**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-Q**

 

**(MARKONE)**

 

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

 

**For the Quarterly Period ended September 30, 2010**

 

**OR**

 

**o****         TRANSITION REPORTPURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934**

 

**For the Transition Period from                  to                  **

 

**Commission File No. 000-51896**

 

**COMMUNITYSOUTHFINANCIAL CORPORATION**

(Exact name of registrant as specified in its charter)

 

| **South Carolina**           | ** ** | **20-0934786**      |
|------------------------------|------------|---------------------|
| (State or other jurisdiction |       | (I.R.S. Employer    |
| of incorporation)            |       | Identification No.) |

 

**6602 Calhoun Memorial Highway**

**Easley, South Carolina 29640**

(Address of principal executive offices)

 

**(864) 306-2540**

(Registrant’s telephone number, including area code)

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes x   Noo

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files). o Yes    o No

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reportingcompany.  See the definitions of “large accelerated filer,” “acceleratedfiler” and “smaller reporting company” in Rule 12b-2 of the Exchange Act).

 

| Large accelerated filer o                   |   | Accelerated filer o         |
|---------------------------------------------|--------|-----------------------------|
|                                        |   |                        |
| Non-accelerated o                           |   | Smaller reporting company x |
| (do not check if smaller reporting company) |   |                        |

 

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

 

Indicatethe number of shares outstanding of each of the issuer’s classes of commonstock, as of the latest practicable date: 4,698,697 shares of common stock,$0.01 par value per share, were issued and outstanding as of October 29,2010.

 

 

 

----

 

**CommunitySouth Financial Corporation**

 

**Part I- Financial Information**

 

**Item 1. Financial Statements****.**

 

**CONSOLIDATED BALANCE SHEETS**

(dollars in thousands)

 
| ** **                                                                                                                                                    | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                    | ** ** | **(Unaudited)**                  | ** ** | **(Audited)**                   | ** ** |
| **Assets**                                                                                                                                                    | ** ** | ** **                       | ** ** | ** **                      | ** ** |
|                                                                                                                                                          |       |                             |       |                            |       |
| Cash and cash equivalents                                                                                                                                     |       |                             |       |                            |       |
| Cash and due from bank                                                                                                                                        |       | $                                | 7,480      |                            | $          | 6,876 |   |
| Federal funds sold                                                                                                                                            |       | 46,885                           |       | 31,043                          |       |
| Total cash and cash equivalents                                                                                                                               |       | 54,365                           |       | 37,919                          |       |
| Investment securities, available for sale                                                                                                                     |       | 146,155                          |       | 103,638                         |       |
| Other investments, at cost                                                                                                                                    |       | 1,485                            |       | 1,599                           |       |
| Loans, net of allowance for loan losses of $11,437 at  September 30, 2010 and $12,963 at December 31, 2009                                          |       | 223,053                          |       | 262,141                         |       |
| Accrued interest receivable                                                                                                                                   |       | 984                              |       | 1,440                           |       |
| Property and equipment, net                                                                                                                                   |       | 3,396                            |       | 3,867                           |       |
| Other real estate owned                                                                                                                                       |       | 10,036                           |       | 6,703                           |       |
| Repossessed collateral                                                                                                                                        |       | 741                              |       | 942                             |       |
| Other assets                                                                                                                                                  |       | 461                              |       | 3,285                           |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| Total assets                                                                                                                                                  |       | $                                | 440,676    |                            | $          | 421,534 |   |
|                                                                                                                                                          |       |                             |       |                            |       |
| **Liabilities and  Shareholders’ Equity**                                                                                                                |       |                             |       |                            |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| **Liabilities**                                                                                                                                               |       |                             |       |                            |       |
| Deposits                                                                                                                                                      |       |                             |       |                            |       |
| Non-interest bearing                                                                                                                                          |       | $                                | 24,503     |                            | $          | 21,829 |   |
| Interest bearing                                                                                                                                              |       | 377,870                          |       | 354,734                         |       |
| Total deposits                                                                                                                                                |       | 402,373                          |       | 376,563                         |       |
| Repurchase agreements                                                                                                                                         |       | 30,000                           |       | 30,000                          |       |
| Subordinated debt                                                                                                                                             |       | 4,325                            |       | 4,325                           |       |
| Accrued interest payable                                                                                                                                      |       | 1,383                            |       | 1,307                           |       |
| Accrued expenses                                                                                                                                              |       | 928                              |       | 665                             |       |
| Other liabilities                                                                                                                                             |       | 2                                |       | 3                               |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| Total liabilities                                                                                                                                             |       | 439,011                          |       | 412,863                         |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| Commitments and contingencies                                                                                                                                 |       |                             |       |                            |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| **Shareholders’ Equity**                                                                                                                                 |       |                             |       |                            |       |
| Preferred stock, par value $.01 per share 10,000,000 shares  authorized, no shares issued                                                                     |       | —                           |       | —                          |       |
| Common stock, par value $.01 per share 35,000,000 shares authorized,  4,698,697 issued and outstanding at September 30, 2010 and  December 31, 2009 |       | 47                               |       | 47                              |       |
| Additional paid-in capital                                                                                                                                    |       | 29,872                           |       | 29,824                          |       |
| Accumulated other comprehensive income (loss)                                                                                                                 |       | 814                              |       | (1,134                          | )          |
| Retained earnings                                                                                                                                             |       | (29,068                          | )          | (20,066                         | )          |
| Total shareholders’ equity                                                                                                                               |       | 1,665                            |       | 8,671                           |       |
|                                                                                                                                                          |       |                             |       |                            |       |
| Total liabilities and shareholders’ equity                                                                                                               |       | $                                | 440,676    |                            | $          | 421,534 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

2

----

 

**CommunitySouth Financial Corporation**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

(dollars in thousands)

 
| ** **                                                                        | ** ** | **Three months ended** | ** ** | **Three months ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| **Interest income**                                                               |       |                             |       |                             |       |
| Interest and fees on loans                                                        |       | $                                | 3,206      |                             | $          | 4,270 |   |
| Interest and dividends on investments                                             |       | 474                              |       | 561                              |       |
| Total interest income                                                             |       | 3,680                            |       | 4,831                            |       |
|                                                                              |       |                             |       |                             |       |
| **Interest expense — deposits and other borrowings**                         |       | 2,574                            |       | 2,145                            |       |
|                                                                              |       |                             |       |                             |       |
| Net interest income                                                               |       | 1,106                            |       | 2,686                            |       |
|                                                                              |       |                             |       |                             |       |
| **Provision for loan losses**                                                     |       | 3,000                            |       | 3,500                            |       |
|                                                                              |       |                             |       |                             |       |
| Net interest income (loss) after provision for loan losses                        |       | (1,894                           | )          | (814                             | )          |
| ** **                                                                        |       |                             |       |                             |       |
| **Non-interest income**                                                           |       |                             |       |                             |       |
| Mortgage origination revenue                                                      |       | 279                              |       | 197                              |       |
| Gain on sale of securities                                                        |       | 594                              |       | —                           |       |
| Other                                                                             |       | 225                              |       | 213                              |       |
| Total non-interest income                                                         |       | 1,098                            |       | 410                              |       |
| ** **                                                                        |       |                             |       |                             |       |
| **Non-interest expense**                                                          |       |                             |       |                             |       |
| Salaries and benefits                                                             |       | 1,286                            |       | 1,344                            |       |
| Data processing                                                                   |       | 161                              |       | 225                              |       |
| Occupancy                                                                         |       | 168                              |       | 170                              |       |
| Depreciation                                                                      |       | 153                              |       | 190                              |       |
| Equipment maintenance and rental                                                  |       | 58                               |       | 55                               |       |
| Advertising                                                                       |       | 37                               |       | 64                               |       |
| Professional fees                                                                 |       | 305                              |       | 73                               |       |
| Office supplies                                                                   |       | 13                               |       | 20                               |       |
| Telephone                                                                         |       | 46                               |       | 35                               |       |
| FDIC assessment                                                                   |       | 486                              |       | 135                              |       |
| Net loss on sale/writedown of other real estate owned and repossessed  collateral |       | 522                              |       | 42                               |       |
| Other                                                                             |       | 665                              |       | 472                              |       |
| Total non-interest expense                                                        |       | 3,900                            |       | 2,825                            |       |
|                                                                              |       |                             |       |                             |       |
| **Loss before income taxes**                                                      |       | (4,696                           | )          | (3,229                           | )          |
|                                                                              |       |                             |       |                             |       |
| **Income tax benefit**                                                            |       | —                           |       | (1,095                           | )          |
| ** **                                                                        |       |                             |       |                             |       |
| **Net loss**                                                                      |       | $                                | (4,696     | )                                | $          | (2,134 | ) |
| ** **                                                                        |       |                             |       |                             |       |
| **Losses per share**                                                              |       |                             |       |                             |       |
| Basic                                                                             |       | $                                | (1.00      | )                                | $          | (0.45 | ) |
| Diluted                                                                           |       | $                                | (1.00      | )                                | $          | (0.45 | ) |
|                                                                              |       |                             |       |                             |       |
| **Weighted average shares outstanding**                                           |       |                             |       |                             |       |
| Basic                                                                             |       | 4,698,697                        |       | 4,698,697                        |       |
| Diluted                                                                           |       | 4,698,697                        |       | 4,698,697                        |       |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

3

----

 

**CommunitySouth Financial Corporation**

 

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(UNAUDITED)**

(dollars in thousands)

 
| ** **                                                                        | ** ** | **Nine months ended**  | ** ** | **Nine months ended**  | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| **Interest income**                                                               |       |                             |       |                             |       |
| Interest and fees on loans                                                        |       | $                                | 10,163     |                             | $          | 12,931 |   |
| Interest and dividends on investments                                             |       | 1,832                            |       | 1,460                            |       |
| Total interest income                                                             |       | 11,995                           |       | 14,391                           |       |
|                                                                              |       |                             |       |                             |       |
| **Interest expense — deposits and other borrowings**                         |       | 7,436                            |       | 6,176                            |       |
|                                                                              |       |                             |       |                             |       |
| Net interest income                                                               |       | 4,559                            |       | 8,215                            |       |
|                                                                              |       |                             |       |                             |       |
| **Provision for loan losses**                                                     |       | 5,000                            |       | 6,305                            |       |
|                                                                              |       |                             |       |                             |       |
| Net interest income (loss) after provision for loan losses                        |       | (441                             | )          | 1,910                            |       |
|                                                                              |       |                             |       |                             |       |
| **Non-interest income**                                                           |       |                             |       |                             |       |
| Mortgage origination revenue                                                      |       | 642                              |       | 502                              |       |
| Gain on sale of securities                                                        |       | 1,072                            |       | 520                              |       |
| Other                                                                             |       | 642                              |       | 643                              |       |
| Total non-interest income                                                         |       | 2,356                            |       | 1,665                            |       |
| ** **                                                                        |       |                             |       |                             |       |
| **Non-interest expense**                                                          |       |                             |       |                             |       |
| Salaries and benefits                                                             |       | 3,955                            |       | 3,946                            |       |
| Data processing                                                                   |       | 547                              |       | 696                              |       |
| Occupancy                                                                         |       | 524                              |       | 509                              |       |
| Depreciation                                                                      |       | 486                              |       | 552                              |       |
| Equipment maintenance and rental                                                  |       | 208                              |       | 133                              |       |
| Advertising                                                                       |       | 111                              |       | 161                              |       |
| Professional fees                                                                 |       | 1,013                            |       | 239                              |       |
| Office supplies                                                                   |       | 52                               |       | 62                               |       |
| Telephone                                                                         |       | 113                              |       | 110                              |       |
| FDIC assessment                                                                   |       | 1,667                            |       | 502                              |       |
| Net loss on sale/writedown of other real estate owned and repossessed  collateral |       | 529                              |       | 117                              |       |
| Other                                                                             |       | 1,712                            |       | 1,051                            |       |
| Total non-interest expense                                                        |       | 10,917                           |       | 8,078                            |       |
|                                                                              |       |                             |       |                             |       |
| **Loss before income taxes**                                                      |       | (9,002                           | )          | (4,503                           | )          |
|                                                                              |       |                             |       |                             |       |
| **Income tax benefit**                                                            |       | —                           |       | (1,528                           | )          |
| ** **                                                                        |       |                             |       |                             |       |
| **Net loss**                                                                      |       | $                                | (9,002     | )                                | $          | (2,975 | ) |
| ** **                                                                        |       |                             |       |                             |       |
| **Losses per share**                                                              |       |                             |       |                             |       |
| Basic                                                                             |       | $                                | (1.92      | )                                | $          | (0.63 | ) |
| Diluted                                                                           |       | $                                | (1.92      | )                                | $          | (0.63 | ) |
|                                                                              |       |                             |       |                             |       |
| **Weighted average shares outstanding**                                           |       |                             |       |                             |       |
| Basic                                                                             |       | 4,698,697                        |       | 4,698,697                        |       |
| Diluted                                                                           |       | 4,698,697                        |       | 4,698,697                        |       |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

4

----

 

**CommunitySouth Financial Corporation**

 

**CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY**

**AND COMPREHENSIVE INCOME**

**For the nine month periods ended September 30, 2010 and September 30,2009**

**(UNAUDITED)**

(dollars in thousands, except share amounts)

 
| ** **                                         | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained** | ** ** | **Total  Shareholders’** | ** ** | **Total  Comprehensive** | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                                         | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**              | ** ** | **Amount**                            | ** ** | **Capital**  | ** ** | **Income**                    | ** ** | **Earnings**             | ** ** | **Equity** | ** ** | **Income (Loss)** | ** ** |
| Balance at  December 31, 2009                 |       | —                   |       | $                     | —     |                    | 4,698,697  |                                  | $          | 47           |       | $                             | 29,824     |                     | $          | (1,134 | ) | $ | (20,066 | ) | $ | 8,671 |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Net loss                                           |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | —                        |       | (9,002                   | )          | (9,002 | ) | $ | (9,002 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Other  comprehensive income (loss):                |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Unrealized gains  on securities, net of income tax |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | 3,020                         |       | —                   |       | 3,020 |   | 3,020 |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Reclassification  of realized gains                |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | (1,072                        | )          | —                   |       | (1,072 | ) | (1,072 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Total  comprehensive loss                          |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   | $ | (7,054 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Stock option  compensation                         |       | —                   |       | —                |       | —                  |       | —                                |       | 48           |       | —                        |       | —                   |       | 48 |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Balance at  September 30, 2010                |       | —                   |       | $                     | —     |                    | 4,698,697  |                                  | $          | 47           |       | $                             | 29,872     |                     | $          | 814 |   | $ | (29,068 | ) | $ | 1,665 |   |   |   |

 
| ** **                                         | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Retained** | ** ** | **Total  Shareholders’** | ** ** | **Total  Comprehensive** | ** ** |
|----------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|-------------------------|------------|---------------------------------------|------------|--------------|------------|-------------------------------|------------|--------------------------|------------|
| ** **                                         | ** ** | **Shares**               | ** ** | **Amount**            | ** ** | **Shares**              | ** ** | **Amount**                            | ** ** | **Capital**  | ** ** | **Income**                    | ** ** | **Earnings**             | ** ** | **Equity** | ** ** | **Income (Loss)** | ** ** |
| Balance at  December 31, 2008                 |       | —                   |       | $                     | —     |                    | 4,698,697  |                                  | $          | 47           |       | $                             | 29,760     |                     | $          | 491 |   | $ | (1,770 | ) | $ | 28,528 |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Net loss                                           |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | —                        |       | (2,975                   | )          | (2,975 | ) | $ | (2,975 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Other  comprehensive income (loss):                |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Unrealized gains  on securities, net of income tax |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | 513                           |       | —                   |       | 513 |   | 513 |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Reclassification  of realized gains                |       | —                   |       | —                |       | —                  |       | —                                |       | —       |       | (520                          | )          | —                   |       | (520 | ) | (520 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Total  comprehensive loss                          |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   | $ | (2,982 | ) |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Stock option  compensation                         |       | —                   |       | —                |       | —                  |       | —                                |       | 52           |       | —                        |       | —                   |       | 52 |   |   |   |
|                                               |       |                     |       |                  |       |                    |       |                                  |       |         |       |                          |       |                     |       |   |   |   |   |
| Balance at  September 30, 2009                |       | —                   |       | $                     | —     |                    | 4,698,697  |                                  | $          | 47           |       | $                             | 29,812     |                     | $          | 484 |   | $ | (4,745 | ) | $ | 25,598 |   |   |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

5

----

 

**CommunitySouth Financial Corporation**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

(dollars in thousands)

 
| ** **                                                                                 | ** ** | **Nine months ended**  | ** ** | **Nine months ended**  | ** ** |
|--------------------------------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                                                                 | ** ** | **September 30, 2010** | ** ** | **September 30, 2009** | ** ** |
| **Operating activities**                                                                   |       |                             |       |                             |       |
| Net loss                                                                                   |       | $                                | (9,002     | )                                | $          | (2,975 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |       |                             |       |                             |       |
| Provision for loan losses                                                                  |       | 5,000                            |       | 6,305                            |       |
| Stock option compensation                                                                  |       | 48                               |       | 52                               |       |
| Appreciation of bank-owned life insurance                                                  |       | —                           |       | (51                              | )          |
| Gain on sale of securities                                                                 |       | (1,072                           | )          | (520                             | )          |
| Depreciation                                                                               |       | 486                              |       | 552                              |       |
| Loss on disposal of equipment                                                              |       | 3                                |       | 1                                |       |
| Net loss on sale/writedown of other real estate owned and repossessed  collateral          |       | 529                              |       | 117                              |       |
| Deferred income tax expense                                                                |       | —                           |       | (1,948                           | )          |
| Income tax refund                                                                          |       | 2,480                            |       | —                           |       |
| Decrease in accrued interest receivable                                                    |       | 456                              |       | 92                               |       |
| Increase in accrued interest payable                                                       |       | 76                               |       | 44                               |       |
| Increase in accrued expenses                                                               |       | 263                              |       | 175                              |       |
| Decrease (increase) in other assets                                                        |       | 344                              |       | (381                             | )          |
| Decrease in other liabilities                                                              |       | (1                               | )          | (148                             | )          |
|                                                                                       |       |                             |       |                             |       |
| Net cash provided by (used in) operating activities                                        |       | (390                             | )          | 1,315                            |       |
|                                                                                       |       |                             |       |                             |       |
| **Investing activities**                                                                   |       |                             |       |                             |       |
| Net decrease in loans outstanding                                                          |       | 28,469                           |       | 15,877                           |       |
| Sale of bank owned life insurance                                                          |       | —                           |       | 5,488                            |       |
| Purchase of investment securities                                                          |       | (405,912                         | )          | (71,241                          | )          |
| Sale/call/maturity of investment securities                                                |       | 366,415                          |       | 5,399                            |       |
| Sale of FHLB stock                                                                         |       | 114                              |       | 206                              |       |
| Disposal (purchase) of property and equipment                                              |       | (18                              | )          | 15                               |       |
| Sale of other real estate owned and repossessed collateral                                 |       | 1,958                            |       | —                           |       |
|                                                                                       |       |                             |       |                             |       |
| Net cash provided by (used in) investing activities                                        |       | (8,974                           | )          | (44,256                          | )          |
|                                                                                       |       |                             |       |                             |       |
| **Financing activities**                                                                   | ** ** | ** **                       |       |                             |       |
| Net increase in deposit accounts                                                           |       | 25,810                           |       | 81,171                           |       |
| Repayments to FHLB                                                                         |       | —                           |       | (25,000                          | )          |
| Repayment of note payable                                                                  |       | —                           |       | (1,570                           | )          |
|                                                                                       |       |                             |       |                             |       |
| Net cash provided by financing activities                                                  |       | 25,810                           |       | 54,601                           |       |
|                                                                                       |       |                             |       |                             |       |
| Net increase (decrease) in cash and cash equivalents                                       |       | 16,446                           |       | 11,660                           |       |
|                                                                                       |       |                             |       |                             |       |
| **CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD**                                         |       | 37,919                           |       | 9,876                            |       |
|                                                                                       |       |                             |       |                             |       |
| **CASH AND CASH EQUIVALENTS, END OF PERIOD**                                               |       | $                                | 54,365     |                             | $          | 21,536 |   |
|                                                                                       |       |                             |       |                             |       |
| **SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION**                                       |       |                             |       |                             |       |
| Cash paid for (received from):                                                             |       |                             |       |                             |       |
| Interest                                                                                   |       | $                                | 7,360      |                             | $          | 6,132 |   |
| Income taxes                                                                               |       | $                                | (2,480     | )                                | $          | 419 |   |
|                                                                                       |       |                             |       |                             |       |
| **Schedule of non-cash transactions**                                                      |       |                             |       |                             |       |
| Unrealized gains on investment securities, net of income taxes                             |       | $                                | 1,948      |                             | $          | (7 | ) |
| Loans charged-off                                                                          |       | $                                | 6,526      |                             | $          | 4,068 |   |
| Transfers to other real estate owned and repossessed collateral                            |       | $                                | 5,619      |                             | $          | 8,003 |   |

 

The accompanying notes are an integral part of the consolidatedfinancial statements.

 

6

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**CommunitySouth FinancialCorporation**

 

**Notes to Unaudited Consolidated Financial Statements**

 

**NOTE 1 —NATURE OF BUSINESS AND BASIS OF PRESENTATION**

 

**BusinessActivity and Organization —**CommunitySouth FinancialCorporation (the “Company”) is a South Carolina corporation organized for thepurpose of owning and controlling all of the capital stock of CommunitySouthBank and Trust (the “Bank”).  The Bank isa state chartered bank organized under the laws of South Carolina.  From its inception on March 20, 2004 throughJanuary 18, 2005, the Company engaged in organizational and pre-openingactivities necessary to obtain regulatory approvals and to prepare itssubsidiary, the Bank, to commence business as a financial institution.  The Company received approval from theFederal Deposit Insurance Corporation (“FDIC”), the Federal Reserve Board (“FRB”)and the South Carolina State Board of Financial Institutions in January 2005.

 

The Bank began operations onJanuary 18, 2005.  The Bankprimarily is engaged in the business of accepting deposits insured by the FDIC,and providing commercial, consumer and mortgage loans to the general public.

 

The Company sold 4,681,069shares of common stock at $6.40 per share in an initial public offering thatwas completed on February 15, 2005 (as adjusted for all stocksplits).  The offering raised$29,430,810, net of offering costs.  Thedirectors and officers of the Company purchased 659,531 shares at $6.40 pershare for a total of $4,221,000.

 

**Basisof Presentation —**The accompanying financial statements have beenprepared in accordance with generally accepted accounting principles in theUnited States of America (“GAAP”) and to general practices in the bankingindustry for interim financial information and with the instructions to Form 10-Q.  Accordingly, they do not include all theinformation and footnotes required by GAAP for complete financialstatements.  In the opinion ofmanagement, all adjustments (consisting of normal recurring accruals)considered necessary for a fair presentation have been included.  Operating results for the three and ninemonth periods ended September 30, 2010 are not necessarily indicative ofthe results that may be expected for the year ending December 31,2010.  For further information, refer tothe audited consolidated financial statements and footnotes included in theCompany’s Form 10-K for the year ended December 31, 2009 as filedwith the Securities and Exchange Commission (the “SEC”).

