Form 10-Q

-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ViIf8TJSeXQ4yJlDw7cF7W9cXsE0ldBFNNbb4gaJOvdJB7ZtMIUTyTJ49DK941US M7G8PjufyreJG65puqBE1g== 0001193125-07-239840.txt : 20071108 0001193125-07-239840.hdr.sgml : 20071108 20071108120021 ACCESSION NUMBER: 0001193125-07-239840 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070930 FILED AS OF DATE: 20071108 DATE AS OF CHANGE: 20071108 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NEXITY FINANCIAL CORP CENTRAL INDEX KEY: 0001084727 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 631222937 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-51273 FILM NUMBER: 071224216 BUSINESS ADDRESS: STREET 1: 3500 BLUE LAKE DRIVE STREET 2: SUITE 330 CITY: BIRMINGHAM STATE: AL ZIP: 35243 BUSINESS PHONE: 877-738-6391 MAIL ADDRESS: STREET 1: 3500 BLUE LAKE DRIVE STREET 2: SUITE 330 CITY: BIRMINGHAM STATE: AL ZIP: 35243 10-Q 1 d10q.htm FORM 10-Q Form 10-Q

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, 2007.

¨	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to .

Commission File No. 000-51273

NEXITY FINANCIAL CORPORATION

(Exact name of Registrant as specified in its Charter)


Delaware		63-0523669
(State of Incorporation)		(I.R.S. Employer Identification No.)

3500 Blue Lake Drive

Suite 330

Birmingham, AL

35243

(Address of principal executive offices)

(Zip Code)

(205) 298-6391

(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 ¨

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 ¨ Accelerated filer x Non-accelerated filer ¨

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

The number of outstanding shares of the issuer’s $0.01 par value common stock as of November 8, 2007 was 8,036,680.

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

Nexity Financial Corporation and Subsidiaries

Consolidated Balance Sheets


	September 30,						December 31
	2007			2006			2006
	(Unaudited)
ASSETS
Cash and due from banks	$	8,480,712		$	4,237,244		$	5,590,753
Interest-bearing deposits in other banks		2,946,174			925,260			1,904,898
Federal funds sold		24,089,410			43,250,363			19,977,025
Investment securities available-for-sale, at fair value		246,507,215			235,020,635			239,532,759
Trading securities, at fair value		198,084			0			1,998,500

Loans, net of unearned income		645,799,786			557,725,060			605,953,221
Allowance for loan losses		(7,977,050	)		(7,049,426	)		(7,411,803	)

Net loans		637,822,736			550,675,634			598,541,418

Premises and equipment, net of accumulated depreciation		3,297,309			1,047,566			977,552
Deferred tax asset		3,944,137			4,010,717			3,931,577
Intangible assets		910,655			910,655			910,655
Other real estate owned		3,551,400			1,500,000			4,742,400
Bank owned life insurance		17,155,738			5,505,948			6,767,338
Other assets		8,127,332			6,083,083			6,146,626

Total assets	$	957,030,902		$	853,167,105		$	891,021,501

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Deposits:
Demand Deposits	$	11,608,502		$	7,378,004		$	6,677,509
NOW and money market accounts		256,136,687			214,775,723			240,368,605
Time deposits $100,000 and over		159,708,465			141,761,787			140,145,532
Other time and savings deposits		284,057,710			271,299,498			271,200,816

Total deposits		711,511,364			635,215,012			658,392,462

Federal funds purchased and securities sold under agreements to repurchase		35,256,000			32,000,000			35,000,000
Long-term borrowings		120,000,000			100,000,000			110,000,000
Subordinated debentures		12,372,000			12,372,000			12,372,000
Accrued expenses and other liabilities		10,702,839			10,376,423			10,086,617

Total liabilities		889,842,203			789,963,435			825,851,079

Stockholders’ Equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized; shares issued and outstanding—none in 2007 and 2006		0			0			0
Common stock, $0.01 par value; 50,000,000 shares authorized; shares issued and outstanding including treasury stock—8,740,680 in 2007, 8,724,555 at September 30, 2006, and 8,740,680 at December 31, 2006		87,407			87,246			87,407
Surplus		62,297,633			62,058,402			62,187,656
Retained earnings		13,583,674			7,824,235			9,438,618
Accumulated other comprehensive loss		(1,129,648	)		(2,205,968	)		(1,983,014	)
Treasury Stock, at cost—654,000 shares in 2007, 365,950 shares at September 30, 2006 and December 31, 2006		(7,650,367	)		(4,560,245	)		(4,560,245	)

Total stockholders’ equity		67,188,699			63,203,670			65,170,422

Total liabilities and stockholders’ equity	$	957,030,902		$	853,167,105		$	891,021,501

The accompanying notes to the consolidated financial statements are an integral part of these financial statements.

Nexity Financial Corporation and Subsidiaries

Consolidated Statements of Income

(Unaudited)


	Three months ended September 30				Nine months ended September 30
	2007		2006		2007		2006
INTEREST INCOME:
Interest and fees on loans	$	13,441,971	$	12,060,788	$	38,647,627	$	33,361,422
Interest on investment securities
Taxable		3,004,734		2,897,934		9,021,538		8,083,209
Non-taxable		27,558		0		27,558		0
Interest on federal funds sold		156,658		257,264		356,736		902,006
Other interest income		111,867		52,074		327,051		146,952

Total interest income		16,742,788		15,268,060		48,380,510		42,493,589

INTEREST EXPENSE:
Interest on deposits		8,854,189		7,265,510		24,811,759		19,613,143
Interest on short-term borrowings		209,574		41,386		752,397		84,213
Interest on long-term borrowings		1,208,808		979,128		3,403,107		2,939,740
Interest on subordinated debentures		260,982		262,458		771,921		737,522

Total interest expense		10,533,553		8,548,482		29,739,184		23,374,618

Net interest income		6,209,235		6,719,578		18,641,326		19,118,971
Provision for loan losses		50,000		420,000		490,000		1,175,000

Net interest income after provision for loan losses		6,159,235		6,299,578		18,151,326		17,943,971

NONINTEREST INCOME:
Service charges on deposit accounts		48,712		26,898		119,872		79,431
Commissions and fees		106,259		85,447		303,077		234,261
Gains on sales of investment securities		0		0		0		250,665
Brokerage and investment services income		551,543		172,377		1,189,504		636,738
Other operating income		234,578		93,209		538,213		274,031

Total noninterest income		941,092		377,931		2,150,666		1,475,126

NONINTEREST EXPENSE:
Salaries and employee benefits		3,054,947		2,500,468		8,692,102		7,459,023
Net occupancy expense		188,182		152,017		552,009		444,981
Equipment expense		202,781		180,562		598,161		528,408
Other operating expense		1,603,088		1,326,440		4,545,200		3,886,246

Total noninterest expense		5,048,998		4,159,487		14,387,472		12,318,658

Income before income taxes		2,051,329		2,518,022		5,914,520		7,100,439
Provision for income taxes		616,199		908,984		1,769,464		2,620,260

Net income	$	1,435,130	$	1,609,038	$	4,145,056	$	4,480,179

Net income per share—basic	$	0.18	$	0.19	$	0.50	$	0.52

Net income per share—diluted	$	0.17	$	0.18	$	0.47	$	0.49

Weighted average common shares outstanding—basic		8,115,669		8,383,025		8,264,861		8,541,260

Weighted average common shares outstanding—diluted		8,513,723		8,922,780		8,732,328		9,096,873

The accompanying notes to the consolidated financial statements are an integral part of these financial statements.

Nexity Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

(Unaudited)


	Nine months ended September
	2007			2006
Cash flows from operating activities:
Net income	$	4,145,056		$	4,480,179
Adjustments to reconcile net income to net cash provided by operating activities:
Accretion and amortization of investment securities		(395,266	)		(257,916	)
Depreciation and amortization		577,953			541,321
Provision for loan losses		490,000			1,175,000
Gain on sales of investment securities available-for-sale		0			(250,665	)
Stock based compensation		109,977			50,040
Change in trading securities		1,800,416			0
Change in other assets		(1,375,185	)		(904,665	)
Change in deferred tax asset		(498,643	)		(313,555	)
Change in other liabilities		616,222			3,732,479

Net cash provided by operating activities		5,470,530			8,252,218

Cash flows from investing activities:
Purchase of investment securities available-for-sale		(29,317,816	)		(57,941,866	)
Proceeds from the sales of investment securities available-for-sale		0			12,784,611
Proceeds from maturities of investment securities available-for-sale		24,078,075			19,437,671
Net change in loans		(39,771,318	)		(42,744,160	)
Purchase of bank owned life insurance		(10,000,000	)		0
Capital expenditures		(2,700,631	)		(228,242	)

Net cash used in investing activities		(57,711,690	)		(68,691,986	)

Cash flows from financing activities:
Net change in deposits		53,118,902			38,545,368
Net change in short-term borrowings		256,000			31,440,000
Net change in long-term borrowings		10,000,000			(5,000,000	)
Proceeds from the exercise of stock options		0			103,591
Purchase of treasury stock		(3,090,122	)		(4,560,245	)

Net cash provided by financing activities		60,284,780			60,528,714

Net change in cash and cash equivalents		8,043,620			88,946
Cash and cash equivalents at January 1		27,472,676			48,323,921

Cash and cash equivalents at September 30	$	35,516,296		$	48,412,867

The accompanying notes to the consolidated financial statements are an integral part of these financial statements.

Nexity Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income

(Unaudited)


	Common Stock			Surplus		Retained earnings		Accumulated other comprehensive income (loss)			Treasury Stock, at cost			Total stockholders’ equity
	Shares	Amount		Surplus		Retained earnings		Accumulated other comprehensive income (loss)			Treasury Stock, at cost			Total stockholders’ equity
Balance at January 1, 2006	8,711,175	$	87,111	$	61,904,905	$	3,344,057	$	(2,063,868	)	$	0		$	63,272,205

Common stock activity:
Exercise of stock options, including income tax benefit of $48,071	13,380		134		103,457										103,591
Stock-based compensation					50,040										50,040
Purchase of Treasury Stock (365,950 shares)												(4,560,245	)		(4,560,245	)
Comprehensive income:
Net income							4,480,179								4,480,179
Other comprehensive loss, net of tax and reclassification adjustment:
Unrealized losses on investment securities									(142,100	)					(142,100	)

Total comprehensive income															4,338,079

Balance at September 30, 2006	8,724,555	$	87,245	$	62,058,402	$	7,824,236	$	(2,205,968	)	$	(4,560,245	)	$	63,203,670

Balance at January 1, 2007	8,740,680		87,407		62,187,656		9,438,618		(1,983,014	)		(4,560,245	)		65,170,422

Common stock activity:
Stock-based compensation					109,977										109,977
Purchase of Treasury Stock (288,050 shares)												(3,090,122	)		(3,090,122	)
Comprehensive income:
Net income							4,145,056								4,145,056
Other comprehensive income, net of tax and reclassification adjustment:
Unrealized gains on investment securities									853,366						853,366

Total comprehensive income															4,998,422

Balance at September 30, 2007	8,740,680	$	87,407	$	62,297,633	$	13,583,674	$	(1,129,648	)	$	(7,650,367	)	$	67,188,699

The accompanying notes to the consolidated financial statements are an integral part of these financial statements.

