UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

        x
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended September 30, 2006

OR

        o
         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to ____________


Commission File Number: 0-13358
 
 
 
 
CAPITAL CITY BANK GROUP, INC.
(Exact name of registrant as specified in its charter)


Florida
  
59-2273542
(State or other jurisdiction of incorporation or organization)
  
(I.R.S. Employer Identification No.)


217 North Monroe Street, Tallahassee, Florida
  
32301
(Address of principal executive office)
  
(Zip Code)

             (850) 671-0300
             (Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer x
Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

At October 31, 2006, 18,532,107 shares of the Registrant's Common Stock, $.01 par value, were outstanding.
 



CAPITAL CITY BANK GROUP, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED SEPTEMBER 30, 2006

TABLE OF CONTENTS


PART I - Financial Information
  
       Page
 
Item 1.
4
     
Item 2.
14
     
Item 3.
26
     
Item 4.
28
     
PART II - Other Information
    
 
Item 1.
28
     
Item 1.A.
28
     
Item 2.
28
     
Item 3.
28
     
Item 4.
28
     
Item 5.
28
     
Item 6.
28
     
Signatures
  
29



-2-


INTRODUCTORY NOTE:
Caution Concerning Forward-Looking Statements

This Quarterly Report on Form 10-Q 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.

Our ability to achieve our financial objectives could be adversely affected by the factors discussed in detail in Part I, Item 2., “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II, Item 1A. “Risk Factors” in this Quarterly Report on Form 10-Q, the following sections of our Annual Report on Form 10-K for the year ended December 31, 2005 (the “2005 Form 10-K”): (a) “Introductory Note” in Part I, Item 1. “Business”; (b) “Risk Factors” in Part I, Item 1A., as updated in our subsequent quarterly reports filed on Form 10-Q, and (c) “Introduction” in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in Part II, Item 7. as well as:
 
 
Ÿ
our ability to integrate the business and operations of companies and banks that we have acquired, and those we may acquire in the future;

 
Ÿ
strength of the United States economy in general and the strength of the local economies in which we conduct operations;

 
Ÿ
effects of harsh weather conditions, including hurricanes;

 
Ÿ
inflation, interest rate, market and monetary fluctuations;

 
Ÿ
effect of changes in the stock market and other capital markets;

 
Ÿ
legislative or regulatory changes;

 
Ÿ
willingness of customers to accept third-party products and services for our products and services and vice versa;

 
Ÿ
changes in the securities and real estate markets;

 
Ÿ
increased competition and its effect on pricing;

 
Ÿ
technological changes;

 
Ÿ
changes in monetary and fiscal policies of the U.S. government;

 
Ÿ
changes in consumer spending and savings habits;

 
Ÿ
growth and profitability of our noninterest income;

 
Ÿ
changes in accounting principles, policies, practices or guidelines;

 
Ÿ
other risks described from time to time in filings with the Securities and Exchange Commission; and

 
Ÿ
our ability to manage the risks involved in the foregoing.

However, other factors besides those referenced 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.


-3-


PART I.
FINANCIAL INFORMATION
Item 1.

CAPITAL CITY BANK GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE PERIODS ENDED SEPTEMBER 30
(Unaudited)


   
Three Months Ended
  
Nine Months Ended
  
(Dollars in Thousands, Except Per Share Data)
  
2006
  
2005
  
2006
  
2005
  
INTEREST INCOME
                  
Interest and Fees on Loans
  
$
40,260
  
$
35,331
  
$
116,570
  
$
96,278
  
Investment Securities:
                          
U.S. Treasury
    
132
    
89
    
310
    
347
  
U.S. Govt. Agencies and Corporations
    
929
    
788
    
2,672
    
2,442
  
States and Political Subdivisions
    
650
    
416
    
1,672
    
1,132
  
Other Securities
    
203
    
144
    
606
    
436
  
Funds Sold
    
338
    
121
    
1,463
    
638
  
Total Interest Income
    
42,512
    
36,889
    
123,293
    
101,273
  
                           
INTEREST EXPENSE
                          
Deposits
    
9,985
    
5,480
    
26,423
    
14,407
  
Short-Term Borrowings
    
753
    
691
    
2,352
    
1,875
  
Subordinated Notes Payable
    
936
    
931
    
2,789
    
2,039
  
Other Long-Term Borrowings
    
615
    
783
    
2,189
    
2,272
  
Total Interest Expense
    
12,289
    
7,885
    
33,753
    
20,593
  
                           
NET INTEREST INCOME
    
30,223
    
29,004
    
89,540
    
80,680
  
Provision for Loan Losses
    
711
    
376
    
1,499
    
1,174
  
Net Interest Income After Provision For Loan Losses
    
29,512
    
28,628
    
88,041
    
79,506
  
                           
NONINTEREST INCOME
                          
Service Charges on Deposit Accounts
    
6,450
    
5,635
    
18,226
    
15,018
  
Data Processing
    
673
    
660
    
2,014
    
1,917
  
Asset Management Fees
    
1,215
    
1,050
    
3,420
    
3,175
  
Securities Transactions
    
0
    
9
    
(4
)
  
9
  
Mortgage Banking Revenues
    
824
    
1,317
    
2,448
    
3,116
  
Other
    
4,982
    
4,452
    
15,089
    
12,989
  
Total Noninterest Income
    
14,144
    
13,123
    
41,193
    
36,224
  
                           
NONINTEREST EXPENSE
                          
Salaries and Associate Benefits
    
15,277
    
14,046
    
45,912
    
39,793
  
Occupancy, Net
    
2,354
    
2,119
    
6,935
    
6,091
  
Furniture and Equipment
    
2,492
    
2,285
    
7,652
    
6,589
  
Intangible Amortization
    
1,536
    
1,430
    
4,601
    
3,922
  
Merger Expense
    
-
    
180
    
-
    
414
  
Other
    
8,763
    
8,549
    
26,484
    
23,663
  
Total Noninterest Expense
    
30,422
    
28,609
    
91,584
    
80,472
  
                           
INCOME BEFORE INCOME TAXES
    
13,234
    
13,142
    
37,650
    
35,258
  
Income Taxes
    
4,554
    
4,565
    
13,234
    
12,436
  
                           
NET INCOME
  
$
8,680
  
$
8,577
  
$
24,416
  
$
22,822
  
Basic Net Income Per Share
  
$
.47
  
$
.46
  
$
1.31
  
$
1.26
  
Diluted Net Income Per Share
  
$
.47
  
$
.46
  
$
1.31
  
$
1.26
  
                           
Average Basic Shares Outstanding
    
18,529,926
    
18,623,037
    
18,604,488
    
18,142,502
  
Average Diluted Shares Outstanding
    
18,564,932
    
18,648,504
    
18,627,167
    
18,156,764
  

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

-4-


CAPITAL CITY BANK GROUP, INC.
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
AS OF SEPTEMBER 30, 2006 AND DECEMBER 31, 2005
(Unaudited)