 

**NOTE 2 —SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

**Principlesof Consolidation —**The consolidated financial statements include theaccounts of CommunitySouth Financial Corporation, the parent company, andCommunitySouth Bank and Trust, its wholly owned subsidiary, and All SeasonsProperties, LLC, a subsidiary of the Bank, which was formed in 2009 for thepurpose of holding and marketing repossessed assets. All significantintercompany items have been eliminated in the consolidated financialstatements.

 

**Management’s Estimates** — The preparation ofconsolidated financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of income and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

**Disclosure Regarding Segments** — The Companyreports as one operating segment, as management reviews the results ofoperations of the Company as a single enterprise.

 

**Cash and Cash Equivalents**— For purposesof reporting cash flows, cash and cash equivalents include cash on hand,amounts due from banks, short-term interest bearing deposits and federal fundssold.  Cash and cash equivalents have anoriginal maturity of three months or less.

 

**Concentrations of Credit Risk** — Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of loans receivable, investment securities, federal funds sold andamounts due from banks.

 

7

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**CommunitySouth FinancialCorporation**

 

The Company makes loans to individuals and small businesses for variouspersonal and commercial purposes primarily in the upstate region of SouthCarolina.  The Company’s loan portfoliois not concentrated in loans to any single borrower or to a relatively smallnumber of borrowers.  The Bank does,however, have a concentration of loans classified as commercial real estate.These loans are especially susceptible to being adversely effected by thecurrent economic downturn. The current downturn in the real estate market hasresulted in an increase in loan delinquencies, defaults and foreclosures, andwe believe these trends are likely to continue. In some cases, this downturn has resulted in a significant impairment tothe value of our collateral and our ability to sell the collateral uponforeclosure, and there is a risk that this trend will continue.  The commercial real estate collateral in eachcase provides an alternate source of repayment in the event of default by theborrower and may deteriorate in value during the time the credit isextended.  If real estate values in ourmarket areas continue to decline, it is also more likely that we would berequired to increase our allowance for loan losses.

 

In addition to monitoring potential concentrations of loans toparticular borrowers or groups of borrowers, industries and geographic regions,management monitors exposure to credit risk that could arise from potentialconcentrations of lending products and practices such as loans that subjectborrowers to substantial payment increases (e.g., principal deferral periods,loans with initial interest-only periods, etc.), and loans with high loan-to-valueratios.  Additionally, there are industrypractices that could subject the Company to increased credit risk shouldeconomic conditions change over the course of a loan’s life.  For example, the Company makes variable rateloans and fixed rate principal-amortizing loans with maturities prior to theloan being fully paid (i.e., balloon payment loans).  These loans are underwritten and monitored tomanage the associated risks.  Managementhas determined that there is no concentration of credit risk associated withits lending policies or practices.

 

The Company’s investmentportfolio consists of both marketable and non-marketable equitysecurities.  Management believes creditrisk associated with the equity securities is not significant. The Companyplaces its deposits and correspondent accounts with, and sells its federalfunds to, high quality institutions. Management believes credit risk associated with correspondent accountsis not significant.

 

**InvestmentSecurities** — The Company classifies investments in equity anddebt securities in three categories:

 

1.               *Availablefor sale securities*: These are securities that are not classified aseither held to maturity or as trading securities.  These securities arereported at fair market value.  Unrealized gains and losses are reported,net of income taxes, as separate components of shareholders’ equity(accumulated other comprehensive income).

2.               *Heldto maturity securities*: These are investment securities that theCompany has the ability and intent to hold until maturity.  Thesesecurities are stated at cost, adjusted for amortization of premiums and theaccretion of discounts.

3.               *Tradingsecurities*: These are securities that are bought and heldprincipally for the purpose of selling in the near future.  Tradingsecurities are reported at fair market value, and related unrealized gains andlosses are recognized in the income statement.  The Company has no tradingsecurities.

 

Gains or losses ondispositions of investment securities are based on the differences between thenet proceeds and the adjusted carrying amount of the securities sold, using thespecific identification method.   Premiums and discounts areamortized or accrued into interest income by a method that approximates a levelyield.

 

**Other Investments —**The Bank, as a memberinstitution, is required to own stock investments in the Federal Home Loan Bankof Atlanta (the “FHLB”).  Investment inthe FHLB is a condition of borrowing from the FHLB, and the stock is pledged tocollateralize such borrowings.  No readymarket exists for the stock and it has no quoted market value.  However, redemption of FHLB stock hashistorically been at par value.  At September 30,2010 and December 31, 2009, the Company’s investment in FHLB stock was$1,485,000 and $1,599,300, respectively. The dividend received on this stock is included in interest anddividends on investments.

 

**Loans Receivable** — Loans are stated at theirunpaid principal balance less an allowance for loan losses and net deferredloan origination fees.  Interest incomeis computed using the simple interest method and is recorded in the periodearned. Loan origination fees collected and certain loan origination costs aredeferred and the net amount is accreted as income using a method that approximatesthe level yield method over the life of the related loans.

 

8

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**CommunitySouth FinancialCorporation**

 

Loans are considered to beimpaired when, in management’s judgment and based on current information, thefull collection of principal and interest becomes doubtful according to thecontractual terms of the loan agreement. Factors considered by management in determining impairment includepayment status, collateral value, and the probability of collecting scheduledprincipal and interest payments due. Loans that experience insignificant payment delays and paymentshortfalls generally are not classified as impaired.  Management determines the significance ofpayment delays and payment shortfalls on a case-by-case basis, taking intoconsideration all of the circumstances surrounding the loan and the borrower,including the length of the delay, the reasons for the delay, the borrower’sprior payment record and the amount of the shortfall in relation to the principaland interest owed.  Impairment ismeasured on a loan by loan basis for commercial and construction loans byeither the present value of expected future cash flows discounted at the loan’seffective interest rate, the loan’s obtainable market price, or the fair valueof the collateral if the loan is collateral dependent. A loan is alsoconsidered impaired if its terms are modified in a troubled debt restructuring.

 

Loans are generally placedon non-accrual status when principal or interest becomes 90 days past due, orwhen payment in full is not anticipated.  Additionally, impaired loans aretypically placed in non-performing status if it is determined that the entirebalance of principal and interest of the loan cannot be repaid, and future paymentsare applied to principal until such time as collection of the obligation is nolonger doubtful. Interest accrual resumes only when loans return to performingstatus.  To return to performing status,loans must be fully current, and continued timely payments must be a reasonableexpectation.  When a loan is placed onnon-accrual status, interest accrued but not received is generally reversedagainst interest income.  Cash receipts on non-accrual loans are notrecorded as interest income but are used to reduce principal.

 

The Company identifiesimpaired loans through its normal internal loan review process.  Loans on the Company’s potential problem loanlist are considered potentially impaired loans. These loans are evaluated in determining whether all outstandingprincipal and interest are expected to be collected.  Loans are not considered impaired if aminimal payment delay occurs and all amounts due, including accrued interest atthe contractual interest rate for the period of delay, are expected to be collected.  Management has determined that the Companyhad $68,236,000 and $34,158,000 in impaired loans at September 30, 2010and December 31, 2009, respectively.

 

**Allowance for Loan Losses** — Theallowance for loan losses is established as losses are estimated to haveoccurred through a provision for loan losses charged to earnings.  Loan losses are charged against the allowancewhen management believes the uncollectability of a loan balance is confirmed.  Subsequent recoveries, if any, are creditedto the allowance.

 

The allowance for loanlosses is evaluated on a regular basis by management and is based uponmanagement’s periodic review of the collectability of the loans in light ofhistorical experiences, the nature and volume of the loan portfolio, adverse situationsthat may affect the borrower’s ability to repay, estimated value of anyunderlying collateral and prevailing economic conditions.  This evaluation is inherently subjective asit requires estimates that are susceptible to significant revision as moreinformation becomes available.

 

The allowance for loanlosses consists of specific, general and unallocated components.  The specific component relates to loans thatare classified as either doubtful, substandard or special mention.  For such loans that are also classified asimpaired, an allowance is established when the discounted cash flows (orcollateral value or observable market price) of the impaired loan is lower thanthe carrying value of the loan. The general component covers non-classified loansand is based on historical loss experience adjusted for qualitativefactors.  An unallocated component ismaintained to cover uncertainties that could affect management’s estimate ofprobable losses.  The unallocatedcomponent of the allowance reflects the margin of imprecision inherent in theunderlying assumptions used in the methodologies for estimating specific andgeneral losses in the portfolio.

 

Large groups of smallerbalance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Company does not separatelyidentify individual consumer and residential loans for impairment disclosures,unless such loans are the subject of a restructuring agreement.

 

**Bank-Owned Life Insurance** —As of September 30, 2010, the Company has no remaining bank-owned lifeinsurance policies.  The Companymade the decision to sell these policies in 2009 in order to help reduceassets, thereby improving the Bank’s risk based capital ratio. During the firstquarter of 2009, the Company began the process of divesting of its key employeelife insurance policies by selling policies at no gain or loss.  Income from these policies and changes in thenet cash surrender value were recorded in non-interest income. The final policywas sold in April 2009.

 

**Advertising —** Advertising,promotional, and other business development costs generally are expensed asincurred.  External costs incurred inproducing media advertising are expensed the first time the advertising takesplace.  External costs relating to directmailing costs are expensed in the period in which the direct mailings are sent.

 

9

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**CommunitySouth FinancialCorporation**

 

**Property and Equipment** — Premises, furniture andequipment are stated at cost, less accumulated depreciation.  Depreciation expense is computed using thestraight-line method, based on the estimated useful lives for furniture andequipment of 5 to 10 years.  Leaseholdimprovements are amortized over the life of the lease.  Maintenance and repairs are charged tocurrent expense.  The costs of majorrenewals and improvements are capitalized.

 

**Mortgage Origination Revenue**—The Bank offers residential loan origination services to its customers in itsimmediate market area.  The loans areoffered on terms and prices offered by the Bank’s correspondents and are closedin the name of the Bank with preapproval from the correspondents.  The Bank receives fees for services itprovides in conjunction with the origination services it provides.  The fees are recognized at the time the loansare sold to the Bank’s correspondent.

 

**Income Taxes** — The consolidated financial statements have beenprepared on the accrual basis.  When income and expenses are recognized indifferent periods for financial reporting purposes versus for the purposes ofcomputing income taxes currently payable, deferred taxes are provided on suchtemporary differences.

 

The Company has analyzed filing positions in all of the federal andstate jurisdictions where it is required to file income tax returns, as well asall open tax years in these jurisdictions. The Company believes that its incometax filing positions taken or expected to be taken in its tax returns will morelikely than not be sustained upon audit by the taxing authorities and does notanticipate any adjustments that will result in a material adverse impact on theCompany’s financial condition, results of operations, or cash flow. Therefore,no reserves for uncertain income tax positions have been recorded.

 

Deferred tax assets and liabilities are recognized for the expectedfuture tax consequences of events that have been recognized in the consolidatedfinancial statements or tax returns.  Income taxes are the sum of amountscurrently payable to taxing authorities and the net changes in income taxespayable or refundable in future years. Deferred tax assets and liabilities are measured using the enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be realized or settled.  Income taxes deferred to future years aredetermined utilizing an asset and liability approach.  This method gives consideration to the futuretax consequences associated with differences between financial accounting andtax bases of certain assets and liabilities which are principally the allowancefor loan losses, depreciable premises and equipment, and net operating losscarry-forwards.  As of September 30,2010 and December 31, 2009, due to the Company’s recent financial results,the uncertainty involved in projecting near-term profitability, and evaluationof appropriate tax planning strategies, management has provided a 100%valuation allowance for these deferred tax assets.  This valuation allowance reflects management’sestimate that the deferred tax assets are not more-likely-than-not to berealized.

 

**Earnings(loss) Per Share** — Basic earnings (loss) per share represents thenet income (loss) allocated to shareholders divided by the weighted-averagenumber of common shares outstanding during the period.  Diluted earnings (loss) per share reflect theimpact of additional common shares that would have been outstanding if dilutivepotential common shares had been issued. Potential common shares that may be issued by the Company relate to bothoutstanding warrants and stock options, and are determined using the treasurystock method.

 

**Stock—basedCompensation** — The Company has adopted the fair valuerecognition provisions to account for compensation costs under its stock optionplans.  The Company previously utilizedthe intrinsic value method.  Under theintrinsic value method, no compensation costs were recognized for the Company’sstock options because the option exercise price in its plans equaled the marketprice on the date of grant.

 

TheCompany elected to use the modified prospective method to account for thetransition from the intrinsic value method to the fair value recognitionmethod.  Under the modified prospectivemethod, compensation cost is recognized from the adoption date forward for allnew stock options granted and for any outstanding unvested awards as if thefair value method had been applied to those awards as of the date of grant.

 

**Off-Balance Sheet Financial Instruments** — In theordinary course of business, the Company enters into off-balance sheetfinancial instruments consisting of commitments to extend credit and letters ofcredit.  These financial instruments arerecorded in the financial statements when they become payable by the customer.

 

**RecentlyIssued Accounting Standards —**The following is a summaryof recent authoritative pronouncements that could impact the accounting,reporting, and / or disclosure of financial information by the Company:

 

Income Tax guidance wasamended in April 2010 to reflect an SEC Staff Announcement after thePresident signed the Health Care and Education Reconciliation Act of 2010 on March 30,2010, which amended the Patient Protection and Affordable Care Act signed on March 23,2010.   According to the announcement,although the bills were signed on separate dates,

 

10

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**CommunitySouth FinancialCorporation**

 

regulatory bodies would notobject if the two Acts were considered together for accounting purposes. Thisview is based on the SEC staff’s understanding that the two Acts togetherrepresent the current health care reforms as passed by Congress and signed bythe President.  The amendment had noimpact on the financial statements.

 

In July 2010, theReceivables topic of the ASC was amended to require expanded disclosuresrelated to a company’s allowance for credit losses and the credit quality ofits financing receivables. The amendments will require the allowancedisclosures to be provided on a disaggregated basis.  The Company is required to begin to complywith the disclosures in its financial statements for the year ended December 31,2010.

 

On July 21, 2010,President Obama signed into law the Dodd-Frank Wall Street Reform and ConsumerProtection Act (the “Dodd-Frank Act”), which significantly changes theregulation of financial institutions and the financial servicesindustry.  The Dodd-Frank Act includes several provisions that willaffect how community banks, thrifts, and small bank and thrift holdingcompanies will be regulated in the future.  Among other things, theseprovisions abolish the Office of Thrift Supervision and transfer its functionsto the other federal banking agencies, relax rules regarding interstatebranching, allow financial institutions to pay interest on business checkingaccounts, change the scope of federal deposit insurance coverage, and imposenew capital requirements on bank and thrift holding companies.  TheDodd-Frank Act also establishes the Bureau of Consumer Financial Protection asan independent entity within the FRB, which will be given the authority topromulgate consumer protection regulations applicable to all entities offeringconsumer financial services or products, includingbanks.  Additionally, the Dodd-Frank Act includes a series of provisionscovering mortgage loan origination standards affecting originator compensation,minimum repayment standards, and pre-payments.  Management is activelyreviewing the provisions of the Dodd-Frank Act and assessing its probableimpact on our business, financial condition, and results of operations.

 

In August 2010, twoupdates were issued to amend various SEC rules and schedules pursuant toRelease No. 33-9026: Technical Amendments to Rules, Forms, Schedules andCodification of Financial Reporting Policies and based on the issuance of SECStaff Accounting Bulletin 112.  Theamendments related primarily to business combinations and removed references to“minority interest” and added references to “controlling” and “noncontrollinginterests(s)”.  The updates were effectiveupon issuance but had no impact on the Company’s financial statements.

 

Other accounting standardsthat have been issued or proposed by the FASB or other standards-setting bodiesare not expected to have a material impact on the Company’s financial position,results of operations or cash flows.

 

**Risksand Uncertainties** — In the normal course of its business, the Companyencounters two significant types of risk: economic and regulatory.  There are three main components of economicrisk:  interest rate risk, credit riskand market risk.  The Company is subjectto interest rate risk to the degree that its interest-bearing liabilitiesmature or reprice at different speeds, or on different bases, than its interest-earningassets.  Credit risk is the risk ofdefault on the Company’s loan portfolio that results from the borrower’sinability or unwillingness to make contractually required payments.  Market risk reflects changes in the value ofcollateral underlying loans receivable and the valuation of real estate held bythe Company.

 

The Company is subject tothe regulations of various governmental agencies.  These regulations can and do changesignificantly from period to period.  TheCompany also undergoes periodic examinations by the regulatory agencies, whichmay subject it to further changes with respect to asset valuations, amounts ofrequired loss allowances and operating restrictions from the regulators’judgments based on information available to them at the time of theirexamination.  On September 29, 2009,the Bank entered into a Memorandum of Understanding (the “MOU”) with the SouthCarolina Board of Financial Institutions and the FDIC.  In addition, on February 23, 2010 theBank agreed to the issuance of a Consent Order (the “Consent Order”) with thesesame regulators which supersedes the MOU. Additionally, on March 1, 2010, the Company entered into amemorandum of understanding with the Federal Reserve Bank of Richmond, whichcontains provisions similar to the Bank’s Consent Order with the South CarolinaBoard of Financial Institutions and the FDIC. Please see Note 3 for more details regarding these regulatoryagreements.

 

**Reclassifications** - Certain captions andamounts in the prior financial statements were reclassified to conform with the2010 presentation.  Suchreclassifications had no effect on previously reported net income (loss) orshareholders’ equity.

 

11

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**CommunitySouth FinancialCorporation**

 

**NOTE 3 —REGULATORY ACTIONS AND GOING CONCERN CONSIDERATIONS**

 

***Memorandum of Understanding***

 

As a result of the issuesstemming from the economic downturn, on September 29, 2009 the Bankentered into the MOU with the South Carolina Board of Financial Institutionsand the FDIC.  The MOU required the Bankto, among other things, (1) submit a capital plan to the supervisoryauthorities for returning to a “well-capitalized” designation; (2) developspecific plans and proposals for the reduction and improvement of assets whichare subject to adverse classification and past due loans; (3) implement aplan to decrease the concentration of commercial real estate loans; (4) developand implement an adequate loan review program; and (5) review overallliquidity objectives and develop plans and procedures aimed at improvingliquidity and reducing reliance on volatile liabilities to fund longer-termassets.  In addition, the Bank may notpay dividends without the prior written consent of each supervisory authority.  Since entering into the MOU, the Bank hasbeen actively pursuing the corrective actions required by the MOU in an effortto ensure that the requirements of the MOU are met in a timely manner.  For additional information on the MOU,including actions the Bank has taken in response to the MOU, see “Management’sDiscussion and Analysis of Financial Condition and Results of Operations**—**The Effect of the Current Economic Environment on ourBank — *Memorandum of Understanding*.”

 

In addition, in mid-February 2010the Bank received a supervisory letter from the FDIC dated February 11,2010, which provided for additional restrictions and mandatory actions to betaken by the Bank.  These restrictionsand actions were all substantially addressed and superseded by the subsequentConsent Order discussed in the subsection below.  However, in order to comply with thesupervisory letter, the Bank was required to prepare and submit to the FDIC acapital restoration plan no later than April 2, 2010, which submissiondate was sooner than a similar requirement under the Consent Order.  The Bank submitted its capital restorationplan to the FDIC on April 2, 2010.

 

***Consent Order***

 

Followingthe FDIC’s safety and soundness examination of the Bank in the fourth quarterof 2009, the Bank agreed to the issuance of the Consent Order with the FDIC andthe South Carolina Board of Financial Institutions on February 23,2010.  The Consent Order, whichsupersedes the MOU, conveys specific actions needed to address certain findingsfrom the FDIC’s Report of Examination and to address the Bank’s currentfinancial condition, primarily related to capital planning, liquidity/fundsmanagement, policy and planning issues, management oversight, loanconcentrations and classifications, and non-performing loans.  For additional information on the ConsentOrder, including actions the Bank has taken in response to the Consent Order,see “Management’s Discussion and Analysis of Financial Condition and Results ofOperations**—**The Effect of the Current EconomicEnvironment on our Bank — *Consent Order*.”

 

Additionally, on March 1,2010, the Company entered into an informal agreement with the Federal ReserveBank of Richmond.  The informal agreementcontains provisions similar to those in the Bank’s MOU with the FDIC and theSouth Carolina Board of Financial Institutions, including a requirement thatthe Company obtain the prior written approval of the Federal Reserve Bank ofRichmond before (1) declaring or paying any dividends, (2) directlyor indirectly accepting dividends or any other form of payment representing areduction in capital from the Bank, (3) making any distributions ofinterest, principal or other sums on subordinated debentures or trust preferredsecurities, (4) directly or indirectly, incurring, increasing orguaranteeing any debt, and (5) directly or indirectly, purchasing orredeeming any shares of its stock. Pursuant to our plans to preserve capital and to inject more capitalinto the Bank, the Company has no plans to undertake any of the foregoing activities.

 

***Going Concern Considerations***

 

Due to the conditions andevents discussed in this Form 10-Q, substantial doubt exists as to ourability to continue as a going concern. The going concern assumption is afundamental principle in the preparation of financial statements. It is theresponsibility of management to assess the Company’s ability to continue as agoing concern. In assessing this assumption, the Company has taken into accountall available information about the future, which is at least, but is notlimited to, twelve months from the balance sheet date of September 30,2010. The Company has a history of profitable operations and sufficient sourcesof liquidity to meet its short-term and long-term funding needs. However, theBank’s financial condition has suffered during 2009 and the first nine monthsof 2010 from the extraordinary effects of what may ultimately be the worsteconomic downturn since the Great Depression.

 

The Bank, with a loanportfolio consisting of a concentration in commercial real estate loansincluding residential construction and development loans, has seen a decline inthe value of the collateral securing its portfolio as well as rapid

 

12

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**CommunitySouth FinancialCorporation**

 

deterioration in itsborrowers’ cash flow and ability to repay their outstanding loans to the Bank.As a result, the Bank’s level of nonperforming assets increased substantiallyduring 2009 and has continued to increase through the third quarter of 2010. Asof September 30, 2010, our non-performing assets equaled $47.4 million, or10.8% of assets, as compared to $42.4 million, or 10.1% of assets, as ofDecember 31, 2009. For the year ended December 31, 2009 and for thenine months ended September 30, 2010, the Bank recorded a $17 million anda $5 million provision, respectively, to increase the allowance for loan lossesto a level which, in management’s best judgment, adequately reflected theincreased risk inherent in the loan portfolio as of the year and quarter endperiods, respectively. For the nine months ended September 30, 2010, werecorded net loan charge-offs of $6.5 million, or 2.57% of average loans, ascompared to net loan charge-offs of $4.1 million, for the nine months ended September 30,2009.  Largely as a result of thesecharge-offs and the increase in our loan loss provision, our capital positionhas eroded and, as of September 30, 2010, we are deemed to be “criticallyundercapitalized” with a regulatory leverage ratio of 1.07%.