Nexity Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements (Unaudited)

Note 1 – General

The consolidated financial statements in this report are unaudited, and the consolidated balance sheet at December 31, 2006 is derived from the consolidated audited financial statements of Nexity Financial Corporation (the “Corporation”). These unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information. In the opinion of management, all adjustments necessary to present a fair statement of the results for the interim periods have been made. All such adjustments are of a normal, recurring nature. The information contained in the notes to consolidated financial statements included in Nexity Financial Corporation’s annual report on Form 10-K for the year ended December 31, 2006 should be referred to in connection with the reading of these unaudited interim consolidated financial statements.

Nature of Operations

Nexity Financial Corporation is a registered financial holding company incorporated on March 12, 1999 under the laws of the State of Delaware. We were formed to enter the commercial banking business and to invest in other bank-related businesses. We provide our customers with banking services through our subsidiary, Nexity Bank (the “Bank”), and own 100% of its issued and outstanding capital stock. Nexity Capital Trust II, a statutory trust and wholly owned subsidiary, was established by the Corporation on May 20, 2005. Nexity Capital Trust II is a special interest nonbank subsidiary that issues trust preferred securities, whereby the proceeds from the issuance are loaned to the Corporation.

At September 30, 2007, we operated through our headquarters in Birmingham, Alabama and correspondent banking offices in Atlanta, Georgia, Myrtle Beach and Columbia, South Carolina, Dallas, Texas, Winston-Salem, North Carolina, Orlando, Florida, and Milwaukee, Wisconsin.

Principles of Consolidation

The consolidated financial statements include the accounts of the Corporation and its subsidiaries. All significant intercompany accounts and transactions have been eliminated. In accordance with the revised Financial Accounting Standards Board Interpretation No. 46, (“FIN 46”), “Consolidation of Variable Interest Entities,” which addresses consolidation by business enterprises of variable interest entities, the Corporation deconsolidated one trust subsidiary at September 30, 2007 and all other periods presented, which had been formed to raise capital by issuing preferred securities to institutional investors.

Accounting Estimates and Assumptions

Our accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during periods presented. Different assumptions in the application of these methods or policies could result in material changes in our consolidated financial statements.

Stock-Based Compensation

At September 30, 2007, we had a stock option plan, which is described more fully in Note 16 to the Consolidated Financial Statements in our annual report on Form 10-K. Effective January 1, 2006, we adopted SFAS No. 123 (revised), “Share-Based Payment” (“SFAS 123R”) utilizing the modified prospective approach.

Grant-date fair value is measured on the date of grant using an option-pricing model with market assumptions. The grant-date fair value is amortized into expense on a straight-line basis over the vesting period and we apply the Black-Scholes option-pricing model. Option pricing models require the use of highly subjective assumptions, including but not limited to, expected stock price volatility, forfeiture rates, and interest rates, which if changed can materially affect fair value estimates. Accordingly the model does not necessarily provide a reliable single measure of the fair value of our stock options.

The following is a summary of the Corporation’s weighted average assumptions used to estimate the weighted-average per share fair value of options granted on the date of grant using the Black-Scholes option-pricing model:


	For the three months ended September 30		For the nine months ended September 30
	2007	2006	2007	2006
Expected life (in years)	5	N/A	5	N/A
Expected volatility	0.2090 - 0.3245	N/A	0.1146 - 0.2740	N/A
Risk-free interest rate	4.27% - 4.60%	N/A	4.27% - 4.89%	N/A
Expected dividend yield	N/A	N/A	N/A	N/A
Weighted-average fair value of options granted during the period	$2.77	N/A	$3.17	N/A

At September 30, 2007, there was $246,518 of unrecognized compensation cost related to share-based payments, which is expected to be recognized over a weighted-average period of 2.0 years.

The following table represents stock option activity for the three months and nine months ended September 30, 2007:


	Three months ended September 30, 2007					Nine months ended September 30, 2007
	Number		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life	Number		Weighted- Average Exercise Price		Weighted- Average Remaining Contract Life
Options outstanding, beginning of period	1,877,204		$	7.25		1,846,518		$	7.37
Granted	6,000			7.98		91,250			11.84
Exercised	0			0.00		0			0.00
Terminated	(64,042	)		16.72		(118,606	)		17.84

Options outstanding, end of quarter	1,819,162		$	6.91	2.76 years	1,819,162		$	6.91	2.76 years

Exercisable, end of quarter	1,716,217		$	6.59	2.43 years	1,716,217		$	6.59	2.43 years

Shares available for future stock option grants to employees and directors under existing plans were 260,916 at September 30, 2007. At September 30, 2007 the aggregate intrinsic value of shares outstanding was $1,910,120, and the aggregate intrinsic value of options exercisable was $2,299,731.

Recently Issued Accounting Standards

On January 1, 2007, we adopted Financial Accounting Standards Board Interpretation 48, Accounting for Uncertainty in Income Taxes (FIN 48). Among other things, FIN 48 requires application of a “more likely than not” threshold to the recognition and derecognition of tax positions. It further requires that a change in judgment related to prior years’ tax positions be recognized in the quarter of such change. For the quarter and nine months ended September 30, 2007, the adoption of FIN 48 did not have a material impact on our financial position, results of operations and cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115, (SFAS No. 159), which permits companies to choose to measure many financial instruments and certain other items at fair value. The objective of SFAS No. 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We have not yet adopted SFAS No. 159 and we are currently evaluating the effect that it may have on our consolidated financial statements.

Note 2 – Gross Unrealized Losses on Investment Securities

The fair value and unrealized losses on investment securities with unrealized losses at September 30, 2007 are presented below. The fair value and unrealized losses are presented for those securities that have had unrealized losses for less than 12 months and those that have been in an unrealized loss position for 12 consecutive months or longer.


	Less than 12 months					12 months or longer					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Securities of U.S. Government sponsored agencies and corporations	$	0	$	0		$	39,549,576	$	(179,979	)	$	39,549,576	$	(179,979	)
Mortgage-backed securities		23,531,103		(297,959	)		78,957,472		(2,338,597	)		102,488,575		(2,636,556	)
Municipal securities		2,391,471		(8,616	)		0		0			2,391,471		(8,616	)
Other debt securities		0		0			0		0			0		0

Total debt securities		25,922,574		(306,575	)		118,507,048		(2,518,576	)		144,429,622		(2,825,151	)
Equity securities		0		0			0		0			0		0

Total investment securities	$	25,922,574	$	(306,575	)	$	118,507,048	$	(2,518,576	)	$	144,429,622	$	(2,825,151	)

The above securities are considered temporarily impaired and no loss has been recognized on these securities since there has been no deterioration in the credit quality of the issuers of these securities and the unrealized losses are due to changes in interest rates. We have both the intent and ability to hold the securities for a time necessary to recover the unrealized loss.

Note 3 – Intangible Assets

We had $910,655 in unamortized intangible assets at September 30, 2007 and 2006, and December 31, 2006. The intangible asset is the bank charter. Upon the adoption of SFAS No. 142, “Goodwill and Other Intangible Assets,” on January 1, 2002, we stopped amortizing intangible assets. There was no impairment in the intangible assets during the three and nine months ended September 30, 2007 and 2006.

Note 4 – Per Share Information

The following is a summary of net income per share—basic and diluted calculations:


	For the three months ended September 30						For the nine months ended September 30
	2007			2006			2007			2006
Net income per share—basic computation
Net income	$	1,435,130		$	1,609,038		$	4,145,056		$	4,480,179
Income applicable to common shareholders	$	1,435,130		$	1,609,038		$	4,145,056		$	4,480,179

Weighted average common shares outstanding—basic		8,740,680			8,724,555			8,740,680			8,718,054
Less: Weighted average treasury shares		(625,011	)		(341,530	)		(475,819	)		(176,794	)

Weighted average common shares outstanding—basic net of treasury shares		8,115,669			8,383,025			8,264,861			8,541,260

Net income per share—basic	$	0.18		$	0.19		$	0.50		$	0.52

Net income per share—diluted computation
Income applicable to common shareholders	$	1,435,130		$	1,609,038		$	4,145,056		$	4,480,179

Weighted average common shares outstanding—basic net of treasury shares		8,115,669			8,383,025			8,264,861			8,541,260
Incremental shares from assumed conversions:
Stock options		398,054			539,755			467,467			555,613

Weighted average common shares outstanding—diluted		8,513,723			8,922,780			8,732,328			9,096,873

Net income per share—diluted	$	0.17		$	0.18		$	0.47		$	0.49

Options to purchase 1,819,162 and 1,857,643 shares of common stock at a price range of $4 to $20 per share were outstanding at September 30, 2007 and 2006, respectively.

Note 5 – Business Segments

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that public business enterprises report certain information about operating segments in their annual financial statements. It also requires that enterprises disclose information about products and services provided by significant segments, geographic areas, major customers, differences between the measurement used in reporting segment information and those used in the enterprise’s general-purpose financial statements, and changes in measurement of segment amounts from period to period.

Operating segments are components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision makers in deciding how to allocate resources and in assessing performance. During 2007 and 2006, we did not have any reportable segments.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The discussion and tabular data presented below analyze major factors and trends regarding our financial condition and results of operations for the three and nine months ended September 30, 2007. Results of operations for the three and nine months ended September 30, 2007 are not necessarily indicative of results that may be attained for any other period.

The following discussion and analysis should be read in conjunction with the financial information and the consolidated financial statements (including the notes thereto) contained in this document as well as our annual report filed on Form 10-K for the year ended December 31, 2006. To the extent that any statement below (or elsewhere in this document) is not a statement of historical fact and could be considered a forward-looking statement, actual results could differ materially from those in the forward-looking statement.