(Dollars In Thousands, Except Share Data)
  
September 30, 2006
  
December 31, 2005
  
ASSETS
          
Cash and Due From Banks
  
$
100,781
  
$
105,195
  
Funds Sold and Interest Bearing Deposits
    
35,631
    
61,164
  
Total Cash and Cash Equivalents
    
136,412
    
166,359
  
Investment Securities, Available-for-Sale
    
190,617
    
171,019
  
               
Loans, Net of Unearned Interest
    
2,009,459
    
2,067,494
  
Allowance for Loan Losses
    
(17,311
)
  
(17,410
)
Loans, Net
    
1,992,148
    
2,050,084
  
               
Premises and Equipment, Net
    
84,915
    
73,818
  
Goodwill
    
84,810
    
84,829
  
Other Intangible Assets
    
21,076
    
25,622
  
Other Assets
    
48,895
    
53,731
  
Total Assets
  
$
2,558,873
  
$
2,625,462
  
               
LIABILITIES
              
Deposits:
              
Noninterest Bearing Deposits
  
$
506,331
  
$
559,492
  
Interest Bearing Deposits
    
1,542,908
    
1,519,854
  
Total Deposits
    
2,049,239
    
2,079,346
  
               
Short-Term Borrowings
    
54,171
    
82,973
  
Subordinated Notes Payable
    
62,887
    
62,887
  
Other Long-Term Borrowings
    
43,701
    
69,630
  
Other Liabilities
    
29,833
    
24,850
  
Total Liabilities
    
2,239,831
    
2,319,686
  
               
SHAREOWNERS' EQUITY
              
Preferred Stock, $.01 par value, 3,000,000 shares authorized;
no shares outstanding
    
-
    
-
  
Common Stock, $.01 par value, 90,000,000 shares authorized; 18,532,104 and 18,631,706 shares issued and outstanding at September 30, 2006 and December 31, 2005, respectively
    
185
    
186
  
Additional Paid-In Capital
    
80,938
    
83,304
  
Retained Earnings
    
238,870
    
223,532
  
Accumulated Other Comprehensive Loss, Net of Tax
    
(951
)
  
(1,246
)
Total Shareowners' Equity
    
319,042
    
305,776
  
Total Liabilities and Shareowners' Equity
  
$
2,558,873
  
$
2,625,462
  

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

-5-


CONSOLIDATED STATEMENTS OF CHANGES IN SHAREOWNERS' EQUITY
(Dollars in Thousands, Except Per Share Data)

   
Common Stock
  
Additional Paid-In Capital
  
Retained Earnings
  
Accumulated Other Comprehensive Loss, Net of Taxes
  
Total
  
Balance, December 31, 2005
  
$
186
  
$
83,304
  
$
223,532
  
$
(1,246
)
$
305,776
  
Comprehensive Income:
                                
Net Income
    
-
    
-
    
24,416
    
-
        
Net Change in Unrealized Loss
On Available-for-Sale Securities
    
-
    
-
    
-
    
295
        
Total Comprehensive Income
    
-
    
-
    
-
    
-
    
24,711
  
Cash Dividends ($.4875 per share)
    
-
    
-
    
(9,078
)
  
-
    
(9,078
)
Stock Performance Plan Compensation
    
-
    
1,504
    
-
    
-
    
1,504
  
Issuance of Common Stock
    
1
    
969
    
-
    
-
    
970
  
Repurchase of Common Stock
    
(2
)
  
(4,839
)
  
-
    
-
    
(4,841
)
                                 
Balance, September 30, 2006
  
$
185
  
$
80,938
  
$
238,870
  
$
(951
)
$
319,042
  

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.



-6-

CAPITAL CITY BANK GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30
(Unaudited)

(Dollars in Thousands)
  
2006
  
2005
  
CASH FLOWS FROM OPERATING ACTIVITIES
          
Net Income
  
$
24,416
  
$
22,822
  
Adjustments to Reconcile Net Income to
Cash Provided by Operating Activities:
              
Provision for Loan Losses
    
1,499
    
1,174
  
Depreciation
    
5,251
    
4,324
  
Net Securities Amortization
    
480
    
1,133
  
Amortization of Intangible Assets
    
4,601
    
3,922
  
Loss (Gain) on Sale of Investment Securities
    
4
    
(9
)
Origination of Loans Held-for-Sale
    
(144,719
)
  
(167,172
)
Proceeds From Sales of Loans Held-for-Sale
    
148,330
    
170,667
  
Net Gain From Sales of Loans Held-for-Sale
    
(2,448
)
  
(3,116
)
Non-Cash Compensation
    
1,504
    
1,083
  
Deferred Income Taxes
    
3,704
    
1,450
  
Net Decrease (Increase) in Other Assets
    
4,225
    
(3,447
)
Net Increase in Other Liabilities
    
2,359
    
10,974
  
Net Cash Provided By Operating Activities
    
49,206
    
43,805
  
               
CASH FLOWS FROM INVESTING ACTIVITIES
              
Securities Available-for-Sale:
              
Purchases
    
(95,807
)
  
(78,748
)
Sales
    
283
    
35,142
  
Payments, Maturities, and Calls
    
75,872
    
94,723
  
Net Decrease (Increase) in Loans
    
54,636
    
(107,237
)
Net Cash Acquired in Acquisition
    
-
    
37,412
  
Purchase of Premises & Equipment
    
(16,634
)
  
