CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

In addition to historical information, this Form 10-Q report contains forward-looking statements within the meaning of the federal securities laws. The Corporation cautions that there are various factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the Corporation's forward-looking statements; accordingly, there can be no assurance that such indicated results will be realized.

These factors include risks related to:

· the conditions in the banking system, financial markets, and general economic conditions;
· the Corporation's ability to raise capital;
· the Corporation's ability to maintain liquidity or access other sources of funding;
· the Corporation's construction and land development loans;
· asset quality;
· the adequacy of the allowance for loan losses;
· technology difficulties or failures;
· the Corporation's ability to execute its business strategy;
· the loss of key personnel;
· competition;
· the impact of the Dodd-Frank Act and related regulations and other changes in financial services laws and regulations;
· changes in regulation and monetary policy;
· losses due to fraudulent and negligent conduct of customers, service providers or employees;
· acquisitions or dispositions of assets or internal restructuring that may be pursued by the Corporation;
· changes in or application of environmental and other laws and regulations to which the Corporation is subject;
· political, legal and local economic conditions and developments;
· financial market conditions and the results of financing efforts;
· changes in commodity prices and interest rates; and
· weather, natural disasters and other catastrophic events and other factors discussed in the Corporation's other filings with the Securities and Exchange Commission.

Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of the Corporation. Any such statement speaks only as of the date the statement was made. The Corporation undertakes no obligation to update or revise any forward-looking statements. Additional information with respect to factors that may cause results to differ materially from those contemplated by such forward-looking statements is included in the Corporation's current and subsequent filings with the Securities and Exchange Commission.

Overview

The Corporation is a full-service community bank holding company headquartered in Moultrie, Georgia. The community of Moultrie has been served by the Bank since 1928. We provide comprehensive financial services to consumer, business and governmental customers, which, in addition to conventional banking products, include a full range of mortgage banking, trust, investment and insurance services. Our primary market area incorporates Colquitt County, where we are headquartered, and Baker, Lowndes, Thomas, and Worth Counties, each contiguous with Colquitt County, and the surrounding counties of southwest Georgia. We have six full-service banking facilities and six automated teller machines.

Our strategy is to:

· maintain the diversity of our revenue, including both interest and noninterest income through a broad base of business,
· strengthen our sales and marketing efforts while developing our employees to provide the best possible service to our customers,
· expand our market share where opportunity exists, and
· grow outside of our current geographic market either through de-novo branching or acquisitions into areas proximate to our current market area.

We believe that investing in sales and marketing in this challenging market will provide us with a competitive advantage. To that end, we expanded geographically with a full-service banking center that was completed and opened in June of 2010 and a mortgage origination office that opened in January 2011 both in Valdosta, Georgia. Continuing our expansion in the Valdosta market, we opened our second banking center in March 2012.

The Corporation's 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 and the interest paid on interest-bearing liabilities. The Corporation's earning assets are primarily loans, securities, and short-term interest-bearing deposits with banks and the interest-bearing liabilities are principally customer deposits and borrowings. Net interest income is highly sensitive to fluctuations in interest rates. For example, after the overnight borrowing rate for banks reached 5.25% in September of 2007, the Federal Reserve Bank began decreasing it by 5% to a range of 0% to 0.25%. This historically low interest rate level has remained unchanged for the period from October 2008 through June 2012. To address interest rate fluctuations, we manage our balance sheet in an effort to diminish the impact should interest rates suddenly change.

Broadening our revenue sources helps to reduce the risk and exposure of our financial results to the impact of changes in interest rates, which are outside of our control. Sources of noninterest income include our insurance agency and Empire, the Corporation's commercial mortgage banking subsidiary, as well as fees on customer accounts, and trust and retail brokerage services. In the second quarter of 2012, noninterest income was 32.5% of the Corporation's total revenue.

Our profitability is impacted also by operating expenses such as salaries, employee benefits, occupancy, and income taxes. Our lending activities are significantly influenced by regional and local factors such as changes in population, competition among lenders, interest rate conditions and prevailing market rates on competing uses of funds and investments, customer preferences and levels of personal income and savings in the Corporation's primary market area.