 

As a result of the Bank’s “criticallyundercapitalized” status as of September 30, 2010, a number ofrequirements or restrictions can or will be imposed on the Company and the Bankin addition to those set forth under the Consent Order with the FDIC and theSouth Carolina Board of Financial Institutions and the informal agreement withthe Federal Reserve Bank of Richmond described in this Form 10-Q under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations**—**The Effect of the Current Economic Environment on ourBank — *Consent Order*.”  These additional requirements andrestrictions: (i) prohibit the Bank from paying any bonus to a seniorexecutive officer or providing compensation to a senior executive officer at arate exceeding the officer’s average rate of compensation (excluding bonuses,stock options and profit-sharing) during the 12 months preceding the month inwhich the Bank became undercapitalized, without prior written approval from theFDIC; (ii) require the FDIC to impose one or more of the following on theBank: (A) require a sale of Bank shares or obligations of the Banksufficient to return the Bank to adequately capitalized status; (B) ifgrounds exist for the appointment of a receiver or conservator for the Bank,require the Bank to be acquired or merged with another institution; (C) imposeadditional restrictions on transactions with affiliates beyond the normalrestrictions applicable to all banks; (D) impose more stringent growthrestrictions on the Bank, or require the Bank to further reduce its totalassets; (E) require the Bank to alter, reduce or terminate any activitiesthe FDIC determines pose excessive risk to the Bank; (F) order a newelection of Bank directors; (G) require the Bank to dismiss any seniorexecutive officer or director who held office for more than 180 days before theBank became undercapitalized; (H) require the Bank to employ “qualified”senior executive officers; (I) require the Company to divest the Bank ifthe regulators determine that the divestiture would improve the Bank’sfinancial condition and future prospects; and (J) require the Bank to takeany other action that the FDIC determines will better carry out the purposes ofthe statute requiring the imposition of one or more of the restrictionsdescribed in (A)-(I) above; and (iii) requiring prior regulatoryapproval for material transactions outside the usual course of business,extending credit for a highly leveraged transactions, amending the Bank’sArticles of Incorporation or bylaws, making a material change to accountingmethods, paying excessive compensation or bonuses, and paying interest on newor renewed liabilities at a rate that would increase the Bank’s weightedaverage cost of funds to a level significantly exceeding the prevailing rateson interest on deposits in the Bank’s normal market areas.

 

Under the Federal DepositInsurance Act (the “FDI Act”), a bank that is “critically undercapitalized”must be placed into conservatorship or receivership within 90 days of becomingcritically undercapitalized, unless the bank’s primary Federal regulatoryauthority (for the Bank, the FDIC) determines and documents that “other action”would better achieve the purposes of the FDI Act’s prompt corrective actioncapital requirements.  If the bankremains critically undercapitalized on average during the calendar quarterbeginning 270 days after it became critically undercapitalized, the FDI Actrequires the appointment of a receiver unless the bank and the FDICaffirmatively can determine that, among other things, the bank has positive networth and the FDIC can certify that the bank is viable and not expected tofail.

 

We have determined thatsignificant additional sources of capital will be required for us to continueoperations through the remainder of 2010 and beyond. We also continue tomonitor and address liquidity issues. The Company and the Bank operate in a highly-regulated industry and mustplan for the liquidity needs of each entity separately. A variety of sources ofliquidity are available to the Bank to meet its short-term and long-termfunding needs. Although a number of these sources have been limited followingexecution of the Consent Order with the FDIC and the South Carolina Board ofFinancial Institutions, management has prepared forecasts of these sources offunds and the Bank’s projected uses of funds during 2010 in an effort to ensurethat the sources available are sufficient to meet the Bank’s projectedliquidity needs for this period.

 

The Company relies ondividends from the Bank as its primary source of liquidity. The Company is alegal entity separate and distinct from the Bank. Various legal limitationsrestrict the Bank from lending or otherwise supplying funds to the Company tomeet its obligations, including paying dividends. In addition, the terms of theConsent Order described above and in greater detail under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations**—**The Effect of the

 

13

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**CommunitySouth FinancialCorporation**

 

Current Economic Environmenton our Bank — *Consent Order*” will further limitthe Bank’s ability to pay dividends to the Company to satisfy its fundingneeds.

 

The Company will also needto raise additional capital to increase capital levels to meet the standardsset forth by the FDIC as described in greater detail under “Management’sDiscussion and Analysis of Financial Condition and Results of Operations**—**The Effect of the Current Economic Environment on ourBank — *Consent Order*”. As a result of therecent downturn in the financial markets, the availability of many sources ofcapital (principally to financial services companies) has become significantlyrestricted or has become increasingly costly as compared to the prevailingmarket rates prior to the volatility. Management cannot predict when or if thecapital markets will return to more favorable conditions. Management isactively evaluating a number of capital sources, asset reductions and otherbalance sheet management strategies to ensure that the Bank’s projected levelof regulatory capital can support its balance sheet.

 

There can be no assurancesthat the Company will be successful in its efforts to raise additional capitalduring 2010. An equity financing transaction would result in substantial dilutionto the Company’s current shareholders and could adversely affect the marketprice of the Company’s common stock. It is difficult to predict if theseefforts will be successful, either on a short-term or long-term basis. Shouldthese efforts be unsuccessful, due to the regulatory restrictions which existthat restrict cash payments between the Bank and the Company, the Company maybe unable to realize its assets and discharge its liabilities in the normalcourse of business.

 

As a result of management’sassessment of the Company’s ability to continue as a going concern, theaccompanying consolidated financial statements for the Company have beenprepared on a going concern basis, which contemplates the realization of assetsand the discharge of liabilities in the normal course of business for theforeseeable future, and does not include any adjustments to reflect thepossible future effects on the recoverability or classification of assets.

 

**NOTE 4 —INVESTMENT SECURITIES**

 

The amortized costs and fairvalues of investment securities are as follows (in thousands):

 
| ** **                                       | ** ** | **Amortized** | ** **  | **Gross Unrealized** | ** ** | **Fair**   | ** ** |
|--------------------------------------------------|------------|---------------|-------------|---------------------------|------------|------------|------------|
| **As of September 30, 2010** | ** ** | **Cost**      | ** **  | **Gains**                 | ** ** | **Losses** | ** ** | **Value** | ** ** |
| **Available for sale**                           |       |          |        |                      |       |       |       |   |   |
| US Treasury                                      |       | $             | 74,991      |                      | $          | 1          |       | $ | — |   | $ | 74,992 |   |
| Mortgage-backed                                  |       | 70,320        |        | 821                       |       | (8         | )          | 71,133 |   |
| Marketable securities                            |       | 30            |        | —                    |       | —     |       | 30 |   |
| Total available for sale                         | ** ** | **$**         | **145,341** | ** **                | **$**      | **822**    | ** ** | **$** | (8 | ) | **$** | **146,155** | ** ** |

 
| ** **                                      | ** ** | **Amortized** | ** **  | **Gross Unrealized** | ** ** | **Fair**   | ** ** |
|-------------------------------------------------|------------|---------------|-------------|---------------------------|------------|------------|------------|
| **As of December 31, 2009** | ** ** | **Cost**      | ** **  | **Gains**                 | ** ** | **Losses** | ** ** | **Value** | ** ** |
| **Available for sale**                          |       |          |        |                      |       |       |       |   |   |
| Mortgage-backed                                 |       | 104,672       |        | 77                        |       | (1,211     | )          | 103,538 |   |
| Marketable securities                           |       | 100           |        | —                    |       | —     |       | 100 |   |
| Total available for sale                        | ** ** | **$**         | **104,772** | ** **                | **$**      | **77**     | ** ** | **$** | (1,211 | ) | **$** | **103,638** | ** ** |
|                                                 |            |               |             |                           |            |            |            |  |  |  |  |  |  |

 

**NOTE 5 — LOANS RECEIVABLE**

 

Major classifications ofloans receivable are summarized as follows:

 
| **(dollar amounts in thousands)** | ** ** | **September 30, 2010** | ** **  | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| Real estate - construction                       |       | $                                | 63,391      |                            | $          | 81,128 |   |
| Real estate - mortgage                           |       | 151,722                          |        | 167,296                         |       |
| Commercial and industrial                        |       | 18,252                           |        | 25,028                          |       |
| Consumer and other                               |       | 1,125                            |        | 1,652                           |       |
| Total loans, gross                               |       | 234,490                          |        | 275,104                         |       |
| Less allowance for loan losses                   |       | (11,437                          | )           | (12,963                         | )          |
| Total loans, net                                 | ** ** | **$**                            | **223,053** | ** **                      | **$**      | **262,141** | ** ** |

 

Loans are stated net ofdeferred fees and costs.

 

14

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**CommunitySouth FinancialCorporation**

 

The Bank had $32.6 millionand $29.4 million of loans classified as non-accrual status as of September 30,2010 and December 31, 2009, respectively. At September 30, 2010 and December 31, 2009, loans past due 30days or more, excluding non-accrual loans, amounted to $1.8 million and $4.8million, respectively.  Changes in theallowance for loan losses were as follows (dollars in thousands):

 
| ** **                      | ** ** | **Nine-months ended  September 30, 2010** | ** ** | **Nine-months ended  September 30, 2009** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Balance, beginning of period    |       | $                                                        | 12,963     |                                                     | $          | 8,088 |   |
| Provision charged to operations |       | 5,000                                                    |       | 6,305                                                    |       |
| Net collections (charge-offs)   |       | (6,526                                                   | )          | (4,068                                                   | )          |
| Balance, end of period          | ** ** | **$**                                                    | **11,437** | ** **                                               | **$**      | **10,325** | ** ** |

 
| ** **                                                | ** ** | **Nine-months ended September 30,** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------------------------|------------|
| **Impaired Loans:**                                  | ** ** | **2010**                                           | ** ** | **2009** | ** ** |
| No valuation allowance required                           |       | $                                                  | 36,388     |   | $ | 18,585 |   |
| Valuation allowance required                              |       | 31,848                                             |       | 16,184 |   |
| Total impaired loans                                      | ** ** | **$**                                              | **68,236** | ** ** | **$** | **34,769** | ** ** |
| ** **                                                | ** ** | ** **                                         | ** ** | ** ** | ** ** |
| Allowance for loan losses on impaired loans at period end | ** ** | **$**                                              | **6,670**  | ** ** | **$** | **4,010** | ** ** |

 

**NOTE 6 —LEASES**

 

The Company leases branchlocations in Spartanburg, Mauldin, Anderson, Greer and Greenville, SouthCarolina as well as the loan operations center in Easley, South Carolina. Theinitial lease terms range from three to ten years with various renewal options.The minimum future rental payments under non-cancelable operating leases havingremaining terms in excess of one year, for each of the next five years and inthe aggregate are (in thousands):

 
| Remaining three months of 2010       |       | $     | 91        |       |
|--------------------------------------|------------|-------|-----------|------------|
| 2011                                 |       | 365   |      |
| 2012                                 |       | 343   |      |
| 2013                                 |       | 348   |      |
| 2014                                 |       | 353   |      |
| Thereafter                           |       | 606   |      |
| Total minimum future rental payments | ** ** | **$** | **2,106** | ** ** |

 

Theloan operations center in Easley is leased from a partnership in which aCompany director has a partnership interest.

 

**NOTE 7 —RELATED PARTY TRANSACTIONS**

 

Certain parties (principallycertain directors and executive officers of the Company, their immediatefamilies and business interests) (“affiliates”) are loan customers in thenormal course of business with the Bank. These loans are made on substantially the same terms, including interestrates and collateral, as those prevailing at the time for comparabletransactions with unrelated persons and do not involve more than the normalrisk of collectability.

 

**NOTE 8 — COMMITMENTS AND CONTINGENCIES**

 

The Company is subject toclaims and lawsuits which arise primarily in the ordinary course ofbusiness.  Management is not aware of anylegal proceedings which would have a material adverse effect on the financialposition or operating results of the Company.

 

15

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**CommunitySouth FinancialCorporation**

 

**NOTE 9 —STOCK-BASED COMPENSATION**

 

Upon completion of itsinitial public offering in 2005, the Company agreed to issue warrants to theorganizing directors for the purchase of one share of common stock at $6.40 pershare for every two shares purchased in the stock offering, up to a maximum of15,625 warrants per director. The warrants were fully vested 120 days after January 18,2005 and will expire on January 18, 2015. Warrants held by directors of the Company will expire 90 days after thedirector ceases to be a director or officer of the Company (365 days if due todeath or disability). The Company issued a total of 171,404 warrants.  As of September 30, 2010, the Companyhas 148,202 outstanding warrants to directors and officers.  In addition, the Company has adopted a stockoption plan.  As of September 30,2010, the Company has 729,710 outstanding options to employees and directors.On January 16, 2006, the Company adopted a resolution that terminated the “evergreen”provision of the Company 2005 Stock Incentive Plan. As a result, the number ofshares of common stock issuable under the plan shall not be further increasedin connection with any future share issuances by the Company. The exerciseprice of each option is equal to the market price of the Company’s stock on thedate of grant. The maximum term is ten years, and they typically vest in nogreater than five years. When necessary, the Company may purchase shares on theopen market to satisfy share option exercises. During the ensuing year, theCompany is expected to acquire no shares.

 

The table set forth belowsummarizes stock option activity for the Company’s stock compensation plans forthe period ended September 30, 2010 as adjusted for all stock splits.

 
| ** **                                  | ** ** | **Stock Options** | ** ** | **Warrants**  | ** ** |
|---------------------------------------------|------------|------------------------|------------|---------------|------------|
| ** **                                  | ** ** | ** **             | ** ** | **Weighted-** | ** ** | ** ** | ** ** | **Weighted-** | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | **Average**   | ** ** | ** ** | ** ** | **Average** | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | **Exercise**  | ** ** | ** ** | ** ** | **Exercise** | ** ** |
| ** **                                  | ** ** | **Number**             | ** ** | **Price**     | ** ** | **Number** | ** ** | **Price** | ** ** |
| **Outstanding at  December 31, 2009**  |       | 756,033                |       | $             | 6.99       |   | 171,404 |   | $ | 6.40 |   |
| Granted                                     |       | 3,050                  |       | 0.57          |       | — |   | — |   |
| Forfeited                                   |       | 29,373                 |       | 8.52          |       | 23,202 |   | 6.40 |   |
| Exercised                                   |       | —                 |       | —        |       | — |   | — |   |
| **Outstanding at  September 30, 2010** | ** ** | **729,710**            | ** ** | **6.90**      | ** ** | **148,202** | ** ** | **6.40** | ** ** |
|                                             |            |                        |            |               |            |  |  |  |  |  |  |

 

The table set forth belowsummarizes non-vested stock options as of September 30, 2010.

 
| ** **                                  | ** ** | ** ** | ** ** | **Fair**  | ** ** |
|---------------------------------------------|------------|------------|------------|-----------|------------|
| ** **                                  | ** ** | **Number** | ** ** | **Value** | ** ** |
| **Outstanding at December 31,  2009**  |       | 48,423     |       | $         | 4.32       |   |
| Granted                                     |       | 3,050      |       | 0.39      |       |
| Vested                                      |       | 12,109     |       | 5.08      |       |
| Forfeited                                   |       | 2,799      |       | 2.72      |       |
| **Outstanding at  September 30, 2010** | ** ** | **36,305** | ** ** | **3.86**  | ** ** |
|                                             |            |            |            |           |            |  |

 

As of September 30,2010, there was $107,025 in total unrecognized compensation cost related tonon-vested share-based compensation arrangements, which is expected to berecognized over a weighted average period of 24 months. As of December 31,2009, there was $159,989 in total unrecognized compensation cost related tonon-vested share-based compensation arrangements, which was expected to berecognized over a weighted average period of 32 months.

 

The fair value of eachoption granted is estimated on the grant date using the Black-Scholesoption-pricing model with the following assumptions for 2010:  dividend yield of 0%, expected term of 10years, risk-free interest rate equal to the 10-year treasury rate on therespective grant date, expected life of 10 years, and expected volatilityranging from 53% to 57%.  The followingassumptions were used for the 2009 estimates: dividend yield of 0%, expected term of 10 years, risk-free interest rateequal to the 10-year treasury rate on the respective grant date, and expectedlife of 10 years.  Volatility assumed foroptions granted during 2009 ranged from 38% to 51%.

 

16

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**CommunitySouth FinancialCorporation**

 

The following tablesummarizes information about stock options outstanding under the Company’splans at September 30, 2010 and December 31, 2009.

 
| **September 30, 2010**          | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
|---------------------------------|------------|-----------------|------------|-----------------|------------|
| Number of options               |       | 729,710         |       | 693,205         |       |
| Weighted average remaining life |       | 4.73 years      |       | 4.57 years      |       |
| Weighted average exercise price |       | $               | 6.90       |            | $          | 6.82 |   |
| High exercise price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise price              |       | $               | 0.25       |            | $          | 2.00 |   |
| ** **                      | ** ** | ** **      | ** ** | ** **      | ** ** |
| **December 31, 2009** | ** ** | **Outstanding** | ** ** | **Exercisable** | ** ** |
| Number of options               |       | 756,033         |       | 707,610         |       |
| Weighted average remaining life |       | 5.47 years      |       | 5.29 years      |       |
| Weighted average exercise price |       | $               | 6.99       |            | $          | 6.83 |   |
| High exercise price             |       | $               | 16.80      |            | $          | 16.80 |   |
| Low exercise price              |       | $               | 1.75       |            | $          | 4.55 |   |

 

There were no optionsexercised during the quarter and thus no cash was received related to this typeof transaction. There were no options exercised during 2010 or 2009.

 

At September 30, 2010,all of the 148,202 warrants were exercisable and had an average remaining lifeof 4.30 years. At December 31, 2009, all of the 171,404 warrants wereexercisable and had an average remaining life of 5.05 years.

 

**NOTE 10— FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

GAAP requires disclosure offair value information, whether or not recognized in the consolidated balancesheets, when it is practical to estimate the fair value.  GAAP defines a financial instrument as cash,evidence of an ownership interest in an entity or contractual obligations,which require the exchange of cash, or other financial instruments.  Certain items are specifically excluded fromthe disclosure requirements, including the Company’s common stock, premises andequipment, accrued interest receivable and payable, and other assets andliabilities.

 

The fair value of afinancial instrument is the amount at which the asset or obligation could beexchanged in a current transaction between willing parties, other than in aforced or liquidation sale.  Fair valueestimates are made at a specific point in time based on relevant marketinformation and information about the financial instruments.  Because no market value exists for asignificant portion of the financial instruments, fair value estimates arebased on judgments regarding future expected loss experience, current economicconditions, risk characteristics of various financial instruments, and otherfactors.

 

The Company has usedmanagement’s best estimate of fair value based on the above assumptions.  Thus, the fair values presented may not bethe amounts, which could be realized, in an immediate sale or settlement of theinstrument. In addition, any income taxes or other expenses, which would beincurred in an actual sale or settlement, are not taken into consideration inthe fair values presented.

 

The following methods andassumptions were used to estimate the fair value of significant financialinstruments:

 

***Cash and Due from Banks*** - The carrying amount is areasonable estimate of fair value.

 

***Federal Funds Sold*** - Federal funds sold arefor a term of one day, and the carrying amount approximates the fair value.

 

***Investment Securities*** - The fair values ofmarketable equity securities are valued using quoted fair market prices.

 

***Other Investments*** - The carrying value ofnon-marketable equity securities approximates the fair value since no readymarket exists for the stocks.

 

***Loans Receivable*****-** For certain categories of loans, such as variablerate loans which are repriced frequently and have no significant change incredit risk, fair values are based on the carrying amounts.  The fair value of other types of loans isestimated by discounting the future cash flows using the current rates at whichsimilar loans would be made to borrowers with similar credit ratings and forthe same remaining maturities.  In orderto capture the change in credit risk, the current allowance for loan losses isalso considered when determining fair value of loans receivable.

 

17

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**CommunitySouth FinancialCorporation**

 

***Deposits*****- The fairvalue of demand deposits, savings, and money market accounts is the amountpayable on demand at the reporting date. The fair values of certificates of deposit are estimated using adiscounted cash flow calculation that applies current interest rates to aschedule of aggregated expected maturities.

 

***Repurchase Agreements*** - The fair value ofrepurchase agreements is estimated using a discounted cash flow calculationthat applies prevailing market rates for comparable debt instruments.

 

***Subordinated Debt*** — The fair value ofsubordinated debt is estimated using a discounted cash flow calculation thatapplies prevailing market rates for comparable instruments.  Due to diminishing cash available at theholding company level, we only paid the June and September 2010interest payments to subordinated debt holders that were not officers ordirectors of the Company.  If we areunable to raise additional capital, we may have to discontinue paying intereston the subordinated debentures to all holders after the September 2010payments due to lack of funds, and our fair value calculation reflects this.

 

The carrying values and estimated fair values of the Company’sfinancial instruments at September 30, 2010 and December 31, 2009 areshown in the following table (dollars in thousands).

 
| ** **                                                         | ** ** | **Carrying** | ** ** | **Estimated**       | ** ** |
|--------------------------------------------------------------------|------------|--------------|------------|---------------------|------------|
| ** **                                                         | ** ** | **Amount**   | ** ** | **Fair Value** | ** ** |
| **September 30, 2010**                                   |       |         |       |                |       |
| **Financial Assets**                                               |       |         |       |                |       |
| Cash and due from banks                                            |       | $            | 7,480      |                | $          | 7,480 |   |
| Federal funds sold                                                 |       | 46,885       |       | 46,885              |       |
| Investment securities, available for sale                          |       | 146,155      |       | 146,155             |       |
| Other investments                                                  |       | 1,485        |       | 1,485               |       |
| Loans, gross                                                       |       | 234,490      |       | 231,409             |       |
|                                                               |       |         |       |                |       |
| **Financial Liabilities**                                          |       |         |       |                |       |
| Demand deposit, interest-bearing transaction, and savings accounts |       | $            | 107,796    |                | $          | 107,796 |   |
| Certificates of deposit and other time deposits                    |       | 294,577      |       | 297,669             |       |
| Repurchase agreements                                              |       | 30,000       |       | 32,577              |       |
| Subordinated debt                                                  |       | 4,325        |       | 1,963               |       |
|                                                               |       |         |       |                |       |
| **December 31, 2009**                                         |       |         |       |                |       |
| **Financial Assets**                                               |       |         |       |                |       |
| Cash and due from banks                                            |       | $            | 6,876      |                | $          | 6,876 |   |
| Federal funds sold                                                 |       | 31,043       |       | 31,043              |       |
| Investment securities, available for sale                          |       | 103,638      |       | 103,638             |       |
| Other investments                                                  |       | 1,599        |       | 1,599               |       |
| Loans, gross                                                       |       | 275,104      |       | 260,894             |       |
|                                                               |       |         |       |                |       |
| **Financial Liabilities**                                          |       |         |       |                |       |
| Demand deposit, interest-bearing transaction, and savings accounts |       | $            | 122,712    |                | $          | 122,712 |   |
| Certificates of deposit and other time deposits                    |       | 253,851      |       | 254,930             |       |
| Repurchase agreements                                              |       | 30,000       |       | 31,558              |       |
| Subordinated debt                                                  |       | 4,325        |       | 2,062               |       |

 
| ** **                                   | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **(Dollars in thousands)**         | ** ** | **Notional  Amount**             | ** ** | **Estimated  Fair Value**  | ** ** | **Notional  Amount** | ** ** | **Estimated  Fair Value** | ** ** |
|                                         |       |                             |       |                            |       |   |   |   |   |
| **Off-Balance Sheet Financial Instruments:** |       |                             |       |                            |       |   |   |   |   |
|                                         |       |                             |       |                            |       |   |   |   |   |
| Commitments to extend credit                 |       | $                                | 10,343     |                            | $          | — |   | $ | 14,451 |   | $ | — |   |
| Standby Letters of Credit                    |       | $                                | 840        |                            | $          | — |   | $ | 1,525 |   | $ | — |   |

 

GAAPrequires new disclosure that establishes a framework for measuring fair value,and expands disclosure about fair value measurements.  This disclosure enables the reader of thefinancial statements to assess the inputs used to develop those measurements byestablishing a hierarchy for ranking the quality and reliability of theinformation used to determine fair values. Assets and liabilities carried at fair value will be classified anddisclosed in one of the following three categories:

 

18

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**CommunitySouth FinancialCorporation**

 

·                  Level 1:  Quoted market prices in active markets foridentical assets or liabilities.