(13,264
)
Proceeds From Sales of Premises & Equipment
    
286
    
175
  
Net Cash Provided By (Used In) Investing Activities
    
18,636
    
(31,797
)
               
CASH FLOWS FROM FINANCING ACTIVITIES
              
Net Decrease in Deposits
    
(30,108
)
  
(70,983
)
Net Decrease in Short-Term Borrowings
    
(42,271
)
  
(88,311
)
Proceeds from Subordinated Note Payable
    
-
    
31,959
  
Increase in Other Long-Term Borrowings
    
3,250
    
88,116
  
Repayment of Other Long-Term Borrowings
    
(15,711
)
  
-
  
Dividends Paid
    
(9,078
)
  
(8,371
)
Repurchase of Common Stock
    
(4,841
)
  
-
  
Issuance of Common Stock
    
969
    
785
  
Net Cash Used In Financing Activities
    
(97,790
)
  
(46,805
)
               
NET CHANGE IN CASH AND CASH EQUIVALENTS
    
(29,948
)
  
(35,316
)
               
Cash and Cash Equivalents at Beginning of Period
    
166,359
    
161,545
  
Cash and Cash Equivalents at End of Period
  
$
136,412
  
$
126,229
  
               
Supplemental Disclosure:
              
Interest Paid on Deposits
  
$
26,051
  
$
13,685
  
Interest Paid on Debt
    
7,523
    
6,034
  
Taxes Paid
    
11,530
    
11,129
  
Loans Transferred to Other Real Estate
    
638
    
2,391
  
Issuance of Common Stock as Non-Cash Compensation
    
1,504
    
339
  
Transfer of Current Portion of Long-Term Borrowings
to Short-Term Borrowings
    
13,061
    
42,649
  

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.

-7-

CAPITAL CITY BANK GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - MANAGEMENT'S OPINION AND ACCOUNTING POLICES

Basis of Presentation

The consolidated financial statements included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, including Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. Prior period financial statements have been reformatted and/or amounts reclassified, as necessary, to conform with the current presentation.

In the opinion of management, the consolidated financial statements contain all adjustments, which are those of a recurring nature, and disclosures necessary to present fairly the financial position of the Company as of September 30, 2006 and December 31, 2005, the results of operations for the three and nine month periods ended September 30, 2006 and 2005, and cash flows for the nine month periods ended September 30, 2006 and 2005.

The Company and its subsidiary follow accounting principles generally accepted in the United States of America and reporting practices applicable to the banking industry. The principles that materially affect its financial position, results of operations and cash flows are set forth in the Notes to Consolidated Financial Statements which are included in the Company's 2005 Annual Report on Form 10-K.

Stock-based Compensation

On January 1, 2006, the Company changed its accounting policy related to stock-based compensation in connection with the adoption of Statement of Financial Accounting Standards ("SFAS") No. 123R, "Share-Based Payment (Revised 2004)" ("SFAS 123R"). See Note 7 - Stock-Based Compensation for additional information.

NOTE 2 - INVESTMENT SECURITIES

The amortized cost and related market value of investment securities available-for-sale were as follows:

   
September 30, 2006
  
(Dollars in Thousands)
  
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Market Value
  
U.S. Treasury
  
$
12,083
  
$
29
  
$
33
  
$
12,079
  
U.S. Government Agencies and Corporations
    
60,043
    
47
    
669
    
59,421
  
States and Political Subdivisions
    
83,007
    
19
    
485
    
82,541
  
Mortgage-Backed Securities
    
24,358
    
31
    
461
    
23,928
  
Other Securities(1)
    
12,648
    
-
    
-
    
12,648
  
Total Investment Securities
  
$
192,139
  
$
126
  
$
1,648
  
$
190,617
  

   
December 31, 2005
  
(Dollars in Thousands)
  
Amortized Cost
  
Unrealized Gains
  
Unrealized Losses
  
Market Value
  
U.S. Treasury
  
$
9,065
  
$
-
  
$
50
  
$
9,015
  
U.S. Government Agencies and Corporations
    
75,233
    
-
    
1,017
    
74,216
  
States and Political Subdivisions
    
53,611
    
44
    
512
    
53,143
  
Mortgage-Backed Securities
    
20,948
    
35
    
452
    
20,531
  
Other Securities(1)
    
14,114
    
-
    
-
    
14,114
  
Total Investment Securities
  
$
172,971
  
$
79
  
$
2,031
  
$
171,019
  

(1)
FHLB and FRB stock recorded at cost.


-8-

NOTE 3 - LOANS

The composition of the Company's loan portfolio was as follows:

(Dollars in Thousands)
  
September 30, 2006
  
December 31, 2005
  
Commercial, Financial and Agricultural
  
$
218,442
  
$
218,434
  
Real Estate-Construction
    
183,237
    
160,914
  
Real Estate-Commercial
    
647,302
    
718,741
  
Real Estate-Residential
    
539,828
    
553,124
  
Real Estate-Home Equity
    
174,577
    
165,337
  
Real Estate-Loans Held-for-Sale
    
3,780
    
4,875
  
Consumer
    
242,293
    
246,069
  
Loans, Net of Unearned Interest
  
$
2,009,459
  
$
2,067,494
  


NOTE 4 - ALLOWANCE FOR LOAN LOSSES

An analysis of the changes in the allowance for loan losses for the nine month periods ended September 30 was as follows:

(Dollars in Thousands)
  
2006
  
2005
  
Balance, Beginning of Period
  
$
17,410
  
$
16,037
  
Acquired Reserves
    
-
    
1,385
  
Provision for Loan Losses
    
1,499
    
1,174
  
Recoveries on Loans Previously Charged-Off
    
1,309
    
1,361
  
Loans Charged-Off
    
(2,907
)
  
(2,533
)
Balance, End of Period
  
$
17,311
  
$
17,424
  

Impaired loans are primarily defined as all nonaccruing loans for the loan categories which are included within the scope of SFAS No. 114, "Accounting by Creditors for Impairment of a Loan." Selected information pertaining to impaired loans is depicted in the table below:

 
  
September 30, 2006
  
December 31, 2005
  
Impaired Loans:
                  