The economic downturn continues to challenge our region; however, our strength and stability in the market and our focused efforts enabled us to achieve positive results in 2012. We continued to invest in our people and communities, fully aware of the near-term impact that would have on earnings. Although the economy is slowly recovering, regulatory burdens continue to outpace growth opportunities. Despite those challenges, we will continue to focus on our customers and believe that our strategic positioning, strong balance sheet and capital levels position us to sustain our franchise, capture market share and build customer loyalty.

The Corporation's nonperforming assets increased $1.9 million to $5.3 million at the end of June 2012 compared with the same period last year. The increase in nonperforming assets is due to one large loan placed on nonaccrual during the second quarter. The collateral securing the loan has been placed under contract for sale and closing is scheduled for August 2012. The loan balance has been charged against the loan reserve by the amount of the net proceeds we expect from the sale. Foreclosed assets decreased $909 thousand compared with the second quarter last year.

Critical Accounting Policies

In the course of the Corporation's normal business activity, management must select and apply many accounting policies and methodologies that lead to the financial results presented in the consolidated financial statements of the Corporation. Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy because of the uncertainty and subjectivity inherent in estimating the levels of allowance needed to cover probable credit losses within the loan portfolio and the material effect that these estimates have on the Corporation's results of operations. We believe that the allowance for loan losses as of June 30, 2012, is adequate; however, under adverse conditions or assumptions, future additions to the allowance may be necessary. There have been no significant changes in the methods or assumptions used in our accounting policies that would have resulted in material estimates and assumptions changes. Note 1 to the Consolidated Financial Statements provides a description of our significant accounting policies and contributes to the understanding of how our financial performance is reported.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity management involves the ability to meet the cash flow requirements of customers who may be either depositors wanting to withdraw their funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. In the ordinary course of business, the Corporation's cash flows are generated from interest and fee income as well as from loan repayments and the maturity or sale of other earning assets. In addition, liquidity is continuously provided through the acquisition of new deposits and borrowings or the rollover of maturing deposits and borrowings. The Corporation strives to maintain an adequate liquidity position by managing the balances and maturities of interest-earning assets and interest-earning liabilities so its short-term investments balance, at any given time, will adequately cover any reasonably anticipated immediate need for funds. Additionally, the Bank maintains relationships with correspondent banks that could provide funds on short notice, if needed.

The liquidity and capital resources of the Corporation are monitored on a periodic basis by state and Federal regulatory authorities. As determined under guidelines established by these regulatory authorities, the Bank's liquidity ratios at June 30, 2012, were considered satisfactory. At that date, the Bank's short-term investments were adequate to cover any reasonably anticipated immediate need for funds. We are not aware of any known trends, events, or uncertainties that will have or that are reasonably likely to have a material adverse effect on the Corporation's liquidity or operations. At June 30, 2012, the Corporation's and the Bank's risk-based capital ratios were considered adequate based on guidelines established by regulatory authorities. During the six months ended June 30, 2012, total capital increased $316 thousand to $28.9 million and increased $935 thousand from the same period last year. Also, the Corporation continues to maintain a healthy level of capital adequacy as measured by its equity-to-asset ratio of 9.15% as of June 30, 2012. The Corporation is not aware of any events or trends likely to result in a material change in capital resources other than the effects of normal operations on the retention of net earnings. Also, the Corporation's management is not aware of any current recommendations by the regulatory authorities which, if they were implemented, would have a material effect on the Corporation's capital resources.

RESULTS OF OPERATIONS

The Corporation's results of operations are determined by its ability to effectively manage interest income and expense, to minimize loan and investment losses, to generate noninterest income and to control noninterest expense. Since interest rates are determined by market forces and economic conditions beyond the control of the Corporation, the ability to generate net interest income is dependent upon the Bank's ability to obtain an adequate spread between the rate earned on interest-earning assets and the rate paid on interest-bearing liabilities. Thus, the key performance measure for net interest income is the interest margin or net yield, which is taxable-equivalent net interest income divided by average earning assets.

Performance Summary

The Corporation's net income after taxes for the three-month period ending June 30, 2012, was $305 thousand, down $286 thousand, or 48.4%, from net income of $591 thousand for the second quarter of 2011. This decrease in net income was primarily due to a large pension contribution. Excluding the $850 thousand quarter-to-date pension contribution, net income would have been $866 thousand for the second quarter 2012. Partially offsetting this expense was a $150 thousand quarterly increase in gains on the sale of securities.