 

·                  Level 2:  Observable market based inputs orunobservable inputs that are corroborated by market data.

 

·                  Level 3:  Unobservable inputs that are not corroboratedby market data.

 

In determining appropriatelevels, the Company performs a detailed analysis of the assets and liabilitiesthat are subject to fair value measurement. At each reporting period, all assets and liabilities for which the fairvalue measurement is based on significant unobservable inputs are classified asLevel 3.

 

The tables below present thebalances of assets and liabilities measured at fair value on a recurring basisby level within the valuation hierarchy (as described above) as of September 30,2010.

 
| ** **                                | ** ** | **September 30, 2010** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| **(Dollars in thousands)**      | ** ** | **Total**                        | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Investment securities, available for sale |       | $                                | 146,155    |   | $ | — |   | $ | 146,155 |   | $ | — |   |
|                                           |            |                                  |            |  |  |  |  |  |  |  |  |  |  |

 

Certain assets andliabilities are measured at fair value on a nonrecurring basis; that is, theinstruments are not measured at fair value on an ongoing basis but are subjectto fair value adjustments in certain circumstances (for example, when there isevidence of impairment).  The followingtables present the assets and liabilities carried on the balance sheet bycaption and by level within the valuation hierarchy (as described above) as of September 30,2010 for which a nonrecurring change in fair value has been recorded during thenine months ended September 30, 2010.

 
| ** **                                       | ** ** | **Carrying Value at September 30, 2010** | ** ** |
|--------------------------------------------------|------------|-------------------------------------------------------------------|------------|
| **(Dollars in thousands)**             | ** ** | **Total**                                                         | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Impaired loans, net of allowance for loan losses |       | $                                                                 | 61,566     |   | $ | — |   | $ | — |   | $ | 61,566 |   |
| Other real estate owned                          |       | 10,036                                                            |       | — |   | — |   | 10,036 |   |
| Repossessed collateral                           |       | 741                                                               |       | — |   | — |   | 741 |   |
|                                                  |            |                                                                   |            |  |  |  |  |  |  |  |  |  |  |

** **
| ** **                           | ** ** | **Fair Value Measurements Using Significant Unobservable Inputs** | ** ** |
|--------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **(Level 3)**                                                                              | ** ** |
| **(Dollars in thousands)** | ** ** | **Impaired  Loans**                                                                             | ** ** | **Other Real  Estate Owned** | ** ** | **Repossessed  Collateral** | ** ** | **Total** | ** ** |
| Balance at December 31, 2009    |       | $                                                                                               | 34,158     |   | $ | 6,703 |   | $ | 942 |   | $ | 41,803 |   |
| Gains/(losses) included in earnings  |       | —                                                                                          |       | (502 | ) | (27 | ) | (529 | ) |
| Net additions                        |       | 27,408                                                                                          |       | 3,835 |   | (174 | ) | 31,069 |   |
| Transfers in/(out) of level 3        |       | —                                                                                          |       | — |   | — |   | — |   |
| Balance at September 30, 2010   |       | $                                                                                               | 61,566     |   | $ | 10,036 |   | $ | 741 |   | $ | 72,343 |   |

 

**NOTE 11— SUBSEQUENT EVENTS**

 

The Bank has evaluatedevents and transactions through our filing date for potential recognition ordisclosure in the consolidated financial statements, and has determined thereare no subsequent events to disclose.

 

19

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**Item2.  Management’s Discussion andAnalysis of Financial Condition and Results of Operations.**

 

*Thefollowing discussion reviews our results of operations and assesses ourfinancial condition.  You should read thefollowing discussion and analysis in conjunction with the accompanyingconsolidated financial statements.  Thecommentary should be read in conjunction with the discussion of forward-lookingstatements, the financial statements, and the related notes and the other statisticalinformation included in this report.  Forfurther information, refer to Management’s Discussion and Analysis of FinancialCondition and Results of Operations appearing in our Annual Report on Form 10-Kfor the year ended December 31, 2009.*

 

**DISCUSSIONOF FORWARD-LOOKING STATEMENTS**

 

ThisReport, including information included or incorporated by reference in thisdocument, contains statements which constitute forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. Forward-looking statements relate tothe financial condition, results of operations, plans, objectives, futureperformance, and business of the Company. Forward-looking statements are basedon many assumptions and estimates and are not guarantees of future performance.Our actual results may differ materially from those anticipated in anyforward-looking statements, as they will depend on many factors about which weare unsure, including many factors which are beyond our control , including thepotential that (1) we may not be able to continue as a going concern and (2) becauseof our critically undercapitalized status, our regulators may initiateadditional enforcement actions against us, which could include placing the Bankunder conservatorship or into receivership. The words “may,” “would,” “could,” “should,”“will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,”“believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well assimilar expressions, are meant to identify such forward-looking statements.Potential risks and uncertainties that could cause our actual results to differmaterially from those anticipated in our forward-looking statements include,but are not limited to, those described under the heading “Risk Factors” in ourAnnual Report on Form 10-K for the year ended December 31, 2009 asfiled with the SEC and the following:

 

·                  our efforts toraise capital or otherwise increase our regulatory capital ratios;

·                  the effects ofour efforts to raise capital on our balance sheet, liquidity, capital, andprofitability;

·                  our ability toretain our existing customers, including our deposit relationships;

·                  our ability tocomply with the terms of the enforcement actions between our Company, Bank, andour regulatory authorities within the time frames specified, or our ability tocomply with statutory obligations applicable to critically undercapitalizedinstitutions under prompt corrective action or to comply with other regulatoryrequirements which could result in the imposition of further enforcement actionimposing additional restrictions on our operations or placing the Bank intoconservatorship or receivership at any time;

·                  the rate ofdelinquencies and amounts of loans charged-off;

·                  our rapidgrowth through 2008 and short operating history;

·                  reducedearnings due to higher credit losses generally and specifically because lossesin the sectors of our loan portfolio secured by real estate are greater thanexpected due to economic factors, including declining real estate values,decreasing interest rates, increasing unemployment, or changes in paymentbehavior or other factors;

·                  reducedearnings due to higher credit losses because our loans are concentrated by loantype, industry segment, borrower type, or location of the borrower orcollateral;

·                  the amount ofour real estate based loans, and the weakness in the commercial real estatemarket;

·                  our reliance onavailable secondary funding sources such as Federal Reserve Discount Windowborrowings, sales of securities and loans, and secured federal funds lines ofcredit from correspondent banks, to meet our liquidity needs;

·                  significantincreases in competitive pressure in the banking and financial servicesindustries;

·                  changes in theinterest rate environment which could reduce anticipated or actual margins;

·                  changes inpolitical conditions or the legislative or regulatory environment, includingthe effect of recent financial reform legislation on the banking industry;

·                  generaleconomic conditions, either nationally or regionally and especially in ourprimary service area, becoming less favorable than expected resulting in, amongother things, a deterioration in credit quality;

·                  changesoccurring in business conditions and inflation;

·                  changes intechnology;

·                  changes indeposits flows;

·                  changes inmonetary and tax policies;

·                  the lack ofseasoning of our loan portfolio, especially given our rapid loan growth through2008;

·                  adequacy of thelevel of our allowance for loan losses;

·                  increasedfunding costs due to market illiquidity, increased competition for funding,and/or regulatory requirements;

 

20

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·                  adverse changesin asset quality and resulting credit risk-related losses and expenses,including the risk of further impairment to the value of our collateral onloans for which we have already taken specific reserves;

·                  loss ofconsumer confidence and economic disruptions resulting from terroristactivities or other military actions;

·                  changes in thesecurities markets; and

·                  other risks anduncertainties detailed from time to time in our filings with the SEC.

 

We have based ourforward-looking statements on our current expectations about future events.Although we believe that the expectations reflected in our forward-lookingstatements are reasonable, we cannot guarantee you that these expectations willbe achieved. We undertake no obligation to publicly update or otherwise reviseany forward-looking statements, whether as a result of new information, futureevents, or otherwise.

 

These risks are exacerbatedby the recent developments in national and international financial markets, andwe are unable to predict what impact these uncertain market conditions willhave on us.  During 2008, 2009, and thusfar in 2010, the capital and credit markets continued to experience extendedvolatility and disruption.  There can beno assurance that these unprecedented recent developments will not continue tomaterially and adversely impact our business, financial condition, and resultsof operations, as well as our ability to raise capital or other funding forliquidity and business purposes.

 

**Overview**

 

Thefollowing discussion describes our results of operations for the nine monthsended September 30, 2010 and also analyzes our financial condition as of September 30,2010.  We received approvals from theFDIC, the FRB, and the South Carolina Board of Financial Institutions duringJanuary 2005, and commenced business on January 18, 2005.

 

The Company is a bankholding company headquartered in Easley, South Carolina.  Our subsidiary, the Bank, opened for businesson January 18, 2005.  All SeasonsProperties, LLC, a subsidiary of the Bank, was formed in 2009 for the purposeof holding and marketing repossessed assets. In addition to the main office in Easley, the Bank has five branchlocations in the upstate region of South Carolina.  We opened our Mauldin branch in the fourthquarter of 2005, our Spartanburg branch in the first quarter of 2006, ourAnderson branch in the third quarter of 2006, our Greer branch in the fourthquarter of 2006 and our Greenville branch in the third quarter of 2007.  The Bank provides banking services todomestic markets, principally in the Upstate of South Carolina.  The deposits of the Bank are insured by theFDIC.

 

Like most community banks,we derive most of our income from interest we receive on our loans andinvestments.  Our primary source of fundsfor making these loans and investments is our deposits, on which we payinterest.  Consequently, one of the keymeasures of our success is our amount of net interest income, or the differencebetween the income on our interest-earning assets, such as loans and investments,and the expense on our interest-bearing liabilities, such as deposits.  Another key measure is the spread between theyield we earn on these interest-earning assets and the rate we pay on ourinterest-bearing liabilities.

 

**CurrentEconomic Environment**

 

Markets in the UnitedStates, including our market areas, have experienced extreme volatility anddisruption for more than 24 months. According to the National Bureau of Economic Research, the United Statesentered into an economic recession in December 2007.  Dramatic slowdowns in the residential housingindustry with falling home prices, increasing foreclosures, and risingunemployment levels have created strains on the loan portfolios of manyfinancial institutions.  Median homesales continued to decline during 2009 and in the first nine months of 2010nationally and in our primary market area, South Carolina.  As a result, the level of foreclosures onhomebuilders and homeowners continued to increase.

 

As a result of the currenteconomic recession, many borrowers are unable to repay their loans, and thecollateral securing these loans has, in some cases, declined below the loanbalance with the drop in real estate values, making it difficult for financialinstitutions to fully recover the principal and interest owed.  In addition, the rapidly deterioratingeconomic conditions in our country have evolved into a crisis of confidence inthe safety and soundness of larger financial institutions, brokerage firms, andinsurance companies, resulting in extreme liquidity pressure throughout theUnited States financial system for all financial companies including communityfinancial institutions such as ours. This pressure has caused many banks to tighten lending standards, whichhas constrained the ability of businesses and consumers to obtain credit.  Anxiety over liquidity and credit risk hasgrown in recent months and banks have curbed lending to each other, furtherlimiting liquidity sources available to financial institutions.

 

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**TheEffect of the Current Economic Environment on our Bank**

 

Likemany financial institutions across the United States and in South Carolina, ouroperations have been adversely affected by the current economic crisis.  Beginning in 2008 and continuing through thefirst nine months of 2010, we recognized that construction, acquisition, anddevelopment real estate projects were slowing, guarantors were becomingfinancially stressed, and increasing credit losses were surfacing.  During the first nine months of 2010,delinquencies over 90 days continued to increase, resulting in an increase innon-accrual loans indicating significant credit quality deterioration andprobable losses.  In particular, loanssecured by real estate, including acquisition, construction, and developmentprojects, demonstrated stress given reduced cash flows of individual borrowers,limited bank financing and credit availability, and slow property sales.  This deterioration manifested itself in ourborrowers in the following ways: (i) the cash flows from underlyingproperties supporting the loans decreased (e.g., slower property sales fordevelopment type projects or lower occupancy rates or rental rates foroperating properties); (ii) cash flows from the borrowers themselves andguarantors were under pressure given illiquid personal balance sheets anddrainage by investing additional personal capital in the projects; and(iii) fair values of real estate related assets declined, resulting inlower cash proceeds from sales or fair values declining to the point thatborrowers were no longer willing to sell the assets at such deep discounts.

 

As of September 30,2010, approximately 91.7% of our loans had real estate as a primary orsecondary component of collateral. The Bank had approximately 90.3% of suchloans at December 31, 2009. Included in our loans secured by real estate, we have approximately$29.7 million of acquisition and development (“A&D”) loans as of September 30,2010, most of which are on properties located in the Upstate of South Carolinaand Western North Carolina.  A&D loans are typically comprised ofloans to borrowers for real estate to be developed (into properties such assub-divisions or spec houses).  Normally, these loans are repaid with the proceeds from the sale of thedeveloped property.  The greater degree of strain on these types of loansand the significance to our overall loan portfolio has caused us to apply agreater degree of scrutiny in analyzing the ultimate collectability of amountsdue.  The majority of these borrowers are having financialdifficulties.  Our analysis has resultedin a significant provision expense in order to meet the estimated allowance forloan loss reserve requirement.

 

Included in our loanssecured by real estate, we have approximately $32.2 million of acreage andfinished or buildable lot loans as of September 30, 2010.  The Bank had approximately $40.6 million ofsuch loans at December 31, 2009. These loans are comprised of loans toborrowers for raw land and lots in subdivisions that have utilities and areready to be built on individually but not as part of an entire developmentproject.  These loans are generallyrepaid with the proceeds from the sale of the property.  As with our A&D loans, many of theseborrowers are also experiencing financial difficulties and the greater degreeof strain on these types of loans and the significance to our overall loanportfolio has caused us to apply a greater degree of scrutiny in analyzing theultimate collectability of amounts due. Our analysis has resulted in a significant provision expense in order tomeet the estimated allowance for loan loss reserve requirement.

 

The result of the above wasan increase in the level of our non-performing assets during the first nine monthsof 2010.  As of September 30, 2010,our non-performing assets equaled $47.4 million, or 10.8% of assets, ascompared to $42.4 million, or 10.1% of assets, as of December 31,2009.  For the nine months ended September 30,2010, we recorded a provision for loan losses of $5 million and net loancharge-offs of $6.5 million, or 2.57% of average loans, as compared to a $6.3million provision for loan losses and net loan charge-offs of $4.1 million, forthe nine months ended September 30, 2009. In addition, our net interest margin decreased to 1.37% for the ninemonths ended September 30, 2010 from 2.89% for the nine months ended September 30,2009.  In total, the above reduced ourearnings for the nine months ended September 30, 2010 by $3.7 millioncompared to the same period in 2009.  Asa result, as of September 30, 2010, we are deemed to be “criticallyundercapitalized.”

 

Under the FDI Act, a bankthat is “critically undercapitalized” must be placed into conservatorship orreceivership within 90 days of becoming critically undercapitalized, unless theinstitution’s primary Federal regulatory authority (for the Bank, the FDIC)determines and documents that “other action” would better achieve the purposesof PCA. If the bank remains critically undercapitalized on average during thecalendar quarter beginning 270 days after it became criticallyundercapitalized, the FDI Act requires the appointment of a receiver unless thebank and the FDIC affirmatively can determine that, among other things, thebank has positive net worth and the FDIC can certify that the bank is viableand not expected to fail.

 

The adverse economicenvironment has also placed greater pressure on our deposits, as we have beentaking steps to decrease our reliance on brokered deposits, while at the sametime the competition for local deposits among banks in our market has beenincreasing in the past years.  Wegenerally obtained out-of-market time deposits of $100,000 or more throughbrokers with whom we maintain ongoing relationships.  As of September 30, 2010, we hadbrokered deposits of $94.8 million, representing 23.6% of our total deposits.As a result of the limitations on brokered deposits imposed by the ConsentOrder 

 

22

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and our “criticallyundercapitalized” designation, we must find other sources of liquidity toreplace these deposits as they mature. At the end of the fourth quarter of 2009, the Bank started using aninternet based certificate of deposit gathering service.  This product has provided a source of fundsto replace our brokered deposits, as we have repaid all of our brokereddeposits as of November 15, 2010. The Bank’s internet based deposits have increased from $1.8 million at December 31,2009 to $113.6 million as of September 30, 2010.  Secondary sources of liquidity may includeproceeds from FHLB advances and federal funds lines of credit fromcorrespondent banks.  However, the FHLBhas informed us that due to our financial condition we are not currentlypermitted to receive any more advances. At September 30, 2010, we had federal funds lines of credit withunrelated banks totaling $5.0 million. These lines are available for general corporate purposes but may beterminated at any time based on our financial condition.  Thus, we can make no assurances that thisfunding source will continue to be available to us.  As a result, we must limit our growth, raiseadditional capital, or sell assets, which could materially and adversely affectour financial condition and results of operations.  Additionally, deposit levels may be affectedby a number of factors, including rates paid by competitors, general interestrate levels, regulatory capital requirements, returns available to customers onalternative investments and general economic conditions.  Because the Bank is not well capitalized, itwould normally be restricted from offering an effective yield on deposits ofmore than 75 basis points over the national rates published by the FDIC weeklyon its website.  However, on April 1,2010, we applied for and received a determination from the FDIC that our marketareas were all high interest rate areas. As a result, we have permission to pay deposit rates of up to 75 basispoints over the local rates (assuming the local rates exceed the applicablenon-local rates) on non-local deposits gathered in our normal market area evenif these rates exceed non-local rates by more than 75 basis points.  Nevertheless, if we are unable to attractsufficient deposits to meet our liquidity needs, then the Bank may be placedinto a federal conservatorship or receivership by the FDIC, with the FDICappointed as conservator or receiver.

 

***Memorandum of Understanding***

 

As a result of the issuesstemming from the economic downturn, on September 29, 2009 the Bankentered into the MOU with the Commissioner of Banking of the South CarolinaBoard of Financial Institutions and the Regional Director of the FDIC’s AtlantaRegional Office.  The MOU required theBank to, among other things, (1) submit a capital plan to the supervisoryauthorities for returning to a “well-capitalized” designation; (2) developspecific plans and proposals for the reduction and improvement of assets whichare subject to adverse classification and past due loans; (3) implement aplan to decrease the concentration of commercial real estate loans; (4) developand implement an adequate loan review program; and (5) review overallliquidity objectives and develop plans and procedures aimed at improvingliquidity and reducing reliance on volatile liabilities to fund longer-termassets.  In addition, the Bank may notpay dividends without the prior written consent of each supervisory authority.

 

Sinceentering into the MOU, the Bank has been actively pursuing the correctiveactions required by the MOU in an effort to ensure that the requirements of theMOU are met in a timely manner.  Forexample:

 

·                  As of September 30, 2010, we are deemedto be “critically undercapitalized.”  Asdescribed below, we did not meet the Consent Order deadline to achieve andmaintain a “well-capitalized” designation, therefore, we submitted a revisedcapital plan to the FDIC and the South Carolina Board of Financial Institutionson July 28,  2010.  Our capital plan outlines how we intend toreturn our Bank’s risk-based capital ratio level over 10% by (i) reducingour overall amount of assets and, in particular, our amount of risk-basedassets and (ii) raising additional capital.  To reduce our amount of assets, we have soldassets such as our bank-owned life insurance and some of our available for salesecurities.  In addition, we are activelyseeking buyers for part of our loan portfolio. As a result of these steps, we decreased our amount of risk-based assetsby $37.7 million from December 31, 2009 to September 30, 2010.  We are also exploring additional financingalternatives to strengthen the capital levels of the Bank.  However, there can be no assurances that theCompany will be successful in its efforts to raise additional capital.  Should these efforts be unsuccessful, due tothe regulatory restrictions which exist that restrict cash payments between theBank and the Company, the Company may be unable to realize its assets anddischarge its liabilities in the normal course of business.

 

·                  We have developed and implemented a plan toreduce our amount of classified loans by establishing an IMPAC committee(Improving Problem Asset Committee) to focus on the development of work-outplans for our other real estate owned (OREO) and classified loans and to exploreapproaches to provide additional capital to support our classified loans or toreduce the level of such loans, such as through the sale of loans to thirdparties. As a result, we have created a more risk-based loan review program,which we believe has enhanced the underwriting and monitoring of our loanportfolio.

 

23

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·                  We have implemented a plan to decrease theconcentration of our commercial real estate loans.  Since January 2009, we have effectivelyceased making any new commercial real estate loans and we are decreasing theexisting level of these loans through the normal sale of real estate byborrowers and by encouraging borrowers who are not full relationship clients ofthe Bank to seek other financing when their loans mature.  We are also actively seeking secondary marketpermanent financing for recently completed residential constructionprojects.  As a result of these efforts,our amount of commercial real estate loans decreased from $151.6 million at December 31,2008 to $101.3 million at September 30, 2010.

 

·                  We continue to work on improvements within the loanreview area.  An external firm currently serves as the bank’s internalloan review party and has helped to ensure that the bank has stayed on coursewith its 2010 loan review plan.  Also, the Bank continues to aggressivelytrack and request current financial statements as well as re-assess individualloan grades as new information is obtained.  Finally, the Bank hasexpanded the scope of the special assets area by hiring a senior officer withan extensive background in real estate.

 

·                  On September 10, 2009, we submitted tothe FDIC and the South Carolina Board of Financial Institutions a revised FundsManagement Policy to reflect our plan to continue to improve liquidity levelsand reduce our reliance on brokered deposits and other non-core funding sourcesover the next 18 months.  We grew rapidlyin our initial years of operations, which we funded with a combination of localdeposits and wholesale funding, including brokered deposits.  As of September 30, 2010, we are deemedto be “critically undercapitalized” and, as a result, can no longer accept,renew or roll over brokered deposits. Thus, we have been actively focused oneliminating brokered deposits on our balance sheet.  We improved the Bank’s liquidity position byraising approximately $133.8 million in new deposits, net of a $107.9 milliondecrease in brokered deposits, through the use of an internet based depositgathering system along with growth of local deposits from December 31,2009 to September 30, 2010, and we have repaid all of our brokereddeposits as of November 15, 2010.

