuant to "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. The Company's actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, including unanticipated changes in the Company's local economies, the national economy, governmental monetary and fiscal policies, deposit levels, loan demand, loan collateral values and securities portfolio values; difficulties in interest rate risk management; the effects of competition in the banking business; difficulties in expanding the Company's business into new markets; changes in governmental regulation relating to the banking industry, including regulations relating to branching and acquisitions; failure of assumptions underlying the establishment of reserves for loan losses, including the value of collateral underlying delinquent loans; and other factors. The Company cautions that such factors are not exclusive. The Company does not undertake to update any forward-looking statement that may be made from time to time by, or on behalf of, the Company.

Critical Accounting Estimates
The accounting and financial reporting policies of the Company and its subsidiaries conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Of these policies, management has identified the allowance for loan losses as a critical accounting estimate that requires difficult, subjective judgment and is important to the presentation of the financial condition and results of operations of the Company.
The allowance for loan losses is established through a provision for loan losses charged to expense, which affects the Company's earnings directly. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely. Subsequent recoveries are added to the allowance. The allowance is an amount that reflects management's estimate of the level of inherent losses in the portfolio. Factors considered by management in determining the adequacy of the allowance include, but are not limited to:
(1) detailed reviews of individual loans; (2) historical and current trends in loan charge-offs for the various portfolio segments evaluated; (3) the level of the allowance in relation to total loans and to historical loss levels;
(4) levels and trends in non-performing and past due loans; (5) collateral values of properties securing loans; (6) management's assessment of economic conditions. The Company's Board of Directors reviews the recommendations of management regarding the appropriate level for the allowance for loan losses based upon these factors. The provision for loan losses is the charge to operating earnings necessary to maintain an adequate allowance for loan losses. The Company has developed policies and procedures for evaluating the overall quality of its loan portfolio and the timely identification of problem credits. Management continues to review these policies and procedures and makes further improvements as needed. The adequacy of the Company's allowance for loan losses and the effectiveness of the Company's internal policies and procedures are also reviewed periodically by the Company's regulators and the Company's internal loan review personnel. The Company's regulators may advise the Company to recognize additions to the allowance based upon their judgments about information available to them at the time of their examination. Such regulatory guidance is considered, and the Company may recognize additions to the allowance as a result. The Company continues to refine the methodology on which the level of the allowance for loan losses is based, by comparing historical loss ratios utilized to actual experience and by classifying loans for analysis based on similar risk characteristics. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement; however, cash receipts on impaired and nonaccrual loans for which the accrual of interest has been discontinued are applied to principal and interest income depending upon the overall risk of principal loss to the Company.

Performance Overview
The Company's net income for the first quarter of 2009 was $56, which was a decrease of $2,579 (97.9%) compared to net income of $2,635 for the first quarter of 2008. Diluted net income per share for the three months ended March 31, 2009 was $0.01 compared to $0.44 for the three months ended March 31, 2008. The decrease in net income for the three months ended March 31, 2009 as compared with the three months ended March 31, 2008, was primarily a result of increases in the provision for loan losses due to increased levels of nonperforming assets and an impairment loss on certain investments related to Silverton Financial Services. Interest income on loans decreased due to lower interest rates and increased levels of nonaccrual loans somewhat offset by increased volumes. Interest income on investment securities increased due to increased volumes and higher yields. Interest expense on deposits, securities sold under repurchase agreements and other borrowings decreased as a result of lower interest rates offset in part by higher volumes of interest bearing liabilities.
Factors contributing to the increase in noninterest income for the three months ended March 31, 2009, were increases in gain on sales of loans somewhat offset by a decrease in net investment securities gains, retail investment income, trust service fees and service charges and fees on deposits. Gain on sales of loans increased substantially as mortgage rates declined and mortgage refinancing activity increased. Investment securities gains decreased $202 over 2008 primarily due to an impairment charge for the investment in Silverton Financial Services, and were somewhat offset by the Company taking advantage of favorable market conditions to liquidate and reinvest certain US Agency securities. Service charges and fees on deposits decreased primarily due to decreases in NSF income. The decline in NSF income was primarily due to reduced consumer activity. Noninterest expense increased during the three months ended March 31, 2009 compared to the same period ended March 31, 2008, primarily due to increases in salaries due to increased commissions paid on mortgage production, occupancy expense related to Company growth and increased accruals for FDIC deposit insurance.