With Related Valuation Allowance
  
$
5,554
  
$
2,143
  
$
5,612
  
$
2,915
  
Without Related Valuation Allowance
    
3,455
    
-
    
1,658
    
-
  


NOTE 5 - INTANGIBLE ASSETS

The Company had intangible assets of $105.9 million and $110.5 million at September, 2006 and December 31, 2005, respectively. Intangible assets were as follows:

   
September 30, 2006
  
December 31, 2005
  
 
(Dollars in Thousands)
  
Gross
Amount
  
Accumulated
Amortization
  
Gross
Amount
  
Accumulated
Amortization
  
Core Deposit Intangibles
  
$
47,176
  
$
27,544
  
$
47,176
  
$
23,312
  
Goodwill
    
88,596
    
3,786
    
88,615
    
3,786
  
Customer Relationship Intangible
    
1,867
    
449
    
1,867
    
305
  
Non-Compete Agreement
    
539
    
513
    
483
    
287
  
Total Intangible Assets
  
$
138,178
  
$
32,292
  
$
138,141
  
$
27,690
  


-9-

Net Core Deposit Intangibles: As of September 30, 2006 and December 31, 2005, the Company had net core deposit intangibles of $19.6 million and $23.9 million, respectively. Amortization expense for the first nine months of 2006 and 2005 was $4.2 million and $3.6 million, respectively. Estimated annual amortization expense is $5.6 million.

Goodwill: As of September 30, 2006 and December 31, 2005, the Company had goodwill, net of accumulated amortization, of $84.8 million. Goodwill is the Company's only intangible asset that is no longer subject to amortization under the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets."

Other: As of September 30, 2006 and December 31, 2005, the Company had a customer relationship intangible, net of accumulated amortization, of $1.4 million and $1.6 million, respectively. This intangible was recorded as a result of the March 2004 acquisition of trust customer relationships from Synovus Trust Company. Amortization expense for the first nine months of 2006 and 2005 was $144,000. Estimated annual amortization expense is $191,000 based on use of a 10-year useful life.

As of September 30, 2006 and December 31, 2005, the Company also had a non-compete intangible, net of accumulated amortization, of $26,000 and $196,000, respectively. This intangible was recorded as a result of the October 2004 acquisition of Farmers and Merchants Bank of Dublin, Georgia. Amortization expense for the first nine months of 2006 and 2005 was $226,000 and $178,000, respectively. Estimated amortization expense for the remainder of 2006 is $26,000.


NOTE 6 - DEPOSITS

The composition of the Company's interest bearing deposits at September 30, 2006 and December 31, 2005 was as follows:

(Dollars in Thousands)
  
September 30, 2006
  
December 31, 2005
  
NOW Accounts
  
$
533,549
  
$
520,878
  
Money Market Accounts
    
387,906
    
331,094
  
Savings Deposits
    
129,884
    
144,296
  
Other Time Deposits
    
491,569
    
523,586
  
Total Interest Bearing Deposits
  
$
1,542,908
  
$
1,519,854
  


NOTE 7 - STOCK-BASED COMPENSATION

In accordance with the Company’s adoption of SFAS No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"), in the first quarter of 2003, the cost related to stock-based associate compensation included in net income has been accounted for under the fair value method in all reported periods.

On January 1, 2006, the Company adopted SFAS 123R. The Company continues to include the cost of its share-based compensation plans in net income under the fair value method.

As of September 30, 2006, the Company had three stock-based compensation plans, consisting of the 2005 Associate Incentive Plan ("AIP"), the 2005 Associate Stock Purchase Plan ("ASPP"), and the 2005 Director Stock Purchase Plan ("DSPP"). Total compensation expense associated with these plans for the nine months ended September 30, 2006 and 2005, was approximately $1.5 million and $1.1 million, respectively.

AIP. The Company's AIP allows the Company's Board of Directors to award key associates various forms of equity-based incentive compensation. Under the AIP, the Company has adopted the Stock-Based Incentive Plan (the "Incentive Plan"), effective January 1, 2006, which is a performance-based equity bonus plan for selected members of management, including all executive officers. Under the Incentive Plan, all participants are eligible to earn an equity award, consisting of performance shares, in each year of the five-year period ending December 31, 2010. Annual awards are tied to the annual earnings progression necessary to achieve the Project 2010 goal of $50.0 million in annual net income. The grant-date fair value of an annual compensation award is approximately $1.5 million. A total of 43,437 shares are eligible for issuance annually.


-10-

At the end of each calendar year, the Compensation Committee of the Company’s Board of Directos will confirm whether the performance goals have been met prior to the payout of any awards. Any performance shares earned under the Incentive Plan will be issued in the calendar quarter following the calendar year in which the shares were earned.

In accordance with the provisions of SFAS 123R, the Company recognized expense of approximately $1.1 million for the first nine months of 2006 related to the Incentive Plan. Under a substantially similar predecessor plan, the Company recognized expense of $581,000 for the first nine months of 2005. A total of 875,000 shares of common stock have been reserved for issuance under the AIP. To date, the Company has issued 28,093 shares of common stock.

Executive Stock Option Agreement. In 2006, under the provisions of the AIP, the Company's Board of Directors approved a stock option agreement for a key executive officer (William G. Smith, Jr. - Chairman, President and CEO, CCBG). Similar stock option agreements were approved in 2003-2005. These agreements grant a non-qualified stock option award upon achieving certain annual earnings per share conditions set by the Board, subject to certain vesting requirements. The options granted under the agreements have a term of ten years and vest at a rate of one-third on each of the first, second, and third anniversaries of the date of grant. Under the 2004 and 2003 agreements, 37,246 and 23,138 options, respectively, were issued, none of which have been exercised. The fair value of a 2004 option was $13.42, and the fair value of a 2003 option was $11.64. The exercise prices for the 2004 and 2003 options are $32.69 and $32.96, respectively. Under the 2005 agreement, the earnings per share conditions were not met; therefore, no economic value was earned by the executive. In accordance with the provisions of SFAS 123R and SFAS 123, the Company recognized expense of approximately $146,000 and $145,000 for the first nine months of 2006 and 2005, respectively, related to the aforementioned agreements.