 

In addition, in mid-February 2010the Bank received a supervisory letter from the FDIC dated February 11,2010, which provided for additional restrictions and mandatory actions to betaken by the Bank.  These restrictionsand actions were all substantially addressed and superseded by the subsequentConsent Order discussed in the subsection below.  However, in order to comply with thesupervisory letter, the Bank was required to prepare and submit to the FDIC acapital restoration plan no later than April 2, 2010, which submissiondate was sooner than a similar requirement under the Consent Order.  The Bank submitted its capital restorationplan to the FDIC on April 2, 2010. As discussed above, the plan wasrejected due to the Bank’s inability to meet the September 23, 2010deadline to achieve and maintain a “well-capitalized” designation.  The Bank submitted a revised capital plan tothe FDIC on July 28, 2010.

 

***Consent Order***

 

Followingthe FDIC’s safety and soundness examination of the Bank in the fourth quarterof 2009, the Bank entered into the Consent Order with the FDIC and the SouthCarolina Board of Financial Institutions on February 23, 2010.  The Consent Order, which supersedes the MOU,conveys specific actions needed to address certain findings from the FDIC’sReport of Examination and to address the Bank’s current financial condition,primarily related to capital planning, liquidity/funds management, policy andplanning issues, management oversight, loan concentrations and classifications,and non-performing loans.  A summary ofthe requirements of the Consent Order and the Bank’s status on complying withthe Consent Order is as follows:

 
| **Requirements of the Consent Order**                                                                                                                                       | ** ** | **Bank’s Compliance Status**                                                                                                                                                                                                                                                                                                                                                                                   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Establish,  within 30 days from the effective date of the Consent Order, a plan to  monitor compliance with the Consent Order, which shall be monitored by the  Bank’s board of directors. |       | A  plan to monitor compliance with the Consent Order was established by the  Bank’s board of directors at a meeting held on March 16, 2010. Pursuant  to the plan, the board created and appointed four of its members to serve on  a consent order compliance committee to monitor the Bank’s compliance with  the Consent Order. The committee has met six times since its creation on  March 16, 2010. |
|                                                                                                                                                                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                          |
| Ensure the Bank has qualified management in place  to carry out the policies of the Bank’s board of directors and operate the  Bank in a safe and sound manner.                            |       | A management plan, which includes organizational  structure and management assessment, was approved by the Bank’s board of  directors and submitted to the supervisory authorities on April 12,  2010. The Bank has also taken                                                                                                                                                                                      |

 

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | steps to implement this management plan, including  accepting on April 6, 2010 the resignation of the Bank’s president, and  restructuring reporting lines.                                                                                                                                                                                                          |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Achieve and maintain, within 120 days from the  effective date of the Consent Order, Total Risk Based capital at least equal  to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of  total assets.                                                                                                                                                                                                                                                                                                                                                                                                                                    |   | The Bank did not meet this deadline. The Bank  submitted a revised written plan to the FDIC on July 28, 2010 describing  the means and timing by which the Bank will increase such ratios up to or in  excess of the established minimums.                                                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Develop, within 45 days from the effective date of  the Consent Order, a written analysis and assessment of the Bank’s management  and staffing needs.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   | The Bank prepared a written analysis and  assessment of its management and staffing needs and submitted this analysis  to the supervisory authorities on April 12, 2010.                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Establish, within 60 days from the effective date  of the Consent Order, a comprehensive policy for determining the adequacy of  the Bank’s allowance for loan and lease losses, which must provide for a  review of the Bank’s allowance for loan and lease losses at least once each  calendar quarter.                                                                                                                                                                                                                                                                                                                                       |   | The Bank’s board of directors and consent order  compliance committee reviewed and approved a comprehensive policy for  determining the adequacy of the Bank’s allowance for loan and lease losses,  and this policy was submitted to the supervisory authorities prior to the  April 27, 2010 deadline.                                                        |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Enhance, within 60 days from the effective date of  the Consent Order, the Bank’s written plan for the reduction of classified  assets, which shall include, among other things, a reduction of the Bank’s  risk position in each asset in excess of $250,000 that is classified as  “Substandard” or “Doubtful.”                                                                                                                                                                                                                                                                                                           |   | A plan to reduce the Bank’s classified assets was  reviewed and approved by the Bank’s board of directors and consent order  compliance committee on April 20, 2010. The plan was submitted to the  supervisory authorities on the April 27, 2010 deadline.                                                                                                |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Not extend any additional credit to any borrower  who has a loan or other extension of credit from the Bank that has been  charged off or classified, in whole or in part, “loss” or “doubtful” and is  uncollected. In addition, the Bank may not extend any additional credit to  any borrower who has a loan or other extension of credit from the Bank that  has been classified, in whole or in part, “substandard” and is uncollected,  unless the Bank’s board of directors determines that failure to extend  further credit to a particular borrower would be detrimental to the best  interests of the Bank. |   | The Bank is not aware of any instance it extended,  directly or indirectly, any additional credit to, or for the benefit of, any  borrower who was a loan or other extension of credit from the Bank that has  been charged off or classified, in whole or in part, “loss” or “doubtful” and  is uncollected.                                              |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Perform, within 45 days from the effective date of  the Consent Order, a risk segmentation analysis with respect to the Bank’s  Concentrations of Credit and a written plan to systematically reduce any  segment of the portfolio that is an undue concentration of credit.                                                                                                                                                                                                                                                                                                                                                                         |   | The Bank performed a risk segmentation analysis  with respect to its concentrations of credit, and this analysis was reviewed  and approved by the consent order compliance committee on April 6, 2010  and by the Bank’s board of directors on April 8, 2010. This analysis was  submitted to the supervisory authorities by the April 12, 2010 deadline. |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   |                                                                                                                                                                                                                                                                                                                                                                           |
| Revise, within 60 days from the effective date of  the Consent Order, the Bank’s internal loan review and grading system to  provide for the periodic review of the Bank’s loan portfolio in order to  identify and categorize the Bank’s loans, and other extensions of credit  which are carried on the Bank’s books as loans, on the basis of credit  quality.                                                                                                                                                                                                                                                                     |   | The Bank revised and updated its internal loan  review plan, which was reviewed and approved by the Bank’s board of directors  and the consent order compliance committee on April 20, 2010. The plan  was submitted to the supervisory authorities prior to the April 27, 2010  deadline.                                                                      |

 

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| Formulate  and implement, within 60 days from the effective date of the Consent Order, a  profit plan and comprehensive budget for all categories of income and  expense, which must address, at minimum, goals and strategies for improving  and sustaining the earnings of the Bank, the major areas in and means by  which the Bank will seek to improve the Bank’s operating performance, and the  operating assumptions that form the basis for and adequately support major  projected income and expense components of the plan. |   | The  Bank created profit plan and budget for all categories of income and expense,  which includes adjustments where the Bank either exceeded budget or had  budget shortfalls in order to provide realistic projections going forward.  The profit plan and budget were reviewed and approved by the Bank’s board of  directors on April 20, 2010 and were submitted to the supervisory  authorities prior to the April 27, 2010 deadline.                                  |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |
| Enhance,  within 60 days from the effective date of the Consent Order, the Bank’s  written funds management plan addressing liquidity, contingent funding, and  asset liability management.                                                                                                                                                                                                                                                                                                                                             |   | The  Bank’s funds management plan, which addresses liquidity, contingent funding,  and asset liability management, was reviewed and approved by the Bank’s board  of directors and the consent order compliance committee on April 20,  2010 and was submitted to the supervisory authorities prior to the  April 27, 2010 deadline.                                                                                                                                    |
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| Not  accept, renew, or rollover any brokered deposits. The Bank must develop and  submit to the FDIC, within 30 days from the effective date of the Consent  Order, a plan for eliminating its reliance on brokered deposits.                                                                                                                                                                                                                                                                                                                |   | A  plan was approved by the Bank’s board of directors and consent order  compliance committee on March 24, 2010 and was submitted to the FDIC on  March 25, 2010. Since entering into the Consent Order, the Bank has not  accepted, renewed, or rolled-over any brokered deposits and has repaid $107.9  million during the first nine months of 2010. As of November 15, 2010,  all brokered deposits have been repaid through local and internet obtained  deposits. |
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| Not  offer an effective yield in excess of 75 basis points over interest paid on  deposits (including brokered deposits, if approval is granted for the Bank to  accept them) of comparable size and maturity in either the Bank’s normal  market area or in the market area in which such deposits would otherwise be  accepted.                                                                                                                                                                                                       |   | On  April 1, 2010, we applied for and received a determination from the FDIC  that our market areas were all high interest rate areas. As a result, we have  permission to pay deposit rates of up to 75 basis points over the local rates  (assuming the local rates exceed the applicable non-local rates) on non-local  deposits gathered in our normal market area even if these rates exceed  non-local rates by more than 75 basis points.                                       |
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| Not declare or pay any dividends or bonuses or  make any distributions of interest, principal, or other sums on subordinated  debentures without the prior approval of the supervisory authorities.                                                                                                                                                                                                                                                                                                                                          |   | Since entering into the Consent Order, the Bank  has not declared or paid any dividends or bonuses or made any distributions  of interest, principal, or other sums on subordinated debentures.                                                                                                                                                                                                                                                                                             |
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| Furnish, within 45 days from the effective date of  the Consent Order and within 45 days of the end of each quarter thereafter,  written progress reports to the supervisory authorities detailing the form  and manner of any actions taken to secure compliance with the Consent Order.  The Bank has furnished written progress reports to the supervisory  authorities as required by the Consent Order.                                                                                                                                 |   | The Bank has furnished written progress reports to  the supervisory authorities as required by the Consent Order.                                                                                                                                                                                                                                                                                                                                                                           |

 

Additionally, on March 1,2010, the Company entered into an informal agreement with the Federal ReserveBank of Richmond.  The informal agreementcontains provisions similar to those in the Bank’s MOU with the FDIC and theSouth Carolina Board of Financial Institutions, including a requirement thatthe Company obtain the prior written approval of the Federal Reserve Bank ofRichmond before (1) declaring or paying any dividends, (2) directlyor indirectly accepting dividends or any other form of payment representing areduction in capital from the Bank, (3) making any distributions ofinterest, principal or other sums on subordinated debentures or trust preferredsecurities, (4) directly or indirectly, incurring, increasing orguaranteeing any debt, and (5) directly or indirectly, purchasing orredeeming any shares of its stock. Pursuant 

 

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to our plans to preservecapital and to inject more capital into the Bank, the Company has no plans toundertake any of the foregoing activities.

 

***Going Concern Considerations***

 

Due to the conditions andevents discussed in this Form 10-Q, substantial doubt exists as to ourability to continue as a going concern. The going concern assumption is afundamental principle in the preparation of financial statements. It is theresponsibility of management to assess the Company’s ability to continue as agoing concern. In assessing this assumption, the Company has taken into accountall available information about the future, which is at least, but is notlimited to, twelve months from the balance sheet date of September 30,2010. The Company has a history of profitable operations and sufficient sourcesof liquidity to meet its short-term and long-term funding needs. However, theBank’s financial condition has suffered during 2009 and the first nine monthsof 2010 from the extraordinary effects of what may ultimately be the worsteconomic downturn since the Great Depression.

 

The Bank, with a loanportfolio consisting of a concentration in commercial real estate loansincluding residential construction and development loans, has seen a decline inthe value of the collateral securing its portfolio as well as rapiddeterioration in its borrowers’ cash flow and ability to repay theiroutstanding loans to the Bank. As a result, the Bank’s level of nonperformingassets increased substantially during 2009 and has continued to increase throughthe third quarter of 2010. As of September 30, 2010, our non-performingassets equaled $47.4 million, or 10.8% of assets, as compared to $42.4 million,or 10.1% of assets, as of December 31, 2009. For the year ended December 31,2009 and for the nine months ended September 30, 2010, the Bank recorded a$17 million and a $5 million provision, respectively, to increase the allowancefor loan losses to a level which, in management’s best judgment, adequatelyreflected the increased risk inherent in the loan portfolio as of the year andquarter end periods, respectively. For the nine months ended September 30,2010, we recorded net loan charge-offs of $6.5 million, or 2.57% of averageloans, as compared to net loan charge-offs of $4.1 million, for the nine monthsended September 30, 2009.  Largelyas a result of these change-offs and the increase in our loan loss provision,our capital position has eroded and, as of September 30, 2010, we aredeemed to be “critically undercapitalized.” For additional information on the Bank’s “critically undercapitalized”status, including the requirements or restrictions that can or will be imposedon the Company and the Bank as a result of the Bank’s “criticallyundercapitalized” status, please refer to “Note 3 — Regulatory Actions andGoing Concern Considerations***—***Going Concern Considerations”****** of the notes to our unaudited consolidatedfinancial statements.

 

We have determined thatsignificant additional sources of capital will be required for us to continueoperations through the remainder of 2010 and beyond. We also continue tomonitor and address liquidity issues. The Company and the Bank operate in a highly-regulated industry and mustplan for the liquidity needs of each entity separately. A variety of sources ofliquidity are available to the Bank to meet its short-term and long-termfunding needs. Although a number of these sources have been limited followingexecution of the Consent Order with the FDIC and the South Carolina Board ofFinancial Institutions, management has prepared forecasts of these sources offunds and the Bank’s projected uses of funds during 2010 in an effort to ensurethat the sources available are sufficient to meet the Bank’s projectedliquidity needs for this period.

 

The Company relies ondividends from the Bank as its primary source of liquidity. The Company is alegal entity separate and distinct from the Bank. Various legal limitationsrestrict the Bank from lending or otherwise supplying funds to the Company tomeet its obligations, including paying dividends. In addition, the terms of theConsent Order described above will further limit the Bank’s ability to paydividends to the Company to satisfy its funding needs.

 

The Company will also needto raise additional capital to increase capital levels to meet the standardsset forth by the FDIC under the Consent Order as described above. As a resultof the recent downturn in the financial markets, the availability of manysources of capital (principally to financial services companies) has becomesignificantly restricted or has become increasingly costly as compared to theprevailing market rates prior to the volatility. Management cannot predict whenor if the capital markets will return to more favorable conditions or whetherthe Company will be able to raise a sufficient amount of capital to continueoperations.  Management is activelyevaluating a number of capital sources, asset reductions and other balancesheet management strategies to ensure that the Bank’s projected level ofregulatory capital can support its balance sheet.

 

There can be no assurancesthat the Company will be successful in its efforts to raise additional capitalduring 2010. An equity financing transaction would result in substantialdilution to the Company’s current shareholders and could adversely affect themarket price of the Company’s common stock. It is difficult to predict if theseefforts will be successful, either on a short-term or long-term basis. Shouldthese efforts be unsuccessful, due to the regulatory restrictions which existthat restrict 

 

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cash payments between theBank and the Company, the Company may be unable to realize its assets anddischarge its liabilities in the normal course of business.

 

We may be the subject ofnegative news reports discussing our current financial situation and variousdepartures of senior management as the press and others speculate about whetherwe will be able to continue as a going concern. These reports may have a negativeimpact on our business. For example, even though our deposits are insured bythe FDIC, customers may choose to withdraw their deposits, and new customersmay choose to do business elsewhere. In addition, we may find that our serviceproviders will be reluctant to commit to long-term projects with us. Even if weare able to improve our current financial situation, we may be the object ofnegative publicity and speculation about our future.

 

As a result of management’sassessment of the Company’s ability to continue as a going concern, theaccompanying consolidated financial statements for the Company have beenprepared on a going concern basis, which contemplates the realization of assetsand the discharge of liabilities in the normal course of business for theforeseeable future, and does not include any adjustments to reflect thepossible future effects on the recoverability or classification of assets.

 

**CurrentBusiness Strategy**

 

In addition to the actionsrequired by the MOU, we have been actively pursuing the corrective actionsrequired by the Consent Order in an effort to ensure that the requirements ofthe Consent Order are met in a timely manner. Specifically, we are currently focusing our efforts in the followingareas:

 

·                  **Increasingand Strengthening Our Capital Position.**

 

As of September 30, 2010, the Bank is deemed to be “criticallyundercapitalized.”  Management hasdeveloped a plan to increase and preserve our capital with the goal ofreturning to and maintaining a “well-capitalized” status. These initiativesinclude, among other things, restructuring the Bank’s balance sheet by limitingnew loan activity and aggressively attempting to sell certain realestate-related loans and other assets, and raising additional capital through astock offering.  Additionally, we areactively evaluating a number of capital sources and balance sheet managementstrategies to ensure that our projected level of regulatory capital can supportour balance sheet and meet or exceed minimum requirements.  There can be no assurances that the Companywill be successful in its efforts to raise additional capital or implementbalance sheet strategies to meet or exceed minimum capital requirements.  Should these efforts be unsuccessful, due tothe regulatory restrictions which exist that restrict cash payments between theBank and the Company, the Company may be unable to realize its assets anddischarge its liabilities in the normal course of business.

 

·                  **Managingand Improving Asset Quality.**

 

The economic recession and the deterioration of the housing and realestate markets have had an adverse impact on the credit quality of our loanportfolio. In response, our Bank intends to significantly reduce the amount ofits non-performing assets. Non-performing assets hurt our profitability becausethey reduce the balance of earning assets, may require additional loan lossprovisions or write-downs, and require significant devotion of staff time andfinancial resources to resolve. We believe our asset quality planaggressively addresses these issues.  Forexample,

 

·                  In February of2009, we restructured the credit administration and loan operations departmentsand hired a skilled chief credit officer to oversee the enhancement of ourprocesses and procedures in this area.

 

·                  In September of2009, we established an improving problem asset committee to assist Bankmanagement in policy development, management strategy, and/or liquidation ofproblem assets.

 

·                  In January of2009, we implemented a process for the continuous review of all classifiedloans, watch loans, past due loans, relationships over $500,000, and any otherpotential risky loans and applied conservative risk grades.

 

·                  Throughout 2009and 2010, we conducted disciplined watch loan meetings to track and monitorprogress, including the execution of workout plans, obtainment of currentfinancial data, and detailed progress updates.

 

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·                  Throughout 2009and 2010, we maintained an adequate reserve for loan losses given the riskprofile of our Bank.

 

·                  In May of2009, we implemented a risk-focused internal and external loan review program.

 

·                  During thefirst nine months of 2010, we updated our policies and procedures and enhancedstaffing related to loan work-outs and collection processes.

 

·                  **DecreasingConcentrations in Our Loan Portfolio.**

 

We are focused on reducing our concentrations in commercial real estate(CRE), specifically acquisition development and construction loans, andresidential construction loans.  Since January 2009,we have effectively ceased making any new CRE loans while proactivelydecreasing the level of these existing loan types.  We have worked to decrease our concentrationby various means, including (1) through the normal sale of real estate byborrowers, (2) by proactively seeking secondary market permanent financingfor recently completed residential construction projects, and (3) encouragingtransactional CRE customers to seek other financing when their loansmature.  As a result of these efforts,our amount of CRE loans decreased 33.2% from $151.6 million of our total loanportfolio at December 31, 2008 to $101.3 million of our loan portfolio at September 30,2010.  We have also reduced ourresidential construction portfolio 96.7% from $33.8 million at December 31,2008 to $1.1 million at September 30, 2010.  We expect commercial real estate loanportfolio balances to continue to decrease in 2010 through the continuedsuccessful implementation of the plans outlined above.

 

·                  **ReducingOperating Expenses.**

 

We have always focused on controlling expenses and managing efficientoverhead.  During 2010 and continuing forthe foreseeable future, management intends to further reduce costs in a mannerwhich does not impact the quality of our customer service.  Given the prolonged economic recession, wehave embarked on an extremely aggressive expense reduction campaign.  Management has already reduced salary andbenefits expenses by reducing staffing levels, freezing salaries at 2008levels, and reducing compensation in several positions.  Additionally, we will continue to renegotiatevendor contracts and implement several other cost-saving measures to reducenoninterest expenses.  Reducing our level of nonperforming assetswill also lower our operating costs.

 

·                  **EnhancingFunds Management and Liquidity.**

 

Wehave grown rapidly since our inception through 2008, and have historicallyfunded our asset growth with a combination of local deposits and wholesalefunding, specifically brokered deposits. As of September 30, 2010, we hadbrokered deposits of $94.8 million, representing 23.6% of our total deposits,of which all are scheduled to mature in the fourth quarter of2010.  Because of the limitations on brokered deposits imposed by theConsent Order and our critically undercapitalized status, the Bank may nolonger accept, renew, or roll over brokered deposits.  Thus, we must find other sources of liquidityto replace these deposits as they mature. We have amended our funds managementpolicy to reflect our plan to continue to improve liquidity levels and reduceour use of brokered deposits and other non-core funding sources. Our fundsmanagement policy also includes our plan to reduce assets, certain loans, andother bank-owned real estate. We have reduced our brokered deposit usage byexecuting on our comprehensive deposit acquisition program, which creates anenvironment of consistent deposit growth based on relationship-based banking,advocate-based selling and an aggressive, focused calling program combined withoffering internet based certificates of deposit. Our experienced team ofbankers is actively cross-selling core deposits to our local depositors andborrowers, and is held accountable for production through twice-weekly salesmeetings. Production is enhanced by our relationship-based culture training,which includes advanced customer service techniques and one-on-one coaching. Wealso plan to generate core deposits through a combination of competitiveproducts and pricing, customer service excellence, and targeted marketingcampaigns. As of November 15, 2010, all brokered deposits have been repaidthrough local and internet obtained deposits.

 

·                  **EnhancingOur Bank’s Relationship Culture.**

 

While the bulk of our strategic plan encompasses strategies to survivethe prolonged economic recession, management recognizes that we must also placethe Bank in the best position to thrive as we emerge from this recession. Inthis regard, planning has also centered on enhancing the Bank’s culture. Webelieve the enhancement of our culture will place the Bank in the best positionpossible to provide unmatched customer service and to take advantage of marketopportunities through advocate-based selling and relationship bankingstrategies. Enhancement plans include, among others, the following:

 

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·                  implementingconsistent customer service and communication standards in all areas of theBank;

 

·                  training andcertifying the non-negotiables of relationship banking to all employees;

 

·                  ensuring allemployees are engaged and motivated while enabling management to measure theenhancement of the culture by conducting quarterly employee engagement surveys;

 

·                  implementingconsistent management standards for all supervisors resulting in internal andexternal advocacy;

 

·                  refining theBank’s customer experience measurements, including branch mystery shopping andcustomer survey programs; and ensuring all programs evaluate and measure theBank’s expectations and areas of focus.

 

The Bank will continue toserve customers in all areas, including processing banking transactions, payingcompetitive rates on deposits, and providing access to lines of credit.  All customer deposits are fully insured tothe highest limits set by the FDIC, which are $250,000 for individually titledaccounts and $250,000 for individually titled IRA accounts. In addition, theBank participates in the FDIC Transaction Account Guarantee Program (the “TAGP”).Under this program, all non-interest bearing transaction accounts are fullyguaranteed by the FDIC for the entire amount of the account. The guarantee alsoapplies to interest bearing transaction accounts with interest rates of 0.25%or less. On April 13, 2010, the FDIC approved an interim rule thatextends the TAGP to December 31, 2010. Although the TAGP expires on December 31,2010, a provision of the Dodd-Frank Act requires the FDIC to provide unlimiteddeposit insurance for all deposits in non-interest-bearing transactionaccounts.  This deposit insurance mandatecreated by the Dodd-Frank Act will take effect on December 31, 2010, andwill continue through December 31, 2012. The deposit insurance mandate created by the Dodd-Frank Act is not anextension of the TAGP.  Although the TAGPand the Dodd-Frank Act establish unlimited deposit insurance for certain typesof non-interest-bearing deposit accounts, unlike the TAGP, the coverageprovided by the Dodd-Frank Act does not apply to NOW accounts or IOLTAs andwill be funded through general FDIC assessments, not special assessments. Webelieve participation in the TAGP is enhancing our ability to retain customerdeposits.