Forward-Looking Statements

We may from time to time make written or oral statements, including statements contained in this report, which may constitute forward-looking statements. The words “expect”, “anticipate”, “intend”, “consider”, “plan”, “believe”, “seek”, “should”, “estimate”, and similar expressions are intended to identify such forward-looking statements, but other statements may constitute forward-looking statements. These statements should be considered subject to various risks and uncertainties. Such forward-looking statements are made based upon management’s belief as well as assumptions made by, and information currently available to, management. Our actual results may differ materially from the results anticipated in forward-looking statements due to a variety of factors, such as the risk factors referenced in Part II, Item 1A, and other factors including, without limitation:

(i)

unanticipated deterioration in the financial condition of borrowers resulting in significant increases in loan losses and provisions for those losses,

(ii)

increased competition with other financial institutions,

(iii)

lack of sustained growth in the economy in the southeastern United States and the Dallas, Texas and Midwest areas

(iv)

rapid fluctuations or unanticipated changes in interest rates,

(v)

the inability of our bank subsidiary, Nexity Bank, to satisfy regulatory requirements,

(vi)

our ability to keep pace with technological changes, and

(vii)

changes in the legislative and regulatory environment, including compliance with the various provisions of the Sarbanes-Oxley Act of 2002.

Many of such factors are beyond our ability to control or predict, and readers are cautioned not to put undue reliance on such forward-looking statements. Because of these uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. In addition, our past results of operations do not necessarily indicate our future results.

We do not intend to update or reissue any forward-looking statements contained in this report as a result of new information or other circumstances that may become known to us.

Overview

We were founded in 1999 and operate as a bank holding company that competes in two areas of the commercial banking industry, correspondent banking and Internet banking. Our correspondent banking division markets currently to community banks primarily in the southeastern United States, parts of the Midwest, and Texas. Our Internet banking division provides banking services to consumers and small businesses across the United States via the Internet.

Correspondent banking services include loan participations, investment services, and clearing and cash management services. Income from loan participations was 73.3% of total revenue for the first nine months of 2007. No other product or service accounted for 15 percent or more of our total consolidated revenue. Our asset growth is dependent on our ability to grow loans outstanding, and we generate approximately 90% of our loan production through correspondent lending. We fund this loan production with deposit products and services offered to consumers and small businesses via the Internet. The Internet provides an efficient distribution channel for serving deposit customers without the costly investment in a branch banking network.

We monitor and manage our performance using the same benchmarks as most commercial banks. We compare our performance ratios to that of peer groups that started at the same time as the Corporation and to financial institutions of a similar size. The primary performance ratios include return on assets, return on equity, net interest margin, and the efficiency ratio. Most commercial bank’s, including Nexity Bank’s, primary source of revenue is net interest income. Our net interest income accounted for 89.7% of total revenue for the first nine months of 2007 compared to 92.8% for the same period in 2006. Interest income on loans accounted for 79.9% of total interest income for the nine months ended September 30, 2007 compared to 78.5% for the same period last year.

Our earnings performance is dependent on our ability to generate net interest income and the primary source of net interest income is interest income on loans. The primary risks associated with our income generation are credit risk and interest rate risk.

During the first nine months of 2007 credit quality has remained sound. We manage credit risk with underwriting procedures prior to originating loans and ongoing review systems during the life of the loan. These procedures are discussed in more detail under the section entitled “Loans” of Management’s Discussion and Analysis.

Short-term interest rates, including the prime lending rate decreased 50 basis points during the third quarter of 2007. This yield curve has remained somewhat flat, which creates a challenge for financial institutions in managing interest rate risk. Our net interest margin has decreased from 3.25% for the nine months ended September 30, 2006 to 2.89% for same period in 2007. We manage interest rate risk with monthly analysis of trends related to our net interest margin and the impact of changing interest rates. We also model future performance expectations based on changing interest rates with an internal simulation model for asset/liability management. These procedures are discussed in more detail under the section entitled “Market Risk and Asset/Liability Management” of Management’s Discussion and Analysis.

Our strategy is to continue to focus on growing our correspondent bank business nationally by developing existing relationships with community banks in the Southeast, Midwest, and Texas and aggressively pursuing new relationships in these and other market areas. During the first quarter of 2007 we added a Milwaukee office and a Florida office and started a Wealth Management business. We will also focus on cross-selling our correspondent bank products and services to our community bank customers, which will stimulate growth and supplement our revenue generation. We will continue to research new products and services as well as enhancements to our existing offerings to meet the changing needs of community banks.

We seek to maintain a safe and secure environment for our business transacted via the Internet. We will continue to invest in new technologies and systems to protect our information and enhance our Internet banking products and services. We intend to position our deposit product offerings to provide the necessary funding growth for our balance sheet by monitoring the competitive landscape for interest rates and marketing channels for new customers. We will also continue to develop cross-selling opportunities to our Internet banking customers, which will stimulate deposit growth and supplement our revenue generation.

Third Quarter Financial Highlights

For the third quarter of 2007, we reported net income of $1.4 million, or $0.17 per diluted share. Net income was down 10.8% from the same period in 2006. This decrease in earnings was primarily related to lower net interest income and higher noninterest expense related to the costs associated with expansion of the investment division and start-up of our wealth management business during 2007.

Our net interest income decreased to $6.2 million in the three months ended September 30, 2007 from $6.7 million in the same period in 2006. This decrease was primarily attributable to a lower net interest margin in 2007. Average earning assets increased 11.7% to $895.6 million or 96.3% of average total assets in the three months ended September 30, 2007, compared with $801.9 million or 98.8% in the same period in 2006. The net interest margin decreased to 2.76% for the three months ended September 30, 2007 from 3.32% for the same period in 2006. The decrease in the net interest margin was primarily due to the increased cost of interest-bearing liabilities, a lower level of noninterest bearing sources of funds, and lower loan fee income.

The provision for loan losses decreased $370,000 in the three months ended September 30, 2007 compared to the same period in 2006. The provision for loan losses was down primarily because of lower charge-offs and slower loan growth in 2007. Net charge-offs were $23,007 or 0.01% of average loans for the third quarter of 2007 on an annualized basis versus $86,496 or 0.06% for the same period in 2006.

Noninterest income increased 149.0% in the three months ended September 30, 2007 compared to the same period in 2006, mostly due to higher brokerage and investment services income, which was up 220.0% to $551,543 for the three months ended September 30, 2007, compared to $172,377 for the same period in 2006.

For the three months ended September 30, 2007, noninterest expense was up 21.4% from the same period in 2006, mostly due to start up costs for our Florida and Milwaukee offices and our Wealth Management business.

Total assets were $957.0 million at September 30, 2007, up 12.2% from $853.2 million at September 30, 2006, and up 7.4% from $891.0 million at December 31, 2006. Loans were $645.8 million at September 30, 2007, up 15.8% from $557.7 million at September 30, 2006, and up 6.6% from $606.0 million at December 31, 2006.

At September 30, 2007, nonperforming assets as a percent of total assets increased to 0.71% from 0.18% at September 30, 2006. At December 31, 2006, nonperforming assets as a percent of total assets was 0.59%.

Deposits grew to $711.5 million at September 30, 2007, mostly fueled by growth in certificates of deposit and money market accounts. Long-term debt was $120.0 million at September 30, 2007 compared to $100.0 million at September 30, 2006, and $110.0 million at December 31, 2007.

Critical Accounting Policies and Estimates

Allowance for Loan Losses

Management’s determination of the adequacy of the allowance for loan losses, which is based on the factors and risk identification procedures discussed in the following pages, requires the use of judgments and estimates that may change in the future. Changes in the factors used by management to determine the adequacy of the allowance, or the availability of new information, could cause the allowance for loan losses to be increased or decreased in future periods. Bank regulatory agencies, as part of their examination process, may also require that additions be made to the allowance for loan losses based on their judgments and estimates. See “Allowance for Loan Losses” in the “Balance Sheet Review” section of Management’s Discussion and Analysis.

Deferred Tax Assets

Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income earned by certain subsidiaries and the implementation of various tax plans to maximize realization of the deferred tax asset. Management believes that the bank subsidiary will eventually generate sufficient operating earnings to realize the deferred tax benefits. Our 2004 to 2006 consolidated income tax returns are open for examination. Examination of our income tax returns or changes in tax law may impact our tax liabilities and resulting provisions for income taxes. See “Income Taxes” in the “Earnings Review” section of Management’s Discussion and Analysis.

Earnings Review

For the nine months ended September 30, 2007, we reported net income of $4.1 million, or $0.47 per diluted share compared with $4.5 million, or $0.49 per diluted share for the same period in 2006. The primary factors affecting the decrease in net income in the first nine months of 2007 was a $2.1 million or 16.8% increase in noninterest expense and a $477,645 or 2.5% decrease in net interest income. This change was partially offset by a $685,000 decrease in the provision for loan losses, an $850,796 decrease in the provision for income taxes, and a $675,540 increase in noninterest income.

Net Interest Income

Net interest income, the major component of our income, is the amount by which interest and fees generated by earning assets exceed the total interest costs of the funds used to carry them. Changes in the level of interest rates and the change in the amount and composition of earning assets and interest-bearing liabilities affect net interest income. The following tables compare average balance sheet items and analyze net interest income for the three and nine months ended September 30, 2007 and 2006.