On a per share basis, net income for the second quarter was $.12 per diluted share compared with $.23 per diluted share for the same quarter in 2011. The weighted average common diluted shares outstanding for the quarter were 2.548 million, the same as second quarter last year.

For the six months ended June 30, 2012, net income after taxes was $876 thousand, down from $966 thousand for the first half of 2011. On a per share basis, net income for the first six months of 2012 was $.34 per diluted share compared with $.38 per diluted share for the same period in 2011.

We measure our performance on selected key ratios, which are provided for the previous five quarterly periods.

                                   2nd Qtr     1st Qtr     4th Qtr     3rd Qtr     2nd Qtr
                                    2012        2012        2011        2011        2011
Return on average total assets       0.38 %      0.71 %      0.53 %      0.13 %      0.76 %
Return on average total equity       4.16 %      7.88 %      5.57 %      1.39 %      8.59 %
Average shareholders' equity to
Average total assets                 9.18 %      8.98 %      9.46 %      9.41 %      8.79 %
Net interest margin
(tax equivalent)                     4.24 %      4.10 %      4.29 %      4.13 %      4.21 %

Comparison of Statements of Income for the Quarter

Total interest income decreased $51 thousand to $3.4 million for the three months ended June 30, 2012, compared with the same period in 2011, reflecting lower interest income from investment securities of $152 thousand due to selling securities in order to fund the growth in loans. This decrease was partially offset by an increase in interest income from loans of $93 thousand. Interest on deposits in other banks increased $9 thousand when compared with the second quarter of 2011.

Total interest expense decreased $89 thousand, or 15.7%, to $478 thousand in the second quarter of 2012 compared with the same period in 2011. Interest paid on deposits decreased $78 thousand, or 22.0%, during the second quarter of 2012 due to the low interest rate environment. The average rate paid on average time deposits for the quarter has decreased 36 basis points since June 30, 2011. Interest on total borrowings decreased $12 thousand compared with the same quarter in 2011.

The primary source of revenue for the Corporation is net interest income, which is the difference between total interest income on earning assets and interest expense on interest-bearing sources of funds. Net interest income improved $38 thousand to $2.9 million for the second quarter of 2012. Net interest income after provision for loan losses for the second quarter of 2012 was $2.8 million compared with $2.7 million for the same period in 2011. The provision for loan losses was $105 thousand in the second quarter of 2012 compared with $150 thousand for the second quarter of 2011. The Corporation's net interest margin was 4.24% for the second quarter of 2012, up 3 basis points from the same period last year. Continual improvements in the net interest margin are mainly attributed to changes in the earning asset mix. The growth in higher-yielding loans was funded by decreases in the lower-yielding investment securities portfolio.

Noninterest income, at 32.5% of the Corporation's total revenue for the quarter, was $1.6 million for the second quarter, up $182 thousand from the same period in 2011. The improvement in noninterest income was primarily due to a $150 thousand quarterly increase in gains on the sale of securities. Also, we recognized a $30 thousand lower net loss on the sale or writedown of foreclosed assets compared with the second quarter last year. Income from insurance services increased $19 thousand compared with the same period last year. Partially offsetting these increases, service charges on deposit accounts decreased $20 thousand and income from mortgage banking services decreased $20 thousand compared with second quarter 2011.

Noninterest expense increased $744 thousand to $4.1 million for the second quarter of 2012 compared with the second quarter of 2011. The largest component of noninterest expense, salaries and employee benefits, increased $769 thousand to $2.7 million for the second quarter mainly due to an $850 thousand quarterly pension contribution. While the pension plan's earning assets have earned over 6.3% return on average investments for the past three years, the discount rate used in funding calculations continues to drop dramatically causing large increases in future plan liabilities. Only higher interest rates will reverse the trend. Equipment, data processing and occupancy expense also increased $41 thousand, $25 thousand and $20 thousand, respectively, largely due to our Valdosta expansion and enhancing information technology infrastructure. Other operating expense decreased $110 thousand primarily due to lower foreclosed property expenses and FDIC insurance assessments.