 

However, should the Bankfail to comply with the capital and liquidity funding requirements in theConsent Order, or suffer a continued deterioration in our financial condition,the Bank may be subject to being placed into a federal conservatorship orreceivership by the FDIC, with the FDIC appointed as conservator or receiver.

 

**RecentLegislative and Regulatory Initiatives to Address Financial and Economic Crises**

 

Marketsin the United States and elsewhere have experienced extreme volatility anddisruption for more than 27 months. These circumstances have exerted significant downward pressure on pricesof equity securities and virtually all other asset classes, and have resultedin substantially increased market volatility, severely constrained credit andcapital markets, particularly for financial institutions, and an overall lossof investor confidence.  Loan portfolioperformances have deteriorated at many institutions resulting from, among otherfactors, a weak economy and a decline in the value of the collateral supportingtheir loans.  Dramatic slowdowns in thehousing industry, due in part to falling home prices and increasingforeclosures and unemployment, have created strains on financialinstitutions.  Many borrowers are nowunable to repay their loans, and the collateral securing these loans has, insome cases, declined below the loan balance.  In response to the challenges facing the financial services sector,several regulatory and governmental actions have recently been announcedincluding:

 

·                  The Emergency EconomicStabilization Act, approved by Congress and signed by President Bush on October 3,2008, which, among other provisions, allowed the U.S. Treasury to purchasetroubled assets from banks, authorized the SEC to suspend the application ofmarked-to-market accounting, and raised the basic limit of FDIC depositinsurance from $100,000 to $250,000 through December 31, 2013.

 

·                  On October 7, 2008, theFDIC approved a plan to increase the rates banks pay for deposit insurance.

 

·                  On October 14, 2008,the U.S. Treasury announced the creation of a new program, the Capital PurchaseProgram, that encourages and allows financial institutions to build capitalthrough the sale of senior preferred shares to the U.S. Treasury on terms thatare non-negotiable.

 

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·                  On October 14, 2008,the FDIC announced the creation of the Temporary Liquidity Guarantee Program (“TLGP”),which seeks to strengthen confidence and encourage liquidity in the bankingsystem.  The TLGP has two primarycomponents that are available on a voluntary basis to financial institutions:

 

·                                      Guarantee of newly-issuedsenior unsecured debt; the guarantee would apply to new debt issued on orbefore October 31, 2009 and would provide protection until December 31,2012; issuers electing to participate would pay a 75 basis point fee for theguarantee; and

 

·                                      Unlimited deposit insurancefor non-interest bearing deposit transaction accounts; financial institutionselecting to participate will pay a 10 basis point premium in addition to theinsurance premiums paid for standard deposit insurance.

 

·                  On February 10, 2009,the U.S. Treasury announced the Financial Stability Plan, which earmarked $350billion of the TARP funds authorized under EESA. Among other things, theFinancial Stability Plan includes:

 

·                  A capital assistance program that will investin mandatory convertible preferred stock of certain qualifying institutionsdetermined on a basis and through a process similar to the Capital PurchaseProgram;

 

·                  A consumer and business lending initiative tofund new consumer loans, small business loans and commercial mortgageasset-backed securities issuances;

 

·                  A new public-private investment fund thatwill leverage public and private capital with public financing to purchase upto $500 billion to $1 trillion of legacy “toxic assets” from financialinstitutions; and

 

·                  Assistance for homeowners by providing up to$75 billion to reduce mortgage payments and interest rates and establishingloan modification guidelines for government and private programs.

 

·                  On February 17, 2009, the AmericanRecovery and Reinvestment Act (the “Recovery Act”) was signed into law in aneffort to, among other things, create jobs and stimulate growth in the UnitedStates economy.  The Recovery Actspecifies appropriations of approximately $787 billion for a wide range ofFederal programs and will increase or extend certain benefits payable under theMedicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual andcorporate income tax collections and makes a variety of other changes to taxlaws.  The Recovery Act also imposescertain limitations on compensation paid by participants in the U.S. Treasury’sTroubled Asset Relief Program (“TARP”).

 

·                  On March 23,2009, the U.S. Treasury, in conjunction with the FDIC and the Federal Reserve,announced the Public-Private Partnership Investment Program for Legacy Assetswhich consists of two separate plans, addressing two distinct asset groups:

 

·                  The first planis the Legacy Loan Program, which has a primary purpose to facilitate the saleof troubled mortgage loans by eligible institutions, including FDIC-insuredfederal or state banks and savings associations. Eligible assets are notstrictly limited to loans; however, what constitutes an eligible asset will bedetermined by participating banks, their primary regulators, the FDIC and theTreasury.

 

·                  The second planis the Securities Program, which is administered by the Treasury and involvesthe creation of public-private investment funds (“PPIFs”) to target investmentsin eligible residential mortgage-backed securities and commercialmortgage-backed securities issued before 2009 that originally were rated AAA orthe equivalent by two or more nationally recognized statistical ratingorganizations, without regard to rating enhancements (collectively, “LegacySecurities”). Legacy Securities must be directly secured by actual mortgageloans, leases or other assets, and may be purchased only from financialinstitutions that meet TARP eligibility requirements. Treasury received over100 unique applications to participate in the Legacy Securities PPIP and in July 2009selected nine PPIF managers.  As of September 30,2010, the PPIFs had completed 

 

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theirfundraising and have closed on approximately $7.4 billion of private sectorequity capital, which was matched 100 percent by Treasury, representing $14.7billion of total equity capital. Treasury has also provided $14.7 billion ofdebt capital, representing $29.4 billion of total purchasing power. As of September 30,2010, PPIFs have drawn-down approximately $18.6 billion of total capital whichhas been invested in eligible assets and cash equivalents pending investment.

 

·                  On May 22, 2009, the FDIC levied aone-time special assessment on all banks due on September 30, 2009.

 

·                  On November 12, 2009, the FDIC issued afinal rule to require banks to prepay their estimated quarterly risk-basedassessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012and to increase assessment rates effective on January 1, 2011.

 

·                  On February 2, 2010, the U.S. Presidentcalled on the U.S. Congress to create a new Small Business Lending Fund.  Under this proposal, $30 billion in TARPfunds would be transferred to a new program outside of TARP to support smallbusiness lending.  As proposed, onlysmall- and medium-sized banks would qualify to participate in the program.

 

·                  On July 21, 2010, the U.S. Presidentsigned into law the Dodd-Frank Act, a comprehensive regulatory framework thatwill affect every financial institution in the U.S.    The Dodd-Frank Act includes, among othermeasures, changes to the deposit insurance and financial regulatory systems,enhanced bank capital requirements, and provisions designed to protectconsumers in financial transactions.  TheDodd-Frank Act also alters certain corporate governance matters affectingpublic companies.  Over the next 6 to 18months, regulatory agencies will implement new regulations which will establishthe parameters of the new regulatory framework and provide a clearerunderstanding of the legislation’s effect on banks.

 

·                  Internationally, both the Basel Committee onBanking Supervision (the “Basel Committee”) and the Financial Stability Board(established in April 2009 by the Group of Twenty (“G-20”) FinanceMinisters and Central Bank Governors to take action to strengthen regulationand supervision of the financial system with greater international consistency,cooperation, and transparency) have committed to raise capital standards andliquidity buffers within the banking system (“Basel III”).  On September 12, 2010, the Group ofGovernors and Heads of Supervision agreed to the calibration and phase-in ofthe Basel III minimum capital requirements (raising the minimum Tier 1 commonequity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with fullimplementation by January 2015) and introducing a capital conservationbuffer of common equity of an additional 2.5% with implementation by January 2019.  The U.S. federal banking agencies supportthis agreement.  The Basel Committee isexpected to finalize the new capital and liquidity standard later this year andto present them for approval of the G-20 Finance Minister and Central BankGovernors in November 2010.

 

·                  On September 27, 2010, the U.S.President signed into law the Small Business Jobs and Credit Act which, amongother things, creates a $30 billion fund to provide capital for banks withassets under $10 billion to increase their small-business lending. The U.S.Treasury is currently working to finalize terms of participation for this fund.

 

It is likely that furtherregulatory actions may arise as the Federal government continues to attempt toaddress the economic situation.

 

We are participating in theTAGP component of the TLGP.  As a resultof the enhancements to deposit insurance protection and the expectation thatthere will be demands on the FDIC’s deposit insurance fund, our depositinsurance costs have increased and will continue to increase significantlythroughout the remainder of 2010.  Wehave elected not to participate in the CPP and, as currently structured, wewould not be able to participate in the Small Business Lending Fund createdunder the Small Business Jobs and Credit Act due to the Bank’s troubledcondition designation.  Regardless of ourlack of participation, governmental intervention and new regulations underthese programs could materially and adversely affect our business, financialcondition and results of operations.  Thefollowing discussion and analysis describes our performance in this challengingeconomic environment.

 

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**Resultsof Operations**

 

*ThreeMonths ended September 30, 2010 and 2009*

 

*Overview*

 

Our net loss was $4.7million for the three months ended September 30, 2010 as compared to a netloss of $2.1 million for the three months ended September 30, 2009.  The increase of $2.6 million in net loss for2010 was primarily the result of $1.6 million lower net interest income and$1.1 million higher non-interest expense. This increase in non-interest expenseis the result of the increased administrative expenses including an increase inprofessional fees of $232,000, increased assessments related to the FDIC of$351,000, and writedowns of OREO property of $500,000. We have experienced adecrease in our net interest margin to 0.95% from 2.79% for the quarters ended September 30,2010 and 2009, respectively, which was the primary reason for the drop in netinterest income.  This decrease is due toan increased volume of non-performing assets as well as increased liquidity inanticipation of repayment of brokered deposits maturing in 2010. For the threemonths ended September 30, 2010, we realized $3,680,000 in interestincome, of which $474,000 was from investment activities and $3,206,000 wasfrom loan activities.  For the threemonths ended September 30, 2009, we realized $4,831,000 in interestincome, of which $561,000 was from investment activities and $4,270,000 wasfrom loan activities.  The primary sourceof funding for our loan portfolio is deposits that are acquired both locally,via the national brokered certificate market, and internet obtainedcertificates of deposit. We incurred interest expense of $2,574,000 and$2,145,000 for the three months ended September 30, 2010 and September 30,2009, respectively.

 

*Provisionfor Loan Losses*

 

Our provision for loanlosses for the three months ended September 30, 2010 was $3,000,000compared to $3,500,000 for the comparable prior year period. Although our 2010provision was less than the prior year, we are still experiencing deteriorationof our loan portfolio. ** **As noted earlier, we haveapproximately $29.7 million of acquisition and development (A&D) loansoutstanding at September 30, 2010. We are experiencing increased levels of loan delinquencies, defaults andforeclosures with these loans.  Further,the downturn in the real estate market has adversely impacted the value of theunderlying collateral (real estate) for the A&D loans.  The greater degree of strain on these typesof loans and the significance to our overall loan portfolio has caused us toapply a greater degree of scrutiny in analyzing the ultimate collectability ofamounts due.  As a result of thesefactors, we recognize there may be further deterioration in our loan portfolioin the fourth quarter of 2010.

 

*Non-interestIncome*

 

We had non-interest incomeof $1,098,000 and $410,000 for the three months ended September 30, 2010and 2009, respectively.  The increase wasmainly due to a $594,000 gain on sale of securities for the three months ended September 30,2010. There was no such gain for the three months ended September 30,2009. Mortgage origination revenue for the three months ended September 30,2010 was $279,000.  We had $197,000 inmortgage origination revenue in the third quarter of 2009.  This increase is due to an increased salesstaff and increased demand due to low interest rates.

 

As previously reported, on July 21,2010, the U.S. President signed into law the Dodd-Frank Act.  The Dodd-Frank Act calls for new limits oninterchange transaction fees that banks receive from merchants via cardnetworks like Visa, Inc. and MasterCard, Inc. when a customer uses adebit card.  The results of this proposedlegislation may impact our non-interest income from debit card transactions inthe future.

 

*Non-interestExpense*

 

We incurred non-interestexpense of $3,900,000 during the three months ended September 30, 2010,which was an increase of $1,075,000 over the three months ended September 30,2009.  Included in the expense was$1,286,000 of salaries and employee benefits, $161,000 of data processingexpense, $305,000 of professional fees expense, $37,000 of advertising expense,$13,000 of expense related to office supplies, $46,000 of telephone expense and$486,000 of assessments related to the FDIC. The non-interest expense incurred in the three months ended September 30,2009 was $2,825,000.  Included in theexpense was $1,344,000 of salaries and employee benefits, $225,000 of dataprocessing expense, $73,000 of professional fee expense, $64,000 of advertisingexpense, $20,000 of expense related to office supplies, $35,000 of telephoneexpense and $135,000 of assessments related to the FDIC.

 

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For the three months ended September 30,2010, we incurred other property and equipment expenses of $153,000 in depreciationand $58,000 in equipment maintenance and rental.  For the three months ended September 30,2009, we incurred other property and equipment expenses of $190,000 indepreciation and $55,000 in equipment maintenance and rental.  We incurred $168,000 and $170,000 inoccupancy expense related to all of our office locations for the three monthsended September 30, 2010 and 2009, respectively.

 

The increase in non-interestexpense is the result of the increased administrative expenses including anincrease in professional fees of $232,000, increased assessments related to theFDIC of $351,000, and writedowns of OREO property of $500,000. The higherprofessional fees were related to a stock offering that was abandoned duringthe quarter ended September 30, 2010.

 

*NineMonths ended September 30, 2010 and 2009*

 

*Overview*

 

Our net loss was $9.0million for the nine months ended September 30, 2010 as compared to netloss of $3.0 million for the nine months ended September 30, 2009.  The increase of $6.0 million in net loss for2010 was primarily the result of $1.8 million lower net interest income and$2.8 million higher non-interest expense. For the nine months ended September 30,2010, we realized $11,995,000 in interest income, of which $1,832,000 was frominvestment activities and $10,163,000 was from loan activities.  For the nine months ended September 30,2009, we realized $14,391,000 in interest income, of which $1,460,000 was frominvestment activities and $12,931,000 was from loan activities.  The primary source of funding for our loanportfolio is deposits that are acquired locally, via the national brokeredcertificate market, and internet obtained certificates of deposit.  We incurred interest expense of $7,436,000and $6,176,000 for the nine months ended September 30, 2010 and September 30,2009, respectively.  We have experienceda decrease in our net interest margin to 1.37% from 2.89% for the nine monthsended September 30, 2010 and 2009, respectively.  This decrease is due to an increased volumeof non-performing assets as well as increased liquidity in anticipation ofrepayment of brokered deposits maturing in 2010.  Due to the large volume of brokered depositsmaturing in the third and fourth quarters of 2010, the Bank has had to steadilyincrease other deposits through the first nine months of 2010 to be able toreplace the maturing brokered deposits. The increase in non-interest expense isthe result of the increased administrative expenses including an increase inprofessional fees of $774,000, increased assessments related to the FDIC of$1,165,000, and an increase in OREO writedowns of $500,000.

 

*Rate/Volume Analysis*

 

Net interest income can beanalyzed in terms of the impact of changing interest rates and changingvolumes.  The following tables set forththe effect which the varying levels of interest-earning assets andinterest-bearing liabilities and the applicable rates have had on changes inthe net interest income for the periods presented.

 
| ** **                           | ** ** | **Nine Months Ended September 30, 2010 vs. 2009** | ** ** |
|--------------------------------------|------------|--------------------------------------------------------------------------------------|------------|
| ** **                           | ** ** | **Increase (decrease) Due to**                                        | ** ** |
| ** **                           | ** ** | ** **                                                                           | ** ** | ** ** | ** ** | **Rate /** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)** | ** ** | **Volume**                                                                           | ** ** | **Rate** | ** ** | **Volume** | ** ** | **Total** | ** ** |
| Interest Income                      |       |                                                                                 |       |   |   |   |   |   |   |
| Loans                                |       | $                                                                                    | (2,385     | ) | $ | (469 | ) | $ | 86 |   | $ | (2,768 | ) |
| Investment securities (1)            |       | 1,977                                                                                |       | (558 | ) | (897 | ) | 522 |   |
| Federal funds                        |       | 593                                                                                  |       | (209 | ) | (534 | ) | (150 | ) |
| Total Interest Income                | ** ** | **$**                                                                                | **185**    | ** ** | **$** | **(1,236** | **)** | **$** | **(1,345** | **)** | **$** | **(2,396** | **)** |
|                                 |       |                                                                                 |       |   |   |   |   |   |   |
| Interest Expense                     |       |                                                                                 |       |   |   |   |   |   |   |
| Deposits                             |       | $                                                                                    | (219       | ) | $ | 329 |   | $ | (61 | ) | $ | 49 |   |
| Other borrowings                     |       | 1,533                                                                                |       | (246 | ) | (76 | ) | 1,211 |   |
| Total Interest Expense               | ** ** | **$**                                                                                | **1,314**  | ** ** | **$** | **83** | ** ** | **$** | **(137** | **)** | **$** | **1,260** | ** ** |
|                                 |       |                                                                                 |       |   |   |   |   |   |   |
| Net Interest Income                  | ** ** | **$**                                                                                | **(1,129** | **)** | **$** | **(1,319** | **)** | **$** | **(1,208** | **)** | **$** | **(3,656** | **)** |

 

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(1)               For the purposeof this table, the investment securities include marketable and non-marketablesecurities.

 

34

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*Average Balances, Income and Expenses and Rate*

 

The following table setsforth, for the nine months ended September 30, 2010 and 2009, informationrelated to the Company’s average balance sheet and its average yields onearning assets and average costs of interest-bearing liabilities.  Such yields are derived by dividing income orexpense by the average balance of the corresponding earning assets orinterest-bearing liabilities.  Average balanceshave been derived from the daily balances throughout the periods indicated.

 
| ** **                                      | ** ** | **Nine Months Ended September  30, 2010** | ** **  | **Nine Months Ended September 30,  2009** | ** ** |
|-------------------------------------------------|------------|---------------------------------------------------------------|-------------|---------------------------------------------------------------|------------|
| ** **                                      | ** ** | **Average**                                                   | ** **  | **Income /**                                             | ** ** | **Yield/** | ** ** | **Average** | ** ** | **Income /** | ** ** | **Yield /** | ** ** |
| **(Dollars in thousands)**            | ** ** | **Balance**                                                   | ** **  | **Expense**                                                   | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Expense** | ** ** | **Rate** | ** ** |
| **Assets**                                      |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| Earning assets:                                 |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| Loans (1)                                       |       | $                                                             | 253,851     |                                                          | $          | 10,164 |   | 5.35 | % | $ | 311,250 |   | $ | 12,931 |   | 5.55 | % |
| Investment securities (2)                       |       | 139,494                                                       |        | 1,749                                                         |       | 1.6 0 | % | 53,552 |   | 1,228 |   | 3.07 | % |
| Federal funds sold and other                    |       | 52,010                                                        |        | 82                                                            |       | 0.21 | % | 14621 |   | 232 |   | 2.12 | % |
| Total earning assets                            |       | 445,355                                                       |        | 11,995                                                        |       | 3.60 | % | 379,423 |   | 14,391 |   | 5.07 | % |
| Cash and due from banks                         |       | 7,530                                                         |        |                                                          |       |   |   | 7,409 |   |   |   |   |   |
| Premises and equipment                          |       | 3,641                                                         |        |                                                          |       |   |   | 4,512 |   |   |   |   |   |
| Other assets                                    |       | 11,333                                                        |        |                                                          |       |   |   | 12,597 |   |   |   |   |   |
| Allowance for loan losses                       |       | (12,081                                                       | )           |                                                          |       |   |   | (8,400 | ) |   |   |   |   |
| Total assets                                    | ** ** | **$**                                                         | **455,779** |                                                          |       |   |   | ** ** | **$** | **395,541** |   |   |   |   |   |
| ** **                                      |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| **Liabilities**                                 |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| Interest-bearing liabilities:                   |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| Repurchase agreements                           |       | $                                                             | 30,000      |                                                          | 918        |   | 4.09 | % | $ | 30,000 |   | 729 |   | 3.25 | % |
| Federal funds purchased                         |       | —                                                        |        | —                                                        |       | — | % | 208 |   | 1 |   | 0.64 | % |
| Federal Reserve Discount Window                 |       | —                                                        |        | —                                                        |       | — | % | 84 |   | — |   | — | % |
| Federal Home Loan Bank advances                 |       | —                                                        |        | —                                                        |       | — | % | 7,198 |   | 72 |   | 1.34 | % |
| Note Payable                                    |       | —                                                        |        | —                                                        |       | — | % | 329 |   | 7 |   | 2.84 | % |
| Subordinated Debt                               |       | 4,325                                                         |        | 312                                                           |       | 9.64 | % | 4,325 |   | 372 |   | 11.50 | % |
| Interest-bearing transaction accounts           |       | 17,241                                                        |        | 84                                                            |       | 0.65 | % | 18,511 |   | 163 |   | 1.18 | % |
| Savings deposits                                |       | 67,436                                                        |        | 1,275                                                         |       | 2.53 | % | 22,860 |   | 323 |   | 1.89 | % |
| Time deposits                                   |       | 304,374                                                       |        | 4,847                                                         |       | 2.13 | % | 256,331 |   | 4,509 |   | 2.35 | % |
| Total interest-bearing liabilities              |       | 423,376                                                       |        | 7,436                                                         |       | 2.35 | % | 339,846 |   | 6,176 |   | 2.24 | % |
| Demand deposits                                 |       | 22,994                                                        |        |                                                          |       |   |   | 22,450 |   |   |   |   |   |
| Accrued interest and other liabilities          |       | 2,757                                                         |        |                                                          |       |   |   | 1,473 |   |   |   |   |   |
| Total liabilities                               |       | 449,127                                                       |        |                                                          |       |   |   | 363,769 |   |   |   |   |   |
| Shareholders’ equity                       |       | 6,652                                                         |        |                                                          |       |   |   | 31,772 |   |   |   |   |   |
| Total liabilities and shareholders’ equity |       | **$**                                                         | **455,779** |                                                          |       |   |   |   | **$** | **395,541** |   |   |   |   |   |
| ** **                                      |       |                                                          |        |                                                          |       |   |   |   |   |   |   |   |   |
| Net interest income                             |       |                                                          | ** **  | **$**                                                         | **4,559**  |   |   |   |   | ** ** | **$** | **8,215** |   |   |   |
| Net interest spread                             |       |                                                          |        |                                                          | ** ** | **1.25** | **%** |   |   |   | ** ** | **2.64** | **%** |
| Net interest margin                             |       |                                                          |        |                                                          | ** ** | **1.37** | **%** |   |   |   | ** ** | **2.89** | **%** |

 

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| (1) |   | There were $32.6 million  and $16.2 million of loans in non-accrual status as of September 30,  2010 and 2009, respectively. The effect of fees collected on loans for the  nine months ended September 30, 2010 and 2009 totaled $15,000 and  $137,000, respectively, and increased the annualized yield on loans by zero  basis points for September 30, 2010 and by 5 basis points from 5.50% for  September 30, 2009. The effect of such fees on the annualized yield on  earning assets was an increase of zero basis points for September 30,  2010 and an increase of 5 basis points from 5.02% for September 30,  2009. The effects of such fees on net interest spread were an increase of  zero basis points for September 30, 2010 and an increase of 5 basis  points from 2.59% for September 30, 2009. The effects of such fees on  net interest margin were an increase of 1 basis point from 1.36% for  September 30, 2010 and an increase of 4 basis points from 2.85% for  September 30, 2009. |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

35

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| (2) |   | For the purpose of this  table, the investment securities include marketable and non-marketable  securities. |
|-----|--------|--------------------------------------------------------------------------------------------------------------|

 

*Provisionfor Loan Losses*

 

Our provision for loanlosses for the nine months ended September 30, 2010 was $5,000,000compared to $6,305,000 for the comparable prior year period. Although theprovision was lower for 2010, we are still experiencing deterioration of ourloan portfolio. ** **Asnoted earlier, we have approximately $29.7 million of acquisition anddevelopment (A&D) loans outstanding at September 30, 2010.  We are experiencing increased levels of loandelinquencies, defaults and foreclosures with these loans.  Further, the downturn in the real estatemarket has adversely impacted the value of the underlying collateral (realestate) for the A&D loans.  Thegreater degree of strain on these types of loans and the significance to ouroverall loan portfolio has caused us to apply a greater degree of scrutiny inanalyzing the ultimate collectability of amounts due.  As a result of these factors, we recognizethere may be further deterioration in our loan portfolio in the fourth quarterof 2010.

