Management's discussion and analysis ("MD&A") provides supplemental information, which sets forth the major factors that have affected our financial condition and results of operations and should be read in conjunction with the Consolidated Financial Statements and related notes. The MD&A is divided into subsections entitled "Business Overview," "Financial Overview," "Results of Operations," "Financial Condition," "Market Risk and Interest Rate Sensitivity," "Liquidity and Capital Resources," "Off-Balance Sheet Arrangements," "Legislation," and "Critical Accounting Policies." The following information should provide a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2009 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and subsidiaries, collectively, are referred to as "CCBG," "Company," "we," "us," or "our."

In this MD&A, we present an operating efficiency ratio and an operating net noninterest expense as a percent of average assets ratio, both of which are not calculated based on accounting principles generally accepted in the United States ("GAAP"), but that we believe provide important information regarding our results of operations. Our calculation of the operating efficiency ratio is computed by dividing noninterest expense less intangible amortization and merger expenses, by the sum of tax equivalent net interest income and noninterest income. We calculate our operating net noninterest expense as a percent of average assets by subtracting noninterest expense (excluding intangible amortization and merger expenses) from noninterest income. Management uses these non-GAAP measures as part of its assessment of its performance in managing noninterest expenses. We believe that excluding intangible amortization and merger expenses in our calculations better reflect our periodic expenses and is more reflective of normalized operations.

Although we believe the above-mentioned non-GAAP financial measures enhance investors' understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP. In addition, there are material limitations associated with the use of these non-GAAP financial measures such as the risks that readers of our financial statements may disagree as to the appropriateness of items included or excluded in these measures and that our measures may not be directly comparable to other companies that calculate these measures differently. Our management compensates for these limitations by providing detailed reconciliations between GAAP information and the non-GAAP financial measure as detailed below.

Reconciliation of operating efficiency ratio to efficiency ratio:

                                                   Three Months Ended                                 Nine Months Ended
                                   September 30,        June 30,        September 30,        September 30,        September 30,
                                       2009               2009              2008                 2009                 2008
Efficiency ratio                            76.30 %         77.83 %              62.31 %              77.24 %              66.19 %
Effect of intangible
amortization expense                        (2.44 )%        (2.39 )%             (3.04 )%             (2.42 )%             (3.21 )%
Operating efficiency ratio                  73.86 %         75.44 %              59.27 %              74.82 %              62.98 %

Reconciliation of operating net
noninterest expense ratio:
                                                   Three Months Ended                                 Nine Months Ended
                                   September 30,        June 30,        September 30,        September 30,        September 30,
                                       2009               2009              2008                 2009                 2008
Net noninterest expense as a
percent of average assets                    2.75 %          2.93 %               1.53 %               2.88 %               1.89 %
Effect of intangible
amortization expense                        (0.16 )%        (0.16 )%             (0.23 )%             (0.16 )%             (0.23 )%
Operating net noninterest
expense as a percent of average
assets                                       2.59 %          2.77 %               1.30 %               2.72 %               1.66 %

The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this Quarterly Report on Form 10-Q.

This Quarterly Report on Form 10-Q, including this MD&A section, contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements about our beliefs, plans, objectives, goals, expectations, estimates and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words "may," "could," "should," "would," "believe," "anticipate," "estimate," "expect," "intend," "plan," "target," "goal," and similar expressions are intended to identify forward-looking statements.

All forward-looking statements, by their nature, are subject to risks and uncertainties. Our actual future results may differ materially from those set forth in our forward-looking statements. Please see the Introductory Note and Item 1A. Risk Factors of our 2008 Report on Form 10-K, as updated in our subsequent quarterly reports filed on Form 10-Q, and in our other filings made from time to time with the SEC after the date of this report.

However, other factors besides those listed in our Quarterly Report or in our Annual Report also could adversely affect our results, and you should not consider any such list of factors to be a complete set of all potential risks or uncertainties. Any forward-looking statements made by us or on our behalf speak only as of the date they are made. We do not undertake to update any forward-looking statement, except as required by applicable law.