A summary of the status of the Company’s option shares as of September 30, 2006 is presented below:

Options
  
Shares
  
Weighted-Average Exercise Price
  
Weighted-Average Remaining Term
  
Aggregate Intrinsic Value
  
Outstanding at January 1, 2006
    
60,384
  
$
32.79
    
8.3
  
$
88,161
  
Granted
    
-
    
-
    
-
    
-
  
Exercised
    
-
    
-
    
-
    
-
  
Forfeited or expired
    
-
    
-
    
-
    
-
  
Outstanding at September 30, 2006
    
60,384
  
$
32.79
    
7.8
  
$
-
  
Exercisable at September 30, 2006
    
35,977
  
$
32.79
    
7.8
  
$
-
  

As of September 30, 2006, there was $173,000 of total unrecognized compensation cost related to the nonvested option shares granted under the agreements. That cost is expected to be recognized over a remaining weighted-average period of 10 months.

DSPP. The Company's DSPP allows the directors to purchase the Company's common stock at a price equal to 90% of the closing price on the date of purchase. Stock purchases under the DSPP are limited to the amount of the directors' annual retainer and meeting fees. The DSPP has 93,750 shares reserved for issuance. A total of 16,733 shares have been issued since the inception of the DSPP. For the first nine months of 2006, the Company issued 10,144 shares under the DSPP and recognized $31,000 in expense related to this plan. For the first nine months of 2005, the Company issued 5,418 shares and recognized $21,000 in expense related to the DSPP.

ASPP. Under the Company's ASPP, substantially all associates may purchase the Company's common stock through payroll deductions at a price equal to 90% of the lower of the fair market value at the beginning or end of each six-month offering period. Stock purchases under the ASPP are limited to 10% of an associate's eligible compensation, up to a maximum of $25,000 (fair market value on each enrollment date) in any plan year. Shares are issued at the beginning of the quarter following each six-month offering period. The ASPP has 593,750 shares of common stock reserved for issuance. A total of 36,281 shares have been issued since inception of the ASPP. For the first nine months of 2006, the Company issued 9,343 shares under the ASPP and recognized $67,000 in expense related to this plan. For the first nine months of 2005, the Company issued 8,928 shares and recognized $66,000 in expense related to the ASPP.

Based on the Black-Scholes option pricing model, the weighted average estimated fair value of the purchase rights granted under the ASPP Plan was $6.22 for the first nine months of 2006. For the first nine months of 2005, the weighted average fair value of the purchase rights granted was $6.48. In calculating compensation, the fair value of each stock purchase right was estimated on the date of grant using the following weighted average assumptions:

   
Nine Months Ended September 30,
  
   
2006
  
2005
  
Dividend yield
    
1.95
%
  
1.9
%
Expected volatility
    
23.5
%
  
28.0
%
Risk-free interest rate
    
4.5
%
  
2.6
%
Expected life (in years)
    
0.5
    
0.5
  


-11-
 
NOTE 8 - EMPLOYEE BENEFIT PLANS

The components of the net periodic benefit costs for the Company's qualified benefit pension plan were as follows:

   
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
(Dollars in Thousands)
  
2006
  
2005
  
2006
  
2005
  
Discount Rate
    
5.75
%
  
6.00
%
  
5.75
%
  
6.00
%
Long-Term Rate of Return on Assets
    
8.00
%
  
8.00
%
  
8.00
%
  
8.00
%
                           
Service Cost
  
$
1,250
  
$
1,183
  
$
3,750
  
$
3,263
  
Interest Cost
    
875
    
838
    
2,625
    
2,438
  
Expected Return on Plan Assets
    
(975
)
  
(782
)
  
(2,925
)
  
(2,378
)
Prior Service Cost Amortization
    
50
    
55
    
150
    
165
  
Net Loss Amortization
    
375
    
400
    
1,125
    
990
  
Net Periodic Benefit Cost
  
$
1,575
  
$
1,694
  
$
4,725
  
$
4,478
  

The components of the net periodic benefit costs for the Company's Supplemental Executive Retirement Plan ("SERP") were as follows:

   
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
(Dollars in Thousands)
  
2006
  
2005
  
2006
  
2005
  
Discount Rate
    
5.75
%
  
6.00
%
  
5.75
%
  
6.00
%
Long-Term Rate Of Return On Assets
    
N/A
    
N/A
    
N/A
    
N/A
  
                           
Service Cost
  
$
30
  
$
35
  
$
90
  
$
105
  
Interest Cost
    
56
    
54
    
168
    
162
  
Expected Return On Plan Assets
    
N/A
    
N/A
    
N/A
    
N/A
  
Prior Service Cost Amortization
    
15
    
15
    
45
    
45
  
Net Loss Amortization
    
19
    
21
    
57
    
63
  
Net Periodic Benefit Cost
  
$
120
  
$
125
  
$
360
  
$
375
  
 

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Lending Commitments. The Company is a party to financial instruments with off-balance sheet risks in the normal course of business to meet the financing needs of its customers. These financial instruments consist of commitments to extend credit and standby letters of credit.

The Company’s maximum exposure to credit loss under standby letters of credit and commitments to extend credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in establishing commitments and issuing letters of credit as it does for on-balance sheet instruments. As of September 30, 2006, the amounts associated with the Company’s off-balance sheet obligations were as follows:

(Dollars in Millions)
  
Amount
  
Commitments to Extend Credit(1)
  
$
443.3
  
Standby Letters of Credit
  
$
17.8
  

(1) Commitments include unfunded loans, revolving lines of credit, and other unused commitments.

Commitments to extend credit are agreements to lend to a customer so long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Contingencies. The Company is a party to lawsuits and claims arising out of the normal course of business. In management's opinion, there are no known pending claims or litigation, the outcome of which would, individually or in the aggregate, have a material effect on the consolidated results of operations, financial position, or cash flows of the Company.