 

*Non-interestIncome*

 

We had non-interest incomeof $2,356,000 and $1,665,000 for the nine months ended September 30, 2010and 2009, respectively.  Gain on sale ofsecurities was $1,072,000 and $520,000 for the nine months ended September 30,2010 and 2009, respectively.  Mortgageorigination revenue for the nine months ended September 30, 2010 was$642,000.  We had $502,000 in mortgageorigination revenue for the nine months ended September 30, 2009.  This increase is due to an increased salesstaff and increased demand due to low interest rates.

 

As previously reported, on July 21,2010, the U.S. President signed into law the Dodd-Frank Act.  The Dodd-Frank Act calls for new limits oninterchange transaction fees that banks receive from merchants via cardnetworks like Visa, Inc. and MasterCard, Inc. when a customer uses adebit card.  The results of this proposedlegislation may impact our non-interest income from debit card transactions inthe future.

 

*Non-interestExpense*

 

We incurred non-interestexpense of $10,917,000 during the nine months ended September 30, 2010, anincrease of $2.8 million over the nine months ended September 30, 2009.Included in the expense was $3,955,000 of salaries and employee benefits,$547,000 of data processing expense, $1,013,000 of professional fees expense,$111,000 of advertising expense, $52,000 of expense related to office supplies,$113,000 of telephone expense and $1,667,000 of assessments related toFDIC.  The non-interest expense incurredin the nine months ended September 30, 2009 was $8,078,000.  Included in the expense was $3,946,000 ofsalaries and employee benefits, $696,000 of data processing expense, $239,000of professional fee expense, $161,000 of advertising expense, $62,000 ofexpense related to office supplies, $110,000 of telephone expense and $502,000of assessments related to FDIC. Included in the FDIC assessments for the ninemonths ended September 30, 2009 was a one time FDIC insurance premium thatequated to a $178,000 one time charge to the Bank in 2009.  This was expensed in June 2009 and paid September 30,2009.

 

For the nine months ended September 30,2010, we incurred other property and equipment expenses of $486,000 indepreciation and $208,000 in equipment maintenance and rental.  For the nine months ended September 30,2009, we incurred other property and equipment expenses of $552,000 indepreciation and $133,000 in equipment maintenance and rental.  We incurred $524,000 and $509,000 inoccupancy expense related to all of our office locations for the nine monthsended September 30, 2010 and 2009, respectively.

 

The increase in non-interestexpense is the result of the increased administrative expenses including anincrease in professional fees of $774,000, increased assessments related to theFDIC of $1,165,000, and an increase in OREO writedowns of $500,000. Theincrease in FDIC assessments for 2010 was the result of higher assessment ratesas a result of our financial condition and increased deposit balances as weincreased our liquidity in anticipation of repayment of brokered depositsscheduled to mature in the fourth quarter of 2010.

 

36

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**Assetsand Liabilities**

 

*General*

 

At September 30, 2010,total assets increased 4.54% to $440.7 million as compared to $421.5 million atDecember 31, 2009, primarily a result of an increase in investments of$146.2 million, or 41.0%, as well as an increase in federal funds sold of $15.8million, or 51.0%, and a decrease of $40.6 million in gross loans, or 14.8%,during the first nine months of 2010.  Asdescribed below, federal funds sold increased to $46.9 million at September 30,2010 compared to $31.0 million at December 31, 2009.  Cash and cash equivalents increased $16.4million, or 43.4%, since December 31, 2009.  As described below, deposits increased $25.8million, or 6.9%, during the first nine months of 2010.  At September 30, 2010, shareholders’equity was $1.7 million.

 

*InvestmentSecurities*

 

Investments available forsale increased by $146.2 million, or 41.0%, since December 31, 2009 due tothe purchase of US treasury securities and GNMA CMOs.  This general increase in securities is due toour efforts to increase liquidity in anticipation of repayment of brokereddeposits scheduled to mature in 2010.

 

*OtherInvestments*

 

Other investments,consisting of FHLB stock, were $1.5 million and $1.6 million for both September 30,2010 and December 31, 2009, respectively. All of the FHLB stock is used to collateralize advances with the FHLB.The decrease in the FHLB stock was due to a routine repurchase by the FHLB.

 

*Loans*

 

Since loans typicallyprovide higher interest yields than other types of interest earning assets, weallocate the majority of our earning assets to our loan portfolio.  Gross loans decreased by $40.6 million, or14.8%, during the first nine months of 2010. Loan demand has slowed during the first nine months of 2010 due togeneral economic conditions and the real estate market, along with management’sdecision to shrink the size of the Bank’s loan portfolio to help improve theBank’s risk profile.****We expect thistrend to continue during the next quarter.

 

Balances within major loancategories are as follows:

 
| **(dollar amounts in thousands)** | ** ** | **September 30, 2010** | ** **  | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| Real estate - construction                       |       | $                                | 63,391      |                            | $          | 81,128 |   |
| Real estate - mortgage                           |       | 151,722                          |        | 167,296                         |       |
| Commercial and industrial                        |       | 18,252                           |        | 25,028                          |       |
| Consumer and other                               |       | 1,125                            |        | 1,652                           |       |
| Total loans, gross                               |       | 234,490                          |        | 275,104                         |       |
| Less allowance for loan losses                   |       | (11,437                          | )           | (12,963                         | )          |
| Total loans, net                                 | ** ** | **$**                            | **223,053** | ** **                      | **$**      | **262,141** | ** ** |

 

Generally,we place a delinquent loan in non-accrual status when the loan becomes 90 daysor more past due.  Additionally, wediscontinue accrual of interest on a loan when we conclude it is doubtful thatwe will be able to collect the full amount of principal and interest from theborrower.  We reach this conclusion bytaking into account factors such as the borrower’s financial condition,economic and business conditions, value of the collateral underlying the loan,and the results of our previous collection efforts.  When we place a loan in non-accrual status,we reverse all interest which has been accrued on the loan but remains unpaidand we deduct this interest from earnings as a reduction of reported interestincome.  We do not accrue any additionalinterest on the loan balance until we conclude the collection of both principaland interest is reasonably certain.  At September 30,2010, there were $32.6 million in loans that were non-accruing and $1.8 millionin loans that were 30 days past due, excluding non-accrual loans.  At December 31, 2009, there were $29.4million in loans that were non-accruing and $4.8 million in loans that were 30days past due, excluding non-accrual loans.

 

The increase of $3.2 millionin non-accrual loans from December 31, 2009 to September 30, 2010 isrelated primarily to continued deterioration in the Bank’s overall CommercialReal Estate loan portfolio. The number of loans on non-accrual has increasedfrom 79 to 86 since December 31, 2009. The average non-accrual loan balanceis $372,000 and $379,000 as of December 31, 2009 and September 30,2010, respectively.  At September 30,2010, 95.7% of the non-accrual loans were secured by real estate. At this time,management is unable to determine the length of the economic downturn andtherefore unable to determine the ultimate impact on the Bank’s Commercial RealEstate portfolio.

 

37

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We have approximately $29.7million of A&D loans as of September 30, 2010, most of which are onproperties located in the Upstate of South Carolina and Western NorthCarolina.  A&D loans are typicallycomprised of loans to borrowers for real estate to be developed (intoproperties such as sub-divisions or spec houses).  Normally, these loans are repaid with theproceeds from the sale of the developed property.  The greater degree of strain on these typesof loans and the significance to our overall loan portfolio has caused us toapply a greater degree of scrutiny in analyzing the ultimate collectability ofamounts due.  The majority of theseborrowers are having financial difficulties. Our analysis has resulted in a significant provision expense in order tomeet the estimated allowance for loan loss reserve requirement.

 

Included in our loans securedby real estate, we have approximately $32.2 million of acreage and finished orbuildable lot loans as of September 30, 2010.  These loans are comprised of loans toborrowers for raw land and lots in subdivisions that have utilities and areready to be built on individually but not as part of an entire developmentproject.  These loans are generallyrepaid with the proceeds from the sale of the property.  Many of these borrowers are also experiencingfinancial difficulties.

 

The current economicenvironment in our market area has resulted in a downturn in the real estatemarket, which has placed greater pressure on our borrowers’ repaymentcapabilities.  We are experiencing higherlevels of loan delinquencies, defaults and foreclosures.  Further, the downturn in the real estatemarket has adversely impacted the value of the underlying real estate securingthe loans.  The greater degree of strainon these types of loans and the significance to our overall loan portfolio hascaused us to apply a greater degree of scrutiny in analyzing the ultimatecollectability of amounts due.  Ouranalysis has resulted in a significant provision expense recorded in 2009, andan additional $5,000,000 recorded in the first nine months of 2010, in order tomeet the estimated allowance for loan loss reserve requirement.  Nevertheless, given the current economicenvironment, there is a risk of further impairment to the value of ourcollateral on these loans, which would require even further increases to ourallowance for loan losses and in the corresponding expense charged to ourprovision for loan losses.

 

Changes in the allowance forloan losses for were as follows (dollars in thousands):

 
| ** **                      | ** ** | **Nine-months ended  September 30, 2010** | ** ** | **Nine-months ended  September 30, 2009** | ** ** |
|---------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------|------------|
| Balance, beginning of period    |       | $                                                        | 12,963     |                                                     | $          | 8,088 |   |
| Provision charged to operations |       | 5,000                                                    |       | 6,305                                                    |       |
| Net collections (charge-offs)   |       | (6,526                                                   | )          | (4,068                                                   | )          |
| Balance, end of period          | ** ** | **$**                                                    | **11,437** | ** **                                               | **$**      | **10,325** | ** ** |

 

*ImpairedLoans*

 

TheCompany identifies impaired loans through its normal internal loan reviewprocess.  Loans are considered to beimpaired when, in management’s judgment and based on current information, thefull collection of principal and interest becomes doubtful according to thecontractual terms of the loan agreement. A loan is also considered impaired if its terms are modified in atroubled debt restructuring.  These loansare evaluated in determining whether all outstanding principal and interest areexpected to be collected.  Loans are notconsidered impaired if a minimal payment delay occurs and all amounts due,including accrued interest at the contractual interest rate for the period ofdelay, are expected to be collected. Management has determined that the Company had $68.2 million and $34.2million in impaired loans at September 30, 2010 and December 31,2009, respectively.  $6.7 million and$2.0 million of the allowance for loan loss has been specifically allocated tothese relationships at September 30, 2010 and December 31, 2009,respectively.

 

*PotentialProblem Loans*

 

Potentialproblem loans are loans that are not included in impaired loans, but aboutwhich management has become aware of information about possible credit problemsof the borrowers that causes doubt about their ability to comply with currentrepayment terms.  Loans on the Company’spotentially problem loan list are considered potentially impaired loans.  At September 30, 2010 and December 31,2009, the Company had identified $0 and $15.9 million, respectively, ofpotential problem loans through its internal review procedures.  The results of this internal review processare considered in determining management’s assessment of the adequacy of theallowance for loan losses.

 

38

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*Provisionand Allowance for Loan Losses*

 

The Company has developedpolicies and procedures for evaluating the overall quality of its creditportfolio and the timely identification of potential problem loans.  On a quarterly basis, the Company’s Board ofDirectors reviews and approves the appropriate level for the Company’sallowance for loan losses based upon management’s recommendations, the resultsof the internal monitoring and reporting system, and an analysis of economicconditions in its market.  In 2009, theCompany developed and began to implement an improved loan review program, whichincluded the hiring of a new internal loan review officer and the engagement ofa new external loan review firm and the establishment of a new system fortracking borrower financial statements and the structure of our watch reports.

 

In addition to the Company’sportfolio review process, various regulatory agencies periodically review theCompany’s allowance for loan losses. These agencies may require the Company to recognize additions to the allowancefor loan losses based on their judgments and information available to them atthe time of their examinations. While the Company uses available information torecognize inherent losses on loans, future adjustments to the allowance forloan losses may be necessary based on changes in economic conditions and otherfactors and the impact of such changes and other factors on the Bank’sborrowers.

 

Portions of the allowancefor loan losses may be allocated for specific loans or portfolio segments.  However, the entire allowance for loan lossesis available for any loan that, in management’s judgment, should becharged-off.  While management utilizesthe best judgment and information available to it, the ultimate adequacy of theallowance for loan losses depends on a variety of factors beyond the Company’scontrol, including the performance of the Company’s loan portfolio, theeconomy, changes in interest rates, and the view of the regulatory authoritiestoward loan classifications.

 

Additions to the allowancefor loan losses, which are expensed through the provision for loan losses onthe Company’s income statement, are made periodically to maintain the allowanceat an appropriate level based on management’s analysis of the estimated lossesinherent in the loan portfolio.  Loanlosses and recoveries are charged or credited directly to the allowance.  The amount of the provision is a function ofthe level of loans outstanding, the level of non-performing loans, historicalloan loss experience, the amount of loan losses actually charged against thereserve during a given period, and current and anticipated economic conditions.

 

The Company’s allowance forloan losses is based upon judgments and assumptions about risk elements in theportfolio, future economic conditions, and other factors affectingborrowers.  The process includesidentification and analysis of loss potential in various portfolio segmentsutilizing a credit risk grading process and specific reviews and evaluations ofsignificant problem credits.  However,there is no precise method of estimating credit losses, since any estimate ofloan losses is necessarily subjective and the accuracy depends on the outcomeof future events.  In addition, due toour rapid growth over the past several years and our limited operating history,a large portion of the loans in our loan portfolio was originatedrecently.  In general, loans do not beginto show signs of credit deterioration or default until they have been outstandingfor some period of time, a process referred to as seasoning.  As a result, a portfolio of more mature loanswill usually behave more predictably than a newer portfolio.  Because our loan portfolio is relatively new,the current level of delinquencies and defaults may not be representative ofthe level that will prevail when the portfolio becomes more seasoned, which maybe higher than current levels.  Ifcharge-offs in future periods increase, we may be required to increase ourprovision for loan losses, which would decrease our net income and possibly ourcapital.

 

39

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The current downturn in thereal estate market has resulted in an increase in loan delinquencies, defaultsand foreclosures, and we believe these trends are likely to continue.  In some cases, this downturn has resulted ina significant impairment to the value of our collateral and our ability to sellthe collateral upon foreclosure, and there is a risk that this trend willcontinue. The real estate collateral in each case provides an alternate sourceof repayment in the event of default by the borrower and may deteriorate invalue during the time the credit is extended. If real estate values continue to decline in our market areas, it isalso more likely that we would be required to increase our allowance for loan losses.  We determine the value of real estatecollateral by using a current appraisal. Contrary to any other relevantinformation an appraisal is considered current if it is less than 12 months old except when economic or market changes have caused values to rise or fallsignificantly. If a current appraisal is not maintained, the Bank willgenerally order a new appraisal priorto accepting the property as a result of a deed in lieu of foreclosure orcompletion of a foreclosure action. Commercial appraisals generally takeless than four weeks to complete.  A specific impairment is made as soon as possible upon receipt ofthe appraisal.  Based on presentinformation and an ongoing evaluation, management considers the allowance forloan losses to be adequate to meet presently known and inherent losses in theloan portfolio.  Management’s judgmentabout the adequacy of the allowance is based upon a number of assumptions aboutfuture events which it believes to be reasonable but which may or may not beaccurate.  Thus, there can be noassurance that charge-offs in future periods will not exceed the allowance forloan losses or that additional increases in the allowance for loan losses willnot be required, especially considering the overall weakness in the commercialreal estate market in our market areas.

 

*Deposits*

 

Our primary source of fundsfor loans and investments is our deposits. As of September 30, 2010, total deposits increased by $25.8million, or 6.9%, from December 31, 2009. The largest percentage increase was in time deposits less than $100,000,which increased $154.2 million, or 513.0%, from December 31, 2009 to September 30,2010, of which $111.7 million were through internet obtained deposits.   The internet obtained deposits are fromother financial institutions, have been offered at or below the national ratecap and at this time are considered to be renewable.

 

We have chosen to obtain aportion of our certificates of deposit from areas outside of our market, whichare brokered deposits. The deposits obtained outside of our market areagenerally have been below those being offered for comparable certificates ofdeposit in our local market. Because of this, even though brokered deposits areinterest sensitive, they have been considered a desirable source of funds. Asof September 30, 2010, we had brokered deposits of $94.8 million,representing 23.6% of our total deposits. Because of the limitations onbrokered deposits imposed by the MOU, the Consent Order, and our “criticallyundercapitalized” status, we must find other sources of liquidity to replacethese deposits as they mature or the Bank could be placed into receivershipwith the FDIC.  Secondary sources ofliquidity may include proceeds from FHLB advances and federal funds lines ofcredit from correspondent banks. However, FHLB has informed us that due to our financial condition we arenot currently permitted to receive any more advances.  As a result, we must limit our growth, raiseadditional capital, or sell assets, which could materially and adversely affectour financial condition and results of operations.  In addition, should these efforts beunsuccessful, due to the regulatory restrictions which exist that restrict cashpayments between the Bank and the Company, the Company may be unable to realizeits assets and discharge its liabilities in the normal course of business.  During the first nine months of 2010, werepaid $107.9 million of our brokered deposits, and, as of November 15,2010, all brokered deposits have been repaid through local and internetobtained deposits.

 

Balances within the majordeposit categories are as follows:

 
| **(dollar amounts in thousands)** | ** ** | **September 30, 2010** | ** **  | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|-------------|---------------------------------|------------|
| Non-interest bearing demand                      |       | $                                | 24,502      |                            | $          | 21,829 |   |
| Interest bearing demand                          |       | 17,798                           |        | 18,588                          |       |
| Savings                                          |       | 65,495                           |        | 82,295                          |       |
| Time deposits less than $100,000                 |       | 184,243                          |        | 30,054                          |       |
| Time deposits of $100,000 or over                |       | 15,501                           |        | 21,014                          |       |
| Brokered deposits                                |       | 94,834                           |        | 202,783                         |       |
| Total deposits                                   | ** ** | **$**                            | **402,373** | ** **                      | **$**      | **376,563** | ** ** |

 

Included in time depositsless than $100,000 are $113.6 million and $1.8 million of internet obtainedcertificates of deposit for September 30, 2010 and December 31, 2009,respectively.

 

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Maturitiesof Certificates of Deposit of $100,000 or More (Including Brokered Deposits)

 
| ** **                                         | ** ** | ** ** | ** ** | **After**   | ** ** | **After**   | ** ** | ** ** | ** ** | ** ** | ** ** |
|----------------------------------------------------|------------|------------|------------|-------------|------------|-------------|------------|------------|------------|------------|------------|
| ** **                                         | ** ** | ** ** | ** ** | **Three**   | ** ** | **Six**     | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Within** | ** ** | **Through** | ** ** | **Through** | ** ** | **After**  | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Three**  | ** ** | **Six**     | ** ** | **Twelve**  | ** ** | **Twelve** | ** ** | ** ** | ** ** |
| **(Dollars in thousands)**               | ** ** | **Months** | ** ** | **Months**  | ** ** | **Months**  | ** ** | **Months** | ** ** | **Total**  | ** ** |
| **September 30, 2010**                        |       |       | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Brokered deposits                                  |       | $          | 94,834     |        | $          | —      |       | $          | —     |       | $          | — |   | $ | 94,834 |   |
| Other certificates of  deposit of $100,000 or more |       | 2,906      |       | 1,928       |       | 985         |       | 9,682      |       | 15,501     |       |
| Total                                              |       | $          | 97,740     |        | $          | 1,928       |       | $          | 985        |       | $          | 9,682 |   | $ | 110,335 |   |
|                                               |       |       |       |        |       |        |       |       |       |       |       |
| **December 31, 2009**                         |       |       | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Brokered deposits                                  |       | $          | 6,800      |        | $          | 21,269      |       | $          | 174,714    |       | $          | — |   | $ | 202,783 |   |
| Other certificates of  deposit of $100,000 or more |       | 4,692      |       | 7,868       |       | 6,624       |       | 1,830      |       | 21,014     |       |
| Total                                              |       | $          | 11,492     |        | $          | 29,137      |       | $          | 181,338    |       | $          | 1,830 |   | $ | 223,797 |   |

 

Of the Company’s timedeposits of $100,000 or over as of September 30, 2010 and December 31,2009, 88.58% and 5.14% are scheduled maturities within three months,respectively. As of September 30, 2010 and December 31, 2009, 91.22%and 99.18%, respectively, of the Company’s time deposits of $100,000 or overhad maturities within twelve months.

 

As previously reported, theDodd-Frank Act also permanently raises the current standard maximum depositinsurance amount to $250,000. The standard maximum insurance amount of $100,000had been temporarily raised to $250,000 until December 31, 2013. The FDICinsurance coverage limit applies per depositor, per insured depositoryinstitution for each account ownership category.

 

*SubordinatedDebt*

 

During the third quarter of2008, we commenced a subordinated debt offering to enhance and strengthen thelevels of capital and liquidity of the Company such that we could improve thelevels of regulatory capital at the Bank. We raised $4.325 million inadditional capital through this offering. The subordinated notes were sold to a limited number of purchasers in aprivate offering, bear an interest rate of 11.5%, are callable afterSeptember 30, 2011, at a premium, and mature in 2018. The subordinateddebt has been structured to fully count as Tier 2 regulatory capital on aconsolidated basis.  At September 30,2010, the Company had subordinated debt totaling $4.325 million.

 

Due to diminishing cashavailable at the holding company level, we paid the September 2010interest payments only to subordinated debt holders that were not officers ordirectors of the Company.  If we are unableto raise additional capital, we may have to discontinue paying interest on thesubordinated debentures to all holders after the September 2010 paymentsdue to lack of funds.