Comparison of Statements of Income for the Six-month Period

Total interest income for the first six months of 2012 increased $105 thousand to $6.7 million when compared with the same period in 2011. This increase was primarily due to a $379 thousand increase in interest and fees on loans due to an $18.7 million higher average volume of loans compared with the first six months of 2011. Interest on deposits and certificates of deposit in other banks increased $17 thousand compared with the first half of 2011. These increases were partially offset by a decrease in interest income from investment securities of $292 thousand due to a $19.4 million lower average volume of investments compared with the first six months of last year.

Total interest expense for the six-month period ended June 30, 2012, decreased $194 thousand, or 16.7%, compared with the same period in 2011. The decrease in interest expense was primarily related to lower interest paid on interest-bearing deposits of $177 thousand, or 23.8%, compared with the first half of 2011 reflecting lower interest rates. Interest on total borrowings declined $17 thousand for the first six months of 2012 compared with the same period last year.

Net interest income for the first six months of 2012 was 5.5% higher at $5.7 million compared with $5.4 million for the same period in 2011, mainly as a result of lower interest paid on deposits and higher income from loans. Net interest income after provision for loan losses was $5.5 million for the first half of 2012 compared with $5.1 million for the same period in 2011. The provision for loan losses was $210 thousand in the first half of 2012 compared with $300 thousand for the first half of 2011. Net interest margin was 4.17% for the first six months of 2012, up from 4.01% for the first half of 2011.

For the first six months of 2012, noninterest income was $3.1 million, up 13.0% from the same period in 2011. The increase was primarily attributed to a 245 thousand increase in income from mortgage banking services as well as a $117 thousand higher net gain on the sale of securities for the first six months of 2012 compared with the same period in 2011. Income from insurance and retail brokerage services increased $41 thousand and $26 thousand, respectively, compared with the first six months of 2011. Partially offsetting these increases, service charges on deposit accounts declined $74 thousand when compared with the same period of 2011. Also, the net loss on the sale or disposition of assets increased $43 thousand compared with the same period in 2011.

Noninterest expense increased $971 thousand for the first six months of 2012 compared with the same period last year. The change was mainly due to an $884 thousand increase in salary and employee benefits related to the large pension contribution recognized in the second quarter 2012. Equipment, data processing and occupancy expense increased $83 thousand, $46 thousand and $25 thousand, respectively. Partially offsetting these increases, other operating expenses decreased by $71 thousand, a reflection of lower foreclosed asset expenses and insurance assessments to the FDIC.

Comparison of Financial Condition Statements

At June 30, 2012, total assets were $315.5 million, a 3.2% increase from December 31, 2011. The increase in total assets was primarily due to solid loan growth funded by decrease in investment securities and growth in deposits. Total loans increased $13 million, or 7.2%, to $194.4 million compared with $181.3 million at December 31, 2011. Loan growth was driven primarily by our expansion into the Valdosta market. The Corporation continues to be conservative in its lending practices in order to maintain a quality loan portfolio. Loans, a major use of funds, represented 61.6% of total assets.

Investment securities and short-term investments which include Federal funds sold and interest-bearing deposits in other banks represented 29.5% of total assets at June 30, 2012. Compared with year-end, investment securities decreased $9.2 million and short-term investments increased $4.9 million. This resulted in an overall decrease in investments of $4.3 million since the end of 2011.

Deposits increased to $259.3 million at the end of the second quarter of 2012, up $10.3 million from the end of 2011. The increase was primarily due to increases in money market accounts. At June 30, 2012, total deposits represented 82.2% of total assets.

The following table shows the major contractual obligations for the Corporation.

Long-term debt consists of the following:

                                             June 30,          December 31,          June 30,
                                               2012                2011                2011

Advance from Federal Home Loan Bank
with a 2.23% fixed rate of interest
maturing July 30, 2012.
(transferred to short-term
borrowings)                                          0                   0           2,000,000

Advance from Federal Home Loan Bank
with a 2.79% fixed rate of interest
maturing July 29, 2013.                      2,000,000           2,000,000           2,000,000

Advance from Federal Home Loan Bank
with a 3.85% fixed rate of interest
maturing April 30, 2014.                    10,000,000          10,000,000          10,000,000