Comparative Average Balance Sheets – Yields and Costs


	Three months ended September 30,
	2007						2006
	Average Balance		Revenue/ Expense		Yield/ Rate		Average Balance		Revenue/ Expense		Yield/ Rate
Interest-earning assets:
Loans (1)	$	631,254,233	$	13,441,971	8.45	%	$	544,885,401	$	12,060,788	8.78	%
Investment securities, taxable (2)
Taxable		240,934,188		2,998,839	4.94			235,748,425		2,896,285	4.87
Non Taxable (3)		2,651,838		41,755	6.25			0		0	0.00
Interest-bearing balances due from banks		7,703,039		111,867	5.76			1,982,131		52,074	10.42
Trading securities		1,332,373		5,895	1.76			120,758		1,649	5.42
Federal funds sold and securities purchased under agreements to resell		11,680,810		156,658	5.32			19,151,264		257,264	5.33

Total interest-earning assets		895,556,481		16,756,985	7.42	%		801,887,979		15,268,060	7.22	%

Noninterest-earning assets:
Cash and due from banks		9,052,949						4,654,058
Premises and equipment		3,280,370						1,098,626
Other, less allowance for loan losses		21,783,319						4,206,122

Total noninterest-earning assets		34,116,638						9,958,806

TOTAL ASSETS	$	929,673,119					$	811,846,785

Interest-bearing liabilities:
Interest-bearing deposits:
Interest checking	$	3,656,848		11,194	1.21	%	$	3,873,462		11,889	1.22	%
Savings		279,810		872	1.24			334,764		1,042	1.23
Money market		259,856,523		3,028,658	4.62			220,117,610		2,461,386	4.44
Time deposits		434,692,025		5,813,465	5.31			395,052,910		4,791,193	4.81

Total interest-bearing deposits		698,485,206		8,854,189	5.03			619,378,746		7,265,510	4.65
Federal funds purchased and securities sold under agreements to repurchase		15,523,477		209,574	5.36			3,105,474		41,386	5.29
Long-term debt		116,521,739		1,208,808	4.12			100,000,000		979,128	3.88
Subordinated debentures		12,372,000		260,982	8.37			12,372,000		262,458	8.42

Total interest-bearing liabilities		842,902,422		10,533,553	4.96	%		734,856,220		8,548,482	4.62	%

Noninterest-bearing liabilities:
Demand deposits		10,786,506						6,114,546
Other liabilities		11,550,231						10,070,522

Total noninterest-bearing liabilities		22,336,737						16,185,068

Stockholders’ equity		64,433,960						60,805,498

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	929,673,119					$	811,846,786

Net interest income			$	6,223,432					$	6,719,578

Interest income/earning assets					7.42	%					7.55	%
Interest expense/earning assets					4.66						4.23

Net interest income/earning assets					2.76	%					3.32	%

(1)	Average loan balances are stated net of unearned income and include nonaccrual loans.

(2)	The weighted average yields on securities are calculated on the basis of the yield to maturity based on the book

value of each security.

(3)	Non-taxable income has been adjusted to a tax-equivalent basis using a federal tax rate of approximately 34%.

Comparative Average Balance Sheets – Yields and Costs


	Nine months ended September 30
	2007						2006
	Average Balance		Revenue/ Expense		Yield/ Rate		Average Balance		Revenue/ Expense		Yield/ Rate
Interest-earning assets:
Loans (1)	$	604,761,400	$	38,647,627	8.54	%	$	533,889,601	$	33,361,422	8.35	%
Investment securities, taxable (2)
Taxable		241,116,102		8,982,716	4.98			225,841,783		8,066,294	4.78
Non Taxable (3)		893,660		41,755	6.25			0		0	0.00
Interest-bearing balances due from banks		6,760,772		327,051	6.47			2,315,084		146,952	8.49
Trading securities		819,074		38,822	6.34			339,448		16,915	6.66
Federal funds sold and securities purchased under agreements to resell		8,895,769		356,736	5.36			24,538,727		902,006	4.91

Total interest-earning assets		863,246,777		48,394,707	7.50	%		786,924,643		42,493,589	7.22	%

Noninterest-earning assets:
Cash and due from banks		7,103,067						4,132,914
Premises and equipment		2,859,587						1,146,386
Other, less allowance for loan losses		18,759,290						5,362,812

Total noninterest-earning assets		28,721,944						10,642,112

TOTAL ASSETS	$	891,968,721					$	797,566,755

Interest-bearing liabilities:
Interest-bearing deposits:
Interest checking	$	3,591,017		32,574	1.21	%	$	4,166,666		37,800	1.21	%
Savings		304,328		2,776	1.22			376,921		3,433	1.22
Money market		237,789,599		8,165,680	4.59			226,328,638		7,028,486	4.15
Time deposits		421,007,256		16,610,729	5.28			373,014,166		12,543,424	4.50

Total interest-bearing deposits		662,692,200		24,811,759	5.01			603,886,391		19,613,143	4.34
Federal funds purchased and securities sold under agreements to repurchase		19,251,629		752,397	5.23			2,264,281		84,213	4.97
Long-term debt		112,197,802		3,403,107	4.06			103,626,374		2,939,740	3.79
Subordinated debentures		12,372,000		771,921	8.34			12,372,000		737,522	7.97

Total interest-bearing liabilities		806,513,631		29,739,184	4.93	%		722,149,046		23,374,618	4.33	%

Noninterest-bearing liabilities:
Demand deposits		8,799,566						4,953,595
Other liabilities		11,040,189						8,482,870

Total noninterest-bearing liabilities		19,839,755						13,436,465

Stockholders’ equity		65,615,335						61,981,244

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	891,968,721					$	797,566,755

Net interest income			$	18,655,523					$	19,118,971

Interest income/earning assets					7.50	%					7.22	%
Interest expense/earning assets					4.61						3.97

Net interest income/earning assets					2.89	%					3.25	%

(1)	Average loan balances are stated net of unearned income and include nonaccrual loans.

(2)	The weighted average yields on securities are calculated on the basis of the yield to maturity based on the book value of each security.

(3)	Non-taxable income has been adjusted to a tax-equivalent basis using a federal tax rate of approximately 34%.

Net interest income on a tax equivalent basis decreased $463,448 or 2.4% during the first nine months of 2007 compared to the same period in 2006. This decrease was primarily attributable to a lower net interest margin. The net interest margin decreased 36 basis points from 3.25% for the first nine months of 2006 to 2.89% for the first nine months of 2007, primarily because our cost of funds increased more than our yield on interest earning assets. The net interest margin, computed by dividing net interest income by average earning assets, reflects the impact of noninterest-bearing funds on net interest income. Average noninterest bearing funds were 6.6% of earning assets in the first nine months of 2007 and 8.2% for the same period in 2006.

Interest income on a tax equivalent basis increased $5.9 million or 13.9% in the first nine months of 2007 due to the increased volume of earning assets and a higher yield on earning assets, which increased to 7.50% in the first nine months of 2007 from 7.22% in the first nine months of 2006. Average earning assets increased 9.7% to $863.2 million or 96.8% of average total assets in 2007, compared with $786.9 million or 98.7% in 2006. The two primary types of earning assets are loans and investment securities. The income generated from these assets is a function of their quality, growth, and yield. Average loans increased $70.9 million or 13.3% and average investment securities increased $16.2 million or 7.2%. The yield on earning assets increased 28 basis points in 2007 primarily because the yields on loans were higher due to the increased interest rates.

The Federal Reserve lowered the federal funds target rate 50 basis points on September 18, 2007 to 4.75%. The federal funds target rate was 4.75% at September 30, 2007 compared with 5.25% at September 30, 2006. The prime lending rate decreased to 7.75% at September 30, 2007 from 8.25% at September 30, 2006.

During 2007, loans which are typically our highest yielding earning asset increased as a percentage of earning assets. Average loans were 70.1% of average earning assets in the first nine months of 2007 versus 67.9% in the same period in 2006. The yield on loans increased 19 basis points from 8.35% in the first nine months of 2006 to 8.54% in the same period in 2007 largely due to growth in average loans and the higher interest rate environment during the first nine months of 2007. The prime lending rate has been mostly stable in 2007 until the Federal Reserve lowered rates 50 basis points on September 18, 2007, while rates were rising during the first nine months of 2006. The majority of our loans are variable rate loans. The yield on taxable investment securities increased from 4.78% in the first nine months of 2006 to 4.98% in the first nine months of 2007. During the third quarter of 2007 we added municipal bonds to our portfolio. For the first nine months of 2007 these nontaxable bonds averaged $893,660 and yielded a tax effected rate of 6.25%. The yield on Federal funds sold and securities purchased under agreements to resell, collectively, increased 45 basis points from 4.91% in the first nine months of 2006 to 5.36% in the first nine months of 2007. The yield on interest-bearing deposits with banks decreased 202 basis points from 8.49% in the first nine months of 2006 to 6.47% for the same period in 2007.

The cost of funding sources increased $6.4 million or 27.2% in the first nine months of 2007 compared to the same period in 2006, primarily due to the increased volume of interest-bearing liabilities, a less favorable mix of funding sources, and higher rates. Average interest-bearing liabilities increased $84.4 million or 11.7% in the first nine months of 2007 compared to the same period in 2006. Interest-bearing deposits were up $58.8 million or 9.7%, primarily driven by growth in time deposits. Average long-term debt increased $8.6 million or 8.3% in the first nine months of 2007 compared to the first nine months of 2006. Average long-term debt was 13.9% of interest-bearing liabilities during the first nine months of 2007 versus 14.3% during the same period in 2006. The average rate paid on interest-bearing liabilities increased 60 basis points from 4.33% in the first nine months of 2006 to 4.93% in the same period in 2007, primarily due to the increased interest rate environment. The cost of interest-bearing deposits increased 67 basis points to 5.01% for the first nine months of 2007 versus 4.34% for the same period in 2006. The primary reasons for this increase were the increased interest rate environment and a higher level of certificates of deposit. The average rate paid on subordinated debt increased 37 basis points from 7.97% in the first nine months of 2006 to 8.34% in the same period in 2007, because the rate on subordinated debt is 3-month LIBOR, which is variable, plus 2.8%. Interest-bearing liabilities were 93.4% of earning assets during the first nine months of 2007 and 91.8% for the same period in 2006 which was the primary cause of the less favorable mix of funding sources in 2007.

Provision for Loan Losses

The provision for loan losses represents a charge to earnings necessary to establish an allowance for loan losses that, in management’s evaluation, should be adequate to absorb the inherent losses on outstanding loans. The provision for loan losses was $490,000 and $1,175,000 in the first nine months of 2007 and 2006, respectively. The lower provision for loan losses was primarily due to lower charge-offs in the first nine months of 2007.

Net loan charge-offs were $100,155, or 0.02% of average loans on an annualized basis in the first nine months of 2007 compared to $592,288, or 0.15% of average loans in the first nine months of 2006. The allowance for loan losses totaled 1.24% of loans as of September 30, 2007 compared to 1.26% at September 30, 2006 and 1.22% at December 31, 2006. See “Loans,” “Nonperforming Assets,” and “Allowance for Loan Losses” below.

Noninterest Income

Noninterest income consists of service charges on deposit accounts, brokerage and investment services income, and other commissions and fees generated from various banking activities. As anticipated, noninterest income is becoming a more important contributing factor to our overall profitability in 2007. Noninterest income increased $675,540 or 45.8% in the first nine months of 2007 compared to the same period in 2006.

The largest component of noninterest income is brokerage and investment services income. Brokerage and investment services income is generated through our correspondent banking services, which began operations in 2002. The bulk of the fees generated are through fixed income investment sales to correspondent bank customers. Fees are also generated from the facilitation of brokered CDs and trust preferred securities offerings for these same customers. Brokerage and investment services income was up $552,766 or 86.8% in the first nine months of 2007 compared to the same period last year. The increase in 2007 was primarily due to increased sales volume.