NOTE 10 - COMPREHENSIVE INCOME

SFAS No. 130, "Reporting Comprehensive Income," requires that certain transactions and other economic events that bypass the income statement be displayed as other comprehensive income (loss). Comprehensive income totaled $9.6 million and $24.7 million, respectively, for the three and nine months ended September 30, 2006, and $8.4 million and $22.3 million, respectively, for the comparable periods in 2005. The Company’s comprehensive income consists of net income and changes in unrealized gains (losses) on securities available-for-sale, net of income taxes. Changes in unrealized gains (losses), net of taxes, on securities totaled $963,000 and $295,000, respectively, for the three and nine months ended September, 2006, and $(195,000) and $(540,000), respectively, for the three and nine months ended September 30, 2005. Reclassification adjustments consist only of realized gains and losses on sales of investment securities and were not material for the nine months ended September 30, 2006 and 2005.



-12-

QUARTERLY FINANCIAL DATA (UNAUDITED)

   
2006
  
2005
  
2004
  
(Dollars in Thousands, Except Per Share Data)
  
Third
  
Second
  
First
  
Fourth
  
Third
  
Second
  
First
  
Fourth
  
Summary of Operations:
                                 
Interest Income
  
$
42,512
  
$
41,369
  
$
39,412
  
$
38,780
  
$
36,889
  
$
33,910
  
$
30,474
  
$
29,930
  
Interest Expense
    
12,289
    
11,182
    
10,282
    
9,470
    
7,885
    
6,788
    
5,920
    
5,634
  
Net Interest Income
    
30,223
    
30,187
    
29,130
    
29,310
    
29,004
    
27,122
    
24,554
    
24,296
  
Provision for Loan Losses
    
711
    
121
    
667
    
1,333
    
376
    
388
    
410
    
300
  
Net Interest Income After
Provision for Loan Losses
    
29,512
    
30,066
    
28,463
    
27,977
    
28,628
    
26,734
    
24,144
    
23,996
  
Gain on Sale of Credit Card Portfolios
    
-
    
-
    
-
    
-
    
-
    
-
    
-
    
324
  
Noninterest Income
    
14,144
    
14,003
    
13,045
    
12,974
    
13,123
    
12,041
    
11,060
    
11,596
  
Conversion/Merger Expense
    
-
    
-
    
-
    
24
    
180
    
234
    
-
    
436
  
Noninterest Expense
    
30,422
    
31,070
    
30,092
    
29,318
    
28,429
    
26,362
    
25,267
    
24,481
  
Income Before Provision for Income Taxes
    
13,234
    
12,999
    
11,416
    
11,609
    
13,142
    
12,179
    
9,937
    
10,999
  
Provision for Income Taxes
    
4,554
    
4,684
    
3,995
    
4,150
    
4,565
    
4,311
    
3,560
    
3,737
  
Net Income
  
$
8,680
  
$
8,315
  
$
7,421
  
$
7,459
  
$
8,577
  
$
7,868
  
$
6,377
  
$
7,262
  
Net Interest Income (FTE)
  
$
30,745
  
$
30,591
  
$
29,461
  
$
29,652
  
$
29,329
  
$
27,396
  
$
24,835
  
$
24,619
  
 
                                                  
Per Common Share:
                                                 
Net Income Basic
  
$
.47
  
$
.44
  
$
.40
  
$
.40
  
$
.46
  
$
.44
  
$
.36
  
$
.40
  
Net Income Diluted
    
.47
    
.44
    
.40
    
.40
    
.46
    
.44
    
.36
    
.40
  
Dividends Declared
    
.163
    
.163
    
.163
    
.163
    
.152
    
.152
    
.152
    
.152
  
Diluted Book Value
    
17.18
    
16.81
    
16.65
    
16.39
    
16.17
    
15.87
    
14.69
    
14.51
  
Market Price:
                                                  
High
    
33.25
    
35.39
    
37.97
    
39.33
    
38.72
    
33.46
    
33.60
    
36.78
  
Low
    
29.87
    
29.51
    
33.79
    
33.21
    
31.78
    
28.02
    
29.30
    
30.17
  
Close
    
31.10
    
30.20
    
35.55
    
34.29
    
37.71
    
32.32
    
32.41
    
33.44
  
 
                                                  
Selected Average
                                                 
Balances:
                                                 
Loans
  
$
2,025,112
  
$
2,040,656
  
$
2,048,642
  
$
2,062,775
  
$
2,046,968
  
$
1,932,637
  
$
1,827,327
  
$
1,779,736
  
Earning Assets
    
2,241,158
    
2,278,817
    
2,275,667
    
2,279,010
    
2,250,902
    
2,170,483
    
2,047,049
    
2,066,111
  
Assets
    
2,560,155
    
2,603,090
    
2,604,458
    
2,607,597
    
2,569,524
    
2,458,788
    
2,306,807
    
2,322,870
  
Deposits
    
2,023,523
    
2,047,755
    
2,040,248
    
2,027,017
    
2,013,427
    
1,932,144
    
1,847,378
    
1,853,588
  
Shareowners’ Equity
    
318,041
    
315,794
    
311,461
    
306,208
    
300,931
    
278,107
    
260,946
    
248,773
  
Common Equivalent Average Shares:
                                                  
Basic
    
18,530
    
18,633
    
18,652
    
18,624
    
18,623
    
18,094
    
17,700
    
17,444
  
Diluted
    
18,565
    
18,653
    
18,665
    
18,654
    
18,649
    
18,102
    
17,708
    
17,451
  
 
                                                  
Ratios:
                                                 
ROA
    
1.35
%
  
1.28
%
  
1.16
%
  
1.14
%
  
1.32
%
  
1.28
%
  
1.12
%
  
1.24
%
ROE
    
10.83
%
  
10.56
%
  
9.66
%
  
9.67
%
  
11.31
%
  
11.35
%
  
9.91
%
  
11.61
%
Net Interest Margin (FTE)
    
5.45
%
  
5.38
%
  
5.25
%
  
5.16
%
  
5.17
%
  
5.07
%
  
4.92
%
  
4.75
%
Efficiency Ratio
    
64.35
%
  
66.23
%
  
67.20
%
  
65.22
%
  
63.60
%
  
63.56
%
  
67.06
%
  
63.85
%


-13-


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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," "Liquidity and Capital Resources," "Off-Balance Sheet Arrangements," and "Accounting Policies." Information therein should facilitate a better understanding of the major factors and trends that affect our earnings performance and financial condition, and how our performance during 2006 compares with prior years. Throughout this section, Capital City Bank Group, Inc., and its subsidiary, collectively, are referred to as "CCBG," "Company," "we," "us," or "our."