                                        March 31,        December 31,               Variance
                                          2009               2008            Amount            %
                                                          (Dollars in thousands)
Cash, due from banks and
interest-bearing deposits              $    57,712      $       27,988      $  29,724          106.2 %
Federal funds sold                          61,664               9,780         51,884          530.5 %
Investment securities                      300,984             300,028            956            0.3 %
Loans                                      997,647           1,005,786         (8,139 )         (0.8 %)
Assets                                   1,484,682           1,411,039         73,643            5.2 %
Deposits                                 1,226,683           1,139,552         87,131            7.6 %
Securities sold under repurchase
agreements                                  48,764              62,553        (13,789 )        (22.0 %)
Advances from Federal Home Loan
Bank                                        84,000              84,000              0            0.0 %
Liabilities                              1,389,753           1,316,388         73,365            5.6 %
Stockholders' equity                        94,929              94,651            278            0.3 %

Table 2 highlights significant changes in the balance sheet at March 31, 2009 as compared to December 31, 2008. Assets increased $73,643, primarily the result of higher balances in cash, due from banks, interest-bearing deposits and fed funds sold which increased $81,608. Management increased the level of liquid funds in light of current economic conditions and volatility in the banking industry. Gross loans decreased $8,139 due primarily to decreased demand resulting from the slowing economy. The decreased demand caused normal principal repayments to exceed the originations of new loans during the quarter. In addition, loans decreased due to real estate acquired through foreclosure which increased $1,256. The increase in assets was funded by an increase in deposits of $87,131, somewhat offset by decreases in securities sold under repurchase agreements of $13,789.
The annualized return on average assets for the Company was 0.02% for the three months ended March 31, 2009, compared to 0.86% for the same period last year. While total assets have increased $73,643 since March 31, 2008, net income has decreased $2,579 resulting in a decrease in ROA.
The annualized return on average stockholders' equity was 0.24% for the three months ended March 31, 2009, compared to 11.57% for the same period last year. The decrease is primarily attributable to the decrease in net income. Net Interest Income
The primary source of earnings for the Company is net interest income, which is the difference between income on interest-earning assets, such as loans and investment securities, and interest expense incurred on interest-bearing sources of funds, such as deposits and borrowings. The following table shows the average balances of interest-earning assets and interest-bearing liabilities, annualized average yields earned and rates paid on those respective balances, and the actual interest income and interest expense for the periods indicated. Average balances are calculated based on daily balances, yields on non-taxable investments are not reported on a tax equivalent basis and average balances for loans include nonaccrual loans even though interest was not earned.

       Table 3 - Average Balances, Income and Expenses, Yields and Rates

                                     Three Months Ended March 31, 2009                     Three Months Ended March 31, 2008
                                                     Annualized                                            Annualized
                                                      Average          Amount                               Average          Amount
                                  Average             Yield or        Paid or           Average             Yield or        Paid or
                                  Amount                Rate           Earned           Amount                Rate           Earned
                                                                      (Dollars in thousands)
Interest-earning assets:
Loans                         $     1,000,570               5.54 %    $ 13,805      $       896,500               7.26 %    $ 16,393
Investment securities                 295,419               5.52 %       4,074              248,618               5.25 %       3,261
Federal funds sold                     55,401               0.18 %          24               14,977               2.43 %          91
Interest-bearing deposits
in other banks                          6,029               0.27 %           4                  500               4.60 %           6

Total interest-earning
assets                        $     1,357,419               5.29 %    $ 17,907      $     1,160,595               6.77 %    $ 19,751


Interest-bearing
liabilities:
Deposits                      $     1,077,012               2.56 %    $  6,801      $       874,421               3.61 %    $  7,877
Federal funds purchased /
securities sold under
repurchase agreements                  55,476               0.81 %         111               64,306               3.37 %         540
Other borrowings                      104,547               3.48 %         896               86,511               4.96 %       1,069

Total interest-bearing
liabilities                   $     1,237,035               2.56 %    $  7,808      $     1,025,238               3.71 %    $  9,486


Net interest
margin/income:                                              2.96 %    $ 10,099                                    3.49 %    $ 10,265