Commissions and fees include revenues from debit card services and loan participation fees. Commissions and fees were up $68,816 or 29.4% in the first nine months of 2007 compared to the same period in 2006 primarily due to higher loan participation fee income, which was up 33% for the first nine months of 2007 compared to the same period in 2006.

Service charges on deposit accounts were up $40,441 or 50.9% in the first nine months of 2007 compared to the same period in 2006 due to the growth of our correspondent banking customer accounts.

Gains on sales of investment securities were $0 in the first nine months of 2007 compared to $250,665 during the same period in 2006. During the second quarter of 2006, we had the opportunity to sell our equity position in an illiquid common stock and recorded a gain of $722,505. We also sold $11.0 million in fixed income debt securities with an average yield of 3.84% at a loss of $471,840. As part of this transaction, we purchased $12.0 million in fixed income debt securities with an average yield of 5.86%.

Other operating income was up $264,182 or 96.4% in the first nine months of 2007 compared to the same period in 2006 due primarily to increases in income from cash management services to correspondent banks and higher earnings on bank owned life insurance.

Noninterest Expense

Noninterest expense increased $2.1 million or 16.8% in the first nine months of 2007 compared to the same period in 2006. Noninterest expense was higher primarily due to the start-up costs of our Florida and Milwaukee offices and our Wealth Management business.

Salaries and employee benefits, the largest component of noninterest expense, totaled $8.7 million and $7.5 million in the first nine months of 2007 and 2006, respectively. The increase during the first nine months of 2007 was primarily due to the investment in new personnel in our new offices. We employed 107.5 and 90 full time equivalent employees at September 30, 2007 and September 30, 2006, respectively.

Net occupancy expense increased $107,028 or 24.1% during the first nine months of 2007 compared to the first nine months of 2006, largely due to developing a correspondent lending office in Columbia, South Carolina during the fourth quarter of 2006 and opening offices in Milwaukee, Wisconsin and Orlando, Florida in the first quarter of 2007. Net equipment expense increased $69,753 or 13.2%.

Other operating expense increased $658,954 or 17.0% in the first nine months of 2007 compared to the same period in 2006. The increase in other operating expense was primarily due to write-downs of other real estate, higher legal, data communications, and travel fees. Legal fees increased in the first nine months of 2007 compared to the same period in 2006 primarily due to our expansion in the Midwest and management of our other real estate. The following table presents a comparison of other operating expense by category.


	Three months ended September 30				Nine months ended September 30
	2007		2006		2007		2006
Advertising	$	49,722		124,196	$	137,379	$	365,175
Travel and lodging		190,284		144,800		452,967		405,427
Legal fees		78,014		18,587		243,910		93,678
Director fees		90,500		79,500		271,500		258,000
Software maintenance contracts		93,453		92,460		231,031		267,937
Telephone and data communications		140,121		131,534		390,282		298,933
Postage, freight, & courier service		72,777		59,767		199,795		170,872
Write-down of other real estate		60,149		0		291,497		1,450
Accounting fees		60,829		77,473		222,167		202,977
Home equity closing costs		30,463		40,529		92,690		121,722
Investment seminars		32,218		45,262		123,583		134,540
Franchise taxes		54,610		53,581		169,910		166,570
Other		649,948		458,751		1,718,489		1,398,965

Total	$	1,603,088	$	1,326,440	$	4,545,200	$	3,886,246

Income Taxes

Nexity Financial Corporation and its subsidiaries file a consolidated federal income tax return. We account for income taxes using the liability method pursuant to Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” Under this method, our deferred tax assets and liabilities were determined by applying federal and state tax rates currently in effect to our cumulative temporary book/tax differences. Temporary differences are differences between financial statement carrying amounts and the corresponding tax bases of assets and liabilities. Deferred taxes are provided as a result of such temporary differences.

Total income tax expense included in the Consolidated Statements of Income was $1.8 million in the first nine months of 2007, compared to $2.6 million in the same period in 2006. Our effective income tax rates were 29.9% in the first nine months of 2007 and 36.9% in the same period of 2006. Our effective income tax rate was lower in 2007 due to tax planning strategies implemented during the fourth quarter of 2006, which included investments in tax preferred assets.

We monitor relevant income tax laws for changes in laws or court rulings that may affect our accrued income taxes and income tax planning. We consider the impact on estimates and judgments used in our income tax calculations and make necessary adjustments.

Our federal and state income tax returns for the years 2004 through 2006 are open for review and examination by governmental authorities. In the normal course of these examinations, we are subject to challenges from governmental authorities regarding amounts of taxes due. We believe adequate provision for income taxes has been recorded for all years open for review.

Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing, nature and amount of future income earned by certain subsidiaries and the implementation of various plans to maximize realization of the deferred tax asset. Management believes that the subsidiaries will generate sufficient operating earnings to realize the deferred tax benefits. Management’s determination is based upon the historical taxable profits and projected taxable profits of certain subsidiaries.

Balance Sheet Review

Investment Securities

The investment securities serve as a vehicle to generate interest and dividend income from the investment of funds, provide liquidity to meet funding requirements, manage interest rate risk, and provide collateral for public deposits and borrowed money. All investment securities are recorded at fair value. We primarily invest in securities of U.S. Government agencies and corporations and mortgage related securities with average lives approximating five years.

Investment securities were $246.5 million at September 30, 2007, compared with $235.0 million at September 30, 2006. At September 30, 2007, investment securities represented 25.8% of total assets compared with 27.6% at September 30, 2006. We had an unrealized loss on investment securities available-for-sale, net of tax, of $1.1 million at September 30, 2007, compared with an unrealized loss of $2.2 million at the same time last year.


	September 30						December 31,
	2007			2006			2006
Available for Sale (at fair value)
Securities of U.S. Government sponsored agencies and corporations	$	91,992,594		$	95,679,197		$	95,860,607
Mortgage-backed securities		138,879,983			128,773,538			133,666,652
Municipal Securities		3,328,321			0			0
Other debt securities		4,032,500			4,052,400			3,040,000

Total debt securities		238,233,398			228,505,135			232,567,259
Equity securities		8,273,817			6,515,500			6,965,500

Total	$	246,507,215		$	235,020,635		$	239,532,759

Total securities as a percentage of total assets		25.76	%		27.55	%		26.88	%

Percentage of Total Securities Portfolio
Securities of U.S. Government sponsored agencies and corporations		37.32	%		40.71	%		40.02	%
Mortgage-backed securities		56.33			54.79			55.80
Municipal Securities		1.35			0.00			0.00
Other debt securities		1.64			1.72			1.27

Total debt securities		96.64			97.23			97.09
Equity securities		3.36			2.77			2.91

Total		100.00	%		100.00	%		100.00	%

Average investment securities excluding the unrealized loss on available-for-sale securities were $242.0 million during the first nine months of 2007, an increase of 7.2% from the $225.8 million in 2006. The increase in average investment securities was due to the overall growth in the balance sheet and securities purchased to leverage available capital. The average tax equivalent portfolio yield increased in the first nine months of 2007 to 4.99% from 4.78% in 2006.

The duration of the debt securities portfolio was approximately 3.6 years at September 30, 2007 compared to 4.0 years at September 30, 2006. If interest rates rise, the duration of the portfolio could extend further.

Loans

Loans, the largest component of earning assets, totaled $645.8 million and represented 67.5% of total assets and 90.8% of total deposits at September 30, 2007, compared with $557.7 million and 65.4% of total assets and 87.8% of total deposits at September 30, 2006. During the first nine months of 2007, average loans grew 13.3% to $604.8 million from $533.9 million during the same period in 2006. We have focused our growth in current market areas, strong loan quality, and expansion of existing customer relationships.

The primary strategy for loan generation is buying loan participations from community banks. Community banks sell loan participations primarily due to legal lending limitations, liquidity purposes, and other special needs. Our correspondent lenders focus primarily on small and medium-sized banks in Georgia, Alabama, Florida, Texas, North Carolina, and South Carolina. Our lenders have a high level of experience dealing with community banks and analyzing the different types of loans in these market areas.

Loan policies and procedures provide the overall direction for administration of the loan portfolio. The lending strategy focuses on quality growth in each of our market areas. Our loan underwriting process is intended to ensure that sound and consistent credit decisions are made.

The loans generated through community banks include loan participations that are typically real estate construction loans and commercial real estate loans, and loans secured by common stock of community banks. Since the construction and commercial real estate loans are typically over the community bank’s legal lending limit, the size of the loan is usually between $1 million and $5 million. We use standard underwriting policies and procedures for each loan participation purchased. These loans are geographically dispersed through our market areas and are not concentrated in one small geographic region or state. We attempt to minimize the risk by generally making a significant amount of these type loans only on owner-occupied properties, by requiring collateral values that exceed the loan amount, adequate cash flow to service the debt, and in most cases, the personal guarantees of principals of the borrowers.

We have established concentration limits on commercial real estate – acquisition and development, multifamily, and income producing commercial real estate loans collectively of 575.0% of total capital and at September 30, 2007. These loans totaled $415.6 million or 488.3% of risk based capital. We have established concentration limits on real estate construction loans of 350.0% of total capital and at September 30, 2007, these loans totaled $313.8 million or 364.8% of total capital. While we were slightly over our concentration limit on real estate construction loans at September 30, 2007, we will take the necessary steps to ensure compliance with these limits going forward. We have also established concentration limits on loans secured by common stock of community banks of 125.0% of total capital and at September 30, 2007, these loans totaled $87.1 million or 101.3% of total capital. This limitation includes loans to stockholders of community banks and not loans made directly to bank holding companies.

Even though loan policies and procedures may provide the basis for a quality loan portfolio with minimal risk, at times individual borrowers do encounter problems, which result in lower credit quality and higher risk of loss. Additionally, general deterioration of loan quality may result from weaknesses in specific industries or the economy in general. During the first nine months of 2007, we did not experience credit deterioration attributable to adverse trends in specific markets or changes in the economy.