BUSINESS OVERVIEW

We are a financial holding company headquartered in Tallahassee, Florida and we are the parent of our wholly-owned subsidiary, Capital City Bank (the "Bank" or "CCB"). The Bank offers a broad array of products and services through a total of 69 full-service offices located in Florida, Georgia, and Alabama. The Bank offers commercial and retail banking services, as well as trust and asset management, retail securities brokerage and data processing services.

Our profitability, like most financial institutions, is dependent to a large extent upon net interest income, which is the difference between the interest received on earning assets, such as loans and securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Results of operations are also affected by the provision for loan losses, operating expenses such as salaries and employee benefits, occupancy and other operating expenses including income taxes, and noninterest income such as service charges on deposit accounts, asset management and trust fees, retail securities brokerage fees, mortgage banking revenues, bank card fees, and data processing revenues.

Our philosophy is to grow and prosper, building long-term relationships based on quality service, high ethical standards, and safe and sound banking practices. We maintain a locally oriented, community-based focus, which is augmented by experienced, centralized support in select specialized areas. Our local market orientation is reflected in our network of banking office locations, experienced community executives with a dedicated President for each market, and community boards which support our focus on responding to local banking needs. We strive to offer a broad array of sophisticated products and to provide quality service by empowering associates to make decisions in their local markets.

Our long-term vision is to continue our expansion, emphasizing a combination of growth in existing markets and acquisitions. Acquisitions will continue to be focused on a three state area including Florida, Georgia, and Alabama with a particular focus on financial institutions, which are $100 million to $400 million in asset size and generally located on the outskirts of major metropolitan areas. Five markets have been identified, four in Florida and one in Georgia, in which management will proactively pursue expansion opportunities. These markets include Alachua, Marion, Hernando and Pasco counties in Florida, the western panhandle of Florida, and Bibb and surrounding counties in central Georgia. We continue to evaluate de novo expansion opportunities in attractive new markets in the event that acquisition opportunities are not feasible. Additionally, given the current environment, management monitors the opportunities that may be available through FDIC assisted transactions. Other expansion opportunities that will be evaluated include asset management and mortgage banking.

Much of our lending operations are in the State of Florida, which has been particularly hard hit in the current U.S. economic recession. Evidence of the economic downturn in Florida is reflected in current unemployment statistics. The Florida unemployment rate at September 2009 increased to 11.0% from 8.1% at the end of 2008 and 4.7% at the end of 2007. A worsening of the economic condition in Florida would likely exacerbate the adverse effects of these difficult market conditions on our clients, which may have a negative impact on our financial results.

FINANCIAL OVERVIEW

A summary overview of our financial performance is provided below.

· For the third quarter 2009, we realized a net loss of $1.5 million ($0.08 per diluted share) compared to net income of $0.8 million ($0.04 per diluted share) for the second quarter of 2009 and $4.8 million ($0.29 per diluted share) for the third quarter of 2008. For the first nine months of 2009, we realized a net loss of $0.1 million ($0.00 per diluted share) compared to net income of $16.9 million ($0.99 per diluted share) for the comparable period of 2008.

· The net loss reported for the third quarter of 2009 reflects a loan loss provision of $12.3 million ($0.45 per diluted share) versus $8.4 million ($0.30 per diluted share) in the second quarter of 2009 and $10.4 million ($0.37 per diluted share) in the third quarter of 2008. Earnings for the third quarter of 2008 also included a $6.25 million gain ($0.22 per diluted share) from the sale of a portion of the bank's merchant services portfolio.

· Year-to-date 2009 performance reflects a loan loss provision of $29.2 million ($1.05 per diluted share) and a special FDIC assessment of approximately $1.2 million ($0.04 per diluted share) recorded in the second quarter. Year-to-date earnings for 2008 reflect a loan loss provision of $20.0 million ($0.72 per diluted share), a $6.25 million gain ($0.22 per diluted share) from the sale of the bank's merchant services portfolio, and Visa related transactions, which had a favorable impact on earnings of $3.5 million ($0.13 per diluted share).