Advance from Federal Home Loan Bank
with a 3.39% fixed rate of  interest
maturing August 20, 2018.
(convertible to a variable rate at
quarterly options of Federal Home
Loan Bank - no conversion option has
been made)                                   5,000,000           5,000,000           5,000,000

Advance from Federal Home Loan Bank
with a 2.78% fixed rate of interest
maturing September 10, 2018.
(convertible to a variable rate at
quarterly options of Federal Home
Loan Bank - no conversion option has
been made)                                   5,000,000           5,000,000           5,000,000

Total long-term debt                      $ 22,000,000        $ 22,000,000        $ 24,000,000

The allowance for loan losses represents a reserve for potential losses in the loan portfolio. The adequacy of the allowance for loan losses is evaluated monthly based on a review of all significant loans, with a particular emphasis on nonaccruing, past due, and other loans that management believes require attention.

Other factors used in determining the adequacy of the reserve are management's judgment about factors affecting loan quality and their assumptions about the local and national economy. The allowance for loan losses was 1.50% of total loans outstanding at June 30, 2012, compared with 1.71% of loans outstanding at December 31, 2011, and 1.65% at June 30, 2011. Net charge-offs in the 2012 second quarter were $439 thousand compared with net charge-offs of $110 thousand in the second quarter of 2011. Management considers the allowance for loan losses as of June 30, 2012, adequate to cover potential losses in the loan portfolio. For more information about loans, see Part I, Item 1, "Note 4 - Loans and Allowance for Loan Losses."

Nonperforming assets were $5.3 million, or 1.69% of total assets, in the second quarter of 2012, up from $3.6 million, or 1.18% of total assets, at the end of 2011, and up from $3.5 million, or 1.15% of total assets in the same period last year. Nonaccrual loans increased $2.8 million to $3.2 million in the second quarter of 2012 compared with the second quarter last year. There were $2.0 million of foreclosed properties in nonperforming assets at the end of the second quarter of 2012 compared with $2.9 million at the end of last year's second quarter.

Off-Balance Sheet Arrangements

In the normal course of business, we are a party to financial instruments with off-balance-sheet risk to meet the financing needs of our customers and reduce risk exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit in the form of loans or through letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the financial statements. Since many of the commitments to extend credit and standby letters of credit are expected to expire without being drawn upon, the contractual or notional amounts do not represent future cash requirements.

Financial instruments whose contract amounts
           represent credit risk:                    June 30, 2012          June 30, 2011
(dollars in thousands)
Commitments to extend credit                        $      18,325          $      11,707
Standby letters of credit and financial
guarantees                                          $          25          $          45

The Corporation does not have any special purpose entities or off-balance sheet financing arrangements.

Capital Resources and Dividends

At June 30, 2012, the Corporation's and the Bank's risk-based capital ratios were considered adequate based on guidelines established by regulatory authorities. Our total risk based capital ratio now stands at 16.06%, which is 60 percent in excess of the regulatory standard for a "well-capitalized" bank. Southwest Georgia Financial Corporation's and Southwest Georgia Bank's risk based capital ratios are shown in the following table.

  SOUTHWEST GEORGIA FINANCIAL CORPORATION
         Risk Based Capital Ratios






                                            Southwest Georgia
                                          Financial Corporation                 Regulatory Guidelines
                                                                          For Well
Risk Based Capital Ratios                     June 30, 2012             Capitalized          Minimum Guidelines
Tier 1 capital                                      14.81 %                    6.00 %                     4.00 %
Total risk based capital                            16.06 %                   10.00 %                     8.00 %
Tier 1 leverage ratio                                9.16 %                    5.00 %                     3.00 %

                                          Southwest Georgia
                                                 Bank                       Regulatory Guidelines
                                                                      For Well
Risk Based Capital Ratios                   June 30, 2012           Capitalized          Minimum Guidelines
Tier 1 capital                                    14.17 %                  6.00 %                     4.00 %
Total risk based capital                          15.42 %                 10.00 %                     8.00 %
Tier 1 leverage ratio                              8.75 %                  5.00 %                     3.00 %

In June 2012, the Corporation paid a quarterly cash dividend of $0.04 per common share. In March 2012, the Corporation paid a cash dividend of $0.04 per common share and announced plans to resume paying cash dividends on a quarterly basis. The Board of Directors will continue to assess conditions for future dividend payments. . . .