The period-to-date averages used in this report are based on daily balances for each respective period. In certain circumstances, comparing average balances for the comparable quarters of consecutive years may be more meaningful than simply analyzing year-to-date averages. Therefore, where appropriate, quarterly averages have been presented for analysis and have been noted as such. See Table I for average balances and interest rates presented on a quarterly basis.

In this MD&A, we present an operating efficiency ratio and an operating net noninterest expense as a percent of average assets, 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 non-interest expense less intangible amortization and one-time 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 one-time merger expenses from noninterest income. Management uses these non-GAAP measures as part of its assessment of its performance in managing non-interest expenses. We believe that excluding intangible amortization and one-time 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 -

   
Nine Months Ended September 30
  
   
2006
  
2005
  
Efficiency ratio
    
69.39
%
  
68.32
%
Effect of intangible amortization and one-time merger expenses
    
(3.49
)%
  
(3.68
)%
Operating efficiency ratio
    
65.90
%
  
64.64
%

Reconciliation of operating net noninterest expense to net noninterest expense -

   
Nine Months Ended September 30
  
   
2006
  
2005
  
Net noninterest expense as a percent of average assets
    
2.60
%
  
2.42
%
Effect of intangible amortization and one-time merger expenses
    
(0.24
)%
  
(0.24
)%
Operating net noninterest expense as a percent of average assets
    
2.36
%
  
2.18
%


-14-

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.

CAUTION CONCERNING FORWARD-LOOKING STATEMENTS

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 Annual 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 above, 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 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 also has mortgage lending offices in three additional Florida communities, and one Georgia community. The Bank offers commercial and retail banking services, as well as trust and asset management, merchant services, 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 non-interest income such as service charges on deposit accounts, asset management and trust fees, mortgage banking revenues, merchant service fees, brokerage 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 are a super-community bank in the relationship banking business with 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, and community advisory 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.

Pursuant to our long-term strategic initiative, "Project 2010", we have continued 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. We continue to evaluate de novo expansion opportunities in attractive new markets in the event that acquisition opportunities are not feasible. Other expansion opportunities that will be evaluated include asset management, insurance, and mortgage banking.

Recent Acquisition. On May 20, 2005, we completed our merger with First Alachua Banking Corporation ("FABC"), headquartered in Alachua, Florida. We issued approximately 906,000 shares of common stock and paid approximately $29.0 million in cash for a total purchase price of $58.0 million. FABC's wholly-owned subsidiary, First National Bank of Alachua, had $228.3 million in assets at closing with seven offices in Alachua County and an eighth office in Hastings, Florida, which is in St. Johns County.



-15-

FINANCIAL OVERVIEW

A summary overview of our financial performance for 2006 versus 2005 is provided below.

2006 Financial Performance Highlights -

 
Ÿ
Earnings of $8.7 million, up 1.2% and $24.4 million, up 7.0% for the three and nine months ended September 30, 2006 as compared to the same periods in 2005.

Ÿ  Diluted earnings per share of $.47 for the third quarter of 2006 compared to $.46 for the comparable period in 2005.  Earnings per diluted share for the nine months ended  
         September 30, 2006 of $1.31 represents a 4.0% increase over the same period in 2005.

 
Ÿ
Growth in earnings was attributable to improvement in operating revenues of 5.3% and 11.8% for the three and nine month periods, respectively, driven primarily by higher net interest income and noninterest income.

 
Ÿ
Taxable equivalent net interest income grew 4.8% and 11.3% for the three and nine month periods, respectively, due to an improved net interest margin.

 
Ÿ
Net interest margin percentage improved 28 basis points and 31 basis points for the three and nine month periods, respectively, driven by favorable re-pricing spread and higher yield on new loan production.

 
Ÿ
Noninterest income grew 7.8% and 13.7% for the three and nine month periods, respectively, due primarily to higher deposit fees, asset management fees, retail brokerage fees, and card processing fees.

 
Ÿ
Continued strong credit quality as reflected by a nonperforming asset ratio of .34% and an annualized net charge-off ratio of .13% for the third quarter of 2006 compared to .08% for the same period in 2005. At quarter-end the allowance for loan losses was .86% of outstanding loans and provided coverage of 269% of nonperforming loans compared to .85% and 343%, respectively, for the same period in 2005.

 
Ÿ
We remain well-capitalized with a risk based capital ratio of 14.72%.


-16-


RESULTS OF OPERATIONS

Net Income

Earnings for the three and nine months ended September 30, 2006 were $8.7 million, or $.47 per diluted share, and $24.4 million, or $1.31 per diluted share, respectively. This compared to $8.6 million, or $.46 per diluted share and $22.8 million, or $1.26 per diluted share in 2005. Results include the impact of the acquisition of FABC in May 2005.

The growth in earnings for the third quarter of 2006 was primarily attributable to an increase in operating revenues (defined as net interest income plus noninterest income) of $2.2 million, partially offset by increases in noninterest expense of $1.8 million and loan loss provision of $335,000. The increase in operating revenues is reflective of a 4.2% increase in net interest income and a 7.8% increase in noninterest income.

The growth in earnings for the nine month period of $1.6 million, or 7.0% was primarily attributable to an increase in operating revenues of $13.8 million, or 11.8%, partially offset by an increase in noninterest expense of $11.1 million, or 13.8%, and income taxes of $797,000, or 6.4%. The increase in operating revenue reflects an 11.0% increase in net interest income and a 13.7% increase in noninterest income.