The following table shows the carrying values and mix of the loan portfolio at September 30, 2007 and 2006. Commercial, financial, and agricultural loans increased 30.0% from September 30, 2006 and represent 23.0% of gross loans at September 30, 2007. Real estate-construction loans, which were 48.6% of gross loans at September 30, 2007, increased 24.1% compared to the previous year. The increases of each of the loan categories discussed above are due to improved loan demand in each of our primary market areas. Real estate-mortgage, which includes commercial real estate loans, decreased 4.1% from September 30, 2006 and represent 21.1% of gross loans at September 30, 2007. Commercial real estate loans decreased primarily due to loan payoffs and slower loan demand. Installment loans to individuals, which include residential real estate loans, represent 2.0% of gross loans at September 30, 2007 and decreased 9.3% from September 30, 2006. Some correspondent banks sell us pools of mortgages for short periods of time to help their liquidity position. Installment loans to individuals decreased from September 30, 2006 to September 30, 2007 mainly because we had a higher level of these mortgage pools purchased from correspondent banks at September 30, 2006. Home equity lines of credit decreased 0.4% from September 30, 2006 and represent 5.3% of gross loans at September 30, 2007. Lease financing receivables, which represent 0.03% of gross loans at September 30, 2007, decreased 46.5% compared to the previous year. Other loans decreased $20,509 or 27.2% from September 30, 2006 and represent 0.01% of gross loans at September 30, 2007.

Loan Portfolio Composition


	September 30						December 31,
	2007			2006			2006
Commercial, financial, and agricultural	$	148,434,094		$	114,137,926		$	127,268,666
Real estate—construction		313,809,426			252,042,703			290,876,262
Real estate—mortgage		135,950,851			142,256,029			139,634,491
Installment loans to individuals		13,111,518			14,447,957			14,539,865
Home equity lines of credit		34,239,332			34,392,943			33,200,177
Lease financing receivables		199,601			372,770			294,298
Other		54,964			75,473			139,609

Gross loans		645,799,786			557,725,801			605,953,368
Unearned income		0			(741	)		(147	)

Total loans, net of unearned income	$	645,799,786		$	557,725,060		$	605,953,221

Total loans as a percentage of total assets		67.48	%		65.37	%		68.01	%

Percentage of Total Loan Portfolio
Commercial, financial, and agricultural		22.99	%		20.46	%		21.00	%
Real estate—construction		48.59			45.19			48.00
Real estate—mortgage		21.05			25.51			23.05
Installment loans to individuals		2.03			2.59			2.40
Home equity lines of credit		5.30			6.17			5.48
Lease financing receivables		0.03			0.07			0.05
Other		0.01			0.01			0.02

Gross loans		100.00	%		100.00	%		100.00	%

In many lending transactions, collateral is obtained to provide an additional measure of security. Generally, the cash flow and earnings power of the borrower represent the primary source of repayment and collateral is considered as an additional safeguard to further reduce credit risk. The need for collateral is determined on a case-by-case basis after considering the current and prospective creditworthiness of the borrower, terms of the lending transaction, and economic conditions.

Generally, all loans that are past due 90 days or more as to principal or interest, or where reasonable doubt exists as to timely collection, including loans which are individually identified as being impaired, are classified as nonaccrual loans unless well secured and in the process of collection. Previously accrued interest is reversed against current earnings and any subsequent interest is recognized on the cash basis. Interest collections on nonaccrual loans for which ultimate collectibility of principal is uncertain are applied as principal reductions. Otherwise, such collections are credited to income when received.

In accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan,” we measure loans for impairment when it is probable that all amounts, including principal and interest, will not be collected in accordance with the contractual terms of the loan agreement. It is our policy to apply the provisions of SFAS No. 114 to all impaired commercial, commercial real estate, and real estate construction loans on a loan-by-loan basis.

Nonperforming assets consist of nonaccrual loans on which the ultimate collection of the full amount of principal and/or interest is uncertain, restructured loans, loans past due 90 days or more as to principal or interest, and other real estate owned. We do not have any foreign loans or loans for highly leveraged transactions.

Nonperforming Assets


	September 30						December 31,
	2007			2006			2006
Nonaccrual loans	$	3,234,910		$	0		$	513,920
Loans past due 90 days or more		0			0			0
Foreclosed property (other real estate owned)		3,551,400			1,500,000			4,742,400

Total nonperforming assets	$	6,786,310		$	1,500,000		$	5,256,320

Total nonperforming assets as a percentage of total assets		0.71	%		0.18	%		0.59	%

Allowance for loan losses to nonperforming loans		246.59	%		NM			1,442.21	%

NM= Not meaningful

At September 30, 2007, nonperforming assets increased $5.3 million to $6.8 million, compared with $1.5 million reported at September 30, 2006. At September 30, 2007, we had $3.2 million in nonaccrual loans, compared to $0 at the same time last year. We added one loan totaling $3.1 million to nonaccrual loans during the third quarter of 2007. This loan is a townhouse project in central Florida and may be a long-term workout situation with limited expected losses. There were no loans past due 90 days or more at September 30, 2007. The increase in foreclosed property was primarily due to a convenience store loan foreclosure. The nonperforming assets to total assets ratio was 0.71% on September 30, 2007, compared to 0.18% on September 30, 2006.

Allowance for Loan Losses

An analysis of activity in the allowance for loan losses is presented in the table below. The allowance for loan losses is established and maintained through charges to expense in the form of a provision for loan losses. Losses on loans are charged to and recoveries are credited to the allowance at the time the loss or recovery occurs.

Our provision for loan losses is a reflection of actual losses experienced during the year and management’s judgment as to the adequacy of the allowance for loan losses. Some of the factors considered by management in determining the amount of the provision and resulting allowance include: (1) detailed reviews of individual loans; (2) gross and net loan charge-offs in the current year; (3) the current level of the allowance in relation to total loans and to historical loss levels; (4) past due and non-accruing loans; (5) collateral values of properties securing loans; (6) the composition of the loan portfolio (types of loans) and risk profiles; and (7) management’s analysis of economic conditions and the resulting impact on the Corporation’s loan portfolio.

A coordinated effort is undertaken to identify credit losses in the loan portfolio for management purposes and to establish the loan loss provision and resulting allowance for accounting purposes. A regular, formal and ongoing loan review is conducted to identify loans with unusual risks or possible losses. The primary responsibility for this review rests with the management of the loan origination staff. Their work is supplemented with reviews by our internal audit staff and loan review staff. This process provides information that helps in assessing the quality of the portfolio, assists in the prompt identification of problems and potential problems, and aids in deciding if a loan represents a probable loss that should be recognized or a risk for which an allowance should be maintained.

We determine our allowance for loan losses in accordance with SFAS No. 114 and SFAS No. 5. In determining the amount of the allowance for loan losses, management uses information from its ongoing loan review process to stratify the loan portfolio into risk grades. The higher-risk-graded loans in the portfolio are assigned estimated amounts of loss based on several factors, including current and historical loss experience of each higher-risk category, regulatory guidelines for losses in each higher-risk category and management’s judgment of economic conditions and the resulting impact on the higher-risk-graded loans.

An analysis of activity in the allowance for loan losses at and for the three and nine months ended September 30, 2007 and 2006, and for the year ended December 31, 2006 is presented in the following table:


	At and for the three months ended September 30						At and for the nine months ended September 30						At and for the year ended December 31,
	2007			2006			2007			2006			2006
Balance at beginning of period	$	7,774,655		$	6,715,922		$	7,411,803		$	6,466,714		$	6,466,714
Provision for loan losses		50,000			420,000			490,000			1,175,000			1,600,000
Recoveries on loans previously charged off		6,434			2,852			10,420			7,112			9,385
Loans charged off		(29,440	)		(89,348	)		(110,574	)		(599,400	)		(664,296	)
Allowance acquired in acquisition of loan portfolio		175,401			0			175,401			0			0

Balance at end of period	$	7,977,050		$	7,049,426		$	7,977,050		$	7,049,426		$	7,411,803

Average Loans	$	631,254,233		$	544,885,401		$	604,761,400		$	533,889,601		$	543,788,897
Loans, end of period		645,799,786			557,725,060			645,799,786			557,725,060			605,953,221
Net charge-offs as a percentage of average loans (annualized)		0.01	%		0.06	%		0.02	%		0.15	%		0.12	%
Allowance for loan losses as a percentage of loans		1.24	%		1.26	%		1.24	%		1.26	%		1.22	%
Allowance for loan losses to nonperforming loans		246.59	%		NM			246.59	%		NM			1,442.21	%

At September 30, 2007, we had 2 loans considered impaired totaling $3.2 million compared with $0 at the same time last year. Impaired loans had a related specific allowance for loan losses of $485,237 and $0 at September 30, 2007 and 2006, respectively. There were no material commitments to lend additional funds to customers whose loans were classified as impaired at September 30, 2007. The vast majority of our impaired loans are dependent upon collateral for repayment. For these loans, impairment is measured by evaluating estimated net realizable value of collateral as compared to the current investment in the loan. For all other impaired loans, we compare the amount of estimated discounted cash flows to the investment in the loan. In the event a particular loan’s collateral value or discounted cash flows are not sufficient to support the collection of the investment in the loan, the loan is specifically considered in the determination of the allowance for loan losses or a charge is immediately taken against the allowance for loan losses.

The ratio of net charge-offs to average loans was 0.02% during the first nine months of 2007 and 0.15% for the same period in 2006. The provision for loans losses for the first nine months of 2007 was $490,000, compared with $1,175,000 in the same period in 2006.

The provision for loan losses was made to reflect potential losses inherent in the loan portfolio at the balance sheet date. Specific reserves are provided on individual loans for which management believed were impaired. The specific reserves are determined on loan-by-loan basis based on management’s evaluation of our exposure for each credit, given the current payment status of the loan and the value of any underlying collateral. Loans for which specific reserves are provided are excluded from the general allowance calculations described above to prevent redundant reserves.

Although it is our policy to immediately charge off as a loss all loan amounts judged to be uncollectible, historical experience indicates that certain losses exist in the loan portfolio that have not been specifically identified. To anticipate and provide for these unidentifiable losses, the allowance for loan losses is established by charging the provision for loan losses expense against current earnings. No portion of the resulting allowance is in any way allocated or restricted to any individual loan or group of loans. The entire allowance is available to absorb losses from any and all loans.

The allowance for loan losses is maintained at a level considered adequate by management to provide for potential losses inherent in the loan portfolio. Management evaluates the adequacy of the allowance on a quarterly basis and it is based on a review of individual loans, recent loss experience, current economic conditions, risk identification procedures previously discussed, underlying collateral values, and other relevant factors. Changes in the factors used by management to determine the adequacy of the allowance or the availability of new information could cause the allowance for loan losses to be increased or decreased in future periods. In addition, bank regulatory agencies, as part of their examination process, may require that additions be made to the allowance for loan losses based on their judgments and estimates.