· Tax equivalent net interest income for the third quarter of 2009 was $27.1 million compared to $27.7 million for the second quarter of 2009 and $27.8 million for the third quarter of 2008. For the first nine months of 2009, tax equivalent net interest income totaled $82.4 million compared to $83.0 million in 2008.

· Noninterest income decreased $0.3 million, or 2.3%, from the prior linked quarter due to lower mortgage banking fees and merchant fees. Year over year, noninterest income declined $5.9 million, or 29.2%, and $10.7 million, or 20.0%, for the three and nine-month periods, respectively. For the three month period, a one-time $6.25 million gain from the sale of a portion of our merchant services portfolio drove the unfavorable variance as well as lower merchant fee revenue reflective of the sale that occurred in July 2008. For the nine-month period, the aforementioned one-time $6.25 million gain, lower merchant fee revenue, as well as a $2.4 million gain from the redemption of Visa shares realized in the first quarter of 2008 drove the unfavorable year over year variance.

· Noninterest expense decreased $1.3 million, or 4.0%, from the prior linked quarter due primarily to lower compensation expense and FDIC insurance expense. Year over year, noninterest expense increased $1.7 million, or 5.7%, and $6.3 million, or 7.0%, for the three and nine-month periods, respectively. For the three month period, higher expense for other real estate properties and legal expense, both attributable to the increase in collection and foreclosure activity, drove the unfavorable variance. For the nine-month period, higher expense for other real estate properties, legal expense, pension expense, and higher FDIC insurance premiums, including a $1.2 million special assessment, drove the unfavorable variance. A one-time entry of $1.1 million in the first quarter of 2008 to reverse a portion of our Visa litigation accrual also contributed to the increase for the comparative nine month period.

· Loan loss provision for the quarter was $12.3 million, as compared to $8.4 million for the prior linked quarter. The higher loan loss provision was driven by an increase in impaired loan reserves for newly identified impaired loans, and to a lesser extent devaluation in real estate collateral securing impaired loans, primarily related to land development. Year over year, the loan loss provision increased $1.9 million and $9.2 million for the three and nine-month periods, respectively, generally reflective of current depressed economic conditions, and stress within our real estate markets, including property devaluation. As of September 30, 2009, the allowance for loan losses was 2.32% of total loans and provided coverage of 41% of nonperforming loans.

· Average earnings assets decreased $17.9 million, or 0.8%, from the second quarter of 2009 and increased $6.5 million, or 0.3%, from the prior year-end. The decline from the prior linked quarter was primarily attributable to a $9.2 million decline in loans reflective of the migration of loans to the other real estate category, and a $7.4 million decrease in investment securities. Compared to the fourth quarter of 2008, the increase in earning assets primarily reflects growth in the loan portfolio, which increased $24.9 million, or 1.3%, partially offset by a reduction in investment securities and short-term investments. Average deposits declined by $21.0 million, or 1.1%, from the second quarter of 2009 and increased $4.3 million, or 0.2%, from the fourth quarter of 2008, respectively.

· As of September 30, 2009, we are well-capitalized with a risk based capital ratio of 14.12% and a tangible capital ratio of 7.43% compared to 14.69% and 7.76%, respectively, at year-end 2008 and 15.15% and 8.67%, respectively, at September 30, 2008.

RESULTS OF OPERATIONS

Net Income

We realized a net loss of $1.5 million ($0.08 per diluted share) for the third quarter of 2009 compared to net income of $0.8 million or ($0.04 per diluted share) for the second quarter of 2009 and $4.8 million ($0.29 per diluted share) for the third quarter of 2008. For the first nine months of 2009, we realized a net loss $0.1 million ($0.00 per diluted share) compared to net income of $16.9 million ($0.99 per diluted share), for the same period of 2008.

The net loss reported for the third quarter of 2009 reflects a loan loss provision of $12.3 million ($0.45 per diluted share) versus $8.4 million ($0.30 per diluted share) in the second quarter of 2009 and $10.4 million ($0.37 per diluted share) in the third quarter of 2008. Earnings for the third quarter of 2008 also included a $6.25 million gain ($0.22 per diluted share) from the sale of a portion of the bank's merchant services portfolio.