A condensed earnings summary is presented below:

   
Three Months Ended September 30,
  
Nine Months Ended September 30,
  
(Dollars in Thousands)
  
2006
  
2005
  
2006
  
2005
  
Interest Income
  
$
42,512
  
$
36,889
  
$
123,293
  
$
101,273
  
Taxable Equivalent Adjustment(1)
    
522
    
325
    
1,256
    
879
  
Interest Income (FTE)
    
43,034
    
37,214
    
124,549
    
102,152
  
Interest Expense
    
(12,289
)
  
(7,885
)
  
(33,753
)
  
(20,593
)
Net Interest Income (FTE)
    
30,745
    
29,329
    
90,796
    
81,559
  
Provision for Loan Losses
    
(711
)
  
(376
)
  
(1,499
)
  
(1,174
)
Taxable Equivalent Adjustment
    
(522
)
  
(325
)
  
(1,256
)
  
(879
)
Net Interest Income After Provision
    
29,512
    
28,628
    
88,041
    
79,506
  
Noninterest Income
    
14,144
    
13,123
    
41,193
    
36,224
  
Merger Expense
    
-
    
(180
)
  
-
    
(414
)
Noninterest Expense
    
(30,422
)
  
(28,429
)
  
(91,584
)
  
(80,058
)
Income Before Income Taxes
    
13,234
    
13,142
    
37,650
    
35,258
  
Income Taxes
    
(4,554
)
  
(4,565
)
  
(13,234
)
  
(12,436
)
Net Income
  
$
8,680
  
$
8,577
  
$
24,416
  
$
22,822
  
                           
Percent Change
    
1.20
%
  
(20.72
)%
  
6.98
%
  
3.22
%
Return on Average Assets(2)
    
1.35
%
  
1.32
%
  
1.26
%
  
1.25
%
Return on Average Equity(2)
    
10.83
%
  
11.31
%
  
10.36
%
  
10.89
%
 
(1)
Computed using a statutory tax rate of 35%
(2)
Annualized


-17-

Net Interest Income

Net interest income represents our single largest source of earnings and is equal to interest income and fees generated by earning assets, less interest expense paid on interest bearing liabilities. Third quarter of 2006 taxable-equivalent net interest income increased $1.4 million, or 4.8%, over the comparable quarter in 2005. During the first nine months of 2006, taxable-equivalent net interest income increased $9.3 million, or 11.3%, respectively, over the first nine months of 2005. This increase was caused by the effect of our acquisition of FABC, higher earning asset yields and a slight improvement in earning asset mix, partially offset by higher funding costs and a change in deposit mix. The increase in yields and funding costs are a result of the higher interest rate environment. The combination of these factors resulted in a 28 basis point improvement in the net interest margin as compared to the third quarter of 2005. Table I provides a comparative analysis of our average balances and interest rates.

For the three month period ended September 30, 2006, taxable-equivalent interest income increased $5.8 million or 15.6%, over the comparable period in 2005. During the first nine months of 2006, taxable-equivalent interest income improved $22.4 million, or 21.9%, respectively, over the comparable period in 2005. The increase was attributable to a change in earning asset mix and higher yields on earning assets. Earning asset yields improved 106 basis points to 7.62% in the third quarter of 2006 from 6.56% in the third quarter of 2005 and 7.35% in the prior quarter, primarily attributable to the higher interest rate environment. Relative to the third quarter, we anticipate income on earning assets will remain down slightly for the fourth quarter resulting from a slight decline in the net interest margin and an anticipated lower level of earning assets.

Interest expense for the three and nine month periods ended September 30, 2006 increased $4.4 million, or 55.9% and $13.2 million, or 63.9%, respectively, from the comparable prior year periods. The increased expense is attributable to higher rates paid on all interest bearing liabilities and an increase in long-term debt costs resulting from debt secured to fund the FABC acquisition. The average rate paid on interest bearing liabilities of 2.84% in the third quarter of 2006 represents an increase of 98 and 26 basis points, respectively, over the third quarter of 2005 and second quarter of 2006. We anticipate that our interest expense will continue to increase in the fourth quarter due to continued upward pressure on our funding costs driven by the higher rate environment, shifting deposit mix, and increased competition for deposits.

Our interest rate spread (defined as the average federal taxable-equivalent yield on earning assets less the average rate paid on interest bearing liabilities) increased from 4.60% for the first nine months of 2005 to 4.75% for the comparable period in 2006.

Our net interest margin (defined as federal taxable-equivalent net interest income divided by average earning assets) was 5.45% and 5.36%, respectively, for the three and nine month periods of 2006, versus 5.17% and 5.05%, respectively, for the comparable periods in 2005. The increase in margin reflects higher asset yields driven by rising interest rates. The net interest margin is expected to decline during the fourth quarter, which is attributable to factors noted above.


Provision for Loan Losses

The provision for loan losses was $711,000 and $1.5 million, respectively, for the three and nine month periods ended September 30, 2006, compared to $376,000 and $1.2 million for the same periods in 2005. The increase in the provision for both periods was due to a higher level of required reserves.

Net charge-offs totaled $664,000, or .13% of average loans for the third quarter of 2006 compared to $403,000, or .08% for the third quarter of 2005. For the nine-month period ended September 30, 2006, net charge-offs totaled $1.6 million, or .10% of average loans compared to $1.2 million, or .08% of average loans for the comparable period in 2005. At quarter-end the allowance for loan losses was .86% of outstanding loans and provided coverage of 269% of nonperforming loans.

Charge-off activity for the respective periods is set forth below:

   
Three Months Ended September 30,
  
Nine Months Ended September 30,
  
(Dollars in Thousands)
  
2006
  
2005
  
2006
  
2005
  
CHARGE-OFFS
                  
Commercial, Financial and Agricultural
  
$
294
  
$
151
  
$
760
  
$
541
  
Real Estate - Construction
    
-
    
-
    
-
    
-
  
Real Estate - Commercial
    
-
    
4
    
291
    
10
  
Real Estate - Residential
    
81
    
115
    
127
    
177
  
Consumer
    
690
    
551
    
1,729
    
1,805
  
Total Charge-offs
    
1,065
    
821
    
2,907
    
2,533
  
                           
RECOVERIES
                          
Commercial, Financial and Agricultural
    
43
    
43
    
168
    
150
  
Real Estate - Construction
    
-
    
-
    
-
    
-
  
Real Estate - Commercial
    
4
    
1
    
9
    
1
  
Real Estate - Residential
    
2
    
20
    
11
    
36
  
Consumer
    
352
    
354
    
1,121
    
1,174
  
Total Recoveries
    
401
    
418
    
1,309
    
1,361
  
                           
Net Charge-offs
  
$
664
  
$
403
  
$
1,598
  
$
1,172
  
                           
Net Charge-offs (Annualized) as a