Funding Sources

Total deposits were $711.5 million and represented 74.4% of total assets at September 30, 2007, compared with $635.2 million and 74.5% of total assets at September 30, 2006. During the first nine months of 2007, average deposits grew 10.3% to $671.5 million from $608.8 million for the same period in 2006, primarily due to our competitive rates offered to commercial and consumer customers. In the first nine months of 2007, the mix of interest-bearing deposits improved slightly

as certificates of deposit increased 7.4%, and money market deposits increased 19.4%. Certificates of deposit represented 62.3% of deposits at September 30, 2007 and 65.0% at September 30, 2006. Money market accounts represented 35.4% of deposits at September 30, 2007 and 33.2% at September 30, 2006.

Types of Deposits


	September 30						December 31,
	2007			2006			2006
Noninterest-bearing demand deposits	$	11,608,502		$	7,378,004		$	6,677,509
Interest-bearing checking		4,170,475			3,794,161			4,079,170
Money market accounts		251,966,213			210,981,562			236,289,435
Savings accounts		272,991			290,481			312,176
Brokered deposits		20,128,000			33,335,000			33,325,000
Time deposits under $100,000		263,656,719			237,674,017			237,563,640
Time deposits of $100,000 or more		159,708,464			141,761,787			140,145,532

Total Deposits	$	711,511,364		$	635,215,012		$	658,392,462


Percentage of Total Deposits
Noninterest-bearing demand deposits		1.63	%		1.16	%		1.01	%
Interest-bearing checking		0.59			0.60			0.62
Money market accounts		35.41			33.21			35.89
Savings accounts		0.04			0.05			0.05
Brokered deposits		2.83			5.25			5.06
Time deposits under $100,000		37.05			37.41			36.08
Time deposits of $100,000 or more		22.45			22.32			21.29

Total Deposits		100.00	%		100.00	%		100.00	%

The table below shows a maturity schedule for time deposits of $100,000 or more at September 30, 2007 and December 31, 2006.

Maturity Distribution of Time Deposits of $100,000 or More


	September 30, 2007		December 31, 2006
Three months or less	$	47,723,635	$	48,581,021
Over three through six months		52,448,219		34,033,044
Over six through twelve months		55,748,899		51,645,140
Over twelve months		3,787,712		5,886,327

Total outstanding	$	159,708,465	$	140,145,532

We continue to utilize cost-effective alternative funding sources, including brokered certificates of deposit and Federal Home Loan Bank (“FHLB”) advances to support balance sheet growth and manage interest rate risk.

Average short-term borrowings increased $17.0 million to $19.3 million during the first nine months of 2007 from $2.3 million for the same period in 2006. We began providing cash management services to community banks in 2003. As part of this service, the Bank manages a pool of overnight federal funds. Most of this pool is invested with upstream correspondent banks and we use a portion as a funding source. At September 30, 2007, the pool of federal funds totaled $173.3 million of which we used $35.3 million as a funding source compared with $177.2 million and $32.0 million, respectively at September 30, 2006.

We are a member of the FHLB and may borrow short-term and long-term funds up to thirty percent of our total assets. Pursuant to collateral agreements with the FHLB, advances are secured by U.S. Treasury or Government agency securities.

Advances from the FHLB with an initial maturity of more than one year totaled $120.0 million at September 30, 2007 and $100.0 million at September 30, 2006. Fixed interest rates on these advances ranged from 2.99% to 4.80%, payable monthly or quarterly, with principal due at various maturities ranging from 2007 to 2017.

Type of Borrowings


	September 30				December 31
	2007		2006		2006
Short-Term Borrowings
Federal Funds purchased and securities sold under agreements to repurchase	$	35,256,000	$	32,000,000	$	35,000,000

Long-Term Borrowings
FHLB Advances		120,000,000		100,000,000		110,000,000
Subordinated notes		12,372,000		12,372,000		12,372,000

Total Long-Term Borrowings		132,372,000		112,372,000		122,372,000

Total Borrowings	$	167,628,000	$	144,372,000	$	157,372,000

We have a line of credit with RBC Centura of $7,000,000 of which none was outstanding at September 30, 2007 and none was outstanding at September 30, 2006. Under the terms of the loan agreement, the loan is secured by 100% of the common stock of Nexity Bank. This line matures on June 29, 2010, and has a floating rate equal to the Prime Rate, appearing in the Wall Street Journal, less 50 basis points (0.50%). Interest is payable quarterly and principal is due on June 29, 2010.

Capital Resources

We maintain a strong level of capital as a margin of safety for our depositors and stockholders, as well as to provide for future growth. At September 30, 2007, stockholders’ equity was $67.2 million versus $63.2 million at September 30, 2006. The increase in stockholders’ equity was primarily the result of higher earnings and decreased accumulated other comprehensive losses. In the first nine months of 2007 we repurchased 288,050 shares of common stock for $3.1 million under our stock repurchase plan. We have not paid any cash dividends.

Book value per share at September 30, 2007 and 2006 was $8.31 and $7.56, respectively. Tangible book value per share at September 30, 2007 and 2006 was $8.20 and $7.45, respectively. Tangible book value was below book value as a result of an intangible asset related to the Corporation’s banking charter. Note 19 of the consolidated financial statements included in Nexity Financial Corporation’s annual report on Form 10-K for the year ended December 31, 2006 sets forth various capital ratios for the Corporation and the Bank. Due to the adoption of FIN 46, the Corporation reports debt associated with trust preferred securities on its consolidated balance sheets as subordinated debentures. Under current regulatory guidelines, these securities continue to qualify for Tier 1 capital treatment. At September 30, 2007 and December 31, 2006, trust preferred securities included in Tier 1 capital totaled $12.0 million. For additional information on these securities, see Note 12 of the consolidated financial statements included in Nexity Financial Corporation’s annual report on Form 10-K for the year ended December 31, 2006.

During 1990, the Federal Reserve Board adopted a minimum leverage ratio of 3.0% for bank holding companies. This ratio (defined as stockholders’ equity less goodwill and certain other intangibles divided by average assets) was 8.50% and 9.35% at September 30, 2007 and 2006, respectively, for the Corporation. As part of forming the holding company, the Federal Reserve Bank required the Corporation and the Bank to maintain a minimum leverage ratio of 5.0%. The Alabama State Banking Department required the Bank to maintain a minimum leverage ratio of 7.0%.

The Federal Reserve Board adopted risk-based capital guidelines, which assign risk-weightings to assets and off-balance sheet items. The guidelines define and set minimum capital requirements (risk-based capital ratios). All banks are required to maintain core capital (Tier 1) of at least 4.0% of risk-adjusted assets and total capital of 8.0% of risk-adjusted assets. Tier 1 capital consists principally of stockholders’ equity less goodwill and certain other intangibles, while total capital consists of Tier 1 capital, certain debt instruments, and a portion of the allowance for loan losses. Banks, which meet or exceed a Tier 1 ratio of 6.0%, a total capital to risk-adjusted assets ratio of 10.0% and a Tier 1 leverage ratio of 5.0% are considered well-capitalized by regulatory standards. We had a Tier 1 capital ratio of 9.97% and 10.86% at September 30, 2007 and 2006, respectively, and a total risk-based capital ratio of 10.97% and 11.86% at September 30, 2007 and 2006, respectively, well above the regulatory requirements for a well-capitalized institution.

The table below sets forth various capital ratios for Nexity Financial Corporation and Nexity Bank. Under current regulatory guidelines, debt associated with trust preferred securities qualifies for Tier 1 capital treatment. At September 30, 2007, trust preferred securities included in Tier 1 capital totaled $12.0 million.


	September 30, 2007		Well Capitalized Requirement
Nexity Financial Corporation
Total risk-based capital	10.97	%	N/A
Tier 1 risk-based capital	9.97		N/A
Leverage ratio	8.50		N/A

Nexity Bank
Total risk-based capital	10.71	%	10.00	%
Tier 1 risk-based capital	9.70		6.00
Leverage ratio	8.25		5.00

Return on Assets and Stockholders’ Equity

The following table shows return on average assets (annualized net income divided by average total assets), return on average equity (annualized net income divided by average stockholders’ equity), dividend payout ratio (dividends declared per share divided by net income per share) and stockholders’ equity to asset ratio (average stockholders’ equity divided by average total assets) for the nine month period ended September 30, 2007 compared to the year ended December 31, 2006.


	Nine months ended September 30, 2007 (1)		Year ended December 31, 2006
Return on average assets	0.62	%	0.75	%
Return on average equity	8.45	%	9.78	%
Dividend payout ratio	—	%	—	%
Average equity to average assets ratio	7.36	%	7.70	%

(1)	The return on average assets and return on average equity for the nine months ended September 30, 2007 was computed by annualizing the numerator to a twelve-month period.

Market Risk and Asset/Liability Management

Asset/liability management is the process by which we monitor and attempt to control the mix and maturities of our assets and liabilities in order to maximize net interest income. The functions of asset/liability management are to ensure adequate liquidity and to maintain an appropriate balance between interest-sensitive assets and liabilities. We manage our exposure to fluctuations in interest rates through policies established by our Asset/Liability Management Committee (“ALCO”) and approved by the Board of Directors. An ALCO report is presented to the Board of Directors on a quarterly basis.

The Corporation measures the effects of changes in interest rates through the use of a simulation model. The simulation model is used to analyze the sensitivity of net interest income to a ratable change in interest rates measured over a 12-month time horizon. The model also measures the sensitivity of the economic value of equity (“EVE”) to an instantaneous change in interest rates. EVE is a measurement of the inherent, long-term economic value of the Corporation at a given point in time.

The simulation model uses a budgeted balance sheet and takes into account interest rate changes as well as related assumption changes for various rate scenarios. Factors considered in the model assumptions include contractual maturities, prepayments, repricing characteristics, deposit retention, and the relative sensitivity of assets and liabilities to changes in market interest rates. The model assumptions are updated each quarter. Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any additional actions we could undertake in response to changes in interest rates.

Interest-sensitive assets and liabilities are those that are subject to repricing in the near term, including floating rate instruments and those with near-term maturities. The interest-sensitivity gap is the difference between total interest-sensitive

assets and liabilities during a given time period. Management’s objective is to maintain the difference between interest-sensitive assets and liabilities at a level that will minimize the effects of significant interest rate shifts on the net interest income.

In analyzing net interest income, we calculate net interest income under several different rate scenarios over a twelve-month period. This reports a case in which interest rates remain flat and reports variations that occur when rates ratably increase 100 and 200 basis points and decrease 100 and 200 basis points. These rates assume a shift in all yield curves as well. The table below shows the effect that the indicated changes in interest rates would have on net interest income as projected for the next twelve months using a budgeted balance sheet for each set of interest rate scenarios, compared to the flat interest rate scenario at September 30, 2007 levels.