Year-to-date 2009 performance reflects a loan loss provision of $29.2 million ($1.05 per diluted share) and a special FDIC assessment of approximately $1.2 million ($0.04 per diluted share) recorded in the second quarter. Year-to-date earnings for 2008 reflect a loan loss provision of $20.0 million ($0.72 per diluted share), a $6.25 million gain ($0.22 per diluted share) from the sale of the bank's merchant services portfolio, and Visa related transactions, which had a favorable impact on earnings totaling $3.5 million ($0.13 per diluted share).

A condensed earnings summary of each major component of our financial performance is provided below:

                                                   Three Months Ended                               Nine Months Ended
(Dollars in Thousands, except      September 30,        June 30,       September 30,       September 30,        September 30,
per share data)                         2009              2009              2008                2009                 2008
Interest Income                   $        30,787      $   31,180     $        34,654     $        93,020      $       109,637
Taxable equivalent Adjustments                576             584                 617               1,743                1,841
Total Interest Income (FTE)                31,363          31,764              35,271              94,763              111,478
Interest Expense                            4,235           4,085               7,469              12,378               28,518
Net Interest Income (FTE)                  27,128          27,679              27,802              82,385               82,960
Provision for Loan Losses                  12,347           8,426              10,425              29,183               19,999
Taxable Equivalent Adjustments                576             584                 617               1,743                1,841
Net Interest Income After
provision for Loan Losses                  14,205          18,669              16,760              51,459               61,120
Noninterest Income                         14,304          14,634              20,212              42,980               53,729
Noninterest Expense                        31,615          32,930              29,916              96,802               90,470
Income Before Income Taxes                 (3,106 )           373               7,056              (2,363 )             24,379
Income Taxes                               (1,618 )          (401 )             2,218              (2,299 )              7,451
Net Income                        $        (1,488 )    $      774     $         4,838     $           (64 )    $        16,928

Basic Net Income Per Share        $         (0.08 )    $     0.04     $          0.29     $          0.00      $          0.99
Diluted Net Income Per Share      $         (0.08 )    $     0.04     $          0.29     $          0.00      $          0.99

Return on Average Equity                    (2.15 )%         1.12 %              6.34 %             (0.03 )%              7.53 %
Return on Average Assets                     (.24 )%         0.12 %              0.76 %              0.00 %               0.87 %

Tax equivalent net interest income for the third quarter of 2009 was $27.1 million compared to $27.7 million for the second quarter of 2009 and $27.8 million for the third quarter of 2008. For the first nine months of 2009, tax equivalent net interest income totaled $82.4 million compared to $83.0 million in 2008.

The decrease in the net interest income on a linked quarter basis was partially due to the downward repricing of earning assets and a slight (3 basis points) increase in the costs of funds. One additional calendar day in the third quarter and a lower level of foregone interest on nonaccrual loans helped to offset the decline. The loan portfolio declined during the quarter and also continued to reprice lower without the offsetting benefit in funding costs. Compared to the linked quarter, the costs of funds increased primarily in interest bearing non-maturity deposits, reflecting a money market promotion launched during the third quarter.

The decline from the third quarter of 2008 reflects the downward repricing of earning assets, higher foregone interest on nonaccrual loans, and lower loan fees. Partially offsetting the decline was the lower costs of funds. We responded aggressively to the federal funds rate reductions, which began in September 2007. This, coupled with a favorable shift in mix of deposits, has resulted in a significantly lower cost of funds year over year.

The net interest margin of 4.99% declined 12 basis points over the linked quarter, attributable to lower earning assets yields and a slightly higher cost of funds. As compared to the third quarter of 2008, the margin experienced a slight decline of two basis points, reflecting compression in earning asset yields and lower loan fees, partially offset by aggressive deposit repricing.

The slight decrease in net interest income for the first nine months of 2009 as compared to the same period in 2008 resulted from lower earning assets yields, higher foregone interest and lower loan fees, partially offset by the lower costs of funds.

Over the next couple of quarters, we anticipate some continued reduction in our asset yields with a slight increase in our cost of funds, which during the first nine months half of 2009 has averaged 76 basis points. Therefore, we expect to experience some slight margin compression during the fourth quarter of 2009.