 

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*Federal Home Loan Bank Advances, Fed Funds Lines of Credit, FederalReserve Discount Window, and Securities Sold Under Agreements to Repurchase*

 

Our other borrowings havetraditionally included proceeds from FHLB advances, federal funds lines ofcredit from correspondent banks, and securities sold under agreements torepurchase.  As of September 30,2010 the FHLB has informed us that due to our financial condition we are notcurrently permitted to receive any more advances. At September 30, 2010,we had federal funds lines of credit with unrelated banks totaling $5million.  These lines are available forgeneral corporate purposes.  These linesmay be terminated at any time based on our financial condition. We also havecredit availability through the Federal Reserve Discount Window.  As of September 30, 2010, $3.6 millionwas available, based on qualifying collateral. The Federal Reserve Discount Window borrowing capacity has beencurtailed to only overnight terms, contingent upon credit approval for eachtransaction.  Availability of the FederalReserve Discount Window may be terminated at any time by the Federal Reserve,and we can make no assurances that this funding source will continue to beavailable to us.  At September 30,2010, the Bank had $30.0 million of securities under agreements to repurchasewith brokers with a weighted average rate of 4.16% and an average maturity of69 months.  The maximum amountoutstanding at any month-end was $30.0 million. These agreements were secured with approximately $37.6 million of investmentsecurities.  In addition, the Bank was indefault under a $15.0 million repurchase agreement due to the Bank’s “criticallyundercapitalized” designation.  However,the broker elected to amend the agreement and waive its right to terminatebased on this issue through December 31, 2010 in exchange for the Bankproviding an additional 7% of collateral based on the outstanding balance.

 

**Liquidity**

 

Liquidity is the ability tomeet current and future obligations through liquidation or maturity of existingassets or the acquisition of liabilities. We manage both assets and liabilities to achieve appropriate levels ofliquidity.  Cash, federal funds andinvestments available for sale are our primary sources of asset liquidity.  These funds provide a cushion againstshort-term fluctuations in cash flow from both deposits and loans.  Historically, individual and commercialdeposits have been our primary source of funds for credit activities.  These include brokered deposits, whichcomprise 23.6% of our deposit base as of September 30, 2010.  These have proven to be a reliable source offunds.  However, pursuant to the ConsentOrder and our current financial condition, our ability to access brokereddeposits through the wholesale funding market is restricted.  Specifically, the Consent Order restricts theBank’s ability to accept, renew, or rollover brokered deposits.  Management believes that this will not haveany liquidity impact through the fourth quarter of 2010 due to the extendedmaturities of the brokered deposits and the amount of short-term investmentsand federal funds sold at September 30, 2010.  With access to the brokered deposit marketunavailable, the Bank must replace those funds with core deposits.  Deposit balances, net of brokered deposits,have increased $25.8 million from December 31, 2009 to September 30,2010.  This was due to intentionalrestructuring to replace brokered deposits with local and internet obtaineddeposits.  We believe internet depositsmay be obtained without restriction under the guidelines of the ConsentOrder.  We anticipate that our fundingcost and funding mix will now remain stable. As of November 15, 2010, allbrokered deposits have been repaid through local and internet obtaineddeposits.

 

In addition to our on balance sheet sources of funds, we also rely onoff-balance sheet lines of credit.  At September 30,2010, we had lines of credit with a correspondent bank totaling $5million.  This line is available forgeneral corporate purposes.  This linemay be terminated at any time based on our financial condition. We also havecredit availability through the Federal Reserve Discount Window.  As of September 30, 2010, $3.6 millionwas available, based on qualifying collateral. The Federal Reserve Discount Window borrowing capacity has beencurtailed to only overnight terms, contingent upon credit approval for eachtransaction.  Availability of the FederalReserve Discount Window may be terminated at any time by the Federal Reserve,and we can make no assurances that this funding source will continue to beavailable to us.  In addition, the FHLBhas informed us that due to our financial condition we are not currentlypermitted to receive any more advances.

 

Following the execution ofthe Consent Order with the FDIC and the South Carolina Board of FinancialInstitutions, we revised our comprehensive liquidity risk managementprogram.  This program assesses ourcurrent and projected funding needs to ensure that sufficient funds or accessto funds exist to meet those needs.  Theprogram includes effective methods to achieve and maintain sufficient liquidityand to measure and monitor liquidity risk including the preparation andsubmission of liquidity reports on a regular basis to the FDIC.  The program contains a contingency fundingplan that forecasts funding needs and funding sources under different stressscenarios.  Our plan details how the Bankis complying with the restrictions in the Consent Order, including therestriction against brokered deposits, as well as providing reports detailingall funding sources and obligations under best case and worse case scenarios.

 

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The level of liquidity is measured by the cash, cash equivalents andunpledged securities available for sale to total assets ratio, which was at35.8% at September 30, 2010, compared to 23.8% at December 31, 2009.We anticipate that this will continue to increase with the combination ofdeposit growth and shrinkage of assets until the brokered deposits are paid offor mature during the remainder of 2010.

 

We believe our liquiditysources are adequate to meet our needs through the fourth quarter of 2010 and2011. See section “Maturities of Certificates of Deposit of $100,000 or More(Including Brokered Deposits)” above.  Ifwe are unable to meet our liquidity needs during the fourth quarter of 2010,then the Bank may be placed into a federal conservatorship or receivership bythe FDIC, with the FDIC appointed as conservator or receiver.

 

**Impact of Off-Balance Sheet Instruments**

 

Through the operations ofour Bank, we have made contractual commitments to extend credit in the ordinarycourse of our business activities.  Thesecommitments are legally binding agreements to lend money to our customers atpredetermined interest rates for a specified period of time.  At September 30, 2010, we had issuedcommitments to extend credit of $11.2 million through various types of lendingarrangements.  We evaluate each customer’scredit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us uponextension of credit, is based on our credit evaluation of the borrower.  Collateral varies but may include accountsreceivable, inventory, property, plant and equipment, commercial andresidential real estate.  We manage thecredit risk on these commitments by subjecting them to normal underwriting andrisk management processes.  The followingtable summarizes our off-balance-sheet financial instruments whose contractamounts represent credit risk:

 
| **(dollar amounts in thousands)** | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
|                                             |       |                             |       |                            |       |
| Commitments to extend credit                     |       | $                                | 10,343     |                            | $          | 14,451 |   |
|                                             |       |                             |       |                            |       |
| Letters of credit                                |       | $                                | 840        |                            | $          | 1,525 |   |

 

**CapitalResources**

 

Total shareholders’ equitydecreased from $8.7 million at December 31, 2009 to $1.7 million at September 30,2010.  The decrease is principally due tothe net loss for the nine months ended September 30, 2010 of $9.0 millionoffset partially by an increase in market value of available for salesecurities.

 

The FRB and bank regulatoryagencies require bank holding companies and financial institutions to maintaincapital at adequate levels based on a percentage of assets and off-balancesheet exposures, adjusted for risk weights ranging from 0% to 100%.

 

The FRB guidelines containan exemption from the capital requirements for “small bank holding companies”to cover most bank holding companies with less than $500 million in totalassets that do not have a material amount of debt or equity securitiesoutstanding registered with the SEC. Although our class of common stock is registered under Section 12of the Securities Exchange Act, we believe that because our stock is not listedon any exchange or otherwise actively traded, the FRB will interpret its newguidelines to mean that we qualify as a small bank holding company.  Nevertheless, our Bank remains subject tothese capital requirements.  Failure tomeet minimum capital requirements can initiate certain mandatory and possiblyadditional discretionary actions by regulators that, if undertaken, could havea direct material effect on the Bank’s financial statements.  Under capital adequacy guidelines and theregulatory framework for prompt corrective action, the Bank must meet specificcapital guidelines that involve quantitative measures of the Bank’s assets,liabilities, and certain off-balance sheet items as calculated under regulatoryaccounting practices.  The Bank’s capitalamounts and classifications are also subject to qualitative judgments by theregulators about components, risk weightings, and other factors.

 

Under the capital adequacyguidelines, regulatory capital is classified into two tiers.  These guidelines require an institution tomaintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets.  Tier 1 capital consists of commonshareholders’ equity, excluding the unrealized gain or loss on securitiesavailable for sale, minus certain intangible assets.  In determining the amount of risk-weightedassets, all assets, including certain off-balance sheet assets, are multipliedby a risk-weight factor of 0% to 100% based on the risks believed to beinherent in the type of asset.  Tier 2capital consists of Tier 1 capital plus the general reserve for loan losses, subjectto certain limitations.  We are alsorequired to maintain capital at a minimum level based on total average assets,which is known as the Tier 1 leverage ratio.

 

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At the Bank level, we aresubject to various regulatory capital requirements administered by the federalbanking agencies.  Under the regulationsadopted by the federal regulatory authorities, a bank will be categorized as:

 

·                  Well capitalized if the institution has atotal risk-based capital ratio of 10.0% or greater, a Tier 1 risk-basedcapital ratio of 6.0% or greater, a leverage ratio of 5.0% or greater, and isnot subject to any order or written directive by any such regulatory authorityto meet and maintain a specific capital level for any capital measure.

·                  Adequately capitalized if the institution hasa total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-basedcapital ratio of 4.0% or greater, a leverage ratio of 4.0% or greater, and isnot categorized as well capitalized.

·                  Undercapitalized if the institution has atotal risk-based capital ratio that is less than 8.0%, a Tier 1 risk-basedcapital ratio of less than 4.0%, or a leverage ratio of less than 4.0%.

·                  Significantly undercapitalized if theinstitution has a total risk-based capital ratio of less than 6.0%, aTier 1 risk-based capital ratio of less than 3.0%, or a leverage ratio ofless than 3.0%.

·                  Critically undercapitalized if theinstitution’s tangible equity is equal to or less than 2.0% of averagequarterly tangible assets.

 

In addition, an institutionmay be downgraded to, or deemed to be in, a capital category that is lower thanindicated by its capital ratios if it is determined to be in an unsafe orunsound condition or if it receives an unsatisfactory examination rating withrespect to certain matters.  A bank’scapital category is determined solely for the purpose of applying promptcorrective action regulations, and the capital category may not constitute anaccurate representation of a bank’s overall financial condition or prospectsfor other purposes.

 

If a bank is not wellcapitalized, it cannot accept brokered deposits without prior FDICapproval.  In addition, a bank that isnot well capitalized cannot offer an effective yield in excess of 75 basispoints over interest paid on deposits of comparable size and maturity in suchinstitution’s normal market area for deposits accepted from within its normalmarket area, or national rate paid on deposits of comparable size and maturityfor deposits accepted outside the Bank’s normal market area.  Moreover, the FDIC generally prohibits adepository institution from making any capital distributions (including paymentof a dividend) or paying any management fee to its parent holding company ifthe depository institution would thereafter be categorized as undercapitalized.Undercapitalized institutions are subject to growth limitations (anundercapitalized institution may not acquire another institution, establishadditional branch offices or engage in any new line of business unlessdetermined by the appropriate federal banking agency to be consistent with anaccepted capital restoration plan, or unless the FDIC determines that theproposed action will further the purpose of prompt corrective action) and arerequired to submit a capital restoration plan. The agencies may not accept acapital restoration plan without determining, among other things, that the planis based on realistic assumptions and is likely to succeed in restoring thedepository institution’s capital. In addition, for a capital restoration planto be acceptable, the depository institution’s parent holding company mustguarantee that the institution will comply with the capital restoration plan.The aggregate liability of the parent holding company is limited to the lesserof an amount equal to 5.0% of the depository institution’s total assets at thetime it became categorized as undercapitalized or the amount that is necessary(or would have been necessary) to bring the institution into compliance withall capital standards applicable with respect to such institution as of thetime it fails to comply with the plan. If a depository institution fails tosubmit an acceptable plan, it is categorized as significantly undercapitalized.

 

Significantlyundercapitalized categorized depository institutions may be subject to a numberof requirements and restrictions, including orders to sell sufficient votingstock to become categorized as adequately capitalized, requirements to reducetotal assets, and cessation of receipt of deposits from correspondentbanks.  The appropriate federal bankingagency may take any action authorized for a significantly undercapitalizedinstitution if an undercapitalized institution fails to submit an acceptablecapital restoration plan or fails in any material respect to implement a planaccepted by the agency.  A criticallyundercapitalized institution is subject to having a receiver or conservatorappointed to manage its affairs and for loss of its charter to conduct bankingactivities.

 

An insured depositoryinstitution may not pay a management fee to a bank holding company controllingthat institution or any other person having control of the institution if,after making the payment, the institution would be undercapitalized.  In addition, an institution cannot make acapital distribution, such as a dividend or other distribution, that is insubstance a distribution of capital to the owners of the institution iffollowing such a distribution the institution would be undercapitalized.  Thus, if payment of such a management fee orthe making of such would cause a bank to become undercapitalized, it could notpay a management fee or dividend to the bank holding company.

 

At September 30, 2010,the Bank was categorized as “critically undercapitalized” under the regulatory framework.  As of December 31, 2009, the Bank wascategorized “undercapitalized” under the regulatory framework.

 

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TheBank’s regulatory capital ratios are set forth in the following table (dollarsin thousands).

 
| ** **                               | ** ** | **September 30, 2010** | ** ** | **December 31, 2009** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **Amount**                       | ** ** | **Ratio**                       | ** ** | **Amount** | ** ** | **Ratio** | ** ** |
|                                     |       |                             |       |                            |       |   |   |   |   |
| Tier 1 capital (to risk-weighted assets) |       | $                                | 5,181      |                            | 2.18       | % | $ | 13,643 |   | 4.96 | % |
| Total capital (to risk-weighted assets)  |       | 8,254                            |       | 3.47                            |       | 17,201 |   | 6.25 |   |
| Tier 1 capital (to average assets)       |       | 5,181                            |       | 1.07                            |       | 13,643 |   | 3.12 |   |
|                                          |            |                                  |            |                                 |            |  |  |  |  |  |  |

 

Our losses for 2009 and thefirst nine months of 2010 have adversely impacted our capital. As a result, wehave been pursuing a plan to increase our capital ratios in order to strengthenour balance sheet and satisfy the commitments required under the Consent Orderthat we entered into with the FDIC and the South Carolina Board of FinancialInstitutions on February 23, 2010. In addition, the Consent Order requiresus to achieve and maintain, by September 23, 2010, Total Risk Basedcapital at least equal to 10% of risk-weighted assets and Tier 1 capital atleast equal to 8% of total assets. We did not meet that requirement and havesubmitted a revised capital plan to the FDIC on July 28, 2010.  In addition, under the FDI Act, banks thatare “critically undercapitalized” must be placed into conservatorship orreceivership within 90 days of becoming critically undercapitalized, unless thebank’s primary Federal regulatory authority (for the Bank, the FDIC) determinesand documents that “other action” would better achieve the purposes of the FDIAct prompt corrective action capital requirements.  If the bank remains criticallyundercapitalized on average during the calendar quarter beginning 270 daysafter it became critically undercapitalized, the FDI Act requires theappointment of a receiver unless the bank and the FDIC affirmatively candetermine that, among other things, the bank has positive net worth and theFDIC can certify that the bank is viable and not expected to fail.  Ourauditors have noted that the uncertainty of our ability to obtain sufficientcapital or address our upcoming liquidity needs raises substantial doubt aboutour ability to continue as a going concern. For additional information on theBank’s “critically undercapitalized” status, including the requirements orrestrictions that can or will be imposed on the Company and the Bank as aresult of the Bank’s “critically undercapitalized” status, please refer to “Note3 — Regulatory Actions and Going Concern Considerations***—***GoingConcern Considerations”****** of the notes to our unaudited consolidatedfinancial statements.

 

**CriticalAccounting Policies**

 

We have adopted variousaccounting policies that govern the application of GAAP and with general practiceswithin the banking industry in the preparation of our financialstatements.  Our significant accountingpolicies are described in Note 2 to the financial statements.

 

Certain accounting policiesinvolve significant judgments and assumptions by us that have a material impacton the carrying value of certain assets and liabilities.  We consider these accounting policies to becritical accounting policies.  Thejudgments and assumptions we use are based on historical experience and otherfactors, which we believe to be reasonable under the circumstances.  Because of the nature of the judgments andassumptions we make, actual results could differ from these judgments andestimates that could have a material impact on the carrying values of ourassets and liabilities and our results of operations.

 

We believe the allowance for loan losses is the critical accountingpolicy that requires the most significant judgments and estimates used inpreparation of our consolidated financial statements.  Some of the more critical judgmentssupporting the amount of our allowance for loan losses include judgments aboutthe credit worthiness of borrowers, the estimated value of the underlyingcollateral, the assumptions about cash flows, the determination of loss factorsfor estimating credit losses, the impact of current events, and conditions, andother factors impacting the level of probable inherent losses.  Under different conditions or using differentassumptions, the actual amount of credit losses incurred by us may be differentfrom management’s estimates provided in our consolidated financialstatements.  Refer to the portion of thisdiscussion that addresses our allowance for loan losses for a more completediscussion of our processes and methodology for determining our allowance forloan losses.

 

*Allowance for Loan Losses*

 

The allowance for loanlosses represents an amount that we believe will be adequate to absorb probablelosses on existing loans that may become uncollectible. Assessing theadequacy of the allowance for loan losses is a process that requiresconsiderable judgment. Our judgment in determining the adequacy of theallowance is based on evaluations of the collectability of loans, includingconsideration of factors such as the balance of impaired loans; the quality,mix and size of our overall loan portfolio; economic conditions that may affectthe borrower’s ability to repay; the amount and quality of collateral securingthe loans; our historical loan loss experience; and a review of specificproblem loans. We adjust the

 

45

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amount of the allowanceperiodically based on changing circumstances as a component of the provisionfor loan losses. We charge recognized losses against the allowance and addsubsequent recoveries back to the allowance.

 

We calculate the allowancefor loan losses for specific types of loans and evaluate the adequacy on anoverall portfolio basis utilizing our credit grading system which we apply toeach loan.  We combine our estimates of the reserves needed for eachcomponent of the portfolio, including loans analyzed on a pool basis and loansanalyzed individually.  The allowance is divided into twoportions: (1) an amount for specific allocations on significant individualcredits that are considered impaired and (2) a general reserve amount.

 

*Specific Reserve*

 

We analyze individual loanswithin the portfolio and make allocations to the allowance based on eachindividual loan’s specific factors and other circumstances that affect the collectabilityof the credit. Significant individual credits classified as impaired within ourcredit grading system require both individual analysis and specific allocation.

 

In these situations where aloan is determined to be impaired (primarily because it is probable that allprincipal and interest due according to the terms of the loan agreement willnot be collected as scheduled), the loan is excluded from the general reservecalculations described below and is assigned a specific reserve.  Wecalculate specific reserves on those impaired loans exceeding$250,000.  These reserves are based on a thorough analysis of themost probable source of repayment which is usually the liquidation of theunderlying collateral, but may also include discounted future cash flows or, inrare cases, the market value of the loan itself.

 

Generally, for largercollateral dependent loans, current market appraisals are ordered to estimatethe current fair value of the collateral.  However, in situationswhere a current market appraisal is not available, management uses the bestavailable information (including recent appraisals for similar properties,communications with qualified real estate professionals, information containedin reputable trade publications and other observable market data) to estimatethe current fair value.  The estimated costs to sell the subjectproperty are then deducted from the estimated fair value to arrive at the “netrealizable value” of the loan and to determine the specific reserve on eachimpaired loan reviewed.  The credit risk management groupperiodically reviews the fair value assigned to each impaired loan and adjuststhe specific reserve accordingly.

 

*General Reserve*

 

We calculate our generalreserve based on a percentage allocation for each of the categories of thefollowing unclassified loan types such as:  real estate, commercial,consumer, A&D/construction and mortgage.  We apply historicaltrend loss factors to each category and adjust these percentages for qualitativeor environmental factors, as discussed below.  The general estimateis then added to the specific allocations made to determine the amount of thetotal allowance for loan losses.

 

We also maintain our generalreserve in accordance with December 2006 regulatory interagency guidancein our assessment of the loan loss allowance.  This general reserveconsiders qualitative or environmental factors that are likely to causeestimated credit losses including, but not limited to:  changes indelinquent loan trends, trends in risk grades and net chargeoffs,concentrations of credit, trends in the nature and volume of the loanportfolio, general and local economic trends, collateral valuations, theexperience and depth of lending management and staff, lending policies andprocedures, the quality of loan review systems, and other external factors.

 

The current economicenvironment has adversely affected our general reserve requirement.  Historical data, environmental factors andloan trends have all deteriorated over the past year.  This has resulted in a larger calculatedgeneral reserve requirement than compared to a year ago.

 

*OtherReal Estate Owned*

 

We obtain current appraisalsupon possession of all properties to be held as other real estate owned andadjust property values as appropriate. Updated appraisals are obtained periodically and further adjustments arealso made as appropriate based on general market conditions and other relatedfactors.

 

**Item 3.Quantitative and Qualitative Disclosures About Market Risk.**

 

Not applicable.

 

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**Item 4.Controls and Procedures****.**

 

As of the end of the periodcovered by this report, we carried out an evaluation, under the supervision andwith the participation of our management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of our disclosure controlsand procedures as defined in Exchange Act Rule 13a-15(e).  Based upon that evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that our currentdisclosure controls and procedures are effective as of September 30,2010.  There have been no significantchanges in our internal controls over financial reporting during the fiscalquarter ended September 30, 2010 that have materially affected, or arereasonably likely to materially affect, our internal controls over financialreporting.

 

The design of any system ofcontrols and procedures is based in part upon certain assumptions about thelikelihood of future events.  There canbe no assurance that any design will succeed in achieving its stated goalsunder all potential future conditions, regardless of how remote.

 

**Part II- Other Information**

 

**Item 1.Legal Proceedings.**

 

NotApplicable.

 

**Item1A. Risk Factors.**

 

NotApplicable.

 

**Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.**

 

Notapplicable.

 

**Item 3.Defaults Upon Senior Securities.**

 

Notapplicable.

 

**Item 4.(Removed and Reserved).**

 

**Item 5.Other Information.**

 

Notapplicable.

 

**Item 6.Exhibits.**

 

31.1        Rule 13a-14(a) Certification of the PrincipalExecutive Officer.

 

31.2        Rule 13a-14(a) Certification of the PrincipalFinancial Officer.

 

32           Section 1350 Certifications.

 

47

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** **

**SIGNATURES**

 

Inaccordance with the requirements of the Securities Exchange Act of 1934, theRegistrant caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
| Date:  November 15, 2010 | By:                                           | /s/  C. Allan Ducker, III |
|-------------------------------|-----------------------------------------------|--------------------------------|
|                          | C.  Allan Ducker, III                    |
|                          | Chief  Executive Officer                      |
|                          | (Principal  Executive Officer)                |
|                          |                                          |                           |
| Date:  November 15, 2010 | By:                                           | /s/  John W. Hobbs             |
|                          | John  W. Hobbs                                |
|                          | Chief  Financial Officer                      |
|                          | (Principal  Financial and Accounting Officer) |

 

48

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**EXHIBIT INDEX**

 
| **Exhibit** | ** ** | ** **                                                                  |
|-------------|------------|-----------------------------------------------------------------------------|
| **Number**  | ** ** | **Description**                                                             |
|        |       |                                                                        |
| 31.1        |       | Rule 13a-14(a) Certification  of the Principal Executive Officer. |
|        |       |                                                                        |
| 31.2        |       | Rule 13a-14(a) Certification  of the Principal Financial Officer. |
|        |       |                                                                        |
| 32          |       | Section 1350  Certifications.                                          |

 

49

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