Net Interest Income at Risk Analysis


Interest Rate Scenario	Annualized Hypothetical Percentage Change in Net Interest Income
2.00%	5.58	%
1.00	2.78
Flat	—
(1.00)	(2.71	)
(2.00)	(5.37	)

The overall net interest income profile shows positive changes in net interest income if rates ratably increase 100 or 200 basis points. This increase is primarily attributable to a high level of variable rate loans. The down 100 basis point scenario reflects greater variation also due to the high level of variable rate loans and certain deposit rates that have reached what management believes to be an acceptable lower limit thus limiting the interest expense reduction from repricing these deposits by the entire 100 basis points.

We also calculate EVE under several different rate scenarios. This reports a case in which interest rates remain flat and reports variations that occur when rates immediately increase and decrease 200 basis points. These rates assume an instantaneous shift in all the yield curves. The table below shows the effect that the indicated changes in interest rates would have on economic value of equity as projected using a static balance sheet for each set of interest rate scenarios compared to the flat interest rate scenario. The economic value of equity represents the fair value of net assets and is in no way indicative of our shareholders’ equity.

Economic Value of Equity Risk Analysis at September 30, 2007


Interest Rate Scenario	Annualized Hypothetical Percentage Change in Economic Value of Equity
2.00%	(17.0	)%
Flat	—
(2.00)	11.4

Generally, a liability-sensitive position indicates that declining interest rates would have a positive impact on net interest income and rising interest rates would adversely affect net interest income. Rising and declining interest rates, respectively, would typically have the opposite effect on net interest income in an asset-sensitive position. Other factors, including the speed at which assets and liabilities reprice in response to changes in market rates and competitive factors can influence the ultimate impact on net interest income resulting from changes in interest rates. Although management actively monitors and reacts to a changing interest rate environment, it is not possible to fully insulate us against interest rate risk. Given the current mix and maturity of our assets and liabilities, it is possible that a rapid, significant and prolonged increase or decrease in interest rates could have an adverse impact on our net interest margin.

Each of the above analyses may not, on their own, be an accurate indicator of how our net interest income will be affected by changes in interest rates. Income associated with interest-earning assets and costs associated with interest-bearing liabilities may not be affected uniformly by changes in interest rates. In addition, the magnitude and duration of changes in interest rates may have a significant impact on net interest income. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Interest rates on certain types of assets and liabilities fluctuate in advance of changes in general market rates, while interest rates on other types may lag behind changes in general market rates. In addition, certain assets, such as adjustable rate mortgage loans, have features (generally referred to as “interest rate caps and floors”), which limit changes in interest rates. Prepayment and early withdrawal levels also could deviate significantly from those assumed in calculating the maturity of certain

instruments. The ability of many borrowers to service their debts also may decrease during periods of rising interest rates. ALCO reviews each of the above interest rate sensitivity analyses along with several different interest rate scenarios as part of its responsibility to provide a satisfactory, consistent level of profitability within the framework of established liquidity, loan, investment, borrowing, and capital policies.

We may also use derivative financial instruments to improve the balance between interest-sensitive assets and interest-sensitive liabilities and as one tool to manage our interest rate sensitivity while continuing to meet the credit and deposit needs of our customers. At September 30, 2007 and 2006, we had not entered into any derivative contracts to assist managing our interest rate sensitivity.

Liquidity Risk Management

Liquidity management involves meeting our cash flow requirements, which arise primarily from withdrawal of deposits, extensions of credit, and payment of operating expenses. Traditional sources of liquidity for a bank include asset maturities, growth in core deposits, and earnings. A bank may achieve its desired liquidity objectives from the management of its assets and liabilities and by internally generated funding through its operations. Funds invested in marketable instruments that can be readily sold and the continuous maturing of other earning assets are sources of liquidity from an asset perspective. The liability base provides sources of liquidity through attraction of increased deposits and borrowing funds from various other institutions.

Changes in interest rates also affect our liquidity position. We currently price deposits in response to market rates and our management intends to continue this policy. If deposits are not priced in response to market rates, a loss of deposits could occur which would negatively affect our liquidity position.

Scheduled loan payments are a relatively stable source of funds, but loan payoffs and deposit flows can fluctuate significantly, being influenced by interest rates, general economic conditions and competition. Additionally, debt security investments are subject to prepayment and call provisions that could accelerate their payoff prior to stated maturity. We attempt to price our deposit products to meet our asset/liability objectives consistent with market conditions. Our ALCO is responsible for monitoring our ongoing liquidity needs. Our regulators also monitor our liquidity and capital resources on a periodic basis.

Nexity Bank has access to borrowings from the FHLB and maintains short-term lines of credit from correspondent banks. FHLB advances outstanding as of September 30, 2007, totaled $120.0 million. At September 30, 2007, we had $166.7 million of unused borrowing capacity from the FHLB. This capacity may be used when we have available collateral to pledge. Until we make collateral available (other than cash) to secure additional FHLB advances, we will fund its short-term needs principally with deposits, including brokered certificates of deposit, federal funds purchased, and the sale of securities available for sale. In addition, we may purchase securities to provide additional FHLB-qualifying collateral. At September 30, 2007 and December 31, 2006, we had unused short-term lines of credit totaling $5.0 million with correspondent banks.

Our management believes that we have adequate liquidity to meet all known contractual obligations and unfunded commitments, including loan commitments and reasonable borrower, depositor, and creditor requirements over the next twelve months.

Off-Balance Sheet Arrangements

At September 30, 2007, we had outstanding standby letters of credit of $15.2 million and unfunded loan commitments outstanding of $204.6 million. Because these commitments generally have fixed expiration dates and many will expire without being drawn upon, the total commitment level does not necessarily represent future cash requirements. If we needed to fund these outstanding commitments, we have the ability to liquidate federal funds sold or securities available-for-sale, or on a short-term basis to borrow and purchase federal funds from correspondent banks. At September 30, 2007, we had accommodations with upstream correspondent banks for unsecured short-term advances. These accommodations have various covenants related to their term and availability, and in most cases must be repaid within less than a month.

The following table presents additional information about our unfunded commitments as of September 30, 2007, which by their terms have contractual maturity dates subsequent to September 30, 2007 (dollars in thousands):


	Less than One year		1 - 3 Years		4 - 5 Years		After 5 Years		Total
Unfunded commitments:
Letters of credit	$	5,862	$	9,064	$	250	$		$	15,176
Loan commitments		68,977		81,744		4,987		48,874		204,582

Total	$	74,839	$	90,808	$	5,237	$	48,874	$	219,758

Impact of Inflation

The consolidated financial statements and related consolidated financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States and practices within the banking industry which require the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution’s performance than the effects of general levels of inflation.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

See “Market Risk and Asset/Liability Management” in Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations for quantitative and qualitative disclosures about market risk, which information is incorporated herein by reference.

Item 4.

Controls and Procedures

Our management, with the participation of the Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, our disclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by us in the reports that we file or submit under the Exchange Act.

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time, we are involved in legal proceedings and claims that arise in the ordinary course of business.

Item 1A.

Risk Factors

There were no material changes from the risk factors previously disclosed in our annual report on Form 10-K for the period ended December 31, 2006.

Item 2.

Unregistered sales of Equity Securities and Use of Proceeds

In connection with stock repurchases, we have repurchased shares of our common stock in private transactions and open-market purchases, as authorized by our Board of Directors. The following table presents information about our stock repurchases of the three months ended September 30, 2007.

Issuer Purchases of Equity Securities


Period	Total number Of shares Purchased	Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans	Maximum Number of Shares that may yet be purchased under plan (1)
September 1, 2007 to September 30, 2007	34,000	8.19	654,000	796,000

(1)	In July of 2007, the Corporation announced a new stock repurchase plan authorizing the Corporation to repurchase up to 800,000 shares of common stock.

Item 3.

Defaults upon Senior Securities

None

Item 4.

Submission of Matters to a Vote of Securities Holders

None

Item 5.

Other Information

None

Item 6.

Exhibits


31.1		Certificate of the Chief Executive Officer pursuant to Rule 13a-14a/15(d)-14(a) of the Securities and Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certificate of the Chief Financial Officer pursuant to Rule 13a-14a/15(d)-14(a) of the Securities and Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certificate of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2		Certificate of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Corporation has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Nexity Financial Corporation

Date: November 8, 2007	By:	/s/ Greg L. Lee
		Greg L. Lee
		Chairman and Chief Executive Officer

	By:	/s/ John J. Moran
		John J. Moran
		Executive Vice President and Chief Financial Officer

EX-31.1 2 dex311.htm SECTION 302 CEO CERTIFICATION Section 302 CEO Certification

Exhibit 31.1

RULE 13a-14(a)/15d-14(a) CERTIFICATION

CHIEF EXECUTIVE OFFICER

I, Greg L. Lee, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nexity Financial Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a–15(e) and 15d–15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a–15(f) and 15d–15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated November 8, 2007


By:		/s/ Greg L. Lee
		Greg L. Lee
		Chairman and Chief Executive Officer

EX-31.2 3 dex312.htm SECTION 302 CFO CERTIFICATION Section 302 CFO Certification

Exhibit 31.2

RULE 13a-14(a)/15d-14(a) CERTIFICATION

CHIEF FINANCIAL OFFICER

I, John J. Moran, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Nexity Financial Corporation;

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated November 8, 2007


By:		/s/ John J. Moran
		John J. Moran
		Executive Vice President and Chief Financial Officer

EX-32.1 4 dex321.htm SECTION 906 CEO CERTIFICATION Section 906 CEO Certification

Exhibit 32.1

SECTION 1350 CERTIFICATION

Pursuant to 18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Nexity Financial Corporation (the “Company”), hereby certifies, to such officer’s knowledge, that the Company’s quarterly report on Form 10-Q for the period ended September 30, 2007 (the “Report”) fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934 and the information contained in the Report fairly represents, in all material respects, the financial condition and results of operations of the Company.

Dated November 8, 2007


By:		/s/ Greg L. Lee
		Greg L. Lee
		Chairman and Chief Executive Officer

EX-32.2 5 dex322.htm SECTION 906 CFO CERTIFICATION Section 906 CFO Certification

Exhibit 32.2

SECTION 1350 CERTIFICATION

Dated November 8, 2007


By:		/s/ John J. Moran
		John J. Moran
		Executive Vice President and Chief Financial Officer

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