Provision for Loan Losses

The provision for loan losses for the third quarter of 2009 was $12.3 million compared to $8.4 million for the second quarter of 2009 and $10.4 million for the third quarter of 2008. The higher loan loss provision compared to the prior quarter was driven by an increase in impaired loan reserves for newly identified impaired loans and, to a lesser extent, devaluation in real estate collateral securing impaired loans, primarily related to land development. For the nine-month period, our loan loss provision was $29.2 million compared to $20.0 million for the same period of 2008 with the increase generally reflecting weakened economic conditions and real estate market stress, including declining property values, primarily vacant land.

Net charge-offs in the third quarter totaled $8.7 million (1.76% of average loans) compared to $6.8 million (1.39% of average loans) in the second quarter of 2009 and $2.4 million (.50% of average loans) in the third quarter of 2008. For the nine-month period of 2009, our net charge-offs totaled $20.8 million (1.41% of average loans), compared to $7.5 million (.53% of average loans) for the same period in 2008. At quarter-end, the allowance for loan losses was 2.32% of outstanding loans (net of overdrafts) and provided coverage of 41% of nonperforming loans.

                                                  Three Months Ended                               Nine Months Ended
(Dollars in Thousands, except      September 30,       June 30,        September 30,       September 30,       September 30,
per share data)                        2009               2009             2008                2009                 2008

CHARGE-OFFS
Commercial, Financial and
Agricultural                       $          633      $      388      $          275      $        1,878      $        1,318
Real Estate - Construction                  2,315           3,356                  77               5,991                 807
Real Estate - Commercial
Mortgage                                    1,707             123                (35)               2,833               1,205
Real Estate - Residential                   3,394           2,379                 797               7,748               1,791
Consumer                                    1,324           1,145               1,797               4,586               4,199
Total Charge-offs                           9,373           7,391               2,911              23,036               9,320

RECOVERIES
Commercial, Financial and
Agricultural                                   64              84                  68                 222                 263
Real Estate - Construction                    150               -                   4                 535                   4
Real Estate - Commercial
Mortgage                                        8               1                   1                   9                  15
Real Estate - Residential                      92              51                   6                 202                  33
Consumer                                      331             439                 433               1,281               1,484
Total Recoveries                              645             575                 512               2,249               1,799

Net Charge-offs                    $        8,728      $    6,816      $        2,399      $       20,787      $        7,521
Net Charge - Offs ( Annualized)              1.76 %          1.39 %              0.50 %              1.41 %              0.53 %
  as a percent of Average
  Loans Outstanding, Net of
  Unearned Interest

Noninterest Income

Noninterest income for the third quarter of 2009 totaled $14.3 million compared to $14.6 million in the second quarter of 2009 and $20.2 million for the third quarter of 2008. Compared to the linked quarter, the $0.3 million, or 2.3%, decline was due to lower mortgage banking fees ($239,000) and merchant fees ($270,000), partially offset by higher retail brokerage fees ($141,000). Compared to the prior year quarter, the $5.9 million, or 29.2%, decline primarily reflects a one-time $6.25 million pre-tax gain from a sale of a portion of the bank's merchant services portfolio in 2008.

For the first nine months of 2009, as compared to same period of 2008, noninterest income decreased $10.7 million, or 20.0%, due to the one-time $6.25 million pre-tax gain from the bank's sale of the merchant services portfolio in the third quarter of 2008, a $2.4 million pre-tax gain from the redemption of Visa shares realized in the first quarter of 2008, and an unfavorable year over year variance in merchant fees of $2.9 million related to the aforementioned merchant services portfolio sale.

Noninterest income represented 35.0% and 34.7% of operating revenues, respectively, for the three and nine month periods of 2009 compared to 42.6% and 39.8%, respectively, for the same three and nine month periods of 2008. The higher ratio for 2008 is primarily due to the impact of the $6.25 million pre-tax gain from the bank's merchant services portfolio sale, and the $2.4 million pre-tax gain from the redemption of Visa shares.

. . .