Net interest income decreased $166 (1.62%) during the three month period as compared to the same period in 2008. Loan interest income decreased $2,588 in the three month period as a result of decreasing interest rates and increased levels of nonaccrual loans offset in part by growth in account balances. Deposit interest expense decreased $1,076 in the three month period as a result of decreasing interest rates offset in part by the continued growth of account balances. The annual average balance for loans was $1,000,570 at March 31, 2009 with an annualized average yield of 5.54% compared to $896,500 at March 31, 2008 with an annualized average yield of 7.26%. Loan yields were impacted by decreases in market interest rates as well as increased levels of nonaccrual loans. Since March 31, 2008 the federal funds target rate declined from 2.25% to 0.25% which resulted in a decrease of 2.00% in the Bank's prime rate from 5.25% to 3.25%. In addition, nonaccrual loans increased $11,099 from December 2008 and resulted in the reversal of $661 in interest income which reduced the average loan yield by approximately 7 basis points. Interest-bearing deposits had an annual average balance of $1,077,012 with an annualized average rate of 2.56% at March 31, 2009 compared to $874,421 and 3.61% at March 31, 2008. Other contributing factors during the three month period included increases in interest income on investment securities and decreases in interest expense on securities sold under repurchase agreements.
The Company's net interest margin for the three months ended March 31, 2009 decreased 53 basis points to 2.96% as compared to 3.49% for the three months ended March 31, 2008. This decrease in the net interest margin for the first quarter was impacted by increased levels of nonaccrual loans which resulted in the reversal of $661 in interest income. This trend of increasing nonaccrual loans and the resultant impact on net interest income could continue as long as regional and national economic trends remain negative. The rate for earning assets decreased 148 basis points for the three month period with lower average yields on loans and federal funds sold accounting for most of the decrease. The cost to fund earning assets decreased 115 basis points for the three month period primarily due to lower rates on deposits and securities sold under repurchase agreements.

Noninterest Income
                          Table 4 - Noninterest Income

                                           Three Months Ended
                                               March 31,                       Variance
                                          2009            2008           Amount            %
                                                        (Dollars in thousands)
Service charges and fees on
deposits                               $    1,641       $   1,670      $      (29 )         (1.7 %)
Gain on sales of loans                      2,237           1,260             977           77.5 %
Gain on sale of fixed assets                   26               3              23          766.7 %
Investment securities
(losses) gains, net                          (164 )            38            (202 )       (531.6 %)
Retail investment income                      209             289             (80 )        (27.7 %)
Trust services fees                           253             286             (33 )        (11.5 %)
Increase in cash surrender value of
bank-owned life insurance                     180             164              16            9.8 %
Miscellaneous income                          163             221             (58 )        (26.2 %)

Total noninterest income               $    4,545       $   3,931      $      614           15.6 %

Noninterest income increased $614 (15.6%) during the three month period as compared to the same period in 2008. The most significant changes for the three month period were an increase in gain on sales of loans somewhat offset by decreases in net investment securities gains (losses), retail investment income, trust services fees and service charges and fees on deposits. The increased gain on sales of loans was due to a significant increase in refinancing volume. Net investment securities gains were down in 2009 as compared to 2008 due primarily to the impairment loss on the common stock and trust preferred securities of Silverton Financial Services, Inc., parent holding company of Silverton Bank, N.A. Silverton Bank was placed in receivership on May 1, 2009, and other-than-temporary-impairment losses associated with our Silverton holdings totaled approximately $908, and were somewhat offset by the sale of certain US Agency securities which generated approximately $765 in gains.

Noninterest Expense
                         Table 5 - Noninterest Expense

                                             Three Months Ended
                                                  March 31,                 Variance
                                              2009          2008        Amount        %
                                                       (Dollars in thousands)
    Salaries and other personnel expense   $    5,658      $ 5,171     $    487        9.4 %
    Occupancy expenses                          1,141        1,026          115       11.2 %
    Other operating expenses                    3,034        2,724          310       11.4 %

    Total noninterest expense              $    9,833      $ 8,921     $    912       10.2 %

Noninterest expense increased $912 (10.2%) during the three-month period. Salaries and other personnel expenses:
Salaries and other personnel expense increased $487 (9.4%) for the first quarter 2009 as compared to the same period in 2008. This increase was primarily due to . . .